SAUER INC, 424B1, 1998-05-13

SAUER INC
424B1, 1998-05-13
MISC INDUSTRIAL & COMMERCIAL MACHINERY & EQUIPMENT

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<PAGE> 1

9,000,000 Shares

[SAUER INC. LOGO]
Common Stock
($.01 par value)
------------------
Sauer Inc. is issuing and selling 3,000,000 shares of its Common Stock, $.01 par
value (the "Common Stock"), and certain stockholders (the "Selling
Stockholders") named herein under "Principal and Selling Stockholders" are
selling 6,000,000 shares of Common Stock. Of the 9,000,000 shares of Common
Stock being offered, 4,500,000 shares are initially being offered in the United
States and Canada (the "U.S. Shares") by the U.S. Underwriters (the "U.S.
Offering") and 4,500,000 shares are initially being concurrently offered in
Germany and elsewhere outside the United States and Canada (the "International
Shares") by the Managers (the "International Offering" and, together with the
U.S. Offering, the "Combined Offering"). The final allocation of Common Stock
between the U.S. Underwriters and the Managers may differ from the amounts set
forth above. See "The Combined Offering." Shares of Common Stock are being
reserved for sale to employees, directors and certain other persons associated
with the Company at the initial public offering price. See "Underwriting." It is
expected that such sales will not exceed 5% of the Common Stock to be offered in
the Combined Offering.

The public offering price, the underwriting discounts and the commissions and
concession and discount
to dealers for the International Offering are the same as in the U.S. Offering,
except that purchasers have the option to pay the public offering price of the
International Shares at the Deutsche mark equivalent thereof. Prior to the
Combined Offering, there has been no public market for the Common Stock. For
information relating to the factors considered in determining the initial
offering price to the public, see "The Combined Offering -- Determination of
Offering Price" and "Underwriting." The Common Stock has been approved for
listing on the New York Stock Exchange under the symbol "SHS" and on the
Frankfurt Stock Exchange under the symbol "SAR," subject to official notice of
issuance. Credit Suisse First Boston Aktiengesellschaft has sponsored the
application for listing on the Frankfurt Stock Exchange.

FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH
AN INVESTMENT IN THE COMMON STOCK, SEE "RISK FACTORS" BEGINNING ON PAGE 8
HEREIN.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND PROCEEDS TO SELLING
PUBLIC COMMISSIONS COMPANY(1) STOCKHOLDERS
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Per Share................................ $18.00 $0.90 $17.10 $17.10
Total(2)................................. $162,000,000 $8,100,000 $51,300,000 $102,600,000
</TABLE>

(1) Before deduction of expenses payable by the Company estimated at $2,535,000.

(2) Klaus H. Murmann and K. Murmann & Co. KG, two of the Selling Stockholders,
have granted the U.S. Underwriters and the Managers an option, exercisable
by Credit Suisse First Boston Corporation for 30 days from the date of this
Prospectus, to purchase a maximum of 1,350,000 additional shares of Common
Stock to cover over-allotments, if any. If the option is exercised in full,
the total Price to Public will be $186,300,000, Underwriting Discounts and
Commissions will be $9,315,000, Proceeds to Company will be $51,300,000 and
Proceeds to Selling Stockholders will be $125,685,000.

Global Coordinator
CREDIT SUISSE FIRST BOSTON

The U.S. Shares are offered by the several U.S. Underwriters when, as and
if delivered to and accepted by the U.S. Underwriters and subject to their right
to reject orders in whole or in part. It is expected that the U.S. Shares will
be ready for delivery on or about May 15, 1998, against payment in immediately
available funds.

CREDIT SUISSE FIRST BOSTON
SALOMON SMITH BARNEY
DEUTSCHE MORGAN GRENFELL
Prospectus dated May 11, 1998
<PAGE> 2

[SAUER INC. FARM EQUIPMENT PHOTO]

[SAUER INC. LOGO]
<PAGE> 3

NO ACTION HAS BEEN OR WILL BE TAKEN IN ANY JURISDICTION BY THE COMPANY, THE
SELLING STOCKHOLDER OR ANY UNDERWRITER THAT WOULD PERMIT A PUBLIC OFFERING OF
THE SHARES OF COMMON STOCK OR POSSESSION OR DISTRIBUTION OF THIS PROSPECTUS IN
ANY JURISDICTION WHERE ACTION FOR THAT PURPOSE IS REQUIRED, OTHER THAN THE
UNITED STATES AND GERMANY. PERSONS INTO WHOSE POSSESSION THIS PROSPECTUS COMES
ARE REQUIRED BY THE COMPANY, THE SELLING STOCKHOLDERS AND THE UNDERWRITERS TO
INFORM THEMSELVES ABOUT AND TO OBSERVE ANY RESTRICTIONS AS TO THE OFFERING OF
THE SHARES OF COMMON STOCK AND THE DISTRIBUTION OF THIS PROSPECTUS.
------------------------

CERTAIN OF THE INFORMATION CONTAINED IN THE "PROSPECTUS SUMMARY" AND IN
"BUSINESS" CONCERNING THE DEFINITION, SIZE AND DEVELOPMENT OF THE VARIOUS
PRODUCT MARKETS IN WHICH THE COMPANY PARTICIPATES, AND THE COMPANY'S GENERAL
EXPECTATIONS CONCERNING THE DEVELOPMENT OF SUCH PRODUCT MARKETS, ARE BASED ON
ESTIMATES PREPARED BY THE COMPANY USING DATA FROM VARIOUS SOURCES, WHICH DATA
THE COMPANY HAS NO REASON TO BELIEVE ARE UNRELIABLE, AND ON ASSUMPTIONS MADE BY
THE COMPANY, BASED ON SUCH DATA AND ITS KNOWLEDGE OF THE RELEVANT INDUSTRIES,
WHICH THE COMPANY BELIEVES TO BE REASONABLE. WHILE THE COMPANY IS NOT AWARE OF
ANY MISSTATEMENTS CONTAINED IN THESE SECTIONS, THE COMPANY'S ESTIMATES, IN
PARTICULAR AS THEY RELATE TO THE COMPANY'S GENERAL EXPECTATIONS CONCERNING THE
PRODUCT MARKETS IN WHICH THE COMPANY PARTICIPATES, INVOLVE RISKS AND
UNCERTAINTIES AND ARE SUBJECT TO CHANGE BASED ON VARIOUS FACTORS, INCLUDING
THOSE DISCUSSED UNDER THE CAPTION "RISK FACTORS" IN THIS PROSPECTUS.

DATA CONTAINED IN THIS PROSPECTUS UNDER "PROSPECTUS SUMMARY," "BUSINESS"
AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" RELATING TO THE COMPANY'S SALES BY MARKET APPLICATION AND RELATED
MARKET SHARE DATA HAVE BEEN DERIVED FROM INTERNAL MANAGEMENT SOURCES. THE
DEVELOPMENT OF THESE DATA REQUIRES JUDGMENTS AS TO THE DEFINITION OF PRODUCT
CATEGORIES AND THE ALLOCATION OF SALES TO PARTICULAR CATEGORIES. THESE DATA ARE
NOT DERIVED FROM THE COMPANY'S ACCOUNTING RECORDS AND ARE NOT SUBJECT TO THE
CONTROLS PRESENT IN THE COMPANY'S ACCOUNTING SYSTEM. HOWEVER, MANAGEMENT
BELIEVES THAT THESE DATA HAVE BEEN DEVELOPED ON A REASONABLE BASIS AND
ACCURATELY REPRESENT THE COMPANY'S SALES BY PRODUCT CATEGORY IN ALL MATERIAL
RESPECTS.

BRAND NAMES AND TRADEMARKS APPEARING IN THIS PROSPECTUS ARE THE PROPERTY OF
THEIR HOLDERS.
------------------

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE SHARES OF COMMON
STOCK OFFERED HEREBY, INCLUDING OVER-ALLOTMENTS, STABILIZING TRANSACTIONS,
SYNDICATE SHORT COVERING TRANSACTIONS AND PENALTY BIDS. FOR A DESCRIPTION OF
THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE> 4

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and consolidated financial
statements (including the notes thereto) appearing elsewhere in this Prospectus.
As used herein, "Sauer" and "Company" refer to Sauer Inc. and its consolidated
subsidiaries. Unless otherwise indicated, the information in this Prospectus
does not give effect to the exercise of the over-allotment option. All share and
per share data contained in this Prospectus have been adjusted for a
12,500-for-1 stock split effective on April 22, 1998.

Certain information contained in this summary and elsewhere in this
Prospectus, including information with respect to the Company's plans and
strategy for its business, outlook, capital expenditure program and new
products, consists of forward-looking statements that involve risks and
uncertainties. For a discussion of important factors that could cause actual
results to differ materially from the forward-looking statements contained
herein, see "Risk Factors."

THE COMPANY

Sauer is a worldwide leader in the design, manufacture and sale of highly
engineered hydraulic systems and components ("mobile hydraulics") for use
primarily in demanding applications of off-highway mobile equipment. Sauer's
products include hydrostatic transmissions, open circuit piston pumps, gear
pumps and motors, valves, mechanical gear boxes and controls. Sauer is the
worldwide leader in hydrostatic transmissions, with an estimated 35% share
(based on sales) of the world market. In addition, Sauer is a world leader in
the production of gear pumps and motors, with both special designs and a
standard range of high performance units.

Sauer is a leader in the design and manufacture of high performance mobile
hydraulics components and has the ability to bring these components together in
a total vehicle system using electronic sensors and microprocessor controls
programmed with the Company's proprietary software. Increasingly, the propulsion
and work function systems are being integrated with all other elements of
vehicle performance, including engine management and safety and data gathering
for productivity and maintenance, to achieve optimum vehicle performance.
Customers are looking to consolidate their supplier base, devote their
engineering resources to overall vehicle design and use a supplier's expertise
to design and supply hydraulic systems to achieve the vehicle's performance
objective. Because the components and systems supplied by Sauer are usually the
most technically advanced and highest value products on a vehicle (excluding the
engine), the Company is in a leading position to be selected by customers as a
key supplier and systems integrator. To meet the full range of vehicle
propulsion and work function demands, Sauer is increasingly working with
customers, suppliers and other component manufacturers to develop total
hydraulic systems, including braking, steering, cooling and an overall
microprocessor control system. Sauer's strong market position, technology
leadership and systems expertise have led to, and are expected to continue to
lead to, close working relationships with its customers.

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<PAGE> 5

Europe through sales subsidiaries in Belgium, France, Holland, Italy, Slovakia,
Spain, Sweden and the United Kingdom. With 13 manufacturing facilities in the
United States, Europe and China, the Company can adapt its products to local
market needs and has significant flexibility to meet customer delivery
requirements. In addition, Sauer licenses its hydrostatic transmission
technology to manufacturers that operate in Brazil, India and Japan.

INDUSTRY OVERVIEW

The United States, Europe and Japan are the primary markets in which mobile
hydraulic products are manufactured and sold. Over 80% of such products are
produced and incorporated into vehicles manufactured in these three regions.
International competition is primarily between large U.S. and German suppliers.
Historically Japanese companies have licensed mobile hydraulic technology from
U.S. and German companies and have focused almost exclusively on the East Asian
market.

Sales of the Company's products and systems have grown at a faster rate
than the underlying mobile hydraulic markets. The Company's revenues have grown
at a compound annual growth rate over a five-year and ten-year period of 22.0%
and 12.9%, respectively, in the United States, 6.5% and 2.5%, respectively, in
Europe (or 9.0% and 2.8%, respectively, excluding exchange rate effects), and
15.3% and 7.9%, respectively, in total. In the United States, as reported by the
National Fluid Power Association ("NFPA"), the five-year and ten-year compound
annual growth rates for mobile hydraulics have been 17.3% and 8.9%,
respectively. In Europe, as reported by the European Committee for Oil Hydraulic
& Pneumatic Transmission ("CETOP"), the rates have been 6.9% and 2.9%,
respectively. The CETOP data are for both mobile and industrial hydraulic
production. The Company believes that in Europe the mobile hydraulic market is
growing somewhat faster than the industrial hydraulic market. The Company
expects overall market growth rates to increase somewhat in Europe while
moderating in the United States.

GROWTH STRATEGY

Sauer's strategy is to be the technology leader, market leader and total
quality leader in the manufacture and supply of components and systems to
transmit and control hydraulic power in mobile equipment in major world markets,
although no assurance can be given that Sauer's efforts to become the technology
leader, market leader and total quality leader in the manufacture and supply of
such components and systems will be successful. Sauer competes based on
technological product innovation, quality and customer service. The key
components of Sauer's growth strategy are as follows:

Enhance Product Offering and Expand Content on Existing Vehicles. Sauer
has concentrated on significantly broadening and enhancing its product
offering. The Company's broader product line, including integrated
solutions utilizing microprocessor controls, provides a more complete
range of choice to the Company's OEM customers. Sauer intends to achieve
significant growth by increasing its sales content per vehicle to
existing customers.

Expand into New Mobile Hydraulic Vehicle Applications. Sauer plans to
develop mobile hydraulic products to enter into new vehicle markets,
such as industrial forklift trucks and agricultural and industrial
tractors, where hydrostatic transmissions have not been widely used;
however, there can be no assurance that Sauer will be successful in
developing products for any of these markets. The application of the
Company's hydrostatic technology to previously untapped markets
represents a significant future growth opportunity for the Company.

Capitalize on Global Presence; Build Asian Presence. Sauer is committed
to being a global company in order to serve the needs of its global
customers. The Company's customers manufacture and sell their products
throughout the world and require convenient access to their suppliers'
products and services. To meet this requirement, the Company has modern
manufacturing facilities in the United States and Europe and a network
of sales companies, licensees, distributors and authorized service
center locations around the world. The Company's presence in Asia is
currently limited. To expand its presence in the East Asian market, the
Company has recently established both a new manufacturing facility and
sales office in China.

2
<PAGE> 6

Improve Gross Margins Through Operating Effectiveness and Lower
Costs. The Company intends to improve margins by reducing overhead
costs, improving worker productivity, shortening production cycle times
and rationalizing its product mix. The Company is expanding and
equipping existing facilities and building new manufacturing facilities
to increase production capacity for new and existing products and to
enhance production efficiencies. For example, a portion of the Company's
1998-2000 capital expenditures will be used to upgrade machine tools to
reduce tool changeover times and improve machining tolerances, which
will improve product quality and reduce production times. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Liquidity and Capital Resources" and
"Business -- Manufacturing." The major expansion of investment in
Slovakia, where total employment cost is approximately 15% of that in
Germany, will also improve margins in Europe. In addition, the Company
believes that the most important contribution to cost reduction comes
from investment in a skilled workforce able to adapt to new technology
and equipment.

Make Selective Acquisitions. Sauer may make selective acquisitions that
broaden the products and systems offered by the Company and enhance
Sauer's technological leadership, although no assurance can be given
that any acquisitions will be made or that, if made, any acquisition
will broaden the products offered by the Company or enhance its
technological position. In particular, Sauer seeks to take advantage of
the consolidation occurring in the electrohydraulics industry. Such
acquisitions are likely to involve smaller niche or regional companies,
and could also include larger acquisitions.

HISTORY AND ORGANIZATION

Sauer and its predecessor organizations have been active in the mobile
hydraulics industry since the 1960s. Established in 1987, the Company combined
the business of Sauer Getriebe AG ("Sauer Getriebe") in Europe and Sundstrand
Hydraulic Power Systems in North America. A predecessor to Sauer Getriebe was
founded in Germany in 1884. Sundstrand was founded in 1905 in the United States
and established its Hydro Transmission division in 1964. In 1967, Sauer
Getriebe, which was owned by Klaus H. Murmann, became a licensee of Sundstrand
to manufacture and sell hydrostatic transmissions in Europe. Recognizing the
need to serve their OEM customers on a more global basis, Sauer Getriebe and
Sundstrand combined their non-U.S. and U.S. mobile hydraulics transmission
businesses in an equal joint venture in 1987. In 1989, the Murmann family and
certain of the Company's executive officers bought Sundstrand's interest in the
joint venture. As a result of that transaction and a related restructuring in
1990, Sauer Inc. became the holding company for its operations. The Company's
United States operations are conducted through Sauer-Sundstrand Company (the
"U.S. Operating Company"), a wholly owned subsidiary of Sauer Inc., and the
Company's German operations are conducted through Sauer-Sundstrand GmbH & Co., a
German partnership (the "German Operating Company"), of which Sauer Inc. is a
general partner and 80% owner.

Upon completion of the Combined Offering, the Murmann family will own
approximately 56.5% of the outstanding Common Stock of the Company (or 51.6% if
the U.S. Underwriters' and Managers' over-allotment option is exercised in
full). See "Principal and Selling Stockholders" and "Description of Capital
Stock." The Murmann family also owns separate limited partnership interests in
the German Operating Company. Under the limited partnership agreement, the
German Operating Company is required to make an annual cash payment to the
limited partners of 8.5% (7.6% pro forma for the Combined Offering) of the
Company's consolidated income before taxes and before the Murmann family's
limited partnership interests. See "Relationship with Principal
Stockholder -- Murmann Family Limited Partnership Interests in the German
Operating Company."

The Company was incorporated under the name Sundstrand Venture Company in
Delaware on September 25, 1986. On January 22, 1990, the Company changed its
name to Sauer Inc. The Company's dual executive offices are located at 2800 East
13th Street, Ames, Iowa 50010, telephone number (515) 239-6000, and at Krokamp
35, 24539 Neumunster, Federal Republic of Germany, telephone number
011-49-4321-871-0.

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<PAGE> 7

THE COMBINED OFFERING

Common Stock Offered:

U.S. Offering....................... 4,500,000 Shares(1)(2)(3)

International Offering.............. 4,500,000 Shares(1)(2)(3)
-----------------------------------------------------
Total............................ 9,000,000 Shares(1)
=====================================================

Offered by the Company.............. 3,000,000 Shares

Offered by the Selling
Stockholders.......................... 6,000,000 Shares(1)

Total............................ 9,000,000 Shares(1)
=====================================================

Outstanding after the Combined
Offering.............................. 27,225,000 Shares

New York Stock Exchange symbol........ SHS

Frankfurt Stock Exchange symbol....... SAR

Use of Proceeds....................... For general corporate purposes,
including repayment of approximately
$15.4 million of indebtedness
incurred in the acquisition,
consummated on May 1, 1998 (subject
to local government approval), of the
real estate and building for the
Company's main facility in Germany,
repayment of $15.0 million of
long-term indebtedness of Sauer and
funding of a portion of the Company's
1998-2000 capital expenditure
program. Pending such application,
the net proceeds will be used to
reduce approximately $18.3 million of
short-term indebtedness. The Company
will not receive any proceeds from
the sale of Common Stock by the
Selling Stockholders.

Dividend Policy....................... The Company currently intends to pay
regular quarterly cash dividends of
$.07 on its Common Stock subject to
declaration by the Company's Board of
Directors. See "Dividend Policy."

Certain debt instruments to which the
Company or its subsidiaries are
parties restrict the ability of the
Company or its subsidiaries to pay
dividends or redeem or repurchase
capital stock. See "Management's
Discussion and Analysis of Financial
Condition and Results of
Operations -- Liquidity and Capital
Resources" and "Description of
Capital Stock -- Limitations on
Dividends and Other Financial
Restrictions on the Company and its
Subsidiaries."

Controlling Stockholder............... For information regarding the
Company's controlling stockholder,
see "Relationship with Principal
Stockholder."
- ---------------
(1) Excludes the 1,350,000 shares of Common Stock that may be purchased from
Klaus H. Murmann and K. Murmann & Co. KG pursuant to the over-allotment
option.

(2) The final allocation of Common Stock between the U.S. Offering and the
International Offering may differ from the initial allocation set forth
above.

(3) Includes an aggregate of 300,000 Shares reserved for the Employee Offering.

4
<PAGE> 8

For additional information concerning the Combined Offering, including
information relating to the determination of the initial public offering price,
see "The Combined Offering."

RISK FACTORS

Prospective investors should consider all the information contained in this
Prospectus before making an investment in the Common Stock. In particular,
prospective investors should consider carefully the factors discussed under
"Risk Factors."

5
<PAGE> 9

SUMMARY FINANCIAL DATA

The following summary consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's consolidated financial statements
(including the notes thereto) appearing elsewhere in this Prospectus.

<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997
--------------------------
ACTUAL AS ADJUSTED(3)
-------- --------------
<S> <C> <C>
BALANCE SHEET DATA
Total assets................................................ $390,903 $408,591
Current liabilities......................................... 139,302 122,755
Long-term debt.............................................. 75,198 66,468
Stockholders' equity........................................ 85,301 128,266
</TABLE>

- ---------------
(1) Pro forma basic and diluted net income per share is computed based upon: (i)
pro forma net income which gives effect to the elimination of interest
expense, net of income tax and minority interest, related to $15.0 million
of long-term indebtedness and (ii) the basic and diluted weighted average
common shares outstanding, as adjusted to reflect the sale by the Company of
922,509 shares of Common Stock offered by it hereby and the application of
the net proceeds therefrom to repay $15.0 million of long-term indebtedness
as described in "Use of Proceeds."

(2) EBITDA for any relevant period presented above represents net income (loss),
plus provision for income taxes and net interest expense, plus depreciation
and amortization. EBITDA may not be comparable to similarly titled measures
reported by other companies. While EBITDA should not be construed as a
substitute for operating income or a better indicator of liquidity than cash
flow from operating activities, which is determined in accordance with
generally accepted accounting principles, it is included herein to provide
additional information with respect to the ability of the Company to meet
its future debt service, capital expenditures and working capital
requirements. EBITDA is not necessarily a measure of the Company's ability
to fund its cash needs, and its discretionary use of EBITDA will be subject
to the Company's future cash needs relating to its capital expenditures,
working capital

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<PAGE> 10

requirements, future debt service requirements and dividend payments. See
the Company's consolidated financial statements (including the notes
thereto) appearing elsewhere in this Prospectus.

(3) As adjusted to give effect to the issuance of 3,000,000 shares of Common
Stock in the Combined Offering (after deducting the estimated expenses of
the Combined Offering payable by the Company, including underwriting
commissions on the Common Stock sold by the Company) and the application of
the net proceeds therefrom to reduce approximately $18.3 million of
short-term and $15.0 million of long-term indebtedness. Additionally, the
application of the net proceeds therefrom will be utilized to repay
indebtedness incurred in connection with the acquisition of the German
facility, consummated on May 1, 1998, subject to local government approval.
In connection with the acquisition of the German facility, "As adjusted"
gives effect to recording: (i) approximately $17.7 million for the German
facility at the seller's historical cost basis, (ii) the mortgage of
approximately $8.0 million at its carrying value and (iii) a reduction in
additional paid-in capital of approximately $5.8 million for the difference
between the appraised value and the seller's historical cost basis in the
German facility.

RECENT DEVELOPMENTS

Based on preliminary, unaudited data for the three-month period ended March
29, 1998, the Company expects to report net sales of $152.9 million and net
income of $6.5 million. Net sales of $152.9 million increased by $17.0 million,
or 12.5%, from first quarter 1997 net sales of $135.9 million. Net sales
increased by 15.0% excluding the impact of currency fluctuation. Compared to the
first quarter of 1997, North American sales increased by 17.7% and European
sales increased by 4.2%, or 10.6% excluding the impact of currency fluctuation.
East Asian sales decreased by $3.1 million, or 55.7%.

Operating margins for first quarter 1998 were down compared to first
quarter 1997 for both North America and Europe. Operating margins were adversely
affected by the significant investments being made in engineering, research and
development and manufacturing processes and capacity, including the move of the
Minneapolis operations and construction of the Lawrence plant, as well as
declines in the higher margin Asian sales.

Net income for first quarter 1998 of $6.5 million decreased by $1.4
million, or 17.7%, from first quarter 1997 net income of $7.9 million. In
addition to the impact of the lower operating margins, net income was also
impacted by an increase in interest expense of $0.9 million. North American
first quarter 1998 net income of $6.5 million decreased by $0.5 million, or
7.1%, from first quarter 1997 net income of $7.0 million. European first quarter
1998 net income of $1.7 million decreased by $1.7 million, or 50%, from first
quarter 1997 net income of $3.4 million.

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<PAGE> 11

RISK FACTORS

An investment in the shares of Common Stock offered hereby involves a
significant degree of risk. Prospective investors should consider carefully the
following factors, together with the other information contained in this
Prospectus, in evaluating whether to purchase the Common Stock.

COMPETITION

The mobile hydraulics industry is intensely competitive, with competition
principally based on breadth of product offerings, systems capability, product
performance, quality, price, durability and availability of skilled aftermarket
support. There are a relatively small number of competitors, usually divisions
of large companies such as Mannesmann (Rexroth division), Eaton,
Aeroquip-Vickers, Linde AG and Parker Hannifin, that offer broad product ranges
across international markets. In addition, the Company competes with a large
number of smaller companies that typically offer a single, specialized product
on a more limited geographic basis. Certain of the Company's competitors have
greater financial and other resources and may have lower cost structures than
the Company and can thus better withstand adverse economic or market conditions.
Companies not currently in direct competition with the Company may introduce
competing products in the future. For example, the Company may face competition
from current and prospective OEM customers, who evaluate the Company's products
against the merits of manufacturing components internally. To remain
competitive, the Company must continue to make capital and operational
expenditures, invest in research and development, maintain and enhance quality
levels, deliver finished products on a reliable basis and compete favorably on
the basis of price. Failure of the Company to continue to compete effectively
could have a material adverse effect on the Company's business, financial
condition and results of operations.

PRICING AND COMPETITIVE PRESSURES FROM OEM CUSTOMERS

Approximately 70% of the Company's sales are directly to OEM customers.
Increasingly, OEM customers are seeking to use their positions as volume
purchasers in the mobile hydraulics market to obtain preferential pricing and to
obtain substantial quality assurance protection from suppliers. To remain
competitive with others selling to these OEMs, the Company will continue to face
significant limitations on its ability to raise and, in some cases, maintain
current price levels on sales to such customers. In addition, the Company
expects that additional capital and operating expenditures will be required to
meet the enhanced quality assurance protection its OEM customers require. These
developments could have a significant impact on the Company's operating results.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."

CYCLICALITY; RISKS ASSOCIATED WITH GENERAL ECONOMIC CONDITIONS

The capital goods industry in general and the mobile hydraulics industry in
particular are subject to economic cycles. Cyclical downturns have in the past
had and could in the future have a material adverse effect on the demand for the
Company's products and, consequently, on the Company's business, financial
condition and results of operations. Demand for the Company's products is
dependent upon the general condition of the off-highway mobile equipment
industry which may be affected by numerous factors, including levels of
construction activity, weather conditions and interest rates. The Company's
results of operations are also subject to price competition and the cost of
supplies and labor, both of which are affected by general economic conditions.
The Company derives substantial sales from cyclical industries, including the
turf care, material handling, construction and agricultural equipment
industries. Periods of economic recession in the United States or Europe or any
other major industrial market could cause a substantial decrease in the
Company's net sales and have a material adverse effect on the Company's
business, financial condition and results of operations. Currently, markets in
the East Asia region in which the Company does business are experiencing an
economic disruption. In 1997, the Company had sales of $15.5 million in East
Asia or 3.0% of the Company's total revenues. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Other
Matters -- Asian Crisis Impact."

RISKS RELATING TO GROWTH STRATEGY

A key element of the Company's growth strategy is its continued success in
developing new, enhanced hydraulic systems and components for its existing
markets and new applications of its technology to new

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<PAGE> 12

market segments. The Company may not be successful in developing these new
products, or such products may not compete successfully in the market.

In pursuing its growth strategy, the Company intends to expand its presence
in existing markets and to enter new product markets, both of which will require
significant increases in manufacturing capacity and research, engineering and
development efforts. The Company has commenced an expansion program requiring
capital expenditures to construct new facilities and expand existing operations.
The expansion program may take longer or require more capital than is currently
planned. The Company may finance these capital expenditures from cash flow from
operations, bank or institutional borrowings or the issuance of equity or debt
securities. The Company may not be able to obtain such financing or, if
available, such financing may not be on terms acceptable to the Company.

The Company's expansion program and product development efforts are
expected to require significant expenditures in advance of anticipated revenues.
This may have a negative effect on the Company's operating results until such
time as these expenses are offset by increased revenues.

DEPENDENCE ON SKILLED PERSONNEL

The Company's future operating results and its development of new
technologies and products depend to a significant degree upon the continued
contribution of its technical, engineering and research personnel and skilled
labor force. This segment of the labor market in the United States and in the
United Kingdom is currently experiencing very tight supply conditions. The
Company competes for qualified technical, engineering and research personnel
with numerous other employers, some of which have greater financial and other
resources than the Company. The Company's continued success depends on its
ability to attract and retain a skilled labor force at all its facilities. While
the Company has been successful in attracting and retaining skilled employees in
the past, the Company may not continue to be successful in attracting or
retaining the personnel it requires to develop, manufacture and market its
products and expand its operations in the future.

INTERNATIONAL SALES; CURRENCY FLUCTUATIONS AND INVESTMENTS IN EMERGING MARKETS

In 1997, approximately 62% of the Company's net sales were generated in
U.S. dollars, 37% in European currencies and 1% in Chinese currency. The Company
expects that sales outside the United States will continue to account for a
significant portion of its net sales in future periods. International sales are
subject to various risks, including the impact of possible recessionary
environments in various economies, unexpected changes in regulatory
requirements, tariffs and other trade barriers, potentially adverse tax
consequences, trade or currency restrictions and, particularly in emerging
economies, potential political and economic instability and regional conflicts.
Any or all of these factors could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

In 1997, approximately 38% of the Company's sales were made in currencies
other than the U.S. dollar, including 20% in Deutsche marks, 9% in British
pounds and 3% in Italian lira. The Company's financial statements, which are
presented in U.S. dollars, can be impacted by foreign exchange fluctuations
through both translation risk and transaction risk. Translation risk is the risk
that the financial statements of the Company for a particular period or as of a
certain date are affected by changes in the exchange rates that are used to
translate the financial statements of the Company's foreign operations from
foreign currency into U.S. dollars. Transaction risk is the risk of the Company
receiving its sales proceeds or holding its assets in a currency different from
that in which it pays its expenses and holds its liabilities. Transaction gains
and losses have not been significant given the Company's balanced global
manufacturing presence. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Impact of Currency Fluctuations."

Since 1995, the Company has made substantial investments in two facilities
in Slovakia and has entered into a joint venture in Shanghai, China. Operations
in emerging economies such as Slovakia and China often are subject to numerous
risks and uncertainties, including political, economic and legal risks such as
unexpected changes in regulatory requirements, taxes, tariffs, customs, duties
and other trade barriers, difficulties in staffing and managing foreign
operations, foreign exchange controls that restrict or prohibit repatriation of
funds, and technology export and import restrictions or prohibitions. The
success of market reforms undertaken in these countries is also uncertain, and
further economic and political instability may
9
<PAGE> 13

occur. Legal systems in emerging economies have limited experience with
commercial transactions between private parties. The extent to which contractual
obligations will be honored and enforced is uncertain.

CONCENTRATION OF SUPPLIERS

As part of the Company's strategy to cut costs, the Company looks to
concentrate its purchases to fewer suppliers. The Company believes this move to
a more limited number of suppliers results in closer working and technical
relationships with its suppliers that contribute to advances in technology. In
addition, these suppliers, as a result of the increased volume of the Company's
purchases, are expected to provide more efficient and reliable service and more
competitive prices when selected as the single supplier. While this reliance on
a reduced number of suppliers has not in the past resulted in any disruption in
deliveries of supplies that materially affected the Company's business or
results of operations, in the future one or more of the Company's suppliers'
operations could be disrupted or a supplier could decide to discontinue
supplying the Company, in which case the Company's operations or operating
results could be adversely affected. Although the Company believes that in such
case it would be able to find an acceptable replacement supplier, it may take
time to find a new supplier and for such supplier to provide the needed
material. The new supplier may not provide financial terms or services as
advantageous as the replaced supplier.

TECHNOLOGICAL CHANGE

The hydraulic industry and markets for component parts of mobile hydraulics
are subject to technological change, evolving industry standards, changing
customer requirements and improvements in and expansion of product offerings.
Although the Company believes that it has the technological capabilities to
remain competitive, technological advances or developments by competitors or
others could result in the Company making significant capital expenditures in
order to remain competitive and to avoid material adverse effects on its
business, financial condition and results of operations.

CONCENTRATION OF OWNERSHIP OF THE COMPANY; MURMANN FAMILY'S LIMITED PARTNERSHIP
INTERESTS

Upon completion of the Combined Offering, the Murmann family, the Company's
principal stockholders, will own approximately 56.5% of the outstanding Common
Stock of the Company (or 51.6% if the over-allotment option is exercised in
full). See "Relationship with Principal Stockholder." Accordingly, persons
purchasing Common Stock in the Combined Offering will not, either alone or
acting collectively, be able to elect any members of the Company's Board of
Directors or control any corporate actions.

The Murmann family also owns limited partnership interests in the German
Operating Company. Pursuant to the limited partnership agreement, the consent of
the limited partners is required for the German Operating Company to take
certain actions. In addition, under the limited partnership agreement, the
German Operating Company is required to make an annual cash payment to the
limited partners of 8.5% (7.6% pro forma for the Combined Offering) of the
Company's consolidated income before taxes and before the Murmann family's
limited partnership interests. See "Relationship with Principal
Stockholder -- Murmann Family Limited Partnership Interests in the German
Operating Company."

