Overview

Baldor is a leading manufacturer of industrial electric motors, drives, generators, and other mechanical power transmission products, currently supplying over 9,000 customers in more than 160 industries. Our products are sold to a diverse customer base consisting of original equipment manufacturers and distributors serving markets in the United States and throughout the world. We focus on providing customers with value through a combination of quality products and customer service, as well as short lead times and attractive total cost of ownership, which takes into account initial product cost, product life, maintenance costs and energy consumption.

On August 29, 2008, Baldor acquired Poulies Maska, Inc. (Maska) of Ste-Claire, Quebec, Canada. The purchase price was $43.2 million which was funded with cash and borrowings under the revolving credit facility. Maska is a designer, manufacturer and marketer of sheaves, bushings, couplings and related mechanical power transmission components. The acquisition gives Baldor a second plant in both Canada and China and expands the Company's market share of sheaves and bushings in North America. The Company's consolidated financial statements include the results of operations of Maska beginning August 30, 2008.

Generally, our financial performance is driven by industrial spending and the strength of the economies in which we sell our products, and is also influenced by:

• Investments in manufacturing capacity, including upgrades, modifications, and expansions of existing manufacturing facilities, and the creation of new manufacturing facilities;

• Our customers' needs for greater variety, timely delivery, and higher quality at a competitive cost; and

• Our large installed base, which creates a significant replacement demand.

We are not dependent on any one industry or customer for our financial performance, and no single customer represented more than 10% of our net sales for the quarters and nine months ended October 3, 2009, and September 27, 2008. For the quarters ended October 3, 2009 and September 27, 2008, domestic net sales generated through distributors, representing primarily sales of replacement products, amounted to 52.4% and 49.7% of total product sales, respectively. For the nine month periods ended October 3, 2009 and September 27, 2008, domestic net sales generated through distributors amounted to 49.2% and 49.1%, respectively. Domestic sales to OEMs were approximately 47.6% and 50.3% of total domestic product sales for the quarters ended October 3, 2009 and September 27, 2008, respectively. For the nine month periods ended October 3, 2009 and September 27, 2008, domestic sales to OEMs were approximately 50.8% and 50.9%, respectively. OEMs primarily use our products in new installations. This expands our installed base and leads to future replacement product sales through distributors.

We manufacture substantially all of our products. Consequently, our costs include the cost of raw materials, including steel, copper and aluminum, and energy costs. Should these costs increase and our sales prices are not adjusted, our margins are negatively impacted. We seek to offset increases through a continued focus on product design improvements, including redesigning our products to reduce material content and investing in capital equipment that assists in eliminating waste, hedging of certain raw material prices, and by modest price increases in our products. Our manufacturing facilities are also significant sources of fixed costs. Our margins are negatively impacted to the extent we cannot promptly decrease these costs to match declines in net sales. During the first nine months of 2009, we have been successful in reducing our fixed costs to partially offset the margin impact of declining sales in 2009.

Industry Trends

The demand for products in the power transmission equipment industry is closely tied to growth trends in the economy and levels of industrial activity and capital investment. We believe that specific drivers of demand for our products include process automation, efforts in energy conservation and productivity improvement, regulatory and safety requirements, new technologies and replacement of worn parts. Our products are typically critical parts of customers' end-applications, and the end user's cost associated with their failure is high. Consequently, we believe that end users of our products base their purchasing decisions on quality, reliability, efficiency and availability as well as customer service, rather than the price alone. We believe key success factors in our industry include strong reputation and brand preference, good customer service and technical support, product availability, and a strong distribution network.

Business conditions continued to be challenging during the third quarter with sales declining approximately 25% from record third quarter 2008 sales. During third quarter 2009, sales to distributors improved slightly from second quarter 2009. While our distributor customers are not restocking inventories yet, it appears that destocking has come to an end and distributor order rates improved as the quarter progressed. The improvement in distributor sales was offset by further declines in sales to OEM customers and recent order rates lead us to believe this trend will continue in the fourth quarter. In addition, fourth quarter 2009 consists of 13 weeks of sales and production compared to 14 weeks in the same period last year. As a result, we expect fourth quarter 2009 overall sales to be down in a range of 20% - 25% from fourth quarter 2008.

