RPM International (RPM) 10-K 2006 FY Annual report

Exhibit 13.1

management’s discussion and analysis

MANAGEMENT’S DISCUSSIONandANALYSIS
ofRESULTSofOPERATIONSandFINANCIAL CONDITION

SEGMENT INFORMATION

We operate a portfolio of businesses that manufacture and sell a variety of specialty paints, protective coatings and roofing systems, sealants and adhesives. We manage our portfolio by organizing our businesses into two reportable operating segments — industrial and consumer — based on the nature of business activities, products and services, the structure of management and the structure of information as presented to the Board of Directors. Within each segment, individual operating companies or groups of companies generally address common markets, utilize similar technologies, and can share manufacturing or distribution capabilities. We evaluate the profit performance of our segments based on income before income taxes, but also look to earnings before interest and taxes (“EBIT”) as a performance evaluation measure because interest expense is essentially related to corporate acquisitions, as opposed to segment operations.

Industrial segment products are sold throughout North America and account for most of our sales in Europe, South America, Asia, Africa, Australia and the Middle East. The industrial product line is sold primarily to distributors, contractors and to end users, such as industrial manufacturing facilities, educational and governmental institutions, and commercial establishments. Industrial segment products reach their markets through a combination of direct sales, sales representative organizations, distributor sales and sales of licensees and joint ventures.

Consumer segment products are sold throughout North America to mass merchandisers, home centers, hardware stores, paint stores, automotive supply stores and craft shops. Consumer segment products are sold to retailers through a combination of direct sales, sales representative organizations and distributor sales.

In addition to two reportable operating segments, there are certain business activities, referred to as corporate/other, that do not constitute an operating segment, including corporate headquarters and related administrative expenses, results of our captive insurance companies, gains or losses on the sales of certain assets and other expenses not directly associated with either operating segment. Related assets consist primarily of investments, prepaid expenses, deferred pension assets, and headquarters’ property and equipment. These corporate and other assets and expenses reconcile operating segment data to total consolidated net sales, income before income taxes, identifiable assets, capital expenditures, and depreciation and amortization.

The following table reflects the results of our reportable operating segments consistent with our management philosophy, and represents the information we utilize, in conjunction with various strategic, operational and other financial performance criteria, in evaluating the performance of our portfolio of businesses. For further information pertaining to our segments, refer to Note I, “Segment Information,” to our Consolidated Financial Statements.

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management’s discussion and analysis

SEGMENT INFORMATION

(In thousands)

Year Ended May 31	2006			2005			2004
Net Sales
Industrial Segment	$	1,811,590		$	1,441,548		$	1,272,781
Consumer Segment		1,196,748			1,114,187			1,034,772
Consolidated	$	3,008,338		$	2,555,735		$	2,307,553
Income (Loss) Before Income Taxes(a)
Industrial Segment
Income Before Income Taxes(a)	$	201,230		$	168,578		$	140,706
Interest (Expense), Net		(1,711	)		532			192
EBIT(b)	$	202,941		$	168,046		$	140,514
Consumer Segment
Income Before Income Taxes(a)	$	159,147		$	147,601		$	142,852
Interest (Expense), Net		(142	)		415			104
EBIT(b)	$	159,289		$	147,186		$	142,748
Corporate/Other
(Loss) Before Income Taxes(a)	$	(482,852	)(c)	$	(152,451	)(c)	$	(65,942	)
Interest (Expense), Net		(39,490	)		(36,325	)		(29,241	)
EBIT(b)	$	(443,362	)	$	(116,126	)	$	(36,701	)
Consolidated
Income (Loss) Before Income Taxes(a)	$	(122,475	)	$	163,728		$	217,616
Interest (Expense), Net		(41,343	)		(35,378	)		(28,945	)
EBIT(b)	$	(81,132	)	$	199,106		$	246,561

(a)	The presentation includes a reconciliation of Income (Loss) Before Income Taxes, a measure defined by Generally Accepted Accounting Principles (GAAP) in the United States, to EBIT.
(b)	EBIT is defined as earnings (loss) before interest and taxes. We evaluate the profit performance of our segments based on income before income taxes, but also look to EBIT as a performance evaluation measure because interest expense is essentially related to corporate acquisitions, as opposed to segment operations. We believe EBIT is useful to investors for this purpose as well, using EBIT as a metric in their investment decisions. EBIT should not be considered an alternative to, or more meaningful than, operating income as determined in accordance with GAAP, since EBIT omits the impact of interest and taxes in determining operating performance, which represent items necessary to our continued operations, given our level of indebtedness and ongoing tax obligations. Nonetheless, EBIT is a key measure expected by and useful to our fixed income investors, rating agencies and the banking community all of whom believe, and we concur, that this measure is critical to the capital markets’ analysis of our segments’ core operating performance. We also evaluate EBIT because it is clear that movements in EBIT impact our ability to attract financing. Our underwriters and bankers consistently require inclusion of this measure in offering memoranda in conjunction with any debt underwriting or bank financing. EBIT may not be indicative of our historical operating results, nor is it meant to be predictive of potential future results.
(c)	The asbestos charges, totaling $380.0 million in fiscal 2006 and $78.0 million in fiscal 2005, reflected in Corporate/Other, relate to our Bondex International, Inc. subsidiary (See Note H to the Consolidated Financial Statements).

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our Consolidated Financial Statements include the accounts of RPM International Inc. and its majority-owned subsidiaries. Preparation of our financial statements requires the use of estimates and assumptions that affect the reported amounts of our assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We continually evaluate these estimates, including those related to allowances for doubtful accounts; inventories; allowances for recoverable taxes; useful lives of property, plant and equipment; goodwill; environmental and other contingent liabilities; income tax valuation allowances; pension plans; and the fair value of financial instruments. We base our estimates on historical experience and other assumptions, which we believe to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying value of our assets and liabilities. Actual results may differ from these estimates under different assumptions and conditions.

We have identified below the accounting policies that are critical to our financial statements.

Revenue Recognition

Revenues are recognized when realized or realizable, and when earned. In general, this is when title and risk of loss pass to the customer. Further, revenues are generally realizable when we have persuasive evidence of a sales arrangement, the product has been shipped or the services have been provided to the customer, the sales price is fixed or determinable, and collectibility is reasonably assured. We reduce our revenues for estimated customer returns and allowances, certain rebates, sales incentives and promotions in the same period the related sales are recorded.

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In general, we account for long-term construction-type contracts under the percentage-of-completion method, and therefore record contract revenues and related costs as our contracts progress. This method recognizes the economic results of contract performance on a timelier basis than does the completed-contract method; however, application of this method requires reasonably dependable estimates of progress toward completion, as well as other dependable estimates. When reasonably dependable estimates cannot be made, or if other factors make estimates doubtful, the completed-contract method is applied. Under the completed-contract method, billings and costs are accumulated on the balance sheet as the contract progresses, but no revenue is recognized until the contract is complete or substantially complete.

Translation of Foreign Currency Financial Statements and Foreign Currency Transactions

Our reporting currency is the U.S. dollar. However, the functional currency of all of our foreign subsidiaries is their local currency. We translate the amounts included in our consolidated statements of income from our foreign subsidiaries into U.S. dollars at weighted average exchange rates, which we believe are fairly representative of the actual exchange rates on the dates of the transactions. Our foreign subsidiaries’ assets and liabilities are translated into U.S. dollars from local currency at the actual exchange rates as of the end of each reporting date, and we record the resulting foreign exchange translation adjustments in our consolidated balance sheets as a component of accumulated other comprehensive income (loss). Translation adjustments will be included in net earnings in the event of a sale or liquidation of any of our underlying foreign investments, or in the event that we distribute the accumulated earnings of consolidated foreign subsidiaries. If we determined that the functional currency of any of our foreign subsidiaries should be the U.S. dollar, our financial statements would be affected. Should this occur, we would adjust our reporting to appropriately account for such change(s).

As appropriate, we use permanently invested intercompany loans as a source of capital to reduce exposure to foreign currency fluctuations at our foreign subsidiaries. These loans are treated as analogous to equity for accounting purposes. Therefore, foreign exchange gains or losses on these intercompany loans are recorded in accumulated other comprehensive income (loss). If we were to determine that the functional currency of any of our subsidiaries should be the U.S. dollar, we would no longer record foreign exchange gains or losses on such intercompany loans.

Goodwill

We apply the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” which addresses the initial recognition and measurement of goodwill and intangible assets acquired in a business combination. We also apply the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill be tested on an annual basis, or more frequently as impairment indicators arise. We have elected to perform the required impairment tests, which involve the use of estimates related to the fair market values of the business operations with which goodwill is associated, during our fourth fiscal quarter. Calculating the fair market value of the reporting units requires significant estimates and assumptions by management. We estimate the fair value of our reporting units by applying third-party market value indicators to the respective reporting unit’s annual projected earnings before interest, taxes, depreciation and amortization. In applying this methodology, we rely on a number of factors, including future business plans, actual operating results and market data. In the event that our calculations indicate that goodwill is impaired, a fair value estimate of each tangible and intangible asset and liability would be established. This process would require the application of discounted cash flows expected to be generated by each asset in addition to independent asset appraisals, as appropriate. Cash flow estimates are based on our historical experience and our internal business plans, and appropriate discount rates are applied. Losses, if any, resulting from goodwill impairment tests would be reflected in operating income in our income statement.

Other Long-Lived Assets

We assess identifiable non-goodwill intangibles and other long-lived assets for impairment whenever events or changes in facts and circumstances indicate the possibility that the carrying value may not be recoverable. Factors considered important, which might trigger an impairment evaluation, include the following:

• significant under-performance relative to historical or projected future operating results;

• significant changes in the manner of our use of the acquired assets;

• significant changes in the strategy for our overall business; and

• significant negative industry or economic trends.

Additionally, we test all indefinitely-lived intangible assets for impairment annually. Measuring a potential impairment of non-goodwill intangibles and other long-lived assets requires various estimates and assumptions, including determining which cash flows are directly related to the asset being evaluated, the useful life over which those cash flows will occur, their amount and the asset’s residual value, if any. If we determine that the carrying value of these assets may not be recoverable based upon the existence of one or more of the above-described indicators, any impairment would be measured based on projected net cash flows expected from the asset(s), including eventual disposition. The determination of impairment loss would be based on the best information available, including internal discounted cash flows, quoted market prices when available and independent appraisals as appropriate to determine fair value. Cash flow estimates would be based on our historical

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management’s discussion and analysis

experience and our internal business plans, with appropriate discount rates applied. We have not incurred any such impairment loss to date.

Deferred Income Taxes

The provision for income taxes is calculated using the liability method. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and certain changes in valuation allowances. We provide valuation allowances against deferred tax assets if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

In determining the adequacy of the valuation allowance, management considers cumulative and anticipated amounts of domestic and international earnings or losses, anticipated amounts of foreign source income, as well as the anticipated taxable income resulting from the reversal of future taxable temporary differences.

We intend to maintain the recorded valuation allowances until sufficient positive evidence (for example, cumulative positive foreign earnings or additional foreign source income) exists to support a reversal of the tax valuation allowances.

Contingencies

We are party to claims and lawsuits arising in the normal course of business, including the various asbestos-related suits discussed herein and in Note H to the Consolidated Financial Statements. Although we cannot precisely predict the amount of any liability that may ultimately arise with respect to any of these matters, we record provisions when we consider the liability probable and reasonably estimable. The provisions are based on historical experience and legal advice, are reviewed quarterly and are adjusted according to developments. Estimating probable losses requires analysis of multiple forecasted factors that often depend on judgments about potential actions by third parties such as regulators, courts, and state and federal legislatures. Changes in the amount of the provisions affect our consolidated statements of income. Due to the inherent uncertainties in the loss reserve estimation process, we are unable to estimate an additional range of loss in excess of our accruals. We may incur asbestos costs in addition to any amounts reserved, which may have a material adverse effect on our financial condition, results of operations or cash flows.

Our environmental-related accruals are similarly established and/or adjusted as information becomes available upon which costs can be reasonably estimated. Here again, actual costs may vary from these estimates because of the inherent uncertainties involved, including the identification of new sites and the development of new information about contamination. Certain sites are still being investigated and, therefore, we have been unable to fully evaluate the ultimate cost for those sites. As a result, reserves have not been taken for certain of these sites and costs may ultimately exceed existing reserves for other sites. We have received indemnities for potential environmental issues from purchasers of certain of our properties and businesses and from sellers of some of the properties or businesses we have acquired. We have also purchased insurance to cover potential environmental liabilities at certain sites. If the indemnifying or insuring party fails to, or becomes unable to, fulfill its obligations under those agreements or policies, we may incur environmental costs in addition to any amounts reserved, which may have a material adverse effect on our financial condition, results of operations or cash flows.

RESULTS OF OPERATIONS

Fiscal 2006 Compared with Fiscal 2005

Net SalesConsolidated net sales for the year ended May 31, 2006 of $3.008 billion improved 17.7%, or $452.6 million, over last year’s net sales of $2.556 billion. Contributing to this improvement over last year was primarily growth in organic sales of approximately $272.1 million, or 10.7%, including 3.3% pricing, plus nine acquisitions during the past two years, net of one small divestiture, resulting in another 6.9% growth in sales, or $176.9 million. Net favorable foreign exchange rates, relating primarily to the Canadian and Latin American currencies, partly offset by mainly the euro, provided the remaining 0.1%, or $3.6 million, of the growth in sales over last year.

Industrial segment net sales for fiscal 2006 grew 25.7% to $1.812 billion from last year’s $1.442 billion, comprising 60.2% of the current year’s consolidated net sales. This segment’s net sales growth comes primarily from organic sales growth of 13.1%, including 3.2% pricing, plus 12.4% from illbruck (refer to Note A [4]) and six smaller acquisitions, with the remaining 0.1% from net favorable foreign exchange differences. Within the segment, the most notable growth in organic sales occurred among molded composite structures, corrosion control coatings, construction sealants and admixtures, roofing, powder coatings and exterior insulating finishes. Much of this demand improvement relates to increased industrial sector maintenance and improvement activity across North America, but also in Europe, Latin America, Africa and the Middle East, as well as increased commercial and industrial construction. We continue to secure new business and grow market share among our industrial segment operations.

Consumer segment net sales for the year grew 7.4% to $1.197 billion from last year’s $1.114 billion, comprising 39.8% of the current year’s consolidated net sales. Growth in organic sales added 7.5% (3.4% from pricing) to the consumer segment sales total, plus 0.1% from favorable foreign exchange differences, offset by 0.2% from a small

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management’s discussion and analysis

divestiture, net of two small acquisitions. Beginning in February 2005, our retail merchandising services arrangements were changed with certain customers, resulting in a year-over-year reduction in net sales and gross profit, with a related reduction in selling expenses; otherwise, organic sales growth this year would have been 8.4%, or 0.9% stronger. There were notable organic sales increases in this segment among caulks and sealants; primer-sealers; confectionary, sliced fruit and pharmaceutical glazes; and small-project paints and coatings. Retail demand by the consumer remained fairly steady throughout the year, augmented by continuous product development among our businesses.

Gross Profit MarginConsolidated gross profit margin of 41.6% of net sales this year declined from 43.3% a year ago. This margin decline of 1.7%, or 170 basis points (“bps”), results from several factors, including the higher costs of a number of our raw and packaging materials, particularly petrochemical-based, net of higher pricing initiatives (50 bps), coupled with the inherently lower gross margin structures of several of our recent acquisitions, particularly illbruck (60 bps). Numerous price increases have been initiated throughout the operating segments to help compensate or recover these higher material costs, many of which have recently begun to moderate. The additional gross margin decline resulted from a comparatively lower-margin mix of sales, including increased services sales which characteristically carry lower gross margins, plus the change in merchandising services arrangements (20 bps).

Industrial segment gross profit margin for this year declined to 43.0% of net sales from 44.8% last year. This 180 bps margin decline mainly relates to the recent acquisitions, particularly illbruck (110 bps) and a primarily service-driven lower-margin mix of sales. The productivity gains from this segment’s 9.9% organic unit sales growth, combined with pricing initiatives, more than offset raw material cost increases this year.

Consumer segment gross profit margin for this fiscal year declined to 39.5% of net sales from 41.3% last year. The higher raw material costs, net of pricing initiatives, impacted this segment’s margin by approximately 100 bps, while the change in merchandising services arrangements had a negative impact of 50 bps. A partly service-driven lower-margin mix of sales accounted for the difference.

Selling, General and Administrative Expenses
(“SG&A”)Consolidated SG&A expense levels improved by 80 bps, declining to 31.7% of net sales compared with 32.5% a year ago. The 7.4% organic unit sales growth, higher pricing initiatives during the past year (90 bps), the favorable SG&A cost structure of illbruck and other acquisitions (30 bps), and the change in merchandising services arrangements (10 bps) primarily drove this expense-level improvement. This combination of favorable factors more than offset higher employment-related costs, including health care and other benefits, compensation and incentives, as well as higher fuel-related distribution costs; warranty claims; legal, audit and environmental, and other growth-related expenditures and investments, in addition to the $10.2 million of one-time costs incurred during this year’s second quarter, comprised primarily of additional costs associated with the finalization of the Dryvit national residential class action settlement ($5.0 million) and the loss on sale of a small non-core subsidiary ($2.7 million), along with uninsured hurricane-related losses and costs associated with a European pension plan.

Industrial segment SG&A improved by 140 bps to 31.8% of net sales this year from 33.2% a year ago, reflecting principally the leverage benefit from 9.9% organic unit sales growth, higher pricing (80 bps), the favorable SG&A cost structure of illbruck and other acquisitions (50 bps), and cost containment and savings programs collectively more than offsetting higher employment-related costs, fuel-related distribution costs, legal costs, and other growth-related expenditures and investments.

Consumer segment SG&A improved by 190 bps to 26.2% of net sales this year compared with 28.1% a year ago, reflecting principally higher pricing effect (90 bps), the leverage benefit from 5.0% organic unit sales growth, this segment’s change in merchandising servicing arrangements (40 bps), and cost containment and savings programs more than offsetting higher employment-related costs, warranty claims, certain environmental costs and other growth-related expenditures and investments.