ASIAN ECONOMIC CRISIS

The Company has a 60% interest in a joint venture located in Shanghai,
China and makes export sales into Asia. Several countries in Asia are
experiencing a severe economic crisis, which is affecting and will continue to
affect the joint venture business and export sales and the Company's operating
margins and net income. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Other Matters -- Asian Crisis Impact." In
addition, the Asian crisis may have an impact on sales of the Company's
customers in Asia, which could adversely impact the Company's sales. The Company
does not expect the impact of the Asian crisis on its joint venture business,
export sales and sales to customers, individually or in the aggregate, to have a
material adverse effect on its financial condition or results of operations,
although there can be no assurance in this regard.

LIABILITIES RELATED TO NEUMUNSTER FACILITIES

The German Operating Company previously leased its principal facilities
from Sauer GmbH & Co. Hydraulik KG ("Sauer Hydraulik"), which is wholly owned by
the Murmann family. Effective May 1, 1998 (subject to local government
approval), the Company purchased such facilities from Sauer Hydraulik. See

10
<PAGE> 14

"Use of Proceeds." Pursuant to the purchase agreement and the lease, the German
Operating Company is, and will continue to be, obligated to fully indemnify
Sauer Hydraulik against all liabilities incurred in connection with the premises
and the conduct of the business, including environmental liabilities, and is
responsible for all environmental damages to the premises, including the cost of
clean-up of such damages, regardless of whether the liabilities or damages were
incurred by, or result from the use of, a previous owner of the facilities. The
Company does not believe that these liabilities under the purchase agreement and
the lease will have a material adverse effect on its business, results of
operations or financial condition, although there can be no assurance in this
regard. See "Business -- Environmental Matters."

NO PRIOR TRADING MARKET FOR COMMON STOCK

Prior to the Combined Offering, there has been no public market for the
Common Stock. Although the Common Stock has been approved for listing on the New
York Stock Exchange and on the Frankfurt Stock Exchange, subject to official
notice of issuance, an active trading market may not develop or be sustained
either in the United States or in Germany after the Combined Offering. The
initial public offering price has been negotiated among the Company, the
representatives of the Selling Stockholders and the representatives of the
Underwriters and may not be indicative of prices that will prevail in the
trading market after the Combined Offering, and the market price of shares of
Common Stock after the Combined Offering might fall below the initial public
offering price. See "The Combined Offering -- Determination of Offering Price"
and "Underwriting" for a discussion of the factors used to determine the initial
public offering price.

DILUTION

Purchasers of the shares of Common Stock offered hereby will experience
immediate dilution in the net tangible book value per share. See "Dilution."

SHARES ELIGIBLE FOR FUTURE SALE

Subject to applicable United States federal securities laws and the
agreement described below, after completion of the Combined Offering, the
Murmann family and management may sell or distribute any and all of the shares
of Common Stock they own. Sales or distribution by the Murmann family or
management of substantial amounts of Common Stock, or the perception that such
sales or distribution could occur, could adversely affect the prevailing market
price for the Common Stock. The Murmann family has advised the Company that its
current intent is to continue to hold at least 50.1% of the Common Stock
outstanding following the Combined Offering. However, the Murmann family is not
subject to any contractual obligation to retain any shares of Common Stock,
except that the Murmann family, as well as certain members of management, have
agreed not to sell or otherwise dispose of any shares of the Common Stock for a
period of 180 days after the date of this Prospectus without the prior written
consent of Credit Suisse First Boston Corporation, as representative of the U.S.
Underwriters and Managers, subject to certain exceptions. The Company has agreed
to register shares held by the Murmann family for future sales from time to time
upon request. See "Shares Eligible for Future Sale" and "Underwriting."

ANTI-TAKEOVER PROVISIONS

Certain provisions of the Company's Restated Certificate of Incorporation
and By-Laws may render more difficult or have the effect of discouraging
unsolicited takeover bids from third parties or the removal of incumbent
management of the Company. See "Description of Capital Stock -- Certain
Provisions of the Restated Certificate of Incorporation and By-Laws That May
Have an Anti-Takeover Effect." Although such provisions do not have a
substantial practical significance to investors while the Principal Stockholder
controls the Company, such provisions could have the effect of depriving
stockholders of an opportunity to sell their shares at a premium over prevailing
market prices should the Principal Stockholder's voting power decrease to less
than 50%. In addition, certain of the Company's and its subsidiaries' credit
agreements contain default provisions with respect to certain changes of control
of Sauer. See "Description of Capital Stock -- Limitations on Dividends and
Other Financial Restrictions on the Company and its Subsidiaries."

11
<PAGE> 15

THE COMBINED OFFERING

GENERAL

Of the 9,000,000 shares of Common Stock being sold in the Combined
Offering, the Company is issuing and selling 3,000,000 shares of Common Stock
and the Selling Stockholders are selling 6,000,000 shares of Common Stock. In
addition, Klaus H. Murmann and K. Murmann & Co. K.G. have granted the
Underwriters and Managers an option to purchase up to an aggregate of 1,350,000
additional shares of Common Stock at the initial public offering price less
underwriting discounts and commissions for the purpose of covering
over-allotments, if any. Upon completion of the Combined Offering, the Murmann
family will own approximately 56.5% of the outstanding Common Stock (or 51.6% if
the over-allotment option is exercised in full). See "Principal and Selling
Stockholders." The Company will not receive any proceeds from the sale of the
Common Stock by the Selling Stockholders.

The Common Stock is being offered by the U.S. Underwriters in the U.S.
Offering and by the Managers in the International Offering.

The U.S. Underwriters and Managers have reserved for sale, at the initial
public offering price, up to 300,000 shares of Common Stock (or approximately 3%
of the shares offered in the Combined Offering, assuming the over-allotment
option is not exercised) for employees, directors and certain other persons
associated with the Company who have expressed an interest in purchasing such
shares in the Combined Offering. The number of shares available for sale to
investors in the Combined Offering will be reduced to the extent such persons
purchase such reserved shares. Any reserved shares not so purchased will be
offered by the U.S. Underwriters or the Managers to investors on the same terms
as the other shares offered hereby.

The U.S. Offering

An offering of 4,500,000 shares of Common Stock will be made by the U.S.
Underwriters to the public in the United States and on a private placement basis
in Canada. Credit Suisse First Boston Corporation, Smith Barney Inc. and
Deutsche Morgan Grenfell Inc. are the representatives of the U.S. Underwriters.
The Common Stock has been approved for listing on the New York Stock Exchange
under the symbol SHS, subject to official notice of issuance.

The International Offering

An offering of 4,500,000 shares of Common Stock will be made by the
Managers in Germany and elsewhere outside the United States and Canada. The
offering of 4,500,000 shares of Common Stock in Germany will be a public
offering. Credit Suisse First Boston (Europe) Limited, Deutsche Bank AG and
Smith Barney Inc. are the Managers. The Common Stock has been approved for
listing on the Frankfurt Stock Exchange under the symbol SAR, subject to
official notice of issuance. Credit Suisse First Boston Aktiengesellschaft has
sponsored such application.

The final allocation of Common Stock between the U.S. Underwriters and
Managers may differ from the amounts set forth above.

DETERMINATION OF OFFERING PRICE

Prior to the Combined Offering, there has not been any public market for
the Common Stock. The initial public offering price has been determined by
negotiation among the Company, the representatives of the Selling Stockholders
and the representatives of the U.S. Underwriters and Managers. In determining
the initial public offering price, consideration has been given to, among other
things, the current financial position and results and future prospects of the
Company, the general condition of the German, United States and other securities
markets, prices of similar securities of German and U.S. companies, market
conditions for initial public offerings and other relevant factors. The prices
at which the shares of Common Stock will trade in the public market could be
lower than the initial public offering price.

12
<PAGE> 16

USE OF PROCEEDS

The net proceeds to be received by the Company from the issuance of the
3,000,000 shares of Common Stock being sold by the Company in the Combined
Offering are estimated to be $48.8 million, after deducting the estimated
expenses of the Combined Offering payable by the Company, including underwriting
commissions with respect to the Common Stock sold by the Company. Such net
proceeds will be used by the Company for general corporate purposes, including
approximately $15.4 million to repay indebtedness incurred in connection with
the acquisition, consummated on May 1, 1998 (subject to local government
approval), of the real estate and building of its main facility in Germany owned
by the Murmann family, $15.0 million to repay long-term indebtedness of Sauer
under a revolving credit agreement and the remainder to fund a portion of the
Company's 1998-2000 capital expenditure program. The indebtedness incurred to
acquire the principal German facility bears interest at a rate of 5% per year
and matures on November 1, 1998. The long-term indebtedness to be repaid bears
interest at a rate of 7.05% per year as of December 31, 1997 and matures in
August 2001. See "Relationship with Principal Stockholder" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

The Company presently expects capital expenditures to be in the range of
$150-$230 million during the 1998-2000 period. The Company expects these capital
expenditures to be used primarily for the construction of new manufacturing
facilities and the purchase of manufacturing equipment for all its business
units to increase production capacity for new and existing products, to increase
production efficiencies and for replacement purposes. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources." Pending such application, the
net proceeds will be used to reduce approximately $18.3 million of short-term
indebtedness under a revolving credit facility used to fund working capital,
which bears interest at a rate of 4.29% per year as of December 31, 1997,
matures at various times over the next year and is callable at any time. Repaid
amounts of such short-term indebtedness will be reborrowed to pay capital
expenditures as they are incurred.

DILUTION

The pro forma net tangible book value of the Company at December 31, 1997
prior to the Combined Offering was $76.5 million, or $3.16 per share, reflecting
a reduction in additional paid-in capital for the difference between the
appraised value and the seller's historical cost basis of the acquisition of the
German facility consummated on May 1, 1998. Pro forma net tangible book value
per share is determined by dividing the pro forma net tangible book value of the
Company (tangible assets less liabilities) by the number of outstanding shares
of Common Stock. After giving effect to the issuance of 3,000,000 shares of
Common Stock being sold by the Company in the Combined Offering (after deducting
the estimated expenses of the Combined Offering payable by the Company,
including underwriting commissions), at December 31, 1997, the pro forma net
tangible book value of the Company would have been $125.3 million, or $4.60 per
share, representing an immediate increase in net tangible book value of $1.44
per share to the existing stockholders and an immediate dilution of $13.40 per
share to the new investors in the Combined Offering. The following table
illustrates the per share dilution to the new investors in the Combined Offering
at December 31, 1997 (after deducting the estimated expenses payable by the
Company, including underwriting commissions):

<TABLE>
<CAPTION>
PER
SHARE
------
<S> <C>
Initial public offering price............................... $18.00
Pro forma net tangible book value at December 31, 1997 prior
to the Combined Offering.................................. 3.16
Increase in net tangible book value attributable to
purchasers in the Combined Offering....................... 1.44
Pro forma net tangible book value after the Combined
Offering.................................................. 4.60
------
Dilution in net tangible book value to purchasers of shares
of Common Stock in the Combined Offering.................. $13.40
======
</TABLE>

13
<PAGE> 17

The following table summarizes, as of December 31, 1997, the difference
between the number of shares of Common Stock purchased or to be purchased from
the Company, the total consideration paid or to be paid and the average
consideration paid or to be paid by the existing stockholders and the new
investors in the Combined Offering:

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
--------------------- ------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- -------- ------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Existing Stockholders................... 24,225,000 89.0% $ 74,759 58.1% $ 3.09
Purchasers of Common Stock in the
Combined Offering..................... 3,000,000 11.0 54,000 41.9 18.00
---------- ----- -------- ----- ------
Total......................... 27,225,000 100.0% $128,759 100.0% $ 4.73
========== ===== ======== ===== ======
</TABLE>

DIVIDEND POLICY

The Company expects to pay dividends in the future consistent with its cash
requirements and growth needs. The amount of dividends will be dependent upon
the Company's current and expected future financial performance, general
business conditions and other relevant factors. The Company currently expects to
pay quarterly dividends of $.07 per share. This anticipated dividend policy
could be changed and the Company could pay no dividends. The Company is a
holding company with no business operations of its own. The Company is therefore
dependent upon payments, dividends and distributions from its operating
subsidiaries for funds to pay dividends to holders of Common Stock.

Certain of the financing agreements restrict Sauer's ability to pay
dividends to its stockholders or redeem or repurchase capital stock. In
addition, the Company's ability to pay dividends on the Common Stock is
effectively limited by certain restrictive covenants contained in the credit
agreements to which the U.S. Operating Company and the German Operating Company
are parties, which effectively limit the amount of dividends the U.S. Operating
Company or the German Operating Company can distribute to Sauer. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Description of Capital
Stock -- Limitations on Dividends and Other Financial Restrictions on the
Company and its Subsidiaries."

14
<PAGE> 18

CAPITALIZATION

The following table sets forth the capitalization of the Company at
December 31, 1997. This table should be read in conjunction with "Selected
Consolidated Financial Data," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Company's consolidated financial
statements, (including the notes thereto), appearing elsewhere in this
Prospectus.

<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------
ACTUAL AS ADJUSTED(1)
-------- --------------
(IN THOUSANDS)
<S> <C> <C>
Short-term debt (including current maturities of long-term
debt)..................................................... $ 61,230 $ 44,683
======== ========
Long-term debt.............................................. $ 75,198 $ 66,468
-------- --------
Minority interest in net assets of consolidated companies... 32,799 32,799
-------- --------
Stockholders' equity:
Common Stock, $.01 par value.............................. 249 279
Additional paid-in capital................................ 74,723 117,658
Cumulative translation adjustment......................... 256 256
Retained earnings......................................... 12,773 12,773
Common Stock in treasury (at cost)........................ (2,700) (2,700)
-------- --------
Total stockholders' equity........................ 85,301 128,266
-------- --------
Total capitalization........................................ $193,298 $227,533
======== ========
</TABLE>

- ---------------
(1) As adjusted to give effect to the issuance of 3,000,000 shares of Common
Stock in the Combined Offering (after deducting the estimated expenses of
the Combined Offering payable by the Company, including underwriting
commissions on the Common Stock sold by the Company) and the application of
the net proceeds therefrom to reduce $15.0 million of long-term indebtedness
and to reduce approximately $18.3 million of short-term indebtedness.
Additionally, the net proceeds therefrom will be utilized to repay
indebtedness incurred in the acquisition of the German facility, consummated
on May 1, 1998 subject to local government approval. In connection with the
acquisition of the German facility, "As Adjusted" gives effect to recording
the approximately $8.0 million carrying value of the mortgage and an
approximately $5.8 million reduction in additional paid-in-capital for the
difference between the appraised value and the seller's historical cost
basis in the German facility.

15
<PAGE> 19

SHARES ELIGIBLE FOR FUTURE SALE

Upon the completion of the Combined Offering, there will be 27,225,000
shares of Common Stock outstanding. Of the outstanding shares, 9,000,000 shares
sold in the Combined Offering will be freely tradeable without restriction under
the Securities Act (except for any shares purchased by affiliates of the
Company). Beginning 90 days after the date of this Prospectus, an additional
18,225,000 shares (including those owned by the Murmann family) will be eligible
for sale in the U.S. public market subject to compliance with the applicable
provisions of Rule 144. In addition, the Murmann family has the right pursuant
to an agreement, dated as of May 1, 1998, to require the Company to register
from time to time upon request all or any portion of the 15,390,625 shares
(14,040,625 shares if the over-allotment option is exercised in full) owned by
the Murmann family for sale in the U.S. public market. The Murmann family has
advised the Company that it has no current plans to exercise its registration
rights; however, subject to its agreement described below, it is not under any
contractual restriction against doing so. Sales or distributions of substantial
amounts of Common Stock by the Murmann family or management, or the perception
that such sales or distribution could occur, could adversely affect the
prevailing market price for the Common Stock.

The 27,225,000 outstanding shares (including those owned by the Murmann
family) may also be sold on the Frankfurt Stock Exchange upon listing of the
shares on the Frankfurt Stock Exchange. The sale of shares of Common Stock over
the Frankfurt Stock Exchange may affect the market price of the Common Stock on
the Frankfurt Stock Exchange, which in turn may affect the market price of the
Common Stock in the United States.

In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, a person (or persons whose shares of Common Stock
are required to be aggregated) who is deemed an affiliate is entitled to sell,
within any three-month period, a number of shares that does not exceed the
greater of 1% of the then outstanding number of shares of such class
(approximately 272,250 shares after the Combined Offering) or the average weekly
trading volume in composite trading on all national securities exchanges during
the four calendar weeks preceding the filing of the required notice of such
sale. As defined in Rule 144, an "affiliate" of an issuer is a person that
directly or indirectly, through one or more intermediaries, controls or is
controlled by, or is under common control with, such issuer. Klaus Murmann and
the Murmann family are affiliates of the Company.

While the Murmann family has advised the Company that its current intent is
to continue to hold at least 50.1% of the Common Stock outstanding following the
Combined Offering, it is not subject to any contractual obligation to retain any
shares of Common Stock. However, the Company, the Murmann family, certain
members of management and directors have agreed not to offer, sell, contract to
sell, announce their intention to sell, pledge or otherwise dispose of, directly
or indirectly, or file with the Securities and Exchange Commission a
registration statement under the Securities Act of 1933 relating to, any
additional shares of Common Stock or securities convertible into or exchangeable
or exercisable for any shares of Common Stock for a period of 180 days after the
date of this Prospectus without the prior written consent of Credit Suisse First
Boston Corporation on behalf of the U.S. Underwriters and the Managers, subject
to certain exceptions, including that any such restriction shall not apply to
issuances pursuant to the exercise of employee stock options outstanding on the
date hereof. See "Underwriting."

16
<PAGE> 20

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the historical Consolidated Financial Statements
(including the notes thereto) appearing elsewhere in this Prospectus. The
selected historical consolidated financial data have been derived from the
Consolidated Financial Statements of the Company for each of the fiscal years in
the five-year period ended December 31, 1997, which have been audited by Arthur
Andersen LLP, independent public accountants.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF INCOME AND LOSS DATA
Net sales........................................ $274,492 $362,482 $446,774 $467,566 $535,173
-------- -------- -------- -------- --------
Costs and expenses:
Cost of sales.................................. 219,189 274,206 336,700 354,034 404,065
Selling, general and administrative............ 38,046 43,934 48,128 51,856 52,575
Research and development....................... 14,573 16,068 18,796 20,505 20,655
-------- -------- -------- -------- --------
Total costs and expenses..................... 271,808 334,208 403,624 426,395 477,295
-------- -------- -------- -------- --------
Operating income................................. 2,684 28,274 43,150 41,171 57,878
Nonoperating income (expenses):
Interest expense............................... (8,018) (6,675) (6,932) (6,523) (8,305)
Interest income................................ 884 989 275 564 698
Royalty income................................. 1,139 1,094 1,695 1,156 1,150
Other, net..................................... (1,076) (579) 21 (584) 144
-------- -------- -------- -------- --------
Nonoperating expenses, net..................... (7,071) (5,171) (4,941) (5,387) (6,313)
-------- -------- -------- -------- --------
Income (loss) before income taxes and minority
interest....................................... (4,387) 23,103 38,209 35,784 51,565
Provision for income taxes....................... (1,439) (7,281) (5,182) (10,243) (15,944)
-------- -------- -------- -------- --------
Income (loss) before minority interest........... (5,826) 15,822 33,027 25,541 35,621
Minority interest in income of consolidated
companies(1)................................... (992) (4,448) (6,447) (6,643) (8,492)
-------- -------- -------- -------- --------
Net income (loss)................................ $ (6,818) $ 11,374 $ 26,580 $ 18,898 $ 27,129
======== ======== ======== ======== ========
Basic and diluted net income (loss) per common
share.......................................... $ (.30) $ .47 $ 1.10 $ .78 $ 1.12
======== ======== ======== ======== ========
Pro forma basic and diluted net income per common
share(2)....................................... $ 1.10
========
Basic and diluted weighted average common shares
outstanding.................................... 22,725 24,050 24,187 24,225 24,225
======== ======== ======== ======== ========
Cash dividends declared per common share......... $ 0 $ .08 $ .32 $ .32 $ .32
======== ======== ======== ======== ========
OTHER DATA
Backlog (at year-end)............................ $100,700 $187,400 $235,600 $227,000 $277,500
Capital expenditures............................. 13,334 21,350 45,689 56,284 66,750
Depreciation and amortization.................... 16,557 18,204 19,898 24,830 25,835
EBITDA(4)........................................ 18,312 42,545 58,317 59,930 76,515
Cash flows from (used in):
Operating activities........................... 25,391 40,904 36,694 47,670 42,744
Investing activities........................... (12,978) (21,048) (45,544) (56,198) (70,311)
Financing activities........................... (12,857) (13,543) 13,235 9,268 23,351
</TABLE>

17
<PAGE> 21

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Total assets........................... $200,288 $235,146 $304,237 $337,527 $390,903
Current liabilities.................... 82,629 92,705 144,557 126,944 139,302
Long-term debt......................... 36,200 34,451 27,582 56,334 75,198
Stockholders' equity................... 27,628 37,962 59,491 70,874 85,301
</TABLE>

- ---------------
(1) Includes Murmann family's limited partnership interests of $532, $(1,744),
$(2,954), $(2,707) and $(4,001) for 1993, 1994, 1995, 1996 and 1997,
respectively.

(2) Pro forma basic and diluted net income per share is computed based upon: (i)
pro forma net income which gives effect to the elimination of interest
expense, net of income tax and minority interest, related to $15.0 million
of long-term indebtedness and (ii) the basic and diluted weighted average
common shares outstanding, as adjusted to reflect the sale by the Company of
922,509 shares of Common Stock offered by it hereby and the application of
the net proceeds therefrom to repay $15.0 million of long-term indebtedness
as described in "Use of Proceeds."

(3) EBITDA for any relevant period presented above represents net income (loss),
plus provision for income taxes and net interest expense, plus depreciation
and amortization. EBITDA may not be comparable to similarly titled measures
reported by other companies. While EBITDA should not be construed as a
substitute for operating income or a better indicator of liquidity than cash
flow from operating activities, which is determined in accordance with
generally accepted accounting principles, it is included herein to provide
additional information with respect to the ability of the Company to meet
its future debt service, capital expenditures and working capital
requirements. EBITDA is not necessarily a measure of the Company's ability
to fund its cash needs, and its discretionary use of EBITDA will be subject
to the Company's future cash needs relating to its capital expenditures,
working capital requirements, future debt service requirements and dividend
payments. See the Company's Consolidated Financial Statements and the
related notes thereto appearing elsewhere in this Prospectus.

RECENT DEVELOPMENTS

Operating margins for first quarter 1998 were down compared to first
quarter 1997 for both North America and Europe. Operating margins were adversely
affected by the significant investments being made in engineering, research and
development and manufacturing processes and capacity, including the move of the
Minneapolis operations and construction of the Lawrence plant as well as
declines in the higher margin Asian sales.

18
<PAGE> 22

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with
the Company's financial statements and notes thereto included elsewhere in this
Prospectus. The Company's financial statements are stated in U.S. dollars and
have been prepared in accordance with U.S. GAAP.

OVERVIEW

The Company designs, manufactures and sells its products in North America
and Europe and sells its products throughout the rest of the world either
directly or through distributors. Recently, the Company has begun to manufacture
its products in East Asia at its new manufacturing plant in Shanghai, China.

Sauer's products are used by original equipment manufacturers ("OEMs") of
off-highway mobile equipment, including construction, road building and
maintenance, agricultural, turf care, material handling and oil field equipment.
These markets are typically cyclical depending on general economic conditions,
interest rates and weather. The effect of cyclicality is moderated somewhat
because the Company has substantial sales and operations in North America and
Europe, markets whose economic cycles may vary. There have been, however, times
- -- as in 1991 -- when cycles coincided, resulting in losses for both the North
American and European operations of the Company. Over the last three years the
Company's sales have been stronger in North America than in Europe, reflecting
stronger economic and market conditions in North America than in Europe.
Likewise, the effect of cyclicality can be moderated somewhat by the Company
selling to different market segments. For example, the turf care market might be
strong while the agricultural market is weak.

The Company sells primarily the same components and systems in North
America and Europe to many of the same large, global OEMs. The market segments
are also the same between North America and Europe with the exception of the
turf care market, which is primarily a North American market segment.

While the Company's customers may be the same for North America and Europe,
they can have very different needs. For example, North American customers
typically require higher power transmissions than those required in Europe,
while European customers have historically demanded more sophisticated controls.

Operating profit margins during the past three years have differed between
North America and Europe. North American margins have been significantly higher
than those in Europe, which have been declining. North American margins have
benefited from the stronger market conditions mentioned above. European margins
have been hurt by the sluggish economic conditions and higher labor costs,
especially those in Germany. The European margins have also been hurt by the
start-up costs of moving production into Slovakia. See Note 15 of Notes to
Consolidated Financial Statements included elsewhere in this Prospectus.

The Company expects overall market growth rates to increase somewhat in
Europe while moderating in North America. Sales growth is expected to come
primarily from volume increases as price increases are expected to be minimal,
reflecting the pressure on pricing from OEM customers.

In pursuing its growth strategy, the Company is making significant
investments in engineering, research and development as well as in manufacturing
processes and capacity. The Company expects these increased expenditures to have
an impact in the short term on operating margins.

IMPACT OF CURRENCY FLUCTUATIONS

The Company has operations and sells its products in many different
countries of the world and therefore conducts its business in various
currencies. The Company's financial statements, which are presented in U.S.
dollars, can be impacted by foreign exchange fluctuations through both
translation risk and transaction risk. Translation risk is the risk that the
financial statements of the Company, for a particular period or as of a certain
date, may be affected by changes in the exchange rates that are used to
translate the financial statements of the Company's operations from foreign
currencies into U.S. dollars. Transaction risk is the risk

19
<PAGE> 23

from the Company receiving its sale proceeds or holding its assets in a currency
different from that in which it pays its expenses and holds its liabilities.

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

<TABLE>
<CAPTION>
PERCENTAGE SALES GROWTH
OVER PRIOR YEAR
-------------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
As Reported................................................. 23.3% 4.7% 14.5%
Without Currency Impact..................................... 18.9 6.1 18.9
</TABLE>

With respect to transaction risk, the impact on the Company's operating
results is not significant. With its various manufacturing plants located
primarily in its customers' countries of operation, generally the Company sells
in the same currency in which it incurs its expenses.

OTHER MATTERS

Year 2000 Compliance -- The Company is currently in the process of
evaluating its information technology infrastructure for Year 2000 compliance.
The Company has plans in place to upgrade its business systems software in the
U.S. and Europe that will modify the software to make it Year 2000 compliant.
The upgrades are obtained from the Company's software vendors under the normal
ongoing maintenance agreements. The upgrades will be implemented primarily by
the Company's information technology staff, with support from outside
contractors as needed. The cost of the Company's information technology staff to
upgrade the business systems software is not separately accounted for or
estimated. The cost of outside contractors is not expected to be material to the
Company's results of operations. The Company's manufacturing operations make
extensive use of computer controlled machine tools. The Company is currently
evaluating Year 2000 compliance impact on these machine tools and has determined
they will need to be upgraded to make them Year 2000 compliant. The Company does
not have an estimate of the cost of upgrading these machine tools. As part of
the evaluation the Company is working with the suppliers of the machine tools to
understand their plans. The Company's products are not affected by the Year 2000
issue. The Company does not currently have any information concerning the Year
2000 compliance status of its suppliers and customers. In the event that any of
the Company's significant suppliers or customers does not successfully and
timely achieve Year 2000 compliance, the Company's business or operations could
be adversely affected.

Euro Currency Conversion -- The Company has formed a team to evaluate and
plan for the Euro currency conversion. The Company's business systems are
multi-currency functional and the Company's European operations transact
business today in various European currencies. The Company does not have an
estimate of the cost to implement the Euro currency, but does not expect the
cost to have a material effect on the Company's financial condition or results
of operations.

Asian Crisis Impact -- Several countries in Asia are experiencing a severe
economic crisis, characterized by reduced economic activity, lack of liquidity,
highly volatile foreign currency exchange and interest rates and unstable stock
markets. The Company has a 60% interest in a joint venture located in Shanghai,
China, which manufactures and sells high power hydrostatic transmissions, and
the Company also has export sales into Asia. The joint venture business and
export sales have been and will continue to be affected by the economic crisis.
With total assets of $10.5 million located in China and total Asian sales for
1997 of $15.5 million, the Company expects the crisis to have some effect on
results of operations, particularly given the higher margins of such sales. Many
of the Company's customers also sell into Asia. Any impact on their sales could
have an impact on the Company's sales. The Company does not believe this impact
on its sales, either individually or together with the impact of the Asian
crisis on export sales and the joint venture business, will have a material
adverse effect on its financial condition or results of operations, although
there can be no assurance in this regard.

20
<PAGE> 24

NEW ACCOUNTING PRINCIPLES

During 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings per Share," and SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." These changes did not
have any impact on the Company's financial position or results of operations.

RESULTS OF OPERATIONS

The Company's net sales by product line and geographic area, showing the
percentage change from the prior year, as reported and without the impact of
currency fluctuation, are set forth in the following table:

<TABLE>
<CAPTION>
1995 1996 1997
------ ---------------------------- ----------------------------
(U.S. DOLLARS IN MILLIONS, EXCEPT PERCENTAGES)
--------------------------------------------------------------------
% CHANGE % CHANGE
------------------- -------------------
NET NET AS W/O NET AS W/O
AMOUNT AMOUNT REPORTED CURRENCY AMOUNT REPORTED CURRENCY
------ ------ -------- -------- ------ -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales by product line:
Hydrostatic Transmissions... $340.0 $350.9 3.2% 5.0% $408.8 16.5% 21.5%
Gear Pumps and Motors ...... 63.1 64.2 1.8 1.7 64.4 0.3 2.2
Electrohydraulics and
other.................... 43.7 52.5 20.0 21.6 62.0 18.0 21.5
------ ------ ------
Total............... $446.8 $467.6 4.7% 6.1% $535.2 14.5% 18.9%
====== ====== ======
Net sales by geographic area:*
North America............... $241.1 $263.5 9.3% 9.3% $323.0 22.6% 22.6%
Europe...................... 199.4 189.1 (5.2) (2.0) 196.7 4.0 14.8
East Asia................... 6.3 15.0 138.1 143.3 15.5 3.3 7.0
------ ------ ------
Total.................... $446.8 $467.6 4.7% 6.1% $535.2 14.5% 18.9%
====== ====== ======
</TABLE>

- ---------------
* Net sales are attributed to geographic area based on location of customer.

1997 COMPARED TO 1996

Net sales -- Net sales for 1997 of $535.2 million increased by $67.6
million, or 14.5%, from 1996 net sales of $467.6 million. Net sales increased by
18.9% excluding the impact of currency fluctuation. Unit volume growth accounted
for the majority of the growth in net sales, with net price increases accounting
for less than 1% of the growth. Sales of hydrostatic transmissions accounted for
the major portion of the growth in net sales, growing by 21.5%, excluding the
impact of currency fluctuation. This growth came from the strong North American
and European growth of 22.6% and 14.8%, respectively. Gear pumps and motors
showed little growth in net sales, affected by the slower growing European
markets, the principal market for the Company's gear pumps and motors, compared
to the North American market. Electrohydraulics' and other products' net sales
grew by 21.5%, excluding the impact of currency fluctuation, reflecting the
strong growth of the Company's electrohydraulic valve business in North America.

Cost of sales -- Cost of sales for 1997 of $404.1 million was 75.5% of net
sales, compared to 75.7% of net sales for 1996. The slight improvement (decrease
in cost of sales as a percent of net sales) can be attributed to the favorable
impact of increased production volumes from net sales growth offsetting the
current year's unfavorable impact of increased capital investment in
manufacturing capacity. Cost of sales as a percentage of net sales improved in
North America, while that in Europe worsened in 1997 compared to 1996.

Selling, general and administrative expenses -- Selling, general and
administrative expenses for 1997 of $52.6 million increased by $0.7 million, or
1.4%, from 1996 expenses of $51.9 million. The small increase reflects general
inflation, partially offset by the cost reduction efforts in Germany and the
favorable impact of currency fluctuations in translation. As a percentage of net
sales, 1997 expenses were 9.8% compared to 11.1%

21
<PAGE> 25

for 1996. This improvement is a result of the growth in net sales compared to
the relatively fixed nature of these expenses, along with the cost reduction
efforts referred to above.

Research and development expenses -- Research and development expenses for
1997 of $20.7 million increased by $0.2 million, or 1.0%, from 1996 expenses of
$20.5 million. Without the impact of currency fluctuations the increase was
4.2%. This reflects normal increases in wage rates and other general inflation.

Nonoperating expenses, net -- Net nonoperating expenses for 1997 of $6.3
million increased by $0.9 million from 1996 net nonoperating expenses of $5.4
million. Net interest expense for 1997 of $7.6 million increased by $1.6 million
from 1996 net expense of $6.0 million due to the increase of 1% in the weighted
average interest rate for 1997 compared to 1996 and the increase of $4.1 million
in the average daily short-term borrowings for 1997 compared to 1996. Other,
net, increased by $.7 million due to changes in gains and losses relating to
disposals of fixed assets and currency transactions.

