Sauer Danfoss (SHS) 10-Q 2007 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2007
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from                   to

Commission File Number 1-14097

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

Delaware	36-3482074
(State or other jurisdiction of	(IRS Employer
incorporation or organization)	Identification No.)
250 Parkway Drive, Suite 270, Lincolnshire, Illinois	60069
Krokamp 35, Neumunster, Germany	24539
(Address of principal executive office)	(Zip Code)

Registrant’s telephone number, including area code  (515) 239-6000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  o    Accelerated Filer  x    Non-Accelerated Filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o    No  x

As of November 1, 2007, 48,149,461 shares of Sauer-Danfoss Inc. common stock, $.01 par value, were outstanding.

Table of Contents

PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Statements of Income: Three and Nine Months Ended September 30, 2007 and 2006
	Consolidated Balance Sheets: As of September 30, 2007 and December 31, 2006
	Consolidated Statements of Stockholders’ Equity and Comprehensive Income: As of September 30, 2007 and December 31, 2006
	Consolidated Statements of Cash Flows: Nine Months Ended September 30, 2007 and 2006
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risks
Item 4.	Controls and Procedures
PART II	OTHER INFORMATION
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.	Exhibits
SIGNATURES
CERTIFICATIONS

2

Sauer-Danfoss Inc. and Subsidiaries

Consolidated Statements of Income

(Dollars in thousands, except per share data)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Net Sales	$	451,771		$	381,895		$	1,478,376		$	1,335,710
Cost of sales	357,550			299,395			1,147,275			1,018,763
Gross profit	94,221			82,500			331,101			316,947
Selling, general and administrative	54,845			51,164			176,591			160,983
Research and development	16,492			15,647			50,538			45,659
Impairment charges and net loss (gain) on disposal of fixed assets	81			(176		)	531			2,024
Loss on sale of businesses	662			—			8,702			—
Total operating expenses	72,080			66,635			236,362			208,666
Operating income	22,141			15,865			94,739			108,281
Nonoperating Expenses:
Interest expense, net	(5,600		)	(4,293		)	(16,720		)	(13,323		)
Other, net	(2,029		)	(1,009		)	(3,449		)	(3,572		)
Nonoperating expenses, net	(7,629		)	(5,302		)	(20,169		)	(16,895		)
Income Before Income Taxes and Minority Interest	14,512			10,563			74,570			91,386
Minority Interest	(869		)	(1,949		)	(15,512		)	(18,094		)
Income Before Income Taxes	13,643			8,614			59,058			73,292
Income Tax Expense	(8,144		)	(1,536		)	(20,557		)	(17,486		)
Net Income	$	5,499		$	7,078		$	38,501		$	55,806
Net Income per common share, basic	$	0.11		$	0.15		$	0.80		$	1.17
Net Income per common share, diluted	$	0.11		$	0.15		$	0.80		$	1.16
Weighted average basic shares outstanding	48,098,961			47,705,779			48,092,829			47,698,015
Weighted average diluted shares outstanding	48,275,442			48,439,499			48,270,653			48,146,886
Dividends declared per common share	$	0.18		$	0.16		$	0.54		$	0.44

See accompanying notes to consolidated financial statements.

3

Sauer-Danfoss Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except per share data)

	September 30,		December 31,
	2007		2006
	(Unaudited)
Assets
Current Assets:
Cash and cash equivalents	$	30,735	$	29,112
Accounts receivable, less allowances of $5,142 and $5,705 at September 30, 2007 and December 31, 2006, respectively	314,247		259,976
Inventories	282,764		272,286
Other current assets	53,701		43,931
Total current assets	681,447		605,305
Property, Plant and Equipment, net of accumulated depreciation of $771,685 and $784,661 at September 30, 2007 and December 31, 2006, respectively	529,363		503,977
Other Assets:
Goodwill	114,328		108,811
Other intangible assets, net	25,755		27,160
Deferred income taxes	57,884		58,217
Other	5,978		5,685
Total other assets	203,945		199,873
	$	1,414,755	$	1,309,155
Liabilities and Stockholders’ Equity
Current Liabilities:
Notes payable and bank overdrafts	$	59,147	$	46,952
Long-term debt due within one year	131,680		120,243
Accounts payable	153,435		142,234
Accrued salaries and wages	63,521		56,923
Accrued warranty	19,024		17,022
Other accrued liabilities	62,757		54,588
Total current liabilities	489,564		437,962
Long-Term Debt	182,379		182,388
Other Liabilities:
Long-term pension liability	83,012		80,607
Postretirement benefits other than pensions	38,142		35,193
Deferred income taxes	30,304		30,590
Other	24,304		22,976
Total other liabilities	175,762		169,366
Minority Interest in Net Assets of Consolidated Companies	62,069		53,448
Stockholders’ Equity:
Preferred stock, par value $0.01 per share, authorized 4,500,000 shares, no shares issued or outstanding	—		—
Common stock, par value $0.01 per share, authorized shares 75,000,000 in 2007 and 2006; issued and outstanding 48,149,461 in 2007 and 47,746,279 in 2006	481		477
Additional paid-in capital	330,441		336,146
Retained earnings	115,782		103,278
Accumulated other comprehensive income	58,277		26,090
Total stockholders’ equity	504,981		465,991
	$	1,414,755	$	1,309,155

See accompanying notes to consolidated financial statements.

4

Sauer-Danfoss Inc. and Subsidiaries

Consolidated Statement of Stockholders’ Equity and Comprehensive Income

(Dollars in thousands, except per share data)

	Number of Shares Outstanding	Common Stock			Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income		Total
Year Ended December 31, 2006	47,746,279	$	477		$	336,146			$	103,278			$	26,090	$	465,991
Period Ended September 30, 2007 (Unaudited)
Comprehensive income:
Net income	—	—			—				38,501				—
Pension adjustments	—	—			—				—				1,194
Unrealized gains on hedging activities	—	—			—				—				1,585
Currency translation	—	—			—				—				29,408
Total comprehensive income	—	—			—				—				—		70,688
Performance units vested	379,682	4			(4			)	—				—		—
Minimum tax withholding net settlement	—	—			(8,967			)	—				—		(8,967		)
Restricted stock grant	23,500	—			—				—				—		—
Restricted stock and performance unit compensation	—	—			3,266				—				—		3,266
Cash dividends declared ($0.18 per share)	—	—			—				(25,997			)	—		(25,997		)
Ending Balance	48,149,461	$		481	$		330,441		$		115,782		$	58,277	$	504,981

See accompanying notes to consolidated financial statements.

