<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                    FORM 10-K
(MARK ONE)
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934
     FOR THE FISCAL YEAR ENDED JANUARY 3, 1997
                                       OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 
     FOR THE TRANSITION PERIOD FROM           TO
                                   -----------   -----------  
                 
                          COMMISSION FILE NUMBER 1-5601
                       AMERICAN PRECISION INDUSTRIES INC.
             (Exact name of registrant as specified in its charter)

            DELAWARE                                    16-1284388
(State of incorporation)                   (I.R.S. Employer Identification No.)

2777 WALDEN AVENUE, BUFFALO, NEW YORK                               14225
(Address of principal executive offices)                          (Zip Code)

                                 (716) 684-9700
              (Registrant's telephone number, including area code)

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

COMMON STOCK, $.66-2/3 PAR VALUE              NEW YORK STOCK EXCHANGE
    (Title of each class)           (Name of each exchange on which registered)

Securities Registered Pursuant to Section 12(g) of the Act:  NONE

       Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X   NO
                                              ---    ---

       Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

       The aggregate market value of the voting stock held by non-affiliates of
the Registrant, at March 21, 1997 was approximately $108,000,000.

       The number of shares of Registrant's Common Stock outstanding on March
21, 1997 was 7,322,535.

                       DOCUMENTS INCORPORATED BY REFERENCE

       Portions of the definitive Proxy Statement for the 1997 Annual Meeting of
Shareholders are incorporated by reference into Part III.

       Exhibit Index can be found on page 46 of this document.

                                       1

<PAGE>   2



AMERICAN PRECISION INDUSTRIES INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED JANUARY 3, 1997

TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
PART I.
------
     ITEM 1.      BUSINESS
<S>                     <C>                                                               <C>
                        Products and Marketing                                            3
                        Competition                                                       6
                        Backlog                                                           6
                        Suppliers                                                         6
                        Patents and Licenses                                              7
                        Customers                                                         7
                        Research and Development                                          7
                        Environmental Matters                                             7
                        Employees                                                         7
                        Lines of Business and Industry Segment Information              7-8
                        Foreign Operations                                                8
     ITEM 2.      PROPERTIES                                                              9
     ITEM 3.      LEGAL PROCEEDINGS                                                      10
     ITEM 4.      SUBMISSION OF MATTERS TO A VOTE OF                                     10
                        SECURITY HOLDERS

PART II.
--------
     ITEM 5.      MARKET FOR REGISTRANT'S COMMON EQUITY AND
                        RELATED STOCKHOLDER MATTERS                                      11
     ITEM 6.      SELECTED FINANCIAL DATA                                                12
     ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                        FINANCIAL CONDITION AND RESULTS OF OPERATIONS                 13-16
     ITEM 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                            16
     ITEM 9.      CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
                        ON ACCOUNTING AND FINANCIAL DISCLOSURE                           38

PART III.
---------
     ITEM 10.     DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                     39
     ITEM 11.     EXECUTIVE COMPENSATION                                                 39
     ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT         39
     ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                         39

PART IV.
--------
     ITEM 14.     EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
                        REPORTS ON FORM 8-K                                           40-43

SIGNATURES                                                                            44-45

</TABLE>
                                       2
<PAGE>   3


                                     PART I
                                     ------

ITEM 1.         BUSINESS
                --------
         a.     PRODUCTS AND MARKETING

                The registrant through its subsidiaries (the "Company" or "API")
                conducts operations in three major industrial classifications,
                namely, Heat Transfer Technology, Motion Technologies, and
                Electronic Components.

                The Company continues to direct its efforts towards major sales
                drives for current products in its served markets and target
                markets. In addition, the Company continues to seek profitable
                growth by enhancing and complementing its existing technology
                base.


                API HEAT TRANSFER INC.
                ----------------------

                API Heat Transfer Inc., which is comprised of API BASCO, API
                AIRTECH, API KETEMA, and most recently API SCHMIDT-BRETTEN,
                engineers and manufactures a broad range of industrial heat
                transfer equipment. API Heat Transfer serves the heat transfer
                needs of a wide range of industries including power, chemical,
                petrochemical, HVAC, and food and dairy, and many of their
                support industries. Products range from small standard units to
                large custom-designed heat exchangers.

                API BASCO INC.  manufactures a full line of standard and custom
                shell and tube heat exchangers, plate fin intercoolers and
                aftercoolers, and Centraflow steam surface condensers.

                API AIRTECH INC. manufactures a complete line of aluminum air to
                air, air to liquid, and liquid to liquid heat exchangers. The
                liquid to liquid heat exchanger provides the refrigeration
                market with a more advantageous evaporation and condenser
                combination through reduced piping, smaller footprint, and more
                efficient heat transfer surface. In December 1996, API Airtech
                moved into a new 82,000 square foot facility which will
                accommodate current and planned growth.

                Both API Basco and API Airtech achieved ISO 9001 certification
                during 1996, an important factor in the Company's plans for
                international growth.

                API KETEMA INC., which was acquired on April 1, 1996, has a
                strong position in both the general industrial and refrigeration
                heat transfer marketplace. This subsidiary manufactures shell
                and tube heat exchangers, chiller barrels, condensers, flooded
                evaporators and industrial packaged chillers.

                API SCHMIDT-BRETTEN GMBH, which was acquired on January 31,
                1997, is a plate and frame heat exchanger manufacturer with a
                solid position in the chemical and food markets in Germany and
                the Netherlands. The addition of API Schmidt-



                                       3
<PAGE>   4

                Bretten, which is located in Germany, not only adds a new
                dimension to the group's heat transfer capabilities, but also
                establishes a conduit to move plate products into the U.S.
                market and, at the same time, move heat transfer products
                manufactured at various domestic locations into European
                markets.

                API MOTION INC.
                ---------------

                API Motion Inc., comprised of API CONTROLS, API DELTRAN, API
                GETTYS and API HAROWE, is a designer and manufacturer of high
                performance motion control products and systems.

                API CONTROLS INC. offers complete lines of step and servo drives
                and packaged drive systems for a wide variety of motion control
                applications including factory automation, semiconductor
                equipment, printing, packaging, and winding equipment,
                positioning tables and electronics assembly applications. In
                1996, API Controls developed and introduced three major new
                product lines and a new software development tool to assist
                customers in the installation of products so there is little or
                no start-up learning curve. The completely new Intelligent
                MicroStepper and Intelligent Servo drives and controllers and
                new line of Centennial all-digital drives, address the needs of
                original equipment manufacturers that require high-performance
                single- or multi-axis solutions.

                API DELTRAN INC. designs and manufactures high quality,
                precision electromagnetic clutches, brakes and clutch/brake
                assemblies used in sophisticated rotary motion control
                applications. During 1996, API Deltran developed a new line of
                servo motor brakes primarily to meet the needs of servo motor
                manufacturers and for use in factory automation applications.
                Furthermore, an adjunct to the API Harowe manufacturing facility
                in St. Kitts was started for API Deltran, providing the ability
                to produce volume clutches at competitive prices.

                API GETTYS INC. designs and manufactures precision servo and
                step motors for a broad range of industrial drive applications
                including DC brush and AC brushless servo motors and
                NEMA-standard step motors with linear actuating assemblies. API
                Gettys developed and introduced a new line of Turbo Stepper
                motors in 1996, offering a variety of sizes of high torque
                motors for use in semiconductor, factory automation, packaging
                and medical instrumentation markets. A new line of high torque
                Turbo Servo motors was also introduced for semiconductor,
                machine tool, factory automation, medical instrumentation, and
                packaging markets. During 1996 the electronics portion of API
                Gettys was consolidated within the API Controls operation,
                enabling API Gettys, as a motors-only facility, to focus better
                on its core products.

                API HAROWE INC. designs and manufactures high performance
                resolvers, encoders, brushless motors, gearmotors and other
                specialty rotating electromagnetic components for industrial,
                medical, military and commercial aerospace applications. In
                1996, API Harowe developed a new line of small frame brushless
                DC motors that can be provided in over 4,500 different model
                variations.

                                       4
<PAGE>   5

                The new line enables API to respond quickly to the needs of a
                wide variety of markets such as medical instrumentation. The
                digital resolver electronics package was also introduced in
                1996. It was developed for applications that require the
                ruggedness of a resolver with a digital output signal.

                API ELECTRONIC COMPONENTS INC.
                ------------------------------

                API Electronic Components Inc., which is comprised of API
                DELEVAN INC. and API SMD INC., designs, manufactures and markets
                an extensive line of quality inductors, chokes, and magnetics to
                satisfy various electrical and electronic filtering
                requirements. This group concentrates on producing high
                performance inductive devices to meet stringent government and
                customer specifications relating to product quality, reliability
                and dependability.

                Global competitive forces continue to push the market towards
                improved product quality with lower product costs. This
                competition from off-shore manufacturing is being neutralized
                through major improvements in the group's manufacturing
                capabilities.

                Productivity throughout the workplace also continues to improve
                through the success of Total Quality Management practices and
                the High Performance Work Team approach. With an open team
                culture, the group is able to be flexible and responsive to both
                the market place and specific customer needs. In 1996, API
                Delevan and API SMD completed automation and process improvement
                projects that enabled them to produce quality products at a
                lower cost than in any previous year.

                During the year, both subsidiaries introduced additional new
                products and expanded existing product designs to enhance
                further their presence in both the high frequency and the power
                markets, including various leaded and surface mountable
                magnetics that have been developed to grow product offerings in
                the broad power market. By expanding product offerings with
                competitively priced inductors, the group is able to serve
                existing customer needs better while attracting new customers.

                Along with cost reduction initiatives and new product
                introductions, both API Delevan and API SMD implemented a new
                MRP computer-based business system. The conversion from the
                prior system took a concentrated team effort of nine months, but
                the results of this effort are already apparent. Forward looking
                capacity planning and material management save valuable time so
                that the subsidiaries can provide for their customers improved
                on-time delivery performance.

                                       5
<PAGE>   6


         b.     COMPETITION
                -----------

                In each of its segments the Company faces substantial
                competition from a number of companies, some of which have
                off-shore manufacturing facilities, and many of which are larger
                and have greater resources. In the electronic components market,
                several of the Company's domestic competitors have become part
                of a single organization through a series of acquisitions. The
                inductor market continues to be faced with strong global
                competition and trends towards product miniaturization and lower
                costs. The Company relies primarily on the quality of its
                products and service to meet competition. Although the Company
                is not aware of definitive industry statistics by manufacturer
                for the products it makes, in the opinion of management, the
                Company is a significant competitive factor in the markets for
                high quality electronic-magnetic motion control components,
                industrial heat exchangers and micro-miniature electronic coils.

         c.     BACKLOG
                -------

                The Company's backlog of unfilled orders believed to be firm at
                January 3, 1997 was approximately $39,216,000. All backlog
                orders are expected to be completed in the current fiscal year.
                The following table shows the backlog of orders for products
                associated with the three business segments:
<TABLE>
<CAPTION>


                                    Heat          Motion      Electronic
                                  Transfer     Technologies   Components       Total
                                  --------     ------------   ----------       -----

<S>              <C>            <C>            <C>            <C>           <C>
                 1996           $20,639,000    $15,924,000    $2,653,000    $39,216,000

                 1995           $13,778,000    $14,229,000    $2,434,000    $30,441,000
</TABLE>

                Backlogs have increased for the Heat Transfer and Motion
                Technologies segments primarily due to a focused strategic
                account sales program and the general business climate, combined
                with the acquisition of API Ketema and API Gettys. While the
                Electronic Components segment sales have increased, the backlog
                has remained steady and is the result of reduced lead times for
                delivery required by customers.

         d.     SUPPLIERS
                ---------

                The Company is not dependent upon any single supplier for any of
                the raw materials used in manufacturing its products and has not
                encountered significant difficulties in purchasing sufficient
                quantities of raw materials on the open market.

