UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934
For the Fiscal Year Ended December 31, 200530, 2006
Commission file number 1-4171
 
Kellogg Company
(Exact Name of Registrant as Specified in its Charter)
   
Delaware 38-0710690
(State of Incorporation) (I.R.S. Employer Identification No.)
One Kellogg Square
Battle Creek, Michigan 49016-3599
(Address of Principal Executive Offices)
Registrant’s telephone number: (269) 961-2000
 
Securities registered pursuant to Section 12(b) of the Securities Act:
   
Title of each class: Name of each exchange on which registered:
Common Stock, $0.25$.25 par value per share
 New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Securities Act: None
 
Indicate by a check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ  No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.Securities Exchange Act of 1934.  Yes o  No þ
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to thisForm 10-K.  þo
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” inRule 12b-2 of the Securities Exchange Act.Act of 1934. (Check one)
 
Large accelerated filer þ                    Accelerated filer o                    Non-accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Act)Securities Exchange Act of 1934).  Yes o  No þ
 As of February 17, 2006, the
The aggregate market value of the common stock held by non-affiliates of the registrant (assuming only for purposes of this computation that the W.K. Kellogg Foundation Trust, directors and executive officers may be affiliates) was approximately $13.1$14.5 billion, as determined by the July 1, 2005,June 30, 2006, closing price of $44.64$48.43 for one share of common stock, as reported for the New York Stock Exchange — Composite Transactions.
 
As of January 27, 2006, 405,472,15626, 2007, 397,969,170 shares of the common stock of the registrant were issued and outstanding.
 
Parts of the registrant’s Proxy Statement for the Annual Meeting of Share OwnersShareowners to be held on April 21, 200627, 2007 are incorporated by reference into Part III of this Report.
 The Exhibit Index starts on page 52.

TABLE OF CONTENTS

PART I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, and Executive Officers of the Registrantand Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits, Financial Statements andStatement Schedules
SIGNATURES
EXHIBIT INDEX
Executive Survivor IncomeAmended and Restated Five-Year Credit Agreement dated as of November 10, 2006
364-Day Credit Agreement dated as of January 31, 2007
Form of Multicurrency Global Note related to Euro-Commercial Paper Program
2003 Long-Term Incentive Plan, as amended and restated as of December 8, 2006
Domestic and Foreign Subsidiaries of the Company
Consent of Independent Registered Public Accounting Firm
Powers of Attorney
Rule 13a-14(a)/15d-14(a) Certification by James M. JennessA.D. David Mackay
Rule 13a-14(a)/15d-14(a) Certification by Jeffrey BoromisaJohn A. Bryant
Section 1350 Certification by James M. Jennessof A.D. David Mackay
Section 1350 Certification by Jeffrey Boromisaof John A. Bryant


PART I
Item 1.Business
The Company.  Kellogg Company, founded in 1906 and incorporated in Delaware in 1922, and its subsidiaries are engaged in the manufacture and marketing ofready-toready-to-eat-eat cereal and convenience foods.
The address of the principal business office of Kellogg Company is One Kellogg Square, P.O. Box 3599, Battle Creek, Michigan Creek49016-3599. Unless otherwise specified or indicated by the context, the term “Company” as used in this report means“Kellogg,” “we,” “us” and “our” refer to Kellogg Company, its divisions and subsidiaries.
In March, 2001, the Company acquired Keebler Foods Company in a cash transaction valued at $4.56 billion.
Financial Information About Segments.  Information on segments is located in Note 14 within Notes to the Consolidated Financial Statements which are included herein under Part II, Item 8.
Principal Products. The  Our principal products of the Company areready-toready-to-eat-eat cereals and convenience foods, such as cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles and meat alternatives.veggie foods. These products were, as of December 31, 2005,30, 2006, manufactured by the Companyus in 17 countries and marketed in more than 180 countries. The Company’sOur cereal products are generally marketed under theKellogg’sname and are sold principally to the grocery trade through direct sales forces for resale to consumers. The Company usesWe use broker and distribution arrangements for certain products. ItWe also generally usesuse these, or similar arrangements, in less-developed market areas or in those market areas outside of itsour focus.
The Company
We also marketsmarket cookies, crackers, and other convenience foods, under brands such asKellogg’s, Keebler,Cheez-It, Murray, AustinandFamous Amos, to supermarkets in the United States through a direct store-door (DSD) delivery system, although other distribution methods are also used.
Additional information pertaining to the relative sales of the Company’sour products for the years 20032004 through 20052006 is located in Note 14 within Notes to the Consolidated Financial Statements, which are included herein under Part II, Item 8.
Raw Materials.  Agricultural commodities are the principal raw materials used in the Company’sour products. Cartonboard, corrugated, and plastic are the principal packaging materials used by the Company.us. World supplies and prices of such commodities (which include such packaging materials) are constantly monitored, as are government trade policies. The cost of such commodities may fluctuate widely due to government policy and regulation, weather conditions, or other unforeseen circumstances. Continuous efforts are made to maintain and improve the quality and supply of such commodities for purposes of the Company’sour short-term and long-term requirements.
The principal ingredients in the products produced by the Companyus in the United States include corn grits, wheat and wheat derivatives, oats, rice, cocoa and chocolate, soybeans and soybean derivatives, various fruits, sweeteners, flour, shortening, dairy products, eggs, and other filling ingredients, which ingredients are obtained from various sources. Most of these commodities are purchased principally from sources in the United States.
The Company enters
We enter into long-term contracts for the commodities described in this section and purchasespurchase these items on the open market, depending on the Company’sour view of possible price fluctuations, supply levels, and the Company’sour relative negotiating power. While the cost of some of these commodities has, and may continue to, increase over time, the Company believeswe believe that itwe will be able to purchase an adequate supply of these items as needed. The CompanyAs further discussed herein under Part II, Item 7A, we also usesuse commodity futures and options to hedge some of itsour costs.
Raw materials and packaging needed for internationally based operations are available in adequate supply and are sometimes imported from countries other than those where used in manufacture.manufacturing.
Cereal processing ovens at major domestic and international facilities are regularly fueled by natural gas or propane, which are obtained from local utilities or other local suppliers. Short-term standby propane storage exists at several plants for use in the event of an interruption in natural gas supplies. Oil may also be used to fuel certain operations at various plants in the event of natural gas shortages or when its use presents economic advantages. In addition, considerable amounts of diesel fuel are used in connection with the distribution of the Company’sour products. As further discussed herein under Part II, Item 7A, beginning in 2006, we have usedover-the-counter commodity price swaps to hedge some of our natural gas costs.
Trademarks and Technology.  Generally, the Company’sour products are marketed under trademarks it owns. The Company’swe own. Our principal trademarks are itsour housemarks, brand names, slogans, and designs related to cereals and convenience foods manufactured and marketed by the Company, with the Companyus, and we also licensinggrant licenses to third parties to use these

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marks on various goods. These trademarks includeKellogg’sfor cereals, and convenience foods and our other products, of the Company, and the brand


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names of certainready-toready-to-eat-eat cereals, includingAll-Bran, Apple Jacks, Bran Buds, CompleteBranCompleteBran Flakes,CompleteWheat Flakes,Cocoa Krispies, Cinnamon Crunch Crispix, Corn Pops, Cruncheroos, Kellogg’s Corn Flakes, Cracklin’ Oat Bran, Crispix, Froot Loops, Kellogg’s Frosted Flakes, Frosted Mini-Wheats, Frosted Krispies, Just Right, Kellogg’s Low Fat Granola,Mueslix, Nutri-Grain, POPS,Pops, Product 19, Kellogg’s Raisin Bran, Rice Krispies, Raisin Bran Crunch, Smacks, Smart Start, Special K andSpecial K Red Berries andKellogg’s Honey Crunch Corn Flakesin the United States and elsewhere;Zucaritas, Choco Zucaritas, Crusli Sucrilhos, SucrilhosChocolate,SucrilhosBanana,Vector, Musli, Nutridia, andChoco Krispisfor cereals in Latin America;ViveandVectorin Canada;Choco Pops, Chocos, Frosties, Muslix, Fruit ‘n’’n’ Fibre, Kellogg’s Crunchy Nut Corn Flakes, Kellogg’s Crunchy Nut Red Corn Flakes, Honey Loops, Kellogg’s Extra, Sustain, Mueslix, Country Store, Ricicles, Smacks, Start, Smacks Choco Tresor, Pops,andOptimafor cereals in Europe; andCerola, Sultana Bran, Supercharged, Chex, Frosties, Goldies, Rice Bubbles, Nutri-Grain, Kellogg’s Iron Man Food, andBeBigfor cereals in Asia and Australia. Additional Company trademarks are the names of certain combinations ofKellogg’sready-to-eat cereals, includingHandi-Pak, Snack-A-Longs, Fun Pak, Jumbo, andVariety PakVariety.. Other Company brand names includeKellogg’sCorn Flake Crumbs;Croutettesfor herb season stuffing mix;Kuadri-Krispies,All-Bran, Choco Krispis, Froot Loops, Nutridia, Kuadri-Krispis, Zucaritas, Special K, andCruslifor cereal bars,Keloketas for cookies,Kompletefor biscuits; andKaos for snacks in Mexico and elsewhere in Latin America;Pop-Tarts Pastry Swirlsfor toaster danish;Pop-TartsandPop-Tarts Snak-Stixfor toaster pastries;Eggo, Special K, Froot LoopsandNutri-Grainfor frozen waffles and pancakes;Rice Krispies Treatsfor baked snacks and convenience foods;Rice Krispies Treats Krunchfor popcorn;Nutri-Grain, Nutri-GrainMuffin Bars, cereal bars,Nutri-GrainMinis yogurt bars,All-Bran bars,Smart Start bars andNutri-Grain TwistsKellogg’s Crunch bars for convenience foods in the United States and elsewhere;K-Time, Rice Bubbles, Day Dawn, Be Natural, SunibriteandSunibrite andLCMsfor convenience foods in Asia and Australia;Nutri-GrainSquares,Nutri-Grain Elevenses, andRice Krispies Squaresfor convenience foods in Europe;Fruit Windersfor fruit snacks in the United Kingdom;Kellogg’s KraveKashifor refueling snack bars;andKashiGoLeanfor certain cereals, nutrition bars, and mixes;TLC for crackers;Vectorfor meal replacement products; andMorningstar Farms, Loma Linda, Natural Touch, andWorthingtonfor certain meat and egg alternatives.
The Company
We also marketsmarket convenience foods under trademarks and tradenames which includeKeebler,Cheez-It, E. L. Fudge, Murray, Famous Amos, Austin, Ready Crust, Chips Deluxe, Club, Fudge Shoppe,Hi-Ho, Sunshine, Munch’Ems, Right Bites, Sandies, Soft Batch, Toasteds, Town House, Vienna Fingers, Wheatables, andZestaZesta.. One of itsour subsidiaries is also the exclusive licensee of theCarr’sbrand name in the United States.
Company
Our trademarks also include logos and depictions of certain animated characters in conjunction with the Company’sour products, includingSnap!Crackle!Pop!forCocoa KrispiesandRice Krispiescereals andRice Krispies Treatsconvenience foods;Tony the TigerforKellogg’s Frosted Flakes, Zucaritas, SucrilhosandFrostiescereals and convenience foods;Ernie Keeblerfor cookies, convenience foods and other products; theHollow Treelogo for certain convenience foods;Toucan SamforFroot Loops; Dig ‘Em’EmforSmacks; Coco the MonkeyforCocoa KrispiesandCoco Pops; CorneliusforKellogg’s Corn Flakes; Melvinthe elephant for certain cereal and convenience foods;Chocosthe Bear andKobithe Bear for certain cereal products.
The slogansThe Best To You Each Morning, The Original and BestandThey’reGr-r-reat!, used in connection with the Company’sourready-toready-to-eat-eat cereals, along withL’ Eggo my Eggo, used in connection with the Company’sour frozen waffles and pancakes, andElfin Magicused in connection with convenience food products are also important CompanyKellogg trademarks.
The trademarks listed above, among others, when taken as a whole, are important to the Company’sour business. Certain individual trademarks are also important to the Company’sour business. Depending on the jurisdiction, trademarks are generally valid as long as they are in useand/or their registrations are properly maintained and they have not been found to have become generic. Registrations of trademarks can also generally be renewed indefinitely as long as the trademarks are in use.
The Company considers
We consider that, taken as a whole, the rights under itsour various patents, which expire from time to time, are a valuable asset, but the Company doeswe do not believe that itsour businesses are materially dependent on any single patent or group of related patents. The Company’sOur activities under licenses or other franchises or concessions which it holdswe hold are similarly a valuable asset, but are not believed to be material.
Seasonality.  Demand for the Company’sour products has generally been approximately level throughout the year, although some of the Company’sour convenience foods have a bias for stronger demand in the second half of the year due to events and holidays. The CompanyWe also custom-bakescustom-bake cookies for the Girl Scouts of the U.S.A., which are principally sold in the first quarter of the year.

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Working Capital.  Although terms vary around the world and by business types, in the United States the Companywe generally hashave required payment for goods sold eleven or sixteen days subsequent to the date of invoice as 2% 10/net 11 or 1% 15/net 16. Receipts from goods sold, supplemented as


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required by borrowings, provide for the Company’sour payment of dividends, capital expansion, and for other operating expenses and working capital needs.
Customers. The Company’s  Our largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 17%18% of consolidated net sales during 2005,2006, comprised principally of sales within the United States. At December 31, 2005,30, 2006, approximately 12%14% of the Company’sour consolidated receivables balance and 17%22% of the Company’sour U.S. receivables balance was comprised of amounts owed by Wal-Mart Stores, Inc. and its affiliates. During 2005, the Company’s2006, our top five customers, collectively, accounted for approximately 31%33% of the Company’sour consolidated net sales and approximately 42% of U.S. net sales. There has been significant worldwide consolidation in the grocery industry in recent years and the Company believeswe believe that this trend is likely to continue. Although the loss of any large customer for an extended length of time could negatively impact the Company’sour sales and profits, the Company doeswe do not anticipate that this will occur to a significant extent due to the consumer demand for the Company’sour products and the Company’sour relationships with itsour customers. Products of the CompanyOur products have been generally sold through itsour own sales forces and through broker and distributor arrangements, and have been generally resold to consumers in retail stores, restaurants, and other food service establishments.
Backlog.  For the most part, orders are filled within a few days of receipt and are subject to cancellation at any time prior to shipment. The backlog of any unfilled orders at December 31, 200530, 2006 and January 1,December 31, 2005, was not material to the Company.us.
Competition. The Company has  We have experienced, and expectsexpect to continue to experience, intense competition for sales of all of itsour principal products in itsour major product categories, both domestically and internationally. The Company’sOur products compete with advertised and branded products of a similar nature as well as unadvertised and private label products, which are typically distributed at lower prices, and generally with other food products. Principal methods and factors of competition include new product introductions, product quality, taste, convenience, nutritional value, price, advertising, and promotion.
Research and Development.  Research to support and expand the use of the Company’sour existing products and to develop new food products is carried on at the W.K. Kellogg Institute for Food and Nutrition Research in Battle Creek, Michigan, and at other locations around the world. The Company’sOur expenditures for research and development were approximately $190.6 million in 2006, $181.0 million in 2005 and $148.9 million in 2004 and $126.7 million in 2003.2004.
Regulation. The Company’s  Our activities in the United States are subject to regulation by various government agencies, including the Food and Drug Administration, Federal Trade Commission and the Departments of Agriculture, Commerce and Labor, as well as voluntary regulation by other bodies. Various state and local agencies also regulate the Company’sour activities. Other agencies and bodies outside of the United States, including those of the European Union and various countries, states and municipalities, also regulate the Company’sour activities.
Environmental Matters. The Company’s  Our facilities are subject to various U.S. and foreign federal, state, and local laws and regulations regarding the discharge of material into the environment and the protection of the environment in other ways. The Company isWe are not a party to any material proceedings arising under these regulations. The Company believesWe believe that compliance with existing environmental laws and regulations will not materially affect theour consolidated financial condition or theour competitive position of the Company. The Company is currently in substantial compliance with all material environmental regulations affecting the Company and its properties.position.
Employees.  At December 31, 2005, the Company30, 2006, we had approximately 25,60026,000 employees.
Financial Information About Geographic Areas.  Information on geographic areas is located in Note 14 within Notes to the Consolidated Financial Statements, which are included herein under Part II, Item 8.
Executive Officers.  The names, ages, and positions of theour executive officers of the Company (as of February 15, 2006)2007) are listed below together with their business experience. Executive officers are generally elected annually by the Board of Directors at the meeting immediately prior to the Annual Meeting of Share Owners.Shareowners.
James M. Jenness
Chairman of the Board  and60
Chief Executive Officer           59
Mr. Jenness has been our Chairman and Chief Executive Officer of the Company since February 2005 and has served as a Kellogg director of the Company since 2000. From February 2005 until December 2006, he also served as our Chief Executive Officer. He was Chief Executive Officer of Integrated Merchandising Systems, LLC, a leader in outsource management of retail promotion and branded merchandising from 1997 to December 2004. He is also a director of Kimberly-Clark Corporation.
A. D. David Mackay
President and Chief OperatingExecutive Officer  50
51
Mr. Mackay became our President and Chief Executive Officer on December 31, 2006 and has served as a Kellogg director since February 2005. Mr. Mackay joined Kellogg Australia in 1985 and held several positions with Kellogg USA, Kellogg Australia and Kellogg

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Australia and New Zealand before leaving Kellogg in 1992. He rejoined Kellogg Australia in 1998 as managing director.


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director and was appointed managing director of Kellogg United Kingdom and Republic of Ireland later in 1998. He was named Senior Vice President and President, Kellogg USA in July 2000, Executive Vice President in November 2000, and President and Chief Operating Officer in September 2003. He is also a director of Fortune Brands, Inc.
John A. Bryant
Executive Vice President,
Chief Financial Officer, Kellogg Company and
President,
Kellogg International  40
41
Mr. Bryant joined Kellogg Company in March 1998, working in support of the global strategic planning process. He was appointed Senior Vice President and Chief Financial Officer, Kellogg USA, in August 2000, was appointed as our Chief Financial Officer in February 2002 and was appointed Executive Vice President later in 2002. He also assumed responsibility for the Natural and Frozen Foods Division, Kellogg USA, in September 2003. He was appointed to his current position in June 2004.
Alan F. Harris
Executive Vice President and Chief Marketing
and Customer Officer           51
Mr. Harris joined Kellogg Company of Great Britain Limited as a product manager in 1984. In 1992, he was promoted to Director of Global Marketing and Assistant to the Chairman. In 1993, he was promoted to President of Kellogg Canada and in 1994 to Executive Vice President — Marketing and Sales, Kellogg USA. Mr. Harris was promoted to Executive Vice President and President of Kellogg Latin America in 1997 and to President of Kellogg Europe in 1999. He was named Executive Vice President and President, Kellogg International in October 2000June 2004 and was namedappointed to his current position in October 2003.December 2006.
Jeffrey W. Montie
Executive Vice President and President,
Kellogg North America  44
45
Mr. Montie joined Kellogg Company in 1987 as a brand manager in theU.S. ready-toready-to-eat-eat cereal (RTEC) business and held assignments in Canada, South Africa and Germany, and then served as Vice President, Global Innovation for Kellogg Europe before being promoted. In December 2000, Mr. Montie was promoted to President, Morning Foods Division of Kellogg USA and, in August 2002, to Senior Vice President, Kellogg Company. Mr. Montie has been Executive Vice President of Kellogg Company, President of the Morning Foods Division of Kellogg North America since September 2003 and President of Kellogg North America since June 2004.
Donna J. Banks
Senior Vice President, Global Supply Chain  49
50
Dr. Banks joined the CompanyKellogg in 1983. She was appointed to Senior Vice President, Research and Development in 1997, to Senior Vice President, Global Innovation in 1999 and to Senior Vice President, Research, Quality and Technology in 2000. She was appointed to her current position in June 2004.
Jeffrey M. Boromisa
Senior Vice President and Chief Financial Officer           50
Mr. Boromisa joined Kellogg Company in 1981 as a senior auditor. He served in various financial positions until he was named Vice President — Purchasing of Kellogg North America in 1997. In November 1999, Mr. Boromisa was promoted to Vice President and Corporate Controller of Kellogg Company and in 2002, he was promoted to Senior Vice President. He assumed his current position in June 2004.
Celeste Clark
Senior Vice President, Global Nutrition and
Corporate Affairs  52
Ms.53
Dr. Clark has been Kellogg Company’sKellogg’s Senior Vice President of Global Nutrition and Corporate Affairs since August 2003.June 2006. She joined the CompanyKellogg in 1977 and served in several roles of increasing responsibility before being appointed to Vice President, Worldwide Nutrition Marketing in 1996 and then to Senior Vice President, Nutrition and Marketing Communications, Kellogg USA in 1999. In October 2002, sheShe was appointed to Vice President, Corporate and Scientific Affairs for the Company.in October 2002, and to Senior Vice President, Corporate Affairs in August 2003.
Gary H. Pilnick
Senior Vice President, General Counsel,
Corporate Development and Secretary  41
42
Mr. Pilnick was appointed Senior Vice President, General Counsel and Secretary in August 2003 and assumed responsibility for Corporate Development in June 2004. He joined the CompanyKellogg as Vice President — Deputy General Counsel and Assistant Secretary in September 2000 and served in that position until August 2003. Before joining the Company,Kellogg, he served as Vice President and Chief Counsel of Sara Lee Branded Apparel and as Vice President and Chief Counsel, Corporate Development and Finance at Sara Lee Corporation.
Kathleen Wilson-Thompson
Senior Vice President,
Global Human Resources  48
49
Kathleen Wilson-Thompson has been Kellogg Company’s Senior Vice President, Global Human Resources since July 2005. She served in various legal roles until 1995, when she assumed the role of Human Resources Manager for one of the Company’sour plants. In 1998, she returned to the legal department as Corporate Counsel, and was promoted to Chief Counsel, Labor and Employment in November 2001, a position she held until October 2003, when she was promoted to Vice President, Chief Counsel, U.S. Businesses, Labor and Employment.

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Alan R. Andrews
Vice President and Corporate Controller  50
51
Mr. Andrews joined Kellogg Company in 1982. He served in various financial roles before relocating to China as general manager of Kellogg China in 1993. He subsequently served in several leadership innovation and finance roles before being promoted to Vice President, International Finance, Kellogg International in 2000. In 2002, he was appointed to Assistant Corporate Controller and assumed his current position in June 2004.
Availability of Reports; Website Access; Other Information.  Our internet address ishttp://www.kelloggcompany.com.. Through “Investor Relations” — “Financials” — “SEC Filings” on our home page, we make available free of charge our proxy statements, our annual report onForm 10-K, our quarterly reports onForm 10-Q, our current reports onForm 8-K, SEC Forms 3, 4 and 5 and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically


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file such material with, or furnish it to, the Securities and Exchange Commission. Our reports filed with the Securities and Exchange Commission are also made available to read and copy at the SEC’s Public Reference Room at 450 Fifth100 F Street, N.W.N.E., Washington, D.C. 20549. You may obtain information about the Public Reference Room by contacting the SEC at1-800-SEC-0330. Reports filed with the SEC are also made available on its website at www.sec.gov.
Copies of the Corporate Governance Guidelines, the Charters of the Audit, Compensation and Nominating and Governance Committees of the Board of Directors, the Code of Conduct for Kellogg Company directors and Global Code of Ethics for Kellogg Company employees (including the chief executive officer, chief financial officer and corporate controller) can also be found on the Kellogg Company website. Amendments or waivers to the Global Code of Ethics applicable to the chief executive officer, chief financial officer and corporate controller can also be found in the “Investor Relations” section of the Kellogg Company website. The CompanyWe will provide copies of any of these documents to any Share OwnerShareowner upon request.
Forward-Looking Statements.  This Report contains “forward-looking statements” with projections concerning, among other things, the Company’sour strategy, financial principles, and plans; initiatives, improvements and growth; sales, gross margins, advertising, promotion, merchandising, brand building, operating profit, and earnings per share; innovation; investments; capital expenditure; asset write-offs and expenditures and costs related to productivity or efficiency initiatives; the impact of accounting changes and significant accounting estimates; the Company’sour ability to meet interest and debt principal repayment obligations; minimum contractual obligations; future common stock repurchases or debt reduction; effective income tax rate; cash flow and core working capital improvements; interest expense; commodity and energy prices; and employee benefit plan costs and funding. Forward-looking statements include predictions of future results or activities and may contain the words “expect,” “believe,” “will,” “will deliver,” “anticipate,” “project,” “should,” or words or phrases of similar meaning. For example, forward-looking statements are found in this Item 1 and in several sections of Management’s Discussion and Analysis incorporated by reference. The Company’sAnalysis. Our actual results or activities may differ materially from these predictions. The Company’sOur future results could be affected by a variety of factors, including the impact of competitive conditions; the effectiveness of pricing, advertising, and promotional programs; the success of innovation and new product introductions; the recoverability of the carrying value of goodwill and other intangibles; the success of productivity improvements and business transitions; commodity and energy prices, and labor costs; the availability of and interest rates on short-term and long-term financing; actual market performance of benefit plan trust investments; the levels of spending on systems initiatives, properties, business opportunities, integration of acquired businesses, and other general and administrative costs; changes in consumer behavior and preferences; the effect of U.S. and foreign economic conditions on items such as interest rates, statutory tax rates, currency conversion and availability; legal and regulatory factors; business disruption or other losses from war, terrorist acts, or political unrest and the risks and uncertainties described in Item 1A below. Forward-looking statements speak only as of the date they were made, and the Company undertakeswe undertake no obligation to publicly update them.
Item 1A.  Risk Factors
Item 1A.     Risk Factors
In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially adversely affect the Company’sour business, financial condition and results of operations. Additional risks and uncertainties not presently known to the Companyus or that the Companywe currently deemsdeem immaterial also may impair the Company’sour business operations and financial condition.

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The Company’sOur performance is affected by general economic and political conditions and taxation policies.
The Company’s
Our results in the past have been, and in the future may continue to be, materially affected by changes in general economic and political conditions in the United States and other countries, including the interest rate environment in which the Company conductswe conduct business, the financial markets through which the Company accesseswe access capital and currency, political unrest and terrorist acts in the United States or other countries in which the Company carrieswe carry on business.
The enactment of or increases in tariffs, including value added tax, or other changes in the application of existing taxes, in markets in which the Company iswe are currently active or may be active in the future, or on specific products that it sellswe sell or with which itsour products compete, may have an adverse effect on itsour business or on itsour results of operations.
The Company operatesWe operate in the highly competitive food industry.
The Company faces
We face competition across itsour product lines, includingready-toready-to-eat-eat cereals and convenience foods, from other companies which have varying abilities to withstand changes in market conditions. Some of the Company’sour competitors have substantial financial, marketing and other resources, and competition with them in the Company’sour various markets and


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product lines could cause the Companyus to reduce prices, increase capital, marketing or other expenditures, or lose category share, any of which could have a material adverse effect on theour business and financial results of the Company.results. Category share and growth could also be adversely impacted if the Company iswe are not successful in introducing new products.
The Company’sOur consolidated financial results and demand for the Company’sour products are dependent on the successful development of new products and processes.
There are a number of trends in consumer preferences which may impact on the Companyus and the industry as a whole. These include changing consumer dietary trends and the availability of substitute products.
The Company’s
Our success is dependent on anticipating changes in consumer preferences and on successful new product and process development and product relaunches in response to such changes. The Company aimsWe aim to introduce products or new or improved production processes on a timely basis in order to counteract obsolescence and decreases in sales of existing products. While the Company devoteswe devote significant focus to the development of new products and to the research, development and technology process functions of itsour business, itwe may not be successful in developing new products or itsour new products may not be commercially successful. The Company’sOur future results and itsour ability to maintain or improve itsour competitive position will depend on itsour capacity to gauge the direction of itsour key markets and upon itsour ability to successfully identify, develop, manufacture, market and sell new or improved products in these changing markets.
An impairment in the carrying value of goodwill or other acquired intangible could negatively affect the Company’sour consolidated operating results and net worth.
The carrying value of goodwill represents the fair value of acquired businessbusinesses in excess of identifiable assets and liabilities as of the acquisition date. The carrying value of other intangibles represents the fair value of trademarks, trade names, and other acquired intangibles as of the acquisition date. Goodwill and other acquired intangibles expected to contribute indefinitely to theour cash flows of the Company are not amortized, but must be evaluated by management at least annually for impairment. If carrying value exceeds current fair value, the intangible is considered impaired and is reduced to fair value via a charge to earnings. Events and conditions which could result in an impairment include changes in the industries in which the Company operates,we operate, including competition and advances in technology; a significant product liability or intellectual property claim; or other factors leading to reduction in expected sales or profitability. Should the value of one or more of the acquired intangibles become impaired, the Company’sour consolidated earnings and net worth may be materially adversely affected.
As of December 31, 2005,30, 2006, the carrying value of intangible assets totaled approximately $4.9$4.87 billion, of which $3.5$3.45 billion was goodwill and $1.4$1.42 billion represented trademarks, trade names,tradenames, and other acquired intangibles compared to total assets of $10.6$10.71 billion and shareholders’ equity of $2.3$2.07 billion.
The CompanyWe may not achieve itsour targeted cost savings from cost reduction initiatives.
The Company’s
Our success depends in part on itsour ability to be an efficient producer in a highly competitive industry. The Company hasWe have invested a significant amount in capital expenditureexpenditures to improve itsour operational facilities. Ongoing operational issues are likely to occur when carrying out major production, procurement, or logistical changes and these, as well as any failure by the Companyus to achieve itsour planned cost savings, could have a material adverse effect on itsour business and consolidated financial position and on the consolidated results of itsour operations and profitability.

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The Company hasWe have a substantial amount of indebtedness.
The Company has
We have indebtedness that is substantial in relation to itsour shareholders’ equity. As of December 31, 2005, the Company30, 2006, we had total debt of approximately $4.9$5.04 billion and shareholders’ equity of $2.3$2.07 billion.
The Company’s
Our substantial indebtedness could have important consequences, including:
• the ability to obtain additional financing for working capital, capital expenditure or general corporate purposes may be impaired, particularly if the ratings assigned to the Company’sour debt securities by rating organizations were revised downward;
 
• restricting the Company’sour flexibility in responding to changing market conditions or making itus more vulnerable in the event of a general downturn in economic conditions or itsour business;
 
• a substantial portion of the cash flow from operations must be dedicated to the payment of principal and interest on the Company’sour debt, reducing the funds available to itus for other purposes including expansion through acquisitions, marketing spending and expansion of itsour product offerings; and
 
• the Companywe may be more leveraged than some of itsour competitors, which may place the Companyus at a competitive disadvantage.
The Company’s
Our ability to make scheduled payments or to refinance itsour obligations with respect to indebtedness will depend on the Company’sour financial and operating performance, which in turn, is subject


6

to prevailing economic conditions, the availability of, and interest rates on, short termshort-term financing, and to financial, business and other factors beyond the Company’sour control.
TheOur results of the Company may be materially and adversely impacted as a result of increases in the price of raw materials, including agricultural commodities, fuel and labor.
Agricultural commodities, including corn, wheat, soybean oil, sugar and cocoa, are the principal raw materials used in the Company’sour products. Cartonboard, corrugated, and plastic are the principal packaging materials used by the Company.us. The cost of such commodities may fluctuate widely due to government policy and regulation, weather conditions, or other unforeseen circumstances. To the extent that any of the foregoing factors affect the prices of such commodities and the Company iswe are unable to increase itsour prices or adequately hedge against such changes in prices in a manner that offsets such changes, the results of itsour operations could be materially and adversely affected.
Cereal processing ovens at major domestic and international facilities are regularly fuelled by natural gas or propane, which are obtained from local utilities or other local suppliers. Short-term stand-by propane storage exists at several plants for use in case of interruption in natural gas supplies. Oil may also be used to fuel certain operations at various plants. In addition, considerable amounts of diesel fuel are used in connection with the distribution of the Company’sour products. The cost of fuel may fluctuate widely due to economic and political conditions, government policy and regulation, war, or other unforeseen circumstances which could have a material adverse effect on the Company’sour consolidated operating results or financial condition.
A shortage in the labor pool or other general inflationary pressures or changes in applicable laws and regulations could increase labor cost, which could have a material adverse effect on the Company’sour consolidated operating results or financial conditions.
Additionally, the Company’sour labor costs include the cost of providing benefits for employees. The Company sponsorsWe sponsor a number of defined benefit plans for employees in the United States and various foreign locations, including pension, retiree health and welfare, active health care, severance and other postemployment. The Companypostemployment benefits. We also participatesparticipate in a number of multiemployer pension plans for certain of itsour manufacturing locations. The Company’sOur major pension plans and U.S. retiree health and welfare plans are funded with trust assets invested in a globally diversified portfolio of equity securities with smaller holdings of bonds, real estate and other investments. The annual cost of benefits can vary significantly from year to year and is materially affected by such factors as a changechanges in the assumed andor actual rate of return on major plan assets, a change in the weighted-average discount rate used to measure obligations, the rate or trend of health care cost inflation, and the outcome of collectively bargainedcollectively-bargained wage and benefit agreements.
The CompanyWe may be unable to maintain itsour profit margins in the face of a consolidating retail environment. In addition, the loss of one of the Company’sour largest customers could negatively impact itsour sales and profits.
The Company’s
Our largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 17%18% of consolidated net sales during 2005,2006, comprised principally of sales within the United States. At December 31, 2005,30, 2006, approximately 12%14% of the Company’sour consolidated receivables balance and 17%22% of the Company’sour U.S. receivables balance was comprised of amounts owed by Wal-Mart Stores, Inc. and its affiliates. During 2005, the Company’s2006, our top five

7

customers, collectively, accounted for approximately 31%33% of our consolidated net sales and approximately 42% of U.S. net sales. As the retail grocery trade continues to consolidate and mass marketers become larger, theour large retail customers of the Company may seek to use their position to improve their profitability through improved efficiency, lower pricing and increased promotional programs. If the Company iswe are unable to use itsour scale, marketing expertise, product innovation and category leadership positions to respond, theour profitability or volume growth of the Company could be negatively affected. The loss of any large customer for an extended length of time could negatively impact itsour sales and profits.
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products and brands.
We consider our intellectual property rights, including particularly and most notably our trademarks, but also including patents, trade secrets, copyrights and licensing agreements, to be a significant and valuable aspect of our business. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, as well as licensing agreements, third party nondisclosure and assignment agreements and policing of third party misuses of our intellectual property. Our failure to obtain or adequately protect our trademarks, products, new features of our products, or our technology, or any change in law or other changes that serve to lessen or remove the current legal protections of our intellectual property, may diminish our competitiveness and could materially harm our business.
We may be unaware of intellectual property rights of others that may cover some of our technology, brands or products.


7

Any litigation regarding patents or other intellectual property could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Third party claims of intellectual property infringement might also require us to enter into costly license agreements. We also may be subject to significant damages or injunctions against development and sale of certain products.
Changes in tax, environmental or other regulations or failure to comply with existing licensing, trade and other regulations and laws could have a material adverse effect on the Company’sour consolidated financial condition.
The Company’s
Our activities, both in and outside of the United States, are subject to regulation by various federal, state, provincial and local laws, regulations and government agencies, including the U.S. Food and Drug Administration, U.S. Federal Trade Commission, the U.S. Departments of Agriculture, Commerce and Labor, as well as similar and other authorities of the European Union and various state, provincial and local governments, as well as voluntary regulation by other bodies. Various state and local agencies also regulate the Company’sour activities.
The manufacturing, marketing and distribution of food products is subject to governmental regulation that is becoming increasingly onerous. Those regulations control such matters as ingredients, advertising, relations with distributors and retailers, health and safety and the environment. The Company isWe are also regulated with respect to matters such as licensing requirements, trade and pricing practices, tax and environmental matters. The need to comply with new or revised tax, environmental or other laws or regulations, or new or changed interpretations or enforcement of existing laws or regulations, may have a material adverse effect on the Company’sour business and results of operations.
The Company’sOur operations face significant foreign currency exchange rate exposure which could negatively impact itsour operating results.
The Company holds
We hold assets and incursincur liabilities, earnsearn revenue and payspay expenses in a variety of currencies other than the U.S. dollar, primarily the British Pound, Euro, Australian dollar, Canadian dollar and Mexican peso. Because the Company’sour consolidated financial statements are presented in U.S. dollars, the Companywe must translate itsour assets, liabilities, revenue and expenses into U.S. dollars at then-applicable exchange rates. Consequently, increases and decreases in the value of the U.S. dollar may negatively affect the value of these items in the Company’sour consolidated financial statements, even if their value has not changed in their original currency. To the extent the Company failswe fail to manage itsour foreign currency exposure adequately, the Company’sour consolidated results of operations may be negatively affected.
If the Company’sour food products become adulterated or misbranded, itwe might need to recall those items and may experience product liability if consumers are injured as a result.
The Company
We may need to recall some of itsour products if they become adulterated or misbranded. The CompanyWe may also be liable if the consumption of any of itsour products causecauses injury. A widespread product recall could result in significant losses due to the costs of a recall, the destruction of product inventory, and lost sales due to the unavailability of product for a period of time. The CompanyWe could also suffer losses from a significant product liability judgment against it.us. A significant product recall or product liability case could also result in a loss of consumer confidence in the Company’sour food products, which could have a material adverse effect on itsour business results and the value of itsour brands.
Item 1B.Unresolved Staff Comments
None.
Item 2.Properties
The Company’s
Our corporate headquarters and principal research and development facilities are located in Battle Creek, Michigan.
The Company
We operated, as of December 31, 2005,30, 2006, manufacturing plants and distribution and warehousing facilities totaling more than 28 million (28,000,000) square feet of building area in the United States and other countries. The Company’sOur plants have been designed and constructed to meet itsour specific production requirements, and the Companywe periodically investsinvest money for capital and technological improvements. At the time of its selection, each location was considered to be favorable, based on the location of markets, sources of raw materials, availability of suitable labor, transportation facilities, location of our other Company plants producing similar products, and other factors. ManufacturingOur manufacturing facilities of the Company in the United States include four cereal plants and warehouses located in Battle Creek, Michigan; Lancaster, Pennsylvania; Memphis, Tennessee; and Omaha, Nebraska and other plants in San Jose, California; Atlanta, Augusta, Columbus, Macon, and Rome, Georgia; Chicago, Illinois; Kansas City, Kansas; Florence, Louisville, and Pikeville, Kentucky; Grand Rapids, Michigan; Blue Anchor, New Jersey; Cary and

8

Charlotte, North Carolina; Cincinnati, Fremont, and Zanesville, Ohio; Muncy, Pennsylvania; Rossville, Tennessee and Allyn, Washington.
Outside the United States, the Companywe had, as of December 31, 2005,30, 2006, additional manufacturing locations, some with warehousing facilities, in Australia, Brazil, Canada, Colombia, Ecuador,


8

Germany, Great Britain, Guatemala, India, Japan, Mexico, South Africa, South Korea, Spain, Thailand, and Venezuela.
The
We generally own our principal properties, of the Company, including itsour major office facilities, generally are owned by the Company, although some manufacturing facilities are leased, and no owned property is subject to any major lien or other encumbrance. Distribution facilities (including related warehousing facilities) and offices of non-plant locations typically are leased. In general, the Company considers itswe consider our facilities, taken as a whole, to be suitable, adequate, and of sufficient capacity for itsour current operations.
Item 3.Legal Proceedings
The Company is
We are not a party to any pending legal proceedings which could reasonably be expected to have a material adverse effect on the Companyus and itsour subsidiaries, considered on a consolidated basis, nor are any of the Company’sour properties or subsidiaries subject to any such proceedings.
Item 4.Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities
Information on the market for the Company’sour common stock, number of share ownersshareowners and dividends is located in Note 13 within Notes to the Consolidated Financial Statements, which are included herein under Part II, Item 8.
The following table provides information with respect to acquisitions by the Companyus of our shares of its common stock during the quarter ended December 31, 2005.30, 2006.
(millions, except per share data)
ISSUER PURCHASES OF EQUITY SECURITIES
                 
 
  (d)
  (c) Approximate
  Total Number of Dollar Value of
  Shares Purchased Shares that May
  (a) (b) as Part of Publicly Yet Be Purchased
  Total Number of Average Price Announced Plans Under the Plans
  Shares Purchased Paid Per Share or Programs or Programs
Period        
 
Month #1: 10/2/05-10/29/05  —  $46.11   —  $411.9 
Month #2: 10/30/05-11/26/05  10.2  $42.93   10.2  $10.8 
Month #3: 11/27/05-12/31/05  .3  $44.44   .3   — 
Total(1)  10.5  $42.98   10.5     
 
                 
 
      (c)
 (d)
  (a)
 (b)
 Total number of shares
 Approximate dollar value of shares
(millions, except per share data)
 Total number of
 Average price
 purchased as part of publicly
 that may yet be purchased
Period shares purchased paid per share announced plans or programs under the plans or programs
 
 
Month #1: 10/1/06-10/28/06  .1  $49.27   .1  $70.1 
Month #2: 10/29/06-11/25/06  2.1  $49.80   2.1  $14.4 
Month #3: 11/26/06-12/30/06  .9  $50.21   .9   — 
Total (1)  3.1  $49.91   3.1     
 
 
(1)Shares included in the preceding table above were purchased as part of publicly announced plans or programs, as follows:
a)a) Approximately 9.41.4 million shares were purchased during the fourth quarter of 20052006 under programsa program authorized by the Company’sour Board of Directors to repurchase up to $675$650 million of Kellogg common stock during 2006 for general corporate purposes and to offset issuances for employee benefit programs. An initial $400 million repurchase program was publicly announced in a press release on December 7, 2004. On October 28, 2005, the Board of Directors approved an increase in the authorized amount of 2005 stock repurchase to $675 million and an additional $650 million for 2006. This second repurchase program was publicly announced in a press release on October 31, 2005. On December 8, 2006, our Board of Directors authorized a stock repurchase program of up to $650 million for 2007, which was publicly announced in a press release on December 11, 2006.
 
b) b) Approximately 1.11.7 million shares were purchased during the fourth quarter of 20052006 from employees and directors in stock swap and similar transactions pursuant to various shareholder-approved equity-based compen- sationcompensation plans described in Note 8 within Notes to the Consolidated Financial Statements, which are included herein under Part II, Item 8.


