
<PAGE>   1
                                                                      Exhibit 13

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

Year Ended June 30, 1997 vs 1996
--------------------------------
Sales in 1997 increased 1.4% to $1,160.3 million from 1996 sales of $1,143.7
million. The lower level of sales increase resulted from an overall slowing in
certain industries which exhibited strength in the prior year, particularly in
certain traditionally cyclical industries. The decline in sales growth was also
affected by the sale of the Dixie Bearings Aircraft Division during the first
quarter of fiscal 1997. The Company expects to continue expanding its business
through strategic acquisitions. The Company also expects to grow revenues
through sales of additional products to customers who traditionally relied on
the Company for bearing products.
   Gross margin (net sales less cost of sales) as a percent of sales increased
to 26.4% in 1997 from 25.8% in 1996. The increase in the gross margin resulted
from an increase in favorable LIFO cost adjustments (see Note 5 to the
Consolidated Financial Statements) and from changes in the product mix, as sales
of lower margin bearing products declined and sales of non-bearing products with
higher margins continued to grow.
   Selling, distribution and administrative expenses as a percent of sales were
22.0% in 1997 and 21.5% in 1996. The increase in expenses as a percent of sales
was primarily the result of increased compensation and health care costs.
   Operating income increased to $50.6 million in 1997 from $49.3 million in
1996. As a percent of sales, operating income increased to 4.4% in 1997 from
4.3% in 1996. This improved operating margin resulted from higher gross margins
on sales.
   Interest expense for 1997 decreased $2.5 million or 28% as a result of
decreased borrowings.
   Income tax expense as a percentage of income before income taxes decreased to
39.9% in 1997 from 42.9% in 1996. The decrease in the effective tax rate
resulted from lower effective state and local income tax rates and from Federal
income tax credits.
   Net income for the fiscal year ended June 30, 1997 improved 16.1% over the
prior year. 
   The number of associates was 4,101 at June 30, 1997 and 4,133 at June 30, 
1996.

Year Ended June 30, 1996 vs 1995
--------------------------------
Sales in 1996 increased 8% to $1,143.7 million from 1995 sales of $1,054.8
million. The sales increase was approximately 4% due to price increases and 4%
due to volume increases. In 1996, the Company continued to implement its
strategy, which began in 1992, of selling additional products to its existing
customers, as well as better penetration of the market with products beyond the
traditional bearing product lines.
   Gross margin, as a percent of sales was 25.8% in 1996 and 1995. Margins
remained constant, even though the benefits from favorable LIFO cost adjustments
were significantly lower in 1996 than 1995 (see Note 5 to the Consolidated
Financial Statements). The lower LIFO benefits were offset by a change in
product mix.
   Selling, distribution and administrative expenses as a percent of sales were
21.5% in 1996 and 22.3% in 1995. The decrease in expenses as a percent of sales
was the result of a continued effort to control expenses and improve
productivity. While these expenses decreased as a percent of sales, they did
increase 5% in absolute dollars primarily due to higher compensation costs from
an increase in the number of associates, costs associated with acquisitions and
the accelerated vesting of Performance Accelerated Restricted Stock (PARS) based
upon the price performance of the Company's common stock during the year.
   Operating income increased to $49.3 million in 1996 from $36.9 million in
1995. As a percent of sales, operating income increased to 4.3% in 1996 from
3.5% in 1995. This improved operating margin resulted from higher sales volume
and improved productivity.
   Interest expense for 1996 increased $1.3 million as a result of increased
borrowings and higher interest rates on short-term debt. 
   Income tax expense as a percentage of income before income taxes was 42.9% in
1996 and 43.0% in 1995. 
   Net income for the fiscal year ended June 30, 1996 improved 38% over the 
prior year. 
   The number of associates was 4,133 at June 30, 1996 and 4,080 at June 30, 
1995.

Liquidity and Working Capital
-----------------------------
The Company generated cash from operating activities of $41.8 million and $36.4
million in 1997 and 1996, respectively.
   Cash flow from operations depends primarily upon generating operating income,
controlling the investment in inventory and receivables, and managing the timing
of payments to suppliers.
   The Company is obligated for rental payments for operating leases on 175 of
its 347 branch, distribution center and other operating locations. (See Note 11
to the Consolidated Financial Statements for annual rental commitments.)


<PAGE>   2

   Investments in property totaled $21.6 million and $23.5 million in 1997 and
1996, respectively. These capital expenditures were primarily made for building
and upgrading branch and distribution center facilities, furniture and equipment
for the new corporate headquarters facility in Cleveland, vehicles and data
processing equipment. A new company-owned distribution center in Atlanta opened
in September 1996 and a new Fort Worth, Texas build-to-suit distribution center
financed under an operating lease opened in May 1997. Working capital at June
30, 1997, was $164.7 million compared to $151.9 million at June 30, 1996. This
increase is primarily due to increased cash provided from operations, the
receipt of proceeds from the sale of the Aircraft Division, and the refund of
insurance deposits. The current ratio was 2.4 at June 30, 1997 and 2.1 at June
30, 1996.

Capital Resources
-----------------
Capital resources are obtained from income retained in the business,
indebtedness under the Company's lines of credit and long-term debt and from
operating lease arrangements.
   Average combined short-term and long-term borrowing was $89.4 million in 1997
and $111.8 million in 1996. Effective interest rates on short-term borrowings
were 6.3% in 1997 and 6.2% in 1996. The Company has short-term lines of credit
with commercial banks totaling $155 million. The Company had $25.4 million of
borrowings under these bank short-term lines of credit at June 30, 1997. The
Company also has an agreement with the Prudential Insurance Company of America
for an uncommitted shelf facility to borrow up to $50 million in additional
long-term financing, at its sole discretion, with terms ranging from seven to
twenty years. The entire $50 million is available for future financing needs as
no borrowings have been made as of June 30, 1997.
   The Company sold its Dixie Bearings Aircraft Division business in August
1996. The Company received proceeds from the sale of $9.1 million which were
used to reduce short-term borrowings.
   The Board of Directors has authorized the purchase of up to 158,000 shares of
the Company's Common Stock during fiscal 1998 and beyond to fund employee
benefit programs and stock option and award programs. These purchases can be
made in open market or negotiated transactions, from time to time, depending
upon market conditions. Under a previous Board authorization, the Company
acquired 150,500 shares of its Common Stock for $4.1 million during the year
ended June 30, 1997.
   Management expects that capital resources provided from operations, available
lines of credit, long-term debt and operating leases will be sufficient to
finance normal working capital needs, business acquisitions, enhancement of
facilities and equipment and the purchase of additional Company Common Stock.
Management also believes that additional long-term debt and line of credit
financing could be obtained if desired.

