SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

COMMISSION FILE NUMBER: 000-00822

The Oilgear Company

(Exact name of registrant as specified in its charter)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:

(414) 327-1700

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, $1.00 PAR VALUE (TITLE OF CLASS)

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes o          No þ

      As of June 30, 2004, the aggregate market value of the shares of Common Stock (based upon the $3.80 per share last sale price on June 30, 2004 in the Nasdaq Small Cap Stock Market) held by non-affiliates was approximately $3,184,381. Shares of Common Stock held by each executive officer and director of the Company have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

      As of March 31, 2005, 1,991,766 shares of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Registrant’s Proxy Statement for its Annual Meeting of Shareholders to be held on May 10, 2005 are incorporated by reference into Part III of this Form 10-K.

PART I

General

      The primary business of The Oilgear Company (“Oilgear” or the “Registrant”; together with its subsidiaries, the “Company”) and its subsidiaries is the manufacture and distribution of value engineered fluid power components and electronic controls for a broad range of industrial machinery and industrial processes. Oilgear was incorporated under the laws of Wisconsin in 1921. For additional information describing the business of the Company, see note 3, “Business Description and Operations” in the Notes to Consolidated Financial Statements included in Item 8 of this report.

Principal Products, Markets and Methods of Distribution

      The Company’s products primarily involve the flow, pressure, and condition control and measurement of liquids, which the Company refers to as fluid power. The Company provides advanced technology in the design and production of fluid power components, systems and electronic controls. Its product line includes hydraulic pumps, high pressure intensifier pumps, valves, controls, cylinders, motors and fluid meters. The Company manufactures both radial and axial piston type hydraulic pumps in sizes delivering from approximately 4 gallons per minute to approximately 230 gallons per minute at pressures ranging up to 15,000 pounds per square inch. The intensifier pumps are reciprocating pumps operating at pressures up to 60,000 pounds per square inch. The valves manufactured are pressure control, directional control, servo valves and prefill valves for pressures up to 15,000 pounds per square inch. The Company’s pumps and valves are controlled through the actions of manual, hydraulic, pneumatic, electric, and electrohydraulic controls or control systems.

      The Company offers an engineering and manufacturing team capable of providing advanced technology in the design and production of unique fluid power components and electronic controls. The Company’s global involvement focuses its expertise on markets in which customers demand top quality, prompt delivery, high performance and responsive aftermarket support. Our principal products include piston pumps, motors, valves, controls, manifolds, electronics and components, reservoirs, skids, and meters. They are used in disparate industries including primary metals, machine tool, automobile, petroleum, aerospace, civil, construction equipment, chemical, plastic, glass, lumber, rubber and food. The Company strives to serve those markets requiring high technology and expertise where reliability, top performance and longer service life are needed. The products are sold as individual components or integrated into high performance systems. The Company supports responsive, high quality aftermarket sales and flexible rebuilding services which include exchange, factory rebuild and field repair service, along with customer training.

Restatement

      On March 18, 2005 the Company announced that it would restate previously issued financial statements to write off certain assets on its balance sheet that were capitalized in error by the Company’s Italian subsidiary, Oilgear Towler Srl, from 1997 through 2002. Also, the economic useful lives used to calculate depreciation on fixed assets used by the Italian subsidiary have been changed to more appropriately reflect the expected useful lives of the assets, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information. The required adjustments did not affect net earnings or loss for 2003 or 2004. As a result of these adjustments, the Company restated certain of the previously filed financial statements for the years ended December 31, 2000, 2001, 2002 and 2003. Financial information included in reports on Form 10-K, Form 10-Q and Form 8-K previously filed by the Company for these periods should not be relied upon and are superseded by the information in this Annual Report on Form 10-K.

      All financial information contained in this Annual Report on Form 10-K gives effect to this restatement. Information regarding the effect of the restatement on the Company’s financial position as of

December 31, 2003 and results of operations for 2002 is provided in note 2 of the Notes to Consolidated Financial Statements.

      Also, see Item 6 “Selected Financial Data”, for the effect of the restatement on the Company’s 2000 and 2001 financial statements.

Domestic Segment

      The Company’s products are sold in the United States and Canada by sales engineers and by a network of approximately 57 distributors. Sales engineers are located in Milwaukee, Wisconsin; Hot Springs Village, Arkansas; Belding, Ionia and Novi, Michigan; Cleveland, Centerville and Leetonia, Ohio; Longview, Sanger and Rockwall, Texas; Atlanta and McDonough, Georgia; Trenton, South Carolina; Mead and Tacoma, Washington; Melbourne, Florida; and Ajax, Ontario, Canada.

European Segment

      The Company’s products are sold in Europe directly through 5 wholly-owned subsidiaries and by a network of approximately 15 distributors. Sales offices are located in Leeds, England; Paris, France; Hernani, Spain; Hattersheim, Germany; and Montirone, Italy.

International Segment

      The Company conducts business outside of the United States, Canada and Europe by direct export sales and through subsidiary operations providing sales, engineering, manufacturing and field services to customers worldwide. The Company’s 100% owned subsidiaries are located in Taren Point, Australia; Taejon City, Korea; Nagoya, Japan; Pachuca, Mexico; and Campinas, Brasil. The Company also has a 49% owned joint venture, Oilgear Towler Polyhydron Pvt. Ltd, located in Belgaum, India, and a 58% owned joint venture operation located in Taipei, Taiwan, with both companies serving customers with hydraulic products. In 2002, the Company acquired 100% ownership of Towler Enterprise Solutions Pvt. Ltd located in Bangalore, India by purchasing the minority interests. The Company opened a sales office in Beijing, China in 2005. In addition to the above, the Company sells its products through twelve distributors in selected countries.

Competition

      The Company is a supplier of components for the capital goods industry. Vigorous competition exists in this industry. The Company’s products compete worldwide against the products of a number of domestic and foreign firms presently engaged in the industry, most of which have greater overall size and resources than the Company. The principal methods of competition include price, product performance, product availability, service and warranty.

Customers

      No material part of the Company’s business is dependent upon a single customer or a very few customers.

Backlog

      The Company’s backlog of orders believed to be firm as of December 31, 2004 was approximately $34,034,000, an increase of approximately $5,122,000 from the backlog of orders as of December 31, 2003, which was approximately $28,912,000. The Company expects that substantially all orders in the backlog will be filled in 2005. The Company’s backlog is significant to its operations but is not seasonal in any significant respect. Backlog is generally dependent upon economic cycles affecting capital spending in the industries which utilize the Company’s products.

Raw Materials

      During the year, iron and steel castings, bearings, steel and other raw materials were generally available from a number of sources, and the Company is generally not dependent on any one supplier. However, price surcharges for steel have increased steel costs throughout 2004.

