Applied Industrial Annual Report 2009

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FY2009 Annual Report · Applied Industrial

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2009 ANNUAL REPORT

APPlIED® AT A GLANCE

Applied Industrial Technologies is one of North America’s largest industrial distributors serving Maintenance Repair

Operations (MRO), Original Equipment Manufacturing (OEM), and Government markets with a diverse range of quality

products, including bearings, power transmission components, fluid power components and systems, industrial rubber

products, linear components, tools, safety products, and general maintenance and mill supply products. We also provide

customized shop services for mechanical, fabricated rubber and fluid power products, as well as services to meet storeroom

management and maintenance training needs.

Headquarters: Cleveland, Ohio, USA

Operating Facilities: 464 in 48 U.S. states, 6 Canadian provinces, Puerto Rico and 13 Mexican states

E-Commerce: www.Applied.com

Distribution Centers: 7

Stock Keeping Units (SKUs) Available to Customers: More than 3 million

Product Manufacturers: More than 2,000

Stock Ticker Symbol: AIT is listed on the New York Stock Exchange

Employee Associates: 4,729

Data current as of June 30, 2009

This report contains statements that are forward-looking, as that term is defined by the Securities and Exchange

Commission in its rules, regulations and releases. Applied intends that such forward-looking statements be subject

to the safe harbors created thereby. All forward-looking statements are based on current expectations regarding

important risk factors, including those identified on pages 10 and 11 of this report and in our Annual Report on Form

10-K for the fiscal year ended June 30, 2009. Accordingly, actual results may differ materially from those expressed

in the forward-looking statements, and the making of such statements should not be regarded as a representation by

Applied or any other person that results expressed therein will be achieved.

Decisive ActionDetermined SpiritLETTER TO OUR SHAREHOLDERS

David L. Pugh, Benjamin J. Mondics

Dear Shareholder:

Fiscal 2009 proved to be a challenging year for Applied Industrial Technologies. We saw a slow economy quickly decline

into a widespread economic recession, resulting in one of the most difficult business environments that we’ve ever

experienced. In the face of this tough challenge, we responded, not with panic or trepidation, but rather with decisive

action and a determined spirit.

YEAR IN REvIEW

A collapse of financial markets, an unprecedented drop in

The recession manifested itself shortly after we completed the

housing starts, and the bankruptcies of two of the Big Three

acquisition of Fluid Power Resource, llC (FPR) in August of

automakers evidenced the decline of the U.S. industrial

2008, and became more pronounced as the year progressed.

economy during our fiscal 2009. In response, many of our

This slowdown negatively impacted operations and led to the

customers idled production and reduced capital expenditures.

impairment of goodwill for our Fluid Power Businesses by

Over the course of the year, we saw three key economic

fiscal year-end.

indicators fall to severe recessionary levels – Industrial

Production, Manufacturing Capacity Utilization, and the ISM

Manufacturing Index. Demand for maintenance and repair

parts fell commensurately, and our performance for the year

was well below our original expectations.

While it is disappointing to incur an impairment charge, we

recognize that many industrial companies have had to do the

same in this economy. The impairment charge did not result

in any cash expenditures, did not adversely affect compliance

with covenants under our debt agreements, and did not affect

Net sales in fiscal 2009 decreased by 8.0% to $1.9 billion from

our cash position, cash flows from operating activities, or our

$2.1 billion in the previous year. Sales to customers within 11

revolving line of credit. Our balance sheet is still strong, and

industry groups out of our top 30 fell by 20% or more. In only

we remain steadfast in our belief that the companies obtained

four industry groups out of the top 30 did we experience an

in the purchase of FPR are well-positioned and will provide

overall sales increase for the year.

excellent value to our shareholders in the future.

As a result of this economic decline, a goodwill impairment

We established our operating margin goal at an aggressive

charge was taken in the fourth quarter, reducing our operating

5.0% for the last half of the fiscal year. We have maintained

income by $36.6 million. For the fiscal year, our net income

a heavy focus on protecting our margins in the face of intense

was $42.3 million and earnings per share was $0.99. These

pressure, and as a result, we have moved ahead of our most

earnings reflect the negative impact of $0.54 per share for the

direct competitors in this area. Excluding the goodwill

goodwill impairment charge.

impairment charge taken in our fourth quarter, we stayed

relatively close to that target. Continual cost control activities

(Continued on next page)

Applied Industrial Technologies, Inc. and Subsidiaries 1

(Continued from previous page)

helped to keep our selling, distribution and administrative

in the credit markets. We are continuing to evaluate when we

expenses (SD&A) at competitive levels. Our SD&A increased

should resume purchases of our company’s common stock on

slightly to 21.4% of sales compared to 19.9% last year, primarily

the open market.

due to our high level of fixed costs.

In keeping with our strategy to return value to our shareholders,

We ended fiscal 2009 with a cash position of $27.6 million and

quarterly dividends for the year totaled $25.4 million or $0.60

strong working capital of $369 million. Our debt-to-equity

per share. We are proud of the fact that Applied has paid a

ratio is 15.7%, and the current ratio (current assets to current

cash dividend every quarter for more than 30 years. Overall,

liabilities) is 3.4 to 1. In the latter half of the fiscal year, we felt it

we believe our sound balance sheet, low level of debt and

was prudent to temporarily halt our stock buyback program as

healthy cash generation are strengths in today’s challenging

a means of conserving cash in the face of the financial turmoil

economic environment.

DECISIvE ACTION

One of the benefits of being an 86-year-old company is our

technologies. We also developed a new strategic partnership

experience in navigating through good times and bad. While

late in the year with ORS Nasco, the largest wholesaler of

we can’t improve Industrial Production, change the MCU or

tools, safety products, general industrial items and welding

will the ISM Manufacturing Index to rise, our management

supplies in the U.S. This agreement adds more than 80,000

team was able to adapt quickly to the economic changes. We

items to our product offering and further reinforces our image

were already experiencing a slowing economy as we exited

as a one-stop shop for industrial purchasing. Investments in

fiscal 2008 and proceeded to take action – putting the focus

new products are helping to distinguish our capabilities and to

on what we could control in order to balance our operating

diversify our product portfolio as we deal with the changes in

costs against our sales revenues. We focused our energies on

more mature industries.

managing assets to maximize our efficiency and profitability

– choosing a proactive stance rather than a foxhole mentality

toward the economy.

Fiscal 2009 was also a year in which we expanded our presence

with growing industries such as mining, and the wastewater

and water treatment industries. Our range of value-added

We prudently managed our expense structure through tight

services and our industry knowledge are a vital part of our

oversight of all expense categories

including

incentive/

customers’ success. More than ever before, our customers

compensation/benefits adjustments, consolidation of locations,

have come to rely upon the value we provide. By continually

and workforce reductions where appropriate to remain

improving our industry know-how, we can better understand

competitive in this tough environment. Because we have

our customers’ businesses and help them find ways to manage

structured our executive compensation programs to “pay for

their operations more efficiently and effectively. Our expertise

performance,” our executives experienced a reduction in their

in providing cost-saving ideas helps to address our customers’

overall take home pay at a rate commensurate with earnings.

specific needs and concerns as they focus on streamlining their

Our approach to the current economic landscape is not one of

acceptance, but, rather, one of adapting in order to become

operations. This substantially supports our continuing efforts

to sell value.

more effective in our selling process and more competitive

We understand the technical aspects of energy efficiency,

through product and market expansion. Throughout fiscal

preventive maintenance, parts replacement strategies, inventory

2009, we expanded our product and brand portfolio with

management and training. By bringing these solutions to our

new product authorizations. We gained authorization to

customers, we build loyalty and increase sales, which yield

sell products from THK, a market leader in linear motion

greater shareholder value.

2 Applied Industrial Technologies, Inc. and Subsidiaries

HONORS

Bright spots in fiscal 2009 include numerous awards for our

Customers continued to recognize Applied with significant

operational strengths, including outstanding customer service,

awards throughout the year, reflecting the value our associates

technical support, and overall value added. Applied was

and service centers provide. We were proud to receive the

named to the Forbes magazine Platinum 400 list of the “Best

highest supplier ranking from vulcan Materials, a company

Big Companies in America” for the sixth consecutive year. In

that is dependent on strong relationships with quality vendors

December 2008, we were named to the Selling Power magazine

and one that stands to benefit as stimulus money is invested

annual list of “The 50 Best Companies to Sell For” in the U.S.

in infrastructure improvements. vulcan’s Platinum Alliance

Applied made its debut on the list with a number three ranking

Supplier award was presented to us in recognition of our

in the service company category.

Applied also earned the prestigious Excellence in Partnership

award for the “Most valuable Schedule Contractor” from

the Coalition for Government Procurement and the General

Services Administration.

dedicated support and world-class products. We were also

one of seven suppliers and processors honored with a Supplier

of the Year award from AK Steel for our outstanding service,

value and strategic support of the steelmaker’s business plan.

AK Steel, one of the largest metal producers in the United

States, maintains a relentless pursuit of improvement in every

critical performance measure and we are very pleased to be so

honored for our work on their behalf.

DETERMINED SPIRIT

As of early August 2009, we have yet to see any concrete signs of

them, and we are choosing to be aggressive in the marketplace.

recovery in the industrial sector. The ISM Manufacturing Index

As our customers’ markets improve, we are prepared to help

at our fiscal year-end indicates that manufacturing continues

them ramp-up production. Keeping a positive attitude benefits

to contract, but at a slower rate. Manufacturing Capacity

our customers, our suppliers and Applied.

Utilization continues to fall. Job losses, while below their peak,

are still in recession territory. While there is speculation of

some improvement in the economy around the first quarter of

calendar 2010, we feel the improvement will likely be slow in

our North American markets.

We have continued to invest in our business through strategic

acquisitions that expand our North American footprint, boost

sales opportunities and provide an opportunity for more bolt-

on acquisitions. As we mentioned earlier, we completed the

acquisition of FPR and seven of its fluid power distribution

Our focus remains on executing our Four Cornerstones –

businesses in August 2008, adding 19 dedicated fluid power

Profitable Sales Growth, Margin Enhancement, Cost Control

locations and more than 400 associates. Our fluid power

and Asset Management. These Cornerstones have guided us

product sales now account for 26% of our total sales, up from

for the last eight years and their continued use is helping to

7% in 1998.

improve our performance and to generate a solid return for

our shareholders. While we always try to keep a balance in

managing these Cornerstones, the current economic climate

has dictated a shift to a heavier focus on asset management,

and we’ve responded well. As a result, we were able to

In December 2008, we announced the acquisition of Cincinnati

Transmission Company, a single location, regional distributor

of power transmission and motion control products as well as

gearbox repair solutions located in Cincinnati, Ohio.

mitigate the impact better than most and provide a shareholder

Applied continues to have the capital to expand with acquisitions,

performance which ranked in the top quarter of our peers.

giving us important flexibility to invest for future growth.

We’re pressing onward with sales activity into local, county, state

and federal government entities – establishing our presence,

gaining awareness, and investing for future profitability. We

are choosing to stay close to our customers and to take care of

Applied Industrial Technologies, Inc. and Subsidiaries 3

PRESENT-MINDED, FUTURE-FOCUSED

Our goal has been and will continue to be the dynamic

and the variable components of our costs. We’re maintaining

management of our business – focusing on what is directly

our focus to right-size our company and to provide top customer

before us while keeping an eye on the future. We believe our

service from a reduced asset base. We will continue to set our

decisive action and determined spirit will move us forward –

sights on an improved economy so that we can take maximum

toward new opportunities and to newfound success. We have

advantage of a recovery when it comes. We fully expect to

a capable leadership team, experienced in being an agent

emerge a stronger and more resilient company as a result of

of change.

our experience.

The task in front of us in this climate is obvious – to maximize

As always, we appreciate the ongoing trust and support of our

our current performance levels, to function at the highest levels

fellow shareholders. Rest assured, our focus is on maximizing

of quality, and to stay aggressive in managing our gross margins

your return.

David l. Pugh

Benjamin J. Mondics

Chairman & Chief Executive Officer

President & Chief Operating Officer

August 19, 2009

NET SALES
(DOllARS IN BIllIONS)

NET INCOME PER SHARE
(DOllARS)

SHAREHOLDERS’ EqUITy
(DOllARS IN MIllIONS)

$2.01

$1.90

$2.09

$1.92

$1.72

$2.19

$1.93

$1.57

$1.20

$0.99

$502.1 $508.1

$451.0

$414.8

$393.3

* The goodwill impairment charge in fiscal 2009

reduced net income per share by $0.54.

4 Applied Industrial Technologies, Inc. and Subsidiaries

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

OVERVIEW
With more than 4,700 associates across North America, Applied Industrial
Technologies (“Applied,” the “Company,” “We,” “Us” or “Our”) is an
industrial distributor that offers parts critical to the operations of MRO and
OEM customers in a wide range of industries. In addition, Applied provides
engineering, design and systems integration for industrial and fluid power
applications, as well as customized fluid power shop, mechanical and
fabricated rubber services. As an authorized distributor for more than 2,000
manufacturers, we offer access to approximately 3 million stock keeping
units (“SKUs”). A large portion of our business is selling replacement parts
to manufacturers and other industrial concerns for repair or maintenance of
machinery and equipment. We have a long tradition of growth dating back
to 1923, the year our business was founded in Cleveland, Ohio. At June 30,
2009, business was conducted in the United States, Canada, Mexico and
Puerto Rico from 464 facilities.

When reviewing the discussion and analysis set forth below, please note that
the majority of SKUs we sell in any given year were not sold in the prior year,
resulting in the inability to quantify certain commonly used comparative
metrics analyzing sales, such as changes in product mix and volume.

On August 29, 2008, Applied completed the acquisition of certain assets of
Fluid Power Resource, LLC, (“FPR”). The results of FPR’s operations have
been included in the consolidated financial statements since that date.

Our fiscal 2009 sales came in at $1.9 billion, a decrease of $166.3 million or
8.0% compared to the prior year. The effects of the worldwide recession are
being felt in the industries we serve. Declines in same-store business of
14.6% were only partially offset by net sales from acquired businesses which
added $160.6 million. Our operating margin declined to 3.8% compared to
the prior year’s 7.3%. The current year includes the impact of a goodwill
impairment charge of $36.6 million related to our Fluid Power Businesses
segment, which decreased operating margins by 1.9% and earnings per
share by $0.54. Gross margin declined slightly to 27.0% from 27.2% in the
prior year. Our earnings per share was $0.99 versus $2.19 in fiscal year
for
2008, a decline of 54.8%.
approximately half of this decline, whereas the remaining decline represents
the impact of lower sales and higher net interest costs partially offset by
reductions in operating expenses.

impairment accounted

Goodwill

During the fourth quarter of fiscal 2009, the Company performed an interim
goodwill impairment test based on current and expected market conditions,
including reduced operating results and a worsening economic outlook. As
a result of this test, the Company determined that all of the goodwill
associated with the Fluid Power Businesses segment was impaired as of
June 30, 2009. Accordingly, the Company recognized an impairment charge
of $36.6 million for goodwill in the fourth quarter of fiscal 2009, which
decreased net income by $23.0 million and earnings per share by $0.54.

Our consolidated balance sheet remains strong. Shareholders’ equity is
$508.1 million, up slightly from the June 30, 2008 level of $502.1 million.
Working capital decreased $40.1 million from June 30, 2008 to $369.0
million at June 30, 2009, primarily reflecting the impact of the FPR
acquisition. Our current ratio remains strong at 3.4 to 1 versus 3.1 to 1 in
fiscal year 2008.

Applied monitors several economic indices that have proven to be key
indicators for industrial economic activity. These include the Manufacturing
Index published by the Institute for Supply Management (“ISM”), and the

Manufacturing Capacity Utilization (“MCU”) published by the Federal
Reserve Board.

Historically our performance correlates well with the MCU, which measures
productivity and calculates a ratio of actual manufacturing output versus
potential full capacity output. When manufacturing plants are running at a
high rate of capacity, they tend to wear out machinery and require
replacement parts. Our sales tend to lag the MCU on the upswing and
move with the decline.

Over the last five quarters, both of these indices have been signifying a
severe recessionary economy for the United States, which has heavily
impacted the industries we serve. Our U.S. same-store sales have declined
steadily during this same period. For instance, our U.S. service center same-
store sales fell compared to the same quarter of the prior year as follows:

Quarter Ended
June 2008
September 2008
December 2008
March 2009
June 2009

Sales Decline

2%
3%
13%
23%
27%

Although there has been some improvement in the ISM Manufacturing Index
through the first two calendar quarters of 2009, it (along with the MCU) is
still showing an economy in recession. Hence, we believe our sales will be
sluggish through most, if not all, of fiscal 2010, barring any sudden and
dramatic increase in capacity utilization.

from companies acquired since

YEAR ENDED JUNE 30, 2009 vs. 2008
Net sales in fiscal 2009 were $1.9 billion or 8.0% below the prior year. Net
sales
the prior year contributed
approximately $160.6 million. Our same-store sales declined 14.6% due to
the slowing industrial economy. Currency translation accounted for
approximately $32.4 million of the decline or 1.5%. In local currency, our
Canadian business was up 0.5% from fiscal 2008 levels. Net sales from our
Mexican operations more than doubled to $50.6 million, driven primarily by
newly acquired businesses. The number of selling days in fiscal 2009 was
the same as in fiscal 2008.