9

9

Item 6.Selected Financial Data
Kellogg Company and Subsidiaries
Selected Financial Data
                      
 
(in millions, except per share data and number of employees) 2005 2004 2003 2002 2001
 
Operating trends
                    
Net sales $10,177.2  $9,613.9  $8,811.5  $8,304.1  $7,548.4 
Gross profit as a % of net sales  44.9%  44.9%  44.4%  45.0%  44.2%
Depreciation  390.3   399.0   359.8   346.9   331.0 
Amortization  1.5   11.0   13.0   3.0   107.6 
Advertising expense  857.7   806.2   698.9   588.7   519.2 
Research and development expense  181.0   148.9   126.7   106.4   110.2 
Operating profit  1,750.3   1,681.1   1,544.1   1,508.1   1,167.9 
Operating profit as a % of net sales  17.2%  17.5%  17.5%  18.2%  15.5%
Interest expense  300.3   308.6   371.4   391.2   351.5 
Earnings before cumulative effect of accounting change (a):  980.4   890.6   787.1   720.9   474.6 
Average shares outstanding:                    
 Basic  412.0   412.0   407.9   408.4   406.1 
 Diluted  415.6   416.4   410.5   411.5   407.2 
Earnings per share before cumulative effect of accounting change (a):                    
 Basic  2.38   2.16   1.93   1.77   1.17 
 Diluted  2.36   2.14   1.92   1.75   1.16 
 
Cash flow trends
                    
Net cash provided from operating activities $1,143.3  $1,229.0  $1,171.0  $999.9  $1,132.0 
Capital expenditures  374.2   278.6   247.2   253.5   276.5 
Net cash provided from operating activities
reduced by capital expenditures (c)		  769.1   950.4   923.8   746.4   855.5 
Net cash used in investing activities  (415.0)  (270.4)  (219.0)  (188.8)  (4,143.8)
Net cash provided from (used in) financing activities  (905.3)  (716.3)  (939.4)  (944.4)  3,040.2 
Interest coverage ratio (b)  7.1   6.8   5.1   4.8   4.5 
 
Capital structure trends
                    
Total assets (d) $10,574.5  $10,561.9  $9,914.2  $9,990.8  $10,140.1 
Property, net  2,648.4   2,715.1   2,780.2   2,840.2   2,952.8 
Short-term debt  1,194.7   1,029.2   898.9   1,197.3   595.6 
Long-term debt  3,702.6   3,892.6   4,265.4   4,519.4   5,619.0 
Shareholders’ equity  2,283.7   2,257.2   1,443.2   895.1   871.5 
 
Share price trends
                    
Stock price range $42-47  $37-45  $28-38  $29-37  $25-34 
Cash dividends per common share  1.060   1.010   1.010   1.010   1.010 
 
Number of employees  25,606   25,171   25,250   25,676   26,424 
 
                       
 
(in millions, except per share data and number of employees) 2006 2005 2004 2003 2002  
Operating trends
                      
Net sales $10,906.7  $10,177.2  $9,613.9  $8,811.5  $8,304.1   
Gross profit as a % of net sales  44.2%  44.9%  44.9%  44.4%  45.0%  
Depreciation  351.2   390.3   399.0   359.8   346.9   
Amortization  1.5   1.5   11.0   13.0   3.0   
Advertising expense  915.9   857.7   806.2   698.9   588.7   
Research and development expense  190.6   181.0   148.9   126.7   106.4   
Operating profit  1,765.8   1,750.3   1,681.1   1,544.1   1,508.1   
Operating profit as a % of net sales  16.2%  17.2%  17.5%  17.5%  18.2%  
Interest expense  307.4   300.3   308.6   371.4   391.2   
Net earnings  1,004.1   980.4   890.6   787.1   720.9   
Average shares outstanding:                      
Basic  397.0   412.0   412.0   407.9   408.4   
Diluted  400.4   415.6   416.4   410.5   411.5   
Net earnings per share:                      
Basic  2.53   2.38   2.16   1.93   1.77   
Diluted  2.51   2.36   2.14   1.92   1.75   
 
 
Cash flow trends
                      
Net cash provided by operating activities $1,410.5  $1,143.3  $1,229.0  $1,171.0  $999.9   
Capital expenditures  453.1   374.2   278.6   247.2   253.5   
 
 
Net cash provided by operating activities reduced by capital expenditures (a) $957.4  $769.1  $950.4  $923.8  $746.4   
 
 
Net cash used in investing activities  (445.4)  (415.0)  (270.4)  (219.0)  (188.8)  
Net cash used in financing activities  (789.0)  (905.3)  (716.3)  (939.4)  (944.4)  
Interest coverage ratio (b)  6.9   7.1   6.8   5.1   4.8   
 
 
Capital structure trends
                      
Total assets (c) $10,714.0  $10,574.5  $10,561.9  $9,914.2  $9,990.8   
Property, net  2,815.6   2,648.4   2,715.1   2,780.2   2,840.2   
Short-term debt  1,991.3   1,194.7   1,029.2   898.9   1,197.3   
Long-term debt  3,053.0   3,702.6   3,892.6   4,265.4   4,519.4   
Shareholders’ equity (c)  2,069.0   2,283.7   2,257.2   1,443.2   895.1   
 
 
Share price trends
                      
Stock price range $42-51  $42-47  $37-45  $28-38  $29-37   
Cash dividends per common share  1.137   1.060   1.010   1.010   1.010   
 
 
Number of employees
  25,856   25,606   25,171   25,250   25,676   
 
 
(a)Earnings before cumulative effect of accounting change for 2001 exclude the effect of a charge of $1.0 after tax to adopt SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities.”
(b)Interest coverage ratio is calculated based on earnings before interest expense, income taxes, depreciation, and amortization, divided by interest expense.
(c)The Company uses this non-GAAP financial measure to focus management and investors on the amount of cash available for debt repayment, dividend distribution, acquisition opportunities, and share repurchase.repurchase, which is reconciled above.
 
(d)(b)During 2005,Interest coverage ratio is calculated based on earnings before interest expense, income taxes, depreciation, and amortization, divided by interest expense.
(c)The Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the Company reclassified $578.9 attributableend of its 2006 fiscal year. The standard generally requires company plan sponsors to its direct store-door (DSD) delivery system from indefinite-lived intangiblesreflect the net over- or under-funded position of a defined postretirement benefit plan as an asset or liability on the balance sheet. Accordingly, the 2006 balances associated with the identified captions within this summary were materially affected by the adoption of this standard. Refer to goodwill, net of an associated deferred tax liability of $228.5. Prior periods were likewise reclassified, resulting in a net reduction to total assets of $228.5.Note 1 for further information.


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10

Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Kellogg Company and Subsidiaries
 Results Of Operations
 Results Of Operations
Overview
Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles, and meat alternatives.veggie foods. Kellogg products are manufactured and marketed globally. We currently manage our operations based on thein four geographic regionsoperating segments, comprised of North America and the three International operating segments of Europe, Latin America, and Asia Pacific. This organizational structure isFor the basis ofperiods presented, the Asia Pacific operating segment data presentedincluded Australia and Asian markets. Beginning in 2007, this report.segment will also include South Africa, which was formerly a part of Europe.
We manage our Company for sustainable performance defined by our long-term annual growth targets. During the periods presented, these targets ofwere low single-digit for internal net sales, mid single-digit for internal operating profit, and high single-digit for net earnings per share. (Our measureshare, which we met or exceeded in each of “internal growth” excludes the impact of currency2004, 2005, and if applicable, acquisitions, dispositions, and shipping day differences.) 2006:
               
 
Consolidated results
        
(dollars in millions)   2006 2005 2004
 
Net sales   $10,906.7  $10,177.2  $9,613.9 
 
 
Net sales growth: As reported  7.2%   5.9%   9.1% 
 
 
  Internal (a)  6.8%   6.4%   5.0% 
 
 
Operating profit   $1,765.8  $1,750.3  $1,681.1 
 
 
Operating profit growth: As reported (b)  .9%   4.1%   8.9% 
 
 
  Internal (a)  4.3%   5.2%   4.5% 
 
 
Diluted net earnings per share (EPS) $2.51  $2.36  $2.14 
 
 
EPS growth (b)    6%   10%   11% 
 
 
(a)Our measure of “internal growth” excludes the impact of currency and, if applicable, acquisitions, dispositions, and shipping day differences. Specifically, internal net sales and operating profit growth for 2005 and 2004 exclude the impact of a 53rd shipping week in 2004. Internal operating profit growth for 2006 also excludes the impact of adopting SFAS No. 123(R) “Share-Based Payment.” Accordingly, internal operating profit growth for 2006 is a non-GAAP financial measure, which is further discussed and reconciled to GAAP-basis growth on pages 11 and 12.
(b)At the beginning of 2006, we adopted SFAS No. 123(R) “Share-Based Payment,” which reduced our fiscal 2006 operating profit by $65.4 million ($42.4 million after tax or $.11 per share), due primarily to recognition of compensation expense associated with employee and director stock option grants. Correspondingly, our reported operating profit and net earnings growth for 2006 was reduced by approximately 4%. Diluted net earnings per share growth was reduced by approximately 5%. Refer to the section beginning on page 21 entitled “Stock compensation” for further information on the Company’s adoption of SFAS No. 123(R).
In combination with an attractive dividend yield, we believe this profitable growth has and will continue to provide a strong total return to our shareholders. We plan to continue to achieve this sustainability through a strategy focused on growing our cereal business, expanding our snacks business, and pursuing selected growth opportunities. We support our business strategy with operating principles that emphasize profit-rich, sustainable sales dollars over shipment volume(Volume to Value),growth, as well as cash flow and return on invested capital(Manage for Cash).capital. We believe the success of our strategy and operating principles are reflected in our steady growth in earnings andgrowth, strong cash flow, overand continued investment during a multi-year period of significant commodity and energy-driven cost inflation demonstrates the past several years. This performance has been achieved despite significant challenges such as rising commodity, fuel, energy,strength and employee benefit costs, as well as increased investment in brand building, innovation, and cost-reduction initiatives.flexibility of our business model.
For the year ended December 31, 2005, the Company reported diluted net earnings per share of $2.36, a 10% increase over fiscal 2004 results. Consolidated net sales grew approximately 6%, operating profit increased 4%, and net earnings were up 10%. For the year ended January 1, 2005, net earnings per share were $2.14, an 11% increase over fiscal 2003 net earnings per share of $1.92. For 2005, net cash provided from operating activities was $1,143.3 million and included nearly $200 million of incremental benefit plan funding, as compared to the 2004 amount of $1,229.0 million.
Net sales and operating profit
2006 compared to 2005
The following tables provide an analysis of net sales and operating profit performance for 2006 versus 2005:
                           
 
        Asia
      
  North
   Latin
 Pacific
   Consoli-
  
(dollars in millions) America Europe America (a) Corporate dated  
 
 
2006 net sales
 $7,348.8  $2,143.8  $890.8  $523.3  $—  $10,906.7   
 
 
2005 net sales
 $6,807.8  $2,013.6  $822.2  $533.6  $—  $10,177.2   
 
 
% change — 2006 vs. 2005:                          
Volume (tonnage) (b)  3.5%   1.4%   4.5%   −1.2%   —   3.1%   
Pricing/mix  4.0%   4.0%   4.0%   .9%   —   3.7%   
 
 
Subtotal — internal business
  7.5%   5.4%   8.5%   −.3%   —   6.8%   
Foreign currency impact  .4%   1.1%   −.2%   −1.6%   —   .4%   
 
 
Total change
  7.9%   6.5%   8.3%   −1.9%   —   7.2%   
 
 
                           
 
        Asia
      
  North
   Latin
 Pacific
   Consoli-
  
(dollars in millions) America Europe America (a) Corporate dated  
 
 
2006 operating profit
 $1,340.5  $334.1  $220.1  $76.9  $(205.8) $1,765.8   
 
 
2005 operating profit
 $1,251.5  $330.7  $202.8  $86.0  $(120.7) $1,750.3   
 
 
% change — 2006 vs. 2005:                          
Internal business
  6.5%   .7%   9.3%   −8.7%   −16.2%   4.3%   
SFAS No. 123(R) adoption impact  —   —   —   —   −54.1%   −3.7%   
Foreign currency impact  .6%   .3%   −.8%   −1.9%   —   .3%   
 
 
Total change
  7.1%   1.0%   8.5%   −10.6%   −70.3%   .9%   
 
 
(a)Includes Australia and Asia.
(b)We measure the volume impact (tonnage) on revenues based on the stated weight of our product shipments.
During 2006, our consolidated net sales increased 7%, with strong results in both North America and the total of our International segments. Internal net sales also grew 7%, building on a 6% rate of internal growth during 2005. Successful innovation, brand-building (advertising and consumer promotion) investment, and in-store execution continued to drive broad-based sales growth across each


11

of our enterprise-wide product groups. In fact, we achieved growth in retail cereal sales within each of our operating segments.
For 2006, our North America operating segment reported a net sales increase of 8%. Internal net sales growth was also 8%, with each major product group contributing as follows: retail cereal +3%; retail snacks (cookies, crackers, toaster pastries, cereal bars, fruit snacks) +11%; frozen and specialty (food service, vending, convenience, drug stores, custom manufacturing) channels +8%. The significant growth achieved by our North America snacks business represented nearly one-half of the total dollar increase in consolidated internal net sales for 2006. The 2006 growth in North America retail cereal sales was on top of 8% growth in 2005 and represented the 6th consecutive year in which we’ve increased our dollar share of category sales. Although North America consumer retail cereal consumption remained steady throughout 2006, our shipment revenues declined in the fourth quarter of 2006 by approximately 2% versus the prior-year period. We believe this decline was largely attributable to year-end retail trade inventory adjustments, which brought inventories in line with year-end 2005 levels after several successive quarters of slight inclines.
Our International operating segments collectively achieved net sales growth of approximately 6% or 5% on an internal basis, with leading dollar contributions from our UK, France, Mexico, and Venezuela business units. Internal sales of our Asia Pacific operating segment (which represents less than 5% of our consolidated results) were approximately even with the prior year, as solid growth in Australia cereal and Asian markets was offset by weak performance in our Australia snack business.
Consolidated operating profit for 2006 grew 1%, with internal operating profit up 4% versus 2005. As discussed on page 11, our measure of internal operating profit growth is consistent with our measure of internal sales growth, except that during 2006, internal operating profit growth also excluded the impact of incremental stock compensation expense associated with our adoption of SFAS No. 123(R). We used this non-GAAP financial measure during our first year of adopting this FASB standard in order to assist management and investors in assessing the Company’s financial operating performance against comparative periods, which did not include stock option-related compensation expense. Accordingly, corporate selling, general, and administrative (SGA) expense was higher and operating profit was lower by $65.4 million for 2006, reducing consolidated operating profit growth by approximately four percentage points. Refer to the section beginning on page 21 entitled “Stock compensation” for further information on the Company’s adoption of SFAS No. 123(R).
As further discussed beginning on page 14, our measure of internal operating profit growth includes up-front costs related to cost-reduction initiatives. Although total 2006 up-front costs of $82 million were not significantly changed from the 2005 amount of $90 million, ayear-over-year shift in operating segment allocation of such costs affected relative segment performance. The 2006 versus 2005 change in project cost allocation was a $44 million decline in North America (improving 2006 segment operating profit performance by approximately 4%) and a $28 million increase in Europe (reducing 2006 segment operating profit performance by approximately 8%).
Our current-year operating profit growth was affected by significant cost pressures as discussed in the “Margin performance” section beginning on page 13. Expenditures for brand-building activities increased at a low single-digit rate; this rate of growth incorporates savings reinvestment from our recent focus on media buying efficiencies and global leverage of promotional campaigns. Within our total brand-building metric, advertising expenditures grew at a high single-digit rate for 2006, which is a dynamic that we expect to continue through 2007 due to a relatively heavier focus on promotional efficiencies. Consistent with our long-term commitment, we expect to return to higher rates of growth for total brand-building expenditures, beginning in 2008.
2005 compared to 2004
The following tables provide an analysis of net sales and operating profit performance for 2005 versus 2004:
                          
 
  North   Latin Asia  
(dollars in millions) America Europe America Pacific(a) Corporate Consolidated
 
2005 net sales
 $6,807.8  $2,013.6  $822.2  $533.6  $—  $10,177.2 
 
2004 net sales
 $6,369.3  $2,007.3  $718.0  $519.3  $—  $9,613.9 
 
% change — 2005 vs. 2004:                        
 Volume (tonnage) (b)  5.6%   -.2%   7.5%   .8%   —   4.5% 
 Pricing/mix  2.2%   2.0%   3.2%   .4%   —   1.9% 
 
Subtotal — internal business
  7.8%   1.8%   10.7%   1.2%   —   6.4% 
 Shipping day differences (c)  -1.4%   -.9%   —   -1.0%   —   -1.1% 
 Foreign currency impact  .5%   -.6%   3.8%   2.6%   —   .6% 
 
Total change
  6.9%   .3%   14.5%   2.8%   —   5.9% 
 
                          
 
  North   Latin Asia  
(dollars in millions) America Europe America Pacific(a) Corporate Consolidated
 
2005 operating profit
 $1,251.5  $330.7  $202.8  $86.0  $(120.7) $1,750.3 
 
2004 operating profit
 $1,240.4  $292.3  $185.4  $79.5  $(116.5) $1,681.1 
 
% change — 2005 vs. 2004:                        
 
Internal business
  2.4%   14.9%   6.6%   7.4%   -4.1%   5.2% 
 Shipping day differences (c)  -2.1%   -1.0%   —   -2.2%   .4%   -1.8% 
 Foreign currency impact  .6%   -.8%   2.8%   3.0%   —   .7% 
 
Total change
  .9%   13.1%   9.4%   8.2%   -3.7%   4.1% 
 
                           
 
        Asia
      
  North
   Latin
 Pacific
   Consoli-
  
(dollars in millions) America Europe America (a) Corporate dated  
 
2005 net sales
 $6,807.8  $2,013.6  $822.2  $533.6  $—  $10,177.2   
 
 
2004 net sales
 $6,369.3  $2,007.3  $718.0  $519.3  $—  $9,613.9   
 
 
% change — 2005 vs. 2004:                          
Volume (tonnage) (b)  5.6%   −.2%   7.5%   .8%   —   4.5%   
Pricing/mix  2.2%   2.0%   3.2%   .4%   —   1.9%   
 
 
Subtotal — internal business
  7.8%   1.8%   10.7%   1.2%   —   6.4%   
Shipping day differences (c)  −1.4%   −.9%   —   −1.0%   —   −1.1%   
Foreign currency impact  .5%   −.6%   3.8%   2.6%   —   .6%   
 
 
Total change
  6.9%   .3%   14.5%   2.8%   —   5.9%   
 
 
(a)Includes Australia and Asia.
 
(b)We measure the volume impact (tonnage) on revenues based on the stated weight of our product shipments.
 
(c)Impact of 53rd week in 2004. Refer to Note 1 within Notes to Consolidated Financial Statements for further information.information on our fiscal year end.


12

11

                           
 
        Asia
      
  North
   Latin
 Pacific
   Consoli-
  
(dollars in millions) America Europe America (a) Corporate dated  
 
2005 operating profit
 $1,251.5  $330.7  $202.8  $86.0  $(120.7) $1,750.3   
 
 
2004 operating profit
 $1,240.4  $292.3  $185.4  $79.5  $(116.5) $1,681.1   
 
 
% change — 2005 vs. 2004:                          
Internal business
  2.4%   14.9%   6.6%   7.4%   −4.1%   5.2%   
Shipping day differences (c)  −2.1%   −1.0%   —   −2.2%   .4%   −1.8%   
Foreign currency impact  .6%   −.8%   2.8%   3.0%   —   .7%   
 
 
Total change
  .9%   13.1%   9.4%   8.2%   −3.7%   4.1%   
 
 
(a)Includes Australia and Asia.
(b)We measure the volume impact (tonnage) on revenues based on the stated weight of our product shipments.
(c)Impact of 53rd week in 2004. Refer to Note 1 within Notes to Consolidated Financial Statements for further information on our fiscal year end.
During 2005, consolidated net sales increased nearly 6%. Internal net sales also grew approximately 6%, which was on top of 5% internal sales growth in the prior year.2004.
During the year,
For 2005, successful innovation and brand-building investment continued to drivedrove strong growth across our North American business units, which collectively reported a 7% increase in net sales versus 2004. Internal net sales of our North America retail cereal business increased 8%, with strong performance in both the United States and Canada. As a result, our dollar share of the U.S. ready-to-eat cereal category increased 40 basis points during 2005, to 33.7% as of January 1, 2006, representing the sixth consecutive year of share growth.
Internal net sales of our North America retail snacks business (consisting of wholesome snacks, cookies, crackers, and toaster pastries) increased 7% on top of 8% growth in 2004. This growth was attributable principally to sales of fruit snacks, toaster pastries, cracker products, and major cookie brands. Partially offsetting this growth was the impact of proactively managing discontinuation of marginal cookie innovations.
Internal net sales of our North America frozen and specialty channel (which includes food service, vending, convenience, drug stores, and custom manufacturing) businesses collectively increased approximately 8%, led by solid contributions from ourEggo®frozen foods and food service businesses.
Net sales in
In 2005, our EuropeanInternational operating segment were approximately even with 2004, with internal net sales growth at nearly 2%. This growth was largely due to cereal and snacks sales across southern Europe, partially offset by a sales decline in our Nordics market, which resulted from a temporary delisting by a major customer. Despite intense competitive pressures on our U.K. business unit, we were able to maintain sales within this market at nearly the prior-year level.
Strong performance in Latin America resulted insegments collectively achieved net sales growth of nearly 15%,4% on both a reported and internal basis, with our Latin America operating segment contributing approximately two-thirds of the total dollar increase. Nevertheless, we achieved our long-term annual growth targets of low single-digit for internal sales growth at 11%. Most of this growth was due to strong performance by our Mexico, Venezuela, and Caribbean business units, although sales increased in virtually all the Latin American markets in which we do business.
Netnet sales in our Europe and Asia Pacific operating segment increased approximately 3%, with internal net sales growth at 1%. This sales increase was largelysegments due primarily to innovation-related growthsolid innovation performance in our Asian markets, partially offset by a decline in our Australian business, which was unfavorably impacted by competitive nutritional claimssouthern Europe and timing of snack product innovation versus the prior year. In late 2005, we introduced new products and undertook health-oriented initiatives which we believe will mitigate these in-market factors during 2006.Asia.
Consolidated operating profit increased 4% during 2005, with our EuropeanEurope operating segment contributing approximately one-half of the total dollar increase. This disproportionate contribution was attributable to ayear-over-year shift in segment allocation of charges from cost-reduction initiatives. As discussed in the section beginning on page 14, the year-over-year2005 versus 2004 change in project cost allocation was a $65 million decline in Europe (improving 2005 segment operating profit performance by approximately 22%) and a $46 million increase in North America (reducing 2005 segment operating profit performance by approximately 4%).
Internal growth in consolidated operating profit was 5%. This internal growth was achieved despite doubledespite-double digit growth in brand-building and innovation expenditures and significant cost pressures on gross margin, as discussed in the section beginning on page 13.following section. During 2005, we increased our consolidated brand-building (advertising and consumer promotion) expenditures by more than 11/2 times the rate of sales growth.
2004 compared to 2003
The following tables provide an analysis of net sales and operating profit performance for 2004 versus 2003:
                          
 
  North   Latin Asia  
(dollars in millions) America Europe America Pacific(a) Corporate Consolidated
 
2004 net sales
 $6,369.3  $2,007.3  $718.0  $519.3  $—  $9,613.9 
 
2003 net sales
 $5,954.3  $1,734.2  $666.7  $456.3  $—  $8,811.5 
 
% change — 2004 vs. 2003:                        
 Volume (tonnage) (b)  2.4%   -.1%   6.1%   -.4%   —   2.1% 
 Pricing/mix  2.6%   3.7%   5.0%   2.7%   —   2.9% 
 
Subtotal — internal business
  5.0%   3.6%   11.1%   2.3%   —   5.0% 
 Shipping day differences (c)  1.5%   1.0%   —   1.2%   —   1.3% 
 Foreign currency impact  .5%   11.1%   -3.4%   10.3%   —   2.8% 
 
Total change
  7.0%   15.7%   7.7%   13.8%   —   9.1% 
 
                          
 
  North   Latin Asia  
(dollars in millions) America Europe America Pacific(a) Corporate Consolidated
 
2004 operating profit
 $1,240.4  $292.3  $185.4  $79.5  $(116.5) $1,681.1 
 
2003 operating profit
 $1,134.2  $279.8  $168.9  $61.1  $(99.9) $1,544.1 
 
% change — 2004 vs. 2003:                        
 
Internal business
  6.5%   -7.4%   14.1%   13.8%   -16.1%   4.5% 
 Shipping day differences (c)  2.4%   1.1%   —   2.8%   -.5%   2.0% 
 Foreign currency impact  .5%   10.8%   -4.3%   13.4%   —   2.4% 
 
Total change
  9.4%   4.5%   9.8%   30.0%   -16.6%   8.9% 
 
(a)Includes Australia and Asia.
(b)We measure the volume impact (tonnage) on revenues based on the stated weight of our product shipments.
(c)Impact of 53rd week in 2004. Refer to Note 1 within Notes to Consolidated Financial Statements for further information.

12

During 2004, consolidated net sales increased approximately 9%. Internal net sales grew 5%, which was on top of approximately 4% growth in the prior year. During 2004, successful innovation and brand-building investment continued to drive growth in most of our businesses.
North America reported net sales growth of approximately 7%, with internal growth across all major product groups. Internal net sales of our North America retail cereal business increased approximately 2%, with successful innovation and consumer promotion activities supporting sales growth and category share gains in both the United States and Canada. Internal net sales of our North America retail snacks business increased 8%, with the wholesome snacks, crackers, and toaster pastries components of our snacks portfolio all contributing to that growth. While our cookie sales were essentially unchanged from the prior year, we were pleased with this performance, in light of a category decline in measured channels of approximately 4%. We believe the recovery of our snacks business this year was due primarily to successful product and packaging innovation, combined with effective execution in our direct store-door (DSD) delivery system. Internal net sales of our North America frozen and specialty channel businesses collectively increased approximately 4%.
Net sales in our European operating segment increased approximately 16%, with internal sales growth of nearly 4%. Both our U.K. business unit and pan-European cereal business achieved internal net sales growth for the year of approximately 2%. Sales of our snack products within the region grew at a strong double-digit rate.
Strong performance in Latin America resulted in net sales growth of approximately 8%, with internal net sales growth of 11% more than offsetting unfavorable foreign currency movements. Most of this growth was due to very strong price/mix and tonnage improvements in both cereal and snack sales by our Mexican business unit.
Net sales in our Asia Pacific operating segment increased approximately 14% due primarily to favorable foreign currency movements, with internal net sales growth at 2%. Strong internal net sales performance in Australia was partially offset by a sales decline in Asia, due primarily to the effect of negative publicity regarding sugar-containing products in Korea throughout most of the year.
Consolidated operating profit increased approximately 9% during 2004, with internal growth of more than 4%. This internal growth was achieved despite increased brand-building expenditures and significantly higher commodity costs. Furthermore, corporateCorporate operating profit for 2004 included a charge of $9.5 million related to CEO transition expenses. Lastly, as discussed in the“Cost-reduction initiatives”section beginning on page 14, we absorbed in operating profit significant up-front costs in both 2003 and 2004, with 2004 charges exceeding 2003 charges by approximately $38 million.
The CEO transition expenses, which arose from the departure of Carlos Gutierrez, the Company’s former CEO, related to his appointment as U.S. Secretary of Commerce in early 2005. The total charge (net of forfeitures) of $9.5 million was comprised principally of $3.7 million for special pension termination benefits and $5.5 million for accelerated vesting of 606,250 stock options.
Operating Segment operating profit for each of fiscal 2003 and 2004 includesincluded intangibles impairment losses of approximately $10 million. The 2003 loss was to reduce the carrying value of a contract-based intangible asset and was included in North American operating profit. The 2004 loss was$10.4 million, comprised of $7.9 million to write off the remainingcarrying value of this samea contract-based intangible asset in North America and $2.5 million to write off goodwill in Latin America.
Margin performance
Margin performance is presented in the following table.
                     
 
  Change vs.
  prior year
  (pts.)
 
  2005 2004 2003 2005 2004
 
Gross margin  44.9%   44.9%   44.4%   —   .5 
 
SGA% (a)  -27.7%   -27.4%   -26.9%   -.3   -.5 
 
Operating margin  17.2%   17.5%   17.5%   -.3   — 
 
                       
 
        Change vs. prior
  
        year (pts.)  
 
  2006 2005 2004 2006 2005  
 
Gross margin  44.2%   44.9%   44.9%   (.7)  —   
SGA% (a)  −28.0%   −27.7%   −27.4%   (.3)  (.3)  
 
 
Operating margin  16.2%   17.2%   17.5%   (1.0)  (.3)  
 
 
(a)Selling, general, and administrative expense as a percentage of net sales.
Our long-term goal is to achieve annual improvements in
We strive for gross margin andexpansion to reinvest this growth in brand-building and innovation expenditures, so as to maintain a relatively steady operating margin.expenditures. Our strategy for expanding our gross margin is to manage external cost pressures through sales-driven operating leverage,product pricing and mix improvements, productivity savings, and technological initiatives to reduce the cost of product ingredients and packaging. In 2004, our consolidated
Our gross margin increased by 50 basis points to 44.9%. Forperformance for 2005 we were able to maintain our consolidated gross margin at this level, overcomingand 2006 reflects the impact of several significant cost factors as discussed in the following paragraphs. Supported by late 2005 price increases in various marketsfuel, energy, and pay-back from prior investment, we expect to moderately expand our gross margin again in 2006.
In 2005, we experienced an uncontrollable, weather-related hike in fuel and energy costs during the second half of the year, while in 2004, our

13

commodity costs rose significantly and remained historically high throughout 2005. In summary, we believe market price inflation negatively impactedexperienced throughout most of that time, as well as increased employee benefit costs. In the aggregate, these input cost pressures reduced our consolidated gross margin by approximately 90150 basis points for 2006 and 60 basis points in 2004 and a net 30 basis points in 2005 (60 basis points from fuel/energy partially offset by an easing in certain commodity prices). Our profitability projections for2005. For 2006, currently include a 90-100 basis point unfavorableour gross margin impact from fuel, energy,performance was also unfavorably impacted by incremental logistics and other

13

innovationstart-up costs related to the recent, significant sales growth within our North America operating segment.
While the majority of the inflationary pressure during 2005 and 2006 was commodity price inflation.
Employeeand energy-driven, employee benefit costs (the majority of which isare recorded in cost of goods sold) also increased for both 2004 and 2005,during that time period, with total active and retired employee benefits expense reaching nearly $300approximately $325 million in 2006 versus $290 million in 2005 versus approximatelyand $260 million in 20042004. For 2007, the combined effect of favorable trust asset performance and $240 million in 2003. Our profitability projections for 2006 currently include incremental employeerising interest rates is expected to have a moderating effect on underlying health care cost inflation. As a result, we expect 2007 benefits expense to be approximately even with the 2006 amount.
For 2007, we expect this inflationary trend to continue, with input cost (fuel, energy, commodity, and benefits) pressures forecasted to exceed realized savings. As compared to 2006 results, we currently expect $110-$130 million of $20-$40 million.incremental cost inflation, primarily associated with the prices of our 2007 ingredient purchases. Accordingly, we believe our 2007 consolidated gross margin could decline by up to 50 basis points.
In addition to external cost pressures, our discretionary investment in cost reductioncost-reduction initiatives(refer (refer to following section)has placed short-term pressure oncreated variability in our gross margin performance during the periods presented. The portion ofAlthough total annual program-related charges were relatively steady over the past several years, the amount recorded in cost of goods sold wasvaried by year (in millions): 2005-2006−$74; 2005−$90; 2004-2004−$46; 2003-$67.46. Additionally, cost of goods sold for 2005 includes a charge of approximately $12 million, related to a lump-sum payment to members of the major union representing the hourly employees at our U.S. cereal plants for ratification of a wage and benefits agreement with the Company covering the four-year period ended October 2009.
For 2006, both our SGA% and operating margin were affected by our fiscal 2006 adoption of SFAS No. 123(R). During 2006, we reported incremental stock compensation expense of $65.4 million, which increased our SGA% and reduced our operating margin by approximately 60 basis points. Refer to the section beginning on page 21 entitled “Stock compensation” for further information on this subject.
Cost-reduction initiatives
We view our continued spending on cost-reduction initiatives as part of our sustainable growth model ofongoing operating principles to reinvest earnings reinvestment forso as to provide greater reliability in meeting long-term growth targets. Initiatives undertaken must meet certain pay-back and internal rate of return (IRR) targets. We currently require each project to recover total cash implementation costs within a five-year period of completion or to achieve an IRR of at least 20%. Each cost-reduction initiative is normally one to three years in duration. Upon completion (or as each major stage is completed in the case of relatively short duration (normally one year or less)multi-year programs), andthe project begins to deliver cash savingsand/or reduced depreciation, during the first year of implementation, which is then used to fund new initiatives. To implement these programs, the Company has incurred various up-front costs, including asset write-offs, exit charges, and other project expenditures, which we include in our measure and discussion of operating segment profitability within the ““Net sales and operating profit”profit ” section beginning on page 11.
In 2006, we commenced a multi-year European manufacturing optimization plan to improve utilization of our facility in Manchester, England and to better align production in Europe. Based on forecasted foreign exchange rates, the Company currently expects to incur approximately $60 million in total up-front costs (including those already incurred in 2006), comprised of approximately 80% cash and 20% non-cash asset write-offs, to complete this initiative. The cash portion of the total up-front costs results principally from our plan to eliminate approximately 220 hourly and salaried positions from the Manchester facility by the end of 2008 through voluntary early retirement and severance programs. For 2006, we incurred approximately $28 million of total up-front costs and expect to incur a similar amount in 2007, leaving a relatively insignificant amount to be incurred in 2008. Cash requirements for this initiative are expected to exceed projected cash charges by approximately $10 million in total due to incremental pension trust funding requirements of early retirements; most of this incremental funding occurred in 2006.
Also during 2006, we implemented several short-term initiatives to enhance the productivity and efficiency of our U.S. cereal manufacturing network and streamlined our sales distribution system in a Latin American market. In 2005, we undertook an initiative to consolidate U.S. snacks bakery capacity, resulting in the closure and sale of two facilities by mid 2006. Major initiatives commenced in 2004 were the global rollout of the SAP information technology system, reorganization of pan-European operations, consolidation of U.S. meat alternativesveggie foods manufacturing operations, and relocation of our U.S. snacks business unit to Battle Creek, Michigan. Major actions implemented in 2003 included a wholesome snack plant consolidation in Australia,Except for the aforementioned European manufacturing capacity rationalization in the Mercosur region of Latin America, and a plant workforce reduction in Great Britain. Additionally, during all periods presented, we have undertaken various manufacturing capacity rationalization and efficiencyoptimization plan, our other initiatives primarily in our North American and European operating segments, as well as the 2003 disposal of a manufacturing facility in China.were substantially complete at December 30, 2006. Details of each initiative are described in Note 3 within Notes to Consolidated Financial Statements.