5

Sauer-Danfoss Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Nine Months Ended September 30,
	2007			2006
Cash Flows from Operating Activities:
Net Income	$	38,501		$	55,806
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	75,193			67,711
Minority interest	15,512			18,094
Restricted stock and performance unit compensation	3,266			5,460
Impairment charge and net loss on disposal of fixed assets	531			2,024
Loss on sale of businesses	8,702			—
Changes in operating assets and liabilities
Accounts receivable, net	(40,190		)	(22,073		)
Inventories	(5,234		)	(12,158		)
Accounts payable	1,398			15,101
Accrued liabilities	17,310			27,895
Change in deferred income taxes	(249		)	(4,092		)
Other	(15,738		)	268
Net cash provided by operating activities	99,002			154,036
Cash Flows from Investing Activities:
Purchases of property, plant and equipment	(83,036		)	(65,209		)
Proceeds from sales of property, plant and equipment	5,111			4,382
Proceeds from sale of businesses, net of payment for acquisition, net of cash acquired	7,006			—
Net cash used in investing activities	(70,919		)	(60,827		)
Cash Flows from Financing Activities:
Net borrowings on notes payable and bank overdrafts	6,096			8,863
Net borrowings (repayments) on revolving credit facility	3,600			(90,427		)
Repayments of long-term debt	(9,929		)	(26,693		)
Borrowings of long-term debt	5,978			51,514
Cash dividends	(24,968		)	(19,066		)
Distribution to minority interest partners	(7,987		)	(5,984		)
Net cash used in financing activities	(27,210		)	(81,793		)
Effect of Exchange Rate Changes on Cash	750			(693		)
Cash and Cash Equivalents:
Net increase during the year	1,623			10,723
Beginning balance	29,112			14,194
Ending balance	$	30,735		$	24,917
Supplemental Cash Flow Disclosures:
Interest paid	$	16,881		$	11,450
Income taxes paid	$	14,831		$	15,703

See accompanying notes to consolidated financial statements.

6

Sauer-Danfoss Inc. and Subsidiaries

Notes To Consolidated Financial Statements

(Dollars in thousands, except per share data)

(Unaudited)

1)Summary of Significant Accounting Policies -

Basis of Presentation and Principles of Consolidation –

The consolidated financial statements of Sauer-Danfoss Inc. and subsidiaries (the Company) included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, and represent the consolidation of all companies in which the Company has a controlling financial ownership interest or a majority of the interest in earnings or losses. Certain information and disclosures normally included in comprehensive financial statements, prepared in accordance with U.S. generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, the financial statements reflect all adjustments, which are of a normal recurring nature, necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows for the periods presented. It is suggested that these interim financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s latest annual report on Form 10-K as filed with the Securities and Exchange Commission on March 12, 2007.

Use of Estimates —

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results may differ from those estimates.

New Accounting Principles –

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company  adopted FIN 48 in the first quarter of 2007 with no impact on the consolidated financial statements. As of the adoption date, the tax years subject to review in the U.S., Denmark, and Germany were the years after 2001, 2002, and 2003, respectively. The Company recognizes interest related to taxes as interest income or expense. No penalties have been accrued.

In June 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation),” which allows companies to adopt a policy of presenting taxes in the income statement on either a gross or net basis. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer. The Company adopted EITF Issue No. 06-3 in the first quarter of 2007. Taxes collected from customers and remitted to governmental authorities are presented net in the consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 157, “Fair Value Measurements” which clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The Company has not yet determined the impact that the implementation of SFAS No. 157 will have on the consolidated financial statements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115”  which permits many financial instruments and certain other items to be measured at fair value at the option of the Company. SFAS No. 159 is effective for financial statements issued for fiscal

7

years beginning after November 15, 2007. The Company does not expect SFAS No. 159 to have a significant impact on the consolidated financial statements.

The Company adopted the provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” in December 2006. As a result of the adoption of this statement, accumulated other comprehensive income decreased by $29,326. The decrease was incorrectly reported as a component of comprehensive income in the 2006 Consolidated Statement of Stockholders’ Equity and Comprehensive Income. Total comprehensive income was incorrectly reported as $52,428 and should have been reported as $81,754 for the year ended  December 31, 2006. The decrease due to adopting the statement should have been reported as a direct adjustment to accumulated other comprehensive income. The Company will correct the error in the presentation of changes in accumulated other comprehensive income in the next annual report on Form 10-K filing.

2)Basic and Diluted Per Share Data -

Basic net income per common share is based on the weighted average number of shares of common stock outstanding for the period less restricted stock shares issued in connection with the Company’s long-term incentive plans and subject to risk of forfeiture. Diluted net income per common share assumes that outstanding common shares were increased by shares issuable upon (i) vesting of restricted stock shares, and (ii) granting of shares under the long-term incentive plans, after it becomes certain that the performance requirements needed to be met in accordance with the incentive plans will be achieved. Shares under both the restricted stock plan and the long-term incentive plan have an exercise price of zero.

The reconciliation of basic net income per common share to diluted net income per common share is shown in the following table for the three and nine month periods ended September 30, 2007 and 2006:

	September 30, 2007					September 30, 2006
	Net Income		Shares	EPS		Net Income		Shares	EPS
Three Months
Basic net income	$	5,499	48,098,961	$	0.11	$	7,078	47,705,779	$	0.15
Effect of dilutive securities:
Restricted stock	—		22,895	—		—		19,989	—
Performance units	—		153,586	—		—		713,731	—
Diluted net income	$	5,499	48,275,442	$	0.11	$	7,078	48,439,499	$	0.15
Nine Months
Basic net income	$	38,501	48,092,829	$	0.80	$	55,806	47,698,015	$	1.17
Effect of dilutive securities:
Restricted stock	—		24,238	—		—		21,761	—
Performance units	—		153,586	—		—		427,110	(0.01		)
Diluted net income	$	38,501	48,270,653	$	0.80	$	55,806	48,146,886	$	1.16

3)Restructuring Charges –

In March 2006, the Company announced its plans to close the LaSalle, Illinois plant, outsourcing certain products to reduce costs and increase efficiencies. Costs related to the LaSalle plant closing are included in the Propel segment and are substantially complete at the end of the third quarter 2007. The Propel segment has also incurred costs related to the relocation of certain production lines between production facilities in the U.S, which is expected to be complete by the end of 2007.

In April 2007, the Company sold its direct current (DC) electric motors business. The loss on sale of business of approximately $6,700 is not included in the restructuring numbers below. In preparation for this disposition the Company incurred restructuring costs to transfer all DC production lines to one location. These costs are included in the Controls segment. The Controls segment has also incurred costs related to the relocation of certain production lines, which is also expected to be complete by the end of 2007.

In 2006, the Company announced plans to discontinue production of certain product lines manufactured in Swindon, England and incurred restructuring costs in anticipation of this shutdown. In June 2007, the assets related to this production facility

8

were sold as discussed in Note 10. All costs incurred in 2007 related to the sale of the production assets are included in the loss on sale of business line on the income statement and are not included in the restructuring numbers below.

