Sauer-Danfoss ARS 2008
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NOTICE OF 2008 ANNUAL MEETING
PROXY STATEMENT FOR 2008 ANNUAL MEETING
2007 ANNUAL REPORT
April 28, 2008
Dear Fellow Stockholder:
You are cordially invited to attend the Annual Meeting of Stockholders of Sauer-Danfoss Inc. to be held on Thursday, June 12, 2008 at Gateway Hotel and Conference Center, 2100 Green Hills Drive, Ames, Iowa 50014 at 8:30 A.M., local time.
The attached Notice of Annual Meeting and Proxy Statement describe the formal business to be transacted at the Annual Meeting. At the Annual Meeting, stockholders will be asked to elect ten directors, to ratify the appointment of our auditor, and to approve amendments to the Sauer-Danfoss certificate of incorporation (as amended to date) that will eliminate the 80% supermajority voting requirement for stockholder approval of amendments to Articles FIFTH through TENTH of our certificate of incorporation and stockholder-approved amendments to our bylaws.
YOUR VOTE IS IMPORTANT, REGARDLESS OF THE NUMBER OF SHARES YOU OWN. WE URGE YOU TO SIGN, DATE AND MAIL THE ENCLOSED PROXY CARD AS SOON AS POSSIBLE EVEN IF YOU CURRENTLY PLAN TO ATTEND THE ANNUAL MEETING. This will not prevent you from voting in person, but will assure that your vote is counted if you are unable to attend the meeting.
It is always a pleasure for me and the other members of our Board of Directors to meet with our stockholders.
On behalf of our Board of Directors, thank you for your continued interest and support.
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO OUR STOCKHOLDERS:
The annual meeting of stockholders of Sauer-Danfoss Inc., a Delaware corporation, will be held at Gateway Hotel & Conference Center, 2100 Green Hills Drive, Ames, Iowa 50014, on Thursday, June 12, 2008, commencing at 8:30 a.m. local time. At the meeting, stockholders will act on the following matters:
Stockholders of record at the close of business on April 16, 2008 are entitled to notice of and to vote at the annual meeting or any postponement, adjournment, or adjournments.
Whether or not you expect to attend the Annual Meeting, please either complete, date, sign, and return the accompanying proxy card in the provided envelope or vote your shares by telephone or via the Internet using the instructions on the enclosed proxy card as promptly as possible in order to ensure your representation at the meeting. Even if you have given your proxy, whether by mail, by telephone, or via the Internet, you may still vote in person if you attend the meeting. If your shares are held of record by a broker, bank, or other nominee ("Street Name") you will need to obtain from the institution that holds your shares and bring to the meeting a proxy issued in your name, authorizing you to vote the shares.
Solicitation and Revocability of Proxies
The enclosed proxy is being solicited on behalf of the Board of Directors of Sauer-Danfoss Inc. (the "Company") for use at the annual meeting of the stockholders to be held on June 12, 2008 (the "Annual Meeting"), and at any postponement or adjournment. Most stockholders have a choice of voting via the Internet, by using a toll-free telephone number, or by completing a proxy card and mailing it in the envelope provided. Check your proxy card or the information forwarded by your bank, broker, or other holder of record to see which options are available to you. Please be aware that if you vote over the Internet, you may incur costs such as telecommunication and Internet access charges for which you will be responsible. The telephone voting facilities and the Internet voting facilities for stockholders of record will be available until 11:59 pm CDT on June 11, 2008, one day prior to the Annual Meeting.
Any proxy given does not affect your right to vote in person at the meeting and may be revoked at any time before it is exercised by notifying Kenneth D. McCuskey, Corporate Secretary, by mail, telegram, or facsimile, by timely delivery of a properly executed, later-dated proxy (including an Internet or telephone vote) or by appearing at the Annual Meeting in person and voting by ballot. Persons whose shares are held of record by a brokerage house, bank, or other nominee and who wish to vote at the meeting, must obtain from the institution holding their shares a proxy issued in such person's name.
The Company intends to mail this Proxy Statement and the accompanying proxy on or about April 28, 2008.
Expense of Solicitation
The Company will bear the entire cost of solicitation of proxies, including the preparation, assembly, printing, and mailing of this Proxy Statement, the accompanying proxy and any additional information furnished to stockholders. The Company will reimburse banks, brokerage houses, custodians, nominees, and fiduciaries for reasonable expenses incurred in forwarding proxy material to beneficial owners. In addition to solicitations by mail, officers, other regular employees and directors of the Company may, but without compensation other than their regular compensation, solicit proxies in person or by telephone, facsimile or electronic means. The Company has retained Innisfree M&A Incorporated ("Innisfree") to assist in soliciting proxies. The Company will bear the entire cost of Innisfree's solicitation services, which has been set at $15,000 plus certain variable expenses.
Voting of Proxies
All shares entitled to vote and represented by properly completed proxies received prior to the Annual Meeting and not revoked will be voted in accordance with the instructions on the proxy. If no instructions are indicated on a properly completed proxy, the shares represented by that proxy will be voted for the election of the nominees for director designated below, for ratification of the appointment of
KPMG LLP as independent registered public accounting firm of the Company for 2008, and for the amendment and restatement of the Company's Amended and Restated Certificate of Incorporation (the "Certificate of Incorporation").
Persons Entitled to Vote
Only holders of common stock of the Company of record as of the close of business on April 16, 2008 are entitled to notice of and to vote at the Annual Meeting. At the close of business on that date, 48,258,663 shares of common stock were outstanding. Holders of common stock are entitled to one (1) vote for each share held on all matters to be voted upon. Shares cannot be voted at the Annual Meeting unless the owner is present in person or represented by proxy. The directors shall be elected by an affirmative vote of a plurality of the shares that are entitled to vote on the election of directors and that are represented at the meeting by stockholders who are present in person or by proxy, assuming a quorum is present. The ten nominees for director receiving the greatest number of votes at the Annual Meeting will be elected as directors.
The proposal to amend the Company's Certificate of Incorporation in order to eliminate the 80% supermajority voting requirements requires the affirmative "FOR" vote of at least 80% of the holders of the outstanding shares of capital stock entitled to vote generally in the election of directors. Because passage of this proposal requires the vote of at least 80% of the holders of the shares of capital stock outstanding and entitled to vote, an abstention or Broker Nonvote (as described below) as to this matter will have the effect of a vote "AGAINST." The New York Stock Exchange has advised the Company that it considers the proposed amendment to be a sufficiently "routine" matter to permit brokers, banks, and other nominees to use their discretion to vote shares as to which they do not receive instructions from the beneficial owners.
For all other matters to be voted upon at the Annual Meeting, the affirmative vote of a majority of shares present in person or represented by proxy, and entitled to vote on the matter, is necessary for approval.
When a broker or other nominee holding shares for a customer votes on one proposal, but does not vote on another proposal because the broker or nominee does not have discretionary voting power with respect to such proposal and has not received instructions from the beneficial owner, it is referred to as a "Broker Nonvote." Properly executed proxies marked "Abstain" or proxies required to be treated as "Broker Nonvotes" will be treated as present for purposes of determining whether there is a quorum at the meeting. Abstentions will be considered shares entitled to vote in the tabulation of votes cast on proposals presented to the stockholders and will have the same effect as negative votes. Broker Nonvotes are counted towards a quorum, but are not counted for any purpose in determining whether a matter has been approved.
The following table sets forth certain information as of April 16, 2008, with respect to shares of common stock of the Company that were owned beneficially by: (i) each beneficial owner of more than 5% of the outstanding shares of common stock; (ii) each of the directors; (iii) each of the named executive officers of the Company; and (iv) all executive officers and directors of the Company as a group.
the Holding Company. Sauer Holding disclaims beneficial ownership of the 18,541,962 shares directly owned in the aggregate by the Holding Company and the Stiftung. Klaus H. Murmann, Nicola Keim, and Sven Murmann, directors of the Company who are members of Sauer Holding, have neither shared nor sole voting or dispositive power over the 36,329,787 shares directly owned in the aggregate by Sauer Holding, the Holding Company, and the Stiftung for purposes of calculating beneficial ownership under Section 13(d) of the Exchange Act; nevertheless, their membership in Sauer Holding is noted here to avoid misunderstanding.
Prospective Change in Control Transaction
On March 10, 2008, Danfoss A/S ("Danfoss") and Sauer Holding GmbH ("Sauer Holding") entered into a Share Purchase Agreement (the "Purchase Agreement") pursuant to which Danfoss agreed to purchase, and Sauer Holding agreed to sell, a controlling interest in the Company (the "Share Purchase Transaction"). The closing of the Share Purchase Transaction is conditioned, among other things, on the stockholders' approval of the amendment and restatement of the Company's Certificate of Incorporation. The consummation of the Share Purchase Transaction will result in a change in control of the Company, as Sauer Holding will sell to Danfoss (i) 8,358,561 shares of the Company's common stock and (ii) all of the remaining issued and outstanding shares of Danfoss Murmann Holding A/S, a Danish corporation jointly owned by Sauer Holding and Danfoss (the "Holding Company"). By virtue of the Share Purchase Transaction, control of a majority of the issued and outstanding shares of the Company's common stock will shift from Danfoss and Sauer Holding jointly, to Danfoss alone.
At closing of the Share Purchase Transaction, Sauer Holding and Danfoss intend to execute a Stockholders Agreement (the "Stockholders Agreement") that will replace the Joint Venture Agreement, dated January 22, 2000, as amended as of February 22, 2000, by and among Danfoss, Sauer Holding and the Holding Company (the "Joint Venture Agreement"), in governing the rights and obligations of the parties with respect to their ownership and control of the Company and the Company's common stock that they hold (including arrangements with respect to the composition of the Company's Board of Directors and the consequent alteration of the existing rights of Danfoss and Sauer Holding with respect to the nomination of members of the Company's Board of Directors).
The Share Purchase Transaction and the Stockholders Agreement to be executed at closing of the Share Purchase Transaction will alter Sauer Holding's and Danfoss' respective rights to nominate members of the Company's Board of Directors. As is presently the case under the Joint Venture Agreement, the
Stockholders Agreement will provide that the Company's Board of Directors will consist of ten (10) members. However, under the Stockholders Agreement, Sauer Holding will possess nomination rights with respect to two such members (one independent and one non-independent) and Danfoss will possess nomination rights with respect to eight such members (two independent and six non-independent members) (each determination of independence to be made in accordance with the rules of the New York Stock Exchange). The contractual rights of Sauer Holding and Danfoss under the Joint Venture Agreement with respect to the Nominating Committee of the Company's Board of Directors will be effectively terminated under the prospective Stockholders Agreement.
The Share Purchase Transaction and the Stockholders Agreement to be executed at closing of the Share Purchase Transaction will furthermore result in the creation of various new contractual rights and obligations of Sauer Holding and Danfoss vis-à-vis one another related to transfers of Company common stock by them. Under the Stockholders Agreement, Sauer Holding will grant to Danfoss the right to purchase from Sauer Holding (via exercise of a call option), and Danfoss will grant to Sauer Holding the right to sell to Danfoss (via exercise of a put option), the remaining 10,029,264 shares of Company common stock held by Sauer Holding, in two equal stages of 5,014,632 shares each, during the 21-day windows of time (starting on August 1, 2010 and August 1, 2012, respectively) following the delivery of the Company's audited financial statements to Sauer Holding for the Company's 2009 and 2011 fiscal years, respectively. The exact purchase price for the shares subject to the call option and put option will be calculated based on the Company's operating income and adjusted with respect to the net debt level in the 2009 and 2011 fiscal years, respectively, but will fall within the range of $29.67 and $49.45 per share, subject to adjustment as a result of stock splits, reclassifications of stock, combinations of stock, or similar transactions. Under the prospective Stockholders Agreement, Danfoss will have the right, at any time, to accelerate its exercise of either or both stages of the call option by electing to purchase Sauer Holding's shares of Company common stock subject to such option at a price equal to $49.45 per share, subject to adjustment as a result of stock splits, reclassifications of stock, combinations of stock, or similar transactions. Sauer Holding, on the other hand, will be entitled to accelerate its exercise of either or both stages of its put option and to sell its shares of Company common stock subject to such option to Danfoss at a price equal to $29.67 or $39.56 per share (depending on the identity of the third party involved in the transaction giving rise to the acceleration right), subject to adjustment as a result of stock splits, reclassifications of stock, combinations of stock, or similar transactions, only under certain limited circumstances. The number of shares subject to the put and call options will be subject to reduction based on shares of Company common stock sold by Sauer Holding as a result of Danfoss' exercise of drag-along rights or Sauer Holding's exercise of tag-along rights under the Stockholders Agreement.
In addition to the put and call options, the Stockholders Agreement provides for drag-along rights and a right of first refusal for Danfoss, and tag-along rights for Sauer Holding. These rights would apply in the case of a proposal by either Danfoss or Sauer Holding to sell shares of Company common stock to a third party.
The Purchase Agreement provides that the obligation of Danfoss and Sauer Holding to close the Share Purchase Transaction is subject to several conditions precedent. One condition, mentioned above, is that the stockholders approve the proposed amendment and restatement of the Certificate of Incorporation. Another condition is that the Board of Directors abolish the Company's Executive Committee and the Company's Nominating Committee. The closing is further conditioned on the Company's adoption of a set of Amended and Restated Bylaws (the "Amended and Restated Bylaws"). The Amended and Restated Bylaws, if adopted, will be changed by, among other things, removing the current 80% supermajority voting requirement that would apply under the current Bylaws if the Board of Directors were to vote on certain major transactions, including but not limited to, a sale of substantially all of the Company's assets, a merger, or an amendment to the Certificate of Incorporation or Bylaws. Each of these conditions to the closing of the Share Purchase Transaction will make it easier for Danfoss and directors nominated by Danfoss to direct the policies, business, and affairs of the Company, subject to the requirements of the Stockholders Agreement.
The Company's Board of Directors (the "Board") currently has ten members, three of whom meet the New York Stock Exchange standard for independence. The Board has an Executive Committee, an Audit Committee, a Compensation Committee, and a Nominating Committee. All members of the Audit Committee and Compensation Committee are independent directors, but the two members of the Nominating Committee are not independent. The corporate governance listing standards of the New York Stock Exchange provide that a company of which more than 50% of the voting power is held by an individual, a group or another company (a "controlled company") need not comply with the Exchange's listing standards requiring that a majority of the Board be independent and that listed companies have a nominating/corporate governance committee and a compensation committee each composed entirely of independent directors with a written charter that addresses specific items. The Company considers itself to be a controlled company because approximately 73.4% of the voting power of the Company's common stock is owned or controlled by Danfoss Murmann Holding A/S. Accordingly, the Company has elected to utilize the exemption from the requirement that a majority of the Board be independent and from the provisions relating to a nominating/corporate governance committee.
The Board held four meetings during 2007. Each director attended at least 75% of the aggregate of the total number of meetings of the Board and the total number of meetings held by all committees of the Board on which the directors served during 2007. It is the policy of the Board that each director of the Company is expected to attend annual meetings of the stockholders of the Corporation, it being understood, however, that a director infrequently may be unable to attend annual meetings of the stockholders of the Company due to illness, a previously scheduled meeting of importance or other irreconcilable conflict. All of the directors attended the Company's annual stockholders meeting in June of 2007.
The non-management directors of the Company have adopted a schedule to meet in private session at the end of or prior to each regular meeting of the Board without any management director or executive officer being present. The non-management directors have also adopted the policy that the Chairman of the Board, or in his absence, the Vice Chairman, shall preside at all such meetings. In addition, at least once a year, only independent, non-employee directors shall meet in private session.
Basis for Board Determination of Independence of Directors
The Board has adopted Corporate Governance Guidelines (the "Guidelines"), that provide, among other things, that at least three directors must be independent. The Guidelines can be viewed on the Company's investor relations website at http://ir.sauer-danfoss.com, and the Company will mail, without charge, a copy of the Guidelines upon written request to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010. To be considered "independent" under the Guidelines, a person must be determined by the Board to have no material relations, directly or indirectly, with the Company or its affiliates or any other director or elected officer of the Company, and must otherwise be independent as that term is defined under the listing standards of the New York Stock Exchange, but also without the appearance of any conflict in serving as a director. In addition to applying these guidelines, the Board shall consider all relevant facts and circumstances in making an independence determination.
The Board undertook its annual review of director independence with respect to the three persons considered independent at its meeting on March 12, 2008. The Board determined whether the three persons under consideration met the objective listing standards of the New York Stock Exchange regarding the definition of "independent director," which standards provide that a director is not independent if:
The Board also considered whether there were any other transactions or relations between each of said three persons or any member of his immediate family and the Company and its subsidiaries and affiliates that would affect the independence of such persons and concluded that there were none.
As a result of its review, the Board affirmatively determined that Johannes F. Kirchhoff, F. Joseph Loughrey and Steven H. Wood are independent of the Company and its management under the standards set forth in the Guidelines.
The Executive Committee possesses all of the powers of the Board, except for certain powers specifically reserved by Delaware law to the Board. The Executive Committee held two meetings and several telephone conferences during 2007. Jørgen M. Clausen, Sven Murmann, and David J. Anderson are the current members of the Executive Committee.
The Audit Committee is currently composed of three directors, none of whom is an employee of the Company. The Audit Committee currently consists of Messrs. Wood (Chairman), Kirchhoff and Loughrey. All of the members of the Audit Committee are independent within the meaning of the Securities and Exchange Commission's ("SEC") regulations, the current listing standards of the New York Stock Exchange and the Company's Corporate Governance Guidelines. In addition, the Board has determined that at least one member of the Audit Committee meets the New York Stock Exchange listing standard of having accounting or related financial management expertise.