Other Matters
-------------
Effective August 1, 1997, the Company completed the acquisition of Invetech
Company, a privately held industrial distributor based in Detroit, Michigan. The
aggregate purchase price including the issuance of 2.1 million shares of Company
Common Stock was $93.9 million. The cash portion of the purchase price of $23.4
million was financed through available short-term lines of credit. The Company
expects to incur a pre-tax nonrecurring charge of approximately $4.0 million in
the quarter ending September 30, 1997 for consolidation expenses and costs
associated with the disposal of duplicative capital assets. (See Note 2 to the
Consolidated Financial Statements.)
   The 1990 agreement for the acquisition of King Bearing included specific
indemnification of Applied Industrial Technologies, Inc. and King for any
financial damages or losses related to a lawsuit pending against King in the
Superior Court of Orange County, California. The indemnification was also
guaranteed by the ultimate parent of King's former owner, a Fortune 500 company
with stockholders' equity exceeding five billion dollars at June 30, 1997. As
further explained in Note 12 to the Consolidated Financial Statements,
management believes that the outcome of this matter will not have a material
adverse effect on the consolidated financial position or results of operations
of the Company due to the indemnification and guarantee.

<PAGE>   3

<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------------------------
STATEMENTS OF CONSOLIDATED INCOME




                                                       Applied Industrial Technologies, Inc. and Subsidiaries

                                                                                           Year Ended June 30

                                                                      1997             1996              1995
(Thousands, except per share amounts)

 ...........................................................................................................................
<S>                                                             <C>              <C>               <C>       
NET SALES                                                       $1,160,251       $1,143,749        $1,054,809
 ...........................................................................................................................
COST AND EXPENSES
   Cost of sales                                                   854,230         848,682            783,105
   Selling, distribution and administrative                        255,422          245,786           234,781
 ...........................................................................................................................
                                                                 1,109,652        1,094,468         1,017,886
 ...........................................................................................................................
OPERATING INCOME                                                    50,599           49,281            36,923
 ...........................................................................................................................
Interest Expense                                                     6,463            8,975             7,650
Interest Income                                                       (956)             (528)             (386)
 ...........................................................................................................................
                                                                     5,507            8,447             7,264
 ...........................................................................................................................
INCOME BEFORE INCOME TAXES                                          45,092           40,834            29,659
 ...........................................................................................................................
INCOME TAX EXPENSE
   Federal                                                          15,700           14,250            10,630
   State and local                                                   2,300            3,250             2,120
 ...........................................................................................................................
                                                                    18,000           17,500            12,750
 ...........................................................................................................................
NET INCOME                                                      $   27,092       $   23,334        $   16,909
---------------------------------------------------------------------------------------------------------------------------
NET INCOME PER SHARE                                            $     2.19       $     1.90        $     1.46
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

See notes to consolidated financial statements.

<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------------------------
                                                                                                CONSOLIDATED BALANCE SHEETS

                                                                     Applied Industrial Technologies, Inc. and Subsidiaries

                                                                                                            June 30

                                                                                                    1997              1996
(Amounts in thousands)
 ...........................................................................................................................
<S>                                                                                             <C>               <C>     
ASSETS
   Current assets
     Cash and temporary investments                                                             $ 22,405          $  9,243
     Accounts receivable, less allowance of $2,400                                               153,080           155,524
     Inventories                                                                                 103,069           127,937
     Other current assets                                                                          6,905             2,434
 ...........................................................................................................................
   Total current assets                                                                          285,459           295,138
 ...........................................................................................................................
   Property - at cost
     Land                                                                                         12,281            13,529
     Buildings                                                                                    66,157            64,441
     Equipment                                                                                    81,132            71,938
 ...........................................................................................................................
                                                                                                 159,570           149,908
     Less accumulated depreciation                                                                68,809            63,574
 ...........................................................................................................................
   Property - net                                                                                 90,761            86,334
 ...........................................................................................................................
   Other assets                                                                                   17,894            22,600
 ...........................................................................................................................
      TOTAL ASSETS                                                                              $394,114          $404,072
---------------------------------------------------------------------------------------------------------------------------
LIABILITIES
   Current liabilities
     Notes payable                                                                              $ 25,415          $ 30,056
     Current portion of long-term debt                                                            11,429            11,429
     Accounts payable                                                                             49,469            67,652
     Compensation and related benefits                                                            19,025            19,081
     Other current liabilities                                                                    15,398            14,964
 ...........................................................................................................................
   Total current liabilities                                                                     120,736           143,182
   Long-term debt                                                                                 51,428            62,857
   Other liabilities                                                                              14,366             8,741
 ...........................................................................................................................
      TOTAL LIABILITIES                                                                          186,530           214,780
 ...........................................................................................................................
SHAREHOLDERS' EQUITY
   Preferred stock - no par value; 2,500
     shares authorized; none issued or outstanding
   Common stock - no par value; 30,000 shares
     authorized; 13,954 shares issued                                                             10,000            10,000
   Additional paid-in capital                                                                     10,311             7,528
   Income retained for use in the business                                                       216,642           197,232
   Treasury shares - at cost (1,541 and 1,577 shares)                                            (22,983)          (21,260)
   Shares held in trust for deferred compensation plans                                           (5,436)           (3,008)
   Unearned restricted common stock compensation                                                    (950)           (1,200)
 ...........................................................................................................................
      TOTAL SHAREHOLDERS' EQUITY                                                                 207,584           189,292
 ...........................................................................................................................
      TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                                                $394,114          $404,072
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

See notes to consolidated financial statements.

