Exhibit (13) to Report

On Form 10-K for Fiscal

Year Ended June 30, 2003

By Parker-Hannifin Corporation

Forward-Looking Statements

Forward-looking statements contained in this Annual Report and other written reports and oral statements are made based on known events and circumstances at the time of release, and as such, are subject in the future to unforeseen uncertainties and risks. All statements regarding future performance, earnings projections, events or developments are forward-looking statements. It is possible that future performance and earnings projections of the Company and individual segments may differ materially from current expectations, depending on economic conditions within both its industrial and aerospace markets, and the Company’s ability to achieve anticipated benefits associated with announced realignment activities, strategic initiatives to improve operating margins and growth initiatives. A change in economic conditions in individual markets may have a particularly volatile effect on segment projections. Among other factors which may affect future performance are:

The Company undertakes no obligation to update or publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this Report.

13-1

MANAGEMENT’S DISCUSSION AND ANALYSIS

Management’s discussion and analysis is designed to provide the reader of the financial statements a narrative summary of the Company’s results of operations and financial condition. The discussion below is structured to separately discuss each of the financial statements presented on pages 13-10 to 13-14. All year references are to fiscal years.

Discussion of Consolidated Statement of Income

The Consolidated Statement of Income summarizes the Company’s operating performance over the last three fiscal years.

Net sales of $6.41 billion for 2003 were 4.3 percent higher than the $6.15 billion for 2002. Acquisitions completed in 2003 and the effects of foreign currency rate changes accounted for all of the sales increase. Lower demand was experienced in virtually all of the markets in the Industrial North American operations as the recession-like business conditions experienced in 2002 continued to prevail throughout 2003. Sales in the Industrial International operations were higher across most businesses in Latin America and the Asia Pacific region while sales in Europe remained flat. The Aerospace operations experienced lower demand in the commercial original equipment and aftermarket businesses.

Net sales of $6.15 billion for 2002 were 2.8 percent higher than the $5.98 billion for 2001. Acquisitions completed in 2002 accounted for all of the increase. Lower demand was experienced across all of the Company’s operations during 2002 except in the Climate & Industrial Controls Segment. The lower demand in 2002 resulted from recessionary business conditions that were present throughout the year. In the Industrial North American operations, lower demand was experienced across most markets, most notably in semi-conductor manufacturing, heavy-duty trucks and factory automation. Sales in the Industrial International operations were lower across all businesses in Europe, Latin America and the Asia Pacific region. Currency rate changes reduced volume increases within the Industrial International operations by $26.7 million. The Aerospace operations experienced lower demand in the commercial original equipment and aftermarket businesses.

The Company expects sales in the Industrial North American operations to remain essentially the same as 2003 with operating profits improving as a result of the Company’s continued focus on financial performance initiatives. Sales in the Industrial European operations are expected to increase marginally with profits improving as a result of financial performance initiatives, including the continued movement of production facilities to low cost countries. Sales and profits in the Asia Pacific and Latin America regions are anticipated to grow as business conditions in substantially all markets are expected to improve. In Latin America, the economic uncertainty in Argentina and Brazil may temper the extent of the market improvements. The Aerospace operations expect the commercial OEM and aftermarket businesses to be depressed throughout 2004. The defense business is projected to remain relatively constant. The Climate & Industrial Controls operations are expected to experience the same economic conditions as the Industrial North American operations. As part of the Company’s financial performance initiatives, the recognition of additional business realignment charges may be required in 2004.

Gross profit margin as a percent of sales was 17.2 percent in 2003 compared to 16.8 percent in 2002 and 20.9 percent in 2001. The higher margins in 2003 reflect the effect of the Company’s financial performance initiatives and less business realignment costs recorded in 2003 than in 2002.

The lower margins in 2002 reflect lower sales volume experienced across all of the Company’s operations and a reduction in inventories in the Industrial operations, resulting in the underabsorption of manufacturing costs, as well as the effect of business realignment costs.

Selling, general and administrative expenses as a percent of sales remained at the 2002 level of 11.2 percent, and declined from 11.4 percent in 2001. Effective July 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” and ceased amortizing goodwill as of that date. Selling, general and administrative expenses in 2001 included $59.6 million of goodwill amortization.

Goodwill impairment loss of $39.5 million in 2002 resulted from the Company’s goodwill impairment tests required to be performed under the provisions of SFAS No. 142. No impairment loss was required to be recognized in 2003.

Interest expense decreased by $0.9 million in 2003 after a decrease of $13.3 million in 2002. The decrease in both 2003 and 2002 was primarily due to lower weighted-average interest rates. Interest expense in 2001 included $5.4 million related to an early-redemption premium and the write-off of deferred issuance costs.

Interest and other (income), net was $3.0 million in 2003 compared to $2.5 million in 2002 and $4.8 million in 2001. Fiscal 2001 includes a $3.7 million gain on the sale of marketable equity securities and $3.0 million of business realignment charges.

13-2

Loss (gain) on disposal of assets was a $3.8 million loss in 2003, an $8.5 million loss in 2002 and a $47.7 million gain in 2001. The loss in 2003 includes $10.2 million in losses related to fixed asset disposals and a $7.4 million gain on the divestiture of a business. The loss in 2002 includes $9.4 million of certain asset impairments (see Note 3 on page 13-20 for further discussion) offset by a $4.5 million gain on business divestitures. The gain in 2001 included a gain on the sale of real property offset by certain asset impairments (see Note 3 on page 13-20 for further discussion).