Provision for income taxes -- Provision for income taxes for 1997 of $15.9
million increased by $5.7 million from the 1996 provision of $10.2 million. The
increase comes from the increase in net income before income taxes and minority
interest of $15.8 million and the increase in the effective tax rate for 1997 of
30.9% from the 1996 rate of 28.6%.

Net income -- Net income of $27.1 million increased by $8.2 million from
1996 net income of $18.9 million, reflecting the 14.5% increase in net sales.
North America accounted for the increase which was in line with its increase in
net sales. European 1997 net income remained unchanged compared to 1996, due to
level sales between years and the weaker Deutsche mark which had a negative
impact on U.S. dollar intersegment purchases from North America, but from which
North America benefited on intersegment purchases from Europe.

1996 COMPARED TO 1995

Net sales -- Net sales for 1996 of $467.6 million increased by $20.8
million, or 4.7%, from 1995 net sales of $446.8 million. Net sales increased by
6.1% excluding the impact of currency fluctuation. Unit volume growth accounted
for the majority of the growth in net sales. Hydrostatics sales grew by 5.0%,
excluding the impact of currency fluctuation, with the North American market
growth of 9.3% being offset by the decrease in European sales of 2.0%. Gear
pumps and motors showed little growth in net sales due to the decrease in
European sales, the principal market for the Company's gear pumps and motors.
Electrohydraulics' and other products' net sales grew by 21.6%, excluding the
impact of currency fluctuation, attributable primarily to a new product
introduction by the Company's United Kingdom business unit.

Cost of sales -- Cost of sales for 1996 of $354.0 million were 75.7% of net
sales, compared to 75.3% of net sales for 1995. The slight increase in cost of
sales as a percentage of net sales was attributable to the Company's European
business and was caused by the negative impact on cost of sales from a reduction
of inventories causing lower production volumes in 1996 compared to the 1995
positive impact on cost of sales from an increase in inventories resulting in
higher production volumes. Cost of sales as a percentage of net sales improved
in North America for 1997 compared to 1996.

Selling, general and administrative expenses -- Selling, general and
administrative expenses for 1996 of $51.9 million increased by $3.8 million, or
7.9%, from 1995 expenses of $48.1 million. As a percentage of net sales, 1996
expenses were 11.1% compared to 10.8% for 1995. The increase in 1996 expenses
was due to normal increases in wage rates and general inflation and a $1.5
million write-off of goodwill relating to the 1994 acquisition of Control
Concepts, Inc.

Research and development expenses -- Research and development expenses for
1996 of $20.5 million increased by $1.7 million, or 9.0%, from 1995 expenses of
$18.8 million. Without the impact of currency fluctuations, the increase was
11.3%. The increase relates primarily to the U.S. and is the result of increased
investment in product development by adding engineers.

Nonoperating expenses, net -- Net nonoperating expenses for 1996 of $5.4
million increased by $0.5 million from 1995 net nonoperating expenses of $4.9
million. Net interest expense for 1996 of $6.0 million

22
<PAGE> 26

decreased by $0.7 million from 1995 net expense of $6.7 million, reflecting the
decrease of 2.4% in the weighted average interest rates from 1995 to 1996 more
than offsetting the increase in the average daily short-term borrowings from
1995 to 1996. Royalty income for 1996 of $1.2 million decreased by $0.5 million
from 1995 income of $1.7 million. A major part of the royalty income comes from
the Company's Japanese licensee and is a percentage of the licensee's sales,
primarily made in Japan in Japanese yen. The decrease in royalty income reflects
a decrease in the rate of royalty paid by the Company's Japanese licensee under
a new ten-year contract effective April 1, 1996.

Provision for income taxes -- Provision for income taxes for 1996 of $10.2
million increased by $5 million from the 1995 provision of $5.2 million. The
increase comes from the increase in the effective tax rate for 1996 of 28.6%
from the 1995 rate of 13.6%. The low 1995 rate resulted from the use of $7.2
million of operating loss and foreign tax credit carryforwards to lower the 1995
tax provision.

Net income -- Net income of $18.9 million decreased by $7.7 million from
1995 net income of $26.6 million. The decrease was related to the European
business, with North America showing a slight increase in 1996 net income
compared to 1995. European 1995 net income was strong due to the increased
production levels from increases in inventories mentioned above and due to the
benefit of the strong Deutsche mark in 1995 in making U.S. dollar intersegment
purchases from North America. The use of operating loss and foreign tax credit
carryforwards to lower the 1995 income tax provision (as mentioned above) also
contributed to the higher 1995 net income.

LIQUIDITY AND CAPITAL RESOURCES

The Company's principal sources of liquidity have been from internally
generated funds and borrowings under its credit facilities. Net cash provided by
operating activities was $36.7 million, $47.7 million and $42.7 million for
1995, 1996 and 1997, respectively. Net borrowing increases under short- and
long-term credit facilities were $21.8 million, $18.6 million and $35.7 million
for 1995, 1996 and 1997, respectively. The cash provided by operating activities
and borrowings has funded capital expenditures of $45.7 million, $56.3 million
and $66.8 million for 1995, 1996 and 1997, respectively, along with a dividend
for each of the three years of approximately $7.8 million.

Net cash provided by operating activities for 1997 of $42.7 million
decreased $5.0 million from $47.7 million for 1996. The decrease comes from
increases in inventories and accounts receivable being partially offset by an
increase in accounts payable and net income. Net cash provided by operating
activities for 1996 of $47.7 million increased by $11.0 million from $36.7
million for 1995. The increase relates primarily to decreases in inventories in
1996 compared to the increases in inventories and accounts receivable in 1995.

Capital expenditures for the years 1995-1997 totaled $168.7 million. These
expenditures were primarily for investments in machine tools for all of the
Company's manufacturing plants, including the new leased plants in Slovakia and
China, and the building of a new plant in West Branch, Iowa for the manufacture
of gear pumps and motors. These investments have been made to increase
production capacity, flexibility and efficiency, to improve product quality and
for replacement purposes.

The Company believes that increased levels of capital expenditures will be
required over the next three years to expand capacity, improve efficiency and
remain competitive. As a result, the Company expects capital expenditures to be
in the range of $150-$230 million during 1998-2000. Capital expenditures will be
applied primarily to the building of a new manufacturing facility in the United
States, to the acquisition of the real estate and building of its main facility
in Germany previously leased, to the purchase of manufacturing equipment for
each of its manufacturing plants to increase production capacity for new and
existing products, to increase production efficiencies, to improve product
quality and for replacement purposes. The new U.S. manufacturing plant will
produce medium power hydrostatic transmissions. The additional plant will free
up capacity at the Company's Ames facility which will be used to expand the
production of high power hydrostatic transmissions. The Company's manufacturing
plants in Slovakia and China, which started production in 1995 and 1997,
respectively, are still under development and will require further investment in
production machinery to increase their operating capacity and efficiency. The
Company plans to fund this increased level of capital expenditures from
internally generated funds, increased borrowings under its credit
23
<PAGE> 27

facilities and funds obtained from the sale of shares in the Combined Offering.
These sources of funds are expected to be sufficient to support the planned
capital expenditures and the Company's working capital requirements.

The Company previously leased the real estate and building of its main
facility in Germany from the Murmann family. As mentioned above, the Company
acquired (subject to local government approval) the facility to eliminate the
related party relationship with the Murmann family. The Company purchased the
facility at fair market value as determined by an independent appraiser, with a
note that will be repaid with a portion of the net proceeds of the Combined
Offering. The purchase price for the facility was approximately $23.4 million,
which Sauer-Sundstrand GmbH paid by assuming approximately $8.0 million in
indebtedness of Sauer Hydraulik and by issuing a note of approximately $15.4
million to Sauer Hydraulik. See "Use of Proceeds" and Note 17 to the Company's
Consolidated Financial Statements included elsewhere in this Prospectus.

Dividend Restrictions. At December 31, 1997, the Company had $52.0 million
of unused lines of credit, consisting primarily of committed U.S. lines of
credit and uncommitted European lines of credit. The Company's credit facility
restricts the Company's ability to pay dividends to its stockholders or to
redeem or repurchase its capital stock, except from executive officers. Pursuant
to such agreement, $17.6 million of dividends could be paid by the Company as of
December 31, 1997. In addition, the Company's ability to pay dividends is
effectively limited by certain restrictive covenants contained in the U.S.
Operating Company's and German Operating Company's credit agreements, which
limit the amount of dividends the U.S. Operating Company and German Operating
Company can distribute to the Company. During 1997, the U.S. Operating Company
made distributions to the Company of $19.5 million. At December 31, 1997, an
additional $2.9 million was not restricted as to payments of dividends by the
U.S. Operating Company. The German Operating Company did not make distributions
to the Company during 1997. At December 31, 1997, $2.7 million were not
restricted as to the payment of dividends. In addition, Klaus H. Murmann has
entered into two loan agreements pursuant to which he has agreed not to agree to
change the dividend policy of the Company; however, Mr. Murmann has informed the
Company that he intends to repay the loans with a portion of the proceeds of the
Combined Offering immediately upon its completion.

OUTLOOK

The Company expects 1998 net sales to continue to show the positive growth
over 1997 as was reflected for the first quarter of 1998, although with some
moderation. North American sales growth is not expected to continue at the high
rate reported for the first quarter, while European sales growth is expected to
continue at or about the first quarter rate. East Asian sales are expected to
continue to show a decrease compared to 1997.

Net income for 1998 is expected to show only a slight increase over 1997.
The Company expects operating margins to be flat for 1998 compared to 1997.
Operating margins will continue to be impacted by the investments being made to
pursue the Company's growth strategy and the decline in higher margin Asian
sales.

This "Outlook" section contains forward-looking statements that involve
risks and uncertainties that could cause actual results to differ materially
from those in the forward-looking statements. The Company's forward-looking
statements rely heavily on its interpretation of what it considers key economic
assumptions. Significant factors which could affect such forward-looking
statements include general economic conditions, foreign currency movements and
pricing and product initiatives taken by competitors. See "Risk Factors",
"Business" and other information contained herein for a discussion of important
factors that could cause actual results to differ materially from the
forward-looking statements.

24
<PAGE> 28

BUSINESS

THE COMPANY

Mobile hydraulics are used in two critical vehicle systems: propulsion
drive systems, which transmit and control power for the propulsion of a vehicle,
and work function systems, which provide power for the work performed by the
vehicle. The function of mobile hydraulics is to transmit power from an engine,
diesel or gasoline fueled, to the location on the vehicle where it is required,
i.e., the propulsion or work function. Mobile hydraulics offer greater
flexibility of layout, more compact design, a higher performance-to-weight ratio
and greater productivity and reliability than other forms of motion control,
such as mechanical or electrical systems. Mobile hydraulics also allow the
vehicle to perform functions which could be difficult and costly to perform
using mechanical shafts, gear boxes, clutches, belts and pulleys such as
rotating the drum on a concrete transit mixer at variable speed independent of
the vehicle engine speed. As a result, mobile hydraulics are the dominant
technology for the propulsion and work function of off-highway equipment as well
as for the work function of on-highway special purpose vehicles.

The Company is a leader in the design and manufacture of high performance
mobile hydraulics components and has the ability to bring these components
together in a total vehicle system using electronic sensors and microprocessor
controls programmed with the Company's proprietary software. Increasingly, the
propulsion and work function systems are being integrated with all other
elements of vehicle performance, including engine management and safety and data
gathering for productivity and maintenance to achieve optimum vehicle
performance. Customers are looking to consolidate their supplier base, devote
their engineering resources to overall vehicle design and use a supplier's
expertise to design and supply hydraulic systems to achieve the vehicle's
performance objective. Because the components and systems supplied by Sauer are
usually the most technically advanced and highest value products on a vehicle
(excluding the engine), the Company is in a leading position to be selected by
customers as a key supplier and systems integrator. To meet the full range of
vehicle propulsion and work function demands, Sauer is increasingly working with
customers, suppliers and other component manufacturers to develop total
hydraulic systems, including braking, steering, cooling and an overall
microprocessor control system. Sauer's strong market position, technology
leadership and systems expertise have led to, and are expected to continue to
lead to, close working relationships with its customers.

Sauer sells to original equipment manufacturers ("OEMs") of off-highway
mobile equipment, including agricultural, construction, turf care, road building
and maintenance, material handling and oil field equipment. The Company's
principal OEM customers include AGCO Corp., Bomag GmbH, Case Corp., Caterpillar
Inc., Claas KGaA, Deere & Company, Ingersoll-Rand Company and its Melroe unit,
JCB Ltd., Liebherr GmbH, New Holland N.V., Svedala Industri AB and its Dynapac
Division and the Toro Company, most of which are customers in both North America
and Europe. Sauer sells its products directly to OEMs in North America, Europe
and Asia, and through approximately 80 independent distributors. Sauer also
sells its products in Europe through sales subsidiaries in Belgium, France,
Holland, Italy, Slovakia, Spain, Sweden and the United Kingdom. With 13
manufacturing facilities in the United States, Europe and China, the Company can
adapt its products to local market needs and has significant flexibility to meet
customer delivery requirements. In addition, Sauer licenses its hydrostatic
transmission technology to manufacturers that operate in Brazil, India and
Japan.

25
<PAGE> 29

The following table sets forth the Company's net sales by product line in
dollars and as a percentage of total net sales for the years indicated:

<TABLE>
<CAPTION>
1993 1994 1995 1996 1997
---------------- ---------------- ---------------- ---------------- ----------------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Hydrostatic
Transmissions(1)...... $216,534 78.9% $280,254 77.3% $339,945 76.0% $350,847 75.0% $408,802 76.4%
Gear Pumps and Motors... 41,724 15.2 49,827 13.7 63,094 14.1 64,218 13.7 64,414 12.0
Electrohydraulics and
Other(2).............. 16,234 5.9 32,401 9.0 43,735 9.9 52,501 11.3 61,957 11.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total........... $274,492 100.0% $362,482 100.0% $446,774 100.0% $467,566 100.0% $535,173 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>

- ---------------
(1) Includes certain electrohydraulic products.
(2) Includes open circuit piston pumps and mechanical gear boxes.

The following table sets forth the Company's net sales by market
application, in dollars and as a percentage of total net sales, for the years
indicated:

<TABLE>
<CAPTION>
1993 1994 1995 1996 1997
---------------- ---------------- ---------------- ---------------- ----------------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Agriculture.............. $ 41,298 15.0% $ 65,424 18.0% $ 76,596 17.1% $ 84,183 18.0% $ 99,925 18.7%
Construction............. 38,125 13.9 53,749 14.8 69,955 15.7 71,335 15.3 76,441 14.3
Turf care................ 48,105 17.5 69,828 19.3 81,532 18.2 85,017 18.2 104,578 19.5
Road-building and
maintenance............ 41,687 15.2 49,960 13.8 65,983 14.8 56,333 12.0 67,972 12.7
Other.................... 17,748 6.5 19,537 5.4 28,540 6.4 31,964 6.8 34,334 6.4
Distribution and
aftermarket............ 87,529 31.9 103,984 28.7 124,168 27.8 138,734 29.7 151,923 28.4
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total............ $274,492 100.0% $362,482 100.0% $446,774 100.0% $467,566 100.0% $535,173 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>

The United States, Europe and Japan are the primary markets in which mobile
hydraulic products are manufactured and sold. Over 80% of such products are
produced and incorporated into vehicles manufactured in these three regions.
International competition is primarily between large U.S. and German suppliers.
Historically, Japanese companies have licensed mobile hydraulic technology from
U.S. and German companies and have focused almost exclusively on the East Asian
market.

Sales of the Company's products and systems have grown at a faster rate
than the underlying mobile hydraulic markets. The Company's revenues have grown
at a compound annual growth rate over a five-year and ten-year period of 22.0%
and 12.9%, respectively, in the United States, 6.5% and 2.5%, respectively, in
Europe (or 9.0% and 2.8%, respectively, excluding exchange rate effects) and
15.3% and 7.9%, respectively, in total. In the United States, as reported by the
National Fluid Power Association ("NFPA"), the five- and ten-year compound
annual growth rates for mobile hydraulics have been 17.3% and 8.9%,
respectively. In Europe, as reported by the European Committee for Oil Hydraulic
& Pneumatic Transmission ("CETOP"), the rates have been 6.9% and 2.9%,
respectively. The CETOP data are for both mobile and industrial hydraulic
production. The Company believes that in Europe the mobile hydraulic market is
growing somewhat faster than the industrial hydraulic market. The Company
expects overall market growth rates to increase somewhat in Europe while
moderating in the United States.

The following table sets forth the Company's net sales by customers'
geographic market, in dollars and as a percentage of total net sales, for the
years indicated:

<TABLE>
<CAPTION>
1993 1994 1995 1996 1997
---------------- ---------------- ---------------- ---------------- ----------------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
North America........... $155,716 56.7% $212,717 58.7% $241,072 54.0% $263,500 56.4% $322,973 60.3%
Europe.................. 113,365 41.3 143,574 39.6 199,394 44.6 189,060 40.4 196,676 36.7
East Asia............... 5,411 2.0 6,191 1.7 6,308 1.4 15,006 3.2 15,524 3.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total........... $274,492 100.0% $362,482 100.0% $446,774 100.0% $467,566 100.0% $535,173 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>

See Note 15 to the Company's Consolidated Financial Statements included
elsewhere in this Prospectus for additional geographic market information.

26
<PAGE> 30

COMPETITIVE ADVANTAGES

Sauer believes it has a strong competitive position in the mobile
hydraulics industry that reflects the Company's core strengths.

Technology Leadership

Sauer has a long-standing tradition of developing industry-leading
technology and is committed to continue to enhance the capabilities of its
products. The Company provides superior, highly engineered hydraulic systems and
components that address the most demanding applications of its target end-user
markets. In the past, Sauer's customers have been willing to pay a premium for
the Company's industry-leading, highly engineered systems and components. The
Company's design principles for hydrostatic transmissions are now the worldwide
standard for almost all new product development in this area and Sauer's vast
experience, with production of more than ten million hydrostatic pump and motor
units since 1964, provides a significant advantage over competitors that have
more recently changed to Sauer's type of design. The Company has reinvested a
significant percentage of net sales in engineering, research and development in
recent years and plans to continue doing so to remain on the leading
technological edge in its markets. The Company's engineering, research and
development efforts have included the development of new products and testing,
evaluation and improvement of existing products and the development of
proprietary software for its microprocessor-based systems. To meet its
customers' needs, Sauer has developed systems that integrate hydraulics,
hydrostatics and mechanics with electronic sensors and controls utilizing the
Company's proprietary software. These systems are designed to work effectively
and more efficiently by performing more vehicle propulsion and work functions at
economical cost and increasingly integrating all vehicle functions, including
engine management and safety.

Customization and Integration with Customers

Many of the products which the Company designs and manufactures are
customized to meet customers' specifications. By providing high performance and
customized products, the Company has distinguished itself from the commodity
segment of the hydraulic components market and achieved, for many of its
products, higher operating margins than its competitors. The Company has the
ability to adjust its production cycle to manufacture products in large or small
quantities according to customers' demands. This allows the Company to
"mass-customize" its products without incurring additional costs, thus providing
value-added services to its customers. The Company's design engineers work
closely with its customers in providing product proposals and prototypes and in
developing high quality, specialized products. The design of a Company product
or system is often created in collaboration with the design of the customer's
vehicle of which the Company's product or system will be a component part.

Strong U.S. and European Presence

The Company's ability to design and manufacture mobile hydraulic products
in both the United States and Europe provides it with a competitive advantage.
This dual manufacturing and engineering capability permits the Company to adapt
its products to meet market needs in North America and Europe and provides
flexibility to meet OEM customers' delivery requirements. In addition, the dual
manufacturing capability allows the Company to manufacture and sell in Europe
and in North America on the basis of local currencies, thereby reducing the
impact on the Company's operating income of exchange rate fluctuations between
those currencies. The Company is expanding its presence in East Asia through a
100% owned sales and marketing office in Shanghai and a 60% owned manufacturing
facility in the Pudong area of Shanghai. Management believes that the Company
enjoys a competitive advantage through its ability to supply and service the
international requirements of its customers directly to the locations where they
are doing business.

27
<PAGE> 31

Customer, Market and Geographic Diversification

During 1997, no single customer accounted for more than 10% of the
Company's net sales. In 1997, net sales in North America, Europe and the East
Asia region accounted for approximately 60%, 37% and 3%, respectively, of the
Company's total net sales. In addition to the Company's geographically
diversified customer base, the Company has been able to adapt and sell its
products for use in a wide range of applications and industries. These
applications include construction, road repair and maintenance, agricultural,
turf care, material handling, oil field equipment and an extensive range of
specialized machinery. This diversification reduces the Company's dependence on
any one customer, any one market or any one geographic market.

Stable Aftermarket Sales

A further source of income support is the Company's diversified aftermarket
service. The large installed base of components, in particular hydrostatic
transmissions, provides the Company with a relatively stable source of revenues
which exhibits countercyclical tendencies. The aftermarket services provided
include service and repair of products at the Company's own manufacturing and
sales facilities and sales of service parts to more than 200 independent
authorized service centers. With direct end-user support on a convenient
worldwide basis, margins on aftermarket service and parts sales are higher than
those on new unit sales to OEMs.

Reputation for Quality and Service

Sauer and its predecessor organizations have been active in the mobile
hydraulics market since the 1960s. The Company believes it has a widely
recognized reputation in the mobile hydraulics market for engineering
innovation, customized solutions, industry leading performance, product
reliability and durability and aftermarket service. Sauer's OEM customers are
increasingly seeking to use their positions as volume purchasers in the
hydraulic market to require quality assurance protection. To meet this demand,
the Company is investing in product development and in new manufacturing
technology and facilities. A key focus of these efforts is to reduce cycle time,
in both the development and production stages. Response to customers is being
significantly enhanced by integrating order processing with production
scheduling in many of the Company's facilities. The Company intends to leverage
its strong name recognition to attract new customers requiring high-performance,
specialty hydraulic systems and components.

GROWTH STRATEGY

Sauer's strategy is to be the technology leader, market leader and total
quality leader in the manufacture and supply of components and systems to
transmit and control hydraulic power in mobile equipment in major world markets,
although no assurance can be given that Sauer's efforts to become the technology
leader, market leader and total quality leader in the manufacture and supply of
such components and systems will be successful. The key components of Sauer's
growth strategy are as follows:

Enhance Product Offering and Expand Content of Existing Vehicles

Over the last several years, Sauer has significantly broadened and enhanced
its mobile hydraulics product offering. The Company's broader product line,
including integrated solutions utilizing microprocessor controls, provides a
more complete range of choice to the Company's OEM customers. Mobile hydraulics
are growing at a higher rate than the machinery and equipment markets they serve
as hydraulics replace other power transmission types and existing hydraulic
systems grow in scope and sophistication. For example, the high power
transmission line of products introduced by Sundstrand has been replaced by two
new lines, Series 90 and Series 42. Both new series are more compact, have added
features, a broader range of control types and superior controllability than the
products they replace. These enhancements have allowed the Company to achieve
higher unit selling prices and, together with similar advances in electronic
controls, sensors and microprocessors, reach new sectors of the market such as
small bulldozers, industrial forklift trucks and forestry equipment.

28
<PAGE> 32

Sauer intends to achieve significant growth by increasing the sales content
to existing customers. The move by Sauer's customers to fewer suppliers and the
benefits of Sauer's integrated systems to these customers open opportunities for
the Company to both add existing products and to design new products to increase
sales content per customer vehicle. Because the components and systems supplied
by Sauer are usually the most technically advanced and highest value products on
a vehicle (excluding the engine), the Company is in a leading position to be
selected by customers as a key supplier and systems integrator. The Company's
reputation for technical excellence and close working relationships with its
customers' engineers enhances these opportunities. For example, in 1995, the
Company sold only a hydrostatic transmission to U.S. manufacturers of concrete
transit mixer trucks. Today, the Company sells four additional products on the
same vehicle with a more than fourfold increase in dollar content per vehicle.

Expand into New Mobile Hydraulic Vehicle Applications

Sauer plans to develop mobile hydraulic products to enter into new vehicle
markets. Potential new vehicle markets include industrial forklift trucks and
agricultural and industrial tractors, where hydrostatic transmissions have not
been widely used, however there can be no assurance that Sauer will be
successful in developing products for any of these markets. Entering these new
vehicle markets would also provide the Company with the opportunity to sell
related products. For example, Sauer is in the forefront of developing new
proprietary hydro-mechanical propulsion drives for tractors. Hydro-mechanical
transmissions offer the benefits of hydrostatic transmissions (e.g., infinitely
variable speed and controllability) with the benefits of mechanical
transmissions (e.g., efficiency at constant vehicle speed at high power levels).
The Company is working with several major OEMs to further develop the
application of the Company's hydro-mechanical technology. Already one tractor
manufacturer, Fendt in Germany, has introduced new tractor designs using the
Company's hydro-mechanical technology and has received favorable response from
customers.

Capitalize on Global Presence; Build Asian Presence

Sauer is committed to being a global company in order to serve the needs of
its global customers. The Company's customers manufacture and sell their
products throughout the world and require convenient access to their suppliers'
products and services. To meet this requirement, the Company has modern
manufacturing facilities in the United States, Europe and East Asia and a
network of sales companies, licensees, distributors and authorized service
center locations around the world. The Company believes that a significant
factor in its market share growth has been its reputation for on-time delivery
to meet rapidly expanding demand.

In increasing its global operations, the Company intends to expand its
presence in East Asia, one of the three leading geographic markets for hydraulic
systems products. To capitalize on this market, the Company has established a
100% owned sales and marketing office in Shanghai and a 60% owned manufacturing
facility in the Pudong area of Shanghai and has developed strong licensee
relationships, such as with Daikin, the Company's licensee in Japan. The Company
intends to make a long-term investment of management resources and capital to
build up its East Asian presence.

Improve Gross Margins Through Operating Efficiencies and Lower Costs

The Company intends to improve margins by reducing overhead costs,
improving worker productivity, shortening production cycle times and
rationalizing its products mix. The Company is expanding and equipping existing
facilities and building new manufacturing facilities to increase production
capacity for new and existing products and to enhance production efficiencies.
For example, a portion of the Company's 1998-2000 capital expenditures will be
used to upgrade machine tools to reduce tool changeover times and improve
machining tolerances, which will improve product quality and reduce production
times. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources" and
"Business -- Manufacturing." New equipment investment incorporates the latest
advances in metal cutting technology, robotics and computerized assembly and
testing equipment. These technologies reduce labor cost, reduce the cost of
quality and reduce inventories. A major reduction in the number of material
suppliers gives the Company more purchasing advantage with each supplier in
terms of advanced technology, improved quality of supplies and lower
administrative purchasing costs. The Company's experi-
29
<PAGE> 33

ence with manufacturing cells and flexible manufacturing systems, well
established in U.S. operations, is now in the process of adoption in Europe and
will aid margins. The major expansion in Slovakia, where total employment cost
per employee is approximately 15% of that in Germany and where there is more
flexibility in manning high capital cost machinery, will also improve margins in
Europe.

Finally, the Company believes that the most important contribution to cost
reduction comes from investment in a skilled workforce able to adapt to new
technology and equipment.

Make Selective Acquisitions

Sauer may make selective acquisitions that broaden the products and systems
offered by the Company and to enhance Sauer's technological leadership, although
no assurance can be given that any acquisition will broaden the products offered
by the Company or enhance its technological position. In particular, Sauer seeks
to take advantage of the consolidation occurring in the electrohydraulics
industry. See "Business -- Competition." Such acquisitions are likely to involve
smaller niche or regional companies, like Control Concepts, Inc. ("CCI"), and
could also include larger acquisitions.

HISTORY AND ORGANIZATION

Sauer and its predecessor organizations have been active in the mobile
hydraulics industry since the 1960s. Established in 1987, the Company combined
the business of Sauer Getriebe in Europe and Sundstrand Hydraulic Power Systems
in North America. A predecessor to Sauer Getriebe was founded in Germany in
1884. Sundstrand was founded in 1905 in the United States and established its
Hydro Transmission division in 1964. In 1967, Sauer Getriebe, which was owned by
Klaus H. Murmann, became a licensee of Sundstrand to manufacture and sell
hydrostatic transmissions in Europe. Recognizing the need to serve their OEM
customers on a more global basis, Sauer Getriebe and Sundstrand combined their
non-U.S. and U.S. mobile hydraulics businesses in an equal joint venture in
1987. In 1989, the Murmann family and certain executive officers bought
Sundstrand's interest in the joint venture. As a result of that transaction and
a related restructuring in 1990, Sauer Inc. became the holding company for its
operations. Sauer does not currently derive any sales from, or conduct any
material business with, Sundstrand. Sundstrand does, however, license the
Sundstrand name to the Company. The license expires in 2004. Klaus H. Murmann is
a director of Sundstrand. See "Management -- Directors and Executive Officers."

Sauer operates on a worldwide basis through its U.S. and German Operating
Companies. The Company's operations are fully integrated but managed on a
decentralized basis in order to promote a worldwide operating philosophy. The
Company maintains dual corporate headquarters and locates its senior managers at
major operating sites.

In 1991, the Company and Agri-Fab, Inc. formed a joint venture, Hydro-Gear,
to manufacture integrated hydrostatic transmissions and axles for sale to OEMs
in the turf care equipment market. Sauer has a 60% interest in the joint
venture. See "-- Products and Services -- Hydrostatic
Transmissions -- Hydro-Gear."

PRODUCTS AND SERVICES

Hydrostatic Transmissions

Sauer designs, manufactures and sells a range of closed-circuit axial
piston hydrostatic transmissions for both the propulsion and work functions of
off-highway mobile equipment in the United States, Europe and East Asia. The
function of a transmission is to transmit power from an engine, diesel or
gasoline fueled, to the location on the vehicle where it is required (i.e., the
propulsion or work function), and to do so in the most useful form in terms of
speed, torque and controllability. Hydrostatic transmissions permit equipment to
operate efficiently by providing infinitely variable speeds (up to a certain
maximum) in both forward and reverse at a given engine throttle setting and by
acting as a brake. By eliminating gear shifting, they permit the operator to
concentrate on the work at hand and reduce the likelihood of damage to the
transmission due to operator error. Hydrostatic transmissions provide advantages
over mechanical transmissions in terms of

30
<PAGE> 34

control and coordination of vehicle function and flexibility in installation and
vehicle design. However, they are typically more expensive and may require more
frequent routine maintenance than mechanical transmissions.

High power (typically over 50 horsepower) and medium power (typically 25-50
horsepower) applications for hydrostatic transmissions manufactured by the
Company include construction and agricultural mobile equipment. Light power
(typically 15-25 horsepower) and bantam power (typically under 15 horsepower)
applications for hydrostatic transmissions manufactured by the Company include
light agricultural and turf care mobile equipment. However, any one vehicle may
include applications at all four power levels depending on the specific vehicle
functions. Hydrostatic transmissions have, over the past 30 years, become the
dominant type of propulsion drive train for off-highway mobile equipment with
the exception of industrial forklift trucks in North America and agricultural
and industrial wheel tractors. The Company expects both these types of vehicles
to be sources of market growth. Success in these sectors will come from recently
developed microprocessor controls and matching control features of the new
Series 42 products and from the compactness and high power density of new
hydrostatic pumps and motor elements utilized in hydro-mechanical transmissions.
All these developments evolve from the Company's leading technology base and
extensive application experience.

MAJOR APPLICATIONS

<TABLE>
<CAPTION>
ROAD BUILDING
AGRICULTURAL CONSTRUCTION TURF CARE AND MAINTENANCE OTHER
- ---------------- ------------------- ----------------- ---------------- --------------
<S> <C> <C> <C> <C>
Ag Tractors Bulldozers Commercial Mowers Chip Spreaders Aerial Lifts
Air Seeders Concrete Mixers General Turf Concrete Saws Industrial
Combines Concrete Pumps Maintenance Oil Distributors Lift Trucks
Cotton Pickers Ditchers/Trenchers Lawn Tractors Pavers Sweepers
Cotton Strippers Excavators Sand Trap Rakes Planers Logging
Detasselers Grinders Rollers Marine
Harvesters Landfill Compactors Transit Mixers Mining
Sprayers Skid Steer Loaders Oil Field
Windrowers Utility Tractors R T Fork Lifts
Wheel Loaders Railway
Maintenance
Snowgroomers
Truck and Bus
Generator
Drives
</TABLE>

In each of the last five years, sales of hydrostatic transmissions have
accounted for a majority of the Company's net sales. Approximately 70% of 1997
net sales of hydrostatic transmissions were made directly to OEMs of off-highway
mobile equipment, which were primarily large OEMs, and the remaining 30% were to
independent distributors. The Company sells to approximately 80 of these
independent distributors, which operate over 200 service centers. These
independent distributors generally sell transmissions manufactured by the
Company to smaller OEMs and also sell transmissions and parts manufactured by
the Company to end-users for replacement purposes.

Approximately 9-12% of net sales of hydrostatic transmissions in each of
the past five years were of aftermarket service parts. Sales of aftermarket
service parts are typically made in the United States to independent
distributors that repair and rebuild transmissions originally manufactured by
the Company. Aftermarket service part sales are primarily service parts for high
and medium power hydrostatic transmissions. High power transmissions in
off-highway mobile equipment are typically rebuilt once during the life of the
equipment. While the Company and its independent distributors repair and rebuild
transmissions, there are a number of service centers unaffiliated with the
Company, primarily in North America, that repair and rebuild transmissions
originally manufactured by the Company, sometimes using service parts not made
by the Company. In Europe, this market is predominantly serviced by the
Company's own sales companies.