Corporate/Other SG&A expenses increased during the year to $63.4 million from $38.1 million during last year, reflecting primarily the $10.2 million of one-time costs incurred during this year’s second quarter, outlined previously, plus $13.5 million toward increased employment-related costs, including $7.9 million in higher health care costs for covered U.S. and Canadian employees and $1.8 million for additional grants made under the October 2004 Omnibus Equity and Incentive Plan (“Omnibus Plan”).

License fee and joint venture income of approximately $2.2 million and $0.6 million for the years ended May 31, 2006 and 2005, respectively, are reflected as reductions of consolidated SG&A expenses.

We recorded total net periodic pension and postretirement benefit cost of $19.7 million and $16.0 million for the years ended May 31, 2006 and 2005, respectively. This combined expense increase of $3.7 million was essentially attributable to increased pension service and interest cost approximating $3.6 million, in combination with additional net actuarial losses incurred of $1.0 million, partly offset by improvement against the expected return on plan assets of $0.9 million. A change of 0.25% in the discount rate or expected rate of return on plan assets assumptions would result in $1.2 million and $0.5 million higher pension expense,

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management’s discussion and analysis

respectively. The assumptions and estimates used to determine the discount rate and expected return on plan assets are more fully described in Note F, “Pension Plans,” and Note G, “Postretirement Health Care Benefits,” to our Consolidated Finanical Statements. We expect that pension expense will continue to fluctuate on a year-to-year basis depending upon the investment performance of plan assets, but such changes are not expected to be material as a percentage of income before income taxes.

Asbestos ChargesAs described in Note H to the Consolidated Financial Statements, we recorded asbestos charges of $380.0 million and $78.0 million during the years ended May 31, 2006 and 2005, respectively. Please refer to our Consolidated Financial Statements for further information.

Net Interest ExpenseNet interest expense was $6.0 million higher this year than a year ago. Interest rates averaged 5.19% during this year, compared with 4.85% a year ago, accounting for nearly $3.1 million in increased interest expense. This average rate increase is largely related to the Federal Reserve Bank rate increases during the past year, which directly affects the interest rates on our variable-rate indebtedness. Additional borrowings associated with recent acquisitions added approximately $6.6 million more interest expense this year, while reductions of outstanding debt during the past year reduced interest cost by approximately $2.2 million and improved investment income performance provided approximately $1.5 million of additional income.

Income (Loss) Before Income Taxes (“IBT”)
Consolidated loss before taxes this year of $122.5 million represents a decline of $286.2 million, or 174.8%, from IBT of $163.7 million last year, with margin comparisons of (4.1)% of net sales versus 6.4% a year ago. Excluding both years’ asbestos charges, consolidated IBT this year would have amounted to $257.5 million, an improvement of $15.8 million, or 6.5%, from adjusted IBT of $241.7 million last year, with margin comparisons of 8.6% of net sales versus 9.5% a year ago. This decline in margin year-over-year reflects primarily the one-time costs incurred during this year’s second quarter, as previously discussed; the negative margin impact from higher material costs this year; and relatively low first-year IBT results, as expected, from the illbruck acquisition.

Industrial segment IBT grew by $32.6 million, or 19.4%, to $201.2 million from last year’s $168.6 million, mainly from the strength of this segment’s organic sales growth. Consumer segment IBT improved by $11.5 million, or 7.8%, to $159.1 million from $147.6 million last year, also reflecting mainly organic sales growth along with cost controls, partly offset by the negative margin impact from higher material costs in this segment. Combined operating IBT improved by $44.2 million, or 14.0%, over last year.

For a reconciliation of IBT to earnings before interest and taxes, see the Segment Information table located on page 15 of this Annual Report.

Income Tax RateThe effective income tax benefit rate was 37.8% for 2006 compared to an effective income tax expense rate of 35.8% for 2005.

In 2006, and to a lesser extent in 2005, the effective tax rate differed from the federal statutory rate principally as a result of an increase in valuation allowances associated with losses incurred by certain of our foreign businesses, valuation allowances related to U.S. federal foreign tax credit carryforwards, and other non-deductible business operating expenses. The increases in the effective tax rate were partially offset by the U.S. federal tax impact of foreign operations and reductions in state and local taxes, including an income tax benefit relating to changes in state tax laws and the effects of lower tax rates enacted during fiscal 2006.

As of May 31, 2006, we have determined, based on the available evidence, that it is uncertain whether we will be able to recognize certain deferred tax assets. Therefore, in accordance with the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” we intend to maintain the tax valuation allowances recorded at May 31, 2006 for certain deferred tax assets until sufficient positive evidence (for example, cumulative positive foreign earnings or additional foreign source income) exists to support the reversal of the tax valuation allowances.

The valuation allowances relate to U.S. federal foreign tax credit carryforwards, certain foreign net operating losses and net foreign deferred tax assets. The most significant portion of the valuation allowance is associated with deferred tax assets recorded in purchase accounting. Any reversal of the valuation allowance that was recorded in purchase accounting would reduce goodwill.

The effective income tax benefit rate for 2006 reflects the impact of the $380.0 million asbestos liability charges. Excluding these asbestos charges, the effective income tax rate for this year would have been adjusted to a pro forma effective income tax expense rate of 34.7%. The effective income tax rate for 2005 reflects the impact of the $78.0 million asbestos liability charges that year. Excluding those asbestos charges, the effective income tax rate for 2005 would have been adjusted to a pro forma effective income tax rate of 36.1%.

Net Income (Loss)Net loss of $76.2 million for the year ended May 31, 2006 compares to net income of $105.0 million last year. This $181.2 million decline reflects the impact of the $244.3 million after-tax asbestos charges taken this year, versus $49.5 million last year, for a net difference of $194.8 million. Excluding the impact of these asbestos charges, this year’s net income would have been an adjusted $168.1 million, representing an increase of $13.6 million, or 8.8%, from last year’s $154.5 million.

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Margin on sales would have been an adjusted 5.6% this year compared with 6.0% of sales during last year, with this 40 bps margin difference mainly the result of the higher year-over-year material costs and lower first-year earnings results, as expected, from the illbruck acquisition.

Diluted earnings (loss) per common share this year of ($0.65) compare with $0.86 last year. Excluding the asbestos charges, adjusted 2006 diluted earnings per common share would have increased by 8.0%, to $1.35 from an adjusted $1.25 a year ago.

Fiscal 2005 Compared with Fiscal 2004

Net SalesNet sales for the year ended May 31, 2005 of $2.556 billion increased 10.8%, or $248.2 million, over 2004’s net sales of $2.308 billion. Contributing to this improvement was the continued growth in organic sales of $187.6 million, or 8.1% (1.9% pricing), plus eight small acquisitions completed during fiscal 2005 and 2004, net of one small divestiture, resulting in another 1.3% growth in sales, or $28.4 million. Favorable foreign exchange rates, relating primarily to the euro ($16.3 million) and the Canadian dollar ($12.0 million), provided the remaining 1.4%, or $32.2 million, of the growth in sales over 2004.

Industrial segment net sales grew 13.3% to $1.442 billion from fiscal 2004’s $1.273 billion, comprising 56.0% of the 2005 consolidated net sales. This segment’s net sales growth came primarily from organic sales growth of 9.4% (1.3% pricing), another 1.9% from favorable foreign exchange differences, and six small acquisitions, net of the one small divestiture, added the remaining 2.0% of growth to industrial sales. There were notable organic sales improvements among powder coatings; corrosion control coatings; roofing, including services; and in construction sealants, admixtures and exterior insulating finishes, with much of this latter growth related to increased U.S. commercial construction activity. The demand for most of our industrial product lines increased in 2005 as the economy in general, and the industrial sector in particular, improved.

Consumer segment net sales grew 7.7% to $1.114 billion from 2004’s $1.035 billion, comprising 44.0% of consolidated net sales. Organic sales growth added 6.6% (2.6% pricing) to the consumer segment sales total, in addition to 0.8% from favorable foreign exchange differences. Two small bolt-on product line acquisitions provided the remaining 0.3% of sales growth. There were notable organic sales improvements among wood care products, primer-sealers, caulks and sealants, and small-project paints and coatings. This strong organic growth was the result of fairly steady retail demand by the consumer throughout fiscal 2005, coupled with continuous product development among our businesses.

Gross Profit MarginConsolidated gross profit margin of 43.3% of net sales for 2005 declined from 44.7% in 2004. Continued higher costs of raw materials, particularly petroleum-based, impacted this margin by approximately 260 bps, and, combined with a lower-margin mix of sales among product lines and services, more than offset margin benefits generated primarily from the leverage of higher organic sales volume and price increases (170 bps) implemented by our businesses.

Industrial segment gross profit margin declined to 44.8% of net sales from 45.7% in fiscal 2004. The principal factors contributing to the decline in gross margins in this segment were continued higher raw material costs, which impacted margins by approximately 170 bps, partly offset by price increases of approximately 120 bps, and a lower-margin mix of sales.

Consumer segment gross profit margin for 2005 declined to 41.3% of net sales from 43.4% in 2004. There were approximately 370 bps of negative margin impact from higher raw material and packaging costs in this segment, plus certain changes in the mix of sales, which exceeded the 240 bps benefit from price increases implemented during 2005, plus margin leverage from the higher organic sales volume.

Selling, General and Administrative Expenses (“SG&A”)Consolidated SG&A expense levels in 2005 improved 150 bps to 32.5% of net sales compared with 34.0% in 2004. The leverage of organic sales growth over 2004 was the primary contributing factor to the improvement in this category. The higher cost of fuel, which contributed to higher distribution costs (30 bps), the adoption of SFAS No. 123 (refer to Notes A and D), in combination with the expensing of initial grants under the 2004 Omnibus Equity and Incentive Plan (20 bps), increased compensation, and other growth-related investments partially offset these gains.

Industrial segment SG&A improved by 150 bps to 33.2% of net sales in 2005 from 34.7% in 2004. The main contributors to SG&A improvement were the leverage of organic sales growth along with cost containment and other savings programs. These improvements were partially offset by higher distribution costs (30 bps), increased compensation (50 bps) and other growth-related investments.

Consumer segment SG&A improved by 160 bps to 28.1% of net sales in 2005 compared with 29.7% in 2004. This segment’s organic growth in sales also provided leverage benefits along with continued cost containment and other savings programs. Partly offsetting these benefits were increased compensation and other growth-related investments made in this segment, in addition to increased fuel-related distribution costs (30 bps).

Corporate/Other costs increased to $38.1 million in 2005 from $36.7 million in 2004. Generally lower insurance costs (approximately $3.1 million) and certain other expense reductions partly offset higher costs related to the combination of the adoption of SFAS No. 123 and the

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expensing of initial grants under the Omnibus Plan, approximating $3.8 million, as well as higher corporate governance costs, principally start-up costs related to Sarbanes-Oxley Section 404 compliance, approximating $2.0 million.

License fee and joint venture income of $0.6 million for 2005 and $0.7 million for 2004 are reflected as reductions of consolidated SG&A expenses.

We recorded total net periodic pension expense of $14.5 million and $15.9 million for the years ended May 31, 2005 and 2004, respectively. Additionally, we recorded net periodic postretirement expense of $1.5 million and $1.2 million for the years ended May 31, 2005 and 2004, respectively. The decreased pension expense of $1.4 million was largely attributable to a net improvement in the expected return on plan assets, approximating $3.3 million, combined with decreased net actuarial losses recognized, which positively impacted year-over-year expense by approximately $0.9 million. Offsetting those benefits were increased pension service and interest cost totaling approximately $2.8 million. A change of 0.25% in the discount rate or expected return on plan assets assumptions would result in $0.9 million and $0.4 million higher pension expense, respectively. The assumptions and estimates used to determine the discount rate and expected return on plan assets are more fully described in Note F, “Pension Plans,” and Note G, “Postretirement Health Care Benefits,” to our Consolidated Financial Statements. We expect that pension expense will fluctuate on a year-to-year basis depending upon the performance of plan assets, but such changes are not expected to be material as a percent of income before income taxes.

Asbestos ChargesAs described above and in Note H to the Consolidated Financial Statements, certain of our wholly owned subsidiaries, principally Bondex, along with many other U.S. companies, are and have been involved in a large number of asbestos-related suits filed primarily in state courts during the past two decades with a vast majority of current claims pending in five states — Illinois, Ohio, Mississippi, Texas and Florida. During the fiscal year ended May 31, 2003, we recorded an asbestos charge of $140.0 million for measurable and known claims, which included a $51.2 million provision for future claims estimable as of May 31, 2003. We believed that this reserve would be sufficient to cover asbestos-related cash flow requirements over the estimated three-year life of the reserve. The $140.0 million charge also included $15.0 million in total projected defense costs over the estimated three-year life of the reserve.

Additionally, Bondex’s share of costs (net of then-available third-party insurance) for asbestos-related product liability was $6.7 million for the year ended May 31, 2003. In fiscal 2004, Bondex’s asbestos-related cash payments, net of insurance contributions, amounted to $54.0 million and were charged against the balance sheet reserve established in 2003. Based on our review of our asbestos reserve for the second quarter ended November 30, 2004, we concluded that the $56.0 million balance of the $140.0 million reserve would not likely be sufficient to cover our asbestos-related cash flow requirements for the remainder of the full three-year period originally contemplated by the reserve. Accordingly, we concluded that an increase in our existing reserve was appropriate and took an asbestos reserve adjustment of $47.0 million for the quarter ended November 30, 2004, which we believed would be sufficient to cover any incremental cash flow requirements through fiscal 2006 not covered by the $140.0 million reserve, as well as the additional cash flow requirements for the balance of our then-pending known claims and anticipated higher defense costs. Approximately $32.0 million of the $47.0 million reserve adjustment was allocated to anticipated higher future defense costs.

During the third fiscal quarter ended February 28, 2005, based on a review of our then-pending known claims, coupled with a review of our defense costs, we concluded that an increase in our existing reserve was again appropriate. An asbestos reserve adjustment of $15.0 million was taken for the quarter ended February 28, 2005. With cash outlays of $21.9 million in the third quarter, our asbestos reserves aggregated $96.3 million at February 28, 2005, which we believed would be sufficient to cover the cash flow requirements for the balance of our then-pending known claims and defense costs. Our $15.0 million reserve increase assumed that approximately $6.1 million will be allocated to higher future defense costs, which we expected to continue. During the fourth quarter ended May 31, 2005, an additional $16.0 million was added to the asbestos reserve based on management’s quarterly review of pending claims and defense costs. With cash outlays of $11.1 million during the fourth quarter, our asbestos reserves totaled $101.2 million at May 31, 2005, which we believed would be sufficient to cover the cash flow requirements for the balance of our pending known claims, including defense costs. Of the $16.0 million reserve increase, approximately $15.8 million was expected to be allocated to anticipated higher future defense costs, which we expected to continue.

Net Interest ExpenseNet interest expense was $6.4 million higher in 2005 than 2004. Interest rates overall averaged 4.9% during 2005, compared with 4.2% in 2004, accounting for $6.8 million of the interest cost increase. Additional debt outstanding during 2005 cost approximately $1.6 million more as compared to the same cost during 2004. These increases are primarily due to our debt refinancings (refer to “Liquidity and Capital Resources” section), including the $200 million 6.25% Senior Notes issued in December 2003 and the $200 million 4.45% Senior Unsecured Notes issued in September 2004. Higher average net borrowings in 2005 of approximately $24.0 million, associated with recent acquisitions, added $0.8 million of interest cost, while investment income performance improved year-over-year, providing $2.8 million of additional income.

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management’s discussion and analysis

Income Before Income Taxes (“IBT”)Consolidated IBT for 2005 of $163.7 million compared with $217.6 million in 2004, with $78.0 million of this decline resulting from the asbestos charges taken during fiscal 2005. Excluding the charges, IBT in 2005 would have been an adjusted $241.7 million, or ahead by $24.1 million, or 11.1%, from 2004’s $217.6 million, resulting in margins at 9.5% and 9.4% of sales for 2005 and 2004, respectively. This reflects the combined positive impacts from the higher organic sales volume, cost controls, productivity improvements and pricing initiatives, offsetting the approximate 260 bps impact of higher material costs, plus higher fuel-related distribution costs, the continuation of growth-related investments during fiscal 2005 in both operating segments and higher interest expense.

Industrial segment IBT in 2005 grew by $27.9 million, or 19.8%, to $168.6 million, or 11.7% of sales, from 2004’s $140.7 million, or 11.1% of sales, mainly from the higher organic sales volume. Consumer segment IBT in 2005 grew by $4.7 million, or 3.3%, to $147.6 million, or 13.2% of sales, from 2004’s $142.9 million, or 13.8% of sales, with the margin decline mainly from higher material costs more than offsetting pricing increases and organic sales growth leverage in this segment. Combined, operating IBT in 2005 grew to $316.2 million, or 12.4% of sales, ahead $32.6 million, or 11.5%, over 2004’s $283.6 million, or 12.3% of sales.

For a reconciliation of IBT to earnings before interest and taxes, see the Segment Information table located on page 15 of this Annual Report.

Income Tax RateThe effective income tax rate was 35.8% for 2005 compared to an effective income tax rate of 34.8% for 2004. The effective income tax rate for 2005 reflects the impact of the $78.0 million asbestos liability charges taken during the year. Excluding the asbestos charges, the adjusted effective income tax rate for 2005 would have been a pro forma rate of 36.1%. This increase in the adjusted effective income tax rate, excluding the asbestos charges, is principally due to an increase in tax valuation allowances recorded in 2005, the reduction in the extraterritorial income exclusion benefit, changes in the jurisdictional mix of income and the impact of our foreign operations.

As of May 31, 2005, we determined, based on the available evidence, that it was uncertain whether we would be able to recognize certain deferred tax assets. Therefore, in accordance with the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” we intend to maintain tax valuation allowances for certain deferred tax assets until sufficient positive evidence exists to support the reversal of the tax valuation allowances, such as cumulative positive foreign earnings or additional foreign source income.