International sales of approximately $62.9 million for the third quarter of 2009 were down 26.7% from the same period last year and comprised 16.5% of total product sales for the quarter compared to 17.0% for the same period last year. The smallest decline occurred in Asia Pacific and the largest occurred in Europe.

We continue to manage our inventories to match current business levels. During the third quarter of 2009, we reduced total inventories approximately $22.8 million, bringing our year-to-date reduction to $56.5 million. Having the appropriate quantities and mix of finished goods inventories is a competitive advantage for us, particularly as our distributors adjust their inventories. Effective management of our inventories allows us to maximize working capital utilization for debt reduction and take advantage of sales opportunities when they are presented. We continue to manage our inventories in a way that will not negatively impact our customers or inhibit our ability to take advantage of new order opportunities. Our manufacturing systems and proximity to our customers allow us to adjust inventories up or down quickly as incoming order rates change.

During the fourth quarter of 2008, we began implementing cost reduction initiatives across the Company, and began accelerating integration projects related to our recent acquisitions. Through the third quarter of 2009, we are on track to achieve more than $92 million of cost reductions for fiscal year 2009. We expect these cost reductions to amount to approximately $115 million on an annual basis. Our proactive cost reduction achievements combined with continued productivity improvements are evident in our sequentially improving operating margins during the first three quarters of 2009 when compared to fourth quarter 2008. We expect our operating margin to continue to improve in the fourth quarter. As part of our acceleration of integration projects in April 2009, we announced the consolidation of two of our manufacturing facilities into other existing facilities in the United States. We expect these consolidations to provide annual cost savings of approximately $9.0 million at a one-time cost of approximately $5.0 million. These consolidations were substantially completed during the second and third quarters of 2009 and will be finalized during fourth quarter of 2009.

We have also implemented a bounty hunt sales strategy targeted to obtain specifically identified new customers in 2009. Our broad product offering, continuous introduction of new products, and our manufacturing flexibility allows us to serve new customers quickly when business from our existing customers slows.

We believe it is unlikely that we are at risk of failing step one of the annual goodwill impairment test. However, the fair value of one of our indefinite-lived intangibles exceeds the carrying value by approximately 3.1%. Should business conditions not improve in the near future, it is reasonably possible that this indefinite-lived intangible could be impaired. We believe, as a result of our continued new product development, sales initiatives, cost reductions, and continued debt repayment, that we are well positioned to capitalize on opportunities as economic conditions improve.

Results of Operations

Third quarter 2009 compared to third quarter 2008

Net sales for the quarter decreased 24.8% to $380.4 million, compared to $506.2 million in 2008. Sales of industrial electric motor products decreased 27.4% for the quarter as compared to third quarter 2008 and comprised 63.4% of total sales for the quarter compared to 65.6% for the same period last year. Sales of mounted bearings, gearing, and other mechanical power transmission products, decreased 21.3% for the quarter as compared to third quarter 2008 and comprised 29.1% of total sales compared to 27.8% for the same period last year. Sales of other products decreased 13.8% for the quarter as compared to third quarter 2008 and

comprised 7.5% of total sales for the quarter compared to 6.6% for the same period last year. While sales of Super-E® premium-efficient motors declined 3.7% for the quarter, they increased to 14.9% of total motor sales. We expect sales of premium-efficient motors to continue to outperform standard-efficiency motors as customers prepare for the December 2010 implementation of the 2007 Energy Independence and Security Act (EISA). Once the EISA takes effect in 2011, we expect sales of premium-efficient products to be approximately 50% of our total motor sales.

Gross profit margin increased to 30.2% in the third quarter of 2009 compared to 29.0% in the third quarter 2008 and operating profit margin increased to 13.8% from 12.2% in the third quarter 2008. Third quarter 2009 manufacturing costs included approximately $1.5 million of one-time costs related to the consolidations of our Ft. Mill, SC and Columbus, IN manufacturing facilities into other existing facilities in the U.S. As a result of continued product design improvements, reduction of waste, and price improvement in certain commodities, our materials cost as a percentage of sales improved in the third quarter of 2009 when compared to the same period last year. In addition, we achieved significant manufacturing cost reductions during the third quarter of 2009 when compared to third quarter 2008. These cost reductions combined with the improvement in materials costs more than offset the impact of decreased net sales and one-time restructuring costs, resulting in improved gross profit margin. As we did in manufacturing, we realized reductions in selling and administrative overhead costs from our cost reduction initiatives. These reductions combined with materials and manufacturing reductions offset the impact of decreased net sales and resulted in improved operating margin when compared to third quarter 2008. In addition, third quarter 2009 operating profit margin included approximately $3.7 million gain (approximately 1% of operating profit margin) on sale of long-lived property.

