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 certain 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," "projects," "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. Readers should bear in mind that past experience may not be a good guide to anticipating actual future results. The economies in the U.S., Europe, and Asia-Pacific are suffering from the shockwaves of the worldwide credit crisis, continued weakness in the housing and residential construction markets, growing weakness in the commercial and public-sector construction markets, and uncertainty surrounding job creation, interest rates, and crude oil prices. At this point, it appears that the worldwide economic downturn will continue throughout 2009. Any 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, material handling 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 significant 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 the Company's product mix; future levels of indebtedness and capital spending; the ability and willingness of Danfoss A/S, the Company's majority stockholder, to lend money to the Company at sufficient levels and on terms favorable enough to enable the Company to meet its capital needs; the Company's ability to access the capital markets or traditional credit sources to supplement or replace the Company's borrowings from Danfoss A/S if the need should arise; claims, including, without limitation, warranty claims, field retrofit claims, product liability 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 in 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; the sub-prime credit market crisis, credit market disruptions, and significant changes in capital market liquidity and funding costs affecting the Company and its customers; general economic conditions, including interest rates, the rate of inflation, and commercial and consumer confidence; energy prices; the impact of new or changed tax and other legislation and regulations in jurisdictions in which the Company and its affiliates operate; actions by the U.S. Federal Reserve Board and the central banks of other nations; actions by other regulatory agencies, including those taken in response to the global credit crisis; actions by rating agencies; changes in accounting standards; worldwide political stability; the effects of terrorist activities and resulting political or economic instability; natural catastrophes; 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.

About the Company

Sauer-Danfoss Inc. and subsidiaries (the Company) is a worldwide leader in the design, manufacture, and sale of engineered hydraulic and electronic systems and components that generate, transmit and control 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, material handling, and specialty equipment. The Company designs, manufactures, and markets its products in the Americas, Europe, and the Asia-Pacific region, and markets its products throughout the rest of the world either directly or through distributors.

Executive Summary of 2008 Compared to 2007

The nature of the Company's operations as a global producer and supplier in the fluid power industry means the Company is impacted by changes in local economies, including currency exchange rate fluctuations. In order to gain a better understanding of the Company's base results, a financial statement user needs to understand the impact of those currency exchange rate fluctuations. The following table summarizes the change in the Company's results from operations by separately identifying changes due to

currency fluctuations and the underlying change in operations from 2007 to 2008. This analysis is more consistent with how the Company's management internally evaluates results.

                                                      Currency        Underlying
                                        2007        fluctuations        change         2008
                                                           (in millions)
Net Sales                             $ 1,972.5       $       85.0     $      33.0   $ 2,090.5
    Gross Profit                          427.7               21.9           (14.0 )     435.6
    % of Net Sales                         21.7 %                                         20.8 %
Selling, general and administrative       233.8               10.4            14.3       258.5
Research and development                   70.6                3.6             8.7        82.9
Impairment charges                            -                  -            58.2        58.2
Loss on sale of businesses and              9.4                0.5            (0.3 )       9.6
asset disposals

    Total operating costs                 313.8               14.5            80.9       409.2

    Operating income                      113.9                7.4           (94.9 )      26.4
    % of Net Sales                          5.8 %                                          1.3 %
Net interest expense                      (22.7 )             (0.9 )          (1.0 )     (24.6 )
Other income (expense), net                (3.6 )             (2.3 )           6.8         0.9

Income before taxes and minority           87.6                4.2           (89.1 )       2.7
interest
Minority interest                         (21.6 )             (0.5 )           4.3       (17.8 )

    Income (loss) before taxes             66.0                3.7           (84.8 )     (15.1 )
    % of Net Sales                          3.3 %                                         (0.7 )%
    Income tax expense                    (18.8 )             (0.8 )           5.6       (14.0 )

Net income (loss)                     $    47.2       $        2.9     $     (79.2 ) $   (29.1 )

Net sales for the year ended December 31, 2008 increased 2 percent compared to the year ended December 31, 2007, excluding the effects of currency. Sales increased 3 percent excluding the effects of currency and divestitures. Excluding the effects of currency and divestitures, sales increased 3 percent in the Americas and 23 percent in Asia Pacific, while sales remained nearly level in Europe. Sales in the Propel segment were up 4 percent, sales in the Work Function segment increased 2 percent and sales in the Controls segment increased 1 percent.