The valuation allowances relate to U.S. federal foreign tax credit carryforwards, certain foreign net operating losses and net foreign deferred tax assets recorded in purchase accounting. The most significant portion of the valuation allowance is associated with deferred tax assets recorded in purchase accounting. Any reversal of the valuation allowance that was recorded in purchase accounting would reduce goodwill. A reduction of the valuation allowance of $0.5 million was accordingly allocated to goodwill during 2005.

Net IncomeNet income for fiscal 2005 of $105.0 million compared with 2004’s $141.9 million, reflecting the $49.5 million after-tax cost of the asbestos liability charges taken during the fiscal year. Excluding these charges, 2005’s adjusted net income would have been $154.5 million, ahead $12.6 million, or 8.9%, from 2004. The margin on sales would have been an adjusted 6.0% and 6.1% of sales for 2005 and 2004, respectively, despite the net impact from higher material costs. Similarly, 2005 diluted earnings per common share would have increased to an adjusted $1.25, or ahead by 7.8% from an adjusted $1.16 in 2004. As a result of our adoption of EITF 04-8, as outlined in Notes A and D, diluted earnings per share for the year ended May 31, 2005, 2004 and 2003 have been restated to include the 8,034,355 shares issuable upon conversion of our contingently convertible debt.

LIQUIDITY AND CAPITAL RESOURCES

Operating Activities

Operating activities generated positive cash flow of $185.5 million during fiscal 2006 compared with $157.4 million generated during 2005, a net increase of 17.9% or $28.1 million. Factoring out the after-tax asbestos-related cash payments of $37.7 million and $42.8 million, respectively, operating activities generated positive cash flow of $223.1 million in fiscal 2006 compared with $200.2 million during the prior year, up $22.9 million or 11.4%. During fiscal 2006, net income was affected by $380.0 million ($244.3 million after tax) in charges for asbestos-related liabilities, which had no effect on cash flow. Fiscal 2006 adjusted net income of $168.1 million, excluding the asbestos charges, represents a $13.6 million increase over 2005 adjusted net income of $154.5 million. Cash flow from operations during 2006 was positively impacted by additional depreciation and amortization of $8.3 million versus the prior year. Trade accounts receivable provided $3.9 million in cash flow year-over-year, principally associated with improved collections procedures, which resulted in a favorable reduction of 2.0 days sales outstanding (“DSO”) since May 31, 2005. Inventories provided $2.2 million in operating cash year-over-year as a result of improvements in our days outstanding in inventory, which improved by 1.5 days since May 31, 2005. Accounts payable required $26.7 million additional cash year-over-year, mainly as a result of a 9.1 day improvement in accounts payable days outstanding during last fiscal year versus a 1.3 day decline during the current fiscal year.

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management’s discussion and analysis

Prepaid expenses and other current assets provided a year-over-year favorable change of approximately $15.2 million, primarily from an insurance receivable recorded during fiscal 2005, and the timing of payments and receipts. Accrued compensation and benefits provided a change of $31.9 million, a large portion of which resulted from an increase in pension obligations associated with adjustments to our actuarial assumptions relating to our Canadian pension plans, along with positive year-over-year changes in bonus and employee benefit-related accruals. Accrued loss reserves resulted in an unfavorable year-over-year change of $7.5 million, primarily as a result of the recording of additional loss reserves related to product liability during 2005 versus 2006. Accrued other liabilities were a use of cash of $4.0 million, mainly as a result of year-over-year net reductions in interest accruals. Other long-term assets had an unfavorable year-over-year change of $13.2 million, mostly as a result of entering into multi-year contractual arrangements during this fiscal year.

Changes in long-term and short-term asbestos-related reserves, net of taxes, of approximately $37.7 million in fiscal 2006 and $42.8 million in fiscal 2005 were a year-over-year improvement in cash flow of $5.1 million. As disclosed in our “Critical Accounting Policies and Estimates” and our discussion on asbestos litigation (also refer to Note H), the significant increase in asbestos claims activity and costs relating to our Bondex subsidiary caused our related third-party insurance to be depleted during the first quarter of fiscal 2004. Accordingly, we are now funding costs previously covered by insurance with cash from operations. We anticipate that cash from operations and other sources will continue to be sufficient to meet all asbestos-related obligations on a short-term and long-term basis.

All other remaining balance sheet changes related to cash flows from operations had a net unfavorable impact of $0.7 million, mostly due to timing or exchange differences.

Cash provided from operations remains our primary source of financing internal growth, with limited use of short-term debt.

Investing Activities

Capital expenditures, other than for ordinary repairs and replacements, are made to accommodate our continued growth through improved production and distribution efficiencies and capacity, and to enhance administration. Capital expenditures during fiscal 2006 of $61.2 million compare with depreciation of $56.5 million. While we are not a capital intensive business and capital expenditures generally do not exceed depreciation in a given year, capital spending is expected to outpace our depreciation level in 2007, and possibly beyond, as additional capacity is brought on-line to support our continued growth. With these additional minor plant expansions, we believe there will be adequate production and distribution capacity to meet our needs at normal growth rates.

During fiscal 2006, we invested a total of $185.4 million for the acquisitions of illbruck (refer to Note A) and five smaller businesses or product lines. In addition, we divested one small business for gross proceeds of $10.6 million.

Our captive insurance companies invest in marketable securities in the ordinary course of conducting their operations, and this activity will continue. Differences in these activities between years are attributable to the timing and performance of their investments.

Financing Activities

On September 30, 2004, we issued and sold $200 million aggregated principal amount of 4.45% Senior Unsecured Notes due 2009 (“4.45% Senior Notes”), which we concurrently swapped back to floating interest debt (refer to interest rate risk below). The 4.45% Senior Notes were offered to qualified institutional buyers under Rule 144A. While the net proceeds were primarily earmarked to pre-fund the retirement of the 7% Senior Notes, which matured June 15, 2005, portions of the net proceeds had been used to retire the $15.0 million 6.12% Senior Notes, which matured November 15, 2004, and to repay our then-outstanding $68.0 million commercial paper. On April 26, 2005, pursuant to a Registration Rights Agreement between the Company and the initial purchasers of the 4.45% Notes, we completed an exchange offer to allow holders to exchange the 4.45% Senior Notes for the same principal amount of the Notes registered under the Securities Act of 1933.

During November 2004, we entered into a $330 million five-year revolving credit facility (“Credit Agreement”), due November 19, 2009. This facility will be used for general corporate purposes, including acquisitions and to provide back-up liquidity for the issuance of commercial paper. The facility provides for borrowings in U.S. dollars and several foreign currencies in an aggregate amount of up to $25.0 million and a swing-line up to $20.0 million for short-term borrowings of less than 15 days. In addition, the size of the facility may be expanded upon our request by up to an additional $100.0 million, thus potentially expanding the facility to $430.0 million, subject to lender approval. As of May 31, 2006, we had $10.0 million outstanding under this facility.

On October 19, 2005, we issued and sold $150 million aggregated principal amount of 6.7% Senior Unsecured Notes due 2015 (“6.7% Senior Unsecured Notes”) of our indirect wholly owned subsidiary, RPM United Kingdom G.P. RPM International Inc. will fully and unconditionally guarantee the payment obligations under the Senior Unsecured Notes. The net proceeds of the offering of the Senior Unsecured Notes were used by RPM United Kingdom G.P. for refinancing $138 million of revolving credit facility borrowings associated with the August 31, 2005 acquisition of illbruck and for other general corporate purposes. Concurrent with the issuance of the 6.7% Senior Unsecured Notes, RPM United Kingdom G.P. entered into a cross

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management’s discussion and analysis

currency swap, which fixed the interest and principal payments in euros for the life of Senior Unsecured Notes and results in an effective euro fixed-rate borrowing of 5.31%. The Senior Unsecured Notes were offered to qualified institutional buyers under Rule 144A of the Securities Act of 1933. The Notes have not been and will not be registered under the Securities Act of 1933 or any state securities laws.

On July 18, 2006, we prepaid our 6.61% Senior Notes, Series B, due November 15, 2006, and our 7.30% Senior Notes, Series C, due November 15, 2008 (collectively, the “Notes”). We paid all amounts due pursuant to the terms of the Purchase Agreement and did not incur any material early termination penalties in connection with our termination of the Notes.

We are exposed to market risk associated with interest rates. We do not use financial derivative instruments for trading purposes, nor do we engage in foreign currency, commodity or interest rate speculation. In addition to the hedge risk associated with our 6.7% Senior Unsecured Notes discussed above, our only other hedged risks are associated with certain fixed debt whereby we have a $200 million notional amount interest rate swap contract designated as a fair value hedge to pay floating rates of interest based on six-month LIBOR that matures in fiscal 2010. As of May 31, 2006 and 2005, the fair value of our hedges totaled $23.9 million and $2.4 million, respectively. Because critical terms of the debt and interest rate swap match, the hedge is considered perfectly effective against changes in fair value of debt, and therefore, there is no need to periodically reassess the effectiveness during the term of the hedge.

Our available committed liquidity beyond our cash balance at May 31, 2006 stood at $405.7 million (refer to Note B). Our debt-to-capital ratio was 48.6% at May 31, 2006 compared with 44.7% at May 31, 2005. Had we been able to reduce our total outstanding debt by all of our cash and short-term investments available as of May 31, 2006 and May 31, 2005, our adjusted net (of cash) debt-to-capital would have been 45.3% and 38.7%, respectively. This difference primarily reflects the additional indebtedness related to the August 31, 2005 illbruck acquisition (refer to Notes A and B).

We maintain excellent relations with our banks and other financial institutions to provide continual access to financing for future growth opportunities.

The following table summarizes our financial obligations and their expected maturities at May 31, 2006 and the effect such obligations are expected to have on our liquidity and cash flow in the periods indicated.

Contractual Obligations

			Payments Due In
	Total Contractual
(In thousands)	Payment Stream		2007		2008-09		2010-11		After 2011
Long-term debt obligations	$	876,556	$	6,141	$	277,096	$	240,771	$	352,548
Operating lease obligations		89,212		27,524		34,352		13,926		13,410
Other long-term liabilities1		386,380		58,821		84,981		81,448		161,130
Total	$	1,352,148	$	92,486	$	396,429	$	336,145	$	527,088

¹ These amounts represent our estimated cash contributions to be made in the periods indicated for our pension and postretirement plans, assuming no actuarial gains or losses, assumption changes or plan changes occur in any period. The projection results assume $11.9 million will be contributed to the U.S. plan in fiscal 2007; all other plans and years assume the required minimum contribution will be contributed. Also included are expected interest payments on long-term debt.

The condition of the U.S. dollar fluctuated throughout the year, and was moderately weaker against other major currencies where we conduct operations at the fiscal year end over the previous year end, causing a favorable change in the accumulated other comprehensive income (loss) (refer to Note A) component of stockholders’ equity of $28.2 million this year versus $15.0 million last year. This change was in addition to changes of $(9.3) million and $1.0 million related to adjustments required for minimum pension liabilities and unrealized gain (loss) on securities, respectively.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financings, other than the minimum leasing commitments described in Note E. We have no subsidiaries that are not included in our financial statements, nor do we have any interests in or relationships with any special purpose entities that are not reflected in our financial statements.

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management’s discussion and analysis

QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk from changes in interest rates and foreign currency exchange rates because we fund our operations through long- and short-term borrowings and denominate our business transactions in a variety of foreign currencies. We utilize a sensitivity analysis to measure the potential loss in earnings based on a hypothetical 1% increase in interest rates and a 10% change in foreign currency rates. A summary of our primary market risk exposures follows.

Interest Rate Risk

Our primary interest rate risk exposure results from our floating rate debt, including various revolving and other lines of credit (refer to Note B). At May 31, 2006, approximately 37.9% of our debt was subject to floating interest rates. If interest rates were to increase 100 bps from May 31, 2006 and assuming no changes in debt from the May 31, 2006 levels, the additional annual interest expense would amount to approximately $3.3 million on a pre-tax basis. A similar increase in interest rates in fiscal 2005 would have resulted in approximately $3.0 million in additional interest expense.

Our hedged risks are associated with certain fixed-rate debt whereby we have a $200.0 million notional amount interest rate swap contract designated as a fair value hedge to pay floating rates of interest based on six-month LIBOR that matures in fiscal 2010. Because critical terms of the debt and interest rate swap match, the hedge is considered perfectly effective against changes in the fair value of debt, and therefore, there is no need to periodically reassess the effectiveness during the term of the hedge.

All derivative instruments are recognized on the balance sheet and measured at fair value. Changes in the fair values of derivative instruments that do not qualify as hedges and/or any ineffective portion of hedges are recognized as a gain or loss in our consolidated statement of income in the current period. Changes in the fair value of derivative instruments used effectively as fair value hedges are recognized in earnings (losses), along with the change in the value of the hedged item. Such derivative transactions are accounted for under SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted. The Company does not hold or issue derivative instruments for speculative purposes.

Foreign Currency Risk

Our foreign sales and results of operations are subject to the impact of foreign currency fluctuations (refer to Note A). As most of our foreign operations are in countries with fairly stable currencies, such as Belgium, Canada and the United Kingdom, this effect has not generally been material. In addition, foreign debt is denominated in the respective foreign currency, thereby eliminating any related translation impact on earnings.

If the U.S. dollar continues to weaken, our foreign results of operations will be positively impacted, but the effect is not expected to be material. A 10% change in foreign currency exchange rates would not have resulted in a material impact to net income for the years ended May 31, 2006 and 2005. We do not currently hedge against the risk of exchange rate fluctuations.

FORWARD-LOOKING STATEMENTS

The foregoing discussion includes forward-looking statements relating to our business. These forward-looking statements, or other statements made by us, are made based on our expectations and beliefs concerning future events impacting us and are subject to uncertainties and factors (including those specified below) that are difficult to predict and in many instances, are beyond our control. As a result, our actual results could differ materially from those expressed in or implied by any such forward-looking statements. These uncertainties and factors include: (a) general economic conditions; (b) the price and supply of raw materials, particularly petroleum-based, titanium dioxide, certain resins, aerosols and solvents; (c) continued growth in demand for our products; (d) legal, environmental and litigation risks inherent in our construction and chemicals businesses and risks related to the adequacy of our reserves and insurance coverage for such matters; (e) the effect of changes in interest rates; (f) the effect of fluctuations in currency exchange rates upon our foreign operations; (g) the effect of non-currency risks of investing in and conducting operations in foreign countries, including those relating to domestic and international political, social, economic and regulatory factors; (h) risks and uncertainties associated with our ongoing acquisition and divestiture activities; (i) risks inherent in our contingent liability reserves, including for the Company’s existing and future asbestos-related claims; and other risks detailed in our other reports and statements filed with the Securities and Exchange Commission, including the risk factors set forth in our prospectus and prospectus supplement included as part of our Registration Statement on Form S-3 (file No. 333-120536) and in our Annual Report on Form 10-K for the fiscal year ended May 31, 2006, as the same may be amended from time to time.

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consolidatedbalance sheets
(In thousands, except per share amounts)

May 31	2006		2005
Assets
Current Assets
Cash and short-term investments	$	108,616	$	184,140
Trade accounts receivable (less allowances of $20,252 in 2006 and $18,565 in 2005)		650,945		553,084
Inventories		399,014		334,404
Deferred income taxes		48,885		40,876
Prepaid expenses and other current assets		161,758		156,491
Total current assets		1,369,218		1,268,995
Property, Plant and Equipment, at Cost
Land		28,849		24,510
Buildings and leasehold improvements		267,899		236,576
Machinery and equipment		590,528		514,478
		887,276		775,564
Less allowance for depreciation and amortization		442,584		385,586
Property, plant and equipment, net		444,692		389,978
Other Assets
Goodwill		750,635		663,224
Other intangible assets, net of amortization		321,942		275,744
Deferred income taxes, non-current		20,248
Other		73,483		49,534
Total other assets		1,166,308		988,502
Total Assets	$	2,980,218	$	2,647,475
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts payable	$	333,684	$	274,573
Current portion of long-term debt		6,141		97
Accrued compensation and benefits		136,384		95,667
Accrued loss reserves		66,678		65,452
Asbestos-related liabilities		58,925		55,000
Other accrued liabilities		111,688		84,550
Total current liabilities		713,500		575,339
Long-Term Liabilities
Long-term debt, less current maturities		870,415		837,948
Asbestos-related liabilities		362,360		46,172
Other long-term liabilities		108,002		71,363
Deferred income taxes				78,914
Total long-term liabilities		1,340,777		1,034,397
Total liabilities		2,054,277		1,609,736
Stockholders’ Equity
Preferred stock, par value $0.01; authorized 50,000 shares; none issued
Common stock, par value $0.01; authorized 300,000 shares; issued and outstanding 118,743 as of May 2006; issued and outstanding 117,554 as of May 2005		1,187		1,176
Paid-in capital		545,422		526,434
Treasury stock, at cost
Accumulated other comprehensive income		29,839		10,004
Retained earnings		349,493		500,125
Total stockholders’ equity		925,941		1,037,739
Total Liabilities and Stockholders’ Equity	$	2,980,218	$	2,647,475

The accompanying notes to consolidated financial statements are an integral part of these statements.

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consolidatedstatementsofincome
(In thousands, except per share amounts)

Year Ended May 31	2006			2005		2004
Net Sales	$	3,008,338		$	2,555,735	$	2,307,553
Cost of Sales		1,756,770			1,449,184		1,276,372
Gross Profit		1,251,568			1,106,551		1,031,181
Selling, General and Administrative Expenses		952,700			829,445		784,620
Asbestos Charges		380,000			78,000
Interest Expense, Net		41,343			35,378		28,945
Income (Loss) Before Income Taxes		(122,475	)		163,728		217,616
Provision (Benefit) for Income Taxes		(46,270	)		58,696		75,730
Net Income (Loss)	$	(76,205	)	$	105,032	$	141,886
Average Number of Shares of Common Stock Outstanding
Basic		116,837			116,899		115,777
Diluted		116,837			126,364		124,744
Earnings (Loss) per Common Share
Basic	$	(0.65	)	$	0.90	$	1.23
Diluted	$	(0.65	)	$	0.86	$	1.16
Cash Dividends per Share of Common Stock	$	0.63		$	0.59	$	0.55

The accompanying notes to consolidated financial statements are an integral part of these statements.