Patents, Licenses, Franchises

      The Company has a number of United States and foreign patents. It does not consider its business to be materially dependent upon any patent, patent application or patent license agreement.

Research and Development

      The Company’s research and development activities are conducted by members of its engineering staff at its Milwaukee, Wisconsin and Leeds, England plants, who spend a substantial amount of their time on research and development. The research and development expenditures for 2004, 2003 and 2002 were $1,700,000, $1,700,000 and $1,600,000, respectively. The Company’s product development efforts continue to be focused on the expansion of its line of axial piston pumps and the customizing of products to suit specific customer applications.

Environmental Matters

      To date, compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had any material effect on the capital expenditures, earnings and competitive position of the Company. The Company does not presently anticipate that compliance with such provisions will have any material effect on its capital expenditures, earnings and competitive position in the future.

Employees

      At December 31, 2004, the Company had approximately 750 employees.

Seasonal Aspects of Business

      The Company’s business is not seasonal to any significant extent.

Industry Segments and Principal Products

      The individual subsidiaries of the Company operate predominantly in one industry, the manufacture and distribution of fluid power systems and components for industrial machinery and industrial processes. The Company also provides repair parts and service for most of the products it manufactures. See “Principal Products, Markets and Methods of Distribution” above. The Company manages its operations in three reportable segments based upon geographic area. Domestic is the United States, Canada and certain exports serviced directly by the Domestic factories. European is Europe and International is Asia, Latin America, Australia and Africa.

Segment Sales

      For further information about the Company’s sales by segment, see note 3, “Business Description and Operations” in the Notes to Consolidated Financial Statements included in Item 8 of this report.

Financial Information About Geographic Areas

      The Company’s revenues by geographic area are described in note 3, “Business Description and Operations” in the Notes to Consolidated Financial Statements included in Item 8 of this report.

      Substantially all of the Company’s Domestic and European real property is pledged as collateral under the terms of the new financing arrangement that closed in February 2005. Mortgages have been recorded on these assets. See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition and Liquidity.”

Domestic

      Oilgear owns a one-story general office and factory building located on 19.23 acres of land at 2300 South 51st Street in Milwaukee, Wisconsin. This building is constructed of concrete, steel and brick and contains approximately 276,000 square feet of floor space. In 2002, the Company closed its manufacturing plant in Longview, Texas, constructed of concrete block and steel, which has approximately 44,000 square feet of floor space. The Longview property is currently leased to a third-party who has an obligation to purchase the property by 2008. The Company leases a 141,000 square foot manufacturing facility on 14 acres of land located in Fremont, Nebraska. As discussed in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K, the Company paid off the Industrial Revenue Bonds and obtained title to this property in March 2005. For additional information regarding the lease of the Fremont, Nebraska facility, see note 6, “Long Term Debt” in the Notes to Consolidated Financial Statements included in Item 8 of this report.

European

      The Company’s Oilgear GmbH subsidiary owns a three level concrete block and steel building with approximately 21,160 square feet in Hattersheim, Germany. This office and shop facility is constructed on 2.335 acres of land and is subject to a mortgage.

      The Company’s Oilgear Towler Ltd. subsidiary owns a one-story manufacturing plant and two office buildings constructed of concrete, steel and brick totaling approximately 52,000 square feet on six acres of land in Leeds, England, and an additional prefabricated facility being used for document storage. As discussed in Item 7 the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this 2004 annual report, the land and building are expected to be sold in 2005 and the subsidiary will move into a leased facility in the same area.

      The Company’s Oilgear Towler S.A. subsidiary owns a two-story manufacturing plant and office constructed of concrete and brick totaling approximately 29,700 square feet on approximately one acre of land in Hernani, Spain.

      The Company’s Oilgear Towler S.A. subsidiary owns a 9,900 square foot office building constructed of prefabricated steel materials located on approximately one-half acre of land in Paris, France.

      The Company’s Oilgear Towler S.r.l. subsidiary owns a 17,000 square foot two-story prefabricated concrete building on approximately one acre of land in Montirone, Italy. The facility is used to repair and assemble customer equipment, as well as to house sales and service functions.

International

      The Company leases facilities in all international locations except for the Company’s Oilgear Towler Polyhydron Pvt. Ltd joint venture. The Company’s Oilgear Towler Polyhydron Pvt. Ltd joint venture owns two plants; plant number 1 is a masonry, three story building with approximately 6,000 square feet on approximately 13,000 square feet of land, and plant number 2 is a one story, masonry building with approximately 16,000 square feet on approximately 258,000 square feet of land.

      The Company’s South Korean subsidiary, Oilgear Towler Korea Co. Ltd, owns .5 acres of vacant land in Taejon City, Korea.

      Properties in all segments are maintained in good condition and are adequate for present operations.

      Borrowings under the Company’s domestic and foreign loan agreements are collateralized by substantially all the assets of the Company. For further information about the Company’s outstanding debt, see note 5, “Short-Term Borrowings” and note 6, “Long-Term Debt” in the Notes To Consolidated Financial Statements included in Item 8 of this report. See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” - “Financial Condition and Liquidity” for further discussion.

      The Company is a defendant in several product liability actions which it believes are adequately covered by insurance, and certain other litigation incidental to its business, none of which is expected to materially impact the Company’s operations or financial results.

      No matters were submitted to a vote of security holders during the fourth quarter of 2004.

Executive Officers of the Registrant

      The names, ages, offices and positions held, and periods of service in their present offices, of all executive officers of the Registrant are listed below. Except in the case of mid-term vacancies, officers are elected for one-year terms at the Board of Directors meeting following the annual meeting of shareholders each year.

PART II

      The Company’s common stock is traded on The Nasdaq Stock Small Cap Market under the symbol OLGR. As of January 24, 2005, the number of record holders of the Company’s common stock was 437.

      For additional information regarding the Company’s common stock and dividend payments, see “Financial Condition and Liquidity” and “Quarterly Financial Information (Unaudited)” in Item 7 of this report.

      In 2002, the Company sold an aggregate of 11,000 of shares of its common stock (“Shares”) pursuant to the Company’s Key Employee Stock Purchase Plan, as amended and restated September 6, 1990 (the “Plan”). The Shares were sold to officers and other key employees in exempt offerings pursuant to Section 4(2) of the Securities Act of 1933, as amended. The purchase price paid for each Share was $7.92, which was the market bid price on the date of purchase. In payment thereof, each purchaser delivered two promissory notes to the Company bearing annual interest at a rate of 5%. One of the notes, for one-half of the aggregate purchase price, is payable in three equal annual installments due on the 2nd, 3rd and 4th February 28th after the date of purchase. The other note, for the other half of the aggregate purchase price, will be forgiven if none of the Shares has been resold and the purchaser is still in the employ of the Company on the due dates, which are the 4th, 5th and 6th February 28th after the date of purchase.