<PAGE>   4

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
STATEMENTS OF CONSOLIDATED CASH FLOWS



                                                                     Applied Industrial Technologies, Inc. and Subsidiaries

                                                                                                                Year Ended June 30

                                                                                           1997             1996              1995
(Amounts in thousands)
 ..................................................................................................................................
<S>                                                                                 <C>               <C>              <C>   
CASH FLOWS FROM OPERATING ACTIVITIES
   Net income                                                                       $27,092           $23,334          $16,909
   Adjustments to reconcile net income to cash provided by operating activities:
     Depreciation                                                                    13,574            13,478           13,275
     Deferred income taxes                                                            1,900            (1,444)          (3,345)
     Provision for losses on accounts receivable                                      1,743             2,123            1,710
     Gain on sale of property                                                          (921)           (1,119)          (1,412)
     Amortization of restricted common stock
      compensation and goodwill                                                         857             1,959              680
     Treasury shares contributed to employee
      benefit and deferred compensation plans                                         4,372             4,496            3,935
   Changes in current assets and liabilities, net of acquisitions and dispositions:
     Accounts receivable                                                             (2,315)           (9,132)         (16,313)
     Inventories                                                                     18,868           (12,889)          (5,075)
     Other current assets                                                            (4,471)            1,722               (4)
     Accounts payable and accrued expenses                                          (18,949)           13,908            2,548
   Other - net                                                                                                             513
 ..................................................................................................................................
NET CASH PROVIDED BY OPERATING ACTIVITIES                                            41,750            36,436           13,421
 ..................................................................................................................................
CASH FLOWS FROM INVESTING ACTIVITIES
   Property purchases                                                               (21,579)          (23,536)         (15,055)
   Proceeds from property sales                                                       6,898             4,803            4,081
   Proceeds from sale of Dixie Bearings Aircraft Division                             9,090
   Acquisition of businesses, less cash acquired                                                       (4,328)          (1,852)
   Deposits and other                                                                 4,234            (7,729)            (164)
 ..................................................................................................................................
NET CASH USED IN INVESTING ACTIVITIES                                                (1,357)          (30,790)         (12,990)
 ..................................................................................................................................
CASH FLOWS FROM FINANCING ACTIVITIES
   Borrowings (repayments) under:
     Line-of-credit agreements - net                                                 (4,641)           11,481           (1,230)
     Long-term debt                                                                 (11,429)           (5,714)
   Exercise of stock options                                                          1,089             1,781            3,924
   Dividends paid                                                                    (7,682)           (6,528)          (5,397)
   Purchases of treasury shares                                                      (4,568)           (2,212)          (3,874)
 ..................................................................................................................................
NET CASH USED IN FINANCING ACTIVITIES                                               (27,231)           (1,192)          (6,577)
 ..................................................................................................................................
   Increase (decrease) in cash
     and temporary investments                                                       13,162             4,454           (6,146)
   Cash and temporary investments
     at beginning of year                                                             9,243             4,789           10,935
 ..................................................................................................................................
CASH AND TEMPORARY INVESTMENTS
   AT END OF YEAR                                                                   $22,405           $ 9,243          $ 4,789
----------------------------------------------------------------------------------------------------------------------------------

Supplemental Cash Flow Information Cash paid during the year for:
     Income taxes                                                                   $19,107           $17,842          $14,827
     Interest                                                                       $ 6,873           $ 8,291          $ 8,411
</TABLE>

See notes to consolidated financial statements.


<PAGE>   5

<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------
                                                          STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY
                                                                            



                                                   Applied Industrial Technologies, Inc. and Subsidiaries

                                                         For the Years Ended June 30, 1997, 1996 and 1995

                                                                                                         
                                                                                  Income                 
                                       Shares of                Additional  Retained for     Treasury    
                                    Common Stock       Common      Paid-in    Use in the    Shares-at     
                                     Outstanding        Stock      Capital      Business         Cost     
(Thousands, except per share amounts)                                                                    
 .........................................................................................................
<S>                                       <C>         <C>           <C>         <C>           <C>         
BALANCE AT JULY 1, 1994                   11,319      $10,000       $6,962      $165,807      ($32,278)   
   Net income                                                                     16,909                 
   Cash dividends - $.47 per share                                                (5,397)                
   Purchases of common stock for treasury   (180)                                               (3,874)   
   Treasury shares issued for:                                                                           
     401(k) Savings Plan contributions       140                     1,124                       1,788   
     Exercise of stock options               225                     1,565                       2,789   
     Restricted common stock awards          138                     1,232                       1,727   
     Deferred compensation plans              46                       428                         595   
   Amortization of restricted                                                                            
     common stock compensation                                                                           
   Other                                                                              83                 
 .........................................................................................................
BALANCE AT JUNE 30, 1995                                                                                 
   As previously reported                 11,688       10,000       11,311       177,402       (29,253)   
   Pooling of interests                                                                                  
     with Engineered Sales                   486                    (6,499)        3,024         6,408   
 .........................................................................................................
BALANCE AS RESTATED                       12,174       10,000        4,812       180,426       (22,845)   
   Net income                                                                     23,334                 
   Cash dividends - $.54 per share                                                (6,528)                
   Purchases of common stock for treasury    (86)                                               (2,212)   
   Treasury shares issued for:                                                                           
     Retirement Savings Plan contributions   138                     1,692                       1,805   
     Exercise of stock options               107                       391                       1,390   
     Restricted common stock awards            1                        13                          19   
     Deferred compensation plan               43                       416                         583   
   Amortization of restricted                                                                            
     common stock compensation                                         204                               
   Increase in fair value of shares                                                                      
     held in trust                                                                                       
 .........................................................................................................
BALANCE AT JUNE 30, 1996                  12,377       10,000        7,528       197,232       (21,260)   
   Net income                                                                     27,092                 
   Cash dividends - $.62 per share                                                (7,682)                
   Purchases of common stock for treasury   (166)                                               (4,568)   
   Treasury shares issued for:                                                                           
     Retirement Savings Plan contributions   109                     1,809                       1,568   
     Exercise of stock options                52                       342                         747   
     Restricted common stock awards            6                        68                          67   
     Deferred compensation plans              35                       532                         463   
   Amortization of restricted                                                                            
     common stock compensation                                          32                               
   Increase in fair value of shares 
     held in trust                                                        
 .........................................................................................................
Balance at June 30, 1997                  12,413      $10,000      $10,311       $216,642     ($22,983)   
---------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>