Gross profit declined 3 percent during the year ended December 31, 2008, excluding the impact of currency. This decline is primarily driven by $11.2 million in severance costs related to recent actions taken in response to the slowing economy, and a $10.4 million increase in field recall costs, primarily related to the Controls segment. During the year ended December 31, 2007, the Propel and Controls segments incurred $10.4 million of restructuring costs primarily to relocate production lines to other production facilities within the Company and remaining costs to close the LaSalle, Illinois plant.

Selling, general and administrative costs increased 6 percent during 2008 when compared to the same period in 2007, excluding the effects of currency. This increase is primarily attributed to $4.9 million of severance costs, and a $7.8 million increase in sales and marketing costs, excluding the impacts of currency, due primarily to the addition of a new sales office in Russia, as well as increases in headcount earlier in 2008. Research and development costs increased 12 percent excluding the impacts of currency, primarily driven by increasing product development, particularly in the Controls and Propel segments.

The Company reported impairment charges of $58.2 million, consisting of goodwill impairment charges of $22.9 million and property, plant, and equipment impairment charges of $35.3 million. The goodwill impairment related to the motors and steering reporting units within the Work Function segment and the electric drives reporting unit within the Controls segment. It was incurred as a result of lower profitability in the reporting units than the Company had previously expected, and lower future expectations in certain end markets. The property, plant and equipment impairment related to the Work

Function segment and resulted from lower expectations related to the products produced within the asset group.

During the year ended December 31, 2008 the Company signed an agreement to sell its alternating current (AC) electric motor business for the material handling market. In connection with this transaction, which is expected to close in 2009, the Company incurred charges of $8.4 million in 2008. During the year ended December 31, 2007 the Company incurred a loss of $6.6 million related to the sale of the direct current (DC) electric motor business located in Berching, Germany and a loss of $2.4 million on the sale of the assets and product lines which were manufactured in Swindon, England. These activities were part of the Company's plan to divest of product lines that do not fit the Company's long-term strategic direction.

During the year ended December 31, 2008, the Propel segment recorded a gain of $1.4 million related to the sale of the LaSalle, Illinois plant and the Controls segment incurred $0.4 million of equipment write-off costs related to the closure of the facility in Hillsboro, Oregon.

Operating Results-2008 Compared to 2007

Sales Growth by Market

    The following table summarizes the Company's sales growth by market. The
table and following discussion is on a comparable basis, which excludes the
effects of currency fluctuations.

                                     Americas    Asia-Pacific     Europe     Total
       Agriculture/Turf Care                 4 %             3 %       22 %      10 %
       Construction/Road Building           (5 )            12        (11 )      (5 )
       Material Handling/Specialty         (13 )            77         (8 )      (5 )
       Distribution                          9              14          0         7

Agriculture/Turf Care

Sales into the agriculture/turf care markets increased 10 percent during the year ended December 31, 2008 compared to 2007. Agriculture sales in Europe remained strong throughout 2008, but started to show signs of slowing towards the end of the year. Agriculture sales increased in the Americas due to strong commodity prices, however they started to show signs of weakening late in 2008. Increased sales into the Americas agriculture market were offset by decreased sales into the turf care market, primarily driven by the decline in housing starts and concerns regarding the slowing economic conditions.

Construction/Road Building

Sales into the construction/road building markets decreased 5 percent during 2008, with the majority of the decrease occurring in the fourth quarter. The decrease is driven by an 11 percent decrease in the European market and a 5 percent decrease in the Americas market, both due to weakening economic conditions, reduced housing starts, and customers' focus on reducing inventory levels. Asia-Pacific experienced a 12 percent increase due to strength in the Chinese road building market throughout most of 2008, although this market began to show signs of weakening during the fourth quarter of 2008. Export sales out of the Asia-Pacific region also started to weaken during the fourth quarter of 2008.

Material Handling/Specialty

Specialty vehicles are comprised of a variety of markets including forestry, material handling, marine, waste management and waste recycling. Overall the material handling/specialty markets declined 5 percent, driven by declines in Europe and the Americas due to weak non-residential construction and reductions in capital expenditures by rental companies. Sales through the third quarter of 2008 were level with 2007 but decreased in the fourth quarter as a result of the economic downturn. The decreases in

Europe and the Americas were partly offset by strength in the Asia-Pacific region due primarily to a strong market for railway construction machines.

Distribution

Products related to all of the above markets are sold to distributors, who then serve smaller OEMs.

Order Backlog

    The following table shows the Company's order backlog and orders written
activity for 2007 and 2008, separately identifying the impact of currency
fluctuations.