Income taxes decreased to an effective rate of 34.0 percent in 2003, compared to 40.3 percent in 2002 and 35.5 percent in 2001. The higher tax rate in 2002 was primarily due to the effect of the goodwill impairment loss, which was non deductible for tax purposes.

Net income of $196.3 million for 2003 was 50.8 percent higher than 2002. Net income of $130.2 million for 2002 was 61.8 percent lower than 2001. Net income as a percentage of sales was 3.1 percent in 2003, compared to 2.1 percent in 2002 and 5.7 percent in 2001. In addition to the individual income statement items discussed above, net income in 2003 and 2002 was adversely affected by an additional expense of approximately $16.9 million and $23.5 million, respectively, related to domestic qualified defined benefit plans. The increase in expense associated with the Company’s domestic qualified defined benefit plans results from a lower market value of plan assets and changes in actuarial assumptions regarding the long-term rate of return on plan assets and the discount rate. Net income in 2004 is expected to be adversely affected by an additional $30.0 million in excess of the 2003 expense for domestic qualified defined benefit plans.

Other comprehensive income (loss) – Items included in other comprehensive income (loss) are gains and losses that under generally accepted accounting principles are recorded directly into stockholders’ equity. The Company’s items of comprehensive income (loss) include foreign currency translation adjustments, unrealized gains or losses on marketable equity securities and a minimum pension liability. The effect of currency rate changes resulted in an increase in shareholders’ equity of $99.0 million in 2003 compared to an increase of $69.7 million in 2002 and a decrease of $89.7 million in 2001. The change in 2003 and 2002 resulted primarily from a weaker U.S. dollar against the Euro. In 2003 and 2002, a minimum pension liability of $425.0 million ($297.5 million after-tax) and $172.3 million ($107.6 million after-tax), respectively, was recorded in comprehensive income in accordance with the requirements of SFAS No. 87 (see Note 10 on page 13-25 for further discussion).

Discussion of Business Segment Information

The Business Segment information presents sales, operating income and assets on a basis that is consistent with the manner in which the Company’s various businesses are managed for internal review and decision-making. See Note 1 on page 13-15 for a description of the Company’s reportable business segments.

Industrial Segment

Sales for the Industrial North American operations were $2.84 billion in 2003, a 1.7 percent increase from 2002, following a decrease in 2002 of 5.1 percent over 2001. All of the sales increase in 2003 was attributable to current-year acquisitions. Customer demand in virtually all of the North American Industrial markets continued to be weak throughout 2003 as the North American economy remained stagnant. Sales in 2002 reflect the continuation of the lower demand that began in 2001 in virtually all markets. Markets affected more than others in 2002 included semi-conductor manufacturing, telecommunications, mobile equipment and factory automation.

Industrial International sales were $1.58 billion in 2003, a 23.9 percent increase from 2002, after remaining unchanged in 2002 from 2001. Current-year acquisitions and the effect of foreign currency exchange rates accounted for about 80 percent of the sales increase. Higher volume was experienced in virtually all markets in the Latin America and Asia Pacific regions while sales in the European businesses were flat. Sales in 2002 reflect the sales contribution from acquisitions being offset by lower volume experienced across almost all of the Industrial International businesses in Europe and the semi-conductor manufacturing businesses in the Asia Pacific region and the negative impact of foreign currency rate changes.

Industrial North American operating income was $155.3 million, an increase of 9.9 percent from 2002, following a decline in 2002 of 56.2 percent from 2001. Income from operations as a percent of sales was 5.5 percent in 2003 compared to 5.1 percent in 2002 and 11.0 percent in 2001. Included in operating income in 2003, 2002 and 2001 are business realignment charges of $8.3 million, $8.9 million and $13.2 million, respectively. The business realignment charges resulted from actions the Company took to structure the Industrial North American operations to operate in their

13-3

then current economic environment and primarily consisted of severance costs and costs relating to the consolidation of manufacturing operations. Operating income in 2001 included goodwill amortization of $31.1 million. The increase in margins in 2003 was primarily due to operating efficiencies and product mix. Margins in 2002 were adversely affected by the lower sales volume experienced across virtually all markets, with a significant decline in sales volume experienced by historically higher margin markets. Acquisitions, not yet fully integrated, also negatively impacted margins in both 2003 and 2002.

Industrial International operating income was $96.3 million, an increase of 58.6 percent from 2002, following a decrease of 39.8 percent in 2002 from 2001. Income from operations as a percent of sales was 6.1 percent in 2003 compared to 4.7 percent in 2002 and 7.3 percent in 2001. Operating income in 2003, 2002 and 2001 included $7.9 million, $7.4 million and $5.9 million, respectively, of business realignment charges that were taken primarily to appropriately structure the European operations. Operating income in 2001 included goodwill amortization of $12.4 million. The higher margins in 2003 were primarily due to the higher volume in the Asia Pacific region as well as operating efficiencies experienced in most of the European businesses. In 2002 lower margins were earned across most businesses in Europe and the Asia Pacific region due to the lower sales volume and the resulting underabsorption of overhead costs.

Industrial Segment order rates were lower throughout 2003 as virtually all markets continued to experience weak end-user demand. The Company expects order entry levels in most markets of the Industrial North American operations to be relatively flat throughout 2004 reflecting the continuation of the recession-like conditions experienced in 2003. Operating income in the Industrial North American operations is expected to increase as a result of the Company’s financial performance initiatives and improvements stemming from recent business realignment actions. Industrial European operations in 2004 are anticipated to track closely with the Industrial North American operations with improvements in profitability stemming from recent business realignment actions, including expanding the use of low-cost countries for production. The Asia Pacific region and Latin American operations are expected to continue to improve as the Company continues to expand its operations into these regions with demand in substantially all markets expected to grow in 2004. The extent of the expected improvement in Latin America will be affected by the economic uncertainties in Argentina and Brazil. As part of the Company’s financial performance initiatives, the recognition of additional business realignment charges may be required in 2004.

Backlog for the Industrial Segment was $638.8 million at June 30, 2003, compared to $688.8 million at the end of 2002 and $667.9 million at the end of 2001. The decrease in backlog from 2002 to 2003 results from shipments exceeding new order rates. The increase in backlog from 2001 to 2002 is attributable to acquisitions partially offset by lower order rates experienced across most Industrial markets throughout 2002.

Assets for the Industrial Segment increased 1.9 percent in 2003 after an increase of 11.5 percent in 2002. The increase in 2003 was primarily due to the effect of currency fluctuations partially offset by decreases in accounts receivable, inventory and property, plant and equipment. The increase in 2002 was primarily due to the addition of assets from acquisitions and the effect of currency fluctuations.

Aerospace Segment

Sales for the Aerospace operations were $1.11 billion in 2003, a 5.4 percent decline from 2002, following a decrease in 2002 of 2.7 percent over 2001. The decrease in sales in 2003 was primarily due to a decline in both commercial original equipment manufacturers (OEM) and aftermarket volume, partially offset by an increase in military volume. The lower sales in 2002 reflected the slowdown in activity in both the commercial original equipment and aftermarket businesses as commercial carriers delayed shipments of new aircraft and required fewer replacement parts for existing aircraft. Partially offsetting the sales decline was an increase in the military original equipment and aftermarket businesses.

Aerospace operating income was $157.3 million in 2003, $189.4 million in 2002 and $218.9 million in 2001. Included in operating income in 2003 and 2002 were $2.5 million and $4.7 million, respectively, in business realignment charges primarily related to severance costs as the workforce was adjusted in response to declining commercial aircraft orders. Operating income in 2001 included goodwill amortization of $7.8 million. The lower margins in 2003 were primarily due to lower sales in the commercial OEM and aftermarket businesses partially offset by an increase in volume in military business. The lower margins in 2002 resulted from a lower mix of higher margin aftermarket business as well as the overall lower sales volume, resulting in lower capacity utilization.

Backlog at June 30, 2003 and 2002 was $1.01 billion compared to $1.21 billion in 2001. Backlog remained flat in 2003

13-4

due to higher order rates in military business being offset by lower order rates in the commercial aircraft and regional jet market. The lower backlog in 2002 reflects the slowdown in order rates in the commercial aircraft and regional jet market. The downward trend in commercial order rates experienced in 2003 is expected to continue throughout 2004 as commercial airline carriers continue to delay orders for new aircraft and existing aircraft log fewer miles due to reduced commercial airline travel. Order rates in the military market are expected to remain steady in 2004.

Assets declined 8.3 percent in 2003 after declining 4.4 percent in 2002. The decline in 2003 was primarily due to a decline in accounts receivable, inventory and property, plant and equipment. The decline in 2002 was primarily due to a decline in accounts receivable resulting from the lower sales volume.

Climate & Industrial Controls Segment

The Climate & Industrial Controls Segment consists of several business units which produce motion-control systems and components for use in the refrigeration and air conditioning and transportation industries. These businesses were previously included in the Other Segment. All prior year amounts have been reclassified to conform to the current year presentation.

Climate & Industrial Controls Segment sales in 2003 were $665.6 million, an 8.7 percent increase from 2002, following a 13.7 percent increase from 2001. Acquisitions and the effect of foreign currency exchange rates accounted for about one-half of the sales increase in 2003. Higher demand in the mobile and refrigeration and air conditioning markets accounted for the balance of the sales increase in 2003 and the increase in sales from 2001 to 2002. Operating income increased 32.2 percent in 2003 following an increase in 2002 of 19.3 percent from 2001. Operating income in 2003 and 2002 includes $1.2 million and $2.3 million, respectively, of business realignment charges. Operating income in 2001 included goodwill amortization of $4.3 million. The higher margins were primarily the result of the higher sales volume.

Backlog was $117.3 million at June 30, 2003, compared to $122.3 million at the end of 2002 and $100.1 million at the end of 2001. The increase in the backlog in 2002 was primarily due to acquisitions.

Assets decreased 2.6 percent in 2003 after an increase of 33.3 percent in 2002. The decrease in assets in 2003 was due to the effect of currency fluctuations. The increase in assets in 2002 was due to acquisitions.

Other Segment

The Other Segment consists of a business unit which designs and manufactures custom-engineered buildings (beginning in 2001) and a business unit which develops and manufactures chemical car care and industrial products (beginning in 2002). In June 2002 the Company divested businesses included in the Other Segment only in 2002 which administered vehicle service contract programs and product-related service programs. All of these businesses were classified as assets held for sale prior to the inclusion in the Other Segment.

Other Segment sales were $210.3 million in 2003, $293.0 million in 2002 and $17.7 million in 2001. The decrease in sales in 2003 was primarily due to the divestitures noted above. The inclusion of sales from businesses previously classified as assets held for sale accounted for all of the sales increase from 2001 to 2002. Operating income was $11.6 million in 2003, $6.7 million in 2002 and $1.2 million in 2001. Operating income in 2003 and 2002 included $1.3 million and $4.7 million, respectively, of business realignment charges. The increase in margins in 2003 was primarily due to operating efficiencies. The decline in margins in 2002 was attributable to businesses previously classified as assets held for sale, which were not fully integrated.

Backlog was $41.0 million at June 30, 2003, compared to $42.0 million at the end of 2002 and $9.1 million at the end of 2001. The increase in 2002 is attributable to the businesses previously classified as assets held for sale.

Assets increased 11.5 percent in 2003 after an increase of 90.0 percent in 2002. The increase in assets in 2003 was primarily due to the effect of currency fluctuations. The increase in assets in 2002 was due to the inclusion of assets from businesses previously classified as held for sale.

Corporate assets increased 33.5 percent in 2003 and declined 20.3 percent in 2002. The increase in 2003 was primarily due to an increase in cash and cash equivalents. The 2001 amount included assets from businesses previously classified as held for sale.

13-5

Discussion of Consolidated Balance Sheet

The Consolidated Balance Sheet shows the Company’s financial position at year-end, compared with the previous year-end. This statement provides information to assist in assessing factors such as the Company’s liquidity and financial resources.

The effect of currency rate changes during the year caused a $99.0 million increase in Shareholders’ equity. These rate changes also caused significant increases in accounts receivable, inventories, goodwill, plant and equipment, accounts payable, various accrual accounts and long-term debt.

Working capital and the current ratio were as follows:

Accounts receivable are primarily receivables due from customers for sales of product ($912.1 million at June 30, 2003, compared to $923.1 million at June 30, 2002). The current year decrease in accounts receivable is primarily due to a decrease in sales volume primarily in the Industrial North American and Aerospace operations, partially offset by the effect of currency rate changes. Days sales outstanding for the Company remained constant at 55 days in 2003 compared to 2002. The allowance for doubtful accounts in 2003 was unchanged from 2002.

Inventories decreased to $997.2 million at June 30, 2003, compared to $1,052.0 million a year ago. The decrease was primarily due to a concerted effort in the Industrial North American and Aerospace operations to reduce inventory levels, partially offset by the effect of currency rate changes. Days supply of inventory on hand decreased to 82 days in 2003 from 87 days in 2002.

Plant and equipment, net of accumulated depreciation, decreased $39.5 million in 2003 as a result of depreciation expense exceeding capital expenditures.

Investments and other assets increased $44.1 million in 2003 primarily as a result of a discretionary cash contribution made by the Company to its qualified defined benefit plans.

Goodwill increased $24.8 million in 2003 as a result of the effect of foreign currency changes. Effective July 1, 2001 the Company adopted SFAS No. 142 and therefore further amortization of goodwill has been discontinued.

Intangible assets, net consist primarily of patents, trademarks and engineering drawings. Intangible assets, net increased $8.2 million in 2003 primarily due to current-year acquisitions.

Notes payable and long-term debt payable within one year and Long-term debt – see Cash Flows from Financing Activities discussion on page 13-7.

Accounts payable, trade decreased $6.4 million in 2003 as a result of lower purchasing levels in the Company’s Industrial North American operations, partially offset by the effect of currency rate changes.

Accrued payrolls and other compensation increased to $197.7 million in 2003 from $187.0 million in 2002 primarily as a result of the effect of currency rate changes.

Accrued domestic and foreign taxes increased to $65.1 million in 2003 from $48.3 million in 2002 primarily due to higher foreign taxable income in 2003.

Pensions and other postretirement benefits increased 81.1 percent in 2003. The change in this amount is explained further in Note 10 to the Consolidated Financial Statements.

Deferred income taxes decreased $56.2 million in 2003 primarily due to the tax effect related to the additional minimum pension liability recorded in 2003.

Common stock in treasury increased to $4.5 million in 2003 from $3.6 million in 2002 due to current year share repurchases.

Discussion of Consolidated Statement of Cash Flows

The Consolidated Statement of Cash Flows reflects cash inflows and outflows from the Company’s operating, investing and financing activities.

Cash and cash equivalents increased $199.5 million in 2003 after increasing $22.8 million in 2002.

13-6

Cash Flows From Operating Activities – The Company’s largest source of cash continues to be net cash provided by operating activities. Net cash provided by operating activities in 2003 was $557.5 million compared to $631.0 million in 2002 and $528.8 million in 2001. The decrease in net cash provided by operating activities in 2003 was primarily the result of a $108.0 million discretionary cash contribution to the Company’s qualified defined benefit plans.

Cash Flows Used In Investing Activities – Net cash used in investing activities was $137.2 million in 2003 compared to $608.7 million in 2002 and $819.8 million in 2001. The significant decrease in the amount of cash used in investing activities in 2003 is attributable to a reduction in acquisition activity as well as a reduction in capital expenditures. The reduction in capital expenditures in 2003 can be attributed to the consolidation of manufacturing facilities, lean manufacturing initiatives, and a decline in product demand. Refer to Note 2 on page 13-19 for a summary of net assets of acquired companies at their respective acquisition dates.

Cash Flows From Financing Activities – Net cash used in financing activities was $222.2 million in 2003 compared to using cash of $0.8 million in 2002 and providing cash of $247.5 million in 2001. In 2003 the Company decreased its outstanding borrowings by a net total of $145.8 million compared to an increase of $61.7 million in 2002. The lower borrowing level in 2003 was due to the decline in acquisition activity and capital expenditure requirements.

During 2003 the Company issued $225 million of fixed rate senior notes due 2013 utilizing its universal shelf registration statement. The proceeds from this issuance were used to reduce commercial paper note borrowings. After giving effect to this issuance, the Company now has the availability to issue securities with an aggregate initial offering price of up to $775 million. Securities that may be issued under this shelf registration statement include debt securities, common stock, serial preferred stock, depositary shares, warrants, stock purchase contracts and stock purchase units.

The Company’s goal is to maintain no less than an “A” rating on senior debt to ensure availability and reasonable cost of external funds. As a means of achieving this objective, the Company has established a financial goal of maintaining a ratio of debt to debt-equity of 34 to 37 percent.

Common share activity in 2003 primarily includes the exercise of stock options and the purchase of shares of the Company’s common stock for treasury.

Dividends have been paid for 212 consecutive quarters, including a yearly increase in dividends for the last 47 fiscal years. The current annual dividend rate is $.76 per share.

As of June 30, 2003 the Company has committed lines of credit totaling $825 million through two multi-currency unsecured revolving credit agreements. The credit agreements support the Company’s commercial paper note program, which is rated A-1 by Standard & Poor’s, P-1 by Moody’s and F-1 by Fitch, Inc. The revolving credit agreements contain provisions that increase the facility fee of the credit agreement in the event the Company’s credit ratings are changed. A credit rating change would not limit the Company’s ability to use the credit agreements nor would it accelerate the repayment of any outstanding borrowings.

The Company seeks to minimize its total cost of borrowing and therefore uses its commercial paper note program as its primary source of working capital liquidity. The primary alternative source of borrowing for working capital liquidity is the committed lines of credit, which typically bear a higher cost of borrowing.

The Company’s revolving credit agreements and certain debt agreements contain certain financial and other covenants, the violation of which would limit or preclude the use of the agreements for future borrowings. The Company is in compliance with all covenants and expects to remain in compliance during the term of the agreements.

Based upon the Company’s past performance and current expectations, management believes the cash flows generated from future operating activities should provide adequate funds to support internal growth and continued improvements in the Company’s manufacturing facilities and equipment. The Company’s worldwide financial capabilities may be used to support planned growth as needed.

Contractual Obligations – The Company is obligated to make future payments in fixed amounts primarily under long-term debt and various lease agreements. The following table summarizes the Company’s fixed contractual obligations.

13-7

Quantitative and Qualitative Disclosures About Market Risk

The Company enters into forward exchange contracts, costless collar contracts and cross-currency swap agreements to reduce its exposure to fluctuations in related foreign currencies. The total carrying and fair value of open contracts and any risk to the Company as a result of these arrangements is not material to the Company’s financial position, liquidity or results of operations.

The Company’s debt portfolio contains variable rate debt, inherently exposing the Company to interest rate risk. The Company’s objective is to maintain a 60/40 mix between fixed rate and variable rate debt thereby limiting its exposure to changes in near-term interest rates. In addition, the Company has entered into an interest rate swap agreement for a $200 million notional principal amount. The agreement is with a major financial institution and the risk of loss is considered remote. The carrying value and fair value of the swap agreement is not material to the Company’s financial position, liquidity or results of operations. A 100 basis point increase in near-term interest rates would increase annual interest expense on variable rate debt by approximately $3 million.

Off-Balance Sheet Arrangements

The Company does not have off-balance sheet arrangements with unconsolidated entities.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The policies discussed below are considered by management to be more critical than other policies because their application places the most significant demands on management’s judgment.

Revenue recognition – Substantially all of the Industrial Segment, the Climate & Industrial Controls Segment and the Other Segment revenues are recognized when the risks and rewards of ownership and title to the product has transferred to the customer. This generally takes place at the time the product is shipped. The Aerospace Segment uses the percentage of completion method to recognize a portion of its revenue. The percentage of completion method requires the use of estimates of costs to complete long-term contracts and for some contracts includes estimating costs related to aftermarket orders. The estimation of these costs requires substantial judgment on the part of management due to the duration of the contracts as well as the technical nature of the products involved. Adjustments to estimated costs are made on a consistent basis and a contract reserve is established when the costs to complete a contract exceed the contract revenues.