                                               Shares Held       Unearned                    
                                              in Trust for     Restricted                    
                                                  Deferred         Common            Total   
                                              Compensation          Stock    Shareholders'   
                                                     Plans   Compensation           Equity  
 .........................................................................................    
<S>                                                <C>           <C>           <C>           
BALANCE AT JULY 1, 1994                                                        $150,491      
   Net income                                                                    16,909      
   Cash dividends - $.47 per share                                               (5,397)     
   Purchases of common stock for treasury                                        (3,874)     
   Treasury shares issued for:                                                               
     401(k) Savings Plan contributions                                            2,912      
     Exercise of stock options                                                    4,354      
     Restricted common stock awards                              ($2,959)                    
     Deferred compensation plans                   ($1,023)                                  
   Amortization of restricted                                                                
     common stock compensation                                       326            326      
   Other                                              (403)                        (320)     
 .........................................................................................    
BALANCE AT JUNE 30, 1995                                                                     
   As previously reported                           (1,426)       (2,633)       165,401      
   Pooling of interests                                                                      
     with Engineered Sales                                                        2,933      
 .........................................................................................    
BALANCE AS RESTATED                                 (1,426)       (2,633)       168,334      
   Net income                                                                    23,334      
   Cash dividends - $.54 per share                                               (6,528)     
   Purchases of common stock for treasury                                        (2,212)     
   Treasury shares issued for:                                                               
     Retirement Savings Plan contributions                                        3,497      
     Exercise of stock options                                                    1,781      
     Restricted common stock awards                                  (32)                    
     Deferred compensation plan                       (999)                                  
   Amortization of restricted                                                                
     common stock compensation                                     1,465          1,669      
   Increase in fair value of shares                                                          
     held in trust                                    (583)                        (583)     
 .........................................................................................    
BALANCE AT JUNE 30, 1996                            (3,008)       (1,200)       189,292      
   Net income                                                                    27,092      
   Cash dividends - $.62 per share                                               (7,682)     
   Purchases of common stock for treasury                                        (4,568)     
   Treasury shares issued for:                                                               
     Retirement Savings Plan contributions                                        3,377      
     Exercise of stock options                                                    1,089      
     Restricted common stock awards                                 (135)                    
     Deferred compensation plans                      (995)                                  
   Amortization of restricted                                                                
     common stock compensation                                       385            417      
   Increase in fair value of shares held                                                     
     in trust                                       (1,433)                      (1,433)     
 .........................................................................................    
BALANCE AT JUNE 30, 1997                           ($5,436)        ($950)      $207,584      
-----------------------------------------------------------------------------------------    
                                                                             
See notes to consolidated financial statements.

</TABLE>

<PAGE>   6

--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                          Applied Industrial Technologies, Inc. and Subsidiaries

                                        Years Ended June 30, 1997, 1996 and 1995

(Dollar amounts in thousands, except per share amounts)

 ................................................................................

1.   Business and Accounting Policies

Name Change
-----------
In October 1996, shareholders approved a change in the Company's name from
Bearings, Inc. to Applied Industrial Technologies, Inc. effective January 1,
1997.

Business
--------
The Company distributes bearings, electrical and mechanical drive systems
products, fluid power products and systems, industrial rubber products, general
maintenance products and related specialty items. The Company offers technical
application support for these products and provides creative solutions to help
customers minimize downtime and reduce overall procurement costs. Although the
Company does not generally manufacture the products it sells, it does assemble
and repair certain products and systems. Most of the Company's sales are in the
maintenance and replacement markets, to customers in a wide range of industries
principally in the United States.

Consolidation
-------------
The consolidated financial statements include the accounts of Applied Industrial
Technologies, Inc. and its wholly-owned subsidiaries. All significant
intercompany transactions and balances have been eliminated in consolidation.

Estimates
---------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities at the date of the
financial statements and the reported amount of revenues and expenses during the
period. Actual results may differ from the estimates and assumptions used in
preparing the consolidated financial statements.

Cash Equivalents
----------------
The Company considers all temporary investments with maturities of three months
or less to be cash equivalents for purposes of the statements of consolidated
cash flows.

Goodwill
--------
Goodwill is recorded for the purchase price of acquired operations in excess of
the fair value of identifiable net assets. Goodwill is amortized on a
straight-line basis over 15 to 20 years.

Inventories
-----------
Inventories are valued at the lower of cost or market, using the last-in,
first-out (LIFO) method. (See Note 5 for further information regarding
inventories.)

Depreciation
------------
Depreciation of buildings and equipment is computed using the straight-line
method over the estimated useful lives of the assets. Buildings and related
improvements are depreciated over 10 to 30 years and equipment over 3 to 8
years.
<PAGE>   7

Income Taxes
------------
Income taxes are determined based upon income and expenses recorded for
financial reporting purposes. Deferred income taxes are recorded for estimated
future tax effects of differences between the bases of assets and liabilities
for financial reporting and income tax purposes giving consideration to enacted
tax laws.

Net Income Per Share
--------------------
Net income per share is computed using the weighted average number of common
shares outstanding for the period. Net income per share has not been adjusted
for the effect of stock options as the dilutive effect would be less than 3% for
each year. All shares and per-share data have been restated to reflect a
three-for-two stock split effective December 4, 1995.
   In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share.
This statement simplifies the current standard for computing earnings per share
(EPS). At June 30, 1997, the Company had stock options outstanding, which would
currently have a less than 3% dilution effect for reporting Diluted EPS under
SFAS No. 128. SFAS No. 128 becomes effective for interim and annual financial
statements beginning in the second quarter of fiscal 1998; earlier application
is not permitted.