14

Related to
For 2006, the aforementioned U.S. snacks bakery consolidation, we expect to incurCompany recorded total program-related charges of approximately $82 million, comprised of $20 million of asset write-offs, $30 million for severance and other exit costs, $9 million for other cash expenditures, $4 million for a multiemployer pension plan withdrawal liability, and $19 million for pension and other postretirement plan curtailment losses and special termination benefits. Approximately $74 million of project coststhe total 2006 charges were recorded in 2006, two-thirds comprised of cash costs and one-third asset write-offs. Other potential initiatives to be commenced in 2006 are still in the planning stages and individual actions will be announced as management commits to these discretionary investments. Our 2006 earnings target includes projected charges related to potential cost reduction initiatives of approximately $90 million or $.15 per share. Except for the portion attributable to the aforementioned U.S. snacks bakery consolidation of $30 million, the specific cash versus non-cash mix or cost of goods sold versuswithin operating segment results, with approximately $8 million recorded in SGA impact of the remaining $60 million has not yet been determined.expense within corporate results. The Company’s operating segments were impacted as follows (in millions): North America−$46; Europe−$28.
For 2005, total program-related charges were approximately $90 million, comprised of $16 million for a multiemployer pension plan withdrawal liability, $44 million of asset write-offs, $21 million in severance and $30other exit costs, and $9 million for severance and other cash expenditures. All of the charges were recorded in cost of goods sold within the Company’sour North AmericanAmerica operating segment.
For 2004, total program-related charges were approximately $109 million, comprised of $41 million in asset write-offs, $1 million for special pension termination benefits, $15 million in severance and other exit costs, and $52 million in other cash expenditures such as relocation and consulting. Approximately $46 million of the total 2004 charges were recorded in cost of goods sold, with approximately $63 million recorded in selling, general, and administrative (SGA)SGA expense. The 2004 charges impacted our operating segments as follows (in millions): NorthAmerica- America−$44,Europe-44; Europe−$65.
For 2003, total program-related charges were approximately $71 million, comprised of $40 million in asset write-offs, $8 million for special pension termination benefits, and $23 million in severancethe periods presented, cash requirements to implement these programs approximated the exit costs and other cash exit costs. Approximately $67charges incurred in each year, except for approximately $8 million of incremental pension trust funding that occurred in 2006 in connection with the total 2003 chargesEuropean manufacturing optimization plan. At December 30, 2006, the Company’s remaining cash commitments to complete the executed programs were recorded in cost of

14

goods sold, with approximately $4 million recorded in SGA expense. The 2003 charges impacted our operating segments as follows (in millions): NorthAmerica-$36,Europe-$21, LatinAmerica-$8, AsiaPacific-$6.
Exitcomprised of: 1) exit cost reserves were approximately $13of $14 million at December 31, 2005, consisting principally of severance obligations associated with projects commenced in 2005, which are expected to be paid out in 2006. At January 1, 2005, exit2007; 2) approximately $25 million of projected spending and pension trust funding during 2007 and 2008 associated with the European manufacturing optimization plan; and 3) an estimated multiemployer pension plan withdrawal liability of $20 million, which will not be finally determined until 2008 and once determined, is payable to the pension fund over a20-year maximum period. We expect these cash requirements to be funded by operating cash flow.
Our 2007 earnings target includes total projected charges related to in-progress and potential cost-reduction initiatives of approximately $80 million or $.14 per share. Approximately one-third of this total is allocated to the European manufacturing optimization plan. However, the specific cash versus non-cash mix or cost reserves wereof goods sold versus SGA expense impact of the remainder has not yet been determined. Other potential initiatives to be commenced in 2007 are still in the planning stages and individual actions will be announced as we commit to these discretionary investments.
Interest expense
As illustrated in the following table, annual interest expense for the2004-2006 period has been relatively steady at approximately $300 million per year, which reflects a stable effective interest rate on total debt and a relatively constant debt balance throughout most of that time. Interest income (recorded in other income) has trended upward from approximately $7 million in 2004 to $11 million representing severance costsin 2006, resulting in net interest expense of approximately $296 million for 2006. We currently expect that were substantially paid out in 2005.our 2007 net interest expense will approximate the 2006 level.
                       
 
           Change vs.
   
(dollars in millions)          prior year   
 
  2006  2005  2004  2006  2005   
 
Reported interest expense (a) $307.4  $300.3  $308.6           
Amounts capitalized  2.7   1.2   .9           
 
 
Gross interest expense $310.1  $301.5  $309.5   2.9%   −2.6%   
 
 
(a)Reported interest expense for 2005 and 2004 include charges of approximately $13 and $4, respectively, related to the early redemption of long-term debt.
Interest expense
Between the acquisition of Keebler Foods Company in early 2001 and the end of 2004, our Company paid down nearly $2.0 billion of debt, even early-retiring long-term debt in each of the past three years. Net early-retirement premiums are recorded in interest expense and were (in millions): 2005-$13;2004-$4;2003-$17. These premiums were or are expected to be largely recovered through lower short-term interest rates over the original remaining terms of the retired debt. As a result of this debt reduction, interest expense declined significantly from 2003 to 2004, but leveled off in 2005 as we reached a near-term steady state debt position by year-end 2005, which is discussed further in theLiquidity and Capital Resourcessection on page 16. Nevertheless, based on prevailing interest rates, we currently expect 2006 interest expense to decline 4-5% from the 2005 amount, due primarily to a shift in our total debt mix from higher-rate long term to lower-rate short term.
                     
 
    Change vs.
(dollars in millions)   prior year
 
  2005 2004 2003 2005 2004
 
Reported interest expense $300.3  $308.6  $371.4         
 
Amounts capitalized  1.2   .9   —         
 
Gross interest expense $301.5  $309.5  $371.4   -2.6%   -16.7% 
 
Other income (expense), net
Other income (expense), net includes non-operating items such as interest income, charitable donations, and foreign exchange gains and losses, charitable donations, and gains on asset sales.losses. Other income (expense), net for 2005the periods presented was (in millions): 2006−$13.2; 2005−($24.9); 2004−($6.6). The variability in other income (expense), net, among years reflects the timing of certain significant charges explained in the following paragraph and net foreign exchange transaction losses included therein of (in millions): 2006−$2; 2005−$2; 2004−$15.
Other expense includes charges of $16 million for contributions to the Kellogg’s Corporate Citizenship Fund, a private trust established for charitable giving, andas follows (in millions): 2006−$3; 2005−$16; 2004−$9. Other expense for 2005 also includes a charge of approximately $7 million to reduce the carrying value of a corporate commercial facility to estimated selling value. The carrying value of all held-for-sale assets at December 31, 2005,This facility was insignificant.
Other income (expense), net for 2004 includes charges of approximately $9 million for contributions to the Kellogg’s Corporate Citizenship Fund. Other income (expense), net for 2003 includes credits of approximately $17 million related to favorable legal settlements, a charge of $8 million for a contribution to the Kellogg’s Corporate Citizenship Fund, and a charge of $6.5 million to recognize the impairment of a cost-basis investmentsold in an e-commerce business venture.August 2006.


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Income taxes
The
Our long-term objective is to achieve a consolidated effective income tax rate of approximately31-32%. In comparison to a U.S. federal statutory income tax rate of 35%, we pursue planning initiatives globally in order to move toward our long-term target. Excluding the impact of discrete adjustments, our sustainable consolidated effective income tax rate for both 2006 and 2005 was approximately 31%33%, which was below both the 2004 rateis what we currently expect for 2007. Our reported rates of nearly 35%approximately 32% for 2006 and the 2003 rate of less than 33%. As compared31% for 2005 were lower due to the prior-period rates, the 2005favorable effect of various discrete adjustments such as audit settlements, statutory rate changes, and other deferred tax liability adjustments. (Refer to Note 11 within Notes to Consolidated Financial Statements for further information.) Similarly, our 2007 consolidated effective income tax rate benefited primarily from the 2004 reorganization of our European operations and to a lesser extent, from U.S. tax legislation that allows a phased-in deduction from taxable income equal to a stipulated percentage of qualified production income (“QPI”), beginning in 2005. The resulting tax savings have been reinvested, in part, in cost-reduction initiatives, brand-building expenditures, and other growth initiatives. We currently expect our 2006 consolidated effective income tax rate to be 31-32%; however, this projection could be significantlyup to 200 basis points lower than the aforementioned sustainable rate if pending uncertain tax matters, including tax positions that could be affected by the implementation of tax-savingsplanning initiatives, are resolved more favorably than we currently in the planning stages, the settlement of several on-going domestic and international income tax audits, or other similar discrete events within interim periods of 2006.expect. We expect that any incremental benefits from such discrete events would be invested in cost-reduction initiatives and other growth opportunities.
During
The consolidated effective income tax rate for 2004 of nearly 35% was higher than the rates for 2006 and 2005 we electedprimarily because this period preceded the final reorganization of our European operations which favorably affected the country-weighting impact on our rate. (Refer to repatriateNote 3 within Notes to Consolidated Financial Statements for further information on this initiative.) Additionally, the 2004 consolidated effective income tax rate included a provision of approximately $28 million (net of related foreign tax credits) for approximately $1.1 billion of dividends from foreign subsidiaries which qualified for the temporary dividends-received-deduction availablewe elected to repatriate in 2005 under the American Jobs Creation Act. The associated net tax costFinally, 2005 was the first year in which we were permitted to claim a phased-in deduction from U.S. taxable income equal to a stipulated percentage of approximately $40 million was provided for in 2004.qualified production income (“QPI”).

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 Liquidity and Capital Resources
Our principal source of liquidity is operating cash flows, supplemented by borrowings for major acquisitions and other significant transactions. This cash-generating capability is one of our fundamental strengths and provides us with substantial financial flexibility in meeting operating and investing needs. The principal source of our operating cash flow is net earnings, meaning cash receipts from the sale of our products, net of costs to manufacture and market our products. Our cash conversion cycle is relatively short; although receivable collection patterns vary around the world, in the United States, our days sales outstanding (DSO) averages 18-19 days.averaged approximately 19 days during the periods presented. As a result, the growth in our operating cash flow should generally reflect the growth in our net earnings performance over time. As presentedtime, although, as illustrated in the following schedule, to the right, operating cash flow performancespecific results for 2004 generally reflects this principle, except forany particular year may be significantly affected by the level of benefit plan contributions, and working capital movements (operating assets and liabilities). In addition to these two variables, operating cash flow performance for 2005 further deviates from this pattern due principally to the significant portion of net earnings growth for the year attributable to non-cash deferred income tax benefits. and other factors.
               
 
(dollars in millions) 2005 2004 2003
 
Operating activities
            
Net earnings $980.4  $890.6  $787.1 
  
year-over-year change
  10.1%  13.1%    
Items in net earnings not requiring (providing) cash:            
 Depreciation and amortization  391.8   410.0   372.8 
 Deferred income taxes  (59.2)  57.7   74.8 
 Other (a)  199.3   104.5   76.1 
 
Net earnings after non-cash items  1,512.3   1,462.8   1,310.8 
 
  
year-over-year change
  3.4%  11.6%    
Pension and other postretirement benefit plan contributions  (397.3)  (204.0)  (184.2)
Changes in operating assets and liabilities:            
 Core working capital (b)  45.4   46.0   (.1)
 Other working capital  (17.1)  (75.8)  44.5 
 
  Total  28.3   (29.8)  44.4 
 
Net cash provided by operating activities
 $1,143.3  $1,229.0  $1,171.0 
  
year-over-year change
  -7.0%  5.0%    
 
               
 
(dollars in millions) 2006 2005 2004  
 
 
Operating activities
              
Net earnings $1,004.1  $980.4  $890.6   
year-over-year change
  2.4%  10.1%      
Items in net earnings not requiring (providing) cash:              
Depreciation and amortization  352.7   391.8   410.0   
Deferred income taxes  (43.7)  (59.2)  57.7   
Other (a)  235.2   199.3   104.5   
 
 
Net earnings after non-cash items  1,548.3   1,512.3   1,462.8   
 
 
year-over-year change
  2.4%  3.4%      
Pension and other postretirement benefit plan contributions  (99.3)  (397.3)  (204.0)  
Changes in operating assets and liabilities:              
Core working capital (b)  (137.2)  45.4   46.0   
Other working capital  98.7   (17.1)  (75.8)  
 
 
Total  (38.5)  28.3   (29.8)  
 
 
Net cash provided by operating activities
 $1,410.5  $1,143.3  $1,229.0   
year-over-year change
  23.4%  −7.0%      
 
 
(a)Consists principally of non-cash expense accruals for employee compensation and benefit obligationsobligations.
 
(b)Inventory and trade receivables less trade payablespayables.
The increasing level of
Our operating cash flow for 2006 was approximately $267 million higher than 2005, due primarily to lower benefit plan contributions, duringpartially offset by unfavorable working capital movements. Correspondingly, operating cash flow for 2005 was approximately $86 million lower than 2004, due principally to a significant increase in benefit plan contributions. The decline in benefit plan contributions for 2006 reflects the 2003-2005 timeframe primarily reflects our decisions to improve theimproved funded position of several of our major benefit plans that was achieved through a significant amount of funding in the2003-2005 period.
On August 17, 2006, the Pension Protection Act (PPA) became law in the United States. The PPA revised the basis and methodology for determining defined benefit plan minimum funding requirements as well as maximum contributions to and benefits paid from tax-qualified plans. Most of these provisions are first applicable to our U.S. defined benefit pension and retiree health care plans as influenced by tax strategies and market factors. We didin 2008 on a phased-in basis. The PPA will ultimately require us to make additional contributions to our U.S. plans. However, due to our historical


16

funding practices, we currently believe that we will not be required to make any contributions under the new PPA requirements until after 2012. Accordingly, we do not expect to have significant statutory or contractual funding requirements for our major retiree benefit plans during the periods presented, nor do we expect to have in the next several years.
Total minimum benefityears, with total 2007 U.S. and foreign plan contributions for 2006 are currently expected to beestimated at approximately $59$54 million. Actual 2006 or future year’s2007 contributions could exceed our current projections, as influenced by our decision to voluntarily pre-fundundertake discretionary funding of our obligationsbenefit trusts versus other competing investment priorities, future changes in government requirements, or renewals of union contracts.contracts, orhigher-than-expected health care claims experience. Additionally, our projections concerning timing of PPA funding requirements are subject to change primarily based on general market conditions affecting trust asset performance and our future decisions regarding certain elective provisions of the PPA.
In comparison to 2005, the unfavorable movement in core working capital during 2006 was related to trade payables performance and higher inventory balances. At December 30, 2006, our consolidated trade payables balance was within 3% of the balance at year-end 2005. In contrast, our trade payables balance increased approximately 22% during 2005, from a historically-low level at the end of 2004. The higher inventory balance was principally related to higher commodity prices for our raw material and packaging inventories and to a lesser extent, the overall increase in the average number of weeks of inventory on hand. Our consolidated inventory balances were unfavorably affected by U.S. capacity limitations during 2006; nevertheless, our consolidated inventory balances remain at industry-leading levels.
Despite the unfavorable movement in the absolute balance, average core working capital continues to improve as a percentage of net sales. For the trailing fifty-two weeks ended December 30, 2006, core working capital was 6.8% of net sales, as compared to 7.0% as of year-end 2005 and 7.3% as of year-end 2004. We have achieved this multi-year reduction primarily through faster collection of accounts receivable and extension of terms on trade payables. Up until 2006, we had also been successful in implementing logistics improvements to reduce inventory on hand while continuing to meet customer requirements. We believe the opportunity to reduce inventory from year-end 2006 levels could represent a source of operating cash flow during 2007.
For 2005, the net favorable movement in core working capital was related to increasedthe aforementioned increase in trade payables, partially offset by an unfavorable movement in trade receivables, which returned to historical levels (in relation to sales) in early 2005 from lower levels at the end of 2004. We believe these lower levels were related to the timing of our 53rd week over the 2004 holiday period, which impacted the core working capital component of our operating cash flow throughout 2005. Core
As presented in the table on page 16, other working capital aswas a percentage of sales has steadily improved over the past several years, representing 7.0% of net sales for the fiscal year ended December 31, 2005, as compared to 7.3% for 2004 and 8.2% for 2003. We have achieved this multi-year reduction primarily through logistics improvements to reduce inventory on hand while continuing to meet customer requirements, faster collection of accounts receivable, and extension of terms on trade payables. While our long-term goal is to continue to improve this metric, we no longer expect movements in the absolute balance of core working capital to represent a significant source of operating cash flow.
in 2006 versus a use of cash in 2005. Theyear-over-year favorable variance of approximately $116 million was attributable to several factors including lower debt-related currency swap payments in 2006 as well as business-related growth in accrued compensation and promotional liabilities. The unfavorable movementsmovement in other working capital for 2004, as presentedcompared to succeeding years, primarily relates to a decrease in current income tax liabilities which is offset in the preceding table, relate largely to higherdeferred income tax payments and faster payment of customer promotional incentives, as compared to prior years.taxes line item.

16

Our management measure of cash flow is defined as net cash provided by operating activities reduced by expenditures for property additions. We use this non-GAAP financial measure of cash flow to focus management and investors on the amount of cash available for debt repayment, dividend distributions, acquisition opportunities, and share repurchase. Our cash flow metric is reconciled to the most comparable GAAP measure, as follows:
              
 
(dollars in millions) 2005 2004 2003
 
Net cash provided by operating activities $1,143.3  $1,229.0  $1,171.0 
 
Additions to properties  (374.2)  (278.6)  (247.2)
 
Cash flow $769.1  $950.4  $923.8 
 
year-over-year change
  -19.1%  2.9%    
 
              ��
 
(dollars in millions) 2006 2005 2004  
 
 
Net cash provided by operating activities $1,410.5  $1,143.3  $1,229.0   
Additions to properties  (453.1)  (374.2)  (278.6)  
 
 
Cash flow $957.4  $769.1  $950.4   
year-over-year change
  24.5%  −19.1%      
 
 
Our 2006 and 2005 cash flow (as defined) declined approximately 19% versus the prior year, attributable primarily to incremental benefit plan contributions as discussed on page 16 andperformance reflects increased spending for selected capacity expansions to accommodate our Company’s strong sales growth over the past several years. This increased capital spending represented 4.2% of net sales in 2006 and 3.7% of net sales which exceeds our recent historical spending level ofin 2005, as compared to 2.9% in 2004. For 2007, we currently expect property expenditures to remain at approximately 3%4% of net sales, which is consistent with our long-term target for both 2004capital spending. This forecast includes expenditures associated with the construction of a new manufacturing facility in Ontario, Canada, which represents approximately 15% of our 2007 capital plan. This facility is being constructed to satisfy existing capacity needs in our North America business, which we believe will partially ease certain of the aforementioned logistics and 2003.inventory management issues which we encountered during 2006.
For 2007, we are targeting cash flow of $950-$1,025 million. We expect this trend to continue in the near term, with projected 2006 property expenditures reaching approximately 4.0%achieve our target principally through operating


17

profit growth, which is forecasted to offset higher levels of net sales. We currently expect our cash flow for 2006 to be $875-$975 million, with the increase over the 2005 amount funded principally by a decline in benefit plan contributions, partially offset by a slight increase in capital spending as a percentage of sales.and income tax payments during 2007.
In order to support the continued growth of our North American fruit snacks business, we completed two separate business acquisitions during 2005 for a total of approximately $50 million in cash, including related transaction costs. In June 2005, we acquired a fruit snacks manufacturing facility and related assets from Kraft Foods Inc. The facility is located in Chicago, Illinois and employs approximately 400 active hourly and salaried employees. In November 2005, we acquired substantially all of the assets and certain liabilities of a Washington State-based manufacturer of natural and organic fruit snacks.
For 2005,2006, our Board of Directors had originally authorized stock repurchases for general corporate purposes and to offset issuances for employee benefit programs of up to $400 million. In October 2005, our Board of Directors approved an increase in the authorized amount of 2005 stock repurchases to $675 million and an additional $650 million, for 2006. Pursuantwhich we spent to this authorization, in November 2005, we repurchasedrepurchase approximately 9.414.9 million common shares fromshares. This activity consisted principally of a February 2006 private transaction with the W.K. Kellogg Foundation Trust (the “Trust”) for $400 million in a privately negotiated transaction pursuant to an agreement dated as of November 8, 2005 (the “2005 Agreement”). The 2005 Agreement provided (“the Trust with registration rights in certain circumstances for additional common shares which the Trust might desire to sell and provided the Company with rights to repurchase those additional common shares. In combination with open market transactions completed prior to November 2005, we spent a total of $664 millionTrust”) to repurchase approximately 15.412.8 million shares during 2005.for $550 million. Pursuant to similar Board authorizations applicable to those years, we paid $664 million in 2005 to repurchase approximately 15.4 million shares and $298 million in 2004 for approximately 7.3 million shares and $90 million during 2003 for approximately 2.9 million shares.
In connection with our 2006 stock repurchase authorization, we entered into an agreement The 2005 activity consisted principally of a November 2005 private transaction with the Trust dated as of February 16, 2006 (the “2006 Agreement”) to repurchase approximately 12.89.4 million additional shares from the Trust for $550$400 million. The 2006 Agreement extinguished the registration andFor 2007, our Board of Directors has authorized a stock repurchase rights under the 2005 Agreement upon the Company’s repurchaseprogram of those additional shares on February 21, 2006.up to $650 million.
In July 2005, we redeemed $723.4 million of long-term debt, representing the remaining principal balance of our 6.0% U.S. Dollar Notes due April 2006. In October 2005, we repaid $200 million of maturing 4.875% U.S. Dollar Notes. In December 2005, we redeemed $35.4 million of U.S. Dollar Notes due June 2008. These payments were funded principally through issuance of U.S. Dollar short-term debt.
During November 2005, subsidiaries of the Company issued approximately $930 million of foreign currency-denominated debt in offerings outside of the United States, consisting of Euro 550 million of floating rate notes due 2007 (the “Euro Notes”) and approximately C$330 million of Canadian commercial paper. These debt issuances were guaranteed by the Company and net proceeds were used primarily for the payment of dividends pursuant to the American Jobs Creation Act and the purchase of stock and assets of other direct or indirect subsidiaries of the Company, as well as for general corporate purposes.(Refer
To utilize excess cash and reduce financing costs, on January 31, 2007, we announced an early redemption of the Euro Notes, effective February 28, 2007. To partially refinance this redemption, we established a program to issue euro-commercial paper notes up to a maximum aggregate amount outstanding at any time of $750 million or its equivalent in alternative currencies. The notes may have maturities ranging up to 364 days and will be senior unsecured obligations of the applicable issuer, with subsidiary issuances guaranteed by the Company. In connection with these financing activities, we increased our short-term lines of credit from $2.2 billion at December 30, 2006 to approximately $2.6 billion, via a $400 million unsecured364-Day Credit Agreement effective January 31, 2007. The364-Day Agreement contains customary covenants, warranties, and restrictions similar to those applicable to our existing $2.0 billion Five-Year Credit Agreement, which expires in 2011. These facilities are available for general corporate purposes, including commercial paperback-up, although the Company does not currently anticipate any usage under the facilities. (Refer to Note 7 within Notes to Consolidated Financial Statements for further information on theseour debt issuances.issuances and credit facilities.)
At December 31, 2005,30, 2006, our total debt was approximately $4.9$5.0 billion, approximately even with the balancebalances at year-end 2005 and 2004. As discussed in theInterest expensesection on page 15, this debt balance represents nearly a $2.0 billion reduction from a peak level of $6.8 billion in early 2001. During 2005, we increased our benefit trust investments through plan funding by approximately 13%, reduced the Company’s common stock outstanding through repurchase programs by approximately 4%, and implemented a mid-year increase in the shareholder dividend level of approximately 10%. Similarly, during 2006, we further reduced our common stock outstanding through repurchase programs by approximately 4% and implemented a mid-year increase in the shareholder dividend level of approximately 5%. Primarily due to the recent

17

prioritization of these uses of cash flow, plus the aforementioned need to selectively invest in production capacity, we no longer expect todid not reduce our total debt atbalance during the recent historical pace,past two years, but remain committed to net debt reduction (total debt less cash) over the long term. We currently expect the total debt balance at year-end 2007 to be slightly higher than the 2006 to remain at approximately $4.9 billion.year-end level.
We believe that we will be able to meet our interest and principal repayment obligations and maintain our debt covenants for the foreseeable future, while still meeting our operational needs, including the pursuit of selected growth opportunities, through our strong cash flow, our program of issuing short-term debt, and maintaining credit facilities on a global basis. Our significant long-term debt issues do not


18

contain acceleration of maturity clauses that are dependent on credit ratings. A change in the Company’s credit ratings could limit its access to the U.S. short-term debt marketand/or increase the cost of refinancing long-term debt in the future. However, even under these circumstances, we would continue to have access to our credit facilities, which are in amounts sufficient to cover our outstanding commercial paper balance, which was $1.3 billion at December 30, 2006. In addition, assuming continuation of market liquidity, we believe it would be possible to term out certain short-term maturities or obtain additional credit facilities such that the outstanding short-term debt balance and debt principal repaymentsCompany could further extend its ability to meet its long-term borrowing obligations through 2006.2008.
 Off-balance Sheet Arrangements and Other Obligations
Off-balance sheet arrangements
Our off-balance sheet arrangements are generally limited to a residual value guarantee on one operating lease of approximately $13 million, which will expire in July 2007, and guarantees on loans to independent contractors for their purchase of DSD route franchises up to $17 million. We record the estimated fair value of these loan guarantees on our balance sheet, which was insignificant for the periods presented. Refer to Note 6 within Notes to Consolidated Financial Statements for further information.
Contractual obligations
The following table summarizes future estimated cash payments to be made under existing contractual obligations. Further information on debt obligations is contained in Note 7 within Notes to Consolidated Financial Statements. Further information on lease obligations is contained in Note 6.
                             
 
Contractual obligations Payments due by period
 
  2011 and
(millions) Total 2006 2007 2008 2009 2010 beyond
 
Long-term debt(a) $6,476.8  $282.9  $847.2  $653.3  $181.8  $181.7  $4,329.9 
Capital leases  4.6   1.9   1.4   .5   .5   .2   .1 
Operating leases  459.1   102.3   85.6   63.7   47.5   43.3   116.7 
Purchase obligations(b)  447.8   289.0   96.3   30.2   20.9   10.9   .5 
Other long-term(c)  260.2   31.0   12.3   29.5   11.7   15.1   160.6 
 
Total $7,648.5  $707.1  $1,042.8  $777.2  $262.4  $251.2  $4,607.8 
 
                             
 
Contractual obligations Payments due by period
 
              2012 and
(millions) Total 2007 2008 2009 2010 2011 beyond
 
 
Long-term debt:                            
Principal $3,792.4  $723.3  $466.1  $1.2  $1.1  $1,500.5  $1,100.2 
Interest (a)  2,474.0   194.7   187.8   181.0   181.0   131.5   1,598.0 
Capital leases  9.4   2.1   1.4   1.3   1.0   .6   3.0 
Operating leases  575.1   119.7   103.4   85.9   67.7   49.8   148.6 
Purchase obligations (b)  506.1   399.4   62.7   32.3   10.8   .4   .5 
Other long-term (c)  570.0   98.5   90.0   60.6   63.1   58.9   198.9 
 
 
Total $7,927.0  $1,537.7  $911.4  $362.3  $324.7  $1,741.7  $3,049.2 
 
 
(a)Long-termIncludes interest payments on long-term fixed rate debt. As of December 30, 2006, the Company did not have any long-term variable rate debt obligations include amounts due for both principal and fixed-rateor any outstanding interest payments.rate derivative financial instruments.
 
(b)Purchase obligations consist primarily of fixed commitments under various co-marketing agreements and to a lesser extent, of service agreements, and contracts for future delivery of commodities, packaging materials, and equipment. The amounts presented in the table do not include items already recorded in accounts payable or other current liabilities at year-end 2005,2006, nor does the table reflect cash flows we are likely to incur based on our plans, but are not obligated to incur. Therefore, it should be noted that the exclusion of these items from the table could be a limitation in assessing our total future cash flows under contracts.
 
(c)Other long-term contractual obligations are those associated with noncurrent liabilities recorded within the Consolidated Balance Sheet at year-end 20052006 and consist principally of projected commitments under deferred compensation arrangements, multiemployer pension plans, and other retiree benefits in excesssupplemental employee retirement benefits. The table also includes our current estimate of those provided within our broad-based plans. We do not currently have significant statutory or contractual funding requirements for our broad-based retireeminimum contributions to defined benefit pension and postretirement benefit plans during the periods presented and have not included these amounts in the table. Refer to Notes 9 and 10 within Notes to Consolidated Financial Statements for further information on these plans, including expected contributions for fiscal year 2006.through 2012 as follows: 2007−$54; 2008−$49; 2009−$41; 2010−$42; 2011−$42; 2012−$43.
Off-balance sheet arrangements Critical Accounting Policies and
Our off-balance sheet arrangements are generally limited to a residual value guarantee on one operating lease of approximately $13 million and guarantees on loans to independent contractors for their purchase of DSD route franchises up to $17 million. We record the fair value of these loan guarantees on our balance sheet, which we currently estimate to be insignificant. Refer to Note 6 within Notes to Consolidated Financial Statements for further information.
 Significant Accounting Estimates
Our significant accounting policies are discussed in Note 1 within Notes to Consolidated Financial Statements. None of theDuring 2006, we adopted two new accounting pronouncements adopted during the periods presented havewhich had or are expected to have a significant impact on our Company’s financial statements. At the beginning of 2006, we adopted SFAS No. 123(R) “Share-Based Payment,” which materially reduced our fiscal 2006 results, due primarily to the first-time recognition of compensation expense associated with employee and director stock option grants. This topic is further discussed in the section beginning on page 21.
Secondly, at the end of 2006, we adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” which required us to reflect the net over- or under-funded position of our defined postretirement and postemployment benefit plans as an asset or liability on the balance sheet, with unrecognized prior service cost and net experience losses recorded in shareholders’ equity. Under pre-existing guidance, these unrecognized amounts, which totaled approximately $890.8 million at December 30, 2006, were disclosed only in financial statement footnotes. Accordingly, the after-tax presentation of these amounts on the balance sheet reduced consolidated net assets and shareholders’ equity by $591.9 million at year-end 2006. Nevertheless, we do not believe this impact is economically significant because our net earnings, cash flow, liquidity, debt covenants, and plan funding requirements were not affected by this change in accounting principle. Refer to Note 1 within Notes to Consolidated Financial Statements for further information on SFAS No. 158. Refer to the section beginning on page 22 for information on our process for estimating benefit obligations.
At the beginning of our 2007 fiscal year, we adopted FASB Interpretation No. 48 “Accounting for Uncertainty in Income


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Taxes” (FIN No. 48), which affects our process for estimating tax benefits and liabilities, as further discussed in the “Income taxes” section beginning on page 24. The initial application of FIN No. 48 resulted in a net decrease to accrued income tax and related interest liabilities of approximately $2 million, with an offsetting increase to retained earnings. Refer to Note 1 within Notes to Consolidated Financial Statements for further information on FIN No. 48.
In December 2004,September 2006, the FASB issued SFAS No. 123(Revised) “Share-Based Payment,” which we adopted as157 “Fair Value Measurements” to provide enhanced guidance for using fair value to measure assets and liabilities. The standard also expands disclosure requirements for assets and liabilities measured at fair value, how fair value is determined, and the effect of fair value measurements on earnings. The standard applies whenever other authoritative literature requires (or permits) certain assets or liabilities to be measured at fair value, but does not expand the use of fair value. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. Early adoption is permitted. We plan to adopt SFAS No. 157 in the first quarter of our 20062008 fiscal year, usingyear. For the modified prospective method. Accordingly,

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prior years were not restated, but 2006 results are being presented as if we had applied theCompany, balance sheet items carried at fair value methodconsist primarily of accountingderivatives and other financial instruments, assets held for stock-based compensation from our 1996 fiscal year. Ifsale, exit liabilities, and the trust asset component of net benefit plan obligations. Relevant to the “Intangibles” section beginning on this standard had been adoptedpage, we also use fair value concepts to test various long-lived assets for impairment and to initially measure assets and liabilities acquired in 2005, net earnings per share would have been reduced by approximately $.09 and wea business combination. We are currently expect a similarevaluating the impact of adoption for 2006. However, the actual impact on 2006 will, in part, depend on the particular structure of stock-based awards granted during the yearhow these assets and various market factors that affect the fair value of awards. We classify pre-tax stock compensation expense in selling, general, and administrative expense principally within our corporate operations.liabilities are currently measured.
SFAS No. 123(Revised) also provides that any corporate income tax benefit realized upon exercise or vesting of an award in excess of that previously recognized in earnings will be presented in the Statement of Cash Flows as a financing (rather than an operating) cash flow. If this standard had been adopted in 2005, operating cash flow would have been lower (and financing cash flow would have been higher) by approximately $20 million as a result of this provision. The actual impact on 2006 operating cash flow will depend, in part, on the volume of employee stock option exercises during the year and the relationship between the exercise-date market value of the underlying stock and the original grant-date fair value determined for financial reporting purposes.
Our critical accounting estimates, which require significant judgments and assumptions likely to have a material impact on our financial statements, are discussed in the following sections on pages 19-21.20-25.
Promotional expenditures
Our promotional activities are conducted either through the retail trade or directly with consumers and involve in-store displays and events; feature price discounts on our products; consumer coupons, contests, and loyalty programs; and similar activities. The costs of these activities are generally recognized at the time the related revenue is recorded, which normally precedes the actual cash expenditure. The recognition of these costs therefore requires management judgment regarding the volume of promotional offers that will be redeemed by either the retail trade or consumer. These estimates are made using various techniques including historical data on performance of similar promotional programs. Differences between estimated expense and actual redemptions are normally insignificant and recognized as a change in management estimate in a subsequent period. On a full-year basis, these subsequent period adjustments have rarely represented in excess of .4% (.004) of our Company’s net sales. However, as our Company’s total promotional expenditures (including amounts classified as a revenue reduction) represented nearly 30% of 20052006 net sales;sales, the likelihood exists of materially different reported results if different assumptions or conditions were to prevail.
Intangibles
We follow SFAS No. 142 “Goodwill and Other Intangible Assets” in evaluating impairment of intangibles. We perform this evaluation at least annually during the fourth quarter of each year in conjunction with our annual budgeting process. Under this standard,SFAS No. 142, goodwill impairment testing first requires a comparison between the carrying value and fair value of a reporting unit with associated goodwill. Carrying value is based on the assets and liabilities associated with the operations of that reporting unit, which often requires allocation of shared or corporate items among reporting units. The fair value of a reporting unit is based primarily on our assessment of profitability multiples likely to be achieved in a theoretical sale transaction. Similarly, impairment testing of other intangible assets requires a comparison of carrying value to fair value of that particular asset. Fair values of non-goodwill intangible assets are based primarily on projections of future cash flows to be generated from that asset. For instance, cash flows related to a particular trademark would be based on a projected royalty stream attributable to branded product sales. These estimates are made using various inputs including historical data, current and anticipated market conditions, management plans, and market comparables. We periodically engage third partythird-party valuation consultants to assist in this process.
We also follow SFAS No. 142 in evaluating the useful life over which a non-goodwill intangible asset is expected to contribute directly or indirectly to the cash flows of the Company. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized, but is evaluated annually for impairment. Reaching a determination on useful life requires significant judgments and assumptions regarding the future effects of obsolescence, demand, competition, other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in


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distribution channels), the level of required maintenance expenditures, and the expected lives of other related groups of assets.
At December 31, 2005,30, 2006, intangible assets, net, were $4.9 billion, consisting primarily of goodwill and trademarks associated with the 2001 acquisition of Keebler Foods Company. Within this total, approximately $1.4 billion of non-goodwill intangible assets were classified as indefinite-lived, comprised principally of Keebler trademarks. While we currently believe that the fair value of all of our intangibles exceeds carrying value and that those intangibles so classified will contribute indefinitely to the cash flows of the Company, materially different assumptions regarding future performance of our North American snacks business or the weighted averageweighted-average cost of capital used in the valuations could result in significant impairment losses.lossesand/or amortization expense.
Stock compensation
In December 2004, the FASB issued SFAS No. 123(R) “Share-Based Payment,” which generally requires public companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value and to recognize this cost over the requisite service period. We adopted SFAS No. 123(R) as of the beginning of our 2006 fiscal year, using the modified prospective method. Accordingly, prior years were not restated, but our 2006 results include compensation expense associated with unvested equity-based awards, which were granted prior to 2006. With the adoption of this pronouncement, stock-based compensation represents a critical accounting policy of the Company, which is further described in Note 1 within Notes to the Consolidated Financial Statements.
For 2006, our adoption of SFAS No. 123(R) has resulted in an increase in the Company’s corporate SGA expense and a corresponding reduction to earnings and net earnings per share, due primarily to recognition of compensation expense associated with employee and director stock option grants. No such expense was recognized under our previous accounting method in pre-2006 periods; however, we were required to disclose pro forma results under the alternate fair value method prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation.” Using reported results for 2006 and pro forma results for 2005, the comparable impact of stock compensation expense is presented in the following table:
             
 
  Stock-based
  
  compensation expense Diluted EPS
(millions, except per share data) Pre-tax Net of tax impact
 
2006:
            
As reported comparable $30.3  $19.3  $.04 
SFAS No. 123(R) adoption impact  65.4   42.4   .11 
 
 
As reported total $95.7  $61.7  $.15 
 
 
2005:
            
As reported comparable $18.5  $11.8  $.03 
Pro forma incremental  57.9   36.9   .09 
 
 
Pro forma total $76.4  $48.7  $.12 
 
 
As illustrated in the preceding table, the pro forma incremental impact of stock compensation was $.09 per share for 2005 versus an $.11 impact of adopting SFAS No. 123(R) in 2006. The$.02 year-over-year increase in the per-share impact is due principally to an increase in the number of options granted during 2006 and a lower average number of shares outstanding on which the calculation is based. As explained in the following paragraphs, the amount of stock compensation recognized for any particular year is highly dependent on market conditions and other factors outside of our control. Based on historical patterns and predicted market conditions existing at December 30, 2006, we currently expect the 2007 earnings per share impact of stock option expense to be within the range of actual 2005 and 2006 results.
Accounting for stock compensation under SFAS No. 123(R) represents a critical accounting estimate, which requires significant judgments and assumptions likely to have a material impact on our financial statements. Due to the need to determine the grant-date fair value of equity instruments that have not yet been awarded, the actual impact on future results will depend, in part, on actual awards during any reporting period and various market factors that affect the fair value of those awards. Additionally, while the timing and volume of grants associated with a particular year’s long-term incentive compensation are within our control, the timing and volume of “reload” option grants are not. Reload options are awarded to eligible employees and directors to replace previously-owned Company stock used by those individuals to pay the exercise price, including related employment taxes, of vested pre-2004 option awards containing this accelerated ownership feature. Under SFAS No. 123(R), these reload options result in additional compensation expense in the year of grant and for 2006, represented approximately one-third of the Company’s total stock option expense. The


