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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
COMMISSION FILE NUMBER: 333-48299

SAUER-DANFOSS INC.
(Exact name of registrant as specified in its charter)

(515) 239-6000
(Registrant's telephone number, including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:
    None    
(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 ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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

        The aggregate market value of the voting stock of the Registrant held by nonaffiliates at February 28, 2003, was $80,869,826. As of February 28, 2003, there were 47,418,768 shares of common stock, $0.01 par value, of the Registrant outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Proxy Statement for the annual meeting of stockholders to be held June 4, 2003, are incorporated by reference into Parts II and III.

PART I

Item 1.    Business.

(a)    General Development of Business

        Sauer-Danfoss Inc. (Sauer-Danfoss or the Company), a U.S. Delaware corporation, and its predecessor organizations have been active in the mobile hydraulics industry since the 1960s. Sauer-Danfoss and its predecessor organizations, established in 1987, is a global manufacturer of components and integrated hydraulic systems that generate, transmit, and control fluid power in mobile equipment. Principal products are hydrostatic transmissions, gear pumps and motors, orbital motors, hydrostatic steering units, proportional load-sensing valves, microprocessor controls, electric drives, and electrohydraulics. The Company sells its products to original equipment manufacturers (OEMs) who use Sauer-Danfoss products to provide the hydraulic power for the propel, work, and control functions of their vehicles. The Company's products are sold primarily to the construction, road building, agriculture, turf care, and specialty vehicle markets. The Company conducts its business globally under the Sauer-Danfoss name.

        On April 2, 2002, the Company acquired 100% of the low voltage motor business of Thrige Electric (TE). The acquisition was an all cash transaction of approximately $17.4 million and includes factories in Odense, Denmark, Berching, Germany, and Kaiserslautern, Germany. Thrige Electric is engaged in the production of low voltage motors and integrated pump, steering, or drive units used primarily in mobile machines in the material handling market. Thrige Electric has approximately 450 employees and annual sales of approximately $50.0 million. The Company has consolidated the financial results of this business since the date of acquisition. The transaction resulted in approximately $8.3 million of goodwill being recognized. The Company is completing its allocation of the purchase price to the assets and liabilities acquired, and expects to complete this by March 31, 2003.

        During the first quarter 2002, the Company completed the purchase of a minority interest in Comatrol S.p.A.Comatrol, located in Reggio Emilia, Italy, has 90 employees and approximately $16 million in annual sales. The Company, which paid approximately $8.4 million, owns 45% of Comatrol as a minority interest partner and has recorded its share of Comatrol's earnings using the equity method since the date of acquisition. The Company has the option to acquire additional ownership interest in Comatrol in two phases in the future. The first option period runs from March 1, 2003 through March 31, 2003, whereby the Company could acquire an additional 40% of Comatrol's total capital for approximately $8.5 million, at which time the Company would then consolidate the results of Comatrol. If the Company does not exercise this option by March 31, 2003, the option lapses. The second option period runs from April 1, 2004 through April 30, 2004, and allows for the Company to acquire the remaining 15% of Comatrol for approximately $3.4 million, contingent on exercising the first option described above. Should the Company elect to not exercise either of these two options, the sellers would then have a put option which would run from May 1, 2004 through May 31, 2004, during which time the sellers could require the Company to acquire the remaining outstanding shares of Comatrol for approximately the amounts referred to above in the Company's options, adjusted for provisions as defined in the agreement. Should the sellers not exercise their put option by May 31, 2004, all options would lapse and the Company would not be required to purchase any additional ownership interests in Comatrol.

(b)    Financial Information about segments

        Beginning in 2002, the Company has changed the way it reports its operating segments to better reflect the changes to the organizational structure of the Company around its various product lines of Propel, Work Function and Controls. Propel products include hydrostatic transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, and valves that control and

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direct the power of a vehicle. Information about the Company's reportable segments defined by product lines is set forth in Note 15 to the Consolidated Financial Statements on pages 58-60 of this report, and is incorporated herein by reference.

(c)    Description of Business

        Information regarding the Company's principal products, by segment, and the business in general is presented below. Information regarding sales by the Company's product lines is set forth in Note 15 to the Consolidated Financial Statements on page 60, and is incorporated herein by reference. No individual customer, OEM or other, accounted for 10% or more of the Company's overall net sales for 2002.

Propel Segment

Hydrostatic Transmissions

        Sauer-Danfoss designs, manufactures, and sells a range of closed circuit axial piston hydrostatic transmissions for both the propulsion and work functions of mobile equipment in the Americas, Europe, and Asia-Pacific region. High-power (typically over 50 HP) and medium-power (typically 25 to 50 HP) applications for hydrostatic transmissions manufactured by the Company include construction and agricultural mobile equipment. Light-power (typically 15 to 25 HP) and bantam-power (typically under 15 HP) applications for hydrostatic transmissions manufactured by the Company include light agricultural and turf care mobile equipment.

Work Function Segment

Gear Pumps and Motors

        The Company designs, manufactures, and sells custom-designed gear pumps, as well as a broad range of high-performance standard gear pumps and motors. Gear pumps and motors are the most widely used type of mobile hydraulic pumps and motors in the industry. The Company manufactures customized gear pumps at its Swindon, England, facility and standard gear pumps and motors at its facilities in Bologna, Italy, and West Branch, Iowa.

Open Circuit Piston Pumps

        The Company designs, manufactures, and sells custom-designed open circuit piston pumps used to transform mechanical power from the engine to hydraulic power for the work function of the vehicle. The advantages of open circuit piston pumps compared to other types of pumps, such as vane or gear pumps, are the high degree of control within the work function hydraulic system and the more efficient use of engine power. These products are designed and manufactured in the United States and Europe.

Low Speed High Torque Motors

        The Company designs and manufactures a complete line of geroller and gerotor motors at its Nordborg, Denmark, facilities. These motors are used for both propel and work functions in all served markets.

Steering Units

        Sauer-Danfoss designs, manufactures, and sells hydrostatic steering units to customers throughout the world. These steering units are manufactured in three plants; Nordborg, Denmark, Wroclaw, Poland, and Sturtevant, Wisconsin. These steering units convert steering wheel motion into hydraulic flow and pressure to provide steering motion for agriculture tractors, combines, earthmoving equipment, etc.

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Controls Segment

Mobile Electronics

        During 2002, the Company completed the acquisition of the low voltage motor business of Thrige Electric (TE), incorporating a new product family called "Electric Drives". This product family, added to the Company's existing electrohydraulics product line, has become what the Company now refers to as Mobile Electronics (ME).

        ME designs, manufactures, and sells electrohydraulic valves and electronic controls, including microprocessor-based controls and electronic sensors through its electrohydraulics operations in the United States and Sweden and also designs electrohydraulic products in Germany, the United Kingdom, Italy, and Denmark. Electrohydraulic controls and sensors integrate hydraulics, hydrostatic transmissions, and mechanical components with electronic controls and are used by OEMs of mobile equipment to control the Company's hydraulic systems, as well as the hydraulic systems of other manufacturers. The electrohydraulic products bring together the propulsion and work functions by providing standard or custom-designed controls.

        Additionally, Mobile Electronics designs and manufactures both alternating current (AC) and direct current (DC) electric motors, electronic motor controllers, and electrohydraulic power units through its Electric Drives operations in Denmark and Germany.

Control Valves

        Sauer-Danfoss designs, manufactures and sells a variety of spool type control valves to meet its customers' needs, ranging from very sophisticated electrohydraulic valves for highly sophisticated forestry and agricultural harvesting equipment, to very simple low cost valves for high volume Ag Tractors. These products are manufactured in the factories in Caxias do Sul, Brazil, Nordborg, Denmark, and Easley, South Carolina.

        The Company also designs, manufactures and sells a complete line of cartridge valves and hydraulic integrated circuits (HIC's) in the facilities in Reggio Emilia, Italy, Hillsboro, Oregon and Easley, South Carolina. Aerial lift platforms and road building equipment are very large users of cartridge valves.