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consolidatedstatementsofcash flows
(In thousands)

Year Ended May 31	2006			2005			2004
Cash Flows From Operating Activities:
Net income (loss)	$	(76,205	)	$	105,032		$	141,886
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		56,463			49,841			47,840
Amortization		17,836			16,151			15,437
Increase (decrease) in asbestos-related liabilities		380,000			78,000
Increase (decrease) in deferred income taxes		(116,616	)		305			31,815
(Earnings) of unconsolidated affiliates		(890	)		(354	)		(314	)
Changes in assets and liabilities, net of effect from purchases and sales of businesses:
(Increase) decrease in receivables		(59,734	)		(63,611	)		(41,516	)
(Increase) decrease in inventory		(42,255	)		(44,429	)		(31,949	)
(Increase) decrease in prepaid expenses and other current and long-term assets		(18,227	)		(20,220	)		(109	)
Increase (decrease) in accounts payable		42,315			69,037			30,607
Increase (decrease) in accrued compensation and benefits		38,513			6,621			9,124
Increase (decrease) in accrued loss reserves		1,226			8,753			(7,531	)
Increase (decrease) in other accrued liabilities		25,700			16,822			7,908
Payments made for asbestos-related claims		(59,887	)		(67,435	)		(53,976	)
Other, including exchange rate changes		(2,750	)		2,839			4,813
Cash From Operating Activities		185,489			157,352			154,035
Cash Flows From Investing Activities:
Capital expenditures		(61,155	)		(55,609	)		(51,253	)
Acquisition of businesses, net of cash acquired		(174,625	)		(20,100	)		(37,703	)
Purchase of marketable securities		(59,416	)		(44,309	)		(36,955	)
Proceeds from sales of marketable securities		50,105			39,154			21,410
(Investments in) and distributions from unconsolidated affiliates		(895	)		136			(425	)
Proceeds from sale of assets and businesses		9,282			5,426			3,664
Other		2,323			(666	)		(1,284	)
Cash (Used For) Investing Activities		(234,381	)		(75,968	)		(102,546	)
Cash Flows From Financing Activities:
Additions to long-term and short-term debt		186,772			200,153			200,345
Reductions of long-term and short-term debt		(152,862	)		(79,665	)		(206,623	)
Cash dividends		(74,427	)		(68,933	)		(63,651	)
Exercise of stock options		10,636			12,543			5,796
Cash From (Used For) Financing Activities		(29,881	)		64,098			(64,133	)
Effect of Exchange Rate Changes on Cash and Short-Term Investments		3,249			4,099			234
Net Change in Cash and Short-Term Investments		(75,524	)		149,581			(12,410	)
Cash and Short-Term Investments at Beginning of Year		184,140			34,559			46,969
Cash and Short-Term Investments at End of Year	$	108,616		$	184,140		$	34,559
Supplemental Disclosures of Cash Flows Information:
Cash paid during the year for:
Interest	$	50,690		$	39,279		$	25,572
Income taxes	$	68,263		$	48,535		$	59,252
Supplemental Schedule of Non-Cash Investing and Financing Activities:
Shares issued for restricted stock plan	$	3,545		$	1,960		$	1,331
Debt from business combinations	$	10,259
Receivables from sale of assets							$	1,233

The accompanying notes to consolidated financial statements are an integral part of these statements.

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consolidatedstatementsofstockholders’ equity
(In thousands)

										Accumulated
	Common Stock									Other
	Number		Par/							Comprehensive
	of		Stated		Paid-in		Treasury			Income			Retained
	Shares		Value		Capital		Stock			(Loss)			Earnings			Total
Balance at May 31, 2003		115,496	$	1,156	$	503,141	$	(1,167	)	$	(17,169	)	$	385,791		$	871,752
Comprehensive income
Net income														141,886			141,886
Translation gain and other											13,288						13,288
Comprehensive income																	155,174
Dividends paid														(63,651	)		(63,651	)
Stock option exercises, net		555		5		5,453		338									5,796
Restricted stock awards, net		71				502		829									1,331
Balance at May 31, 2004		116,122		1,161		509,096		-0-			(3,881	)		464,026			970,402
Comprehensive income Net income														105,032			105,032
Translation gain and other											13,885						13,885
Comprehensive income																	118,917
Dividends paid														(68,933	)		(68,933	)
Stock option exercises, net		1,109		11		12,532											12,543
Stock based compensation expense						2,850											2,850
Restricted stock awards, net		323		4		1,956											1,960
Balance at May 31, 2005		117,554		1,176		526,434		-0-			10,004			500,125			1,037,739
Comprehensive income Net (loss)														(76,205	)		(76,205	)
Translation gain and other											19,835						19,835
Comprehensive (loss)																	(56,370	)
Dividends paid														(74,427	)		(74,427	)
Stock option exercises, net		823		8		10,628											10,636
Stock based compensation expense						4,818											4,818
Restricted stock awards, net		366		3		3,542											3,545
Balance at May 31, 2006		118,743	$	1,187	$	545,422	$	-0-		$	29,839		$	349,493		$	925,941

The accompanying notes to consolidated financial statements are an integral part of these statements.

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notes to consolidated financial statements

NOTEStoCONSOLIDATED FINANCIAL STATEMENTS
May 31, 2006, 2005, 2004

NOTE A — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1. Consolidation and Basis of Presentation

Our financial statements consolidate all of our affiliates — companies that we control and in which we hold a majority voting interest. We account for our investments in less than majority-owned joint ventures under the equity method. Effects of transactions between related companies are eliminated in consolidation.

Our business is dependent on external weather factors. Historically, we have experienced strong sales and net income in our first, second and fourth fiscal quarters comprised of the three-month periods ending August 31, November 30 and May 31, respectively, with weaker performance in our third fiscal quarter (December through February).

Certain reclassifications have been made to prior-year amounts to conform to this year’s presentation.

2. Accounting Change—Intangibles

We have performed our annual impairment testing of goodwill and intangibles not subject to amortization as of August 31 in each year since our adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” During the fourth quarter of fiscal 2006, we changed the timing of our annual impairment testing to March 1. We adopted this change in timing in order to assess the recorded values of goodwill and intangible assets not subject to amortization for potential impairment at a time closer to our fiscal year-end reporting date. We believe this change is preferable in reducing the risk that an undetected impairment indicator would occur in between the timing of our annual test and the preparation of our year-end financial statements. This change had no effect on reported earnings for any period presented.

3. Use of Estimates

The preparation of financial statements in conformity with Generally Accepted Accounting Principles (GAAP) in the United States requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

4. Acquisitions/Divestitures

On August 31, 2005, Tremco, Inc., a wholly-owned subsidiary of RPM, completed its acquisition of privately-owned illbruck Sealant Systems, located in Cologne, Germany, for approximately $136.4 million, plus debt assumption of approximately $10.3 million, subject to certain post-closing adjustments. illbruck, a leading manufacturer of high-performance sealants and installation systems for prefabricated construction elements and for window and door applications, had sales of approximately $190.0 million for its fiscal year ended December 31, 2004. The acquisition extends our product line offerings to include joint sealing tapes, flashing tapes, cartridge sealants and adhesives, strips, foils and accessories marketed under brand names such as illbruck, Festix, Perennator and Coco.

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notes to consolidated financial statements

The purchase price has been allocated to the underlying assets acquired and liabilities assumed based upon their fair values at the date of acquisition. We have determined the preliminary estimated fair values based on independent appraisals, discounted cash flow analyses, quoted market prices and estimates made by management. Goodwill has been recorded to the extent the purchase price exceeded the preliminary fair values of the net identifiable tangible and intangible assets acquired. Prior to the date of acquisition, we began investigating the potential for synergies associated with restructuring the operations at certain locations, including possible involuntary termination or relocation of certain employees, along with possible closure of certain plants. At this time, restructuring plans have not been finalized, pending investigation of the costs and associated benefits of consolidating operations.

The allocation of the illbruck purchase price is preliminary and subject to adjustment following finalization of the purchase price settlement process. The preliminary goodwill figure of $52.3 million will be assigned to the various subsidiaries of the illbruck Sealant Systems group upon finalization of the allocation of purchase price and will not be deductible for tax purposes.

In addition to the illbruck acquisition, during the year ended May 31, 2006, we completed four other smaller acquisitions of product lines. The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition, with illbruck reflected separately due to its more significant purchase price.

	Amortization Life
(In thousands)	(In Years)		illbruck			Other			Total
Current assets			$	61,774		$	22,506		$	84,280
Property, plant and equipment				32,562			6,853			39,415
Goodwill		N/A		52,272			20,214			72,486
Tradenames — unamortized		N/A		27,190						27,190
Tradenames — other		12 - 15		1,639			4,751			6,390
Other intangible assets		4 - 12		21,805			4,275			26,080
Total Assets Acquired				197,242			58,599			255,841
Liabilities assumed				(60,888	)		(9,550	)		(70,438	)
Net Assets Acquired			$	136,354		$	49,049		$	185,403

Our Consolidated Financial Statements reflect the results of operations of these businesses as of their respective dates of acquisition. During the year ended May 31, 2006, we also divested one small product line.

Pro forma results of operations for the years ended May 31, 2006 and May 31, 2005 were not materially different from reported results and, consequently, are not presented.

5. Foreign Currency

The functional currency of our foreign subsidiaries is their local currency. Accordingly, for the periods presented, assets and liabilities have been translated using exchange rates at year end while income and expense for the periods have been translated using a weighted average exchange rate. The resulting translation adjustments have been recorded in accumulated other comprehensive income (loss), a component of stockholders’ equity, and will be included in net earnings only upon the sale or liquidation of the underlying foreign investment, neither of which is contemplated at this time. Transaction gains and losses have been immaterial during the past three fiscal years.

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notes to consolidated financial statements

6. Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss), which is shown net of taxes, consists of the following components:

	Foreign			Minimum			Unrealized
	Currency			Pension			Gain (Loss)
	Translation			Liability			on
(In thousands)	Adjustments			Adjustments			Securities			Total
Balance at May 31, 2003	$	(9,809	)	$	(6,191	)	$	(1,169	)	$	(17,169	)
Reclassification adjustments for losses included in net income								97			97
Other comprehensive income		9,686			1,603			2,645			13,934
Deferred taxes					(467	)		(276	)		(743	)
Balance at May 31, 2004		(123	)		(5,055	)		1,297			(3,881	)
Reclassification adjustments for (gains) included in net income								(73	)		(73	)
Other comprehensive income (loss)		15,008			(2,379	)		1,082			13,711
Deferred taxes					529			(282	)		247
Balance at May 31, 2005		14,885			(6,905	)		2,024			10,004
Reclassification adjustments for (gains) included in net (loss)								(17	)		(17	)
Other comprehensive income (loss)		28,161			(14,700	)		1,443			14,904
Deferred taxes					5,413			(465	)		4,948
Balance at May 31, 2006	$	43,046		$	(16,192	)	$	2,985		$	29,839

7. Cash and Short-Term Investments

For purposes of the statement of cash flows, we consider all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. We do not believe we are exposed to any significant credit risk on cash and short-term investments.

8. Marketable Securities

Marketable securities, included in other current assets, are considered available for sale and are reported at fair value, based on quoted market prices. Changes in unrealized gains and losses, net of applicable taxes, are recorded in accumulated other comprehensive income (loss) within Stockholders’ Equity. If we were to experience other-than-temporary declines in market value from original cost, those amounts would be reflected in operating income in the period in which the loss were to occur. In order to determine whether an other-than-temporary decline in market value has occurred, the duration of the decline in value and our ability to hold the investment to recovery are considered in conjunction with an evaluation of the strength of the underlying collateral and the extent to which the investment’s carrying value exceeds its related market value. Marketable securities, primarily comprised of equity securities, totaled $59.5 million and $49.1 million at May 31, 2006 and 2005, respectively.

9. Financial Instruments

Financial instruments recorded on the balance sheet include cash and short-term investments, accounts receivable, notes and accounts payable, and debt. The carrying amount of cash and short-term investments, accounts receivable and notes and accounts payable approximates fair value because of their short-term maturity.

An allowance for anticipated uncollectible trade receivable amounts is established using a combination of specifically identified accounts to be reserved, and a reserve covering trends in collectibility. These estimates are based on an analysis of trends in collectibility, past experience, and individual account balances identified as doubtful based on specific facts and conditions. Receivable losses are charged against the allowance when management confirms uncollectibility.

All derivative instruments are recognized on the balance sheet and measured at fair value. Changes in the fair values of derivative instruments that do not qualify as hedges and/or any ineffective portion of hedges are recognized as a gain or loss in our consolidated statement of income in the current period. Changes in the fair value of derivative instruments used effectively as fair value hedges are recognized in earnings (losses), along with the change in the value of the hedged item. Such derivative transactions are accounted for under SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted. We do not hold or issue derivative instruments for speculative purposes.

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notes to consolidated financial statements

The carrying amount of our other debt instruments approximates fair value based on quoted market prices, variable interest rates or borrowing rates for similar types of debt arrangements.

10. Inventories

Inventories are stated at the lower of cost or market, cost being determined on a first-in, first-out (FIFO) basis and market being determined on the basis of replacement cost or net realizable value. Inventory costs include raw material, labor and manufacturing overhead. Inventories were composed of the following major classes:

May 31	2006		2005
(In thousands)
Raw materials and supplies	$	124,573	$	105,060
Finished goods		274,441		229,344
Total Inventories	$	399,014	$	334,404

11. Goodwill and Other Intangible Assets

We adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” as of June 1, 2001, at which time we ceased the amortization of goodwill. During fiscal 2006, we elected to change the timing of performing the required annual impairment assessment from the first quarter of our fiscal year to our fourth quarter. If a loss were to result from the performance of the annual test, it would be reflected in operating income. The annual goodwill impairment assessment involves estimating the fair value of each reporting unit and comparing it with its carrying amount. If the carrying amount of the reporting unit exceeds its fair value, additional steps are followed to recognize a potential impairment loss. Calculating the fair value of the reporting units requires significant estimates and assumptions by management. We estimate the fair value of our reporting units by applying third-party market value indicators to each of our reporting unit’s projected earnings before interest, taxes, depreciation and amortization. In applying this methodology, we rely on a number of factors, including future business plans, actual operating results and market data. In the event that our calculations indicate that goodwill is impaired, a fair value estimate of each tangible and intangible asset and liability would be established. This process would require the application of discounted cash flows expected to be generated by each asset in addition to independent asset appraisals, as appropriate. Cash flow estimates are based on our historical experience and our internal business plans, and appropriate discount rates are applied. The results of our annual impairment tests for the fiscal years ended May 31, 2006, 2005 and 2004 did not require any adjustment to the carrying value of goodwill or other indefinite-lived intangible assets.

The changes in the carrying amounts of goodwill, by reporting segment, for the years ended May 31, 2006 and 2005, are as follows:

	Industrial			Consumer
(In thousands)	Segment			Segment		Total
Balance as of May 31, 2004	$	303,743		$	344,500	$	648,243
Acquisitions		8,657			1,729		10,386
Purchase accounting adjustments *		590					590
Divestitures		(2,114	)				(2,114	)
Translation adjustments		5,550			569		6,119
Balance as of May 31, 2005		316,426			346,798		663,224
Acquisitions		69,252			3,234		72,486
Purchase accounting adjustments *					2,204		2,204
Translation adjustments		11,134			1,587		12,721
Balance as of May 31, 2006	$	396,812		$	353,823	$	750,635

*Relates primarily to other accruals.

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notes to consolidated financial statements

Other intangible assets consist of the following major classes:

			Gross				Net Other
	Amortization		Carrying		Accumulated		Intangible
(In thousands)	Period (in Years)		Amount		Amortization		Assets
As of May 31, 2006
Amortized intangible assets
Formulae		10 to 33	$	190,665	$	74,551	$	116,114
Customer-related intangibles		7 to 33		82,739		23,799		58,940
Trademarks/names		5 to 40		18,607		5,593		13,014
Other		3 to 30		26,468		13,626		12,842
Total Amortized Intangibles				318,479		117,569		200,910
Unamortized intangible assets
Trade names				121,032				121,032
Total Other Intangible Assets			$	439,511	$	117,569	$	321,942
As of May 31, 2005
Amortized intangible assets
Formulae		10 to 33	$	176,884	$	65,628	$	111,256
Customer-related intangibles		7 to 33		69,152		19,346		49,806
Trademarks/names		5 to 40		9,812		3,270		6,542
Other		3 to 30		24,335		12,009		12,326
Total Amortized Intangibles				280,183		100,253		179,930
Unamortized intangible assets
Trade names				95,814				95,814
Total Other Intangible Assets			$	375,997	$	100,253	$	275,744

The aggregate other intangible asset amortization expense for the fiscal years ended May 31, 2006, 2005 and 2004, was $15.3 million, $13.0 million and $12.8 million, respectively. For each of the next five fiscal years through May 31, 2011, the estimated annual intangible asset amortization expense will approximate $15.2 million.

12. Depreciation

Depreciation is computed primarily using the straight-line method over the following ranges of useful lives:

Land improvements	5 to 42 years
Buildings and improvements	5 to 50 years
Machinery and equipment	2 to 20 years

Total depreciation expense for each fiscal period includes the charges to income that result from the amortization of assets recorded under capital leases.

13. Revenue Recognition

Revenues are recognized when realized or realizable, and when earned. In general, this is when title and risk of loss passes to the customer. Further, revenues are generally realizable when we have persuasive evidence of a sales arrangement, the product has been shipped or the services have been provided to the customer, the sales price is fixed or determinable, and collectibility is reasonably assured. We reduce our revenues for estimated customer returns and allowances, certain rebates, sales incentives, and promotions in the same period the related sales are recorded.