The following table summarizes the restructuring charges for the three and nine months ended September 30, 2007 and 2006, as well as the cumulative charges incurred to date:

	Propel		Work Function		Controls		Total
(Three months ended)
Charges incurred for the period ended September 30, 2007	$	1,230	$	—	$	487	$	1,717
Charges incurred for the period ended September 30, 2006	2,127		555		257		2,939
(Nine months ended)
Charges incurred for the period ended September 30, 2007	4,715		—		4,371		9,086
Charges incurred for the period ended September 30, 2006	6,425		2,837		1,057		10,319
Cumulative charges incurred as of September 30, 2007	13,005		3,482		6,095		22,582
Cumulative charges expected to be incurred	13,605		3,482		6,395		23,482

The restructuring costs incurred during the three and nine months ended September 30, 2007 and 2006 are reported  in the income statement as detailed  in the following table:

	Cost of Sales		Selling, General and Administrative Expenses		Impairment Charges and Loss on Disposal of Fixed Assets		Total
(Three months ended)
Charges for the period ended September 30, 2007	$	1,697	$	20	$	—	$	1,717
Charges for the period ended September 30, 2006	2,772		167		—		2,939
(Nine months ended)
Charges for the period ended September 30, 2007	8,397		669		19		9,085
Charges for the period ended September 30, 2006	8,336		328		1,655		10,319

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The following table summarizes the restructuring charges incurred and the activity in the accrued liability during the three and nine months ended September 30, 2007.

	Employee Termination Costs			Employee Training Costs			Impairment Charges			Equipment Moving Costs			Other			Total
Balance as of December 31, 2006	$	3,115		$	—		$	—		$	—		$	—		$	3,115
Charges to expense	1,210			1,713			19			1,572			1,176			5,690
Payments made	(284		)	(1,713		)	(19		)	(1,572		)	(1,176		)	(4,764		)
Balance at of March 31, 2007	$	4,041		$	—		$	—		$	—		$	—		$	4,041
Charges to expense	(610		)	441			—			1,484			364			1,679
Reversal of accrual due to sale of business	(1,915		)	—			—			—			—			(1,915		)
Payments made	(991		)	(441		)	—			(1,484		)	(364		)	(3,280		)
Balance at of June 30, 2007	$	525		$	—		$	—		$	—		$	—		$	525
Charges to expense	—			995			—			530			192			1,717
Payments made	(75		)	(995		)	—			(530		)	(192		)	(1,792		)
Balance at of September 30, 2007 (1)	$	450		$	—		$	—		$	—		$	—		$	450
Cumulative charges incurred as of September 30, 2007	$	4,358		$	3,149		$	2,185		$	4,946		$	7,944		$	22,582
Cumulative charges expected to be incurred	$	4,358		$	3,499		$	2,185		$	5,096		$	8,344		$	23,482

(1)  Approximately $75 of the remaining $450 of accrued liabilities are expected to be paid in 2007 with the remainder paid in 2008.

Included in cumulative charges - other is $1,551 of  pension curtailment costs incurred in 2006. This is the recognition of unamortized prior service costs related to the LaSalle pension plan.

4)Inventories-

The composition of inventories is as follows:

	September 30, 2007			December 31, 2006
Raw materials	$	130,657		$	116,122
Work in progress	54,963			56,274
Finished goods and parts	116,340			117,104
LIFO allowance	(19,196		)	(17,214		)
Total	$	282,764		$	272,286

5)Assets Held for Sale –

In 2003, the Company closed a manufacturing facility in West Branch, Iowa and determined the land and building would be sold. This property was classified as held for sale in other current assets with a carrying value of approximately $3,600 at December 31, 2006. In April of 2007, the location was sold for approximately $3,300. The loss on sale of assets of approximately $300 is reported in the Work Function segment.

10

In connection with the restructuring activity discussed in Note 3, the Company intends to sell the land and building at the LaSalle, Illinois location. The Company reclassified the land and building as property held for sale in other current assets in the first quarter of 2007. The property has a carrying value of $1,500 and is reported in the Propel segment.

6)            Accrued Warranty Costs –

The Company warrants its various products over differing periods depending upon the type of product and application. Consequently, the Company records warranty liabilities for the estimated costs that may be incurred under its basic warranty based on past trends of actual warranty claims compared to the actual sales levels to which those claims apply. These liabilities are accrued at the time the sale of the products are recorded. In addition, the Company, from time to time in the normal course of business, incurs costs to repair or replace defective product with a specific customer, which are known as field recalls. Due to the infrequent nature of field recalls the Company cannot estimate these costs at the time the products are sold and therefore records an accrual at the time the information becomes available to the Company. The following table presents the changes in the Company’s accrued warranty liability:

	Nine Months Ended September 30,
	2007			2006
Balance, beginning of period	$	17,022		$	17,047
Payments	(6,584		)	(7,833		)
Accruals for warranties	7,942			8,446
Currency impact	644			480
Balance, end of period	$	19,024		$	18,140

7)Long-Term Incentive Plans -

Under the 1998 Long-Term Incentive Plan (1998 Incentive Plan), the Board of Directors is authorized to grant non-qualified stock options, incentive stock options, performance units, stock appreciation rights, restricted stock and performance shares to employees. In December 2005, the Board of Directors approved the adoption of the Sauer-Danfoss Inc. 2006 Omnibus Incentive Plan (2006 Incentive Plan), which was approved by the stockholders at the annual meeting in June 2006. The 2006 Incentive Plan provides for grants similar to those under the 1998 Incentive Plan and qualifies certain awards for the performance-based exception to obtain favorable tax treatment. Refer to Note 13 in the Notes to Consolidated Financial Statements in the Company’s 2006 annual report filed on Form 10-K for additional information.

In March 2007, the Compensation Committee granted 259,975 performance units under the 2006 Incentive Plan, 200,427 of which will be settled 100 percent in company stock with shares withheld having a value to meet the minimum statutory withholding requirements and 59,548 performance units granted to certain individuals that would be settled in cash. In April 2007, the Compensation Committee granted 13,126 performance units under the 2006 Incentive Plan which will be settled 100 percent in company stock with shares withheld having a value to meet the minimum statutory withholding requirements. The units to be settled in cash are accounted for as liability units, with the remainder of the units accounted for as equity units.

In accordance with SFAS No. 123R, “Share-Based Payment,” compensation expense is recognized over the vesting period of three years, measured based on the market price of the Company’s stock at the date of grant, with an offsetting increase in additional paid-in capital for the units accounted for under the equity method. The expense related to the performance units granted in March 2007 to be settled in Company stock was based on the market price of the Company’s stock as of  March 20, 2007 and the expense related to the performance units granted in April 2007 was based on the market price of the Company’s stock as of April 17, 2007. The expense related to the grants that will be settled in cash is based on the market price of the Company’s stock as of the balance sheet date. The Company recognized $188 and $3,106 expense in the three month and nine month periods ended September 30, 2007 related to outstanding performance units granted under the 1998 Incentive Plan and the 2006 Incentive Plan. The Company recognized $68 and $1,118 of tax benefit on these amounts during the three month and nine month periods ended September 30, 2007. The Company expects to recognize approximately $7,200 of additional expense through 2009 related to the outstanding performance units under these two plans.