The Company's principal OEM customers for hydrostatic transmissions include
AGCO Corp., Bomag GmbH, Case Corp., Caterpillar Inc., Claas KGaA, Deere &
Company, Ingersoll Rand Company and its

31
<PAGE> 35

Melroe unit, JCB Ltd., Liebherr GmbH, New Holland N.V., Svedala Industri AB and
its Dynapac Division and the Toro Company, most of which are customers in both
North America and Europe. The Company sells to a number of divisions within
these OEMs, many of which make independent purchasing decisions. No individual
customer, OEM or other, accounted for 10% or more of the Company's overall net
sales during 1997.

The product life cycle of the Company's hydrostatic transmissions generally
has been from 15 to 25 years. A key aspect of the Company's development process
has been modifying an original product design using new materials, new
manufacturing techniques and engineering development in order to increase the
life of a product while maintaining the original outside housing. This "design
stretch" process happens over a period of years and allows optimal return on
initial product development and manufacturing investment. In the future, the
Company expects the life cycle of its hydrostatic transmissions to be shorter.
The high power hydrostatic transmission line of products introduced by
Sundstrand in 1964 was replaced by the Company's new range of Series 90
transmissions in the period from 1988 through 1996 and Series 42 transmissions
beginning in 1996. Both are smaller, lighter and have more control features than
the Company's earlier line of transmissions. The Company believes that OEM
customers will increasingly demand smaller, lighter, higher performance
transmissions with more advanced control features to be used in complete system
applications.

Hydro-Gear. The U.S. Operating Company is a 60% partner in the Hydro-Gear
joint venture with Agri-Fab, Inc. The U.S. Operating Company supplied Hydro-Gear
with the technology and equipment to produce bantam power hydrostatic
transmissions, while Agri-Fab, Inc. supplied the technology and equipment to
produce mechanical axles. Hydro-Gear, located in Sullivan, Illinois,
manufactures these combined components to produce bantam power hydrostatic
transmissions integrated with mechanical axles primarily for use in turf care
equipment as an infinitely variable forward and reverse transmission to replace
a five speed mechanical transmission and clutch package. Hydro-Gear's primary
product and the reason for the joint venture company is the Integrated
Hydrostatic Transaxle ("IHT"). The IHT is a completely integrated hydrostatic
transmission and transaxle package that is lightweight, delivered ready to
install and has 3-15 horsepower capabilities.

Since its formation in 1991, the Hydro-Gear joint venture has achieved
substantial growth and helped fuel an industry transformation from using
mechanical transmissions to using IHTs. Hydro-Gear's IHTs tend to have lower
prices and gross profit margins than the Company's other hydrostatic
transmissions. However, higher volume levels, lower marketing costs and a lower
cost of investment make these products attractive to the Company. The Hydro-Gear
joint venture has provided the Company the opportunity to meet certain
customers' vehicle transmission and work function needs on a broader basis.
Customers of Hydro-Gear include MTD, the manufacturer of Yardman and Cub Cadet,
Toro, the manufacturer of Wheelhorse, and Frigidaire Home Products, a
manufacturer of lawn tractors, primarily for Sears.

Electrohydraulics

Sauer designs and manufactures electrohydraulic valves and electronic
controls, including microprocessor-based controls and electronic sensors through
its electrohydraulics operations in the United States and also designs
electrohydraulic products in Germany. Electrohydraulic controls and sensors
integrate hydraulics, hydrostatic transmissions and mechanical components with
electronic controls and are used by OEMs of off-highway mobile equipment to
control both the Company's hydraulic systems as well as the hydraulic systems of
other manufacturers. The electrohydraulic products bring together the propulsion
function and the work function by providing standard or custom designed
controls. These easy-to-use, cost-effective systems are designed to allow
vehicles to work effectively and more efficiently by performing more vehicle
functions at an economical cost. The Company is able to design and sell systems
to fit particular vehicle needs.

Increasingly, the Company's hydrostatic transmission sales include controls
made by the Company's electrohydraulics unit. The Company's electrohydraulic
products include electrohydraulic servo valves, electrohydraulic directional
control valves, microprocessor controls and software, analog control boards, joy
sticks and sensors. Common applications of the Company's electrohydraulic
products have been for the work function of agricultural combine harvesters and
road building equipment. While electrohydraulics' net sales

32
<PAGE> 36

are not a significant part of the Company's overall net sales, the Company
believes that OEM customers increasingly prefer purchasing hydraulic products
from manufacturers, such as the Company, that can provide a sophisticated
integrated system for both the propulsion and work functions, together with an
electronic control system. Certain of the Company's OEM customers, however, also
design and manufacture their own electronic controls for use with the Company's,
as well as other manufacturers', hydraulic systems. Certain of the Company's
electrohydraulic products are purchased by customers for use with other
manufacturers' hydraulic systems.

In February 1994, the Company acquired CCI in order to further expand into
the electrohydraulic valve market. CCI manufactures and designs electrohydraulic
valves primarily for combine harvesters. Electrohydraulic valves are used to
direct the hydraulic power to the various parts of the vehicle that require
power.

Gear Pumps and Motors

The Company designs, manufactures and sells custom designed gear pumps as
well as a broad range of high performance standard gear pumps and motors. Gear
pumps and motors are the most widely used type of mobile hydraulic pump and
motor in the industry. They are the basic "workhorse" product for numerous work
functions across a broad range of mobile equipment, because they are sturdy in
design and able to withstand dirt and contamination in poorly maintained
equipment. They are also very cost-effective components in replacing mechanical
work-function devices. The disadvantages of gear pumps and motors are their
limited controllability compared to open circuit piston pumps and the limited
oil pressure levels and horsepower at which they operate. As OEMs seek higher
performance, there is a trend to replace mechanical devices with gear pumps and
motors, as well as a steady transition from gear pumps to open circuit piston
pumps. One such area is the hydraulic drive of engine cooling fans on buses and
recreational vehicles. Using gear pumps and motors and electronic temperature
sensors and valves, the hydraulic drive allows the cooling system to operate
independently of engine speed, both saving energy and more efficiently using
engine power.

At its Swindon, England facility, special purpose, customized gear pumps
are designed primarily for agricultural and construction applications.
Increasingly, these gear pumps integrate hydraulic control devices that were
previously located elsewhere in the work function system. This reduces the
number of interconnecting hydraulic tubes and hoses in the system, thereby
reducing cost and improving system reliability.

Sauer's range of standard gear pumps and motors offers higher oil pressure
and power levels and better performance and reliability than the products of the
Company's competitors. Most of the Company's gear pump and motor sales have been
made in Europe. Until 1997, the Company produced standard gear pumps and motors
only in Bologna, Italy. In 1997, it started the production of standard gear
pumps and motors at the West Branch, Iowa facility. With the 1997 commencement
of gear pump production in West Branch, Iowa, the Company expects to increase
sales of these products in the United States.

Open Circuit Piston Pumps

Open circuit piston pumps are used to transform mechanical power from the
engine to hydraulic power for the work functions 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. In addition, open circuit
piston pumps are able to operate at higher power levels. Increasingly, OEMs, in
particular agricultural tractor manufacturers, demand the advantages of open
circuit piston pumps as work functions transition to integrated electrohydraulic
controls, despite the premium price of an open circuit piston pump, typically
more than twice the price for a gear or vane pump.

Sauer designs and manufactures open circuit piston pumps in the United
States and Europe. The design and manufacture of open circuit piston pumps has a
certain commonality with the design and manufacture of closed circuit piston
pumps used in hydrostatic transmissions. Drawing on its vast experience in the
design of hydrostatic products, the Company's new Series 45 open circuit piston
pumps have been well received by the market because of their compact size, high
performance and reliability.

33
<PAGE> 37

At its Swindon, England facility, the Company designs and manufactures
special purpose open circuit piston pumps, which combine general features of a
work function system, with oil filtration, main transmission actuation and
steering pump, into one assembly. Used primarily by agricultural tractor
manufacturers, an integrated package assembly allows the OEM to increase work
function performance, improve vehicle reliability, reduce total hydraulic system
cost by eliminating other hydraulic components and reduce the labor costs to
install the system. The sale of a typical integrated package more than doubles
the dollar content of Sauer's products in an agricultural tractor.

Mechanical Gear Boxes

In Europe, the Company designs and manufactures a range of special purpose
mechanical gear boxes. The gear boxes are used in both propulsion and work
function systems to reduce the output speed of a hydraulic motor down to the
desired final speed of the wheel or track of a vehicle or the final speed of the
work function. The gear boxes are complementary to the Company's hydrostatic
transmission product line and sold almost exclusively as components within a
system.

MANUFACTURING

Sauer operates 13 manufacturing facilities in the United States, Europe and
China. The Company's decentralized manufacturing capabilities allow it to adapt
its products to local market needs and meet customer delivery requirements on a
timely basis. It is the Company's view that the optimum size for a stand-alone
manufacturing facility is in the range of 200 to 300 employees. Beyond this
level it is more difficult to develop the work structure and communication lines
that the Company believes are important to achieving its goals.

In North America, the Company manufactures hydrostatic transmissions at its
Ames, Iowa facility and at its La Salle and Freeport, Illinois facilities. A new
manufacturing facility is planned for Lawrence, Kansas, to be in operation in
late 1998 to produce medium power hydrostatic transmissions. The new facility
will free operating capacity at Ames to allow expanded production of the Series
90 high power hydrostatic transmission. Sauer has several flexible manufacturing
systems ("FMS") at the Ames facility for machining iron housings and components.
The systems, which are fully automated and computer controlled, operate an
average of 20 hours per day, seven days a week. The Company has extensive
experience with this type of equipment, and expects that future machinery
investment will be heavily oriented toward FMS to meet customers' "just in time"
needs and to minimize inventories. The La Salle facility is primarily used to
machine iron housings and components. The Freeport facility is primarily used to
machine steel and brass components from barstock. Both facilities utilize
computer controlled and special purpose equipment, including robotics. Housings
and components machined at the La Salle and Freeport facilities are transported
by common carriers to the Ames facility for assembly and testing.

In Europe, the Company produces hydrostatic transmissions at its
Neumunster, Germany facility. Iron housings and components are machined on
special purpose equipment and standard computer controlled equipment with
specially adapted features. The Neumunster facility also employs automated
material handling equipment designed specifically for the manufacture of the
Company's hydrostatic transmissions. In addition, the Company has begun
manufacturing hydrostatic transmissions and components and mechanical gear boxes
at two facilities in Slovakia. The Slovakia facilities supply components to the
Neumunster and Ames facilities, and produce mechanical gear boxes, at much lower
cost levels than the Company's other manufacturing locations. In East Asia, the
Company produces hydrostatic transmissions at the Pudong, Shanghai facility.

The Company designs and manufactures open circuit piston pumps at its Ames,
Iowa and Swindon, England facilities. The Company designs and manufactures
electrohydraulic valves and electronic controls, including microprocessor-based
controls and electronic sensors, at its Minneapolis, Minnesota and Newtown,
Pennsylvania facilities and also designs electrohydraulic products at the
Neumunster facility. Custom-designed gear pumps and motors are manufactured at
the Swindon, England facility and standard-designed gear pumps and motors are
manufactured at the Bologna, Italy and West Branch, Iowa facilities. The West

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<PAGE> 38

Branch gear pump plant was completed and put into production in 1997. In
addition to using special purpose equipment and standard computer controlled
machines similar to the Ames and Neumunster facilities, all gear pump plants
utilize high precision gear-making machinery with automated material handling.

The Company uses common computer aided design and manufacturing systems in
its Ames and Neumunster facilities. This permits engineering and development
work carried out at one facility to be used by the other facility and helps
ensure that parts made at both facilities are identical and interchangeable. In
the near future, all the Company's engineering and manufacturing locations will
be connected into the same system.

In addition to its engineering, research and development staff, the Company
employs in its manufacturing departments a number of engineers and technicians
who are responsible for the development of new manufacturing techniques and
processes and providing technical services for manufacturing.

MARKETING AND SALES

In North America, the Company sells and distributes its products directly
to large OEMs and through independent distributors to smaller OEMs. In Europe,
the Company sells and distributes its products either directly or through sales
subsidiaries located in Belgium, France, Holland, Italy, Slovakia, Spain, Sweden
and the United Kingdom. Sales and marketing efforts include advertising and
participation in trade shows, but the Company relies primarily on direct contact
between the Company's technically qualified sales and engineering staff and its
customers' engineering and manufacturing departments.

Sauer seeks to develop a close working relationship with its principal OEM
customers. The Company's engineers work directly with those OEMs from initial
product design and specifications to field testing. In some instances, the
Company has a design engineer resident within the customer's engineering
department to facilitate and accelerate customized product development. The
Company also provides service support and service parts to further develop
strong and close working relationships with its customers. Sales and marketing
to smaller OEMs in North America are conducted primarily by independent
distributors in the United States. The independent distributors receive Company
training, including factory training for their service engineers, and handle
sales support and service of the Company's products. Total North American
employment for marketing, sales and service was 136 persons at December 31,
1997. In Europe, the networks of independent distributors do not exist to the
same extent as in North America. Therefore, the Company sells directly to both
large and small OEMs and employs a relatively larger number of sales and service
engineers in Europe. Total European employment for marketing, sales and service
was approximately 175 persons at December 31, 1997.

In order to secure long-term production orders, the Company first must
convince prospective OEMs that it has the technical capabilities, production
facilities and quality products that they require. After a period of time during
which the prospective OEM customer assesses the technical capabilities and other
attributes of various manufacturers, one of the competing manufacturers usually
is selected to begin work on developing prototype offerings. After the
development and testing phase is completed, the manufacturer selected for
prototype development is typically selected by the OEM to be the supplier for
long-term production orders during the production life of the equipment.
Changing to an alternative manufacturer at this point would be very costly to
the OEM and is therefore highly unusual. It can be up to a four-year process
from initial assessment to commencement of purchases by the OEM. By producing
highly specialized, made to order products, the Company has been able to develop
long-term relationships with many of its customers.

In response to recent desires of many of its OEM customers to reduce the
number of their suppliers by purchasing more components from fewer suppliers,
the Company has expanded its production of systems that integrate hydraulics,
hydrostatics and mechanics with electronic controls. The Company carries this
integration process even further, in some cases by joining forces with an engine
manufacturer and steering system supplier. The Company at times combines its
components with those of others in completely integrated assemblies. Such
ventures are cost effective, because they help the Company to work at the system
level and provide an opportunity to meet customer vehicle propulsion and work
function needs on a broader basis.

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<PAGE> 39

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 1.5%
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 in both
the United States and Europe. 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 consist
primarily of raw materials and machined iron housings and components. Only small
amounts of assembled finished units are maintained in inventory.

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 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.

ENGINEERING, RESEARCH AND DEVELOPMENT

The engineering and technical personnel employed in engineering, research
and development activities of the Company constitute approximately 7.4% of its
total work force, 152 in the United States and 124 in Europe. The Company's
engineering, research and development efforts have included development of new
products, testing, evaluation and improvement of existing products and the
development of proprietary software for its microprocessor-based systems.
Engineering, research and development are coordinated between Europe and the
United States so as to avoid duplication and to focus expenditures on the most
productive market developments. The Company also works on basic developments
with a number of universities and technical institutes and believes that its
access to technical developments in the United States, Europe, Japan and
elsewhere around the world through its business units and licensing arrangements
will enable it to remain competitive on a technological basis.

Recent engineering, research and development projects have included
hydro-mechanical products, a new line of microprocessor controls and new sizes
of open circuit piston pumps. The Company's research and development
expenditures during 1995, 1996 and 1997 were approximately $18.8 million, $20.5
million and $20.7 million, respectively.

The Company's research and development efforts provide many products,
including software, that are specifically designed for a customer. The Company's
products are very technical in nature, and its design team is a key component of
the sales effort. Design team members work closely with the customer's design
team to develop prototypes and specialized products that are specific to a
particular application. The design of a Company product or system is often
created in collaboration with the design of the customer's vehicle of which the
Company's product or system will be a component part.

The Company has been able to use technology in order to reduce development
times. Each product prototype is designed using Computer Assisted Design ("CAD")
to create a three-dimensional design that can be electronically transmitted to
Company suppliers. Because of the enhanced design techniques, the supplier can
often prepare a sample part in a short period of time that can be tested in the
Company's manufacturing facility. As a result, the average development time of
new products has been reduced from four years in the early 1980s to 18 months
currently.

LICENSING

To ensure worldwide availability of the Company's design of products, the
Company and its predecessors have licensed its technology to companies in
certain countries. The Company licenses all its open and closed circuit piston
pumps and motor and electrohydraulic valve technology to a subsidiary of Daikin
Industries Ltd. in Japan and licenses its original hydrostatic transmission
technology to Power Transmission Industries in

36
<PAGE> 40

Brazil and Larsen & Toubro Ltd. in India. These licenses generally are exclusive
licenses to manufacture and sell hydrostatic transmissions using the Company's
technology in the territory covered by the license. In each license agreement,
the Company reserves the right to sell products based on the licensed technology
in the territory covered by the license but primarily relies on the licensee to
supply the market needs in the territory. These licenses generally provide for
annual royalty payments based on the licensee's net sales. Royalty income
generated by these licenses during 1995, 1996 and 1997 was approximately $1.7
million, $1.2 million and $1.2 million, respectively.

Sauer and its predecessors have had a long-standing working relationship
with the Company's principal licensee, Daikin. The Daikin license, first granted
by one of the Company's predecessors in 1967, has been renewed for successive
ten-year periods and currently expires in 2008. All the Company's open and
closed circuit piston pump and motor and electrohydraulic valve technology is
licensed to Daikin under an agreement which allows the Company to benefit from
any improvements to the technology made by Daikin and vice versa. The Company
and Daikin jointly design and market products to meet worldwide needs and
frequently cooperate in the manufacture of components and complete products so
as to optimize the utilization of manufacturing capacity.

Through these licensing arrangements the Company is able to serve its North
American and European OEM customers as they expand their manufacturing
operations to other parts of the world. Management believes that the worldwide
availability of the Company's products and the local manufacturing capabilities
of its licensees play an important part in the decision of an OEM as to which
supplier to use.

COMPETITION

The mobile hydraulics industry is very competitive. Sauer competes based on
technological product innovation, quality and customer service. The Company
believes that long-term successful suppliers to off-highway vehicle
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.

Closed Circuit Hydrostatic Transmission Industry

The closed circuit hydrostatic transmission industry is highly concentrated
and is intensely competitive. There is a small number of manufacturers of
hydrostatic transmissions with which the Company competes worldwide that are not
captive suppliers of OEMs. These include the Rexroth Hydromatic division of
Mannesmann AG, Eaton Corporation, Linde AG and Aeroquip-Vickers. 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, together with its licensees, is the world leader in terms of product
range, market share and geographic coverage. Only the Rexroth unit of Mannesmann
offers similar geographic coverage.

Open Circuit Work Function Industry

The open circuit work function industry 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 which compete on a global basis,
including the Rexroth unit of Mannesmann, Aeroquip Vickers, Parker Hannifin
Corporation, Robert Bosch AG 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.

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<PAGE> 41

Electrohydraulics Industry

In the electrohydraulics industry, 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
believes it is well positioned to establish itself as a technology leader in the
workfunction segment, as there is no clearly established technology in this
sector that is deemed to be an industry standard.

RAW MATERIALS AND OTHER SUPPLIES

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 domestic and foreign sources in sufficient quantities to meet
current requirements. Over the past five years, the Company has reduced the
number of suppliers with which it does business from 1632 in 1993 to 479 in
1997. The Company believes this move to a reduced number of suppliers results in
a closer working and technical relationship with its suppliers that contributes
to advances in technology. Further, these suppliers are expected to provide more
efficient, reliable service and more competitive prices when selected as the
single supplier.

BACKLOG

The amount of the Company's backlog is significant because, among other
factors, customer orders typically involve long lead times and specific model
types. At December 31, 1997, the Company's backlog (consisting of accepted but
unfilled customer orders primarily scheduled for delivery during the remainder
of 1998) was $277.5 million, as compared with $227.0 million at December 31,
1996. However, orders can be cancelled or rescheduled by customers. Thus, the
level of orders currently in backlog could decline because of cancellation or
rescheduling.

EMPLOYEES

As of December 31, 1997, the Company had approximately 3,750 employees. The
Company's 1,800 employees in the United States are not represented by labor
unions, except for the 190 employees at the Company's La Salle, Illinois
facility. These employees are covered by a collective bargaining agreement with
the United Auto Workers which expires in the fall of 2001. Almost all 1,900
employees of the Company in Europe, other than managerial and professional
employees, are represented by labor unions. The Company has not experienced any
significant strike or work stoppage during the last three years. Management
believes its relationship with employees is good.

Sauer is committed to the continuous development of employee skills at all
levels to achieve the required innovation, flexibility, productivity and total
quality needs of customers. Known within the Company as "Reaching for
Excellence," this process of continuing investment in skills has led to
widespread recognition by customers and suppliers that the Company can carry
through with the type of major developments, in all areas of operation, required
of a world class company.

PROPERTIES

Sauer conducts its manufacturing operations at 13 locations, seven in the
United States, one in Germany, two in Slovakia and one each in Italy, the United
Kingdom and China. As discussed under "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources" to support its growth strategy the Company plans to substantially
increase its manufacturing capacity in the United States and Europe.

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<PAGE> 42

The following table sets forth certain information relating to the
Company's principal facilities:

<TABLE>
<CAPTION>
APPROX.
AREA IN
LOCATION PRINCIPAL PRODUCTS SQ. FT. OWNED/LEASED
-------- ------------------ -------- ------------
<S> <C> <C> <C>
UNITED STATES
Ames, Iowa............................... Hydrostatic transmissions 330,000 Owned
La Salle, Illinois....................... Hydrostatic transmissions 240,000 Owned
Freeport, Illinois....................... Hydrostatic transmissions 183,000 Owned
Minneapolis, Minnesota................... Electrohydraulics 75,000 Leased
West Branch, Iowa........................ Gear pumps and motors 99,000 Owned
Newtown, Pennsylvania.................... Electrohydraulics 96,000 Leased
Sullivan, Illinois....................... Hydrostatic transmissions 141,000 Owned
EUROPE
Neumunster, Germany...................... Hydrostatic transmissions 463,000 Owned (1)
and electrohydraulics
Povazska-Bystrica, Slovakia.............. Hydrostatic transmissions 315,000 Owned
and mechanical gear boxes
Dubnica, Slovakia........................ Hydrostatic transmissions 230,000 Leased
Swindon, England......................... Gear pumps 222,000 Leased
Bologna, Italy........................... Gear pumps and motors 246,000 Owned
ASIA
Shanghai/Pudong, China................... Hydrostatic transmissions 105,000 Leased
</TABLE>

- ---------------

(1) See "Relationship with Principal Stockholder -- Lease Agreement for and
Purchase of Neumunster Facilities."

ENVIRONMENTAL MATTERS

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

PATENTS AND TRADEMARKS

The Company owns or licenses rights to approximately 240 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 Sundstrand under agreements
that extend to March 31, 2004. The Company does not expect to seek renewal of
the license.

LEGAL PROCEEDINGS

The Company is involved in certain legal proceedings in the ordinary course
of its business. Management believes that the outcome of such proceedings will
not have a material adverse effect upon the Company.

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<PAGE> 43

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The following table sets forth certain information regarding the directors
and executive officers of the Company as of December 31, 1997:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Klaus H. Murmann...... 66 Chairman and Chief Executive Officer and Director
Tonio P. Barlage...... 46 President and Chief Operating Officer and Director
David L. Pfeifle...... 52 Executive Vice President and General Manager -- United
States
and Director
David J. 50 Vice President, Sales and Marketing -- United States
Anderson(1).........
Thomas K. Kittel(2)... 49 Vice President, Operations -- Germany and Slovakia
Wolfgang Weisser(2)... 54 Vice President, Sales and Marketing -- Europe
James R. Wilcox(1).... 51 Vice President and General Manager -- Hydrostatics U.S.
Kenneth D. McCuskey... 43 Treasurer and Secretary
Nicola Keim........... 37 Director
Johannes F. 40 Director
Kirchhoff...........
Sven Murmann.......... 30 Director
Agustin A. Ramirez.... 51 Director
Richard M. 60 Director
Schilling...........
</TABLE>

- ---------------
(1) David J. Anderson and James R. Wilcox are Vice Presidents of the U.S.
Operating Company, not Sauer Inc.

(2) Thomas K. Kittel and Wolfgang Weisser are Vice Presidents of the German
Operating Company, not Sauer Inc.

The Company's Board of Directors is divided into three classes with the
initial term of the first class expiring at the annual meeting of the
stockholders to be held in 1999 (Ms. Keim and Mr. Klaus H. Murmann), the second
class expiring at the annual meeting of stockholders to be held in 2000 (Messrs.
Barlage, Sven Murmann and Schilling), and the third class expiring at the annual
meeting of stockholders to be held in 2001 (Messrs. Kirchhoff, Pfeifle and
Ramirez). The executive officers of the Company are elected annually and serve
at the discretion of the Board of Directors.

Klaus H. Murmann has served as Chairman and Chief Executive Officer of
Sauer and its predecessor since 1987. Mr. Murmann founded Sauer Getriebe in 1967
which, as a licensee of and later joint venture partner with Sundstrand, has
been involved in hydrostatics since 1967. He is a member of the supervisory
boards of Fried. Krupp AG, Hoesch-Krupp, Essen, a German industrial company,
Gildemeister AG, Bielefeld, a German manufacturer of machine tools, and
PreussenElektra AG, Hannover, a German utility. He is Chairman of the Board of
Gothaer Insurance Group, Gottingen/Cologne, a German insurance company, Chairman
of the Board of PSVaG, a national pension fund, a member of the board of
Bankgesellschaft Berlin AG, Berlin, a German bank, a member of the advisory
board of Landesbank Schleswig-Holstein Girozentrale, a bank owned principally by
institutions belonging to various States of Germany, and a director of GKN PLC,
United Kingdom, a manufacturing company. Mr. Murmann is also a director of
Sundstrand. For a description of his transactions with the Company, see
"Relationship with Principal Stockholder."

Tonio P. Barlage has been President and Chief Operating Officer of the
Company since 1994. Prior to attaining his current position in 1994, Mr. Barlage
was the Chief Financial Officer of the Company and its predecessor from 1987 to
1994. From 1986 to 1987, Mr. Barlage was also Chief Financial Officer of Sauer
Getriebe. Prior to joining the Company in 1986, Mr. Barlage was with Arthur
Andersen & Co.

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<PAGE> 44

David L. Pfeifle has been Executive Vice President of Sauer and President
of the U.S. Operating Company since 1994. Mr. Pfeifle joined Sundstrand in 1971
and held various management positions with increasing responsibility until 1994.
Mr. Pfeifle is a member of the board of the Construction Industry Manufacturers
Association and of the National Fluid Power Association.

David J. Anderson has been Vice President, Sales and Marketing, United
States of the U.S. Operating Company since November 1997. Mr. Anderson joined
Sundstrand in 1984 and has held various management positions within sales and
marketing with increasing responsibility until 1997. Prior to joining the
Company, Mr. Anderson was Director of Business Development and Manager of Sales
with Dyneer Corporation.

Thomas K. Kittel has been Vice President, Operations of the German
Operating Company since January 1997. He joined the German Operating Company as
Director of Information Technology in 1988 and later became Director of
Production and Logistics. In 1994, he also undertook responsibility for
Engineering and the Slovakian operations.

Wolfgang Weisser has been Vice President, Sales and Marketing, Europe of
the German Operating Company since January 1997. Between 1991 and 1997, Mr.
Weisser was Director of Marketing. Mr. Weisser joined Sauer Getriebe in 1967 and
held various management positions with increasing responsibility until 1991.

James R. Wilcox has been Vice President and General Manager -- Hydrostatics
United States of the U.S. Operating Company since 1995. From 1992 to 1995, Mr.
Wilcox was Vice President of Operations. Prior to joining the Company, Mr.
Wilcox was Vice President, Operations and Plant Manager with Borg Warner
Automotive, Inc.

Kenneth D. McCuskey has been the Treasurer and Secretary of Sauer since
1989. He was International Controller of the Company from 1988 to 1989. Mr.
McCuskey has also been the Director of Finance of the U.S. Operating Company
since 1991.

Nicola Keim has been a Director of the Company since April 1990. Ms. Keim
served as a Member of the Supervisory Board of Sauer Getriebe, a predecessor of
the German Operating Company, from November 1990 through June 1997. Ms. Keim is
the daughter of Klaus H. Murmann.

Johannes F. Kirchhoff has been a Director of the Company since April 1997.
Mr. Kirchhoff has been owner and Managing Director of the FAUN Umwelttechnik
GmbH & Co., a manufacturer of vehicles for waste disposal, since December 1994.
From November 1989 through November 1994, Mr. Kirchhoff served as a Managing
Director of Edelhoff Polytechnik GmbH & Co., a manufacturer of vehicles for
waste disposal. Mr. Kirchhoff also served on the Board of Directors of Edelhoff
AG & Co., the holding company of Edelhoff Polytechnik GmbH & Co., from June 1993
through November 1994; from June 1993 through December 1993, he served as deputy
member of the Board of Directors and thereafter as a Member of the Board of
Directors.

Sven Murmann has been a Director of the Company since April 1994. Mr.
Murmann has served as an Assistant Professor at the University of Zurich since
October 1997. He was a research assistant at Ludwig-Maximilians University in
Munich from April 1994 through August 1995. Mr. Murmann is the son of Klaus H.
Murmann.

Agustin A. Ramirez has been a Director of the Company since December 1997.
Since 1987, Mr. Ramirez has served as President, Chief Executive Officer and
Chairman of HUSCO International, Inc., a manufacturer of hydraulic controls for
mobile equipment applications with operations in North America and Europe. He
served as past Chairman of the Board of the National Fluid Power Association and
as a member of the Advisory Board of Bank One Wisconsin.

Richard M. Schilling has been a Director of the Company since 1985. He
began his career at Sundstrand Corporation in March 1968 as a corporate attorney
and assistant secretary. In 1978, he was named General Counsel and Vice
President and, in 1988, he was elected Secretary of Sundstrand Corporation. Mr.
Schilling retired from Sundstrand Corporation on December 31, 1997 and is
currently a partner at Hinshaw & Culbertson, a law firm in Rockford, Illinois.
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<PAGE> 45

Directors who are not employees of the Company receive annual retainers of
$12,000 plus expenses relating to their duties as directors.

COMMITTEES OF THE BOARD

Audit Committee. The Audit Committee is composed of three directors, none
of whom is an employee of the Company. The Audit Committee makes recommendations
to the Board of Directors regarding the independent auditors to be nominated for
election by the stockholders, reviews the scope of the annual audit activities
of the independent auditors and the Company's internal auditors and reviews
audit results. R. Schilling, J. Kirchhoff and A. Ramirez are the current members
of the Audit Committee.

Compensation Committee. The Compensation Committee is composed of three
directors none of whom is an employee of the Company. The Compensation Committee
reviews and determines the salaries of the executive officers of the Company. J.
Kirchhoff, A. Ramirez and R. Schilling, are the current members of the
Compensation Committee. The Compensation Committee administers the Company's
Bonus Plan and the Sauer Inc. 1998 Long-Term Incentive Plan.

Executive Committee. The Executive Committee is composed of three
directors. Subject to certain exceptions, the Executive Committee is empowered
to exercise all powers of the Board of Directors. The Executive Committee
administers the Company's Phantom Share Plan and the Company's Management
Incentive Plan. K. Murmann, T. Barlage and D. Pfeifle are the current members of
the Executive Committee.

NON-EMPLOYEE DIRECTOR STOCK PLAN

General. The Sauer Inc. Non-employee Director Stock Option and Restricted
Stock Plan (the "Non-employee Director Stock Plan") was adopted by the Board of
Directors on March 12, 1998 and approved by the stockholders on April 22, 1998.
In general, the Non-employee Director Stock Plan permits the grant of awards of
non-qualified stock options and restricted Common Stock to directors of the
Company who are not also employees of the Company. The Non-employee Director
Stock Plan is designed to attract and retain outstanding individuals as
non-employee directors and to furnish incentives linked to the performance of
the Company and its Common Stock. The total number of shares of Common Stock to
be issued under the Non-employee Director Stock Plan shall not exceed 250,000
shares.

Plan Administration. The Non-employee Director Stock Plan will be
administered by the Board of Directors, excluding those directors who are
eligible to participate under the Non-employee Director Stock Plan. The Board of
Directors will have the discretion, in accordance with the provisions of the
Non-employee Director Stock Plan, to determine the number, the value, and other
terms and conditions of options and restricted Common Stock to be granted under
and to construe and interpret the Non-employee Director Stock Plan.