In general, we account for long-term construction-type contracts under the percentage-of-completion method, and therefore record contract revenues and related costs as our contracts progress. This method recognizes the economic results of contract performance on a timelier basis than does the completed-contract method; however, application of this method requires reasonably dependable estimates of progress toward completion, as well as other dependable estimates. When reasonably dependable estimates cannot be made, or if other factors make estimates doubtful, the completed-contract method is applied. Under the completed-contract method, billings and costs are accumulated on the balance sheet as the contract progresses, but no revenue is recognized until the contract is complete or substantially complete.

14. Shipping Costs

Shipping costs paid to third-party shippers for transporting products to customers are included in selling, general and administrative expenses. For the years ended May 31, 2006, 2005 and 2004, shipping costs were $117.5 million, $100.1 million and $86.0 million, respectively.

15. Advertising Costs

Advertising costs are charged to operations when incurred and are included in selling, general and administrative expenses. For the years ended May 31, 2006, 2005 and 2004, advertising costs were $33.9 million, $33.7 million and $37.1 million, respectively.

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notes to consolidated financial statements

16. Research and Development

Research and development costs are charged to operations when incurred and are included in selling, general and administrative expenses. The amounts charged for the years ended May 31, 2006, 2005 and 2004 were $32.3 million, $28.9 million and $26.2 million, respectively.

17. Stock-Based Compensation

Effective June 1, 2004, we voluntarily adopted the preferable fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” for our stock-based employee compensation plans. As outlined by SFAS No. 148, “Accounting for Stock-Based Compensation —Transition and Disclosure,” we chose to apply the modified prospective method in adopting this accounting change. Under this method, stock-based employee compensation expense recognized in fiscal 2006 and 2005 is the same as that which would have been recognized had the fair value recognition provisions of SFAS No. 123 been applied to account for all employee awards from its original effective date. Results of prior periods have not been restated.

The adoption of SFAS No. 123 impacted net income, basic earnings per share and diluted earnings per share for each of the years ended May 31, 2006 and 2005 by approximately $2.4 million, $0.02 per share and $0.02 per share, respectively. Prior to June 1, 2004 we accounted for stock-based compensation in accordance with APB opinion No. 25, “Accounting for Stock Issued to Employees.” The following table represents the effect on net income and earnings per share for the year ended May 31, 2004, as if compensation cost for stock options granted had been determined in accordance with the fair value method prescribed by SFAS No. 123:

	Year Ended
	May 31, 2004
(In thousands, except per share amounts)	Basic			Diluted
Net income, as reported	$	141,886		$	141,886
Add: Income effect of contingently convertible shares1					3,142
Adjusted net income, as reported		141,886			145,028
Add: Stock-based employee compensation expense from restricted stock plans included in reported net income, net of related tax effects		825			825
Deduct: Total stock-based employee compensation determined under fair value-based method for all awards, net of related tax effects		(3,969	)		(3,969	)
Pro Forma Net Income	$	138,742		$	141,884
Earnings per Share:
As Reported	$	1.23		$	1.16
Pro Forma	$	1.20		$	1.14

¹ Refer to Note D, Common Stock, for additional information regarding the accounting treatment of contingently convertible securities.

We grant stock options and stock appreciation rights (“SARs”) to our employees (refer to Note D, “Common Stock” for further details). The fair value of stock options and SARs granted is estimated as of the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions:

	2006			2005			2004
Risk-free interest rate		4.2	%		3.7	%		3.7	%
Expected life of option	6.0 yrs			6.4 yrs			7.0 yrs
Expected dividend yield		3.6	%		3.4	%		3.5	%
Expected volatility rate		27.7	%		31.0	%		35.9	%

18. Interest Expense, Net

Interest expense is shown net of investment income, which consists of interest, dividends and capital gains (losses). Investment income for the years ended May 31, 2006, 2005 and 2004 was $6.5 million, $5.0 million and $2.3 million, respectively.

19. Income Taxes

The provision for income taxes is calculated using the liability method. Under the liability method, deferred income taxes are recognized for the tax effect of temporary differences between the financial statement carrying amount of assets and liabilities and the amounts used for income tax purposes and for certain changes in valuation allowances. Valuation allowances are recorded to reduce certain deferred tax assets when, in our estimation, it is more likely than not that a tax benefit will not be realized.

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notes to consolidated financial statements

We have not provided for U.S. income and foreign withholding taxes on approximately $551.0 million of foreign subsidiaries’ undistributed earnings as of May 31, 2006, because such earnings have been retained and reinvested by the subsidiaries. Accordingly, no provision has been made for U.S. or foreign withholding taxes, which may become payable if undistributed earnings of foreign subsidiaries were paid to us as dividends. The additional income taxes and applicable withholding taxes that would result had such earnings actually been repatriated are not practically determinable.

20. Earnings (Loss) Per Share of Common Stock

The following table sets forth the computation of basic and diluted earnings (loss) per share of common stock:

Year ended May 31	2006			2005		2004
(In thousands, except per share amounts)
Shares Outstanding
For computation of basic earnings per share of common stock Weighted average shares		116,837			116,899		115,777
Total shares for basic earnings per share		116,837			116,899		115,777
For computation of diluted earnings per share of common stock Net issuable common share equivalents1					1,431		933
Additional shares issuable assuming conversion of convertible securities1					8,034		8,034
Total shares for diluted earnings per share		116,837			126,364		124,744
Net Income
Net income (loss) applicable to shares of common stock for basic earnings per share	$	(76,205	)	$	105,032	$	141,886
Add: Income effect of contingently issuable shares1					3,099		3,142
Net income (loss) applicable to shares of common stock for diluted earnings per share	$	(76,205	)	$	108,131	$	145,028
Basic Earnings (Loss) Per Share	$	(0.65	)	$	0.90	$	1.23
Diluted Earnings (Loss) Per Share	$	(0.65	)	$	0.86	$	1.16

¹ For the year ended May 31, 2006, net issuable common share equivalents totaling 2.8 million shares, and shares relating to our convertible securities and their related income effect, totaling 8.0 million shares and $3.7 million, respectively, were not assumed in our computation of fully diluted earnings per share, since the result would have been anti-dilutive.

21. Other Recent Accounting Pronouncements

On October 22, 2004 the American Jobs Creation Act of 2004 (“the Act”) was signed into law. Included in the Act is a provision allowing, in general, a new special tax deduction of up to 9% (once fully phased-in) of the lesser of 1) “qualified production activities income” as defined in the Act or 2) taxable income for the tax year, after deduction for the utilization of any net operating loss carryforwards.

As a result of the new special tax deduction provision included in the Act, the FASB issued FASB Staff Position No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP 109-1) in December 2004. FSP 109-1 provides that the new special tax deduction created in the Act should be accounted for as a special deduction in accordance with SFAS 109 and not as a tax rate reduction.

The effective date of the new special tax deduction included in the Act is for tax years beginning after December 31, 2004. Accordingly, the new provision is first available to us for our fiscal year ending May 31, 2006. The new special tax deduction associated with qualified production activities income has a slightly favorable effect on our annual effective tax rate for this year.

Also included in the Act is a provision allowing corporate taxpayers to claim a special one-time dividends received deduction of certain foreign earnings that are repatriated to the U.S. The new provision is applicable, given our fiscal year-end, for qualifying repatriations made prior to May 31, 2006.

We have not elected to repatriate funds and apply the onetime dividends received deduction. Accordingly, there is no tax impact of the new special one-time dividends received deduction in our results for this year.

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notes to consolidated financial statements

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“Statement 123(R)”). Statement 123(R) requires that all share-based payments be recognized in the financial statements based on their fair values. The provisions of this statement are effective for reporting periods beginning after June 15, 2005. We expect to adopt Statement 123(R), utilizing the modified-prospective method of accounting, on June 1, 2006. We adopted the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” on June 1, 2004, and began expensing stock-based compensation on that date. As such, our adoption of Statement 123(R) is not expected to have a material impact on the results of our operations or financial position, however, the total expense recorded in future periods will depend on several variables, including the number of share-based awards that vest and the fair values of those vested awards.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment to ARB No. 43, Chapter 4.” SFAS No. 151 requires that certain abnormal expenditures, including abnormal idle capacity expense and freight, be recognized as expenses in the current period, and that the amount of fixed production costs allocated to inventory be based on the normal capacity of the production facilities. The requirements of this statement are effective for fiscal years beginning after June 15, 2005. The adoption of Statement 151 is not expected to have a material impact on the results of our operations or financial position.

In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 will become effective for accounting changes and corrections of errors made in fiscal 2007 and beyond. The impact of this statement on our Consolidated Financial Statements will depend on the nature and significance of future accounting changes which are subject to this statement.

NOTE B — BORROWINGS

A description of long-term debt follows:

May 31	2006		2005
(In thousands)
Unsecured 4.45% senior notes due October 15, 2009.(1)	$	189,993	$	197,637
Unsecured 6.25% senior notes due December 15, 2013.		200,000		200,000
Unsecured $297,000 face value at maturity 2.75% senior convertible notes due May 13, 2033.		150,042		150,042
Unsecured 7.00% senior notes due June 15, 2005.(2)				150,000
Unsecured notes due March 1, 2008. Interest, which is tied to LIBOR, averaged 4.99% at May 31, 2006.		100,000		100,000
Unsecured 6.70% senior notes due November 1, 2015.(3)		150,000
Unsecured senior notes due insurance companies: 6.61% due November 15, 2006(4) in the amount of $10,000 and 7.30% due November 15, 2008 in the amount of $30,000.		40,000		40,000
Revolving credit agreement for $330,000 with a syndicate of banks, through November 19, 2009. Interest, which is tied to LIBOR, averaged 5.91% at May 31, 2006.		10,000
Accounts receivable securitization program for $125,000 with two banks, through May 12, 2009. Interest averaged 5.05%.		25,000
Other obligations, including capital leases, and unsecured notes payable at various rates of interest due in installments through 2011.		11,521		366
		876,556		838,045
Less current portion		6,141		97
Total Long-Term Debt, Less Current Maturities	$	870,415	$	837,948

1	We entered into an interest rate swap which has the effect of converting this fixed rate note to variable rates based on the six-month London Interbank Offered Rate (LIBOR). The weighted average effective rate was 5.83% as of May 31, 2006.
2	These obligations, which were refinanced on a long-term basis in June 2005, have been classified as long-term debt.
3	We entered into a cross-currency swap, which fixed the interest and principal payments in euros, resulting in an effective fixed rate borrowing of 5.31%.
4	These obligations, which were refinanced in July 2006, have been classified as long-term debt.

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37

notes to consolidated financial statements

The aggregate maturities of long-term debt for the five years subsequent to May 31, 2006 are as follows: 2007 — $6.1 million; 2008 — $251.3 million (including $150.0 million of 2.75% Senior Convertible Notes based on the date of the noteholders’ first put option); 2009 — $25.8 million; 2010 — $240.5 million; 2011 — $0.3 million; 2012 and thereafter — $352.6 million. Additionally, at May 31, 2006, we had unused lines of credit totaling $405.7 million.

In June 2002, we established an accounts receivable securitization program with several banks for certain of our subsidiaries, providing for a wholly-owned special purpose entity (“SPE”) to receive investments of up to $125.0 million. The securitized accounts receivable are owned in their entirety by RPM Funding Corporation, a wholly-owned consolidated subsidiary of RPM International Inc., and are not available to satisfy claims of our creditors until the participating banks’ obligations have been paid in full. This securitization is accomplished by having certain subsidiaries sell various of their accounts receivable to the SPE, and by having the SPE then transfer those receivables to a conduit administered by two banks. This transaction does not constitute a form of off-balance sheet financing, and is fully reflected in our financial statements. This transaction increased our liquidity and reduced our financing costs by replacing up to $125.0 million of existing borrowings at lower interest rates. The amounts available under the program are subject to changes in the credit ratings of our customers, customer concentration levels or certain characteristics of the underlying accounts receivable. In May 2006, we extended the program for an additional three years through May 2009. In July 2006, we amended this agreement, effective May 31, 2006, to redefine EBITDA. As of May 31, 2006 we had $25.0 million outstanding balance under this arrangement; there was no outstanding balance at May 31, 2005.

In May 2003, we issued $297.0 million face value at maturity unsecured 2.75% Senior Convertible Notes due May 13, 2033. The 2.75% Notes are convertible into 8,034,355 shares of RPM International Inc. common stock at a price of $18.68 per share, subject to adjustment, during any fiscal quarter for which the closing price of the common stock is greater than $22.41 per share for a defined duration of time. The Notes are also convertible during any period in which the credit rating of the Notes is below a specified level or if specified corporate transactions have occurred. We may redeem for cash all or a portion of the Notes at any time on or after May 31, 2008. The 2.75% Notes are redeemable by the holder for the issuance price plus accrued original issue discount in May 2008, 2013, 2018, 2023, 2028 and 2033. Interest on the 2.75% Notes is payable beginning November 13, 2003 until May 13, 2008. After that date, cash interest will not be paid prior to maturity subject to certain contingencies.

In December 2003, we issued and sold $200.0 million of 6.25% Senior Notes due 2013 as a means of refinancing. The entire net proceeds of $197.0 million from this offering were used to repay in full the $128.0 million of then-outstanding borrowings under our $500.0 million revolving credit facility and $69.0 million of the then-outstanding $72.0 million balance under our asset securitization program.

On September 30, 2004, we issued and sold $200.0 million of 4.45% Senior Unsecured Notes due 2009, which we concurrently swapped back to floating interest rate debt. We used a portion of the net proceeds to pay off our $15.0 million 6.12% Senior Notes due 2004, which matured on November 15, 2004 and also our then-outstanding $68.0 million of commercial paper. As of May 31, 2006 and 2005, the fair value of the interest-rate swap was $10.0 million and $2.4 million, respectively. These amounts are reflected in other long-term liabilities on the Consolidated Balance Sheets.

During November 2004, we entered into a $330.0 million five-year revolving credit facility, due November 19, 2009. This facility is used for general corporate purposes, including acquisitions and to provide back-up liquidity for the issuance of commercial paper. The facility provides for borrowings in U.S. dollars and several foreign currencies and provides sublimits for the issuance of letters of credit in an aggregate amount of up to $25.0 million and a swing-line of up to $20.0 million for short-term borrowings of less than 15 days. In addition, the size of the facility may be expanded upon our request by up to an additional $100.0 million, thus potentially expanding the facility to $430.0 million, subject to lender approval. In July 2006, we amended the credit facility, effective May 31, 2006, to modify the definition of EBITDA. As of May 31, 2006, we had $10.0 million outstanding under the agreement.

On October 19, 2005, RPM United Kingdom G.P., an indirect wholly-owned finance subsidiary of RPM International Inc., issued and sold $150 million of 6.70% Senior Unsecured Notes due 2015, which are fully and unconditionally guaranteed by RPM International Inc. The total net proceeds of the offering of the Senior Unsecured Notes were used to refinance $138 million of revolving credit facility borrowings in conjunction with the August 31, 2005 acquisition of illbruck Sealant Systems, and for other general corporate purposes. Concurrent with the issuance of the 6.70% Senior Unsecured Notes, RPM United Kingdom G.P. entered into a cross-currency swap, which fixed the interest and principal payments in euros for the life of the Senior Unsecured Notes and resulted in an effective euro fixed rate borrowing of 5.31%. As of May 31, 2006, the fair value of the cross-currency swap was $13.9 million, which is reflected in other long-term liabilities on the Consolidated Balance Sheets.

On July 18, 2006, we prepaid our 6.61% Senior Notes, Series B, due November 15, 2006, and our 7.30% Senior Notes, Series C, due November 15, 2008 (collectively, the “Notes”). We paid all amounts due pursuant to the terms of the Purchase Agreement and did not incur any material early termination penalties in connection with our termination of the Notes.

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notes to consolidated financial statements

NOTE C — INCOME TAXES

The provision for income taxes is calculated in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires the recognition of deferred income taxes using the liability method.

Income (loss) before income taxes as shown in the consolidated statements of income consisted of the following:

Year Ended May 31	2006			2005		2004
(In thousands)
United States	$	(181,282	)	$	115,192	$	182,032
Foreign		58,807			48,536		35,584
Income (Loss) Before Income Taxes	$	(122,475	)	$	163,728	$	217,616

Provision (benefit) for income taxes consists of the following:

Year Ended May 31	2006			2005			2004
(In thousands)
Current:
U.S. federal	$	35,035		$	31,313		$	30,579
State and local		7,232			8,098			7,138
Foreign		22,771			19,160			14,260
		65,038			58,571			51,977
Deferred:
U.S. federal		(108,373	)		(2,544	)		21,077
State and local		(3,798	)		(218	)		3,011
Foreign		863			2,887			(335	)
		(111,308	)		125			23,753
Provision (Benefit) for Income Taxes	$	(46,270	)	$	58,696		$	75,730

The significant components of deferred income tax assets and liabilities as of May 31, 2006 and 2005 were as follows:

	2006			2005
(In thousands)
Deferred income tax assets related to:
Inventories	$	4,322		$	2,983
Allowance for losses		5,511			7,077
Accrued compensation and benefits		14,560			7,892
Asbestos-related liabilities		151,478			36,964
Accrued other expenses		7,986			6,768
Other long-term liabilities		28,183			25,780
Net operating loss and credit carryforwards		33,647			33,131
Other		3,284			2,972
Total deferred income tax assets		248,971			123,567
Less: valuation allowance		(18,981	)		(13,946	)
Net deferred income tax assets		229,990			109,621
Deferred income tax (liabilities) related to:
Depreciation		(58,449	)		(52,846	)
Prepaid pension		(10,128	)		(10,188	)
Amortization of intangibles		(92,280	)		(84,625	)
Total deferred income tax (liabilities)		(160,857	)		(147,659	)
Deferred Income Tax Assets (Liabilities), Net	$	69,133		$	(38,038	)

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39

notes to consolidated financial statements

At May 31, 2006, we had U.S. federal foreign tax credit carryforwards of approximately $21.0 million which expire starting in 2010. Additionally, we had foreign net operating loss carryforwards of approximately $39.7 million at May 31, 2006 of which approximately $2.0 million expire at various dates beginning in 2007 and approximately $37.7 million which have an indefinite carryforward period. These net operating loss and foreign tax credit carryforwards may be used to offset a portion of future taxable income and thereby reduce or eliminate our U.S. federal or foreign income taxes otherwise payable.