Equity Compensation Plan Information

      The following table provides information about the Company’s equity compensation plans as of December 31, 2004:

      The following table sets forth selected consolidated financial information regarding the Company’s financial position and operating results. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto which appear elsewhere herein.

      On March 18, 2005 the Company announced that it would restate previously issued financial statements to write off certain assets on its balance sheet that were capitalized in error by the Company’s Italian subsidiary, Oilgear Towler Srl, from 1997 through 2002. Also, the economic lives used to calculate depreciation on fixed assets used by the Italian subsidiary have been changed to more appropriately reflect the expected useful lives of the assets. The required adjustments did not affect net earnings or (loss) for 2003 or 2004. Accordingly, the selected financial data has been restated, as indicated. See note 2, “Restatement of Consolidated Financial Statements”, of the Notes to Consolidated Financial Statements.

      The Company has not amended its annual reports on Form 10-K or quarterly reports on Form 10-Q for the quarterly periods affected by the restatement. The information that has been previously filed or otherwise reported for those periods is superseded by the information in this Annual Report on Form 10-K, and the financial statements and related financial information contained in such reports should no longer be relied upon.

5 Year Summary

      The effect of the restatement on the Company’s consolidated financial statements for 2000 through 2003 was as follows:

Increase (Decrease) Adjustments for the Restatement of Prior Years

Restatement of Prior Period Financial Statements

      As further described in note 2 of the Notes to Consolidated Financial Statements, on March 18, 2005, the Company announced that certain of its historical financial statements required restatement. Consequently, Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2003 compared to 2002 is being restated.

      Specifically, during the Company’s preparation of its year-end financial statements for 2004, the Company identified accounting errors in the Company’s Italian subsidiary that were not previously detected in the translation to United States generally accepted accounting principles in the consolidation process. The errors did not affect the results of operations or the cash flows reported for 2003 or 2004. The restatement had no effect on the Company’s compliance with bank covenants.

Overview

      The world economy continued to improve, which helped the Company generate net earnings in all four quarters of 2004. Net sales in 2004 increased by 16.6% over net sales in 2003 and all three of the Company’s business segments experienced an increase in net orders and net sales in 2004. Orders for highly engineered construction projects had the largest improvement in all three segments. The demand for Oilgear hydraulic pumps is continuing to grow and our marketing efforts added new customers in 2004. We continue to invest in new products and product enhancements with emphasis on reducing operating costs to keep the Company competitive in our industry.

Discussion of Results of Operations

      The economic recovery that started late in 2003 continued throughout 2004 with orders for 2004 increasing by 23.9% from 2003. The Domestic segment’s orders increased in 2004 by 25.5% from 2003. Although the increase in orders encompassed most of the products in the Domestic segment, engineered

construction projects, piston pumps and flow meters had the strongest recovery. The economy influenced most of the change but the increase in spending for defense by the United States government caused an increase in orders from the U.S. military for flow meters produced at our Milwaukee plant. In the European segment, orders in 2004 compared to 2003 increased by 16.5%. Some of the increase came from a weaker dollar against the Euro and Pound Sterling. The 2003 to 2004 change in the Euro and British pound average exchange rate relative to the U.S. dollar were increases of approximately 10.2% and 11.7%, respectively. Most of the exchange related increase came from orders received by our subsidiary in Leeds, England for hydraulic equipment used in weapons handling systems for submarines and in our Italian subsidiary for projects using specialty fluids in the steel industry. An increase in orders from customers in Latin America provided most of the 35.1% increase of 2004 orders in the International segment when compared to 2003. Consolidated order levels were stronger in 2004 compared to 2003 for engineered products used in aerospace, forging and aluminum extrusion.

      The increase in orders described above caused net sales in 2004 to increase by 16.6% over 2003, but the increase drops to an 11.7% increase after adjusting for the effect of converting the foreign currencies to U.S. dollars. Net sales for 2004 in the Domestic segment increased by 9.2% over 2003. The increase in piston pump sales was the primary reason for the overall increase while shipments of engineered construction projects have lagged behind because of longer lead time to complete. The European segment net sales for 2004 increased by 17.0% over 2003 but the increase drops to a 4.6% after adjusting for the increase from converting the Euro and British pound sterling to U.S. dollars. The International segment net sales for 2004 increased by 47.0% but the increase drops to a 43.0% after adjusting for the effect of converting the foreign currencies to U.S. dollars. The increase in the European and International segments came from contracts for highly engineered construction projects in the forging and extrusion industries.

      Although the domestic economy started to recover in 2003, the fluid power industry lagged in that recovery. Our net orders in 2003 decreased by 4.8% when compared to 2002. In 2002 our European segment received a large order for approximately $11,000,000 to supply equipment on a new forging press being installed in central France. This single order distorts the comparisons of orders between the periods being reported. Excluding this individual order from the 2002 total, net orders for 2003 would have increased by 9.4% when compared to 2002. Approximately 33% of the 2003 net orders were sold by our European segment and therefore were subject to translation from Euros and British pounds, which further distorts the year to year comparison as the Euro and British pound average exchange rate increased from their 2002 average by approximately 20% and 9%, respectively.

      When 2003 orders in each geographic segment are compared to 2002, the Domestic segment increased by approximately 4.7%, the European segment decreased by approximately 23.7% and the International segment increased by approximately 23.1%. The increase in the Domestic segment resulted from an increase in custom engineered orders for integrated hydraulic and electrical products used on extrusion presses and products used on the Atlas V rocket program in the aerospace industry. The large order discussed above was the primary reason for the decrease in European orders in 2003. If that order is taken out of the calculation, European segment orders increased by approximately 12.2% in 2003. Orders for integrated hydraulic and electrical products used in aluminum extrusion and forging applications were the reason for the 2003 increase in orders in the International segment.

      Net sales in 2003 increased by 7.6% when compared to 2002. When comparing 2003 net sales to 2002 by segment, the Domestic segment increased by 2.0%, the European segment increased by 20.8% and the International segment decreased by 0.4%. Excluding the effect of favorable foreign exchange rates on sales, net sales for 2003 increased by 0.8% over 2002. The economic condition in the fluid power industry was the primary reason net sales, measured in local currencies, remained relatively flat in 2003. Roughly 47%

of the approximately $11,000,000 forging press order entered in 2002 was recognized through net sales in 2003.

      The increase in orders discussed above was the primary reason backlog increased by approximately $5,122,000 or 17.7% at December 31, 2004 compared to the same date in 2003. Approximately 25% of the 2002 forging press order in France or approximately $4,000,000 converted at currency exchange rates at the end of 2004 remained in the backlog. All the remaining equipment on this order is scheduled to be shipped in 2005 and the forging press is to be started up in 2006.

      The 2003 year end backlog decreased by 2.2%, or $650,000, from the year end of 2002. Approximately 53% of the 2002 forging press order in France or approximately $7,000,000 converted at currency exchange rates at the end of 2003 remained in the backlog.