Within the Service Center Based Distribution segment, net sales decreased
$268.7 million or 14.4% compared to fiscal year 2008. Net sales from
acquired businesses contributed $21.1 million, while our same-store sales
saw a net decline of $289.8 million or 15.5%. Within the Fluid Power
Businesses segment, net sales increased $102.4 million or 45.7%. This
increase was primarily due to our U.S. and Mexican acquisitions in this
segment which added $139.5 million to net sales. Same-store sales
declined in our Fluid Power Businesses segment by 16.6%.

The sales product mix for fiscal 2009 was 74.0% industrial products and
26.0% fluid power products compared to 80.0% industrial and 20.0% fluid
power in the prior year. Acquisitions since the prior year have been
primarily in our Fluid Power Businesses segment, accounting for the shift in
product mix.

At June 30, 2009, we had a total of 464 operating facilities in the U.S.,
Canada and Mexico versus 459 at June 30, 2008. The net increase in
facilities reflects 20 new facilities from acquisitions and 2 newly opened
locations, offset by 17 mergers/closures of locations in the current year.

Our gross profit margin declined to 27.0% in fiscal 2009 from 27.2% in
fiscal 2008. LIFO inventory layer liquidations resulted in a $4.4 million

Applied Industrial Technologies, Inc. and Subsidiaries 5

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION (Continued)

positive impact during fiscal 2009, which helped offset a reduction in U.S.
point-of-sale margin.

supply

selling, purchasing, warehousing,

SD&A consists of associate compensation, benefits and other expenses
chain
associated with
management and providing marketing and distribution of the Company’s
products, as well as costs associated with a variety of administrative
functions such as human resources, information technology, treasury,
accounting, legal, and facility related expenses. SD&A decreased $5.5
million or 1.3% during fiscal 2009 compared to the prior year, and
increased as a percent of sales to 21.4% in 2009 from 19.9% in 2008.
Acquisitions added $44.0 million of SD&A compared to the prior year,
including additional amortization expense of $8.1 million. Healthcare costs
and severance expense increased $5.8 million. Associate compensation
and benefits, including amounts tied to financial performance, were $38.5
million lower in the current fiscal year. During the latter half of the year,
we reviewed our operations and reduced staff and hours worked, resulting
in an additional reduction of wage and benefit costs for the year of $4.4
million. Foreign currency translation and reduced discretionary spending
account for the majority of the remaining decrease.

Operating income decreased 52.6% to $72.5 million during fiscal 2009 from
$152.8 million during 2008. As a percent of sales, operating income
decreased to 3.8% in fiscal 2009 from 7.3% in 2008. The $80.3 million
decrease in operating income during fiscal 2009 primarily reflects the impact
of sales declining at a greater rate than SD&A expenses and the goodwill
impairment charge of $36.6 million.

Operating income of both of our segments declined. Operating income as a
percentage of sales for the Service Center Based Distribution segment
declined from 6.7% in fiscal 2008 to 4.7% in fiscal 2009 and for the Fluid
Power Businesses segment from 7.7% to 5.8%. Again, these changes
reflect the impact of a sales decline at a greater rate than SD&A expenses.

Interest expense, net, increased $3.5 million during fiscal 2009 compared
with the prior year. Lower invested cash balances and lower interest rates
on invested cash led to a reduction in interest income of approximately
$2.9 million. Interest expense increased $0.6 million due to higher
average borrowings.

Other expense (income), net, represents certain non-operating items of
income and expense. This line increased $2.0 million due primarily to $1.9
million in foreign currency transaction losses and $1.4 million of a loss in
market value in investments held by deferred compensation trusts. These
losses were partially offset by $1.2 million of foreign currency gains on our
cross-currency swap.

Income tax expense as a percentage of income before taxes was 35.8% for
fiscal 2009 and 37.1% for 2008. The decrease in the effective tax rate was
primarily due to the reversal of a valuation allowance as the related deferred
tax asset is now expected to be utilized. This reduction was partially offset
by higher effective state and local tax rates and foreign income taxes. We

6 Applied Industrial Technologies, Inc. and Subsidiaries

expect our overall tax rate for fiscal 2010 to be in the range of 37.0% to
37.5%, since the valuation allowance reversal will not recur and state and
local taxes are expected to increase.

As a result of the factors addressed above, net income for fiscal 2009
decreased $53.2 million or 55.7% from the prior year. Net income per share
decreased 54.8% to $0.99 in fiscal 2009 from $2.19 in 2008.

The number of Company associates was 4,729 at June 30, 2009 and 4,831
at June 30, 2008. The acquisition of FPR added more than 400 associates in
August 2008; the net decline year-over-year represents the impact of these
additions offset by company-wide reductions in workforce. Additionally,
during the latter half of the year, we took measures to further reduce
compensation costs including reducing scheduled work hours. The number
of associates adjusted to reflect an equivalent full-time work status (“full-
time equivalent”) at June 30, 2009 was about 10% lower than the same
measure at December 31, 2008.

YEAR ENDED JUNE 30, 2008 vs. 2007
Net sales in fiscal 2008 were $2.1 billion or 3.7% above the prior year
sales. This increase was due to improvements in our Service Center Based
Distribution segment sales of 3.3% and in our Fluid Power Businesses
segment sales of 7.7%. The increase in Service Center Based Distribution
segment sales was primarily driven by an increase in national contract
business and the recovery of supplier price increases. Within the Service
Center Based Distribution segment, the impact of the strengthening
Canadian currency was largely offset by a 9.3% volume decline in our
Canadian market. The increase in sales of our Fluid Power Businesses
segment was approximately 45% attributable to favorable currency
fluctuations at the Canadian locations and approximately 25% related to
the VYCMEX S.A. de C.V. (“VYCMEX”) acquisition. Also contributing to
these increases was an additional sales day in fiscal 2008 compared to
fiscal 2007.

The sales product mix for fiscal 2008 was 80.0% industrial products and
20.0% fluid power products compared to 80.2% industrial and 19.8% fluid
power in the prior year.

At June 30, 2008, we had a total of 459 operating facilities in the U.S.,
Canada and Mexico versus 445 at June 30, 2007. The increase in facilities
was largely attributed to 5 facilities from the acquisition of VYCMEX midway
through the fiscal year and 10 facilities from the acquisition of Suministros
Industriales Enol, S.A. de C.V. (“Enol”) at the end of fiscal 2008.

Our gross profit margin maintained the 27.2% achieved in fiscal 2007.
Slightly higher levels of supplier purchasing incentives were largely offset by
continued pressures in gross profit margin with national contracts. LIFO
inventory layer liquidations resulted in a $0.6 million positive impact during
fiscal 2008.

SD&A increased 0.8% during fiscal 2008 compared to the prior year, but
decreased as a percent of sales to 19.9% from 20.5% in 2007.
Approximately one-third of the fiscal 2008 increase was attributable to
SD&A amounts of businesses acquired. The remainder of the increase was
primarily due to increases in associate compensation tied to improved
financial performance.

Operating income increased 13.2% to $152.8 million during fiscal 2008
from $135.0 million during 2007. As a percent of sales, operating income
increased to 7.3% in fiscal 2008 from 6.7% in 2007. The $17.8 million
increase in operating income during fiscal 2008 primarily reflects the impact

of higher sales at a stable gross profit percentage with only modest
increases in SD&A expenses.

expenditures for all years presented consist primarily of information
technology equipment, and buildings and improvements.

Interest expense, net decreased by 62.6% or $1.5 million during fiscal 2008
compared with the prior year, primarily due to repayment of $50.0 million of
long-term debt in December 2007.

Other expense (income), net, represents certain non-operating items of
income and expense. This line decreased $1.4 million due primarily to the
loss in market value in investments held by deferred compensation trusts.

Income tax expense as a percentage of income before taxes was 37.1% for
fiscal 2008 and 35.7% for 2007. The increase in the effective tax rate was
due to higher effective state tax rates and U.S. federal tax law changes that
eliminated the deductibility of certain expenses.

As a result of the factors addressed above, net income for fiscal 2008
increased $9.4 million or 11.0% from the prior year. Net income per share
increased 13.5% to $2.19 in fiscal 2008 from $1.93 in 2007. During fiscal
2008 and 2007, we repurchased 1.1 million and 1.4 million shares,
respectively, which resulted in fewer shares outstanding for the year
compared to the prior year. The buybacks in fiscal 2008 contributed
approximately $0.03 cents per share.

The number of Company associates was 4,831 at June 30, 2008 and 4,649
at June 30, 2007.

LIQUIDITY AND CAPITAL RESOURCES
Net cash flows from operations depend primarily upon generating operating
income, controlling investment in inventories and receivables and managing
the timing of payments to suppliers. We continue to monitor and control
our investments in inventories and receivables by taking advantage of
supplier purchasing programs, making
information system
enhancements and accelerating receivables collection through improvements
in invoice delivery, customer communications, and expanded external
collection efforts.

internal

We generated $81.3 million of cash from operating activities during fiscal
2009, $110.3 million during 2008 and $70.9 million during 2007. Cash
provided by operating activities of $81.3 million decreased $29.0 million
in fiscal 2009 compared with 2008. The slowing of sales in 2009 resulted
in a reduction in income and in cash provided. Cash generated by
declines in receivables was offset by cash used for declines in accounts
payable and compensation related liabilities. Inventories increased
despite the slowdown in sales as we fulfilled purchase commitments in
place before the downturn in the economy. We expect to reduce these
inventory levels over the coming year which will generate cash inflows.
Cash provided from operations in fiscal 2008 benefited from our strong
operating results. Cash flows from operations in fiscal 2007 were also
impacted by the timing of certain income tax payments and the timing of
receipts from certain supplier purchasing programs.

Net cash used by investing activities was $178.4 million during fiscal 2009,
$26.8 million during fiscal 2008 and $10.2 million during 2007. Cash was
primarily used for acquisitions in fiscal 2009 and fiscal 2008, whereas it was
primarily used for capital expenditures in fiscal 2007. In fiscal 2009, net
cash paid for acquisitions of $172.2 million was primarily due to the FPR
acquisition in August 2008 ($166.0 million paid at closing) and a Service
Center Based Distributor acquisition in December 2008 ($4.7 million paid at
closing). In fiscal 2008, we acquired two distributors based in Mexico for
$28.7 million, of which $22.1 million was paid at closing. Capital

For fiscal 2010, our capital expenditures are expected to be in the $8.0
million to $9.5 million range, consisting primarily of additional
information system technology equipment and infrastructure investments.
Depreciation for fiscal 2010 is expected to be in the range of $12.0
million to $13.0 million.

Cash provided by (used in) financing activities was $28.5 million during fiscal
2009, ($103.5) million during fiscal 2008 and ($48.4) million during 2007.
Cash provided by financing activities in fiscal 2009 was primarily due to net
borrowings of $55.0 million on our revolving credit facility, which were
primarily used to fund acquisitions. Partially offsetting these borrowings was
the payment of $25.4 million in dividends in fiscal 2009.

In fiscal 2008, we utilized cash in financing activities to repay $50.0 million
of long-term debt, repurchase $33.2 million worth of shares for our treasury
and pay $25.7 million in dividends which included the effect of an increase
in our quarterly dividend to $0.15 per share. The amount of the dividend
paid is based on judgment, financial performance and payout guidelines
consistent with other industrial companies.

In fiscal 2009, 2008 and 2007, we repurchased 68,000, 1.1 million and 1.4
million shares of the Company’s common stock, respectively, at an average
price per share of $17.80, $29.02, and $24.26, respectively.

The following table shows the approximate value of the Company’s
contractual obligations and other commitments to make future payments as
of June 30, 2009 (in thousands):

Period Less
Than 1 yr

Total

Period
1-3 yrs

Period
4-5 yrs

Period
Over 5 yrs

Other

Operating leases

$ 78,400

$21,800

$ 28,200

$15,300

$13,100

Interest payments
on long-term debt

Planned funding of
postretirement
obligations

FIN 48 liabilities,
including interest
and penalties

Long-term debt

Total Contractual
Cash Obligations

5,100

3,700

1,400

54,000

1,900

3,000

3,300

45,800

2,400

75,000

$2,400

$ 214,900

$27,400

$107,600

$18,600

$58,900

$2,400

Purchase orders for inventory and other goods and services are not included
in our estimates as we are unable to aggregate the amount of such purchase
orders that represent enforceable and legally binding agreements specifying
all significant terms. The table above includes the gross liability for
unrecognized income tax benefits (“FIN 48 liabilities, including interest and
penalties”) in the “Other” column as the Company is unable to make a
reasonable estimate regarding the timing of cash settlements with the
respective taxing authorities. See Note 8 to the consolidated financial
statements, for further information on income taxes and the FIN 48 liability.

The Board of Directors has authorized the repurchase of shares of the
Company’s stock. These purchases may be made in open market and
negotiated transactions, from time to time, depending upon market
conditions. At June 30, 2009, we had authorization to purchase an
additional 997,100 shares.

Applied Industrial Technologies, Inc. and Subsidiaries 7

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION (Continued)

Capital resources are obtained from income retained in the business,
borrowings under the Company’s credit facilities, and operating lease
arrangements.

Debt classified as long-term includes $50.0 million borrowed under our
revolving credit facility as discussed above. The remaining $25.0 million of
long-term debt matures in November 2010.

The revolving credit facility, private placement debt and uncommitted shelf
facility contain restrictive covenants regarding liquidity, net worth,
financial ratios, and other covenants. At June 30, 2009, the most
restrictive of
the Company have
consolidated income before interest, taxes, depreciation and amortization
at least equal to 300% of net interest expense. At June 30, 2009, the
Company was in compliance with all covenants and expects to remain in
compliance during the terms of the agreements.

these covenants

required

that

Management expects that our existing cash, cash equivalents, funds
available under the revolving credit facility, cash provided from operations,
and the use of operating leases will be sufficient to finance normal working
capital needs, payment of dividends, acquisitions, investments in properties,
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 based on the Company’s credit standing
and financial strength, however at higher rates than the Company is
currently paying.

CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of
America requires management to make judgments, assumptions and
estimates at a specific point in time that affect the amounts reported in the
consolidated financial statements and disclosed in the accompanying notes.
Note 1 to the consolidated financial statements describes the significant
accounting policies and methods used in preparation of the consolidated
financial statements. Estimates are used for, but not limited to, determining
the net carrying value of trade accounts receivable, inventories, recording
self-insurance liabilities and other accrued liabilities. Actual results could
differ from these estimates. The following critical accounting policies are
impacted significantly by judgments, assumptions and estimates used in the
preparation of the consolidated financial statements.

LIFO Inventory Valuation and Methodology

Inventories are valued at the lower of cost or market, using the last-in, first-out
(“LIFO”) method for U.S. inventories, and the average cost method for foreign
inventories. We adopted the link chain dollar value LIFO method for
accounting for U.S. inventories in fiscal 1974. Approximately one-third of our
domestic inventory dollars relate to LIFO layers added in the 1970s. The excess
of current cost over LIFO cost is $166.9 million as reflected in our consolidated
balance sheet at June 30, 2009. The Company maintains five LIFO pools
based on the following product groupings: bearings, power transmission
products, rubber products, fluid power products and other products. LIFO
layers and/or liquidations are determined consistently year-to-year in a manner
which is in accordance with the guidance in the 1984 AICPA LIFO Issues
Paper, “Identification and Discussion of Certain Financial Accounting and
Reporting Issues Concerning LIFO Inventories.” See Note 3 to the consolidated
financial statements for further information regarding inventories.

See Note 5 to the consolidated financial statements for details regarding
outstanding debt as of June 30, 2009 and 2008. The average borrowings
totaled $105.0 million during fiscal 2009 and $47.1 million during fiscal
2008. The Company has a five-year committed revolving credit agreement
which expires in June 2012. This agreement provides for unsecured
borrowings of up to $150.0 million. In fiscal 2009, we drew down on our
revolving credit facility; borrowings have primarily been used to fund
acquisitions. We had $55.0 million of borrowings outstanding under this
facility at June 30, 2009, of which $5.0 million is classified as current and
$50.0 million is classified as long-term. It is the Company’s intention to
maintain a balance of at least $50.0 million outstanding on the revolving
credit facility, utilizing the one-month LIBOR borrowing option through
September 19, 2010 per the terms of the interest rate swap agreement
described in Note 6 to the consolidated financial statements, “Risk
Management Activities.” Unused lines under this facility, net of outstanding
letters of credit, total $88.9 million and are available to fund future
acquisitions or other capital and operating requirements. Borrowings under
this agreement carry variable interest rates tied to either LIBOR, prime, or
the bank’s cost of funds at the Company’s discretion. We also have an
uncommitted long-term financing shelf facility which expires in March 2010,
which enables us to borrow up to $100.0 million at our discretion with
terms of up to fifteen years. We had no outstanding borrowings under this
facility at June 30, 2009.