2.   Subsequent Event - Acquisition

Effective August 1, 1997, the Company completed the acquisition of the Invetech
Company (Invetech), a distributor of bearings, mechanical and electrical drive
system products, industrial rubber products and specialty maintenance and repair
products. The aggregate purchase price including the issuance of 2.1 million
shares of Company Common Stock was $93,900. The cash portion of the purchase
price of $23,400 includes a $10,000 escrow account and was financed through
available short-term lines of credit.
   The Company will account for the acquisition as a purchase and will include
Invetech's results of operations from the effective date of the acquisition in
its fiscal 1998 financial statements. The Company expects to incur a pre-tax
nonrecurring charge of approximately $4,000 in the quarter ending September 30,
1997 for consolidation expenses and costs associated with disposal of
duplicative capital assets.
   Unaudited pro forma combined net sales, net income and net income per share
for the year ended June 30, 1997 giving effect to the acquisition as if it
occurred at the beginning of the year would have been $1,481,200, $29,100 and
$2.01, respectively. This unaudited pro forma information includes adjustments
resulting from the allocation of the purchase price to the net assets of
Invetech based on a preliminary analysis of the fair value of assets and
liabilities assumed. The unaudited pro forma amounts do not include the expected
pre-tax nonrecurring charge of approximately $4,000 or any potential expense
reductions from the consolidation of certain facilities and administrative
functions of the two companies. The unaudited pro forma financial information is
not necessarily indicative of results of operations had the acquisition been
made at July 1, 1996 or of future results of operations.

3.   Business Combinations

In February 1996, the Company exchanged 486,000 shares of the Company's Common
Stock for all of the outstanding shares of Engineered Sales, Inc., a distributor
of hydraulic, pneumatic and electro-hydraulic components, systems and related
fluid power engineering services. This business combination was accounted for as
a pooling of interests. The fiscal 1996 consolidated financial statements
include results of operations of Engineered Sales for the entire fiscal year.
The fiscal 1995 consolidated financial statements have not been restated as the
effects are not material. Separate 1996 results of operations for Engineered
Sales prior to the acquisition are not presented as the amounts are not
material.
   In addition, during fiscal 1996, the Company acquired the assets of a
distributor of drive products and a distributor of rubber products, for a total
of $4,328. During fiscal 1995, the Company acquired the assets of a distributor
of fluid power products, and of a distributor of bearings and drive systems
products, for a total of $3,255. The acquisitions of these businesses were
accounted for as purchases and their results of operations are included in the
accompanying consolidated financial statements from their respective acquisition
dates. Results of operations for these acquisitions are not material for all
periods presented. Goodwill recognized in connection with these combinations is
being amortized over 15 years.

4.   Sale of Division

In August 1996, the Company sold the Dixie Bearings Aircraft Division located in
Atlanta, Georgia to Aviation Sales Company for $9,090. The assets were sold at
their approximate net book value. The sale did not have a material effect on the
consolidated financial statements.


<PAGE>   8

5.   Inventories

Current Cost
------------
The current cost of inventories exceeds the LIFO cost as follows:

<TABLE>
<CAPTION>
                                                                                          June 30          
                                                                                                           
                                                                                  1997             1996    
                                                                                                           
          ................................................................................................ 
<S>                                                                             <C>              <C>       
          LIFO cost                                                             $103,069         $127,937  
          Excess of current cost over LIFO cost                                   98,740          100,835  
          ................................................................................................ 
          Current cost                                                          $201,809         $228,772  
          ------------------------------------------------------------------------------------------------ 
</TABLE>
           
LIFO Liquidations

During the years ended June 30, 1997, 1996 and 1995, the Company liquidated LIFO
inventory quantities carried at lower costs prevailing in prior years. The
effect of these liquidations reduced cost of sales and increased net income and
net income per share, respectively, by $3,022, $1,754, and $.14 per share during
1997; $946, $515, and $.04 per share during 1996; and $3,127, $1,692 and $.15
per share during 1995.

6.   Other Assets

Other assets consist of the following:
<TABLE>
<CAPTION>
                                                                                            June 30        
                                                                                                           
                                                                                    1997             1996  
                                                                                                           
          ...............................................................................................  
<S>                                                                              <C>             <C>       
          Deposits and investments                                               $9,225          $12,024   
          Goodwill - net of amortization                                          5,080            5,281   
          Other                                                                   3,589            5,295   
          ...............................................................................................  
          Total                                                                 $17,894          $22,600   
          -----------------------------------------------------------------------------------------------  
          
</TABLE>

Substantially all investments are restricted and consist of money-market or
similar liquid investments which have fair values approximately equal to their
carrying values.

7.   Notes Payable and Long-Term Debt

Notes Payable
-------------
The Company has $155,000 of short-term lines of credit which require payment of
interest at various interest rate options, none of which is in excess of the
banks' prime rate at interest determination dates. Borrowings under these lines
of credit totaled $25,415 at June 30, 1997. The remaining unused lines available
for short-term borrowings at June 30, 1997 totaled $129,585.

Long-Term Debt
--------------
The Company has $62,857 of long-term Senior Unsecured Term Notes, including
$11,429 due during fiscal 1998. Interest is payable quarterly at a fixed
interest rate of 7.82%. The principal amount is to be paid in semi-annual
installments of $5,714 through 2003. These notes contain certain restrictive
covenants regarding liquidity, tangible net worth, financial ratios and other
covenants. At June 30, 1997, the most restrictive of these covenants required
that the Company maintain a minimum tangible net worth of $130,128. Based upon
current market rates for debt of similar maturities, the Company estimates that
the fair value of its long-term debt is more than its carrying value at June 30,
1997 by approximately $1,000.
   The Company has entered into an agreement with Prudential Insurance Company
of America for an uncommitted shelf facility enabling the Company to borrow up
to $50,000 in additional long-term financing. The Company may make long-term
borrowings at its sole discretion, with terms ranging anywhere from seven to
twenty years under this agreement. At June 30, 1997, there were no borrowings
under this agreement.
<PAGE>   9

Interest Rate Swaps
-------------------
Effective March 1, 1996, the Company entered into a two-year interest rate swap
agreement with a major bank that effectively converts $15,000 of variable rate
borrowings to a fixed rate. Under this agreement, the Company receives payments
at variable rates based on LIBOR as determined at monthly intervals and makes
payments at a fixed interest rate of 5.29%. The agreement is accounted for using
the settlement method in which the periodic net cash settlements are recognized
in interest expense when they accrue. The interest rate swap agreement had a
nominal fair value at June 30, 1997.
   During fiscal 1995, the Company terminated a two-year interest rate swap
agreement initiated in fiscal 1994. Costs to terminate were amortized to
interest expense over the original term of the swap agreement.