      Gross profit increased $3.4 million, or 18.3% in 2004 when compared to 2003. In addition, gross profit margin continued to increase in 2004, up 1.3% from 23.1% in 2003 to 23.4% in 2004, despite rising material prices, health care costs, pension costs and intense price competition in our industry. The increase in net sales which contributed to coverage of fixed manufacturing costs and improved profit was the primary reason for the increase in margin.

      Gross profit increased $4.4 million or 30.7% in 2003 when compared to 2002. Gross profit margin also increased in 2003 (from 19.0% to 23.1%) despite the approximately $1,000,000 of added costs incurred from a manufacturing quality problem at our Fremont plant. By the end of 2003, that quality problem was substantially alleviated. The cost savings from closing plants, outsourcing to low cost vendors, a favorable union contract, the use of lean manufacturing techniques and a more favorable mix of products with higher profit margins all helped to improve the gross profit margin.

      Selling, general and administrative expenses, less research and development, decreased by 0.6% or approximately $110,000 in 2004. If the part of these expenses that were incurred in foreign currencies were

converted using the 2003 average exchange rate instead of the 2004 average exchange rate, the expenses would have been approximately $924,000 or 4.7% lower.

      Selling, general and administrative expenses, less research and development, increased by 7.1% or $1,202,000 in 2003. When the local foreign currency expenses were converted to US dollars using the average 2003 exchange rate the expenses were approximately $1,200,000 higher than the expenses would have been if they were converted using the 2002 average exchange rate. This was the primary reason for the increase in 2003. Another factor that increased these expenses in 2003 was the approximately $400,000 increase in pension costs allocated to selling, general and administrative expenses. These increases were partially offset by an approximately $249,000 reduction in charges related to various headcount reductions and other exit costs recorded in 2003 and 2002.

      The Company’s 2004 and 2003 research and development expenses totaled approximately $1,700,000 in each year. These expenses were $1,600,000 in 2002. The Company continues its commitment to the design and manufacture of new and more efficient hydraulic products to gain new customers and to develop new applications for the Company’s products.

      Operating income in 2004 of $2,436,000 compared to a $1,093,000 operating loss in 2003 and a $4,176,000 operating loss in 2002. The improved performance in 2004 was the result of increased net sales with higher gross profit margins and a small decrease in operating expenses. The improved performance in 2003 when compared to 2002 was the result of increased net sales with higher gross profit margins.

      Interest expense increased by approximately $28,000 in 2004 and $75,000 in 2003 as the result of increased interest rates.

      Income tax effective rates were 54.4%, (26.3%) and 4.7% in 2004, 2003 and 2002, respectively. In recent years, the Company has recorded income tax expense on losses before income taxes and minority interest due to significant losses in the Domestic segment that are not benefited for tax purposes, coupled with earnings and related income tax expense in the European and International segments. In 2003, the reserve for income tax exposure items was reduced by approximately $800,000 to an amount supported by the risk associated with the possible tax liability, which is the primary reason for the negative effective tax rate. Changes in the valuation allowance were the principal reason for the fluctuation in effective tax rate in 2002. Also see note 9 of the Notes to the Consolidated Financial Statements for additional reconciliation of the tax rates.

      Net earnings of $423,000 for 2004 compared to a $1,793,000 loss in 2003 was the result of generating operating income in 2004 versus operating losses in 2003.

      The net loss of $1,793,000 for 2003 was primarily the result of approximately $1,000,000 of costs related to the quality problems in our Fremont factory, approximately $500,000 of charges relating to inventory, receivables and fixed assets written off in our International segment and $296,000 of employee termination and other exit costs.

Outlook

      Although the overall growth rates that are reflected in the fluid power index data are starting to slow down from the very rapid growth of 2004, the outlook is still positive according to most forecasts. Our net orders in the first two months of 2005 increased by approximately 26.6% compared to the first two months of 2004, and our backlog at February 28, 2005 is at a record level of approximately $40,537,000, an

increase of $6,503,000, or 19.1% since December 31, 2004. The continued weak value of the US dollar should continue to have a positive effect on net sales and gross margins in the European and International segments. We are continuing to manage costs during this economic expansion as we did in the prior recession years. However, increasing costs for legal, auditing and other Sarbanes-Oxley compliance related costs will erode earnings potential. As part of our cost reduction and efficiency improvement efforts, we are in the process of downsizing our facility in Leeds, England and we expect to sign a lease to move these operations to a more efficient facility in 2005. We have entered into a conditional contract with a developer to sell our existing facility for 4,050,000 British pound sterling. All conditions in the contract have been met except for us moving to a new location. The property has close to a zero book value so the transaction will provide a significant gain in 2005. As of February 2005, the property is encumbered by a 3,200,000 British Pound Sterling mortgage with Barclays Bank.

Inflation and Changing Prices

      Oilgear uses the LIFO method of accounting for approximately 60% of its inventories and has reserves for obsolete and slow moving inventory. Approximately 91% of the total assets of the Company reside in the United States and Western Europe. These assets are in operation and have been maintained in good condition through the years. Management believes that inflation has not significantly affected the net earnings (loss) reported by the Company.

Quarterly Financial Information (Unaudited)

Financial Condition and Liquidity

      On February 7, 2005, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) dated as of January 28, 2005 by and among the Company, LaSalle Business Credit, LLC (“LaSalle”), and two of the Company’s wholly-owned subsidiaries, Oilgear Towler, S.A. (“Oilgear Spain”) and Oilgear Towler GmbH (“Oilgear Germany”). On the same date, the Company and LaSalle

also entered into a Foreign Accounts Loan and Security Agreement dated as of January 28, 2005 (the “EXIM Loan Agreement”).

      The Loan Agreement provides the Company with a $12,000,000 revolving loan facility (subject to advance rates based on eligible accounts receivable and inventory, as well as reserves that may be established in LaSalle’s discretion), of which up to $10,000,000 may be used for the issuance of letters of credit. The Loan Agreement also provides term loans to the Company in the amounts of $2,050,000 (“Term Loan A”) and $4,700,000 (“Term Loan B”), respectively, as well as an $840,000 term loan to Oilgear Germany (“Term Loan C”) and a $1,860,000 term loan to Oilgear Spain (“Term Loan D”).

      The outstanding principal amount of the revolving loan is scheduled to mature on January 28, 2008 (the “Maturity Date”). The Loan Agreement provides, however, that it will automatically renew for successive one year terms unless either the Company or LaSalle elects not to renew, or the liabilities thereunder have been accelerated.