Interest expense increased $5.3 million over third quarter 2008. While we have benefitted from reducing our outstanding debt balance, interest rates on our variable rate debt increased as a result of the March 31, 2009 amendment of our senior secured credit facility. Pre-tax income of $20.3 million for third quarter 2009 decreased 47.3% compared to third quarter 2008 pre-tax income of $38.5 million. Pre-tax income for the third quarter 2009 includes $2.5 million noncash debt discount amortization expense related to the modification of our senior secured credit facility completed March 31, 2009. The total discount of approximately $49.7 million is being amortized over the remaining term of the credit facility which matures January 31, 2014.

The difference between the Company's effective tax rate and the federal statutory tax rate for the three and nine months ended October 3, 2009, and September 27, 2008, relates to state income taxes, permanent differences, changes in management's assessment of the outcome of certain tax matters, and the composition of pre-tax income between domestic and international operations. The significant permanent tax items primarily consist of the deduction for domestic production activities and nondeductible expenses.

Our effective income tax rate was 37.9% in third quarter 2009 compared to 33.0% in third quarter 2008. The change between the effective tax rate during the 3-months ended October 3, 2009 and September 27, 2008 primarily results from a change in the estimated effective state tax rate and adjustments to certain deferred tax items.

Net income of $12.6 million decreased 51.2% from third quarter 2008 net income of $25.8 million. Diluted earnings per common share decreased 50.9% to $0.27 compared to $0.55 in third quarter 2008. Average diluted shares outstanding was 47.0 million for third quarter 2009 compared to 46.6 million for third quarter 2008.

Nine months ended October 3, 2009 compared to nine months ended September 27, 2008

Net sales for the first nine months of 2009 decreased 21.1% to $1,167.7 million, compared to $1,480.7 million in the first nine months of 2008. Sales of industrial electric motor products decreased 21.2% for the first nine months of 2009 as compared to the first nine months of 2008 and comprised 65.2% of total sales compared to 65.3% for the same period last year. Sales of mounted bearings,

gearing, and other mechanical power transmission products, decreased 20.8% for the first nine months of 2009 as compared to the first nine months of 2008 and comprised 28.6% of total sales compared to 28.5% for the same period last year. The first nine months of sales for 2009 include approximately $17.8 million from the operations of Maska compared to $2.7 million in 2008 for the period beginning August 29, 2008. Sales of other products decreased 22.1% for the first nine months of 2009 as compared to the first nine months of 2008 and comprised 6.2% of total sales for both periods. Sales of Super-E® premium-efficient motors grew 10.7% for the first nine months of 2009 when compared to the same period last year and comprised 13.8% of total motor sales. We believe premium-efficient motors will continue to become a larger portion of total product sales as customers prepare for the December 2010 implementation of the 2007 Energy Bill.

Gross profit margin decreased to 29.1% in the first nine months of 2009 compared to 29.9% in the first nine months of 2008 and operating profit margin decreased to 12.1% from 13.3% for the same period. Improved materials costs combined with manufacturing cost reductions have partially offset the impact of decreased net sales on our gross profit margin. Our materials cost improvements and reductions in manufacturing and selling and administrative overhead costs realized in the first nine months of 2009, helped to partially offset the impact of decreased net sales on our operating margin.

Interest expense increased $5.0 million over the first nine months of 2008. While we have benefitted from approximately $87.9 million of net debt repayment during the first nine months of 2009, increased interest rates resulting from the March 31, 2009 amendment of our senior secured credit facility have increased our interest expense. Pre-tax income of $91.6 million for the first nine months of 2009 decreased 26.4% compared to $124.5 for the first nine months of 2008. Pre-tax income for the first nine months of 2009 includes a $35.7 million noncash gain and $5.0 million noncash debt discount amortization expense, resulting from the modification of our senior secured credit facility completed on March 31, 2009. These amounts are included in income from continuing operations.