Stock Options. Beginning with the annual meeting of stockholders in April
of 1999, following which the Board of Directors has agreed that automatic annual
stock options under the Non-employee Director Stock Plan should begin, each
non-employee director shall be granted a non-qualified stock option to purchase
such number of shares of Common Stock as the Board of Directors shall determine
in its absolute discretion, effective on the day following such annual meeting.
However, the Board of Directors has the discretion to make additional
non-qualified stock option grants to non-employee directors at any time, and to
determine the number of shares of Common Stock to which each such option
pertains. The grants of and number of shares of Common Stock pertaining to
non-qualified stock options need not be uniform among the participants. Unless
otherwise determined by the Board of Directors at the time of grant, the
exercise price for each option under the Non-employee Director Stock Plan shall
be at least equal to 100% of the fair market value of a share of Common Stock on
the date the option is granted. Unless otherwise designated by the Board of
Directors, all options granted under the Non-employee Director Stock Plan shall
vest 100% and be immediately exercisable in whole or in part on the date of
grant, and shall remain exercisable until the tenth anniversary of the grant
date. Unless otherwise designated by the Board of Directors, in the event of
death or disability of a participant, all vested options held by such
participant shall remain exercisable at any time prior to such options'
expiration date, or for one year after the date of death or the date of
disability (as determined

42
<PAGE> 46

by the Board of Directors), whichever period is shorter, by the Participant or
his or her heirs or designees. If a director ceases to serve on the Board of
Directors for reasons other than death or disability, all vested options shall
remain exercisable for six months following the date the director's service on
the Board of Directors terminates or until the expiration date of the options,
whichever period is shorter. The exercise price of any option under the
Non-employee Director Stock Plan shall be payable to the Company in cash or in
Common Stock, or by a combination of both. Options under the Non-employee
Director Stock Plan can be transferred other than by will or the laws of dissent
and distribution, but only if and to the extent provided by the Board of
Directors.

Restricted Stock. Beginning with the annual meeting of stockholders to be
held in April 1999, following which the Board of Directors has agreed that
automatic restricted Common Stock grants should begin, upon first being elected
or appointed to the Board of Directors, newly elected or appointed non-employee
directors will each receive a one-time grant of such number of shares of
restricted Common Stock as the Board of Directors shall determine in its
absolute discretion on the day following such election or appointment. The
persons who are currently non-employee directors and who continue as
non-employee directors will each also receive a one-time grant of such number of
shares of Common Stock as the Board of Directors may determine in its absolute
discretion, on the day following the meeting of the Board of Directors to be
held in September of 1998. However, the Board of Directors has the absolute
discretion to provide additional grants of restricted Common Stock at any time
and to determine the number of shares of Common Stock pertaining to each such
grant. The number of shares of Common Stock pertaining to grants of restricted
stock need not be uniform among the participants. Unless otherwise designated by
the Board of Directors, all shares of restricted Common Stock granted under the
Non-employee Director Stock Plan shall vest ratably over a three-year period
such that one-third of the award vests on each anniversary of the date of grant.
The Board of Directors may impose other conditions or restrictions on any shares
of restricted Common Stock as it may deem advisable, including, without
limitation, restrictions: that require the participant's payment of a stipulated
purchase price; restrictions based upon the achievement of specific performance
goals; time-based restrictions on vesting following the attainment of the
performance goals; and restrictions under applicable federal or state securities
laws or other statutes. During the restriction period, the participant is not
entitled to delivery of the restricted Common Stock, restrictions are placed on
the Common Stock's transferability and, unless otherwise determined by the Board
of Directors, the Common Stock will be forfeited upon termination of service
from the Board of Directors for any reason. A holder of restricted Common Stock
will generally have the rights and privileges of a stockholder, including the
right to vote the Common Stock.

Change of Control. In the event of a change of control of the Company (as
defined in the Non-employee Director Stock Plan): (i) any options outstanding
under the Non-employee Director Stock Plan that have not already vested shall
become immediately exercisable and shall remain exercisable throughout their
entire term; and (ii) all restriction periods and restrictions imposed on
outstanding restricted Common Stock shall immediately lapse, other than any
restrictions under applicable federal or state securities laws or other
statutes.

Plan Amendments or Termination. The Board may terminate or suspend the
Non-employee Director Stock Plan in whole or in part, at any time, with respect
to all future grants and awards.

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<PAGE> 47

EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION(1)
--------------------------------------------- ---------------
OTHER ANNUAL LTIP
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) COMPENSATION ($) PAYOUTS ($)
- --------------------------- ---- ---------- --------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Klaus H. Murmann............ 1997 $475,000 $450,000(2) -- --
Chairman and CEO
Tonio P. Barlage............ 1997 375,000 350,000(2) -- --
President and COO 200,000(3)
David L. Pfeifle............ 1997 246,981 220,002(2) 5,760(4) 46,400(5)
Executive Vice President
and General
Manager -- U.S.
James R. Wilcox............. 1997 157,546 81,766(6) 6,000(4) --
Vice President of U.S.
Operating Company
Thomas K. Kittel............ 1997 158,785(8) 25,325(6)(7) 3,560(4) 17,400(5)
Vice President of German
Operating Company
</TABLE>

- ---------------

(1) During 1997, no awards were granted.

(2) These bonuses are paid under the 1990 Sauer Inc. Bonus Plan pursuant to
which the Chairman and CEO, the President and COO and the Executive Vice
President are entitled to receive payments if the Company achieves targeted
financial results as specified in the plan.

(3) A one-time bonus paid to Mr. Barlage for 1997 and awarded by the Company's
Compensation Committee for his efforts related to establishing the Company's
Slovakian operations.

(4) Aggregate quarterly payments under the Company's Phantom Share Plan (as
defined herein). Messrs. Murmann and Barlage do not participate in the
Phantom Share Plan.

(5) Payments made upon the lapsing of restrictions as to certain phantom share
rights granted under the Phantom Share Plan.

(6) These amounts were paid pursuant to the Company's Management Incentive Plan.
Under the Management Incentive Plan officers and management personnel
selected by the Executive Committee (other than officers who receive bonuses
under the Company's Bonus Plan) are entitled to receive payments if the
Company, the employee's business unit and the employee each achieve
specified targets, respectively.

(7) Payment was made in Deutsche marks and converted to U.S. dollars using the
exchange rate as of April 15, 1998.

(8) Payment to Mr. Kittel was made in Deutsche marks, which amount has been
converted to U.S. dollars for this table using a weighted average annual
exchange rate for 1997.

Phantom Share Plan. Under the Company's Restated Phantom Share Plan, dated
April 17, 1995, and 1996 Phantom Share Plan (collectively the "Phantom Share
Plan"), certain officers and other key employees have been granted phantom share
rights ("Phantom Share Rights"). Each Phantom Share Right entitles the grantee
to the market value of a share of Common Stock as of the December 31 immediately
prior to the date the restrictions on such Phantom Share Right lapse and, until
the restrictions lapse, a quarterly payment in an amount determined by the Board
of Directors. It is anticipated that such quarterly payment will equal the
quarterly dividend, if any, declared by the Board of Directors on a share of
Common Stock. The Phantom Share Plan is administered by the Executive Committee
of Sauer.

The restrictions on Phantom Share Rights lapse as to 20% of the aggregate
number of such rights granted on any particular date on the expiration of the
fifth, sixth, seventh, eighth and ninth years after their grant, provided the
grantee remains continuously in the employ of the Company. If a grantee's
employment is terminated by reason of retirement at or after age 65, death, or,
with the consent of the Executive Committee, early retirement, the restrictions
on such grantee's Phantom Share Rights will lapse as of the date of such
termination. Upon termination of a grantee's employment for any other reason,
unless the Executive

44
<PAGE> 48

Committee determines otherwise, all Phantom Share Rights granted to such grantee
shall automatically be canceled.

A total of 400,000 Phantom Share Rights may be granted under the Phantom
Share Plan, but the Executive Committee is currently authorized to grant up to
an aggregate of 200,000 Phantom Share Rights. At December 31, 1997, there were
13 employees of the Company participating in the Phantom Share Plan. There were
then 110,400 Phantom Share Rights outstanding, of which Messrs. Pfeifle, Kittel
and Wilcox held 13,600, 8,600, and 15,000, respectively. The quarterly payments
made under the Phantom Share Plan to those executive officers are set forth in
the Summary Compensation Table under "Other Annual Compensation" and the
payments made upon lapse of restrictions on Phantom Share Rights are set forth
under "LTIP Payouts" in the Summary Compensation Table. No grants of Phantom
Share Rights were made in 1997 to officers named in the Summary Compensation
Table. Messrs. Murmann and Barlage do not participate in the Phantom Share Plan.

The Board of Directors has terminated the Phantom Share Plan to be
effective as of December 31, 1998. Phantom Share Rights outstanding and subject
to restrictions as of the close of business on December 31, 1998 will be
replaced by Restricted Common Stock and Restricted Common Stock Units under the
Sauer Inc. 1998 Long-Term Incentive Plan. See "-- 1998 Long-Term Incentive
Plan."

Management Incentive Plan. Under the Company's Management Incentive Plan
(the "Management Incentive Plan"), executive officers and management personnel
of the Company selected by the Executive Committee are entitled to receive
payments if the Company, the employee's division and/or business unit and the
employee each achieve targeted financial and operating results and personal
objectives. Payments under the Management Incentive Plan are determined in
relation to a return on net assets ("RONA") at the Company and the employee's
division and business unit levels, as applicable. Attaining certain levels of
RONA equal to established benchmarks under the Management Incentive Plan and as
compared to the budget will result in a payment equal to a percentage, as
calculated under the Management Incentive Plan, of annual base compensation,
provided that no payment will be made unless a minimum threshold is achieved. At
December 31, 1997, there were 60 employees participating in the Management
Incentive Plan. Total payments made under this plan in respect of the 1997
fiscal year to all executive officers as a group (excluding the Chairman, the
President and the Executive Vice President who do not participate in the
Management Incentive Plan) were $225,293.

Bonus Plan. Under the Company's Bonus Plan (the "Bonus Plan"), the
Chairman and Chief Executive Officer, the President and Chief Operating Officer
and the Executive Vice President are entitled to receive cash payments if the
Company achieves targeted financial results. The bonuses are measured in
relation to RONA as defined under the Bonus Plan. If RONA is negative or zero,
no bonus will be paid; attaining specified levels of RONA will result in a bonus
equal to a specified percentage of annual base compensation, and achievement of
a RONA of 25% or more will result in a maximum bonus of 100% of annual base
compensation. Occasionally, a special lump sum bonus may be awarded by the
Compensation Committee to reflect extraordinary achievements of the recipient.

1998 LONG-TERM INCENTIVE PLAN

General. The Sauer Inc. 1998 Long-Term Incentive Plan (the "Long-Term
Incentive Plan") was adopted by the Board of Directors on March 12, 1998, and
approved by the stockholders on April 22, 1998, and shall remain in effect,
subject to certain termination rights of the Board of Directors, until all
shares subject to it are purchased, or until April 21, 2008. In general, the
Long-Term Incentive Plan provides for the grant of awards of stock options,
stock appreciation rights, restricted stock, performance units, performance
shares and other incentive awards (the "Awards") to officers and key employees
of the Company. The Long-Term Incentive Plan is designed to attract and retain
outstanding individuals in key positions and to furnish incentives linked to the
performance of the Company and its stock. The Long-Term Incentive Plan is
designed to meet the requirements for tax deductibility under Section 162(m) of
the Internal Revenue Code of 1986, as amended (the "Code"), with respect to
certain compensation.

Plan Administration. The Long-Term Incentive Plan will be administered by
the Compensation Committee of the Board of Directors (the "Committee"), which is
comprised of non-employee directors who

45
<PAGE> 49

meet the applicable requirements of "non-employee director" under Rule 16b-3 of
the General Rules and Regulations of the Exchange Act and of an "outside
director" under Section 162(m) of the Code.

The Committee will have the discretion, in accordance with the provisions
of the Long-Term Incentive Plan, to determine to whom among the eligible persons
an Award is granted and the terms and conditions of the Award. In making such
determinations, the Committee may consider the position and responsibilities of
the participant, the nature and value to the Company of his or her services and
accomplishments, his or her present and potential contribution to the Company
and such other factors as may be deemed relevant.

Shares Reserved for Issuance. The total number of shares of Common Stock
which may be subject to Awards or be issued under the Long-Term Incentive Plan
will not exceed 2,400,000 shares, of which no more than 1,200,000 shares may be
issued as restricted stock. The Long-Term Incentive Plan provides for
adjustments to the number of available shares for certain corporate events,
including: a corporate capitalization such as a stock split; a corporate
transaction such as a merger, consolidation, spin-off or other distribution of
stock or property; any reorganization; or a liquidation of the Company. The
Long-Term Incentive Plan also permits Common Stock not acquired due to
cancellation, expiration or termination of an Award to become available for
reissuance. No Awards may be granted under the Long-Term Incentive Plan after
April 21, 2008. Awards granted prior thereto may extend beyond such date, and
the provisions of the Long-Term Incentive Plan will continue to apply thereto.

Stock Options. The Long-Term Incentive Plan permits the Committee to grant
Awards of stock options to participants and to determine the timing and amount
of such Awards, provided that no individual can receive options for more than
200,000 shares of Common Stock in any fiscal year, subject to equitable
adjustment as set forth above. The Committee may grant either non-qualified
stock options or incentive stock options (as that term is defined in Section
422A of the Code). Incentive stock options may be granted only to employees of
the Company. The Committee will set the exercise price for an option, provided,
however, that an incentive stock option exercise price cannot be less than the
fair market value of a share of Common Stock on the date such option is granted.
Options shall be exercisable at such times as the Committee may determine,
provided, however, that incentive stock options shall not be exercisable later
than the tenth anniversary date of their grant. Additional restrictions shall
apply to any incentive stock options that are granted to an employee who
possesses more than 10% of the total combined voting power of all classes of
shares of the Company within the meaning of Section 422(b)(6) of the Code.
Nonqualified stock options can be transferred other than by will or the laws of
dissent and distribution, but only if and to the extent provided by the
Committee. Payment of the exercise price shall be in cash, in Common Stock or a
combination of both.

Stock Appreciation Rights. The Long-Term Incentive Plan permits the
Committee to award stock appreciation rights ("SARs") to participants and to
determine the timing and amount of such Awards, provided that no individual can
receive more than 200,000 SARs in any fiscal year, subject to equitable
adjustment as set forth above. The Committee may grant freestanding SARs or SARs
in tandem with a related stock option ("Tandem SAR") or a combination of both.
Unless otherwise designated by the Committee at the time of grant, the grant
price of a freestanding SAR is the fair market value of a share of Common Stock
on the date of grant. The grant price of Tandem SARs shall equal the exercise
price of the related stock option. Unless otherwise designated by the Committee,
no SAR will be exercisable after ten years from the date of grant. Upon exercise
of each SAR, the holder is entitled to receive the excess of the fair market
value of the Common Stock on the date of exercise over the grant price. At the
discretion of the Committee, the payment upon exercise of an SAR by the Company
may be in cash, in Common Stock, or a combination of both. The Long-Term
Incentive Plan also permits the Committee to determine the holder's right to
exercise SARs following termination of employment or service. Except as
otherwise provided by the Committee. SARs cannot be transferred other than by
will or the laws of dissent and distribution.

Restricted Stock. The Long-Term Incentive Plan permits the Committee to
grant Awards of restricted Common Stock ("Restricted Common Stock") to
participants and to determine the timing, amount and conditions of such Awards,
provided that no individual can receive more than 50,000 shares of Restricted
Common Stock in any fiscal year, subject to equitable adjustment as set forth
above. Shares awarded as Restricted Common Stock would be issued subject to such
restrictions as the Committee may impose, including, without limitation,
restrictions: that require the participant's payment of a stipulated purchase
price;

46
<PAGE> 50

that are based upon the achievement of specific performance goals; and that are
based on time-based vesting and/or restrictions under applicable federal or
state securities laws. During the restriction period, the participant is not
entitled to delivery of the Common Stock, restrictions are placed on the Common
Stock's transferability, and the Common Stock may be forfeited in the event of
termination of employment or service. A holder of Restricted Common Stock will
generally have the rights and privileges of a stockholder, including the right
to vote the Common Stock. The Committee has discretion to remove restrictions if
it deems that to be appropriate in a particular case.

Performance Units/Shares. The Long-Term Incentive Plan permits the
Committee to grant Awards of performance units and/or performance shares
("Performance Units and/or Performance Shares") to participants based upon
Company performance over a period of time (a "Performance Period") determined by
the Committee. At the time the Committee establishes a Performance Period for a
particular Award, it will also establish Company performance measures
("Performance Measures") applicable to the Award and targets that must be
attained relative to those measures. Performance Measures may be based on any of
the following, alone or in combination, as the Committee deems appropriate for
the Company, its subsidiaries, its affiliates and/or any subdivisions thereof:
(i) return on assets; (ii) cash flow return on investment; (iii) earnings before
interest and taxes; (iv) net earnings; (v) total shareholder return; (vi) return
on sales; (vii) return on equity; (viii) economic value added; (ix) division
operating income; or (x) return on net assets. Following determination of the
level of performance, the Company may adjust the determinations of the degree of
attainment of the pre-established Performance Measures, except that no upward
adjustment will be made if to do so would disqualify the payment as
performance-based compensation under Section 162(m) of the Code.

Awards may be paid by the Company in cash, Common Stock, or a combination
of both following the end of the Performance Period. The aggregate maximum
amount that can be paid with respect to Performance Unit Awards to any
participant in respect of any Performance Period under the Long-Term Incentive
Plan may not have a value in excess of the value of 50,000 shares of Common
Stock, subject to equitable adjustment as set forth above. In the event of
termination of employment prior to attaining the performance target, the
Performance Units/Shares will be forfeited unless the Committee in its
discretion otherwise determines.

Other Incentive Awards. Subject to the terms and provisions of the
Long-Term Incentive Plan, other incentive awards ("Other Incentive Awards") may
be granted to participants in such amount, upon such terms, and at any time and
from time to time as shall be determined by the Committee. Except as otherwise
provided by the Committee, Other Incentive Awards cannot be transferred other
than by will or the laws of dissent and distribution. Payment of Other Incentive
Awards shall be made at such times and in such form, either in cash or in Common
Stock (or a combination thereof), as established by the Committee subject to the
terms of the Long-Term Incentive Plan. Such Common Stock may be granted subject
to any restrictions deemed appropriate by the Committee. Without limiting the
generality of the foregoing, annual incentive awards may be paid in the form of
Other Incentive Awards (which may or may not be subject to restrictions, at the
discretion of the Committee).

Change of Control. In the event of a change of control of the Company (as
defined in the Long-Term Incentive Plan): (i) all options and SARs then
outstanding under the Long-Term Incentive Plan will become immediately
exercisable and remain so throughout their terms; (ii) all restriction periods
and restrictions imposed on Restricted Common Stock then outstanding will lapse;
and (iii) the target payout opportunities attainable under all outstanding
Awards of Performance Units/Performance Shares shall be deemed to have been
fully earned for the entire Performance Period(s) as of the effective date of
the change of control. The vesting of all Awards denominated in Common Stock
shall be accelerated as of the effective date of the change of control, and
there shall be paid out to participants within 30 days following the effective
date of the change of control a pro rata number of shares of Common Stock based
upon an assumed achievement of all relevant targeted performance goals and upon
the length of time within the Performance Period which has elapsed prior to the
change of control. Awards denominated in cash shall be paid pro rata to
participants in cash within 30 days following the effective date of the change
of control, with the proration determined as a

47
<PAGE> 51

function of the length of time within the Performance Period which has elapsed
prior to the change of control, and based on an assumed achievement of all
relevant targeted performance goals.

Plan Amendment or Termination. The Board of Directors may terminate or
suspend the Long-Term Incentive Plan in whole or in part, at any time, with
respect to all future grants and Awards.

Other Information. On April 22, 1998, the Board of Directors made a grant
of 67,050 shares of Restricted Common Stock and 44,700 Restricted Common Stock
Units under the Long-Term Incentive Plan to 13 participants under the Phantom
Share Plan (to be terminated as of December 31, 1998), replacing Phantom Share
Rights that would have been outstanding and subject to restrictions upon the
termination of the Phantom Share Plan. The Restricted Common Stock and
Restricted Common Stock Units will be subject to the same vesting schedule as
the Phantom Share Rights they replace. Grants were made to executive officers
named in the Summary Compensation Table as follows: Mr. Pfeifle - 7,200 shares
of Restricted Common Stock and 4,800 Restricted Common Stock Units; Mr. Wilcox -
9,000 shares of Restricted Common Stock and 6,000 Restricted Common Stock Units;
and Mr. Kittel - 4,800 shares of Restricted Common Stock and 3,200 Restricted
Common Stock Units. Grants to all executive officers as a group consisted of
30,600 shares of Restricted Common Stock and 20,000 Restricted Common Stock
Units. Each Restricted Common Stock Unit will be redeemed for cash on the date
all restrictions lapse in an amount equal to the fair market value of a share of
Common Stock. Also, on April 22, 1998, a grant of 106,500 shares of Restricted
Common Stock and 71,000 Restricted Common Stock Units were made under the 1998
Long-Term Incentive Plan to 33 participants, such grants to be effective as of
June 1, 1998. No grants were made to executive officers named in the Summary
Compensation Table. Total grants made to all executive officers as a group
consisted of 7,500 shares of Restricted Common Stock and 5,000 Restricted Common
Stock Units.

BENEFIT AND RETIREMENT PLANS

U.S. Retirement Plan. The following table sets forth the estimated annual
benefits payable under the Sauer-Sundstrand Employees' Retirement Plan (the
"U.S. Retirement Plan") to participants retiring at a normal retirement date of
January 1, 1998, for the specified average annual earnings and years of
participation. The benefits have been calculated on the basis of a straight-life
annuity.

U.S. RETIREMENT PLAN TABLE

<TABLE>
<CAPTION>
YEARS OF PARTICIPATION
----------------------------------------
REMUNERATION 15 20 25 30
- ------------ ------- ------- ------- -------
<S> <C> <C> <C> <C>
$150,000.................................... $38,112 $50,816 $63,520 $76,224
175,000.................................... 42,437 56,583 70,728 84,874
200,000.................................... 42,798 57,065 71,331 85,597
225,000.................................... 42,798 57,065 71,331 85,597
250,000.................................... 42,798 57,065 71,331 85,597
275,000.................................... 42,798 57,065 71,331 85,597
</TABLE>

The U.S. Retirement Plan is a defined benefit pension plan intended to be
qualified under Section 401(a) of the Code. Benefits are based only on salary
and any sales commissions (the Company currently pays no sales commissions). The
current compensation covered by the U.S. Retirement Plan for Messrs. Pfeifle and
Wilcox are the amounts set forth under "Salary" in the Summary Compensation
Table. No other executive officer named in the Summary Compensation Table
participated in the U.S. Retirement Plan.

Under the U.S. Retirement Plan, the monthly amount of a participant's
retirement benefit at the participant's normal retirement age (generally the
participant's 65th birthday) is calculated pursuant to a formula based on (i)
the average of the participant's highest five-year annual earnings less an
offset for Social Security benefits and (ii) the participant's years of
participation in the Retirement Plan. Messrs. Pfeifle and Wilcox have completed
26 and 6 years of participation, respectively, and their estimated annual U.S.
Retirement Plan benefits at their normal retirement dates, assuming their
present salaries and present Social Security benefits remain unchanged, would be
$85,597 and $55,076, respectively.

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<PAGE> 52

U.S. Supplemental Plans. The Code generally limits to $130,000, as indexed
for inflation, the amount of any annual benefit that may be paid from the U.S.
Retirement Plan. Moreover, the Retirement Plan may consider no more than
$160,000, as indexed for inflation, of a participant's annual compensation in
determining that participant's retirement benefit. In recognition of these two
limitations, the Company has adopted two Supplemental Retirement Benefit Plans
(the "U.S. Supplemental Plans"). Both of these U.S. Supplemental Plans are
designed to provide supplemental retirement benefits to the extent that a
participant's benefits under the Retirement Plan are limited by either the
$130,000 annual benefit limitation or the $160,000 annual compensation
limitation.

One of these two U.S. Supplemental Plans has an additional purpose. It
provides supplemental retirement benefits equal to the difference between the
benefit the participant would have received under the applicable Sundstrand
pension plan for former employees of Sundstrand (if the participant's earnings
and service with the Company had been taken into account under that Sundstrand
plan) and the benefit payable under the U.S. Retirement Plan. Under both U.S.
Supplemental Plans, however, the actual payment of supplemental benefits is
entirely at the discretion of the Company.

At January 1, 1998, Messrs. Pfeifle and Wilcox participated in the U.S.
Supplemental Plans, but only Mr. Pfeifle was eligible for the supplement for
benefits that would have been payable under the Sundstrand plan. The estimated
annual supplemental retirement benefits for Messrs. Pfeifle and Wilcox, at their
normal retirement dates at age 65, assuming their present salaries until
retirement, would be $85,823 and $2,814, respectively. No other executive
officer of the Company named in the Summary Compensation Table under
"-- Executive Compensation" is entitled to benefits under the U.S. Supplemental
Plans.

European Pension Plans. Messrs. Murmann and Barlage are entitled to
retirement benefits from the Company equal to 60% of their annual base salary
immediately prior to retirement. These benefits are payable as a straight-life
annuity, commencing at the normal retirement age of 60. In the event either
executive leaves a surviving spouse, that spouse would be entitled to a
straight-life annuity benefit equal to 60% of the benefit payable to the
deceased executive. Based on his 1997 base salary and an assumed 6% compounded
annual salary growth rate during the 14 years remaining until he attains age 60,
Mr. Barlage would be entitled to an estimated annual retirement benefit of
$508,703 at his normal retirement age. Mr. Murmann has already attained his
normal retirement age, and could therefore receive an annual retirement benefit
of $285,000 if he were to retire immediately.

Mr. Kittel participates in the pension plan covering most of the Company's
German employees. The plan is similar in nature to a defined contribution plan
in the United States, with the exception that the plan is unfunded. Under the
plan, a monthly pension is paid to employees who retire after attaining the age
of 65, calculated pursuant to a formula based on (i) a percentage of each
employee's base monthly salary as of the end of October of each year and (ii)
the participant's years of service. Mr. Kittel completed ten years of service as
of December 31, 1997, and assuming that his present salary remains unchanged and
that he will retire at age 65, his pension will be DM 34,240 per year ($19,043
using the exchange rate as of December 31, 1997). Mr. Kittel does not
participate in the arrangement covering Messrs. Murmann and Barlage.

No other executive officer of the Company named in the Summary Compensation
Table is entitled to benefits under a European pension plan.

U.S. Savings Plan. The Company also maintains the Sauer-Sundstrand
Employees' Savings and Retirement Plan (the "U.S. Savings Plan"). The U.S.
Savings Plan is a defined contribution plan which is intended to be qualified
under Section 401(a) of the Code and includes a Section 401(k) feature.
Substantially all U.S. employees of the Company who are not represented for
collective bargaining purposes are eligible to participate in the U.S. Savings
Plan.

Subject to a number of limitations and nondiscrimination rules,
participants in the U.S. Savings Plan may elect to contribute from 1% to 10%
(or, in the case of nonhighly compensated employees, 1% to 20%) of their
compensation to the U.S. Savings Plan. These contributions are limited to
$10,000 per year (as indexed for inflation), are made on a tax-deferred basis
and are 100% vested at all times. The Company makes certain matching and other
contributions to the U.S. Savings Plan on behalf of participants working at its
West Branch, Iowa facility, who are not covered by the U.S. Retirement Plan. At
January 1, 1998, approximately

49
<PAGE> 53

1,098 employees were eligible to participate in the U.S. Savings Plan, of whom
871 employees (including Messrs. Pfeifle and Wilcox) were contributing to the
Plan. Messrs. Pfeifle and Wilcox were not entitled to a Company contribution
during 1997. No other executive officer named in the Summary Compensation Table
was eligible to participate in the U.S. Savings Plan.

EMPLOYMENT ARRANGEMENTS

The Company has employment contracts with Messrs. Murmann and Barlage
providing for annual salaries of not less than $450,000 and $350,000,
respectively. The employment contracts with Messrs. Murmann and Barlage provide
that each shall participate in the Company's benefits plans for which he is
presently eligible and in any plans substituted therefor, and each shall be
entitled to certain retirement benefits. See "-- Executive Compensation" and
"-- Benefit and Retirement Plans -- European Pension Plans." In the event the
Company terminates the employment of Messrs. Murmann or Barlage in violation of
the contract, he would be entitled to receive all compensation and benefits
provided for under the contract until such time as his employment would
otherwise terminate pursuant to the contract. The employment contracts with
Messrs. Murmann and Barlage expire on December 31, 2001, and contain agreements
not to compete during the period of the employment contract. The German
Operating Company has an employment contract with Mr. Kittel that provides for
an annual salary of DM 300,000 ($166,852 using the exchange rate as of December
31, 1997), which contract expires on December 31, 2002 and does not contain an
agreement not to compete. No other executive officer named in the Summary
Compensation Table is a party to an employment contract with the Company.

RELATIONSHIP WITH PRINCIPAL STOCKHOLDER

Ownership of Sauer Common Stock. Immediately prior to the Combined
Offering, the Murmann family beneficially owned 86.7% of the outstanding Common
Stock of the Company. Upon completion of the Combined Offering, the Murmann
family will beneficially own 56.5% of the outstanding Common Stock (or 51.6% if
the over-allotment option is exercised in full). In addition, the Murmann family
owns limited partnership interests in the German Operating Company as described
below. See "-- Murmann Family Limited Partnership Interests in the German
Operating Company." For as long as the Murmann family continues to beneficially
own shares of Common Stock representing more than 50% of the combined voting
power of the Company's Common Stock and votes those shares as a group, the
Murmann family will be able to direct the election of all members of the
Company's Board of Directors and exercise a controlling influence over the
business and affairs of the Company, including any determinations with respect
to mergers or other business combinations involving the Company. Similarly, the
Murmann family will have the power to determine matters submitted to a vote of
the Company's stockholders without the consent of the Company's other
stockholders, will have the power to prevent a change of control of the Company
and could take other actions that might be favorable to the Murmann family.

The Murmann family has advised the Company of its current intention to
continue to own beneficially no less than 50.1% of the outstanding Common Stock
of the Company following the Combined Offering; however, it is under no
obligation to retain its controlling interest. The Company has agreed to
register the Murmann family's shares of Common Stock from time to time upon
request.

Murmann Family Limited Partnership Interests in the German Operating
Company. Sauer conducts its German operations through the German Operating
Company, a German partnership; Sauer Inc. and Sauer Sundstrand GmbH, a company
wholly owned by Sauer Inc., are the general partners of the German Operating
Company. Sauer GmbH and Klaus H. Murmann & Co. K.G. -- as holding company for
Sauer GmbH & Co. Hydraulik KG -- have limited partnership interests ("Stille
Gesellschafter") (the "Limited Partners") in the German Operating Company. The
Limited Partners are owned entirely by the Murmann Family. The creation of the
limited partnership interests as opposed to the acquisition of the entire share
capital of the Company was a result of tax considerations in connection with the
formation of the Company in 1989. The limited partnership interests remained
essentially unchanged since that date. The German Operating Company is required
to pay annually to the Limited Partners an amount in cash (the "Annual Cash
Payment") equal to a percentage of the Company's consolidated income before
taxes and the Limited Partners' interests ("Percentage"). The Percentage is
subject to adjustment based on changes in the number of outstanding shares of
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<PAGE> 54

Common Stock during the applicable year. The Percentage is equal to the ratio of
2,250,000 shares divided by the sum of 2,250,000 shares and the number of
outstanding shares of Common Stock. See "Use of Proceeds." As of the date of
this Prospectus, the Percentage is equal to 2,250,000/(2,250,000 + 24,225,000),
or 8.5%. After the Combined Offering, the Percentage will decrease to
approximately 7.6%.

The Annual Cash Payment is based on the overall income of Sauer in order to
avoid any potential conflicts between Sauer and the Limited Partners regarding
whether, for example, sales should be made by the U.S. Operating Company or the
German Operating Company and the pricing of intercompany sales between the U.S.
Operating Company and the German Operating Company.

Sauer has the right to elect by the action of its independent directors or
the holders of its Common Stock other than the Murmann family to terminate the
limited partnership interests in exchange for 2,250,000 shares of Common Stock
of Sauer Inc. (subject to antidilution adjustment) and the balance of the
current account of the Limited Partners at any time after notice to the Limited
Partners as specified in the limited partnership agreement. The dissolution of
the German Operating Company will be deemed an election to terminate the limited
partnership interests. Unless Sauer's election to terminate the limited
partnership is related to (i) stock transfers resulting in a decline in the
Murmann family's beneficial ownership (economic or voting) of Sauer Common Stock
to less than 50.1% (subject to adjustment for dilution); (ii) a sale of a
majority in book value of the consolidated assets of Sauer and its subsidiaries
or assets that generated a majority of the consolidated revenues of Sauer and
its subsidiaries in the prior fiscal year; (iii) a transfer of the beneficial
ownership of the limited partnership interest (or any voting rights in respect
thereof) outside the Murmann family; (iv) a merger or other business combination
in which Sauer is not the survivor or the acquisition of at least 50.1% of the
outstanding Common Stock of Sauer pursuant to a tender or exchange offer; or (v)
the withholding of the consent of the Limited Partners in certain circumstances
in a manner adverse to holders of Sauer Common Stock, or is effected after
December 31, 2016, in addition to the payment of the current account balance and
issuance of Common Stock in exchange for and in complete satisfaction of all
Limited Partners' claims with respect to the German Operating Company, Sauer
will pay the Limited Partners an amount in cash equal to the income tax payable
as a result of the exchange of the Sauer shares of Common Stock for the limited
partnership interests. In no event will the payment with respect to the tax
exceed 24 million Deutsche marks. The right to receive the payment in respect of
the taxes is not transferable to persons or companies outside the Murmann family
and companies which are 90% owned by the Murmann family.

