SAUER DANFOSS INC - 10-K Annual Report

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

Common Stock, par value $0.01 per share
(Title of each class)

New York Stock Exchange
Frankfurt (Germany) Stock Exchange
(Name of each exchange on which registered)

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

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.

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.

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.

Construction and Road Building		Agriculture		Turf Care		Specialty Vehicles
Chip spreaders Concrete pumps Concrete saws Crawler dozers Crawler loaders Ditchers/trenchers Excavators Grinders Landfill compactors Oil distributors Pavers Planers Rollers Skid steer loaders Transit mixers Utility tractors Wheel loaders		Combines Cotton pickers Detasselers Seeders Sprayers Tractors Windrowers		Commercial-wide area, walk- behind mowers Commercial zero-turn mowers General turf maintenance Lawn and garden tractors		Fruit pickers Industrial lift trucks Logging equipment Marine equipment Mining equipment Oil field equipment Railway maintenance Rough terrain fork lifts Self-propelled boom aerial lifts Self-propelled scissor aerial lifts Snow groomers Sweepers Tree shakers Truck and bus fan drives

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.

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.

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.

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.

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

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.

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

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.

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.

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:

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.

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.

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

Name	Age	Position	Year Appointed
Klaus H. Murmann (1)(2)	71	Chairman	1989
Joergen M. Clausen (3)	54	Vice Chairman	2000
David J. Anderson (1)	55	President and Chief Executive Officer	2000
Hans J. Cornett (4)	52	Executive Vice President — Sales and Marketing	2000
Karl J. Schmidt (5)	49	Executive Vice President and Chief Financial Officer	2002
James R. Wilcox (6)	57	Executive Vice President and Chief Operating Officer	2000
Richard Jarboe (7)	60	Vice President — Open Circuit	2000
Thomas K. Kittel (1)	54	Vice President — Hydrostatics, Europe	2000
Henrik Krabsen (4)	41	Vice President — Valves	2000
Finn Lyhne (4)	48	Vice President — Motors and Steering	2000
Kenneth D. McCuskey (1)	48	Vice President — Finance, Secretary and Treasurer	2000
Albert Zahalka (8)	51	Vice President — Mobile Electronics	2000

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

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:

	1st		2nd		3rd		4th		Full Year
2002
High	$	11.72	$	12.75	$	11.16	$	9.45	$	12.75
Low	$	7.55	$	9.58	$	8.79	$	7.25	$	7.25
Dividends	$	0.07	$	0.07	$	0.07	$	0.07	$	0.28
2001
High	$	10.29	$	9.95	$	9.43	$	8.48	$	10.29
Low	$	8.41	$	7.27	$	7.37	$	6.64	$	6.64
Dividends	$	0.07	$	0.07	$	0.07	$	0.07	$	0.28

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

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.

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.

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:

(in millions)	2002		2001
Net income as reported	$	14.0	$	4.7
Product rationalization charge after tax		0.8		—
Goodwill impairment charge		0.7		—
Plant closing costs after tax		—		5.4
Bad debt write-off after tax		—		0.9

Net income on comparable basis	$	15.5	$	11.0

Net income per share on comparable basis	$	0.33	$	0.23

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

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.

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.

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

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.

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.

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.

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.

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

Delaware (State or other jurisdiction of incorporation or organization)		36-3482074 (I.R.S. Employer Identification No.)
250 Parkway Drive, Suite 270, Lincolnshire, Illinois (Address of principal executive offices)		60069 (Zip Code)

Location			Segment that Uses the Facility	Approx. Area in Sq. Ft.	Owned/Leased
United States
	Ames, Iowa		Propel	330,000	Owned
	LaSalle, Illinois		Propel	325,000	Owned
	Freeport, Illinois		Propel	183,000	Owned
	Lawrence, Kansas		Propel	162,000	Owned
	Easley, South Carolina		Controls	184,000	Owned
	Hillsboro, Oregon		Controls	60,000	Leased
	Sturtevant, Wisconsin		Work Function	25,000	Leased
	Minneapolis, Minnesota		Controls	75,000	Leased
	West Branch, Iowa		Work Function	105,000	Owned
	Sullivan, Illinois		Propel	176,000	Owned
South America
	Caxias do Sul, Brazil		Controls	29,000	Leased
Europe
	Neumünster, Germany		Propel and Controls	463,000	Owned
	Berching, Germany		Controls	131,000	Leased
	Kaiserslautern, Germany		Controls	8,500	Leased
	Nordborg, Denmark		Work Function and Controls	680,000	Leased
	Odense, Denmark		Controls	121,500	Leased
	Wroclaw, Poland		Work Function	41,000	Owned
	Povazská Bystrica, Slovakia		Propel and Work Function	351,500	Owned
	Dubnica nad Váhom, Slovakia		Propel	236,000	Leased
	Swindon, England		Work Function	229,000	Leased
	Stratford-upon-Avon, England		Controls	5,000	Leased
	Bologna, Italy		Work Function	246,000	Owned
	Cento, Italy		Controls	3,500	Leased
	Reggio Emilia, Italy		Controls	53,000	Leased
	Älmhult, Sweden		Controls	20,000	Owned
Asia
	Shanghai/Pudong, China		Propel	105,000	Leased
	Osaka, Japan		Propel	94,000	Leased

		Total		4,442,000

		2002			2001			2000(1)			1999			1998
		(in thousands except per share and employee data)
Operating Data:
Net sales		$	952,308		$	855,279		$	782,537		$	534,382		$	564,524
Gross profit			219,429			193,233			201,011			125,932			136,213
Marketing			68,054			63,318			40,874			24,727			24,942
Research and development			37,806			38,054			29,874			23,311			22,089
Administration			60,592			59,485			57,302			33,655			29,571
Total operating expenses			166,452			160,857			128,050			81,693			76,602
Earnings before interest and taxes			38,578			24,976			55,347			37,625			50,527
Total interest expense, net			17,219			17,377			11,194			8,566			8,814
Net income			13,972			4,730			26,925			18,120			26,334
Per Share Data:
Income per common share, basic and diluted		$	0.29		$	0.10		$	0.69		$	0.67		$	1.01
Cash dividends per share		$	0.28		$	0.28		$	0.28		$	0.28		$	0.29
Weighted average basic shares outstanding			47,395			46,977			39,216			27,225			26,148
Weighted average diluted shares outstanding			47,404			46,980			39,217			27,240			26,150
Balance Sheet Data:
Inventories		$	164,686		$	141,652		$	146,232		$	73,977		$	89,195
Property, plant and equipment, net			443,147			423,195			422,986			269,485			262,527
Total assets			971,093			884,891			840,963			442,515			459,771
Total debt			318,293			298,799			245,739			131,855			151,027
Stockholder's equity			368,959			347,184			342,397			150,752			148,904
Debt to debt plus equity			44.6	%		44.5	%		39.8	%		41.7	%		45.0	%
Other Data:
Backlog (at year-end)		$	382,815		$	319,905		$	375,052		$	252,400		$	261,700
Depreciation and amortization			72,156			69,474			53,338			35,538			30,635
Capital expenditures			42,278			69,697			67,931			57,149			98,582
EBITDA*			110,734			94,450			108,685			73,163			81,162
Cash flows from (used in):
	Operating activities		98,283			67,266			81,859			77,786			63,535
	Investing activities		(66,272	)		(110,143	)		(62,305	)		(56,779	)		(98,950	)
	Financing activities		(34,417	)		33,497			5,406			(22,940	)		35,077
Number of employees (at year-end)			7,207			6,790			6,733			3,836			3,710