Major Markets and Applications

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General Characteristics

        The Company sells both standard and customized products, with most products being built to order. With respect to some of the most technologically demanding vehicles, such as those used in forestry, construction, and road building, Sauer-Danfoss' engineers work closely with customers from design through manufacture of the final product, a cycle that can take as long as four to six years for a major new machine.

        Sauer-Danfoss operates 27 manufacturing facilities in the Americas, Europe, and the Asia-Pacific region. The Company's decentralized manufacturing capabilities allow it to adapt its products to local market needs and to provide flexibility to meet customer delivery requirements. In North America, the Company sells and distributes its products directly to large OEMs and through independent distributors to smaller OEMs. In Europe, South America, and the Asia-Pacific region, the Company sells and distributes its products either directly or through sales subsidiaries located in Australia, Belgium, Brazil, China, Denmark, Finland, France, Germany, Netherlands, India, Italy, Japan, Norway, Poland, Portugal, Singapore, Slovakia, Spain, Sweden, and the United Kingdom.

        In accordance with standard industry practice for mobile hydraulics, the Company warrants its products to be free from defects in material and workmanship. The warranty period varies from one to three years from the date of first use or date of manufacture, depending on the type of product or, in some cases, the application. The Company's warranty expense has been less than 1.0% of net sales in each of the past three years.

        Because many of its products are designed and developed in conjunction with its customers' design teams to fit their specific needs and to minimize inventory levels, the Company primarily manufactures products to order. The Company typically machines components with long lead times according to a sales forecast and machines certain unique components for specific customers according to firm orders. Inventories at the Company's manufacturing sites consist primarily of raw materials and machined iron housings and components. Only small amounts of assembled finished units are maintained in inventory. Inventories at the Company's sales locations consist mainly of finished units manufactured specifically for distribution to customers in those locations.

        The Company does not normally accept orders subject to late delivery penalties. On occasion, the Company sells its products to government agencies, including those used for military applications, but it does not design its products specifically according to government standards and usually only enters into contracts for the supply of commercial products. There are no government contracts of material value to the Company.

Raw Materials

        The Company purchases iron housings and components from various U.S. and European foundries. The principal materials used by the Company are iron, steel, brass, and aluminum. All materials used by the Company are generally available from a number of sources in quantities sufficient to meet current requirements.

Patents, Trademarks, and Licenses

        The Company owns or licenses rights to approximately 540 patents and trademarks relating to its business. While the Company considers its patents and trademarks important in the operation of its business and in protecting its technology from being used by competitors, its business is not dependent on any single patent or trademark or group of related patents or trademarks. The Company licenses the use of the Sundstrand name from Hamilton Sundstrand (formerly Sundstrand Corporation), a division of United Technologies, under agreements that extend to March 31, 2004. The Company has discontinued the use of the Sundstrand name and does not expect to seek renewal of the license.

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        To ensure worldwide availability of the Company's design of products, the Company has, in the past, licensed its technology to companies in certain countries. Prior to 2001, the Company licensed all its open and closed circuit piston pumps and motor and electrohydraulic valve technology to a subsidiary of Daikin Industries Ltd. in Japan. Effective October 1, 2001, the Company terminated this license and entered into a joint venture agreement with Daikin to jointly manufacture these products for distribution into the Asia-Pacific region. The Company also previously licensed its original hydrostatic transmission technology to Larsen & Toubro Ltd. in India. During 2001, the Company terminated this license agreement in conjunction with its acquisition of Dantal Hydraulics Ltd. As a result, the Company did not recognize any royalty income during 2002. Royalty income generated by these licenses during 2001 and 2000 was approximately $0.9 million and $1.3 million, respectively.

Backlog

        The amount of the Company's backlog is significant because, among other factors, customer orders typically involve long lead times and specific model types. At December 31, 2002, the Company's backlog (consisting of accepted but unfilled customer orders primarily scheduled for delivery during 2003) was $383 million as compared with $320 million at December 31, 2001. However, orders can be canceled or rescheduled by customers. Thus, the level of orders currently in backlog could decline because of cancellation or rescheduling. Additionally, the level of reported backlog can be impacted by currency translation fluctuations and acquisitions. Excluding the impact of currency and acquisitions, backlog at December 31, 2002 was $352 million. Customers' ordering patterns can also impact the level of reported backlog. For example, the Company's U.S. distributor customers are placing orders with shorter lead times due to the Company's ability to fulfill such orders in a shorter time frame.

Competition

        The mobile hydraulics industry is very competitive. Sauer-Danfoss competes based on technological product innovation, quality, and customer service. The Company believes that long-term successful suppliers to mobile equipment manufacturers will be those companies that have the ability to capitalize on the changing needs of the industry by providing technological innovation, shorter product development times, and reduced manufacturing lead times at globally competitive price levels.

Hydrostatic Transmission Market

        The closed circuit hydrostatic transmission market is highly concentrated and intensely competitive. There are a small number of manufacturers of hydrostatic transmissions with which the Company competes worldwide that are not captive suppliers of OEMs. These include Bosch Rexroth AG, Eaton Corporation, and Linde AG. In addition, the Company competes with alternative products, such as mechanical transmissions of other manufacturers.

        The Company competes with a number of smaller companies that typically offer a single, specialized product on a more limited geographic basis as a component of a closed circuit hydrostatic transmission system.

        In terms of global supply of closed circuit hydrostatic transmissions, the Company believes it is the world leader in terms of product range, market share, and geographic coverage. Only Bosch Rexroth AG offers similar geographic coverage.

Open Circuit Piston Pumps and Gear Pumps and Motors Market

        The open circuit work function market is fragmented with a large number of suppliers of all types of products, including open circuit piston pumps, gear pumps and motors, hydraulic and electrohydraulic valves, electronic sensors and controls, and with intensive competition on pricing at the component level. There are approximately ten major companies that compete on a global basis, including Bosch Rexroth

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AG, Parker Hannifin Corporation, and Eaton Corporation, and in Japan, Kayaba and Kawasaki. The supply of standard gear pumps and motors and hydraulic valves is particularly fragmented with more than 50 companies worldwide in each respective area. Most of these competitors have a limited product range and operate in a limited geographic market.

Low Speed High Torque Motor Market

        There are a limited number of competitors who can provide a complete line of low speed, high torque motors (LSHT). Competitors include Eaton Corporation, Bosch Rexroth AG, White Hydraulics, Parker-Hannifin Corporation, and M&S Hydraulics. This market is extremely price-competitive, and is growing, providing Sauer-Danfoss opportunity to develop new products to increase market share.

Steering Unit Market

        Hydrostatic Steering units are provided to the market from the same competitors as LSHT Motors (above) plus Ognibene. Sauer-Danfoss has the largest European market share and a growing share globally. As steering systems grow and needs expand, Sauer-Danfoss is providing electronic control of steering and complete electrical steering solutions to meet the growing demands of the steering market. Today, Sauer-Danfoss leads the industry in this direction for steering.

Mobile Electronics Market

        In the mobile electronics market, which covers both propulsion and work function systems, there are few suppliers of propulsion system controls and only three are worldwide competitors. The main competition in this area comes from major OEMs, who produce controls for their own use. In work function electrohydraulic valves, electronic sensors, and controls, there is a wide range of niche suppliers in limited geographic markets. In recent years, larger companies have increasingly acquired these niche or regional suppliers and thereby have improved their ability to offer integrated systems. The company has closely watched the needs for electric drives grow in the low power market segments. With the Company's addition of alternate current (AC) and direct current (DC) motors and controls the company is now well equipped to serve our customers in these segments with either a hydraulic solution or an electric solution for their propel, work, and steering needs. The Company believes it is well positioned to establish itself as a technology leader in the work function and propel segments, as there is no clearly established technology in this sector that is deemed to be an industry standard.

Control Valves

        The control valve marketplace is fragmented with a large number of suppliers who are primarily focused on limited valve types or flow ranges. Sauer-Danfoss provides a comprehensive line of both spool valves and cartridge valves to meet the specific needs of their customers. Competitors who provide partial lines include Eaton Corporation, Hydra-Force, Sterling Hydraulics, Husco, Sun Hydraulics, Integrated Hydraulics, Walvoil, and Oil Control, plus many others. Complete global control valve line competitors are limited to Parker-Hannifin and Bosch Rexroth AG.