The weighted average interest rate on borrowings under our debt
agreements, including the effects of interest rate swaps, was 4.4%, 8.4%,
and 6.8% in fiscal 2009, 2008 and 2007, respectively. The decrease in the
weighted average interest rate primarily reflects the impact of borrowings
under the revolver at lower interest rates.

We manage interest rate risk through the use of a combination of fixed-rate
long-term debt, variable rate borrowings under a committed revolving credit
agreement and interest rate swaps. At June 30, 2009, we had $55.0 million
of variable rate debt outstanding of which $50.0 million was effectively
converted to fixed-rate debt under the terms of an interest rate swap
agreement. The Company’s private placement debt has been converted
from fixed-rate U.S. dollar denominated debt to fixed-rate Canadian dollar
denominated debt through the use of a cross-currency swap. As such,
consolidated interest expense was affected by changes in the exchange rates
of U.S. and Canadian dollars. See Note 6 to the consolidated financial
statements for additional discussion on our derivative activities.

In fiscal 2008, we paid off $50.0 million of debt that matured in
December 2007. We terminated certain interest rate swap agreements for
favorable settlements in prior years. The settlement gains were amortized
as a reduction in interest expense of $0.8 million per year through
December 2007.

The Company’s working capital at June 30, 2009 was $369.0 million
compared to $409.2 million at June 30, 2008. The current ratio was 3.4
to 1 at June 30, 2009 and 3.1 to 1 at June 30, 2008. The decrease in
working capital at June 30, 2009 was primarily due to utilization of cash
to purchase FPR.

8 Applied Industrial Technologies, Inc. and Subsidiaries

Allowances for Slow-Moving and
Obsolete Inventories

We evaluate the recoverability of our slow-moving or obsolete inventories at
least quarterly. We estimate the recoverable cost of such inventory by
product type while considering factors such as its age, historic and current
demand trends, the physical condition of the inventory, as well as
assumptions regarding future demand. Our ability to recover our cost for
slow moving or obsolete inventory can be affected by such factors as general
market conditions, future customer demand and relationships with suppliers.
Most of the products we hold in inventory have long shelf lives, are not
highly susceptible to obsolescence and are eligible for return under various
supplier return programs.

Allowances for Doubtful Accounts

We evaluate the collectibility of trade accounts receivable based on a
combination of factors. Initially, we estimate an allowance for doubtful
accounts as a percentage of net sales based on historical bad debt
experience. This initial estimate is adjusted based on recent trends of certain
customers and industries estimated to be a greater credit risk, trends within
the entire customer pool and changes in the overall aging of accounts
receivable. While we have a large customer base that is geographically
dispersed, a general economic downturn in any of the industry segments in
which we operate could result in higher than expected defaults, and
therefore, the need to revise estimates for bad debts.

Reflecting the current economic slowdown, as of June 30, 2009 and 2008,
our allowance for doubtful accounts was 3.1% and 2.4% of gross
receivables, respectively. Our provision for losses on accounts receivable
was $4.5 million and $2.6 million in fiscal 2009 and 2008, respectively.

Goodwill and Intangibles

Goodwill is recognized as the amount by which the cost of an acquired
entity exceeds the net amount assigned to assets acquired and liabilities
assumed. As part of purchase accounting, we also recognize acquired
intangible assets such as customer relationships, vendor relationships, trade
names, and non-competition agreements apart from goodwill. Intangibles
are evaluated for impairment when changes in conditions indicate carrying
value may not be recoverable. We evaluate goodwill for impairment at least
annually. This evaluation requires significant judgment by management,
including estimated future operating results, estimated future cash flows, the
long-term rate of growth of our business, and determination of an
appropriate discount rate. While we use available information to prepare
the estimates and evaluations, actual results could differ significantly. For
example, a worsening of economic conditions beyond those assumed in an
impairment analysis could impact the estimates of future growth and result
in an impairment charge in a future period. Any resulting impairment charge
could be viewed as having a material adverse impact on our financial
condition and results of operations.

assets and noted no further impairment. As of June 30, 2009, we had
$63.1 million of goodwill remaining on our consolidated
financial
statements, all of which is related to the Service Center Based Distribution
segment. We believe the fair value of this segment is well in excess of its
carrying value.

Self-Insurance Liabilities

We maintain business insurance programs with significant self-insured
retention covering workers’ compensation, business, automobile, general
product liability and other claims. We accrue estimated losses using
actuarial calculations, models and assumptions based on historical loss
experience. We maintain a self-insured health benefits plan, which provides
medical benefits to employees electing coverage. We maintain a reserve for
all unpaid medical claims including those incurred but not reported based on
historical experience and other assumptions. Although management
believes that the estimated liabilities for self-insurance are adequate, the
estimates described above may not be indicative of current and future
losses. In addition, the actuarial calculations used to estimate self-insurance
liabilities are based on numerous assumptions, some of which are subjective.
We will continue to adjust our estimated liabilities for self-insurance, as
deemed necessary, in the event that future loss experience differs from
historical loss patterns.

Pension and Other Postemployment
Benefit Plans

The measurement of liabilities related to pension plans and other post-
employment benefit plans is based on management’s assumptions related to
future events including interest rates, return on pension plan assets, rate of
compensation increases, and healthcare cost trend rates. We evaluate these
assumptions and adjust them as necessary. Changes to these assumptions
could result in a material change to the Company’s pension obligation
causing a related increase or decrease in reported net operating results in
the period of change in the estimate. A 1% decrease in the discount rate
would result in an additional liability of $3.2 million and additional expense
of $0.2 million. A 1% increase in the discount rate would result in a
decrease in the liability of $2.8 million and a decrease in expense of $0.2
million. A 1% decrease in the salary scale would result in a decrease in the
liability and expense of $1.4 million and $0.3 million, respectively. A 1%
increase in the salary scale would increase the liability and expense by $1.5
million and $0.3 million, respectively. A 1% change in the return on assets
is not material since most of the plans are non-qualified and unfunded.

In fiscal 2007, we adopted Financial Accounting Standards Board (“FASB”)
Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans”
(“SFAS 158”). As a result of our adoption of SFAS 158 in fiscal 2007, we
recorded a decrease in other non-current assets of $0.2 million, an increase
in postemployment benefits of $7.7 million, and a decrease in accumulated
other comprehensive income (loss) of $7.9 million.

Income Taxes

As of June 30, 2009, the Company had recognized $55.4 million of net
including a $0.1 million valuation allowance.
deferred tax assets,
Management believes that sufficient income will be earned in the future to
realize its deferred income tax assets, except for the minor amount for which
a valuation allowance is recorded. The realization of these deferred tax
assets can be impacted by changes to tax laws, statutory tax rates and
future taxable income levels.

Applied Industrial Technologies, Inc. and Subsidiaries 9

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION (Continued)

Effective July 1, 2007, the Company adopted FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48, which
is an interpretation of SFAS No. 109, “Accounting for Income Taxes,”
provides guidance on the manner in which tax positions taken or to be
taken on tax returns should be reflected in an entity’s financial statements
prior to their resolution with taxing authorities. In accordance with FIN
48, the Company recognized an immaterial cumulative effect adjustment
decreasing its liability for unrecognized tax benefits, interest, and
penalties and increasing the July 1, 2007 balance of retained earnings.
See Note 8 to the consolidated financial statements for more information
on income taxes.

the FASB

NEW ACCOUNTING PRONOUNCEMENTS
issued SFAS No. 141(R), “Business
In December 2007,
Combinations” (“SFAS 141(R)”), which replaces SFAS 141. SFAS 141(R)
requires most assets acquired and
in a business
combination, contingent consideration, and certain acquired contingencies to
be measured at their fair values as of the date of acquisition. SFAS 141(R) also
requires that acquisition related costs and restructuring costs be recognized
separately from the business combination. SFAS 141(R) is effective for the
Company for business combinations entered into after July 1, 2009.

liabilities assumed

In December 2008, the FASB issued FASB Staff Position (“FSP”) FAS 132(R)-1
“Employers’ Disclosures about Postretirement Benefit Plan Assets,” which
amends SFAS 132(R) “Employers’ Disclosures about Pensions and Other
Postretirement Benefits.” FSP FAS 132(R)-1 requires additional detailed
disclosures about employers’ plan assets, including employers’ investment
strategies, major categories of plan assets, concentrations of risk within plan
assets, and valuation techniques used to measure the fair value of plan
assets. FSP FAS 132(R)-1 is effective for the Company in fiscal 2010.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting
Standards Codification™ and
the Hierarchy of Generally Accepted
Accounting Principles.” This standard replaces SFAS No. 162, “The
Hierarchy of Generally Accepted Accounting Principles,” and establishes only
two levels of U.S. generally accepted accounting principles (“GAAP”),
authoritative and non-authoritative. The FASB Accounting Standards
Codification™ (the “Codification”) will become the source of authoritative,
non-governmental GAAP, except for rules and interpretive releases of the
Securities and Exchange Commission (“SEC”), which are sources of
authoritative GAAP for SEC registrants. All other non-grandfathered, non-
SEC accounting literature not included in the Codification will become non-
authoritative. The Company will begin to use the new guidelines and
numbering system prescribed by the Codification when referring to GAAP in
the first quarter of fiscal 2010. As the Codification was not intended to
change or alter existing GAAP, the Company does not believe it will have
any impact on the consolidated financial statements.

OTHER MATTERS
We have made acquisitions of other distributors in two of the past three
fiscal years. On August 29, 2008, Applied completed the acquisition of
certain of the assets of FPR for a purchase price of $166.9 million. Also in
fiscal 2009, we acquired an industrial distributor for $5.5 million. In fiscal
2008, we acquired two distributors of industrial and fluid power products
based in Mexico for a combined purchase price of $28.7 million.

Results of operations of all of the above acquisitions, which have been
accounted for as purchases, are included in the accompanying consolidated
financial statements from their respective acquisition dates. Pro-forma

10 Applied Industrial Technologies, Inc. and Subsidiaries

disclosures are included in Note 2 to the consolidated financial statements
related to the FPR acquisition. The results of operations for the other
acquisitions are not material for all years presented.

CAUTIONARY STATEMENT UNDER PRIVATE
SECURITIES LITIGATION REFORM ACT
This Annual Report to Shareholders, including Management’s Discussion
and Analysis, contains statements that are forward-looking based on
management’s current expectations about the future. Forward-looking
statements are often identified by qualifiers, such as “guidance,” “expect,”
“expected,” “expectation,” “believe,” “plan,” “intend,” “will,” “should,”
“could,” “anticipate,” “intention,” “estimated,” “would be,” and similar
expressions. Similarly, descriptions of objectives, strategies, plans, or goals
are also forward-looking statements. These statements may discuss,
among other things, expected growth, future sales, future cash flows,
future capital expenditures, future performance, and the anticipation and
expectations of the Company and its management as to future occurrences
and trends. The Company intends that the forward-looking statements be
subject to the safe harbors established in the Private Securities Litigation
Reform Act of 1995 and by the Securities and Exchange Commission in its
rules, regulations and releases.

All

Readers are cautioned not to place undue reliance on any forward-looking
statements.
forward-looking statements are based on current
expectations regarding important risk factors, many of which are outside the
Company’s control. Accordingly, actual results may differ materially from
those expressed in the forward-looking statements, and the making of those
statements should not be regarded as a representation by the Company or
any other person that the results expressed in the statements will be
achieved. In addition, the Company assumes no obligation publicly to
update or revise any forward-looking statements, whether because of new
information or events, or otherwise, except as may be required by law.

Important risk factors include, but are not limited to, the following: risks
relating to the operations levels of our customers and the economic factors
that affect them; the impact of current economic conditions on the
collectibility of trade receivables; reduced demand for our products in
targeted markets due to reasons including consolidation in customer
industries and the transfer of manufacturing capacity to foreign countries;
changes in customer preferences for products and services of the nature and
brands sold by us; changes in customer procurement policies and practices;
changes in the prices for products and services relative to the cost of
providing them; loss of key supplier authorizations, lack of product
availability, or changes in supplier distribution programs; competitive
pressures; the cost of products and energy and other operating costs;
disruption of our information systems; our ability to retain and attract
qualified sales and customer service personnel; our ability to identify and
complete acquisitions,
their
anticipated benefits; disruption of operations at our headquarters or
distribution centers; risks and uncertainties associated with our foreign
operations, including more volatile economic conditions, political instability,
cultural and legal differences, and currency exchange fluctuations; risks
related to legal proceedings to which we are a party; the variability and
timing of new business opportunities including acquisitions, alliances,
customer relationships, and supplier authorizations; the incurrence of debt
and contingent liabilities in connection with acquisitions; our ability to
access capital markets as needed on reasonable terms; the potential for

them effectively, and

integrate

realize

The Company mitigates its foreign currency exposure from the Canadian
dollar through the use of cross-currency swap agreements as well as foreign-
currency denominated debt. Hedging of the U.S. dollar denominated debt,
used to fund a substantial portion of the Company’s net investment in its
Canadian operations, is accomplished through the use of cross-currency
swaps. Any gain or loss on the hedging instrument offsets the gain or loss
on the underlying debt. Translation exposures with regard to our Mexican
businesses are not hedged.

In the twelve months ended June 30, 2009, we experienced foreign
currency translation losses, totaling $13.0 million, net of tax, which were
included in accumulated other comprehensive (loss) income. The
Canadian and Mexican foreign exchange rates to the U.S. dollar dropped
by approximately 10% and 22%, respectively, since the beginning of the
fiscal year. A 10% strengthening from the levels at June 30, 2009 of the
U.S. dollar relative to foreign currencies that affect the Company would
have resulted in a $1.1 million decrease in net income for the year ended
June 30, 2009. A 10% weakening from the levels at June 30, 2009 of the
U.S. dollar would have resulted in a $0.6 million increase in net income
for the year ended June 30, 2009.

goodwill and intangible asset impairment; changes in accounting policies
and practices; organizational changes within the Company; the volatility of
our stock price and the resulting impact on our consolidated financial
statements; adverse regulation and legislation, including potential changes
in tax regulations (i.e., utilization of LIFO inventory accounting method and
taxation of foreign-sourced income); and the occurrence of extraordinary
events (including prolonged labor disputes, natural events and acts of God,
terrorist acts, fires, floods, and accidents). Other factors and unanticipated
events could also adversely affect our business, financial condition or results
of operations. We discuss certain of these matters more fully throughout our
“Management’s Discussion and Analysis” as well as other of our filings with
the Securities and Exchange Commission, including our Annual Report on
Form 10-K for the year ended June 30, 2009.

QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The Company has evaluated its exposure to various market risk factors,
including its primary market risk exposures through the effects of changes in
exchange rates and changes in interest rates. We occasionally utilize
derivative instruments as part of our overall financial risk management
policy, but do not use derivative instruments for speculative or trading
purposes. We utilize a sensitivity analysis to measure the potential impact
on earnings based on a hypothetical 1% increase in interest rates and a
10% change in foreign currency rates. A summary of our primary market
risk exposures follows.

Interest Rate Risk
The Company manages interest rate risk through the use of a combination
of fixed rate long-term debt, variable rate borrowings under its committed
revolving credit agreement and interest rate swaps. At June 30, 2009, the
Company had $55.0 million outstanding in variable rate borrowings under
its committed revolving credit agreement. In conjunction with this facility,
on September 19, 2008, the Company entered into a two-year agreement
for a $50.0 million interest rate swap to effectively convert a portion of this
variable-rate debt to fixed-rate debt at a fixed rate of 3.33%. The impact of
a 1% increase in the interest rate on the remaining $5.0 million of
outstanding variable rate debt would be immaterial to interest expense. In
the current borrowing environment, borrowings beyond the amounts
available under the revolving credit agreement would carry interest rates
higher than our current borrowing rates.

The Company also had $25.0 million of outstanding long-term debt at fixed
interest rates at June 30, 2009, which is scheduled for repayment in
November 2010.

Foreign Currency Rate Risk
The financial statements of foreign subsidiaries are translated into their U.S.
dollar equivalents at end-of-period exchange rates for assets and liabilities,
while income and expenses are translated at average monthly exchange
rates. Translation gains and losses are included as components of
accumulated other
consolidated
shareholders’ equity. Transaction gains and losses arising from fluctuations
in currency exchange rates on transactions denominated in currencies other
than the functional currency are recognized in the consolidated statements
of income as a component of other expense (income), net. Since we operate
internationally and approximately 12.9% of our fiscal 2009 net sales were
generated outside the Unites States, foreign currency exchange rates can
impact our financial position, results of operations and competitive position.

comprehensive

income

(loss)

Applied Industrial Technologies, Inc. and Subsidiaries 11

STATEMENTS OF CONSOlIDATED INCOME
(In thousands, except per share amounts)

Year Ended June 30,
Net Sales
Cost of Sales

Selling, Distribution and Administrative, including depreciation
Goodwill Impairment
Operating Income
Interest Expense
Interest Income
Other Expense (Income), net

Income Before Income Taxes
Income Tax Expense
Net Income
Net Income Per Share - Basic
Net Income Per Share - Diluted

See notes to consolidated financial statements.