                                       6
<PAGE>   7


         e.     PATENTS AND LICENSES
                --------------------

                The Company has patents covering the design and certain
                manufacturing processes for some of its surface mounted
                inductors which management believes may be material to the
                Electronic Components segment over the next several years. These
                patents have a remaining duration in excess of ten years.
                Otherwise, no single patent or group of patents is material to
                the operations of any industry segment or to the business as a
                whole.

         f.     CUSTOMERS
                ---------

                During 1996, no single customer accounted for more than 10% of
                consolidated sales.

         g.     RESEARCH AND PRODUCT DEVELOPMENT
                --------------------------------
                The Company charges earnings directly for research and product
                development expenses. Costs for Company-sponsored programs,
                excluding capital expenditures, were approximately $1,759,000,
                $1,111,000, and $888,000 in 1996, 1995, and 1994, respectively.

         h.     ENVIRONMENTAL MATTERS
                ---------------------
                In 1990, the U.S. Environmental Protection Agency (EPA) named
                the Company a potentially responsible party (PRP) with respect
                to hazardous substances disposed of at the Envirotek II Site
                (the Site) in Tonawanda, New York. The Company is a member of a
                steering committee which was formed to facilitate discussions
                with the EPA. The Company was named a de minimis participant
                with respect to the first phase of the clean-up action and was
                relieved of any potential liability for the first phase clean-up
                with the payment of a minor fee. The EPA has since advised the
                Company that its name had been removed from the PRP list. The
                State of New York has also indicated to the Envirotek II PRP
                Group its intention to pursue additional remedial measures at a
                site which surrounds the Site. Based upon the small percentage
                of costs incurred to date which were allocated to the Company,
                management expects the Company's share of the total costs of the
                remedial phase action at the Site and the potential clean-up of
                the surrounding area to be a small percentage of such costs and
                not material to its financial statements.

         i.     EMPLOYEES
                ---------
                At January 3, 1997, 1,309 persons were employed by the Company.

         j.     LINES OF BUSINESS AND INDUSTRY SEGMENT INFORMATION
                --------------------------------------------------
                The Company's operations in 1996 were carried on through seven
                divisions and five subsidiaries. On January 3, 1997, the seven
                divisions were legally


                                      7

<PAGE>   8

               restructured into operating subsidiaries. Operations are
               classified into three industry segments based upon the
               characteristics of manufacturing processes and the nature of
               markets served. The operating units which currently comprise the
               segments and their principal products are as follows:

                                    Segment
                                    -------
<TABLE>
<CAPTION>

                   API Heat Transfer:
                   ------------------

<S>                <C>                                             <C>                                      
                   API Airtech                                      Air-to-air aluminum heat exchangers
                   API Basco                                        Shell and tube heat exchangers
                   API Ketema                                       Packaged chillers, refrigeration condensers, and
                                                                      shell and tube heat exchangers
                   API Schmidt-Bretten                              Plate heat exchangers

                   API Motion:
                   -----------

                   API Controls                                     Servo and stepper motor drives, power supplies,
                                                                      and motion controllers
                   API Deltran                                      Electro-magnetic clutches and brakes
                   API Deltran (St. Kitts)                          Electro-magnetic clutches and brakes
                   API Gettys                                       AC and DC servo motors and stepper motors
                   API Harowe                                       Resolvers and DC Motors
                   API Harowe (St. Kitts)                           Resolvers and DC Motors

                   API Electronic Components:
                   --------------------------

                   API Delevan                                      Axial-leaded inductors
                   API SMD                                          Surface mounted inductors

</TABLE>

                Amounts of revenue from sales to unaffiliated customers,
                operating profit or loss, and identifiable assets for the three
                years ended January 3, 1997, are included in Note N of the notes
                to consolidated financial statements.

         k.     FOREIGN OPERATIONS
                ------------------

                Export sales, principally to Europe, Canada, Mexico, and Asia,
                were approximately 15%, 14%, and 17% of consolidated sales for
                1996, 1995, and 1994, respectively. The foreign sales are not
                believed to be subject to any risks other than those normally
                associated with the conduct of business in friendly nations
                having stable governments.

                                       8
<PAGE>   9


ITEM 2.  PROPERTIES
         ----------

         The location of the Company's facilities and their approximate size in
         terms of floor area are as follows:
<TABLE>
<CAPTION>

                                                                    Floor Area
                       Location                                     (Sq. Ft.)
  ----------------------------------------------------           -----------------
  API  HEAT TRANSFER
<S>                                                                      <C>
  API Basco Inc.
  Buffalo                                                                115,600
  New York
  (Walden Avenue)

  API Airtech Inc.
  Arcade                                                                  82,000
  New York
  (North Street)

  API Ketema Inc.
  Grand Prairie                                                          150,000
  Texas
  (West Marshall Drive)

  API MOTION

  API Harowe Inc.
  West Chester                                                            34,500
  Pennsylvania
  (Westtown Road)

  API Controls Inc. and API Deltran Inc.
  Amherst                                                                 43,652
  New York
  (Hazelwood Drive)


  API Gettys Inc.
  Racine                                                                  88,000
  Wisconsin
  (North Green Bay Road)

  API Harowe (St. Kitts) Ltd. and
     API Deltran (St. Kitts) Ltd.
  St. Kitts                                                                8,500
  West Indies
  (Bourkes Road)

  API ELECTRONIC COMPONENTS

  API Delevan Inc.
  East Aurora                                                             50,000
  New York
  (Quaker Road)

  API SMD Inc.
  Arcade                                                                  23,500
  New York
  (North Street)
</TABLE>
                                       9

<PAGE>   10


         The Walden Avenue (API Basco Inc.), Quaker Road (API Delevan Inc.),
         North Street (API Airtech Inc. and API SMD Inc.), West Marshall Drive
         (API Ketema Inc.) and North Green Bay Road (API Gettys Inc.)
         facilities are owned by the Company.
        
         The facilities leased by the Company are as follows:

<TABLE>
<CAPTION>

                                                       Approx.
                                                       Annual          Leased
                     Facility Location                 Rental          Until
         -----------------------------------------------------------------------
         <S>                                         <C>              <C>
         Bourkes Road (API Harowe (St. Kitts) Ltd.
         and API Deltran (St. Kitts) Ltd.)            $ 24,000           2003
         Hazelwood Drive (API Controls Inc. and       $130,000           2002
         API Deltran Inc.)
         Westtown Road (API Harowe Inc.)              $168,000           2001

</TABLE>


         The Company believes all of its existing properties are well
         maintained, are suitable for the operation of its business, and are
         capable of handling production for the coming year.
        
ITEM 3.  LEGAL PROCEEDINGS
         -----------------
         See Item 1(h).


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
         ---------------------------------------------------
         There were no matters submitted to a vote of security holders during
         the fourth quarter of 1996.

                                       10
<PAGE>   11


                                     PART II
                                     -------

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY
         -------------------------------------
         AND RELATED STOCKHOLDER MATTERS
         -------------------------------

         COMMON STOCK PRICES
         
         American Precision Industries Inc. common stock is listed on the New
         York Stock Exchange under the symbol APR and is traded principally in
         that market. The following table shows the Company's high and low
         prices on the New York Stock Exchange, as reported in the Wall Street
         Journal.
<TABLE>
<CAPTION>

                                                                QUARTER
                                          1               2              3               4
                               ---------------------------------------------------------------

        <S>       <C>            <C>              <C>             <C>             <C>
         1996       High           $  13.13         $13.75          $13.13          $20.25
         
                    Low            $  10.75         $11.50          $11.38          $12.25
         
         
         1995       High           $   9.63         $11.13          $14.75          $13.88
         
                    Low            $   7.63         $ 8.50          $10.13          $10.75
</TABLE>


         As of January 3, 1997, there were 1,015 shareholders of record. During
         1995 and 1996 the Company declared cash dividends on its common stock
         of $.2575 and $.26 per share, respectively. The Company has decided to
         eliminate its quarterly cash dividend, effective in the first quarter
         of 1997, and to retain the cash for corporate expansion and
         acquisitions.

                                       11

<PAGE>   12
<TABLE>
<CAPTION>

ITEM 6.  SELECTED FINANCIAL DATA
         -----------------------

         FIVE YEAR SELECTED FINANCIAL DATA
 
         OPERATIONS                           1996            1995          1994             1993             1992
         ---------------------------------------------------------------------------------------------------------------
                                                                
         <S>                              <C>             <C>            <C>               <C>               <C>        
         Revenues                         $117,110,000    $82,660,000    $65,265,000       $51,334,000       $51,295,000
                                                                
         Interest and debt expense        $  1,295,000    $   238,000    $   220,000       $   244,000       $   293,000
                                                                
         Depreciation and                                              
             amortization                 $  3,785,000    $ 2,594,000    $ 2,275,000       $ 1,712,000       $ 1,531,000
                                                                
         Net earnings                     $  6,525,000    $ 4,731,000    $ 3,431,000       $ 2,050,000       $ 2,387,000
                                                                
         Net earnings per common share       $.91            $.67          $.49              $.29              $.34
                                                                
         Net earnings per common                                       
             share - fully diluted*          $.86            $.65            --                --                --
                                                                
         Cash dividends declared                                       
             per share                       $.26            $.2575        $.2475            $.235             $.215
                                                                
                                                                
        FINANCIAL                                                     
        CONDITION                                                     
        --------------------------------------------------------------------------------------------------------------
                                                                
        Current assets                    $ 40,986,000    $31,615,000    $25,113,000       $21,347,000       $20,447,000
                                                                
        Current liabilities               $ 16,794,000    $13,152,000    $10,916,000       $ 5,362,000       $ 4,896,000
                                                                
        Working capital                   $ 24,192,000    $18,463,000    $14,197,000       $15,985,000       $15,551,000
                                                                
         Current ratio                       2.4             2.4           2.3               4.0               4.2
                                                                
        Property, plant and                                           
             equipment, net               $ 27,206,000    $12,269,000    $10,202,000       $ 8,353,000       $ 8,200,000
                                                                
        Total assets                      $ 82,012,000    $57,791,000    $45,344,000       $38,081,000       $37,369,000
                                                                
        Long-term liabilities             $ 24,674,000    $10,292,000    $ 3,523,000       $ 3,507,000       $ 3,761,000
                                                                
        Shareholders' equity              $ 40,544,000    $34,347,000    $30,905,000       $29,212,000       $28,712,000
                                                                
        Shareholders' equity                                          
             per share                      $5.56           $4.82         $4.38             $4.14             $4.07
                                                                
        Number of shares                                              
             outstanding at year-end         7,292,000      7,128,000      7,064,000         7,058,000         7,055,000

* Anti-dilutive in 1994, 1993, and 1992
</TABLE>



                                      12
<PAGE>   13

ITEM 7.         MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                ---------------------------------------
                FINANCIAL CONDITION AND RESULTS OF OPERATIONS
                ---------------------------------------------

                FINANCIAL REVIEW - OPERATIONS

                REVENUES. Consolidated revenues increased 41.7% as compared to
                the prior year. Sales within the Heat Transfer segment increased
                55.7% in 1996 and reflect higher sales of the extended surface
                heat transfer equipment which continues to surpass 1995 levels,
                as well as increased sales volume of the air cooled product line
                to new and existing customers. The 1996 results of the Heat
                Transfer segment were also impacted favorably by sales of
                approximately $16.4 million from API Ketema, which was acquired
                by the Company on April 1, 1996. The Electronic Components
                segment sales increased 1.9% in 1996 as compared to 1995; the
                increase was primarily the result of a slight increase in sales
                volume to existing customers. The increase of 39.9% in sales of
                the Motion Technologies segment was the result of higher sales
                of electromagnetic clutches and brakes and motion control
                devices to new and existing customers, combined with an increase
                in the market share of products offered by Harowe Servo Controls
                Inc. The 1996 results of the Motion Technologies segment were
                also favorably impacted by sales of approximately $7.3 million
                from API Gettys, which was acquired by the Company on April 19,
                1996.