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Company has not granted options containing an accelerated ownership feature since 2003; however, the potential requirement to award reload options over the contractual10-year term of the original grants could continue to significantly impact the amount of our stock-based compensation expense for a number of years.
We estimate the fair value of each stock option award on the date of grant using a lattice-based option valuation model for annual grants and a Black-Scholes model for reload grants. These models require us to make predictive assumptions regarding future stock price volatility, employee exercise behavior, and dividend yield. Our methods for selecting these valuation assumptions are explained in Note 8 within Notes to Consolidated Financial Statements. In particular, our estimate of stock price volatility is based principally on historical volatility of the options granted, and to a lesser extent, on implied volatilities from traded options on the Company’s stock. For the lattice-based model, historical volatility corresponds to the10-year contractual term of the options granted; whereas, for the Black-Scholes model, historical volatility corresponds to the expected term, which is currently 2.5 years. We decided to rely more heavily on historical volatility due to the greater availability of data and reliability of trends over longer periods of time, as compared to the terms of more thinly-traded options, which rarely extend beyond two years. At year-end 2006, historical volatilities using weekly price observations ranged from approximately 23% for 10 years to 12% for 2.5 years. In comparison, implied volatilities averaged approximately 16% for traded options with terms in excess of six months. Based on this data, our weighted-average composite volatility assumption for purposes of valuing our option grants during 2006 was 17.9%, as compared to 22.0% for 2005. All other assumptions held constant, a one percentage point increase or decrease in our 2006 volatility assumption would increase or decrease the grant-date fair value of our 2006 option awards by approximately 4%.
To the extent that actual outcomes differ from our assumptions, we are not required to true up grant-date fair value-based expense to final intrinsic values. However, these differences can impact the classification of cash tax benefits realized upon exercise of stock options, as explained in the following two paragraphs. Furthermore, as historical data has a significant bearing on our forward-looking assumptions, significant variances between actual and predicted experience could lead to prospective revisions in our assumptions, which could then significantly impact theyear-over-year comparability of stock-based compensation expense.
SFAS No. 123(R) also provides that any corporate income tax benefit realized upon exercise or vesting of an award in excess of that previously recognized in earnings (referred to as a “windfall tax benefit”) will be presented in the Consolidated Statement of Cash Flows as a financing (rather than an operating) cash flow. If this standard had been adopted in 2005, operating cash flow would have been lower (and financing cash flow would have been higher) by approximately $20 million as a result of this provision. For 2006, the corresponding reduction in operating cash flow attributable to windfall tax benefits classified as financing cash flow was $21.5 million. The actual impact on future years’ operating cash flow will depend, in part, on the volume of employee stock option exercises during a particular year and the relationship between the exercise-date market value of the underlying stock and the original grant-date fair value previously determined for financial reporting purposes.
For balance sheet classification purposes, realized windfall tax benefits are credited to capital in excess of par value within the Consolidated Balance Sheet. Realized shortfall tax benefits (amounts which are less than that previously recognized in earnings) are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense, potentially resulting in volatility in our consolidated effective income tax rate. Under the transition rules for adopting SFAS No. 123(R) using the modified prospective method, we were permitted to calculate a cumulative memo balance of windfall tax benefits from post-1995 years for the purpose of accounting for future shortfall tax benefits. We completed such study prior to the first period of adoption and currently have sufficient cumulative memo windfall tax benefits to absorb projected arising shortfalls, such that 2007 earnings are not currently expected to be affected by this provision. However, as employee stock option exercise behavior is not within our control, the likelihood exists of materially different reported results if different assumptions or conditions were to prevail.
Retirement benefits
Our Company sponsors a number of U.S. and foreign defined benefit employee pension plans and also provides retiree health care and other welfare benefits in the United States and Canada. Plan funding strategies are influenced by tax regulations. A substantial majority of plan assets are invested in a globally diversified portfolio of equity securities with smaller holdings of debt securities and other investments. We follow SFAS No. 87 “Employers’ Accounting for Pensions” and SFAS No. 106 “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (as amended by SFAS No. 158, effective as of our fiscal year-end 2006) for the measurement and recognition of obligations and expense related to our retiree benefit plans. Embodied in both of these standards is


22

the concept that the cost of benefits

19

provided during retirement should be recognized over the employees’ active working life. Inherent in this concept is the requirement to use various actuarial assumptions to predict and measure costs and obligations many years prior to the settlement date. Major actuarial assumptions that require significant management judgment and have a material impact on the measurement of our consolidated benefits expense and accumulated obligation include the long-term rates of return on plan assets, the health care cost trend rates, and the interest rates used to discount the obligations for our major plans, which cover employees in the United States, United Kingdom, and Canada.
To conduct our annual review of the long-term rate of return on plan assets, we work with third partythird-party financial consultants to model expected returns over a20-year investment horizon with respect to the specific investment mix of each of our major plans. The return assumptions used reflect a combination of rigorous historical performance analysis and forward-looking views of the financial markets including consideration of current yields on long-term bonds, price-earnings ratios of the major stock market indices, and long-term inflation. Our U.S. plan model, corresponding to approximately 70% of our trust assets globally, currently incorporates a long-term inflation assumption of 2.8% and an active management premium of 1% (net of fees) validated by historical analysis. Although we review our expected long-term rates of return annually, our benefit trust investment performance for one particular year does not, by itself, significantly influence our evaluation. Our expected rates of return are generally not revised, provided these rates continue to fall within a “more likely than not” corridor of between the 25th and 75th percentile of expected long-term returns, as determined by our modeling process. Our assumed rate of return for U.S. plans in 20052006 of 8.9% equated to approximately the 50th percentile expectation of our 20052006 model. Similar methods are used for various foreign plans with invested assets, reflecting local economic conditions. Foreign plantrust investments represent approximately 30% of our global benefit plan investments.assets.
Based on consolidated benefit plan assets at December 31, 2005,30, 2006, a 100 basis point reduction in the assumed rate of return would increase 20062007 benefits expense by approximately $36$42 million. Correspondingly, a 100 basis point shortfall between the assumed and actual rate of return on plan assets for 20062007 would result in a similar amount of arising experience loss. Any arising asset-related experience gain or loss is recognized in the calculated value of plan assets over a five-year period. Once recognized, experience gains and losses are amortized using a declining-balance method over the average remaining service period of active plan participants, which for U.S. plans is presently about 1213 years. Under this recognition method, a 100 basis point shortfall in actual versus assumed performance of all of our plan assets in 20062007 would reduce pre-tax earnings by approximately $1 million in 2007,2008, increasing to approximately $6$7 million in year 2011.2012. For each of the three years ending December 31, 2005,December��30, 2006, our actual return on plan assets exceeded the recognized assumed return by the following amounts (in millions):2005- 2006−$257.1; 2005−$39.4;2004- 2004−$95.6;2003-$269.4.95.6.
To conduct our annual review of health care cost trend rates, we work with third partythird-party financial consultants to model our actual claims cost data over a five-year historical period, including an analysis of pre-65 versus post-65 age groups and other important demographic components of our covered employeeretiree population. This data is adjusted to eliminate the impact of plan changes and other factors that would tend to distort the underlying cost inflation trends. Our initial health care cost trend rate is reviewed annually and adjusted as necessary to remain consistent with recent historical experience and our expectations regarding short-term future trends. In comparison to our actual five-year compound annual claims cost growth rate of approximately 9%8%, our initial trend rate for 20062007 of 10.5%9.5% reflects the expected future impact of faster-growing claims experience for certain demographic groups within our total employee population. Our initial rate is trended downward by 1% per year, until the ultimate trend rate of 4.75% is reached. The ultimate trend rate is adjusted annually, as necessary, to approximate the current economic view on the rate of long-term inflation plus an appropriate health care cost premium. Based on consolidated obligations at December 31, 2005,30, 2006, a 100 basis point increase in the assumed health care cost trend rates would increase 20062007 benefits expense by approximately $17$18 million. A 100 basis point excess of 20062007 actual health care claims cost over that calculated from the assumed trend rate would result in an arising experience loss of approximately $9 million. Any arising health care claims cost-related experience gain or loss is recognized in the calculated valueamount of claims costexperience over afour-year period. Once recognized, experience gains and losses are amortized using a straight-line method over 15 years, resulting in at least the average remaining service period of active plan participants, which for U.S. plans is presently about 15 years.minimum amortization prescribed by SFAS No. 106. The combined net experience lossgain arising from recognition of all prior-years2006 claims experience together with the revised trend rate assumption, was approximately $129$6 million.


23

To conduct our annual review of discount rates, we use several published market indices with appropriate duration weighting to assess prevailing rates on high quality debt securities, with a primary focus on theCitigroup Pension Liability Index®for our U.S. plans. To test the appropriateness of these indices, we

20

periodically engage third partythird-party financial consultants to conduct a matching exercise between the expected settlement cash flows of our plans and bond maturities, consisting principally of AA-rated (or the equivalent in foreign jurisdictions) non-callable issues with at least $25 million principal outstanding. The model does not assume any reinvestment rates and assumes that bond investments mature just in time to pay benefits as they become due. For those years where no suitable bonds are available, the portfolio utilizes a linear interpolation approach to impute a hypothetical bond whose maturity matches the cash flows required in those years. As of threefour different interim dates induring 2005 and 2006, this matching exercise for our U.S. plans produced a discount rate within +/- 10− 15 basis points of the equivalent-datedCitigroup Pension Liability Index®.. The measurement dates for our defined benefit plans are generally consistent with our Company’s fiscal year end. Thus, we select discount rates to measure our benefit obligations that are consistent with market indices during December of each year. Based on consolidated obligations at December 31, 2005,30, 2006, a 25 basis point decline in the weighted averageweighted-average discount rate used for benefit plan measurement purposes would increase 20062007 benefits expense by approximately $15$17 million. All obligation-related experience gains and losses are amortized using a straight-line method over the average remaining service period of active plan participants.
Despite the previously describedpreviously-described rigorous policies for selecting major actuarial assumptions, we periodically experience material differences between assumed and actual experience. As of December 31, 2005,30, 2006, we had consolidated unamortized prior service cost and net experience losses of approximately $1.29 billion.$.9 billion, as compared to approximately $1.4 billion at December 31, 2005. Theyear-over-year decline in net unamortized amounts was attributable largely to trust asset performance and the favorable impact of rising interest rates on our benefit obligations. Of thisthe total unamortized amounts at December 30, 2006, approximately 70%80% was related to discount rate reductions, 13% waswith the remainder primarily related to net unfavorable health care claims cost experience (including upward revisions in the assumed trend rate), with the remainder related to asset returns and other demographic factors.rate.) For 2006,2007, we currently expect incrementaltotal amortization of prior service cost and net experience losses to be approximately $25 million lower than the actual 2006 amount of approximately $10$123 million. As discussed on page 14, total employee benefits expense for 2007 is expected to be approximately even with the 2006 amount, with higher active health care claims cost and postretirement service and interest cost components offsetting the lower amortization expense.
Assuming actual future experience is consistent with our current assumptions, annual amortization of accumulated prior service cost and net experience losses during each of the next several years would remain approximately level with the 20062007 amount.
Income taxes
Our consolidated effective income tax rate is influenced by tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our effective tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are supportable, we believe that certain positions are likely to be challenged and that we may not succeed. We adjust these reserves in light of changing facts and circumstances, such as the progress of a tax audit. Our effective income tax rate includes the impact of reserve provisions and changes to reserves that we consider appropriate. While it is often difficultFor the periods presented, our income tax and related interest reserves have averaged approximately $150 million. Reserve adjustments for individual issues have rarely exceeded 1% of earnings before income taxes annually. Nevertheless, the accumulation of individually insignificant discrete adjustments throughout a particular year has historically impacted our consolidated effective income tax rate by up to predict the final outcome or the timing of resolution of any particular tax matter,200 basis points. As discussed on page 16, for 2007, we believe our rate could be up to 200 basis points lower if pending uncertain tax matters, including tax positions that could be affected by planning initiatives, are resolved more favorably than we currently expect.
For the periods presented, our policy was to establish reserves reflectthat reflected the probable outcome of known tax contingencies. Favorable resolution would bewas recognized as a reduction to our effective tax rate in the period of resolution. OurAs compared to a contingency approach, FIN No. 48 (which we adopted at the beginning of 2007) is


24

based on a benefit recognition model, which we believe could result in a greater amount of benefit (and a lower amount of reserve) being initially recognized in certain circumstances. Provided that the tax position is deemed more likely than not of being sustained, FIN No. 48 permits a company to recognize the largest amount of tax benefit that is greater than 50 percent likely of being ultimately realized upon settlement. The tax position must be derecognized when it is no longer more likely than not of being sustained. Despite this difference in conceptual approach, we do not currently expect the adoption of FIN No. 48 to have a significant impact on the amount of benefits recognized in connection with our uncertain tax positions during 2007. The current portion of our tax reserves areis presented in the balance sheet principally within accrued income taxes.taxes and the amount expected to be settled after one year is recorded in other noncurrent liabilities. Significant tax reserve adjustments impacting our effective tax rate would be separately presented in the rate reconciliation table of Note 11 within Notes to Consolidated Financial Statements. Historically, tax reserve adjustments for individual issues have rarely exceeded 1% of earnings before income taxes annually.
 Future Outlook
 Future Outlook
Our 2007 forecasted consolidated results are generally based on our long-term annual growth targets are low single-digit foras discussed on page 11, although we currently expect our internal net sales could increase as much as four percent, slightly exceeding our low single-digit growth target. We expect thishigher-than-targeted growth to come principally from continued category expansion in Latin America and strong innovation performance in North America. Despite a projected decline in gross margin of up to 50 basis points, we believe thehigher-than-targeted sales growth will support mid single-digit for internalconsolidated operating profit growth. As discussed on page 15, net interest expense for 2007 is expected to be approximately even with 2006 results and our consolidated effective income tax rate could be lower than the 2006 rate of approximately 32%. These two factors are expected to provide leverage for purposes of achieving our target of high single-digit forgrowth in 2007 net earnings per share. In addition, we remain committed to growing our brand-building investment faster than the rate of sales growth. In general, we expect 2006 results to be consistent with our growth targets for net sales and operating profit. We expect each of our operating segments to deliver low single-digit net sales growthreinvesting in 2006, except for Latin America, which we expect to achieve mid single-digit growth due to a continuation of the more rapid category expansion in that region. We expect the reported increase in net earnings per share to be dampened by approximately $.09, due to the adoption of SFAS No. 123(Revised), as discussed on pages 18 and 19. We will continue to reinvest inbrand building, cost-reduction initiatives, and other growth opportunities.
Lastly, we expect our cash flow performance to remain strong and are currently targeting a level of $950-$1,025 million for 2007.
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
The
Our Company is exposed to certain market risks, which exist as a part of theour ongoing business operations and management usesoperations. We use derivative financial and commodity instruments, where appropriate, to manage these risks. The Company, asAs a matter of policy, doeswe do not engage in trading or speculative transactions. Refer to Note 12 within Notes to the Consolidated Financial Statements which are included herein under Part II, Item 8, for further information on our accounting policies related to derivative financial and commodity instruments.
Foreign exchange risk
The
Our Company is exposed to fluctuations in foreign currency cash flows related to third-party purchases,

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intercompany transactions,loans and product shipments, and nonfunctional currency denominated third-party debt. TheOur Company is also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. Additionally, theour Company is exposed to volatility in the translation of foreign currency earnings to U.S. Dollars. Primary exposures include the U.S. Dollar versus the British Pound, Euro, Australian Dollar, Canadian Dollar, and Mexican Peso, and in the case of inter-subsidiary transactions, the British Pound versus the Euro. Management assessesWe assess foreign currency risk based on transactional cash flows and translational positionsvolatility and entersenter into forward contracts, options, and currency swaps to reduce fluctuations in net long or short currency positions. Forward contracts and options are generally less than 18 months duration. Currency swap agreements are established in conjunction with the term of underlying debt issuances.
The total notional amount of foreign currency derivative instruments at year-end 2006 was $455 million, representing a settlement obligation of $1 million. The total notional amount of foreign currency derivative instruments at year-end 2005 was $467.3$467 million, representing a settlement obligation of $21.9 million. The total notional amount of foreign currency derivative instruments at year-end 2004 was $375.5 million, representing a settlement obligation of $60.3$22 million. All of these derivatives were hedges of anticipated transactions, translational exposure, or existing assets or liabilities, and mature within 18 months. Assuming an unfavorable 10% change in year-end exchange rates, the settlement obligation would have increased by approximately $46.7$46 million at year-end 20052006 and $37.5$47 million at year-end 2004.2005. These unfavorable changes would generally have been offset by favorable changes in the values of the underlying exposures.


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Interest rate risk
The
Our Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing and future issuances of variable rate debt. Primary exposures include movements in U.S. Treasury rates, London Interbank Offered Rates (LIBOR), and commercial paper rates. ManagementWe periodically usesuse interest rate swaps and forward interest rate contracts to reduce interest rate volatility and funding costs associated with certain debt issues, and to achieve a desired proportion of variable versus fixed rate debt, based on current and projected market conditions.
Note 7 within Notes to the Consolidated Financial Statements which are included herein under Part II, Item 8, provides information on the Company’sour significant debt issues. There were no interest rate derivatives outstanding at year-end 20052006 and 2004.2005. Assuming average variable rate debt levels during the year, a one percentage point increase in interest rates would have increased interest expense by approximately $9.1$20 million in 20052006 and $2.3$9 million in 2004.2005.
Price risk
The
Our Company is exposed to price fluctuations primarily as a result of anticipated purchases of raw and packaging materials, fuel, and energy. Primary exposures include corn, wheat, soybean oil, sugar, cocoa, paperboard, natural gas, and diesel fuel. Management usesWe have historically used the combination of long cash positionslong-term contracts with suppliers, and
exchange-traded futures and option contracts to reduce price fluctuations in a desired percentage of forecasted raw material purchases over a duration of generally less than one year.18 months. During 2006, we entered into two separate10-yearover-the-counter commodity swap transactions to reduce fluctuations in the price of natural gas used principally in its manufacturing processes. The notional amount of the swaps totaled approximately $209 million, which currently equates to approximately 50% of our North America manufacturing needs.
The total notional amount of commodity derivative instruments at year-end 2006, including the natural gas swaps, was $239 million, representing a settlement obligation of approximately $11 million. Assuming a 10% decrease in year-end commodity prices, the settlement obligation would increase by approximately $17 million, generally offset by a reduction in the cost of the underlying commodity purchases. The total notional amount of commodity derivative instruments at year-end 2005 was $21.8$22 million, representing a settlement receivable of approximately $1.0$1 million. Assuming a 10% decrease in year-end commodity prices, this settlement receivable would convert to an obligation of approximately $1.3 million, generally offset by a reduction in the cost of the underlying material purchases. The total notional amount of commodity derivative instruments at year-end 2004 was $61.3 million, representing a settlement obligation of $4.8 million. Assuming a 10% decrease in year-end commodity prices, this settlement obligation would have increased by approximately $5.6$1 million, generally offset by a reduction in the cost of the underlying material purchases.
In addition to the derivative commodity instruments discussed above, management uses long cash positionswe use long-term contracts with suppliers to manage a portion of the price exposure. It should be noted that the exclusion of these positions from the analysis above could be a limitation in assessing the net market risk of theour Company.


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Item 8.Financial Statements and Supplementary Data
Kellogg Company and Subsidiaries
Consolidated Statement of Earnings
              
 
(millions, except per share data) 2005 2004 2003
 
Net sales
 $10,177.2  $9,613.9  $8,811.5 
 
Cost of goods sold  5,611.6   5,298.7   4,898.9 
Selling, general, and administrative expense  2,815.3   2,634.1   2,368.5 
 
Operating profit
 $1,750.3  $1,681.1  $1,544.1 
 
Interest expense  300.3   308.6   371.4 
Other income (expense), net  (24.9)  (6.6)  (3.2)
 
Earnings before income taxes
 $1,425.1  $1,365.9  $1,169.5 
Income taxes  444.7   475.3   382.4 
 
Net earnings
 $980.4  $890.6  $787.1 
 
Net earnings per share:
            
 Basic $2.38  $2.16  $1.93 
 Diluted  2.36   2.14   1.92 
 
               
 
(millions, except per share data) 2006 2005 2004  
 
Net sales
 $10,906.7  $10,177.2  $9,613.9   
Cost of goods sold  6,081.5   5,611.6   5,298.7   
Selling, general, and administrative expense  3,059.4   2,815.3   2,634.1   
Operating profit
 $1,765.8  $1,750.3  $1,681.1   
Interest expense  307.4   300.3   308.6   
Other income (expense), net  13.2   (24.9)  (6.6)  
Earnings before income taxes
  1,471.6   1,425.1   1,365.9   
Income taxes  466.5   444.7   475.3   
Earnings (loss) from joint venture  (1.0)  —   —   
Net earnings
 $1,004.1  $980.4  $890.6   
Per share amounts:
              
Basic $2.53  $2.38  $2.16   
Diluted  2.51   2.36   2.14   
 
 
Refer to Notes to Consolidated Financial Statements.


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Kellogg Company and Subsidiaries
Consolidated Statement of Shareholders’ Equity
                                     
 
        Accumulated  
  Common stock Capital in   Treasury stock other Total Total
    excess of Retained   comprehensive shareholders’ comprehensive
(millions) shares amount par value earnings shares amount income equity income
 
Balance, December 28, 2002  415.5  $103.8  $49.9  $1,873.0   7.6  $(278.2) $(853.4) $895.1  $418.9 
                             
Common stock repurchases                  2.9   (90.0)      (90.0)    
Net earnings              787.1               787.1   787.1 
Dividends              (412.4)              (412.4)    
Other comprehensive income                          124.2   124.2   124.2 
Stock options exercised and other          (25.4)      (4.7)  164.6       139.2     
 
Balance, December 27, 2003  415.5  $103.8  $24.5  $2,247.7   5.8  $(203.6) $(729.2) $1,443.2  $911.3 
                             
Common stock repurchases                  7.3   (297.5)      (297.5)    
Net earnings              890.6               890.6   890.6 
Dividends              (417.6)              (417.6)    
Other comprehensive income                          289.3   289.3   289.3 
Stock options exercised and other          (24.5)  (19.4)  (10.7)  393.1       349.2     
 
Balance, January 1, 2005  415.5  $103.8   —  $2,701.3   2.4  $(108.0) $(439.9) $2,257.2  $1,179.9 
                             
Common stock repurchases                  15.4   (664.2)      (664.2)    
Net earnings              980.4               980.4   980.4 
Dividends              (435.2)              (435.2)    
Other comprehensive income                          (136.2)  (136.2)  (136.2)
Stock options exercised and other  3.0   .8   58.9   19.6   (4.7)  202.4       281.7     
 
Balance, December 31, 2005
  418.5  $104.6  $58.9  $3,266.1   13.1  $(569.8) $(576.1) $2,283.7  $844.2 
 
                                     
 
              Accumulated
    
      Capital in
       other
 Total
 Total
  Common stock excess of
 Retained
 Treasury stock comprehensive
 shareholders’
 comprehensive
(millions) shares amount par value earnings shares amount income equity income
Balance, December 27, 2003  415.5  $103.8  $24.5  $2,247.7   5.8  $(203.6) $(729.2) $1,443.2  $911.3 
                                     
Common stock repurchases                  7.3   (297.5)      (297.5)    
Net earnings              890.6               890.6   890.6 
Dividends              (417.6)              (417.6)    
Other comprehensive income                ��         289.3   289.3   289.3 
Stock options exercised and other          (24.5)  (19.4)  (10.7)  393.1       349.2     
 
 
Balance, January 1, 2005  415.5  $103.8  $—  $2,701.3   2.4  $(108.0) $(439.9) $2,257.2  $1,179.9 
                                     
Common stock repurchases                  15.4   (664.2)      (664.2)    
Net earnings              980.4               980.4   980.4 
Dividends              (435.2)              (435.2)    
Other comprehensive income                          (136.2)  (136.2)  (136.2)
Stock options exercised and other  3.0   .8   58.9   19.6   (4.7)  202.4       281.7     
 
 
Balance, December 31, 2005  418.5  $104.6  $58.9  $3,266.1   13.1  $(569.8) $(576.1) $2,283.7  $844.2 
                                     
Revision (a)          101.4   (101.4)              —     
Common stock repurchases                  14.9   (649.8)      (649.8)    
Net earnings              1,004.1               1,004.1   1,004.1 
Dividends              (449.9)              (449.9)    
Other comprehensive income                          121.8   121.8   121.8 
Stock compensation          85.7                   85.7     
Stock options exercised and other          46.3   (88.5)  (7.2)  307.5       265.3     
Impact of adoption of SFAS No. 158 (a)                          (591.9)  (591.9)    
 
 
Balance, December 30, 2006
  418.5  $104.6  $292.3  $3,630.4   20.8  $(912.1) $(1,046.2) $2,069.0  $1,125.9 
 
 
Refer to Notes to Consolidated Financial Statements.
(a)Refer to Note 5 for further information on these items.


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Kellogg Company and Subsidiaries
Consolidated Balance Sheet
           
 
(millions, except share data) 2005 2004
 
Current assets
        
Cash and cash equivalents $219.1  $417.4 
Accounts receivable, net  879.1   776.4 
Inventories  717.0   681.0 
Other current assets  381.3   247.0 
 
 
Total current assets
 $2,196.5  $2,121.8 
 
Property, net
  2,648.4   2,715.1 
Other assets
  5,729.6   5,725.0 
 
 
Total assets
 $10,574.5  $10,561.9 
 
Current liabilities
        
Current maturities of long-term debt $83.6  $278.6 
Notes payable  1,111.1   750.6 
Accounts payable  883.3   726.3 
Other current liabilities  1,084.8   1,090.5 
 
 
Total current liabilities
 $3,162.8  $2,846.0 
 
Long-term debt
  3,702.6   3,892.6 
Other liabilities
  1,425.4   1,566.1 
Shareholders’ equity
        
Common stock, $.25 par value, 1,000,000,000 shares authorized
Issued: 418,451,198 shares in 2005 and 415,451,198 shares in 2004		  104.6   103.8 
Capital in excess of par value  58.9   — 
Retained earnings  3,266.1   2,701.3 
Treasury stock at cost:        
  13,121,446 shares in 2005 and 2,428,824 shares in 2004  (569.8)  (108.0)
Accumulated other comprehensive income (loss)  (576.1)  (439.9)
 
 
Total shareholders’ equity
 $2,283.7  $2,257.2 
 
 
Total liabilities and shareholders’ equity
 $10,574.5  $10,561.9 
 
           
 
(millions, except share data) 2006 2005  
Current assets
          
Cash and cash equivalents $410.6  $219.1   
Accounts receivable, net  944.8   879.1   
Inventories  823.9   717.0   
Other current assets  247.7   381.3   
 
 
Total current assets
 $2,427.0  $2,196.5   
 
 
Property, net
  2,815.6   2,648.4   
Other assets
  5,471.4   5,729.6   
 
 
Total assets
 $10,714.0  $10,574.5   
 
 
Current liabilities
          
Current maturities of long-term debt $723.3  $83.6   
Notes payable  1,268.0   1,111.1   
Accounts payable  910.4   883.3   
Other current liabilities  1,118.5   1,084.8   
 
 
Total current liabilities
 $4,020.2  $3,162.8   
 
 
Long-term debt
  3,053.0   3,702.6   
Other liabilities
  1,571.8   1,425.4   
Shareholders’ equity
          
Common stock, $.25 par value, 1,000,000,000 shares authorized          
Issued: 418,515,339 shares in 2006 and 418,451,198 shares in 2005  104.6   104.6   
Capital in excess of par value  292.3   58.9   
Retained earnings  3,630.4   3,266.1   
Treasury stock at cost:          
20,817,930 shares in 2006 and 13,121,446 shares in 2005  (912.1)  (569.8)  
Accumulated other comprehensive income (loss)  (1,046.2)  (576.1)  
 
 
Total shareholders’ equity
 $2,069.0  $2,283.7   
 
 
Total liabilities and shareholders’ equity
 $10,714.0  $10,574.5   
 
 
Refer to Notes to Consolidated Financial Statements. In particular, refer to Note 15 for supplemental information on various balance sheet captions.captions and Note 1 for details on the impact of adopting SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”


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Kellogg Company and Subsidiaries
Consolidated Statement of Cash Flows
              
 
(millions) 2005 2004 2003
 
Operating activities
            
Net earnings $980.4  $890.6  $787.1 
Adjustments to reconcile net earnings to operating cash flows:            
 Depreciation and amortization  391.8   410.0   372.8 
 Deferred income taxes  (59.2)  57.7   74.8 
 Other  199.3   104.5   76.1 
Pension and other postretirement benefit plan contributions  (397.3)  (204.0)  (184.2)
Changes in operating assets and liabilities  28.3   (29.8)  44.4 
 
 
Net cash provided from operating activities
 $1,143.3  $1,229.0  $1,171.0 
 
Investing activities
            
Additions to properties $(374.2) $(278.6) $(247.2)
Acquisitions of businesses  (50.4)  —   — 
Dispositions of businesses  —   —   14.0 
Property disposals  9.8   7.9   13.8 
Other  (.2)  .3   .4 
 
 
Net cash used in investing activities
 $(415.0) $(270.4) $(219.0)
 
Financing activities
            
Net increase of notes payable, with maturities less than or equal to 90 days $360.2  $388.3  $208.5 
Issuances of notes payable, with maturities greater than 90 days  42.6   142.3   67.0 
Reductions of notes payable, with maturities greater than 90 days  (42.3)  (141.7)  (375.6)
Issuances of long-term debt  647.3   7.0   498.1 
Reductions of long-term debt  (1,041.3)  (682.2)  (956.0)
Net issuances of common stock  221.7   291.8   121.6 
Common stock repurchases  (664.2)  (297.5)  (90.0)
Cash dividends  (435.2)  (417.6)  (412.4)
Other  5.9   (6.7)  (.6)
 
 
Net cash used in financing activities
 $(905.3) $(716.3) $(939.4)
 
Effect of exchange rate changes on cash  (21.3)  33.9   28.0 
 
Increase (decrease) in cash and cash equivalents $(198.3) $276.2  $40.6 
Cash and cash equivalents at beginning of year  417.4   141.2   100.6 
 
 
Cash and cash equivalents at end of year
 $219.1  $417.4  $141.2 
 
               
 
(millions) 2006 2005 2004  
 
Operating activities
              
Net earnings $1,004.1  $980.4  $890.6   
Adjustments to reconcile net earnings to operating cash flows:              
Depreciation and amortization  352.7   391.8   410.0   
Deferred income taxes  (43.7)  (59.2)  57.7   
Other (a)  235.2   199.3   104.5   
Pension and other postretirement benefit plan contributions  (99.3)  (397.3)  (204.0)  
Changes in operating assets and liabilities  (38.5)  28.3   (29.8)  
 
 
Net cash provided by operating activities
 $1,410.5  $1,143.3  $1,229.0   
 
 
Investing activities
              
Additions to properties $(453.1) $(374.2) $(278.6)  
Acquisitions of businesses   —   (50.4)  —   
Property disposals  9.4   9.8   7.9   
Investment in joint venture and other  (1.7)  (.2)  .3   
 
 
Net cash used in investing activities
 $(445.4) $(415.0) $(270.4)  
 
 
Financing activities
              
Net increase (reduction) of notes payable, with maturities
less than or equal to 90 days		 $(344.2) $360.2  $388.3   
Issuances of notes payable, with maturities greater than 90 days  1,065.4   42.6   142.3   
Reductions of notes payable, with maturities greater than 90 days  (565.2)  (42.3)  (141.7)  
Issuances of long-term debt   —   647.3   7.0   
Reductions of long-term debt  (84.7)  (1,041.3)  (682.2)  
Issuances of common stock  217.5   221.7   291.8   
Common stock repurchases  (649.8)  (664.2)  (297.5)  
Cash dividends  (449.9)  (435.2)  (417.6)  
Other  21.9   5.9   (6.7)  
 
 
Net cash used in financing activities
 $(789.0) $(905.3) $(716.3)  
 
 
Effect of exchange rate changes on cash  15.4   (21.3)  33.9   
 
 
Increase (decrease) in cash and cash equivalents $191.5  $(198.3) $276.2   
Cash and cash equivalents at beginning of year  219.1   417.4   141.2   
 
 
Cash and cash equivalents at end of year
 $410.6  $219.1  $417.4   
 
 
Refer to Notes to Consolidated Financial Statements.
(a)Consists principally ofnon-cash expense accruals for employee compensation and benefit obligations.


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Note 1 Accounting policies
Note 1 Accounting policies
Basis of presentation
The consolidated financial statements include the accounts of Kellogg Company and its majority-owned subsidiaries. Intercompany balances and transactions are eliminated. Certain amounts in the prior-year financial statements have been reclassified to conform to the current-year presentation. In addition, certain current-year disclosures reflect revisions of related amounts as compared to the disclosures reported in the prior year. For purposes of consistency, such revisions have also been reflected in the comparative prior-year amounts presented herein.
The Company’s fiscal year normally ends on the Saturday closest to December 31 and as a result, a 53rd week is added approximately every sixth year. The Company’s 20052006 and 20032005 fiscal years ended on December 3130 and 27,December 31, respectively. The Company’s 2004 fiscal year ended on January 1, 2005, and included a 53rd week.
Cash and cash equivalents
Highly liquid temporary investments with original maturities of less than three months are considered to be cash equivalents. The carrying amount approximates fair value.
Accounts receivable
Accounts receivable consist principally of trade receivables, which are recorded at the invoiced amount, net of allowances for doubtful accounts and prompt payment discounts. Trade receivables generally do not bear interest. Terms and collection patterns vary around the world and by channel. In the United States, the Company generally has required payment for goods sold eleven or sixteen days subsequent to the date of invoice as 2% 10/net 11 or 1% 15/net 16, and days sales outstanding (DSO) averages 18-19 days.has averaged approximately 19 days during the periods presented. The allowance for doubtful accounts represents management’s estimate of the amount of probable credit losses in existing accounts receivable, as determined from a review of past due balances and other specific account data. Account balances are written off against the allowance when management determines the receivable is uncollectible. The Company does not have any off-balance-sheetoff-balance sheet credit exposure related to its customers. Refer to Note 15 for an analysis of the Company’s accounts receivable and allowance for doubtful account balances during the periods presented.
Inventories
Inventories are valued at the lower of cost (principally average) or market.
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 151 “Inventory Costs,”Costs” to converge U.S. GAAP principles with International Accounting Standards on inventory valuation. SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and spoilage should be recognized as period charges, rather than as inventory value. This standard also provides that fixed production overheads should be allocated to units of production based on the normal capacity of production facilities, with excess overheads being recognized as period charges. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted. The Company adopted this standard at the beginning of its 2006 fiscal year. Management believes theThe Company’s pre-existing accounting policy for inventory valuation was generally consistent with this guidance and does not, therefore, currently expectguidance. Accordingly, the adoption of SFAS No. 151 todid not have a significant impact on the Company’s 2006 financial results.
Property
The Company’s property consists mainly of plant and equipment used for manufacturing activities. These assets are recorded at cost and depreciated over estimated useful lives using straight-line methods for financial reporting and accelerated methods, where permitted, for tax reporting. Major property categories are depreciated over various periods as follows (in years): manufacturing machinery and equipment 5-20; computer and other office equipment 3-5; building components15-30; building structures 50. Cost includes an amount of interest associated with significant capital projects. Plant and equipment are reviewed for impairment when conditions indicate that the carrying value may not be recoverable. Such conditions include an extended period of idleness or a plan of disposal. Assets to be abandoned at a future date are depreciated over the remaining period of use. Assets to be sold are written down to realizable value at the time the assets are being actively marketed for sale and the disposal is expected to occur within one year. As of year-end 20042005 and 2005,2006, the carrying value of assets held for sale was insignificant.
Goodwill and other intangible assets
The Company’s intangible assets consist primarily of goodwill and major trademarks arising from the 2001 acquisition of Keebler Foods Company (“Keebler”). Management expects the Keebler trademarks, collectively, to contribute indefinitely to the cash flows of the Company. Accordingly, this asset has been classified as an “indefinite-lived” intangible pursuant to SFAS No. 142 “Goodwill and Other Intangible Assets.” Under


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Intangible Assets.” Under
this standard, goodwill and indefinite-lived intangibles are not amortized, but are tested at least annually for impairment. Goodwill impairment testing first requires a comparison between the carrying value and fair value of a “reporting unit,” which for the Company is generally equivalent to a North American product group or International country market. If carrying value exceeds fair value, goodwill is considered impaired and is reduced to the implied fair value. Impairment testing fornon-amortized intangibles requires a comparison between the fair value and carrying value of the intangible asset. If carrying value exceeds fair value, the intangible is considered impaired and is reduced to fair value. The Company uses various market valuation techniques to determine the fair value of intangible assets and periodically engages third partythird-party valuation consultants for this purpose. Refer to Note 2 for further information on goodwill and other intangible assets.
Revenue recognition and measurement
The Company recognizes sales upon delivery of its products to customers net of applicable provisions for discounts, returns, allowances, and allowances.various government withholding taxes. Methodologies for determining these provisions are dependent on local customer pricing and promotional practices, which range from contractually fixed percentage price reductions to reimbursement based on actual occurrence or performance. Where applicable, future reimbursements are estimated based on a combination of historical patterns and future expectations regarding specific in-market product performance. The Company classifies promotional payments to its customers, the cost of consumer coupons, and other cash redemption offers in net sales. The cost of promotional package inserts are recorded in cost of goods sold. Other types of consumer promotional expenditures are normally recorded in selling, general, and administrative (SGA) expense.
Advertising
The costs of advertising are generally expensed as incurred and are classified within SGA.SGA expense.
Stock compensationResearch and development
For the periods presented, the
The costs of research and development (R&D) are generally expensed as incurred and are classified within SGA expense. R&D includes expenditures for new product and process innovation, as well as significant technological improvements to existing products and processes. Total annual expenditures for R&D are disclosed in Note 15 and are principally comprised of internal salaries, wages, consulting, and supplies attributable to time spent on R&D activities. Other costs include depreciation and maintenance of research facilities and equipment, including assets at manufacturing locations that are temporarily engaged in pilot plant activities.
Stock compensation
The Company used the intrinsic value method prescribed by Accounting Principles Board Opinion (APB) No. 25 “Accounting for Stock Issueduses various equity-based compensation programs to Employees,” to accountprovide long-term performance incentives for its employee stock options and other stock-based compensation. Under this method, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense was recognized. The following table presents the pro forma results for the current and prior years, as if the Company had used the alternate fair value method of accounting for stock-based compensation, prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation” (as amended by SFAS No. 148). Under this pro forma method, the fair value of each option grant (net of estimated unvested forfeitures) was estimated at the date of grant using an option pricing model and was recognized over the vesting period, generally two years. For 2003, the Company used the Black-Scholes option pricing model. For 2004 and 2005, the Company used a lattice-based or binomial model, which management believes to be a superior method for valuing the impact of different employee option exercise patterns under various economic and market conditions. This change in methodology did not have a significant impact on pro forma 2004 and 2005 results versus prior years.global workforce. Refer to Note 8 for further information on these programs and the Company’s stockamount of compensation programs.expense recognized during the periods presented.
              