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The following charts summarize performance unit activity under the plans for the nine months ended September 30, 2007:

Equity Units	Number		Weighted Average Grant Date Fair Value		Weighted Average Vesting Period in Years
Units Outstanding at January 1	934,694		$	20.85	3.0
Units settled	(368,288	)	16.98		3.0
Units granted	213,553		31.20		3.0
Units forfeited	(36,660	)	22.08		3.0
Units Outstanding at September 30	743,299		$	25.68	3.0

Cash Units	Number		Fair Value		Weighted Average Vesting Period in Years
Units Outstanding at January 1	85,151
Units granted	59,548
Units forfeited	(47,503	)
Units Outstanding at September 30	97,196		$	26.68	3.0

8)Pension and Postretirement Benefits Other than Pensions –

Pension Benefits

The Company has noncontributory defined benefit plans covering a significant number of its employees. The benefits under these plans are based primarily on years of service and compensation levels. Pension expense for the three and nine months ended September 30, 2007 and 2006 for the defined benefit plans consists of the following components:

	Three months ended September 30,						Nine months ended September 30,
	2007			2006			2007			2006
Service cost	$	964		$	1,245		$	3,636		$	3,596
Interest cost	2,795			2,747			8,606			7,866
Expected return on plan assets	(2,287		)	(2,146		)	(7,051		)	(6,113		)
Amortization of prior service cost (1)	168			134			1,533			1,932
Amortization of net loss	903			655			2,219			1,883
Net periodic pension expense	$	2,543		$	2,635		$	8,943		$	9,164

(1)The year to date 2006 amount includes $1,551 for the write-off of unamortized prior service costs related to the LaSalle pension plan. The write-off is part of the restructuring activities discussed in Note 3. The year to date 2007 amount includes $1,020 for the write-off of unamortized prior service costs related to the Swindon pension plan. The write-off is included in the loss on the sale of the Swindon assets and product lines as discussed in Note 10.

Postretirement Benefits

The Company provides health benefits for certain retired employees and certain dependents when the employee becomes eligible for these benefits by satisfying plan provisions that include certain age and service requirements.

12

The components of the postretirement benefit expense of the Company-sponsored plans for the three and nine months ended September 30, 2007 and 2006 is as follows:

	Three months ended September 30,				Nine months ended September 30,
	2007		2006		2007		2006
Service cost (1)	$	111	$	142	$	235	$	423
Interest cost	741		470		1,798		1,412
Net deferral and amortization	291		172		710		518
Postretirement benefit expense	$	1,143	$	784	$	2,743	$	2,353

(1)  Service cost decreased in 2007 due to the closure of the LaSalle, Illinois plant in December 2006. The Company is no longer incurring service cost related to these employees, however interest and amortization costs will continue until all benefits have been paid out of the plan.

9)Income Taxes -

The Company reversed $2,492 and $5,928 of valuation allowance on deferred tax assets during the three month and nine month periods ended September 30, 2007, respectively; and $179 and $6,012 during the three and nine month periods ended September 30, 2006, respectively.

10)Sale of Businesses -

In the first quarter of 2007, the Company sold its DC motors business. The sale resulted in a loss of approximately $6,700, including  transaction costs. The loss is reported in the Controls segment. The sale transaction closed in April 2007.

The Company sold the assets and product lines located in the Swindon, England location in June 2007. The assets were used to produce customized open circuit gear pumps. Open circuit gear pumps and motors continue to be produced at other locations within the Company. The Company recognized a loss on the sale of approximately $2,000, including transaction costs, reported in the Work Function segment. The Company had anticipated discontinuing production at this location by the end of 2007 and had established an accrual with the expectation that termination payments would be made to employees at the time production ended. A severance accrual of approximately $2,500, established during 2006 and the first quarter of 2007, was reversed at the time of sale. The reversal of the accrual was reflected as an offset to the loss on sale of business calculation.

11)Business Combination -

In May 2007, the Company acquired all outstanding shares of a company in Denmark which produces steering columns. The acquired company, with annual sales of approximately $4,700, was previously a supplier and was acquired in order to control production and delivery of steering columns used in Work Function products. The Company has consolidated the financial results since the date of acquisition. The purchase price was allocated to inventory and property, plant, and equipment. Goodwill of approximately $2,200 represents the excess of cost over the fair value of net tangible assets and represents a preliminary allocation of the purchase price, subject to valuation finalization, expected to be completed in 2007.

12)Segment and Geographic Information -

The Company’s operating segments are organized around its product lines of Propel, Work Function and Controls. Propel products include hydrostatic transmissions and related products that transmit power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, electric drives and valves that control and direct the power of a vehicle. Segment costs in Global Services relate to internal global service departments and include costs such as consulting for special projects, tax and accounting fees paid to outside third parties, certain insurance premiums, and amortization of intangible assets from certain business combinations.

13

The following table presents the significant items by operating segment for the results of operations for the three and nine month periods ended September 30, 2007 and 2006:

Three months ended

	Propel		Work Function		Controls		Global Services			Total
September 30, 2007
Trade sales	$	207,637	$	124,479	$	119,655	$	—		$	451,771
Segment income (loss)	24,530		880		6,837		(12,135		)	20,112
Interest expense, net										(5,600		)
Minority interest										(869		)
Income before income taxes										13,643
Depreciation and amortization	10,775		8,233		4,868		1,381			25,257
Capital expenditures	12,531		5,375		10,536		1,908			30,350
September 30, 2006
Trade sales	$	166,627	$	113,178	$	102,090	$	—		$	381,895
Segment income (loss)	15,156		6,311		8,657		(15,268		)	14,856
Interest expense, net										(4,293		)
Minority interest										(1,949		)
Income before income taxes										8,614
Depreciation and amortization	10,964		6,520		4,558		949			22,991
Capital expenditures	9,109		6,659		6,328		765			22,861

Nine months ended

	Propel		Work Function		Controls		Global Services			Total
September 30, 2007
Trade sales	$	707,366	$	399,343	$	371,667	$	—		$	1,478,376
Segment income (loss)	111,237		2,254		16,737		(38,938		)	91,290
Interest expense, net										(16,720		)
Minority interest										(15,512		)
Income before income taxes										59,058
Depreciation and amortization	32,391		24,388		14,684		3,730			75,193
Capital expenditures	32,914		22,314		23,556		4,252			83,036
September 30, 2006
Trade sales	$	655,435	$	359,292	$	320,983	$	—		$	1,335,710
Segment income (loss)	94,583		18,233		37,851		(45,958		)	104,709
Interest expense, net										(13,323		)
Minority interest										(18,094		)
Income before income taxes										73,292
Depreciation and amortization	31,829		19,287		12,955		3,640			67,711
Capital expenditures	22,897		25,846		15,182		1,284			65,209

14

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

	Net Sales (1)								Long-Lived Assets (2)
	Three months ended September 30,				Nine months ended September 30,				September 30,
	2007		2006		2007		2006		2007		2006
United States	$	155,370	$	147,448	$	569,757	$	583,115	$	182,625	$	174,259
Germany	45,360		46,526		153,588		136,432		55,796		59,140
Italy	34,588		26,654		110,113		89,408		35,148		30,701
Denmark (3)	7,547		6,840		22,928		20,846		210,840		197,187
Other countries	208,906		154,427		621,990		505,909		191,015		167,924
Total	$	451,771	$	381,895	$	1,478,376	$	1,335,710	$	675,424	$	629,211

(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, goodwill, intangible assets net of accumulated amortization, and certain other long-lived assets.

(3)Majority of this country’s sales are shipped outside of the home country where the product is produced.