                In 1995, consolidated revenues increased 26.7% as compared to
                1994. Sales within the Heat Transfer segment increased 22.6% in
                1995; the increase is attributable to increased sales of
                traditional water cooled heat exchangers to existing customers,
                as well as significant growth in the air cooled heat exchanger
                product line. The Electronic Components segment sales increased
                8.7% due to a higher sales volume in a specific axial-leaded
                product, offset by completion of a major sales order to one
                customer in 1994 which did not recur in 1995. The increase of
                45.4% in sales of the Motion Technologies segment was the result
                of the acquisition of Harowe Servo Controls Inc. in June 1994,
                as well as a slightly higher sales volume of previously existing
                motion control products.

                The Company's consolidated backlog of firm orders at January 3,
                1997 was $39,216,000, up 28.8% from the prior year. This
                reflects a 49.8% increase in the Heat Transfer segment, a 9.0%
                increase in the Electronic Components segment, and a 11.9%
                increase in the Motion Technologies segment. A focused strategic
                account sales program, the favorable general business climate,
                and the acquisition of API Ketema and API Gettys all contributed
                to the increase.

                Investment income increased $70,000, or 27.2% in 1996 as
                compared to 1995. This increase was attributable primarily to
                investment income earned on the undisbursed proceeds from the
                Air Technologies Industrial Revenue Bond financing, which was
                concluded in December 1995.

                Investment income declined $112,000, or 30.4% in 1995 as
                compared to 1994. The decline reflects lower average investment
                asset balances resulting from the 

                                       13
<PAGE>   14

               sale of various bonds to fund both current operations and the
               purchase of Harowe in June 1994 combined with lower average
               interest rates.

               SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative
               expenses increased $7,609,000, or 40.5% in 1996 as compared to
               1995. The majority of the increase was due to: 1) the inclusion
               of API Ketema and API Gettys administrative expenses since the
               dates of acquisition; 2) increased commission expenses as a
               result of the increased sales revenue; 3) increased provision for
               bonus under the Company's incentive plans; and 4) compensation
               expense recorded in connection with stock appreciation rights
               granted to the Chief Executive Officer in 1992.

               Selling and administrative expenses increased $3,219,000, or
               20.7% in 1995 as compared to 1994 primarily as the result of : 1)
               increased commission expense due to increases in sales revenue;
               2) the inclusion of Harowe's selling and administrative expenses
               for the full year in 1995 and only six months in 1994; and 3)
               higher bonus provision under the Company's incentive plans.

               In spite of these increases, selling and administrative expenses
               continue to decline when expressed as a percent of net sales.

               RESEARCH AND PRODUCT DEVELOPMENT. Research and product
               development expenses increased $648,000, or 58.3% in 1996 as
               compared to 1995 and $223,000, or 25.1% in 1995 as compared to
               1994. The increase in 1996 over 1995 for research and product
               development costs reflects the acquisition of API Gettys, as well
               as increased activities in the Motion Technologies segment
               relative to future new product offerings. The acquisition of
               Harowe impacted the increase in 1995. The increase in both
               periods reflects management's continued commitment to the design
               of new products and improvement of existing products.

               INTEREST AND DEBT EXPENSE. Interest and debt expense increased
               $1,057,000, or 444% in 1996 as compared to 1995. This increase
               was due to the outstanding debt associated with the industrial
               revenue bond financings secured for the expansion of the Air
               Technologies facility and the purchase of API Ketema. Also
               contributing to the increase in interest and debt expense was the
               debt incurred under the revolving credit agreement in connection
               with the acquisition of API Ketema and API Gettys.

               Interest and debt expense increased $18,000 or 8.2% in 1995 as
               compared to 1994. The increase was due to lower average principal
               balances in 1995, offset by slightly higher interest rates. While
               total debt increased in 1995 due to the industrial revenue bond
               financing of $6,660,000, there was only a minor impact on
               interest and debt expense because this financing was obtained on
               December 22, 1995. Another contributing factor was the increased
               activity in short-term borrowings in 1995 as compared to 1994.


                                      14
<PAGE>   15


                INCOME TAXES. Income taxes expressed as a percent of earnings
                before taxes were 34.7%, 34.5%, and 35.3% in 1996, 1995, and
                1994, respectively. The lower rates in 1996 and 1995 can be
                attributed to the undistributed earnings of Harowe (St. Kitts),
                the Company's foreign subsidiary, for which no federal tax has
                been provided since it is the intention of the Company to
                reinvest those earnings in the operations of that entity for an
                indefinite period of time.

                NET EARNINGS. Net earnings increased 37.9% in 1996 as compared
                to 1995 and 37.9% in 1995 as compared to 1994. A substantial
                part of these increases can be attributed to the increased net
                sales as discussed previously, offset by higher selling and
                administrative, research and product development costs, and
                interest and debt expense.

                FINANCIAL POSITION. The Company's liquidity is generated
                primarily from operations. In addition, short-term lines of
                credit totaling $4,232,000 and revolving credit of $7,000,000
                were available at January 3, 1997. Information on the Company's
                liquidity position for the past three years is as follows:

<TABLE>
<CAPTION>

                 -------------------------------------------------------------------------
                                                   1996           1995           1994
                 -------------------------------------------------------------------------

<S>                                            <C>            <C>             <C>         
                 Net working capital           $ 24,192,000   $ 18,463,000    $ 14,197,000

                 Current ratio                     2.4            2.4             2.3

                 Cash flow from operations     $  7,755,000   $  3,786,000     $ 3,267,000

                 Cash, cash equivalents, and
                 marketable securities         $  2,412,000   $  5,979,000     $ 3,841,000

                 Capital expenditures          $  8,319,000   $  4,585,000     $ 1,857,000
</TABLE>

                The credit available under the Revolving Credit was reduced to
                $2.4 million following the consummation of the Schmidt-Bretten
                acquisition on January 31, 1997. Future acquisitions may require
                the Company to arrange additional credit facilities with lenders
                or procure financing through issuance of debt or equity
                securities.

                The increase in cash flow from operations from 1996 as compared
                to 1995 is the combined result of increased sales and net
                income, as well as the positive effects generated from the
                acquisition of API Ketema and API Gettys.

                The increase in cash flow from operations from 1995 as compared
                to 1994 is principally the result of the increased sales volume
                and the resulting net income.

                The increase in capital expenditures in 1996 as compared to 1995
                reflects the new building associated with the Air Technologies
                expansion program, as well as


                                       15
<PAGE>   16

         significant investments in new machinery and equipment. Also
         reflected in capital expenditures are investments in new
         machinery and equipment acquired by API Ketema and API Gettys
         since their respective dates of acquisition.
         
         The increase in capital expenditures in 1995 as compared to 1994
         reflects the Company's investment in new machinery and equipment
         and computer systems at both the Heat Transfer and Motion
         Technologies Groups.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
         -------------------------------------------

         REPORT OF INDEPENDENT ACCOUNTANTS 
         To the Board of Directors and Shareholders of 
         American Precision Industries Inc.
         
         In our opinion, the consolidated financial statements listed in
         the index appearing under Item 14 (a)(1) on page 40 present
         fairly, in all material respects, the financial position of
         American Precision Industries Inc. and its subsidiaries at
         January 3, 1997 and December 29, 1995, and the results of their
         operations and their cash flows for each of the three years in
         the period ended January 3, 1997, in conformity with generally
         accepted accounting principles. 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 of these
         statements in accordance with generally accepted auditing
         standards which 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, assessing the accounting
         principles used and significant estimates made by management, and
         evaluating the overall financial statement presentation. We
         believe that our audits provide a reasonable basis for the
         opinion expressed above.





         Price Waterhouse LLP
         Buffalo, New York
         February 17, 1997


                                       16
<PAGE>   17

<TABLE>
<CAPTION>

CONSOLIDATED BALANCE SHEET

ASSETS
--------------------------------------------------------------------------------
                                                           1996         1995
--------------------------------------------------------------------------------
<S>                                                   <C>            <C>        
CURRENT ASSETS

Cash and cash equivalents                             $ 2,412,000    $ 2,486,000

Accounts receivable less allowance for
   doubtful accounts of $487,000 and $264,000          17,912,000     12,691,000

Marketable securities                                          --      3,493,000

Inventories                                            17,431,000     10,589,000

Prepaid expenses                                        1,137,000        967,000

Deferred income tax benefit                             2,094,000      1,389,000
--------------------------------------------------------------------------------
TOTAL CURRENT ASSETS                                   40,986,000     31,615,000
--------------------------------------------------------------------------------
INVESTMENTS                                             3,279,000      6,277,000

OTHER ASSETS

Cost in excess of net assets acquired, net of
   accumulated amortization                             4,472,000      2,153,000

Prepaid pension costs                                   2,104,000      2,140,000

Net cash value of life insurance                        2,655,000      2,222,000

Other                                                   1,310,000      1,115,000
--------------------------------------------------------------------------------
TOTAL OTHER ASSETS                                     10,541,000      7,630,000
--------------------------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT

Land                                                      665,000        211,000

Buildings and improvements                             13,549,000      6,183,000

Machinery, equipment, and furniture                    32,589,000     22,265,000

Construction in process                                 1,502,000      1,450,000
--------------------------------------------------------------------------------
                                                       48,305,000     30,109,000

Less accumulated depreciation                          21,099,000     17,840,000
--------------------------------------------------------------------------------
NET PROPERTY, PLANT AND EQUIPMENT                      27,206,000     12,269,000
--------------------------------------------------------------------------------
                                                      $82,012,000    $57,791,000
</TABLE>

See notes to consolidated financial statements

                                       17
<PAGE>   18

<TABLE>
<CAPTION>


LIABILITIES AND SHAREHOLDERS' EQUITY

--------------------------------------------------------------------------------
                                                         1996          1995
--------------------------------------------------------------------------------

CURRENT LIABILITIES

<S>                                                 <C>             <C>         
Short-term borrowings                               $         --    $  2,602,000

Accounts payable                                       8,511,000       5,136,000

Accrued compensation and payroll taxes                 5,167,000       3,566,000

Other accrued expenses                                 1,341,000         757,000

Dividends payable                                        471,000         463,000

Current portion of long-term obligations               1,292,000         628,000

Federal and state income taxes                            12,000              --
--------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES                             16,794,000      13,152,000
--------------------------------------------------------------------------------
DEFERRED INCOME TAXES                                  1,417,000       1,251,000

OTHER NONCURRENT LIABILITIES                           1,046,000         413,000

LONG-TERM OBLIGATIONS,
   less current portion                               22,211,000       8,628,000

SHAREHOLDERS' EQUITY

Common stock, par value $.66 2/3 per share:
   Authorized - 10,000,000 shares
   Issued - 7,666,011  and
   7,502,000 shares                                    5,110,000       5,001,000

Additional paid-in capital                            11,065,000       9,532,000

Retained earnings                                     27,281,000      22,629,000

Minimum pension liability change, net of tax             (74,000)             --

Net unrealized gain on
   marketable securities                                      --          23,000
--------------------------------------------------------------------------------
                                                      43,382,000      37,185,000