The Limited Partners may elect to terminate the limited partnership
interests at any time upon three months' notice to Sauer and to the German
Operating Company. In such case, the Limited Partners will receive the balance
of their current accounts and Sauer will issue 2,250,000 shares of Sauer Common
Stock (subject to antidilution adjustment) in exchange for, and in complete
satisfaction of, all claims of the Limited Partners. No tax reimbursement will
be payable by Sauer in such event.

The consent of the Limited Partners is required, among other things, to (i)
change the business purpose of the German Operating Company, (ii) admit
additional limited partners who are not members of the Murmann family, (iii)
authorize the German Operating Company to take actions out of the ordinary
course of business of the German Operating Company, (iv) amend the partnership
agreement of the German Operating Company in a manner that adversely affects the
limited partners or amend the limited partnership agreement and (v) partially or
wholly dissolve the German Operating Company. Klaus H. Murmann on behalf of the
Limited Partners has agreed that they will not unreasonably withhold such
consent.

Klaus H. Murmann, on behalf of the Murmann family, has agreed with the
Underwriters not to cause the Company and the Limited Partners to amend the
German limited partnership agreement to increase the Percentage, to change the
basis on which the Annual Cash Payment is computed in a way that is less
favorable to the Company or in any other way adversely affecting the rights of
Sauer or the Sauer stockholders. The Limited Partners may not transfer the
limited partnership interests in the German Operating Company to a person who is
not in the Murmann family without the consent of the Company.

Lease Agreement for and Purchase of Neumunster Facilities. Since 1987, the
German Operating Company leased the real estate and building of the Company's
facility in Neumunster, Germany from the Murmann family. The lease was renewed
in December 1996 with an expiration date of December 31, 2006.
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<PAGE> 55

The lease agreement was between the German Operating Company and Sauer
Hydraulik, which is wholly owned by the Murmann family. If neither of the
parties to the lease gave notice of termination at least one year prior to any
expiration date of the lease, the lease would have automatically extended for an
additional term of five years. The lease payments were DM 3,960,000 per annum
plus value added tax at prevailing rates.

Under the lease agreement, the German Operating Company assumed full
responsibility for the premises and agreed to bear all costs associated with the
premises and the conduct of its business, including, but not limited to, the
costs of repairs, insurance and all overhead. The German Operating Company was
obligated to fully indemnify Sauer Hydraulik against all liabilities incurred in
connection with the premises and the conduct of the business, including
environmental liabilities, whether or not incurred by a previous owner of the
premises. In addition, Sauer Hydraulik can hold the German Operating Company
liable for all environmental damages to the premises, and the German Operating
Company is fully responsible for the clean-up of such damages at its own
expense, whether or not those damages result from the usage of a previous owner.

Under the lease agreement, the German Operating Company had an option to
purchase and Sauer Hydraulik had the right to require the German Operating
Company to purchase the property at any time during the term of the lease
agreement. Any such purchase will be "as is" without warranties and at the fair
market value of the property. In connection with the Combined Offering,
Sauer-Sundstrand GmbH, a wholly owned subsidiary of the Company, purchased the
facility from Sauer Hydraulik effective May 1, 1998, (subject to local
government approval) under this clause of the lease agreement. The purchase
price for the facility was approximately $23.4 million, which Sauer-Sundstrand
GmbH paid by assuming approximately $8.0 million in indebtedness of Sauer
Hydraulik and by issuing a note of approximately $15.4 million to Sauer
Hydraulik. See "Use of Proceeds."

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<PAGE> 56

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth information regarding the beneficial
ownership of the Common Stock as of December 31, 1997, and as adjusted to
reflect the sale of Common Stock in the Combined Offering, by (i) each director
of the Company, (ii) each person known or believed by the Company to own
beneficially 5% or more of the Common Stock, (iii) each Selling Stockholder and
(iv) all directors and executive officers as a group. Unless otherwise
indicated, each person has sole voting and dispositive power with respect to
such shares.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED(2) OWNED(2)
PRIOR TO COMBINED AFTER THE COMBINED
OFFERING NUMBER OF OFFERING
NAME AND ADDRESS --------------------- SHARES BEING ---------------------
OF BENEFICIAL OWNER(1) NUMBER PERCENT OFFERED NUMBER PERCENT
- ---------------------- ---------- ------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C>
Klaus H. Murmann(3)................. 21,012,500 86.7% 5,621,875 15,390,625 56.5%
Tonio P. Barlage(4)................. 750,000 3.1% 112,500 562,500 2.1%
David L. Pfeifle.................... 312,500 1.3% 62,500 250,000 *
Thomas K. Kittel.................... 312,500 1.3% 37,500 275,000 1.0%
Nicola Keim(5)...................... 15,262,500 63.0% 0 15,262,500 56.1%
Johannes F. Kirchhoff............... 0 -- 0 0 --
Sven Murmann(5)..................... 15,262,500 63.0% 0 15,262,500 56.1%
Agustin A. Ramirez.................. 0 -- 0 0 --
Richard M. Schilling................ 0 -- 0 0 --
Hannelore Murmann(5)................ 15,262,500 63.0% 0 15,262,500 56.1%
Brigitta Zoellner(5)................ 15,262,500 63.0% 0 15,262,500 56.1%
Christa Zoellner(5)................. 15,262,500 63.0% 0 15,262,500 56.1%
Wolfgang Weisser.................... 162,500 * 43,750 118,750 *
Maria Barlage(6).................... 750,000 3.1% 75,000 562,500 2.1%
Scott Jeffrey....................... 12,500 * 9,375 3,125 *
Eckhard Skirde...................... 125,000 * 25,000 100,000 *
Martin Ziebell...................... 25,000 * 12,500 12,500 *
All directors and executive officers
as a group (4).................... 22,937,500 94.7% 5,953,125 16,984,375 62.4%
</TABLE>

- ---------------
* Less than one percent.
(1) The address for beneficial owners is in care of the Company at Sauer Inc.,
2800 East 13th Street, Ames IA 50010.
(2) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission.
(3) Shares held either directly or through controlled entities. Klaus H. Murmann
shares voting rights as to 15,262,500 of these shares with his family. If
the over-allotment option is exercised in full, Klaus H. Murmann will
beneficially own 14,040,625 shares of Common Stock (51.6% of the outstanding
shares) after the Combined Offering.
(4) Includes shares held by Maria Barlage.
(5) These shares are held through entities controlled by the Murmann family.
Nicola Keim, Sven Murmann, Hannelore Murmann, Brigitta Zoellner and Christa
Zoellner share voting rights as to these 15,262,500 shares (14,040,625
shares (51.6% of the outstanding shares) if the over-allotment option is
exercised in full) with Klaus H. Murmann.
(6) Includes shares held by Tonio P. Barlage.

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<PAGE> 57

DESCRIPTION OF CAPITAL STOCK

GENERAL

The total authorized capital stock of the Company is 49,500,000 shares,
consisting of 45,000,000 shares of Common Stock, par value $.01 per share, and
4,500,000 shares of Preferred Stock, par value $.01 per share ("Preferred
Stock"). As of May 11, 1998, there were 24,225,000 shares of Common Stock
outstanding. Upon completion of the Combined Offering, 27,225,000 shares of
Common Stock and no shares of Preferred Stock will be issued and outstanding.

Prior to the Combined Offering, there has been no public market for the
Common Stock. See "Risk Factors -- No Prior Trading Market for Common Stock."

The following summary of the rights, privileges, restrictions and
conditions of the Company's capital stock does not purport to be complete and is
subject to the detailed provisions of, and qualified in its entirety by
reference to, the Restated Certificate of Incorporation of the Company and its
By-laws and the Delaware General Corporation Law (the "DGCL").

COMMON STOCK

All outstanding shares of Common Stock are validly issued, fully paid and
nonassessable. The 3,000,000 shares of Common Stock being issued and sold by the
Company in the Combined Offering, when issued and sold by the Company and paid
for, will be validly issued, fully paid and nonassessable.

Holders of the shares of Common Stock are entitled to one vote for each
share of the capital stock having voting power held of record on each matter
properly submitted for a vote by such holders, including election of directors.
There is no cumulative voting. See "Risk Factors -- Concentration of Ownership
of the Company; Murmann Family's Limited Partnership Interests." Subject to the
rights of any then outstanding shares of Preferred Stock, holders of shares of
Common Stock are entitled to receive their pro rata share of (i) any dividends
that may be declared by the Board of Directors of the Company (the "Board") out
of assets legally available therefor and (ii) any assets available upon the
liquidation, dissolution or winding-up of the Company. See "Dividend Policy" and
"-- Limitations on Dividends and Other Financial Restrictions on the Company and
its Subsidiaries."

The shares of Common Stock are not convertible and the holders thereof have
no preemptive or subscription rights to purchase any securities of the Company.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Common Stock in the United States
is First Chicago Trust Company of New York (the "U.S. Transfer Agent").

BOOK-ENTRY-ONLY ISSUANCE OF COMMON STOCK TRADING ON THE FRANKFURT STOCK EXCHANGE

In general, the Common Stock will trade on the Frankfurt Stock Exchange
only through transfers of beneficial interests therein held through Deutsche
Borse Clearing AG ("DBC"). However, any investor who received an actual
certificate representing shares of Common Stock, rather than such a beneficial
interest, and who desires to sell such shares of Common Stock on the Frankfurt
Stock Exchange will be required to deposit, through a DBC participant, such
shares with DBC, or with The Depository Trust Company ("DTC") for credit to
DBC's account as described below, and receive a beneficial interest therein that
is reflected on DBC's books and records. Certificates representing shares of
Common Stock held through DBC will not be issued unless such shares are
withdrawn from DBC, in which case the shares will not be eligible to trade on
the Frankfurt Stock Exchange unless redeposited as described above. DBC will not
hold actual Common Stock,

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<PAGE> 58

but will hold beneficial interests therein through its account with DTC in New
York. DTC, or its nominee, will be the registered owner of all shares of Common
Stock that are held by investors through DBC.

Investors who are beneficial owners of Common Stock held through DBC will
receive confirmations and statements of their holdings only from DBC (through
their brokers or other financial institutions). DBC will register all transfers
of such Common Stock on its books and records through its book-entry system.
Common Stock held by DTC will be registered in the name of DTC's nominee, Cede &
Co. DTC will not know the beneficial owners of the Common Stock that is held
through DBC because DTC's records will reflect only that such shares are
credited to DBC's account. DBC will be responsible for keeping account of its
Common Stock holdings on behalf of its customers.

Any communications by DTC to DBC and by DBC to beneficial owners will be
governed by arrangements between DTC and DBC and by the general rules and
practices of DTC and DBC, subject to any statutory or regulatory requirements
that may be in effect from time to time.

Neither DTC nor Cede & Co. will consent or vote with respect to any Common
Stock held through DBC. Under its usual procedures, DTC will mail an Omnibus
Proxy to the Company as soon as possible after the applicable record date. The
Omnibus Proxy will assign Cede & Co.'s consenting or voting rights to DBC for
all Common Stock credited to DBC's account on the record date. DBC will consent
or vote with respect to such shares on behalf of beneficial owners thereof in
accordance with its standard rules and procedures.

Any dividend or other payments on Common Stock held through DBC will be
made by the Company to Cede & Co., as nominee of DTC. DTC, upon receipt of such
payments, will credit DBC's account at DTC for the amount of such payments.
Payments by DBC to the beneficial owners of Common Stock will be governed by
standing instructions and DBC's customary practices, and will be the sole
responsibility of DBC, subject to any statutory or regulatory requirements as
may be in effect from time to time. The dividends will be converted into
Deutsche marks and distributed by DBC.

PREFERRED STOCK

The Company's Restated Certificate of Incorporation provides that shares of
Preferred Stock may be issued in one or more series from time to time by the
Board. Subject to the provisions of the Company's Restated Certificate of
Incorporation and limitations prescribed by law, the Board is expressly
authorized to adopt resolutions to issue the shares, to fix the number of shares
and to change the number of shares constituting any series and to provide for
the voting powers, designations, preferences and relative participating,
optional or other special rights, qualifications, limitations or restrictions,
including dividend rights (including whether dividends are cumulative), dividend
rates, terms of redemption (including sinking fund provisions), redemption
prices, conversion rights and liquidation preferences of the shares constituting
any series of the Preferred Stock, in each case without any further action or
vote by the stockholders. The Company has no current plans to issue any shares
of Preferred Stock.

One of the effects of undesignated Preferred Stock may be to enable the
Board to render more difficult or to discourage an attempt to obtain control of
the Company by means of a tender offer, proxy contest, merger or otherwise and
to protect the continuity of the Company's management. The issuance of shares of
the Preferred Stock pursuant to the Board's authority described above may
adversely affect the rights of the holders of Common Stock. For example,
Preferred Stock issued by the Company may rank prior to the Common Stock as to
dividend rights, liquidation preference or both, may have full or limited voting
rights and may be convertible into shares of Common Stock. Accordingly, the
issuance of shares of Preferred Stock may discourage bids for the Common Stock
or may otherwise adversely affect the market price of the Common Stock.

CERTAIN PROVISIONS OF THE RESTATED CERTIFICATE OF INCORPORATION AND BY-LAWS THAT
MAY HAVE AN ANTI-TAKEOVER EFFECT

Certain provisions of the Company's Restated Certificate of Incorporation
and By-Laws summarized below may be deemed to have an anti-takeover effect and
may delay, deter or prevent a tender offer or

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<PAGE> 59

takeover attempt that a stockholder might consider to be in its best interest,
including attempts that might result in a premium being paid over the market
price for the shares held by stockholders. In addition, the Company's and its
subsidiaries' credit agreements contain default provisions related to changes of
control of Sauer. See "-- Limitations on Dividends and Other Financial
Restrictions on the Company and its Subsidiaries."

Classified Board of Directors. Following the Combined Offering, the Board
will consist of eight members. The Restated Certificate of Incorporation
provides that the directors of the Company will be divided into three classes,
as nearly equal in number as reasonably possible, as determined by the Board.
The initial term of office of Class I directors will expire on the date of the
1999 annual meeting of stockholders, the initial term of office of Class II
directors will expire on the date of the 2000 annual meeting of stockholders,
and the initial term of office of Class III directors will expire on the date of
the 2001 annual meeting of stockholders, with each class of directors to hold
office until their successors have been duly elected and qualified. At each
annual meeting of stockholders, beginning in 1999 directors elected to succeed
the directors whose terms expire at such annual meeting shall be elected to hold
office for a term expiring at the annual meeting of stockholders in the third
year following the year of their election and until their successors have been
duly elected and qualified. Two annual meetings of stockholders, instead of one,
generally would be required to change a majority of the directors. The
classification of the Board will have the effect of making the removal of
incumbent directors more time consuming and difficult, and may have the effect
of discouraging an unsolicited takeover attempt or an attempt to gain control of
the Board through a proxy solicitation.

Number of Directors; Removal; Filling Vacancies. The Restated Certificate
of Incorporation provides that the number of directors constituting the Board
will be determined from time to time by the Board. The Restated Certificate of
Incorporation provides that in the event of any increase or decrease in the
authorized number of directors, (a) each director then serving as such shall
nevertheless continue as a director of the class of which he is a member until
the expiration of his current term, or his earlier death, retirement,
resignation, or removal, and (b) the newly created or eliminated directorships
resulting from such increase or decrease shall be apportioned by the Board among
the three classes of directors so as to maintain such classes as nearly equal in
number as reasonably possible. The Restated Certificate of Incorporation
provides that directors may be removed other than for cause upon the vote of the
holders of 80% of the outstanding shares of the capital stock of the Company
entitled to vote generally in the election of directors. Preventing removal of
directors other than for cause may impede the sudden removal of directors,
making it more difficult to change the composition or take control of the Board.
The Restated Certificate also provides that vacancies, whether arising through
death, retirement, resignation or removal of a director or through an increase
in the authorized number of directors of any class, may only be filled by a
majority vote of the remaining directors, or by the sole remaining director. A
director elected to fill a vacancy shall serve for the remainder of the then
present term of office of the class to which he is elected. These provisions
would prevent any stockholder from enlarging the Board and then filling the new
directorships with such stockholder's own nominees.

No Stockholder Action by Written Consent; Special Meetings. Pursuant to
the Restated Certificate of Incorporation, any action required or permitted to
be taken by the stockholders of the Company must be duly effected at a duly
called annual or special meeting of stockholders and may not be taken or
effected by any written consent of stockholders in lieu thereof. The By-Laws
provide that special meetings of stockholders of the Company may be called only
by the Chairman of the Board, the President or a majority of the Board pursuant
to a resolution stating the purpose or purposes thereof, and any power of
stockholders to call a special meeting is specifically denied. No business other
than that stated in the notice shall be transacted at any special meeting. These
provisions will have the effect of delaying consideration of a stockholder
proposal until the next annual meeting unless a special meeting is called by the
Chairman, President or the Board for consideration of such proposal.

Advance Notice for Stockholder Nominations and Proposals of New
Business. The By-Laws require notice of any proposal to be presented by any
stockholder at an annual meeting of stockholders or the name of any person to be
nominated by any stockholder for election as a director of the Company at a
meeting of stockholders to be delivered to the Secretary of the Company not less
than 120 calendar days in advance of the
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<PAGE> 60

date that the Company's proxy statement was released to the stockholders in
connection with the previous year's annual meeting of stockholders. Accordingly,
failure by a stockholder to act in compliance with the notice provisions will
mean that the stockholder will not be able to nominate directors or propose new
business. These provisions may discourage or deter a third party from conducting
a solicitation of proxies to elect its own slate of directors or otherwise
attempting to obtain control of the Company.

Amendments. The Restated Certificate of Incorporation provides that the
affirmative vote of the holders of at least 80% of the stock entitled to vote
generally in the election of directors, voting together as a single class, is
required to amend, alter or repeal the By-Laws or the provisions of the Restated
Certificate of Incorporation relating to stockholder action without a meeting,
the number, election and term of the Company's directors, directors' liability,
directors, and officers, indemnification in the event of certain legal
proceedings, the filling of vacancies, and the removal of directors.

CERTAIN PROVISIONS RELATING TO ACQUISITIONS

Delaware Takeover Statute. The Company is subject to Section 203 of the
DGCL ("Section 203"), which, subject to certain exceptions, prohibits a Delaware
corporation from engaging in any "business combination with any interested
stockholder," unless: (i) prior to such date, the board of directors of the
corporation approved either the business combination or the transaction that
resulted in the stockholder becoming an interested stockholder; (ii) upon
consummation of the transaction that resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding for purposes of determining the number of shares
outstanding those shares owned (a) by persons who are directors and also
officers and (b) by employee stock plans in which employee participants do not
have the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or (iii) on or subsequent
to such date, the business combination is approved by the board of directors and
authorized at an annual or special meeting of stockholders, and not by written
consent, by the affirmative vote of at least 66 2/3% of the outstanding voting
stock that is not owned by the interested stockholder.

Section 203 defines "business combination" to include: (i) any merger or
consolidation of the corporation or any direct or indirect majority-owned
subsidiary with the interested stockholder; (ii) any sale, lease, exchange,
mortgage, pledge, transfer or other disposition to or with the interested
stockholder of 10% or more of the aggregate market value of all the assets of
the corporation or the aggregate market value of all the outstanding stock of
the corporation; (iii) subject to certain exceptions, any transaction which
results in the issuance or transfer by the corporation of any direct or indirect
majority owned subsidiary to the interested stockholder; (iv) any transaction
involving the corporation that has the effect, directly or indirectly, of
increasing the proportionate share of the stock of any class or series of the
corporation or of any such subsidiary which is owned by the interested
stockholder; or (v) any receipt by the interested stockholder of the benefit of
any loans, advances, guarantees, pledges, or other financial benefits provided
by or through the corporation. In general, Section 203 defines an interested
stockholder as any entity or person beneficially owning 15% or more of the
outstanding voting stock of the corporation and any entity or person affiliated
with or controlling or controlled by such entity or person.

INDEMNIFICATION AND LIMITATION OF LIABILITY

The Company's Restated Certificate of Incorporation requires the Company to
indemnify its officers and directors to the fullest extent permitted by Delaware
law, including some instances in which indemnification is otherwise
discretionary under Delaware law, and to advance expenses of defending against
claims arising out of an officer's or director's service as such, against an
undertaking by the officer or director to repay such advances if it is
ultimately determined that the person is not entitled to indemnification. The
Company believes these provisions are essential to attracting and retaining
qualified persons as directors and officers.

In addition, the Company has entered into indemnification agreements with
its directors and certain officers pursuant to which the Company generally is
obligated to indemnify its directors and such officers to the maximum extent
permitted by law. The Company also maintains directors and officers liability
insurance.

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<PAGE> 61

The Company's Restated Certificate of Incorporation provides that, pursuant
to Delaware law, the Company's directors shall not be liable for monetary
damages for breach of the director's fiduciary duty of care to the Company and
its stockholders. This provision does not eliminate the duty of care, and in
appropriate circumstances equitable remedies such as an injunction or other
forms of non-monetary relief would remain available under Delaware law. In
addition, each director will continue to be subject to liability for breach of
the director's duty of loyalty to the Company, for acts or omissions not in good
faith or involving intentional misconduct, for knowing violations of law, for
actions leading to improper personal benefit to the director and for payment of
dividends or approval of stock repurchases or redemptions that are unlawful
under Delaware law. The provision also does not affect a director's
responsibilities under any other law, such as the federal securities laws or
state or federal environmental laws.

At present there is no pending litigation or proceeding involving a
director or officer of the Company as to which indemnification is being sought,
nor is the Company aware of any threatened litigation that may result in claims
for indemnification by any director or officer.

LIMITATIONS ON DIVIDENDS AND OTHER FINANCIAL RESTRICTIONS ON THE COMPANY AND ITS
SUBSIDIARIES

Certain of the Company's financing agreements place limitations on its
ability to pay cash dividends and impose other financial restrictions.

Limitations on Dividends. Sauer's Revolving Credit Agreement (the
"Revolving Credit Agreement") provides that it shall not declare or pay
dividends in any year in excess of 65% of its consolidated net income for the
prior year. Pursuant to such Agreement, $17.6 million of dividends could be paid
by Sauer in 1998. In addition, Sauer's ability to pay dividends is effectively
limited by certain restrictive covenants contained in the U.S. Operating
Company's Credit Agreement (the "Credit Agreement") which limit the amount of
dividends the U.S. Operating Company can distribute to Sauer. The German
Operating Company also is a party to credit agreements that effectively limit
its ability to distribute dividends to Sauer. Under these provisions, at
December 31, 1997, $2.9 million were unrestricted as to the payment of dividends
by the U.S. Operating Company. The German Operating Company did not make
distributions to the Company during 1997. At December 31, 1997, $2.7 million was
not restricted as to the payment of dividends. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."

Financial Restrictions and Covenants. Sauer's Revolving Credit Agreement
and the U.S. Operating Company's Credit Agreement and Senior Notes (the "Senior
Notes") contain customary restrictive covenants. One or more of these financing
agreements impose restrictions on Sauer or the U.S. Operating Company and their
subsidiaries with respect to, among other things, (i) sales of substantial
assets, (ii) merger or consolidation with another entity, (iii) substantial
acquisitions or investments, (iv) incurrence of additional indebtedness or
guarantees or other contingent obligations, (v) creation of liens or entering
into transactions with affiliates and (vi) changing the conduct of their
business. In addition, Sauer's Revolving Credit Agreement prohibits it from
redeeming or repurchasing its capital stock except from executive officers of
Sauer.

Under the Revolving Credit Agreement and the U.S. Operating Company's
Credit Agreement or the Senior Notes, Sauer and/or the U.S. Operating Company
are required to meet certain financial and operating tests, including (i) a
maximum leverage ratio, (ii) a minimum consolidated net worth and tangible net
worth, (iii) a minimum interest coverage ratio and (iv) a minimum cash flow. At
December 31, 1997, Sauer and the U.S. Operating Company were in compliance with
these tests.

Sauer's Revolving Credit Agreement and the U.S. Operating Company's Credit
Agreement and Senior Notes contain customary default provisions. In addition,
Sauer would be in default under the Revolving Credit Agreement if the Murmann
family owns less than 50.1% of the capital stock of Sauer or of Sauer Getriebe.
Also, the U.S. Operating Company would be in default under its Credit Agreement
if (a) any person or persons acting in concert other than (i) the Murmann family
or any trust or other entity owned by them, (ii) Tonio P. Barlage, President of
Sauer and/or (iii) David L. Pfeifle, Executive Vice President of Sauer, acquire
ownership of 50% or more of the outstanding shares of voting stock of Sauer or
(b) Sauer shall cease
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<PAGE> 62

to own, free and clear of all liens or any other encumbrances, 75% of the
outstanding shares of voting stock of the U.S. Operating Company on a fully
diluted basis. Upon a default under any of Sauer's or the U.S. Operating
Company's financing agreements, the financing institution may accelerate the
maturity of any indebtedness outstanding under such financing agreement.

The German Operating Company's credit agreements contain similar covenants.
These covenants restrict the German Operating Company in two ways: first, the
"Equity" of the German Operating Company must always exceed 15% of its total
assets. "Equity" is defined as partner capital accounts, capital reserves,
retained earnings and profit for the respective period, together with those
shareholder loans where the shareholder has given an assurance not to demand
repayment, less any loans to shareholders, accumulated losses or losses for the
respective period. Second, the operating cash flow of the German Operating
Company, before capital investments, must be positive.

CERTAIN UNITED STATES FEDERAL TAX CONSEQUENCES
FOR NON-U.S. HOLDERS

The following is a summary of the principal U.S. federal income and estate
tax considerations with respect to the ownership and disposition of Common Stock
by "Non-U.S. Holders" (as defined below). This summary is based on the Internal
Revenue Code of 1986, as amended (the "Code"), existing and proposed Treasury
regulations thereunder and administrative and judicial interpretations thereof
(all as of the date hereof and all of which are subject to change, possibly with
retroactive effect). This summary does not address all U.S. federal income and
estate tax consequences that may be relevant to a Non-U.S. Holder in light of
its particular circumstances or to certain Non-U.S. Holders that may be subject
to special treatment under U.S. federal income tax laws, such as banks,
insurance companies, tax-exempt entities and certain U.S. expatriates.
Furthermore, the following summary does not discuss any aspects of foreign,
state or local taxation. As used herein, the term "Non-U.S. Holder" means a
holder of Common Stock that for U.S. federal income tax purposes is not (i) a
citizen or individual resident of the United States; (ii) a corporation or
partnership created or organized in or under the laws of the United States or
any political subdivision thereof; (iii) an estate the income of which is
subject to United States federal income tax regardless of its source; or (iv) a
trust if both: (A) a court within the United States is able to exercise primary
supervision over the administration of the trust and (B) one or more United
States persons have the authority to control all substantial decisions of the
trust. EACH PROSPECTIVE NON-U.S. HOLDER IS URGED TO CONSULT ITS OWN TAX ADVISER
WITH RESPECT TO THE UNITED STATES FEDERAL INCOME AND ESTATE TAX CONSEQUENCES OF
OWNING AND DISPOSING OF SHARES OF COMMON STOCK, AS WELL AS ANY TAX CONSEQUENCES
ARISING UNDER THE LAWS OF ANY STATE, LOCAL OR OTHER TAXING JURISDICTION.

DIVIDENDS

Dividends that are paid to a Non-U.S. Holder and that are not effectively
connected with a trade or business carried on by such Non-U.S. Holder in the
United States (or, if one or more of certain tax treaties apply, are
attributable to a permanent establishment in the United States maintained by the
Non-U.S. Holder) generally are subject to a 30% U.S. withholding tax, unless
reduced to the extent provided by a tax treaty between the United States and the
country of which the Non-U.S. Holder is a resident for tax purposes.

In order to claim the benefit of an applicable tax treaty, a Non-U.S.
Holder may have to file with the Company or its dividend paying agent an
exemption or reduced treaty rate certificate or letter in accordance with the
terms of such treaty. Under Treasury regulations currently in effect, for
purposes of determining whether tax is to be withheld at a 30% rate or at a
reduced rate as specified by an income tax treaty, the Company ordinarily will
presume that dividends paid to an address in a foreign country are paid to a
resident of such country absent knowledge that such presumption is not
warranted. However, under recently issued Treasury regulations (the "Final
Regulations") that will generally be effective for distributions after December
31, 1999, a Non-U.S. Holder seeking a reduced rate of withholding under an
income tax treaty

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<PAGE> 63

generally would be required to provide to the Company a valid Internal Revenue
Service Form W-8 certifying that such Non-U.S. Holder is entitled to benefits
under an income tax treaty. The Final Regulations also provide special rules for
determining whether, for purposes of assessing the applicability of an income
tax treaty, dividends paid to a Non-U.S. Holder that is an entity should be
treated as being paid to the entity itself or to the persons holding an interest
in that entity. A Non-U.S. Holder that is eligible for a reduced withholding
rate may obtain a refund of any excess amounts withheld by filing an appropriate
claim for a refund with the Internal Revenue Service.

In the case of dividends that are effectively connected with the Non-U.S.
Holder's conduct of a trade or business within the United States or, if an
income tax treaty applies, attributable to a U.S. permanent establishment of the
Non-U.S. Holder, the Non-U.S. Holder will generally be subject to regular U.S.
federal income tax in the same manner as if the Non-U.S. Holder were a U.S.
resident, and will be exempt from U.S. withholding tax provided that the
Non-U.S. Holder complies with the requirements for the exemption from
withholding described above. A non-U.S. corporation receiving effectively
connected dividends also may be subject to an additional "branch profits tax"
which is imposed, under certain circumstances, at a rate of 30% (or such lower
rate as may be specified by an applicable treaty) on the non-U.S. corporation's
"effectively connected earnings and profits," subject to certain adjustments.

GAIN ON DISPOSITION OF COMMON STOCK

A Non-U.S. Holder generally will not be subject to U.S. federal income tax
with respect to gain realized on a sale or other disposition of Common Stock
unless (i) the gain is effectively connected with a trade or business conducted
by the Non-U.S. Holder in the United States, (ii) in the case of a Non-U.S.
Holder who is an individual and holds Common Stock as a capital asset, such
individual is present in the United States for 183 or more days in the taxable
year of the disposition and either (a) such individual has a "tax home" (as
defined for U.S. federal income tax purposes) in the United States or (b) the
gain is attributable to an office or other fixed place of business maintained by
such individual in the United States, (iii) the Non-U.S. Holder is subject to
tax pursuant to the provisions of the U.S. tax law applicable to certain U.S.
expatriates whose loss of U.S. citizenship has as one of its principal purposes
the avoidance of U.S. taxes or (iv) under certain circumstances if the Company
is or has been during certain time periods a "United States real property
holding corporation" within the meaning of Section 897(c)(2) of the Code and,
assuming that the Common Stock is regularly traded on an established securities
market for U.S. federal income tax purposes and the Non-U.S. Holder held,
directly or indirectly at any time within the five-year period preceding such
disposition, more than 5% of the outstanding Common Stock. The Company is not,
and does not anticipate becoming, a United States real property holding
corporation.

INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING

Under the Treasury regulations, the Company must report annually to the
Internal Revenue Service and to each Non-U.S. Holder the amount of dividends
paid to such holder and any tax withheld with respect to such dividends. These
information reporting requirements apply regardless of whether withholding is
required because the dividends were effectively connected with a trade or
business in the United States of the Non-U.S. Holder or withholding was reduced
or eliminated by an applicable income tax treaty. Copies of the information
returns reporting such dividends and withholding may also be made available to
the tax authorities in the country in which the Non-U.S. Holder is a resident
under the provisions of an applicable income tax treaty or agreement.

U.S. backup withholding (which is imposed at the rate of 31% on certain
payments to persons that fail to furnish information under the U.S. information
reporting requirements) generally will not apply to dividends paid to Non-U.S.
Holders that are subject to the 30% withholding discussed above (or that are not
so subject because a tax treaty applies that reduces such 30% withholding) or,
under current law, dividends paid to a Non-U.S. Holder at an address outside of
the United States. However, under the Final Regulations, a Non-U.S. Holder
generally will be subject to backup withholding tax on dividends paid after
December 31, 1999 unless certain certification procedures (or, in the case of
payments made outside the United States with respect to an offshore account,
certain documentary procedures) are satisfied, directly or through a foreign
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<PAGE> 64

intermediary. Backup withholding and information reporting generally will apply
to dividends paid to addresses inside the United States to beneficial owners
that are not "exempt recipients" and that fail to provide, in the manner
required, certain identifying information.

Non-U.S. Holders should consult their tax advisers regarding the
application of information reporting and backup withholding in their particular
situations, the availability of an exemption therefrom and the procedure for
obtaining such an exemption, if available. Backup withholding does not
constitute an additional tax. Any amounts withheld from a payment to a Non-U.S.
Holder under the backup withholding rules will be allowed as a credit against
such Holder's U.S. federal income tax liability and may entitle such Holder to a
refund, provided that the required information is furnished to the Internal
Revenue Service.

FEDERAL ESTATE TAX

An individual Non-U.S. Holder who is treated as the owner of or has made
certain lifetime transfers of an interest in the Common Stock will be required
to include the value thereof in his gross estate for U.S. federal estate tax
purposes and may be subject to U.S. federal estate tax unless an applicable
estate tax treaty provides otherwise.