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

15

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

Sauer-Danfoss Inc. and Subsidiaries (the Company)

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

Actual future results may differ materially from those described in the forward-looking statements due to a variety of factors. It is difficult to determine if past experience is a good guide to the future. While the economy in the U.S. remains unstable due to the uncertainty surrounding continued job creation, interest rates, crude oil prices, and the U.S. government’s stance on the weaker dollar, the economic situation in Europe has been improving in recent months. Any downturn in the Company’s business segments could adversely affect the Company’s revenues and results of operations. Other factors affecting forward-looking statements include, but are not limited to, the following:  specific economic conditions in the agriculture, construction, road building, turf care, material handling and specialty vehicle markets and the impact of such conditions on the Company’s customers in such markets; the cyclical nature of some of the Company’s businesses; the ability of the Company to win new programs and maintain existing programs with its original equipment manufacturer (OEM) customers; the highly competitive nature of the markets for the Company’s products as well as pricing pressures that may result from such competitive conditions; the continued operation and viability of the Company’s significant customers; the Company’s execution of internal performance plans; difficulties or delays in manufacturing; cost-reduction and productivity efforts; competing technologies and difficulties entering new markets, both domestic and foreign; changes in the Company’s product mix; future levels of indebtedness and capital spending; claims, including, without limitation, warranty claims, field retrofit claims, product liability claims, charges or dispute resolutions; ability of suppliers to provide materials as needed and the Company’s ability to recover any price increases for materials in product pricing; the Company’s ability to attract and retain key technical and other personnel; labor relations; the failure of customers to make timely payment; any inadequacy of the Company’s intellectual property protection or the potential for third-party claims of infringement; global economic factors, including currency exchange rates; general economic conditions, including interest rates, the rate of inflation, and commercial and consumer confidence; energy prices; governmental laws and regulations affecting operations, including tax obligations; changes in accounting standards; worldwide political stability; the effects of terrorist activities and resulting political or economic instability; natural catastrophes; U.S. military action overseas; and the effect of acquisitions, divestitures, restructurings, product withdrawals, and other unusual events.

The Company cautions the reader that these lists of cautionary statements and risk factors may not be exhaustive. The Company expressly disclaims any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances. The foregoing risks and uncertainties are further described in Item1A (Risk Factors) in the Company’s latest annual report on Form 10-K filed with the SEC, which should be reviewed in considering the forward-looking statements contained in this quarterly report.

About the Company

Sauer-Danfoss Inc. and subsidiaries (the Company) is a worldwide leader in the design, manufacture, and sale of engineered hydraulic and electronic systems and components that generate, transmit and control power in mobile equipment. The Company’s products are used by original equipment manufacturers (OEMs) of mobile equipment, including construction, road building, agricultural, turf care, material handling, and specialty equipment. The Company designs, manufactures and markets its products in the Americas, Europe and the Asia-Pacific regions, and markets its products throughout the rest of the world either directly or through distributors.

Executive Summary — Three months ended September 30, 2007

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

16

The following table summarizes the Company’s third quarter 2007 and 2006 results from operations, separately identifying the impact of currency fluctuations. This analysis is more consistent with how the Company internally evaluates its results.

(in millions)	Three months ended September 30, 2006			Currency Fluctuations		Underlying increase		Three months ended September 30, 2007
Net sales	$	381.9		$	21.4	$	48.5	$	451.8
Gross profit	82.5			5.6		6.1		94.2
% of Sales	21.6		%					20.8		%
Selling, general and administrative	51.0			2.4		1.5		54.9
Loss on sale of business	—			—		0.7		0.7
Research & development	15.6			0.7		0.2		16.5
Total operating costs	66.6			3.1		2.4		72.1
Operating income	$	15.9		$	2.5	$	3.7	$	22.1
% of Sales	4.2		%					4.9		%

Net sales for the third quarter 2007 increased 13 percent over third quarter 2006, excluding the effects of currency. Sales increased 17 percent excluding the effects of currency and the divestitures of product lines in Swindon, England and the DC motors business. Sales increased in all regions and segments. Excluding the impacts of currency and divestitures, sales grew 28 percent in Asia Pacific, 21 percent in Europe and 10 percent in the Americas. Sales in the Propel segment were up 20 percent. Sales in the Controls segment grew 22 percent, followed by an increase of 8 percent in the Work Funcion segment.

Operating income increased 23 percent, excluding the impacts of currency. Several factors contributed to the increased operating income. The operating margin in the Propel segment increased nearly 3 percentage points. Total restructuring costs declined $1.2 million compared to the three months ended September 30, 2006. Costs incurred to implement a common company-wide business system also declined nearly $0.9 million and incentive plan costs declined $1.1 million. Offsetting these decreases were an additional $0.5 million costs related to a major lean project in Denmark, $0.7 million of costs related to the start-up of a European financial shared services center, as well as increasing headcount, particularly for sales and marketing functions.

The Company incurred an additional loss of $0.7 million during the three months ended September 30, 2007 related to the sale of the assets and product lines which were manufactured in Swindon, England and the sale of the DC motors business. These additional charges were primarily related to the transfer of software licenses and transaction costs.

Restructuring charges incurred during the third quarter of 2007 were $1.7 million, down from the $2.9 million incurred during the third quarter of 2006. The Propel and Controls segments incurred costs related to restructuring activities to relocate production lines, with the majority of the costs charged to cost of sales.

Following is a discussion of the Company’s operating results by market, region, and business segment.

Operating Results -Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

Sales Growth by Market

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

	Americas		Asia- Pacific		Europe		Total
Agriculture/Turf Care	14	%	9	%	24	%	17	%
Construction/Road Building	(2	)	33		13		10
Specialty	16		48		11		14
Distribution	8		16		10		10

17

Agriculture/Turf Care

Sales into the agriculture/turf care market increased in all regions during the third quarter of 2007 compared to the third quarter of 2006. The sales increase in the Americas is driven by a strengthening agriculture market due to strong commodity prices which was offset by a slow turf care market resulting from sharp declines in housing starts and increasing energy prices. Agriculture sales in Europe continue to be strong as a result of the positive economic development in Europe, as well as new sales into the Russian markets. The Asia-Pacific region contributes less than 5 percent of the sales in the agriculture/turf care markets, therefore the increase in the Asia-Pacific region does not significantly impact the total market.

Construction/Road Building

Overall there was an increase in sales into the construction/road building markets during the third quarter of 2007 compared to the third quarter of 2006. The slight decline in the Americas is driven by continued reduction in new housing starts. Sales into the European construction/road building market increased 13 percent. The increase was primarily driven by the construction market and was due primarily to strengthening economic conditions in Europe. Sales into the Asia-Pacific construction/road building markets were up 33 percent, due primarily to the continued strength of the road building market in China.

Specialty

Specialty vehicles are comprised of a variety of markets including forestry, material handling, marine, waste management and waste recycling. All regions contributed to the strong sales growth in the specialty markets in the third quarter. Sales into the telehandler, mining applications, forestry and street sweeper markets were all strong during the third quarter of 2007.