                                             Currency        Underlying
                                2007        fluctuation        change         2008
                                                   (in millions)
     Backlog at December 31   $   921.4      $      (16.2 )   $    (161.5 ) $   743.7
     Orders written             2,214.8              77.8          (364.9 )   1,927.7

Total order backlog at the end of 2008 was $743.7 million, compared to $921.4 million at the end of 2007. On a comparable basis, excluding the impact of currency fluctuation, order backlog decreased 18 percent compared to 2007. New sales orders written for 2008 were $1,927.7 million, a decrease of 16 percent compared to 2007, excluding the impact of currency fluctuations.

Backlog information can vary as customers alter their sales order patterns. The 16 percent decrease in orders written in 2008 reflects the downturn experienced in almost all markets and regions during the fourth quarter of 2008. This downturn is also reflected in our order backlog which declined 18 percent excluding the impacts of currency.

Business Segment Results

The following discussion of operating results by reportable segment relates to information as presented in Note 18 in the Notes to Consolidated Financial Statements. Segment income is defined as the respective segment's portion of the total Company's net income, excluding net interest expense, income taxes, minority interest, and global service expenses. 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, electric drives and valves that control and direct the power of a vehicle.

The following table provides a summary of each segment's net sales and segment income, separately identifying the impact of currency fluctuations during the year.

                                              Currency       Underlying
                                  2007      fluctuation        change         2008
                                                    (in millions)
      Net sales
        Propel                   $ 940.7      $      37.8     $      38.1   $ 1,016.6
        Work Function              534.0             26.0             1.4       561.4
        Controls                   497.8             21.2            (6.5 )     512.5
      Segment income (loss)
        Propel                   $ 146.6      $       8.3     $       1.9   $   156.8
        Work Function               (2.9 )            0.7           (63.5 )     (65.7 )
        Controls                    17.7              0.0           (39.1 )     (21.4 )
        Global Services and        (51.1 )           (4.1 )          12.8       (42.4 )
        other expenses, net

The Propel segment experienced a 4 percent increase in sales, excluding the effects of currency fluctuations, during 2008. Segment income increased 1 percent during the same period. Segment income was negatively impacted by $2.3 million of severance costs, offset by a gain of $1.4 million related to the sale of a building. Field recall costs increased $1.5 million during 2008 and administrative costs increased $3.5 million. Restructuring costs of $5.5 million were recorded during 2007.

Work Function Segment

Sales in the Work Function segment increased slightly, excluding the effects of currency fluctuations, during the year ended December 31, 2008. Sales increased 2 percent excluding the effects of both currency and the divestiture of product lines in Swindon, England in June 2007. Segment income was negatively impacted by goodwill impairment charges of $17.4 million. These charges were incurred as a result of lower profitability in the motors and steering reporting units than the Company had previously expected and lower future expectations in certain end markets. The Work Function segment incurred property, plant and equipment impairment charges of $35.3 million as a result of lower expected cash flow related to the products produced within the motors asset group. Segment income was also negatively impacted by severance costs of $6.5 million as a result of recent actions taken in response to the slowing economy.

Controls Segment

Sales in the Controls segment decreased 1 percent for the year ended December 31, 2008, excluding the effects of currency fluctuations, compared to 2007. Segment income declined $33 million. This decrease is due to several factors, including an $8.4 million increase in field recall costs and a $6.8 million increase in fixed overhead costs due to increases in production capacity. Also contributing to the decline in segment income was an additional $4.5 million of research and development costs.

During 2008, the Controls segment recognized $8.4 million of charges related to the expected sale of the AC electric motor business for the material handling market in 2009, goodwill impairment charges of $5.5 million, severance costs of $5.1 million, and a $0.4 million write-down of fixed assets related to the decision to close the facility in Hillsboro, Oregon. During 2007, the Controls segment recognized a loss of $6.6 million related to the sale of the DC electric motor business and $3.2 million of costs to reorganize the DC and AC electric motor business prior to the sale.

Global Services and other expenses, net

Segment costs in Global Services and other expenses, net, relate to internal global service departments, along with the operating costs of the Company's executive office. Global services include such costs as consulting for special projects, tax and accounting fees paid to outside third parties, internal audit, certain insurance premiums, and the amortization of intangible assets from certain business combinations. Global services and other expenses decreased $12.8 million excluding the impacts of currency, or 25 percent. This is primarily due to a $6.6 million reduction in incentive costs during the year ended December 31, 2008, a reduction of $4.6 million in costs associated with the implementation of the Company's common business system, and a $5.1 million reduction in losses related to foreign currency transactions.