THE FOREGOING DISCUSSION IS INCLUDED FOR GENERAL INFORMATION ONLY.
ACCORDINGLY, EACH PROSPECTIVE PURCHASER IS URGED TO CONSULT HIS TAX ADVISER WITH
RESPECT TO THE UNITED STATES FEDERAL INCOME TAX AND FEDERAL ESTATE TAX
CONSEQUENCES OF THE OWNERSHIP AND DISPOSITION OF COMMON STOCK, INCLUDING THE
APPLICATION AND EFFECT OF THE LAWS OF ANY STATE, LOCAL, FOREIGN, OR OTHER TAX
JURISDICTION.

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<PAGE> 65

UNDERWRITING

Under the terms and subject to the conditions contained in the Underwriting
Agreement, dated May 11, 1998 (the "U.S. Underwriting Agreement"), the
underwriters named below (the "U.S. Underwriters"), for whom Credit Suisse First
Boston Corporation, Smith Barney Inc. and Deutsche Morgan Grenfell Inc. are
acting as representatives (the "Representatives"), have severally but not
jointly agreed to purchase the following number of U.S. Shares:

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER U.S. SHARES
----------- -----------
<S> <C>
Credit Suisse First Boston Corporation...................... 2,250,000
Smith Barney Inc. .......................................... 901,000
Deutsche Morgan Grenfell Inc. .............................. 901,000
CIBC Oppenheimer Corp. ..................................... 64,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 64,000
A.G. Edwards & Sons, Inc. .................................. 64,000
HSBC Securities, Inc. ...................................... 64,000
Invemed Associates, Inc. ................................... 64,000
McDonald & Company Securities, Inc. ........................ 64,000
Charles Schwab & Co., Inc. ................................. 64,000
---------
Total............................................. 4,500,000
=========
</TABLE>

The U.S. Underwriting Agreement provides that the obligations of the U.S.
Underwriters are subject to certain conditions precedent and that the U.S.
Underwriters will be obligated to purchase all the U.S. Shares offered hereby
(other than those shares covered by the over-allotment option described below)
if any are purchased. The U.S. Underwriting Agreement provides that, in the
event of a default by a U.S. Underwriter, in certain circumstances the purchase
commitments of non-defaulting U.S. Underwriters may be increased or the U.S.
Underwriting Agreement may be terminated.

Klaus H. Murmann and K. Murmann & Co. KG, two of the Selling Stockholders,
have granted to the U.S. Underwriters and the Managers an option, exercisable by
Credit Suisse First Boston Corporation, expiring at the close of business on the
30th day after the date of this Prospectus, to purchase up to 1,350,000
additional shares at the initial public offering price, less the underwriting
discounts and commissions, all as set forth on the cover page of this
Prospectus. Such option may be exercised only to cover over-allotments, if any,
in the sale of the shares of Common Stock offered hereby. To the extent that
this option to purchase is exercised, each U.S. Underwriter and each Manager
will become obligated, subject to certain conditions, to purchase approximately
the same percentage of additional shares being sold to the U.S. Underwriters and
to the Managers as the number of U.S. Shares set forth next to such U.S.
Underwriter's name in the preceding table and as the number set forth next to
such Manager's name in the corresponding table in the Prospectus relating to the
International Offering bears to the sum of the total number of shares of Common
Stock in such tables.

The Company has been advised by the Representatives that the U.S.
Underwriters propose to offer the U.S. Shares to the public in the United States
and on a private placement basis in Canada initially at the offering price set
forth on the cover page of this Prospectus and, through the Representatives, to
certain dealers at such price less a concession of $0.54 per share, and the U.S.
Underwriters and such dealers may allow a discount of $0.10 per share on sales
to certain other dealers. After the initial public offering, the offering price
and concession and discount to dealers may be changed by the Representatives.

The Company has entered into a Subscription Agreement with the Managers of
the International Offering (the "Managers") providing for the concurrent offer
and sale of the International Shares outside of the United States and Canada.
The closing of the International Offering is a condition to the closing of the
U.S. Offering and vice versa. The public offering price, the underwriting
discounts and commissions and

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<PAGE> 66

concession and discount to dealers for the International Offering are the same
as the U.S. Offering, except that purchasers have the option to purchase
International Shares at the Deutsche mark equivalent thereof.

Pursuant to an agreement between the U.S. Underwriters and Managers (the
"Intersyndicate Agreement") relating to the Common Stock Offering, changes in
the public offering price, concession and discount to dealers will be made only
upon the mutual agreement of Credit Suisse First Boston Corporation, as
representative of the U.S. Underwriters, and Credit Suisse First Boston (Europe)
Limited ("CSFBL"), on behalf of the Managers.

Pursuant to the Intersyndicate Agreement, each U.S. Underwriter has agreed
that, as part of the distribution of the U.S. Shares and subject to certain
exceptions, it has not offered or sold, and will not offer or sell, directly or
indirectly, any shares of Common Stock or distribute any prospectus relating to
the Common Stock to any person outside the United States or Canada or to any
other dealer who does not so agree. Each of the Managers has agreed or will
agree that, as part of the distribution of the International Shares and subject
to certain exceptions, it has not offered or sold, and will not offer or sell,
directly or indirectly, any shares of Common Stock or distribute any prospectus
relating to the Common Stock in the United States or Canada or to any other
dealer who does not so agree. The foregoing limitations do not apply to
stabilization transactions or to transactions between the U.S. Underwriters and
the Managers pursuant to the Intersyndicate Agreement. As used herein, "United
States" means the United States of America (including the States and the
District of Columbia), its territories, possessions and other areas subject to
its jurisdiction, "Canada" means Canada, its provinces, territories, possessions
and other areas subject to its jurisdiction, and an offer or sale shall be in
the United States or Canada if it is made to (i) any individual resident in the
United States or Canada or (ii) any corporation, partnership, pension,
profit-sharing or other trust or entity (including such entity acting as an
investment adviser with discretionary authority) whose office most directly
involved with the purchase is located in the United States or Canada.

Pursuant to the Intersyndicate Agreement, sales may be made between the
U.S. Underwriters and the Managers of such number of shares of Common Stock as
may be mutually agreed upon. The price of any shares so sold will be the public
offering price, less such amount as may be mutually agreed upon by Credit Suisse
First Boston Corporation, as representative of the U.S. Underwriters, and CSFBL,
on behalf of the Managers, but not exceeding the selling concession applicable
to such shares. To the extent there are sales between the U.S. Underwriters and
the Managers pursuant to the Intersyndicate Agreement, the number of shares of
Common Stock initially available for sale by the U.S. Underwriters or by the
Managers may be more or less than the amount appearing on the cover page of this
Prospectus. Neither the U.S. Underwriters nor the Managers are obligated to
purchase from the other any unsold shares of Common Stock.

The Company, certain Selling Stockholders and certain other stockholders
have agreed that they will not offer, sell, contract to sell, announce their
intention to sell, pledge or otherwise dispose of, directly or indirectly, or
file with the Securities and Exchange Commission a registration statement under
the Securities Act of 1933 (the "Securities Act") relating to, any additional
shares of Common Stock or securities convertible into or exchangeable or
exercisable for any shares of Common Stock without the prior written consent of
Credit Suisse First Boston Corporation for a period of 180 days after the date
of this Prospectus, except issuances pursuant to the exercise of employee stock
options outstanding on the date hereof.

At the request of the Company, the Underwriters are reserving 112,990 U.S.
Shares and 187,010 International Shares from the Offering for sale to certain
persons identified by the Company. Any sales to such persons will be at the
public offering price. Any shares not purchased in this reserve program will be
sold to the general public in the Combined Offering.

The Representatives have informed the Company that they do not expect
discretionary sales by the Underwriters to exceed 5% of the number of shares of
Common Stock being offered hereby.

The Company and certain of the Selling Stockholders have agreed to
indemnify the U.S. Underwriters and the Managers against certain liabilities,
including civil liabilities under the Securities Act, or to contribute to
payments that the U.S. Underwriters and the Managers may be required to make in
respect thereof.

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<PAGE> 67

The Common Stock has been approved for listing on the New York Stock
Exchange under the symbol "SHS" and on the Frankfurt Stock Exchange under the
symbol "SAR," subject to official notice of issuance. Credit Suisse First Boston
Aktiengesellschaft has sponsored the application for listing on the Frankfurt
Stock Exchange. In connection with the listing of the Common Stock on the New
York Stock Exchange, the Underwriters will undertake to sell round lots of 100
shares or more to a minimum of 2,000 beneficial owners.

Prior to the Combined Offering, there has been no public market for the
Common Stock. Accordingly, the initial public offering price for the shares has
been determined by negotiation between the Company, representatives of the
Selling Stockholders and the Representatives. In determining such price,
consideration was given to various factors, including market conditions for
initial public offerings, the history of and prospects for the Company's
business, the Company's past and present operations, its past and present
earnings and current financial position, an assessment of the Company's
management, the market for securities of companies in businesses similar to
those of the Company, the general condition of the securities markets and other
relevant factors. There can be no assurance, however, that the initial public
offering price will correspond to the price at which the Common Stock will trade
in the public market subsequent to the Combined Offering or that an active
trading market for the Common Stock will develop and continue after the Combined
Offering.

The Representatives, on behalf of the U.S. Underwriters and Managers, may
engage in over-allotment, stabilizing transactions, syndicate covering
transactions and penalty bids. Over-allotment involves syndicate sales in excess
of the offering size, which creates a syndicate short position. Stabilizing
transactions are bids to purchase the securities being distributed at prices
that may not exceed a specified maximum. Syndicate covering transactions involve
purchases of the Common Stock in the open market after the distribution has been
completed in order to cover syndicate short positions. Penalty bids permit the
Representatives to reclaim a selling concession from a syndicate member when the
Common Stock originally sold by such syndicate member is purchased in a
syndicate covering transaction to cover syndicate short positions. Such
stabilizing transactions, syndicate covering transactions and penalty bids may
cause the price of the Common Stock to be higher than it would otherwise be in
the absence of such transactions. These transactions may be effected on the New
York Stock Exchange, the Frankfurt Stock Exchange or otherwise and, if
commenced, may be discontinued at any time.

This Prospectus may be used by underwriters or dealers in connection with
sales of International Shares to persons located in the United States to the
extent such sales are permitted by the contractual limitations on sales
described above.

NOTICE TO CANADIAN RESIDENTS

RESALE RESTRICTIONS

The distribution of the "Common Stock" in Canada is being made only on a
private placement basis exempt from the requirement that the Company and the
Selling Stockholders prepare and file a prospectus with the securities
regulatory authorities in each province where trades of Common Stock are
effected. Accordingly, any resale of the Common Stock in Canada must be made in
accordance with applicable securities laws, which will vary depending on the
relevant jurisdiction and may require resales to be made in accordance with
available statutory exemptions or pursuant to a discretionary exemption granted
by the applicable Canadian securities regulatory authority. Purchasers are
advised to seek legal advice prior to any resale of the Common Stock.

REPRESENTATIONS OF PURCHASERS

Each purchaser of Common Stock in Canada who receives a purchase
confirmation will be deemed to represent to the Company, the Selling
Stockholders and the dealer from whom such purchase confirmation is received
that (i) such purchaser is entitled under applicable provincial securities laws
to purchase such Common Stock without the benefit of a prospectus qualified
under such securities laws, (ii) where required by

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<PAGE> 68

law, such purchaser is purchasing as principal and not as agent and (iii) such
purchaser has reviewed the text above under "-- Resale Restrictions."

RIGHTS OF ACTION (ONTARIO PURCHASERS)

The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
section 32 of the Regulation under the Securities Act (Ontario). As a result,
Ontario purchasers must rely on other remedies that may be available, including
common law rights of action for damages or rescission or rights of action, if
any, under the civil liability provisions of the U.S. federal securities laws.

ENFORCEMENT OF LEGAL RIGHTS

All the issuer's directors and officers as well as the experts named herein
and the Selling Stockholders may be located outside Canada and, as a result, it
may not be possible for Canadian purchasers to effect service of process within
Canada upon the issuer or such persons. All or a substantial portion of the
assets of the issuer and such persons may be located outside Canada and, as a
result, it may not be possible to satisfy a judgment against the issuer or such
persons in Canada or to enforce a judgment obtained in Canadian courts against
such issuer or persons outside of Canada.

NOTICE TO BRITISH COLUMBIA RESIDENTS

A purchaser of Common Stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
Common Stock acquired by such purchaser pursuant to this offering. Such report
must be in the form attached to British Columbia Securities Commission Blanket
Order BOR #95/17, a copy of which may be obtained from the Company. Only one
such report must be filed in respect of Common Stock acquired on the same date
and under the same prospectus exemption.

TAXATION AND ELIGIBILITY FOR INVESTMENT

Canadian purchasers of Common Stock should consult their own legal and tax
advisors with respect to the tax consequences of an investment in the Common
Stock in their particular circumstances and with respect to the eligibility of
the Common Stock for investment by the purchaser under relevant Canadian
legislation.

LEGAL OPINIONS

The validity of the Common Stock being sold by the Company will be passed
upon for the Company by Shearman & Sterling, New York, New York and Spencer Fane
Britt & Browne, Kansas City, Missouri, and for the Underwriters by Sullivan &
Cromwell, New York, New York.

EXPERTS

The consolidated financial statements and schedule of Sauer Inc. and
subsidiaries as of December 31, 1996 and 1997 and for each of the fiscal years
in the three-year period ended December 31, 1997, included in this Prospectus
and elsewhere in the Registration Statement of which this Prospectus forms a
part, have been audited by Arthur Andersen LLP, independent public accountants,
as indicated in their reports with respect thereto, and are included herein and
therein in reliance upon the authority of said firm as experts in accounting and
auditing in giving such reports.

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<PAGE> 69

AVAILABLE INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement (which term shall include any amendments
thereto) on Form S-1 under the Securities Act with respect to the shares of
Common Stock offered hereby. This Prospectus, which constitutes a part of the
Registration Statement, does not contain all of the information set forth in the
Registration Statement, certain portions of which have been omitted as permitted
by the rules and regulations of the Commission. For further information with
respect to the Company and the Common Stock, reference is made to the
Registration Statement, including exhibits and schedules thereto, copies of
which may be examined without charge at the Commission's principal office at 450
Fifth Street, N.W., Washington, D.C. 20549 and the regional offices of the
Commission located at 7 World Trade Center, New York, New York 10048 and 500
West Madison Street, 14th Floor, Chicago, Illinois 60661. Copies of such
material may be obtained from the Public Reference Section of the Commission,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at its
public reference facilities in New York, New York and Chicago, Illinois at
prescribed rates, or on the Internet at http://www.sec.gov. Statements contained
in this Prospectus as to the contents of any contract or other document are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each statement being qualified in all respects by such reference. Copies of
materials filed with the Commission may also be inspected at the offices of the
National Association of Securities Dealers, Inc., 1801 K Street, N.W., 8th
Floor, Washington, D.C. 20006.

Upon completion of the Combined Offering, the Company will be subject to
the informational requirements of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and in accordance therewith, will file reports,
proxy and information statements and other information with the Commission. Such
reports, proxy and information statements and other information can be inspected
and copied at the addresses set forth above.

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<PAGE> 70

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

SAUER INC. AND SUBSIDIARIES

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Statements of Income for the years ended
December 31, 1995, 1996 and 1997.......................... F-3
Consolidated Balance Sheets as of December 31, 1996 and
1997...................................................... F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1995, 1996 and 1997.............. F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>

F-1
<PAGE> 71

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders of Sauer Inc. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of SAUER INC.
(a Delaware corporation) AND SUBSIDIARIES as of December 31, 1996 and 1997, and
the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
SAUER INC. AND SUBSIDIARIES as of December 31, 1996 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.

/s/ ARTHUR ANDERSEN LLP

Chicago, Illinois
February 27, 1998 (except
with
respect to the matters
discussed in Note 3 and
Note 17, as to which the
date is April 22, 1998)

F-2
<PAGE> 72

SAUER INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
NET SALES............................................... $ 446,774 $ 467,566 $ 535,173
----------- ----------- -----------
COSTS AND EXPENSES:
Cost of sales......................................... 336,700 354,034 404,065
Selling, general and administrative................... 48,128 51,856 52,575
Research and development.............................. 18,796 20,505 20,655
----------- ----------- -----------
Total costs and expenses........................... 403,624 426,395 477,295
----------- ----------- -----------
Operating income................................... 43,150 41,171 57,878
----------- ----------- -----------
NONOPERATING INCOME (EXPENSES):
Interest expense...................................... (6,932) (6,523) (8,305)
Interest income....................................... 275 564 698
Royalty income........................................ 1,695 1,156 1,150
Other, net............................................ 21 (584) 144
----------- ----------- -----------
Nonoperating expenses, net......................... (4,941) (5,387) (6,313)
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST........ 38,209 35,784 51,565
PROVISION FOR INCOME TAXES.............................. (5,182) (10,243) (15,944)
----------- ----------- -----------
INCOME BEFORE MINORITY INTEREST......................... 33,027 25,541 35,621
MINORITY INTEREST IN INCOME OF CONSOLIDATED COMPANIES... (6,447) (6,643) (8,492)
----------- ----------- -----------
Net income......................................... $ 26,580 $ 18,898 $ 27,129
=========== =========== ===========
Basic and diluted net income per common share......... $ 1.10 $ .78 $ 1.12
=========== =========== ===========
Basic and diluted weighted average common shares
outstanding........................................ 24,187,500 24,225,000 24,225,000
=========== =========== ===========
</TABLE>

The accompanying notes are an integral part of these statements.
F-3
<PAGE> 73

SAUER INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 12,029 $ 7,363
Accounts receivable (net of allowance for doubtful
accounts of $2,690 and $3,195 in 1996 and 1997,
respectively).......................................... 65,655 77,170
Inventories............................................... 78,273 89,031
Other current assets...................................... 9,794 9,557
-------- --------
Total current assets.............................. 165,751 183,121
-------- --------
PROPERTY, PLANT AND EQUIPMENT, net.......................... 152,321 191,690
-------- --------
OTHER ASSETS
Intangible assets, net.................................... 3,323 2,964
Deferred income taxes..................................... 8,761 8,631
Other..................................................... 7,371 4,497
-------- --------
Total other assets................................ 19,455 16,092
-------- --------
$337,527 $390,903
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and bank overdrafts......................... $ 50,366 $ 60,278
Long-term debt due within one year........................ 1,932 952
Accounts payable.......................................... 36,329 46,392
Accrued salaries and wages................................ 6,279 6,385
Accrued warranty.......................................... 7,289 9,398
Other accrued liabilities................................. 24,749 15,897
-------- --------
Total current liabilities......................... 126,944 139,302
-------- --------
LONG-TERM DEBT.............................................. 56,334 75,198
-------- --------
OTHER LIABILITIES:
Long-term pension liability............................... 28,633 28,959
Postretirement benefits other than pensions............... 11,920 11,989
Deferred income taxes..................................... 3,381 4,018
Other..................................................... 14,286 13,337
-------- --------
Total other liabilities........................... 58,220 58,303
-------- --------
MINORITY INTEREST IN NET ASSETS OF CONSOLIDATED COMPANIES... 25,155 32,799
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, par value $.01 per share, authorized
45,000,000 shares in 1996 and 1997; issued 24,900,000
and outstanding 24,225,000 shares in 1996 and 1997..... 249 249
Additional paid-in capital................................ 74,900 74,723
Cumulative translation adjustment......................... 5,029 256
Retained earnings (deficit)............................... (6,604) 12,773
Common stock in treasury (at cost), 675,000 shares in 1996
and 1997............................................... (2,700) (2,700)
-------- --------
Total stockholders' equity............................. 70,874 85,301
-------- --------
$337,527 $390,903
======== ========
</TABLE>

The accompanying notes are an integral part of these statements.
F-4
<PAGE> 74

SAUER INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
NUMBER OF ADDITIONAL CUMULATIVE RETAINED COMMON
SHARES COMMON PAID-IN TRANSLATION EARNINGS STOCK IN
OUTSTANDING STOCK CAPITAL ADJUSTMENT (DEFICIT) TREASURY TOTAL
----------- ------ ---------- ----------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1995:
Beginning balance........... 24,050,000 $ 240 $70,540 $ 3,774 $ (36,592) -- $ 37,962
Net income.................. -- -- -- -- 26,580 -- 26,580
Cash dividends, ($.32 per
share)................... -- -- -- -- (7,738) -- (7,738)
Sale of common stock........ 850,000 9 3,391 -- -- -- 3,400
Purchase of common stock.... (675,000) -- -- -- -- (2,700) (2,700)
Pension adjustment.......... -- -- 1,061 -- -- -- 1,061
Translation adjustment...... -- -- -- 926 -- -- 926
---------- ------ ------- ------- --------- ------- --------
Ending Balance...... 24,225,000 249 74,992 4,700 (17,750) (2,700) 59,491

YEAR ENDED DECEMBER 31, 1996:
Net income.................. -- -- -- -- 18,898 -- 18,898
Cash dividends, ($.32 per
share)................... -- -- -- -- (7,752) -- (7,752)
Pension adjustment.......... -- -- (92) -- -- -- (92)
Translation adjustment...... -- -- -- 329 -- -- 329
---------- ------ ------- ------- --------- ------- --------
Ending balance...... 24,225,000 249 74,900 5,029 (6,604) (2,700) 70,874

YEAR ENDED DECEMBER 31, 1997:
Net income.................. -- -- -- -- 27,129 -- 27,129
Cash dividends, ($.32 per
share)................... -- -- -- -- (7,752) -- (7,752)
Pension adjustment.......... -- -- (177) -- -- -- (177)
Translation adjustment...... -- -- -- (4,773) -- -- (4,773)
---------- ------ ------- ------- --------- ------- --------
Ending balance...... 24,225,000 $ 249 $74,723 $ 256 $ 12,773 $(2,700) $ 85,301
========== ====== ======= ======= ========= ======= ========
</TABLE>

The accompanying notes are an integral part of these statements.
F-5
<PAGE> 75

SAUER INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 26,580 $ 18,898 $ 27,129
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization......................... 19,898 24,830 25,835
Minority interest in income of consolidated
companies........................................... 6,447 6,643 8,492
(Increase) decrease in working capital --
Accounts receivable, net............................ (9,313) (428) (16,620)
Inventories......................................... (18,378) 4,719 (17,260)
Accounts payable.................................... 11,149 (7,126) 13,174
Accrued liabilities................................. 5,419 2,930 (6,394)
Other............................................... (5,108) (2,796) 8,388
-------- -------- --------
Net cash provided by operating activities........ 36,694 47,670 42,744
-------- -------- --------

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment............... (45,689) (56,284) (66,750)
Purchase of minority interest............................ -- -- (3,959)
Proceeds from sales of property, plant and equipment..... 145 86 398
-------- -------- --------
Net cash used in investing activities............ (45,544) (56,198) (70,311)
-------- -------- --------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) on notes payable and bank
overdrafts............................................ 21,657 (18,067) 10,555
Net borrowings of long-term debt......................... 116 36,647 25,171
Sale of common stock..................................... 3,400 -- --
Purchase of common stock................................. (2,700) -- --
Cash dividends........................................... (7,738) (7,752) (7,752)
Distribution to minority interest partners............... (1,500) (1,560) (4,623)
-------- -------- --------
Net cash provided by financing activities........ 13,235 9,268 23,351
-------- -------- --------

EFFECT OF EXCHANGE RATE CHANGES............................ (145) (524) (450)
-------- -------- --------

CASH AND CASH EQUIVALENTS:
Net increase (decrease) during the year.................. 4,240 216 (4,666)
Beginning balance........................................ 7,573 11,813 12,029
-------- -------- --------
Ending balance................................... $ 11,813 $ 12,029 $ 7,363
======== ======== ========
</TABLE>

The accompanying notes are an integral part of these statements.
F-6
<PAGE> 76

SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1996 AND 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(1) THE COMPANY AND ITS OPERATIONS:

Sauer Inc., a U.S. corporation, and subsidiaries (the "Company") is a
leading international manufacturer of components and systems that generate,
transmit and control fluid power in mobile equipment. The Company's products are
used by original equipment manufacturers of mobile equipment, including
construction, agricultural and turf care equipment. The Company's products are
sold throughout North America, Europe and East Asia.

The Company, which is a holding company, conducts its business in North
America as Sauer-Sundstrand Company (the "U.S. Operating Company"), and in
Germany as Sauer-Sundstrand GmbH & Co. (the "German Operating Company"). The
Company also has manufacturing plants in the United Kingdom, Italy, Slovakia,
and China, as well as trading companies in other locations. Sauer-Sundstrand
GmbH (the "German Holding Company"), which is wholly owned by the Company,
functions as a management and holding company on behalf of the Company.

The Company is majority owned by Mr. Klaus H. Murmann and certain of his
family members, directly and through Sauer GmbH and other wholly owned
companies. Sauer GmbH and Sauer GmbH and Co. Hydraulik K.G. ("Sauer Hydraulik")
("Murmann Limited Partners") hold limited partnership interests (the "Murmann
Limited Partnership Interests") in the German Operating Company as described
below. Sauer GmbH and Sauer Hydraulik, a German corporation and a German
partnership, respectively, are wholly owned by the Murmann family.

(2) JOINT VENTURES:

During 1991, the U.S. Operating Company and Agri-Fab, Inc. formed a joint
venture organized as a U.S. limited partnership under the name Hydro-Gear
Limited Partnership ("Hydro-Gear"). The U.S. Operating Company contributed
inventories and machinery and equipment with a carrying amount of $4,066 for a
60% interest in Hydro-Gear. The principal business of Hydro-Gear is the
manufacture, sale and distribution of hydrostatic and axle products to the turf
care market.

On November 29, 1994, the German Holding Company and Povazske Strojarne,
a.s. formed a joint venture organized as a Slovakian corporation under the name
Sauer Mechanika, a.s. The German Holding Company contributed approximately
$6,000 of cash, technology, and machinery and equipment for a 65% interest in
Sauer Mechanika. During 1997, the German Holding Company purchased the 35%
interest held by its partner, Povazske Strojarne, a.s., for $3,959. The
principal business of Sauer Mechanika is the manufacture of gear boxes for
transit mixers.

On February 16, 1995, the Company and Shanghai Hydraulics and Pneumatics
formed a joint venture organized as a Chinese Limited Liability Foreign
Investment Enterprise under the name Sauer Shanghai Hydraulic Transmission
Company, Ltd. ("SHC"). The Company contributed $5,400 of cash, machinery and
equipment and technology for a 50% interest in SHC. Operations commenced during
1996. During 1997, the Company contributed an additional $2,700 of cash to
increase its interest in SHC to 60%. The principal business of SHC is the
manufacture, sale and distribution of high power hydrostatic transmissions to
the Chinese market.

On December 30, 1996, the German Holding Company and ZTS, a.s. formed a
joint venture organized as a Slovakian corporation under the name Sauer ZTS,
a.s. The German Holding Company contributed approximately $5,800 of cash and
technology for a 65% interest in Sauer ZTS, a.s. The principal business of Sauer
ZTS, a.s. is the manufacture of high power hydrostatic transmissions.

F-7
<PAGE> 77
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis of Presentation and Principles of Consolidation --

The accounts of the Company are stated in accordance with generally
accepted accounting principles in the United States of America. The consolidated
financial statements include the accounts of Sauer Inc. and subsidiaries on a
consolidated basis for all periods presented. All significant intercompany
balances and transactions have been eliminated in consolidation.

Sauer Inc. is the general partner and 80% owner of the German Operating
Company. The Murmann Limited Partners have certain rights which include an
annual cash payment equal to 8.5% of the income of Sauer Inc. and subsidiaries
before taxes and the Murmann Limited Partnership Interests and the right to
consent to certain actions of the German Operating Company. The Murmann Limited
Partners have no other property rights in the assets of the Company, the U.S.
Operating Company, the German Operating Company and any other related entity.
However, effective April 21, 1998 the Company has the right to elect by the
action of its independent directors or the holders of its common stock other
than the Murmann family, to terminate the Murmann Limited Partnership Interests
in exchange for 2,250,000 shares of common stock of Sauer Inc. As such, the
Company controls and consolidates the German Operating Company.

Use of Estimates --

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

New Accounting Principles --

During 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings per Share" and SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information". These changes did not
have any impact on the Company's financial position or results of operations.

Reclassification --

Certain previously reported amounts have been reclassified to conform with
the current period presentation.

Minority Interest --

Minority interest in net assets and income reflected in the accompanying
consolidated financial statements consists of:

(a) The Murmann Limited Partners, as holders of limited partnership
interests, in the results of the German Operating Company equal to 8.5% of
the income of Sauer Inc. and subsidiaries before taxes and the Murmann
Limited Partnership Interests for 1995, 1996 and 1997.

(b) A minority interest held by Agri-Fab, Inc. in a U.S. limited
partnership for 1995, 1996 and 1997.

(d) A minority interest held by Shanghai Hydraulics and Pneumatics in
a Chinese equity joint venture for 1996 and 1997.

(e) A minority interest held by ZTS, a.s. in a Slovakian corporation
for 1997.

F-8
<PAGE> 78
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table sets forth the components of minority interest in the
consolidated balance sheets and consolidated statements of income and loss:

MINORITY INTEREST REFLECTED IN
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
German Operating Company................................. $ 9,230 $11,203
Hydro-Gear............................................... 12,797 15,216
Sauer Mechanika, a.s..................................... 3,128 --
SHC...................................................... -- 3,438
Sauer ZTS, a.s........................................... -- 2,942
------- -------
Total.......................................... $25,155 $32,799
======= =======
</TABLE>

MINORITY INTEREST (INCOME) LOSS REFLECTED IN
CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
German Operating Company...................... $(2,954) $(2,707) $(4,001)
Hydro-Gear.................................... (3,681) (4,345) (6,339)
Sauer Mechanika, a.s.......................... 188 168 291
SHC........................................... -- 241 1,480
Sauer ZTS, a.s................................ -- -- 77
------- ------- -------
Total............................... $(6,447) $(6,643) $(8,492)
======= ======= =======
</TABLE>

Translation of Foreign Currencies --

Assets and liabilities of consolidated foreign subsidiaries are translated
into U.S. dollars at exchange rates in effect at year-end, while revenues and
expenses are translated at average exchange rates prevailing during the year.
The resulting translation adjustments are included in stockholders' equity.
Gains or losses on transactions denominated in foreign currencies and the
related tax effects, which are not material, are reflected in net income.

Cash and Cash Equivalents --

Cash equivalents are considered by the Company to be all highly liquid
instruments purchased with original maturities of three months or less.

F-9
<PAGE> 79
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Inventories --

Inventories are valued at the lower of cost or market, using various cost
methods, and include the cost of material, labor and factory overhead. The
percentage of year end inventory using each of the methods was as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
------------
1996 1997
---- ----
<S> <C> <C>
Average Cost................................................ 62% 61%
Last-in, first-out ("LIFO")................................. 30% 32%
First-in, first-out ("FIFO")................................ 8% 7%
</TABLE>

Property, Plant and Equipment and Depreciation --

Property, plant and equipment are stated at historical cost, net of
accumulated depreciation. Assets under capital lease are stated at the lower of
fair market value or the present value of future minimum lease payments, net of
accumulated depreciation. Depreciation is based on the straight-line method.
Additions and improvements that substantially extend the useful life of a
particular asset are capitalized. Repair and maintenance costs ($11,305, $13,110
and $15,184 in 1995, 1996 and 1997, respectively) are charged to expense. Upon
the sale of property, plant and equipment, the cost and related accumulated
depreciation are removed from the accounts and any gain or loss is included in
income.

Intangible Assets and Amortization --

Intangible assets include goodwill, patents and other intangibles. These
assets are stated at cost, net of accumulated amortization, and are being
amortized over the lesser of 20 years or the specific remaining identifiable
life on a straight-line basis. Goodwill was $1,629 and $1,201 as of December 31,
1996 and 1997, net of accumulated amortization of $7,260 and $4,950,
respectively. Amortization of goodwill and other intangibles was $1,649 for
1995, $2,449 for 1996 and $756 for 1997.

Impairment of Long-Lived Assets --

Consistent with the requirements of SFAS 121, the Company periodically
assesses whether events or circumstances have occurred that may indicate the
carrying value of its long-lived tangible and intangible assets may not be
recoverable. The carrying value of long-lived tangible and intangible assets is
evaluated based on the expected future non-discounted operating cash flows. When
such events or circumstances indicate the carrying value of an asset may be
impaired, the Company recognizes an impairment loss. Based upon its most recent
analysis, the Company believes that no impairment exists at December 31, 1997.

Revenue Recognition --

Net sales are recorded at the time of shipment to customers along with
related expenses including warranty expense.

Income Taxes --

The provision for income taxes has been determined using the asset and
liability approach of accounting for income taxes. Under this approach, deferred
taxes represent the future tax consequences expected to occur when the reported
amounts of assets and liabilities are recovered or paid. The provision for
income taxes represents income taxes paid or payable for the current year plus
the change in deferred taxes during the year. Deferred taxes result from
differences between the financial and tax bases of the Company's assets and
liabilities and are adjusted for changes in tax rates and tax laws when changes
are enacted. Valuation

F-10
<PAGE> 80
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

allowances are recorded to reduce deferred taxes when it is more likely than not
that a tax benefit will not be realized.