2009
$ 1,923,148
1,403,138
520,010
410,912
36,605
72,493
5,523
(1,099)
2,255
6,679
65,814
23,554
42,260
1.00
0.99

$
$
$

2008
$2,089,456
1,520,173
569,283
416,459

152,824
4,939
(4,057)
227
1,109
151,715
56,259
95,456
2.23
2.19

$
$
$

2007
$ 2,014,109
1,466,057
548,052
413,041

135,011
5,798
(3,438)
(1,179)
1,181
133,830
47,808
86,022
1.97
1.93

$
$
$

12 Applied Industrial Technologies, Inc. and Subsidiaries

CONSOlIDATED BAlANCE SHEETS
(In thousands)

June 30,
Assets

Current assets

Cash and cash equivalents
Accounts receivable, less allowances of $6,464 and $6,119
Inventories
Other current assets

Total current assets
Property - at cost

Land
Buildings
Equipment

Total Property - at cost

Less accumulated depreciation

Property - net
Goodwill
Intangibles, net
Other assets

Total Assets

Liabilities

Current liabilities

Accounts payable
Short-term debt
Compensation and related benefits
Other current liabilities

Total current liabilities
Long-term debt
Postemployment benefits
Other liabilities

Total Liabilities

Shareholders' Equity

Preferred stock - no par value; 2,500 shares authorized; none issued or outstanding
Common stock - no par value; 80,000 shares authorized; 54,213 shares issued
Additional paid-in capital
Income retained for use in the business
Treasury shares - at cost (11,929 and 11,923 shares)
Accumulated other comprehensive (loss) income

Total Shareholders' Equity
Total Liabilities and Shareholders' Equity

See notes to consolidated financial statements.

2009

2008

$ 27,642
198,792
254,690
44,470
525,594

10,577
72,481
110,951
194,009
131,274
62,735
63,108
95,832
62,059
$ 809,328

$ 80,655
5,000
34,695
36,206
156,556
75,000
43,186
26,484
301,226

10,000
136,895
560,574
(191,518)
(7,849)
508,102
$ 809,328

$ 101,830
245,119
210,723
48,525
606,197

10,639
71,142
108,162
189,943
124,946
64,997
64,685
19,164
43,728
$ 798,771

$ 109,822

56,172
31,017
197,011
25,000
37,746
36,939
296,696

10,000
133,078
543,692
(190,944)
6,249
502,075
$ 798,771

Applied Industrial Technologies, Inc. and Subsidiaries 13

STATEMENTS OF CONSOlIDATED CASH FlOWS
(In thousands)

Year Ended June 30,
Cash Flows from Operating Activities
Net income

Adjustments to reconcile net income to net cash provided by operating activities:

Goodwill impairment
Deferred income taxes
Depreciation
Amortization of intangibles
Provision for losses on accounts receivable
Share-based compensation
Unrealized foreign exchange transaction losses
Treasury shares contributed to employee benefit and deferred compensation plans
Gain on sale of property
Amortization of gain on interest rate swap terminations
Changes in assets and liabilities, net of acquisitions:

Accounts receivable
Inventories
Other operating assets
Accounts payable
Other operating liabilities

Net Cash provided by Operating Activities
Cash Flows from Investing Activities

Property purchases
Proceeds from property sales
Net cash paid for acquisition of businesses, net of cash acquired of $185 and $2,355 in 2009
and 2008, respectively
Other

Net Cash used in Investing Activities
Cash Flows from Financing Activities

Net short-term borrowings under revolving credit facility
Borrowings under revolving credit facility classified as long-term
Long-term debt repayment
Purchases of treasury shares
Dividends paid
Excess tax benefits from share-based compensation
Exercise of stock options and appreciation rights
Other

Net Cash provided by (used in) Financing Activities
Effect of Exchange Rate Changes on Cash
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and Cash Equivalents at End of Year

Supplemental Cash Flow Information

Cash paid during the year for:

Income taxes
Interest

See notes to consolidated financial statements.

14 Applied Industrial Technologies, Inc. and Subsidiaries

2009

2008

2007

$ 42,260

$ 95,456

$ 86,022

36,605
(16,648)
12,736
9,655
4,540
4,092
806
410
(320)

63,929
(20,581)
6,858
(38,124)
(24,918)
81,300

(6,988)
757

(5,809)
12,776
1,663
2,595
3,376

812
(1,214)
(395)

8,306
(1,484)
(13,950)
11,881
(3,710)
110,303

(8,410)
1,372

(6,424)
13,489
1,045
1,462
2,927

1,921
(334)
(791)

(17,415)
(7,934)
(1,369)
(12,220)
10,546
70,925

(11,192)
1,275

(172,199)

(22,105)

(178,430)

5,000
50,000

(1,210)
(25,378)
802
408
(1,120)
28,502
(5,560)
(74,188)
101,830
$ 27,642

2,304
(26,839)

(302)
(10,219)

(50,000)
(33,224)
(25,728)
3,761
1,664

(103,527)
2,228
(17,835)
119,665
$ 101,830

(33,988)
(20,970)
3,885
2,663

(48,410)
941
13,237
106,428
$119,665

$ 43,081
5,265
$

$ 60,049
4,763
$

$ 42,857
$ 5,488

STATEMENTS OF CONSOlIDATED SHAREHOlDERS’ EQUITY
(In thousands, except per share amounts)

Shares of
Common
Stock
Outstanding

Common
Stock
44,067 $ 10,000

Additional
Paid-in
Capital
$ 122,146

Income
Retained
for Use in
the Business
$ 408,847
86,022

Treasury
Shares-
at Cost
$ (130,967)

For the Years Ended June 30, 2009, 2008 and 2007
Balance at July 1, 2006

Net income
Unrealized loss on cash flow hedge, net of income tax of $(59)
Unrealized gain on investment securities available for sale, net of
income tax of $68
Increase in minimum pension liability, net of income tax of $(185)
Foreign currency translation adjustment, net of income tax of $194

Total comprehensive income

Cash dividends - $0.48 per share
Purchases of common stock for treasury
Treasury shares issued for:

Retirement Savings Plan contributions
Exercise of stock options and appreciation rights
Deferred compensation plans

Compensation expense - stock options and appreciation rights
Amortization of restricted common stock compensation
Adjustment to initially apply SFAS 158, net of income tax of $(4,899)
Other

Balance at June 30, 2007

Net income
Unrealized gain on cash flow hedge, net of income tax of $414
Unrealized gain on investment securities available for sale, net of
income tax of $50
Reclassification of pension and postemployment expense into
income, net of income tax of $611
Pension and postemployment adjustment, net of
income tax of $(318)
Foreign currency translation adjustment, net of income tax of $912

Total comprehensive income

Cash dividends - $0.60 per share
Purchases of common stock for treasury
Treasury shares issued for:

Exercise of stock options and appreciation rights
Deferred compensation plans

Compensation expense - stock options and appreciation rights
Amortization of restricted common stock compensation
Other

Balance at June 30, 2008

Net income
Unrealized loss on cash flow hedges, net of income tax of $(457)
Reclassification of interest expense on cash flow hedge, net of
income tax of $264
Unrealized loss on investment securities available for sale, net of
income tax of $(105)
Reclassification of pension and postemployment expense into
income, net of income tax of $691
Pension and postemployment adjustment, net of
income tax of $(1,154)
Foreign currency translation adjustment, net of
income tax of ($3,793)

Total comprehensive income

Cash dividends - $0.60 per share
Purchases of common stock for treasury
Treasury shares issued for:

Exercise of stock options and appreciation rights
Deferred compensation plans

Compensation expense - stock options and appreciation rights
Amortization of restricted common stock compensation
Other

Balance at June 30, 2009

See notes to consolidated financial statements.

Accumulated
Other
Comprehensive
Income (Loss)
$ 4,796

(93)

110

(301)
2,703

(7,897)

(682)

645

998

(520)

5,726

6,249

(569)

437

(177)

Total
Shareholders'
Equity
$ 414,822
86,022
(93)

110

(301)
2,703
88,441
(20,970)
(33,988)

112
4,953
2,659
2,494
433
(7,897)
(76)
450,983
95,456
645

998

(520)

5,726
102,387
(25,728)
(33,224)

4,130
812
2,999
377
(661)
502,075
42,260
(569)

437

(177)

1,127

(1,883)

(13,033)

28,162
(25,378)
(1,210)

1,054
410
3,701
391
(1,103)
$ 508,102

$ (7,849)

(1,401)

5
366
78

(20,970)

(33,988)

65
4,157
1,046

47
796
1,613
2,494
433

1
43,116

10,000

40
127,569

(116)
(159,803)

473,899
95,456

(1,145)

315
26

(22)
42,290

10,000

(25,728)

(33,224)

2,330
402

65
543,692
42,260

(649)
(190,944)

1,800
410
2,999
377
(77)
133,078

(68)

(25,378)

(1,210)

73
18

47
110
3,701
391
(671)
(432)
42,284 $ 10,000 $ 136,895 $ 560,574 $ (191,518)

1,007
300

(29)

Applied Industrial Technologies, Inc. and Subsidiaries 15

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)

NOTE 1: BUSINESS AND ACCOUNTING POLICIES

Business

Applied Industrial Technologies, Inc. and subsidiaries (the “Company,” “Applied”) is one of North America’s leading distributors of industrial products.
Industrial products include bearings, power transmission components, fluid power components and systems, industrial rubber products, linear components,
tools, safety products, general maintenance, and a variety of mill supply products. Fluid power products include hydraulic, pneumatic, lubrication, and
filtration components and systems. The Company also provides shop services for mechanical, rubber and fluid power products. The Company offers
technical application support for these products and provides 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 North America.

Consolidation

The consolidated financial statements include the accounts of Applied Industrial Technologies, Inc. and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation. The financial results of the Company’s Canadian and Mexican subsidiaries are included in
the consolidated financial statements for the twelve months ended May 31.

Foreign Currency

The financial statements of the Company’s Canadian and Mexican subsidiaries are measured using local currencies as their functional currencies. Assets
and liabilities are translated into U.S. dollars at current exchange rates, while income and expenses are translated at average exchange rates. Translation
gains and losses are included as components of accumulated other comprehensive (loss) income in consolidated shareholders’ equity. Gains and losses
resulting from transactions denominated in foreign currencies are included in the statements of consolidated income as a component of other expense
(income), net.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to
make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent 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 and Cash Equivalents

The Company considers all short-term, highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents.
Cash and cash equivalents are carried at cost, which approximates market value.

Marketable Securities

The primary marketable security investments of the Company include money market and mutual funds. These are included in other assets, are classified as
trading securities and reported at fair value, based on quoted market prices. Unrealized gains and losses are recorded in other expense (income), net in the
statements of consolidated income and reflect changes in the fair value of the investment during the period.

Concentration of Credit Risk

The Company has a broad customer base representing many diverse industries doing business throughout North America. As such, the Company does not
believe that a significant concentration of credit risk exists.

The Company maintains its cash and cash equivalents with federally insured financial institutions. Deposits held with banks may exceed insurance limits.
These deposits may be redeemed upon demand.

Allowances for Doubtful Accounts

The Company evaluates the collectibility of trade accounts receivable based on a combination of factors. Initially, the Company estimates an allowance for
doubtful accounts as a percentage of net sales based on historical bad debt experience. This initial estimate is adjusted based on recent trends of
customers and industries estimated to be a greater credit risk, trends within the entire customer pool and changes in the overall aging of accounts
receivable. While the Company has a large customer base that is geographically dispersed, a general economic downturn in any of the industry segments in
which the Company operates could result in higher than expected defaults, and therefore, the need to revise estimates for bad debts.

Inventories

Inventories are valued at the lower of cost or market, using the last-in, first-out (“LIFO”) method for U.S. inventories and the average cost method for
foreign inventories. The Company adopted the link chain dollar value LIFO method of accounting for U.S. inventories in fiscal 1974. At June 30, 2009,
approximately one-third of the Company’s domestic inventory dollars relate to LIFO layers added in the 1970s. The Company maintains five LIFO pools
based on the following product groupings: bearings, power transmission products, rubber products, fluid power products and other products. LIFO layers
and/or liquidations are determined consistently year-to-year in a manner which is in accordance with the guidance in the 1984 AICPA LIFO Issues Paper,
“Identification and Discussion of Certain Financial Accounting and Reporting Issues Concerning LIFO Inventories.”

16 Applied Industrial Technologies, Inc. and Subsidiaries

The Company evaluates the recoverability of its slow moving or obsolete inventories at least quarterly. The Company estimates the recoverable cost of such
inventory by product type while considering factors such as its age, historic and current demand trends, the physical condition of the inventory as well as
assumptions regarding future demand. The Company’s ability to recover its cost for slow moving or obsolete inventory can be affected by such factors as
general market conditions, future customer demand and relationships with suppliers. Historically, the Company’s inventories have demonstrated long shelf
lives, are not highly susceptible to obsolescence and are eligible for return under various supplier return programs.

Supplier Purchasing Programs

The Company enters into agreements with certain suppliers providing for inventory purchase incentives. The Company’s inventory purchase incentive
arrangements are unique to each supplier and are generally annual programs ending at either the Company’s fiscal year end or the supplier’s year end.
Incentives are received in the form of cash or credits against purchases upon attainment of specified purchase volumes and are received monthly, quarterly
or annually. The incentives are generally a specified percentage of the Company’s net purchases based upon achieving specific purchasing volume levels.
These percentages can increase or decrease based on changes in the volume of purchases. The Company accrues for the receipt of these inventory
purchase incentives based upon cumulative purchases of inventory. The percentage level utilized is based upon the estimated total volume of purchases
expected during the life of the program. Each supplier program is analyzed, reviewed and reconciled each quarter as information becomes available to
determine the appropriateness of the amount estimated to be received. Upon program completion, differences between estimates and actual incentives
subsequently received have not been material. Benefits under these supplier purchasing programs are recognized under the Company’s LIFO inventory
accounting method as a reduction of cost of sales when the inventories representing these purchases are recorded as cost of sales. The Company’s
accounting for inventory purchase incentives is in accordance with guidance issued by the Financial Accounting Standards Board (“FASB”) in EITF 02-16,
“Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” Accrued incentives expected to be settled as a credit
against purchases are reported on the consolidated balance sheet as an offset to amounts due to the related supplier.

Property and Depreciation

Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets and is
included in selling, distribution and administrative expenses in the accompanying statements of consolidated income. Buildings, building improvements and
leasehold improvements are depreciated over ten to thirty years or the life of the lease if a shorter period, and equipment is depreciated over three to eight
years. The carrying values of property and equipment are reviewed for impairment when events or changes in circumstances indicate that the recorded
value cannot be recovered from undiscounted future cash flows. Impairment losses, if any, are measured based upon the difference between the carrying
amount and the fair value of the assets.

Goodwill and Intangible Assets

Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not
amortized. Goodwill is reviewed for impairment annually as of January 1 or whenever changes in conditions indicate an evaluation should be completed.
These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or
disposition of a significant portion of a reporting unit. The Company utilizes discounted cash flow models and market multiples for comparable businesses
to determine the fair value of reporting units. Evaluating impairment requires significant judgment by management, including estimated future operating
results, estimated future cash flows, the long-term rate of growth of the business, and determination of an appropriate discount rate. While the Company
uses available information to prepare the estimates and evaluations, actual results could differ significantly.

During the fourth quarter of fiscal 2009, the Company performed an interim goodwill impairment test based on current and expected market conditions,
including reduced operating results and a worsening economic outlook. As a result of this test, the Company determined that all of the goodwill associated
with the Fluid Power Businesses segment was impaired as of June 30, 2009. Accordingly, the Company recognized an impairment charge of $36,605 for
goodwill in the fourth quarter of fiscal 2009, which decreased net income by $23,000 and earnings per share by $0.54.

The Company recognizes acquired intangible assets such as customer relationships, trade names, vendor relationships, and non-competition agreements
apart from goodwill. Customer relationship intangibles are amortized using the sum-of-the years digits method over estimated useful lives consistent with
assumptions used in the determination of their value. Amortization of all other intangible assets is computed using the straight-line method over the
estimated period of benefit. Amortization of intangible assets is included in selling, distribution and administrative expenses in the accompanying
statements of consolidated income. The weighted-average amortization period for intangible assets with an unamortized balance as of June 30, 2009 was
18 years for customer relationships, 14 years for vendor relationships, 14 years for trade names, and 7 years for non-competition agreements. Intangible
assets are reviewed for impairment when changes in conditions indicate carrying value may not be recoverable. As a result of the goodwill impairment
recorded on the Fluid Power Businesses segment, the Company performed impairment tests on its long-lived assets (including intangible assets subject to
amortization) as of June 30, 2009. No impairment loss was recognized on intangible assets subject to amortization.

Self-Insurance Liabilities

The Company maintains business insurance programs with significant self-insured retention covering workers’ compensation, business, automobile, general
product liability and other claims. The Company accrues estimated losses including those incurred but not reported using actuarial calculations, models and
assumptions based on historical loss experience. The Company maintains a self-insured health benefits plan, which provides medical benefits to employees
electing coverage under the plan. The Company estimates its reserve for all unpaid medical claims including those incurred but not reported based on
historical experience, adjusted as necessary based upon management’s reasoned judgment.