      Principal on Term Loan A amortizes in 60 equal monthly installments of $34,166.66; principal on Term Loan B amortizes in 120 equal monthly installments of $39,166.66; principal on Term Loan C amortizes in 120 equal monthly installments of $7,000; and principal on Term Loan D amortizes in 120 equal monthly installments of $15,500. Mandatory prepayments of the term loans are required upon the sales of certain assets and from excess cash flow, if available.

      At the Company’s option: (i) the revolving loan bears interest (a) at one-half of one percent in excess of LaSalle’s announced prime rate (the “Prime Rate”) or (b) 350 basis points in excess of LIBOR and (ii) the term loans bear interest (x) at one percent in excess of the Prime Rate or (y) 400 basis points in excess of LIBOR. Upon the occurrence of an event of default, all loans bear interest at two percentage points in excess of the interest rate otherwise payable.

      The EXIM Loan Agreement provides the Company with up to $3,000,000 in revolving loans (subject to advance rates based on eligible accounts receivable and inventory in respect of sales made to non-US customers, and reserves that may be established at LaSalle’s discretion). The outstanding principal amount of these loans is scheduled to mature on the Maturity Date, but the EXIM Loan Agreement is subject to the same renewal terms described above with respect to the Loan Agreement. At the Company’s option, these loans bear interest at either one-half of one percent over the Prime Rate or 350 basis points in excess of LIBOR. Upon the occurrence of an event of default, the loans bear interest at two percentage points in excess of the interest rate otherwise payable.

      Both the Loan Agreement and the EXIM Loan Agreement are secured by a blanket lien against all of the Company’s assets (including intellectual property); a pledge by the Company of its shares or equity interests in its US, Spanish, German, French and Italian subsidiaries; guaranties from each of the foregoing subsidiaries (subject to dollar limitations for each of the non-US subsidiaries); and a real estate mortgage on the Company’s Wisconsin, Nebraska and Texas real property, as well as the real estate owned by its Spanish, German, French and Italian subsidiaries.

      The Loan Agreement and the EXIM Loan Agreement contain customary terms and conditions for asset-based facilities, including standard representations and warranties, affirmative and negative covenants, and events of default, including non-payment, insolvency, breaches of the terms of the respective loan agreements, change of control, and material adverse changes in the Company’s business operations.

      Also on February 7, 2005, the Company’s subsidiary in the United Kingdom, Oilgear Towler Limited (“Oilgear UK”), entered into a series of financing arrangements with Venture Finance PLC (“Venture Finance”). The Venture Finance facilities provide for aggregate loans to Oilgear UK of Pounds Sterling 2,500,000. These loans are apportioned among: (i) a Pounds Sterling 2,000,000 invoice discounting facility pursuant to an Agreement for the Purchase of Debts, (ii) a Pounds Sterling 250,000 equipment loan pursuant to a Plant & Machinery Loan Agreement and (iii) a Pounds Sterling 250,000 stock loan pursuant to a Stock Loan Agreement. The Venture facilities are each dated as of January 28, 2005 and have a stated maturity of three years.

      Loans under the Agreement for the Purchase of Debts bear a discount charge of either two percent over the base rate of Venture Finance’s bankers for prepayments in Pounds Sterling or two percent over Venture Finance’s cost of funds for prepayments in agreed currencies other than Pounds Sterling. Loans under the Plant & Machinery Loan Agreement and the Stock Purchase Agreement bear interest at 3 percent and 2.5 percent, respectively, above the base rate of Venture Finance’s bankers.

      All of the Venture Finance facilities contain standard representations and warranties, general covenants and events of default, including non-payment, breaches of the terms of the respective documents, and insolvency.

      Also on February 7, 2005, Oilgear UK entered into a demand loan facility with Barclays Bank PLC dated as of February 4, 2005 that provides loans of up to the lesser of Pounds Sterling 3,200,000 or 78% of the appraised value of certain assets. Although the Barclays facility is repayable on demand of the bank at any time, it currently is scheduled for review and renewal on August 15, 2005. The Barclays loan bears interest at 2.25 percent over LIBOR, and the outstanding principal amount thereof is to be repaid in a single payment on the renewal date. The Barclays facility is secured by a land charge over the land and buildings owned by Oilgear UK in Leeds, United Kingdom.

      Although the Company successfully entered into the post-balance sheet date refinancing, due to certain subjective acceleration clauses in the related Loan Agreement the entire line of credit borrowings under the Loan Agreement continued to be classified as short-term as of December 31, 2004 as the requirements of SFAS No. 6, “Classification of Short-Term Obligations Expected to Be Refinanced” were not met. In addition, the Company has examined the provisions of the new Loan Agreement and, based on EITF Issue No. 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement” (“EITF 95-22”), and certain provisions in the Loan Agreement, the Company will be required to classify its revolving loan facility as short-term debt for the term of the new Loan Agreement, even though the revolving loan facility does not mature until March 2008. As a result, upon recording the Loan Agreement in February 2005, the Company classified the outstanding portion of the $12 million revolving loan portion of the new Credit Facility as short-term debt, not withstanding the fact that it does not mature until March 2008.

      On February 7, 2005, the Company used a portion of the proceeds from the loan agreements described above to repay and terminate the Seventh Amended and Restated Credit Agreement dated as of March 22, 2004 (the “M&I Credit Agreement”) by and between the Company and M&I Marshall & Ilsley Bank (“M&I Bank”). Also on February 7, 2005 the Company gave notice pursuant to that certain Lease Agreement dated as of October 1, 1997 (the “Lease”) between the County of Dodge, Nebraska as lessor (the “Issuer”) and the Company as lessee, for a part of its facility in Fremont, Nebraska, that the Company would prepay all rental payments due under the Lease in whole in the principal amount of $1,200,000 plus accrued interest on March 21, 2005 (the “Redemption Date”). Concurrent with such prepayment, the Issuer and Wells Fargo Bank, National Association as Trustee (the “Trustee”) redeemed all County of Dodge, Nebraska Variable Rate Demand Industrial Development Revenue Bonds, Series 1997 (The Oilgear Company Project) (the “Bonds”), in whole at a redemption price of $1,200,000 plus accrued interest to the Redemption Date and without premium. The Bonds were secured by, and were paid by a draw on an irrevocable direct-pay letter of credit issued by M&I Bank. The Company’s obligation to reimburse M&I Bank for such draw is secured by funds deposited by the Company with M&I Bank as cash collateral. Upon payment of the Bonds in full, the Issuer terminated and released its interest in the Lease and sold the equipment purchased with the proceeds of the Bonds to the Company for a nominal purchase price. Each of these transactions was in connection with and as a result of the Company’s entry into the new credit agreements described above. The termination did not result in any early termination penalty.

      The Consolidated Balance Sheets present the Company’s financial position at year end compared with the previous year end. This financial presentation provides information intended to assist in assessing factors such as the Company’s liquidity and financial resources.

