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.

We have reclassified certain prior-year amounts to ­conform to this year’s presentation.

The preparation of financial statements in conformity with Generally Accepted Accounting Principles 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.

During the year ended May 31, 2004, we completed four acquisitions of product lines and one minority interest acquisition. As of the respective dates of acquisition, we recorded the following estimated fair values of assets and liabilities assumed:

Our Consolidated Financial Statements reflect the results of operations of these businesses as of their respective dates of acquisition.

Pro forma results of operations for the years ended May 31, 2004 and May 31, 2003 were not materially different from reported results and, consequently, are not presented.

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 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.

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

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.

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 loss within stockholders’ equity. If we were to experience any significant 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 totaled $41.4 million and $22.1 million at May 31, 2004 and 2003, respectively.

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.

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

Inventories are stated at the lower of cost or market, cost being determined substantially 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:

We elected to adopt 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 all goodwill. We also elected to perform the required annual impairment assessment in the first quarter of our fiscal year. 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, which has been defined as one level below our industrial and consumer operating segments, 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 indicated that goodwill was impaired, a fair value estimate of each tangible and intangible asset 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, 2004 and 2003, performed during the first quarter of each respective fiscal year, did not require any adjustment to the carrying value of goodwill.

The aggregate other intangible asset amortization expense for the fiscal years ended May 31, 2004, 2003 and 2002 was $12.8 million, $11.9 million and $11.3 million, respectively. For each of the next five fiscal years through May 31, 2009, the estimated annual intangible asset amortization expense will approximate $13.0 million.

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 3 to 20 years

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 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.

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, 2004, 2003 and 2002, shipping costs were $86.0 ­million, $78.9 million and $77.9 million, respectively.

Advertising costs are charged to operations when incurred and are included in selling, general and administrative expenses. For the years ended May 31, 2004, 2003 and 2002, advertising costs were $71.1 million, $58.7 million and $53.4 million, respectively.

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, 2004, 2003 and 2002 were $26.2 million, $23.8 million and $20.9 million, respectively. The customer-sponsored portion of such expenditures was not significant.

At May 31, 2004, we had two stock-based compensation plans accounted for under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, as more fully described in Note D. In applying the intrinsic value method of accounting for stock-based compensation, we record expense in an amount equal to the excess of the market price of the underlying shares of RPM International Inc. stock at the date of grant over the exercise price of the stock-related award. In general, the market price of stock options at the grant date has not exceeded the exercise price and, therefore, no expense has been recorded for any of the periods presented. Pro forma information regarding the impact of all stock-based compensation on net income and earnings per share is required by SFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” The following table summarizes our pro forma operating results as if compensation cost for stock options granted had been determined in accordance with the fair-value method prescribed by SFAS No. 123.

The fair value of stock options granted is estimated as of the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions:

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, 2004, 2003 and 2002 was $2.3 million, $1.4 million and $2.1 million, respectively.

We file a consolidated federal income tax return that includes the results of RPM International Inc. and our wholly owned domestic subsidiaries. The tax effects of transactions are recognized in the year in which they enter into the determination of net income, regardless of when they are recognized for tax purposes. As a result, income tax expense differs from actual taxes payable. We do not intend to distribute the accumulated earnings of our ­consolidated foreign subsidiaries totaling approximately $130.0 million at May 31, 2004, and, therefore, no provision has been made for the taxes that would result if such earnings were remitted to us.

In December 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits – an amendment of FASB Statement No. 87, 88 and 106,” which was effective as of December 15, 2003. This new SFAS No. 132 expands the disclosure requirements previously included in the pronouncement, including a requirement to disclose the actual and target allocation percentages for broad asset categories, expected employer contributions during the next fiscal year, the accumulated benefit obligation, significant assumptions applied in determining plan obligations and measurement date(s) used. In accordance with the transition provisions of SFAS No.132 (revised 2003), Note F, “Pension Plans,” and Note G, “Postretirement Health Care Benefits,” have been expanded to include the new disclosures required for the current reporting period.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred, and is effective for exit or disposal activities that are initiated after December 31, 2002. Our adoption of the provisions of SFAS No. 146 did not have a material impact on our results of operations, cash flows or financial position.