Applied Industrial Technologies, Inc. and Subsidiaries 17

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

Revenue Recognition

Sales are recognized when the sales price is fixed, collectibility is reasonably assured and the product’s title and risk of loss is transferred to the customer.
Typically, these conditions are met when the product is shipped to the customer. The Company charges shipping and handling fees when products are
shipped or delivered to a customer, and includes such amounts in net sales. The Company reports its sales net of actual sales returns and the amount of
reserves established for anticipated sales returns based on historical rates. Sales tax collected from customers is excluded from net sales in the
accompanying statements of consolidated income.

Shipping and Handling Costs

The Company records freight payments to third parties in cost of sales and internal delivery costs in selling, distribution and administrative expenses in the
accompanying statements of consolidated income. Internal delivery costs in selling, distribution and administrative expenses were approximately $15,400,
$17,000 and $16,000 for the fiscal years ended June 30, 2009, 2008 and 2007, respectively.

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. Uncertain tax positions are provided for in accordance with the requirements of FASB Interpretation No. 48 “Accounting for Uncertainty in
Income Taxes” (“FIN 48”), an interpretation of Statement of Financial Accounting Standards (“SFAS”) No. 109 “Accounting for Income Taxes.” The
Company records interest and penalties related to uncertain tax positions as a component of income tax expense. FIN 48 prescribes a recognition threshold
and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Income tax positions must
meet a more-likely-than-not recognition threshold to be recognized under FIN 48.

Treasury Shares

Shares of common stock repurchased by the Company are recorded at cost as treasury shares and result in a reduction of shareholders’ equity in the
consolidated balance sheets. The Company uses the weighted-average cost method for determining the cost of shares reissued. The difference between
the cost of the shares and the reissuance price is added to or deducted from additional paid-in capital.

New Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS 141. SFAS 141(R) requires most
assets acquired and liabilities assumed in a business combination, contingent consideration, and certain acquired contingencies to be measured at their fair
values as of the date of acquisition. SFAS 141(R) also requires that acquisition related costs and restructuring costs be recognized separately from the
business combination. SFAS 141(R) is effective for the Company for business combinations entered into after July 1, 2009.

In December 2008, the FASB issued FASB Staff Position (“FSP”) FAS 132(R)-1 “Employers’ Disclosures about Postretirement Benefit Plan Assets,” which
amends SFAS 132(R) “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” FSP FAS 132(R)-1 requires additional detailed
disclosures about employers’ plan assets, including employers’ investment strategies, major categories of plan assets, concentrations of risk within plan
assets, and valuation techniques used to measure the fair value of plan assets. FSP FAS 132(R)-1 is effective for the Company in fiscal 2010.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting
Principles.” This standard replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” and establishes only two levels of U.S.
generally accepted accounting principles (“GAAP”), authoritative and non-authoritative. The FASB Accounting Standards Codification™ (the
“Codification”) will become the source of authoritative, non-governmental GAAP, except for rules and interpretive releases of the Securities and Exchange
Commission (“SEC”), which are sources of authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature not included
in the Codification will become non-authoritative. The Company will begin to use the new guidelines and numbering system prescribed by the Codification
when referring to GAAP in the first quarter of fiscal 2010. As the Codification was not intended to change or alter existing GAAP, the Company does not
believe it will have any impact on the consolidated financial statements.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current year presentation.

Subsequent Events

Subsequent events have been evaluated through August 19, 2009; the date the financial statements were issued.

NOTE 2: BUSINESS COMBINATIONS

Results of operations of acquired businesses, which have been accounted for as purchases, are included in the accompanying consolidated financial
statements from their respective acquisition dates based on the Company’s consolidation policy.

Fluid Power Resource Acquisition

On August 29, 2008, Applied completed the acquisition of certain of the assets of Fluid Power Resource, LLC and the following fluid power distribution
businesses: Bay Advanced Technologies, Carolina Fluid Components, DTS Fluid Power, Fluid Tech, Hughes HiTech, Hydro Air, and Power Systems

18 Applied Industrial Technologies, Inc. and Subsidiaries

(collectively “FPR”). Applied acquired certain assets and assumed certain specified liabilities of FPR for an aggregate cash purchase price of $166,000
(originally funded with existing cash balances and $104,000 of borrowings through the Company’s committed revolving credit facility).

The acquired businesses included 19 locations and the associated assembled workforce. This acquisition is part of the Fluid Power Businesses segment
whose base business is distributing fluid power components, assembling fluid power systems, performing equipment repair, and offering technical advice to
customers. This acquisition increased the Company’s capabilities in the following areas: fluid power system integration; manifold design, machining, and
assembly; and the integration of hydraulics with electronics.

The excess of the purchase price over the estimated fair values is assigned to goodwill and is expected to be deductible for tax purposes. Adjustments to
goodwill and initial asset valuations were recorded in the second, third and fourth quarters of fiscal 2009 to reflect updated asset valuation information.

The following table summarizes the fair values of assets acquired and liabilities assumed at the date of acquisition:

Cash and cash equivalents
Accounts receivable
Inventories
Other current assets
Property, plant and equipment
Intangibles
Goodwill (subsequently written off as part of impairment charge in fourth quarter 2009)
Other assets

Total assets acquired
Accounts payable
Other accrued liabilities

Net assets acquired

Purchase price
Direct acquisition costs

Acquisition cost

100
26,500
28,700
300
4,900
86,000
34,000
200

180,700
10,600
3,200

$166,900

$166,000
900

$166,900

Total intangible assets have a weighted-average useful life of 17 years and include customer relationships of $51,900 (19-year weighted-average useful
life), trade names of $22,000 (15-year weighted-average useful life), vendor relationships of $9,600 (15-year weighted-average useful life) and non-
competition agreements of $2,500 (5-year weighted-average useful life).

The table below presents summarized unaudited pro forma results of operations as if FPR had been acquired effective at the beginning of the fiscal years
ended June 30, 2009 and 2008, respectively.

(unaudited)

Net sales

Income before income taxes

Net income

Net income per share - diluted

Other Acquisitions

2009

$ 1,962,882

66,357

42,601

1.00

2008

$2,336,336

155,857

98,049

2.25

On December 5, 2008, the Company acquired certain assets of Cincinnati Transmission Company, an industrial distributor, for $5,535 (of which $4,700
was paid during the second quarter of fiscal 2009). Tangible assets acquired totaled $900 and intangibles, including goodwill, totaled $4,635 as of
June 30, 2009 and are considered part of our Service Center Based Distribution segment.

In fiscal 2008, the Company acquired two distributors based in Mexico for a combined purchase price of $28,703. VYCMEX S.A. de C.V., a distributor of
fluid power products, was acquired in December 2007 (included in our Fluid Power Businesses segment) and Suministros Industriales Enol, S.A. de C.V., an
industrial products distributor, was acquired in May 2008 (included in our Service Center Based Distribution segment).

The Company acquired these distributors to complement and extend its business over a broader geographic area. The results of operations for these
acquisitions are not material for all years presented.

Applied Industrial Technologies, Inc. and Subsidiaries 19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

NOTE 3: INVENTORIES

Inventories consist of the following:

June 30,

U.S. inventories at current cost

Foreign inventories at average cost

Less: Excess of current cost over LIFO cost for U.S. inventories

Inventories on consolidated balance sheets

2009

$367,836

53,742

421,578

166,888

$254,690

2008

$305,377

55,441

360,818

150,095

$210,723

Reductions in certain U.S. inventories during fiscal 2009 and 2008 resulted in the liquidation of LIFO inventory quantities carried at lower costs prevailing in
prior years. The effect of the liquidations increased gross profit by $4,419 and $626, net income by $2,693 and $383, and diluted net income per share by
$0.06 and $0.01, respectively. There were no LIFO layer liquidations during fiscal 2007.

NOTE 4: GOODWILL AND INTANGIBLES

During the fourth quarter of fiscal 2009, the Company performed an interim goodwill impairment test based on current and expected market conditions,
including reduced operating results and a worsening economic outlook. As a result of this test, the Company determined that all of the goodwill associated
with the Fluid Power Businesses segment was impaired as of June 30, 2009. Accordingly, the Company recognized an impairment charge of $36,605 for
goodwill in the fourth quarter of fiscal 2009, which decreased net income by $23,000 and earnings per share by $0.54. In addition, the Company
performed an impairment analysis of its intangible assets and noted no further impairment.

The changes in the carrying amount of goodwill by reportable segment for the years ended June 30, 2009 and 2008 are as follows:

Balance at July 1, 2007
Goodwill acquired during the year
Other, including currency translation

Balance at June 30, 2008

Goodwill acquired during the year
Other, including currency translation
Goodwill impairment

Balance at June 30, 2009

Service Center Based
Distribution Segment

Fluid Power
Businesses Segment

$ 57,304
3,486
657

61,447

2,382
(721)

$ 63,108

246
2,692
300

3,238

34,000
(633)
(36,605)

Total

$ 57,550
6,178
957

64,685

36,382
(1,354)
(36,605)

$63,108

The Company’s intangible assets resulting from business combinations are amortized over their estimated period of benefit and consist of the following:

June 30, 2009

Customer relationships

Trade names

Vendor relationships

Non-competition agreements

Total Intangibles

June 30, 2008

Customer relationships
Trade names
Vendor relationships
Non-competition agreements

Total Intangibles

Amount

$ 65,077

25,576

13,750

4,425

$108,828

Amount

$ 11,824
4,240
4,731
2,441

$ 23,236

Accumulated
Amortization

$ 8,693

1,879

1,442

982

$12,996

Accumulated
Amortization

$2,716
278
575
503

$4,072

Net
Book Value

$56,384

23,697

12,308

3,443

$95,832

Net
Book Value

$ 9,108
3,962
4,156
1,938

$19,164

Amounts include the impact of foreign currency translation. Fully amortized amounts are written off.

20 Applied Industrial Technologies, Inc. and Subsidiaries

During fiscal 2009, the Company recorded intangible assets of $53,600 for customer relationships, $22,080 for trade names, $10,015 for vendor
relationships, and $2,576 for non-competition agreements.

During fiscal 2008, the Company recorded intangible assets of $3,210 for customer relationships, $3,200 for trade names, $3,440 for vendor relationships,
and $1,740 for non-competition agreements.

Amortization expense for intangible assets totaled $9,655, $1,663 and $1,045 in fiscal 2009, 2008 and 2007, respectively, and is included in selling,
distribution and administrative expenses in the statements of consolidated income. Amortization of intangible assets at June 30, 2009 is estimated to be
$10,400 for 2010, $9,900 for 2011, $9,400 for 2012, $8,800 for 2013 and $7,700 for 2014.

NOTE 5: DEBT

The Company’s outstanding borrowings consist of:

June 30,

7.98% Private placement debt, due at maturity in November 2010

Revolving credit agreement

Total outstanding debt

Less: Payable within one year

Long-term portion of outstanding debt

2009

$25,000

55,000

80,000

5,000

$75,000

2008

$ 25,000

25,000

$ 25,000

Based upon current market rates for debt of similar maturities, the Company’s outstanding debt had an estimated fair value of $74,000 and $26,336 as of
June 30, 2009 and 2008, respectively.

The Company has a revolving credit facility with a group of banks expiring in June 2012. This agreement provides for unsecured borrowings of up to
$150,000. Fees on this facility range from 0.07% to 0.15% per year on the average amount of the total revolving credit commitments during the year. As
of June 30, 2009, the Company had $55,000 outstanding on this revolving credit facility, of which $5,000 is classified as current and $50,000 is classified
as long-term. Borrowings under this agreement carry variable interest rates tied to either LIBOR, prime, or the bank’s cost of funds at the Company’s
discretion. At June 30, 2009, the weighted-average interest rate for the outstanding borrowings under this agreement along with the interest rate swap
agreement was 3.08%. It is the Company’s intention to maintain a balance of at least $50,000 outstanding utilizing the one-month LIBOR borrowing
option through September 19, 2010, the date on which the related cash flow hedge ends (described in Note 6, “Risk Management Activities”). Unused
lines under this facility, net of outstanding letters of credit of $6,104 to secure certain insurance obligations, totaled $88,896 at June 30, 2009 and are
available to fund future acquisitions or other capital and operating requirements.

The Company has an agreement with Prudential Insurance Company for an uncommitted shelf facility that enables the Company to borrow up to $100,000
in additional long-term financing at the Company’s sole discretion with terms of up to fifteen years. The agreement expires in March 2010. There were no
borrowings at June 30, 2009.

The revolving credit facility, private placement debt and uncommitted shelf facility contain restrictive covenants regarding liquidity, net worth, financial
ratios, and other covenants. At June 30, 2009, the most restrictive of these covenants required that the Company have consolidated income before
interest, taxes, depreciation and amortization at least equal to 300% of net interest expense. At June 30, 2009, the Company was in compliance with
all covenants.

NOTE 6: RISK MANAGEMENT ACTIVITIES

On January 1, 2009, Applied adopted FASB Statement No. 161 “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB
Statement No. 133” (“SFAS 161”). The adoption of SFAS 161 required additional financial statement disclosures. The Company has applied the
requirements of SFAS 161 on a prospective basis. Accordingly, disclosures related to prior periods have not been presented.

The Company is exposed to market risks, primarily resulting from changes in currency exchange rates and interest rates. To manage these risks, the
Company may enter into derivative transactions pursuant to the Company’s written policy. These transactions are accounted for in accordance with SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). This standard, as amended, requires that all derivative instruments
be recorded on the balance sheet at their fair value and that changes in fair value be recorded each period in current earnings or comprehensive income.
The Company does not hold or issue derivative financial instruments for trading purposes. The criteria for designating a derivative as a hedge include the
assessment of the instrument’s effectiveness in risk reduction, matching of the derivative instrument to its underlying transaction, and the probability that
the underlying transaction will occur.

Applied Industrial Technologies, Inc. and Subsidiaries 21

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

Foreign Currency Exchange Rate Risk

In November 2000, the Company entered into two 10-year cross-currency swap agreements to manage its foreign currency risk exposure on private
placement borrowings related to its wholly-owned Canadian subsidiary. The cross-currency swaps effectively convert $25,000 of debt, and the associated
interest payments, from 7.98% fixed-rate U.S. dollar denominated debt to 7.75% fixed-rate Canadian dollar denominated debt. The terms of the two
cross-currency swaps mirror the terms of the private placement borrowings. One of the cross-currency swaps is designated as a cash flow hedge. There
was no ineffectiveness of this cross-currency swap during fiscal 2009. The unrealized losses on this swap are included in accumulated other comprehensive
(loss) income and the corresponding fair value is included in other liabilities in the consolidated balance sheets.

The other cross-currency swap is not designated as a hedging instrument under the hedge accounting provisions of SFAS 133. Accordingly, the Company
records the fair value of this contract as of the end of its reporting period to its consolidated balance sheet with changes in fair value recorded in the
Company’s statements of consolidated income. The balance sheet classification for the fair value of this contract is to other assets for unrealized gains or
other liabilities for unrealized losses. The income statement classification for the fair value of this swap is to other expense (income), net for both unrealized
gains and losses.

Interest Rate Risk

Effective September 19, 2008, the Company entered into a two-year agreement for a $50,000 interest rate swap to effectively convert $50,000 of its
variable-rate debt to fixed-rate debt at a fixed rate of 3.33%. This instrument has been designated as a cash flow hedge, the objective of which is to
eliminate the variability of cash flows in interest payments attributable to changes in the benchmark one-month LIBOR interest rates. There was no
ineffectiveness of this interest rate swap contract during fiscal 2009. The unrealized loss on this interest rate swap is included in accumulated other
comprehensive (loss) income and the corresponding fair value is included in other liabilities in the consolidated balance sheet. Based upon market
valuations at June 30, 2009, approximately $700 is expected to be reclassified into the statement of consolidated income over the next twelve months, as
cash flow payments are made in accordance with the interest rate swap agreements.

The following table summarizes the fair value of derivative instruments as recorded in the consolidated balance sheet as of June 30:

Consolidated Balance
Sheet Classification

Fair Value
2009

Derivatives designated as hedging instruments:

Cross-currency swap

Interest rate swap

Total derivatives designated as hedging instruments

Other liabilities

Derivative not designated as a hedging instrument - cross-currency swap

Other liabilities

Total Derivatives

$6,689

1,381

8,070

1,672

$9,742

The following table summarizes the effects of derivative instruments on income and other comprehensive income (“OCI”) for the year ended June 30, 2009
(amounts presented exclude any income tax effects):

Derivatives in Cash Flow Hedging
Relationships

Amount of Gain (Loss) Recognized in OCI
on Derivatives (Effective Portion)

Amount of Loss Reclassified from Accumulated OCI into Income
(Effective Portion), Included in Interest Expense

Cross-currency swap

Interest rate swap

Total

Derivative Not Designated
as Hedging Instrument

Cross-currency swap

$ 3,790

(1,381)

$ 2,409

Amount of Gain (Loss) Recognized in
Income on Derivative, Included in Other
Expense (Income), net

$947

$ (701)

NOTE 7: FAIR VALUE MEASUREMENTS

Fair value as defined by SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), is the price that would be received to sell an asset or be paid to transfer
a liability in an orderly transaction between market participants at the measurement date. SFAS 157 classifies the inputs to measure fair value into three
tiers. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices
in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists,
therefore requiring an entity to develop its own assumptions.