Less cost of 374,262  treasury shares                  2,838,000       2,838,000
--------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY                            40,544,000      34,347,000
--------------------------------------------------------------------------------
                                                    $ 82,012,000    $ 57,791,000
</TABLE>


See notes to consolidated financial statements

                                       18
<PAGE>   19
<TABLE>
<CAPTION>


CONSOLIDATED STATEMENT OF EARNINGS



                                                      1996           1995           1994

<S>                                               <C>            <C>            <C>         
NET SALES                                         $116,783,000   $ 82,403,000   $ 64,896,000
INVESTMENT INCOME                                      327,000        257,000        369,000
--------------------------------------------------------------------------------------------
REVENUES                                           117,110,000     82,660,000     65,265,000
--------------------------------------------------------------------------------------------
COSTS AND EXPENSES
     COST OF PRODUCTS SOLD                          77,652,000     55,289,000     43,270,000
     SELLING AND ADMINISTRATIVE                     26,410,000     18,801,000     15,582,000
     RESEARCH AND PRODUCT DEVELOPMENT                1,759,000      1,111,000        888,000
     INTEREST AND DEBT EXPENSE                       1,295,000        238,000        220,000
--------------------------------------------------------------------------------------------
                                                   107,116,000     75,439,000     59,960,000
--------------------------------------------------------------------------------------------
EARNINGS BEFORE INCOME TAXES                         9,994,000      7,221,000      5,305,000
FEDERAL AND STATE INCOME TAXES                       3,469,000      2,490,000      1,874,000
--------------------------------------------------------------------------------------------
NET EARNINGS                                      $  6,525,000   $  4,731,000   $  3,431,000
--------------------------------------------------------------------------------------------
NET EARNINGS PER COMMON SHARE                     $        .91   $        .67   $        .49
--------------------------------------------------------------------------------------------
NET EARNINGS PER COMMON SHARE - FULLY DILUTED*    $        .86   $        .65   $         --
--------------------------------------------------------------------------------------------
AVERAGE COMMON SHARE OUTSTANDING                     7,190,000      7,090,000      7,062,000
AVERAGE COMMON SHARES OUTSTANDING-FULLY DILUTED      7,605,000      7,330,000             --
</TABLE>

* Anti-dilutive in 1994.




See notes to consolidated financial statements.



                                      19
<PAGE>   20
    CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                                                  Net
                                                                                              Unrealized
                                                                                              Gain (Loss)
                                       Common Stock            Additional                         on         Minimum
                                   ----------------------        Paid-in         Retained      Marketable    Pension    
                                   Shares        Amount          Capital         Earnings      Securities   Liability   
                                  ----------   ----------       ----------     -----------    -----------   ----------
<S>                                <C>          <C>            <C>             <C>            <C>          <C>           
Balance at                                                                                                      
December 31, 1993                  7,436,103    $4,958,000      $9,073,000     $18,043,000    $       -     $       -    
                                                                                                                
     Net earnings - 1994               -            -               -            3,431,000            -             -       
                                                                                                                
     Stock options                                                                                              
     exercised, net                    5,945         3,000          25,000          -                 -             -       
                                                                                                                
     Cash dividends                                                                                             
     declared,                                                                                                  
     $.2475 per share                  -            -               -           (1,748,000)           -             -       
                                                                                                                
     Net unrealized (loss)                                                                                      
     on marketable                                                                                              
     securities                        -            -               -               -              (18,000)        -       
--------------------------------------------------------------------------------------------------------------------------
Balance at                                                                                                      
December 30, 1994                  7,442,048     4,961,000       9,098,000      19,726,000         (18,000)        -       
                                                                                                                
     Net earnings - 1995               -            -               -            4,731,000           -             -       
                                                                                                                
     Stock options                                                                                              
     exercised, net                   59,952        40,000         422,000          -                -             -       
                                                                                                                
     Treasury shares issued                                                                                     
     as bonus                          -            -               12,000          -                -             -       
                                                                                                                
     Cash dividends                                                                                             
     declared,                                                                                                  
     $.2575 per share                  -            -               -           (1,828,000)         -              -       
                                                                                                                
     Net unrealized gain                                                                                        
     on marketable                                                                                              
     securities                        -            -               -               -               41,000         -       
-------------------------------------------------------------------------------------------------------------------------- 
Balance at                                                                                                      
December 29, 1995                  7,502,000     5,001,000       9,532,000      22,629,000          23,000         -       
                                                                                                                
                                                                                                                
     Net earnings - 1996               -            -               -            6,525,000           -             -       
                                                                                                                
     Stock options                                                                                              
     exercised, net                  164,011       109,000       1,533,000          -                -             -       
                                                                                                                
     Cash dividends                                                                                             
     declared,                                                                                                  
     $.26 per share                    -            -               -           (1,873,000)          -             -       
                                                                                                                
     Minimum pension                                                                                            
     liability changes, net            -            -               -               -                -           (74,000)  
                                                                                                                
     Net unrealized (loss)                                                                                      
     on marketable                                                                                              
     securities                        -            -               -               -              (23,000)        -       
--------------------------------------------------------------------------------------------------------------------------
Balance at                                                                                                      
January 3, 1997                    7,666,011    $5,110,000     $11,065,000     $27,281,000           $0.00      ($74,000)  
                                                                                                                   
                                                                                                                   
<CAPTION>                                                                                                                   
                                       Treasury Stock
                                  ------------------------
                                     Shares        Amount
                                    --------     --------
<S>                               <C>         <C>
Balance at                       
December 31, 1993                    378,262     $2,862,000
                                 
     Net earnings - 1994               -             -
                                 
     Stock options               
     exercised, net                    -             -
                                 
     Cash dividends              
     declared,                   
     $.2475 per share                  -             -
                                 
     Net unrealized (loss)       
     on marketable               
     securities                        -             -

--------------------------------------------------------------                                                                  
Balance at                       
December 30, 1994                    378,262     2,862,000
                                 
     Net earnings - 1995                -             -
                                 
     Stock options               
     exercised, net                     -             -
                                 
     Treasury shares issued      
     as bonus                         (4,000)       (24,000)
                                 
     Cash dividends              
     declared,                   
     $.2575 per share                   -             -
                                 
     Net unrealized gain         
     on marketable               
     securities                         -             -
                               
--------------------------------------------------------------                                                                  
Balance at                       
December 29, 1995                    374,262      2,838,000
                                 
     Net earnings - 1996                -             -
                                 
     Stock options               
     exercised, net                     -             -
                                 
     Cash dividends              
     declared,                   
     $.26 per share                     -             -
                                 
     Minimum pension             
     liability changes, net             -             -
                                 
     Net unrealized (loss)       
     on marketable               
     securities                         -             -
--------------------------------------------------------------                                 
Balance at                       
January 3, 1997                      374,262     $2,838,000
</TABLE>


    See notes to consolidated financial statements


                                      20

<PAGE>   21

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF CASH FLOWS

------------------------------------------------------------------------------------------------------------------------------------
                                                                                        1996             1995             1994      
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                    
Cash Flows from Operating Activities                                                                                                
<S>                                                                              <C>               <C>              <C>             
     Net earnings                                                                $  6,525,000      $ 4,731,000      $ 3,431,000     
     Adjustments to reconcile net income to cash and                                                                                
        cash equivalents provided by operating activities:                                                                          
          Depreciation and amortization                                             3,785,000        2,594,000        2,275,000     
          Gain on sale of investments/fixed assets                                     46,000           42,000             --       
          Increase in supplemental benefit program                                    100,000          125,000          176,000     
          Recognition of pension expense (income) under FASB #87                       36,000         (136,000)        (280,000)    
          Stock compensation programs                                                 582,000          202,000             --       
          Change in various allowance accounts                                       (639,000)         (95,000)          91,000     
          Treasury stock issued as bonus                                                 --             36,000             --       
     (Increase) Decrease in:                                                                                                        
          Accounts receivable                                                        (472,000)      (2,028,000)      (2,168,000)    
          Inventories                                                              (2,006,000)      (1,785,000)      (1,267,000)    
          Prepaid expenses                                                           (115,000)         (75,000)        (199,000)    
          Prepaid federal and state income taxes                                        6,000             --             58,000     
          Deferred income taxes                                                      (691,000)        (386,000)        (267,000)    
          Prepaid pension cost                                                           --               --            (24,000)    
          Net cash value of life insurance                                           (433,000)        (571,000)        (548,000)    
          Other assets, net                                                          (459,000)        (475,000)        (140,000)    
     Increase (Decrease) in:                                                                                                        
          Accounts payable                                                          1,613,000          373,000          953,000     
          Accrued expenses                                                           (385,000)         902,000        1,062,000     
          Federal and state income taxes                                               12,000          (79,000)         (93,000)    
          Deferred income taxes                                                       199,000          376,000           31,000     
          Other noncurrent liabilities                                                 51,000           35,000          176,000     
-------------------------------------------------------------------------------------------------------------------------------     
Net cash provided by Operating Activities                                           7,755,000        3,786,000        3,267,000     
-------------------------------------------------------------------------------------------------------------------------------     
Cash Flows from Investing Activities                                                                                                
          Investments in API Gettys & API Ketema net of cash &                                                                      
           cash equivalents acquired                                              (17,359,000)            --               --       
          Purchases of investments and marketable securities                         (127,000)      (6,233,000)      (2,546,000)    
          Additions to property, plant and equipment                               (8,319,000)      (4,585,000)      (1,857,000)    
          Proceeds from investments and marketable securities                       6,609,000        1,797,000        7,225,000     
          Investment in Harowe Servo Controls Inc.                                       --               --         (5,195,000)    
          Proceeds from sale of fixed assets                                           46,000           36,000            7,000     
-------------------------------------------------------------------------------------------------------------------------------     
Net cash used by Investing Activities                                             (19,150,000)      (8,985,000)      (2,366,000)    
-------------------------------------------------------------------------------------------------------------------------------     
Cash Flows from Financing Activities                                                                                                
          Exercise of stock options                                                 1,642,000          462,000           28,000     
          Payments of long-term obligations, including current maturities          (1,785,000)        (368,000)        (519,000)    
          Dividends paid                                                           (1,865,000)      (1,806,000)      (1,730,000)    
          Increase in long-term debt                                               15,931,000        6,660,000             --       
          (Decrease) increase in short-term Borrowings                             (2,602,000)         602,000        2,000,000     
-------------------------------------------------------------------------------------------------------------------------------     
Net cash provided (used) by Financing Activities                                   11,321,000        5,550,000         (221,000)    
-------------------------------------------------------------------------------------------------------------------------------     
                                                                                                                                    
Net (Decrease) Increase in Cash and Cash Equivalents                                  (74,000)         351,000          680,000     
                                                                                                                                    
Cash and Cash Equivalents at Beginning of Year                                      2,486,000        2,135,000        1,455,000     
-------------------------------------------------------------------------------------------------------------------------------     
                                                                                                                                    
Cash and Cash Equivalents at End of Year                                         $  2,412,000      $ 2,486,000      $ 2,135,000     
</TABLE>

See notes to consolidated financial statements


                                      21

<PAGE>   22

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the years ended January 3, 1997, December 29, 1995, and December 30, 1994.

A.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     (1)  NATURE OF OPERATIONS American Precision Industries Inc. (the
          "Company") is a diversified manufacturing company whose principal
          lines of business include the production and sale of heat transfer
          products, motion control devices, and electronic components. Sales of
          these products are primarily to customers in industrialized nations
          both domestic and foreign.