      Working capital decreased substantially in 2004, which was mostly due to the bank debt coming due on April 1, 2005. The current ratio decreased to 1.29 at December 31, 2004 from 2.30 at December 31, 2003. The expiring bank financing arrangement caused all the domestic bank debt to be classified as current debt, and that was the primary reason for the decrease in the current ratio.

      Due to constraints in the Company’s expired debt agreement, the interest bearing debt was paid down by $1,200,000 in 2004.

      Shareholders’ equity was increased during 2004 by (i) the consolidated net earnings in 2004 of approximately $423,000, (ii) the fact that the return on pension assets caused a decrease in the equity adjustment for minimum pension liability by $988,000 and (iii) the foreign currency rate changes during 2004 brought on by a weaker US dollar caused a $1,303,000 increase in total shareholders’ equity.

      In the fourth quarter of 2002 the Company switched from the Nasdaq National Market to the Nasdaq Small Cap Stock Market because of the decrease in the valuation of its stock. The Company’s common stock is traded under the symbol “OLGR”. Oilgear believes it is desirable for its employees to have an ownership interest in the Company. Several programs that are described in note 10 to the Consolidated Financial Statements further this concept.

      In December 2000 the Company announced a stock buy back program for a total of 100,000 shares of common stock during the following three years. The Company bought 660 shares in 2002. No shares were repurchased in 2003 or 2004.

      Net cash provided by operating activities was $424,000 in 2004 compared to $2,062,000 provided in 2003. Net earnings provided cash in 2004 compared to a net loss that used cash in 2003. Depreciation and amortization remained consistent in 2004 and 2003. Slow payment of accounts payable was the primary reason for the $2,256,000 and $1,851,000 increases in the account in 2004 and 2003, respectively. Increased net sales caused the use of approximately $833,000 of cash from trade accounts receivable in 2004 compared to $850,000 of cash provided in 2003. The increase in work-in-process inventory resulting from an increase in net sales caused total inventories to increase in 2004 and 2003 which resulted in the use of cash of $1,109,000 and $865,000, respectively. Contracts using percentage-of-completion had more accumulated costs than billings in 2004 causing billings, costs and estimated earnings on uncompleted contracts to use $2,399,000 of cash. In 2003, the contracts using percentage-of-completion had more billings and payments than accumulated costs and provided $1,333,000 of cash.

      Net property, plant and equipment was $18,163,000 at December 31, 2004 compared to $19,682,000 at December 31, 2003. Capital expenditures in 2004 were $1,178,000 compared to depreciation and amortization of $3,122,000.

      Capital expenditures in 2003 were $1,047,000 compared to depreciation and amortization of $3,068,000. The Company did not enter into any new operating leases in 2004 and 2003. On September 26, 2003 the Company entered into a “Net” lease agreement with a company in Longview, Texas for the lease of its Longview facility. The lease ends September 30, 2008, and the lessee is obligated to purchase the property on that date or an earlier date specified by the lessee.

      The Company did not declare or pay any dividends in 2004 or 2003.

      The following table provides information as of December 31, 2004, with respect to the Company’s known contractual obligations.

      Under the new three year Loan Agreement, principal payments against the approximately $10,400,000 of long-term loans will be approximately $1,320,000 per year. The amounts drawn (subject to advance rates based on eligible accounts receivable and inventory) on the approximately $18,800,000 of revolving line of credit loan facilities will be classified as current debt. The approximately $6,175,000 demand loan from Barclays Bank PLC will be paid back when the Company realizes the proceeds (estimated at $7,700,000) from the sale of our facility in Leeds, England. The Company expects to move the Leeds factory in 2005 and therefore remove the last remaining condition to complete this transaction.

      The Company has approximately $2,226,000 and $4,000,000 in open bank guarantees, letters of credit and insurance bonds covering our performance of contracts and down payment guarantees to our customers at December 31, 2004 and 2003, respectively. There are no other off-balance sheet arrangements.

Critical Accounting Policies

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions for the reporting period and as of the financial statement date. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses. Actual results could differ from those amounts. A more complete description of our accounting policies is presented in note 1 to the Consolidated Financial Statements.

      Critical accounting policies are those that are important to the portrayal of the Company’s financial condition and results, and which require management to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. The Company believes that critical accounting policies include accounting for percentage-of-completion contracts, accounting for allowances for doubtful accounts receivable, accounting for pensions, accounting for inventory obsolescence and accounting for income taxes.

      Accounting for contracts using percentage-of-completion requires estimates of costs to complete each contract. Revenue earned is recorded based on accumulated incurred costs to total estimated costs to perform each contract. Management reviews these estimated costs on a monthly basis and revises costs and income recognized when changes in estimates occur. To the extent the estimate of costs to complete varies, so does the timing of recording profits or losses on contracts.

      Management is required to make judgments, based on historical experience and future expectations, as to the collectibility of accounts receivable. The allowance for doubtful accounts represents allowances for customer trade accounts receivable that are estimated to be partially or entirely uncollectible. These

allowances are used to reduce gross trade receivables to their net realizable value. The Company records these allowances based on estimates related to the following factors: (i) customer specific allowances; (ii) amounts based upon an aging schedule; and (iii) an estimated amount, based on the Company’s historical experience, for issues not yet identified.

      Our accounting for pension benefits is primarily affected by our assumptions about the discount rate, expected and actual return on plan assets and other assumptions made by management, and is impacted by outside factors such as equity and fixed income market performance. Pension liability is principally the estimated present value of future benefits, net of plan assets. Pension expense is principally the sum of interest and service cost of the plan, less the expected return on plan assets and the amortization of the difference between our assumptions and actual experience. The expected return on plan assets is calculated by applying an assumed rate of return to the fair value of plan assets. If plan assets decline due to poor performance by the equity markets and/or long-term interest rates decline, as was experienced in 2002 and 2001, our pension liability and cash funding requirements will increase, ultimately increasing future pension expense.

      Inventories are stated at the lower of cost or market value and are categorized as raw materials, work-in-progress or finished goods. Inventory reserves are recorded for damaged, obsolete, excess and slow-moving inventory. Management uses estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory.

      A valuation allowance has been recorded for certain deferred tax assets, principally related to certain domestic and foreign net operating loss carryforwards. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

New Accounting Pronouncements

      In December 2003, the Financial Accounting Standards Board (“FASB”) issued a revised Interpretation No. 46, Consolidation of Variable Interest Entities (“Interpretation 46R”), which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. Interpretation 46R replaces Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. The Company is required to apply Interpretation 46R to interests in variable interest entities (“VIE”) created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under Interpretation 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date Interpretation 46R first applies may be used to measure the assets, liabilities and non-controlling interest of the VIE. The adoption of Interpretation 46R did not have a material impact on the Company’s 2004 financial statements.