 
  2005 2004 2003
(millions except per share data)      
 
Stock-based compensation expense, net of tax:            
 As reported (a) $11.8  $11.4  $12.5 
 Pro forma $48.7  $41.8  $42.1 
Net earnings:            
 As reported $980.4  $890.6  $787.1 
 Pro forma $943.5  $860.2  $757.5 
Basic net earnings per share:            
 As reported $2.38  $2.16  $1.93 
 Pro forma $2.29  $2.09  $1.86 
Diluted net earnings per share:            
 As reported $2.36  $2.14  $1.92 
 Pro forma $2.27  $2.07  $1.85 
 
             
 
Weighted-average pricing 2005 2004 (a) 2003
model assumptions      
 
Risk-free interest rate  3.81%  2.73%  1.89%
Dividend yield  2.40%  2.60%  2.70%
Volatility  22.00%  23.00%  25.75%
Average expected term (years)  3.42   3.69   3.00 
Fair value of options granted $7.35  $6.39  $4.75 
 
(a)As reported stock-based compensation expense for 2004 includes a pre-tax charge of $5.5 ($3.6 after tax) related to the accelerated vesting of .6 stock options pursuant to a separation agreement between the Company and its former CEO. This modification to the terms of the original awards was treated as a renewal under FASB Interpretation No. 44 “Accounting for Certain Transactions involving Stock Compensation.” Accordingly, the Company recognized in SGA the intrinsic value of the awards at the modification date. The pricing assumptions for this renewal are excluded from the table above and were: risk-free interestrate-2.32%; dividendyield-2.6%;volatility-23%; expectedterm-.33 years, resulting in a per-option fair value of $9.16.
In December 2004, the FASB issued SFAS No. 123(Revised)123(R) “Share-Based Payment,” which generally requires public companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value and to recognize this cost over the requisite service period.
The standard is effective for public companies for annual periods beginning after June 15, 2005, with several transition options regarding prospective versus retrospective application. The Company

28

adopted SFAS No. 123(Revised)123(R) as of the beginning of its 2006 fiscal year, using the modified prospective method. Accordingly, prior years were not restated, but 2006 results are being presented as ifinclude compensation expense associated with unvested equity-based awards, which were granted prior to 2006.
Prior to adoption of SFAS No. 123(R), the Company had appliedused the fairintrinsic value method of accountingprescribed by Accounting Principles Board Opinion (APB) No. 25 “Accounting for stock-based compensation fromStock Issued to Employees” to account for its 1996 fiscal year. If this standard had been adopted in 2005, net earnings per share would have been reduced by approximately $.09 and management currently expects a similar impact of adoption for 2006. However, the actual impact on 2006 will, in part, depend on the particular structure of stock-based awards granted during the year and various market factors that affect the fair value of awards. The Company classifies pre-tax stock compensation expense in selling, general, and administrative expense principally within its corporate operations.
SFAS No. 123(Revised) also provides that any corporate income tax benefit realized upon exercise or vesting of an award in excess of that previously recognized in earnings will be presented in the Statement of Cash Flows as a financing (rather than an operating) cash flow. If this standard had been adopted in 2005, operating cash flow would have been lower (and financing cash flow would have been higher) by approximately $20 million as a result of this provision. The actual impact on 2006 operating cash flow will depend, in part, on the volume of employee stock option exercises duringoptions and other stock-based compensation. Under this method, because the yearexercise price of stock options granted to employees and directors equaled the relationship between the exercise-date market valueprice of the underlying stock andon the original grant-date fair value determined for financial reporting purposes.date of the grant, no compensation expense was recognized. Expense attributable to other types of stock-based awards was generally recognized in the Company’s reported results under APB No. 25.
Certain of the Company’s equity-based compensation plans contain provisions that accelerate vesting of awards upon retirement, disability, or death of eligible employees and directors. For the periods presented,Prior to adoption of SFAS No. 123(R), the Company generally recognized stock compensation expense over the stated vesting period of the award, with any unamortized expense recognized immediately if an acceleration event occurred. SFAS 123(Revised)No. 123(R) specifies that a stock-based award is considered vested for expense attribution purposes when the employee’s retention of the award is no longer contingent on providing subsequent service. Accordingly, beginning in 2006, the Company has prospectively revised its expense attribution method so that the related compensation cost is recognized immediately for awards granted to retirement-eligible individuals or over the


32

period from the grant date to the date retirement eligibility is achieved, if less than the stated vesting period. Management expects
The Company classifies pre-tax stock compensation expense principally in SGA expense within its corporate operations. Expense attributable to awards of equity instruments is accrued in capital in excess of par value within the Consolidated Balance Sheet.
SFAS No. 123(R) also provides that any corporate income tax benefit realized upon exercise or vesting of an award in excess of that previously recognized in earnings (referred to as a “windfall tax benefit”) will be presented in the Consolidated Statement of Cash Flows as a financing (rather than an operating) cash flow. Realized windfall tax benefits are credited to capital in excess of par value in the Consolidated Balance Sheet. Realized shortfall tax benefits (amounts which are less than that previously recognized in earnings) are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense. Under the transition rules for adopting SFAS No. 123(R) using the modified prospective method, the Company was permitted to calculate a cumulative memo balance of windfall tax benefits from post-1995 years for the purpose of accounting for future shortfall tax benefits. The Company completed such study prior to the first period of adoption and currently has sufficient cumulative memo windfall tax benefits to absorb arising shortfalls, such that earnings were not affected in 2006. Correspondingly, the Company includes the impact of pro forma deferred tax assets (i.e., the “as if” windfall or shortfall) for purposes of determining assumed proceeds in the treasury stock calculation of diluted earnings per share under SFAS No. 128 “Earnings Per Share.”
Employee postretirement and postemployment benefits
The Company sponsors a number of U.S. and foreign plans to provide pension, health care, and other welfare benefits to retired employees, as well as salary continuance, severance, and long-term disability to former or inactive employees. Refer to Notes 9 and 10 for further information on these benefits and the amount of expense recognized during the periods presented.
In order to improve the reporting of pension and other postretirement benefit plans in the financial statements, in September 2006, the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” which is effective at the end of fiscal years ending after December 15, 2006. Prior periods are not restated. The standard generally requires company plan sponsors to measure the net over- or under-funded position of a defined postretirement benefit plan as of the sponsor’s fiscal year end and to display that position as an asset or liability on the balance sheet. Any unrecognized prior service cost, experience gains/losses, or transition obligation are reported as a component of other comprehensive income, net of tax, in shareholders’ equity. In contrast, under pre-existing guidance, these unrecognized amounts were generally disclosed only in financial statement footnotes, often resulting in a disparity between plan balance sheet positions and the funded status. Furthermore, plan measurement dates could occur up to three months prior to year end.
The Company adopted SFAS No. 158 as of the end of its 2006 fiscal year. The Company had previously applied postretirement accounting concepts for purposes of recognizing its postemployment benefit obligations; accordingly, the adoption of SFAS No. 158 as of December 30, 2006, affected the balance sheet display of both the Company’s postretirement and postemployment benefit obligations, as follows:
               
 
  Before
   After
  
  application
   application
  
  of SFAS
   of SFAS
  
(millions) No. 158 (a) Adjustments No. 158  
 
 
Other assets:              
Other intangibles — pension $9.5  $(9.5) $—   
Pension  855.5   (502.9)  352.6   
 
 
  $865.0  $(512.4) $352.6   
 
 
Total assets $865.0  $(512.4) $352.6   
 
 
Other current liabilities:              
Pension, postretirement, and postemployment benefits  53.0   (34.2)  18.8   
 
 
  $53.0  $(34.2) $18.8   
 
 
Other liabilities:              
Pension, postretirement, and postemployment benefits (a)  287.2   412.6   699.8   
Deferred income taxes (b)  (6.8)  (298.9)  (305.7)  
 
 
  $280.4  $113.7  $394.1   
 
 
Total liabilities $333.4  $79.5  $412.9   
 
 
Accumulated other comprehensive income (loss) (a) $(12.2) $(591.9) $(604.1)  
 
 
(a)Includes additional minimum pension liability adjustment under pre-existing guidance of $28.5, which reduced accumulated other comprehensive income by $12.2 on an after-tax basis.
(b)Represents an asset component of deferred tax liabilities, which are presented on a net basis at the jurisdiction level.
The Company’s net earnings, cash flow, liquidity, debt covenants, and plan funding requirements were not affected by this change in expense attribution methodaccounting principle. The Company has historically used its fiscal year end as the measurement date for its company-sponsored defined benefit plans.


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Recently issued pronouncements
Uncertain tax positions
In July 2006, the FASB issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (FIN No. 48) to clarify what criteria must be met prior to recognition of the financial statement benefit, in accordance with FASB Statement No. 109, “Accounting for Income Taxes,” of a position taken in a tax return. The provisions of the final interpretation apply broadly to all tax positions taken by an enterprise, including the decision not to report income in a tax return or the decision to classify a transaction as tax exempt. The prescribed approach is based on a two-step benefit recognition model. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, based on the technical merits and without consideration of detection risk, that the position will be immaterial.sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the appropriate amount of the benefit to recognize. The amount of benefit to recognize is measured as the largest amount of tax benefit that is greater than 50 percent likely of being ultimately realized upon settlement. The tax position must be derecognized when it is no longer more likely than not of being sustained. The interpretation also provides guidance on recognition and classification of related penalties and interest, classification of liabilities, and disclosures of unrecognized tax benefits. The change in net assets, if any, as a result of applying the provisions of this interpretation is considered a change in accounting principle with the cumulative effect of the change treated as an offsetting adjustment to the opening balance of retained earnings in the period of transition. The final interpretation is effective for the first annual period beginning after December 15, 2006, with earlier application encouraged.
The Company adopted FIN No. 48 as of the beginning of its 2007 fiscal year. Prior to adoption, the Company’s pre-existing policy was to establish reserves for uncertain tax positions that reflected the probable outcome of known tax contingencies. As compared to the Company’s historical approach, the application of FIN No. 48 resulted in a net decrease to accrued income tax and related interest liabilities of approximately $2 million, with an offsetting increase to retained earnings.
Interest recognized in accordance with FIN No. 48 may be classified in the financial statements as either income taxes or interest expense, based on the accounting policy election of the enterprise. Similarly, penalties may be classified as income taxes or another expense. The Company has historically classified income tax-related interest and penalties as interest expense and SGA expense, respectively, and will continue to do so under FIN No. 48.
Fair value
In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements” to provide enhanced guidance for using fair value to measure assets and liabilities. The standard also expands disclosure requirements for assets and liabilities measured at fair value, how fair value is determined, and the effect of fair value measurements on earnings. The standard applies whenever other authoritative literature requires (or permits) certain assets or liabilities to be measured at fair value, but does not expand the use of fair value. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. Early adoption is permitted. The Company plans to adopt SFAS No. 157 in the first quarter of its 2008 fiscal year. For the Company, balance sheet items carried at fair value consist primarily of derivatives and other financial instruments, assets held for sale, exit liabilities, and the trust asset component of net benefit plan obligations. Additionally, the Company uses fair value concepts to test various long-lived assets for impairment and to initially measure assets and liabilities acquired in a business combination. Management is currently evaluating the impact of adoption on how these assets and liabilities are currently measured.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.


34

Note 2 Acquisitions, other investments, and intangibles
Acquisitions
In order to support the continued growth of its North American fruit snacks business, the Company completed two separate business acquisitions during 2005 for a total of approximately $50 million in cash, including related transaction costs. In June 2005, the Company acquired a fruit snacks manufacturing facility and related assets from Kraft Foods Inc. The facility is located in Chicago, Illinois and employs approximately 400 active hourly and salaried employees. The Company has begun to pack some of its contract-manufactured products within this facility and is planning to in-source some of this production during 2006. In November 2005, the Company acquired substantially all of the assets and certain liabilities of a Washington State-based manufacturer of natural and organic fruit snacks. Assets, liabilities, and results of the acquired businesses have been included in the Company’s consolidated financial statements since the respective dates of acquisition. As of December 31, 2005, theThe combined purchase price allocationfor both transactions was substantially complete with the combined total allocated to property ($22 million); goodwill and other indefinite-lived intangibles ($16 million); and inventory and other working capital ($12 million).
Joint venture arrangement
In early 2006, a subsidiary of the Company formed a joint venture with a third-party company domiciled in Turkey, for the purpose of selling co-branded products in the surrounding region. As of December 30, 2006, the Company had contributed approximately $3.5 million in cash for a 50% equity interest in this arrangement. The Turkish joint venture is reflected in the consolidated financial statements on the equity basis of accounting. Accordingly, the Company records its share of the earnings or loss from this arrangement as well as other direct transactions with or on behalf of the joint venture entity such as product sales and certain administrative expenses. Summary financial information for one hundred percent of the joint venture is as follows:
     
 
(millions) 2006
 
 
Net sales $6.0 
Gross profit  1.9 
Net earnings (loss)  (1.9)
 
 
Current assets  5.9 
Noncurrent assets  — 
Current liabilities  1.3 
Noncurrent liabilities  — 
 
 
Goodwill and other intangible assets
During 2005, the Company reclassified $578.9 million attributable to its direct store-door (DSD) delivery system from indefinite-lived intangible assets to goodwill, net of an associated deferred tax liability of $228.5 million. Prior periods were likewise reclassified.
For 2004, the Company recorded in selling, general, and administrative (SGA) expense impairment losses of $10.4 million to write off the remaining carrying value of certain intangible assets. As presented in the following tables, the total amount consisted ofa $7.9 million attributable to a long-term licensing

29

agreementcontract-based intangible asset in North America and $2.5 million of goodwill in Latin America.
                 
 
Intangible assets subject to amortization
 
  Gross carrying Accumulated
(millions) amount amortization
 
  2005 2004 2005 2004
 
Trademarks $29.5  $29.5  $20.5  $19.4 
Other  29.1   29.1   27.1   26.7 
 
Total $58.6  $58.6  $47.6  $46.1 
 
         
 
Amortization expense (a) 2005 2004(b)
 
Year-to-date $1.5  $11.0 
 
For the periods presented, the Company’s intangible assets consisted of the following:
                 
 
Intangible assets subject to amortization
 
  Gross carrying
 Accumulated
(millions) amount amortization
 
  2006 2005 2006 2005
 
 
Trademarks $29.5  $29.5  $21.6  $20.5 
Other  29.1   29.1   27.5   27.1 
 
 
Total $58.6  $58.6  $49.1  $47.6 
 
 
         
 
  2006 2005
 
 
Amortization expense (a) $1.5  $1.5 
 
 
(a)The currently estimated aggregate amortization expense for each of the 5four succeeding fiscal years is approximately $1.5 per year and $1.1 for the fifth succeeding fiscal year.
         
 
Intangible assets not subject to amortization
 
(millions) Total carrying amount
 
  2006 2005
 
 
Trademarks $1,410.2  $1,410.2 
Pension (a)  —   17.0 
 
 
Total $1,410.2  $1,427.2 
 
 
(a)The Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the end of its 2006 fiscal year. The standard generally requires company plan sponsors to reflect the net over- or under-funded position of a defined postretirement benefit plan as an asset or liability on the balance sheet. Accordingly, the pension-related intangible included in the preceding table for 2005 was eliminated by the adoption of this standard. Refer to Note 1 for further information.
                     
 
Changes in the carrying amount of goodwill
 
        Asia
  
  United
   Latin
 Pacific
 Consoli-
(millions) States Europe America (a) dated
 
 
January 1, 2005 $3,443.3   —   —  $2.2  $3,445.5 
Acquisitions  10.2   —   —   —   10.2 
Other  (.3)  —   —   (.1)  (.4)
 
 
December 31, 2005 $3,453.2   —   —  $2.1  $3,455.3 
Purchase accounting adjustments (b)  (7.0)  —   —   —   (7.0)
Other  (.1)  —   —   .1   — 
 
 
December 30, 2006
 $3,446.1   —   —  $2.2  $3,448.3 
 
 
(a)Includes Australia and Asia.
 
(b)Amortization for 2004 includes impairment lossRelates principally to the recognition of approximately $7.9.an acquired tax benefit arising from the purchase of Keebler Foods Company in 2001.
         
 
Intangible assets not subject to amortization
 
(millions) Total carrying amount
 
  2005 2004
 
Trademarks $1,410.2  $1,404.0 
Other  17.0   25.7 
 
Total $1,427.2  $1,429.7 
 
                     
 
Changes in the carrying amount of goodwill
 
(millions) United States Europe Latin America Asia Pacific(a) Consolidated
 
December 27, 2003 $3,444.2   —  $2.5  $2.1  $3,448.8 
Purchase accounting adjustments  (.9)  —   —   —   (.9)
Impairments  —   —   (2.5)  —   (2.5)
Other  —   —   —   .1   .1 
 
January 1, 2005 $3,443.3   —   —  $2.2  $3,445.5 
Acquisitions  10.2   —   —   —   10.2 
Other  (.3)  —   —   (.1)  (.4)
 
December 31, 2005
 $3,453.2   —   —  $2.1  $3,455.3 
 
(a)Includes Australia and Asia.


35

Note 3 Cost-reduction initiatives
Note 3 Cost-reduction initiatives
The Company undertakesviews its continued spending on cost-reduction initiatives as part of its sustainable growth model ofongoing operating principles to reinvest earnings reinvestment forso as to provide greater reliability in meeting long-term growth targets. Initiatives undertaken must meet certain pay-back and internal rate of return (IRR) targets. Each cost-reduction initiative is normally one to three years in duration. Upon completion (or as each major stage is completed in the case of relatively short duration, and normallymulti-year programs), the project begins to deliver cash savingsand/or reduced depreciation, during the first year of implementation, which is then used to fund new initiatives. To implement these programs, the Company has incurred various up-front costs, including asset write-offs, exit charges, and other project expenditures.
Cost summary
For 2006, the Company recorded total program-related charges of approximately $82 million, comprised of $20 million of asset write-offs, $30 million for severance and other exit costs, $9 million for other cash expenditures, $4 million for a multiemployer pension plan withdrawal liability, and $19 million for pension and other postretirement plan curtailment losses and special termination benefits. Approximately $74 million of the total 2006 charges were recorded in cost of goods sold within operating segment results, with approximately $8 million recorded in selling, general, and administrative (SGA) expense within corporate results. The Company’s operating segments were impacted as follows (in millions): North America−$46; Europe−$28.
For 2005, the Company recorded total program-related charges of approximately $90 million, comprised of $16 million for a multiemployer pension plan withdrawal liability, $44 million of asset write-offs, and $30$21 million for severance and other exit costs, and $9 million for other cash expenditures. All of the 2005 charges were recorded in cost of goods sold within the Company’s North AmericanAmerica operating segment.
For 2004, the Company recorded total program-related charges of approximately $109 million, comprised of $41 million in asset write-offs, $1 million for special pension termination benefits, $15 million in severance and other exit costs, and $52 million in other cash expenditures such as relocation and consulting. Approximately $46 million of the total 2004 charges were recorded in cost of goods sold, with approximately $63 million recorded in selling, general, and administrative (SGA)SGA expense. The 2004 charges impacted the Company’s operating segments as follows (in millions): North America-America−$44, Europe-44; Europe−$65.
For 2003, the Company recorded total program-related charges of approximately $71 million, comprised of $40 million in asset write-offs, $8 million for special pension termination benefits, and $23 million in severance and other cash costs. Approximately $67 million of the total 2003 charges were recorded in cost of goods sold, with approximately $4 million recorded in SGA expense. The 2003 charges impacted the Company’s operating segments as follows (in millions): North America-$36, Europe-$21, Latin America-$8, Asia Pacific-$6.
Exit cost reserves were approximately $13$14 million at December 31, 2005,30, 2006, consisting principally of severance obligations associated with projects commenced in 2005,2006, which are expected to be paid out in 2006.2007. At January 1,December 31, 2005, exit cost reserves were approximately $11$13 million, primarily representing severance costs that were substantially paid out in 2005.2006.
Specific initiatives
In September 2006, the Company approved a multi-year European manufacturing optimization plan to improve utilization of its facility in Manchester, England and to better align production in Europe. Based on forecasted foreign exchange rates, the Company currently expects to incur approximately $60 million in total up-front costs (including those already incurred in 2006), comprised of approximately 80% cash and 20% non-cash asset write-offs, to complete this initiative. The cash portion of the total up-front costs results principally from management’s plan to eliminate approximately 220 hourly and salaried positions from the Manchester facility by the end of 2008 through voluntary early retirement and severance programs. The pension trust funding requirements of these early retirements are expected to exceed the recognized benefit expense impact by approximately $10 million; most of this incremental funding occurred in 2006. During this period, certain manufacturing equipment will also be removed from service. For 2006, the Company incurred approximately $28 million of total up-front costs, including $9 million of pension plan curtailment losses and special termination benefits.
During 2006, the Company commenced several initiatives to enhance the productivity and efficiency of its U.S. cereal manufacturing network, primarily through technological and sourcing improvements in warehousing and packaging operations. In conjunction with these initiatives, the Company offered voluntary separation incentives, which resulted in the retirement of approximately 80 hourly employees by early 2007. During the fourth quarter of 2006, the Company incurred approximately $15 million of total up-front costs, comprised of approximately 20% asset write-offs and 80% cash costs, including $10 million of pension and other postretirement plan curtailment losses.
Also during 2006, the Company undertook an initiative to improve customer focus and selling efficiency within a particular Latin American market, leading to a shift from a third-party distributor to a direct sales force model. As a result of this initiative, the Company paid $8 million in cash during


36

30

Specific initiatives
the fourth quarter of 2006 to exit the existing distribution arrangement.
To improve operational efficiency and better position its North American snacks business for future growth, during 2005, managementthe Company undertook an initiative to consolidate U.S. bakery capacity, resultingwhich was completed by the end of 2006. The project resulted in the closure and sale of the Company’s Des Plaines, Illinois facility in late 2005 and planned closure of its Macon, Georgia facility by midin April 2006, with sale occurring in September 2006. As a resultThese closures resulted in the elimination of over 700 hourly and salaried employee positions, through the combination of involuntary severance and attrition. Related to this initiative, approximately 350 employee positions were eliminated through separation and attrition in 2005 and an additional 350 positions are expected to be eliminated in 2006. Thethe Company incurred up-front costs of approximately $80 million in 2005, and expects to incur an additional $30 million in 2006 to complete this initiative. The total project costs are expected to includecomprised of approximately $45 million in accelerated depreciation and otherone-half asset write-offs and $65 million ofone-half cash costs, including severance, removals, and$16 million for the present value of a pension plan withdrawal liability. Theprojected multiemployer pension plan withdrawal liability is related to trust asset under-performance in a multiemployer plan that covers the majorityassociated with closure of the Company’s union employeesMacon facility. The Company incurred approximately $31 million in up-front costs for 2006, comprised of approximately one-third asset write-offs and two-thirds cash costs, including a $4 million increase in the Macon bakery and is payable over a period not to exceed 20 years. The final amount of theCompany’s estimated pension plan withdrawal liability will not be determinable until early 2008. Resultsto $20 million. This increase was principally attributable to investment loss experienced during 2005 in conjunction with increased benefit levels for 2005 include management’s current estimateall participating employers. The final calculation of this liability of approximately $16 million, which is subject to adjustment through early 2008 based on trust asset performance, employer contributions,pending full-year 2007 employee hours attributable to the Company’s remaining participation in this plan, and other factors.is therefore subject to adjustment in early 2008. The associated cash obligation is payable to the pension fund over a20-year maximum period; management has not currently determined the actual period over which the payments will be made. Except for this pension plan withdrawal liability, the Company’s cash obligations attributable to this initiative were substantially paid out by year end 2006.
During 2004, the Company commenced an operational improvement initiative which resulted in the consolidation of meat alternativesveggie foods manufacturing at its Zanesville, Ohio facility and the closure and sale of its Worthington, Ohio facility by mid 2005. As a result of this closing, approximately 280 employee positions were eliminated through separation and attrition. TheRelated to this initiative, the Company recognized approximately $20 million of up-front costs related to this initiative in 2004 and recorded an additional $10 million in 2005. For both years, the total amounts were comprised of approximately two-thirds asset write-offs and one-third cash costs insuch as severance and removal, which were entirely paid out by the end of 2005.
During 2004, the Company’s global rollout of its SAP information technology system resulted in accelerated depreciation of legacy software assets to be abandoned in 2005, as well as related consulting and other implementation expenses. Total incremental costs for 2004 were approximately $30 million. In close association with this SAP rollout, management undertook a major initiative to improve the organizational design and effectiveness of pan-European operations. Specific benefits of this initiative were expected to include improved marketing and promotional coordination across Europe, supply chain network savings, overhead cost reductions, and tax savings. To achieve these benefits, management implemented, at the beginning of 2005, a new European legal and operating structure headquartered in Ireland, with strengthened pan-European management authority and coordination. During 2004, the Company incurred various up-front costs, including relocation, severance, and consulting, of approximately $30 million. Additional relocation and other costs to complete this business transformation during the next several years are expected to beafter 2004 have been insignificant.
In order to integrate it with the rest of our U.S. operations, during 2004, the Company completed the relocation of its U.S. snacks business unit from Elmhurst, Illinois (the former headquarters of Keebler Foods Company) to Battle Creek, Michigan. About one-third of the approximately 300 employees affected by this initiative accepted relocation or reassignment offers. The recruiting effort to fill the remaining open positions was substantially completed by year-end 2004. Attributable to this initiative, the Company incurred approximately $15 million in relocation, recruiting, and severance costs during 2004. Subject to achieving certain employment levels and other regulatory requirements, management expects to defray a significant portion of these up-front costs through various multi-year tax incentives, which began in 2005. The Elmhurst office building was sold in late 2004, and the net sales proceeds approximated carrying value.
During 2003, the Company implemented a wholesome snack plant consolidation in Australia, which involved the exit of a leased facility and separation of approximately 140 employees. The Company incurred approximately $6 million in exit costs and asset write-offs during 2003 related to this initiative.
Also in 2003, the Company undertook a manufacturing capacity rationalization in the Mercosur region of Latin America, which involved the closure of an owned facility in Argentina and separation of approximately 85 plant and administrative employees during 2003. The Company recorded an impairment loss of approximately $6 million to reduce the carrying value of the manufacturing facility to estimated fair value, and incurred approximately $2 million of severance and closure costs during 2003 to complete this initiative. In 2004, the Company began importing its products for sale in Argentina from other Latin America facilities.Note 4 Other income (expense), net
In Great Britain, management initiated changes in plant crewing to better match the work pattern to the demand cycle, which resulted in voluntary workforce reductions of approximately 130 hourly and salaried employee positions. During 2003, the Company incurred approximately $18 million in separation benefit costs related to this initiative.

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Note 4 Other income (expense), net
Other income (expense), net includes non-operating items such as interest income, charitable donations, and foreign exchange gains and losses. Net foreign exchange transaction losses charitable donations, and gains on asset sales. for the periods presented were approximately (in millions): 2006−$2; 2005−$2; 2004−$15.
Other income (expense) for 2005expense includes charges of $16 million for contributions to the Kellogg’s Corporate Citizenship Fund, a private trust established for charitable giving, andas follows (in millions): 2006−$3; 2005−$16; 2004−$9. Other expense for 2005 also includes a charge of approximately $7 million to reduce the carrying value of a corporate commercial facility to estimated selling value. The carrying value of all held-for-sale assets at December 31, 2005,This facility was insignificant.
Other income (expense), net for 2004 includes charges of approximately $9 million for contributions to the Kellogg’s Corporate Citizenship Fund. Other income (expense), net for 2003 includes credits of approximately $17 million related to favorable legal settlements, a charge of $8 million for a contribution to the Kellogg’s Corporate Citizenship Fund, and a charge of $6.5 million to recognize the impairment of a cost-basis investmentsold in an e-commerce business venture.August 2006.


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Note 5 Equity
Note 5 Equity
During the year ended December 30, 2006, the Company revised the classification of $101.4 million of prior net losses realized upon reissuance of treasury shares from capital in excess of par value to retained earnings on the Consolidated Balance Sheet. Such reissuances occurred in connection with employee and director stock option exercises and other share-based settlements. The revision did not have an effect on the Company’s results of operations, total shareholders’ equity, or cash flows.
Earnings per share
Basic net earnings per share is determined by dividing net earnings by the weighted averageweighted-average number of common shares outstanding during the period. Diluted net earnings per share is similarly determined, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued. Dilutive potential common shares are comprised principally of employee stock options issued by the Company. Basic net earnings per share is reconciled to diluted net earnings per share as follows:in the following table. The total number of anti-dilutive potential common shares excluded from the reconciliation for each period was (in millions): 2006−.7; 2005−1.5; 2004−4.3.
              
 
  Average  
  shares  
(millions, except per share data) Earnings outstanding Per share
 
2005
            
 Basic $980.4   412.0  $2.38 
 Dilutive potential common shares  —   3.6   (.02)
 
 Diluted $980.4   415.6  $2.36 
 
2004            
 Basic $890.6   412.0  $2.16 
 Dilutive potential common shares  —   4.4   (.02)
 
 Diluted $890.6   416.4  $2.14 
 
2003            
 Basic $787.1   407.9  $1.93 
 Dilutive potential common shares  —   2.6   (.01)
 
 Diluted $787.1   410.5  $1.92 
 
               
 
    Average shares
 Per
  
(millions, except per share data) Earnings outstanding share  
 
 
2006
              
Basic $1,004.1   397.0  $2.53   
Dilutive potential common shares   —   3.4   (.02)  
 
 
Diluted $1,004.1   400.4  $2.51   
 
 
2005              
Basic $980.4   412.0  $2.38   
Dilutive potential common shares  —   3.6   (.02)  
 
 
Diluted $980.4   415.6  $2.36   
 
 
2004              
Basic $890.6   412.0  $2.16   
Dilutive potential common shares  —   4.4   (.02)  
 
 
Diluted $890.6   416.4  $2.14   
 
 
Stock transactions
The Company issues shares to employees and directors under various equity-based compensation and stock purchase programs, as further discussed in Note 8. The number of shares issued during the periods presented was (in millions): 2006−7.2; 2005−7.7; 2004−10.7. Additionally, during 2006, the Company establishedKellogg Directtm,a direct stock purchase and dividend reinvestment plan for U.S. shareholders and issued less than .1 million shares for that purpose in 2006.
To offset these issuances and for general corporate purposes, the Company’s Board of Directors has authorized management to repurchase specified amounts of the Company’s common stock in each of the periods presented. In 2006, the Company spent $650 million to repurchase approximately 14.9 million shares. This activity consisted principally of a February 2006 private transaction with the W.K. Kellogg Foundation Trust to repurchase approximately 12.8 million shares for $550 million. In 2005, the Company spent $664 million to repurchase approximately 15.4 million shares. This activity consisted principally of a November 2005 private transaction with the W.K. Kellogg Foundation Trust to repurchase approximately 9.4 million shares for $400 million. In 2004, the Company spent $298 million to repurchase approximately 7.3 million shares.
On December 8, 2006, the Company’s Board of Directors authorized a stock repurchase program of up to $650 million for 2007.
Comprehensive Incomeincome
Comprehensive income includes net earnings and all other changes in equity during a period except those resulting from investments by or distributions to shareholders. ComprehensiveOther comprehensive income for the periods presented consists of net earnings, minimum pension liabilityforeign currency translation adjustments (referpursuant to Note 9),SFAS No. 52 “Foreign Currency Translation,” unrealized gains and losses on cash flow hedges pursuant to SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” and foreign currency translationminimum pension liability adjustments pursuant to SFAS No. 52 “Foreign Currency Translation”87 “Employers’ Accounting for Pensions.” Additionally, accumulated other comprehensive income at December 30, 2006, reflects the adoption of SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as follows:of the
               
 
  Pretax Tax (expense) After-tax
(millions) amount benefit amount
 
2005
            
 
Net earnings         $980.4 
Other comprehensive income:            
 Foreign currency translation adjustments $(85.2) $—   (85.2)
 Cash flow hedges:            
  Unrealized gain (loss) on cash flow hedges  (3.7)  1.6   (2.1)
  Reclassification to net earnings  26.4   (9.9)  16.5 
 Minimum pension liability adjustments  (102.7)  37.3   (65.4)
 
  $(165.2) $29.0   (136.2)
 
Total comprehensive income         $844.2 
 
2004            
 
Net earnings         $890.6 
Other comprehensive income:            
 Foreign currency translation adjustments $71.7  $—   71.7 
 Cash flow hedges:            
  Unrealized gain (loss) on cash flow hedges  (10.2)  3.1   (7.1)
  Reclassification to net earnings  19.3   (6.9)  12.4 
 Minimum pension liability adjustments  308.9   (96.6)  212.3 
 
    $389.7  $(100.4)  289.3 
 
Total comprehensive income         $1,179.9 
 


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32

               
 
  Pretax Tax (expense) After-tax
(millions) amount benefit amount
 
2003            
 
Net earnings         $787.1 
Other comprehensive income:            
 Foreign currency translation adjustments $81.6  $—   81.6 
 Cash flow hedges:            
  Unrealized gain (loss) on cash flow hedges  (18.7)  6.6   (12.1)
  Reclassification to net earnings  10.3   (3.8)  6.5 
 Minimum pension liability adjustments  75.7   (27.5)  48.2 
 
    $148.9  $(24.7)  124.2 
 
Total comprehensive income         $911.3 
 
Company’s 2006 fiscal year end. Refer to Note 1 for further information.
               
 
    Tax
    
  Pretax
 (expense)
 After-tax
  
(millions) amount benefit amount  
 
2006
              
 
 
Net earnings         $1,004.1   
Other comprehensive income:              
Foreign currency translation adjustments $10.0  $—   10.0   
Cash flow hedges:              
Unrealized loss on cash flow hedges  (12.6)  4.6   (8.0)  
Reclassification to net earnings  11.9   (4.3)  7.6   
Minimum pension liability adjustments  172.3   (60.1)  112.2   
 
 
  $181.6  $(59.8)  121.8   
 
 
Total comprehensive income         $1,125.9   
 
 
2005              
 
 
Net earnings         $980.4   
Other comprehensive income:              
Foreign currency translation adjustments $(85.2) $—   (85.2)  
Cash flow hedges:              
Unrealized loss on cash flow hedges  (3.7)  1.6   (2.1)  
Reclassification to net earnings  26.4   (9.9)  16.5   
Minimum pension liability adjustments  (102.7)  37.3   (65.4)  
 
 
  $(165.2) $29.0   (136.2)  
 
 
Total comprehensive income         $844.2   
 
 
2004              
 
 
Net earnings         $890.6   
Other comprehensive income:              
Foreign currency translation adjustments $71.7  $—   71.7   
Cash flow hedges:              
Unrealized loss on cash flow hedges  (10.2)  3.1   (7.1)  
Reclassification to net earnings  19.3   (6.9)  12.4   
Minimum pension liability adjustments  308.9   (96.6)  212.3   
 
 
  $389.7  $(100.4)  289.3   
 
 
Total comprehensive income         $1,179.9   
 
 
Accumulated other comprehensive income (loss) at year end consisted of the following:
         
 
(millions) 2005 2004
 
Foreign currency translation adjustments $(419.5) $(334.3)
Cash flow hedges — unrealized net loss  (32.2)  (46.6)
Minimum pension liability adjustments  (124.4)  (59.0)
 
Total accumulated other comprehensive income (loss) $(576.1) $(439.9)
 
           
 
(millions) 2006 2005  
 
Foreign currency translation adjustments $(409.5) $(419.5)  
Cash flow hedges — unrealized net loss  (32.6)  (32.2)  
Minimum pension liability adjustments   —   (124.4)  
Postretirement and postemployment benefits:          
Net experience loss  (540.5)  —   
Prior service cost  (63.6)  —   
 
 
Total accumulated other comprehensive income (loss) $(1,046.2) $(576.1)  
 
 
Note 6 Leases and other commitments
The Company’s leases are generally for equipment and warehouse space. Rent expense on all operating leases was $115.1 million in 2005, $107.4 million in 2004, and $107.9 million in 2003.(in millions): 2006–$122.8; 2005–$115.1; 2004–$107.4. Additionally, the Company is subject to a residual value guarantee on one operating lease of approximately $13 million.million which expires in July 2007. At December 31, 2005,30, 2006, the Company had not recorded any liability related to this residual value guarantee. During 2006 and 2005, the Company entered into approximately $2 million and $3 million, respectively, in capital lease agreements to finance the purchase of equipment. Similar transactions in 2004 and 2003 were insignificant.
At December 31, 2005,30, 2006, future minimum annual lease commitments under noncancelable capitaloperating and operatingcapital leases were as follows:
         
 
  Operating Capital
(millions) leases leases
 
2006 $102.3  $1.9 
2007  85.6   1.4 
2008  63.7   .5 
2009  47.5   .5 
2010  43.3   .2 
2011 and beyond  116.7   .1 
 
Total minimum payments $459.1  $4.6 
Amount representing interest      (.3)
 
Obligations under capital leases      4.3 
Obligations due within one year      (1.9)
 
Long-term obligations under capital leases     $2.4 
 
           
 
  Operating
 Capital
  
(millions) leases leases  
 
 
2007 $119.7  $2.1   
2008  103.4   1.4   
2009  85.9   1.3   
2010  67.7   1.0   
2011  49.8   .6   
2012 and beyond  148.6   3.0   
 
 
Total minimum payments $575.1  $9.4   
Amount representing interest      (1.6)  
 
 
Obligations under capital leases      7.8   
Obligations due within one year      (2.1)  
 
 
Long-term obligations under capital leases     $5.7   
 
 
One of the Company’s subsidiaries is guarantor on loans to independent contractors for the purchase of DSD route franchises. At year-end 2005,2006, there were total loans outstanding of $16.4$16.0 million to 517 franchisees. All loans are variable rate with a term of 10 years. Related to this arrangement, the Company has established with a financial institution a one-year renewable loan facility up to $17.0 million with a five-year term-out and servicing arrangement. The Company has the right to revoke and resell the route franchises in the event of default or any other breach of contract by franchisees. Revocations are infrequent. The Company’s maximum potential future payments under these guarantees are limited to the outstanding loan principal balance plus unpaid interest. The estimated fair value of these guarantees is recorded in the Consolidated Balance Sheet and is currently estimated to be insignificant.was insignificant for the periods presented.
The Company has provided various standard indemnifications in agreements to sell business assets and lease facilities over the past several years, related primarily to pre-existing tax, environmental, and employee benefit obligations. Certain of these indemnifications are limited by agreement in either amountand/or term and others are unlimited. The Company has also provided various “hold harmless” provisions within certain service type agreements. Because


39

the Company is not currently aware of any actual exposures associated with these indemnifications, management is unable to estimate the maximum potential future payments to be made. At December 31, 2005,30, 2006, the Company had not recorded any liability related to these indemnifications.
Note 7 Debt
Notes payable at year end consisted of commercial paper borrowings in the United States and Canada, and to a lesser extent, bank loans of foreign subsidiaries at competitive market rates, as follows:
                 
 
(dollars in millions) 2005 2004
 
  Effective   Effective
  Principal interest Principal interest
  amount rate amount rate
 
U.S. commercial paper $797.3   4.4%  $690.2   2.5% 
Canadian commercial paper  260.4   3.4%   12.1   2.7% 
Other  53.4       48.3     
 
  $1,111.1      $750.6     
 

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(dollars in millions) 2006 2005
 
    Effective
   Effective
  Principal
 interest
 Principal
 interest
  amount rate amount rate
 
 
U.S. commercial paper $1,140.7   5.3% $797.3   4.4%
Canadian commercial paper  87.5   4.4%  260.4   3.4%
Other  39.8       53.4     
 
 
  $1,268.0      $1,111.1     
 
 
Long-term debt at year end consisted primarily of issuances of fixed rate U.S. Dollar and floating rate Euro Notes, as follows:
         
 
(millions) 2005 2004
 
(a) 4.875% U.S. Dollar Notes due 2005 $—  $199.8 
(b) 6.0% U.S. Dollar Notes due 2006  —   722.2 
(b) 6.6% U.S. Dollar Notes due 2011  1,495.4   1,494.5 
(b) 7.45% U.S. Dollar Debentures due 2031  1,087.3   1,086.8 
(c) 4.49% U.S. Dollar Notes due 2006  75.0   150.0 
(d) 2.875% U.S. Dollar Notes due 2008  464.6   499.9 
(e) Guaranteed Floating Rate Euro Notes due 2007  650.6   — 
Other  13.3   18.0 
 
   3,786.2   4,171.2 
Less current maturities  (83.6)  (278.6)
 
Balance at year end $3,702.6  $3,892.6 
 
           
 
(millions) 2006 2005  
 
(a) 6.6% U.S. Dollar Notes due 2011 $1,496.2  $1,495.4   
(a) 7.45% U.S. Dollar Debentures due 2031  1,087.8   1,087.3   
(b) 4.49% U.S. Dollar Notes due 2006   —   75.0   
(c) 2.875% U.S. Dollar Notes due 2008  464.6   464.6   
(d) Guaranteed Floating Rate Euro Notes due 2007  722.1   650.6   
Other  5.6   13.3   
 
 
   3,776.3   3,786.2   
Less current maturities  (723.3)  (83.6)  
 
 
           
Balance at year end $3,053.0  $3,702.6   
 
 
(a)In October 1998, the Company issued $200 of seven-year 4.875% fixed rate U.S. Dollar Notes to replace maturing long-term debt. In conjunction with this issuance, the Company settled $200 notional amount of interest rate forward swap agreements, which, when combined with original issue discount, effectively fixed the interest rate on the debt at 6.07%. These Notes were repaid in October 2005.
(b)In March 2001, the Company issued $4,600$4.6 billion of long-term debt instruments, primarily to finance the acquisition of Keebler Foods Company. The preceding table above reflects the remaining principal amounts outstanding as of year-end 20052006 and 2004.2005. The effective interest rates on these Notes, reflecting issuance discount and swap settlement, were as follows: due 2006-6.39%2011 – 7.08%; due 2011-7.08%; due 2031-7.62%2031 – 7.62%. Initially, these instruments were privately placed, or sold outside the United States, in reliance on exemptions from registration under the Securities Act of 1933, as amended (the “1933 Act”). The Company then exchanged new debt securities for these initial debt instruments, with the new debt securities being substantially identical in all respects to the initial debt instruments, except for being registered under the 1933 Act. These debt securities contain standard events of default and covenants. The Notes due 2006 and 2011 and the Debentures due 2031 may be redeemed in whole or in part by the Company at any time at prices determined under a formula (but not less than 100% of the principal amount plus unpaid interest to the redemption date). In December 2003 and 2004, the Company redeemed $172.9 and $103.7, respectively, of the Notes due 2006. In July 2005, the Company redeemed $723.4, representing the remaining principal balance of the Notes due 2006.
 