     (2)  CONSOLIDATION The accounts of all subsidiaries are included in the
          consolidated financial statements. The fiscal years consisted of 52
          weeks, except for 1996 which consisted of 53 weeks and ended on
          January 3, 1997. The Statement of Earnings and Statement of Cash Flows
          include the results of API Ketema and API Gettys since April 1, 1996
          and April 19, 1996, respectively, the dates of acquisition. The
          Consolidated Statement of Earnings and Statement of Cash Flows also
          includes the results of Harowe Servo Controls Inc. since June 30,
          1994, the date of acquisition.

     (3)  INVENTORIES Inventories are valued at the lower of cost or market, net
          of progress payments. At January 3, 1997 and December 29, 1995
          inventories comprising approximately 61% and 50%, respectively, of
          total inventories were valued using the last-in, first-out (LIFO)
          method. Other inventories are priced using the first-in, first-out
          (FIFO) method.

     (4)  PROPERTY, PLANT AND EQUIPMENT These assets are stated at cost and are
          depreciated over their estimated useful lives; building and
          improvements - 10 to 45 years; machinery, equipment, and furniture - 2
          to 15 years.

          Expenditures for maintenance and repairs are charged to expense;
          renewals and betterments are capitalized and depreciated. Properties
          are removed from the accounts when they are disposed of, and the
          related cost and accumulated depreciation are eliminated from the
          accounts. Associated gains and losses, if any, are included in
          consolidated net earnings.

          The Company adopted the provisions of SFAS No. 121 "Accounting for the
          Impairment of Long-Lived Assets and for Long-Lived Assets to Be
          Disposed Of" on January 1, 1996. Adoption of this Statement had no
          impact on the Company's financial position, results of operations, or
          liquidity.

                                       22



<PAGE>   23

     (5)  GOODWILL The excess of the purchase cost over the fair value of net
          assets acquired in an acquisition (goodwill) is separately disclosed,
          net of accumulated amortization, and is being amortized over 25 years
          on a straight-line basis. Amortization expense amounted to $163,000 in
          1996 and $102,000 in 1995. Accumulated amortization of goodwill at
          January 3, 1997 was $309,000.

     (6)  INCOME TAXES The Company provides for deferred income taxes under the
          asset and liability approach. This method requires the recognition of
          deferred tax liabilities and assets for the expected future tax
          consequences of temporary differences between the carrying amounts and
          tax basis of assets and liabilities. No provision has been made for
          United States income taxes applicable to undistributed earnings of a
          foreign subsidiary as it is the intention of the Company to
          indefinitely reinvest those earnings in the operations of that entity.

     (7)  EMPLOYEE BENEFIT PLANS Benefits under the Company's salaried defined
          benefit and supplemental benefit plans are based upon years of service
          and average compensation during an individual's last years of
          employment for the defined benefit plan and final pay for the
          supplemental benefit plan.

          Benefits under the salaried defined benefit plan are funded annually
          based upon the maximum contribution deductible for federal income tax
          purposes. The supplemental benefit program is funded through
          company-owned life insurance contracts on the lives of the
          participants, but the benefit obligation to certain participants will
          be offset by the participant's interest in a split-dollar insurance
          contract.

          Benefits under the hourly defined benefit plan of Harowe are based
          upon years of service, not to exceed 35, times a fixed rate specified
          in the union contract. Benefits under this plan are funded annually
          based upon funding recommendations of the plan actuaries.

          All union employees are covered under defined contribution plans. The
          Company's contribution to these plans are set forth under the
          provisions of the specific union contracts.

     (8)  STOCK OPTIONS Proceeds from the sale of common stock issued under
          employee stock option plans are credited to capital accounts. There
          are no charges to income with respect to the plans; however,
          compensation expense is recorded with respect to the increase in value
          of stock appreciation rights. The Company has adopted certain
          disclosure requirements as prescribed by FASB Statement No. 123.


                                       23
<PAGE>   24

     (9)  EARNINGS PER SHARE Earnings per share are based on the weighted
          average number of shares outstanding during each year. Net earnings
          per common share are based on the weighted average number of common
          shares outstanding during the respective years. The effect of common
          stock equivalents, consisting of stock options, on net earnings per
          common share is not material except on a fully diluted basis in 1996.

     (10) ADVERTISING The Company expenses the production costs of advertising
          in the year in which the advertising takes place. Total advertising
          expense in 1996, 1995, and 1994 was $879,000, $874,000, and $664,000,
          respectively.

     (11) ESTIMATES The preparation of financial statements in conformity with
          generally accepted accounting principles requires management to make
          estimates and assumptions that affect the reported amounts of assets
          and liabilities and disclosure of contingent assets and liabilities at
          the date of the financial statements and the reported amounts of
          revenues and expenses during the reporting period. Actual results
          could differ from these estimates.


B.   BUSINESS ACQUISITIONS

     BUSINESS ACQUISITIONS On April 1, 1996, API Ketema Inc., a wholly-owned
     subsidiary of the Company, acquired the assets and assumed certain
     liabilities of the Heat Transfer Division (HTD) of Ketema, Inc. at a cost
     of approximately $12,000,000. HTD manufactures shell and tube heat
     exchangers, refrigeration condensers, and packaged chillers.

     On April 19, 1996, API Gettys Inc., a wholly-owned subsidiary of the
     Company acquired the assets and assumed certain liabilities of Gettys
     Corporation and Gettys Property Corporation (Gettys) at a cost of
     approximately $4,800,000. Gettys manufactures AC and DC servo motors,
     amplifiers, and control electronics.

     On June 30, 1994, the Company acquired 100% of the stock of Harowe Servo
     Controls, Inc. (HSC), a Delaware corporation and Harowe Servo Controls (St.
     Kitts) Limited (HSC Limited), a corporation organized under the laws of the
     Island of St. Christopher and Nevis, from Hawker Siddeley Holdings Inc., at
     a cost of approximately $5,200,000.

     The following table presents unaudited pro forma results of operations as
     if the acquisition of HSC and HSC Limited had occurred on January 1, 1994
     and 1993, respectively, and the acquisition of HTD and Gettys had occurred
     on January 1, 1996 and 1995, respectively, after giving effect to certain
     adjustments, including amortization of goodwill, loss of interest income on
     tax-exempt municipal bonds sold to fund the purchase cost, adjusted
     depreciation 

                                       24

<PAGE>   25

     of fair value of assets acquired, addition of interest expense on
     additional debt required to fund the acquisitions, and the related income
     tax effects. The pro forma results have been prepared for comparative
     purposes only and do not purport to be indicative of what would have
     occurred had the acquisitions occurred at the beginning of 1995 for Gettys
     and Ketema and 1993 for HSC and HSC Limited or of results which may occur
     in the future. Furthermore, no effect has been given in the pro forma
     information for operating and synergistic benefits that are expected to be
     realized through the combination of the entities because precise estimates
     of such benefits cannot be quantified.
<TABLE>
<CAPTION>

Thousands of Dollars,
Except per Share Data   
(Unaudited)                               1996       1995      1994        1993
-------------------------------------------------------------------------------
<S>                                    <C>        <C>        <C>        <C>     
Revenues                               $125,778   $116,762   $ 69,631   $ 61,195
Earnings before Income Taxes           $ 10,416   $  4,585   $  5,641   $  3,681
Net Earnings                           $  6,863   $  2,972   $  3,517   $  2,335
Net Earnings Per
    Common Share                       $    .95   $    .42   $    .50   $    .33
Net Earnings Per Common
    Share - Fully diluted              $    .90   $    .41   $     --   $     --
</TABLE>


C.   CASH EQUIVALENTS, MARKETABLE SECURITIES, AND INVESTMENTS

     (1)  Cash equivalents consist of money market funds, commercial paper, and
          certificates of deposit with original maturities of three months or
          less. Marketable securities, consisting of municipal bonds, are
          carried at market. Investments primarily consist of marketable
          municipal bonds, which are carried at market. Included in Investments
          in 1996 and 1995 is $3,272,000 and $6,233,000 of funds obtained under
          industrial revenue bond financing. Use of these funds is restricted
          and can only be applied to the purchase of capital assets for the
          related expansion program.

          For the purpose of determining gross realized gains and losses, the
          cost of securities sold is based upon specific identification.

          The Company classifies debt and equity securities not classified as
          either held-to-maturity or trading as "available for sale" and
          reported at market value. Unrealized gains and losses are reported as
          a separate component of shareholders' equity.

                                       25
<PAGE>   26
<TABLE>
<CAPTION>


     (2)  Additional information pertaining to the Consolidated Statement of Cash Flows is as follows:

--------------------------------------------------------------------------------
                                                1996          1995          1994
---------------------------------------------------------------------------------
Cash paid during the year for:

<S>                                       <C>           <C>           <C>       
Interest                                  $1,038,000    $  225,000    $  184,000

Income taxes net of tax refunds           $3,598,000    $2,513,000    $2,145,000

D.   INVENTORIES
<CAPTION>


     The major classes of inventories are as follows:
--------------------------------------------------------------------------------
                                                      1996                  1995
--------------------------------------------------------------------------------
<S>                                            <C>                   <C>        
Finished goods                                 $ 3,867,000           $   995,000

Work in process                                  3,834,000             2,538,000

Raw materials                                    9,730,000             7,056,000
--------------------------------------------------------------------------------
                                               $17,431,000           $10,589,000
</TABLE>



     Had the cost of all inventories at January 3, 1997 and December 29, 1995
     been determined by the FIFO method, the amounts thereof would have been
     greater by $1,147,000 and $1,187,000, respectively.

E.   OTHER NONCURRENT LIABILITIES

     In 1996 and 1995, other noncurrent liabilities consist of the noncurrent
     portion of bonus obligations under the Company's incentive plans, deferred
     compensation associated with the stock appreciation rights granted to the
     Chief Executive Officer in 1992, and discount on options granted to certain
     members of the Board of Directors of the Company in lieu of certain
     directors' fees.

F.   SHORT AND LONG-TERM OBLIGATIONS

     (1)  Short-Term Obligations There were no significant short-term borrowings
          during 1996. As of December 29, 1995, the Company had $2,602,000
          outstanding on its line of credit. This amount was outstanding for
          four business days. The Company had available unsecured, short-term
          lines of credit totaling $4,232,000 and $7,398,000 at the prime rate
          on January 3, 1997 and December 29, 1995, respectively.


                                      26
<PAGE>   27

<TABLE>
<CAPTION>

     (2)  LONG-TERM OBLIGATIONS CONSIST OF THE FOLLOWING:

-------------------------------------------------------------------------------
                                                     1996               1995
--------------------------------------------------------------------------------
<S>                                               <C>                <C>        
Industrial revenue bonds                          $13,405,000        $ 8,112,000
Revolving credit debt                               9,000,000                 --
Supplemental benefit program                        1,098,000          1,144,000
--------------------------------------------------------------------------------
                                                   23,503,000          9,256,000
Less current obligations                            1,292,000            628,000
--------------------------------------------------------------------------------
Long-term obligations                             $22,211,000        $ 8,628,000
</TABLE>

     During 1996 the Company entered into a Credit Agreement with Marine Midland
     Bank which provides an unsecured Revolving Credit facility of $16,000,000.
     The Revolving Credit matures on March 29, 1999, at which time the Company
     may convert the amount outstanding under the Revolving Credit to a term
     loan payable over a four year term. The interest rate on the Revolving
     Credit as of January 3, 1997, under the LIBOR Rate Option in the Credit
     Agreement, was 6.33%.

     During the third quarter of 1996, the Company concluded a $6,000,000
     15-year industrial revenue bond ("IRB") financing with the Grand Prairie
     Industrial Development Authority. Substantially all of the proceeds were
     used in connection with the purchase of the Heat Transfer Division of
     Ketema, Inc. on April 1, 1996.

