of the decline coming in certain businesses that serve the electronics industry, where it is important to look at the combined impact of volume and price. On a geographic basis, local-currency sales growth in 2004 was led by the Asia Pacific area.

 

Operating Expenses:

 

Cost of Sales:

Cost of sales decreased 0.8 percentage points in 2005. Cost of sales as a percent of net sales benefited from the combination of improved selling prices, favorable product mix, productivity gains, factory efficiency and sourcing, which helped offset the impact of higher raw material prices.  Raw material costs increased approximately 6.0% for 2005 when compared to 2004, with this impact mitigated through commodity hedging programs and negotiated supply contracts.  Cost of sales includes manufacturing, engineering and freight costs.

 

The 2004 decrease as a percent of net sales was driven by a combination of higher volumes, productivity gains, ongoing benefits of corporate initiatives and positive currency impacts (including hedging impacts). While 3M raw material costs increased during the year, 3M’s global sourcing initiative was important in enabling 3M to minimize raw material cost increases during a period of commodity price inflation.

 

Research, Development and Related Expenses:

Research, development and related expenses as a percent of sales were flat when comparing 2005 to 2004. However, spending in dollars increased approximately 4%, reflecting 3M’s continuing commitment to fund future growth for the Company.

 

Selling, General and Administrative Expenses:

Selling, general and administrative (SG&A) expenses as a percent of net sales were flat when comparing 2005 to 2004. 3M continues to invest in growth programs and brand building throughout the portfolio as a means of stimulating growth. SG&A in the fourth quarter of 2005 was impacted by a pre-tax charge of approximately $30 million in connection with settlement agreements of one pending LePage’s follow-on class actions and of two individual follow-on actions, all involving direct purchasers of transparent tape. For more detail, refer to the discussion in Note 11 to the Consolidated Financial Statements.

 

Selling, general and administrative expenses improved by 0.5 percentage points in 2004 compared to 2003. The improvement in 2004 as a percent of net sales was helped by leverage related to 3M’s strong growth in the Asia Pacific area. SG&A expenses in U.S. dollars increased in 2004, negatively impacted by currency translation and increased advertising and merchandising spending to support 3M’s strong brand portfolio. On an ongoing basis, the Company is shifting SG&A dollars toward faster-growth businesses and geographic areas.

 

Other Expense:

In 2003, 3M recorded pre-tax charges of $93 million ($58 million after-tax) related to an adverse ruling in a lawsuit filed against 3M in 1997 by LePage’s Inc. The pre-tax charge of $93 million is classified as “Other expense” within operating income.



Operating Income:

3M uses operating income as one of its primary business segment performance measurement tools. Operating income in 2005 was 23.7% of sales, up from 22.9% of sales in 2004