Income Taxes

The Company incurred income tax expense of $14.1 million on a loss of $15.1 million in 2008.

In 2008 the Company recorded $22.9 million for the impairment of goodwill, of which $18.8 million was not deductible for income tax purposes and therefore no tax benefit was recorded on this expense. Valuation allowances and contingency reserves of $3.0 million were recorded as tax expense in 2008 which relates to impaired tax assets in the US, Italy and Germany. Other non-deductible expenses and the world-wide earnings mix also impacted the 2008 effective tax rate.

Executive Summary of 2007 Compared to 2006

    The following table summarizes the change in the Company's results from
operations by separately identifying changes due to currency fluctuations and
the underlying change in operations from 2006 to 2007. This analysis is more
consistent with how the Company's management internally evaluates results.

                                                Currency        Underlying
    (in millions)                 2006        fluctuations        change         2007
    Net Sales                   $ 1,739.1       $       98.3     $     135.1   $ 1,972.5
        Gross Profit                396.8               24.5             6.4       427.7
        % of Net Sales               22.8 %                                         21.7 %
    Selling, general and
    administrative                  215.6               11.8             6.4       233.8
    Research and development         61.9                3.5             5.2        70.6
    Impairment charges                1.5                  -            (1.5 )         -
    Loss on sale of
    businesses and asset
    disposals                         1.7                  -             7.7         9.4

        Total operating costs       280.7               15.3            17.8       313.8

        Operating income            116.1                9.2           (11.4 )     113.9
        % of Net Sales                6.7 %                                          5.8 %
    Net interest expense            (17.8 )             (1.0 )          (3.9 )     (22.7 )
    Other expense, net               (5.7 )             (2.3 )           4.4        (3.6 )

    Income before taxes and
    minority interest                92.6                5.9           (10.9 )      87.6
    Minority interest               (21.6 )              0.2            (0.2 )     (21.6 )

        Earnings before taxes        71.0                6.1           (11.1 )      66.0
        % of Net Sales                4.1 %                                          3.3 %
        Income tax benefit
        (expense)                   (17.0 )             (0.6 )          (1.2 )     (18.8 )

    Net income                  $    54.0       $        5.5     $     (12.3 ) $    47.2

Net sales for the year ended December 31, 2007 increased 8 percent compared to the year ended December 31, 2006, excluding the effects of currency. Sales increased 10 percent excluding the effects of currency and the divestitures of product lines in Swindon, England and the direct current (DC) motor business. Sales increased in all regions and segments. Excluding the impacts of currency and divestitures, sales grew 14 percent in Europe, 13 percent in Asia Pacific, and 5 percent in the Americas. Sales in the Controls segment were up 17 percent. Sales in the Propel and Work Function segments were up 8 percent.

Selling, general and administrative costs increased 3 percent during 2007 when compared to the same period in 2006, excluding the effects of currency. This increase is primarily attributed to $1.9 million costs related to the start-up of a European financial shared services center, as well as increasing headcount, particularly for sales and marketing functions. Research and development costs increased $5.2 million excluding the impacts of currency, primarily driven by increasing product development, particularly in the Controls and Propel segments.

During the year ended December 31, 2007 the Company incurred a loss of $6.6 million related to the sale of the DC electric motor business located in Berching, Germany and a loss of $2.4 million on the sale of the assets and product lines which were manufactured in Swindon, England. These activities were part of the Company's plan to divest of product lines that do not fit the Company's long-term strategic direction.

During the year ended December 31, 2007, the Propel and Controls segments incurred $10.4 million of restructuring costs primarily to relocate production lines to other production facilities within the

Company and remaining costs to close the LaSalle, Illinois plant. Restructuring charges incurred during the year ended December 31, 2006 were $13.5 million, primarily related to restructuring in the Propel and Work Function segments.

Operating Results-2007 Compared to 2006

Sales Growth by Market

    The following table summarizes the Company's sales growth by market. The
table and following discussion is on a comparable basis, which excludes the
effects of currency fluctuations.

                                      Americas    Asia-Pacific    Europe     Total
        Agriculture/Turf Care                 2 %             4 %      15 %       6 %
        Construction/Road Building          (11 )            17        13         4
        Material Handling/Specialty          14              31        11        13
        Distribution                          8               9         8         8

Agriculture/Turf Care

Sales into the agriculture/turf care markets increased 6 percent during the year ended December 31, 2007 compared to 2006. Agriculture sales in Europe continue to be strong as a result of strong markets and favorable commodity . . .