     During the fourth quarter of 1995, the Company obtained adjustable rate IRB
     capital lease financing of $6,660,000 for asset purchases associated with
     its Air Technologies expansion program.

     Unexpended revenue bond proceeds of $3,272,000 were held and invested by a
     trustee at the end of 1996 and are included in Investments in the
     accompanying consolidated balance sheet. Such amount is restricted and can
     only be applied to the purchase of capital assets for the related expansion
     program, and such assets will be pledged as collateral for the bonds.

     The adjustable rate IRB capital lease financing is collateralized by assets
     with a depreciated value of $11,314,000 at January 3, 1997.

     The interest rate on the IRBs approximates 60% of the prime rate and is
     adjustable every seven days in order for the Remarketing Agent to sell the
     bonds at par value.


                                       27
<PAGE>   28


     The following are the weighted average interest and debt expense rates for
     1996:

            Industrial Revenue Bonds                          5.51%

            Revolving Credit Debt                             6.13%

     All the industrial revenue bonds are subject to mandatory sinking fund
     repayment schedules with various dates extending through 2015. The
     Revolving Credit and each of the IRB's are subject to various restrictive
     covenants, with respect to which the Company is in compliance.

     Under the supplemental benefit program, the Company provides retirement or
     death benefits to directors and certain officers meeting specified service
     requirements. Directors are entitled to an annual benefit of $10,000 per
     year for ten years. Participating officers are provided an annual benefit
     equal to 20% of their current salary payable over fifteen years, except for
     the Chief Executive Officer whose annual benefit, payable over fifteen
     years, is currently approximately $112,000 and indexed to the Consumer
     Price Index. In the case of several executives, these benefits will be
     partially or totally funded through split-dollar life insurance contracts.
     The estimated future benefits to be paid directly by the Company under this
     program are accrued over the participants' service lives by estimating the
     present value of such future benefits assuming a 9% rate of interest. The
     Company has also invested in company-owned life insurance contracts on the
     lives of the participants, the cash surrender values of which are recorded
     in Other Assets. It is actuarially assumed that over the term of this
     program all costs will be offset by benefits provided from the underlying
     contracts.

     Over the next five years, the Company will make long-term obligation
     payments of approximately $1,292,000 in 1997, $1,322,000 in 1998,
     $1,358,000 in 1999, $1,378,000 in 2000, and $1,371,000 in 2001. Such
     amounts exclude the revolving credit.

G.   OPERATING LEASES

     The Company leases certain office and manufacturing facilities and
     automotive and other equipment through operating leases. Certain of these
     provide for the payment of taxes, insurance and maintenance costs and most
     contain renewal options. Net future minimum lease commitments do not have a
     material impact on the consolidated financial statements. Total rental
     expense for 1996, 1995, and 1994, was $730,000, $587,000, and $568,000,
     respectively.

                                       28
<PAGE>   29



H.   EMPLOYEE BENEFITS

     Retirement Plans - In addition to the aforementioned supplemental benefit
     program, the Company has a defined benefit retirement plan covering all
     nonunion employees ("Salaried Plan") and makes contributions to
     union-sponsored plans. Harowe has a defined benefit retirement plan
     covering all hourly employees in its West Chester, Pennsylvania location
     ("HSC Hourly Plan"). The total expense for such plans, net of the
     recognition of net periodic pension income was $392,000, $227,000, and
     $44,000, in 1996, 1995, and 1994, respectively.

     The following summarizes the funded status of the Company's and Harowe's
     defined benefit retirement plans:
<TABLE>
<CAPTION>

--------------------------------------------------------------------------------------------------------------
                                                              1996                           1995
                                                       HSC                            HSC        
                                                     HOURLY        SALARIED          HOURLY         SALARIED
                                                      PLAN           PLAN             PLAN            PLAN
--------------------------------------------------------------------------------------------------------------
      Actuarial present value of benefit
         obligations

<S>                                             <C>            <C>               <C>            <C>             
           Vested Benefits                      $   724,000    $ 5,401,000       $   712,000    $ 4,649,000     
                                                                                                                
           Nonvested benefits                        10,000        106,000            17,000         74,000     
-------------------------------------------------------------------------------------------------------------   
      Accumulated benefit obligations               734,000      5,507,000           729,000      4,723,000     
-------------------------------------------------------------------------------------------------------------   
      Projected benefit obligations                 724,000      6,556,000           729,000      5,646,000     
                                                                                                                
      Plan assets at fair value                     385,000     10,396,000           393,000      9,336,000     
-------------------------------------------------------------------------------------------------------------   
      Assets in excess of (less than)                                                                           
         projected benefit obligation              (339,000)     3,840,000          (336,000)     3,690,000     
                                                                                                                
      Unrecognized prior service cost               187,000             --            13,000         30,000     
                                                                                                                
      Less:                                                                                                     
                                                                                                                
           Accumulated unrecognized net loss             --             --            20,000             --     
                                                                                                                
           Unrecognized net gain (loss) at                                                                      
              transition being recognized                                                                       
              over 15 years                         (77,000)       491,000                --        614,000     
                                                                                                                
           Additional minimum liability             107,000                                                     
                                                                                                                
           Unrecognized net gain arising                                                                        
              since transition                           --      1,492,000                --        973,000     
-------------------------------------------------------------------------------------------------------------   
      (Accrued) prepaid pension cost            $  (339,000)   $ 2,044,000       $  (316,000)   $ 2,116,000     
</TABLE>


                                       29
<PAGE>   30


     Net periodic pension (cost) income associated with the salaried plan and
     the HSC Hourly Plan for 1996 and 1995 included the following components:

<TABLE>
<CAPTION>

                                               1996                      1995
---------------------------------------------------------------------------------------
                                        HSC                       HSC
                                       HOURLY      SALARIED      HOURLY       SALARIED
                                        PLAN        PLAN          PLAN         PLAN
----------------------------------------------------------------------------------------
<S>                                  <C>          <C>          <C>          <C>       
Service costs - benefits earned
   during the period                 $ (21,000)   $(577,000)   $ (19,000)   $(347,000)

Interest on projected benefit
   obligations                         (51,000)    (440,000)     (51,000)    (392,000)

Actual return on assets                 14,000      831,000       24,000      754,000

Amortization of transition
   assets and deferrals                  7,000      113,000           --      121,000
----------------------------------------------------------------------------------------
Net periodic pension (cost) income   $ (51,000)   $ (73,000)   $ (46,000)   $ 136,000
</TABLE>



     An assumed discount rate of 7.75%, a rate increase in future compensation
     of 4.0%, and an expected long-term rate of return of 9.0% have been used in
     determining the actuarial present value of projected benefit obligations of
     the Salaried Plan for 1996 and 1995. The HSC Hourly Plan includes an
     assumed discount rate and expected long-term rate of return of 7.5% for
     1996 and 1995.

I.   FAIR VALUE OF FINANCIAL INSTRUMENTS

     During 1996, the Company adopted the provisions of Statement of Financial
     Accounting Standard No. 107, "Disclosures about Fair Value of Financial
     Instruments". This statement requires that companies disclose the estimated
     "fair value" of their financial instruments. Financial instruments
     primarily consist of trade receivables and payables, investments in
     municipal bond funds, and debt facilities with various third party lenders.
     At January 3, 1997, management believes the carrying amounts of financial
     instruments, approximates fair value.

J.   SHAREHOLDERS' EQUITY

     (1) PREFERRED  STOCK - None of the Company's authorized 20,000 shares 
     of preferred stock (par value $50 a share) have been issued.

     (2) STOCK OPTIONS - The Company has granted incentive stock options (ISO)
     to officers and other key employees and nonqualified options (NQO) for 100
     common shares to most other employees after one year of employment. The
     grants were made at an exercise price of not less than 100% of the market
     value on the date of grant. Options may be exercised in cumulative annual
     increments of 20% for ISOs and 50% for NQOs beginning one year from the
     date of grant. All options expire ten years from date of grant.



                                       30

<PAGE>   31

     The Company applies APB Opinion No. 25 in accounting for its stock option
     plans. Accordingly, no compensation expense has been charged to earnings
     for options granted in 1996 and 1995 since all such options have an
     exercise price equal to 100% of market value on the date of grant. Had the
     Company adopted the provisions of FASB Statement No. 123, compensation
     expense for options granted in 1996 and 1995 would have reduced the
     Company's net earnings and earnings per share to the pro forma amounts
     shown below.


<TABLE>
<CAPTION>

                                                                        1996                  1995
                                                                  -----------------     -----------------

        Net earnings:
<S>                                                               <C>                   <C>       
             As reported                                          $6,525,000            $4,731,000
             Pro forma                                            $6,217,000            $4,636,000

        Earnings per share:
             As reported - per common share                             $.91                  $.67
             As reported - fully diluted                                $.86                  $.65
             Pro forma - per common share                               $.86                  $.65
             Pro forma - fully diluted                                  $.82                  $.63
</TABLE>

     The fair value of each option granted in 1996 and 1995 was estimated using
     the Black-Scholes option pricing model with the following assumptions for
     1996 and 1995, respectively:

         risk-free interest rates of 6.6% and 7.1%; dividends of 0 and $.19;
         expected term of 9.2 years and 9.2 years; annual standard deviation
         (volatility) of 25% and 24%.

     The weighted average fair value of options granted in 1996 and 1995
     was $6.32 and $4.67, respectively.

                                       31
<PAGE>   32


     A summary of the status of options granted under all employee plans and
     pursuant to the employment of the Company's Chief Executive Officer is
     presented below.
<TABLE>
<CAPTION>

                                   Number of        Weighted
                                    Shares           Average
                                   Subject to        Exercise
                                    Options          Price ($)
                                   ----------        --------

<S>                                 <C>               <C> 
Outstanding December 31, 1993       781,826           8.18
Granted in 1994                     157,500           6.84
Exercised in 1994                    (7,059)          5.11
Forfeited in 1994                   (41,277)          8.20
-------------------------------------------------------------
Outstanding December 30, 1994       890,990           8.05
Granted in 1995                     214,350           9.22
Exercised in 1995                   (79,430)          7.76
Forfeited in 1995                   (14,085)          7.49
-------------------------------------------------------------
Outstanding December 29, 1995     1,011,825           8.33
Granted in 1996                     212,500          12.48
Exercised in 1996                  (181,081)          8.58
Forfeited in 1996                   (41,287)          8.04
-------------------------------------------------------------
Outstanding January 3, 1997       1,001,957           9.15
</TABLE>



     The number of shares subject to options exercisable at the end of 1996,
     1995, and 1994 were 488,087, 470,970, and 486,315, respectively.

                                       32
<PAGE>   33


     The following table summarizes information about options outstanding at
January 3, 1997:

<TABLE>
<CAPTION>
                                Options Outstanding                                 Options Exercisable
      ------------------------------------------------------------------------  -----------------------------
                                                Weighted-
                                                 average         Weighted-                       Weighted-
            Range of                            remaining         average                         average
            Exercise            Number         contractual       exercise           Number        exercise
           Prices ($)         Outstanding          life          price ($)        exercisable    price ($)
      ------------------------------------------------------------------------  -----------------------------

<S>    <C>                       <C>             <C>                <C>              <C>             <C> 
        6.625 -  9.76            709,046         6.1 years           7.93            419,026          7.87
       10.50 -  13.00            288,911         7.8 years          12.00             69,061         10.95
               17.625              4,000         9.9 years          17.63                  0             -
</TABLE>

     On June 16, 1992, the Company's new Chief Executive Officer was granted
     options to acquire 200,000 shares of the Company's common stock, along with
     50,000 stock appreciation rights (SARs) which must be exercised in tandem
     with the exercise of the options at the rate of one SAR for each four
     options exercised. The options and SARs have a term of ten years, are
     exercisable at $7.75 per share or right, the fair market value at date of
     grant, and become exercisable over a five year period at the rate of 20%
     per year. Data related to the CEO options are included in the tables above.
     The Company recorded compensation expense of $452,000 and $148,000 in 1996
     and 1995, respectively, in connection with the increase in value of the
     SARs.