Basic and Diluted Per Share Data --

Basic and diluted income per common share data have been computed by
dividing net income by the basic and diluted weighted average number of shares
of common stock outstanding.

(4) INVENTORIES:

The composition of inventories is as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Raw materials............................................ $34,735 $41,851
Work in process.......................................... 12,053 13,101
Finished goods and parts................................. 37,327 40,461
LIFO allowance........................................... (5,842) (6,382)
------- -------
Total.......................................... $78,273 $89,031
======= =======
</TABLE>

(5) PROPERTY, PLANT AND EQUIPMENT:

The estimated useful lives used in computing depreciation are as follows:

<TABLE>
<CAPTION>
DESCRIPTION LIFE
- ----------- --------
<S> <C>
Land improvements........................................... 20 years
Buildings................................................... 37 years
Building improvements....................................... 10 years
Building equipment.......................................... 20 years
Machinery and equipment..................................... 12 years
Durable tools............................................... 3 years
Automobiles and trucks...................................... 4 years
Office equipment............................................ 10 years
Information systems and data-handling devices............... 5 years
</TABLE>

The cost and related accumulated depreciation of property, plant and
equipment are summarized as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
--------- ---------
<S> <C> <C>
Cost --
Land and improvements............................ $ 3,138 $ 3,771
Buildings and improvements....................... 33,378 43,527
Machinery and equipment.......................... 289,487 307,364
Construction in progress......................... 15,184 27,485
Plant and equipment under capital lease............ 1,447 638
--------- ---------
Total cost.................................... 342,634 382,785
Less -- Accumulated depreciation................... (190,313) (191,095)
--------- ---------
Net property, plant and equipment............. $ 152,321 $ 191,690
========= =========
</TABLE>

Depreciation expense for 1995, 1996 and 1997 was $18,249, $22,381 and
$25,079, respectively.

F-11
<PAGE> 81
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(6) PENSION BENEFITS:

The Company has noncontributory defined benefit plans covering
substantially all employees. The benefits under these plans are based primarily
on years of service and compensation levels. The Company's funding policy
outside of Germany is to contribute annually an amount that falls within the
range determined to be deductible for federal income tax purposes. The net
pension liabilities reflected in the accompanying consolidated balance sheets
result principally from unfunded pension plans of the Company's operations in
Germany, where it is common practice to fund pension obligations at the time
payments are made to retirees.

Pension expense for 1995, 1996 and 1997 for these defined benefit plans
consists of the following components:

<TABLE>
<CAPTION>
1995 1996 1997
-------- ------- -------
<S> <C> <C> <C>
Service cost................................. $ 2,560 $ 2,846 $ 3,042
Interest on projected benefit obligation..... 6,065 6,181 7,422
Actual return on assets...................... (10,014) (7,418) (9,305)
Net amortization and deferral................ 5,495 3,250 3,511
-------- ------- -------
Net pension expense..................... $ 4,106 $ 4,859 $ 4,670
======== ======= =======
</TABLE>

The following table sets forth the plans' funded status as of the
respective balance sheet dates:

<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997
-------------------------- --------------------------
ASSETS ACCUMULATED ASSETS ACCUMULATED
EXCEED BENEFITS EXCEED BENEFITS
ACCUMULATED EXCEED ACCUMULATED EXCEED
BENEFITS ASSETS BENEFITS ASSETS
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Obligations --
Vested benefit.................. $12,484 $ 50,148 $13,085 $ 57,837
Nonvested benefit............... -- 7,787 -- 4,726
------- -------- ------- --------
Accumulated benefit obligation.... 12,484 57,935 13,085 62,563
Effect of projected salary
increases....................... 2,887 12,377 2,834 13,279
------- -------- ------- --------
Projected benefit obligation...... 15,371 70,312 15,919 75,842
Plan assets at fair value......... 20,127 45,167 22,560 50,527
------- -------- ------- --------
Projected benefit obligation (in
excess of) less than plan
assets.......................... 4,756 (25,145) 6,641 (25,315)
Unrecognized transition asset..... (1,487) -- (1,479) --
Unrecognized prior year service
cost............................ 646 1,549 567 1,285
Other unrecognized gain........... (1,396) (4,005) (2,753) (5,596)
Adjustment to recognize minimum
liability....................... -- (1,604) -- (71)
------- -------- ------- --------
Net pension asset (liability)..... 2,519 (29,205) 2,976 (29,697)
Less -- Current portion........... -- 572 -- 738
------- -------- ------- --------
Net pension asset (liability),
long-term....................... $ 2,519 $(28,633) $ 2,976 $(28,959)
======= ======== ======= ========
</TABLE>

F-12
<PAGE> 82
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant assumptions used in determining pension expense and related
pension obligations are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Discount rates --
United States......................................... 7.5% 7.5% 7.5%
Germany............................................... 7.5 7.5 7.5
United Kingdom........................................ 9.0 9.0 9.0
Rates of increase in compensation levels --
United States......................................... 5.0 5.0 5.0
Germany............................................... 3.5 3.5 3.5
United Kingdom........................................ 8.0 8.0 8.0
Expected long-term rate of return on assets --
United States......................................... 8.5 8.5 8.5
United Kingdom........................................ 9.0 9.0 9.0
</TABLE>

The plans' assets consist principally of short-term U.S. Government
securities, equity securities, fixed income contracts and insurance contracts.

(7) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS:

The Company provides health benefits for retired employees and certain
dependents when the employee becomes eligible for these benefits by satisfying
plan provisions which include certain age and/or service requirements. Health
benefits for retirees of non-U.S. operations, where applicable, are provided
through government sponsored plans to which contributions by the Company are
required. The health benefit plans covering substantially all U.S. employees are
contributory, with contributions reviewed annually and adjusted as appropriate.
These plans contain other cost-sharing features such as deductibles and
coinsurance. The Company does not pre-fund these plans and has the right to
modify or terminate any of these plans in the future.

The components of the postretirement benefit provisions of the Company
sponsored plans for 1995, 1996 and 1997 were as follows:

<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Service cost......................................... $ 326 $ 323 $ 365
Interest cost........................................ 886 948 997
Net deferral and amortization........................ -- 22 20
------ ------ ------
Postretirement benefit provision..................... $1,212 $1,293 $1,382
====== ====== ======
</TABLE>

F-13
<PAGE> 83
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The funded status of the Company sponsored plans was as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
-------- --------
<S> <C> <C>
Accumulated postretirement benefit obligations:
Retirees............................................. $ (5,074) $ (4,995)
Eligible active plan participants.................... (3,237) (3,472)
Other active plan participants....................... (5,292) (5,163)
-------- --------
Accumulated postretirement benefit obligation.......... (13,603) (13,630)
Unrecognized net loss.................................. 1,683 1,641
-------- --------
Postretirement benefit liability....................... $(11,920) $(11,989)
======== ========
</TABLE>

The assumed weighted average annual rate of increase in the per capita cost
of medical benefits is 7.0% for 1998 and is assumed to decrease gradually in
1999 and 2000 and remain level at 5.5% thereafter.

U.S. employees retiring after March 1, 1993 and hired prior to January 1,
1993 will receive the standard health benefits up to age 65 and then will be
eligible for a Medicare reimbursement allowance based on years of service. U.S.
employees hired after January 1, 1993 will only be eligible after age 65 for a
Medicare reimbursement allowance based on years of service.

A one percent increase in the annual health care trend rates would have
increased the accumulated postretirement benefit obligation at December 31, 1997
by $1,625, and increased postretirement benefit expense for 1997 by $177. The
weighted average discount rate used to estimate the accumulated postretirement
benefit obligation was 7.5% for 1996 and 1997.

(8) PHANTOM SHARE PLAN:

Under the Company's Phantom Share Plan, the Board of Directors may grant up
to 400,000 Phantom Share Rights to eligible employees. Each Phantom Share Right
entitles the grantee to the market value of a common share as of the December 31
immediately prior to the date the restrictions on such Phantom Share Right lapse
and, until the restrictions lapse, a quarterly payment in an amount determined
by the Board of Directors. Restrictions on Phantom Share Rights consist of the
vesting schedule under which such rights vest 20% in each of the fifth through
ninth years after grant date. If no stock price quotation is available upon the
lapse of restrictions with respect to a Phantom Share Right, the amount of the
payment is determined pursuant to a formula set forth in the Phantom Share Plan
based on the earnings and book value of the Company as adjusted to account for
stock market trends. At December 31, 1996 and 1997, 91,400 and 110,400 Phantom
Share Rights, respectively, were outstanding. Compensation expense is recognized
ratably over the period from the date of grant to the date the restrictions on a
right lapse. Earnings are also charged or credited for the aggregate
appreciation or depreciation of the rights during the period as well as any
quarterly payment to the grantees. Phantom share compensation expense was
$1,162, $902, and $955 for 1995, 1996 and 1997, respectively. The total value of
the Phantom Shares outstanding as of December 31, 1996 and 1997 was $2,651 and
$3,257, respectively.

F-14
<PAGE> 84
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(9) INCOME TAXES:

The Company's income before income taxes and minority interest are as
follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
United States................................. $22,981 $31,308 $43,370
Europe and other.............................. 15,228 4,476 8,195
------- ------- -------
Total............................... $38,209 $35,784 $51,565
======= ======= =======
</TABLE>

The Company's primary German operation is structured as a partnership. This
operation is subject to United States as well as German income tax regulations.
The above analysis of pretax income and the following analysis of the income tax
provision by taxing jurisdiction are therefore not directly related.

The (provision) benefit for income taxes by taxing jurisdiction location
are as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
Current:
United States
Federal................................ $(4,355) $ (4,994) $(11,476)
State.................................. (851) (877) (1,261)
European and other........................ (3,078) (4,096) (3,443)
------- -------- --------
Total current............................. (8,284) (9,967) (16,180)
------- -------- --------
Deferred:
United States
Federal................................ 711 400 1,593
State.................................. 1,667 (67) (204)
European and other........................ 724 (609) (1,153)
------- -------- --------
Total deferred............................ 3,102 (276) 236
------- -------- --------
Total income tax provision.................. $(5,182) $(10,243) $(15,944)
======= ======== ========
</TABLE>

A reconciliation of the statutory and effective income tax (provision)
benefit based on the Company's income before income taxes and minority interest
is as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
United States income tax provision at the
statutory rate of 35%.................... $(13,373) $(12,524) $(18,047)
Deferred tax benefit not previously
recognized from U.S. loss carryforwards,
foreign tax credits and other............ 9,176 2,069 1,923
European and Asian locations' losses not
tax benefited............................ (305) (1,367) (1,686)
Taxes on European locations' income at
rates which differ from the U.S. rate.... 89 443 (270)
State income taxes, net of U.S. federal tax
benefit.................................. (724) (614) (871)
Taxes on minority interest................. 1,568 1,289 3,518
Other...................................... (1,613) 461 (511)
-------- -------- --------
Total income tax provision................. $ (5,182) $(10,243) $(15,944)
======== ======== ========
</TABLE>

F-15
<PAGE> 85
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's foreign deferred income tax liability results from temporary
differences relating principally to pension benefits and to property, plant and
equipment.

The components of the Company's net deferred tax asset are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
U.S. tax credit carryforwards............................ $ 1,944 $ 1,575
Internal Revenue Code Section 743 and Other Tax Basis
Step-Ups............................................... 5,224 4,473
Deferred compensation, post-retirement and accrued
pension benefits....................................... 10,854 11,407
Tax over book depreciation............................... (3,437) (5,055)
Inventory and warranty reserves not deducted for tax..... 5,111 5,283
Other items.............................................. 1,500 2,125
------- -------
Gross deferred tax asset................................. 21,196 19,808
Valuation allowance...................................... (3,734) (3,187)
------- -------
Net deferred tax asset................................... 17,462 16,621
Less -- current portion.................................. (8,701) (7,990)
------- -------
Deferred tax asset, long-term............................ $ 8,761 $ 8,631
======= =======
</TABLE>

In 1990, the Company issued common stock in exchange for a 40.404% interest
in the Sundstrand-Sauer Company partnership. The partnership filed an election
under Internal Revenue Code (IRC) Section 754 and, accordingly, a tax basis step
up was provided to the Company under IRC Section 743. In 1994, certain assets
were sold from the German Operating Company to the German Holding Company to
facilitate the establishment of Sauer Mechanika a.s., described in Note 2. For
tax purposes, this was a taxable transaction and, accordingly, resulted in a tax
basis step-up when the assets were ultimately contributed to Sauer Mechanika
a.s. The remaining, unamortized balances of these tax basis step-ups were $5,224
and $4,473 at December 31, 1996 and 1997, respectively.

During 1997 the valuation allowance relating to the Company's deferred
income tax asset decreased by $547. The decrease was due to the realization in
the current period of certain tax benefits for which a valuation allowance had
been previously provided.

As of December 31, 1997, the Company had not provided federal income taxes
on $3,018 of undistributed earnings recorded by certain subsidiaries outside the
United States, since these earnings were deemed permanently invested. Although
it is not practicable to determine the deferred tax liability on the unremitted
earnings, foreign tax credits would be available to reduce any U.S. tax
liability if these foreign earnings were remitted.

The Company had the following tax return carryforwards available to offset
future years' taxes at December 31, 1997:

<TABLE>
<CAPTION>
EXPIRATION
AMOUNT DATES
------- ----------
<S> <C> <C>
German net operating losses........................... $48,030 Indefinite
U.S. foreign tax credits.............................. $ 4,292 1998-2002
</TABLE>

The German net operating losses do not produce a deferred tax asset on a
consolidated basis due to the treatment of the German Operating Company as a
partnership combined with the impact of foreign tax credits.

F-16
<PAGE> 86
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company and its subsidiaries paid net income taxes of $8,008, $7,625
and $18,495 in 1995, 1996 and 1997, respectively.

(10) NOTES PAYABLE AND LONG-TERM DEBT:

Long-term debt consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Company's Revolving Credit Agreement, due August, 2001... $15,000 $15,000
U.S. Operating Company's Revolving Credit Facility, due
March, 2002............................................ 28,000 24,000
U.S. Operating Company's Senior Notes due through
December, 2007......................................... -- 25,000
U.S. Operating Company's Industrial Development Revenue
Bonds, due May, 2026................................... 9,000 9,000
European and other borrowings............................ 6,266 3,150
------- -------
Total debt..................................... 58,266 76,150
Less scheduled current maturities........................ (1,932) (952)
------- -------
Total long-term debt........................... $56,334 $75,198
======= =======
</TABLE>

The Company's Revolving Credit Agreement ("Agreement") allows the Company
to borrow up to $15,000 at an interest rate based on the London interbank
offered rate ("LIBOR"). At December 31, 1996 and 1997, the interest rate on
outstanding borrowings under the Agreement was 7.0% and 7.05%, respectively. The
Agreement requires the maintenance of certain financial results including
maintaining minimum levels of net worth and cash flow and contains limitations
on the payment of cash dividends. At December 31, 1997 the Company was in
compliance with these requirements and $17,600 of dividends could be paid by the
Company.

The U.S. Operating Company's Revolving Credit Facility, dated November 6,
1997, permits the U.S. Operating Company to choose between two interest rate
options and to specify what portion of the loan is covered by a specific
interest rate option and the applicable funding period to which the interest
rate option is to apply. The interest rate options are based on the bank's prime
lending rate and LIBOR. The U.S. Operating Company's Revolving Credit Facility
permits unsecured borrowings up to $45,000. At December 31, 1996 and 1997, the
weighted average interest rate on outstanding borrowings was approximately 6.6%
and 6.73% respectively.

The U.S. Operating Company's Revolving Credit Facility contains certain
restrictions and requires the U.S. Operating Company to maintain certain
financial ratios, including limitations on the payment of cash dividends and
maintaining profit before interest and taxes at least 2.5 times interest
expense. Additionally, the U.S. Operating Company's Revolving Credit Facility
requires the maintenance of net worth (as defined). The U.S. Operating Company
was in compliance with the requirements at December 31, 1997 and required net
worth was $56,307.

On May 1, 1996, the U.S. Operating Company issued $9,000 of Industrial
Development Revenue Bonds ("Bonds"). The Bonds are at variable interest rates.
At December 31, 1996 and 1997, the interest rate on the bonds was 5.1% and 4.7%,
respectively. The Bonds are secured by a bank letter of credit. The bonds
contain certain covenants and restrictions similar to those included in the U.S.
Operating Company's Revolving Credit Facility. At December 31, 1997, the U.S.
Operating Company was in compliance with these requirements.

F-17
<PAGE> 87
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On December 15, 1997, the U.S. Operating Company issued $25,000 of 6.68%
Senior Notes ("Senior Notes"). The Senior Notes have scheduled annual repayments
starting with December 15, 2001 through December 15, 2007. The Senior Notes
contain certain restrictions and require the maintenance of certain financial
ratios which are similar to the U.S. Operating Company's Revolving Credit
Facility. At December 31, 1997, the U.S. Operating Company was in compliance
with these requirements.

Payments required on long-term debt outstanding as of December 31, 1997,
during the years 1998 through 2002 and for years thereafter, are $952, $930,
$858, $18,140, $27,000 and $28,270, respectively.

The Company from time to time employs off-balance sheet financial
instruments to reduce its exposure to fluctuations in interest rates. These
instruments include interest rate caps and swaps. The Company designates
interest rate swaps as hedges of LIBOR-based bank debt, and accrues as interest
expense the differential to be paid or received under the agreements as rates
change over the lives of the contracts.

The Company continually monitors its positions with, and the credit quality
of, the financial institutions which are counterparties to its off-balance sheet
financial instruments and does not expect non-performance by the counterparties.

At December 31, 1996, the Company had $20,000 (notional amount) of interest
rate contracts outstanding. At December 31, 1996, the carrying value was $0, and
the estimated fair value was approximately $108. There were no interest rate
contracts outstanding as of December 31, 1997. The fair market value is
calculated by an independent party and is the amount that would be received if
the contract was terminated.

The Company also maintains revolving credit facilities, notes payable and
bankers' acceptances for its European and other operations. The German Operating
Company's credit agreement contains restrictions similar to those in the U.S.
Operating Company's agreements. The German Operating Company was in compliance
with the requirements at December 31, 1997 and required net worth was $10,920.
At December 31, 1997, accounts receivable, inventories, property, plant and
machinery and equipment in the amount of $27,688 were pledged as collateral
under these European and other operations credit facilities.

The weighted average interest rates on short-term borrowings at year-end
were 7.5% in 1995, 6.6% in 1996 and 6.8% in 1997.

The status of lines of credit as of December 31, 1996, and 1997, is
summarized below:

<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Lines of credit
Used................................... $70,283 $74,696
Unused................................. 51,501 51,975
</TABLE>

Interest paid was $6,707, $6,826 and $8,107 for 1995, 1996 and 1997,
respectively.

The fair market value of long-term debt at December 31, 1996 and 1997
approximates the amounts recorded in the balance sheet based on information
available to the Company with respect to interest rates and terms for similar
financial instruments.

(11) STOCKHOLDERS' EQUITY:

On May 17, 1995 the Company sold 850,000 newly issued shares to a group of
management. The net proceeds of $3,400 were used to reduce borrowings. On May
30, 1995 the Company purchased 675,000 of its shares from an existing
shareholder for $2,700.

(12) RELATED-PARTY TRANSACTIONS:

Sauer Hydraulik leases certain property, plant and equipment to the German
Operating Company. The German Operating Company has the option to purchase the
property leased from Sauer Hydraulik at fair

F-18
<PAGE> 88
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

market value. On April 16, 1998, the Company exercised its purchase option. See
Footnote 17. Rent expense associated with the leased property was $2,795, $2,633
and $2,278 for 1995, 1996 and 1997, respectively.

Minimum rental commitments of the German Operating Company required under
all non-cancelable leases with Sauer Hydraulik as of December 31, 1997, are
$2,202 during each of the years 1998 through 2002, and $8,810 thereafter.

(13) COMMITMENTS AND CONTINGENCIES:

The Company leases certain facilities and equipment under operating leases,
many of which contain renewal options. Total rental expense on all operating
leases during 1995, 1996 and 1997 was $4,855, $5,484 and $5,835, respectively.

Minimum future rental commitments under all non-cancelable leases as of
December 31, 1997, are as follows:

<TABLE>
<CAPTION>
OPERATING
LEASES
---------
<S> <C>
1998............................................... $ 5,365
1999............................................... 4,608
2000............................................... 4,322
2001............................................... 4,164
2002............................................... 3,900
2003 and after..................................... 10,745
-------
$33,104
=======
</TABLE>

The Company is involved in certain legal proceedings in the ordinary course
of its business. Management does not believe that the outcome of such
proceedings will have a material adverse effect upon the Company's financial
position or results of operations.

(14) QUARTERLY FINANCIAL DATA (UNAUDITED):

<TABLE>
<CAPTION>
QUARTER
--------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
1996 --
Net sales................. $133,981 $125,064 $ 99,093 $109,428 $467,566
Gross profit.............. 34,535 30,376 22,534 26,087 113,532
Net income................ 5,890 6,071 3,070 3,867 18,898
Basic and diluted net
income per common
share --............... .24 .25 .13 .16 .78
1997 --
Net sales................. 135,860 146,273 118,906 134,134 535,173
Gross profit.............. 34,520 39,143 30,023 27,422 131,108
Net income................ 7,894 10,258 5,512 3,465 27,129
Basic and diluted net
income per common
share --............... .33 .42 .23 .14 1.12
</TABLE>

F-19
<PAGE> 89
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(15) SEGMENT AND GEOGRAPHIC INFORMATION:

The Company has two reportable segments defined by geographic region due to
the difference in economic characteristics in which these segments operate. The
activities of each reportable segment consists of the design, manufacture and
sale of hydraulic systems and other related components.

The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates individual
segment performance based on net income. Intersegment sales are made at
established transfer prices. The following table presents the significant items
by segment:

<TABLE>
<CAPTION>
NORTH AMERICA EUROPE ALL OTHER ELIMINATIONS TOTAL
------------- -------- --------- ------------ --------
<S> <C> <C> <C> <C> <C>
1995
Trade sales............. $247,380 $199,394 $ -- $ -- $446,774
Intersegment sales...... 30,588 21,640 -- (52,228)(1) --
Interest income......... 747 341 112 (925)(2) 275
Interest expense........ 1,864 4,562 1,431 (925)(2) 6,932
Depreciation and
amortization......... 10,846 8,596 456 -- 19,898
Net income (loss)....... 17,238 14,395 (1,698) (3,355)(3) 26,580
Total assets............ 144,718 167,208 129,632 (137,321)(4) 304,237
Capital expenditures.... 26,504 19,185 -- -- 45,689

1996
Trade sales............. $272,780 $194,627 $ 159 $ -- $467,566
Intersegment sales...... 25,343 28,344 -- (53,687)(1) --
Interest income......... 1,377 212 411 (1,436)(2) 564
Interest expense........ 2,760 3,864 1,335 (1,436)(2) 6,523
Depreciation and
amortization......... 13,358 10,993 479 -- 24,830
Net income (loss)....... 18,471 6,543 (3,094) (3,022)(3) 18,898
Total assets............ 173,325 173,655 133,287 (142,740)(4) 337,527
Capital expenditures.... 24,556 31,550 178 -- 56,284

1997
Trade sales............. $332,974 $201,130 $ 1,069 $ -- $535,173
Intersegment sales...... 36,557 32,424 582 (69,563)(1) --
Interest income......... 1,441 518 228 (1,489)(2) 698
Interest expense........ 3,692 5,028 1,074 (1,489)(2) 8,305
Depreciation and
amortization......... 13,834 11,230 771 -- 25,835
Net income (loss)....... 26,873 6,142 (1,500) (4,386)(3) 27,129
Total assets............ 202,335 184,533 159,223 (155,188)(4) 390,903
Capital expenditures.... 41,781 24,851 118 -- 66,750
</TABLE>

Reconciliations:

(1) Elimination of intersegment sales.

(2) Elimination of intersegment interest income and expense from borrowings
made between segments.

F-20
<PAGE> 90
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(3) Net income eliminations:

<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Minority interest in German Operating
Company............................... $ (2,954) $ (2,707) $ (4,001)
Intersegment profit on intersegment
sales................................. (401) (315) (385)
--------- --------- ---------
Total net income eliminations........... $ (3,355) $ (3,022) $ (4,386)
========= ========= =========
</TABLE>

(4) Total assets eliminations:

<TABLE>
<S> <C> <C> <C>
Investment in subsidiaries.............. $(121,873) $(127,415) $(137,095)
Intersegment receivables................ (16,058) (13,783) (16,230)
Intersegment profit in inventory........ 610 (1,542) (1,863)
--------- --------- ---------
Total assets eliminations............... $(137,321) $(142,740) $(155,188)
========= ========= =========
</TABLE>

A summary of the Company's net sales by product line is presented below:

<TABLE>
<CAPTION>
NET SALES
--------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Hydrostatic transmissions.................. $339,945 $350,847 $408,802
Gear pumps and motors...................... 63,094 64,218 64,414
Electrohydraulics and others............... 43,735 52,501 61,957
-------- -------- --------
Total............................ $446,774 $467,566 $535,173
======== ======== ========
</TABLE>

A summary of the Company's net sales and long-lived assets by geographic
area is presented below :

<TABLE>
<CAPTION>
LONG-LIVED
NET SALES(1) ASSETS(2)
-------------------------------- --------------------
1995 1996 1997 1996 1997
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
United States........ $227,264 $247,339 $272,783 $ 75,974 $106,120
Germany.............. 48,294 45,909 49,931 28,625 26,517
United Kingdom....... 41,043 39,428 39,050 18,577 19,400
Other countries...... 130,173 134,890 173,409 32,940 44,067
-------- -------- -------- -------- --------
Total...... $446,774 $467,566 $535,173 $156,116 $196,104
======== ======== ======== ======== ========
</TABLE>

- ---------------
(1) Net sales are attributed to countries based on location of customer.

(2) Long-lived assets include property, plant and equipment net of accumulated
depreciation, intangible assets net of accumulated amortization and certain
other long-term assets.

No single customer accounted for 10% or more of total consolidated sales in
any year presented.

F-21
<PAGE> 91
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(16) SAUER INC. (PARENT ONLY) FINANCIAL STATEMENTS:

The condensed financial statements of Sauer Inc. (the parent company) are
presented below:

SAUER INC. (PARENT ONLY)

CONDENSED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1997

<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
ASSETS
Current assets --
Cash................................................. $ 546 $ 19
Other current assets................................. -- 2,116
-------- --------
Total current assets......................... 546 2,135
Receivables from subsidiaries.......................... 3,896 4,669
Intangible assets, net................................. 812 391
Equity investment in subsidiaries*..................... 89,358 101,924
Other.................................................. 619 4,479
-------- --------
$ 95,231 $113,598
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities.................................... $ 6,212 $ 1,913
Long-term debt......................................... 15,000 15,000
Payables to subsidiaries............................... 3,145 3,023
Other long term liabilities............................ -- 8,361
-------- --------
Total liabilities............................ 24,357 28,297
-------- --------
Stockholders' equity --
Common stock, par value $.01 per share, authorized
45,000,000 in 1996 and 1997; issued 24,900,000 and
outstanding 24,225,000 shares in 1996 and 1997.... 249 249
Additional paid-in capital........................... 74,900 74,723
Cumulative translation adjustment.................... 5,029 256
Retained earnings (deficit).......................... (6,604) 12,773
Common stock in treasury (at cost), 675,000 shares in
1996 and 1997..................................... (2,700) (2,700)
-------- --------
Total stockholders' equity................... 70,874 85,301
-------- --------
$ 95,231 $113,598
======== ========
</TABLE>

- ---------------
* Equity investment in subsidiaries, net, reported in the above condensed
balance sheet as of December 31, 1997, includes $59,254 and $21,905 of net
worth related to the U.S. and German Operating Companies, respectively. The
U.S. Operating Company is subject to financial covenants related to its
Revolving Credit Facility that, among other things, require that the U.S.
Operating Company maintain net worth (as defined) of not less than the sum of
$46,800, plus 35% of the U.S. Operating Company's quarterly net income, if
positive, for each fiscal quarter ending on or after March 31, 1997. At
December 31, 1997, required net worth was $56,307. The German Operating
Company is subject to similar financial covenants that require the German
Operating Company to maintain net worth of not less than 15% of total assets.
At December 31, 1997, required net worth was $10,920.

F-22
<PAGE> 92
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SAUER INC. (PARENT ONLY)

CONDENSED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

<TABLE>
<CAPTION>
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
Equity earnings of subsidiaries............. $ 26,762 $ 16,990 $ 28,567
Expenses, net --
Selling, general and administrative....... 4,988 3,298 5,921
Interest expense.......................... 1,319 927 735
Other expense, net........................ (108) 389 (31)
----------- ----------- -----------
Expenses, net.......................... 6,199 4,614 6,625
----------- ----------- -----------
Income from operations before income
taxes................................ 20,563 12,376 21,942
Benefit for income taxes.................... 6,017 6,522 5,187
----------- ----------- -----------
Net income............................. $ 26,580 $ 18,898 $ 27,129
=========== =========== ===========
Basic and diluted net income per common
share..................................... $ 1.10 $ .78 $ 1.12
=========== =========== ===========
Basic and diluted weighted average common
shares outstanding........................ 24,187,500 24,225,000 24,225,000
=========== =========== ===========
</TABLE>

F-23
<PAGE> 93
SAUER INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SAUER INC. (PARENT ONLY)

CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

<TABLE>
<CAPTION>
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities --

Net income....................................... $ 26,580 $ 18,898 $ 27,129
Adjustments to reconcile net income to net cash
provided by operating activities --
Equity earnings of subsidiaries............... (26,762) (16,990) (28,567)
Dividends received from subsidiaries.......... 14,805 16,200 21,879
Depreciation and amortization................. 456 422 421
Change in working capital..................... 3,990 (3,522) (6,415)
Other......................................... (3,707) (272) 3,353
-------- -------- --------
Net cash provided by operating activities... 15,362 14,736 17,800
-------- -------- --------
Cash flows used in investing activities --
Contributions to subsidiaries.................... (2,091) (4,442) (9,680)
-------- -------- --------
Cash flows from financing activities --
Repayments of long-term debt..................... -- (5,000) --
Net financing from (to) subsidiaries............. (6,212) 2,982 (895)
Sale of common stock............................. 3,400 -- --
Purchase of common stock......................... (2,700) -- --
Cash dividends................................... (7,738) (7,752) (7,752)
-------- -------- --------
Net cash used in financing activities....... (13,250) (9,770) (8,647)
-------- -------- --------
Cash --
Net increase (decrease) during the year.......... 21 524 (527)
Beginning balance................................ 1 22 546
-------- -------- --------
Ending balance................................... $ 22 $ 546 $ 19
======== ======== ========
</TABLE>

(17) SUBSEQUENT EVENTS:

On March 12, 1998, the Board of Directors authorized a class of preferred
stock with 300 shares authorized at $.01 par value. No preferred shares have
been issued.

On April 6, 1998, the Board of Directors adopted, and on April 22, 1998,
the Stockholders approved, an amendment to the Certificate of Incorporation
increasing the number of authorized shares of common stock from 3,000 to
45,000,000 and an increase in the number of shares of authorized preferred stock
from 300 to 4,500,000.

On April 7, 1998, the Board of Directors adopted, and on April 22, 1998,
the Stockholders approved, a 12,500-for-1 common stock split, in the form of a
reclassification and exchange, increasing the number of shares of common stock
issued and outstanding from 1,992 and 1,938, respectively, to 24,900,000 and
24,225,000, respectively, and the par value of a share of common stock was
reduced from $5,000 to $.01. As a result of the reduction in the par value of
the common stock, the amount of the Company's common stock was reduced by
transferring $9,711,000 from the common stock account to the additional
paid-in-capital account. The financial statements (including share and per share
amounts) have been restated to reflect these actions.

On April 16, 1998, Sauer Hydraulik signed an agreement to sell property,
plant and equipment, which was previously leased, at fair market value, as
determined by an independent appraisal, to the German Holding Company, in
exchange for a note payable and assumption of a mortgage. The transaction is
expected to be consummated on May 1, 1998.

F-24
<PAGE> 94

- ------------------------------------------------------

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS, AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT
TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
COMPANY SINCE SUCH DATE.
------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary...................... 1
Risk Factors............................ 8
The Combined Offering................... 12
Use of Proceeds......................... 13
Dilution................................ 13
Dividend Policy......................... 14
Capitalization.......................... 15
Shares Eligible for Future Sale......... 16
Selected Consolidated Financial Data.... 17
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................ 19
Business................................ 25
Management.............................. 40
Relationship with Principal
Stockholder........................... 50
Principal and Selling Stockholders...... 53
Description of Capital Stock............ 54
Certain United States Federal Tax
Consequences for Non-U.S. Holders..... 59
Underwriting............................ 62
Notice to Canadian Residents............ 64
Legal Opinions.......................... 65
Experts................................. 65
Available Information................... 66
Index to Consolidated Financial
Statements............................ F-1
</TABLE>

------------------

UNTIL JUNE 5, 1998, ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

======================================================

[SAUER INC. LOGO]

9,000,000 Shares
Common Stock
($.01 par value)

PROSPECTUS
CREDIT SUISSE FIRST BOSTON
SALOMON SMITH BARNEY
DEUTSCHE MORGAN GRENFELL
- ------------------------------------------------------