8.   Income Taxes

Provision
---------
The provision (benefit) for income taxes consists of:

<TABLE>
<CAPTION>

                                                                             Year Ended June 30            
                                                                                                           
                                                                  1997              1996             1995  
                                                                                                           
          ................................................................................................ 
<S>                                                            <C>               <C>              <C>      
          Current                                              $16,100           $18,944          $16,095  
          Deferred                                               1,900            (1,444)          (3,345) 
          ................................................................................................ 
          Total                                                $18,000           $17,500          $12,750  
          ------------------------------------------------------------------------------------------------ 
          
</TABLE>

The exercise of non-qualified stock options during fiscal 1997, 1996 and 1995
resulted in $368, $501 and $431, respectively, of income tax benefits to the
Company derived from the difference between the market price at the date of
exercise and the option price. Also, the accelerated vesting of Performance
Accelerated Restricted Stock (PARS) in fiscal 1997 and 1996 resulted in $32 and
$204, respectively, of income tax benefits. These tax benefits were credited to
additional paid-in capital.

Effective Tax Rates
-------------------
The following is a reconciliation between the federal statutory income tax rate
and the Company's effective tax rate:

<TABLE>
<CAPTION>

                                                                              Year Ended June 30             
                                                                                                             
                                                                   1997              1996             1995   
                                                                                                             
          .................................................................................................  
<S>                                                                <C>               <C>              <C>    
           Statutory tax rate                                      35.0%             35.0%            35.0%  
           Effects of:                                                                                       
              State and local income taxes                          3.3               5.2              4.7   
              Non-deductible expenses                               1.5               2.0              2.3   
              Other, net                                             .1                .7              1.0   
          .................................................................................................  
           Effective tax rate                                      39.9%             42.9%            43.0%  
          -------------------------------------------------------------------------------------------------  
</TABLE>

Balance Sheet   
-------------
The significant components of the Company's deferred tax assets (liabilities)
are as follows: 

<TABLE>
<CAPTION>
                                                                              June 30
                                                                       1997             1996   
                                                                                                         
          .............................................................................................. 
<S>                                                                            <C>              <C>      
          Depreciation and differences in property bases                       $(4,846)         $(4,618) 
          Inventory                                                             (8,440)          (8,301) 
          Compensation liabilities not currently deductible                      4,760            5,623  
          Reserves not currently deductible                                      4,103            4,327  
          Goodwill                                                               1,283            1,393  
          Other                                                                    408              744  
          .............................................................................................. 
          Net deferred tax liability                                           $(2,732)         $  (832) 
          ---------------------------------------------------------------------------------------------- 
</TABLE>
          

Certain balances from fiscal year 1996 have been reclassified to be consistent
with fiscal 1997.
<PAGE>   10

9.   Stock Incentive Plans

The 1990 Long-Term Performance Plan (the "1990 Plan") provides for granting of
stock options, stock awards, cash awards, and such other awards or combinations
as the Executive Organization and Compensation Committee of the Board of
Directors may determine. The number of shares of Common Stock which may be
awarded in each fiscal year under the 1990 Plan is two percent (2%) of the total
number of shares of Common Stock outstanding on the first day of each year for
which the plan is in effect. Common Stock available for distribution under the
1990 Plan, but not distributed, may be carried over to the following year.
Shares available for future grants at June 30, 1997 were 144,698 and 125,129 at
June 30, 1996.
   Under the 1990 Plan, the Company has awarded PARS and stock options to
officers and other key associates. PARS recipients are entitled to receive
dividends and have voting rights on their respective shares but are restricted
from selling or transferring the shares prior to vesting. The restricted stock
vests after a period of six years, with accelerated vesting based upon
achievement of certain return on asset objectives or minimum stock price levels.
The aggregate fair market value of the restricted stock is considered unearned
compensation at the time of grant and is amortized over the six-year vesting
period or until such time as acceleration of vesting takes place. In fiscal 1997
and 1996, the Company recognized accelerated vesting of 5,000 and 64,000 shares,
respectively, of previously awarded PARS. The stock options vest over a period
of 4 years and expire after 10 years.
   At June 30, 1997, the Company has a fixed stock option plan as described
above. The Company applied APB Opinion No. 25 and related interpretations in
accounting for options granted under the 1990 Plan; accordingly, no compensation
cost has been recognized for stock options granted. Had compensation cost for
the Company's stock options been determined based on fair value at the grant
dates for awards under the 1990 Plan consistent with the method of FASB No. 123,
the Company's net income and earnings per share would have been reduced to
$26,502 and $2.14 in 1997 and $22,984 and $1.87 in 1996.
   Disclosures under the fair value method are estimated using the Black Scholes
option pricing model. The assumptions used for grants issued in 1997 and 1996
are:

<TABLE>
<CAPTION>

<S>                                                                            <C>     
          Expected life ........................................................7 years
          Risk-free interest rate ..............................................6.4%
          Dividend yield .......................................................2.0%
          Volatility ..........................................................20.1%
</TABLE>
                                                                      
Information regarding these option plans is as follows:

<TABLE>
<CAPTION>

                                                                           1997                     1996

                                                                        Weighted-                Weighted-  
                                                                          Average                  Average  
                                                                         Exercise                 Exercise  
                                                              Shares        Price       Shares       Price  
                                                                                                            