     Beginning on July 1, 1995, the Company has granted stock options to certain
     directors of the Company on the first day of each calendar quarter under
     the 1995 Directors Stock Option Plan. Under this plan, a director may elect
     to receive options in lieu of his annual cash retainer and meeting fees.
     The option exercise price is 30% of the fair market value of a share on the
     date of grant, and the cash fees foregone by the director are equivalent to
     70% of the fair market value. Options become exercisable six months after
     date of grant and expire ten years from date of grant. Options outstanding
     January 3, 1997 totaled 23,336 shares, of which 16,179 were exercisable on
     that date and 26,664 shares were available for future grants of options
     under the plan.


K.   INVESTMENT INCOME

     Investment income consists of the following:

<TABLE>
<CAPTION>

       -------------------------------------------------------------------------
                                                 1996         1995        1994
       -------------------------------------------------------------------------

<S>                                           <C>          <C>          <C>     
       Gain on sale of investments            $ 27,000     $     --     $  2,000

       Interest and dividend income            300,000      257,000      367,000
       ------------------------------------------------------------------------- 
                                              $327,000     $257,000     $369,000
</TABLE>

                                       33
<PAGE>   34

L.  INCOME TAXES
<TABLE>
<CAPTION>

     The provision for income taxes includes the following:
-------------------------------------------------------------------------------
                                 1996                 1995                 1994
-------------------------------------------------------------------------------
<S>                            <C>                <C>               <C>        
Federal:
   Current                     $ 3,434,000        $ 2,114,000       $ 1,830,000
   Deferred                       (421,000)             4,000          (187,000)
State:
   Current                         527,000            368,000           280,000
   Deferred                        (71,000)             4,000           (49,000)
-------------------------------------------------------------------------------
                               $ 3,469,000        $ 2,490,000       $ 1,874,000
</TABLE>


The provision for income taxes for 1996 does not include the tax benefit of
$346,000 associated with the exercise of stock options which has been credited
to paid in capital.

Deferred tax liabilities (assets) at January 3, 1997 and December 29,1995 are
comprised of the following:


--------------------------------------------------------------------------------
                                                       1996              1995
--------------------------------------------------------------------------------
   Accelerated depreciation                        $   662,000      $   662,000

   Pension                                             780,000          844,000

   Other                                               340,000          311,000
--------------------------------------------------------------------------------
   Gross deferred tax liabilities                    1,782,000        1,817,000
--------------------------------------------------------------------------------
   Deferred compensation                              (803,000)        (623,000)

   Various reserves                                   (824,000)        (634,000)

   Other                                              (832,000)        (698,000)
--------------------------------------------------------------------------------
   Gross deferred tax assets                        (2,459,000)      (1,955,000)
--------------------------------------------------------------------------------
   Deferred tax assets valuation allowance                  --               --
--------------------------------------------------------------------------------
                                                   $  (677,000)     $  (138,000)

                                       34
<PAGE>   35


     The provision for income tax differs from the federal statutory rate of 34%
due to the following:

<TABLE>
<CAPTION>

-------------------------------------------------------------------------------
                                                     1996      1995       1994
-------------------------------------------------------------------------------
<S>                                                 <C>        <C>        <C>
Statutory rate                                      34.0%      34.0%      34.0%

State income taxes, less federal effect              2.9        3.3        2.9

Nontaxable investment income                        (0.6)      (0.9)      (1.7)

Effect of undistributed net earnings
   of foreign subsidiaries                          (1.3)      (2.2)        --

Other                                               (0.3)       0.3        0.1
-------------------------------------------------------------------------------
Effective tax rate                                  34.7%      34.5%      35.3%
</TABLE>

     The Company has not recorded deferred income taxes applicable to
     undistributed earnings of a foreign subsidiary that are indefinitely
     reinvested in foreign operations. Undistributed earnings amounted to
     approximately $978,000 at January 3, 1997. If the earnings of such foreign
     subsidiary were not reinvested, a deferred tax liability of approximately
     $374,000 would have been required.


M.   SUBSEQUENT EVENT

     On January 31, 1997, API Schmidt-Bretten GmbH, a newly formed wholly-owned
     subsidiary of the Company organized under the laws of the Federal Republic
     of Germany, acquired all of the shares of Schmidt-Bretten GmbH from Deutz
     Aktiengesellschaft, formerly Kloeckner-Humboldt-Deutz AG, and KHD Humboldt
     Wedag Aktiengesellschaft, both stock corporations organized under the laws
     of the Federal Republic of Germany. Neither seller is affiliated with the
     Company or any of its affiliates. The purchase price of DM 13,000,000
     (approximately $7,900,000) was based upon the unaudited balance sheet of
     Schmidt-Bretten GmbH at December 31, 1996. An amount of DM 10,000,000
     (approximately $6,100,000) was paid in cash on January 31, 1997 and a note
     for DM 3,000,000 (approximately $1,800,000) is due and payable on December
     31, 1997. Payment of this final installment, which is subject to interest
     at a per annum rate of 5.5% commencing as of January 31, 1997, is
     guaranteed by the Company. The acquisition will be accounted for as a
     purchase in 1997 in accordance with APB No. 16 Business Combinations.

     The Company funded this transaction with funds borrowed under an existing
     Credit Agreement with Marine Midland Bank dated March 29, 1996.

                                       35
<PAGE>   36


N.   BUSINESS SEGMENT DATA

     The Company conducts operations in three major industrial classifications:
     Heat Transfer Technology, Motion Technologies, and Electronic Components.
     The operations of the Heat Transfer Technology segment include the
     production and sale of water and air-cooled heat transfer equipment to
     industrial customers. Operations of the Motion Technologies segment
     comprises production and sale of electro-magnetic clutches and brakes, high
     performance servo motors, stepper motors, controllers, and resolvers.
     Operations of the Electronic Components segment involve production and sale
     of inductors and coils.

     Total revenues by segment consist entirely of sales to unaffiliated
     customers. Operating profit is total revenue less operating expenses.
     Operating profit does not include the following items: general corporate
     income and expense, investment income, interest expense, other income and
     expense, or income taxes. Identifiable assets by segment consist of those
     assets that are, or will be, used in the segmental operations. Corporate
     assets are principally cash, cash equivalents, marketable securities,
     investments, and other assets.

     Export sales, principally to Europe, Canada, Mexico, and Asia, were
     approximately 15% of consolidated sales for 1996. In 1995 and 1994, export
     sales were 14% and 17%, respectively of consolidated sales.

                                       36
<PAGE>   37
Information about the Company's operations in different industries, stated in
thousands of dollars, are as follows:
<TABLE>
<CAPTION>


-------------------------------------------------------------------------------
                                              1996          1995          1994
-------------------------------------------------------------------------------
REVENUES
<S>                                         <C>          <C>          <C>      
     Heat Transfer                          $  63,536    $  40,819    $  33,276
     Motion                                    40,016       28,599       19,674
     Electronic Components                     13,231       12,985       11,946
     General Corporate                            327          257          369
--------------------------------------------------------------------------------
Consolidated                                $ 117,110    $  82,660    $  65,265
--------------------------------------------------------------------------------
OPERATING PROFIT
     Heat Transfer                          $   8,230    $   5,542    $   5,331
     Motion                                     3,908        2,466          614
     Electronic Components                      2,300        2,058        1,790
--------------------------------------------------------------------------------
          Combined                             14,438       10,066        7,735
     General Corporate expense, net            (3,149)      (2,607)      (2,210)
     Interest and debt exense                  (1,295)        (238)        (220)
--------------------------------------------------------------------------------
Earnings before income taxes                $   9,994    $   7,221    $   5,305
--------------------------------------------------------------------------------
IDENTIFIABLE ASSETS
     Heat Transfer                          $  42,357    $  23,673    $  14,607
     Motion                                    22,274       15,179       12,370
     Electronic Components                      6,488        6,821        6,071
     General Corporate                         10,893       12,118       12,296
--------------------------------------------------------------------------------
Total assets                                $  82,012    $  57,791    $  45,344
--------------------------------------------------------------------------------
DEPRECIATION
     Heat Transfer                          $   1,378    $     877    $     735
     Motion                                     1,593          964          637
     Electronic Components                        534          558          598
     General Corporate                             58           61           62
--------------------------------------------------------------------------------
Total Depreciation                          $   3,563    $   2,460    $   2,032
--------------------------------------------------------------------------------
NET CAPITAL EXPENDITURES
     Heat Transfer                          $   5,878    $   1,789    $   1,358
     Motion                                       842        2,218          188
     Electronic Components                        575          449          259
     General Corporate                             77           33           10
--------------------------------------------------------------------------------
Total net capital expenditures              $   7,372    $   4,489    $   1,815
--------------------------------------------------------------------------------
</TABLE>




                                      37
<PAGE>   38


O.  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>


                                                                                                 FISCAL
                                         FIRST           SECOND        THIRD         FOURTH        YEAR
---------------------------------------------------------------------------------------------------------
                                                       (Thousands except per share information)
<S>                                 <C>           <C>           <C>           <C>           <C>          
1996
Revenues                            $      22,022 $      31,541 $      31,658 $      31,889 $     117,110
Gross profit                                7,380        10,102        10,613        11,036        39,131
Net earnings                                1,399         1,573         1,736         1,817         6,525
Net earnings per common share                 .20           .22           .24           .25           .91
Net earnings per common share
     - fully diluted                          .19          .021           .23           .24           .86
Cash dividends declared per share            .065          .065          .065          .065           .26


                                                                                                     1995
Revenues                            $      19,289 $      20,360 $      20,850 $      22,161 $      82,660
Gross profit                                6,254         6,410         7,264         7,186        27,114
Net earnings                                1,042         1,122         1,200         1,367         4,731
Net earnings per common share                 .15           .16           .17           .19           .67
Net earnings per common share
     - fully diluted                          .15           .16           .16           .19           .65
Cash dividends declared per share           .0625          .065          .065          .065         .2575
</TABLE>




ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         ---------------------------------------------------------------
         FINANCIAL DISCLOSURE
         --------------------

There were no changes in accountants or disagreements with Price Waterhouse on
accounting or financial disclosure.





                                       38
<PAGE>   39

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
          --------------------------------------------------

          The information required by this item concerning the directors and
          executive officers of the Company, appearing in the Company's
          definitive Proxy Statement for its 1997 Annual Meeting of
          Shareholders, which has been filed with the Commission pursuant to
          Regulation 14A, is incorporated herein by reference.

ITEM 11.  EXECUTIVE COMPENSATION
          ----------------------
          The information required by this item concerning executive
          compensation appearing in the Company's definitive Proxy Statement for
          its 1997 Annual Meeting of Shareholders, which has been filed with the
          Commission pursuant to Regulation 14A, is incorporated herein by
          reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
          --------------------------------------------------------------

 a) & b)  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
          ---------------------------------------------------------------
        
          The information required by this item, appearing in the Company's
          definitive Proxy Statement for its 1997 Annual Meeting of
          Shareholders, which has been filed with the Commission pursuant to
          Regulation 14A, is incorporated herein by reference.

      c)  CHANGES IN CONTROL
          ------------------
          The Company knows of no contractual arrangements which may, at a
          subsequent date, result in a change in control of the Company.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
          ----------------------------------------------

          a)  TRANSACTIONS WITH MANAGEMENT AND OTHERS
              ---------------------------------------
                None.

          b)  CERTAIN BUSINESS RELATIONSHIPS
              ------------------------------

                None.

          c)  INDEBTEDNESS OF MANAGEMENT
              --------------------------

                None.

          d)  TRANSACTIONS WITH PROMOTERS
              ---------------------------

                None.