22 Applied Industrial Technologies, Inc. and Subsidiaries

In February, 2008, the FASB finalized FASB Staff Position 157-2, “Effective Date of FASB Statement No. 157.” This Staff Position delays the effective date
of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on
a recurring basis (at least annually). The effective date for Applied for items within the scope of this FASB Staff Position is July 1, 2009.

Financial assets and liabilities measured at fair value on a recurring basis are as follows at June 30, 2009:

Assets:

Marketable securities

$8,211

Recorded Value

Liabilities:

Cross-currency swaps

Interest rate swap

Total Liabilities

$8,361

1,381

$9,742

Fair Value Measurements

Significant Other
Observable Inputs

Level 2

Significant
Unobservable Inputs

Level 3

Quoted Prices in Active
Markets for Identical
Instruments

Level 1

$8,211

$ 8,361

1,381

$ 9,742

Marketable securities in the above table are held in a rabbi trust for a non-qualified deferred compensation plan. The marketable securities are included in other
assets in the consolidated balance sheets. The fair values were derived using quoted market prices. Marketable securities totaled $10,527 at June 30, 2008.

Fair values for cross-currency and interest rate swaps shown in the above table are derived using foreign currency exchange rates and inputs readily
available in the public swap markets for similar instruments adjusted for terms specific to these instruments. Since the inputs used to value these
instruments are observable and the counterparty is credit worthy, the Company has classified them as Level 2 inputs. These liabilities are included in other
liabilities in the consolidated balance sheets.

NOTE 8: INCOME TAXES

Income Before Income Taxes

The components of income before income taxes are as follows:

Year Ended June 30,

U.S.

Foreign

Total income before income taxes

Provision

The provision (benefit) for income taxes consists of:

2009

$ 54,916

10,898

$ 65,814

2008

$136,179

15,536

$151,715

2007

$119,275

14,555

$133,830

Year Ended June 30,

2009

2008

2007

Current:

Federal

State and local

Foreign

Total current

Deferred:

Federal

State and local

Foreign

Total deferred

Total

$ 30,142

4,235

5,825

40,202

(14,492)

(769)

(1,387)

(16,648)

$ 23,554

$ 49,532

7,025

5,511

62,068

(5,028)

(346)

(435)

(5,809)

$ 43,325

5,341

5,566

54,232

(5,914)

(342)

(168)

(6,424)

$ 56,259

$ 47,808

The exercise of non-qualified stock options and stock appreciation rights during fiscal 2009, 2008 and 2007 resulted in $452, $3,140 and $2,860,
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.

Applied Industrial Technologies, Inc. and Subsidiaries 23

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

Vesting of stock awards and other stock compensation in fiscal 2009, 2008 and 2007 resulted in $422, $577 and $1,025, respectively, of incremental
income tax benefits over the amounts previously reported for financial reporting purposes. These tax benefits were recorded in additional paid-in capital.

Effective Tax Rates

The following reconciles the federal statutory income tax rate and the Company’s effective income tax rate:

Year Ended June 30,

Statutory income tax rate

Effects of:

State and local taxes

U.S. tax on foreign income, net

Foreign tax credit carryforwards

Valuation allowance

Foreign income taxes

Deductible dividend

Other, net

Effective income tax rate

2009

35.0%

3.2

6.4

(6.0)

(1.5)

(.4)

(1.2)

35.8%

2008

35.0%

2.8

(.9)

(.5)

(.1)

37.1%

Consolidated Balance Sheets

Significant components of the Company’s net deferred tax assets are as follows:

June 30,

Deferred tax assets:

Compensation liabilities not currently deductible

Expenses and reserves not currently deductible

Goodwill and intangibles

Net operating loss carryforwards (expiring in years 2014-2024)

Foreign tax credits

Other

Total deferred tax assets

Less: Valuation allowance

Deferred tax assets, net of valuation allowance

Deferred tax liabilities:

Currency translation

Inventories

Depreciation and differences in property bases

Other

Total deferred tax liabilities

Net deferred tax assets

Net deferred tax assets are reflected in the accompanying consolidated balance sheets as follows:

June 30,

Deferred tax assets:

Other current assets

Other assets

Deferred tax liabilities:

Other current liabilities

Other liabilities

Net deferred tax assets

24 Applied Industrial Technologies, Inc. and Subsidiaries

2009

$33,751

7,220

12,588

370

3,954

1,452

59,335

(105)

59,230

(232)

(2,403)

(1,229)

(3,864)

$55,366

2009

$ 9,930

46,650

(926)

(288)

$55,366

2007

35.0%

2.3

(.8)

(.5)

(.3)

35.7%

2008

$33,248

7,523

451

880

42,102

(1,019)

41,083

(4,024)

(1,813)

(124)

(52)

(6,013)

$35,070

2008

$ 9,288

25,782

$35,070

Valuation allowances are provided against deferred tax assets where it is considered more-likely-than-not that the Company will not realize the benefit of
such assets. In fiscal 2008, changes in U.S. tax regulations resulted in limitations to the deductibility of certain expenses and management believed it was
not likely the Company would be able to utilize certain expenses, so a valuation allowance was established against them. In fiscal 2009, the Company
determined it would be able to utilize these deferred tax assets and the related valuation allowance was reversed. The remaining net deferred tax asset is
the amount management believes is more-likely-than-not of being realized. The realization of these deferred tax assets can be impacted by changes to tax
laws, statutory rates and future income levels.

No provision has been made for income taxes on undistributed earnings of non-U.S. subsidiaries of approximately $29.7 million at June 30, 2009, since it is
the Company’s intention to indefinitely reinvest undistributed earnings of its foreign subsidiaries. Determination of the net amount of the unrecognized tax
liability with respect to these earnings is not practicable; however, foreign tax credits would be available to partially reduce U.S. income taxes in the event
of a distribution. In fiscal 2009, the Company declared and received a dividend of $30.8 million from a Canadian subsidiary. Net U.S. tax expense of $1.1
million (or a 1.7% impact on the effective income tax rate) was recorded related to this transaction.

Unrecognized Income Tax Benefits

The Company and its subsidiaries file income tax returns in the U.S. federal, various state and local and foreign jurisdictions. Effective July 1, 2007, the
Company adopted FIN 48. The following is a reconciliation of the Company’s total gross unrecognized tax benefits for the years ended June 30, 2009
and 2008:

Unrecognized Tax Benefits at July 1, 2008 and 2007, respectively

Current year tax positions

Prior year tax positions

Expirations of statutes of limitations

Settlements

Unrecognized Tax Benefits at June 30, 2009 and 2008, respectively

2009

$2,004

183

(51)

(167)

(109)

$1,860

2008

$1,903

369

(31)

(216)

(21)

$2,004

Included in the balance of unrecognized tax benefits at June 30, 2009 and 2008, are $984 and $1,124, respectively, of tax benefits that, if recognized,
would affect the effective income tax rate.

The Company recognizes accrued interest and penalties related to unrecognized income tax benefits in the provision for income taxes. During 2009 and
2008, the Company recognized $32 and $97, respectively, for interest and penalties related to unrecognized benefits in its statements of consolidated
income. The Company had a liability for penalties and interest of $526 and $494, as of June 30, 2009 and 2008, respectively. The Company does not
anticipate a significant change to the total amount of unrecognized income tax benefits within the next twelve months.

The Company is subject to U.S. federal jurisdiction income tax examinations for the tax years 2006 through 2009. In addition, the Company is subject to
foreign, state and local income tax examinations for the tax years 2005 through 2009.

The Company’s unrecognized tax benefits are classified as non-current liabilities since payment of cash is not expected within one year.

NOTE 9: SHAREHOLDERS’ EQUITY

Net Income Per Share

The following is a computation of basic and diluted earnings per share:

Year Ended June 30,

Net Income

Average Shares Outstanding:

Weighted-average common shares outstanding for basic computation

Dilutive effect of potential common shares

Weighted-average common shares outstanding for dilutive computation

Net Income Per Share – Basic

Net Income Per Share – Diluted

2009

$42,260

42,287

507

42,794

$ 1.00

$ 0.99

2008

$95,456

42,797

755

43,552

2.23

2.19

2007

$86,022

43,630

865

44,495

1.97

1.93

Stock options and stock appreciation rights relating to the acquisition of 1,208, 255 and 460 shares of common stock were outstanding at June 30, 2009,
2008 and 2007, respectively, but were not included in the computation of diluted earnings per share for the fiscal years then ended as they were anti-dilutive.

Applied Industrial Technologies, Inc. and Subsidiaries 25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

Share-Based Incentive Plans

The 2007 Long-Term Performance Plan (the “2007 Plan”), which expires in 2012, provides for granting of stock options, stock appreciation rights
(“SARs”), stock awards, cash awards, and such other awards or combination thereof as the Executive Organization and Compensation Committee or the
Corporate Governance Committee of the Board of Directors may determine to officers, other key associates and members of the Board of Directors. Grants
are generally made by the two committees at regularly scheduled meetings. The aggregate number of shares of common stock which may be awarded
under the 2007 Plan is 2,000. Shares available for future grants at June 30, 2009 were 1,585.

Stock Option and Stock Appreciation Rights

SARs and non-qualified stock options are granted with an exercise price equal to the market price of the Company’s common stock at the date of grant.
SARs and stock option awards generally vest over four years of continuous service and have 10-year contractual terms.

Compensation expense related to stock options and SARs recorded for the years ended June 30, 2009, 2008 and 2007 was $3,702, $2,999 and $2,494,
respectively. Such amounts are included in selling, distribution and administrative expense in the accompanying statements of consolidated income.
Compensation expense for stock options and SARs has been determined using the Black-Scholes option pricing model. Determining the appropriate fair
value of share-based awards requires management to select a fair value model and make certain estimates and assumptions.

The weighted-average assumptions used for SARs and stock option grants issued in fiscal 2009, 2008 and 2007 are:

Expected life, in years

Risk free interest rate

Dividend yield

Volatility

2009

5.5

2.9%

2.2%

48.4%

2008

5.3

4.4%

2.2%

45.9%

2007

5.1

4.8%

2.2%

46.7%

The expected life is based upon historical exercise experience of the officers, other key associates and members of the Board of Directors. The risk free
interest rate is based upon the U.S. Treasury zero-coupon bonds with remaining terms equal to the expected life of the stock options and SARs. The
assumed dividend yield has been estimated based upon the Company’s historical results and expectations for changes in dividends and stock prices. The
volatility assumption is calculated based upon historical daily price observations of the Company’s common stock for a period equal to the expected life.

It has been the Company’s practice to issue shares from Treasury to satisfy requirements of SARs and stock option exercises. SARs are redeemable solely in
Company common stock. The exercise price of stock option awards may be settled by the holder with cash or by tendering Company common stock.

A summary of stock option and SARs activity is presented below:

2009
(Share amounts in thousands)

Outstanding, beginning of year

Granted

Exercised

Forfeited

Outstanding, end of year

Exercisable at end of year

Weighted-average fair value of SARs and options granted during year

2008
(Share amounts in thousands)

Outstanding, beginning of year
Granted
Exercised

Outstanding, end of year

Exercisable at end of year

Weighted-average fair value of SARs and options granted during year

2,195

349

(97)

(1)

2,446

1,823

2,384
263
(452)

2,195

1,596

Weighted-Average
Exercise Price

$15.17

26.51

8.26

20.99

$17.06

$14.08

$10.31

Weighted-Average
Exercise Price

$13.15
25.32
10.43

$15.17

$12.61

$ 9.79

26 Applied Industrial Technologies, Inc. and Subsidiaries

2007
(Share amounts in thousands)

Outstanding, beginning of year
Granted
Exercised

Outstanding, end of year

Exercisable at end of year

Weighted-average fair value of SARs and options granted during year

2,486
319
(421)

2,384

1,533

Weighted-Average
Exercise Price

$11.23
22.11
8.61

$13.15

$10.63

$ 8.74

The weighted-average remaining contractual terms for SARs/stock options outstanding and exercisable at June 30, 2009 were 5.32 and 4.33 years,
respectively. The aggregate intrinsic values of SARs/stock options outstanding and exercisable at June 30, 2009 were $12,156. The aggregate intrinsic
value of the SARs/stock options exercised during fiscal 2009, 2008 and 2007 was $1,453, $9,356, and $7,887, respectively.

A summary of the status of the Company’s nonvested stock options and SARs at June 30, 2009, all of which are expected to vest, is presented below:

2009
(Share amounts in thousands)

Nonvested, beginning of year

Granted

Vested

Nonvested, end of year

599

349

(325)

623

Weighted-Average
Grant-Date
Fair Value

$ 8.64

10.31

7.61

$10.12

As of June 30, 2009, unrecognized compensation cost related to stock options and SARs amounted to $2,231. That cost is expected to be recognized over
a weighted-average period of 2.7 years. The total fair value of shares vested during fiscal 2009, 2008 and 2007 was $2,495, $3,190 and $2,116,
respectively.

Restricted Stock

Restricted stock award recipients are entitled to receive dividends on, and have voting rights with respect to their respective shares, but are restricted from
selling or transferring the shares prior to vesting. Restricted stock awards vest over a period of one to four years. The aggregate fair market value of the
restricted stock is considered unearned compensation at the time of grant and is amortized over the vesting period. At June 30, 2009 and 2008, the
Company had 31 and 14 shares of unvested restricted stock outstanding at weighted-average prices of $17.19 and $23.94, respectively. During fiscal
2009, 29 shares of restricted stock were granted at an average grant price of $16.68 per share. Unamortized compensation related to unvested restricted
stock awards aggregated $273 and $375 at June 30, 2009 and 2008, respectively. The unamortized compensation cost related to restricted stock is
expected to be amortized over the weighted-average remaining vesting period of 0.7 years.

Long-Term Performance Grants

The Executive Organization and Compensation Committee also makes annual awards of three-year performance grants to key officers. A target payout is
established at the beginning of each three-year performance period. The actual payout at the end of the period is calculated based upon the Company’s
achievement of sales growth, return on sales, and total shareholder return targets. Total shareholder return is calculated based upon the increase in the
Company’s common stock price, including dividend reinvestment, over the performance period as compared to the Company’s peers, as defined in the
plan. Payouts are made in cash, common stock, or a combination thereof, as determined by the Committee at the end of the performance period.
During fiscal 2009, 2008 and 2007, the Company recorded $7, $493 and $549, respectively, of compensation expense for achievement relative to the
total shareholder return-based goals of the Company’s performance grants. At June 30, 2009, and 2008, the Company had accrued $769 and $762,
respectively, for compensation expense relative to these goals. At June 30, 2009, the maximum potential compensation expense related to the
outstanding performance grants was $3,115. Any amounts estimated to be earned up to the related potential would be recognized during the remaining
performance period of two years.

Treasury Shares

At June 30, 2009, 596 shares of the Company’s common stock held as treasury shares were restricted as collateral under escrow arrangements relating to
change in control and director and officer indemnification agreements.

Applied Industrial Technologies, Inc. and Subsidiaries 27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

Accumulated Other Comprehensive (Loss) Income

Accumulated other comprehensive (loss) income is comprised of the following:

June 30,

Unrealized losses on cash flow hedges, net of taxes

Unrealized gains on investment securities available for sale, net of taxes

Foreign currency translation, net of taxes

Pension liability, net of taxes

Total accumulated other comprehensive (loss) income

NOTE 10: BENEFIT PLANS

Retirement Savings Plan

2009

(151)

161

2,933

(10,792)

$ (7,849)

2008

(19)

338

15,966

(10,036)

$ 6,249

Substantially all U.S. associates participate in the Applied Industrial Technologies, Inc. Retirement Savings Plan. The Company makes a discretionary profit-
sharing contribution to the Retirement Savings Plan generally based upon a percentage of the Company’s U.S. income before income taxes and before the
amount of the contribution (2.5% for fiscal 2009 and 5% for fiscal 2008 and 2007). The Company also partially matched 401(k) contributions by
participants through December 31, 2008. Participants may elect to contribute up to 50% of their compensation, subject to Internal Revenue Code
maximums. Effective January 1, 2009, the Company suspended the 401(k) match indefinitely. The Company’s expense for contributions to the above plan
was $3,086, $12,442 and $11,548 during fiscal 2009, 2008 and 2007, respectively.

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.

Postemployment Benefit Plans

The Company provides the following postemployment benefits which, except for the Qualified Defined Benefit Retirement Plan, are unfunded:

Supplemental Executive Retirement Benefits Plan
The Company has a non-qualified pension plan to provide supplemental retirement benefits to certain officers. Benefits are payable beginning at
retirement and determinable at retirement based upon a percentage of the participant’s historical compensation.

Qualified Defined Benefit Retirement Plan
The Company has a qualified defined benefit retirement plan that provides benefits to certain hourly associates at retirement. These associates do not
participate in the Retirement Savings Plan. The benefits are based on length of service and date of retirement.