          ................................................................................................. 
<S>                                                       <C>              <C>         <C>         <C>     
           Outstanding at July 1                          584,750          $ 16.36     491,572     $ 13.12 
           Granted                                        223,100            28.79     217,275       21.71 
           Exercised                                      (51,838)           13.89    (107,597)      12.01 
           Expired/canceled                               (11,376)           22.26     (16,500)      18.59 
          ................................................................................................. 
           Outstanding at June 30                         744,636          $ 20.17     584,750     $ 16.36 
          ------------------------------------------------------------------------------------------------- 
                                                                                                            
           Options exercisable at June 30                 337,946          $ 14.43    296,142      $ 12.88 
          ------------------------------------------------------------------------------------------------- 
           Weighted-average                                                                                 
              fair value of options                                                                         
              granted during the year                                      $  8.53                 $  6.45 
</TABLE>
          
<PAGE>   11

The following table summarizes information about stock options outstanding at
June 30, 1997:

<TABLE>
<CAPTION>
                                                                                                           
                                                       Options Outstanding             Options Exercisable 
                                                                                                           
                                                          Weighted-                                        
                                                            Average    Weighted-                Weighted-  
                                                          Remaining      Average                  Average  
             Ranges of                      Numbers     Contractual     Exercise       Number    Exercise      
          Exercise Prices               Outstanding            Life        Price  Exercisable       Price      
                                                                                                           
          ..............................................................................................  
          <S>                              <C>             <C>           <C>          <C>          <C>     
          $  9  - $14                      192,104         3.9 Years     $ 12.04      192,104      $12.04  
            14  -  20                      118,536         6.1             14.62       84,938       14.62  
            20  -  25                      215,146         8.0             21.71       60,904       21.70  
            25  -  30                      218,850         9.3             28.79                          
          ..............................................................................................  
                                           744,636                                    337,946            
          ----------------------------------------------------------------------------------------------  
</TABLE>

At June 30, 1997, option prices related to outstanding options ranged from $9.46
to $29.94 per share.

10.  Benefit Plans

Qualified Retirement Plans
--------------------------
Substantially all associates of the Company are covered by the Applied
Industrial Technologies, Inc. Retirement Savings Plan. This plan is the result
of a combination, effective July 1, 1995, of the Employees' Profit-Sharing Trust
and the 401(k) Savings Plan. The Company makes a discretionary profit-sharing
contribution to the Retirement Savings Plan generally based upon a percentage of
the Company's income before income taxes and before the amount of the
contribution. The Company also partially matches 401(k) contributions by
participants, who may elect to contribute up to 15 percent of their
compensation. The matching contribution is made with the Company's Common Stock
and is determined quarterly using rates based on achieving certain quarterly
earnings per share levels.
   The Company's expense for contributions to the plan was $4,895, $4,953, and
$3,958 for the years ended June 30, 1997, 1996, and 1995, respectively.

Retiree Medical Benefits
------------------------
The Company provides health care benefits to eligible retired associates who
elect to pay the Company a specified monthly premium. Premium payments are based
upon current insurance rates for the type of coverage provided and are adjusted
annually. Certain monthly health care premium payments are partially subsidized
by the Company. At June 30, 1997 and 1996 the accumulated post-retirement
benefit obligation was $860 and $830, respectively. The costs recognized for
post-retirement benefits for fiscal 1997, 1996, and 1995 were not material.

Supplemental Executive Retirement Benefit Plan (SERP)
-----------------------------------------------------
The Company has a non-qualified pension plan to provide supplemental retirement
benefits to certain officers. Benefits are payable at retirement based upon a
percentage of the participant's compensation. The plan specifies minimum annual
retirement benefits for certain participants.

The funded status of the SERP plan is:

<TABLE>
<CAPTION>

                                                                                   June 30        
                                                                                                  
                                                                           1997             1996  
                                                                                                  
          ....................................................................................... 
<S>                                                                     <C>               <C>     
          Projected benefit obligation                                  $5,228            $4,852  
          Unrecognized net loss                                           (887)             (802) 
          Unrecognized prior service cost                                 (126)             (145) 
          ....................................................................................... 
          Accrued pension liability, included in                                                  
                                                                                                  
             Other liabilities on the Consolidated                                                
                                                                                                  
             Balance Sheets                                             $4,215            $3,905  
          --------------------------------------------------------------------------------------- 
          Accumulated benefit obligation, fully vested                  $4,165            $3,848  
          --------------------------------------------------------------------------------------- 
</TABLE>

<PAGE>   12
          
Periodic pension cost for the SERP consists of:

<TABLE>
<CAPTION>
                                                                             Year Ended June 30           
                                                                                                          
                                                                  1997              1996             1995 
                                                                                                          
          ............................................................................................... 
<S>                                                              <C>               <C>               <C>  
          Service cost - benefits earned                         $ 145             $ 132             $115 
          Interest cost on projected benefit obligation            387               368              350 
          Net amortization and deferral                             88               349              361 
          ............................................................................................... 
          Total                                                  $ 620             $ 849             $826 
          ----------------------------------------------------------------------------------------------- 
</TABLE>
          
Pension cost and benefit obligations shown above were determined using a
discount rate of 8.0% and a rate of increase in compensation levels of 5.5%. At
June 30, 1997 there were no assets under the plan. The Company funds the
benefits when payments are made to participants.

Deferred Compensation Plans
---------------------------
The Company has deferred compensation plans that enable certain associates of
the Company to defer receipt of a portion of their compensation and non-employee
directors to defer receipt of director fees. The Company funds these deferred
compensation liabilities by making contributions to rabbi trusts. Contributions
consist of Company Common Stock and investments in money market and mutual
funds. While held in trust, the Common Stock is reported as a contra-equity
account and the money market and mutual fund investments are included in other
assets in the accompanying consolidated balance sheets. The deferred
compensation liabilities of $6,405 and $3,286 at June 30, 1997 and 1996,
respectively, are recorded in other liabilities in the consolidated balance
sheets.