Distribution

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

Business Segment Results

The following discussion of operating results by segment relates to information as presented in Note 12 in the Notes to the Consolidated Financial Statements. Segment income is defined as the respective segment’s portion of the total Company’s net income, excluding net interest expense, income taxes, minority interest, and global services expenses. Propel products include hydrostatic transmissions and related products that transmit power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, electric drives and valves that control and direct the power of a vehicle. The following table provides a summary of each segment’s sales and segment income, separately identifying the impact of currency fluctuations.

(in millions)	Three months ended September 30, 2006			Currency Fluctuations			Underlying increase (decrease)			Three months ended September 30, 2007
Net sales
Propel	$	166.6		$	7.6		$	33.4		$	207.6
Work Function	113.2			7.2			4.1			124.5
Controls	102.1			6.6			11.0			119.7
Segment income (loss)
Propel	$	15.2		$	1.4		$	7.9		$	24.5
Work Function	6.3			0.3			(5.7		)	0.9
Controls	8.7			0.9			(2.8		)	6.8
Global Services and other expenses, net	(15.3		)	(0.7		)	3.9			(12.1		)

Propel Segment

The Propel segment experienced a strong 20 percent increase in sales, excluding the effects of currency fluctuations, during the third quarter 2007 compared to 2006, mainly due to strong demand in the European markets throughout the summer months. Segment income increased an even stronger 52 percent during the quarter. The Propel segment experienced a 3 percentage point increase in operating profit margin during the three months ended September 30, 2007 compared to the three months ended September 30, 2006.

18

The Propel segment experienced some margin decline during the third quarter of 2006 as a result of the U.S. locations implementing the common business system and working through some related inefficiencies. Restructuring charges decreased $0.9 million during the three months ended September 30, 2007 as compared to the three months ended Septemeber 30, 2006.

Work Function Segment

Sales in the Work Function segment increased 4 percent, excluding the effects of currency fluctuations, in the third quarter of 2007. Despite the increase in sales, Work Function segment income decreased compared to the third quarter of 2006. Continued investment in a major lean project in Denmark resulted in costs of $0.5 million, contributing to the decline in segment income. Operational issues contributed $2.4 million of costs due to expedited freight costs and increased overtime to keep up with increasing demand, primarily in Denmark.

Controls Segment

Net sales in the Controls segment for third quarter 2007, excluding the effects of currency fluctuations, increased 11 percent compared to the third quarter 2006. Despite the increases in sales, segment income declined during the third quarter of 2007. The decline is mainly due to increased order fulfillment costs, air freight and overtime of $1.9 million due to increased demand levels for certain products in the Controls segment. Restructuring costs were also $0.2 million higher in the third quarter 2007 compared to the third quarter 2006.

Global Services and other expenses, net

Segment costs in Global Services and other expenses, net, relate to internal global service departments, along with the operating costs of the Company’s executive office. Global services include such costs as consulting for special projects, tax and accounting fees paid to outside third parties, internal audit, certain insurance premiums, and the amortization of intangible assets from certain business combinations. Global services and other expenses decreased $3.9 million excluding the impacts of currency, due primarily to a reduction in incentive costs.

Income Taxes

The Company’s effective tax rate was 60 percent for the third quarter of 2007 compared to 18 percent for the same period in 2006. The effective tax rate increased during the third quarter of 2007 primarily due to an increase in deferred tax expense in Germany due to a legislative statutory tax rate reduction from approximately 38 percent to approximately 29 percent, resulting in reductions of deferred tax assets. In addition, the Company incurred one time losses in 2007 that are not able to be tax benefited. In third quarter 2006, tax expense was offset by the reversal of valuation allowance on deferred tax assets related to foreign and research credits that were expected to be utilized. The Company’s effective tax rate can also vary significantly from quarter to quarter due to the mix of earnings between countries.

19

Executive Summary — Nine months ended September 30, 2007

The following table summarizes the Company’s results from operations for the Nine months ended September 30, 2007 and 2006, separately identifying the impact of currency fluctuations. This analysis is more consistent with how the Company internally evaluates its results.

(in millions)	Nine months ended September 30, 2006			Currency Fluctuations		Underlying increase (decrease)			Nine months ended September 30, 2007
Net sales	$	1,335.7		$	64.5	$	78.2		$	1,478.4
Gross profit	316.9			17.4		(3.2		)	331.1
% of Sales	23.7		%						22.4		%
Selling, general and administrative	163.0			7.8		6.4			177.2
Loss on sale of business	—			—		8.7			8.7
Research & development	45.6			2.3		2.6			50.5
Total operating costs	208.6			10.1		17.7			236.4
Operating income	$	108.3		$	7.3	$	(20.9	)	$	94.7
% of Sales	8.1		%						6.4		%

Net sales for the nine months ended September 30, 2007 increased 6 percent compared to the nine months ended September 30, 2006, excluding the effects of currency. Sales increased 8 percent excluding the effects of currency and the divestitures of product lines in Swindon, England and the DC motors business. Sales increased in all regions and segments. Excluding the impacts of currency and divestitures, sales grew 13 percent in Europe, 11 percent in Asia Pacific, and 2 percent in the Americas. Sales in the Work Function segment were up 16 percent. Sales in the Controls segment grew 13 percent, followed by an increase of 1 percent in the Propel segment.

There were several factors contributing to the decrease in operating income, excluding the effects of currency. Operational issues contributed $14.0 million of costs. These costs related to work stoppages in Denmark due to contract negotiations and increased order fulfillment costs related to expediting and overtime costs to meet increased demand in the Work Function and Controls segments. Also contributing to the decreased operating income was a $6.4 million increase in selling, general, and administrative costs excluding the effects of currency. This increase is primarily attributed to $2.3 million costs related to the start-up of a European financial shared services center, as well as increasing headcount, particularly for sales and marketing functions. Research and development costs increased $2.6 million excluding the impacts of currency, primarily driven by increasing headcount and ongoing product development in the Controls segment.

The Company incurred a loss of $6.7 million related to the sale of the direct current (DC) electric motor business located in Berching, Germany and a loss of $2.0 million on the sale of the assets and product lines which were manufactured in Swindon, England during the nine months ended September 30, 2007. These activities were part of the Company’s plan to divest of product lines that do not fit the Company’s long-term strategic direction.

During the nine months ended September 30, 2007, the Propel and Controls segments incurred $9.1 million of restructuring costs primarily to relocate production lines to other production facilities within the Company and to close the LaSalle, Illinois plant. Restructuring charges incurred during the nine months ended September 30, 2006 were $10.3 million, primarily related to restructuring in the Propel and Work Function segments.

Following is a discussion of the Company’s operating results by market, region, and business segment.

20

Operating Results -Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

Sales Growth by Market

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

	Americas		Asia- Pacific		Europe		Total
Agriculture/Turf Care	(1	)%	1	%	13	%	3	%
Construction/Road Building	(17	)	12		12		(1	)
Specialty	18		32		12		14
Distribution	5		10		9		8

Agriculture/Turf Care

Sales into the agriculture/turf care markets were up slightly during the nine months ended September 30, 2007 compared to the same period in 2006. The 1 percent decrease in the Americas is primarily driven by slowing turf care sales resulting from sharp declines in housing starts and increasing energy prices. Agriculture sales increased  in the Americas due to strengthening commodity prices resulting partly from rapidly expanding ethanol production. Agriculture sales in Europe continue to be strong as a result of the positive economic development in Europe. The Asia-Pacific region contributes less than 5 percent of the sales in the agriculture/turf care markets, therefore the decrease in the Asia-Pacific region does not significantly impact the total market.