Management has determined, based on the available evidence, that it is uncertain that future taxable income of certain of our foreign subsidiaries as well as anticipated foreign source income will be significant enough to recognize certain of these deferred tax assets. As a result, a valuation allowance of approximately $19.0 million has been recorded as of May 31, 2006.

The valuation allowance relates to U.S. federal foreign tax credit carryforwards, certain foreign net operating losses and net foreign deferred tax assets recorded in purchase accounting. A portion of the valuation allowance is associated with deferred tax assets recorded in purchase accounting. Any reversal of the valuation allowance that was recorded in purchase accounting would reduce goodwill. In the current year, there was no reversal of valuation allowance allocated to goodwill.

The following table reconciles income tax expense computed by applying the U.S. statutory federal income tax rate against income (loss) before income taxes to the provision (benefit) for income tax expense:

Year Ended May 31	2006			2005			2004
(In thousands)
Income tax expense (benefit) at the U.S. statutory federal income tax rate	$	(42,866	)	$	57,305		$	76,166
Impact of foreign operations		(7,859	)		(7,810	)		(2,930	)
State and local income taxes, net of federal income tax benefit		2,232			5,122			6,597
Tax benefits from the extraterritorial income exclusion		(783	)		(754	)		(2,870	)
Valuation allowance		4,760			4,287			278
Other		(1,754	)		546			(1,511	)
Provision (Benefit) for Income Tax Expense	$	(46,270	)	$	58,696		$	75,730
Effective Income Tax Rate		37.8	%		35.8	%		34.8	%

NOTE D — COMMON STOCK

There were 300,000,000 shares of common stock authorized at May 31, 2006 and 2005 with a par value of $0.01 per share. At May 31, 2006 and 2005, there were 118,743,000 and 117,554,000 shares outstanding, respectively, each of which is entitled to one vote.

Basic earnings per share are computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding during each year. To compute diluted earnings per share, the weighted average number of shares of common stock outstanding during each year was increased by common stock options with exercisable prices lower than the average market prices of common stock during each year and reduced by the number of shares assumed to have been purchased with proceeds from the exercised options. Additionally, shares related to our convertible securities are also included in our computation of fully diluted earnings per share. However, for the year ended May 31, 2006, conversion of the net issuable common share equivalents and the shares related to our convertible securities were not included in our calculation of diluted earnings per share, since the result would have been anti-dilutive.

In October 2004, the Financial Accounting Standards Board ratified the consensus of the Emerging Issues Task Force (the “EITF”) with respect to EITF issue 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share.” The consensus requires us to consider all instruments with contingent conversion features that include a market price trigger in our diluted earnings per share calculations, regardless of whether that market price trigger has been met. Therefore, our calculation of fully diluted earnings per share includes the 8,034,355 contingent shares of our common stock related to our convertible debt, which includes a market price trigger, by applying the “if-converted” method.

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40

notes to consolidated financial statements

Effective October 10, 2003, the RPM International Inc. 2003 Restricted Stock Plan for Directors (the “2003 Plan”) was approved by our stockholders. The plan was established primarily for the purpose of recruiting and retaining directors, and to align the interests of directors with the interests of our stockholders. Only directors who are not employees of RPM International Inc. are eligible to participate. Under the 2003 Plan, up to 500,000 shares of RPM International Inc. may be awarded. For the year ended May 31, 2006, 20,000 shares were granted at a weighted-average price of $17.65, with 438,400 shares available for future grant. Unamortized deferred compensation expense relating to restricted stock grants for directors of $0.4 million at May 31, 2006, is being amortized over a three-year vesting period.

On October 8, 2004, our stockholders approved the RPM International Inc. Omnibus Equity and Incentive Plan (the “Omnibus Plan”). The Omnibus Plan is intended to be the primary stock-based award program for covered employees. A wide variety of stock and stock-based awards, as well as dollar-denominated performance-based awards, may be granted under the Omnibus Plan. A total of 6,000,000 shares of our common stock may be subject to awards under the Omnibus Plan. Of the 6,000,000 shares of common stock issuable under the Omnibus Plan, up to 3,000,000 shares may be subject to “full-value” awards such as restricted stock, restricted stock unit, performance stock and performance stock unit awards. We also granted stock appreciation rights (“SARs”) to employees. The SARs are issued at fair value at the date of grant, have up to ten-year terms and vest over four years. Currently all SARs outstanding are to be settled with stock. For the year ended May 31, 2006, 560,000 shares of SARs were granted under the Omnibus Plan at a weighted-average grant price of $17.65. As of May 31, 2006, there were 555,000 SARs outstanding. In addition, we also granted 328,500 shares of restricted stock under the Omnibus Plan at a weighted-average grant price of $17.65. The restricted stock cliff vests over three years. The unamortized deferred compensation expense for the full-value awards as of May 31, 2006 was $7.8 million. As of May 31, 2006, 4,790,000 shares are available for future grant including 2,350,000 shares available for full-value awards.

In addition to the restricted shares outstanding under the Omnibus Plan, we have restricted shares outstanding under two equity compensation plans for employees — the Performance Accelerated Restricted Stock Plan (the “PARS Plan”) and the 1997 Restricted Stock Plan (“1997 Plan”). Under the terms of PARS Plan, up to 1,000,000 shares may be awarded to certain employees, generally subject to forfeiture until the completion of ten years of service or the attainment of certain performance goals. No shares were issued under the PARS Plan in 2006. Under the 1997 Plan, up to 1,562,500 shares may be awarded to certain employees, generally subject to forfeiture. The shares vest upon the latter of attainment of age 55 and the fifth anniversary of the May 31^stimmediately preceeding the date of the grant. For the year ended May 31, 2006, 37,778 shares were awarded under the 1997 Plan at a weighted average price of $18.79. At May 31, 2006, 68,400 shares were vested in this plan (59,500 at May 31, 2005) subject to certain resale restrictions. Unamortized deferred compensation expense at May 31, 2006 of $3.2 million relating to the PARS Plan is being amortized over a ten-year period, and $0.4 million relating to the 1997 Plan is being amortized over the applicable vesting periods.

Gross compensation expense relating to restricted stock awards for the years ended May 31, 2006, 2005 and 2004 was $3.6 million, $1.9 million and $1.3 million, respectively.

Our Shareholder Rights Plan provides existing stockholders the right to purchase stock of RPM International Inc. at a discount in certain circumstances as defined by the Plan. The rights are not exercisable at May 31, 2006 and expire in May 2009.

We have options outstanding under two stock option plans, the 1989 Stock Option Plan and the 1996 Key Employees Stock Option Plan, the latter of which provides for the granting of options for up to 9,000,000 shares. Stock options are granted to employees and directors at an exercise price equal to the fair market value of RPM International Inc. stock at the date of grant. These options are generally exercisable cumulatively in equal annual installments commencing one year from the grant date, and have expiration dates ranging from October 2006 to October 2014. At May 31, 2006 and 2005, 64,247 shares were available for future grant.

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41

notes to consolidated financial statements

The following table summarizes option activity under the Plans during the last three fiscal years:

	2006					2005					2004
	Weighted		Number			Weighted		Number			Weighted		Number
	Average		of Shares			Average		of Shares			Average		of Shares
	Exercise		Under			Exercise		Under			Exercise		Under
Shares Under Option	Price		Option			Price		Option			Price		Option
(In thousands, except per share amounts)
Outstanding, beginning of year
(Prices ranging from $8.69 to $17.63)	$	13.90		6,764		$	13.23		7,403		$	12.86		6,937
Options granted
(Prices ranging from $15.15 to $17.63)							17.60		584			14.10		1,254
Options canceled/expired
(Prices ranging from $9.26 to $17.63)		14.06		(77	)		13.57		(76	)		12.98		(206	)
Options exercised
(Prices ranging from $8.69 to $17.63)		12.93		(823	)		11.53		(1,147	)		10.73		(582	)
Outstanding, end of year
(Prices ranging from $8.69 to $17.63)	$	14.03		5,864		$	13.90		6,764		$	13.23		7,403
Exercisable, end of year
(Prices ranging from $8.69 to $17.63)	$	13.68		4,585		$	13.41		4,578		$	13.15		4,775

			Options Outstanding				Options Exercisable
			at May 31, 2006				at May 31, 2006
(Shares in thousands)			Wtd. Avg.		Weighted				Weighted
			Remaining		Average				Average
			Contractual		Exercise				Exercise
Exercise Price Range	Shares		Life (Years)		Price		Shares		Price
$8.69 to $9.99		798		4.3	$	9.33		798	$	9.33
$10.00 to $11.99		151		5.3	$	10.26		151	$	10.26
$12.00 to $14.99		2,682		6.1	$	14.03		1,829	$	14.00
$15.00 to $16.99		1,664		1.7	$	15.39		1,661	$	15.39
$17.00 to $17.63		569		8.3	$	17.62		146	$	17.62
		5,864		4.8	$	14.03		4,585	$	13.68

We apply Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” for our stock-based employee compensation plans. As outlined in SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” we chose to apply the modified prospective method in adopting this accounting change. Under this method, stock-based employee compensation expense in fiscal 2006 is the same as that which would have been recognized had the fair value recognition provisions of SFAS No. 123 been applied to account for all employee awards from its original effective date. Results of prior periods have not been restated. See Note A, “Summary of Significant Accounting Policies,” for the pro forma disclosures of net income and earnings per share required under SFAS No. 123 for fiscal year ended May 31, 2004.

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notes to consolidated financial statements

NOTE E — LEASES

We lease certain property, plant and equipment under long-term lease agreements, some of which provide for increased rental payments based upon increases in the cost-of-living index. The following table illustrates our future minimum lease commitments under all non-cancelable lease agreements, for each of the next five years and in the aggregate, as of May 31, 2006:

May 31
(In thousands)
2007	$	27,524
2008		21,276
2009		13,076
2010		8,622
2011		5,304
Thereafter		13,410
Total Minimum Lease Commitments	$	89,212

Total rental expense for all operating leases amounted to $26.8 million in 2006, $29.4 million in 2005, and $27.1 million in 2004.

NOTE F — PENSION PLANS

We sponsor several pension plans for our employees, including our principal plan (the “Retirement Plan”), which is a non-contributory defined benefit pension plan covering substantially all domestic non-union employees. Pension benefits are provided for certain domestic union employees through separate plans. Employees of our foreign subsidiaries receive pension coverage, to the extent deemed appropriate, through plans which are governed by local statutory requirements. The measurement date used to determine pension benefit measurements for both the U.S. and Non-U.S. plans was February 28, 2006.

The Retirement Plan provides benefits that are based upon years of service and average compensation with accrued benefits vesting after five years. Benefits for union employees are generally based upon years of service, or years of service and average compensation. Our funding policy is to contribute an amount on an annual basis that can be deducted for federal income tax purposes, using a different actuarial cost method and different assumptions from those used for financial reporting. For the fiscal year ending May 31, 2007, we expect to contribute approximately $11.9 million to the Retirement Plans in the U.S., in addition to the approximate $4.1 million that we expect to contribute to our foreign plans.

Net periodic pension cost (income) consisted of the following for the three years ended May 31, 2006:

	U.S. Plans									Non-U.S. Plans
(In thousands)	2006			2005			2004			2006			2005			2004
Service cost	$	13,270		$	11,231		$	9,879		$	2,475		$	2,154		$	1,695
Interest cost		8,245			7,481			7,228			4,741			4,359			3,612
Expected return on plan assets		(10,108	)		(9,759	)		(7,385	)		(4,599	)		(4,117	)		(3,188	)
Amortization of:
Prior service cost		194			294			294
Net gain on adoption of SFAS No. 87		(2	)		(3	)		(23	)
Net actuarial losses recognized		2,375			1,500			2,542			1,511			1,394			1,237
Net Pension Cost	$	13,974		$	10,744		$	12,535		$	4,128		$	3,790		$	3,356

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43

notes to consolidated financial statements

The changes in benefit obligations and plan assets, as well as the funded status of our pension plans at May 31, 2006 and 2005, were as follows:

	U.S. Plans							Non-U.S. Plans
(In thousands)	2006				2005			2006			2005
Benefit obligation at beginning of year	$	148,505			$	128,666		$	89,190		$	77,533
Service cost		13,270				11,231			2,475			2,154
Interest cost		8,245				7,481			4,741			4,359
Benefits paid		(9,627	)			(9,730	)		(3,067	)		(2,723	)
Participant contributions									773			681
Acquisitions and new plans									1,230
Plan amendments									258
Actuarial losses		1,276				10,857			9,997			2,487
Currency exchange rate changes									(1,884	)		4,699
Benefit Obligation at End of Year	$	161,669			$	148,505		$	103,713		$	89,190
Fair value of plan assets at beginning of year	$	118,091			$	109,920		$	65,923		$	56,377
Actual return on plan assets		13,591				5,031			8,015			4,316
Employer contributions		8,213				12,870			2,661			3,642
Participant contributions									773			681
Acquisitions and new plans									119
Benefits paid		(9,627	)			(9,730	)		(3,067	)		(2,723	)
Currency exchange rate changes									(1,442	)		3,630
Fair Value of Plan Assets at End of Year	$	130,268			$	118,091		$	72,982		$	65,923
Benefit obligations in excess of plan assets at end of year	$	(31,401	)		$	(30,414	)	$	(30,731	)	$	(23,267	)
Contributions after measurement date		1,941				4			1,268			183
Unrecognized actuarial losses		43,409				47,992			33,147			28,826
Unrecognized prior service cost		2,352				2,546			232
Unrecognized net transitional asset						(2	)
Net Amount Recognized	$	16,301			$	20,126		$	3,916		$	5,742
Amounts recognized in the consolidated balance sheets:
Prepaid benefit cost	$	16,672			$	20,369		$			$	8,676
Accrued benefit liability		(848	)			(755	)		(19,019	)		(11,260	)
Accumulated other comprehensive loss		468				481			22,935			8,326
Intangible asset		9		��		31
Net Amount Recognized	$	16,301			$	20,126		$	3,916		$	5,742
Accumulated Benefit Obligation	$	125,208			$	114,553		$	92,784		$	76,706

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44

notes to consolidated financial statements

The following table summarizes the relationship between our plans’ benefit obligations and assets.

	U.S. Plans
	2006				2005
	Benefit		Plan		Benefit		Plan
(In thousands)	Obligation		Assets		Obligation		Assets
Plans with projected benefit obligation in excess of plan assets	$	161,669	$	130,268	$	145,633	$	114,840
Plans with accumulated benefit obligation in excess of plan assets	$	1,866	$	987	$	1,757	$	998
Plans with assets in excess of projected benefit obligations	$	—	$	—	$	2,872	$	3,251
Plans with assets in excess of accumulated benefit obligations	$	123,342	$	129,281	$	112,796	$	117,093

	Non-U.S. Plans
	2006				2005
	Benefit		Plan		Benefit		Plan
(In thousands)	Obligation		Assets		Obligation		Assets
Plans with projected benefit obligation in excess of plan assets	$	103,713	$	72,982	$	89,190	$	65,923
Plans with accumulated benefit obligation in excess of plan assets	$	92,784	$	72,982	$	48,839	$	37,396
Plans with assets in excess of accumulated benefit obligations	$	—	$	—	$	27,867	$	28,527

To develop the expected long-term rate of return on pension plan assets assumption, we consider the current and expected target asset allocations of the pension portfolio, as well as historical returns and future expectations for returns on various categories of plan assets. The following weighted average assumptions were used to determine our year-end benefit obligations and net periodic pension cost under the plans:

	U.S. Plans									Non-U.S. Plans
Year-End Benefit Obligations	2006			2005			2004			2006			2005			2004
Discount rate		5.75	%		5.75	%		6.00	%		4.89	%		5.40	%		5.65	%
Rate of compensation increase		3.73	%		3.50	%		3.50	%		3.39	%		3.63	%		3.48	%

	U.S. Plans									Non-U.S. Plans
Net Periodic Pension Cost	2006			2005			2004			2006			2005			2004
Discount rate		5.75	%		6.00	%		6.70	%		5.40	%		5.68	%		6.43	%
Expected return on plan assets		8.75	%		8.75	%		8.75	%		6.93	%		7.31	%		7.25	%
Rate of compensation increase		3.50	%		3.50	%		4.00	%		3.63	%		3.66	%		3.95	%

The following tables illustrate the weighted average actual and target allocation of plan assets:

	U.S. Plans										Non-U.S. Plans
	Target			Actual Asset							Target			Actual Asset
	Allocation			Allocation							Allocation			Allocation
	as of February										as of February
	2006			2006			2005				2006			2006			2005
Equity securities		70	%		65	%		70	%	Equity securities		55	%		51	%		58	%
Fixed income securities		25	%		20	%		16	%	Fixed income securities		43	%		47	%		36	%
Cash					10	%		9	%	Cash								2	%
Other		5	%		5	%		5	%	Property and other		2	%		2	%		4	%
Total assets		100	%		100	%		100	%	Total assets		100	%		100	%		100	%

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45

notes to consolidated financial statements

The primary objective for the investments of the Retirement Plan is to provide for long-term growth of capital without undue exposure to risk. This is accomplished by utilizing a strategy of equities, fixed income securities and cash equivalents in a mix that is conducive to participation in a rising market while allowing for adequate protection in a falling market. The Plan Investment Committee oversees the investment allocation process, which includes the selection and evaluation of investment managers, the determination of investment objectives and risk guidelines, and the monitoring of actual investment performance. In order to properly manage investment risk, plan policy prohibits short selling, securities lending, financial futures, options and other specialized investments except for certain alternative investments specifically approved by the Investment Committee. The Investment Committee reviews, on a quarterly basis, reports of actual plan investment performance provided by independent third parties, in addition to their review of the plan investment policy on an annual basis.

The investment objectives are similar with regard to our plans outside the U.S., subject to local regulations. In general, investments are managed by private investment managers, reporting to our Investment Committee on a regular basis.

