in the European companion animal market.

The increase in Animal Health revenues in 2005, as compared to 2004, was attributable to:

• for livestock products, the good performance of Excede (long acting anti-infective) in the U.S. and Draxxin in Europe and in the U.S., as well as Spectramast (antibiotic formulated to treat clinical mastitis), which was launched in the U.S. in May 2005;

• for companion animal products, increased promotional activities throughout our markets resulted in Revolution and Clavamox (an antibiotic for dogs and cats) growing at double-digit rates in 2005, and the launch of Simplicef (small animal anti-infective) in the U.S. in the fourth quarter of 2004; and

• the favorable impact of the weakening of the U.S. dollar relative to many foreign currencies.

Costs and Expenses

Cost of Sales

Cost of sales increased 6% in 2006 and increased 13% in 2005, while revenues increased 2% in 2006 and decreased 3% in 2005. Cost of sales as a percentage of revenues increased in 2006 compared to 2005 and in 2005 compared to 2004.

Cost of sales in 2006, compared to 2005, increased as a result of:

• higher costs of $268 million related to our AtS productivity initiative;

• the timing of implementation of inventory management initiatives;

• the unfavorable impact on expenses of foreign exchange; and

• charges related to certain inventory and manufacturing equipment write-downs,

partially offset by:

• changes in sales mix;

• operational efficiencies, reflecting savings related to our AtS productivity initiative; and

• $73 million in write-offs of inventory and exit costs in 2005 related to suspension of sales and marketing of Bextra.

Cost of sales in 2005, compared to 2004, increased as a result of:

• unfavorable geographic, segment and product mix, and adverse changes in production volume, among other factors, which reflected the loss of U.S. exclusivity for certain of our pharmaceutical products and the uncertainty regarding the selective COX-2 inhibitors;

• $124 million related to our AtS productivity initiative; and

• $73 million in write-offs of inventory and exit costs related to suspension of sales and marketing of Bextra.

Selling, Informational and Administrative (SI&A) Expenses

SI&A expenses increased 2% in 2006, which reflects:

• higher promotional investments in new product launches and in-line product promotional programs;

• expenses related to share-based payments; and

• higher costs of $92 million related to our AtS productivity initiative,

partially offset by:

• the favorable impact on expenses of foreign exchange; and

• savings related to our AtS productivity initiative.

SI&A expenses were flat in 2005 compared to 2004, which reflects:

• the unfavorable impact on expenses of foreign exchange; and

• $151 million in expenses related to our AtS productivity initiative,

offset by:

• an increase in acquisition-related synergies;

• savings from our AtS productivity initiative; and

• lower marketing expenses for our pharmaceutical products compared to 2004, due primarily to lower spending on products which have lost exclusivity and the withdrawal of Bextra.

Research and Development (R&D)