The Board has also determined that Steven H. Wood meets the SEC's criteria of an "audit committee financial expert." Mr. Wood's extensive background and experience includes presently serving as Chief Financial Officer of Becker-Underwood, Inc., a supplier of non-pesticide specialty chemical and biological products within the agricultural, landscape, turf, and horticulture industries, and formerly serving as Vice President and Corporate Controller of Metaldyne Corporation, a global designer and supplier of metal-based components, assemblies and modules for the automotive industry, and before that as Executive Vice President and Chief Financial Officer of Maytag Corporation. Prior to joining Maytag, he was an auditor with Ernst & Young, a public accounting firm, and successfully completed the examination for Certified
Public Accountants. Mr. Wood is independent as that term is used in the New York Stock Exchange's listing standards relating to director independence.
The Audit Committee is directly responsible for the appointment, compensation, retention and oversight of the independent registered public accounting firm. The Committee also reviews the scope of the annual audit activities of the independent registered public accounting firm and the Company's internal auditors, reviews audit and quarterly results and administers the Worldwide Code of Legal and Ethical Business Conduct and the Code of Ethics for Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer or Controller and Other Senior Finance Staff. All of the Committee's duties and responsibilities are set forth in a written Audit Committee Charter. The Charter can be viewed on the Company's investor relations website at http://ir.sauer-danfoss.com and the Company will mail, without charge, a copy of the Audit Committee Charter upon written request to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010. The Audit Committee held four meetings and four telephonic meetings during 2007.
The Compensation Committee is currently composed of three directors, none of whom is an employee of the Company. The current members of the Compensation Committee are Messrs. Kirchhoff (Chairman), Loughrey and Wood, all of whom are independent as defined under the current listing standards of the New York Stock Exchange. The Compensation Committee reviews and determines the salaries of the executive officers of the Company and administers the Company's Annual Officer Performance Incentive Plan, the 1998 Long-Term Incentive Plan, the 2006 Omnibus Incentive Plan, the Deferred Compensation Plan for Selected Employees, the 409A Deferred Compensation Plan for Selected Employees, and the Supplemental Executive Savings & Retirement Plan. All of the duties of the Compensation Committee are set forth in a written Charter last amended and restated as of April 27, 2005, which can be viewed on the Company's investor relations website at http://ir.sauer-danfoss.com and the Company will mail, without charge, a copy of the Compensation Committee Charter upon written request to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010. The Compensation Committee held four meetings and one telephonic meeting in 2007.
The current members of the Nominating Committee are Messrs. Jørgen M. Clausen and Klaus H. Murmann, neither of whom is independent under the New York Stock Exchange's current listing standards. The Nominating Committee recommends to the Board proposed nominees whose election at the next annual meeting of stockholders will be recommended by the Board. The Nominating Committee acted once by unanimous written consent in 2007. The Nominating Committee does not currently have a written charter, but does follow the guidelines described in the following section.
Consideration of Nominees, Qualifications and Procedures
The Nominating Committee adopted the policy in March 2004 that it will consider qualified candidates for director that are suggested by stockholders. Stockholders can recommend qualified candidates for director by writing to: Chairman of the Board of Directors, Attention: Kenneth D. McCuskey, Corporate Secretary, Sauer-Danfoss Inc., 2800 East 13th Street, Ames, Iowa 50010. Recommendations should set forth detailed information regarding the candidate, including the person's background, education, business, community and educational experience, other Boards of Directors of publicly held corporations on which the candidate currently serves or has served in the past and other qualifications of the candidate to serve as a director of the Company. All recommendations must be received by January 1 in order to be considered as a nominee for director at the annual meeting of stockholders to be held in such year. Recommendations that are received that meet the conditions set forth above shall be forwarded to the Board for further review and consideration.
The Nominating Committee is responsible for recommending to the full Board nominees for election as directors. In evaluating director nominees, the Nominating Committee considers, among other things, the following factors:
The Nominating Committee also considers such other relevant factors as it deems appropriate, including the current composition of the Board, the need for independent directors, the need for Audit Committee expertise and the evaluations of other candidates. Other than considering the factors set forth above, there are no stated minimum criteria for director nominees.
The Nominating Committee identifies candidates by first evaluating the current members of the Board willing to continue in service. If any member of the Board does not wish to continue in service or if the Nominating Committee or the Board decides not to re-nominate a member for election to the Board, the Nominating Committee shall identify the desired skills and experience of a new candidate in light of the factors set forth above. Current members of the Board may be polled for suggestions as to individuals meeting the criteria of the Nominating Committee, and qualified candidates recommended by stockholders shall be considered. Research may be performed to identify qualified individuals. The Nominating Committee may, but shall not be required to, engage third parties to identify or evaluate or assist in identifying potential candidates. The Nominating Committee has from time to time utilized an executive search firm to assist in identifying potential candidates.
In connection with its evaluation of candidates, the Nominating Committee shall determine which, if any, candidates shall be interviewed, and if warranted, one or more members of the Nominating Committee, and others as appropriate, shall interview prospective candidates in person or by telephone. After completing this evaluation and interview process, the Nominating Committee shall make a recommendation to the full Board as to the persons who should be nominated by the Board.
Agreement Regarding Nominees for Director
Entities and persons under the control of Klaus H. Murmann, Chairman Emeritus and a director of the Company, and Sven Murmann, Vice Chairman and a director of the Company (the "Murmann Family"), and Danfoss are parties to the Joint Venture Agreement, which contains certain agreements regarding their ownership and voting of the Company common stock owned by the Holding Company. In
anticipation of closing of the Share Purchase Transaction and execution of the Stockholders Agreement, the Murmann Family and Danfoss have agreed to proceed under the terms of the prospective Stockholders Agreement rather than the terms of the Joint Venture Agreement for purposes of making nominations for the election of the Board at the Annual Meeting. Pursuant to the prospective Stockholders Agreement, the Murmann Family will identify one non-independent and one independent candidate for director and Danfoss will identify six non-independent and two independent candidates for director for recommendation to the Board. With respect to the current nominees for election as directors, Sven Murmann was the non-independent nominee recommended by the Murmann Family and Niels B. Christiansen, Jørgen M. Clausen, Kim Fausing, William E. Hoover, Jr., Frederik Lotz, and Sven Ruder were the non-independent nominees recommended by Danfoss. Johannes F. Kirchhoff was the independent nominee recommended by the Murmann Family, and F. Joseph Loughrey and Steven H. Wood were the independent nominees recommended by Danfoss.
Stockholder Communications with the Board
The Corporate Governance Guidelines of the Company set forth the method by which stockholders may communicate with the Board. Stockholders and other parties interested in communicating directly with the Chairman of the Board or with the non-management directors as a group or with the entire Board of Directors as a group or with an individual director may do so in writing addressed to such person or group at: Sauer-Danfoss Inc., 2800 East 13th Street, Ames, Iowa 50010, Attn: Corporate Secretary. The Corporate Secretary shall review all such correspondence and shall forward all those not deemed frivolous, threatening or otherwise inappropriate to each member of the group or to the individual director to whom the correspondence is directed. The Corporate Secretary shall maintain a log of all correspondence received by the Company that is addressed to members of the Board and directors may at any time review such log and request copies of any such correspondence. Letters containing concerns relating to accounting, internal controls or auditing matters will immediately be brought to the attention of the Company's Internal Corporate Counsel and handled in accordance with procedures established by the Audit Committee with respect to such matters.
Code of Conduct and Code of Ethics
The Company's Worldwide Code of Legal and Ethical Business Conduct (the "Code of Conduct") has been in effect for a number of years and was last updated in January 2007. The Code of Conduct applies to every employee, agent, representative, consultant and director of the Company. The Code of Conduct requires that the Company's employees, agents, representatives, consultants and directors avoid conflicts of interest, comply with all laws and other legal requirements, conduct business in an honest and ethical manner and otherwise act with integrity and in the Company's best interests.
Overall administration of the Code of Conduct is the responsibility of the Audit Committee. Day-to-day administration of the Code of Conduct is the responsibility of the Corporate Business Conduct Committee that assists the Company's employees in complying with the requirements of the Code of Conduct. Employees are encouraged to report any conduct that they believe in good faith to be an actual or apparent violation of the Code of Conduct.
The Company has also adopted the Sauer-Danfoss Inc. Code of Ethics for Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer or Controller and Other Senior Finance Staff (the "Code of Ethics"). The Code of Ethics is intended to comply with the provisions of Section 406 of the Sarbanes-Oxley Act of 2002 and regulations of the SEC. The Code of Ethics is intended to promote honesty and integrity, the avoidance of conflicts of interests, full, accurate, and timely disclosure of financial reports, and compliance with laws and regulations and other matters.
The Code of Conduct and the Code of Ethics are posted on the Company's investor relations website at http://ir.sauer-danfoss.com. The Company will mail without charge, upon written request, a copy of the
Code of Conduct and/or Code of Ethics. Requests should be sent to Kenneth D. McCuskey, Corporate Secretary at 2800 East 13th Street, Ames, Iowa 50010.
Transactions with Related Persons
In connection with the acquisition of Danfoss Fluid Power on May 3, 2000, the Company entered into several agreements with Danfoss to purchase ongoing operational services from Danfoss. These services include rental of shared facilities, administrative support and information technology support. Fees are paid on a monthly basis. Total expense recognized for goods and services purchased from Danfoss for 2007 was approximately $72.4 million. Danfoss is an indirect beneficial owner of more than 5% of the outstanding common stock of the Company.
For a number of years, the Company has sold products to FAUN Umwelttechnik GmbH & Co. KG, which is owned by Johannes F. Kirchhoff, a director of the Company, and members of his family. These sales are made pursuant to purchase orders entered into in the ordinary course of business. Sales in 2007 totaled approximately $1.7 million.
Review, Approval or Ratification of Transactions with Related Persons
The Company has a written policy pursuant to which the Company informs all of its directors and executive officers, as well as other personnel who serve in positions that give them routine knowledge of potential transactions with related persons, that they must inform specified individuals in management of transactions that meet the definitions provided in Item 404(a) of Regulation S-K ("related-person transactions"). Potential related-person transactions are reviewed by the Company's Audit Committee, which has the authority to approve or deny any such transaction. At least once per quarter, the Company's Secretary inquires of the individuals designated to receive reports of potential related-person transactions and relays any previously unreported transactions to the Audit Committee.
The Audit Committee of the Board of Directors (the "Board") of Sauer-Danfoss Inc. (the "Corporation") acts under the Sauer-Danfoss Inc. Audit Committee Charter, as amended and restated by the Board on February 22, 2006, which Charter provides that the purpose of the Audit Committee is to represent and assist the Board with the oversight of:
Management has the primary responsibility for the Corporation's financial statements and the financial reporting process, including the system of internal controls. The full text of the Audit Committee Charter is available under the Corporate Governance section of the Corporation's investor relations website at http://ir.sauer-danfoss.com.
In fulfilling its oversight responsibilities, the Audit Committee has discussed with KPMG LLP ("KPMG"), the Corporation's independent registered public accounting firm, the overall scope and plans for their audit. The Audit Committee met with both management and KPMG to review and discuss the audited financial statements.
The Audit Committee reviewed with KPMG their judgments as to the quality and acceptability of the Corporation's accounting principles. The Audit Committee's review included discussion with KPMG of the matters required to be discussed pursuant to Statement on Auditing Standards No. 61, as adopted by the Public Company Accounting Oversight Board in Rule 3200T.
The Audit Committee has received and reviewed the written disclosures and the letter from KPMG required by the Independence Standards Board, Standard No. 1, "Independence Discussions With Audit Committees," as adopted by the Public Company Accounting Oversight Board in Rule 3600T, and has discussed with KPMG, among other things, matters relating to its independence. The Audit Committee has also considered the compatibility of the non-audit services provided by KPMG with its independence.
Based on the reviews and discussions referred to above, the Audit Committee recommends to the Board of Directors that the audited financial statements for the year ended December 31, 2007 be included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2007, for filing with the Securities and Exchange Commission.
Sauer-Danfoss Inc. (the "Company" or "we") presents this Compensation Discussion and Analysis ("CD&A") to discuss its executive compensation program. Our Chief Executive Officer (the "CEO"), Chief Financial Officer (the "CFO") and other executive officers participate in the executive compensation program.
The Summary Compensation Table on page II-26 and the subsequent disclosure tables reflect compensation paid to our CEO, CFO and to certain other executive officers (collectively, the "Named Executive Officers" or "NEOs"). In general, this CD&A discussion applies equally to each of the NEOs. Where needed for clarification, we have provided information on the treatment of individual NEOs.
Under SEC rules, we are reporting information in the Summary Compensation Table for Mr. Anderson as CEO, for Mr. Schmidt as CFO and for Messrs. Cornett, Kittel and Schramm as the three most highly compensated executive officers of the Company, other than the CEO and CFO. We are also reporting information in the Summary Compensation Table for Messrs. Wilcox and Lyhne, who were considered executive officers at some time during 2007 and who would have been among the top three most highly compensated executive officers, had they still been executive officers at year end.
Role of Compensation Committee and Management in Executive Compensation Matters
The Compensation Committee of our Board of Directors (the "Committee") consists of three independent directors as defined by current New York Stock Exchange listing standards. The Committee has the final say and ultimate authority in all matters relating to our executive compensation program. The Committee's authority encompasses areas such as:
From time to time, the Committee uses Hewitt Associates, LLP ("Hewitt") as its consultant with respect to executive compensation matters. At the request of the Committee in 2007, Hewitt performed a market-based review of certain executive compensation elements, as detailed later in the CD&A section entitled "Hewitt Market Review2007." Hewitt also provided historical return on net assets results for a broad range of industrial companies to assist the Committee in developing performance targets under the Company's long-term incentive plan. Hewitt's sole consulting relationship with the Company is related to the work done directly for the Committee.
Management's role with respect to executive compensation matters is limited to making recommendations to the Committee, based on Management's understanding of the Company's compensation and performance objectives. Management's recommendations to the Committee include the CEO's annual performance evaluations of the other executive officers along with the CEO's recommendation for annual base salary changes for each such officer based on individual performance and market comparisons. The Committee considers Management's input and recommendations, but exercises independent judgment in making final decisions with respect to all matters affecting our executive compensation program.
Executive Compensation Goals and Objectives
The Sauer-Danfoss Total Rewards Strategy, newly adopted and approved by the Committee in 2007, provides a general framework for Total Rewards offerings to all employees on a global basis.
Our executive compensation program fits within our Total Rewards Strategy and is designed to meet certain goals and objectives. Specifically, we designed our executive compensation program to enable us to:
We design our executive compensation program to reward performance. Within the program, we combine individual, business unit, division and company-wide performance elements. For our senior executives and Named Executive Officers, company-wide performance elements generally have the greatest impact on total compensation. We stress company-wide performance elements for the Named Executive Officers because they have the greatest impact on shareholder value creation. Company-wide performance elements also help us to promote global teamwork and cooperation among business units and divisions.
The following analysis shows how the Company's performance against preestablished performance targets can impact our executive officers' compensation levels. Performance Based Compensation Earned, as presented below, equals the sum of the Stock Awards column and the Non-Equity Incentive Plan Compensation column in our Summary Compensation Table. The Total Compensation amount comes directly from the Summary Compensation Table. 2006 data is not presented for Messrs. Schramm and Lyhne because they were not Named Executive Officers in 2006.
The reduction in Performance Based Compensation Earned from 2006 to 2007 for the Named Executive Officers resulted from the Company's failure to meet its minimum profitability threshold under the Annual Incentive Plan. This reduction in Performance Based Compensation Earned was the primary reason for the decline in Total Compensation for the Named Executive Officers from 2006 to 2007.
Mr. Wilcox's Performance Based Compensation Earned shows as a negative amount in 2007, due to the forfeiture of certain Stock Awards upon his termination of employment in 2007. The negative amount represents a reversal of financial statement expense that had been recognized in prior years on these forfeited Stock Awards. Mr. Wilcox's Total Compensation for 2007 includes the value of certain post-termination compensation paid to him, as discussed elsewhere in this CD&A.
We design our executive compensation program to be market-based. Based on a review of survey data from a variety of external sources, we believe our executive compensation program is comparable to, and
competitive with, the market median of compensation programs for similarly sized companies in similar industries. In comparing our executive compensation program to market, we consider such items as the proper balance between fixed and variable compensation and the proper annual and long-term incentive target opportunities. In our market comparisons, we generally look to survey data related to durable goods manufacturing companies with comparable revenue size.
We also consider internal equity in the administration of our executive compensation program. We perform a formal job evaluation process for all executive positions, rating them on a point-factor basis. We then use the position ratings to help ensure that our executive compensation program is aligned for comparable positions on a global basis.
The Committee routinely reviews our executive compensation program and its individual elements in light of the goals and objectives outlined above.
Hewitt Market Review2007
In 2007, the Committee engaged Hewitt to perform a market-based review of executive officer base salaries and incentive compensation awards. As part of its review, Hewitt provided market data on base salaries and target levels, expressed as a percentage of base salary, for annual and long-term incentive awards. Hewitt's market data was based on its review of data for a comparator group of companies based on similar revenue size and industry (industrial manufacturing). Hewitt recommended and the Committee approved the comparator group which consisted of the following companies:
The Committee considered the Hewitt market data, along with other Company provided data, in determining 2007 base salary and incentive plan target percentage levels. One change made in 2007 involved a lowering of the maximum possible payout under the Long-Term Incentive Plan Awards from 200% to 156%. This reduction was proposed by the Company and approved by the Committee so that the economic value of long-term incentive award grants would be more consistent with median market practice.