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Research and Development

        The Company's research and development expenditures during 2002, 2001, and 2000 were approximately $37.8 million, $38.1 million, and $29.9 million, respectively.

Environmental Matters

        In all countries in which it operates, the Company is subject to environmental laws and regulations concerning emissions to air, discharge to waterways, and the generation, handling, storage, transportation, treatment, and disposal of waste materials. These laws and regulations are constantly evolving, and it is impossible to predict accurately the effect they will have on the Company in the future. The regulations are subject to varying and conflicting interpretations and implementation. In some cases, compliance can only be achieved by additional capital expenditures. The Company cannot accurately predict what capital expenditures, if any, may be required to comply with applicable environmental laws and regulations in the future; however, the Company does not currently estimate that any future capital expenditures for environmental control facilities will be material. The Company is not currently subject to any governmental remediation order, nor is the Company aware of any environmental problems that would have a materially adverse effect on the Company.

Employees

        As of December 31, 2002, 2001, and 2000 the Company had 7,207, 6,790, and 6,733 employees, respectively.

Financial Information about Geographic Areas

        Information regarding the Company's net sales and long-lived assets by geographic area is set forth in Note 15 to the Consolidated Financial Statements on pages 59-60 of this report, and is incorporated herein by reference.

Available Information

        The Company maintains an Internet Website and the address of that site is http://www.sauer-danfoss.com. Commencing with the filing of this Form 10-K, the Company will make available free of charge on its Internet website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission.

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Item 2. Properties.

        Sauer-Danfoss Inc. conducts its manufacturing operations at 27 locations; ten in the United States, three in Italy and Germany, two in the United Kingdom, Denmark, and Slovakia, and one each in Brazil, China, Japan, Poland, and Sweden. The following table sets forth certain information relating to the Company's principal manufacturing facilities:

Item 3. Legal Proceedings.

        From time to time, the Company is involved in various legal matters considered normal in the course of its business. The Company intends to vigorously defend against all such claims. It is the Company's policy to accrue for amounts related to these matters if it is probable that a liability has been incurred and an amount can be reasonably estimated. Although the outcome of such matters cannot be predicted with certainty and no assurances can be given with respect to such matters, the Company believes that the outcome of these matters in which it is currently involved will not have a materially adverse effect on its results of operations, liquidity, or financial position.

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Item 4.    Submission of Matters to a Vote of Security Holders.

        The Company did not submit any matter to a vote of security holders, through a solicitation of proxies or otherwise, during the fourth quarter of 2002.

EXECUTIVE OFFICERS OF THE COMPANY

        The following table sets forth certain information regarding the executive officers of the Company:

(1)

These executive officers have served in various capacities with the Company or its subsidiaries for more than the past five years.

(2)

Klaus Murmann is the father of Nicola Keim and Sven Murmann, who are directors of the Company.

(3)

Mr. Clausen's principal occupation is serving as the President and Chief Executive Officer and a member of the Executive Committee of Danfoss A/S for more than the past five years.

(4)

Prior to being appointed to a position with the Company, each of these executive officers served in various capacities with Danfoss A/S or its subsidiaries for more than the past five years.

(5)

Prior to joining the Company, Mr. Schmidt was employed by Degussa — Huls Corporation as Vice President and Chief Financial Officer.

(6)

Prior to joining the Company, Mr. Wilcox was employed by Omniquip — Textron as President — Material Handling unit from October 1999 through October 2000. Prior to being employed by Omniquip, Mr. Wilcox served as the Vice President and General Manager for the Company's U.S. Hydrostatics business.

(7)

Prior to joining the Company, Mr. Jarboe was employed by Danfoss Fluid Power as Vice President, Sales and Marketing for North America. Prior to joining Danfoss Fluid Power, Mr. Jarboe was employed by Aeroquip Vickers as Vice President Sales, Marketing and Engineering.

(8)

Prior to joining the Company, Mr. Zahalka was employed by Emerson Electric in various executive capacities.

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PART II

Item 5.    Market for the Company's Common Stock and Related Stockholder Matters.

Market and Dividend Information

        The Company's Common Stock is traded on the New York Stock Exchange and the Frankfurt (Germany) Stock Exchange. As of February 27, 2003, there were approximately 224 stockholders of record. Although exact information is unavailable, the Company also estimates that there are 3,500 additional beneficial owners of the Company's Common Stock, based upon the 2003 proxy solicitation.

        The Company is currently paying a quarterly dividend of $0.07 per share. The payment of dividends is subject to restrictions as described in Management's Discussion and Analysis of Financial Conditions and Results of Operations — Liquidity and Capital Resources, on pages 19-24 of this report.

        The following table sets forth the high and low prices on the New York Stock Exchange for the Company's Common Stock since January 1, 2001, and the quarterly cash dividends paid in 2002 and 2001:

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Item 6.    Selected Financial Data.

SELECTED FINANCIAL DATA

*

EBITDA represents net income, plus provision for income taxes and net interest expense, plus depreciation and amortization. EBITDA may not be comparable to similarly titled measures reported by other companies. While EBITDA should not be construed as a substitute for operating income or a better indicator of liquidity than cash flow from operating activities, which is determined in accordance with accounting principles generally accepted in the United States, it is included herein to provide additional information as management of the Company feels it provides an indication with respect to the ability of Sauer-Danfoss to meet its future debt service, capital expenditures, and working capital requirements.

(1)

Includes results of Danfoss Fluid Power since May 3, 2000.

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Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

Safe Harbor Statement

        This Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as other portions of this annual report on Form 10-K, contain statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. All statements regarding future performance, growth, sales and earnings projections, conditions or developments are forward-looking statements. Words such as "anticipates," "in the opinion," "believes," "intends," "expects," "may," "will," "should," "could," "plans," "forecasts," "estimates," "predicts," "potential," "continue," and similar expressions may be intended to identify forward-looking statements.

        Actual future results may differ materially from those described in the forward-looking statements due to a variety of factors, including the fact that the economy generally, and the agriculture, construction, road building, turf care and specialty vehicle markets specifically, have recently been in a state of uncertainty, making it difficult to determine if past experience is a good guide to the future. There is a continuing concern that the earlier economic recovery the Company was experiencing in prior quarters may be receding. A continuing downturn in the Company's business segments could adversely affect the Company's revenues and results of operations. Other factors affecting forward-looking statements include, but are not limited to, the following: specific economic conditions in the agriculture, construction, road building, turf care and specialty vehicle markets and the impact of such conditions on the Company's customers in such markets; the cyclical nature of some of the Company's businesses; the ability of the Company to win new programs and maintain existing programs with its original equipment manufacturer (OEM) customers; the highly competitive nature of the markets for the Company's products as well as pricing pressures that may result from such competitive conditions; the continued operation and viability of the Company's major customers; the Company's execution of internal performance plans; difficulties or delays in manufacturing; cost-reduction and productivity efforts; competing technologies and difficulties entering new markets, both domestic and foreign; changes in our product mix; future levels of indebtedness and capital spending; claims, including, without limitation, warranty claims, charges or dispute resolutions; ability of suppliers to provide materials as needed and the Company's ability to recover any price increases for materials and product pricing; the Company's ability to attract and retain key technical and other personnel; labor relations; the failure of customers to make timely payment; any inadequacy of the Company's intellectual property protection or the potential for third-party claims of infringement; global economic factors, including currency exchange rates; general economic conditions, including interest rates, the rate of inflation, and commercial and consumer confidence; energy prices; governmental laws and regulations affecting domestic and foreign operation, including tax obligations; changes in accounting standards; worldwide political stability; the effects of terrorist activities and resulting political or economic instability; including U.S. military action overseas; and the effect of acquisitions, divestitures, restructurings, product withdrawals, and other unusual events.

        The Company cautions the reader that these lists of cautionary statements and risk factors may not be exhaustive. The Company expressly disclaims any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances.