                                       39
<PAGE>   40


                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
          ----------------------------------------------------------------

<TABLE>
<CAPTION>

                                                                                             PAGE IN
         a)     1.  FINANCIAL STATEMENTS                                                     FORM 10-K
                    --------------------                                                     ----------
<S>                                                                                         <C>
                    Report of Independent Accountants                                              16
                    Consolidated Balance Sheet                                                  17-18
                    Consolidated Statement of Earnings                                             19
                    Consolidated Statement of Shareholders' Equity                                 20
                    Consolidated Statement of Cash Flows                                           21
                    Notes to Consolidated Financial Statements                                  22-38


                2.  FINANCIAL STATEMENT SCHEDULES
                    -----------------------------
                    All schedules are omitted because they are inapplicable,
                    immaterial, or not required under the instructions, or the
                    information is included in the financial statements or notes
                    thereto.

         b)     REPORTS ON FORM 8-K
                -------------------
                There were no reports on Form 8-K for the three months ended
                January 3, 1997.

         c)     EXHIBITS
                --------
     
                    Exhibit No.
                    -----------
                      2-A           Management Agreement dated December
                                       23, 1994 among American Precision
                                       Industries Inc., Gettys Corporation,
                                       and Gettys Property Corporation,
                                       including List of Exhibits, List of
                                       Schedules, and Exhibit D - Asset
                                       Purchase Agreement                                        m.
                           
                      2-B           Credit Agreement between American
                                       American Precision Industries Inc.
                                       and Marine Midland Bank dated
                                       March 29, 1996                                            k.
                           
                      3-A           Restated Certificate of Incorporation,
                                        as amended on April 26, 1991                             e.
                           
                      3-B           Restated By-Laws, as amended on
                                    June 16, 1992                                                g. 
</TABLE>


                                       40
<PAGE>   41

<TABLE>
<CAPTION>
          C.    EXHIBITS (CONTINUED)
                --------------------
                EXHIBIT NO.
                -----------
<S>                 <C>             <C>                                                         <C>                                 
                  * 10-A            Form of Agreement relating to the
                                        Directors Supplemental Death Benefit
                                        and Fee Continuation Plan, as amended
                                        March 11, 1991                                           b.

                  * 10-B            Form of Agreement relating to the
                                        Executive Supplemental Death Benefit
                                        and Retirement Plan, as amended on
                                        March 11, 1991                                           b.

                  * 10-C            Form of Indemnification Agreement with
                                        directors dated February 25, 1991                        c.

                  * 10-D            Form of Indemnification Agreement with
                                        officers dated February 25, 1991                         b.

                  * 10-E            Long-Term Incentive Stock Option Plan                        c.

                  * 10-F            1989 Stock Option Plan                                       d.

                  * 10-G            Amendment to the American Precision
                                        Industries Inc. 1989 Stock Option Plan                   j.

                  * 10-H            Executive Employment Agreement dated
                                        April 14, 1992 between Kurt Wiedenhaupt
                                        and American Precision Industries Inc.                   f.

                  * 10-I            Stock Option and Tandem Stock Appreciation
                                        Rights Agreement dated June 16, 1992
                                        between Kurt Wiedenhaupt and American
                                        Precision Industries Inc.                                f.
                  * 10-J            Agreement dated April 24, 1992 between
                                        Robert J. Fierle and American Precision
                                        Industries Inc.                                          f.
                  * 10-K            Life Insurance Split-Dollar Agreement
                                        dated August 26, 1992 between Kurt
                                        Wiedenhaupt and American Precision
                                        Industries Inc.                                          h.

                  * 10-L            Executive Supplemental Retirement Plan
                                        dated July 1, 1992 between Kurt
                                        Wiedenhaupt and American Precision
                                        Industries Inc.                                          h.
</TABLE>


                                       41
<PAGE>   42
<TABLE>
<CAPTION>

         c.     Exhibits (continued)
                --------------------
                Exhibit No.
                -----------
<S>                 <C>            <C>                                                 <C>
                  * 10-M           1993 Employees Stock Option Plan                     i.

                  * 10-N            Amendment to the American Precision Industries
                                       Inc. 1993 Employees Stock Option Plan            j.

                  * 10-O            1995 Directors Stock Option Plan                    j.

                  * 10-P            1995 Employees Stock Option Plan                    j.

                  * 10-Q            Form of Change in Control Agreement between
                                        American Precision Industries Inc. and
                                        James W. Bingel, John M. Murray, Craig J.
                                        VanTine, and Richard S. Warzala dated
                                        October 21, 1996                                l.

                  * 10-R            Change in Control in Agreement between
                                        American Precision Industries Inc. and
                                        Kurt Wiedenhaupt dated July 1, 1996             l.

                  * 10-S            Amendment to and Restatement of Executive
                                        Employment Agreement between American
                                        Precision Industries Inc. and Kurt
                                        Wiedenhaupt dated July 1, 1996                  l.

                  * 10-T            First Amendment to American Precision
                                        Industries Inc. Grant of Restricted Stock
                                        and bonus to Kurt Wiedenhaupt dated
                                        July 1, 1996                                    l.

                  * 10-U            Executive Supplemental Retirement Plan
                                        (as restated) between American Precision
                                        Industries Inc. and Kurt Wiedenhaupt dated
                                        July 1, 1996                                    l.

                  * 10-V            Amendment to Life Insurance Split-Dollar
                                        Agreement between American Precision
                                        Industries Inc. and Kurt Wiedenhaupt
                                        dated as of July 1, 1994                        l.

                  * 10-W            Life Insurance Split-Dollar (as restated)
                                        between American Precision Industries
                                        Inc. and Kurt Wiedenhaupt dated
                                        July 1, 1996                                    l.

</TABLE>

                                       42


<PAGE>   43
<TABLE>

<S>            <C>                                                                        <C>
               11   Computation of Earnings Per Share                                          **

               21   List of Subsidiaries                                                       **

               23   Consent of independent accountants                                    Page 49 of
                                                                                          Form 10-K

               27   Financial Data Schedule                                                    ** 

*     Management Contract or Compensatory Plan or Agreement.

**    Documents filed herewith.

               a.   Incorporated by reference to Exhibits A and B in the
                    definitive Proxy Statement dated March 22, 1991.

               b.   Incorporated by reference to Exhibits 10A-D in the Annual
                    Report on Form 10-K for the fiscal year ended December 28,
                    1990.

               c.   Incorporated by reference to Exhibit 4.4 in the Registration
                    Statement on Form S-8 (#2-85320), filed July 22, 1983.

               d.   Incorporated by reference to Exhibit 4(a) in the
                    RegistrationStatement on Form S-8 (#33-31315) filed
                    September 28, 1989.

               e.   Incorporated by reference to Exhibits 3-B and 3-D in the
                    Annual Report on Form 10-K for the fiscal year ended January
                    3, 1992.

               f.   Incorporated by reference to Exhibits 10(i) - (iii) in the
                    Quarterly Report on Form 10-Q for the fiscal quarter ended
                    July 3, 1992.

               g.   Incorporated by reference to Exhibits B(i) - (ii) in the
                    Quarterly Report on Form 10-Q for the fiscal quarter ended
                    October 1, 1993.

               h.   Incorporated by reference to Exhibits 10(i) - (ii) in the
                    Quarterly Report on Form 10-Q for the fiscal quarter ended
                    April 2, 1993.

               i.   Incorporated by reference to Exhibit A in the definitive
                    Proxy Statement dated March 22, 1993.

               j.   Incorporated by reference to Exhibits A-C in the definitive
                    Proxy Statement dated March 24, 1995.

               k.   Incorporated by reference to Exhibit 2(iii) in the Quarterly
                    Report on Form 10-Q for the fiscal quarter ended March 29,
                    1996.

               l.   Incorporated by reference to Exhibits 10(i)-(vii) in the
                    Quarterly Report on Form 10-Q for the fiscal quarter ended
                    September 27, 1996.

               m.   Incorporate by reference to Exhibit 2-A in the Annual Report
                    on Form 10-K from the fiscal year ended December 30, 1994.
</TABLE>

                                       43
<PAGE>   44




                                   SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.



                                            AMERICAN PRECISION INDUSTRIES INC.




March 21, 1997                              By: /s/ Kurt Wiedenhaupt
                                               -------------------------------
                                               Kurt Wiedenhaupt
                                                        President and Director




March 21, 1997                              By: /s/ Bruce McH. Kirchner
                                                ------------------------------
                                                Bruce McH. Kirchner 
                                                        Chief Financial Officer




March 21, 1997                              By: /s/ John M. Murray
                                                ------------------------------
                                                John M. Murray
                                                        Vice President-Finance
                                                        and Treasurer




March 21, 1997                              By: /s/ Thomas M. Huebsch
                                                -------------------------------
                                                Thomas M. Huebsch 
                                                        Corporate Controller



                                       44
<PAGE>   45


                                   SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.


/s/ Robert J. Fierle                                     February 25, 1997
---------------------------------------                  ---------------------
Robert J. Fierle  Chairman of the Board                  Date


/s/ John M. Albertine                                    February 25, 1997
---------------------------------------                  ---------------------
John M. Albertine              Director                  Date



/s/ Bernard J. Kennedy                                   February 25, 1997
---------------------------------------                  ---------------------
Bernard J. Kennedy             Director                  Date



/s/ Douglas J. MacMaster                                 February 25, 1997
---------------------------------------                  ---------------------
Douglas J. MacMaster           Director                  Date


/s/ Klaus K. Oertel                                      February 25, 1997
---------------------------------------                  ---------------------
Klaus K. Oertel                Director                  Date


/s/ William P. Panny                                     February 25, 1997
---------------------------------------                  ---------------------
William P. Panny               Director                  Date


/s/ Victor Rice                                           February 25, 1997
---------------------------------------                  ---------------------
Victor Rice                    Director                   Date


/s/ Jerre L. Stead                                        February 25, 1997
---------------------------------------                  ---------------------
Jerre L. Stead                 Director                   Date


/s/ Kurt Wiedenhaupt                                      February 25, 1997
---------------------------------------                  ---------------------
Kurt Wiedenhaupt               Director                   Date


                                       45
<PAGE>   46

                                    * * * * *

          Safe Harbor Statement Under the Private Securities Litigation
                               Reform Act of 1995:


With the exception of historical factual information, the matters and statements
discussed, made or incorporated by reference in this Annual Report on Form 10-K
constitute forward-looking statements based upon current expectations and are
discussed, made or incorporated by reference pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements involve certain assumptions, risks and uncertainties
that could cause actual results to differ materially from those included in or
contemplated by the statements. These assumptions, risks and uncertainties
include, but are not limited to, the possibility that the sales revenues are not
achieved, as well as the risks and uncertainties associated with general
economic cycles in either North America or Europe. The Registrant disclaims any
obligation to update any forward-looking statements as a result of developments
occurring after the filing of this Report.

                                    * * * * *

                                  EXHIBIT INDEX
                                  -------------

                11         Computation of Earnings Per Share

                21         Subsidiaries of the Registrant

                23         Consent of Independent Accountants

                27         Financial Data Schedule


                                       46