(c)(b)In November 2001, a subsidiary of the Company issued $375 million of five-year 4.49% fixed rate U.S. Dollar Notes to replace other maturing debt. These Notes arewere guaranteed by the Company and maturematured $75 million per year over the five-year term.term, with the final principal payment made in November 2006. These Notes, which were privately placed, containcontained standard warranties, events of default, and covenants. They also requirerequired the maintenance of a specified consolidated interest expense coverage ratio, and limitlimited capital lease obligations and subsidiary debt. In conjunction with this issuance, the subsidiary of the Company entered into a $375 million notional US$/Pound Sterling currency swap, which effectively converted this debt into a 5.302% fixed rate Pound Sterling obligation for the duration of the five-year term.
 
(d)(c)In June 2003, the Company issued $500 million of five-year 2.875% fixed rate U.S. Dollar Notes, using the proceeds from these Notes to replace maturing long-term debt. These Notes were issued under an existing shelf registration statement. In conjunction with this issuance, the Company settled $250 notional amount of forward interest rate contracts for a loss of $11.8, which is being amortized to interest expense over the term of the debt. Taking into account this amortization and issuance discount, theThe effective interest rate on these five-year Notes, reflecting issuance discount and swap settlement, is 3.35%. The Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions. In December 2005, the Company redeemed $35.4 million of these Notes.
 
(e)(d)In November 2005, a subsidiary of the Company (the “Borrower”) issued Euro 550 million of Guaranteed Floating Rate Notes (the “Euro Notes”) due May 2007. The Euro Notes were issued and sold in transactions outside of the United States in reliance on Regulation S ofexemptions from registration under the Securities Act of 1933 as amended.Act. The Euro Notes are guaranteed by the Company and generally bear interest at a rate of 0.12% per annum above three-month EURIBOR for each quarterly interest period. The Euro Notes may be redeemed in whole or in part at par on interest payment dates or upon the occurrence of certain events in 2006 and 2007. The Euro Notes contain customary covenants that limit the ability of the Company and its restricted subsidiaries (as defined) to incur certain liens or enter into certain sale and lease-back transactions. The Euro Notes were redeemable in whole or in part at par on interest payment dates or upon the occurrence of certain events in 2006 and 2007. In accordance with these terms, on January 31, 2007, the Borrower announced


40

that it had exercised its right to call for early redemption all of the outstanding Euro Notes effective February 28, 2007, at a redemption price equal to the principal amount, plus accrued and unpaid interest through the redemption date.
At December 31, 2005,30, 2006, the Company had $2.1$2.2 billion of short-term lines of credit, virtually all of which were unused and available for borrowing on an unsecured basis. These lines were comprised principally of an unsecured Five-Year Credit Agreement, expiringwhich the Company entered into during November 2006 to replace an existing facility, which would have expired in 2009. The agreement allows the Company to borrow, on a revolving credit basis, up to $2.0 billion, to obtain letters of credit in an aggregate amount up to $75 million, and to provide a procedure for the lenders to bid on short-term debt of the Company. The Credit Agreementagreement contains customary covenants and warranties, including specified restrictions on indebtedness, liens, sale and leaseback transactions, and a specified interest expense coverage ratio. If an event of default occurs, then, to the extent permitted, the administrative agent may terminate the commitments under the new credit facility, accelerate any outstanding loans, and demand the deposit of cash collateral equal to the lender’s letter of credit exposure plus interest. The facility is available for general corporate purposes, including commercial paperback-up, although the Company does not currently anticipate any usage under the facility.
Scheduled principal repayments on long-term debt are (in millions): 2006-2007−$83.6; 2007-723.3; 2008−$652.5; 2008-466.1; 2009−$465.5; 2009-1.2; 2010−$0.8; 2010-1.1; 2011−$0.8; 20111,500.5; 2012 and beyond-beyond−$2,600.4.1,100.2.
Interest paid was (in millions): 2005-2006−$299; 2005−$295; 2004-2004−$333; 2003-$372.333. Interest expense capitalized as part of the construction cost of fixed assets was (in millions): 2005-2006−$2.7; 2005−$1.2; 2004-2004−$0.9; 2003-$0..9.
Note 8 Stock compensation
Subsequent events
As discussed in preceding subnote (d), on January 31, 2007, a subsidiary of the Company announced an early redemption, effective February 28, 2007, of Euro 550 million of Guaranteed Floating Rate Notes otherwise due May 2007. To partially refinance this redemption, the Company and two of its subsidiaries (the “Issuers”) established a program under which the Issuers may issue euro-commercial paper notes up to a maximum aggregate amount outstanding at any time of $750 million or its equivalent in alternative currencies. The notes may have maturities ranging up to 364 days and will be senior unsecured obligations of the applicable Issuer. Notes issued by subsidiary Issuers will be guaranteed by the Company. The notes may be issued at a discount or may bear fixed or floating rate interest or a coupon calculated by reference to an index or formula.
In connection with these financing activities, the Company increased its short-term lines of credit from $2.2 billion at December 30, 2006 to approximately $2.6 billion, via a $400 million unsecured364-Day Credit Agreement effective January 31, 2007. The364-Day Agreement contains customary covenants, warranties, and restrictions similar to those described herein for the Five-Year Credit Agreement. The facility is available for general corporate purposes, including commercial paperback-up, although the Company does not currently anticipate any usage under the facility.
Note 8 Stock compensation
The Company uses various equity-based compensation programs to provide long-term performance incentives for its global workforce. Currently, these incentives consist principally of stock options, and to a lesser extent, executive performance shares and restricted stock grants. The Company also sponsors a discounted stock purchase plan in the United States and matching-grant programs in several international locations. Additionally, the Company awards stock options and restricted stock to its outside directors. These awards are administered through several plans, as described within this Note.
The 2003 Long-Term Incentive Plan (“2003 Plan”), approved by shareholders in 2003, permits benefits to be awarded to employees and officers in the form of incentive and non-qualified stock options, performance units, restricted stock or restricted stock units, and stock appreciation rights. The 2003 Plan authorizes the issuance of a total of (a) 25 million shares plus (b) shares not issued under the 2001 Long-Term Incentive Plan, with no more than 5 million shares to be issued in satisfaction of performance units, performance-based restricted shares and other awards (excluding stock options and stock appreciation rights), and with additional annual limitations on awards or payments to

34

individual participants. OptionsAt December 30, 2006, there were 15.0 million remaining authorized, but unissued, shares under the 2003 Plan. During the periods presented, specific awards and terms of those awards granted under the 2003 Plan generally vest over two years, subject to earlier vesting upon retirement, death, or disabilityare described in the following sections of the grantee or if a change of control occurs. Restricted stock and performance share grants under the 2003 Plan generally vest in three years, subject to earlier vesting and payment if a change in control occurs.this Note.
The Non-Employee Director Stock Plan (“Director Plan”) was approved by shareholders in 2000 and allows each eligible non-employee director to receive 1,700 shares of the Company’s common stock annually and annual grants of options to purchase 5,000 shares of the Company’s common stock. At December 30, 2006, there were


41

.4 million remaining authorized, but unissued, shares under this plan. Shares other than options are placed in the Kellogg Company Grantor Trust for Non-Employee Directors (the “Grantor Trust”). Under the terms of the Grantor Trust, shares are available to a director only upon termination of service on the Board. Under this plan, awards were as follows: 2005-55,0002006−50,000 options and 17,000 shares; 2004-55,0002005−55,000 options and 17,000 shares; 2004−55,000 options and 18,700 shares; 2003-55,000 options and 18,700 shares.
Options granted to directors under all plans previously describedthis plan are granted with exercise prices equal to the fair market value of the Company’s common stock at the time of the grant and have a term of no more than ten years, if they are incentive stock options, or no more than ten years and one day, if they are non-qualified stock options. These plans permit stock option grants to contain an accelerated ownership feature (“AOF”). An AOF option is generally granted when Company stock is used to pay the exercise price of a stock option or any taxes owed. The holder ofincluded in the option is generally granted an AOF option for the number of shares so used with the exercise price equal to the then fair market value of the Company’s stock. For all AOF options, the original expiration date is not changed but the options vest immediately. Subsequent to 2003, the terms of options granted to employees and directors have not contained an AOF feature.activity tables within this Note.
In addition to employee stock option grants presented in the tables on page 36, under its long-term incentive plans, the Company granted restricted stock and restricted stock units to eligible employees as follows (approximate number of shares):2005-141,0002004-140,000;2003-209,000. Restrictions with respect to sale or transferability generally lapse after three years and the grantee is normally entitled to receive shareholder dividends during the vesting period. During the periods presented, the Company recognized associated compensation expense, including amortization of similar pre-2003 grants, over the vesting period based on the grant-date market price of the underlying shares.
Additionally, the Company granted performance units in 2003 and performance shares in 2005 to a limited number of senior executive-level employees, which entitled these employees to receive shares of the Company’s common stock on the vesting date, provided cumulative three-year financial performance targets were met. The 2003 grant represented the right to receive a fixed dollar equivalent in common stock, valued on the vesting date, provided a target gross margin level was achieved. The 2003 award was modified in February 2006 to permit cash settlement under certain circumstances. The 2003 award was earned at 74% of target and vested in February 2006 for a total dollar equivalent of $2.9 million. The 2005 grant represents the right to receive a specified number of shares provided a target net sales growth level is achieved. Based on the market price of the Company’s common stock at year-end 2005, the maximum future value that could be awarded on the vesting date in 2007 is approximately $23.6 million. During the periods presented, the Company recognized associated compensation expense, including amortization of similar pre-2003 grants, over the performance period based on the expected dollar value to be awarded on the vesting date. For the years 2003-2005, stock-based compensation expense, as reported, is presented in Note 1 and consisted principally of amounts recognized for executive performance plans.
The 2002 Employee Stock Purchase Plan was approved by shareholders in 2002 and permits eligible employees to purchase Company stock at a discounted price. This plan allows for a maximum of 2.5 million shares of Company stock to be issued at a purchase price equal to the lesser of 85% of the fair market value of the stock on the first or last day of the quarterly purchase period. Total purchases through this plan for any employee are limited to a fair market value of $25,000 during any calendar year. At December 30, 2006, there were 1.5 million remaining authorized, but unissued, shares under this plan. Shares were purchased by employees under this plan as follows (approximate number of shares):2005-218,000;2004-214,000;2003-248,000. 2006−237,000; 2005−218,000; 2004−214,000. Options granted to employees to repurchase discounted stock under this plan are included in the option activity tables within this Note.
Additionally, during 2002, a foreign subsidiary of the Company established a stock purchase plan for its employees. Subject to limitations, employee contributions to this plan are matched 1:1 by the Company. Under this plan, shares were granted by the Company to match an approximately equal number of shares purchased by employees as follows (approximate number of shares): 2005-80,000;2004-82,000;2003-94,000.2006−80,000; 2005−80,000; 2004−82,000.
The Executive Stock Purchase Plan was established in 2002 to encourage and enable certain eligible employees of the Company to acquire Company stock, and to align more closely the interests of those individuals and the Company’s shareholders. This plan allows for a maximum of 500,000 shares of Company stock to be issued. At December 30, 2006, there were .5 million remaining authorized, but unissued, shares under this plan. Under this plan, shares were granted by the Company to executives in lieu of cash bonuses as follows (approximate number of shares): 2005-2,000; 2004-8,000; 2003-11,000.2006−4,000; 2005−2,000; 2004−8,000.

35

Transactions under these plans are presented in
For 2006, the tables below.Company used the fair value method prescribed by SFAS No. 123(R) “Share-Based Payment” to account for its equity-based compensation programs. Prior to 2006, the Company used the intrinsic value method prescribed by Accounting Principles Board Opinion (APB) No. 25 “Accounting for Stock Issued to Employees.” Refer to Note 1 for further information on the Company’s methodaccounting policy for stock compensation.
For the year ended December 30, 2006, compensation expense for all types of equity-based programs and the related income tax benefit recognized was $95.7 million and $34.0 million, respectively. As a result of adopting SFAS No. 123(R) in 2006, the Company’s reported pre-tax stock-based compensation expense for the year was $65.4 million higher (with net earnings and net earnings per share (basic and diluted) correspondingly lower by $42.4 million and $.11, respectively) than if it had continued to account for its equity-based programs under APB No. 25. Amounts for the prior years are presented in the following table in accordance with SFAS No. 123 “Accounting for Stock-Based Compensation” and related interpretations. Reported amounts consist principally of expense recognized for executive performance share and restricted stock awards; pro forma amounts are attributable primarily to stock option grants.
           
 
(millions, except per share data) 2005 2004  
 
Stock-based compensation expense, pre-tax:          
As reported $18.5  $17.5   
Pro forma $76.4  $64.1   
Associated income tax benefit recognized:          
As reported $6.7  $6.1   
Pro forma $27.7  $22.3   
Stock-based compensation expense, net of tax:          
As reported $11.8  $11.4   
Pro forma $48.7  $41.8   
Net earnings:          
As reported $980.4  $890.6   
Pro forma $943.5  $860.2   
Basic net earnings per share:          
As reported $2.38  $2.16   
Pro forma $2.29  $2.09   
Diluted net earnings per share:          
As reported $2.36  $2.14   
Pro forma $2.27  $2.07   
 
 
           
As of December 30, 2006, total stock-based compensation cost related to nonvested awards not yet recognized was approximately $36 million and the weighted-average period over which this amount is expected to be recognized was approximately 1.4 years.
Cash flows realized upon exercise or vesting of stock-based awards in the periods presented are included in the following table. Within this table, the 2006 windfall tax benefit (amount realized in excess of that previously recognized in earnings) of $21.5 million represents the operating cash flow reduction (and financing cash flow increase) related to the Company’s adoption of SFAS No. 123(R) in 2006. (Refer to Note 1 for further information on the Company’s accounting policies


42

regarding tax benefit windfalls and shortfalls.) Cash used by the Company to settle equity instruments granted under stock-based awards was insignificant.
               
 
(millions) 2006 2005 2004  
 
 
Total cash received from option exercises and similar instruments $217.5  $221.7  $291.8   
 
 
Tax benefits realized upon exercise or vesting of stock-based awards:              
Windfall benefits classified as financing cash flow $21.5   n/a   n/a   
Other amounts classified as operating cash flow  23.4   40.3   38.6   
 
 
Total $44.9  $40.3  $38.6   
 
 
Shares used to satisfy stock-based awards are normally issued out of treasury stock, although management is authorized to issue new shares to the extent permitted by respective plan provisions. Refer to Note 5 for these plans.information on shares issued during the periods presented to employees and directors under various long-term incentive plans and share repurchases under the Company’s stock repurchase authorizations. The Company does not currently have a policy of repurchasing a specified number of shares issued under employee benefit programs during any particular time period.
              
 
(millions, except per share data) 2005 2004 2003
 
Under option, beginning of year  32.5   37.0   38.2 
 Granted  8.3   9.7   7.5 
 Exercised  (10.9)  (12.9)  (6.0)
 Cancelled  (1.1)  (1.3)  (2.7)
 
Under option, end of year  28.8   32.5   37.0 
 
Exercisable, end of year  21.3   22.8   24.4 
 
Average prices per share
Under option, beginning of year		 $35  $33  $33 
 Granted  44   40   31 
 Exercised  34   32   28 
 Cancelled  41   41   35 
 
Under option, end of year $38  $35  $33 
 
Exercisable, end of year $37  $35  $34 
 
Shares available, end of year, for stock-based awards that may be granted under the following plans:            
Kellogg Employee Stock Ownership Plan  —   1.4   1.3 
2000 Non-Employee Director Stock Plan  .5   .5   .6 
2002 Employee Stock Purchase Plan  1.7   1.9   2.1 
Executive Stock Purchase Plan  .5   .5   .5 
2003 Long-Term Incentive Plan (a)  20.1   24.7   30.5 
 
Total  22.8   29.0   35.0 
 
(a)Refer to description of Plan within this note for restrictions on availability.
Employee
Stock Options
During the periods presented, non-qualified stock options outstandingwere granted to eligible employees under the 2003 Plan with exercise prices equal to the fair market value of the Company’s stock on the grant date, a contractual term of ten years, and exercisablea two-year graded vesting period. Grants to outside directors under the Non-Employee Director Stock Plan included similar terms, but vested immediately. Additionally, “reload” options were awarded to eligible employees and directors to replace previously-owned Company stock used by those individuals to pay the exercise price, including related employment taxes, of vested pre-2004 option awards containing this accelerated ownership feature. These reload options are immediately vested, with an expiration date which is the same as the original option grant.
Management estimates the fair value of each annual stock option award on the date of grant using a lattice-based option valuation model. Due to the already-vested status and short expected term of reload options, management uses a Black-Scholes model to value such awards. Composite assumptions, which are not materially different for each of the two models, are presented in the following table. Weighted-average values are disclosed for certain inputs which incorporate a range of assumptions. Expected volatilities are based principally on historical volatility of the Company’s stock, and to a lesser extent, on implied volatilities from traded options on the Company’s stock. For the lattice-based model, historical volatility corresponds to the contractual term of the options granted; whereas, for the Black-Scholes model, historical volatility corresponds to the expected term. The Company generally uses historical data to estimate option exercise and employee termination within the valuation models; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted (which is an input to the Black-Scholes model and an output from the lattice-based model) represents the period of time that options granted are expected to be outstanding; the weighted-average expected term for all employee groups is presented in the following table. The risk-free rate for periods within the contractual life of the options is based on the U.S. Treasury yield curve in effect at the time of grant.
               
 
Stock option valuation model assumptions
        
for grants within the year ended: 2006 2005 2004  
 
 
Weighted-average expected volatility  17.94%  22.00%  23.00%  
Weighted-average expected term (years)  3.21   3.42   3.69   
Weighted-average risk-free interest rate  4.65%  3.81%  2.73%  
Dividend yield  2.40%  2.40%  2.60%  
 
 
Weighed-average fair value of options granted $6.67  $7.35  $6.39   
 
 
A summary of option activity for the year ended December 30, 2006, is presented in the following table:
                   
 
      Weighted-
    
    Weighted-
 average
 Aggregate
  
    average
 remaining
 intrinsic
  
Employee and director
 Shares
 exercise
 contractual
 value
  
stock options (millions) price term (yrs.) (millions)  
 
 
Outstanding, beginning of year  28.8  $38           
Granted  9.6   46           
Exercised  (10.9)  37           
Forfeitures  (.3)  43           
Expirations  (.2)  43           
 
 
Outstanding, end of year  27.0  $41   6.1  $243.0   
 
 
Exercisable, end of year  19.9  $40   5.1  $199.0   
 
 


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Additionally, option activity for comparable prior-year periods is presented in the following table:
           
 
(millions, except per share data) 2005 2004  
 
 
Outstanding, beginning of year  32.5   37.0   
Granted  8.3   9.7   
Exercised  (10.9)  (12.9)  
Forfeitures and expirations  (1.1)  (1.3)  
 
 
Outstanding, end of year  28.8   32.5   
 
 
Exercisable, end of year  21.3   22.8   
 
 
Weighted-average exercise price:          
Outstanding, beginning of year $35  $33   
Granted  44   40   
Exercised  34   32   
Forfeitures and expirations  41   41   
 
 
Outstanding, end of year $38  $35   
 
 
Exercisable, end of year $37  $35   
 
 
The total intrinsic value of options exercised during the periods presented was (in millions): 2006−$114; 2005−$116; 2004−$119.
Other stock-based awards
During the periods presented, other stock-based awards consisted principally of executive performance shares and restricted stock granted under the 2003 Plan.
In 2005 and 2006, the Company granted performance shares to a limited number of senior executive-level employees, which entitled these employees to receive a specified number of shares of the Company’s common stock on the vesting date, provided cumulative three-year net sales growth targets were achieved. Subsequent to the adoption of SFAS No. 123(R), management has estimated the fair value of performance share awards based on the market price of the underlying stock on the date of grant, reduced by the present value of estimated dividends foregone during the performance period. The 2005 and 2006 target grants (as revised for non-vested forfeitures and other adjustments) currently correspond to approximately 275,000 and 260,000 shares, respectively; each with a grant-date fair value of approximately $41 per share. The actual number of shares issued on the vesting date could range from zero to 200% of target, depending on actual performance achieved. Based on the market price of the Company’s common stock at year-end 2006, the maximum future value that could be awarded on the vesting date is (in millions): 2005 award−$27.5; 2006 award−$25.8. In addition to these performance share plans, asa 2003 performance unit plan (payable in stock or cash under certain conditions) was settled at 74% of target in February 2006 for a total dollar equivalent of $2.9 million.
The Company also periodically grants restricted stock and restricted stock units to eligible employees under the 2003 Plan. Restrictions with respect to sale or transferability generally lapse after three years and the grantee is normally entitled to receive shareholder dividends during the vesting period. Management estimates the fair value of restricted stock grants based on the market price of the underlying stock on the date of grant. A summary of restricted stock activity for the year ended December 31, 2005,30, 2006, is presented in the following table:
           
 
    Weighted-
  
    average
  
Employee restricted stock
 Shares
 grant-date
  
and restricted stock units (thousands) fair value  
 
 
Non-vested, beginning of year  447  $39   
Granted  190   47   
Vested  (176)  34   
Forfeited  (27)  43   
 
 
Non-vested, end of year  434  $45   
 
 
Grants of restricted stock and restricted stock units for comparable prior-year periods were: 2005−141,000; 2004−140,000.
                     
 
(millions, except per share data)
  Outstanding Exercisable
     
    Weighted  
    Weighted average   Weighted
Range of   average remaining   average
exercise Number exercise contractual Number exercise
prices of options price life (yrs.) of options price
 
$24 - 33  6.0  $28   5.1   5.8  $28 
34 - 38  5.4   35   4.7   5.4   35 
39 - 43  6.5   39   7.2   3.9   40 
44 - 51  10.9   44   6.3   6.2   45 
 
   28.8           21.3     
 
The total fair value of restricted stock and restricted stock units vesting in the periods presented was (in millions): 2006−$8; 2005−$4; 2004−$4.
Note 9 Pension benefits
The Company sponsors a number of U.S. and foreign pension plans to provide retirement benefits for its employees. The majority of these plans are funded or unfunded defined benefit plans, although the Company does participate in a few multiemployer or other defined contribution plans for certain employee groups. Defined benefits for salaried employees are generally based on salary and years of service, while union employee benefits are generally a negotiated amount for each year of service. The Company uses its fiscal year end as the measurement date for the majority of its defined benefit plans.
Obligations and funded status
The aggregate change in projected benefit obligation, plan assets, and funded status is presented in the following tables. For 2005,The Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the end of its 2006 fiscal year. The impact of amendmentsthe adoption is discussed in Note 1. The standard generally requires company plan sponsors to reflect the net over- or under-


44

funded position of a defined postretirement benefit plan as an asset or liability on the projected benefit obligation is principally related to incremental benefits under an agreement between the Company and the major union representing the hourly employees at the Company’s U.S. cereal plants, which covers the four-year period ending October 2009.balance sheet.
         
 
(millions) 2005 2004
 
Change in projected benefit obligation
        
Beginning of year $2,972.9  $2,640.9 
Service cost  80.3   76.0 
Interest cost  160.1   157.3 
Plan participants’ contributions  2.5   2.8 
Amendments  42.2   23.0 
Actuarial loss  114.3   144.2 
Benefits paid  (144.0)  (155.0)
Foreign currency adjustments  (84.6)  68.8 
Curtailment and special termination benefits  1.3   8.7 
Other  .1   6.2 
 
End of year $3,145.1  $2,972.9 
 
Change in plan assets
        
Fair value beginning of year $2,685.9  $2,319.2 
Actual return on plan assets  277.9   319.1 
Employer contributions  156.4   139.6 
Plan participants’ contributions  2.5   2.8 
Benefits paid  (132.3)  (149.3)
Foreign currency adjustments  (67.9)  53.0 
Other  .1   1.5 
 
Fair value end of year $2,922.6  $2,685.9 
 
Funded status
 $(222.5) $(287.0)
Unrecognized net loss  826.3   868.4 
Unrecognized transition amount  1.9   2.4 
Unrecognized prior service cost  100.1   70.0 
 
Prepaid pension $705.8  $653.8 
 
Amounts recognized in the Consolidated Balance Sheet consist of
        
Prepaid benefit cost $683.3  $730.9 
Accrued benefit liability  (185.8)  (190.5)
Intangible asset  17.0   24.7 
Other comprehensive income — minimum pension liability  191.3   88.7 
 
Net amount recognized $705.8  $653.8 
 
           
 
(millions) 2006 2005  
 
 
Change in projected benefit obligation
          
Beginning of year $3,145.1  $2,972.9   
Service cost  94.2   80.2   
Interest cost  172.0   160.1   
Plan participants’ contributions  1.7   2.5   
Amendments  24.2   42.2   
Actuarial loss (gain)  (96.7)  114.3   
Benefits paid  (160.4)  (144.0)  
Curtailment and special termination benefits  15.3   1.3   
Foreign currency adjustments and other  113.9   (84.4)  
 
 
End of year $3,309.3  $3,145.1   
 
 
Change in plan assets
          
Fair value beginning of year $2,922.6  $2,685.9   
Actual return on plan assets  448.4   277.9   
Employer contributions  85.7   156.4   
Plan participants’ contributions  1.7   2.5   
Benefits paid  (149.6)  (132.3)  
Foreign currency adjustments and other  117.7   (67.8)  
 
 
Fair value end of year $3,426.5  $2,922.6   
 
 
Funded status at year end
 $117.2  $(222.5)  
Unrecognized net loss  —   826.3   
Unrecognized transition amount  —   1.9   
Unrecognized prior service cost  —   100.1   
 
 
Net balance sheet position $117.2  $705.8   
 
 
Amounts recognized in the Consolidated Balance Sheet consist of
          
Prepaid benefit cost     $683.3   
Accrued benefit liability      (185.8)  
Intangible asset      17.0   
Other comprehensive income — minimum pension liability      191.3   
Noncurrent assets $352.6       
Current liabilities  (9.6)      
Noncurrent liabilities  (225.8)      
 
 
Net amount recognized $117.2  $705.8   
 
 
Amounts recognized in accumulated other comprehensive income consist of
          
Net experience loss $502.7       
Prior service cost  115.5       
 
 
Net amount recognized $618.2  $191.3   
 
 
The accumulated benefit obligation for all defined benefit pension plans was $2.87$2.99 billion and $2.70$2.87 billion at December 31 200530, 2006 and January 1,December 31, 2005, respectively. Information for pension plans

36

with accumulated benefit obligations in excess of plan assets were:
         
 
(millions) 2005 2004
 
Projected benefit obligation $1,621.4  $411.2 
Accumulated benefit obligation  1,473.7   350.2 
Fair value of plan assets  1,289.1   160.5 
 
           
 
(millions) 2006 2005  
 
Projected benefit obligation $253.4  $1,621.4   
Accumulated benefit obligation  202.5   1,473.7   
Fair value of plan assets  55.5   1,289.1   
 
 
The significant increasedecrease in accumulated benefit obligations in excess of plan assets for 20052006 is relateddue primarily to unfavorable movementfavorable asset returns in one of thea major U.S. pension plans, partially offset by favorable movements in several international plans.plan.
At December 31, 2005, a cumulative after-tax charge of $124.4 million ($191.3 million pretax) has been recorded in other comprehensive income to recognize the additional minimum pension liability in excess of unrecognized prior service cost. Refer to Note 5 for further information on the changes in minimum liability included in other comprehensive income for each of the periods presented.
Expense
The components of pension expense are presented in the following table. Pension expense for defined contribution plans relates principally to multi-employermultiemployer plans in which the Company participates on behalf of certain unionized workforces in the United States. The amountamounts for 2006 and 2005 includes a chargeinclude charges of approximately $4 million and $16 million, respectively, for the Company’s current estimate of a multiemployer plan withdrawal liability, which is further described in Note 3.
              
 
(millions) 2005 2004 2003
 
Service cost $80.3  $76.0  $67.5 
Interest cost  160.1   157.3   151.1 
Expected return on plan assets  (229.0)  (238.1)  (224.3)
Amortization of unrecognized transition obligation  .3   .2   .1 
Amortization of unrecognized prior service cost  10.0   8.2   7.3 
Recognized net loss  64.5   54.1   28.6 
Other Adjustments  (.1)  —   — 
Curtailment and special termination benefits — net loss  1.6   12.2   8.1 
 
Pension expense:            
 Defined benefit plans  87.7   69.9   38.4 
 Defined contribution plans  31.9   14.4   14.3 
 
 Total $119.6  $84.3  $52.7 
 
Certain of the Company’s subsidiaries sponsor 401(k)
               
 
(millions) 2006 2005 2004  
 
 
Service cost $94.2  $80.2  $76.0   
Interest cost  172.0   160.1   157.3   
Expected return on plan assets  (256.7)  (229.0)  (238.1)  
Amortization of unrecognized transition obligation  —   .3   .2   
Amortization of unrecognized prior service cost  12.4   10.0   8.2   
Recognized net loss  79.8   64.5   54.1   
Curtailment and special termination benefits — net loss  16.7   1.6   12.2   
 
 
Pension expense:              
Defined benefit plans  118.4   87.7   69.9   
Defined contribution plans  18.7   31.9   14.4   
 
 
Total $137.1  $119.6  $84.3   
 
 
Any arising obligation-related experience gain or similar savings plans for active employees. Expense related to these plans was (in millions): 2005-$30; 2004-$26; 2003-$26. Company contributions to these savings plans approximate annual expense. Company contributions to multiemployer and other defined contribution pension plans approximate the amount of annual expense presented in the table above.
All gains and losses, other than those related to curtailment or special termination benefits, are recognizedloss is amortized using a straight-line method over the average remaining service period of active plan participants. Any asset-related experience gain or loss is recognized as described on page 46. The estimated net experience loss and prior service cost for defined benefit pension plans that will be amortized from accumulated other comprehensive income into pension expense over the next fiscal year are approximately $61 million and $13 million, respectively.
Net losses from curtailment and special termination benefits recognized in 2006 are related primarily to plant workforce reductions in the United States and England, as further described in Note 3. Net losses from curtailment and special termination benefits recognized in 2004 are related primarily to special termination benefits granted to the Company’s former CEO and other former executive officers pursuant to separation agreements, and to a lesser extent, liquidation of the Company’s pension fund in South Africa and continuing plant workforce reductions in Great Britain. Net losses from special termination benefits recognized
Certain of the Company’s subsidiaries sponsor 401(k) or similar savings plans for active employees. Expense related


45

to these plans was (in millions): 2006–$33; 2005–$30; 2004–$26. Company contributions to these savings plans approximate annual expense. Company contributions to multiemployer and other defined contribution pension plans approximate the amount of annual expense presented in 2003 are related primarily to a plant workforce reduction in Great Britain. Refer to Note 3 for further information on this initiative.the preceding table.
Assumptions
The worldwide weighted-average actuarial assumptions used to determine benefit obligations were:
             
 
  2005 2004 2003
 
Discount rate  5.4%   5.7%   5.9% 
Long-term rate of compensation increase  4.4%   4.3%   4.3% 
 
               
 
  2006 2005 2004  
 
 
Discount rate  5.7%  5.4%  5.7%  
Long-term rate of compensation increase  4.4%  4.4%  4.3%  
 
 
The worldwide weighted-average actuarial assumptions used to determine annual net periodic benefit cost were:
             
 
  2005 2004 2003
 
Discount rate  5.7%   5.9%   6.6% 
Long-term rate of compensation increase  4.3%   4.3%   4.7% 
Long-term rate of return on plan assets  8.9%   9.3%   9.3% 
 
               
 
  2006 2005 2004  
 
Discount rate  5.4%  5.7%  5.9%  
Long-term rate of compensation increase  4.4%  4.3%  4.3%  
Long-term rate of return on plan assets  8.9%  8.9%  9.3%  
 
 
To determine the overall expected long-term rate of return on plan assets, the Company works with third party financial consultants to model expected returns over a20-year investment horizon with respect to the specific investment mix of its major plans. The return assumptions used reflect a combination of rigorous historical performance analysis and forward-looking views of the financial markets including consideration of current yields on long-term bonds, price-earnings ratios of the major stock market indices, and long-term inflation. The U.S. model, which corresponds to approximately 70% of consolidated pension and other postretirement benefit plan assets, incorporates a long-term inflation assumption of 2.8% and an active management premium of 1% (net of fees) validated by historical analysis. Similar methods are used for various foreign plans with invested assets, reflecting local economic conditions. Although management reviews the Company’s expected long-term rates of return annually, the benefit trust investment performance for one particular year does

37

not, by itself, significantly influence this evaluation. The expected rates of return are generally not revised, provided these rates continue to fall within a “more likely than not” corridor of between the 25th and 75th percentile of expected long-term returns, as determined by the Company’s modeling process. The expected rate of return for 20052006 of 8.9% equated to approximately the 50th percentile expectation. Any future variance between the expected and actual rates of return on plan assets is recognized in the calculated value of plan assets over a five-year period and once recognized, experience gains and losses are amortized using a declining-balance method over the average remaining service period of active plan participants.
Plan assets
The Company’s year-end pension plan weighted-average asset allocations by asset category were:
         
 
  2005 2004
 
Equity securities  73%   76% 
Debt securities  24%   23% 
Other  3%   1% 
 
Total  100%   100% 
 
           
 
  2006 2005  
 
 
Equity securities  76%  73%  
Debt securities  21%  24%  
Other  3%  3%  
 
 
Total  100%  100%  
 
 
The Company’s investment strategy for its major defined benefit plans is to maintain a diversified portfolio of asset classes with the primary goal of meeting long-term cash requirements as they become due. Assets are invested in a prudent manner to maintain the security of funds while maximizing returns within the Company’s guidelines. The current weighted-average target asset allocation reflected by this strategy is: equity securities-74%securities−74%; debt securities-24%securities−24%; other-2%other−2%. Investment in Company common stock represented 1.5% of consolidated plan assets at December 31, 200530, 2006 and January 1,December 31, 2005. Plan funding strategies are influenced by tax regulations. The Company currently expects to contribute approximately $39 million to its defined benefit pension plans during 2006.2007.
Benefit payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in millions): 2006-2007−$147; 2007-169; 2008−$150; 2008-174; 2009−$154; 2009-184; 2010−$159; 2010-189; 2011−$166; 2011-2015-191; 2012 to 2016−$943.1,075.
Note 10 Nonpension postretirement and postemployment benefits
Postretirement
The Company sponsors a number of plans to provide health care and other welfare benefits to retired employees in the United States and Canada, who have met certain age and service requirements. The majority of these plans are funded or unfunded defined benefit plans, although the Company does participate in a few multiemployer or other defined contribution plans for certain employee groups. The Company contributes to voluntary employee benefit association (VEBA) trusts to fund certain U.S. retiree health


46

and welfare benefit obligations. The Company uses its fiscal year end as the measurement date for these plans.
Obligations and funded status
The aggregate change in accumulated postretirement benefit obligation, plan assets, and funded status was:is presented in the following tables. The Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the end of its 2006 fiscal year. The impact of the adoption is discussed in Note 1. The standard generally requires company plan sponsors to reflect the net over- or under-funded position of a defined postretirement benefit plan as an asset or liability on the balance sheet.
         
 
(millions) 2005 2004
 
Change in accumulated benefit obligation
        
Beginning of year $1,046.7  $1,006.6 
Service cost  14.5   12.1 
Interest cost  58.3   55.6 
Actuarial loss  164.6   24.3 
Benefits paid  (60.4)  (53.9)
Foreign currency adjustments  1.2   2.0 
 
End of year $1,224.9  $1,046.7 
 
Change in plan assets
        
Fair value beginning of year $468.4  $402.2 
Actual return on plan assets  32.5   54.4 
Employer contributions  240.9   64.4 
Benefits paid  (59.1)  (52.6)
 
Fair value end of year $682.7  $468.4 
 
Funded status
 $(542.2) $(578.3)
Unrecognized net loss  446.0   291.2 
Unrecognized prior service cost  (26.3)  (29.2)
 
Accrued postretirement benefit cost recognized as a liability $(122.5) $(316.3)
 
           
 
(millions) 2006 2005  
 
 
Change in accumulated benefit obligation
          
Beginning of year $1,224.9  $1,046.7   
Service cost  17.4   14.5   
Interest cost  65.8   58.3   
Actuarial loss (gain)  (54.4)  164.6   
Amendments  3.6   —   
Benefits paid  (56.0)  (60.4)  
Curtailment and special termination benefits  6.2   —   
Foreign currency adjustments  .1   1.2   
 
 
End of year $1,207.6  $1,224.9   
 
 
Change in plan assets
          
Fair value beginning of year $682.7  $468.4   
Actual return on plan assets  123.6   32.5   
Employer contributions  13.6   240.9   
Benefits paid  (56.0)  (59.1)  
 
 
Fair value end of year $763.9  $682.7   
 
 
Funded status
 $(443.7) $(542.2)  
Unrecognized net loss  —   446.0   
Unrecognized prior service credit  —   (26.3)  
 
 
Accrued postretirement benefit cost $(443.7) $(122.5)  
 
 
Amounts recognized in the Consolidated Balance Sheet consist of
          
Current liabilities $(1.4)      
Noncurrent liabilities  (442.3)      
 
 
Total liabilities $(443.7) $(122.5)  
 
 
Amounts recognized in accumulated other comprehensive income consist of
          
Net experience loss $294.8  $—   
Prior service credit  (19.2)  —   
 
 
Net amount recognized $275.6  $—   
 
 
Expense
Components of postretirement benefit expense were:
              
 
(millions) 2005 2004 2003
 
Service cost $14.5  $12.1  $12.5 
Interest cost  58.3   55.6   60.4 
Expected return on plan assets  (42.1)  (39.8)  (32.8)
Amortization of unrecognized prior service cost  (2.9)  (2.9)  (2.5)
Recognized net losses  19.8   14.8   12.3 
 
Postretirement benefit expense:            
 Defined benefit plans  47.6   39.8   49.9 
 Defined contribution plans  1.3   1.8   1.3 
 
 Total $48.9  $41.6  $51.2 
 
All gains
               
 
(millions) 2006 2005 2004  
 
 
Service cost $17.4  $14.5  $12.1   
Interest cost  65.8   58.3   55.6   
Expected return on plan assets  (58.2)  (42.1)  (39.8)  
Amortization of unrecognized prior service credit  (2.6)  (2.9)  (2.9)  
Recognized net loss  30.6   19.8   14.8   
Curtailment and special termination benefits — net loss  6.2   —   —   
 
 
Postretirement benefit expense:              
Defined benefit plans  59.2   47.6   39.8   
Defined contribution plans  1.9   1.3   1.8   
 
 
Total $61.1  $48.9  $41.6   
 
 
Any arising health care claimscost-related experience gain or loss is recognized in the calculated amount of claims experience over afour-year period and once recognized, is amortized using astraight-line method over 15 years, resulting in at least the minimum amortization prescribed by SFAS No. 106. Anyasset-related experience gain or loss is recognized as described for pension plans on page 46. The estimated net experience loss for defined benefit plans that will be amortized from accumulated other comprehensive income into nonpension postretirement benefit expense over the next fiscal year is approximately $24 million, partially offset by amortization of prior service credit of $3 million.
Net losses other than those related tofrom curtailment orand special termination benefits are

38

recognized overin 2006 are related primarily to plant workforce reductions in the average remaining service period of active plan participants.United States as further described in Note 3.
Assumptions
The weighted-average actuarial assumptions used to determine benefit obligations were:
             
 
  2005 2004 2003
 
Discount rate  5.5%   5.8%   6.0% 
 
               
 
  2006 2005 2004  
 
 
Discount rate  5.9%  5.5%  5.8%  
 
 
The weighted-average actuarial assumptions used to determine annual net periodic benefit cost were:
             
 
  2005 2004 2003
 
Discount rate  5.8%   6.0%   6.9% 
Long-term rate of return on plan assets  8.9%   9.3%   9.3% 
 
               
 
  2006 2005 2004  
 
 
Discount rate  5.5%  5.8%  6.0%  
Long-term rate of return on plan assets  8.9%  8.9%  9.3%  
 
 
The Company determines the overall expected long-term rate of return on VEBA trust assets in the same manner as that described for pension trusts in Note 9.


47

The assumed health care cost trend rate is 10.5%9.5% for 2006,2007, decreasing gradually to 4.75% by the year 2012 and remaining at that level thereafter. These trend rates reflect the Company’s recent historical experience and management’s expectations regarding future trends. A one percentage point change in assumed health care cost trend rates would have the following effects:
         
 
  One percentage One percentage
(millions) point increase point decrease
 
Effect on total of service and interest cost components $8.1  $(7.7)
Effect on postretirement benefit obligation $143.0  $(118.4)
 
           
 
  One
 One
  
  percentage
 percentage
  
(millions) point increase point decrease  
 
 
Effect on total of service and interest cost components $9.2  $(10.5)  
Effect on postretirement benefit obligation $127.8  $(125.4)  
 
 
Plan assets
The Company’s year-end VEBA trust weighted-average asset allocations by asset category were:
         
 
  2005 2004
 
Equity securities  78%   77% 
Debt securities  22%   23% 
 
Total  100%   100% 
 
           
 
  2006 2005  
 
 
Equity securities  77%  78%  
Debt securities  22%  22%  
Other  1%  —   
 
 
Total  100%  100%  
 
 
The Company’s asset investment strategy for its VEBA trusts is consistent with that described for its pension trusts in Note 9. The current target asset allocation is 74%75% equity securities and 25% debt securities and 1% other.securities. The Company currently expects to contribute approximately $20$15 million to its VEBA trusts during 2006.2007.
Postemployment
Under certain conditions, the Company provides benefits to former or inactive employees in the United States and several foreign locations, including salary continuance, severance, and long-term disability. The Company recognizes an obligation for any of these benefits that vest or accumulate with service. Postemployment benefits that do not vest or accumulate with service (such as severance based solely on annual pay rather than years of service) or costs arising from actions that offer benefits to employees in excess of those specified in the respective plans are charged to expense when incurred. The Company’s postemployment benefit plans are unfunded. Actuarial assumptions used are generally consistent with those presented for pension benefits on page 37.46. The Company previously applied postretirement accounting concepts for purposes of recognizing its postemployment benefit obligations. Accordingly, the Company’s adoption of SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the end of its 2006 fiscal year impacted its presentation of postemployment benefits as discussed in Note 1. The aggregate change in accumulated postemployment benefit obligation and the net amount recognized were:
         
 
(millions) 2005 2004
 
Change in accumulated benefit obligation
        
Beginning of year $37.9  $35.0 
Service cost  4.5   3.5 
Interest cost  2.0   1.9 
Actuarial loss  7.4   7.8 
Benefits paid  (9.0)  (10.8)
Foreign currency adjustments  (.6)  .5 
 
End of year $42.2  $37.9 
 
Funded status
 $(42.2) $(37.9)
Unrecognized net loss  19.1   15.1 
 
Accrued postemployment benefit cost recognized as a liability $(23.1) $(22.8)
 
           
 
(millions) 2006 2005  
 
 
Change in accumulated benefit obligation
          
Beginning of year $42.2  $37.9   
Service cost  4.3   4.5   
Interest cost  2.0   2.0   
Actuarial loss (gain)  (.8)  7.4   
Benefits paid  (8.6)  (9.0)  
Foreign currency adjustments  .4   (.6)  
 
 
End of year $39.5  $42.2   
 
 
Funded status
 $(39.5) $(42.2)  
Unrecognized net loss  —   19.1   
 
 
Accrued postemployment benefit cost $(39.5) $(23.1)  
 
 
Amounts recognized in the Consolidated Balance Sheet consist of
          
Current liabilities $(7.8)      
Noncurrent liabilities  (31.7)      
 
 
Total liabilities $(39.5) $(23.1)  
 
 
Amounts recognized in accumulated other comprehensive income consist of
          
Net experience loss $16.0  $—   
 
 
Net amount recognized $16.0  $—   
 
 
Components of postemployment benefit expense were:
             
 
(millions) 2005 2004 2003
 
Service cost $4.5  $3.5  $3.0 
Interest cost  2.0   1.9   2.0 
Recognized net losses  3.5   4.5   3.0 
 
Postemployment benefit expense $10.0  $9.9  $8.0 
 
               
 
(millions) 2006 2005 2004  
 
 
Service cost $4.3  $4.5  $3.5   
Interest cost  2.0   2.0   1.9   
Recognized net loss  2.4   3.5   4.5   
 
 
Postemployment benefit expense $8.7  $10.0  $9.9   
 
 
All gains and losses are recognized over the average remaining service period of active plan participants. The estimated net experience loss that will be amortized from accumulated other comprehensive income into postemployment benefit expense over the next fiscal year is approximately $2 million.
Benefit payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
         
 
(millions) Postretirement Postemployment
 
2006 $67.1  $9.5 
2007  71.3   9.3 
2008  75.0   8.6 
2009  78.3   8.3 
2010  81.2   8.4 
2011-2015  429.4   42.8 
 
               
   
(millions)   Postretirement Postemployment  
   
 
2007     $64.0  $8.0   
2008      67.7   7.3   
2009      71.2   7.0   
2010      73.9   7.3   
2011      76.5   7.7   
2012-2016      397.5   44.4   
 
 


48

39

Note 11 Income taxes
Note 11 Income taxes
Earnings before income taxes and the provision for U.S. federal, state, and foreign taxes on these earnings were:
               
 
(millions) 2005 2004 2003
 
Earnings before income taxes
            
 United States $971.4  $952.0  $799.9 
 Foreign  453.7   413.9   369.6 
 
  $1,425.1  $1,365.9  $1,169.5 
 
Income taxes
            
 Currently payable            
  Federal $376.8  $249.8  $141.9 
  State  26.4   30.0   40.5 
  Foreign  100.7   137.8   125.2 
 
   503.9   417.6   307.6 
 
 Deferred            
  Federal  (69.6)  51.5   91.7 
  State  .6   5.3   (8.6)
  Foreign  9.8   .9   (8.3)
 
   (59.2)  57.7   74.8 
 
Total income taxes $444.7  $475.3  $382.4 
 
               
 
(millions) 2006 2005 2004  
 
 
Earnings before income taxes
              
United States $1,048.3  $971.4  $952.0   
Foreign  423.3   453.7   413.9   
 
 
  $1,471.6  $1,425.1  $1,365.9   
 
 
Income taxes
              
Currently payable              
Federal $342.0  $376.8  $249.8   
State  34.1   26.4   30.0   
Foreign  134.1   100.7   137.8   
 
 
   510.2   503.9   417.6   
 
 
Deferred              
Federal  (9.6)  (69.6)  51.5   
State  (4.4)  .6   5.3   
Foreign  (29.7)  9.8   .9   
 
 
   (43.7)  (59.2)  57.7   
 
 
Total income taxes $466.5  $444.7  $475.3   
 
 
The difference between the U.S. federal statutory tax rate and the Company’s effective income tax rate was:
             
 
  2005 2004 2003
 
U.S. statutory income tax rate  35.0%  35.0%  35.0%
Foreign rates varying from 35%  -3.8   -.5   -.9 
State income taxes, net of federal benefit  1.2   1.7   1.8 
Foreign earnings repatriation  —   2.1   — 
Net change in valuation allowances  -.2   -1.5   -.1 
Statutory rate changes, deferred tax impact  —   .1   -.1 
Other  -1.0   -2.1   -3.0 
 
Effective income tax rate  31.2%  34.8%  32.7%
 
               
 
  2006 2005 2004  
 
 
U.S. statutory income tax rate  35.0%  35.0%  35.0%  
Foreign rates varying from 35%  −3.5   −3.8   −.5   
State income taxes, net of federal benefit  1.3   1.2   1.7   
Foreign earnings repatriation  1.2   —   2.1   
Tax audit settlements  −1.7   —   —   
Net change in valuation allowances  .5   −.2   −1.5   
Statutory rate changes, deferred tax impact   —   —   .1   
Other  −1.1   −1.0   −2.1   
 
 
Effective income tax rate  31.7%  31.2%  34.8%  
 
 
As presented in the preceding table, the Company’s 2006 consolidated provision for income taxes included two significant, but partially-offsetting, discrete adjustments. First, during the second quarter, the Company revised its repatriation plan for certain foreign earnings, giving rise to an incremental net tax cost of $18 million. Also in the second quarter, the Company reduced its reserves for uncertain tax positions by $25 million, related principally to closure of several domestic tax audits.
The consolidated effective income tax rate for 2005 was approximately 31%, which was below both the 2004 rate of nearly 35% was higher than the rates for 2006 and 2005 primarily because this period preceded the 2003 rate of less than 33%. As compared to the prior-period rates, the 2005 consolidated effective income tax rate benefited primarily from the 2004final reorganization of the Company’s European operations (referwhich favorably affected the country-weighting impact on the rate. (Refer to Note 3 for further information) andinformation on this initiative.) Additionally, the 2004 consolidated effective income tax rate included a provision of approximately $40 million, partially offset by related foreign tax credits of approximately $12 million, for approximately $1.1 billion of dividends from foreign subsidiaries which the Company elected to a lesser extent,repatriate in 2005 under the U.S. tax legislation that allowsAmerican Jobs Creation Act. Finally, 2005 was the first year in which the Company was permitted to claim a phased-in deduction from U.S. taxable income equal to a stipulated percentage of qualified production income (“QPI”), beginning in 2005..
During 2005, the Company elected to repatriate approximately $1.1 billion of dividends from foreign subsidiaries which qualified for the temporary dividends-received-deduction available under the American Jobs Creation Act. The associated net tax cost of approximately $40 million was provided for in 2004, partially offset by related foreign tax credits of approximately $12 million. At December 31, 2005, remaining foreign subsidiary earnings of approximately $700 million were considered permanently invested in those businesses. Accordingly, U.S. income taxes have not been provided on these earnings.
Generally, the changes in valuation allowances on deferred tax assets and corresponding impacts on the effective income tax rate result from management’s assessment of the Company’s ability to utilize certain operating loss and tax credit carryforwards prior to expiration. For 2004, the 1.5 percent rate reduction presented in the preceding table primarily reflects reversal of a valuation allowance against U.S. foreign tax credits, which were utilized in conjunction with the aforementioned 2005 foreign earnings repatriation. Total tax benefits of carryforwards at year-end 20052006 and 20042005 were approximately $23$29 million and $57$23 million, respectively. Of the total carryforwards at year-end 2005,2006, less than $2 million expire in 20062007 with the remainder principally expiring after five years. After valuation allowance, the carrying value of carryforward tax benefits at year-end 20052006 was only $3$1 million.
Income tax benefits realized from stock option exercises for which no compensation expense is recognized under the intrinsic value method (refer to Note 1) are recorded in Capital in excess of par value within the Consolidated Balance Sheet. Such benefits were approximately (in millions): 2005 — $39; 2004 — $37; 2003 — $12.
The deferred tax assets and liabilities included in the balance sheet at year end are presented in a table on page 50. The Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the following table. During 2005,end of its 2006 fiscal year. The standard generally requires company plan sponsors to reflect the Company reclassified $578.9 million attributable to its direct store-door (DSD) delivery system from indefinite-lived intangibles to goodwill and accordingly reduced noncurrentnet over- or under-funded position of a defined postretirement benefit plan as an asset or liability on the balance sheet. Any unrecognized prior service cost, experience gains/losses, or transition obligation are reported as a component of other comprehensive income, net of tax, in shareholders’ equity. As a result of adopting this standard, the employee benefits component of the Company’s deferred tax assets increased (or liabilities decreased) by $228.5 million. Prior periods were likewise reclassified.a total of $298.9 million at December 30, 2006. Refer to Note 1 for further information.
                   
 
  Deferred tax assets Deferred tax liabilities
 
(millions) 2005 2004 2005 2004
 
Current:
                
 U.S. state income taxes $12.1  $6.8  $—  $— 
 Advertising and promotion-related  18.6   18.5   8.8   8.4 
 Wages and payroll taxes  28.8   29.9   —   — 
 Inventory valuation  25.5   20.2   6.3   6.9 
 Employee benefits  32.0   34.9   —   — 
 Operating loss and credit carryforwards  7.0   34.6   —   — 
 Hedging transactions  17.5   26.4   .1   — 
 Depreciation and asset disposals  .1   —   —   — 
 Foreign earnings repatriation  —   —   —   40.5 
 Deferred intercompany revenue  76.3   —   —   — 
 Other  22.6   8.8   22.0   13.6 
 
   240.5   180.1   37.2   69.4 
  Less valuation allowance  (3.2)  (3.8)  —   — 
 
  $237.3  $176.3  $37.2  $69.4 
 


49

40

                   
 
  Deferred tax assets Deferred tax liabilities
 
(millions) 2005 2004 2005 2004
 
Noncurrent:
                
 U.S. state income taxes $—  $—  $54.4  $48.6 
 Employee benefits  20.4   21.6   129.7   111.6 
 Operating loss and credit carryforwards  15.5   22.4   —   — 
 Hedging transactions  1.7   1.3   —   — 
 Depreciation and asset disposals  12.7   14.8   340.8   376.9 
 Capitalized interest  5.1   5.8   12.7   15.5 
 Trademarks and other intangibles  .1   .1   472.4   461.6 
 Deferred compensation  34.9   37.5   —   — 
 Other  15.3   1.4   2.1   9.8 
 
   105.7   104.9   1,012.1   1,024.0 
  Less valuation allowance  (16.2)  (18.5)  —   — 
 
   89.5   86.4   1,012.1   1,024.0 
 
Total deferred taxes $326.8  $262.7  $1,049.3  $1,093.4 
 
                   
 
  Deferred tax assets Deferred tax liabilities  
 
(millions) 2006 2005 2006 2005  
 
 
Current:
                  
U.S. state income taxes $7.6  $12.1  $—  $—   
Advertising and promotion-related  19.7   19.4   11.0   8.8   
Wages and payroll taxes  26.3   28.8   —   —   
Inventory valuation  22.5   25.5   4.6   6.3   
Employee benefits  18.0   32.0   —   —   
Operating loss and credit carryforwards  13.9   7.0   —   —   
Hedging transactions  19.2   17.5   .8   .1   
Depreciation and asset disposals  .1   .1   —   —   
Deferred intercompany revenue  6.1   76.3   —   —   
Other  26.4   22.6   15.2   22.8   
 
 
   159.8   241.3   31.6   38.0   
Less valuation allowance  (15.2)  (3.2)  —   —   
 
 
  $144.6  $238.1  $31.6  $38.0   
 
 
Noncurrent:
                  
U.S. state income taxes $—  $—  $47.0  $54.4   
Employee benefits  217.4   20.4   53.2   129.7   
Operating loss and credit carryforwards  15.2   15.5   —   —   
Hedging transactions  2.0   1.7   —   —   
Depreciation and asset disposals  15.1   12.7   306.5   340.8   
Capitalized interest  5.3   5.1   11.9   12.7   
Trademarks and other intangibles  .1   .1   473.9   472.4   
Deferred compensation  40.6   34.9   —   —   
Stock options  22.4   —   —   —   
Other  12.0   15.3   6.3   2.1   
 
 
   330.1   105.7   898.8   1,012.1   
Less valuation allowance  (13.0)  (16.2)  —   —   
 
 
   317.1   89.5   898.8   1,012.1   
 
 
Total deferred taxes $461.7  $327.6  $930.4  $1,050.1   
 
 
The change in valuation allowance against deferred tax assets was:
             
 
(millions) 2005 2004 2003
 
Balance at beginning of year $22.3  $36.8  $34.7 
Additions charged to income tax expense  .2   13.3   2.6 
Reductions credited to income tax expense  (3.2)  (28.9)  (4.1)
Currency translation adjustments  .1   1.1   3.6 
 
Balance at end of year $19.4  $22.3  $36.8 
 
               
 
(millions) 2006 2005 2004  
 
 
Balance at beginning of year $19.4  $22.3  $36.8   
Additions charged to income tax expense  11.4   .2   13.3   
Reductions credited to income tax expense  (3.6)  (3.2)  (28.9)  
Currency translation adjustments  1.0   .1   1.1   
 
 
Balance at end of year $28.2  $19.4  $22.3   
 
 
At December 30, 2006, accumulated foreign subsidiary earnings of approximately $1.1 billion were considered permanently invested in those businesses. Accordingly, U.S. income taxes have not been provided on these earnings.
Cash paid for income taxes was (in millions): 2005-2006−$428; 2005−$425; 2004-2004−$421; 2003-$289.421. Income tax benefits realized from stock option exercises and deductibility of other equity-based awards are presented in Note 8.
Note 12 Financial instruments and credit risk concentration
The fair values of the Company’s financial instruments are based on carrying value in the case of short-term items, quoted market prices for derivatives and investments, and in the case of long-term debt, incremental borrowing rates currently available on loans with similar terms and maturities. The carrying amounts of the Company’s cash, cash equivalents, receivables, and notes payable approximate fair value. The fair value of the Company’s long-term debt at December 31, 2005,30, 2006, exceeded its carrying value by approximately $357$275 million.
The Company is exposed to certain market risks which exist as a part of its ongoing business operations andoperations. Management uses derivative financial and commodity instruments, where appropriate, to manage these risks. In general, instruments used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the contract. In accordance with SFAS No. 133, the Company designates derivatives as either cash flow hedges, fair value hedges, net investment hedges, or other contracts used to reduce volatility in the translation of foreign currency earnings to U.S. Dollars. The fair values of all hedges are recorded in accounts receivable or other current liabilities. Gains and losses representing either hedge ineffectiveness, hedge components excluded from the assessment of effectiveness, or hedges of translational exposure are recorded in other income (expense), net. Within the Consolidated Statement of Cash Flows, settlements of cash flow and fair value hedges are classified as an operating activity; settlements of all other derivatives are classified as a financing activity.
Cash flow hedges
Qualifying derivatives are accounted for as cash flow hedges when the hedged item is a forecasted transaction. Gains and losses on these instruments are recorded in other comprehensive income until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive income to the Consolidated Statement of Earnings on the same line item as the underlying transaction. For all cash flow hedges, gains and losses representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness were insignificant during the periods presented.
The total net loss attributable to cash flow hedges recorded in accumulated other comprehensive income at December 31, 2005,30, 2006, was $32.2$32.6 million, related primarily to forward interest rate contracts settled during 2001 and 2003 in conjunction


50

with fixed-ratefixed rate long-term debt issuances. This lossissuances and to a lesser extent, to10-year natural gas price swaps entered into in 2006. The interest rate contract losses will be reclassified into interest expense over the next 3-2625 years. The natural gas swap losses will be reclassified to cost of goods sold over 10 years. Other insignificant amounts related to foreign currency and commodity price cash flow hedges will be reclassified into earnings during the next 18 months.
Fair value hedges
Qualifying derivatives are accounted for as fair value hedges when the hedged item is a recognized asset, liability, or firm commitment. Gains and losses on these instruments are recorded in earnings, offsetting gains and losses on the hedged item. For all fair value hedges, gains and losses representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness were insignificant during the periods presented.
Net investment hedges
Qualifying derivative and nonderivative financial instruments are accounted for as net investment hedges when the hedged item is a foreignnonfunctional currency investment in a subsidiary. Gains and losses on these instruments are recorded as a foreign currency translation adjustment in other comprehensive income.

41

Other contracts
The Company also periodically enters into foreign currency forward contracts and options to reduce volatility in the translation of foreign currency earnings to U.S. Dollars. Gains and losses on these instruments are recorded in other income (expense), net, generally reducing the exposure to translation volatility during a full-year period.
Foreign exchange risk
The Company is exposed to fluctuations in foreign currency cash flows related primarily to third-party purchases, intercompany transactions, and nonfunctional currency denominated third partythird-party debt. The Company is also exposed to fluctuations in the value of foreign currency investments in subsidiaries and cash flows related to repatriation of these investments. Additionally, the Company is exposed to volatility in the translation of foreign currency earnings to U.S. Dollars. The CompanyManagement assesses foreign currency risk based on transactional cash flows and translational positionsvolatility and enters into forward contracts, options, and currency swaps to reduce fluctuations in net long or short currency positions. Forward contracts and options are generally less than 18 months duration. Currency swap agreements are established in conjunction with the term of underlying debt issues.
For foreign currency cash flow and fair value hedges, the assessment of effectiveness is generally based on changes in spot rates. Changes in time value are reported in other income (expense), net.
Interest rate risk
The Company is exposed to interest rate volatility with regard to future issuances of fixed rate debt and existing issuances of variable rate debt. The Company currentlyperiodically uses interest rate swaps, including forward-starting swaps, to reduce interest rate volatility and funding costs associated with certain debt issues, and to achieve a desired proportion of variable versus fixed rate debt, based on current and projected market conditions.
Variable-to-fixed interest rate swaps are accounted for as cash flow hedges and the assessment of effectiveness is based on changes in the present value of interest payments on the underlying debt.Fixed-to-variable interest rate swaps are accounted for as fair value hedges and the assessment of effectiveness is based on changes in the fair value of the underlying debt, using incremental borrowing rates currently available on loans with similar terms and maturities.
Price risk
The Company is exposed to price fluctuations primarily as a result of anticipated purchases of raw and packaging materials, fuel, and energy. The Company useshas historically used the combination of long cash positionslong-term contracts with suppliers, and exchange-traded futures and option contracts to reduce price fluctuations in a desired percentage of forecasted raw material purchases over a duration of generally less than 18 months. During 2006, the Company entered into two separate10-yearover-the-counter commodity swap transactions to reduce fluctuations in the price of natural gas used principally in its manufacturing processes.
Commodity contracts are accounted for as cash flow hedges. The assessment of effectiveness for exchange-traded instruments is based on changes in futures prices. The assessment of effectiveness forover-the-counter transactions is based on changes in designated indexes.
Credit risk concentration
The Company is exposed to credit loss in the event of nonperformance by counterparties on derivative financial and commodity contracts. This credit loss is limited to the


51

cost of replacing these contracts at current market rates. Management believes the probability of such loss is remote.
Financial instruments, which potentially subject the Company to concentrations of credit risk are primarily cash, cash equivalents, and accounts receivable. The Company places its investments in highly rated financial institutions and investment-grade short-term debt instruments, and limits the amount of credit exposure to any one entity. Management believes concentrations of credit risk with respect to accounts receivable is limited due to the generally high credit quality of the Company’s major customers, as well as the large number and geographic dispersion of smaller customers. However, the Company conducts a disproportionate amount of business with a small number of large multinational grocery retailers, with the five largest accounts comprising approximately 22%27% of consolidated accounts receivable at December 31, 2005.30, 2006.

42

Note 13 Quarterly financial data (unaudited)
                 
 
  Net sales Gross profit
 
(millions, except per share data) 2005 2004 2005 2004
 
First $2,572.3  $2,390.5  $1,135.9  $1,035.0 
Second  2,587.2   2,387.3   1,198.6   1,080.2 
Third  2,623.4   2,445.3   1,186.0   1,126.2 
Fourth  2,394.3   2,390.8   1,045.1   1,073.8 
 
  $10,177.2  $9,613.9  $4,565.6  $4,315.2 
 
                         
 
  Net earnings Net earnings per share
 
  2005 2004 2005 2004
 
      Basic Diluted Basic Diluted
         
First $254.7  $219.8  $.62  $.61  $.54  $.53 
Second  259.0   237.4   .63   .62   .58   .57 
Third  274.3   247.0   .66   .66   .60   .59 
Fourth  192.4   186.4   .47   .47   .45   .45 
 
  $980.4  $890.6                 
 
                 
 
  Net sales Gross profit
 
(millions, except
        
per share data) 2006 2005 2006 2005
 
 
First $2,726.5  $2,572.3  $1,196.7  $1,135.9 
Second  2,773.9   2,587.2   1,235.5   1,198.6 
Third  2,822.4   2,623.4   1,273.3   1,186.0 
Fourth  2,583.9   2,394.3   1,119.7   1,045.1 
 
 
  $10,906.7  $10,177.2  $4,825.2  $4,565.6 
 
 
                         
 
  Net earnings Net earnings per share
 
  2006 2005 2006 2005
 
      Basic Diluted Basic Diluted
         
 
First $274.1  $254.7  $.69  $.68  $.62  $.61 
Second  266.5   259.0   .68   .67   .63   .62 
Third  281.1   274.3   .71   .70   .66   .66 
Fourth  182.4   192.4   .46   .45   .47   .47 
 
 
  $1,004.1  $980.4                 
 
 
The principal market for trading Kellogg shares is the New York Stock Exchange (NYSE). The shares are also traded on the Boston, Chicago, Cincinnati, Pacific, and Philadelphia Stock Exchanges. At year-end 2005,2006, the closing price (on the NYSE) was $43.22$50.06 and there were 42,19341,450 shareholders of record.
Dividends paid per share and the quarterly price ranges on the NYSE during the last two years were:
             
 
  Stock price
  Dividend  
  per share High Low
 
2005 — Quarter
            
 
First $.2525  $45.59  $42.41 
Second  .2525   46.89   42.35 
Third  .2775   46.99   43.42 
Fourth  .2775   46.70   43.22 
 
  $1.0600         
 
2004 — Quarter            
 
First $.2525  $39.88  $37.00 
Second  .2525   43.41   38.41 
Third  .2525   43.08   39.88 
Fourth  .2525   45.32   41.10 
 
  $1.0100         
 
             
 
  Dividend
 Stock price
  per share High Low
 
 
2006 — Quarter
            
 
 
First $.2775  $45.78  $42.41 
Second  .2775   48.50   43.06 
Third  .2910   50.87   47.31 
Fourth  .2910   50.95   47.71 
 
 
  $1.1370         
 
 
2005 — Quarter            
 
 
First $.2525  $45.59  $42.41 
Second  .2525   46.89   42.35 
Third  .2775   46.99   43.42 
Fourth  .2775   46.70   43.22 
 
 
  $1.0600         
 
 
Note 14 Operating segments
Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles, and meat alternatives.veggie foods. Kellogg products are manufactured and marketed globally. Principal markets for these products include the United States and United Kingdom. The Company currently manages its operations based on thein four geographic regionsoperating segments, comprised of North America and the three International operating segments of Europe, Latin America, and Asia Pacific. This organizational structure isFor the basis ofperiods presented, the followingAsia Pacific operating segment data. included Australia and Asian markets. Beginning in 2007, this segment will also include South Africa, which was formerly a part of Europe.
The measurement of operating segment results is generally consistent with the presentation of the Consolidated Statement of Earnings and Balance Sheet. Intercompany transactions between reportable operating segments were insignificant in all periods presented.
During 2005, the Company reclassified $578.9 million attributable to its U.S. direct store-door (DSD) delivery system from indefinite-lived intangibles to goodwill, net of an associated deferred tax liability of $228.5 million. Prior periods were likewise reclassified, resulting in a net reduction to total and long-lived assets of $228.5 million within the United States, the Company’s North America operating segment, and consolidated balances.
              
 
(millions) 2005 2004 2003
 
Net sales
            
 North America $6,807.8  $6,369.3  $5,954.3 
 Europe  2,013.6   2,007.3   1,734.2 
 Latin America  822.2   718.0   666.7 
 Asia Pacific(a)  533.6   519.3   456.3 
 
 Consolidated $10,177.2  $9,613.9  $8,811.5 
 
Segment operating profit
            
 North America $1,251.5  $1,240.4  $1,134.2 
 Europe  330.7   292.3   279.8 
 Latin America  202.8   185.4   168.9 
 Asia Pacific(a)  86.0   79.5   61.1 
 Corporate  (120.7)  (116.5)  (99.9)
 
 Consolidated $1,750.3  $1,681.1  $1,544.1 
 
               
 
(millions) 2006 2005 2004  
 
 
Net sales
              
North America $7,348.8  $6,807.8  $6,369.3   
Europe  2,143.8   2,013.6   2,007.3   
Latin America  890.8   822.2   718.0   
Asia Pacific (a)  523.3   533.6   519.3   
 
 
Consolidated $10,906.7  $10,177.2  $9,613.9   
 
 
Segment operating profit
              
North America $1,340.5  $1,251.5  $1,240.4   
Europe  334.1   330.7   292.3   
Latin America  220.1   202.8   185.4   
Asia Pacific (a)  76.9   86.0   79.5   
Corporate  (205.8)  (120.7)  (116.5)  
 
 
Consolidated $1,765.8  $1,750.3  $1,681.1   
 
 
(a) Includes Australia and Asia.

43

              
 
(millions) 2005 2004 2003
 
Depreciation and amortization
            
 North America $272.3  $261.4  $246.4 
 Europe  61.2   95.7   71.1 
 Latin America  20.0   15.4   21.6 
 Asia Pacific(a)  20.9   20.9   20.0 
 Corporate  17.4   16.6   13.7 
 
 Consolidated $391.8  $410.0  $372.8 
 
Interest expense
            
 North America $1.4  $1.7  $4.0 
 Europe  12.4   15.6   18.2 
 Latin America  .2   .2   .2 
 Asia Pacific(a)  .3   .2   .3 
 Corporate  286.0   290.9   348.7 
 
 Consolidated $300.3  $308.6  $371.4 
 
Income taxes
            
 North America $372.7  $371.5  $345.0 
 Europe  30.2   64.5   54.6 
 Latin America  21.5   39.8   40.0 
 Asia Pacific(a)  12.4   (.8)  3.3 
 Corporate  7.9   .3   (60.5)
 
 Consolidated $444.7  $475.3  $382.4 
 
Total assets
            
 North America $7,944.6  $7,641.5  $7,735.8 
 Europe  2,356.7   2,324.2   1,765.4 
 Latin America  450.6   411.1   341.2 
 Asia Pacific(a)  294.7   347.4   300.4 
 Corporate  5,336.4   5,619.0   6,362.2 
 Elimination entries  (5,808.5)  (5,781.3)  (6,590.8)
 
 Consolidated $10,574.5  $10,561.9  $9,914.2 
 
Additions to long-lived assets
            
 North America $320.4  $167.4  $185.6 
 Europe  42.3   59.7   35.5 
 Latin America  38.5   37.2   15.4 
 Asia Pacific(a)  14.4   9.9   10.1 
 Corporate  .4   4.4   .6 
 
 Consolidated $416.0  $278.6  $247.2 
 
(a)Includes Australia and Asia.