Impairment of Goodwill and Long-lived Assets – Goodwill is tested for impairment, at the reporting unit level, on an annual basis and between annual tests whenever events or circumstances indicate that the carrying value of a reporting unit’s goodwill may exceed its fair value. A discounted cash flow model is used to estimate the fair value of a reporting unit. This model requires the use of long-term planning forecasts and assumptions regarding industry specific economic conditions that are outside the control of the Company. Long-lived assets held for use are evaluated for impairment whenever events or circumstances indicate that the undiscounted net cash flows to be generated by their use and eventual disposition is less than their carrying value. The long-term nature of these assets require the estimation of its cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of the impairment test.

13-8

Inventories – Inventories are valued at the lower of cost or market. Cost is determined on the last-in, first-out basis for a majority of U.S. inventories and on the first-in, first-out basis for the balance of the Company’s inventories. Inventories have been reduced by an allowance for excess and obsolete inventories. The estimated allowance is based on management’s review of inventories on hand compared to estimated future usage and sales.

Pensions and Postretirement Benefits Other Than Pensions – The annual net periodic expense and benefit obligations related to the Company’s defined benefit plans are determined on an actuarial basis. This determination requires critical assumptions regarding the discount rate, long-term return on plan assets, increases in compensation levels, amortization periods for actuarial gains and losses and health care cost trends. Assumptions are determined based on Company data and appropriate market indicators, and are evaluated each year as of the plan’s measurement date. Changes in the assumptions to reflect actual experience could result in a material change in the annual net periodic expense and benefit obligations reported in the financial statements. For the Company’s domestic defined benefit plans, a one-half percentage point change in the assumed long-term rate of return on plan assets is estimated to have a $6 million effect on pension expense and a one-half percentage point decrease in the discount rate is estimated to increase pension expense by $13 million.

Further information on pensions and postretirement benefits other than pensions is provided in Note 10 to the Consolidated Financial Statements.

Other Loss Reserves – The Company has a number of loss exposures incurred in the ordinary course of business such as environmental claims, product liability, litigation, recoverability of deferred income tax benefits and accounts receivable reserves. Establishing loss reserves for these matters requires management’s estimate and judgment with regards to risk exposure and ultimate liability or realization. These loss reserves are reviewed periodically and adjustments are made to reflect the most recent facts and circumstances.

Recently Issued Accounting Pronouncements

In April 2003 the Financial Accounting Standards Board (FASB) issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and is effective for contracts entered into or modified after June 30, 2003. In May 2003 the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for classifying and measuring financial instruments with characteristics of both liabilities and equity. It requires classifying a financial instrument that is within its scope as a liability and is effective in the first interim period beginning after June 15, 2003. The implementation of these accounting pronouncements is not expected to have a material effect on the Company’s results of operations, cash flows or financial position.

13-9

Consolidated Statement of Income

The accompanying notes are an integral part of the financial statements.

Consolidated Statement of Comprehensive Income

The accompanying notes are an integral part of the financial statements.

13-10

Business Segment Information

By Industry

13-11

By Geographic Area (d)

Certain prior year amounts have been reclassified to conform to the current year presentation including the presentation of Climate & Industrial Controls as a separate reporting segment as a result of the net sales of this business exceeding the 10% materiality threshold set forth in SFAS No. 131.

The accounting policies of the business segments are the same as those described in the Significant Accounting Policies footnote except that the business segment results are prepared on a management basis that is consistent with the manner in which the Company disaggregates financial information for internal review and decision-making.

13-12

Consolidated Balance Sheet

The accompanying notes are an integral part of the financial statements.

13-13

Consolidated Statement of Cash Flows

The accompanying notes are an integral part of the financial statements.

13-14

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

The significant accounting policies followed in the preparation of the accompanying consolidated financial statements are summarized below.

Nature of Operations - The Company is a leading worldwide full-line manufacturer of motion-control products, including fluid power systems, electromechanical controls and related components. The Company evaluates performance based on segment operating income before Corporate general and administrative expenses, Interest expense and Income taxes.

The Company operates in two principal business segments: Industrial and Aerospace. The Industrial Segment is an aggregation of several business units which manufacture motion-control and fluid power system components for builders and users of various types of manufacturing, packaging, processing, transportation, agricultural, construction, and military vehicles and equipment. Industrial Segment products are marketed primarily through field sales employees and independent distributors. The North American Industrial business represents the largest portion of the Company’s manufacturing plants and distribution networks and primarily services North America. The International Industrial operations provide Parker products and services to countries throughout Europe, Asia Pacific and Latin America.

The Aerospace Segment produces hydraulic, fuel and pneumatic systems and components which are utilized on virtually every domestic commercial, military and general aviation aircraft and also performs a vital role in naval vessels, land-based weapons systems, satellites and space vehicles. This Segment serves original equipment and maintenance, repair and overhaul customers worldwide. Aerospace Segment products are marketed by field sales employees and are sold directly to manufacturers and end users.