In addition to the defined benefit pension plans discussed above, we also sponsor employee savings plans under Section 401(k) of the Internal Revenue Code, which cover most employees in the United States. We record expense for defined contribution plans for any employer matching contributions made in conjunction with services rendered by employees. The majority of our plans provide for matching contributions based upon qualified employee contributions. Matching contributions are invested in the same manner that the participants invest their own contributions. Matching contributions charged to income were $8.6 million, $8.2 million and $7.8 million for years ending May 31, 2006, 2005 and 2004, respectively.

We expect to pay the following estimated pension benefit payments in the next five years (in millions): $10.9 in 2007; $12.4 in 2008; $13.8 in 2009; $14.3 in 2010; $15.6 in 2011. In the five years thereafter (2012-2016) we expect to pay $102.5 million.

NOTE G — POSTRETIREMENT HEALTH CARE BENEFITS

We sponsor several unfunded health care benefit plans for certain of our retired employees. Eligibility for these benefits is based upon minimum age and service requirements. The following table illustrates the effect on operations of these plans for the three years ended May 31, 2006:

	U.S. Plans							Non-U.S. Plans
(In thousands)	2006			2005		2004		2006		2005		2004
Service cost — Benefits earned during this period	$	—		$	11	$	11	$	365	$	265	$	205
Interest cost on the accumulated obligation		615			661		634		539		473		396
Amortization of prior service cost		(27	)
Amortization of unrecognized (gains) losses		59			27				47		28
Net Periodic Postretirement Expense	$	647		$	699	$	645	$	951	$	766	$	601

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46

notes to consolidated financial statements

The changes in the benefit obligations of the plans at May 31, 2006 and 2005 were as follows:

	U.S. Plans						Non-U.S. Plans
(In thousands)	2006			2005			2006			2005
Accumulated postretirement benefit obligation at beginning of year	$	11,169		$	11,465		$	8,331		$	6,815
Service cost					11			365			265
Interest cost		615			661			539			473
Benefit payments		(849	)		(1,013	)		(190	)		(122	)
Actuarial (gains) losses		(1,488	)		353			1,068			333
Amendments		(13	)		(308	)
Currency exchange rate changes								711			567
Accumulated postretirement benefit obligation at end of year		9,434			11,169			10,824			8,331
Unrecognized actuarial gains (losses)		(249	)		(1,796	)		(2,695	)		(1,542	)
Unrecognized prior service cost (benefit)		294			308
Accrued Postretirement Health Care Benefits	$	9,479		$	9,681		$	8,129		$	6,789

In determining the postretirement benefit amounts outlined above, measurement dates as of May 31 for each period were applied.

The following weighted average assumptions were used to determine our year-end benefit obligations and net periodic postretirement benefit costs under the plans:

	U.S. Plans									Non-U.S. Plans
Year-End Benefit Obligations	2006			2005			2004			2006			2005			2004
Discount rate		6.00	%		5.75	%		6.00	%		5.50	%		6.00	%		6.25	%
Current healthcare cost trend rate		9.50	%		10.00	%		10.00	%		7.00	%		8.00	%		9.00	%
Ultimate healthcare cost trend rate		5.00	%		5.00	%		5.00	%		5.00	%		5.00	%		5.00	%
Year ultimate healthcare cost trend rate will be realized		2015			2015			2014			2008			2008			2008

	U.S. Plans									Non-U.S. Plans
Net Periodic Postretirement Benefit Cost		2006		2005			2004			2006			2005			2004
Discount rate		5.75	%		6.00	%		6.70	%		6.00	%		6.25	%		7.00	%
Healthcare cost trend rate		10.00	%		10.00	%		9.00	%		8.00	%		9.00	%		9.00	%
Ultimate healthcare cost trend rate		5.00	%		5.00	%		5.00	%		5.00	%		5.00	%		5.00	%
Year ultimate healthcare cost trend rate will be realized		2015			2014			2007			2008			2008			2007

Increasing or decreasing current healthcare cost trend rates by 1% would affect accumulated postretirement benefit obligation and net postretirement expense by the following amounts for the years ended May 31, 2006 and 2005:

	U.S. Plans						Non-U.S. Plans
(In thousands)	2006			2005			2006			2005
1% Increase in trend rate
Accumulated Benefit Obligation	$	808		$	950		$	2,408		$	1,617
Postretirement Cost		55			60			211			163
1% Decrease in trend rate
Accumulated Benefit Obligation	$	(708	)	$	(830	)	$	(1,844	)	$	(1,262	)
Postretirement Cost		(49	)		(50	)		(151	)		(123	)

We expect to pay approximately $1.0 million in estimated postretirement benefits in each of the next five years. In the five years thereafter (2012-2016) we expect to pay $5.9 million.

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47

notes to consolidated financial statements

In connection with the Medicare Prescription Drug Improvement and Modernization Act of 2003, we are expected to receive a federal subsidy amounting to approximately $1.8 million to subsidize the prescription drug coverage provided by the U.S. nonpension postretirement benefit plan over a period of approximately 10 years beginning in 2006. We will utilize the subsidy for the purpose of reducing both employer and participant contributions for prescription drug related coverage. We expect to begin receiving this subsidy in calendar 2006.

In accordance with the provision of FASB Staff Position FSP FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” we have included the impact of our portion of the subsidy in the determination of accumulated postretirement benefit obligation for the U.S. nonpension postretirement benefit plan for the period ended May 31, 2006, the measurement date. The impact of the subsidy resulted in a reduction in the benefit obligation of approximately $2.2 million with a $0.3 million decrease in net periodic cost in fiscal 2006.

We reflected the impact of the Act for the first time in the fiscal year end 2005 accumulated postretirement benefit obligation (“APBO”) and the fiscal year end 2006 net periodic postretirement expense. We reflected the change in the APBO as an actuarial gain in accordance with FASB Staff Position No. FAS 106-2. As of May 31, 2006, we have not received any reimbursements from Medicare. We expect to begin recovering payments on a quarterly basis beginning in late 2006.

NOTE H — CONTINGENCIES AND LOSS RESERVES

Accrued loss reserves and asbestos-related liabilities consist of the following:

May 31	2006		2005
(In thousands)
Accrued product liability reserves	$	53,764	$	57,414
Accrued warranty reserves		7,524		5,822
Accrued environmental reserves		5,390		2,216
Accrued loss reserves — current		66,678		65,452
Asbestos-related liabilities — current		58,925		55,000
Total Reserves — Current	$	125,603	$	120,452
Accrued warranty and product liability reserves — noncurrent	$	14,758	$	8,044
Asbestos-related liabilities — noncurrent		362,360		46,172
Total Reserves — Noncurrent	$	377,118	$	54,216

We provide, through our wholly-owned insurance subsidiaries, certain insurance coverage, primarily product liability, to our other subsidiaries. Excess coverage is provided by third party insurers. Our reserves provide for these potential losses as well as other uninsured claims. Product warranty expense is recorded within selling, general and administrative expense. As of May 31, 2006, the current portion of these reserves amounted to $53.8 million as compared with $57.4 million at May 31, 2005, while the total long-term reserves increased to $13.3 million at May 31, 2006 from $6.8 million at May 31, 2005, primarily as a result of our continuing evaluation of our liability under a class action lawsuit settlement covering our Dryvit residential exterior insulated finish systems product line (“EIFS”). Based upon the final court order approving the national class action settlement and Dryvit’s claims experience to date, Dryvit determined that a $11.9 million increase to its existing reserves was necessary and appropriate to fully cover the anticipated costs of the settlement. It is anticipated that $5.0 million of this reserve increase will be recovered from third-party insurance carriers and accordingly, insurance receivables were increased by that amount. Third-party excess insurers have historically paid varying shares of Dryvit’s defense and settlement costs for individual commercial and residential EIFS lawsuits under various cost-sharing agreements. Dryvit has increasingly assumed a greater share of the costs associated with its EIFS litigation as it seeks funding commitments from our third-party excess insurers and will likely continue to do so pending the outcome of coverage litigation involving these same third-party insurers. One of our excess insurers filed suit seeking a declaration with respect to its rights and obligations for EIFS related claims under its applicable policies. During the third quarter, the court granted Dryvit’s motion to stay the federal filing based on a more complete state court complaint filed against these same insurers and our insurance broker. The coverage case will now proceed in state court.

Certain of our wholly-owned subsidiaries, principally Bondex International, Inc. (collectively referred to as the subsidiaries), are defendants in various asbestos-related bodily injury lawsuits filed in various state courts with the vast majority of current claims pending in five states —Illinois, Ohio, Mississippi, Texas and Florida. These cases generally seek unspecified damages for asbestos-related diseases based on alleged exposures to asbestos-containing products previously manufactured by our subsidiaries.

Our subsidiaries vigorously defend these asbestos-related lawsuits and in many cases, the plaintiffs are unable to demonstrate that any injuries they have incurred, in fact, resulted from exposure to one of our subsidiaries’ products. In such cases, the subsidiaries are generally dismissed

RPM International Inc. and Subsidiaries

48

notes to consolidated financial statements

without payment. With respect to those cases where compensable disease, exposure and causation are established with respect to one of our subsidiaries’ products, the subsidiaries generally settle for amounts that reflect the confirmed disease, the particular jurisdiction, applicable law, the number and solvency of other parties in the case and various other factors which may influence the settlement value each party assigns to a particular case at the time.

As of May 31, 2006, our subsidiaries had a total of 10,580 active asbestos cases compared to a total of 8,646 cases as of May 31, 2005. For the quarter ended May 31, 2006, our subsidiaries secured dismissals and/or settlements of 106 claims and made total payments of $12.9 million, which included defense costs paid during the current quarter of $7.1 million. For the comparable period ended May 31, 2005, dismissals and/or settlements covered 305 claims and total payments were $11.1 million, which included defense costs paid during the quarter of $8.1 million. For the year ended May 31, 2006, our subsidiaries secured dismissals and/or settlements of 945 claims and made total payments of $59.9 million, which included defense costs paid during the current year of $24.0 million. For the comparable period ended May 31, 2005, dismissals and/or settlements covered 982 claims and total payments were $67.4 million, which included defense costs paid during the year of $20.8 million. In some jurisdictions, cases may involve more than one individual claimant. As a result, settlement or dismissal statistics on a per case basis are not necessarily reflective of the payment amounts on a per claimant basis and the amounts and rates can vary widely depending on a variety of factors including the mix of malignancy and non-malignancy claims and the amount of defense costs incurred during the period.

The rate at which plaintiffs filed asbestos-related suits against our subsidiaries, particularly Bondex, increased since the fourth fiscal quarter of 2002, influenced by the bankruptcy filings of numerous other defendants in asbestos-related litigation. Based on the significant increase in asbestos claims activity, which in many cases disproportionately increased Bondex’s exposure in joint and several liability law states, our third-party insurance was depleted within the first fiscal quarter of 2004. Our third-party insurers historically had been responsible, under various cost-sharing arrangements, for the payment of approximately 90% of the indemnity and defense costs associated with our asbestos litigation. Prior to this sudden precipitous increase in loss rates, the combination of book loss reserves and insurance coverage was expected to adequately cover asbestos claims for the foreseeable future. We have reserved our rights with respect to several of our third-party insurers’ claims of exhaustion, and in late calendar 2002 commenced a review of our known insurance policies to determine whether other insurance limits may be available to cover our asbestos liabilities.

As a result of an examination of our subsidiaries’ historical insurance and as previously disclosed, certain of our subsidiaries filed a complaint in July 2003 for declaratory judgment, breach of contract and bad faith against various third-party insurers, challenging their assertion that their policies covering asbestos-related claims have been exhausted. The coverage litigation involves, among other matters, insurance coverage for claims arising out of alleged exposure to asbestos containing products manufactured by the previous owner of Bondex before March 1, 1966. On March 1, 1966, Republic Powdered Metals Inc. (as it was known then), purchased the assets and assumed the liabilities of the previous owner of Bondex, which subsequently dissolved and was never a subsidiary of Republic Powdered Metals, Bondex, RPM, Inc. or the Company. Because of the earlier assumption of liabilities, however, Bondex has historically and must continue to respond to lawsuits alleging exposure to these asbestos containing products. The Company discovered that the defendant insurance companies in the coverage litigation had wrongfully used cases alleging exposure to these pre-1966 products to erode their aggregate limits. This conduct, apparently known by the insurance industry based on discovery conducted to date, was in breach of the insurers’ policy language. While this pending litigation could, in the future, result in third party coverage for a substantial amount of these future asbestos claims, the Company has not considered any such future recovery in determining the scope and amount of its reserve for future unknown asbestos claims. Two of the defendant insurers have filed counterclaims seeking to recoup certain monies should the plaintiffs prevail on their claims. Pursuant to a revised case management order, the parties are to complete fact discovery by August 4, 2006 (fact discovery was substantially completed in accordance with a previous order by July 14, 2006), expert discovery by November 17, 2006, and dispositive motions by no later than December 29, 2006, with replies due no later than March 16, 2007. A trial date was previously set for January 29, 2007. Although the most recent case management order did not change the scheduled trial date, the changes to the discovery and dispositive motion deadlines will necessarily postpone the trial date, likely until the end of the fiscal year. It is possible that this and other dates may be modified as the case progresses.

We are unable at the present time to predict the timing or ultimate outcome of this insurance coverage litigation. Consequently, we are unable to predict whether, or to what extent, any additional insurance may be available to cover a portion of our subsidiaries’ asbestos liabilities. We have not included any potential benefits from this litigation either in our financial statements or in calculating our current asbestos reserve. Our wholly-owned captive insurance companies have not provided any insurance or reinsurance coverage for any of our subsidiaries’ asbestos-related claims.

RPM International Inc. and Subsidiaries

49

notes to consolidated financial statements

During the last seven months of 2003, new state liability laws were enacted in three states (Mississippi, Ohio and Texas) where at that time more than 80% of the claims against Bondex were pending. The changes generally provided for liability to be determined on a “proportional cause” basis, thereby limiting Bondex’s responsibility to only its share of the alleged asbestos exposure. During the third and fourth fiscal quarters of 2004, two of the three previously mentioned states that adopted “proportional cause” liability in 2003 passed additional legislation impacting medical criteria and product identification in asbestos-related litigation. While there have been some changes in the type of claims filed in certain of these states, the ultimate influence these law changes will have on future claims activity and settlement values is still developing. Claim filings in these three states at the quarter ended May 31, 2006, coupled with the non-malignancy filings in Florida, currently comprise approximately 73% of the total aggregate claims filed against Bondex.

At the end of 2002 and through the third fiscal quarter of 2003, Bondex had concluded it was not possible to estimate the cost of disposing all of the asbestos-related claims that might be filed against Bondex in the future due to a number of reasons, including its lack of sufficient comparable loss history from which to assess either the number or value of any future asbestos-related claims. As previously disclosed, during the fourth fiscal quarter of 2003, Bondex retained a consulting firm to assist in analyzing its loss history data, to evaluate whether it would be possible to estimate the cost of disposing pending claims in light of both past and recent loss history, and to assist in determining whether future asbestos-related claims reasonably expected to be filed against Bondex were measurable, given recent changes in various state laws and the prospect of potential federal asbestos-related legislation. Bondex provided these consultants with all relevant data regarding asbestos-related claims filed against Bondex through May 31, 2003. At the time, management concluded, with the consultants’ input, that it was not possible to estimate the full range of the cost of resolving all future asbestos-related claims against Bondex because of the uncertainties associated with the litigation of those claims.

Estimating the future cost of asbestos related claims was and continues to be subject to many uncertainties, including (i) the ultimate number of claims filed; (ii) the cost of resolving both current known and future unknown claims; (iii) the amount of insurance, if any, available to cover such claims, including the outcome of coverage litigation against the subsidiaries’ third party insurers; (iv) future earnings and cash flow of our subsidiaries; (v) the impact of bankruptcies of other companies whose share of liability may be imposed on our subsidiaries under certain state liability laws; (vi) the unpredictable aspects of the litigation process including a changing trial docket and the jurisdictions in which trials are scheduled; (vii) the outcome of any such trials including judgments or jury verdicts, as a result of our more aggressive defense posture which includes taking selective cases to verdict; (viii) the lack of specific information in many cases concerning exposure to the subsidiaries’ products and the claimants’ diseases; (ix) potential changes in applicable federal and/or state law; and (x) the potential impact of various proposed structured settlement transactions or subsidiary bankruptcies by other companies, some of which are the subject of federal appellate court review, the outcome of which could materially affect any future asbestos-related liability estimates. In addition to the foregoing, ongoing debate in the Senate concerning the establishment of a trust fund to pay future asbestos related claims and remove such cases from federal and state courts with industry and insurers funding the trust continues to be a significant variable that makes it increasingly difficult to predict with certainty the full exposure of future, unknown asbestos-related claims.

Based on the foregoing considerations, at May 31, 2003, we concluded that we could not fully estimate the liability that would result from all future asbestos claims. We established a reserve for those pending cases that had progressed to a stage where the cost to dispose of these cases could, at the time, reasonably be estimated, as well as a $51.2 million provision for future unasserted claims that were estimable at May 31, 2003. The estimation of even pending cases was and is always difficult due to the dynamic nature of asbestos litigation including the variables discussed above. As described below, the estimated range of potential loss covering measurable known asbestos claims and this provision for future claims that were estimable at May 31, 2003 was $140.0 million to $145.0 million. Accordingly, we established a reserve equal to the lower end of this range of potential loss by taking an asbestos charge to fiscal 2003 operations of $140.0 million. At the time of the reserve, we believed that this asbestos reserve would be sufficient to cover asbestos-related cash flow requirements over the estimated three-year life of the reserve. The $140.0 million charge also included $15.0 million in total projected defense costs over the estimated three-year life of the reserve. By comparison, Bondex’s share of costs (net of then-available third-party insurance) for asbestos-related product liability was $6.7 million and $2.8 million for the years ended May 31, 2003 and 2002, respectively.

RPM International Inc. and Subsidiaries

50

notes to consolidated financial statements

Since May 31, 2003, we have reviewed and evaluated on a quarterly basis the adequacy of our asbestos reserve. The range of loss calculation for the $140 million reserve was based on an extensive analysis of the most critical factors that influence our asbestos-related costs including: (i) the gross number of open malignancy claims (principally mesothelioma claims) as these claims have the most significant impact on our asbestos settlement costs; (ii) historical and current settlement costs and dismissal rates by various categories; (iii) analysis of the jurisdiction and governing law of the states in which these claims are pending; and (iv) outside defense counsel’s opinions and recommendations with respect to the merits of such claims. Although the number of open malignancy claims has since increased, our average settlement costs for these claims have declined and dismissal rates have increased. Several favorable verdicts during the past two fiscal years have further contributed to lower settlement values and higher dismissal rates. Our defense costs, however, have increased significantly as a result of this more aggressive defense strategy.

Based on our review of our asbestos reserve for the second quarter ending November 30, 2004, we concluded that an increase in our reserve was appropriate and recorded an asbestos reserve adjustment of $47.0 million for the quarter ended November 30, 2004, which we believed would be sufficient to cover any incremental cash flow requirements through fiscal 2006 not covered by the $140.0 million reserve, as well as the additional cash flow requirements for the balance of our then pending known claims and anticipated higher defense costs. Approximately $32.0 million of the $47.0 million reserve adjustment was allocated to anticipated higher future defense costs. Consistent with this methodology, additional asbestos reserves were taken for the third and fourth quarters of fiscal 2005 and in each of the first three quarters of fiscal 2006.

For the third quarter ended February 28, 2006, the additional asbestos reserve amounted to $15.0 million based on management’s quarterly review of pending claims and defense costs. This reserve adjustment put our total asbestos reserves at approximately $99.2 million, which we believed would be sufficient to cover the cash flow requirements for the balance of our pending known claims and defense costs. Our $15.0 million reserve increase was based on our experience for the third quarter and our valuation of our known existing claims. Approximately $7.7 million of the $15.0 million reserve adjustment was allocated to anticipated higher future defense costs.

As part of our ongoing assessment of our asbestos liability exposure, during the third quarter we also considered whether (i) our recent verdict experience, (ii) venue reforms, (iii) medical criteria requirements, (iv) proportionate share liability and other known tort reforms provided sufficient relevant and reliable information to reasonably estimate our future liability for asbestos-related claims. Accordingly, as previously disclosed, in the third quarter, we retained Crawford & Winiarski (“C&W”), an independent, third-party consulting firm with expertise in the area of asbestos valuation work, to assist us in calculating an estimate of our liability for unasserted potential future asbestos-related claims.

The methodology used by C&W to project our liability for unasserted potential future asbestos-related claims included C&W doing an analysis of (a) widely accepted forecast of the population likely to have been exposed to asbestos; (b) epidemiological studies estimating the number of people likely to develop asbestos-related diseases; (c) historical rate at which mesothelioma incidences resulted in the payment of claims by us; (d) historical settlement averages to value the projected number of future compensable mesothelioma claims; (e) historical ratio of mesothelioma related indemnity payments to non-mesothelioma indemnity payments; and (f) historical defense costs and their relationship with total indemnity payments.

As a result, at the end of the fiscal 2006 fourth quarter, we increased our reserve for asbestos claims by approximately $335.0 million, while paying out the $12.9 million for dismissals and/or settlements resulting in our reserve moving from $99.2 million at February 28, 2006 to $421.3 million at May 31, 2006. This reserve increase is based upon C&W’s analysis of our total estimated liability for pending and unasserted potential future claims through May 31, 2016. This amount was calculated on a pre-tax basis and was not discounted for the time value of money. In light of the uncertainties inherent in making long-term projections, we have determined that the ten-year period through 2016 is the most reasonable time period over which reasonably accurate estimates might still be made for projecting asbestos liabilities and defense costs and, accordingly, the reserve does not include asbestos liabilities for any period past 2016.

In determining the amount of our asbestos reserves, we relied on assumptions that are based on currently known facts and projection models. Our actual expenses could be significantly higher or lower than those recorded if assumptions used in our or C&W’s calculations vary

RPM International Inc. and Subsidiaries

51

notes to consolidated financial statements

significantly from actual results. Key variables in these assumptions include the period of exposure to asbestos claims, the number and type of new claims to be filed each year, the rate at which mesothelioma incidences result in compensable claims against us, the average cost of disposing of each such new claim, the dismissal rates each year and the related annual defense costs. Furthermore, predictions with respect to these variables are subject to greater uncertainty as the projection period lengthens. A significant upward or downward trend in the number of claims filed, depending on the nature of the alleged injury; the jurisdiction where filed; the average cost of resolving each such claim and the quality of the product identification, could change our estimated liability, as could any substantial adverse verdict at trial. A federal legislative solution, further state tort reform or structured settlement transaction could also change the estimated liability.

Subject to the foregoing variables, based on currently available data and upon the analysis of C&W, we believe that our current asbestos reserves are sufficient to cover asbestos-related cash flow requirements for our known pending and unasserted potential future asbestos-related claims. However, given the uncertainties associated with projecting matters into the future and numerous other factors outside of our control, we believe that it is reasonably possible we may incur asbestos liabilities for the period through 2016 and beyond in excess of the C&W projection and our recorded reserve. While it is reasonably possible that such excess liabilities could be material to operating results in any given quarter or year, we do not believe that it is reasonably possible that such excess liabilities would have a material adverse effect on our long-term results of operations, liquidity or consolidated financial position.

We recognize that future facts, events and legislation, both state and/or federal, may alter our estimates of pending claims and unasserted potential future claims. With our outside advisors, we will continue to monitor the number and mix (disease type) of claims filed and paid each period against the estimates calculated by our asbestos liability model, the impact of state law changes and the evolving nature of federal legislative efforts to address asbestos litigation including the pending federal criminal investigation into the conduct of at least three plaintiffs’ law firms (all of whom have filed claims against our Subsidiaries and many other defendants) with respect to their asbestos claim-filing practices. This federal investigation, coupled with recent judicial findings in Texas, calls into question from a medical and legal perspective, the veracity of a significant number of asbestos claims for all defendants, including our Subsidiaries. We will continue to explore all feasible alternatives available to resolve our asbestos-related exposure in a manner consistent with the best interests of our stockholders.

The following table illustrates the movement of current and long-term asbestos-related liabilities for the three years ended May 31, 2006:

Asbestos Liability Movement
(Current and Long-Term)

	Balance at				Deductions			Balance at
	Beginning		Additions to		(Primarily			End of
(In thousands)	of Period		Asbestos Charge		Claims Paid)			Period
Year Ended May 31, 2006	$	101,172	$	380,000	$	59,887		$	421,285
Year Ended May 31, 2005		90,607		78,000		67,435			101,172
Year Ended May 31, 2004		144,583				53,976	(a)		90,607

(a) Represents our portion of total claims paid during the fiscal year ended May 31, 2004 of $63.4 million, net of insurer contributions totaling $9.4 million. Insurance coverage was depleted in the first quarter of fiscal year 2004.

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notes to consolidated financial statements

In addition, like others in similar businesses, we are involved in several proceedings relating to environmental matters. It is our policy to accrue remediation costs when it is probable that such efforts will be required and the related costs can be reasonably estimated. These liabilities are undiscounted. Provision for estimated warranty costs is recorded at the time of sale and periodically adjusted to reflect actual experience.

Due to the uncertainty inherent in the loss reserve estimation process, we are unable to estimate an additional range of loss in excess of our accruals. It is at least reasonably possible that actual costs will differ from estimates, but, based upon information presently available, such future costs are not expected to have a material adverse effect on our competitive or financial position or our ongoing results of operations. However, such costs could be material to results of operations in a future period.

NOTE I — SEGMENT INFORMATION

We operate a portfolio of businesses that manufacture and sell a variety of specialty paints, protective coatings and roofing systems, sealants and adhesives. We manage our portfolio by organizing our businesses into two reportable segments — industrial and consumer — based on the nature of business activities, products and services; the structure of management; and the structure of information as presented to our Board of Directors. Within each reportable segment, individual operating segments or groups of companies generally address common markets, utilize similar technologies, and can share manufacturing or distribution capabilities.

In addition to two reportable segments, there are certain business activities, referred to as corporate/other, that do not constitute an operating segment, including corporate headquarters and related administrative expenses, results of our captive insurance companies, gains or losses on the sales of certain assets and other expenses not directly associated with either reportable operating segment. Related assets consist primarily of investments, prepaid expenses, deferred pension assets, and headquarters property and equipment. These corporate and other assets and expenses reconcile reportable segment data to total consolidated net sales, income before income taxes, identifiable assets, capital expenditures, and depreciation and amortization.

The ten largest consumer segment customers represented approximately 22%, 25% and 25% of our consolidated net sales and approximately 55%, 57% and 55% of consumer net sales for 2006, 2005 and 2004, respectively. Sales to The Home Depot represented 10%, 11% and 11% of our consolidated net sales and 25%, 26% and 25% of our consumer segment net sales for 2006, 2005 and 2004, respectively.

We reflect income from our joint ventures on the equity method, and receive royalties from our licensees. Total income from royalties and joint ventures amounted to approximately 2% or less of income before income taxes for each of the periods presented, and is therefore included as an offset to selling, general and administrative expenses. Export sales amounted to less than 10% of net sales for each of the three years presented.

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notes to consolidated financial statements

The following table reflects the results of our reportable operating segments consistent with our management philosophy, and represents the information we utilize, in conjunction with various strategic, operational and other financial performance criteria, in evaluating the performance of our portfolio of businesses.

Year Ended May 31	2006			2005			2004
(In thousands)
Segment Information
Net Sales
Industrial	$	1,811,590		$	1,441,548		$	1,272,781
Consumer		1,196,748			1,114,187			1,034,772
Total	$	3,008,338		$	2,555,735		$	2,307,553
Income (Loss) Before Income Taxes
Industrial	$	201,230		$	168,578		$	140,706
Consumer		159,147			147,601			142,852
Corporate/Other		(482,852	)1		(152,451	)1		(65,942	)
Total	$	(122,475	)	$	163,728		$	217,616
Identifiable Assets
Industrial	$	1,628,038		$	1,278,234		$	1,111,978
Consumer		1,102,687			1,144,909			1,090,531
Corporate/Other		249,493			224,332			142,693
Total	$	2,980,218		$	2,647,475		$	2,345,202
Capital Expenditures
Industrial	$	39,274		$	30,714		$	26,043
Consumer		20,800			24,175			23,303
Corporate/Other		1,081			720			1,907
Total	$	61,155		$	55,609		$	51,253
Depreciation and Amortization
Industrial	$	40,536		$	33,213		$	30,764
Consumer		29,938			29,264			29,503
Corporate/Other		3,825			3,515			3,010
Total	$	74,299		$	65,992		$	63,277
Geographic Information
Net Sales (based on shipping location)
United States	$	2,248,259		$	2,009,748		$	1,841,837
Foreign
Canada		222,602			192,579			172,894
Europe		411,548			250,585			207,557
Other Foreign		125,929			102,823			85,265
Total Foreign		760,079			545,987			465,716
Total	$	3,008,338		$	2,555,735		$	2,307,553
Long-Lived Assets
United States	$	1,190,722		$	1,158,138		$	1,148,773
Foreign
Canada		121,137			98,880			90,538
Europe		260,866			103,070			98,025
Other Foreign		18,027			18,392			16,858
Total Foreign		400,030			220,342			205,421
Total	$	1,590,752		$	1,378,480		$	1,354,194

¹ The asbestos charge, totaling $380.0 million in fiscal 2006 and $78.0 million in fiscal 2005, reflected in Corporate/Other, relates to our Bondex International, Inc. subsidiary.

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notes to consolidated financial statements

NOTE J — QUARTERLY INFORMATION (UNAUDITED)

The following is a summary of the quarterly results of operations for the years ended May 31, 2006 and 2005:

	For Quarter Ended
(In thousands, except per share amounts)	August 31		November 30		February 28			May 31
2006
Net Sales	$	747,352	$	739,350	$	612,475		$	909,161
Gross Profit		316,119		299,259		244,340			391,850
Net Income (Loss)		49,961		18,527		(2,687	)		(142,006	)(c)
Basic Earnings (Loss) Per Share	$	0.43	$	0.16	$	(0.02	)	$	(1.21	)
Diluted Earnings (Loss) Per Share(a)	$	0.40	$	0.15	$	(0.02	)(b)	$	(1.21	)(b)
Dividends Per Share	$	0.15	$	0.16	$	0.16		$	0.16

	For Quarter Ended
(In thousands, except per share amounts)	August 31		November 30		February 28			May 31
2005
Net Sales	$	661,513	$	623,469	$	516,337		$	754,416
Gross Profit		294,887		270,688		211,117			329,859
Net Income (Loss)		54,486		9,112		(4,772	)		46,206
Basic Earnings (Loss) Per Share	$	0.47	$	0.08	$	(0.04	)	$	0.39
Diluted Earnings (Loss) Per Share(a)	$	0.44	$	0.08	$	(0.04	)(b)	$	0.37
Dividends Per Share	$	0.14	$	0.15	$	0.15		$	0.15

(a)	Includes dilutive effect of EITF 04-8 as discussed in Note D.
(b)	Conversion of the net issuable common share equivalents and the shares related to convertible securities for the three month periods ended February 28, 2006 and 2005, and May 31, 2006 were not assumed, since the results would have been anti-dilutive.
(c)	During the fourth quarter ended May 31, 2006, we increased our reserve for asbestos claims by $335.0 million ($215.6 million after-tax), representing our estimation of our liability for pending and unasserted claims through May 31, 2016. See Note H to the Consolidated Financial Statements for discussion.

Quarterly earnings per share may not total to the yearly earnings per share due to the weighted average number of shares outstanding in each quarter.

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QUARTERLY STOCK PRICE AND DIVIDEND INFORMATION

RPM shares of common stock are traded on the New York Stock Exchange under the symbol RPM. The high and low sales prices for the shares of common stock, and the cash dividends paid on the common stock, for each quarter of the two most recent fiscal years are set forth in the table below.

Range of Sales Prices and Dividends Paid

					Dividends paid
Fiscal 2006	High		Low		per share
First Quarter	$	19.21	$	17.47	$	0.15
Second Quarter	$	19.15	$	16.90	$	0.16
Third Quarter	$	19.00	$	16.96	$	0.16
Fourth Quarter	$	19.70	$	17.40	$	0.16

					Dividends paid
Fiscal 2005	High		Low		per share
First Quarter	$	16.02	$	13.85	$	0.14
Second Quarter	$	18.99	$	15.71	$	0.15
Third Quarter	$	19.95	$	17.58	$	0.15
Fourth Quarter	$	19.25	$	16.51	$	0.15

Source: The Wall Street Journal

Cash dividends are payable quarterly, upon authorization of the Board of Directors. Regular payment dates are approximately the last day of July, October, January and April.

The number of holders of record of RPM common stock as of August 1, 2006 was approximately 33,519.

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of RPM International Inc. is responsible for establishing and maintaining adequate internal control over financial reporting for the company, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. RPM’s internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Consolidated Financial Statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may be inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of RPM’s internal control over financial reporting as of May 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. The scope of such assessment did not include illbruck Sealant Systems, which was acquired by the Company in a purchase business combination on August 31, 2005. illbruck Sealant Systems’ total assets and net sales represent approximately 6.9% and 5.0%, respectively, of the accompanying consolidated financial statement amounts as of and for the year ended May 31, 2006. illbruck Sealant Systems will be included in our assessment of internal controls during fiscal 2007. Based on this assessment, management concluded that, as of May 31, 2006, RPM’s Internal Control over financial reporting is effective.

The independent registered public accounting firm Ernst & Young LLP, has also audited the Company’s assessment of internal control over financial reporting as of May 31, 2006 and their report thereon is included on page 59 of this report.

Frank C. Sullivan President and Chief Executive Officer	Robert L. Matejka Vice President, Chief Financial Officer and Controller

July 24, 2006

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS AND STOCKHOLDERS

RPM International Inc. and Subsidiaries
Medina, Ohio

We have audited the accompanying consolidated balance sheet of RPM International Inc. and Subsidiaries (“RPM” or “the Company”) as of May 31, 2006 and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended. 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 audit.

We conducted our audit in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the 2006 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of RPM at May 31, 2006 and the consolidated results of their operations and their cash flows for the year then ended in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of RPM’s internal control over financial reporting as of May 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 24, 2006 expressed an unqualified opinion thereon.

Cleveland, Ohio
July 24, 2006

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS AND STOCKHOLDERS

RPM International Inc. and Subsidiaries
Medina, Ohio

We have audited management’s assessment, included in the accompanying “Management’s Report on Internal Control Over Financial Reporting,” that RPM International Inc. and Subsidiaries (“RPM” or “the Company”) maintained effective internal control over financial reporting as of May 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). RPM’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

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

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

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of illbruck Sealant Systems (illbruck), which was acquired by RPM on August 31, 2005, and is included in the 2006 consolidated financial statements of RPM and constituted approximately $204 million of total assets as of May 31, 2006 and approximately $149 million and $6.1 million of revenue and pre-tax income, respectively, for the year then ended. Our audit of internal control over financial reporting of RPM as of May 31, 2006 also did not include an evaluation of the internal control over financial reporting of illbruck.

In our opinion, management’s assessment that RPM maintained effective internal control over financial reporting as of May 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, RPM maintained, in all material respects, effective internal control over financial reporting as of May 31, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of RPM International Inc. and Subsidiaries as of May 31, 2006 and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended, and our report dated July 24, 2006, expressed an unqualified opinion thereon.

Cleveland, Ohio
July 24, 2006

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS AND STOCKHOLDERS

RPM International Inc. and Subsidiaries
Medina, Ohio

We have audited the accompanying balance sheet of RPM International Inc. and Subsidiaries (the “Company”), as of May 31, 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the two years in the period ended May 31, 2005. These financial statements are the responsibility of the management of the Company. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of May 31, 2005 and the results of its operations and its cash flows for each of the two years in the period ended May 31, 2005, in conformity with U.S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of May 31, 2005, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 7, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Cleveland, Ohio

July 7, 2005, except as to Note K of the Annual Report on
Form 10-K for the year ended May 31, 2005, which is as of
July 22, 2005.

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