Elements Of Executive Compensation Program
Our executive compensation program is comprised of the following elements which are described in further detail below:
We provide a base salary to our CEO and executive officers. The Committee determines the base salary for the CEO and our executive officers each year based upon a variety of factors.
A key factor in the Committee's determination of base salaries is a comparison to benchmark market data. In 2007, the Committee reviewed the following data for benchmark purposes:
We target our base salaries at the 50th percentile for similar positions within the benchmark group. The following factors also impact base salary determinations and will cause the base salaries to differ from the 50th percentile target:
With one exception, the base salary of each of our Named Executive Officers for 2007 was within an acceptable range (+/- 15%) of the benchmark market median. The sole exception is the CEO's base salary, which was below the benchmark market median by slightly over 20% in 2007. This situation has arisen over time and is caused, in part, by the Company's sizeable growth in recent years. The Committee recognizes this shortfall and has been working to correct the situation.
Base salaries are one of the most readily comparable elements of compensation between different companies. We consider maintaining adequate annual base salary levels to be critical towards the stated goal of attracting, motivating and retaining quality leaders. By considering individual performance ratings in the annual base salary review process, our strongest performing executive officers will generally receive the largest percentage increases in annual base salary each year. This helps us meet our goal of motivating quality leaders and strengthens the tie between executive compensation and business results.
Annual Incentive Awards
We provide Annual Incentive Award opportunities to our CEO and executive officers under the Company's Omnibus Incentive Plan. For 2007, the Annual Incentive Awards were designed to pay out a target percentage of a participant's base salary based upon achievement of certain earnings before interest and taxes ("EBIT") margins on a Divisional, Business Unit, and/or Total Company basis. To promote teamwork and cooperation across Divisions and business units, the Named Executive Officers generally participate in the Annual Incentive Plan on a Total Company basis. In 2006, Thomas Kittel participated in the Annual Incentive Plan based, in part, on the results of our Propel Division. In 2007, Finn Lyhne participated in the Annual Incentive Plan based, in part, on the results of our Mobile Electronics business unit.
Actual payouts under the Annual Incentive Awards can range from 25% to 200% of target, depending upon achieved EBIT margins. Below certain minimum EBIT margin thresholds, no payout will be made under the Annual Incentive Awards. The Committee determines the target percentage of each executive
officer's base salary for Annual Incentive Award purposes based on a review of market survey information for similar positions in comparable companies and also based on internal equity.
For 2007 the Annual Incentive Plan's target, threshold and maximum payouts, expressed as a percentage of base salary, for each of our Named Executive Officers was as follows:
In 2007, the Committee authorized an increase in Mr. Anderson's target payout percentage from 60% to 90%. This increase stemmed from a review of market data for CEO positions within the benchmark group.
Mr. Wilcox's right to an Annual Incentive Award payout based on Company performance for 2007 was forfeited upon his termination of employment in 2007. Under the terms of Mr. Wilcox's separation, he was provided a pro-rata Annual Incentive payout for 2007 based on his original target percentage of 60%. The value of this pro-rata Annual Incentive payment is shown later in this CD&A.
Prior to 2007, our Annual Incentive Awards included both a sales growth target and an EBIT margin target. Beginning in 2007, the sales growth target has been eliminated from our Annual Incentive Awards. At the same time, a sales growth element was added to our Long-Term Incentive Award targets. We made this change to reflect the fact that our sales efforts are generally longer-term in nature and to recognize that the combination of growth and profitability are keys to longer-term shareholder value creation.
The Committee reviews and approves the EBIT margin levels that are required to earn the target payout at the beginning of each year. These levels are generally tied to our annual operating budgets. Our annual budgeting process produces aggressive goals which are considered to have a reasonable chance of being met through strong operating performance. We use EBIT margin performance factors to encourage and reward profitability on a Total Company and/or Divisional or Business Unit basis.
We have determined that the Annual Incentive Award EBIT margin targets and their basis for computation involve confidential financial information and that disclosure could result in competitive harm to the Company. Therefore, we have not disclosed these targets within this CD&A and proxy statement.
The following table, which shows the five-year payout history under the Annual Incentive awards for our Total Company measure, provides an indication of the difficulty in meeting the performance goals. The
2003 payout percentage of 70% includes a discretionary 20% reduction in payout percentage as allowed by the Plan.
Under the Omnibus Incentive Plan, the Committee reserves the discretion to reduce, but not increase, the final payouts to executive officers. During 2006, the Committee authorized final payouts based on the achieved sales growth and EBIT margin performance, without reduction. In 2007, no annual incentive awards were earned by the Named Executive Officers because threshold EBIT margins were not attained.
With a clear relationship between financial results and payouts, our Annual Incentive Awards program helps us link our executive officer compensation levels to achieved business results. As a market-based program, it also helps us attract, motivate and retain quality leaders. Finally, the design of the shareholder-approved Omnibus Incentive Plan and the Annual Incentive Awards made thereunder helps ensure the tax deductibility of the Annual Incentive Awards earned in 2006.
Long-Term Incentive Awards
We provide Long-Term Incentive Awards to our CEO and executive officers. The Omnibus Incentive Plan sets forth the terms and conditions under which our Long-Term Incentive Awards are made. The Company's established practice is to make Long-Term Incentive Award grants once each year, at the time of its regularly scheduled first quarter Compensation Committee meeting. The Omnibus Incentive Plan allows for a variety of forms of Long-Term Incentive Awards (e.g., Stock Options, Performance Units, Restricted Stock). The Omnibus Incentive Plan also provides for a variety of performance measures for performance-based Long-Term Incentive Awards (e.g., Return on Sales, Return on Net Assets, Total Shareholder Return).
In 2007, consistent with past practice, the Committee determined that the Long-Term Incentive Awards would be made 100% in the form of Performance Units. In addition, the Committee determined that average Return on Net Assets (RONA) over a three-year performance period would be the performance measure used for the Long-Term Incentive Awards. The three-year performance period promotes performance over a reasonable timeframe and builds an employee retention component into the Long-Term Incentive Awards.
We use RONA as the performance measure because we view this metric over an extended period of time to be an important driver in shareholder value creation. The Committee set a three-year target for average RONA considering the Company's expected performance throughout the economic cycle and considering median RONA performance compiled by Hewitt for similarly sized companies in the Industrial Machinery sector.
Beginning in 2007, a sales growth modifier was added to the Long-Term Incentive Plan's performance targets to encourage long-term growth in addition to profitability. Depending upon the average sales growth over the three-year performance period, the earned payout under the 2007 performance unit grant can be increased by up to 20%.
Actual payouts under the 2007 Long-Term Incentive Award grants can range from 46% to 156% of target, depending upon achieved average RONA and sales growth over the three-year performance period.
Below certain minimum average RONA thresholds, no payout will be made under the Long-Term Incentive Awards.
The RONA thresholds, targets and maximums, along with the corresponding payout levels, are as follows:
The Committee determines the target percentage of a participant's base salary for Long-Term Incentive Award purposes each year, without consideration of prior awards, based on a review of market survey information for similar positions in comparable companies and based on internal equity.
For 2007 the Long Term Incentive Plan target award level, expressed as a percentage of adjusted base salary, for each of our Named Executive Officers was 125%. The only exception is Mr. Lyhne, whose target award level as a percentage of adjusted base salary was 80%. Adjusted base salary for this purpose equals the beginning of the year base salary plus 3%, as an approximation for the full-year base salary after merit pay increases which occur in April.
The target number of performance units granted to each participant is determined by dividing the dollar value of the participant's Long-Term Incentive target by the average closing price of the Company's shares during the fourth quarter of the preceding year.
For example, Mr. Anderson was granted 26,025 performance units in 2007, determined as follows:
performance units = Base Salary × 103% × Target % / 4th Quarter Avg Share Price
Dividend equivalents on outstanding Performance Units are paid at the same time and at the same rate as dividends declared by the Company's Board of Directors on its common stock. During the performance period, the dividend equivalents are paid based on the target number of Performance Units held by each participant. By tying the payment of dividend equivalents into the Company's common stock dividends, the participants have incentive to focus on cash flow measures that drive shareholder value and returns.
To promote share ownership, the Committee generally requires that earned Performance Units under the Long-Term Incentive Awards program be paid to participants 100% in shares of Company stock, with a number of shares withheld from the payout equal to the value needed to cover the Company's minimum statutory tax withholding requirements. By direction of the Committee, earned Performance Units from the 2007 Performance Unit grant for three of our Named Executive Officers, Messrs. Anderson, Wilcox and Kittel, are to be paid out 100% in cash. The Committee determined that Messrs. Anderson, Wilcox
and Kittel had significant levels of Company stock ownership, ranging from approximately 5 times to 15 times their annual base salaries.
The Performance Unit Award Agreements generally provide for automatic forfeiture upon a termination from service prior to the end of the performance period and/or the payout date. Mr. Wilcox's outstanding Performance Unit Awards granted in 2005, 2006 and 2007 were forfeited upon his termination from service in August of 2007.
The Performance Unit Award Agreements provided under our Long-Term Incentive Awards program discussed above provide for pro-rata, post-employment payouts of earned Performance Units under the following situations:
Mr. Anderson's Performance Unit Award Agreements were modified in 2007 to allow for a full payout at target levels in the event that his employment is terminated, other than by the Company for Cause or by Mr. Anderson without Good Reason (with the terms "Cause" and "Good Reason" as defined in Mr. Anderson's employment agreement). These amendments were made in order to provide an extra retention incentive for Mr. Anderson in his role as CEO.
The Long-Term Incentive Awards are subject to immediate vesting and payout, at the target level, upon a Change In Control of the Company, as defined in the Omnibus Incentive Plan.
Under the Omnibus Incentive Plan, the Company has the right to seek a reimbursement of amounts previously paid to any Participant who engaged in misconduct or was aware of and failed to report misconduct when such misconduct leads to a restatement of financial earnings. The Company also has certain automatic forfeiture rights under Section 304 of the Sarbanes-Oxley Act of 2002. In 2005, Performance Units were granted to participants, including the Named Executive Officers, under the Sauer-Danfoss Inc. 1998 Long-Term Incentive Plan. The 1998 Long-Term Incentive Plan was a predecessor to the Omnibus Incentive Plan and contains features similar to those described above.
The 2005 Performance Unit grants were subject to a three-year performance period and provided for a payout from 50% to 200% of the target number of Performance Units granted. Based on achieved average RONA performance of 11.6% for the three-year period ended December 31, 2007, the 2005 Performance Units were paid out at 57.5% upon completion of the Company's financial audit in February of 2008. Generally, each earned Performance Unit equates to one share of Sauer-Danfoss Inc. stock. An analysis of the target number of Performance Units granted, along with actual earned Performance Units for each of the Named Executive Officers, is as follows:
Details concerning the value of the earned payouts under the 2005 Performance Unit Award Agreements for each of the Named Executive Officers can be found in the Outstanding Equity Awards At Fiscal Year-End Table appearing later in this proxy statement.
At the time of his hiring in April 2007, Wolfgang Schramm was granted 10,000 shares of restricted stock under the Company's Omnibus Incentive Plan. The restricted shares vest 50% on his one-year service anniversary (April 2008) and 50% on his two-year service anniversary (April 2009). The restricted share issuance to Mr. Schramm served as a recruiting measure and as a short-term retention measure. The restricted share issuance bridges the period from Mr. Schramm's hire date until he is eligible to receive any earned payouts under the Company's 2007 Performance Unit Award Agreement at the end of calendar year 2009.
With a clear relationship between financial results and payouts, our Long-Term Incentive Awards program helps us tie our executive compensation levels to achieved business results. As an equity-based program, it also ties our executive compensation levels into returns earned by our shareholders. As a market-based program, it also helps us attract, motivate and retain quality leaders. Finally, the design of the shareholder-approved Omnibus Incentive Plan and Long-Term Incentive Awards granted thereunder helps ensure the tax deductibility of Long-Term Incentive Awards ultimately paid out.
Retirement & Savings Plans
The Retirement & Savings Plans in which our executive officers participate consist of the following:
Our Local Pension and/or 401(k) Savings Plans are made available to all eligible employees, including the Named Executive Officers, and vary by country. Our Named Executive Officers generally participate in their country-specific Local Pension and/or 401(k) Savings Plans on the same terms and conditions made available to all other participants in the respective plans. Our Local Pension Plans are described in further detail in the Pension Benefits Table and narrative beginning on page II-32.
Our Supplemental Retirement and/or Savings Plans are made available to those U.S. officers and employees whose annual compensation exceeds certain limits imposed by the IRS and whose retirement benefits under the Local Pension and/or 401(k) Savings Plans are limited as a result. The Supplemental Retirement and/or Savings Plans operate to replace the retirement benefits that would be lost as a result of the IRS limits. Messrs. Anderson, Schmidt, Wilcox, and Cornett participate in the Supplemental Retirement and/or Savings Plans.
Our Local Pension and/or 401(k) Savings Plan benefits and our Supplemental Retirement and/or Savings Plan benefits are determined primarily by considering base salary. Payouts under the Annual Incentive Plan Awards or the Long-Term Incentive Plan Awards generally do not impact the amount a participant will receive under these plans. As a Danish employee, Mr. Lyhne received Company contributions into his Local Danish Retirement Plan based on the value of both his base salary and incentive plan award payouts. This is consistent with the treatment of all other Danish employees who participate in the Company's incentive plans.
The Elective Deferred Compensation Plans for Cash Compensation are made available to U.S. Vice Presidents and executive officers as a means to allow them to save, on a tax-deferred basis, all or a portion of their annual cash compensation (Base Salary and Annual Incentive Award). Deferred compensation under these plans represents an unfunded, unsecured liability of the Company. During the deferral period,
participants' deferred compensation accounts are credited with a variable earnings credit that is tied to ten-year U.S. treasury yields and a credit risk spread based on the Company's credit profile. Messrs. Anderson and Wilcox have elected to participate in the Elective Deferred Compensation Plans for Cash Compensation.
The Elective Deferred Compensation Plan for Long-Term Incentive Compensation has been made available to Messrs. Anderson, Schmidt, Wilcox and Cornett as a means to allow them to defer the receipt of their payouts under the Company's Long-Term Incentive Awards program. The determination of whether to extend the invitation to participate is made by the Committee on a grant-by-grant basis and depends, in part, on the Company's exposure to compensation deduction limitations under Internal Revenue Code Section 162(m). During the deferral period, the deferred compensation retains its original form (i.e., Performance Units). At the end of the deferral period, the deferred Performance Units are paid in the same form, shares or cash, as originally determined by the Committee. During the deferral period, dividend equivalents earned on the deferred Performance Units are also deferred and represent an unfunded, unsecured liability of the Company. During the deferral period, the deferred dividend equivalent accounts are credited with a variable earnings credit that is tied to ten-year U.S. treasury yields and a credit risk spread based on the Company's credit profile. Messrs. Anderson, Wilcox and Schmidt have elected to participate in the Elective Deferred Compensation Plan for Long-Term Incentive Compensation.
Executives participating in the Elective Deferred Compensation Plan for Long-Term Incentive Compensation can experience adverse capital gains tax consequences if the Company's share value declines during the deferral period. A decline in share value during the deferral period causes the net shares received by the participant, after payroll tax withholding, to have a lower tax basis. A later sale of these lower tax basis shares results in a greater capital gain or lower taxable loss than would have resulted had the shares not been deferred. The Committee has agreed to make a capital gains tax protection payment to participants if their deferred Performance Units are paid out at a time when the shares are lower in value than on the date when the Performance Units would have originally been paid, based on a fixed formula. As of December 31, 2007, the potential tax basis protection payouts to Messrs. Wilcox and Schmidt would total $108,376 and $57,270, respectively, based on the December 31, 2007 closing share price of $25.05. The actual tax basis protection payouts, if any, will depend upon the share price on the date that deferred performance units are paid out.
The Supplemental Retirement and/or Savings Plans and the Elective Deferred Compensation Plans are described in further detail in the Nonqualified Deferred Compensation Table and narrative beginning on page II-34.
Based on observed market practices, we believe our Retirement & Savings Plans are comparable to those found in the marketplace for senior executives. These plans help us attract, motivate and retain quality leaders. In addition, the elective deferred compensation programs can help ensure the corporate tax deductibility of compensation in years when an executive's compensation might otherwise exceed the tax deductible compensation limits of Internal Revenue Code Section 162(m).
Additional Cash Compensation and Perquisites
We provide a few additional elements of cash compensation and/or perquisites to our executives. These elements include:
Automobile allowances are paid to Messrs. Anderson, Schmidt, Cornett and Schramm, and were paid to Mr. Wilcox prior to his termination, in lieu of providing company cars for their use. As European-based officers, Mr. Kittel and Mr. Lyhne are each provided a company car for business and personal use. Automobile allowances or allowing the use of a company car are common in the market for senior executives and are used by us to attract, motivate and retain quality leaders.
The relocation stipend paid to Messrs. Anderson, Wilcox, Schmidt and Cornett was put in place at the time they relocated to our Lincolnshire, Illinois office. The Compensation Committee determined that the executives should be given a stipend to assist them with the higher cost of housing in the Chicago area. The stipends have a limited term (60 months) and ended in August 2006 for Mr. Cornett, April 2007 for Mr. Wilcox, May 2007 for Mr. Anderson and will end in August 2008 for Mr. Schmidt.
Mr. Schramm, as a recent new hire, and Mr. Lyhne, due to a transfer of roles, both received relocation assistance from the Company during 2007. The full cost of any such relocation assistance has been included in the Other Compensation Column of the Summary Compensation Table.
The Company's Paid Time Off (PTO) plan allows US employees, including officers, to sell back up to 80 hours of paid time off (i.e. vacation) per year. This may be preferable for employees who are nearing their maximum PTO accrual and would otherwise begin to lose the value of their full PTO benefit. Hans Cornett utilized the PTO sell-back option in 2007. The resulting cash payment to him has been included in the Other Compensation Column of the Summary Compensation Table.
Similarly, departing employees are able to receive a cash payout of their remaining PTO accrual balance upon their termination of employment. Mr. Wilcox received such a payout upon his termination from service in August of 2007. The cash payment to him has been included in the Other Compensation Column of the Summary Compensation Table.
Due to a high frequency of international travel, we allow spouses to accompany executives on up to two international trips per year. The Company pays coach class airfare for any such spousal trips. The executive is responsible for any income taxes resulting from such Company-paid spousal trips.
Other Potential Post-Employment Compensation
The Company has Employment Agreements in place with its executive officers, including all of the Named Executive Officers that provide the potential for post-employment compensation in certain instances (i.e., triggers). The triggers that would provide for post-employment compensation are as follows:
Based on observed market practices, the triggers identified above, which can lead to post-employment compensation, are comparable to those found in the marketplace for CEOs and other senior executives.
The material terms of the Employment Agreements, including the provisions relating to potential post-employment compensation, are discussed in detail in the Potential Payments Upon Termination or Change in Control section beginning on page II-37.
In July of 2007, the Company notified Mr. Wilcox of its intent to invoke the Termination Without Cause provisions within his employment agreement. After the requisite 30-day notification period, Mr. Wilcox's employment ended.
As a result of this Termination Without Cause, Mr. Wilcox was paid or provided the following amounts pursuant to his employment agreement:
The first three items listed above were paid to Mr. Wilcox in 2007 and are included in the All Other Compensation column of the Summary Compensation Table on page II-26.
In February of 2008, the Company and Mr. Lyhne mutually agreed to terms of employment termination as provided for in his employment agreement. Mr. Lyhne was released from his duties as of February 22, 2008 and, in accordance with Danish employment law, his employment shall end on August 31, 2008.
Amounts payable in 2008 as a result of Mr. Lyhne's employment termination are documented in the discussion of Potential Payments Upon Termination or Change in Control beginning on page II-37.
Stock Ownership Guidelines
The Company has no formal stock ownership guidelines due, in part, to the closely-held nature of the Company. The Committee strongly encourages share ownership among the senior executives and monitors such share ownership on an annual basis.
Financial Accounting and Tax Impacts of Executive Compensation Program
Internal Revenue Code ("IRC") Section 162(m) limits U.S. and state tax deductions for compensation in excess of $1,000,000 paid to the CEO and to the other Named Executive Officers during any taxable year.
The Company's Omnibus Incentive Plan has been designed to meet the qualifying criteria for the performance-based compensation exception to IRC Section 162(m). Incentive awards granted under the Omnibus Incentive Plan are designed to be fully deductible for U.S. and state tax purposes.
The Company's 1998 Long-Term Incentive Plan does not currently meet all the criteria for the performance-based compensation exception to IRC Section 162(m). Therefore, the value of Performance Units to be paid out in February of 2008 with respect to the 2005 performance unit grant may not be fully tax deductible.
The cash-based elements of our executive compensation program, including Base Salary and Annual Incentive Awards, are treated as a financial statement expense in the year incurred. The Long-Term Incentive Awards are accounted for pursuant to the Rules of Financial Accounting Standard 123R with financial statement expense recognized over the three-year performance period.
Compensation Committee Interlocks and Insider Participation
The Committee's members during 2007 were Johannes F. Kirchhoff, F. Joseph Loughrey, and Steven H. Wood, none of whom is or has ever been an officer or employee of the Company. Johannes F. Kirchhoff and members of his family are owners of FAUN Umwelttechnik GmbH & Co. KG, which purchased products from the Company in 2007 for an aggregate purchase price of approximately $1.7 million.
Compensation Committee Report
The information contained in the following report shall not be deemed to be "soliciting material" or "filed" or incorporated by reference in future filings with the Securities and Exchange Commission, or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference into a document filed under the Securities Act of 1933 or the Securities Exchange Act of 1934.
The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis (CD&A) with management and, based on the review and discussion, has recommended to the Board that the CD&A be included in the Company's Proxy Statement and be incorporated by reference into the Company's Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the Securities and Exchange Commission.
March 12, 2008
Footnotes To Summary Compensation Table
Footnote to Grants of Plan-Based Awards Table
Each of the Named Executive Officers has an Employment Agreement with Sauer-Danfoss Inc. which details, among other things, the components of such officer's compensation. The Employment Agreements for the Named Executive Officers, other than Mr. Schramm, were entered into in December of 2002 and continue in effect until termination of employment. Mr. Schramm's Employment Agreement was entered into on April 16, 2007 and contains a two-year term, automatically renewable in the absence of written notice by either party. Rights of the officers to certain post-employment compensation under the terms of the Employment Agreements are discussed in the Potential Payments upon Termination or Change in Control section beginning on page II-37.
The officer Employment Agreements provide for base salary levels, which increase under the Company's annual salary review process, as described in the CD&A. Once increased, the Employment Agreements indicate that an officer's base salary cannot be decreased without the officer's consent, unless as part of a blanket decrease to the base salaries of all officers.
The Named Executive Officers have outstanding Performance Unit grants from 2005 under the Company's 1998 Long-Term Incentive Plan and from 2006 and 2007 under the Company's Omnibus Incentive Plan. In addition, Mr. Schramm has 10,000 Restricted Shares awarded under the Company's Omnibus Incentive Plan at the time of his hiring. The target numbers of Performance Units and Restricted Shares outstanding are detailed later in the Outstanding Equity Awards At Fiscal Year-End Table.
The performance unit award agreements call for the payout of Performance Units based on average Return on Net Asset (RONA) performance over a three-year performance period. The Performance Unit awards generally allow for a percentage payout of the target number of Units, depending upon RONA performance. Below established RONA thresholds, there is no payout under the Performance Unit awards. Beginning in 2007, a sales growth modifier was added to the performance measurements for purposes of determining earned Performance Unit payouts.
The Performance Unit award agreements include forfeiture upon termination of service from the Company prior to payment, except terminations due to Retirement, Disability or Death, in which case pro-rated payouts will be made, based on final RONA performance. The Compensation Committee can make exceptions to the automatic forfeiture provisions, in its sole discretion. Mr. Wilcox's outstanding Performance Unit awards were forfeited upon his termination from service.
The performance unit award agreements also call for a payout, at target levels, of Performance Units in the event of a Change in Control of the Company, as defined in the agreements.
By decision of the Compensation Committee, earned Performance Units are payable in shares of Company stock, with a number of shares withheld to cover the Company's minimum statutory tax withholding requirements. Earned Performance Units under the 2006 and 2007 award agreements for Messrs. Anderson and Kittel are payable in cash, based on the Company's closing share price on December 31, 2008 and December 31, 2009, respectively.
The performance unit awards allow for the payment of dividend equivalents, as declared by the Company's Board of Directors. The practice of the Board has been to authorize the payment of dividend equivalents, based on the number of target Performance Units held, at the same time and at the same rate as dividends declared on the Company's common stock.
Non-Equity Incentive Compensation
The Non-Equity Incentive Compensation represents amounts granted to and earned by the Named Executive Officers under the Company's Annual Incentive Award program. The Annual Incentive Award
program is performance-based and is tied to the Company's performance against pre-determined targets for Earnings Before Interest & Taxes (EBIT) margins.
Annual Incentive Award payouts are based on a range of 25% to 200% of pre-established payout targets depending upon EBIT margin performance. Below certain minimum threshold EBIT margin levels, there is no payout under the Annual Incentive Award program.
Mr. Wilcox's 2007 Annual Incentive Award was forfeited upon his termination from service. However, he did receive a Pro-Rata Annual Incentive Payout under the terms of his Employment Agreement.
In 2007, base salary made up roughly 43%, 47%, 48%, 60%, 46%, 24% and 51% of the Total Compensation for Messrs. Anderson, Schmidt, Cornett, Kittel, Schramm, Wilcox and Lyhne, respectively. Also in 2007, performance-based stock awards and non-equity incentive plan grants made up roughly 33%, 46%, 45%, 31%, 46%, and 30% of the Total Compensation for Messrs. Anderson, Schmidt, Cornett, Kittel, Schramm, and Lyhne, respectively.
Footnotes To Outstanding Equity Awards At Fiscal Year-End Table
Footnotes To Option Exercises and Stock Vested Table
Sauer-Danfoss Employees' Retirement Plan
The Pension Benefits table above details the present value of the accumulated retirement benefits accrued by Messrs. Anderson, Schmidt, Cornett, Schramm and Wilcox under the Sauer-Danfoss Employees' Retirement Plan (the "U.S. Retirement Plan"). The amounts shown represent the retirement
annuities that each of them would be eligible to receive at normal retirement age (65), based on years of service through December 31, 2007, discounted to a December 31, 2007 present value using a discount rate of 6.5%.
The U.S. Retirement Plan is a defined benefit pension plan intended to be qualified under Section 401(a) of the Internal Revenue Code. Under the U.S. Retirement Plan, participants accrue retirement benefits over time using either a final average pay formula or a cash balance formula. The final average pay formula is available only to participants who were hired prior to October 2, 2000 and who did not make a one-time election to switch to the cash balance formula. All other participants accrue benefits under the cash balance formula.
Under the final average pay formula, a participant's retirement benefit at normal retirement date, age 65, will be based on (i) the average of the participant's highest consecutive five-year annual earnings, (ii) the number of years of participation in the plan and (iii) a reduction/offset for Social Security benefits. Under the terms of the plan, the average annual earnings will be multiplied by 2% for each year of participation, up to a maximum of 30 years or 60%, to determine the annual pension amount. The annual pension amount is converted to a monthly annuity. Depending upon hire date, participants may choose from a variety of payment options, including ordinary life annuities, joint and survivor annuities and ordinary life annuities with guaranteed term certain provisions. The portion of a final average pay benefit accrued prior to December 31, 1990 can, at the election of the participant, be paid out in a lump sum.
Under the cash balance formula, participants are provided an annual credit, equal to 2% of eligible pay, to their cash balance accounts. The cumulative account balances earn annual interest credits, tied to the one-year treasury bill rate. At the normal retirement date, age 65, the accumulated cash balance is converted into a monthly annuity for payment and is paid out as either a single-life annuity or as a joint and survivor annuity.
For both the final average pay formula and the cash balance formula, eligible pay is generally limited to a participant's base salary.
Mr. Anderson participates in the U.S. Retirement Plan under the final average pay formula. Messrs. Schmidt, Cornett, Schramm and Wilcox participate in the U.S. Retirement Plan under the cash balance formula. Mr. Wilcox also has a frozen, final average pay benefit stemming from 7.7 years of prior service. As a German employee, Mr. Kittel does not participate in the U.S. Retirement Plan.
Under the U.S. Retirement Plan, reduced early retirement benefits may be taken beginning at age 55. Messrs. Anderson (age 60), Wilcox (age 61) and Cornett (age 57) are currently eligible for early retirement under the above-named plan. Upon early retirement, the normal age 65 retirement benefit is reduced by 0.5% for each month by which the participant is less than age 65 when early retirement benefit payments commence.
Mr. Schramm has not yet served the requisite five years to be vested in his benefits under the U.S. Retirement Plan.
Sauer-Danfoss Supplemental Retirement Plan
The Pension Benefits table above details the present value of the accumulated retirement benefit accrued by Mr. Anderson under the Sauer-Danfoss Supplemental Retirement Benefit Plan (the "U.S. Supplemental Plan"). The amount shown represents the supplemental retirement annuity that Mr. Anderson would be eligible to receive at normal retirement age (65), based on years of service through December 31, 2007, discounted to a December 31, 2007 present value using a discount rate of 6.5%.
The Internal Revenue Code generally limits to $180,000, indexed for inflation, the amount of any annual benefit that may be paid from the U.S. Retirement Plan. Moreover, the U.S. Retirement Plan may
consider no more than $225,000, 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 a Supplemental Retirement Benefit Plan (the "U.S. Supplemental Plan"). The U.S. Supplemental Plan is designed to provide supplemental retirement benefits to the extent that a participant's benefits under the U.S. Retirement Plan are limited by either the $180,000 annual benefit limitation or the $225,000 annual compensation limitation. Under the U.S. Supplemental Plan, however, the actual payment of supplemental benefits is entirely at the discretion of the Company.
The benefit under the U.S. Supplemental Plan is payable in a lump sum on the one-year anniversary of a participant's termination from service.
At December 31, 2007, Mr. Anderson was a participant in the U.S. Supplemental Plan. No other Named Executive Officer is entitled to benefits under the U.S. Supplemental Plan.
Messrs. Schmidt, Wilcox and Cornett are covered by a separate, nonqualified deferred compensation plan which provides additional benefits for cash balance account participants in the U.S. Retirement Plan whose retirement benefits are limited by the Internal Revenue Code limitations on qualified plans. This separate plan is discussed in the Nonqualified Deferred Compensation narrative which follows below.
German Company Pension Scheme
The Pension Benefits table above details the present value of the accumulated retirement benefit accrued by Mr. Kittel under the German Company Pension Scheme. The amount shown represents the retirement annuity that Mr. Kittel would be eligible to receive at normal retirement age (65), based on years of service through December 31, 2007, discounted to a December 31, 2007 present value using a discount rate of 5.5%.
The German Company Pension Scheme is a pension plan covering a majority of the Company's German employees. The plan is similar in nature to a defined benefit 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 had completed 19.9 years of service in the plan as of December 31, 2007.
Footnotes To Nonqualified Deferred Compensation Table
The nonqualified deferred compensation amounts shown above reflect participants' balances in the following three nonqualified deferred compensation plans or arrangements:
The elective deferred compensation plans provide a means for eligible executives to save a portion of their compensation, on a tax-deferred basis, for retirement and other purposes.
The Supplemental Executive Savings and Retirement Plan operates to provide additional Company contributions to Messrs. Schmidt, Wilcox and Cornett, whose Company contributions into their qualified retirement plans are limited by IRS rules. These additional contributions allow the affected executives to receive, on a percentage of compensation basis, the same level of Company contributions towards retirement that all other U.S. employees enjoy.
The key provisions of the three nonqualified, deferred compensation plans are reflected below.
Elective Deferred Compensation Plans for Cash Compensation
Elective Deferred Compensation Plan for Long-Term Incentive Compensation
Supplemental Executive Savings and Retirement Plan
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL
Each Named Executive Officer has entered into an Employment Agreement with Sauer-Danfoss which provides for the payment of certain amounts upon a termination of employment for various reasons. These amounts are in addition to the amounts shown above in the Pension Benefits Table and the Nonqualified Deferred Compensation Table.
Upon termination of employment for any reason, a Named Executive Officer will receive base salary, vacation pay, and Annual Incentive Awards that have been earned, but not yet paid.
The Named Executive Officer will receive additional payments if the termination from employment occurs in any of the following circumstances:
The following table sets forth the estimated value of these potential post-employment payments assuming a triggering event had occurred on December 31, 2007, after the vesting of the 2007 Annual Incentive Award, and based on the closing share price on December 31, 2007 of $25.05. The tabular disclosure is followed by a more detailed narrative concerning the various types of triggering events. The table reflects the actual value of Mr. Lyhne's post-employment compensation payable in 2008.
Payments Due To Death Or Disability
In the event of a termination of employment due to Death or Disability, the Named Executive Officer or his estate or beneficiary, as the case may be, shall receive the following payments and/or continuing benefits:
The Employment Agreements define Disability to mean the inability of the Named Executive Officer to perform his principal duties because of physical or mental incapacity for 180 consecutive days in any twelve-month period.
Mr. Schramm's Employment Agreement does not provide for the payment of the lump sum cash payment equal to 100% of base salary, in the event of termination of employment due to Death or Disability.
Payments Due To Termination By Company Without Cause & Termination By Employee With Good Reason
In the event of a termination of employment initiated by the Company Without Cause or initiated by the Employee With Good Reason, the Named Executive Officer shall receive the following payments and/or continuing benefits:
Under the Employment Agreements the circumstances under which the Company can terminate employment of a Named Executive Officer for Cause and thereby avoid the payment described in this section are limited to the following:
Under the Employment Agreements, the following circumstances, except where agreed to by the Named Executive Officer in writing, are those which would allow the Named Executive Officer to terminate his employment under the With Good Reason clause and thereby qualify for the payments described in this section:
Payments Following A Change In Control
In the event of a termination of employment within the first two years following a Change In Control of the Company that is either initiated by the Company Without Cause or initiated by the Employee With Good Reason, the Named Executive Officer shall receive the following payments and/or continuing benefits:
A Change In Control is generally defined as an acquisition by an unrelated third party of a 30% or greater interest in the ownership of the Company. The prospective change in control transaction described on pages II-4 and II-5 will not constitute a Change in Control for purposes of the Employment Agreements of the Named Executive Officers.
The excise tax gross-up payment is intended to make the Named Executive Officer whole in the event that any excise tax is owed under Internal Revenue Code Section 280G. The excise tax gross-up payment will cover not only the excise tax itself, but will be grossed-up to cover additional income and excise taxes owed as a result of the gross-up payment.
Mr. Schramm's Employment Agreement does not provide for the payment of the excise tax gross-up payment. Mr. Schramm's Employment Agreement does allow for a reduction of payouts to the minimum amount needed to avoid any excise tax under Internal Revenue Code Section 280G, if this is deemed to be more advantageous to Mr. Schramm.