The Company also reports a Climate & Industrial Controls Segment and an Other Segment. The Climate & Industrial Controls Segment consists of several business units which manufacture motion-control systems and components for use primarily in the refrigeration and air conditioning and transportation industries. The Other Segment consists of a business unit which designs and manufactures custom-engineered buildings (beginning in 2001) and a business unit which develops and manufactures chemical car care and industrial products (beginning in 2002). In June 2002 the Company divested businesses included in the Other Segment only in 2002 which administered vehicle service contract programs and product-related service programs (See Note 2 for further discussion). The products in the Climate & Industrial Controls Segment and the Other Segment are marketed primarily through field sales employees and independent distributors.

See the table of Business Segment Information “By Industry” and “By Geographic Area” on pages 13-11 and 13-12 for further disclosure of business segment information.

There are no individual customers to whom sales are four percent or more of the Company’s consolidated sales. Due to the diverse group of customers throughout the world the Company does not consider itself exposed to any concentration of credit risks.

The Company manufactures and markets its products throughout the world. Although certain risks and uncertainties exist, the diversity and breadth of the Company’s products and geographic operations mitigate significantly the risk that adverse changes would materially affect the Company’s operating results.

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Basis of Consolidation - The consolidated financial statements include the accounts of all domestic and foreign subsidiaries. All material intercompany transactions and profits have been eliminated in the consolidated financial statements. The Company does not have off-balance sheet arrangements with unconsolidated special-purpose entities. Within the Business Segment Information, intersegment and interarea sales are recorded at fair market value and are immaterial in amount.

13-15

Revenue Recognition - Revenue is recognized when the risks and rewards of ownership and title to the product has transferred to the customer. The Company’s revenue recognition policies are in compliance with the SEC’s Staff Accounting Bulletin (SAB) No. 101. Shipping and handling costs billed to customers are included in Net sales and the related costs in Cost of sales.

Cash - Cash equivalents consist of short-term highly liquid investments, with a three-month or less maturity, carried at cost plus accrued interest, which are readily convertible into cash.

Inventories - Inventories are stated at the lower of cost or market. The majority of domestic inventories are valued by the last-in, first-out method and the balance of the Company’s inventories are valued by the first-in, first-out method.

Long-term Contracts - The Company enters into long-term contracts for the production of aerospace products and the manufacture of custom-engineered buildings. For financial statement purposes, revenues are recognized using the percentage-of-completion method. Unbilled costs on these contracts are included in inventory. Progress payments are netted against the inventory balances. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.

Plant, Equipment and Depreciation - Plant and equipment are recorded at cost and are depreciated principally using the straight-line method for financial reporting purposes. Depreciation rates are based on estimated useful lives of the assets, generally 40 years for buildings; 15 years for land improvements and building equipment; 10 years for machinery; seven years for equipment; and three to five years for vehicles and office equipment. Improvements which extend the useful life of property are capitalized, and maintenance and repairs are expensed. When property is retired or otherwise disposed of, the cost and accumulated depreciation are removed from the appropriate accounts and any gain or loss is included in current income.

Investments and Other Assets - Investments in joint-venture companies in which ownership is 50% or less and in which the Company does not have operating control are stated at cost plus the Company’s equity in undistributed earnings. These investments and the related earnings are not material to the consolidated financial statements. During 2003 and 2002 the Company recorded a charge of $2,565 ($.02 per share) and $4,973 charge ($.04 per share), respectively, related to an adjustment in an equity investment in a publicly traded Japanese company. Investments and Other Assets includes a prepaid pension cost at June 30, 2003 and 2002 of $354,330 and $270,750, respectively, and an intangible asset recognized in connection with an additional minimum pension liability of $100,294 and $115,242 at June 30, 2003 and 2002, respectively.

Goodwill - On July 1, 2001 the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” and therefore ceased amortizing goodwill as of that date. Prior to the adoption of SFAS No. 142, the Company amortized goodwill, on a straight-line basis, over periods ranging from 15 years to 40 years. The Company conducts a formal impairment test of goodwill on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.

Intangible Assets- Intangible assets primarily include patents, trademarks and engineering drawings and are recorded at cost and amortized on a straight-line method over their legal or estimated useful life.

Income Taxes - Income taxes are provided based upon income for financial reporting purposes. Deferred income taxes arise from temporary differences in the recognition of income and expense for tax purposes. Tax credits and similar tax incentives are applied to reduce the provision for income taxes in the year in which the credits arise.

Product Warranty- In the ordinary course of business the Company warrants its products against defect in design, materials and workmanship over various time periods. The warranty accrual at June 30, 2003 and 2002 is immaterial to the financial position of the Company and the change in the accrual during 2003 was immaterial to the Company’s results of operations and cash flows.

13-16

Foreign Currency Translation - Assets and liabilities of most foreign subsidiaries are translated at current exchange rates, and income and expenses are translated using weighted average exchange rates. The effects of these translation adjustments, as well as gains and losses from certain intercompany transactions, are reported in the Accumulated other comprehensive (loss) component of Shareholders’ equity. Such adjustments will affect Net income only upon sale or liquidation of the underlying foreign investments, which is not contemplated at this time. Exchange gains and losses from transactions in a currency other than the local currency of the entity involved, and translation adjustments in countries with highly inflationary economies, are included in Net income.