11.  Commitments, Lease Obligations and Rent Expenses

The Company leases its corporate headquarters along with certain branch and
distribution center facilities and computer equipment under non-cancellable
lease agreements accounted for as operating leases. The minimum annual rental
commitments under operating leases, are $11,274 in 1998; $7,700 in 1999; $5,860
in 2000; $4,390 in 2001; $3,611 in 2002 and $36,835 after 2002.
   In connection with the lease of the corporate headquarters facility the
Company has guaranteed repayment of $5,678 of bonds issued by the
Cleveland-Cuyahoga County Port Authority as lessor and Cuyahoga County to fund
construction of the facility.
   Rental expenses incurred for operating leases, principally from leases for
real property, vehicles and computer equipment were $12,891 in 1997, $12,077 in
1996, and $10,756 in 1995.
   The Company had outstanding letters of credit of $7.8 million at June 30,
1997. These letters of credit secure certain employee benefit and insurance
obligations.

12.  Litigation

The 1990 agreement for the acquisition of King Bearing, Inc. (King) included
specific indemnification of Applied Industrial Technologies, Inc. and King for
any financial damages or losses related to a lawsuit pending against King in the
Superior Court of Orange County, California. The indemnification was also
guaranteed by the ultimate parent of King's former owner, a Fortune 500 company
with stockholders' equity exceeding five billion dollars at June 30, 1997. A
$32,400 judgment relating to this lawsuit was rendered against King in June
1992. The judgment was strongly contested by counsel retained by the indemnitor
on behalf of King, and in September 1992, the trial court granted the motion of
King for a new trial as to all but $219 in damages returned by the jury. On
appeal, the California Court of Appeals, in September 1996, remanded the matter
to the trial court for a new trial and reversed the trial court's exclusion of
the $219 in damages from the new trial order. All alleged events relevant to the
judgment occurred prior to the Company's purchase of King, and the jury found no
liability on the part of the Company. In January 1997, King was merged into
Applied Industrial Technologies, Inc. Due to the indemnification and guarantee,
management believes that the outcome of this matter will not have a material
adverse effect on the consolidated financial position or results of operations
of the Company.
   The Company is a defendant in several lawsuits for product liability matters.
The Company is vigorously defending these lawsuits, which management believes
are without merit. Although management cannot predict the outcomes of these
lawsuits, they are not expected to have a material adverse effect on the
Company's consolidated financial position.

13.  Subsequent Event-Stock Split

On August 15, 1997, the Company's Board of Directors approved a three-for-two
common stock split payable on September 15,1997 to shareholders of record on
August 29, 1997. Pro forma net income per share, giving retroactive effect to
the three-for-two split, is as follows: $1.46 in 1997, $1.27 in 1996, and $0.97
in 1995. Financial information contained elsewhere in this annual report has not
been adjusted to reflect the impact of the common stock split.

<PAGE>   13


--------------------------------------------------------------------------------
                                                    INDEPENDENT AUDITORS' REPORT


                                                      [DELOITTE AND TOUCHE LOGO]


Shareholders and Board of Directors
Applied Industrial Technologies, Inc.

We have audited the accompanying consolidated balance sheets of Applied
Industrial Technologies, Inc. and its subsidiaries as of June 30, 1997 and 1996
and the related statements of consolidated income, shareholders' equity, and
cash flows for each of the three years in the period ended June 30, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
   We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
   In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of the Company at June 30, 1997 and
1996 and the results of their operations and their cash flows for each of the
three years in the period ended June 30, 1997 in conformity with generally
accepted accounting principles.


/s/ Deloitte & Touche LLP
Cleveland, Ohio
August 7, 1997 (August 15, 1997 as to Note 13.)
<PAGE>   14

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
10 YEAR SUMMARY

                                                                                                                                   

                                                       1997                   1996                    1995                   1994  
(Thousands, except per share amounts)
 ...........................................................................................................................
<S>                                              <C>                    <C>                     <C>                      <C>       
CONSOLIDATED OPERATIONS-
   YEAR ENDED JUNE 30
Net sales                                        $1,160,251             $1,143,749              $1,054,809               $936,254  
Operating income                                     50,599                 49,281                  36,923                 27,817  
Net income                                           27,092                 23,334                  16,909                 12,687  
Per share data (A)

   Net income                                          2.19                   1.90                    1.46                   1.12  
   Cash dividend                                        .62                    .54                     .47                    .43  

YEAR-END POSITION - JUNE 30
Working capital                                    $164,723               $151,956                $153,555               $144,605  
Long-term debt                                       51,428                 62,857                  74,286                 80,000  
Total assets                                        394,114                404,072                 359,231                343,519  
Shareholders' equity                                207,584                189,292                 165,401                150,491  

YEAR-END STATISTICS - JUNE 30
Current ratio                                           2.4                    2.1                     2.4                    2.4  
Branches                                                331                    337                     338                    339  
Number of Shareholders                                4,676                  4,636                   4,379                  4,478  

<FN>
(A) All per share data have been restated to reflect a three for two stock split effective December 4, 1995.
</TABLE>

<TABLE>
<CAPTION>
                                                                             Applied Industrial Technologies, Inc. and Subsidiaries
                                                                                                                                   
         1993                    1992                   1991                    1990                   1989                    1988
                                                                                                                                   
                                                                                                                                   
                                                                                                                                   
                                                                                                                                   
<S>  <C>                     <C>                    <C>                     <C>                    <C>                     <C>     
     $831,432                $817,813               $814,000                $651,271               $630,281                $542,883
       20,521                   4,703                 17,115                  25,281                 33,463                  25,000
        8,927                 (1,666)                  4,282                  12,201                 18,313                  14,948
                                                                                                                                   
                                                                                                                                   
          .82                   (.16)                    .41                    1.13                   1.63                    1.26
          .43                     .43                    .43                     .43                    .37                     .33
                                                                                                                                   
                                                                                                                                   
     $130,860                 $41,967                $54,695                 $64,091                $75,134                 $77,606
       80,000                                                                                                                      
      315,935                 330,619                327,939                 380,224                251,376                 222,957
      134,940                 128,830                134,203                 135,338                134,848                 128,919
                                                                                                                                   
                                                                                                                                   
          2.4                     1.2                    1.3                     1.3                    1.7                     1.9
          323                     333                    341                     363                    267                     266
        4,449                   4,354                  4,025                   3,583                  3,204                   4,051
</TABLE>