Salary Continuation Benefits

The Company has agreements with certain retirees of acquired companies to pay monthly retirement benefits for a period not in excess of 15 years. The
discount rate used in determining the benefit obligation was 6.0% at June 30, 2009 and 2008.

Retiree Health Care Benefits

The Company provides health care benefits to eligible retired associates who 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. Additionally, in conjunction with a fiscal 1998 acquisition, the Company assumed the obligation for a post-
retirement medical benefit plan which provides health care benefits to eligible retired associates at no cost to the individual.

The Company uses a June 30 measurement date for all plans.

28 Applied Industrial Technologies, Inc. and Subsidiaries

The changes in benefit obligations, plan assets and funded status for the postemployment plans described above were as follows:

Change in benefit obligation:

Benefit obligation at beginning of the year

Service cost

Interest cost

Plan participants’ contributions

Benefits paid

Amendments

Actuarial (gain) loss during year

Benefit obligation at end of year

Change in plan assets:

Pension Benefits

Retiree Health Care Benefits

2009

2008

2009

2008

$ 42,576

2,139

2,518

(3,061)

1,749

(455)

$ 42,210

2,090

2,413

(4,655)

249

269

$ 3,924

$ 4,173

228

(232)

190

167

271

(207)

419

(812)

$ 45,466

$ 42,576

$ 4,353

$ 3,924

Fair value of plan assets at beginning of year

$ 5,530

Actual loss on plan assets

Employer contributions

Plan participants’ contributions

Benefits paid

Fair value of plan assets at end of year

Funded status at end of year

Amounts recognized in the consolidated
balance sheets:

Prepaid benefit cost

Current liabilities

Noncurrent liabilities

Net amount recognized

Amounts recognized in accumulated
other comprehensive loss (income):

Net actuarial loss (gain)

Prior service cost

Total amounts recognized in accumulated
other comprehensive loss (income)

(949)

3,237

(3,061)

$ 4,757

$(40,709)

$ (1,656)

(39,053)

$(40,709)

$ 12,854

5,165

$ 5,893

(249)

4,541

(4,655)

$ 5,530

$(37,046)

$ (2,953)

(34,093)

$(37,046)

$ 12,834

4,330

$ 197

(232)

$ (4,353)

$ (220)

(4,133)

$ (4,353)

$ (1,171)

560

176

(207)

$ 0

$ (3,924)

$ (270)

(3,654)

$ (3,924)

$ (1,465)

490

$ (975)

$ 18,019

17,164

(611)

The following table provides information for pension plans with an accumulated benefit obligation and projected benefit obligation in excess of plan assets:

Projected benefit obligations

Accumulated benefit obligations

Fair value of plan assets

Pension Benefits

2009

$ 45,466

38,229

4,757

2008

$42,576

35,385

5,530

Applied Industrial Technologies, Inc. and Subsidiaries 29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

The net postemployment benefit costs are as follows:

Service cost

Interest cost

Expected return on plan assets

Recognized net actuarial loss

Amortization of prior service cost

Net periodic pension cost

Service cost

Interest cost

Recognized net actuarial (gain)

Amortization of prior service cost

Net periodic postemployment benefit cost

Pension Benefits

2008

$2,090

2,413

(466)

962

635

$5,634

Retiree Health Care Benefits

2008

$ 49

271

(107)

119

$ 332

2009

$2,139

2,518

(436)

911

920

$6,052

2009

$ 41

228

(125)

119

$ 263

2007

$1,685

2,032

(415)

804

658

$4,764

2007

$ 56

222

(109)

$ 218

The estimated net loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive (loss) income into net
periodic benefit cost over the next fiscal year are $924 and $797, respectively. The estimated net gain and prior service cost for the retiree health care
benefits that will be amortized from accumulated other comprehensive (loss) income into net periodic benefit cost over the next fiscal year are $87 and
$147, respectively.

Assumptions

The discount rate is used to determine the present value of future payments. In general, the Company’s liability increases as the discount rate decreases
and decreases as the discount rate increases. The Company computes a weighted-average discount rate taking into account anticipated plan payments and
the associated interest rates from the Citigroup Pension Discount Yield Curve.

The weighted-average actuarial assumptions at June 30 used to determine benefit obligations for the plans were as follows:

Discount rate

Expected return on plan assets

Rate of compensation increase

Pension Benefits

Retiree Health Care Benefits

2009

6.0%

8.0%

5.5%

2008

6.0%

8.0%

5.5%

2009

6.0%

N/A

2008

6.0%

N/A

The assumed health care cost trend rates used in measuring the accumulated benefit obligation for post-retirement benefits other than pensions were 9%
and 8% as of June 30, 2009 and 2008, respectively, decreasing to 5% by 2018 and 2015, respectively. A one-percentage point change in the assumed
health care cost trend rates would have had the following effects as of June 30, 2009 and for the year then ended:

Effect on total service and interest cost components of periodic expense
Effect on post-retirement benefit obligation

One-Percentage
Point Increase

One-Percentage
Point Decrease

$ 44
650

$ (36)
(539)

30 Applied Industrial Technologies, Inc. and Subsidiaries

Plan Assets

The Company’s Qualified Defined Benefit Retirement Plan weighted-average asset allocation and target allocation are as follows:

Asset Category:

Equity securities

Debt securities

Other

Total

Target
Allocation

2010

40 – 70%

20 – 50%

0 – 20%

100%

Percentage of Pension Plan
Assets At Fiscal Year End

2009

2008

48%

47%

100%

57%

39%

100%

Equity securities do not include any Company common stock.

The Company has established an investment policy and regularly monitors the performance of the assets of the trust maintained in conjunction with the
Qualified Defined Benefit Retirement Plan. The strategy implemented by the trustee of the Qualified Defined Benefit Retirement Plan is to achieve long-
term objectives and invest the pension assets in accordance with ERISA and fiduciary standards. The long-term primary objectives are to provide for a
reasonable amount of long-term capital, without undue exposure to risk; to protect the Qualified Defined Benefit Retirement Plan assets from erosion of
purchasing power; and to provide investment results that meet or exceed the actuarially assumed long-term rate of return. The expected long-term rate of
return on assets assumption was developed by considering the historical returns and the future expectations for returns of each asset class as well as the
target asset allocation of the pension portfolio.

Cash Flows

Employer Contributions

The Company expects to contribute $1,700 to its pension benefit plans and $200 to its retiree health care benefit plans in 2010.

Estimated Future Benefit Payments

The following benefit payments, which reflect expected future service, as applicable, are expected to be paid in each of the next five years and in the
aggregate for the subsequent five years:

During Fiscal Years

Pension Benefits

Retiree Health Care Benefits

2010

2011

2012

2013

2014

2015 through 2019

NOTE 11: LEASES

$ 1,800

1,900

900

1,000

2,300

31,000

$ 200

300

1,400

The Company leases its corporate headquarters facility along with many service center and distribution center facilities, vehicles and equipment under non-
cancelable lease agreements accounted for as operating leases. Future minimum rental commitments under operating leases having initial or remaining
non-cancelable terms exceeding one year as of June 30, 2009 are as follows:

During Fiscal Years

2010
2011
2012

2013

2014

Thereafter

Total minimum lease payments

$21,800
15,700
12,500

8,800

6,500

13,100

$78,400

Rental expenses incurred for operating leases, principally from leases for real property, vehicles and computer equipment were $30,900 in 2009, $29,000 in
2008, and $28,300 in 2007.

Applied Industrial Technologies, Inc. and Subsidiaries 31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share amounts)

NOTE 12: SEGMENT AND GEOGRAPHIC INFORMATION

The Company has identified two reportable segments: Service Center Based Distribution and Fluid Power Businesses. The Service Center Based Distribution
segment provides customers with solutions to their maintenance, repair and original equipment manufacturing needs through the distribution of industrial
products including bearings, power transmission components, fluid power components, industrial rubber products, linear motion products, safety products,
general maintenance and a variety of mill supply products. The Fluid Power Businesses segment distributes fluid power components and operates shops
that assemble fluid power systems and components, performs equipment repair, and offers technical advice to customers.

The accounting policies of the Company’s reportable segments are the same as those described in Note 1. Sales between the Service Center Based
Distribution segment and the Fluid Power Businesses segment have been eliminated.

Segment Financial Information

Year Ended June 30, 2009

Net sales

Operating income for reportable segments

Assets used in the business

Depreciation

Capital expenditures

Year Ended June 30, 2008

Net sales
Operating income for reportable segments
Assets used in the business
Depreciation
Capital expenditures

Year Ended June 30, 2007

Net sales
Operating income for reportable segments
Assets used in the business
Depreciation
Capital expenditures

Service Center
Based Distribution

Fluid Power
Businesses

$1,596,998

75,411

611,255

10,876

5,537

$ 1,865,663
124,271
712,546
11,441
7,550

$ 1,806,284
122,684
715,864
12,166
10,074

$326,150

18,942

198,073

1,860

1,451

$ 223,793
17,320
86,225
1,335
860

$ 207,825
14,427
61,505
1,323
1,118

A reconciliation of operating income for reportable segments to the consolidated income before income taxes is as follows:

Year Ended June 30,

Operating income for reportable segments

Adjustments for:

Goodwill impairment

Corporate and other (income) expense, net

Total operating income

Interest expense, net

Other expense (income), net

Income before income taxes

2009

$ 94,353

36,605

(14,745)

72,493

4,424

2,255

$ 65,814

2008

$141,591

(11,233)

152,824

882

227

$151,715

Total

$ 1,923,148

94,353

809,328

12,736

6,988

$ 2,089,456
141,591
798,771
12,776
8,410

$ 2,014,109
137,111
777,369
13,489
11,192

2007

$137,111

2,100

135,011

2,360

(1,179)

$133,830

The change in corporate and other (income) expense, net is due to various changes in the levels and amounts of expenses being allocated to the segments.
The expenses being allocated include miscellaneous corporate charges for working capital, logistics support and other items.

Amortization expense is not included in the operating income for reportable segments; amortization expense for Fluid Power Businesses was $7,390, $418
and $137 for fiscal 2009, 2008 and 2007, respectively and $2,265, $1,245 and $908 for the Service Center Based Distribution segment, respectively.

32 Applied Industrial Technologies, Inc. and Subsidiaries

Product Category

Net sales by product category are as follows:

Year Ended June 30,

Industrial

Fluid power

Net sales

2009

$1,422,518

500,630

$1,923,148

2008

$1,670,464

418,992

$2,089,456

2007

$1,614,515

399,594

$2,014,109

The fluid power product category includes sales of hydraulic, pneumatic, lubrication and filtration components and systems, and repair services through the
Company’s service centers as well as the Fluid Power Businesses segment.

Geographic Information

Net sales are presented in geographic areas based on the location of the subsidiary making the sale. Long-lived assets are based on physical locations and
are comprised of the net book value of property, goodwill and intangible assets. Information by geographic area is as follows:

Year Ended June 30,

Net Sales:

United States

Canada

Mexico

Total

June 30,

Long-Lived Assets:

United States

Canada

Mexico

Total

2009

2008

2007

$ 1,674,769

197,795

50,584

$ 1,923,148

$1,839,410

222,121

27,925

$2,089,456

$ 1,778,993

211,446

23,670

$ 2,014,109

2009

2008

$189,720

16,481

15,474

$221,675

$107,384

19,455

22,007

$148,846

NOTE 13: COMMITMENTS AND CONTINGENCIES

In connection with the construction and lease of its corporate headquarters facility, the Company has guaranteed repayment of a total of $5,678 of taxable
development revenue bonds issued by Cuyahoga County and the Cleveland-Cuyahoga County Port Authority. These bonds were issued with a 20-year term
and are scheduled to mature in March 2016. Any default, as defined in the guarantee agreements, would obligate the Company for the full amount of the
outstanding bonds through maturity. Due to the nature of the guarantee, the Company has not recorded any liability on the consolidated financial
statements. In the event of a default and subsequent payout under any or all guarantees, the Company maintains the right to pursue all legal options
available to mitigate its exposure.

The Company is a party to various pending judicial and administrative proceedings. Based on circumstances currently known, the Company believes the
likelihood is remote that the ultimate resolution of any of these matters will have, either individually or in the aggregate, a material adverse effect on the
Company’s consolidated financial position, results of operations, or cash flows.

NOTE 14: OTHER EXPENSE (INCOME), NET

Other expense (income), net consists of the following:

Year Ended June 30,

Unrealized loss (gain) on assets held in rabbi trust for a

nonqualified deferred compensation plan

Foreign currency transaction losses (gains)

Unrealized (gain) loss on cross-currency swap

Other, net

Total other expense (income), net

2009

$1,741

1,466

(947)

(5)

$2,255

2008

$ 327

(384)

277

$ 227

2007

$(1,397)

(27)

243

$(1,179)

The Company is the owner and beneficiary under life insurance policies acquired in conjunction with a fiscal 1998 acquisition, with benefits in force of
$14,000 and a net cash surrender value of $3,000 at June 30, 2009.

Applied Industrial Technologies, Inc. and Subsidiaries 33

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Applied Industrial Technologies, Inc.
Cleveland, Ohio

We have audited the accompanying consolidated balance sheets of Applied Industrial Technologies, Inc. and subsidiaries (the "Company") as
of June 30, 2009 and 2008, and the related statements of consolidated income, shareholders' equity, and cash flows for each of the three
years in the period ended June 30, 2009. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at June 30,
2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2009, in
conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's
internal control over financial reporting as of June 30, 2009, based on the criteria established in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 19, 2009 expressed an
unqualified opinion on the Company's internal control over financial reporting.

Cleveland, Ohio
August 19, 2009

34 Applied Industrial Technologies, Inc. and Subsidiaries

MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING

The Management of Applied Industrial Technologies, Inc. is responsible for establishing and maintaining adequate internal control over
financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Chairman & Chief
Executive Officer and the Vice President – Chief Financial Officer & Treasurer, and effected by the Company’s Board of Directors, management
and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated
financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America and that receipts and expenditures of the Company are being made only in
accordance with authorizations of the Company’s Management and Board of Directors; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the
consolidated financial statements.

Because of inherent limitations, internal control over financial reporting can provide only reasonable, not absolute, assurance with respect to
the preparation and presentation of the consolidated financial statements and may not prevent or detect misstatements. Further, because of
changes in conditions, effectiveness of internal control over financial reporting may vary over time.

Management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2009. This
evaluation was based on the criteria set forth in the framework Internal Control — Integrated Framework, issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on this evaluation, Management determined that the Company’s internal
control over financial reporting was effective as of June 30, 2009.

The effectiveness of the Company’s internal control over financial reporting has been audited by Deloitte & Touche LLP, an independent
registered public accounting firm, as stated in their report which is included herein.

David L. Pugh
Chairman & Chief Executive Officer

Mark O. Eisele

Vice President – Chief Financial Officer & Treasurer

Benjamin J. Mondics
President & Chief Operating Officer

Daniel T. Brezovec
Corporate Controller

August 19, 2009

Applied Industrial Technologies, Inc. and Subsidiaries 35

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Applied Industrial Technologies, Inc.
Cleveland, Ohio

We have audited the internal control over financial reporting of Applied Industrial Technologies, Inc. and subsidiaries (the “Company”) as of
June 30, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s
Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial
reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk,
and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive
and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a
material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may
become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2009, based
on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated
balance sheet and the related statements of consolidated income, shareholders’ equity and cash flows as of and for the year ended June 30,
2009 of the Company and our report dated August 19, 2009 expressed an unqualified opinion on those consolidated financial statements.

Cleveland, Ohio
August 19, 2009

36 Applied Industrial Technologies, Inc. and Subsidiaries

QUARTERlY OPERATING RESUlTS AND MARKET DATA
(In thousands, except per share amounts)

(UNAUDITED)

2009
First Quarter
Second Quarter
Third Quarter
Fourth Quarter

2008
First Quarter
Second Quarter
Third Quarter
Fourth Quarter

2007
First Quarter
Second Quarter
Third Quarter
Fourth Quarter

Net Sales

Gross Profit

Operating Income
(Loss)

Net Income
(Loss)

Per Common Share (A)
Net Income
(Loss)-
Diluted (B)

Cash
Dividend

$ 543,906
502,412
451,647
425,183
$ 1,923,148

518,547
511,008
530,156
529,745
$ 2,089,456

492,590
472,365
521,129
528,025
$ 2,014,109

$ 146,058
135,469
122,246
116,237
$ 520,010

$ 142,056
139,491
144,500
143,236
$ 569,283

$ 135,134
130,151
140,572
142,195
$ 548,052

$ 37,375
28,807
21,019
(14,708)
$ 72,493

$ 39,216
37,268
37,685
38,655
$ 152,824

$ 33,377
28,929
34,105
38,600
$ 135,011

$ 22,536
16,194
11,560
(8,030)
$ 42,260

$ 24,457
22,967
23,595
24,437
$ 95,456

$ 21,117
18,568
21,697
24,640
$ 86,022

$ 0.52
0.38
0.27
(0.19)
$ 0.99

$ 0.56
0.52
0.55
0.57
$ 2.19

$ 0.47
0.42
0.49
0.56
$ 1.93

$ 0.15
0.15
0.15
0.15
$ 0.60

$ 0.12
0.12
0.12
0.12
$ 0.48

(A) On August 11, 2009 there were 6,198 shareholders of record including 4,048 shareholders in the Applied Industrial Technologies, Inc. Retirement Savings Plan. The Company's common stock is

listed on the New York Stock Exchange. The closing price on August 11, 2009 was $22.00 per share.