The difference between the Company's effective tax rate and the federal statutory tax rate for the three and nine months ended October 3, 2009, and September 27, 2008, relates to state income taxes, permanent differences, changes in management's assessment of the outcome of certain tax matters, and the composition of pre-tax income between domestic and international operations. The significant permanent tax items primarily consist of the deduction for domestic production activities and nondeductible expenses.

Our effective income tax rate was 38.0% in the first nine months of 2009 compared to 35.1% in the first nine months of 2008. The change between the effective tax rate during the 9-months ended October 3, 2009 and September 27, 2008 primarily results from changes in statutory tax rates in certain international tax jurisdictions and additional valuation allowances for net operating loss carryforwards generated by foreign affiliates.

Net income of $56.8 million, including $21.6 million, net of tax, related to the gain on debt modification, decreased 29.7% from the first nine months of 2008 net income of $80.8 million. Diluted earnings per common share of $1.22, including $0.47 related to the gain on debt modification, decreased 29.9% compared to $1.74 in the first nine months of 2008. Average diluted shares outstanding was 46.7 million for the first nine months of 2009 compared to 46.4 million for the first nine months of 2008.

Environmental Remediation: We believe, based on our internal reviews and other factors, that any future costs relating to environmental remediation and compliance will not have a material effect on our capital expenditures, earnings, cash flows, or competitive position.

Liquidity and Capital Resources: Our primary sources of liquidity are cash flows from operations and funds available under our senior secured revolving credit facility. We expect that ongoing requirements for working capital, capital expenditures, dividends, and debt service will be adequately funded from these sources. At October 3, 2009, we had no outstanding borrowings under the revolving credit facility. We have approximately $180.3 million of borrowing capacity under the senior secured revolving credit facility which matures in 2012. The current financial market conditions have not affected our ability to borrow from our revolving credit facility.

Cash flows from operations amounted to $151.7 million in the first nine months of 2009 and $62.3 million in the first nine months of 2008. Reductions in inventories, particularly during the second and third quarters, contributed $56.4 million to operating cash flows in the first nine months of 2009.

Net cash used in investing activities was $26.0 million in the first nine months of 2009 and related primarily to capital expenditures. Net cash used in investing activities was $42.5 million for the first nine months of 2008. During the first nine months of 2008, we funded capital expenditures of $25.4 million and funded $40.4 million for the acquisition of Maska. The first nine months of 2008 included proceeds from the sale of real estate of $23.3 million.

Financing activities in the first nine months of 2009 included dividends paid to shareholders of $31.6 million, amendment fees of $7.3 million to amend our senior secured credit agreement, and net debt payments of $87.9 million. Due to the timing of our quarter end, we funded the fourth quarter 2008 dividend in addition to the first quarter 2009 dividend during first quarter 2009. Financing activities for the first nine months of 2008 included dividends paid to shareholders of $23.5 million and net debt payments of $38.8 million. Borrowings of $40.0 million to fund the acquisition of Maska are included in the 2008 net debt payments.

We have a corporate family credit rating of BB- and senior secured debt rating of Ba3 with a negative outlook by Moody's Investors Services, Inc. ("Moody's"). We have a long-term issuer credit rating of B1 and senior secured debt rating of BB+ with a negative outlook by Standard & Poor's Rating Service ("S&P"). We have senior unsecured debt ratings of B3 by Moody's and B by S&P. Both ratings agencies recently affirmed our ratings, and Moody's upgraded our liquidity rating from SGL-3 to SGL-2, following the successful amendment of our credit agreement on March 31, 2009. Our senior secured credit facility has a downward rating trigger that increases the margin paid on variable rate borrowings from 3.25% to 3.50% for any period during which our Moody's corporate family rating is below BB- or our S&P long-term issuer rating is below B1. We have no downward rating triggers that would accelerate the maturity of amounts drawn under our senior secured credit facility. Also, we have no downward rating triggers under our senior unsecured notes.