Overview

        Sauer-Danfoss Inc. and subsidiaries (the Company) is a leading international supplier of components and systems that generate, transmit and control fluid power in mobile equipment. The Company's products are used by original equipment manufacturers (OEMs) of mobile equipment, including construction, road building, agricultural, turf care and specialty equipment. The Company designs, manufactures and sells its products in the Americas, Europe and the Asia-Pacific region, and sells its products throughout the rest of the world either directly or through distributors.

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Results of Operations

2002 Compared to 2001

Consolidated Results

        Net income in 2002 was $14.0 million, or $0.29 per diluted share, compared with net income per diluted share of $0.10 in 2001. Special pretax charges of $1.9 million in 2002 and $9.7 million in 2001 had a negative impact on the results for the respective years. The special charges for 2002 were $1.2 million related to rationalizing overlapping product lines within the Controls segment relating to the acquisition of the low voltage motor business (TE) and a one-time noncash after-tax charge of $0.7 million for goodwill impairment. The special charges in 2001 related to plant closing costs of $8.3 million and a bad debt write-off of $1.4 million relating to a customer in the aerial lift market filing for bankruptcy. The following table, although not a U.S. GAAP disclosure, shows net income for the two years adjusted for these special charges in order to provide a more comparable picture of the Company's net operating results:

        Excluding the special charges in both years, net income in 2002 increased by 41% over 2001. The primary driver for this improvement was the Company's broad-based cost control initiatives, particularly in the areas of fixed production costs, selling, general and administrative expenses, and research and development expenses. In addition, the Company focused significant attention on working capital management that resulted in a $13.2 million reduction in trade receivables. These factors helped generate a record operating cash flow of $98.3 million, or an increase of 45% over 2001.

        Net sales in 2002 of $952.3 million increased by $97.0 million, or 11.4%, over the 2001 sales of $855.3 million. Excluding the impact of currency exchange fluctuations, net sales increased 8.6% (i.e. net sales of businesses outside the United States measured in U.S. dollars would have been lower had currency exchange/translation rates remained at the same levels as the rates that prevailed during 2001.) Excluding the impact of currency exchange fluctuations and acquisitions, net sales increased 1.6% over 2001.

        Gross profit in 2002 of $219.4 million increased $26.2 million or 13.6% from 2001 gross profit of $193.2 million. The majority of the reported increase is a result of acquisitions completed in 2002 or those completed in 2001 and included for a full year in 2002. Gross profit as a percentage of sales for 2002 was 23.0%, compared to 22.6% for 2001. While fixed production costs were reported to be $5.2 million higher in 2002 compared to 2001, the Company successfully reduced overall fixed production costs by $4.1 million compared to 2001 when the impact of currency exchange fluctuations and acquisitions are excluded.. Had the Company not achieved this cost reduction, gross profit as a percentage of sales would have declined slightly from 2001. Pricing pressures within the markets the Company serves continue to challenge the Company to maintain profitability levels. While the Company was successful in reducing fixed costs in 2002, it is not feasible to believe that the Company can attain this same year-over-year reduction in this area. Therefore, the Company has embarked on a global procurement initiative by establishing a global procurement office with resources in the U.S., Europe, South America, and Asia-Pacific. The focus of this global procurement will be to leverage the Company's global purchasing power to help reduce both direct and indirect material costs with a goal to obtain a 1%-2% margin improvement over the next 12 months. In

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addition, significant focus will be placed on the procurement of nonproductive materials, supplies and services in order to achieve additional cost reductions to offset the ongoing pricing pressures.

        The Company's selling, general and administrative expenses increased $5.8 million, or 4.7%, over the 2001 reported amount of $122.8 million. Excluding the impact of currency exchange fluctuations, selling, general and administrative expenses increased $2.7 million, and excluding acquisitions, these expenses actually declined from the 2001 levels by $7.9 million, reflecting the Company's focus on reducing fixed costs during 2002.

        Research and development activities in 2002 were essentially flat with the 2001 levels in terms of reported amounts. Excluding the impact of currency exchange fluctuations and acquisitions, these expenses were $3.1 million less than the 2001 levels. While the Company was focused on reducing fixed costs in all areas of the business, the Company remains committed to investing in new technology and product development. Much of the Company's product development activities continue to be driven by ongoing customer inquiries.

        Net nonoperating expenses increased by $2.9 million over 2001 due primarily to foreign currency exchange losses and to the fact that the Company no longer receives royalty income from its former Japanese licensee as a result of forming a joint venture in the fourth quarter of 2001. This accounts for a $3.1 million increase, which was offset by slightly lower net interest expense for 2002.

        The Company's effective tax rate for 2002 of 34.6% was lower than the 2001 effective tax rate of 37.8%. The primary driver for the lower effective rate in 2002 is related to the mix of the Company's net income with a higher portion of the Company's net income being generated in countries with lower effective tax rates.

Business Segment Results

        The following discussion of operating results by reportable segment relates to information as presented in Note 15 to the Consolidated Financial Statements. Segment income is defined as the respective segment's portion of the total Company's net income, excluding net interest, income taxes, minority interest, equity in net earnings of affiliates, and corporate expenses. The format of this discussion for comparing the 2002 results from operations to 2001 is different from prior years due to the Company changing its reportable segments beginning in 2002 to reflect the changes in organizational structure of the Company around its various product lines of Propel, Work Function and Controls. Propel products include hydrostatic transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, and valves that control and direct the power of a vehicle. Because historical information for the year 2000 does not exist in this new segment format, the prior year's discussion and analysis of results from operations has been presented on the same basis as last year's report.

Propel Segment

        Net sales for the Propel segment of $440.2 million increased $40.7 million, or 10.2%, from 2001 net sales of $399.5 million. All geographic regions in which the Propel segment operates experienced net sales growth. Excluding the impact of currency fluctuations, net sales increased $35.2 million. Additionally, excluding the impact of acquisitions, net sales increased $11.0 million from 2001. Approximately $10.0 million of the increase in net sales was driven by a new product introduction for compact utility tractors in the U.S. and from the infinitely variable transmission for agriculture tractors developed for John Deere. In the turf care market, $14.0 million of increased sales were generated by the Company's joint venture located in Sullivan, Illinois. However, these increases in the U.S. were partially offset by declines in the agriculture, construction, specialty and distribution markets. In Europe, both the agriculture and road building markets experienced growth over 2001. The agriculture market in Europe recovered somewhat in

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2002 after several difficult years caused by the foot and mouth disease scare. These increases in Europe were offset be declines in the construction, turf care, and specialty markets.

        Propel segment income in 2002 of $47.3 million increased $10.4 million, or 28%, over segment income of $36.9 million in 2001. Excluding the impact of currency exchange fluctuations and acquisitions, Propel segment income increased $6.7 million, with all of this increase being driven by the turf care market.

Work Function Segment

        Net sales in the Work Function segment of $295.0 million in 2002 increased by $26.6 million, or 9.9%, over 2001 net sales of $268.4 million. Excluding the impact of currency exchange fluctuations and acquisitions, net sales increased $15.9 million, or 5.9%, from 2001. While sales of steering units and low speed high torque motors increased $12.4 million over 2001, this was partially offset by a decline of gear pump and motor sales of $4.4 million.

        Work Function segment income in 2002 of $19.5 million increased $9.9 million, or 103.1%, over 2001 segment income of $9.6 million. Excluding the impact of currency exchange fluctuations, Work Function segment income increased $8.9 million from 2001. The Work Function segment was impacted by a one-time special charge of $0.7 million in 2002 related to goodwill impairment. The 2001 segment income was negatively impacted by a one-time pretax charge of $8.3 million related to plant closing costs. Excluding these special charges and the impact of currencies, segment income for the Work Function segment increased $1.3 million, or 13.6%, over 2001, driven by the overall higher sales levels within this segment.

Controls Segment

        Net sales in the Controls segment in 2002 of $217.1 million increased $29.7 million, or 15.8%, over 2001 segment net sales of $187.4 million. During 2002, the Company completed the acquisition of TE. The addition of this business added $34.2 million of sales to this segment. Excluding this acquisition and the impact of currency exchange fluctuations, net sales for 2002 would have declined by $11.8 million from the comparable 2001 levels. The majority of this decrease comes from the aerial lift market in the U.S. that continues to be depressed.