(B) The sum of the quarterly per share amounts may not equal per share amounts reported for year to date. This is due to changes in the number of weighted shares outstanding and the effects of

rounding for each period.

Cost of sales for interim financial statements are computed using estimated gross profit percentages which are adjusted throughout the year based upon available information. Adjustments to actual
cost are primarily made based on periodic physical inventory and the effect of year end inventory quantities on LIFO costs. Reductions in year end inventories in certain LIFO inventory pools during
the fiscal years ended June 30, 2009 and 2008 resulted in liquidations of LIFO inventory quantities carried at lower costs prevailing in prior years. The effect of these liquidations for the years ended
June 30, 2009 and 2008 increased gross profit by $4,419 and $626, respectively, net income by $2,693 and $383, respectively and net income per share by $0.06 and $0.01, respectively. There were
no LIFO layer liquidations for fiscal 2007.

The fiscal 2009 fourth quarter includes a goodwill impairment charge of $36.6 million, which decreased net income by $23.0 million and earnings per share by $0.54.

Additionally, SD&A was reduced by $3.5 million relating to the reversal of prior years’ long-term incentive accruals and other items not expected to re-occur, and income tax expense was reduced by
$1.3 million due to tax benefits not expected to re-occur. These items combined to increase net income per share by $0.08.

QUARTERlY vOlUME, PRICE AND DIvIDEND INFORMATION

Shares Traded

Average Daily Volume

High

Low

Price Range

2009
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2008
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2007
First Quarter
Second Quarter
Third Quarter
Fourth Quarter

23,839,000
25,940,700
27,478,700
22,937,700

21,416,800
19,630,600
26,431,600
26,215,300

20,528,900
16,447,500
17,787,400
18,389,300

372,500
405,300
450,500
364,100

339,900
306,700
433,300
409,600

325,900
261,100
291,600
291,900

$ 31.29
26.78
20.49
23.95

$ 33.26
35.68
30.68
32.20

$ 25.50
30.00
26.95
30.73

$22.92
14.12
14.63
16.25

$ 22.90
28.01
22.05
23.81

$ 20.75
23.61
22.72
24.26

Applied Industrial Technologies, Inc. and Subsidiaries 37

10 YEAR SUMMARY
(In thousands, except per share amounts and statistical data)

Consolidated Operations - Year Ended June 30
Net sales
Operating income
Income before cumulative effect of accounting change
Net income
Per share data

Income before cumulative effect of accounting change

Basic
Diluted
Net income
Basic
Diluted
Cash dividend

Year-End Position - June 30
Working capital
Long-term debt (including long-term debt classified as current)
Total assets
Shareholders' equity

Year-End Statistics - June 30
Current ratio
Operating facilities
Shareholders of record

2009 (a)

2008

2007

2006

2005

2004

2003

2002

2001

2000

$1,923,148
72,493
42,260
42,260

$2,089,456
152,824
95,456
95,456

$2,014,109
135,011
86,022
86,022

1.00
0.99

1.00
0.99
0.60

$ 369,038
75,000
809,328
508,102

3.4
464
6,329

2.23
2.19

2.23
2.19
0.60

$ 409,186
25,000
798,771
502,075

3.1
459
6,305

1.97
1.93

1.97
1.93
0.48

$ 365,523
75,395
777,369
450,983

2.6
445
6,242

$1,900,780

$1,717,055

$1,517,004

$1,464,367

$1,446,569

$1,625,755

$1,601,084

115,592

72,299

1.62

1.57

1.62

1.57

0.40

76,186

730,671

414,822

3.0

452

6,192

87,968

55,339

1.24

1.20

1.24

1.20

0.29

76,977

690,170

393,287

2.9

440

6,079

51,448

31,471

0.73

0.71

0.73

0.71

0.21

77,767

596,841

339,535

2.9

434

6,154

36,254

19,832

0.47

0.46

0.47

0.46

0.21

78,558

553,404

307,856

2.8

440

6,157

30,834

14,755

2,655

0.34

0.06

0.21

83,478

534,566

298,147

2.9

449

6,455

55,001

28,048

0.64

0.63

0.64

0.63

0.21

113,494

578,854

311,518

3.2

469

6,697

57,779

31,048

0.68

0.67

0.68

0.67

0.21

112,168

594,667

299,331

2.6

478

6,548

$ 370,013

$ 345,806

$ 286,022

$ 259,359

$ 250,644

$ 279,001

$ 255,132

(a) The goodwill impairment charge in fiscal 2009 reduced operating income by $36.6 million, net income by $23.0 million and net income per share by $0.54.

NET INCOME PER SHARE
(DOllARS)

NET SALES
(DOllARS IN BIllIONS)

NET INCOME
(DOllARS IN MIllIONS)

9
0
.
2
$

1
0
.
2
$

2
9
.
1
$

0
9
.
1
$

0
6
.
1
$

3
6
.
1
$

5
4
.
1
$

6
4
.
1
$

2
7
.
1
2 $
5
.
1
$

9
1
.
2
3 $
9
.
1
$

7
5
.
1
$

0
2
.
1
$

)
a
(
9
9
.
0
$

7
6
.
0
$

3
6
.
0
$

1
7
.
0
6 $
4
.
0
$

6
0
.
0
$

5
.
5
9
0 $
.
6
8
$

3
.
2
7
$

3
.
5
5
$

)
a
(
3
.
2
4
$

0
.
1
3
$

0
.
8
2
$

5
.
1
3
$

8
.
9
1
$

7
.
2
$

38 Applied Industrial Technologies, Inc. and Subsidiaries

Consolidated Operations - Year Ended June 30

Income before cumulative effect of accounting change

Net sales

Operating income

Net income

Per share data

Net income

Basic

Diluted

Basic

Diluted

Cash dividend

Year-End Position - June 30

Working capital

Total assets

Shareholders' equity

Year-End Statistics - June 30

Current ratio

Operating facilities

Shareholders of record

72,493

42,260

1.00

0.99

1.00

0.99

0.60

75,000

809,328

508,102

3.4

464

6,329

152,824

95,456

2.23

2.19

2.23

2.19

0.60

25,000

798,771

502,075

3.1

459

6,305

135,011

86,022

1.97

1.93

1.97

1.93

0.48

75,395

777,369

450,983

2.6

445

6,242

Long-term debt (including long-term debt classified as current)

$ 369,038

$ 409,186

$ 365,523

(a) The goodwill impairment charge in fiscal 2009 reduced operating income by $36.6 million, net income by $23.0 million and net income per share by $0.54.

2009 (a)

2008

2007

2006

2005

2004

2003

2002

2001

2000

$1,923,148

$2,089,456

$2,014,109

$1,900,780
115,592
72,299
72,299

$1,717,055
87,968
55,339
55,339

$1,517,004
51,448
31,471
31,471

$1,464,367
36,254
19,832
19,832

$1,446,569
30,834
14,755
2,655

$1,625,755
55,001
28,048
28,048

$1,601,084
57,779
31,048
31,048

1.62
1.57

1.62
1.57
0.40

1.24
1.20

1.24
1.20
0.29

0.73
0.71

0.73
0.71
0.21

0.47
0.46

0.47
0.46
0.21

0.34
0.34

0.06
0.06
0.21

0.64
0.63

0.64
0.63
0.21

0.68
0.67

0.68
0.67
0.21

$ 370,013
76,186
730,671
414,822

$ 345,806
76,977
690,170
393,287

$ 286,022
77,767
596,841
339,535

$ 259,359
78,558
553,404
307,856

$ 250,644
83,478
534,566
298,147

$ 279,001
113,494
578,854
311,518

$ 255,132
112,168
594,667
299,331

3.0
452
6,192

2.9
440
6,079

2.9
434
6,154

2.8
440
6,157

2.9
449
6,455

3.2
469
6,697

2.6
478
6,548

SHAREHOLDER’S EqUITy
(DOllARS IN MIllIONS)

DIvIDENDS PER SHARE
(DOllARS)

1
.
8
0
5
$

1
.
2
0
5
$

0
.
1
5
4
$

8
.
4
1
4
$

3
.
3
9
3
$

5
.
9
3
3
$

3
.
9
9
2
$

5
.
1
1
3
$

9
.
7
0
3
$

1
.
8
9
2
$

0
6
.
0
$

8
4
.
0
$

0
4
.
0
$

9
2
.
0
$

1
2
.
0
$

Applied Industrial Technologies, Inc. and Subsidiaries 39

DIRECTORS

WILLIAM G. BARES (3, 4) Age 68

JOHN F. MEIER (4) Age 61

Former Chairman and Chief Executive Officer

Chairman and Chief Executive Officer

PETER C. WALLACE (4) Age 55

President & Chief Executive Officer

The Lubrizol Corporation (Specialty Chemical Products)

Libbey Inc. (Tableware Products)

Robbins & Myers, Inc. (Equipment Manufacturer)

THOMAS A. COMMES (1, 3) Age 67

J. MICHAEL MOORE (1) Age 66

STEPHEN E. YATES (1) Age 61

Former President and Chief Operating Officer

President

Executive Vice President & Chief Information Officer

The Sherwin-Williams Company (Paints and Coatings)

Oak Grove Consulting Group, Inc.

KeyCorp (Financial Services)

PETER A. DORSMAN (2) Age 54

Senior Vice President, Global Operations

NCR Corporation (Self-Service Technology Solutions)

L. THOMAS HILTZ (2) Age 63

Attorney

EDITH KELLY-GREEN (2) Age 56

Former Vice President and Chief Sourcing Officer

FedEx Express (Express Transportation)

(Management Consulting)

Former Chairman and Chief Executive Officer

Invetech Company (Industrial Distributor)

DAVID L. PUGH (3) Age 60

Chairman & Chief Executive Officer

Applied Industrial Technologies, Inc.

JERRY SUE THORNTON, Ph.D. (1) Age 62

President

Cuyahoga Community College

(Two-Year Educational Institution)

OFFICERS

Committees of The Board

(1) Audit Committee

(2) Corporate Governance Committee

(3) Executive Committee

(4) Executive Organization and Compensation

Committee

DAVID L. PUGH Age 60

FRED D. BAUER Age 43

RICHARD C. SHAW Age 60

Chairman & Chief Executive Officer

Vice President – General Counsel & Secretary

Vice President – Communications and Learning

BENJAMIN J. MONDICS Age 51

President & Chief Operating Officer

THOMAS E. ARMOLD Age 54

MICHAEL L. COTICCHIA Age 46

DANIEL T. BREZOVEC Age 48

Vice President – Chief Administrative Officer

Corporate Controller

and Government Business

Vice President – Marketing and Strategic Accounts

MARK O. EISELE Age 52

TODD A. BARLETT Age 54

Vice President – Acquisitions and

Global Business Development

Vice President – Chief Financial Officer & Treasurer

JEFFREY A. RAMRAS Age 54

Vice President – Supply Chain Management

JODY A. CHABOWSKI Age 49

Assistant Controller

ALAN M. KRUPA Age 53

Assistant Treasurer

OTHER KEY MANAGEMENT

IVAN J. BATISTA Age 36

General Director –

Rafael Benitez Carrillo, Inc. (Puerto Rico)

ROBERT E. CURLEY Age 49

Vice President – Southeast Area

BARBARA D. EMERY Age 50

Vice President – Human Resources

MARY E. KERPER Age 58

RONALD A. SOWINSKI Age 48

Vice President – Operational Excellence

President & Chief Operating Officer –

LONNY D. LAWRENCE Age 46

Applied Industrial Technologies Ltd. (Canada)

Vice President – Information Technology

MARK A. STONEBURNER Age 45

JOHN M. LEYO Age 58

Vice President – North Atlantic Area

SERGIO H. NEVÁREZ Age 51

Vice President – Midwest Area

DONN G. VEENHUIS Age 60

Vice President – Western Area

THEODORE L. WOLICKI Age 55

Vice President – Central States Area

WARREN E. “Bud” HOFFNER Age 49

General Director – Applied Mexico

Vice President, General Manager – Fluid Power

40 Applied Industrial Technologies, Inc. and Subsidiaries

SHAREHOlDER INFORMATION

Applied Industrial Technologies, Inc. common stock is listed on the New York

Investor relations inquiries should be directed to:

Stock Exchange under the symbol AIT. The Company is identified in most

MARK O. EISELE

financial listings as “AppliedIndlTch.”

Vice President – Chief Financial Officer & Treasurer

Research on Applied Industrial Technologies is available through:

BB&T CAPITAL MARKETS

Holden Lewis, 804/782-8820

CLEVELAND RESEARCH COMPANY

Adam Uhlman, 216/649-7241

KEYBANC CAPITAL MARKETS

Jeffrey D. Hammond, 216/443-2825

MORGAN KEEGAN

Brent D. Rakers, 901/579-4427

SIDOTI & CO.

Joseph Mondillo, 212/894-3339

SOLEIL – GREAT LAKES REVIEW

Elliot Schlang, 216/767-1340

STEPHENS INC.

Matt Duncan, 501/377-3723

WELLS FARGO SECURITIES, LLC

Allison Poliniak-Cusic, 212/214-5062

SHAREHOLDER INQUIRIES

Requests to transfer Applied Industrial Technologies, Inc. shares and all

correspondence regarding address change information, duplicate mailings,

missing certificates, failure to receive dividend checks in a timely manner or to

participate in the Company’s direct stock purchase program should be directed

to the Company’s transfer agent and registrar:

COMPUTERSHARE INVESTOR SERVICES

250 Royall Street

Canton, MA 02021

800/988-5291

Applied Industrial Technologies

1 Applied Plaza

Cleveland, OH 44115-5014

Telephone: 216/426-4000, Fax: 216/426-4845

ANNUAL REPORT ON FORM 10-K

The Applied Industrial Technologies, Inc. Annual Report on Form 10-K for

the fiscal year ended June 30, 2009, including the financial statements and

schedules thereto, is available at our website at www.Applied.com. It is

also available without charge upon written request to the Vice President –

Chief Financial Officer & Treasurer at the preceding address.

REGULATORY CERTIFICATIONS

In fiscal 2009, the Chief Executive Officer (CEO) of Applied Industrial Technologies,

Inc. provided to the New York Stock Exchange (NYSE) the annual CEO certification

regarding the Company’s compliance with NYSE corporate governance listing

standards. In addition, the Company’s CEO and Chief Financial Officer filed with the

Securities and Exchange Commission the required certifications regarding the quality

of the Company’s public disclosures in its fiscal 2009 reports and the effectiveness of

internal control over financial reporting.

ANNUAL MEETING

The Annual Meeting of Shareholders will be held at 10:00 a.m., Tuesday, October 20,

2009, at the Corporate Headquarters of Applied Industrial Technologies, 1 Applied

Plaza, East 36th and Euclid Avenue, Cleveland, Ohio 44115.

COMPARISON OF FIvE-YEAR CUMUlATIvE TOTAl RETURN

Applied Industrial Technologies, Inc., S&P 500 Index, Old Peer Group, and New Peer Group

(Performance Results from 7/1/04 through 6/30/09)

$250

$200

$150

$100

$50

Applied Industrial Technologies, Inc.

Old Peer Group

Standard & Poor’s 500

New Peer Group

2004

2005

2006

2007

2008

2009

Assumes $100 invested at the close of trading 6/30/04 in Applied Industrial Technologies, Inc. stock.

Cumulative total return assumes reinvestment of dividends.

The returns of the companies in the peer groups are weighted based on the companies’ relative
stock market capitalization.

The Old Peer Group is comprised of Airgas, Inc., Genuine Parts Company, W. W. Grainger, Inc.,
Kaman Corporation, Lawson Products, Inc., MSC Industrial Direct Co., Inc., The Timken Company,
and WESCO International, Inc.

The New Peer Group is comprised of DXP Enterprises, Inc., Fastenal Company, Genuine Parts
Company, W. W. Grainger, Inc., Kaman Corporation, Lawson Products, Inc., MSC Industrial Direct
Co., Inc., and WESCO International, Inc.

Applied selects its peer group companies on a line-of-business basis. After reevaluating the
group’s components this year, Applied elected to change its peer group because we believe the
companies in the New Peer Group are more reflective of Applied’s business and therefore provide
a more meaningful comparison of stock performance.

Applied Industrial Technologies, Inc.
S&P 500
Old Peer Group
New Peer Group

Source: Research Data Group, Inc.

2004
$100.00
100.00
100.00
100.00

2005
$163.56
106.32
104.25
107.19

2006
$187.68
115.50
139.91
140.71

2007
$232.13
139.28
165.57
162.04

2008
$194.12
121.01
146.92
141.33

2009
$163.00
89.29
119.55
121.77

Applied Industrial Technologies, Inc. and Subsidiaries 41

Corporate Headquarters

1 Applied Plaza

Cleveland, Ohio 44115

Toll Free Phone: 1-877-279-2799

Applied.com