Construction/Road Building

Sales into the construction/road building markets decreased slightly during the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006. The decrease is driven by the Americas region, which is primarily the result of a reduction in new housing starts. Sales into the European construction/road building markets increased 12 percent. This increase was driven by the construction market and was due primarily to strengthening economic conditions in Europe. Sales into the Asia-Pacific construction/road building market were also up 12 percent due primarily to continued strength in the Chinese road building market.

Specialty

Specialty vehicles are comprised of a variety of markets including forestry, material handling, marine, waste management and waste recycling. All regions contributed to the strong sales growth in the specialty markets in the third quarter. Sales into the telehandler, energy-related marine and offshore equipment, mining applications, and street sweeper markets were all strong.

Distribution

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

Business Segment Results

The following discussion of operating results by segment relates to information as presented in Note 12 in the Notes to the Consolidated Financial Statements. Segment income is defined as the respective segment’s portion of the total Company’s net income, excluding net interest expense, income taxes, minority interest, and global services expenses.

21

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

(in millions)	Nine months ended September 30, 2006			Currency Fluctuations			Underlying increase (decrease)			Nine months ended September 30, 2007
Net sales
Propel	$	655.4		$	21.2		$	30.8		$	707.4
Work Function	359.3			23.3			16.7			399.3
Controls	321.0			20.0			30.7			371.7
Segment income (loss)
Propel	$	94.6		$	4.3		$	12.3		$	111.2
Work Function	18.2			1.1			(17.1		)	2.2
Controls	37.9			2.0			(23.2		)	16.7
Global Services and other expenses, net	(46.0		)	(1.8		)	9.0			(38.8		)

Propel Segment

The Propel segment experienced a 5 percent increase in sales, excluding the effects of currency fluctuations, during the nine months ended September 30, 2007 compared to 2006. Segment income increased 13 percent during the same period. Several factors contributed to this increase. The Propel segment showed a 1 percentage point increase in operating profit margin during the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006. This increase is due partly to a $1.7 million reduction in restructuring costs classified in cost of goods sold as well as reduced field recall costs of approximately $0.8 million.

Work Function Segment

Sales in the Work Function segment increased 5 percent, excluding the effects of currency fluctuations, during the nine months ended September 30, 2007. Despite the increase in sales, Work Function segment income decreased compared to the nine months ended September 30, 2006. Continued investment in a major lean project in Denmark resulted in $4.1 million of charges. Operational issues contributed an additional $4.9 million of costs due primarily to increased order fulfillment charges and costs associated with work stoppages in Denmark. In March 2006, the Company announced plans to discontinue production of certain product lines manufactured in the Swindon, England plant. Expense of $2.8 million was recognized during the nine months ended September 30, 2006 related to asset impairment and future employee termination payments. During 2007, the assets and product lines which were manufactured in Swindon, England were sold, and a loss on the sale of $2.0 million was recognized.

Controls Segment

Net sales in the Controls segment for the nine months ended September 30, 2007, excluding the effects of currency fluctuations, increased 10 percent compared to the nine months ended September 30, 2006. Despite the increase in sales, segment income declined. The decline is mainly due to a loss of $6.7 million on the sale of the DC electric motor business in March 2007 and $3.2 million of costs to reorganize the DC and AC electric motors business prior to the sale. Expediting and overtime costs of $8.7 million were also incurred due to increased demand for certain products in the Controls segment. Research and development costs increased $2.1 million excluding the impacts of currency due primarily to continued investment in new product development.

Global Services and other expenses, net

Segment costs in Global Services and other expenses, net, relate to internal global service departments, along with the operating costs of the Company’s executive office. Global services include such costs as consulting for special projects, tax and accounting fees paid to outside third parties, internal audit, certain insurance premiums, and the amortization of intangible assets from certain business combinations. Global services and other expenses decreased $9.0 million excluding the impacts of currency, or 20 percent. This is primarily due to a $7.0 million reduction in incentive costs during the nine months ended September 30, 2007, as well as a reduction of $1.6 million in costs associated with the implementation of the Company’s common business system.

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Income Taxes

The Company’s effective rate was 35 percent for the nine months ended September 30, 2007 compared to 24 percent for the same period in 2006. The effective tax rate was lower in 2006 because tax expense associated with income in the U.S. was offset by the reversal of valuation allowances on deferred tax assets related to foreign and research credits that are expected to be utilized. The Company’s effective tax rate can also vary significantly from period to period due to the mix of earnings between countries.

Order Backlog

The following table shows the Company’s order backlog at September 30, 2007 and 2006 and orders written in the nine-month periods ended September 30, 2007 and 2006, separately identifying the effect of currency fluctuations. Order backlog represents the amount of customer orders that have been received for future shipment.

(in millions)	2006		Currency Fluctuation		Underlying increase		2007
Backlog at September 30	$	568.4	$	42.5	$	147.2	$	758.1
Orders written	1,450.2		75.4		77.9		1,603.5

Total order backlog at September 30, 2007 was $758.1 million, compared to $568.4 million at September 30, 2006, an increase of 33 percent. Excluding the effect of currency fluctuations, order backlog increased 26 percent during this same period. New sales orders written during the nine months ended September 30, 2007 were $1,603.5 million, an increase of 5 percent over 2006, excluding the impact of currency fluctuations.

In recent years backlog information has become less reliable as an indicator of future sales levels as customers alter their sales order patterns. The 5 percent increase in orders written during the nine months ended September 30, 2007 is reflective of the strong sales levels compared to 2006. Backlog remains strong at September 30, 2007 with over $758 million of customer orders received for future delivery.

Market Risk

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

Foreign currency changes

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 exposure and transaction risk. Translation exposure is when 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 potential expense or income due to 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. Foreign currency transaction related expense of $3.5 million was incurred during the nine months ended September 30, 2007, compared to expense of $3.7 million during the same period in 2006.

Fluctuations of currencies against the U.S. dollar can be substantial and therefore significantly impact comparisons with prior periods. The U.S. dollar weakened compared to other currencies between December 31, 2006 and September 30, 2007.

In 2005, the Company began to enter into forward contracts to minimize the impact of currency fluctuations on cash flows related to forecasted sales denominated in currencies other than the functional currency of the selling location. The forecasted sales represent sales to both external and internal parties. Any effects of the forward contracts related to sales to internal parties are eliminated in the consolidation process until the related inventory has been sold to an external party. The forward contracts qualify for hedge accounting and therefore are subject to effectiveness testing at the inception of the contract and throughout the life of the contract. The fair value of forward contracts outstanding at September 30, 2007 was an asset of $3.2 million.