        Controls segment income for 2002 of $5.8 million decreased $0.8 million, or 12%, from 2001 segment income of $6.6 million. The TE business added $1.3 million to the Controls segment income. Excluding the impact of acquisitions and currency exchange fluctuations, the Controls segment income declined $2.3 million from 2001. However, in 2002, the Controls segment was negatively impacted by a special pretax charge of $1.2 million relating to product line rationalization as a result of overlapping product lines within this segment relating to the acquisition of the TE business. On a comparable basis to 2001, Controls segment income declined $1.1 million, or 16.7%, from 2001.

Corporate Function

        The Company's Corporate Function incurs costs that relate to worldwide services such as worldwide tax and accounting fees paid to outside third parties, certain insurance premiums, the amortization of intangible assets from certain business combinations, and internal global services departments, along with the operating costs of the Company's executive office which was established in 2002 located in Lincolnshire, Illinois. For 2002, total corporate charges amounted to $22.9 million, or an increase of $2.7 million from the 2001 charges of $20.2 million.

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Order Backlog

        Total order backlog at the end of 2002 was $382.8 million, compared to $319.9 million at the end of 2001, an increase of 19.7%. On a comparable basis, excluding the effects of acquisitions, order backlog increased 15.7% from the year-end 2001 levels, or 10.2% excluding the additional impact of currency fluctuations. During the fourth quarter of 2002, $249.7 million in new orders were written, an increase of 8.1% compared to the fourth quarter of 2001. Excluding the impact of acquisitions, orders written in the fourth quarter were $239.1 million, which was 3.5% more than the orders written in the fourth quarter of 2001, but a decrease of 1.6% excluding the additional impact of currency fluctuation.

2001 Compared to 2000

        Net Sales — Sales for 2001 of $855.3 million increased by $72.8 million, or 9.3%, from the prior year. However, all of this increase was due to the impact of acquisitions, both from having a full-year effect of acquisitions made in 2000, and the effect of acquisitions made during 2001. On a comparable basis, including a full year of 2000 sales from Danfoss Fluid Power (DFP) and excluding the effects of acquisitions made during 2001, net sales decreased 7.9% in local currencies, and were down 9.5% as reported in U.S. dollars. Further comparisons of the Company's markets are very difficult due to acquisitions, however, by including DFP for the full year of 2000, the Company experienced decreases in most of its markets as follows: construction declined 6.9%, road building was down 6.1%, turf care declined 5.1% and the distributor area was down 8.3%. The only bright spots were in agriculture, which increased a modest 4.9% compared to significantly lower levels in the prior couple of years, and in the specialty market which was essentially flat with the prior year.

        The following table sets forth the Company's net sales by market, including DFP for the full year 2000, in millions of dollars and as a percentage of total net sales, for the years ended December 31, 2001 and 2000:

Gross Profit

        Gross profit for 2001 of $193.2 million, or 22.6% of sales, was down from the reported $201.0 million of gross profit in 2000, which was 25.7% of sales. The lower gross profit experienced in 2001 was due in large part to lower plant utilization experienced from the dramatic decline in sales in North America with a slightly lower impact in Europe. Coupled with this effect was a pretax charge of $8.3 million of unexpected additional costs associated with the final closure of the Racine, Wisconsin, plant and associated move to the Company's West Branch, Iowa, plant. In addition, the Company took a bad debt write-off of $1.4 million before taxes relating to a customer in the aerial lift market filing for bankruptcy during the second quarter. During 2001 the Company took several actions to reduce manufacturing expenses including reductions in factory headcount commensurate with the volume reduction, several weeklong plant shutdowns, and other cost reduction activities. However, these measures were not enough to completely offset the effects of the above-mentioned items.

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Selling, General and Administrative Expenses

        Selling, general and administrative expenses for 2001 of $122.8 million increased by $24.6 million, or 25.1%, from the same period of 2000. The inclusion of four additional months in 2001 of DFP results accounts for $13.7 million of this increase. An additional $3.5 million of expense was incurred due to a full year's amortization of goodwill from DFP, and additional amortization from other intangibles established from the final appraisals related to the DFP and other acquisitions. The Company anticipates that ongoing amortization will be reduced by approximately $2.8 million per year for 2002 and beyond due to the cessation of goodwill amortization under Statement of Financial Accounting Standards No. 142. See "Other Matters" below for further discussion on this new accounting pronouncement. The majority of the remaining $7.4 million increase is due to acquisitions made in 2001.

Research and Development Expenses

        Research and development expenses of $38.1 million increased by $8.2 million, or 27.4%, from 2000 and represent 4.5% of total net sales for 2001 compared to 3.8% of net sales in 2000. The additional four months of DFP in 2001 accounts for $1.7 million of the increase. The remaining increase reflects the effects of acquisitions made during 2001 and the Company's ongoing development of new customer programs, such as the recent introduction of the infinitely variable transmission for the agriculture tractor market.

Nonoperating Expenses, Net

        Net nonoperating expenses for 2001 of $16.9 million were $9.0 million higher than 2000 net expenses of $7.9 million. Net interest expense for 2001 of $17.4 million increased by $6.2 million from the 2000 net expense of $11.2 million. Despite overall declines in the Company's floating borrowing rates during 2001 (see discussion of the Company's borrowing rates in Note 11 of the Consolidated Financial Statements), the higher overall bank borrowings used to fund acquisitions during the year drove the net interest expense significantly higher along with the additional four months of borrowings in 2001 for the DFP acquisition in May 2000. Other income, net for 2001 of $0.5 million decreased by $2.8 million from 2000's other income of $3.3 million related primarily to currency exchange gains. In addition, the Company realized $0.4 million less royalty income from its Japanese licensee, Daikin Industries, Ltd., due to the formation of a joint venture with Daikin as of October 1, 2001. The license agreement was terminated as of that date, and the Company will no longer receive royalties from Daikin.

Provision for Income Taxes

        Provision for income taxes for 2001 of $2.9 million decreased $14.3 million from the 2000 provision for income taxes of $17.2 million. The decrease is a direct result of the decrease in income before income taxes of $36.6 million coupled with a slight decrease in the effective tax rate for 2001 of 37.8% compared to an effective tax rate for 2000 of 39.0%.

Net Income

        The Company ended 2001 with net income of $4.7 million, down $22.2 million from the $26.9 million of net income in 2000. The economic downturn experienced by most of the Company's markets, coupled with the nonrecurring plant shutdown costs, bad debt write-off discussed above, and higher interest expense contributed to this decline.

Order Backlog

        Total order backlog at the end of 2001 was $319.9 million, compared to $375.0 million at the end of 2000, a decrease of 14.7%. On a comparable basis, excluding the effects of acquisitions, order backlog declined 17.1% from the year-end 2000 levels, or 15.2% excluding the impact of currency fluctuations.

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During the fourth quarter of 2001, $229.8 million in new orders were written, a decrease of 5.2% compared to the fourth quarter of 2000. Excluding the impact of acquisitions, orders written in the fourth quarter were $207.1 million, which was 14.5% less than the orders written in the fourth quarter of 2000, or a decrease of 13.6% excluding the impact of currency fluctuation.

Market Risk

        The Company is naturally exposed to various market risks, including changes in foreign currency exchange rates, interest rates, and prices

Impact of Foreign Currency

        The Company has historically not entered into any type of foreign currency hedging or derivative arrangements to manage its exposure to fluctuations in the foreign currency markets. However, during 2002, the Company did enter into a foreign currency hedge contract to protect against the effects of foreign currency fluctuations for a loan to the U. S. holding company from a Danish bank denominated in euros. In addition, the Company assumed a foreign currency exchange contract through its acquisition of the Thrige Electric business in Denmark. In all other instances, the Company feels it is well balanced between its U.S. and European operations because the Company generates its sales in the same country in which it incurs its expenses. However, the Company is impacted by foreign currency fluctuations in terms of comparing results from period to period as discussed below.

        The Company has operations and sells its products in many different countries of the world and therefore conducts its business in various currencies. The Company's financial statements, which are presented in U.S. dollars, can be impacted by foreign exchange fluctuations through both translation risk and transaction risk. Translation risk is the risk that the financial statements of the Company, for a particular period or as of a certain date, may be affected by changes in the exchange rates that are used to translate the financial statements of the Company's operations from foreign currencies into dollars. Transaction risk is the risk from the Company receiving its sale proceeds or holding its assets in a currency different from that in which it pays its expenses and holds its liabilities. With respect to transaction risk, the impact on the Company's operating results has not been significant.

        With respect to translation risk, fluctuations of currencies against the U.S. dollar can be substantial and therefore significantly impact comparisons with prior periods. The impact is primarily a reporting consideration and does not affect the underlying results of operations. The translation impact on making prior period comparisons with respect to the Company's net sales can be material. However, as shown in the table below, historically the translation impact on net sales has not been significant in recent years.

(1)

Includes the effect of DFP for the full year of 2000 and excludes the effects of acquisitions made in 2001.

(2)

Excludes the effects of the DFP sales since May 3, 2000, for comparison purposes.

        During 2002, the U.S. dollar weakened substantially against most foreign currencies, especially the euro. Between December 31, 2001 and December 31, 2002, the U.S. dollar weakened by 15% against the euro. This has resulted in approximately one-third of the Company's total balance sheet being stated 15% higher than the prior year since roughly one-third of the Company's total assets and liabilities are

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denominated in the euro. While this translation difference does not affect the underlying results of operations, it does affect comparisons between periods.

Interest Rates

        The Company does not currently enter into any type of interest rate hedging or derivative arrangements to manage its exposure to interest rate changes. The following table summarizes the maturity of the Company's debt obligations for fixed and variable rate debt:

Liquidity and Capital Resources

        The Company's principal sources of liquidity have been from internally generated funds from operations and from borrowings under its credit facilities in 2002, 2001, and 2000.

        Net cash provided by operating activities for 2002 of $98.3 million increased by $31.0 million from $67.3 million for 2001. The 2002 operating cash flow level is the highest in the Company's history, led by reductions in trade receivables of $13.2 million reflecting the Company's emphasis on collecting from its customers, particularly in the U.S. The reduction in receivables coupled with increases in accrued liabilities generated a combined $17.5 million of increased cash flow offset by reductions in trade payables and other working capital accounts of $17.1 million.

        The high level of operating cash flow allowed the Company to fund all of its 2002 capital expenditures of $42.3 million, which was down $27.4 million from the 2001 capital expenditure levels of $69.7 million. In addition, the Company was able to complete two cash acquisitions for $25.1 million utilizing cash flow from operations. Heading into 2003, the Company expects that its capital expenditures will increase slightly from the record low levels in 2002. However, the Company intends to control the level of capital expenditures as it monitors the economy and markets that it serves. The Company believes it has existing production capacity, flexibility and efficiency to handle any market upturn in the near future. For 2002, the percentage of capital expenditures by region were approximately 35% in North America, 63% in Europe and the remaining amount in Asia, compared to the year 2001 split of 40% in North America, 59% in Europe and a small amount in Asia.

        In addition to funding all of the Company's investing activities, the cash provided by operating activities also funded dividends of $13.3 million and distributions to minority interest partners of $9.6 million. Net borrowings under short- and long-term credit facilities decreased in 2002 by $11.5 million compared to an increase in 2001 of $60.3 million. The decrease in net borrowings in 2002 reflects repayments from excess cash flow generated. Net borrowings for 2001 reflected the financing of acquisitions during the year.

        The Company operates under certain covenants as defined under its various credit agreements with its banks. During 2001, the Company renegotiated its U.S. Revolving Credit Facility. This negotiation resulted in changes to covenants related to earnings performance and cash flow. Although the Company is currently meeting these new covenants, certain factors such as the uncertain economy in the U.S. coupled with the

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Company's financial performance could put the Company at risk of continuing to meet these covenants. Should the Company not meet these covenants, the result would be a default on the U.S. Revolving Credit Facility. As of December 31, 2002, the entire outstanding balance of the U.S. Revolving Credit Facility is classified as current since the agreement ends in October 2003. The Company is currently working on a new worldwide credit arrangement with a number of banks and expects to have this arrangement completed by the end of the second quarter of 2003.

        The following table discloses the Company's future commitments under contractual obligations as of December 31, 2002:

Other Matters

The Company's Critical Accounting Policies

        In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management must make a variety of decisions which impact the reported amounts and related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied, the assumptions on which to base accounting estimates, and the consistent application of those accounting principles. Due to the type of industry in which the Company operates and the nature of its business, the following accounting policies are those that management believes are most important to the portrayal of the Company's financial condition and results and that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. A more comprehensive list of the Company's accounting policies is presented in Note 1 to the Consolidated Financial Statements.

        Inventory Valuation — Being a manufacturer, inventory is a substantial portion of the total assets of the Company. Therefore, the Company must periodically evaluate the carrying value of its inventory to assess the proper valuation. This includes having adequate allowances and period adjustments to 1) cover losses in the normal course of operation, 2) provide for excess and obsolete inventory, and 3) ensure that inventory is valued at the lower of cost or market as required by accounting principles generally accepted in the United States of America. For all of these, the Company applies consistent practices based upon historical data such as actual loss experience, past and projected usage, and actual margins generated from trade sales of its products.

        Warranty Provisions — The Company warrants its various products over differing periods depending upon the type of product and application. Consequently, the Company, from time to time in the normal course of business, incurs costs to repair or replace defective products. In these instances, the Company will record a specific provision for the costs it will incur to repair or replace these products utilizing information from customers and internal information regarding the specific cost of materials and labor. In addition, the Company records a provision for future warranty claims against its applicable product sales based on past trends of actual warranty claims compared to the actual sales levels to which those claims apply. This analysis is prepared quarterly.

        Useful Lives of Property, Plant and Equipment — The Company has a significant amount invested in manufacturing plants and machine tools. This requires the Company to periodically assess the estimated useful lives of its assets in order to match, through depreciation, the cost of those assets with the benefits derived over the period of usefulness. The useful lives of these assets can be shortened through greater use

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due to volume increases, rapidly changing technology such as the use of electronics and computer-operated controls, and through inadequate maintenance. Despite management's best efforts to determine the appropriate useful lives of its equipment, certain situations arise that lead to an asset or group of assets becoming impaired, meaning their economic value becomes less than the value at which the Company is carrying the asset on its books. Examples of these situations are product rationalization efforts or restructuring of manufacturing facilities. When these situations arise, the Company tests the assets for impairment and will write down the asset in the period when the impairment becomes known.

        Valuation of Trade Receivables — The Company records trade receivables due from its customers at the time a sale is recorded in accordance with its revenue recognition policy. The future collectability of these amounts can be impacted by the Company's collection efforts, the financial stability of its customers, and the general economic climate in which it operates. The Company applies a consistent practice of establishing an allowance for accounts that it feels may become uncollectible through reviewing the historical aging of its receivables and by monitoring the financial strength of its customers. Where the Company becomes aware of a customer's inability to meet its financial obligations (i.e., where it has filed for bankruptcy), the Company establishes a specific allowance for the potential bad debt to reduce the net recognized receivable to the amount it reasonably believes will be collected. The valuation of trade receivables is performed quarterly.

        Workers Compensation — The Company has an insurance policy to cover workers compensation claims in which the Company pays the first $0.25 million per claim, per incident. The Company establishes its workers compensation reserve based on historic growth factors of claims and an estimate of incurred, but not reported claims. This analysis is performed on a quarterly basis, or more frequently if factors dictate a more frequent review.

        Pensions — The Company has noncontributory defined benefit pension plans for most of its employees. The Company's funding policy for the U.S. plans is to contribute amounts sufficient to meet the minimum funding requirement of the Employee Retirement Income Security Act of 1974, plus any additional amounts the Company may deem to be appropriate. The Company accounts for its defined benefit pension plans in accordance with Statement of Financial Accounting Standards (SFAS) No. 87, "Employers' Accounting for Pensions," which requires that amounts recognized in financial statements be determined on an actuarial basis. A minimum liability is required to be established on the Consolidated Balance Sheets representing the amount of unfunded accrued pension cost. This represents the difference between the accumulated benefit obligation and the fair value of plan assets. When it is necessary to establish an additional minimum pension liability, an amount is recorded as an intangible pension asset limited to unrecognized prior service cost. Any amount in excess of unrecognized prior service cost is recorded as a reduction to stockholders' equity through accumulated other comprehensive income, net of tax, in the Consolidated Balance Sheets. As of December 31, 2002, the Company has recorded an intangible pension asset of $9.4 million and an accumulated reduction to stockholders' equity of $2.1 million.

        To account for its defined benefit pension plans in accordance with SFAS No. 87, the Company must make three main determinations at the end of each year: First, it must determine the actuarial assumption for the discount rate used to reflect the time value of money in the calculation of the projected benefit obligations for the end of the current year and to determine the net periodic pension cost for the subsequent year. For guidance in determining this rate, the Company looks at rates of return on high-quality fixed-income investments and periodic published rate ranges. See Note 7 to the Consolidated Financial Statements for a listing of the discount rates used in the various countries where the Company has these pension plans.

        Second, the Company must determine the actuarial assumption for rates of increase in compensation levels used in the calculation of the accumulated and projected benefit obligation for the end of the current year and to determine the net periodic pension cost for the subsequent year. See Note 7 to the

21

Consolidated Financial Statements for a table showing the rates used for the various countries where the Company has these pension plans.

        Third, the Company must determine the expected long-term rate of return on assets assumption that is used to determine the expected return on plan assets component of the net periodic pension cost for the subsequent year. The difference between the actual return on plan assets and the expected return is deferred under SFAS No. 87 and is recognized to net periodic pension cost over a four-year period. See the table in Note 7 to the Consolidated Financial Statements for the expected long-term rates used for 2002.

        Postretirement Benefits Other Than Pensions — The Company provides a single postretirement health care benefit for certain employee groups in the United States. This plan is contributory and contains certain other cost-sharing features such as deductibles and coinsurance. The Company does not pre-fund this plan and has the right to modify or terminate this plan in the future.

        The Company accounts for its postretirement benefits in accordance with SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," which requires the postretirement liability recognized in the Consolidated Balance Sheets and the postretirement cost recognized in the Consolidated Statements of Income be determined on an actuarial basis.

        To account for its postretirement benefits in accordance with SFAS No. 106, the Company must make two determinations. First, it must determine the actuarial assumption for the discount rate used to reflect the time value of money in the calculation of the accumulated postretirement benefit obligation for the end of the current year and to determine the postretirement cost for the subsequent year. For guidance in determining this rate, the Company looks at rates of return on high-quality fixed-income investments and periodic published rate ranges.

        Second, the Company must determine the actuarial assumption for the health care trend rate used in the calculation of the accumulated postretirement benefit obligation for the end of the current year and to determine the net periodic postretirement benefit cost for the subsequent year. See Note 8 to the Consolidated Financial Statements for information on the assumptions used as of December 31, 2002.

New Accounting Policies

        In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also provides new criteria in the determination of intangible assets, including goodwill acquired in a business combination, and expands the financial disclosures concerning business combinations consummated after June 30, 2001. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually at the reporting level using a two-step impairment test.

        Effective January 1, 2002, the Company adopted SFAS No. 142. In connection with the adoption of SFAS No. 142, the Company reclassified approximately $6.1 million of "Established Workforce" from other intangibles into goodwill and performed an evaluation of goodwill as of January 1, 2002. The results of this evaluation indicated that goodwill related to the open circuit reporting unit within the Work Function segment was impaired. The performance of this reporting unit has not met management's original expectations, primarily due to economic factors and the competitive nature of this commodity-type product. The Company measured the amount of impairment based on a comparison of the fair value to its carrying value. Fair value was determined using a discounted cash flow methodology by applying an appropriate weighted average cost of capital, and cost methodology. The Company retained the services of a third party appraisal firm in determining the fair value of the open circuit reporting unit. Accordingly, the Company recognized a $0.7 million noncash after-tax charge as a cumulative effect of change in accounting principle for the write-off of goodwill related to the open circuit reporting unit. The Company expects the performance of the open circuit business will improve over the next few years as a result of product

22

rationalization and the moving of manufacturing into lower-cost countries. The Company remains committed to this business.

        In June 2002, FASB issued SFAS No. 146, "Accounting for the Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to recognize liabilities and costs associated with exit or disposal activities initiated after December 15, 2002, when they are incurred, rather than when management commits to a plan to exit an activity. While the Company is undergoing a number of activities to restructure its sales and distribution activities in Europe and to rationalize certain production facilities and products in the future, the Company does not expect the adoption of SFAS No. 146 to have a material effect on the Company's financial position or net income.

Business Combinations and Business Ventures

        During the first quarter 2002, the Company completed the purchase of a minority interest in Comatrol S.p.A. Comatrol, located in Reggio Emilia, Italy, has 90 employees and approximately $16.0 million in annual sales. The Company, which paid approximately $8.4 million, owns 45% of Comatrol as a minority interest partner and has recorded its share of Comatrol's earnings using the equity method since the date of acquisition. The Company has the option to acquire additional ownership interest in Comatrol in two phases in the future. The first option period runs from March 1, 2003 through March 31, 2003, whereby the Company could acquire an additional 40% of Comatrol's total capital for approximately $8.5 million, at which time the Company would then consolidate the results of Comatrol. If the Company does not exercise this option by March 31, 2003, the option lapses. The second option period runs from April 1, 2004 through April 30, 2004, and allows for the Company to acquire the remaining 15% of Comatrol for approximately $3.4 million, contingent on exercising the first option described above. Should the Company elect to not exercise either of these two options, the sellers would then have a put option which would run from May 1, 2004 through May 31, 2004, during which time the sellers could require the Company to acquire the remaining outstanding shares of Comatrol for approximately the amounts referred to above in the Company's options, adjusted for provisions as defined in the agreement. Should the sellers not exercise their put option by May 31, 2004, all options would lapse and the Company would not be required to purchase any additional ownership interests in Comatrol.

        During the second quarter 2002, the Company acquired the assets of the low-voltage motor business of Thrige Electric. The acquisition was an all cash transaction of approximately $17.4 million and includes factories in Odense, Denmark, Berching, Germany, and Kaiserslautern, Germany. Thrige Electric is engaged in the production of low-voltage motors and integrated pump, steering or drive units used primarily in mobile machines in the material handling market. Thrige Electric has approximately 450 employees and annual sales of approximately $50.0 million. The Company owns 100% of the Thrige Electric operations and has consolidated the financial results of this business since the date of acquisition. The transaction resulted in approximately $8.3 million of goodwill being recognized. The Company is completing its allocation of the purchase price to the assets and liabilities acquired, and expects to complete this by March 31, 2003.

Dividend Restrictions

        The Company's ability to pay dividends to its stockholders is effectively limited by certain restrictive covenants contained in the U.S. Revolving Credit Facility, Danish Revolving Credit Facility, and German credit agreements, which limit the amount of dividends the U.S. Operating Company, Danish Operating Company, and German Operating Company can distribute to the Company. During 2002, the U.S. Operating Company did not make any distributions to the Company. At December 31, 2002, $4.0 million was not restricted as to the payment of dividends to the Company. The German Operating Company did not make any distributions to the Company during 2002, and at December 31, 2002, $2.7 million was not restricted as to the payment of dividends. The Danish holding company distributed $2.6 million to the Company during 2002. The Danish holding company is not restricted from paying dividends to the

23

Company through its revolving credit facility. However, the Danish holding company must receive governmental approval in advance of making dividend payments.

Non-Audit Services of Independent Auditors

        Our auditors, KPMG LLP, perform the following non-audit services that have been approved by the Audit Committee of the Board of Directors: statutory audits; international and U.S. tax planning and compliance services; tax and financial due diligence for acquisitions; and expatriate tax services.

Outlook

        The Company continues to be cautious in its outlook for 2003. Sales into most of the Company's markets increased during 2002 from 1% to 22% with turf care having the highest growth. Road building continued to be depressed, declining an additional 2% on top of prior years' declines. The ongoing weak road building market reflects the constraints of States and their budgets to fund highway projects in the Americas, with sales to all major OEMs declining during the year. The stronger euro currency to the U.S. dollar is affecting the competitiveness of European manufacturers to sell into the North American markets.

        Uncertain of what the economic conditions will be throughout 2003, the Company is focusing on what it can control to continue to deliver improved operating results. As mentioned earlier, a global procurement team has been organized to reduce the cost of both direct and indirect materials. Resources are being deployed in Asia-Pacific, the Americas and Europe to capitalize on the many opportunities around the world. Within the European region, an initiative is underway to reorganize the sales and marketing structure through consolidation of many of these functions. The Company expects to incur approximately $4.0 million of costs in 2003 to carry out this restructuring with the benefits of this activity being realized near the end of 2003 and at a significant rate of savings beginning in 2004 onward. The work function segment is undergoing a process of outsourcing selective lower margin, lower volume product lines. Eliminating these lower volume, infrequent production runs will reduce cost by improving operating efficiencies in the affected plants. Continued emphasis is being placed on the Six-Sigma quality process that was formally launched within Sauer-Danfoss during 2001 as a complement to our lean manufacturing processes. Finally, continuing efforts are being made to move production from high-cost countries to lower-cost countries, such as the expansion that is continuing within our Slovakia manufacturing plants.

        Overall, the Company expects its 2003 sales to increase by 3% to 5% from 2002 levels, and expects its contribution margin to improve by 1% to 2% as a result of the global procurement initiative discussed earlier. The Company will continue to closely monitor its need for capital expenditures, but expects that this will increase from the 2002 levels of $42.3 million to a range of $55.0 million to $65.0 million in 2003. Should the Company be successful in accomplishing these expectations in 2003, it expects net income per share to be in a range of $0.40 to $0.50 per share.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

        Certain market risks are discussed on page 18 and page 19 of this report, and the other disclosure requirements are either considered not applicable or not material.

Item 8. Financial Statements and Supplementary Data.

        The Consolidated Financial Statements, Report of Management, and Independent Auditors' Report are presented on pages 35-62 of this report.

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PART III

Item 10. Directors and Executive Officers of the Registrant

        Information regarding directors of the Company is set forth under the section entitled "Election of Directors" of the Company's Proxy Statement for the annual meeting of stockholders to be held June 4, 2003, and is incorporated herein by reference. Information regarding executive officers of the Company is set forth in Part I of this report under the caption "Executive Officers of the Company." Information regarding the failure of certain officers of the Company to file on a timely basis reports required by Section 16(a) of the Securities Exchange Act of 1934 is set forth under the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" of the Company's Proxy Statement for the annual meeting of stockholders to be held June 4, 2003, and is incorporated herein by reference.

Item 11. Executive Compensation

        Information as to Executive Compensation is set forth under the section entitled "Executive Compensation" of the Company's Proxy Statement for the annual meeting of stockholders to be held June 4, 2003, and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management

        Information regarding securities authorized for issuance under equity compensation plans is set forth under the section entitled "Executive Compensation — Equity Compensation" of the Company's Proxy Statement for the annual meeting of stockholders to be held June 4, 2003, and is incorporated herein by reference. Information regarding security ownership is set forth under the section entitled "Security Ownership of Certain Beneficial Owners and Management" of the Company's Proxy Statement for the annual meeting of stockholders to be held June 4, 2003, and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

        In connection with the acquisition of Danfoss Fluid Power in May 2000 and the acquisition of additional assets and business operations of the fluid power business of Danfoss A/S in January 2001, the Company has entered into several agreements with Danfoss A/S to purchase ongoing operational services from Danfoss A/S. Information regarding these relationships and agreements is set forth in Note 12 to the Consolidated Financial Statements on page 56 of this report, and is incorporated herein by reference.

Item 14. Controls and Procedures

        Within 90 days prior to the date of this report, the Registrant carried out an evaluation under the supervision and with the participation of the Registrant's management, including the Registrant's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Registrant's disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Registrant files or submits under the Exchange Act is recorded, processed, summarized, and reported as required and within the time periods specified in the Securities and Exchange Commission's rules and forms. There have been no significant changes in the Registrant's internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation discussed in this Item 14.

PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a)

The following documents are filed as a part of this report.

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        (1)  The following consolidated financial statements and related information, included in Item 8, are filed as a separate section of this report:

Consolidated Statements of Income for the years ended December 31, 2002, 2001, and 2000, on page 35.

Consolidated Balance Sheets as of December 31, 2002 and 2001, on page 36.

Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended December 31, 2002, 2001, and 2000, on page 37.

Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000, on page 38.

Notes to Consolidated Financial Statements, December 31, 2002, 2001, and 2000, on pages 39-60.

Report of Management and Report of KPMG LLP as independent auditors, on pages 61-62.

        (2)  The following financial statements and schedules:

Schedule I

Sauer-Danfoss Inc. (Parent Only) Condensed Balance Sheets as of December 31, 2002 and 2001 on page 63.

Sauer-Danfoss Inc. (Parent Only) Condensed Statements of Income for the Years Ended December 31, 2002, 2001, and 2000 on page 64.

Sauer-Danfoss Inc. (Parent Only) Condensed Statements of Cash Flows for the Years Ended December 31, 2002, 2001, and 2000 on page 65.

Schedule II, Valuation and Qualifying Accounts, on page 66.

Report of KPMG LLP, independent auditors, on Schedules I and II, on page 67.

All other schedules for which provision is made in Regulation S-X of the Securities and Exchange Commission, are not required under the related instructions or are inapplicable and, therefore, have been omitted.

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        (3)  Exhibits

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28

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(b)

Reports on Form 8-K.

On November 1, 2002, the Company filed a Current Report on Form 8-K for the purpose of disclosing one press release dated October 30, 2002 announcing the Company's third quarter 2002 financial results.

On December 6, 2002, the Company filed a Current Report on Form 8-K for the purpose of disclosing two press releases. The first press release dated December 4, 2002, announced the appointment of Steven H. Wood as a member of the Company's Board of Directors. The second press release dated December 4, 2002, announced the Company's fourth quarter dividend.

On January 10, 2003, the Company filed a Current Report on Form 8-K for the purpose of disclosing one press release dated January 9, 2003, announcing the retirement of Klaus H. Murmann as an employee of the Company.

On February 21, 2003, the Company filed a Current Report on Form 8-K for the purpose of disclosing one press release dated February 19, 2003, announcing the Company's fourth quarter 2002 financial results.

(c)

The exhibits that are listed under Item 14(a)(3) are filed or incorporated by reference hereunder.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

        Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report below.

        Each person signing below also hereby appoints David J. Anderson and Kenneth D. McCuskey, and each of them singly, his or her lawful attorney-in-fact with full power to execute and file any and all amendments to this report together with exhibits thereto and generally to do all such things as such attorney-in-fact may deem appropriate to enable Sauer-Danfoss Inc. to comply with the provisions of the Securities Exchange Act of 1934 and all requirements of the Securities and Exchange Commission.

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Certifications

I, David J. Anderson, certify that:

        1.    I have reviewed this annual report on Form 10-K of Sauer-Danfoss Inc.;

        2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

        3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

        4.    The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        (a)  designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

        (b)  evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

        (c)  presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.    The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors:

        (a)  all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

        (b)  any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

        6.    The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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I, Karl J. Schmidt, certify that:

        1.    I have reviewed this annual report on Form 10-K of Sauer-Danfoss Inc.;

        2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

        3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

        4.    The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        (a)  designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

        (b)  evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

        (c)  presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.    The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors:

        (a)  all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

        (b)  any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

        6.    The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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Sauer-Danfoss Inc. and Subsidiaries

Consolidated Statements of Income

For The Years Ended December 31, 2002, 2001, And 2000

(in thousands, except per share data)

See accompanying notes to consolidated financial statements.

35

Sauer-Danfoss Inc. and Subsidiaries

Consolidated Balance Sheets

As of December 31, 2002, and 2001

(in thousands, except per share data)

See accompanying notes to consolidated financial statements.

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Sauer-Danfoss Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity and Comprehensive Income

For The Years Ended December 31, 2002, 2001, and 2000

(in thousands, except per share data)