Our senior secured credit facility and senior unsecured notes contain various customary covenants, which limit, among other things, indebtedness and dispositions of assets, and which require us to maintain compliance with certain quarterly financial ratios. The primary financial ratios in our credit agreement are total leverage (total debt/EBITDA, as defined) and senior secured leverage (senior secured debt/EBITDA, as defined). We have maintained compliance with all covenants and were in compliance at October 3, 2009. Our total leverage ratio and senior secured leverage ratios were 3.84x and 2.14x, respectively, at October 3, 2009. These were within our maximum covenant requirements of 5.25x and 2.75x, respectively.

On March 31, 2009, we amended our senior secured credit facility. The amendment relaxed our total leverage and senior secured leverage ratio requirements and will help to ensure we maintain sufficient headroom under our covenants as we navigate through the current economic recession. In conjunction with the amendment, the margin applied to LIBOR on our variable term loan and revolver borrowings was increased to 3.25%, and a LIBOR floor of 2.00% was implemented.

The amendment of the senior secured term loan was considered a substantial modification of the debt. As a result, the senior secured term loan was recorded at fair value as of the modification date which resulted in a noncash debt discount of $49.7 million being recorded in long-term obligations on the condensed consolidated balance sheet and a $35.7 million gain on debt modification included in income from continuing operations in the condensed consolidated statement of income. Fees paid related to the amendment of $5.7 million along with unamortized fees related to the original agreement of $8.3 million were considered when calculating the gain. The discount is being amortized to other expense over the remaining term of the debt. Amortization amounted to $2.5 million and $5.0 million, respectively, for the three and nine months ended October 3, 2009.

The amendment did not change the borrowing capacity of the revolving credit facility; therefore, fees of $1.6 million related to the amendment were deferred and are being amortized over the remaining term of the facility agreement and unamortized fees of $1.1 million related to the original agreement continue to be amortized over the remaining term.

As a result of the senior secured credit facility amendment, pricing on the outstanding term loan borrowings and future revolver borrowings was increased from 1.75% to 3.25% and a LIBOR floor of 2.00% was added to the variable rate borrowings.

The table below summarizes Baldor's contractual obligations related to long-term debt as of October 3, 2009.

                                                                      Payments due by years
(In thousands)                             Total       Less than 1      1 - 3       3 - 5      More than 5
Contractual Obligations:
Long-term debt obligations (a)          $ 1,791,091   $     105,590   $ 210,314   $ 806,456   $     668,731

(a) Includes interest on both fixed and variable rate obligations. Interest associated with variable rate obligations is based upon interest rates in effect at October 3, 2009. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.

Dividend Policy: Dividends paid to shareholders amounted to $0.51 per common share in the first nine months of 2009 and 2008. Our objective is for shareholders to receive dividends while also participating in Baldor's growth. The terms of our credit agreement and indenture limit our ability to increase dividends in the future.

Recently Issued Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued guidance that establishes a framework for measuring fair value in U.S. generally accepted accounting principles and expands disclosures about fair value measurements. In February 2008, the FASB issued guidance that delayed the effective date for nonfinancial assets and liability, except for those recognized or disclosed at fair value on a recurring basis. The Company adopted the guidance at the beginning of 2009 and the adoption did not have a material impact on the consolidated financial statements.

In December 2007, the FASB issued guidance that establishes principles and requirements on how an acquirer recognizes and measures in its financial statements identifiable assets acquired, liabilities assumed, non-controlling interest in the acquiree, goodwill or gain from a bargain purchase and accounting for transaction costs. Additionally, the guidance determines what information must be disclosed to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The Company adopted the guidance at the beginning of 2009.

In March 2008, the FASB issued guidance that expands disclosure requirements about how derivative and hedging activities affect an entity's financial position, financial performance, and cash flows. It became effective for fiscal years beginning after November 15, 2008; therefore, the Company adopted the guidance during the first quarter of fiscal 2009. See Note C: Financial Derivatives for required disclosures.

In April 2009, the FASB issued guidance that requires disclosures about fair value of financial instruments in interim financial statements. The Company adopted the guidance during the second quarter of 2009. See Note L: Fair Value Measurements for required disclosures.

In May 2009, the FASB issued guidance which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. It became effective on a prospective basis for interim or annual financial periods ending after June 15, 2009 and the adoption did not have a material impact on the consolidated financial statements and disclosures. See Note A, "Basis of Presentation" above for required disclosures.