      In December, 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). SFAS 123R addresses the accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R supersedes APB No. 25 and requires that such transactions be accounted for using a fair-value based method. SFAS 123R requires companies to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee

stock purchase plans. The Company is required to implement the proposed standard no later than July 1, 2005. The cumulative effect of adoption, applied on a modified prospective basis, would be measured and recognized on July 1, 2005. The Company is currently evaluating option valuation methodologies and assumptions related to its stock compensation plans. Current estimates of option values using the Black-Scholes method may not be indicative of results from valuation methodologies ultimately adopted.

      In December, 2004, the FASB issued FASB Staff Position 109-2 “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”), in response to the American Jobs Creation Act of 2004 which was signed into law in October, 2004 and which provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated (as defined). Based on the Company’s decision to reinvest rather than to repatriate current and prior year’s unremitted foreign earnings, the application of FSP 109-2 did not affect income tax expense or related disclosures in the period and is not expected to impact the measurement of income tax expense in future periods.

      In November, 2004, the FASB issued SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 is the result of a broader effort by the FASB to improve the comparability of cross-border financial reporting by working with the International Accounting Standards Board (“IASB”) toward development of a single set of high-quality accounting standards. The FASB and the IASB noted that ARB 43, Chapter 4 and IAS 2, “Inventories,” require that abnormal amounts of idle freight, handling costs, and wasted materials be recognized as period costs; however, the Boards noted that differences in the wording of the two standards could lead to inconsistent application of those similar requirements. The FASB concluded that clarifying the existing requirements in ARB 43 by adopting language similar to that used in IAS 2 is consistent with its goals of improving financial reporting in the United States and promoting convergence of accounting standards internationally. Adoption of SFAS 151 is required for fiscal years beginning after June 15, 2005. The provisions of SFAS 151 will be applied prospectively and are not expected to have a material impact on results of operations and financial position of the Company.

Cautionary Factors

      The discussions in this section and elsewhere contain various forward-looking statements concerning the Company’s prospects that are based on the current expectations and beliefs of management. Forward-looking statements may also be made by the Company from time to time in other reports and documents as well as oral presentations. When used in written documents or oral statements, the words “anticipate”, “believe”, “estimate”, “expect”, “objective”, and similar expressions are intended to identify forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond the Company’s control, that could cause the Company’s actual results and performance to differ materially from what is expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company:

      The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Market Risk Management

      The Company is exposed to market risk stemming from changes in foreign exchange rates and interest rates. Changes in these factors could cause fluctuations in earnings and cash flows. The Company has significant foreign operations, for which the functional currencies are denominated primarily in the euro and British pound sterling. As the values of the currencies of the foreign countries in which the Company has operations increase or decrease relative to the US Dollar, the sales, expenses, profits, assets and liabilities of the Company’s foreign operations, as reported in the Company’s Consolidated Financial Statements, increase or decrease accordingly. If foreign exchange rates would have been collectively 10% weaker against the US dollar in 2004, the net earnings would have decreased by approximately $90,000.

      The Company’s debt structure and interest rate risk are managed through the use of fixed and floating rate debt. The Company’s primary exposure is to United States interest rates (see notes 5 and 6 to the Consolidated Financial Statements). A 100 basis point movement in interest rates on floating rate debt outstanding at December 31, 2004 would result in a change in earnings before income taxes of approximately $226,000.

      The Company occasionally uses forward contracts to reduce fluctuations in foreign currency cash flows related to third party material purchases, intercompany product shipments and intercompany loans. At December 31, 2004, the Company had no open forward exchange contracts.

CONSOLIDATED STATEMENTS OF OPERATIONS AND SHAREHOLDERS’ EQUITY

THE OILGEAR COMPANY AND SUBSIDIARIES

Years Ended December 31, 2004, 2003 and 2002

See accompanying notes to consolidated financial statements.

CONSOLIDATED BALANCE SHEETS

THE COMPANY AND SUBSIDIARIES

December 31, 2004 and 2003

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

THE OILGEAR COMPANY AND SUBSIDIARIES

Years Ended December 31, 2004, 2003 and 2002

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

THE OILGEAR COMPANY AND SUBSIDIARIES

Years Ended December 31, 2004, 2003 and 2002

See accompanying notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES

Years Ended December 31, 2004, 2003 and 2002

      These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. They include the accounts of The Oilgear Company and its subsidiaries (Company), including two joint ventures (one in India in which the Company has a 49% interest and one in Taiwan in which the Company has a 58% interest). During 2002, the Company acquired the minority interest in the second Indian joint venture that existed at December 31, 2001. Also during 2002, the Company obtained two new 100% owned subsidiaries, OSL Offshore Systems and Deck Machinery and Oilgear Towler Japan Company. These transactions were immaterial to the Company’s consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation.

      All assets and liabilities of foreign subsidiaries are translated at the exchange rate prevailing at the balance sheet date and substantially all income and expense accounts are translated at the weighted average exchange rate during the year. Translation adjustments are not included in determining net earnings (loss), but are a component of accumulated other comprehensive income (loss) in shareholders’ equity. Gains and losses resulting from foreign currency transactions are included in net earnings (loss).

      For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents totaled approximately $914,000 and $1,315,000 at December 31, 2004 and 2003, respectively, and consisted primarily of money market funds, commercial paper and short-term U.S. Government securities.

      Inventories are stated at the lower of cost or market. Cost has been calculated on the last-in, first-out (LIFO) method for the majority of the domestic inventories. For the balance of inventories, cost has been calculated under the first-in, first-out (FIFO) or average actual cost methods. Market means current replacement cost not to exceed net realizable value. Reserves for obsolete and slow moving inventory are charged to cost of sales.

      Property, plant and equipment are stated at cost. Depreciation on plant and equipment is calculated on the straight-line method over the estimated useful lives of the assets. Estimated useful lives range from 20 to 40 years for buildings, 5 to 15 years for machinery and equipment and 5 to 17 years for drawings, patterns and patents.

      The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES — (Continued)

      The Company recognizes revenue on construction contracts on the percentage-of-completion method. Revenue earned is recorded based on the percentage of costs incurred to internal engineering estimates of total costs to perform each contract. Contract costs include all direct material, labor, and those indirect costs related to contract performance. Changes in performance, conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Losses are recognized at the time a loss is projected. Revenue is recognized on sales of products other than percentage-of-completion contracts upon shipment to the customer, which is when the risk of ownership passes.