Financial Instruments - The Company’s financial instruments consist primarily of investments in cash, cash equivalents and long-term investments as well as obligations under notes payable and long-term debt. The carrying values for Cash and cash equivalents, Investments and other assets and Notes payable approximate fair value. See Note 9 for fair value of long-term debt.

The Company enters into forward exchange contracts (forward contracts), costless collar contracts, and cross-currency swap agreements to reduce its exposure to fluctuations in related foreign currencies. These contracts are with major financial institutions and the risk of loss is considered remote. The Company does not hold or issue derivative financial instruments for trading purposes.

Gains or losses on forward contracts that hedge specific transactions are recognized in Net income, offsetting the underlying foreign currency gains or losses. Gains or losses on costless collar contracts are recognized in Net income when the spot rate of the contract falls outside the collar range.

Cross-currency swap agreements are recorded in Long-term debt as dollar-denominated receivables with offsetting foreign-currency payables. If the receivables more than offset the payables, the net difference is reclassified to an asset. Gains or losses are accrued monthly as an adjustment to Net income, offsetting the underlying foreign currency gains or losses. The differential between interest to be received and interest to be paid is accrued monthly as an adjustment to Interest expense. At June 30, 2003 there were no outstanding cross-currency swap agreements.

The Company has entered into an interest rate swap agreement for a $200 million notional principal amount. The swap agreement converts a portion of variable rate debt to a fixed rate through 2004. The net payments or receipts under this agreement are recognized as an adjustment to Interest expense. The agreement is with a major financial institution and the risk of loss is considered remote.

In addition, the Company’s foreign locations, in the ordinary course of business, enter into financial guarantees, through financial institutions, which enable customers to be reimbursed in the event of nonperformance by the Company.

The total carrying and fair value of open contracts and any risk to the Company as a result of the above mentioned arrangements is not material.

Stock Options - In 2003 the Company adopted the provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” The Company continues to apply the intrinsic-value based method to account for stock options granted to employees or Directors to purchase common shares. The option price equals the market price of the underlying common shares on the date of grant, therefore no compensation expense is recognized. The Company does recognize compensation expense related to the issuance of restricted stock. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested stock awards:

13-17

Recent Accounting Pronouncements - In April 2003 the Financial Accounting Standards Board (FASB) issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and is effective for contracts entered into or modified after June 30, 2003. In May 2003 the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for classifying and measuring financial instruments with characteristics of both liabilities and equity and is effective in the first interim period beginning after June 15, 2003. The implementation of these accounting pronouncements is not expected to have a material effect on the Company’s results of operations, cash flows or financial position.

Reclassifications - Certain prior period amounts have been reclassified to conform to the current year presentation. Interest expense and Income taxes in the 2001 Consolidated Statement of Income have been restated as a result of adopting SFAS No. 145, which prohibits the presentation of the early redemption of debt as an extraordinary item.

Acquisitions - On July 16, 2001 the Company completed the acquisition of Dana Corporation’s Chelsea Products Division (Chelsea). Chelsea is a supplier of power take-offs and related auxiliary power devices for medium and heavy-duty mobile equipment. On August 31, 2001 the Company acquired the Aeroquip Air Conditioning and Refrigeration (AC&R) business from Eaton Corporation. AC&R produces mechanical controls and fluid systems for the residential and commercial air conditioning and refrigeration markets. On October 19, 2001 the Company acquired the assets of the global fluid management business of Dayco Industrial from MarkIV/BC Partners. The Dayco assets acquired include Imperial-Eastman products and a wide array of hydraulic and industrial hose and connectors. On February 1, 2002 the Company completed its acquisition of ITR SpA, a subsidiary of the SAIAG Group. ITR is a manufacturer of hoses, fittings and rubber compounds for hydraulic, industrial and oil and gas applications. On May 23, 2002 the Company acquired the assets of Camfil Farr’s Engine Air Filter business (Farr). Farr produces air-intake filtration products for heavy-duty off-road equipment, marine applications and power generation. Combined annual sales for these operations, for their most recent fiscal year prior to acquisition, were approximately $608 million. Total purchase price for these businesses was approximately $367 million in cash and $13 million in common stock.

On July 21, 2000 the Company completed the acquisition of Wynn’s International, Inc. (Wynn’s). Wynn’s is a leading manufacturer of precision-engineered sealing media for the automotive, heavy-duty truck and aerospace markets. On September 29, 2000 the Company acquired the pneumatics business of Invensys plc, which specializes in the design and production of equipment and controls for automated processes. On April 30, 2001 the Company acquired the Miller Fluid Power and Wilkerson businesses of CKD-Createc. Miller Fluid Power manufactures both pneumatic and hydraulic cylinders and Wilkerson manufactures a complete line of compressed air treatment and control products. Combined annual sales for these operations, for their most recent fiscal year prior to acquisition, were approximately $713 million. Total purchase price for these businesses was approximately $506 million in cash and assumed debt of $65 million.

13-18

All acquisitions were accounted for by the purchase method, and results of operations for all acquisitions except a portion of Wynn’s, which was initially classified as assets held for sale, are included as of the respective dates of acquisition. The purchase price allocation for acquisitions in 2003, 2002 and 2001 are presented below. Some of the 2003 purchase price allocations are preliminary and may require subsequent adjustment.