Interest Rates

The Company uses interest rate swap agreements on a limited basis to manage the interest rate risk on its total debt portfolio. The

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Company has not entered into any new interest rate swap agreements as of September 30, 2007. Additional information regarding interest rate swaps is set forth in the Company’s most recent annual report filed on Form 10-K and is incorporated herein by reference. There has been no material change in this information.

Liquidity and Capital Resources

The Company’s principal sources of liquidity have continued to be from internally generated funds from operations and from borrowings under various credit facilities. The Company has multiple funding sources that have been and continue to be available; therefore, the Company expects to have sufficient sources of liquidity to meet its funding needs for the foreseeable future.

The Company has a multicurrency revolving credit facility (the facility) to permit unsecured borrowings up to $300.0 million through December 2010. The facility includes an additional 40 million euro term loan facility that matures in 2013. At September 30, 2007 there was $167.8 million outstanding under the facility, compared to $158.5 million outstanding at December 31, 2006. The Company is in compliance with the financial covenants related to its debt facilities.

Cash Flow from Operations

Cash flow from operations was $99.0 million during the nine months ended September 30, 2007 compared to $154.0 million for the nine months ended September 30, 2006.

Changes in operating assets and liabilities resulted in $26.7 million cash used during the nine months ended September 30, 2007 compared to $8.8 million of cash provided during the nine months ended September 30, 2006. The increase in cash used in 2007 is the result of increases in accounts receivable balances driven by strong third quarter sales in 2007, as well as a decrease in cash provided by accounts payable and accrued liabilities of $24.3 million.

Cash Used in Investing Activities

Capital expenditures in the first nine months of 2007 were $83.0 million compared to $65.2 million in the first nine months of 2006. In 2007, the Company received proceeds from the sale of businesses, net of cash paid to acquire a business, of $7.0 million.

Cash Used in Financing Activities

The Company continues to pay a dividend to its stockholders on a quarterly basis. Dividend payments in 2007 were $25.0 million compared to $19.1 million in 2006. Net borrowings provided $5.7 million of cash in the first nine months of 2007 compared to net repayment of borrowings which used $56.7 million of cash in 2006. In addition, the Company makes varying distributions to its minority interest partners from its various joint venture activities depending on the amount of undistributed earnings of the businesses and the needs of the partners.

Other Matters

Critical Accounting Estimates

In preparing its most recent annual report on Form 10-K, the Company disclosed information about critical accounting estimates the Company makes in applying its accounting policies. The Company has made no changes to the methods of application or the assumptions used in applying these policies from what was disclosed in its most recent annual report on Form 10-K.

New Accounting Principles

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 in the first quarter of 2007 with no material impact on the consolidated financial statements. As of the adoption date, the tax years subject to review in the U.S., Denmark, and Germany were the years 2001, 2002, and 2003, respectively. The Company recognizes interest related to taxes as interest income or expense. No penalties have been accrued.

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In June 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross versus Net Presentation),” which allows companies to adopt a policy of presenting taxes in the income statement on either a gross or net basis. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer. The Company adopted EITF Issue No. 06-3 in the first quarter of 2007. Taxes collected from customers and remitted to governmental authorities are presented net in the consolidated financial statements.

In September 2006, the FASB issued Statemenf of Financial Accounting Standard (SFAS) No. 157, “Fair Value Measurements” which clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The Company has not yet determined the impact that the implementation of SFAS No. 157 will have on the consolidated financial statements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” which permits many financial instruments and certain other items to be measured at fair value at the option of the Company. SFAS No. 159 is effective for financial statements issued for first fiscal years beginning after November 15, 2007. The Company does not expect SFAS No. 159 to have a significant impact on the consolidated financial statements.

Outlook

Sales levels are expected to remain strong throughout 2007. As noted earlier, operating income has been negatively impacted in the first nine months of 2007 by operational issues involving capacity and increased costs to deliver products to customers. The Company is addressing these issues.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Information disclosing market risk is set forth in the Company’s most recent annual report filed on Form 10-K (Item 7A), and is incorporated herein by reference. There has been no material change in this information.

Item 4. Controls and Procedures

At the end of the period covered by this report, the Registrant carried out an evaluation under the supervision and with the participation of the Registrant’s management, including the Registrant’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Registrant’s disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Registrant’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Registrant files or submits under the Exchange Act is recorded, processed, summarized, and reported as required and within the time periods specified in the Securities and Exchange Commission’s rules and forms and that the Registrant’s disclosure controls and procedures are effective for the purpose of ensuring that material information required to be in the Registrant’s Form 10-Q for the fiscal quarter ended September 30, 2007 was made known to management and others, as appropriate, to allow timely decisions regarding required disclosures.

The Company has established a European Financial Shared Service Center which began to manage the accounts payable, accounts receivable, fixed assets and general ledger processes for four of the Company’s European sales locations during the third quarter of

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2007. There were no material changes to internal controls related to the implementation of the Shared Service Center. Processes for the remaining European locations will be transitioned to the Shared Service Center during the remainder of 2007 and 2008.

In addition, the Company implemented a new business system at two of its European sales locations during the third quarter of 2007. This resulted in a number of controls being enhanced, such as certain manual processes being replaced with automated processing and system integrated account postings. While other controls within the system environment were changed as a result of the conversions, there were no changes to internal controls over financial reporting, other than those mentioned above, that have materially affected, or are reasonably likely to materially impact, the Company’s internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Company has discovered that it may not have provided all components of the prospectus for the Company stock fund to some participants in its 401(k) plans. To the extent the prospectus delivery requirements of the Securities Act of 1933 applied to transactions by these participants in the Company stock fund, the affected participants may be eligible to rescind their stock fund purchases made during the one-year rescission period provided under the Securities Act.

Participants in the plans who may be eligible for rescission purchased plan interests involving approximately 25,000 shares of Company common stock from October 1, 2006 through September 30, 2007. Although the actual rescission period may begin somewhat after October 1, 2006 and end somewhat later than September 30, 2007, the Company believes that its potential liability for the rescission remedy would not be material to its financial condition or results of operations. The Company is in the process of distributing the required prospectus components to all 401(k) plan participants who invest in the Company stock fund and has instituted new procedures to insure future compliance with the prospectus delivery and record keeping requirements.

Item 6. Exhibits.

Exhibit No.	Description of Document
10.1	The Executive Employment Agreement with Wolfgang Schramm dated October 1, 2007, is attached hereto.
10.2	The Sauer-Danfoss Inc. Final Average Pay Supplemental Retirement Benefit Plan is attached as Exhibit 10 to the Company’s Form 8-K filed on September 17, 2007, and is incorporated herein by reference.
10.3	The Employment Separation Agreement and General Release between James R. Wilcox and the Company dated August 14, 2007 is attached as Exhibit 10 to the Company’s Form 8-K filed on August 17, 2007, and is incorporated herein by reference.
31.1	Certification by the Chief Executive Officer Pursuant to Rule 13a-14(a).
31.2	Certification by the Chief Financial Officer Pursuant to Rule 13a-14(a).
32.1	Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.
32.2	Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Sauer-Danfoss Inc.
	By	/s/ Kenneth D. McCuskey
	Kenneth D. McCuskey
	Vice President and Chief Accounting Officer, Secretary
Date: November 2, 2007

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