      The Company measures compensation cost for stock options using the intrinsic value-based method. Compensation cost, if any, is recorded based on the excess of the quoted market price at grant date over the amount any employee must pay to acquire the stock. The Company has evaluated the pro forma effects of using the fair value-based method of accounting and, as such, net earnings (loss), basic earnings (loss) per share of common stock, and diluted earnings (loss) per share of common stock would have been as follows:

      The fair value of the Company’s stock options used to compute pro forma net earnings (loss) and earnings (loss) per share disclosures is the estimated fair value at grant date using the Black-Scholes option pricing model with a risk-free interest rate equivalent to 3 year Treasury securities and an expected life of 3.5 years. The Black-Scholes option pricing model also used the following weighted-average assumptions: 2004- expected volatility of 45% and expected dividend yield of 0%; 2003- expected volatility of 43% and expected dividend yield of 0%; 2002- expected volatility of 31% and expected dividend yield of 0%. Option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s options have characteristics significantly different from traded options, and because changes in the subjective input can materially affect the fair value estimates, in the opinion of management, the existing models do not necessarily provide a reliable single value of its options and may not be representative of the future effects on reported net earnings or the future stock

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES — (Continued)

price of the Company’s common stock. For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the option’s vesting period.

      The Company recognizes derivatives as either assets or liabilities in the balance sheet and measures those instruments at fair value. Derivative financial instruments are used by the Company principally in managing its foreign currency exposure. The Company periodically enters into forward foreign exchange contracts to hedge the risk from changes in fair value to unrecognized firm purchase commitments. These firm commitments generally require the Company to exchange U.S. dollars for foreign currencies. The Company does not hold or issue derivative financial instruments for trading purposes. The Company did not have any forward foreign exchange contracts at December 31, 2004 or December 31, 2003.

      Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings (loss) in the period that includes the enactment date.

      Research and development costs are charged to selling, general and administrative expenses in the year they are incurred. Total research and development expense was approximately $1,700,000 in 2004, $1,700,000 in 2003, and $1,600,000 in 2002.

      Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.

      Basic earnings per share (EPS) is computed by dividing net earnings (loss) available to common shareholders by the weighted-average number of common shares outstanding for the period. Basic EPS does not consider common stock equivalents. Diluted EPS reflects the dilution that would occur if common shares that participated in the net earnings of the Company were issued upon the exercise of dilutive employee stock options. The computation of diluted EPS uses the “if converted” and “treasury stock” methods to reflect dilution.

      The weighted-average number of shares outstanding used in calculating basic EPS was 1,960,298 in 2004, 1,955,898 in 2003, and 1,951,136 in 2002. The weighted-average number of shares outstanding used in calculating diluted EPS was 1,982,538 in 2004, 1,955,898 in 2003, and 1,951,136 in 2002. In the computation of diluted earnings per share for the years ended December 31, 2003 and 2002, 71,985 and 93,882 stock options were excluded from the computation as their inclusion would be anti-dilutive.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES — (Continued)

      Certain amounts as originally reported in 2003 and 2002 have been reclassified to conform with the 2004 presentation.

      In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). SFAS 123R addresses the accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R supersedes APB No. 25 and requires that such transactions be accounted for using a fair-value based method. SFAS 123R requires companies to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. The Company is required to implement the proposed standard no later than July 1, 2005. The cumulative effect of adoption, applied on a modified prospective basis, would be measured and recognized on July 1, 2005. The Company is currently evaluating option valuation methodologies and assumptions related to its stock compensation plans. Current estimates of option values using the Black Scholes method may not be indicative of results from valuation methodologies ultimately adopted.

      In December 2004, the FASB issued FASB staff Position 109-2 “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”), in response to the American Jobs Creation Act of 2004 which was signed into law in October 2004, and which provides for a special one-time tax deduction of 85% of certain foreign earnings that are repatriated (as defined). Based on the Company’s decision to reinvest rather than to repatriate current and prior years’ unremitted foreign earnings, the application of FSP 109-2 did not affect income tax expense or related disclosures in 2004.

      In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 is the result of a broader effort by the FASB to improve the comparability of cross-border financial reporting by working with the International Accounting Standards Board (“IASB”) toward development of a single set of high-quality accounting standards. The FASB and the IASB noted that ARB 43, Chapter 4 and IAS 2, “Inventories,” require that abnormal amounts of idle freight, handling costs, and wasted materials be recognized as period costs, however, the Boards noted that differences in the wording of the two standards could lead to inconsistent application of those similar requirements. The FASB concluded that clarifying the existing requirements in ARB 43 by adopting language similar to that used in IAS 2 is consistent with its goals of improving financial reporting in the United States and promoting convergence of accounting standards internationally. Adoption of SFAS 151 is required for fiscal years beginning after June 15, 2005. The provisions of SFAS 151 will be applied prospectively and are not expected to have a material impact on results of operations and the financial position of the Company.

      On March 18, 2005, the Company announced that certain of its historical financial statements required restatement. Specifically, the Company identified accounting errors in the Company’s Italian subsidiary that were not previously detected in the translation to United States generally accepted accounting principles in the consolidation process. As a result, the Company restated the financial statements presented here for years 2002 and 2003. These errors did not affect the results of operations reported for 2003.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES — (Continued)

      The following table presents the impact of the financial statement adjustments on the Company’s previously reported consolidated statement of operations for the year ended December 31, 2002.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES — (Continued)

      The following table presents the impact of the financial statement adjustments on the Company’s previously reported consolidated balance sheet at December 31, 2003.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES — (Continued)

      The Company manages its operations in three reportable segments based upon geographic area. Domestic is the United States, Canada and certain exports serviced directly by the domestic factories. European is Europe and International is Asia, Latin America, Australia and most of Africa.

      The individual subsidiaries of the Company operate predominantly in the fluid power industry. The Company offers an engineering and manufacturing team capable of providing advanced technology in the design and production of unique fluid power components and electronic controls. The Company’s global involvement focuses its expertise on markets in which customers demand top quality, prompt delivery, high performance and responsive aftermarket support. Our products include piston pumps, motors, valves, controls, manifolds, electronics and components, cylinders, reservoirs, skids and meters. Industries that use these products include primary metals, machine tool, automobile, petroleum, construction equipment, chemical, plastic, glass, lumber, rubber and food. The Company strives to serve those markets requiring high technology and expertise where reliability, top performance and longer service life are needed. The products are sold as individual components or integrated into high performance applications. The Company also provides aftermarket sales and rebuilding services which include exchange, factory rebuild and field repair service, along with customer education.

      The accounting policies of the segments are the same as those of the Company as described in note 1, except that segment financial information is presented on a basis that is consistent with the manner in which the Company disaggregates financial information for internal review and decision-making. Segment net sales are attributed to the subsidiary from which the product is sold. In computing operating income by segment, no allocations of corporate expenses, research and development costs (R&D), interest expense, non-operating income, income taxes or minority interest have been made. Identifiable assets of the European and International segments are those assets related to the operations of the applicable subsidiaries. Domestic assets consist of all other operating assets of the Company except for corporate assets, which are principally assets used in the Company’s research and development facilities.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

THE OILGEAR COMPANY AND SUBSIDIARIES — (Continued)

      Geographic segment information is as follows: