SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

COMMISSION FILE NUMBER: 000-00822

The Oilgear Company

(Exact name of registrant as specified in its charter)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:

(414) 327-1700

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

NONE

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

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

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

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

PART I

General

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

Principal Products, Markets and Methods of Distribution

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

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

Restatement

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

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

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

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

Domestic Segment

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

European Segment

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

International Segment

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

Competition

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

Customers

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

Backlog

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

Raw Materials

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

Patents, Licenses, Franchises

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

Research and Development

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

Environmental Matters

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

Employees

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

Seasonal Aspects of Business

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

Industry Segments and Principal Products

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

Segment Sales

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

Financial Information About Geographic Areas

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

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

Domestic

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

European

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

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

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

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

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

International

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

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

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

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

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

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

Executive Officers of the Registrant

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

PART II

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

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

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

Equity Compensation Plan Information

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

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

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

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

5 Year Summary

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

Increase (Decrease) Adjustments for the Restatement of Prior Years

Restatement of Prior Period Financial Statements

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

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

Overview

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

Discussion of Results of Operations

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Outlook

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

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

Inflation and Changing Prices

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

Quarterly Financial Information (Unaudited)