In the event of a Change In Control, Performance Units under the Company's Long-Term Incentive Plan are subject to accelerated vesting. The Performance Units vest at their target level and are payable immediately upon vesting.
Key Employment Agreement Provisions
In return for the agreement by Sauer-Danfoss to make the other potential post-employment payments described above, the Named Executive Officers agree to certain conduct during the term of their employment and immediately thereafter. Specifically, the Named Executive Officers, by signing the Employment Agreements, agree to the following:
Footnotes To Director Compensation Table
Non-employee directors earn cash-based director's fees according to the following schedule:
Non-employee directors receive an annual grant of restricted shares of Sauer-Danfoss Inc. common stock under the Company's Non-Employee Director Stock Option and Restricted Stock Plan. The terms of each restricted share grant can vary in accordance with the plan document. For the past several years the annual grants have consisted of 1,500 shares with a three-year vesting period. The restricted shares are forfeitable upon termination of service from the Board for any reason prior to the vesting date, unless
otherwise determined by the Board, in its sole discretion. The restricted shares provide for voting and dividend rights during the period of restriction.
U.S. non-employee directors can elect to defer a portion of their cash-based director's fees by participating in the Sauer-Danfoss Inc. 409A Deferred Compensation Plan for Selected Employees and U.S. Non-Employee Directors. The terms of such deferral are similar to those made available to Sauer-Danfoss employees and have been described previously in the Nonqualified Deferred Compensation Narrative.
The sole employee member of the Board, Mr. Anderson, is not entitled to any compensation for such service.
The Board of Directors of the Company (the "Board") has nominated ten directors for election. All directors are elected annually.
If elected, each of the nominees will serve until the 2009 Annual Meeting and until a successor has been elected and qualified, or until such director's earlier death, resignation, or removal.
Each share is entitled to one vote for each of ten directors. The persons named in the accompanying proxy will vote it for the election of the nominees named below as directors unless otherwise directed by the stockholder. Each nominee has consented to be named and to serve if elected. In the unanticipated event that a nominee becomes unavailable for election for any reason, the proxies will be voted for the other nominees and for any substitute.
Nominees to Serve for Directors
Niels B. Christiansen, age 42. Mr. Christiansen has been Vice Chief Executive Officer of Danfoss A/S since November 15, 2006. From November 15, 2006 through December 31, 2007, he also served as Chief Operating Officer of Danfoss A/S. From November 1, 2004 through November 14, 2006, he served as Executive Vice President and Chief Operating Officer of Danfoss A/S. From January 1, 2003 through September 30, 2004, Mr. Christiansen was an Executive Vice President at GN Store Nord A/S, a Danish developer of telecommunications networking and hand-held communications solutions. From January 1, 2000 through September 30, 2004, he was President and Chief Executive Officer of GN Netcom A/S, a Danish subsidiary of GN Store Nord A/S.
Mr. Christiansen serves on the Boards of Directors of Axcel A/S, a Danish private equity fund, TrygVesta A/S, a publicly traded Danish insurance company, B&O a/s, a publicly traded Danish manufacturer of audio and video products, and William Demant Holding A/S, a publicly traded Danish manufacturer of audio products.
Jørgen M. Clausen, age 59, has been a director of the Company since May 3, 2000, Chairman of the Company since May 5, 2004, and prior to that served as Vice Chairman of the Company from 2000 to 2004. He has served as the President and Chief Executive Officer and a member of the Executive Committee of Danfoss A/S for more than the past five years.
Kim Fausing, age 43. Mr. Fausing has been Executive Vice President and Chief Operating Officer of Danfoss A/S since January 2008. In 2007, Mr. Fausing became a divisional president of Danfoss A/S, having previously worked at Hilti Corporation, a privately owned manufacturer of construction and engineering products, from 1990 through 2007. He served as Hilti's President and Managing Director from 1990 through 2003, and as a Division President and member of its Executive Committee from 2003 through 2007.
William E. Hoover, Jr., age 58. Mr. Hoover worked for McKinsey & Co., a management consulting firm, for approximately 30 years until July 2007. Mr. Hoover serves on the Boards of Directors of Danfoss A/S and GN Great Nordic, a Danish manufacturer of hearing instruments that is listed on the Copenhagen Stock Exchange.
Johannes F. Kirchhoff, age 50, has been a director of the Company since April 17, 1997. Mr. Kirchhoff has been owner and Managing Director of FAUN Umwelttechnik GmbH & Co. KG, a German manufacturer of vehicles for waste disposal, for more than the past five years. He is Chairman of the Compensation Committee of the Board and a member of the Audit Committee of the Board.
F. Joseph Loughrey, age 58, has been a director of the Company since June 23, 2000. He has been President and Chief Operating Officer of Cummins Inc. since May 2005. From October 1999 until May 2005, he was Executive Vice President of Cummins Inc. and PresidentEngine Business. From 1996 to 1999, Mr. Loughrey served as Executive Vice President of Cummins Engine Company and Group
PresidentIndustrial and Chief Technical Officer. He also is a director of Cummins Inc. Mr. Loughrey is a member of the Audit Committee and the Compensation Committee of the Board.
Frederik Lotz, age 39. Mr. Lotz has been Chief Financial Officer of Danfoss A/S since May 1, 2007 and an Executive Vice President of Danfoss A/S since February 1, 2007. He served as Chief Financial Officer of Ferrosan A/S, a Danish corporation in the consumer health care industry, from December 1, 2002 through December 31, 2006.
Sven Murmann, age 40, has been a director of the Company since April 21, 1994, and Vice Chairman of the Company since May 5, 2004. Mr. Murmann is Managing Director of Sauer Holding GmbH, an investment company controlled by the Murmann family, a position he has held for more than the past five years, and is Chairman of Bibus Hydraulik AG, a distributor of industrial and mobile hydraulic systems and electronic components for the Swiss market. He previously served from August 2000 to August 2002 as Manager of HAKO Holding GmbH & Co., a global manufacturer of indoor and outdoor cleaning equipment based in Germany. He is a member of the Board of Danfoss A/S. Mr. Murmann is the son of Klaus H. Murmann, Chairman Emeritus and a director of the Company, and a brother of Nicola Keim, a director of the Company, each of whom will cease to serve as directors of the Company upon the election of the new Board at the Annual Meeting. He is a member of the Executive Committee of the Board.
Sven Ruder, age 51. Mr. Ruder has been the President of the Motion Controls division of Danfoss A/S since January 2001. Mr. Ruder serves on the Boards of Directors of Danfoss Turbocor Compressors BV, a privately held joint venture between Danfoss A/S and Turbocorp BV, and of Danfoss Turbocor Compressors, Inc., a subsidiary of Danfoss Turbocor Compressors BV that is engaged in the manufacture of air conditioning and refrigeration compressors.
Steven H. Wood, age 50, has been a director of the Company since January 1, 2003. Mr. Wood is currently the Chief Financial Officer of Becker-Underwood, Inc., a supplier of non-pesticide specialty chemical and biological products within the agricultural, landscape, turf, and horticulture industries. He was formerly Vice President and Corporate Controller for Metaldyne Corporation, a global designer and supplier of metal-based components, assemblies and modules for the automotive industry, from May 2004 until May 2006. From 2000 until 2003, he was the Executive Vice President and Chief Financial Officer of Maytag Corporation, and from 1996 to 2000 he was Vice President-Financial Reporting and Audit of Maytag. Mr. Wood held various other financial leadership positions within Maytag from 1989 to 1996. Prior to joining Maytag, he was an auditor with Ernst & Young, a public accounting firm, and successfully completed the examination for Certified Public Accountants. He is Chairman of the Audit Committee and a member of the Compensation Committee of the Board.
The Board recommends that stockholders vote FOR the election of the nominees named above as directors.
The following persons are not nominees for director, but they will continue to attend Board meetings as valued advisors.
David J. Anderson, age 60, a director of the Company since July 1, 2002, has been President and Chief Executive Officer of the Company since July 1, 2002. Effective upon the election of the new Board at the Annual Meeting, Mr. Anderson will cease to serve as a director of the Company, but he will become the Executive Director and Co-Vice Chairman of the Company, in addition to continuing to serve as the Company's President and Chief Executive Officer. He served as Executive Vice PresidentStrategic Business Development of the Company from May 3, 2000, until July 1, 2002. Since joining the Company in 1984, Mr. Anderson has held various senior management positions with the Company and Sauer-Danfoss (US) Company with increasing responsibility. He is a member of the Board of several of the Company's subsidiaries and joint ventures. He is also a member of the Board and an officer of the National Fluid Power Association.
Klaus H. Murmann, age 76, a director of the Company since April 18, 1990, is currently Chairman Emeritus of the Company. From 1987 to May 3, 2000, he served as Chairman and Chief Executive Officer
of the Company and its predecessor. He retired as an active employee of the Company as of December 31, 2002. Effective upon the election of the new Board at the Annual Meeting, Mr. Murmann will cease to serve as a director of the Company, but he will remain as the Company's Chairman Emeritus. Mr. Murmann founded Sauer Getriebe, a predecessor to the Company, in 1967, and has been involved in the hydrostatics business for more than 40 years. He was Chairman of the Board of PSV AG, Cologne, a German national pension fund, for more than five years until he stepped down in July 2006. Klaus Murmann is the father of Nicola Keim, a director of the Company who will cease to serve on the Board upon the election of the new Board at the Annual Meeting, and Sven Murmann, Vice Chairman and a director of the Company.
The Audit Committee of the Board has appointed KPMG LLP as the independent registered public accounting firm to audit the consolidated financial statements of the Company and its subsidiaries for 2008, subject to ratification of the stockholders at the Annual Meeting. A representative of KPMG LLP is expected to be present at the Annual Meeting and will have the opportunity to make a statement if he or she so desires and to respond to appropriate questions. The affirmative vote of a majority of the shares present and entitled to vote on this item at the Annual Meeting is necessary for the approval of the appointment of KPMG LLP as the Company's independent registered public accounting firm for 2008. In the event stockholders do not ratify the appointment of KPMG LLP, the appointment will be reconsidered by the Audit Committee. Even if the selection is ratified, the Audit Committee in its discretion may direct the appointment of a different independent registered public accounting firm at anytime during the year if they determine that such a change would be in the best interests of the Company and its stockholders.
Fees to Independent Registered Public Accounting Firm for 2007 and 2006
The following table presents fees for professional services rendered by KPMG LLP for the audit of the Company's Annual Financial Statements for the years ended December 31, 2007 and 2006 and fees billed for other services rendered by KPMG LLP during those periods:
Policy Regarding Pre-Approval of Audit and Non-Audit Services of Independent Registered Public Accounting Firm
The Audit Committee's policy is to pre-approve all audit and non-audit services provided by the independent registered public accounting firm. These services may include audit services, audit related services, tax services and other services that are not prohibited from being provided by the independent registered public accounting firm by the Sarbanes-Oxley Act of 2002 or rules issued thereunder ("Permitted Services"). Pre-approval is granted on an annual basis, generally at the first meeting of the Audit Committee held during each year, and any pre-approval shall be detailed as much as possible as to the particular service or category of services and shall generally be subject to a specific budget. The Committee may delegate pre-approval authority to one or more of its members with respect to Permitted Services when expedition of services is necessary, and has delegated such pre-approval authority to its Chairman. The independent registered public accounting firm and management are required to
periodically report to the full Audit Committee (generally at each regular quarterly meeting of the Audit Committee, but the Audit Committee may request a report at any time), regarding the extent of services provided by the independent registered public accounting firm in accordance with any pre-approval, and the fees for the services performed to date. All audit fees, audit related fees, tax fees and other fees paid in 2007 and 2006 were pre-approved by the Audit Committee.
The Board recommends that stockholders vote FOR ratification of the appointment of KPMG LLP as the Company's independent registered public accounting firm for 2008.
On March 12, 2008, the Board approved an amendment and restatement of the Certificate of Incorporation (the "Restated Charter") that amends the currently effective version of such document by eliminating provisions requiring the approval of at least 80% of the outstanding shares of the capital stock of the Company entitled to vote generally in the election of directors for the amendment, alteration, or repeal of any provisions of (i) Articles FIFTH through TENTH of the Company's Certificate of Incorporation, or (ii) the Company's Bylaws (or the adoption of new bylaws in replacement thereof) by the Company's stockholders. The Restated Charter would effectively replace such 80% supermajority voting threshold with a simple majority threshold. The Board has directed that the elimination of such supermajority requirements be submitted to the Company's stockholders for approval. The exact text of the deleted supermajority provisionsas found in Articles SIXTH and TENTH of the existing Certificate of Incorporation, respectivelyis included in the marked-up version of the Restated Charter annexed hereto as Appendix A.
Description of Supermajority Provisions Being Eliminated
The proposed Restated Charter deletes, in its entirety, Article TENTH of the Company's existing Certificate of Incorporation, which provides that the affirmative vote of the holders of not less than 80% of the outstanding shares of the capital stock of the Company entitled to vote generally in the election of directors, is required to amend, alter, or repeal any provision of Articles FIFTH, SIXTH, SEVENTH, EIGHTH, NINTH or TENTH of the Certificate of Incorporation. Upon deletion of such supermajority voting requirement, by default, under Section 242 of the General Corporation Law of the State of Delaware, any future amendments to the Certificate of Incorporation would require the approval of the holders of a simple majority of all outstanding shares of the Company's stock entitled to vote thereon.
The portions of the Certificate of Incorporation subject to the current 80% supermajority standardArticles FIFTH, SIXTH, SEVENTH, EIGHTH, NINTH and TENTHcover a variety of subject matters, including the following: the size and manner of selection of the Board of Directors; the alteration, amendment or repeal of the Bylaws; the limitation of liability of members of the Board of Directors to the Company's stockholders for breach of fiduciary duties; the limitation on the Company's stockholders' right to take action via written consent in lieu of a meeting; the indemnification rights of all officers, directors, employees, other representatives or persons serving in capacities upon request of the Company for liability arising from their roles as such, and the Company's related right to maintain insurance with respect to any such liability, whether covered by such indemnification rights or not. If approved by the stockholders, the Restated Charter would provide that any such provisions would now be subject to future amendment based on the approval of the holders of a simple majority of the Company's outstanding shares of stock entitled to vote with respect to such matters.
The Restated Charter would furthermore delete the requirement currently set forth in Article SIXTH of the Certificate of Incorporation that mandates that the approval of the holders of 80% of the outstanding shares of capital stock of the Company entitled to vote generally in the election of directors be obtained for the alteration, amendment or repeal of the Bylaws (or the adoption of new bylaws) by the Company's stockholders, and would explicitly replace such 80% supermajority voting requirement with a
simple majority voting requirement. Under the Company's Certificate of Incorporation, any provision of the Company's Bylaws that is adopted or amended by the Company's stockholders (as opposed to by the Board of Directors) cannot be subsequently amended by the Board of Directors (unless stated otherwise in the relevant provision so adopted or amended by the stockholders). Thus, the effect of the proposed amendment to Article SIXTH of the Certificate of Incorporation would be to allow the holders of a simple majority of the Company's outstanding shares of stock to adopt or amend portions of, or all of, the Bylaws in a manner that cannot subsequently be amended by the Board of Directors.
Rationale for Proposed Elimination of Supermajority Voting Provisions
The Board of Directors believes that it is in the best interests of the Company and the stockholders to replace the supermajority voting provisions of the current Certificate of Incorporation with the simple majority requirements under the Restated Charter. The amendment and restatement of the Certificate of Incorporation is designed to provide a degree of stability and continuity that is in the best interests of the Company and its stockholders. Adoption of Item 3 is a condition to the closing of the Share Purchase Transaction (as defined on page II-4), pursuant to which Danfoss intends to acquire a controlling interest in the Company from Sauer Holding. Today, Danfoss and the Murmann Family (through its ownership of Sauer Holding) share the controlling interest in the Company, which gives rise to the possibility of a deadlock in the event a significant opportunity, such as a sale of the Company or a major acquisition, should present itself. The Board believes that the Company and its stockholders will benefit from making the way clear for Danfoss and Sauer Holding to complete the Share Purchase Transaction.
In addition to its positive ramifications for these matters of internal governance, the Board believes that the amendment and restatement of the Certificate of Incorporation may increase the attractiveness of the Company to potential third-party acquirers. The Board believes that any potential acquirer of the Company would view the existing supermajority requirements as an anti-takeover mechanism. By adopting Item 3, the Company may increase the likelihood of becoming a recipient of a third-party acquisition proposal, so the Board believes that adoption of Item 3 will enhance the value of the Company. Other than the Share Purchase Transaction, the Company is not aware of any acquisition proposals involving the Company or its capital stock.
Interest of Directors and Executive Officers
Jørgen M. Clausen, Chairman of the Board of Directors, and Hans Kirk, a member of the Board, are affiliated with Danfoss. Mr. Clausen has served as President and Chief Executive Officer and as a member of the Executive Committee of Danfoss for more than six years. Mr. Kirk has served as Executive Vice President and a member of the Executive Committee of Danfoss for more than six years and as Chief Development Officer of Danfoss since May 15, 2005. On March 10, 2008, Danfoss and Sauer Holding entered into the Purchase Agreement (as defined on page II-4) providing for the sale by Sauer Holding to Danfoss of (i) 8,358,561 shares of the Company's common stock and (ii) all of the remaining issued and outstanding shares of Danfoss Murmann Holding A/S, a Danish corporation (the "Holding Company"), which holds a substantial interest in the Company's common stock. As a result of the consummation of the Share Purchase Transaction, there will be a change in control of the Company, as control of a majority of the issued and outstanding shares of the Company's Common Stock will be shifted to Danfoss solely.