52

               
 
(millions) 2006 2005 2004  
 
 
Depreciation and amortization
              
North America $241.8   272.3  $261.4   
Europe  66.4   61.2   95.7   
Latin America  21.9   20.0   15.4   
Asia Pacific (a)  17.2   20.9   20.9   
Corporate  5.4   17.4   16.6   
 
 
Consolidated $352.7   391.8  $410.0   
 
 
Interest expense
              
North America $8.7  $1.4  $1.7   
Europe  27.0   12.4   15.6   
Latin America  .1   .2   .2   
Asia Pacific (a)  .4   .3   .2   
Corporate  271.2   286.0   290.9   
 
 
Consolidated $307.4  $300.3  $308.6   
 
 
Income taxes
              
North America $396.2  $372.7  $371.5   
Europe  9.8   30.2   64.5   
Latin America  31.8   21.5   39.8   
Asia Pacific (a)  14.4   12.4   (.8)  
Corporate  14.3   7.9   .3   
 
 
Consolidated $466.5  $444.7  $475.3   
 
 
Total assets(b)
              
North America $7,996.2  $7,944.6  $7,641.5   
Europe  2,380.7   2,356.7   2,324.2   
Latin America  661.4   450.6   411.1   
Asia Pacific (a)  328.8   294.7   347.4   
Corporate  4,934.0   5,336.4   5,619.0   
Elimination entries  (5,587.1)  (5,808.5)  (5,781.3)  
 
 
Consolidated $10,714.0  $10,574.5  $10,561.9   
 
 
Additions to long-lived assets(c)
              
North America $316.0  $317.0  $167.4   
Europe  62.6   42.3   59.7   
Latin America  52.8   38.1   37.2   
Asia Pacific (a)  18.9   14.4   9.9   
Corporate  2.8   .4   4.4   
 
 
Consolidated $453.1  $412.2  $278.6   
 
 
(a)Includes Australia and Asia.
(b)The Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the end of its 2006 fiscal year. The standard generally requires company plan sponsors to reflect the net over- or under-funded position of a defined postretirement benefit plan as an asset or liability on the balance sheet. Accordingly, the Company’s consolidated and corporate total assets for 2006 were reduced by $512.4 and $152.4 respectively. Operating segment total assets were reduced as follows: North America−$71.8; Europe−$284.3; Latin America−$2.9; Asia Pacific−$1.0. Refer to Note 1 for further information.
(c)Includes plant, property, equipment, and purchased intangibles.
The Company’s largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 17%18% of consolidated net sales during 2006, 17% in 2005, and 14% in 2004, and 13% in 2003, comprised principally of sales within the United States.
Supplemental geographic information is provided below for net sales to external customers and long-lived assets:
              
 
(millions) 2005 2004 2003
 
Net sales
            
 United States $6,351.6  $5,968.0  $5,608.3 
 United Kingdom  836.9   859.6   740.2 
 Other foreign countries  2,988.7   2,786.3   2,463.0 
 
 Consolidated $10,177.2  $9,613.9  $8,811.5 
 
Long-lived assets
            
 United States $6,880.9  $7,036.2  $7,122.0 
 United Kingdom  663.2   734.1   435.1 
 Other foreign countries  810.7   648.2   627.6 
 
 Consolidated $8,354.8  $8,418.5  $8,184.7 
 
               
 
(millions) 2006 2005 2004  
 
 
Net sales
              
United States $6,842.8  $6,351.6  $5,968.0   
United Kingdom  893.9   836.9   859.6   
Other foreign countries  3,170.0   2,988.7   2,786.3   
 
 
Consolidated $10,906.7  $10,177.2  $9,613.9   
 
 
Long-lived assets(a)
              
United States $6,629.5  $6,576.8  $6,539.2   
United Kingdom  369.2   323.8   432.5   
Other foreign countries  684.9   641.3   631.1   
 
 
Consolidated $7,683.6  $7,541.9  $7,602.8   
 
 
(a)Includes plant, property, equipment, and purchased intangibles.
Supplemental product information is provided below for net sales to external customers:
              
 
(millions) 2005 2004 2003
 
North America            
 Retail channel cereal $2,587.7  $2,404.5  $2,304.7 
 Retail channel snacks  2,976.6   2,801.4   2,547.6 
 Other  1,243.5   1,163.4   1,102.0 
International            
 Cereal  2,932.8   2,829.2   2,583.5 
 Convenience foods  436.6   415.4   273.7 
 
Consolidated $10,177.2  $9,613.9  $8,811.5 
 
               
 
(millions) 2006 2005 2004  
 
 
North America              
Retail channel cereal $2,667.0  $2,587.7  $2,404.5   
Retail channel snacks  3,318.4   2,976.6   2,801.4   
Frozen and specialty channels  1,363.4   1,243.5   1,163.4   
International              
Cereal  3,010.3   2,932.8   2,829.2   
Convenience foods  547.6   436.6   415.4   
 
 
Consolidated $10,906.7  $10,177.2  $9,613.9   
 
 
Note 15 Supplemental financial statement data
             
(millions)      
 
Consolidated Statement of Earnings 2005 2004 2003
 
Research and development expense $181.0  $148.9  $126.7 
Advertising expense $857.7  $806.2  $698.9 
 
             
 
Consolidated Statement of Cash Flows 2005 2004 2003
 
Trade receivables $(86.2) $13.8  $(36.7)
Other receivables  (25.4)  (39.5)  18.8 
Inventories  (24.8)  (31.2)  (48.2)
Other current assets  (15.3)  (17.8)  .4 
Accounts payable  156.4   63.4   84.8 
Other current liabilities  23.6   (18.5)  25.3 
 
Changes in operating assets and liabilities $28.3  $(29.8) $44.4 
 

44

          
(millions)    
 
Consolidated Balance Sheet 2005 2004
 
Trade receivables $782.7  $700.9 
Allowance for doubtful accounts  (6.9)  (13.0)
Other receivables  103.3   88.5 
 
 
Accounts receivable, net
 $879.1  $776.4 
 
Raw materials and supplies $188.6  $188.0 
Finished goods and materials in process  528.4   493.0 
 
 
Inventories
 $717.0  $681.0 
 
Deferred income taxes $207.6  $101.9 
Other prepaid assets  173.7   145.1 
 
 
Other current assets
 $381.3  $247.0 
 
Land $75.5  $78.3 
Buildings  1,458.8   1,504.7 
Machinery and equipment  4,692.4   4,751.3 
Construction in progress  237.3   159.6 
Accumulated depreciation  (3,815.6)  (3,778.8)
 
 
Property, net
 $2,648.4  $2,715.1 
 
Goodwill $3,455.3  $3,445.5 
Other intangibles  1,485.8   1,488.3 
 -Accumulated amortization  (47.6)  (46.1)
Pension  629.8   689.8 
Other  206.3   147.5 
 
 
Other assets
 $5,729.6  $5,725.0 
 
Accrued income taxes $148.3  $96.2 
Accrued salaries and wages  276.5   270.2 
Accrued advertising and promotion  320.9   322.0 
Other  339.1   402.1 
 
 
Other current liabilities
 $1,084.8  $1,090.5 
 
Nonpension postretirement benefits $74.5  $269.7 
Deferred income taxes  945.8   959.1 
Other  405.1   337.3 
 
 
Other liabilities
 $1,425.4  $1,566.1 
 
             
(millions)      
 
Allowance for doubtful accounts 2005 2004 2003
 
Balance at beginning of year $13.0  $15.1  $16.0 
Additions charged to expense  —   2.1   6.4 
Doubtful accounts charged to reserve  (7.4)  (4.3)  (7.3)
Currency translation adjustments  1.3   .1   — 
 
Balance at end of year $6.9  $13.0  $15.1 
 
During 2005, the Company reclassified $578.9 million attributable to its direct store-door (DSD) delivery system from indefinite-lived intangibles to goodwill, net of an associated deferred tax liability of $228.5 million. Prior periods were likewise reclassified, resulting in a net increase to goodwill of $350.4 million, a decrease to other intangibles of $578.9 million, and a decrease to noncurrent deferred income tax liabilities of $228.5 million.
               
(millions)
        
 
Consolidated Statement of Earnings 2006 2005 2004  
 
 
Research and development expense $190.6  $181.0  $148.9   
Advertising expense $915.9  $857.7  $806.2   
 
 
Note 16 Subsequent events
               
 
Consolidated Statement of Cash Flows 2006 2005 2004  
 
 
Trade receivables $(57.7) $(86.2) $13.8   
Other receivables  (21.0)  (25.4)  (39.5)  
Inventories  (107.0)  (24.8)  (31.2)  
Other current assets  (10.8)  (15.3)  (17.8)  
Accounts payable  27.5   156.4   63.4   
Accrued income taxes  65.6   74.7   (13.5)  
Accrued interest expense  4.3   (6.3)  (38.4)  
Other current liabilities  60.6   (44.8)  33.4   
 
 
Changes in operating assets and liabilities
 $(38.5) $28.3  $(29.8)  
 
 
In connection with the Company’s 2005 stock repurchase authorization, in November 2005, the Company repurchased approximately 9.4 million common shares from the W.K. Kellogg Foundation Trust (the “Trust”) for $400 million in a privately negotiated transaction pursuant to an agreement dated as of November 8, 2005 (the “2005 Agreement”). The 2005 Agreement provided the Trust with registration rights in certain circumstances for additional common shares which the Trust might desire to sell and provided the Company with rights to repurchase those additional common shares.
In connection with the Company’s 2006 stock repurchase authorization, the Company entered into an agreement with the Trust dated as of February 16, 2006 (the “2006 Agreement”) to repurchase approximately 12.8 million additional shares from the Trust for $550 million. The 2006 Agreement extinguished the registration and repurchase rights under the 2005 Agreement upon the Company’s repurchase of those additional shares on February 21, 2006.
           
(millions)
      
 
Consolidated Balance Sheet 2006 2005  
 
 
Trade receivables $839.4  $782.7   
Allowance for doubtful accounts  (5.9)  (6.9)  
Other receivables  111.3   103.3   
 
 
Accounts receivable, net
 $944.8  $879.1   
 
 
Raw materials and supplies $200.7  $188.6   
Finished goods and materials in process  623.2   528.4   
 
 
Inventories
 $823.9  $717.0   
 
 


53

Refer to Issuer Purchases of Equity Securities table, included herein under Part II, Item 5, for information on the Company’s common stock repurchase programs.

45

           
(millions)
        
 
Consolidated Balance Sheet 2006  2005   
 
 
Deferred income taxes $115.9  $207.6   
Other prepaid assets  131.8   173.7   
 
 
Other current assets
 $247.7  $381.3   
 
 
Land $77.5  $75.5   
Buildings  1,521.3   1,458.8   
Machinery and equipment (a)  4,992.0   4,692.4   
Construction in progress  326.8   237.3   
Accumulated depreciation  (4,102.0)  (3,815.6)  
 
 
Property, net
 $2,815.6  $2,648.4   
 
 
Goodwill $3,448.3  $3,455.3   
Other intangibles (b)  1,468.8   1,485.8   
—Accumulated amortization  (49.1)  (47.6)  
Pension (b)  352.6   629.8   
Other  250.8   206.3   
 
 
Other assets
 $5,471.4  $5,729.6   
 
 
Accrued income taxes $151.7  $148.3   
Accrued salaries and wages  311.1   276.5   
Accrued advertising and promotion  338.0   320.9   
Other (b)  317.7   339.1   
 
 
Other current liabilities
 $1,118.5  $1,084.8   
 
 
Nonpension postretirement benefits (b) $442.3  $74.5   
Deferred income taxes (b)  619.3   945.8   
Other (b)  510.2   405.1   
 
 
Other liabilities
 $1,571.8  $1,425.4   
 
 
(a)Includes an insignificant amount of capitalized internal-use software.
(b)The Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” as of the end of its 2006 fiscal year. The standard generally requires company plan sponsors to reflect the net over- or under-funded position of a defined postretirement benefit plan as an asset or liability on the balance sheet. Accordingly, the 2006 balances associated with the identified captions within the preceding table were materially affected by the adoption of this standard. Refer to Note 1 for further information.
               
(millions)
        
 
Allowance for doubtful accounts 2006 2005 2004  
 
 
Balance at beginning of year $6.9  $13.0  $15.1   
Additions charged to expense  1.6   —   2.1   
Doubtful accounts charged to reserve  (2.8)  (7.4)  (4.3)  
Currency translation adjustments  .2   1.3   .1   
 
 
Balance at end of year
 $5.9  $6.9  $13.0   
 
 

54

Management’s Responsibility for Financial Statements
Management is responsible for the preparation of the Company’s consolidated financial statements and related notes. Management believesWe believe that the consolidated financial statements present the Company’s financial position and results of operations in conformity with accounting principles that are generally accepted in the United States, using our best estimates and judgments as required.
The independent registered public accounting firm audits the Company’s consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board and provides an objective, independent review of the fairness of reported operating results and financial position.
The Board of Directors of the Company has an Audit Committee composed of fourthree non-management Directors. The Committee meets regularly with management, internal auditors, and the independent registered public accounting firm to review accounting, internal control, auditing and financial reporting matters.
Formal policies and procedures, including an active Ethics and Business Conduct program, support the internal controls and are designed to ensure employees adhere to the highest standards of personal and professional integrity. We have a vigorous internal audit program that independently evaluates the adequacy and effectiveness of these internal controls.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange ActRules 13a-15(f). Under the supervision and with the participation of management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.
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 risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Based on our evaluation under the framework inInternal Control — Integrated Framework,management concluded that our internal control over financial reporting was effective as of December 31, 2005.30, 2006. Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 200530, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which follows on page 47.56.
James M. Jenness
ChairmanA.D. David Mackay
President and Chief Executive Officer
Jeffrey M. Boromisa
SeniorJohn A. Bryant
Executive Vice President,
Chief Financial Officer, Kellogg Company
and President, Kellogg International


55

46

REPORT OF
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP
To the Shareholders and Board of Directors

of Kellogg Company:
Introduction
We have completed integrated audits of Kellogg Company’s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements30, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)1 present fairly, in all material respects, the financial position of Kellogg Company and its subsidiaries at December 31, 200530, 2006 and January 1,December 31, 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 200530, 2006 in conformity with accounting principles generally accepted in the United States of America. 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 audits. We conducted our audits of these statements 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 of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounted for share-based compensation and defined benefit pension, other postretirement, and postemployment plans in 2006.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control over Financial Reporting, appearing under Item 8, that the Company maintained effective internal control over financial reporting as of December 31, 200530, 2006 based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005,30, 2006, based on criteria established inInternal Control — Integrated Frameworkissued by the COSO. The Company’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 opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting 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. An audit of internal control over financial reporting includes 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 consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.
Battle Creek, Michigan

February 27, 200623, 2007


56

47

Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.Controls and Procedures
(a) The Company maintainsWe maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’sour Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’sour management, including itsour Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure based on management’s interpretation of the definition of “disclosure controls and procedures,” in underRules 13a-15(e) and15d-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that anyDisclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, rather than absolute, assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.objectives.
As of December 31, 2005,30, 2006, management carried out an evaluation under the supervision and with the participation of the Company’sour Chief Executive Officer and the Company’sour Chief Financial Officer, of the effectiveness of the design and operation of the Company’sour disclosure controls and procedures. Based on the foregoing, the Company’sour Chief Executive Officer and Chief Financial Officer concluded that the Company’sour disclosure controls and procedures were effective.effective at the reasonable assurance level.
(b) Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, the Company haswe have included a report of management’s assessment of the design and effectiveness of itsour internal control over financial reporting as part of this Annual Report onForm 10-K. The independent registered public accounting firm of PricewaterhouseCoopers LLP also attested to, and reported on, management’s assessment of the internal control over financial reporting. Management’s report and the independent registered public accounting firm’s attestation report are included in the Company’s 2005our 2006 financial statements in Item 8 of this Report under the captions entitled “Management’s Report on Internal Control over Financial Reporting” and “Report of Independent Registered Public Accounting Firm” and are incorporated herein by reference.
(c) During the last fiscal quarter, there have been no changes in the Company’sour internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’sour internal control over financial reporting.
Item 9B.Other Information
Not applicable.
PART III
Item 10.Directors, and Executive Officers of the Registrantand Corporate Governance
Directors — Refer to the information in the Company’sour Proxy Statement to be filed with the Securities and Exchange Commission for the Annual Meeting of Share OwnersShareowners to be held on April 21, 200627, 2007 (the “Proxy Statement”), under the caption “Election“Proposal 1 — Election of Directors,” which information is incorporated herein by reference.
Identification and Members of Audit Committee — Refer to the information in the Proxy Statement under the caption “About the Board of Directors,” which information is incorporated herein by reference.
Committee; Audit Committee Financial Expert — Refer to the information in the Proxy Statement under the caption “About the Board of Directors,“Board and Committee Membership,” which information is incorporated herein by reference.
Executive Officers of the Registrant — Refer to “Executive Officers of the Registrant” under Item 1 at pages 3 through 5and 4 of this Report.
For information concerning Section 16(a) of the Securities Exchange Act of 1934, refer to the information under the caption “Security Ownership — Section 16(a) Beneficial Ownership Reporting Compliance” of the Proxy Statement, which information is incorporated herein by reference.
Code of Ethics for Chief Executive Officer, Chief Financial Officer and Controller — The Company hasWe have adopted a Global Code of Ethics which applies to itsour chief executive officer, chief financial officer, corporate controller and all itsour other employees, and which can be found at www.kelloggcompany.com. Any amendments or waivers to the Global Code of Ethics applicable to the Company’sour chief executive officer, chief financial officer or corporate controller may also be found at www.kelloggcompany.com.
Item 11.Executive Compensation
Refer to the information under the captions “Executive Compensation” and “About the Board of Directors —“2006 Non-Employee Director Compensation and Benefits”Benefits,” “Compensation Discussion and Analysis,” “Compensation Committee Interlocks and Insider Participation,” “Executive Compensation,” “Retirement and Non-Qualified Defined Contribution and Deferred Compensation Plans,” “Employment Agreements” and “Potential Post-Employment Payments” of the Proxy Statement, which is incorporated herein by reference. See also the information under the caption “Report of the

48

Compensation“Compensation Committee on Executive Compensation”Report” of the Proxy Statement, which information is incorporated herein by reference; however, such information is only “furnished” hereunder and not incorporated by reference.deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934.


57

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Refer to the information under the captions “Security Ownership — Five Percent Holders” and “Security Ownership — Officer and Director Stock Ownership” and “Securities Authorized for Issuance Under Equity Compensation Plans” of the Proxy Statement, which information is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
             
 
(millions, except per share data)
      Number of
      securities remaining
    Weighted-average
 available for future
  Number of securities
 exercise price
 issuance under
  to be issued upon
 of outstanding
 equity compensation
  exercise of
 options, warrants
 plans (excluding
  outstanding options,
 and rights as of
 securities reflected
  warrants and rights as of
 December 30,
 in column (a)) as of
  December 30, 2006
 2006
 December 30, 2006
Plan category (a) (b) (c)
 
 
Equity compensation plans approved by security holders  26.9  $41   16.9 
Equity compensation plans not approved by security holders  .1  $27   .6 
 
 
Total  27.0  $41   17.5 
 
 
Five plans (including one individual compensation arrangement) are included in the “Equity compensation plans not approved by security holders” line: the Kellogg Share Incentive Plan, which was adopted in 2002 and is available to most U.K. employees of specified Kellogg Company subsidiaries; a similar plan, which is available to employees in the Republic of Ireland; the Kellogg Company Executive Stock Purchase Plan, which was adopted in 2002 and is available to selected senior level Kellogg employees; the Deferred Compensation Plan for Non-Employee Directors, which was adopted in 1986 and amended in 1993 and 2002; and a non-qualified stock option granted in 2000 to Mr. Jenness, when he had just been appointed a Kellogg Director, Chairman of the Board and Chief Executive Officer.
Under the Kellogg Share Incentive Plan, eligible U.K. employees may contribute up to 1,500 Pounds Sterling annually to the plan through payroll deductions. The trustees of the plan use those contributions to buy shares of our common stock at fair market value on the open market, with Kellogg matching those contributions on a 1:1 basis. Shares must be withdrawn from the plan when employees cease employment. Under current law, eligible employees generally receive certain income and other tax benefits if those shares are held in the plan for a specified number of years. A similar plan is also available to employees in the Republic of Ireland. As these plans are open market plans with no set overall maximum, no amounts for these plans are included in the above table. However, approximately 80,000 shares were purchased by eligible employees under the Kellogg Share Incentive Plan, the plan for the Republic of Ireland and other similar predecessor plans during 2006, with approximately an additional 80,000 shares being provided as matched shares.
Under the Kellogg Company Executive Stock Purchase Plan, selected senior level Kellogg employees may elect to use all or part of their annual bonus, on an after-tax basis, to purchase shares of our common stock at fair market value (as determined over athirty-day trading period). No more than 500,000 treasury shares are authorized for use under this plan.
Under the Deferred Compensation Plan for Non-Employee Directors, non-employee Directors may elect to defer all or part of their compensation (other than expense reimbursement) into units which are credited to their accounts. The units have a value equal to the fair market value of a share of our common stock on the appropriate date, with dividend equivalents being earned on the whole units in non-employee Directors’ accounts. Units may be paid in either cash or shares of our common stock, either in a lump sum or in up to ten annual installments, with the payments to begin as soon as practicable after the non-employee Director’s service as a Director terminates. No more than 150,000 shares are authorized for use under this plan, none of which had been issued or allocated for issuance as of December 30, 2006. Because Directors may elect, and are likely to elect, a distribution of cash rather than shares, the contingently issuable shares are not included in column (a) of the table above.
When Mr. Jenness joined Kellogg as a director in 2000, he was granted a non-qualified stock option to purchase 300,000 shares of our common stock. In connection with this option, which was to vest over three annual installments, he agreed to devote 50% of his working time to consulting with Kellogg, with further vesting to immediately stop if he was no longer willing to devote such amount of time to consulting with Kellogg or if Kellogg decided that it no longer wishes to receive such services. During 2001, Kellogg and Mr. Jenness agreed to terminate the consulting relationship, which immediately terminated the unvested 200,000 shares. This option contains the AOF feature described in the Proxy Statement.


58

Item 13.Certain Relationships and Related Transactions, and Director Independence
Refer to the information under the captions “Executive Compensation”“Corporate Governance — Director Independence” and “About the Board of Directors — Non-Employee Director Compensation and Benefits”“Related Person Transactions” of the Proxy Statement, which information is incorporated herein by reference.
Item 14.Principal Accounting Fees and Services
Refer to the information under the captions “Report“Proposal 2 — Ratification of the Audit CommitteeIndependent Auditors for 2007 — Audit Fees” “Report Paid to Independent Registered Accounting Firm” and “Proposal 2 — Ratification of the Audit Committee — Audit-Related Fees,” “Report of the Audit Committee — Tax Fees,” “Report of the Audit Committee — All Other Fees,” and “Report of the Audit CommitteePricewaterhouseCoopers LLP — Preapproval Policies and Procedures” of the Proxy Statement, which information is incorporated herein by reference.
PART IV
PART IV
Item 15.Exhibits, Financial Statements andStatement Schedules
The previous Consolidated Financial Statements and related Notes, together with Management’s Report on Internal Control over Financial Reporting, and the Report thereon of PricewaterhouseCoopers LLP dated February 27, 2006,23, 2007, are included herein in Part II, Item 8.
(a) 1. Consolidated Financial Statements
Consolidated Statement of Earnings for the years ended December 30, 2006, December 31, 2005 and January 1, 2005 and December 27, 2003.2005.
Consolidated Statement of Shareholders’ Equity for the years ended December 31, 2005, January 1, 2005 and December 27, 2003.
Consolidated Balance Sheet at30, 2006, December 31, 2005 and January 1, 2005.
Consolidated Balance Sheet at December 30, 2006 and December 31, 2005.
Consolidated Statement of Cash Flows for the years ended December 30, 2006, December 31, 2005 and January 1, 2005 and December 27, 2003.2005.
Notes to Consolidated Financial Statements.
Management’s Report on Internal Control over Financial Reporting.
Report of Independent Registered Public Accounting Firm.
(a) 2. Consolidated Financial Statement Schedule
All financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
(a) 3. Exhibits required to be filed by Item 601 ofRegulation S-K
The information called for by this Item is incorporated herein by reference from the Exhibit Index on pages 5261 through 5564 of this Report.


59

49

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, this 17th23rd day of February, 2006.2007.
KELLOGG COMPANY
KELLOGG COMPANY
 By: 
/s/James M. JennessA.D. David Mackay
James M. Jenness
Chairman of the Board and
Chief Executive Officer
A.D. David Mackay
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
       
Name
 
Capacity
 
Date
/s/  A.D. David Mackay

A.D. David Mackay		 
/s/James M. Jenness
James M. Jenness		Chairman of the Board,
President and Chief Executive Officer and Director
Director (Principal(Principal Executive Officer)		 February 17, 200623, 2007
/s/Jeffrey M. Boromisa
Jeffrey M. Boromisa		Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)		February 17, 2006
/s/Alan R. Andrews
Alan R. Andrews		Vice President and
Corporate Controller
(Principal Accounting Officer)		February 17, 2006
*
Benjamin S. Carson Sr.		DirectorFebruary 17, 2006
*
John T. Dillon		DirectorFebruary 17, 2006
*
Claudio X. Gonzalez		DirectorFebruary 17, 2006
*
Gordon Gund		DirectorFebruary 17, 2006
*
Dorothy A. Johnson		DirectorFebruary 17, 2006

50

NameCapacityDate
*
L. Daniel Jorndt		DirectorFebruary 17, 2006
*
Ann McLaughlin Korologos		DirectorFebruary 17, 2006
*
A.D. David Mackay		DirectorFebruary 17, 2006
*
William D. Perez		DirectorFebruary 17, 2006
*
William C. Richardson		DirectorFebruary 17, 2006
*
John L. Zabriskie		DirectorFebruary 17, 2006
*By:/s/Gary H. Pilnick
Gary H. Pilnick		Attorney-in-FactFebruary 17, 2006

51

EXHIBIT INDEX
       
    Electronic(E),
    Paper(P) or
Exhibit
/s/  John A. Bryant

John A. Bryant		 Incorp. By
No.DescriptionRef.(IBRF)
2.01Agreement and Plan of Restructuring and Merger dated as of October 26, 2000 between Flowers Industries, Inc.,Executive Vice President, Chief Financial Officer, Kellogg Company and Kansas Merger Subsidiary, Inc., incorporated by reference to Exhibit 2.02 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2000, Commission file number 1-4171.President, Kellogg International
(Principal Financial Officer)		 IBRFFebruary 23, 2007
2.02Agreement and Plan of Merger dated as of October 26, 2000 between Keebler Foods Company, Kellogg Company and FK Acquisition Corporation, incorporated by reference to Exhibit 2.03 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2000, Commission file number 1-4171.IBRF
3.01Amended Restated Certificate of Incorporation of Kellogg Company, incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-8, file number 333-56536.IBRF
3.02Bylaws of Kellogg Company, as amended, incorporated by reference to Exhibit 3.02 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2002, file number 1-4171.IBRF
4.01Fiscal Agency Agreement dated as of January 29, 1997, between the Company and Citibank, N.A., Fiscal Agent, incorporated by reference to Exhibit 4.01 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997, Commission file number 1-4171.IBRF
4.02Five-Year Credit Facility dated as of November 24, 2004 with twenty-three lenders, JPMorgan Chase Bank, N.A. as Administrative Agent, JPMorgan Europe Limited, as London Agent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Agent, JPMorgan Australia Limited, as Australian Agent, Barclays Bank PLC, as Syndication Agent and Bank of America, N.A., Citibank, N.A. and Suntrust Bank, as Co-Documentation Agents, incorporated by reference to Exhibit 4.02 to the Company’s Annual Report on Form 10-K for the fiscal year ended January 1, 2005, Commission file number 1-4171.IBRF
4.03Indenture dated August 1, 1993, between the Company and Harris Trust and Savings Bank, incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-3, Commission file number 33-49875.IBRF
4.04Form of Kellogg Company 47/8% Note Due 2005, incorporated by reference to Exhibit 4.06 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999, Commission file number 1-4171.IBRF
4.05Indenture and Supplemental Indenture dated March 15 and March 29, 2001, respectively, between Kellogg Company and BNY Midwest Trust Company, including the forms of 6.00% notes due 2006, 6.60% notes due 2011 and 7.45% Debentures due 2031, incorporated by reference to Exhibit 4.01 and 4.02 to the Company’s Quarterly Report on Form 10-Q for the quarter ending March 31, 2001, Commission file number 1-4171.IBRF
4.06Form of 2.875% Senior Notes due 2008 issued under the Indenture and Supplemental Indenture described in Exhibit 4.05, incorporated by reference to Exhibit 4.01 to the Company’s Current Report on Form 8-K dated June 5, 2003, Commission file number 1-4171.IBRF
4.07Agency Agreement dated November 28, 2005, between Kellogg Europe Company Limited, Kellogg Company, HSBC Bank and HSBC Institutional Trust Services (Ireland) Limited, incorporated by reference to Exhibit 4.1 of the Company’s Current Report in form 8-K dated November 28, 2005, Commission file number 1-4171.IBRF
4.08Canadian Guarantee dated November 28, 2005, incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K dated November 28, 2005, Commission file number 1-4171.IBRF
10.01Kellogg Company Excess Benefit Retirement Plan, incorporated by reference to Exhibit 10.01 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1983, Commission file number 1-4171.*IBRF
10.02Kellogg Company Supplemental Retirement Plan, incorporated by reference to Exhibit 10.05 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission file number 1-4171.*IBRF
10.03Kellogg Company Supplemental Savings and Investment Plan, as amended and restated as of January 1, 2003, incorporated by reference to Exhibit 10.03 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2002, Commission file number 1-4171.*IBRF

52

       
    Electronic(E),
    Paper(P) or
Exhibit
/s/  Alan R. Andrews

Alan R. Andrews		 Vice President and Corporate Controller
(Principal Accounting Officer)		 Incorp. ByFebruary 23, 2007
No.DescriptionRef.(IBRF)
10.04Kellogg Company International Retirement Plan, incorporated by reference to Exhibit 10.05 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997, Commission file number 1-4171.*IBRF
10.05Kellogg Company Executive Survivor Income Plan, incorporated by reference to Exhibit 10.06 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1985, Commission file number 1-4171.*IBRF
10.06Kellogg Company Key Executive Benefits Plan, incorporated by reference to Exhibit 10.09 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission file number 1-4171.*IBRF
10.07Kellogg Company Key Employee Long Term Incentive Plan, incorporated by reference to Exhibit 10.08 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997, Commission file number 1-4171.*IBRF
10.08Amended and Restated Deferred Compensation Plan for Non-Employee Directors, incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 29, 2003, Commission file number 1-4171.*IBRF
10.09Kellogg Company Senior Executive Officer Performance Bonus Plan, incorporated by reference to Exhibit 10.10 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1995, Commission file number 1-4171.*IBRF
10.10Kellogg Company 2000 Non-Employee Director Stock Plan, incorporated by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-8, file number 333-56536.*IBRF
10.11Kellogg Company 2001 Long-Term Incentive Plan, as amended and restated as of February 20, 2003, incorporated by reference to Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2002.*IBRF
10.12Kellogg Company Bonus Replacement Stock Option Plan, incorporated by reference to Exhibit 10.12 to the Company’s December 31, 1997, Commission file number 1-4171.*IBRF
10.13Kellogg Company Executive Compensation Deferral Plan incorporated by reference to Exhibit 10.13 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997, Commission file number 1-4171.*IBRF
10.14Agreement between the Company and Alan F. Harris, incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2003, Commission file number 1-4171.*IBRF
10.15Amendment to Agreement between the Company and Alan F. Harris, incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 25, 2004, Commission file number 1-4171.*IBRF
10.16Agreement between the Company and David Mackay, incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 2003, Commission file number 1-4171.*IBRF
10.17Retention Agreement between the Company and David Mackay, incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the fiscal period ended September 25, 2004, Commission file number 1-4171.*IBRF
10.18Employment Letter between the Company and James M. Jenness, incorporated by reference to Exhibit 10.18 to the Company’s Annual Report in Form 10-K for the fiscal year ended January 1, 2005, Commission file number 1-4171.IBRF
10.19Separation Agreement between the Company and Carlos M. Gutierrez, incorporated by reference to Exhibit 10.19 of the Company’s Annual Report in Form 10-K for the Company’s fiscal year ended January 1, 2005, Commission file number 1-4171.IBRF
10.20Agreement between the Company and other executives, incorporated by reference to Exhibit 10.05 of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, Commission file number 1-4171.*IBRF
10.21Stock Option Agreement between the Company and James Jenness, incorporated by reference to Exhibit 4.4 to the Company’s Registration Statement on Form S-8, file number 333-56536.*IBRF
10.22Kellogg Company 2002 Employee Stock Purchase Plan, as amended and restated as of December 5, 2002, incorporated by reference to Exhibit 10.21 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2002, Commission file number 1-4171.*IBRF

53

       
    Electronic(E),
    Paper(P) or
Exhibit
*

James M. Jenness		 Chairman of the Board and Director Incorp. ByFebruary 23, 2007
No.DescriptionRef.(IBRF)
10.23Kellogg Company Executive Stock Purchase Plan, incorporated by reference to Exhibit 10.25 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, Commission file number 1-4171.*IBRF
10.24Kellogg Company Senior Executive Annual Incentive Plan, incorporated by reference to Exhibit 10.26 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, Commission file number 1-4171.*IBRF
10.25Kellogg Company 2003 Long-Term Incentive Plan, incorporated by reference to Exhibit 10.28 of the Company’s Annual Report in Form 10-K for the Company’s fiscal year ended January 1, 2005, Commission file number 1-4171.*IBRF
10.26Kellogg Company Senior Executive Annual Incentive Plan, incorporated by reference to Annex II of the Company’s Board of Directors’ proxy statement for the annual meeting of shareholders to be held on April 21, 2006.*IBRF
10.27Kellogg Company Severance Plan, incorporated by reference to Exhibit 10.25 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2002, Commission file number 1-4171.*IBRF
10.28Form of Non-Qualified Option Agreement for Senior Executives under 2003 Long-Term Incentive Plan, incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the fiscal period ended September 25, 2004, Commission file number 1-4171.*IBRF
10.29Form of Restricted Stock Grant Award under 2003 Long-Term Incentive Plan, incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the fiscal period ended September 25, 2004, Commission file number 1-4171.*IBRF
10.30Form of Non-Qualified Option Agreement for Non-Employee Director under 2000 Non-Employee Director Stock Plan, incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the fiscal period ended September 25, 2004, Commission file number 1-4171.*IBRF
10.31Description of 2004 Senior Executive Annual Incentive Plan factors, incorporated by reference to the Company’s Current Report on Form 8-K dated February 4, 2005, Commission file number 1-4171 (the “2005 Form 8-K”).*IBRF
10.32Annual Incentive Plan, incorporated by reference to Exhibit 10.34 of the Company’s Annual Report in Form 10-K for the Company’s fiscal year ended January 1, 2005, Commission file number 1-4171.*IBRF
10.33Description of Annual Incentive Plan factors, incorporated by reference to the 2005 Form 8-K.*IBRF
10.342005-2007 Executive Performance Plan, incorporated by reference to Exhibit 10.36 of the Company’s Annual Report in Form 10-K for the Company’s fiscal year ended January 1, 2005, Commission file number 1-4171.*IBRF
10.35Description of Changes to the Compensation of Non-Employee Directors, incorporated by reference to the 2005 Form 8-K.*IBRF
10.362003-2005 Executive Performance Plan, incorporated by reference to Exhibit 10.38 of the Company’s Annual Report in Form 10-K for the Company’s fiscal year ended January 1, 2005, Commission file number 1-4171.*IBRF
10.37First Amendment to the Key Executive Benefits Plan, incorporated by reference to Exhibit 10.39 of the Company’s Annual Report in Form 10-K for the Company’s fiscal year ended January 1, 2005, Commission file number 1-4171.*IBRF
10.382006-2008 Executive Performance Plan, incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated February 17, 2006, Commission file number 1-4171 (the “2006 Form 8-K”).*IBRF
10.39Compensation changes for named executive officers, incorporated by reference to the 2006 Form 8-K.IBRF
10.40Restricted Stock Grant/Non-Compete Agreement between the Company and John Bryant, incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the period ended April 2, 2005, Commission file number 1-4171 (the “2005 Q1 Form 10-Q”).*IBRF
10.41Restricted Stock Grant/Non-Compete Agreement between the Company and Jeff Montie, incorporated by reference to Exhibit 10.2 of the 2005 Q1 Form 10-Q.*IBRF
10.42Executive Survivor Income Plan.E
21.01Domestic and Foreign Subsidiaries of the Company.E

54

       
    Electronic(E),
    Paper(P) or
Exhibit
*

Benjamin S. Carson Sr.		 Director Incorp. By
No.DescriptionRef.(IBRF)February 23, 2007
     
23.01Consent of Independent Registered Public Accounting Firm.E 
 24.01  Powers of Attorney authorizing Gary H. Pilnick to execute the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, on behalf of the Board of Directors, and each of them. E 
 31.1  Rule 13a-14(a)/15d-14(a) Certification by James M. Jenness.
*

John T. Dillon		DirectorFebruary 23, 2007
  E 
 31.2  Rule 13a-14(a)/15d-14(a) Certification by Jeffrey M. Boromisa. E 
 32.1  Section 1350 Certification by James M. Jenness.
*

Claudio X. Gonzalez		DirectorFebruary 23, 2007
  E 
 32.2  Section 1350 Certification by Jeffrey M. Boromisa.
  E 
*

Gordon Gund		DirectorFebruary 23, 2007
*

Dorothy A. Johnson		DirectorFebruary 23, 2007
*

L. Daniel Jorndt		DirectorFebruary 23, 2007
*

Ann McLaughlin Korologos		DirectorFebruary 23, 2007
*

John L. Zabriskie		DirectorFebruary 23, 2007
*By:
/s/  Gary H. Pilnick

Gary H. Pilnick		Attorney-in-FactFebruary 23, 2007


60

 
EXHIBIT INDEX
         
    Electronic(E),
    Paper(P) or
Exhibit
   Incorp. By
No.
 
Description
 
Ref.(IBRF)
 
 3.01 Amended Restated Certificate of Incorporation of Kellogg Company, incorporated by reference to Exhibit 4.1 to our Registration Statement onForm S-8, filenumber 333-56536.  IBRF 
 3.02 Bylaws of Kellogg Company, as amended, incorporated by reference to Exhibit 3.02 to our Annual Report onForm 10-K for the fiscal year ended December 28, 2002, file number1-4171.  IBRF 
 4.01 Fiscal Agency Agreement dated as of January 29, 1997, between us and Citibank, N.A., Fiscal Agent, incorporated by reference to Exhibit 4.01 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1997, Commission file number1-4171.  IBRF 
 4.02 Amended and Restated Five-Year Credit Agreement dated as of November 10, 2006 with twenty-four lenders, JPMorgan Chase Bank, N.A., as Administrative Agent, J.P. Morgan Europe Limited, as London Agent, JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Agent, J.P. Morgan Australia Limited, as Australian Agent, Barclays Bank PLC, as Syndication Agent and Bank of America, N.A., Citibank, N.A. and Suntrust Bank, as Co-Documentation Agents.  E 
 4.03 Indenture dated August 1, 1993, between us and Harris Trust and Savings Bank, incorporated by reference to Exhibit 4.1 to our Registration Statement onForm S-3, Commission filenumber 33-49875.  IBRF 
 4.04 Form of Kellogg Company 47/8% Note Due 2005, incorporated by reference to Exhibit 4.06 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1999, Commission file number1-4171.  IBRF 
 4.05 Indenture and Supplemental Indenture dated March 15 and March 29, 2001, respectively, between Kellogg Company and BNY Midwest Trust Company, including the forms of 6.00% notes due 2006, 6.60% notes due 2011 and 7.45% Debentures due 2031, incorporated by reference to Exhibit 4.01 and 4.02 to our Quarterly Report onForm 10-Q for the quarter ending March 31, 2001, Commission file number1-4171.  IBRF 
 4.06 Form of 2.875% Senior Notes due 2008 issued under the Indenture and Supplemental Indenture described in Exhibit 4.05, incorporated by reference to Exhibit 4.01 to our Current Report onForm 8-K dated June 5, 2003, Commission file number1-4171.  IBRF 
 4.07 Agency Agreement dated November 28, 2005, between Kellogg Europe Company Limited, Kellogg Company, HSBC Bank and HSBC Institutional Trust Services (Ireland) Limited, incorporated by reference to Exhibit 4.1 of our Current Report inForm 8-K dated November 28, 2005, Commission file number1-4171.  IBRF 
 4.08 Canadian Guarantee dated November 28, 2005, incorporated by reference to Exhibit 4.2 of our Current Report onForm 8-K dated November 28, 2005, Commission file number 1-4171.  IBRF 
 4.09 364-Day Credit Agreement dated as of January 31, 2007 with the lenders named therein, JPMorgan Chase Bank, N.A., as Administrative Agent, and Barclays Bank PLC, as Syndication Agent. J.P. Morgan Securities Inc. and Barclays Capital served as Joint Lead Arrangers and Joint Bookrunners.  E 
 4.10 Form of Multicurrency Global Note related to Euro-Commercial Paper Program.  E 
 10.01 Kellogg Company Excess Benefit Retirement Plan, incorporated by reference to Exhibit 10.01 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1983, