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THE TORO COMPANY

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Introduction

Business Strategy

Products by Market

Professional – We design professional turf products and market them worldwide through a network of distributors and dealers as well as directly to governmental customers. Products are sold by distributors and dealers to professional users engaged in maintaining and creating landscapes such as golf courses, sports fields, municipal properties, and residential and commercial landscapes. Professional turf maintenance equipment marketed under the Toro brand name is our oldest product line, which began in 1921 with tractor-towed mowers for golf courses. Today, we have expanded product lines to include products designed for large turf areas such as golf courses, schools, parks, cemeteries, sports fields, industrial sites, apartments, and townhouse complexes.

Landscape Contractor Market. Products for the landscape contractor market include zero-turning radius riding mowers, 21-inch heavy-duty walk behind mowers, mid-size walk behind mowers, and compact utility loaders. These products are sold through distributors and dealers, and are also available through rental centers to individuals and companies who maintain and create residential and commercial landscapes on behalf of property owners. We market products to landscape contractors under the Toro and Exmark brands. In fiscal 2003, we introduced new lines of Toro and Exmark mowers, including the Toro 500 Series zero-turning radius riding mowers and the Exmark Lazer® Z CT series of riding mowers.

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Grounds Maintenance Market. Products for the grounds maintenance market include riding rotary units with cutting decks ranging from 52 inches to 16 feet, aerators, attachments, and debris management products, which include versatile debris vacuums, blowers and sweepers. Other products include multipurpose vehicles, such as the Workman®, which can be used for turf maintenance, towing, and industrial hauling. These products are sold through distributors, who then sell to owners and/or managers of sports fields, municipal and institutional properties, cemeteries, and facilities such as airports and corporate headquarters.

Residential/ Commercial Irrigation Market. Turf irrigation products marketed under the Toro and Irritrol Systems brand names include sprinkler heads, brass and plastic valves, and electric and hydraulic control devices designed to be used in residential and commercial turf irrigation systems. These products are professionally installed in new systems and can also be used to replace or retrofit existing systems. Most of the product line is designed for underground irrigation systems. Electric and hydraulic controllers activate valves and sprinkler heads in a typical irrigation system. In fiscal 2003, we acquired R & D Engineering, a provider of patented wireless rain and freeze switches for the residential/commercial irrigation market.

Golf Course Market. Products for the golf course market include large reel and rotary riding products for fairway, rough and trim cutting; riding and walking mowers for putting greens and specialty areas; turf sprayer equipment, utility vehicles, turf aerators, and bunker maintenance equipment. We also manufacture and market underground irrigation systems including sprinkler heads and controllers that activate electric, battery-operated, or hydraulic valves. Our professional irrigation systems are designed to use computerized management systems and a variety of technologies to help customers manage water use.

Agricultural Irrigation Market. Products for the agricultural irrigation market include irrigation emission devices that regulate the flow of drip irrigation, including Blue Stripe™ polyethylene tubing, Aqua-TraXX irrigation tape, and Drip In® drip line, all used in low water volume agricultural applications. These products are sold through dealers who then sell to growers for use primarily in vegetable fields, fruit and nut orchards, and vineyards.

Residential – We market our residential products to homeowners through a variety of distribution channels, including dealers, hardware retailers, home centers, mass retailers, and over the Internet. These products are sold mainly in North America, Europe, Asia, and Australia, with the exception of snow removal products, which are sold primarily in North America and Europe.

Walk Power Mower Products. We have manufactured walk power mowers for residential use since 1939. We manufacture and market numerous models under our brand names Toro and Lawn-Boy. Models differ as to cutting width, type of starter mechanism, mulching and bagging attachments, cast aluminum or steel decks, controls, and power sources, and are either self-propelled or push mowers. Some Toro brand lawn mowers are backed by our “Guaranteed To Start” program.

Riding Products. We manufacture and market riding products under the Toro brand name. Riding mowers and tractors range from a 12 horsepower lawn tractor model with a 32-inch deck to a 23 horsepower diesel engine garden tractor model with a 60-inch deck. Many models are available with a variety of decks and accessories. Recycler® cutting decks are available on some models. Models can be equipped with manual or hydrostatic transmissions. In recent years, we introduced a new line of riding products, the TimeCutter® zero-turning radius riding mowers. In fiscal 2003, we introduced a smaller, lighter-weight version of the TimeCutter ZX. We also manufacture riding mower products plus attachments for a third party under a private label agreement.

Home Solutions Products. We design and market electrical products under the Toro brand name. These products include electric and cordless flexible line grass and cordless hedge trimmers, electric blowers, and electric blower vacuums. In fiscal 2003, we introduced a new line of both corded and cordless electric trimmers.

Retail Irrigation Products. We design and market retail irrigation products under the Toro and Lawn Genie brand names. In Australia, we also design and market retail irrigation products under the Pope brand name. These products are designed for homeowner installation and include sprinkler heads, plastic valves, and electronic and mechanical timers. We also design and market landscape drip systems primarily for residential landscapes and gardens.

Snow Removal Products. We manufacture and market a range of electric and gas single-stage and gas two-stage snowthrower models under the Toro and Lawn-Boy brand names. Single-stage snowthrowers, developed and first introduced in 1965, are walk behind units with lightweight two-cycle gasoline engines, most of which we manufacture. Most gas single-stage and electric motor snowthrower models include Power Curve® snowthrower technology for general residential use. Two-stage snowthrowers are designed for relatively large areas of deep, heavy snowfalls and use two- and four-cycle engines ranging from seven to 13 horsepower. We also manufacture and market a hybrid model of single- and two-stage snowthrower technology that is self-propelling, providing the operational ease of a single-stage snowthrower with the power of a two-stage unit. In fiscal 2003, we introduced a new line of two-stage snowthrower models featuring the Power Max™ auger system and the Quick Stick™ chute control.

Financial Information About Foreign and Domestic Operations

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Manufacturing and Production

Engineering and Research

Sources and Availability of Raw Materials

Service and Warranty

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Product Liability

Patents

Seasonality

Effects of Weather

Distribution and Marketing

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Customers

Backlog of Orders

Competition

Environmental Matters and Other Governmental Regulation

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Customer Financing

End-User Financing – During fiscal 2002, we entered into an agreement with a third party financing company to provide lease-financing options to domestic golf course and some grounds equipment customers. The agreement is a sales and marketing tool to give end-user buyers of our products alternative financing options when purchasing our products.

Distributor Financing – We enter into long-term loan and equity investment agreements with some distributors. These transactions are used for expansion of the distributors’ businesses, acquisitions, refinancing working capital agreements, or ownership changes.

Employees

Available Information

Forward-Looking Statements

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  We wish to caution readers not to place undue reliance on any forward-looking statement which speaks only as of the date made and to recognize that forward-looking statements are predictions of future results, which may not occur as anticipated. Actual results could differ materially from those anticipated in the forward-looking statements and from historical results, due to the risks and uncertainties described above, as well as others that we may consider immaterial or do not anticipate at this time. The foregoing risks and uncertainties are not exclusive and further information concerning the company and our businesses, including factors that potentially could materially affect our financial results or condition, may emerge from time to time. We assume no obligation to update forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. We advise you, however, to consult any further disclosures we make on related subjects in our quarterly reports on Form 10-Q and current reports on Form 8-K we file with or furnish to the Securities and Exchange Commission.

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We utilize manufacturing, distribution, warehouse, and office facilities, which as of October 31, 2003 totaled approximately 5.3 million square feet of space. We also utilize 20.34 acres of land in California as a testing facility and 16.3 acres of land in Nebraska as a parking and testing facility. Plant utilization varies during the year depending on the production cycle. We consider each of our current facilities in use to be in good operating condition and adequate for its present use. Management believes we have sufficient manufacturing capacity for fiscal 2004. The following schedule outlines our significant facilities by location, ownership, and function as of October 31, 2003:

We are a party to litigation in the ordinary course of business. Litigation occasionally involves claims for punitive as well as compensatory damages arising out of use of our products. We are also subject to administrative proceedings with respect to claims involving the discharge of hazardous substances into the environment. Some of these claims assert damages and liability for remedial investigations and clean up costs. Management believes that amounts that may be awarded or assessed in connection with these matters will not have a material effect on our financial position. Further, we maintain insurance against some product liability losses.

No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2003.

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Toro Common Stock is listed for trading on the New York Stock Exchange and trades under the symbol “TTC”. The high, low, and last sales prices for Toro Common Stock and cash dividends paid for each of the quarterly periods for fiscal 2003 and 2002 were as follows:

Common Stock – 50,000,000 shares authorized, $1.00 par value, 24,388,999 and 24,342,474 shares outstanding as of October 31, 2003 and 2002, respectively.

Preferred Stock – 1,000,000 voting shares authorized and 850,000 non-voting shares authorized, $1.00 par value, no shares outstanding.

  As of January 7, 2004, Toro had approximately 5,167 stockholders of record.

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The Toro Company is in the business of designing, manufacturing, and marketing professional turf maintenance equipment, turf and agricultural irrigation systems, landscaping equipment, and residential yard products worldwide. Our emphasis is to provide well-built, dependable, and innovative products supported by an extensive service network. A significant portion of our revenues is historically attributable to new and enhanced products, and we will aggressively invest in product development and brand building as we begin our new initiative, “6 + 8: Teamwork to the Top”.

Organization of Financial Information

Significant Transactions and Financial Trends

RESULTS OF OPERATIONS

Overview

Net Earnings

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Fiscal 2003 Compared With Fiscal 2002

Gross Profit. Gross profit as a percentage of net sales increased 1.1 percentage points from 34.7 percent in fiscal 2002 to 35.8 percent in fiscal 2003. This increase was mainly the result of: (i) cost reduction efforts that included reducing raw material costs and moving production to facilities with lower operating costs; (ii) lower manufacturing costs from increased plant utilization as a result of reduced excess manufacturing capacity, mainly related to the closure of three facilities and increased demand for our products; (iii) a reduction of the gross profit elimination percentage due to a change in estimate applied to the ending Toro inventory value at our company-owned distributors; and (iv) the lower cost of the U.S. dollar to our foreign customers. Somewhat offsetting those positive factors were: (i) higher inbound freight costs as we moved some of our production to Juarez, Mexico and (ii) an impairment charge for automation equipment that will no longer be used.

Selling, General, and Administrative Expense (SG&A). SG&A expense increased 7.5 percent from last year. SG&A expense as a percentage of net sales increased slightly to 27.0 percent in fiscal 2003 compared to 26.9 percent in fiscal 2002. These increases were primarily due to the following factors: (i) higher administrative expenses, mainly from increased investments in information systems and distributor changes; (ii) increased marketing expense tied to higher sales; (iii) higher incentive compensation costs due to successful achievement of financial performance which incentive compensation is based; and (iv) higher warranty expense due to higher sales volumes and changes in estimates.

Restructuring and Other Expense (Income). Restructuring and other expense for fiscal 2003 was $1.8 million compared to $8.4 million in fiscal 2002. During fiscal 2003, we announced plans to close our two-cycle engine manufacturing facility located in Oxford, Mississippi that resulted in a pre-tax restructuring and other expense charge of $2.3 million. See Item 1, Environmental Matters and Other Governmental Regulation section for additional information. We also recorded a benefit of $0.2 million for the reversal of the remaining accrual for closing a facility in Australia, which was sold during fiscal 2003.

Interest Expense. Interest expense for fiscal 2003 declined 17.5 percent compared to fiscal 2002 due primarily to lower levels of average debt, as we continue to use earnings to pay down debt.

Other Income, Net. Other income, net for fiscal 2003 increased $2.0 million or 32.9 percent compared to fiscal 2002. This increase was due mainly to the following factors: (i) proceeds from a legal settlement and (ii) insurance recoveries. These positive factors were somewhat offset by: (i) higher levels of currency exchange rate losses; (ii) lower levels of finance charge revenue; and (iii) reduced royalty income.

Provision for Income Taxes. The effective tax rate for fiscal 2003 was 32.5 percent compared to 33.0 percent in fiscal 2002, before a one-time federal tax refund of $1.8 million in fiscal 2002. Including the one-time federal tax refund, the effective tax rate was 31.0 percent for fiscal 2002. The decrease was due mainly to additional federal tax credits received in fiscal 2003.

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Fiscal 2002 Compared with Fiscal 2001

Gross Profit. Gross profit as a percentage of net sales was 34.7 percent in fiscal 2002 compared to 34.0 percent in fiscal 2001. This increase was mainly the result of: (i) cost reduction efforts that included moving production to lower cost facilities and (ii) lower material costs resulting from our “5 by Five” program initiatives. Somewhat offsetting those positive factors were: (i) a higher proportion of sales of the new line of Toro walk power mowers; (ii) higher manufacturing costs from lower plant utilization as we curtailed production levels in response to lower professional segment sales and to implement management’s efforts to reduce both customers’ and our inventory levels; (iii) higher floor plan expenses; and (iv) elimination of gross profit previously recorded with respect to sales of Toro products to a distributor that was experiencing financial difficulties and eventually acquired during fiscal 2003.

Selling, General, and Administrative Expense (SG&A). Adjusted to exclude goodwill amortization, SG&A expense increased 5.2 percent from the prior year. Factoring out the acquisition of a distribution company in fiscal 2001 and excluding goodwill amortization for the purpose of comparison, SG&A expense as a percentage of net sales was 26.8 percent in fiscal 2002 and 26.4 percent in fiscal 2001. This increase was due to the following factors: (i) higher bad debt expense; (ii) higher incentive compensation costs; (iii) increased legal and information service spending; and (iv) rising insurance costs.

Restructuring and Other Expense (Income). Restructuring and other expense for fiscal 2002 was $8.4 million, as previously mentioned. During fiscal 2001, we had pre-tax restructuring and other income of $0.7 million. This income was derived from the reversal of the remaining accrual for closing of the Sardis, Mississippi facility, which was sold in fiscal 2001.

Interest Expense. Interest expense for fiscal 2002 declined 10.3 percent compared to fiscal 2001 due primarily to lower levels of short-term debt as a result of using prior years’ earnings to pay down debt, improved asset management during the second half of fiscal 2002, and lower interest rates.

Other Income, Net. Other income, net for fiscal 2002 declined $1.5 million or 19.8 percent compared to fiscal 2001. This decrease was due to the following factors: (i) lower levels of finance charge revenue; (ii) lower currency exchange rate gains; (iii) increased litigation expense; and (iv) lower levels of insurance recoveries. Somewhat offsetting those negative factors were: (i) increased gains on the disposal of property, plant, and equipment, mainly on the sale of one of our owned facilities located in Riverside, California; (ii) lower levels of valuation charges for investments; and (iii) higher royalty income.

Provision for Income Taxes. The effective tax rate for fiscal 2002 was 33.0 percent compared to 37.0 percent in fiscal 2001, before a one-time federal tax refund of $1.8 million in fiscal 2002. Including the one-time federal tax refund, the effective tax rate was 31.0 percent for fiscal 2002. The decrease was due mainly to the adoption of SFAS No. 142 that eliminated goodwill amortization expense as of the beginning of fiscal 2002. Most of the goodwill amortization was not deductible for tax purposes. The tax rate decrease was also due to increased benefits from foreign tax strategies related to our foreign sales corporation. The one-time federal tax refund of $1.8 million related to our foreign sales corporation from prior fiscal years.

Cumulative Effect of Change in Accounting Principle. In connection with the adoption of SFAS No. 142, we performed an evaluation of goodwill as of November 1, 2001. The results of this evaluation indicated that goodwill related to the agricultural irrigation reporting unit was impaired. We therefore recognized a $24.6 million non-cash charge, net of income tax benefit of $0.5 million, as a cumulative effect of change in accounting principle in fiscal 2002.

Business Segments

Professional –

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Operating Earnings. Operating earnings for the professional segment were $146.8 million in fiscal 2003 compared to $111.7 million in fiscal 2002, an increase of 31.4 percent. Expressed as a percentage of net sales, professional segment operating margins increased to 15.8 percent compared to 13.0 percent in fiscal 2002. However, fiscal 2002 operating earnings were reduced by pre-tax restructuring and other expense of $8.4 million. The operating profit improvement was due mainly to higher gross margins as a result of benefits from our “5 by Five” initiatives and slightly lower SG&A expense as a percentage of net sales due to leveraging the fixed SG&A portion over higher sales volumes. In addition, proceeds from a legal settlement contributed to the profit improvement. Somewhat offsetting the increase in operating earnings was an impairment charge for automation equipment discussed previously.

Residential –

Operating Earnings. Operating earnings for the residential segment increased 6.8 percent in fiscal 2003 compared to fiscal 2002. Expressed as a percentage of net sales, residential segment operating margins slightly increased to 11.0 percent compared to 10.9 percent in fiscal 2002. Fiscal 2003 operating earnings were negatively affected by a restructuring and other expense charge of $2.2 million mainly related to the announced closure of our two-cycle engine manufacturing facility. On a positive note, higher gross margins contributed to fiscal 2003 operating earnings.

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Distribution –

Operating (Losses) Earnings. Operating losses for the distribution segment in fiscal 2003 were $0.5 million compared to operating earnings of $2.3 million in fiscal 2002, an unfavorable change of $2.8 million. This unfavorable change in operating earnings was due mainly to the divestiture of a previously owned distributorship.

Other –

Operating loss. Operating loss for the other segment in fiscal 2003 was up 2.2 percent compared to fiscal 2002. This loss increase was due to higher incentive compensation expenses, rising insurance costs, and increased investments in information systems and distributor changes. Somewhat offsetting the operating loss increase were lower interest expense, higher litigation recovery, and a reduction of the gross profit elimination percentage due to a change in estimate applied to the ending Toro inventory value at our company-owned distributors.

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FINANCIAL CONDITION

Working Capital

Long-Term Assets

Capital Structure

Stock Split. On March 20, 2003, our Board of Directors declared a two-for-one split of our common stock, effected in the form of a 100 percent stock dividend issued to stockholders of record as of April 1, 2003 and paid on April 14, 2003. As a result of this action, approximately 12.5 million shares were issued. Par value of the common stock remains at $1.00 per share and accordingly, approximately $12.5 million was transferred from additional paid-in capital to common stock. All references to the number of common shares and per common share amounts have been adjusted to give retroactive effect to the stock split for all periods presented.

Liquidity and Capital Resources

Cash Flow. Our primary source of funds is cash generated from operations. In fiscal 2003, cash provided by operating activities decreased by 19.0 percent from fiscal 2002. This decline was due to higher receivable and inventory levels described previously, somewhat offset by higher cash-related earnings in fiscal 2003 compared to fiscal 2002. In addition, fiscal 2002 cash generated from operations was unusually high as a result of significantly lower levels of receivables and inventories in fiscal 2002 compared to fiscal 2001.

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Credit Lines and Other Capital Resources. The seasonality of production and shipments causes working capital requirements to fluctuate during the year. Our U.S. seasonal working capital requirements are funded with a $175.0 million medium-term committed unsecured bank credit line with various banks, which expires in February 2005. In fiscal 2003, we also entered into a new $75.0 million secured credit line backed by a multi-year credit agreement, which is expected to reduce our interest costs. Interest expense on these credit lines is determined from a LIBOR or commercial paper rate plus a basis point spread defined in the credit agreements. In addition, our non-U.S. operations and a domestic subsidiary also maintain unsecured short-term lines of credit of approximately $10.9 million. These facilities bear interest at various rates depending on the rates in their respective countries of operation. We also have a letter of credit subfacility as part of our credit agreements. As of October 31, 2003, we had $258.8 million of unutilized availability under our credit agreements.

Share Repurchase Plan. Our Board of Directors has authorized us to repurchase up to 2,000,000 shares of Toro common stock, which was doubled from the original 1,000,000 shares authorized for repurchase as a result of the stock split effective April 1, 2003. As of October 31, 2003, 464,947 shares remained authorized for repurchase. This repurchase program provides shares for use in connection with acquisitions and equity compensation plans so that even with the issuance of shares under those plans, the number of outstanding shares remains relatively constant and the impact on net earnings per share of issuing such shares is minimal.

Off-Balance Sheet Arrangements and Contractual Obligations

Wholesale Financing. Toro Credit Company (TCC), a wholly owned financing subsidiary, provides financing for our North American Toro distributors and approximately 200 domestic dealers for select products that we manufacture. Independent North American Toro and Exmark distributors and dealers that do not finance through TCC generally finance their inventories with third party financing companies.

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End-User Financing. During fiscal 2002, we entered into an agreement with a third party financing company to provide lease-financing options to domestic golf course and some grounds equipment customers. The purpose of the agreement is a sales and marketing tool to give end-user buyers of our products alternative financing options when purchasing our products. Under the terms of this agreement, we could be contingently liable for a portion of the credit collection and residual realization risk on the underlying equipment for leasing transactions financed under this program. Our maximum exposure for credit collection and residual value as of October 31, 2003 was $3.4 million. We have established a reserve for our estimated exposure related to this program.

Distributor Financing. We enter into long-term loan and equity investment agreements with some distributors. These transactions are used for expansion of the distributors’ businesses, acquisitions, refinancing working capital agreements, or to facilitate ownership changes. As of October 31, 2003, we have loaned and/or invested $4.4 million in several distribution companies. This amount is included in other current- and long-term assets on the consolidated balance sheet.

Purchase Commitments. We have purchase commitments with some suppliers for materials and supplies as part of the normal course of business. There are a limited number of supply contracts that contain penalty provisions for either early termination or failure to purchase contracted quantities. We do not expect potential payments under these provisions to materially affect our results of operations or financial condition. This conclusion is based upon reasonably likely outcomes assumed by reference to historical experience and current business plans.

Contractual Obligations. The following table summarizes our contractual obligations as of October 31, 2003:

Inflation

Market Risk

Acquisitions and Divestiture

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Critical Accounting Policies and Estimates

Warranty Reserve. Warranty coverage on our products ranges from a period of six months to seven years, and covers parts, labor, and other expenses for non-maintenance repairs, provided operator abuse, improper use or negligence did not necessitate the repair. We accrue at the time of sale by product line a warranty reserve for estimated costs in connection with future warranty claims. We also establish reserves for major rework campaigns. The amount of our warranty reserves is based on the estimated number of products under warranty, historical average costs incurred to service warranty claims, the trend in the historical ratio of claims to sales, the historical length of time between the sale and resulting warranty claim, and other factors. We periodically assess the adequacy of our warranty reserves based on changes in these factors and record any necessary adjustments if actual claim experience indicates that adjustments are necessary. Actual claims could be higher or lower than amounts estimated, as the amount and value of warranty claims are subject to variation, including performance of new products, significant manufacturing or design defects not discovered until after the product is delivered to customers, product failure rates, higher than expected service costs for a repair, and other similar factors. We believe that analysis of historical trends and knowledge of potential manufacturing or design problems provide sufficient information to establish a reasonable estimate for warranty claims at the time of sale. An unexpected increase in warranty claims or in the costs associated with servicing those claims would result in an increase in our warranty accrual and a decrease in our net earnings.

Accounts and Notes Receivable Valuation. We value accounts and notes receivable, net of an allowance for doubtful accounts. Each quarter, we estimate our ability to collect outstanding receivables and establish an allowance for doubtful accounts. In doing so, we evaluate the age of our receivables, past collection history, current financial conditions of key customers, and economic conditions. Based on this evaluation, we establish a reserve for specific accounts and notes receivable that we believe are uncollectible, as well as an estimate of uncollectible receivables not specifically known. Portions of our accounts receivable are protected by a security interest in products held by customers, which minimizes our collection exposure. A deterioration in the financial condition of any key customer or a significant slow down in the economy could have a material negative impact on our ability to collect a portion or all of the accounts and notes receivable. We believe that analysis of historical trends and current knowledge of potential collection problems provides us sufficient information to establish a reasonable estimate for an allowance for doubtful accounts. However, since we cannot predict with certainty future changes in the financial stability of our customers, our actual future losses from uncollectible accounts may differ from our estimates. In the event we determined that a smaller or larger uncollectible accounts reserve was appropriate, we would record a credit or charge to selling, general, and administrative expense in the period in which we made such a determination.

New Accounting Pronouncements to Be Adopted

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We are exposed to market risk stemming from changes in foreign currency exchange rates, interest rates, and commodity prices. Changes in these factors could cause fluctuations in our net earnings and cash flows. In the normal course of business, we actively manage the exposure of foreign currency market risk by entering into various hedging instruments, authorized under company policies that place controls on these activities, with counterparties that are highly rated financial institutions. Our hedging activities involve the use of a variety of derivative financial instruments. We use derivatives only in an attempt to limit underlying exposure from currency fluctuations and to minimize earnings and cash volatility associated with foreign exchange rate changes, and not for trading purposes. Our market risk on interest rates relates primarily to short-term debt and the potential increase in fair value of long-term debt resulting from a potential decrease in interest rates. However, we do not have a cash flow or earnings exposure due to market risks on long-term debt. See further discussions on these market risks below.

Foreign Currency Exchange Rate Risk. We are exposed to foreign currency exchange rate risk arising from transactions in the normal course of business, such as sales and loans to wholly owned subsidiaries as well as sales to third party customers, purchases from suppliers, and bank lines of credit with creditors denominated in foreign currencies. Because our products are manufactured or sourced primarily from the United States, a stronger U.S. dollar generally has a negative impact on results from operations outside the United States while a weaker dollar generally has a positive effect. Our primary exchange rate exposure is with the euro, the Japanese yen, the Australian dollar, the Canadian dollar, the British pound, and the Mexican peso against the U.S. dollar.

Interest Rate Risk. Our interest rate exposure results from short-term rates, primarily LIBOR-based debt from commercial banks. We currently do not use interest rate swaps to mitigate the impact of fluctuations in interest rates. As of October 31, 2003, our financial liabilities with exposure to changes in interest rates consisted mainly of $2.1 million of short-term debt outstanding. Assuming a hypothetical increase of one percent (100 basis points) in short-term interest rates, with all other variables remaining constant including the average balance of short-term debt outstanding during fiscal 2003, interest expense would have increased $0.4 million in fiscal 2003. Included in long-term debt is $178.9 million of fixed-rate debt, which is not subject to variable interest rate fluctuations. As a result, we have no earnings or cash flow exposure due to market risks on our long-term debt obligations. As of October 31, 2003, the estimated fair value of long-term debt with fixed interest rates was $196.7 million compared to its carrying value of $178.9 million. The fair value is estimated by discounting the projected cash flows using the rate at which similar amounts of debt could currently be borrowed.

Commodities. Some raw materials used in our products are exposed to commodity price changes. We manage some of this risk by using a combination of short- and long-term agreements with some vendors. The primary commodity price exposures are with aluminum, steel, and plastic resin.

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The Stockholders and Board of Directors

We have audited the accompanying consolidated balance sheets of The Toro Company and its subsidiaries as of October 31, 2003 and 2002, and the related consolidated statements of earnings, cash flows, and stockholders’ equity for each of the years in the three year period ended October 31, 2003. Our audits also included the financial statement schedule listed in Item 15(a). These consolidated financial statements and schedule are the responsibility of the company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

Minneapolis, Minnesota

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The financial statements should be read in conjunction with the Notes to Consolidated Financial Statements.

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The financial statements should be read in conjunction with the Notes to Consolidated Financial Statements.

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