Assuming the consummation of the Share Purchase Transaction, Danfoss will benefit from the elimination of the 80% supermajority stockholder voting requirement (and its replacement with a simple majority standard) for amendments to the Certificate of Incorporation or stockholder amendments of the Bylaws, because Danfoss' control of a majority of the issued and outstanding shares of the Company's common stock will provide it with the effective ability to unilaterally approve any such amendments without the support of other stockholders.
Klaus H. Murmann, Chairman Emeritus of the Board of Directors, Nicola Keim, a member of the Board, and Sven Murmann, Vice Chairman of the Board, are members of Sauer Holding. Because
approval of Item 3 is a condition to the closing of the Share Purchase Transaction, each of these three directors stands to benefit financially if Item 3 is adopted.
Restatement of Certificate of Incorporation
Appendix A sets forth the complete text of the Restated Charter. Deletions from the current Certificate of Incorporation are indicated via strikeouts, while additions to the current Certificate of Incorporation are indicated via underlining. As can be seen in the text of the appended Restated Charter, the only substantive change to the Certificate of Incorporation that will be effected via the adoption of the Restated Charter is the elimination of the supermajority provisions, as described in this Item 3.
In addition to the substantive change to the text of the Certificate of Incorporation that will be subject to the vote of the stockholders at the Annual Meeting, there is also one minor, non-substantive change that will not impact corporate governance but which is nevertheless reflected in the Restated Charter. As indicated in the appended version of the Restated Charter, the last two sentences of Article FIFTH will be deleted. These sentences simply convey historical information regarding the elimination of the staggered manner in which the Board of Directors was subject to election up until the 2000 annual meeting of stockholders. Because, assuming the passage of Item 3, the Company will be restating the Certificate of Incorporation, the Board believes that it would be prudent to delete historical information that is no longer relevant or applicable to the Company or its corporate governance at the same time. While deleting the currently inapplicable information, the Restated Certificate nevertheless preserves the first sentence of Article FIFTH, which sets forth the currently effective, substantive rule that the number of members of the Board of Directors is subject to the provisions of the Bylaws.
If the proposed amendments to the Certificate of Incorporation (as described under this Item 3) are approved by the stockholders at the Annual Meeting, promptly thereafter, the Company will file the Restated Charter with the Secretary of State of the State of Delaware to effect the amendments provided for therein. The Restated Charter will become effective immediately upon acceptance of its filing.
Approval of this proposal requires the affirmative FOR vote of at least 80% of the holders of the outstanding shares of the capital stock of the Company entitled to vote generally in the election of directors. An abstention will have the effect of a vote AGAINST. Additionally, any non-vote (including broker non-votes) will have the effect of a vote AGAINST.
The Board recommends that you vote FOR the elimination of the supermajority approval requirements for amendments to Articles FIFTH through TENTH of the Certificate of Incorporation and for stockholder-approved amendments to the Bylaws, as reflected in the Restated Charter. Proxies solicited by the Board will be voted FOR the approval of these amendments to the Certificate of Incorporation unless instructions to the contrary are given. Approval of this Item 3 is not conditioned or dependent upon the approval of any other matter that may be brought before the stockholders at the Annual Meeting.
To permit the Company and its stockholders to deal with stockholder proposals in an informed and orderly manner, the Bylaws of the Company establish an advance notice procedure. No stockholder proposals, nominations for the election of directors or other business may be brought before an annual meeting unless written notice of such proposal or other business is received by the Secretary of the Company at 2800 E. 13th Street, Ames, Iowa 50010 not less than 120 calendar days in advance of the date
that the Company's proxy statement was released to stockholders in connection with the previous year's Annual Meeting. For the Company's annual meeting in the year 2009, the Company must receive this notice on or before December 31, 2008 (i.e., 120 days before April 28, the day this year's proxy statement was released to stockholders). To comply with the Company's Bylaws and applicable rules and regulations of the Securities and Exchange Commission, the notice must contain certain specified information about the matters to be brought before the meeting and about the stockholder submitting the proposal. A copy of the applicable Bylaw provisions may be obtained, without charge, upon written request to the Secretary of the Company at 2800 E. 13th Street, Ames, Iowa 50010.
If any other matters are properly presented at the Annual Meeting for consideration, including, among other things, consideration of a motion to adjourn the Annual Meeting to another time or place, the persons named as proxies and acting thereunder will have discretion to vote on those matters to the same extent as the person delivering the proxy would be entitled to vote. If any other matter is properly brought before the Annual Meeting, proxies in the enclosed form returned to the Company prior to the Annual Meeting will be voted in accordance with the recommendation of the Board or, in the absence of such a recommendation, in accordance with the judgment of the proxy holder. At the date this Proxy Statement went to press, the Company did not anticipate that any other matters would be properly brought before the Annual Meeting.
Section 16(a) Beneficial Ownership Reporting Compliance
Based solely upon a review of Forms 3, 4 and 5 furnished to the Company pursuant to Section 16(a) of the Securities Exchange Act of 1934 with respect to the fiscal year ended December 31, 2007, the Company believes that all of such reports required to be filed during such fiscal year by the Company's officers, directors and 10% beneficial owners were timely filed.
The Company will mail without charge, upon written request, a copy of its Annual Report on Form 10-K filed with the Securities and Exchange Commission, including the financial statements, schedules, and list of exhibits. Requests should be sent to Kenneth D. McCuskey, Corporate Secretary, at 2800 E. 13th Street, Ames, Iowa 50010.
April 28, 2008
(Deletions are indicated by strikeouts and additions are indicated by underlining.)
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
SAUER-DANFOSS INC., a corporation organized and existing under the laws of the State of Delaware (the "Corporation"), hereby certifies as follows:
1. The present name of the corporation is Sauer-Danfoss Inc. Sauer-Danfoss Inc. was originally incorporated under the name Sundstrand Venture Company, and the original Certificate of Incorporation was filed with the Secretary of State of the State of Delaware on September 25, 1986.
2. This Amended and Restated Certificate of Incorporation amends and restates the provisions of the Certificate of Incorporation of this Corporation as heretofore amended or supplemented, and was duly adopted in accordance with the provisions of Sections 242 and 245 of the General Corporation Law of the State of Delaware.
3. The text of the Certificate of Incorporation is hereby amended and restated to read in its entirety as follows:
FIRST: The name of the corporation is Sauer-Danfoss Inc. (hereinafter, the "Corporation").
SECOND: Its registered office in the State of Delaware is to be located at 1209 Orange Street, in the City of Wilmington, County of New Castle, Delaware 19801. The name of its registered agent at such address is The Corporation Trust Company.
THIRD: The nature of the business or purposes to be conducted or promoted is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware.
FOURTH: The total number of shares of all classes of stock which the Corporation shall have authority to issue shall be 79,500,000, of which 75,000,000 shares are to be Common Stock, having a par value of $0.01 per share, and 4,500,000 shares are to be Preferred Stock, having a par value of $0.01 per share.
Authority is hereby expressly granted to the Board of Directors from time to time to issue Preferred Stock, for such consideration and on such terms as it may determine, as Preferred Stock of one or more series and in connection with the creation of any such series to fix by the resolution or resolutions providing for the issue of shares thereof the designation, powers and relative participating, optional, or other special rights of such series, and the qualifications, limitations, or restrictions thereof. Such authority of the Board of Directors with respect to each such series shall include, but not be limited to, the determination of the following:
(a) the distinctive designation of, and the number of shares comprising, such series, which number may be (except where otherwise provided by the Board of Directors in creating such series) increased or decreased (but not below the number of shares thereof then outstanding) from time to time by like action of the Board of Directors;
(b) the dividend rate or amount for such series, the conditions and dates upon which such dividends shall be payable, the relation which such dividends bear to the dividends payable on any other
class or classes or any other series of any class or classes of stock, and whether such dividends shall be cumulative, and if so, from which date or dates for such series;
(c) whether or not the shares of such series shall be subject to redemption by the Corporation and the times, prices, and other terms and conditions of such redemption;
(d) whether or not the shares of such series shall be subject to the operation of a sinking fund or purchase fund to be applied to the redemption or purchase of such shares and if such a fund be established, the amount thereof and the terms and provisions relative to the application thereof;
(e) whether or not the shares of such series shall be convertible into or exchangeable for shares of any other class or classes, or of any other series of any class or classes, of stock of the Corporation and, if provision be made for conversion or exchange, the times, prices, rates, adjustments, and other terms and conditions of such conversion or exchange;
(f) whether or not the shares of such series shall have voting rights, in addition to the voting rights provided by law, and if they are to have such additional voting rights, the extent thereof;
(g) the rights of the shares of such series in the event of any liquidation, dissolution, or winding up of the Corporation or upon any distribution of its assets; and
(h) any other powers, preferences, and relative, participating, optional, or other special rights of the shares of such series, and the qualifications, limitations, or restrictions thereof, to the full extent now or hereafter permitted by law and not inconsistent with the provisions hereof.
number of directors shall be fixed by, or in the manner provided in, the Bylaws of the Corporation.
Board of Directors shall have power to make, and from time to time alter, amend, or repeal the Bylaws of the Corporation; provided, however, that (a) the
stockholders shall have the paramount power to alter, amend and repeal the Bylaws or adopt new Bylaws, exercisable by the affirmative vote of the holders of not less than
SEVENTH: A director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (a) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (b) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (c) under the provisions of Section 174 of the Delaware General Corporation Law and amendments thereto, or (d) for any transaction from which the director derived an improper personal benefit. If the Delaware General Corporation Law is amended to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director of the Corporation shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law, as so amended. No amendment, repeal or adoption of any provision of this Certificate of Incorporation inconsistent with this Article Seventh shall apply or have any effect on the liability of any director of the Corporation for or with respect
to any acts or omissions of such director occurring prior to such amendment, repeal, or adoption of any inconsistent provision.
EIGHTH: The stockholders of the Corporation may not take action by written consent in lieu of a meeting, but must take any such action at a duly called annual or special meeting.
NINTH: (a) Each person who was or is made a party or is threatened to be made a party to or is involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative ("proceeding"), by reason of the fact that he or she, or a person of whom he or she is the legal representative, is or was a director or officer of the Corporation, or is, or was serving, at the request of the Corporation as a director or officer of another corporation, or of a partnership, joint venture, trust or other enterprise, including service with respect to employee benefit plans, whether the basis of such proceeding is alleged action in an official capacity as a director or officer or in any other capacity while serving as a director or officer, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than said laws permitted the Corporation to provide prior to such amendment), against any and all expense, liability loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid or to be paid in settlement and amounts expended in seeking indemnification granted to such person under applicable law, this Article Ninth or any agreement with the Corporation) reasonably incurred or suffered by such person in connection therewith and such indemnification shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of his or her heirs, executors and administrators; provided, however, that, except as provided in paragraph (b) of this Article Ninth, the Corporation shall indemnify any such person seeking indemnity in connection with an action, suit or proceeding (or part thereof) initiated by such person only if (a) such indemnification is expressly required to be made by law, (b) the action, suit or proceeding (or part thereof) was authorized by the Board of Directors of the Corporation, (c) such indemnification is provided by the Corporation, in its sole discretion, pursuant to the powers vested in the Corporation under the Delaware General Corporation Law, or (d) the action, suit or proceeding (or part thereof) is brought to establish or enforce a right to indemnification under an indemnity agreement or any other statute or law or otherwise as required under Section 145 of the Delaware General Corporation Law. Such right shall be a contract right and shall include the right to be paid by the Corporation expenses incurred in defending any such proceeding in advance of its final disposition; provided, however, that, unless the Delaware General Corporation Law then so prohibits, the payment of such expenses incurred by a director or officer of the Corporation in his or her capacity as a director or officer (and in any other capacity in which service was or is tendered by such person while a director or officer, including, without limitation, service to an employee benefit plan) in advance of the final disposition of such proceeding shall be made only upon delivery to the Corporation of an undertaking, by or on behalf of such director of officer, to repay any amounts so advanced if it should be determined ultimately that such director or officer is not entitled to be indemnified under this Article Ninth or otherwise.
(b) If a claim under paragraph (a) of this Article Ninth is not paid in full by the Corporation within thirty (30) days after a written claim has been received by the Corporation, the claimant may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim and, if such suit is not frivolous or brought in bad faith, the claimant shall be entitled to be paid also the expense of prosecuting such claim. The burden of proving such claim shall be on the claimant. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in defending any proceeding in advance of its final disposition where the required undertaking, if any, has been tendered to this Corporation) that the claimant has not met the standards of conduct which make it permissible under the Delaware General Corporation Law for the Corporation to indemnify the claimant for the amount claimed. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) to have made a determination prior to the commencement of such action that
indemnification of the claimant is proper in the circumstances because he or she has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel or its stockholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that claimant has not met the applicable standard of conduct.
(c) The rights conferred on any person in paragraphs (a) and (b) of this Article Ninth shall not be exclusive of any other right which such persons may have or hereafter acquire under any statute, provision of this Certificate of Incorporation, the Bylaws of the Corporation, agreement, vote of stockholders or disinterested directors or otherwise.
(d) The Board of Directors is authorized to enter into a contract with any director, officer, employee or agent of the Corporation, or any person serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, including employee benefit plans, providing for indemnification rights equivalent to or, if the Board of Directors so determines, greater than, those provided for in this Article Ninth.
(e) The Corporation may maintain insurance to the extent reasonably available, at its expense, to protect itself and any such director, officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other enterprise against any such expense, liability or loss, whether or not the Corporation would have the power to indemnify such person against such expense, liability or loss under the Delaware General Corporation Law.
(f) Any amendment, repeal or modification of any provision of this Article Ninth by the stockholders or the directors of the Corporation shall not adversely affect any right or protection of a director or officer of the Corporation existing at the time of such amendment, repeal or modification.
Sauer-Danfoss Inc. (the "Company") (NYSE: SHS) is a global leader in the development, manufacture and marketing of advanced systems for the distribution and control of power in mobile equipment. The Company designs, manufactures, and markets hydraulic, electronic, electric, mechanical components, software, and integrated systems that generate, transmit, and control power in mobile equipment for sale to manufacturers of highly engineered, off-road vehicles used for agriculture, construction, road building, turf care, material handling, and specialty vehicles. The Company engineers advanced components and systems to enable its customers to produce highly reliable, efficient and innovative mobile equipment vehicles.
The composition of the Company's business among its three segments is 48% Propel, 27% Work Function, and 25% Controls. Propel segment products include hydrostatic transmissions, gear boxes, orbital motors, and integrated hydrostatic transaxles. Work Function segment products include steering units, gear pumps and motors, multi-pump assemblies, open circuit pumps, and gear boxes. Controls segment products include a complete line of valves, microcontrollers, solenoid-operated valves, joysticks, speed and positions sensors, grade and slope sensors, and electric drives. All of the segments' products are sold into each of the Company's markets either directly to original equipment manufacturers ("OEMs") or through distributors to OEMs and the aftermarket.
The Company submitted to the New York Stock Exchange last year, on or about August 9, 2007, the unqualified Section 303A.12(a) Annual CEO Certification.
The Company also filed as exhibits 31.1 and 31.2 to its Forms 10-K for the years ended December 31, 2007 and December 31, 2006, the certifications of the CEO and CFO required under Section 302 of the Sarbanes-Oxley Act of 2002.
The following graph shows a comparison of the cumulative total returns from December 31, 2002 to December 31, 2007, for the Company, the Russell 2000 Index and the Hemscott, Inc.Diversified Machinery Index ("Hemscott-Group Index"). The graph assumes that $100 was invested on December 31, 2002 in the Company's common stock, the Russell 2000 Index and the Hemscott-Group Index, a peer group index, and that all dividends were reinvested.
$100 INVESTED ON 12/31/02
Safe Harbor Statement
This Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as other portions of this annual report to stockholders, contain statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. All statements regarding future performance, growth, sales and earnings projections, conditions or developments are forward-looking statements. Words such as "anticipates," "in the opinion," "believes," "intends," "expects," "may," "will," "should," "could," "plans," "forecasts," "estimates," "predicts," "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. weakened throughout 2007, the economic situation in Europe remained strong. 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.
About the Company
Sauer-Danfoss Inc. and subsidiaries (the Company) is a worldwide leader in the design, manufacture, and sale of engineered hydraulic and electronic systems and components that generate, transmit and control power in mobile equipment. The Company's products are used by original equipment manufacturers (OEMs) of mobile equipment, including construction, road building, agricultural, turf care, material handling, and specialty equipment. The Company designs, manufactures, and markets its products in the Americas, Europe, and the Asia-Pacific region, and markets its products throughout the rest of the world either directly or through distributors.
The 2005 financial statement amounts have been restated due to an accounting error identified in 2007. The accounting error relates to application of branch accounting for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes". The impact of the restatement in 2005 resulted in an increase to income tax expense and a decrease to net income of $3.9 million. Refer to Note 19 in the Notes to the Consolidated Financial Statements for further discussion.
Executive Summary of 2007 Compared to 2006
The nature of the Company's operations as a global producer and supplier in the fluid power industry means the Company is impacted by changes in local economies, including currency exchange rate fluctuations. In order to gain a better understanding of the Company's base results, a financial statement user needs to understand the impact of those currency exchange rate fluctuations. The following table summarizes the change in the Company's results from operations by separately identifying changes due to currency fluctuations and the underlying change in operations from 2006 to 2007. This analysis is more consistent with how the Company's management internally evaluates results.
Net sales for the year ended December 31, 2007 increased 8 percent compared to the year ended December 31, 2006, excluding the effects of currency. Sales increased 10 percent excluding the effects of currency and the divestitures of product lines in Swindon, England and the DC motor business. Sales increased in all regions and segments. Excluding the impacts of currency and divestitures, sales grew 14 percent in Europe, 13 percent in Asia Pacific, and 5 percent in the Americas. Sales in the Controls segment were up 17 percent. Sales in the Propel and Work Function segments were up 8 percent.
Selling, general and administrative costs increased 3 percent during 2007 when compared to the same period in 2006, excluding the effects of currency. This increase is primarily attributed to $1.9 million costs related to the start-up of a European financial shared services center, as well as increasing headcount, particularly for sales and marketing functions. Research and development costs increased $5.2 million
excluding the impacts of currency, primarily driven by increasing product development, particularly in the Controls and Propel segments.
During the year ended December 31, 2007 the Company incurred a loss of $6.6 million related to the sale of the direct current (DC) electric motor business located in Berching, Germany and a loss of $2.4 million on the sale of the assets and product lines which were manufactured in Swindon, England. These activities were part of the Company's plan to divest of product lines that do not fit the Company's long-term strategic direction.
During the year ended December 31, 2007, the Propel and Controls segments incurred $10.4 million of restructuring costs primarily to relocate production lines to other production facilities within the Company and remaining costs to close the LaSalle, Illinois plant. Restructuring charges incurred during the year ended December 31, 2006 were $13.5 million, primarily related to restructuring in the Propel and Work Function segments.
Operating Results2007 Compared to 2006
Sales Growth by Market
The following table summarizes the Company's sales growth by market. The table and following discussion is on a comparable basis, which excludes the effects of currency fluctuations.
Sales into the agriculture/turf care markets increased 6 percent during the year ended December 31, 2007 compared to 2006. Agriculture sales in Europe continue to be strong as a result of strong markets and favorable commodity prices. Agriculture sales increased in the Americas due to strengthening commodity prices resulting partly from rapidly expanding ethanol production. Increased sales into the Americas agriculture market were offset by decreased sales into the turf care market, primarily driven by the decline in housing starts and concerns regarding the slowing economic conditions.
Sales into the construction/road building markets increased 4 percent during 2007. The increase is driven by a 13 percent increase in the European construction/road building market due primarily to strong economic conditions, as well as a 17 percent increase in Asia-Pacific due to continued strength in the Chinese road building market. The increases in Europe and Asia-Pacific are offset by decreases in the Americas region, which is primarily the result of a reduction in new housing starts.
Specialty vehicles are comprised of a variety of markets including forestry, material handling, marine, waste management and waste recycling. All regions contributed to the sales growth in the specialty markets. Growth in the forestry market, particularly in eastern Europe, and demand for aerial lifts in the Americas were major contributors to the overall 13 percent increase in sales in 2007.
Products related to all of the above markets are sold to distributors, who then serve smaller OEMs.
The following table shows the Company's order backlog and orders written activity for 2006 and 2007, separately identifying the impact of currency fluctuations.
Total order backlog at the end of 2007 was $921.4 million, compared to $631.0 million at the end of 2006. On a comparable basis, excluding the impact of currency fluctuation, order backlog increased 38 percent over 2006. New sales orders written for 2007 were $2,230.2 million, an increase of 11 percent over 2006, excluding the impact of currency fluctuations.
Backlog information can vary as customers alter their sales order patterns. The 11 percent increase in orders written in 2007 is reflective of the strong sales experienced during the year and backlog remains strong at the end of the year with over $920 million of customer orders received for future delivery.
Business Segment Results
The following discussion of operating results by reportable segment relates to information as presented in Note 18 in the Notes to Consolidated Financial Statements. Segment income is defined as the respective segment's portion of the total Company's net income, excluding net interest expense, income taxes, minority interest, and global service expenses. Propel products include hydrostatic transmissions and related products that transmit the power from the engine to the wheel to propel a vehicle. Work Function products include steering motors as well as gear pumps and motors that transmit power for the work functions of the vehicle. Controls products include electrohydraulic controls, microprocessors, electric drives and valves that control and direct the power of a vehicle.
The following table provides a summary of each segment's net sales and segment income, separately identifying the impact of currency fluctuations during the year.
The Propel segment experienced an 8 percent increase in sales, excluding the effects of currency fluctuations, during 2007. Segment income increased 26 percent during the same period. The Propel segment showed a 2 percentage point increase in operating profit margin during 2007. This increase is due partly to a $3.3 million reduction in restructuring costs classified in cost of goods sold.
Work Function Segment
Sales in the Work Function segment increased 6 percent, excluding the effects of currency fluctuations, during the year ended December 31, 2007. Despite the increase in sales, Work Function segment income decreased. Continued investment in a manufacturing improvement project in Denmark resulted in $4.1 million of charges. Operational issues contributed an additional $5.5 million of costs due primarily to increased order fulfillment charges and costs associated with work stoppages in Denmark. The weakening of the U.S. dollar during 2007 also had a negative impact on segment income as a result of product manufactured in euro-based countries and sold into the U.S. In March 2006, the Company announced plans to discontinue production of certain product lines manufactured in the Swindon, England plant. Expense of $3.5 million was recognized during the year ended December 31, 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 $2.4 million was recognized.
Net sales in the Controls segment for the year ended December 31, 2007, excluding the effects of currency fluctuations, increased 9 percent compared to 2006. Despite the increase in sales, segment income declined. The decline is mainly due to a loss of $6.6 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 motor business prior to the sale. Expediting and overtime costs of $9.6 million were also incurred due to increased demand for certain products in the Controls segment. Research and development costs increased $3.1 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 $12.0 million excluding the impacts of currency, or 20 percent. This is primarily due to a $7.4 million reduction in incentive costs during the year ended December 31, 2007, as well as a reduction of $2.5 million in costs associated with the implementation of the Company's common business system.
The Company's effective tax rate was 28.5 percent in 2007 compared to 24.0 percent in 2006.
The increase in the effective tax rate in 2007 is primarily related to unrecognized tax benefits of $2.2 million related to the sale of foreign assets.
Executive Summary of 2006 Compared to 2005
The following table summarizes the change in the Company's results from operations by separately identifying changes due to currency fluctuations and the underlying change in operations from 2005 to 2006. This analysis is more consistent with how the Company's management internally evaluates results.
The underlying growth in sales, excluding the effect of currency fluctuations, was approximately 12 percent in 2006. Sales were up in all regions and all segments with increases of 11 percent in the Americas, 13 percent in Europe and 12 percent in Asia-Pacific, excluding the impact of currency. The increase in sales was due to overall strong economic conditions, price increases and higher sales volumes. Gross profit margin on total net sales decreased due to several factors, including restructuring costs incurred, costs incurred for the transfer of production lines, labor costs for overtime worked to meet the high demand for product, and costs to expedite product to meet customer demand.
Selling, general and administrative costs decreased 1 percent during 2006 when compared to the same period in 2005. Costs associated with the implementation of a common company-wide business system were $13.7 million in 2006, a decrease of $3.4 million compared to 2005. Costs incurred in 2006 were related to implementation of the system at seven U.S. locations, one Danish location, two Slovakian locations as well as implementations in process in China, Italy and several Scandinavian sales companies. Outside service costs related to the assessment of internal controls under Section 404 of the Sarbanes-Oxley Act of 2002 also decreased $3.4 million. These reductions were partially offset by general price increases.
During the first quarter of 2006 the Company announced plans to close the LaSalle, Illinois plant, to discontinue the production of certain product lines currently manufactured in the Swindon, England plant, and to restructure certain activities in the Propel and Controls segments. The Company incurred a total of $13.5 million in restructuring charges in connection with these plans during 2006: $10.9 million was included in cost of sales, $0.5 million in selling, general and administrative expenses, and $2.1 million was loss on disposal of fixed assets. Costs incurred include employee termination costs of $3.8 million,
impairment and loss on disposal of fixed assets of $2.1 million, accelerated depreciation of $2.1 million, pension curtailment costs of $1.6 million, equipment moving costs of $1.4 million, and other costs of $2.5 million. The restructuring costs as a percent of sales were 0.8 percent in 2006.
In 2006 the Company recognized $5.7 million of other expense, primarily related to foreign currency losses. During 2005 the Company recognized $3.5 million of other income, primarily related to foreign currency gains. The combined negative currency impact of $9.0 million in 2006 is due to the weakening of the U.S. dollar throughout 2006.
Operating Results2006 Compared to 2005
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.
The turf care market in the U.S. was moderately strong through the first half of the year but declined during the last half of the year. The strengthening agriculture market in Brazil and the increasing commodity prices in the U.S. contributed to the increased sales in the agricultural market in the Americas. Sales in the European market increased slightly compared to 2005 due primarily to strengthening economic conditions, particularly in Germany. The Asia-Pacific region contributes less than 5 percent of the sales in the agriculture/turf care markets and therefore the decrease in the Asia-Pacific region does not significantly impact the total market.
All regions experienced sales increases in the construction/road building markets during 2006. Europe experienced the strongest growth at 20 percent. Increases in Europe are attributable to strengthening of the overall economy and strong export markets. The 6 percent increase in sales in the Americas region is primarily driven by strengthening economic conditions in Brazil as well as increased production of skid steer loaders and crawlers, particularly during the first half of the year. The Asia-Pacific market also benefited from the growth in the skid steer loader market, in addition to increased demand from the Chinese transit mixer market. The road building market in the Asia-Pacific region showed strong increases, mainly due to China's increased focus on infrastructure spending.
Specialty vehicles are comprised of a variety of markets including forestry, material handling, marine, waste management and waste recycling. All regions contributed to the sales growth in the specialty markets. Growth in the aerial lift market continues to be the main contributor to the overall 17 percent increase in sales in 2006.
Products related to all of the above markets are sold to distributors, who then serve smaller OEMs.
The following table shows the Company's order backlog and orders written activity for 2005 and 2006, separately identifying the impact of currency fluctuations.
Total order backlog at the end of 2006 was $631.0 million, compared to $504.2 million at the end of 2005. On a comparable basis, excluding the impact of currency fluctuation, order backlog increased 19 percent over 2005. New sales orders written for 2006 were $1,906.8 million, an increase of 16 percent over 2005, excluding the impact of currency fluctuations.
Business Segment Results
The following table provides a summary of each segment's net sales and segment income, separately identifying the impact of currency fluctuations during the year.
The Propel segment experienced strong growth in 2006, with a sales increase of 12 percent excluding the effects of currency fluctuations. Gross profit margin decreased 1.2 percent excluding the effects of currency fluctuations during 2006. The decrease in gross profit margin is primarily due to $8.3 million of restructuring charges. In March 2006 the Company announced plans to close the manufacturing facility in LaSalle, Illinois during 2006 along with certain other restructuring activities. Restructuring costs incurred in 2006 consist of employee termination costs of $1.6 million, pension curtailment charges of $1.6 million, accelerated depreciation of fixed assets of $2.1 million, and $3.0 million of other charges.
Work Function Segment
Sales in the Work Function segment increased 9 percent, excluding the effects of currency fluctuations during 2006. The gross profit margin increased 0.7 percent excluding the impacts of currency fluctuations during 2006. Segment income was negatively impacted by $3.5 million of restructuring costs. In March 2006 the Company announced plans to discontinue production of certain product lines manufactured in the Swindon, England plant resulting in recognizing $1.9 million of employee termination costs and $1.6 million of fixed asset impairment charges.
Net sales in the Controls segment, excluding the effects of currency fluctuations, increased 16 percent during 2006. The gross profit margin decreased 0.5 percent, excluding the impact of currency fluctuations, with increases through September 2006 offset by declines in the fourth quarter due to costs incurred for the introduction of new products. Despite increased sales, operating costs were $0.2 million lower primarily due to higher costs in 2005 for research and development spending for new products in the development stage as well as start-up costs related to a new production facility in India. The increase in sales, nearly flat margins and decreases in operating costs contributed to a 36 percent increase in segment income.
Global Services and other expenses, net
Global Services costs decreased $0.3 million in 2006 compared to the same period in 2005, excluding the effects of currency fluctuations. The Company incurred $5.8 million of losses on foreign currency transactions in 2006 compared to $3.2 million of gains on foreign currency transactions in 2005, which negatively affected other expenses by $9.0 million when comparing to the 2005 results. These increases were offset by a $3.4 million decrease in costs associated with the implementation of a common company-wide business system, decreased long-term incentive plan costs of $2.7 million, and a decrease of $3.4 million in outside service costs related to the assessment of internal controls under Section 404 of the Sarbanes-Oxley Act of 2002.
The Company's effective tax rate was 24.0 percent in 2006 compared to 30.0 percent in 2005.
The decrease in the effective tax rate is attributable to $5.7 million of tax benefits for the reversal of valuation allowances on deferred tax assets. These deferred tax assets were generated in prior years and no tax benefits were recognized.
The Company is naturally exposed to various market risks, including changes in foreign currency exchange rates and interest rates.
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 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 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.
In previous years, the Company had been well balanced between its U.S. and European operations because the Company generated its sales in the same country in which it incurred its expenses, or shipped products between geographic regions on a balanced basis. However, in recent years the balance has shifted and the amount of sales made in U.S. dollars has increased, whereas the production costs are in a currency other than the U.S. dollar, increasing the Company's exposure to transaction risk. In 2007 the Company sold a total of $167.9 million into the U.S. of product that had been produced in European-based currencies compared to sales into Europe of $68.0 million of product produced in U.S. dollars. This imbalance had a significant impact on the results of the Company. In 2007 the results were unfavorable as
the dollar weakened in comparison to other currencies. The Company produces and sells its product in several regions of the world, however the U.S. and European transactions comprise the majority of the imbalance between regions.
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. In 2007, as a result of hedge accounting for the forward contracts, the Company recognized an increase to net sales of $1.5 million and income of $0.6 million was recorded to offset gain on currency transactions. The fair value of forward contracts included on the balance sheet at December 31, 2007 was a net asset of $4.0 million.
The Company is also impacted by translation risk in terms of comparing results from period to period. Fluctuations of currencies against the U.S. dollar can be substantial and therefore, significantly impact comparisons with prior periods. Translation affects the comparability of both the income statement and the balance sheet. As shown in the table below, the translation impact on net sales was significant in 2007 due particularly to the strengthening of the euro against the U.S. dollar.
The change in the exchange rate does affect the comparability of the balance sheet between 2007 and 2006 as the balance sheet accounts are translated at the exchange rate as of December 31. The U.S. dollar weakened by 10 percent against the euro and 9 percent against the Danish kroner from December 31, 2006 to December 31, 2007. The weakening of the dollar has resulted in approximately 20 percent of the Company's total balance sheet being stated 10 percent higher than the prior year and 21 percent being stated 9 percent higher than the prior year.
Interest Rate Changes
The Company uses interest rate swap agreements on a limited basis to manage the interest rate risk on the total debt portfolio. The Company was a party to two interest rate swap agreements at December 31, 2007, with a combined notional amount of $34.4 million, that require the Company to pay interest at a fixed rate and receive interest at a variable rate. The fair value of the interest rate swap agreements is recorded as a liability of $0.4 million on the balance sheet at December 31, 2007, with the offset recorded in accumulated other comprehensive income as the derivatives are accounted for using hedge accounting. The interest rate swap agreements mature in October 2010 and December 2011.
The following table summarizes the maturity of the Company's debt obligations for fixed and variable rate debt (amounts in millions):
Liquidity and Capital Resources
The Company's principal sources of liquidity have been cash flow from operations and from its various credit facilities. The Company historically has accessed diverse funding sources, including short-term and long-term unsecured bank lines of credit in the United States, Europe, and Asia, as well as the private debt markets in the United States as discussed in Note 7 in the Notes to Consolidated Financial Statements. The Company expects to have sufficient sources of liquidity to meet its future funding needs due to the multiple funding sources that have been, and continue to be, available to the Company.
The Company's multicurrency revolving credit facility provides up to $300 million of unsecured credit through December 2010, as well as a 40 million euro (approximately $57.0 million) term loan which expires in July 2013. At December 31, 2007 the Company had $187.3 million outstanding under the revolving credit facility. The Company is required to meet certain financial covenants under this facility as described in Note 7 in the Notes to Consolidated Financial Statements. The Company was in compliance with the covenants at December 31, 2007 and is not aware of any circumstances currently that would impact compliance during the next twelve months.
Cash Flows from Operations
Cash provided by operations was $98.1 million in 2007. The Company used an additional $36.6 million, excluding the effect of currency, to fund increased inventories in 2007 in order to meet the anticipated increase in demand for product in early 2008. In addition, an increase in receivables of $38.5 million contributed to a use of cash due to the higher level of sales in the fourth quarter. These increases were offset by an increase in accounts payable of $11.0 million, partly due to the increase in inventory.
Total cash of the Company decreased $2.3 million from December 31, 2006 to December 31, 2007. At December 31, 2007 cash balances in China totaled $19.5 million, a decrease of $3.5 million from December 31, 2006. The Company is paying dividends from its Chinese entities to the maximum extent possible under current regulations; however, due to the nature of the governmental and other regulatory controls, it is difficult to move cash out of China for reasons other than payment for goods shipped into that country. As the Company continues to consider expanding its manufacturing capabilities in low-cost regions, it will make every effort to utilize the cash balances in those regions to fund future expansions. Total cash outside of China increased by $1.2 million in 2007.
Cash Used in Investing Activities
Capital expenditures for 2007 totaled $135.6 million. Capital expenditures increased primarily related to the addition of production capacity in order to meet current and anticipated future demand levels.
Cash Used in Financing Activities
The Company continues to pay dividends to stockholders on a quarterly basis with $33.6 million of cash used to pay dividends in 2007. In addition, the Company periodically makes distributions to its minority interest partners from its various joint venture activities with distributions totaling $15.9 million in 2007. The distributions can vary from year to year depending on the amount of undistributed earnings of the businesses and the needs of the partners. The Company borrowed an additional $71.4 million in 2007.
Contractual Cash Obligations
The majority of the Company's contractual obligations to make cash payments to third parties are for financing obligations. These include future lease payments under both operating and capital leases. The following table discloses the Company's future commitments under contractual obligations as of December 31, 2007:
The following assumptions are used in the calculation of the contractual cash obligations:
In addition to the above contractual obligations, the Company has certain other funding needs that are non-contractual by nature, including funding of certain pension plans. In 2008 the Company anticipates contributing $26.2 million to its pension and health benefit plans.
Critical Accounting Estimates
The SEC's guidance surrounding the disclosure of critical accounting estimates requires disclosures about estimates a company makes in applying its accounting policies. However, such discussion is limited to "critical accounting estimates," or those that management believes meet two criteria: 1) the accounting
estimate must require a company to make assumptions about matters that are highly uncertain at the time the accounting estimate is made, and 2) different estimates that the company reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the presentation of the company's financial condition, changes in financial condition or results of operations.
Besides the estimates that meet the two criteria for a "critical estimate" above, the Company makes many other accounting estimates in preparing its financial statements and related disclosures. All estimates, whether or not deemed critical, can affect the reported amounts of assets, liabilities, revenues, and expenses as well as disclosures of contingent assets and liabilities. Estimates are based on experience and information available prior to the issuance of the financial statements. Materially different results can occur as circumstances change and additional information becomes known, including estimates not deemed "critical" under the SEC's guidance.
The discussion below should be read in conjunction with disclosures elsewhere in this discussion and in the Notes to the Consolidated Financial Statements related to estimates, uncertainties, contingencies, and new accounting standards. Significant accounting policies are discussed in Note 1 to the Consolidated Financial Statements beginning on page IV-24. The development and selection of accounting estimates, including those deemed "critical," and the associated disclosures in this discussion, have been discussed by management with the audit committee of the Board of Directors.
Inventory ValuationAs a manufacturer in the capital goods industry, inventory is a substantial portion of the assets of the Company, amounting to over 20 percent of total assets at December 31, 2007. The Company must periodically evaluate the carrying value of its inventory to assess the proper valuation. This includes recording period adjustments as needed to 1) record expenses due to excess capacity, 2) provide for excess and obsolete inventory, and 3) ensure that inventory is valued at the lower of cost or market. On a quarterly basis, management within each segment performs an analysis of the underlying inventory to identify the need for appropriate write-downs to cover each of these items. In doing so, management applies consistent practices based upon historical data such as actual loss experience, past and projected usage, actual margins generated from trade sales of its products, and finally its best judgment to estimate the appropriate carrying value of the inventory.
Warranty ProvisionsThe Company warrants its various products over differing periods depending upon the type of product and application. Consequently, the Company records liabilities for the estimated warranty 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 sales of the products are recorded. Factors that affect the Company's warranty liability include the number of units in the field currently under warranty, historical and anticipated rates of warranty claims on those units and the cost per claim to satisfy the Company's warranty obligation. The anticipated rate of warranty claims is the primary factor impacting the Company's estimated warranty obligation. Each quarter, the Company reevaluates its estimates to assess the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
In addition to its normal warranty liability, the Company, from time to time in the normal course of business, incurs costs to repair or replace defective products with a specific customer or group of customers. The Company refers to these as "field recalls" and in these instances, the Company will record a specific provision for the expected costs it will incur to repair or replace these products utilizing information from customers and internal information regarding the specific cost of materials and labor. Typically, field recalls are infrequent in occurrence, however, when they occur, field recalls can be for a large number of units and quite costly to rectify. Because of the sporadic and infrequent nature of field recalls, and due to the range of costs associated with field recalls, the Company cannot accurately estimate these costs at the time the products are sold. Therefore, these costs are recorded at the time information
becomes known to the Company. As the field recalls are settled, the Company relieves the specific liability related to that field recall. These specific field recall liabilities are reviewed on a quarterly basis.
Long-Lived Asset RecoveryA significant portion of the Company's total assets consist of property, plant and equipment (PP&E) and definite life intangibles, as well as goodwill. Changes in technology or in the Company's intended use of these assets, as well as changes in the broad global economy in which the Company operates, may cause the estimated period of use or the carrying value of these assets to change.
This requires the Company to periodically assess the estimated useful lives of its assets in order to match, through depreciation and amortization, the cost of those assets with the benefits derived over the period of usefulness. The useful lives of these assets can be shortened through greater use due to volume increases, rapidly changing technology such as the use of electronics and computer-operated controls, and through inadequate maintenance. Despite management's best efforts to determine the appropriate useful lives of its equipment, certain situations may arise that lead to an asset or group of assets becoming impaired, meaning their economic value becomes less than the value at which the Company is carrying the asset on its books. Examples of these situations are product rationalization efforts or restructuring of manufacturing facilities. When these situations arise, the Company tests the assets for impairment and will write down the asset in the period when the impairment becomes known. In addition, goodwill is tested for impairment at least annually. As of December 31, 2007 a ten percent change in the depreciable lives of the Company's assets would impact depreciation expense by approximately $10.0 million.
Valuation of Trade ReceivablesThe Company records trade receivables due from its customers at the time a sale is recorded in accordance with its revenue recognition policy. The future collectibility of these amounts can be impacted by the Company's collection efforts, the financial stability of its customers, and the general economic climate in which it operates. The Company applies a consistent practice of establishing an allowance for accounts that it believes may become uncollectible through reviewing the historical aging of its receivables, looking at the historical losses incurred as a percentage of net sales, and by monitoring the financial strength of its customers. In addition, local customary practices have to be taken into account due to varying payment terms being applied in various parts of the world where the Company conducts its business. If the Company becomes aware of a customer's inability to meet its financial obligations (e.g., where it has filed for bankruptcy), the Company establishes a specific allowance for the potential bad debt to reduce the net recognized receivable to the amount it reasonably believes will be collected. The valuation of trade receivables is performed quarterly.
Workers CompensationThe Company has an insurance policy to cover workers compensation claims in the United States, in which the Company pays the first $0.25 million per claim, per incident. The Company establishes its workers compensation reserve based on historic growth factors of claims and an estimate of incurred, but not reported claims. This analysis is performed on a quarterly basis.
U.S. Health Care CostsThe Company self insures its U.S. health care costs for eligible employees and their qualified dependents with exposure for any one year, excluding prescription costs, limited to $0.2 million per individual. The Company establishes reserves for its health care cost based on historic claims data and an estimate of incurred, but not reported claims. This analysis is performed on a quarterly basis.
PensionsThe Company has noncontributory defined benefit pension plans for a portion of its employees. In certain countries, such as the United States and the United Kingdom, these plans are funded with plan assets whereas in other countries such as Germany, the plans have historically been unfunded, which is customary. In 2007 the Company started contributing to the German pension plans. The measurement of the Company's pension obligations and costs is dependent on a variety of assumptions determined by management and used by the Company's actuaries. These assumptions include estimates of the present value of projected future pension payments to all plan participants, taking into consideration the likelihood of potential future events such as salary increases and other experience. These
assumptions may have an effect on the amount and timing of future contributions. The plan trustee conducts an independent valuation of the fair value of pension plan assets.
The assumptions used in developing the required estimates include the following key factors:
The Company bases the discount rate assumption on investment yields available at or near year-end on corporate long-term bonds rated AA. The inflation assumption is based on an evaluation of external market indicators. The salary growth assumptions reflect the Company's long-term actual experience, the near-term outlook and assumed inflation. The expected return on plan assets reflects asset allocations, investment strategy, and the views of investment managers and other large pension plan sponsors. Retirement and mortality rates are based primarily on actual plan experience and standard industry actuarial tables, respectively. The effects of actual results differing from our assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense in such future periods.
The Company's funding policy for the U.S. plans are to contribute amounts sufficient to meet the minimum funding requirement of the Employee Retirement Income Security Act of 1974, plus any additional amounts the Company may deem to be appropriate. In 2008 the Company anticipates contributing $2.3 million to its U.S. plans, $16.2 million to its German plans, and $5.0 million to its U.K. plans.
Postretirement Benefits Other Than PensionsThe Company provides postretirement health care benefits for certain employee groups in the United States. This plan is contributory and contains certain other cost-sharing features such as deductibles and coinsurance. The Company does not pre-fund this plan and has the right to modify or terminate this plan in the future.
The postretirement liability, which is determined on an actuarial basis, is recognized in the Company's Consolidated Balance Sheets and the postretirement expense is recognized in the Consolidated Statements of Income. The Company must determine the actuarial assumption for the discount rate used to reflect the time value of money in the calculation of the accumulated postretirement benefit obligation for the end of the current year and to determine the postretirement cost for the subsequent year. For guidance in determining this rate, the Company looks at investment yield trends available near year-end on corporate bonds rated AA. In addition, the Company must determine the actuarial assumption for the health care cost trend rate used in the calculation of the accumulated postretirement benefit obligation for the end of the current year and to determine the net periodic postretirement benefit cost for the subsequent year. As of December 31, 2007 a one-percentage-point change in the assumed health care cost trend rate would impact the expense recognized in 2007 by $0.2 million and would affect the postretirement benefit obligation by $2.8 million. In 2008 the Company anticipates contributing $2.7 million to this plan.
Deferred Income Taxes and Valuation AllowancesTax regulations may require items to be included in the tax return at different times than the items are reflected in the financial statements. Some of the differences are permanent, such as expenses that are not deductible on a tax return, and some of the differences are temporary such as the rate of depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally are attributable to items that can be used as a tax deduction or credit in a tax return in future years but the amount has already been included as an expense in the financial statements. Deferred tax liabilities generally represent deductions that have been taken on the tax return but have not been recognized as expense in the financial statements. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.
New Accounting Policies
The Company adopted the provisions of SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of Financial Accounting Standards Board (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 $29.3 million. The decrease was incorrectly reported as a component of comprehensive income in the 2006 Consolidated Statement of Stockholders' Equity and Comprehensive Income. The decrease due to adopting the statement should have been reported as a direct adjustment to accumulated other comprehensive income. The presentation has been corrected in the Consolidated Statements of Stockholders' Equity and Comprehensive Income on page IV-22.
In June 2006 the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxesan 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 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. 063, "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 2007. Taxes collected from customers and remitted to governmental authorities are presented net in the consolidated financial statements.
In September 2006 FASB issued 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 2008 the FASB issued FASB Staff Position (FSP) No. 157-2, "Effective Date of FASB Statement No. 157." FSP No. 157-2 delays the effective date of SFAS No. 157, except for items that are recognized or disclosed at fair value at least once a year, to fiscal years beginning after November 15, 2008.
In February 2007 the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement No. 115." SFAS No. 159 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 years beginning after November 15, 2007. The Company does not expect the adoption of SFAS 159 to have a significant impact on the consolidated financial statements.
In December 2007 the FASB issued SFAS No. 141R "Business Combinations." SFAS No. 141R replaces SFAS No. 141, and establishes requirements for recognition and measurement of identifiable assets acquired, liabilities assumed, noncontrolling interest of the acquiree, goodwill acquired, and gain from bargain purchase. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the annual reporting period beginning on or after December 15, 2008. The Company does not expect the adoption of SFAS No. 141R to have a significant impact on the consolidated financial statements.
In December 2007 the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51." SFAS No. 160 was issued to improve the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company is currently evaluating the impact that SFAS No. 160 will have on its consolidated financial statements and disclosures.
Non-Audit Services of Independent Registered Public Accounting Firm
The Company's Independent Registered Public Accounting Firm, KPMG LLP, performed the following non-audit services that have been approved by the Audit Committee of the Board of Directors: international tax planning and compliance services, expatriate tax services for persons not in a financial reporting oversight role, and statutory audits and related matters.
Management of the Company anticipates sales growth in 2008 with the European and Asia-Pacific markets showing the strongest growth. The implementation of the Company's common business system will be substantially complete by the end of 2008, with implementation at the Company's Swedish, Japanese, and U.K. locations occurring during the first half of 2008, followed by the remaining sales companies and smaller plants.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
(1) Summary of Significant Accounting Policies:
Basis of Presentation and Principles of Consolidation
Sauer-Danfoss Inc., a U.S. Delaware corporation, 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 of mobile equipment, including construction, road building, agricultural, turf care, material handling, and specialty vehicle equipment. The Company's products are sold throughout the world either directly or through distributors.
The consolidated financial statements represent the consolidation of all companies in which the Company has a controlling interest and are stated in accordance with accounting principles generally accepted in the United States. All significant intercompany balances, transactions, and profits have been eliminated in the consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates.
Net sales are recorded when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectibility is reasonably assured. Estimates for future warranty expense are recorded when the related revenue is recognized. Timing of revenue recognition is consistent with when the risks and rewards of ownership and title to the product have transferred to the customer.
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. At December 31, 2007 cash and cash equivalents balances in China totaled approximately $20,000. The Company is paying dividends from its Chinese entities to the maximum extent possible under current regulations; however, due to the nature of the governmental and other regulatory controls it is difficult to move cash out of this country for reasons other than payment for goods shipped into the country.
The Company records trade receivables due from its customers at the time sales are recorded in accordance with its revenue recognition policy. The future collectibility of these amounts can be impacted by the Company's collection efforts, the financial stability of its customers, and the general economic climate in which it operates. The Company applies a consistent practice of establishing an allowance for accounts that it believes may become uncollectible through reviewing the historical write-offs of accounts,
Sauer-Danfoss Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2007, 2006, and 2005
(Dollars in thousands, except per share data)
(1) Summary of Significant Accounting Policies: (Continued)
aging of its receivables, and by monitoring the financial strength of its customers. If the Company becomes aware of a customer's inability to meet its financial obligations (e.g., where it has filed for bankruptcy), the Company establishes a specific allowance for the potential bad debt to reduce the net recognized receivable to the amount it reasonably believes will be collected. The valuation of trade receivables is performed quarterly.
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 last-in, first-out (LIFO) method was adopted in 1987 and is used to value inventories at the U.S. locations which existed at that time. Inventories at all of the non-U.S. locations and the U.S. locations obtained through acquisition after 1987, which produce products different than those produced at U.S. locations existing at 1987, are valued under the first-in, first-out (FIFO) inventory valuation method. The percentage of year-end inventory valued under the LIFO and FIFO cost methods was 14% and 86%, respectively, for 2007, and 19% and 81%, respectively, for 2006.
Property, Plant and Equipment and Depreciation
Property, plant and equipment are stated at historical cost, net of accumulated depreciation. Depreciation is generally computed using the straight-line method for building equipment and buildings over 10 to 37 years and for machinery and equipment over 3 to 8 years (3 to 12 years for additions in 1999 and prior). Additions and improvements that substantially extend the useful life of a particular asset are capitalized. Repair and maintenance costs ($45,482, $41,729, and $38,697 in 2007, 2006, and 2005, respectively) are charged to expense. When property, plant and equipment are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in the consolidated statements of income.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the estimated fair values of net assets acquired in the purchase of businesses. The Company accounts for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," which requires that goodwill is not amortized, but tested for impairment at least annually. Intangible assets consist primarily of trade names, technology, and customer relationships and are recorded at fair value at the time of acquisition. Intangible assets are amortized on a straight-line basis over their estimated useful lives, which range from three to thirty five years.
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 sales of the products are recorded. Factors that affect the Company's warranty liability include the number of units in the field
Sauer-Danfoss Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2007, 2006, and 2005
(Dollars in thousands, except per share data)
(1) Summary of Significant Accounting Policies: (Continued)
currently under warranty, historical and anticipated rates of warranty claims on those units and the cost per claim to satisfy the Company's warranty obligation. The anticipated rate of warranty claims is the primary factor impacting the Company's estimated warranty obligation.
In addition to its normal warranty liability, the Company, from time to time in the normal course of business, incurs costs to repair or replace defective products with a specific customer or group of customers. The Company refers to these as field recalls and in these instances, the Company records a specific provision for the expected costs it will incur to repair or replace these products utilizing information from customers and internal information regarding the specific cost of materials and labor. Due to the sporadic and infrequent nature of field recalls, and the potential for a range of costs associated with field recalls, the Company cannot accurately estimate these costs at the time the products are sold. Therefore, these costs are recorded at the time information becomes known to the Company. As the field recalls are carried out, the Company relieves the specific liability related to that field recall. These specific field recall liabilities are reviewed on a quarterly basis. The following table represents the change in the Company's accrued warranty liability:
Impairment of Long-Lived Assets and Assets to be Disposed Of
Consistent with the requirements of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," 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 to be held and used is evaluated based on the expected future undiscounted operating cash flows. When events or circumstances indicate the carrying value of an asset or group of assets is impaired, the Company recognizes an impairment loss to the extent that the carrying value of the assets exceeds the fair value of the assets. In 2006 the Company recognized an impairment of long-lived assets to be disposed of related to restructuring activity in the Work Function segment of approximately $1,500 (see Notes 3 and 14 for more information).
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
Sauer-Danfoss Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Continued)
December 31, 2007, 2006, and 2005
(Dollars in thousands, except per share data)
(1) Summary of Significant Accounting Policies: (Continued)
Company's assets and liabilities, net operating loss carryforwards, and tax credit carryforwards and are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when the Company is unable to conclude that realization of the deferred tax assets is more likely than not.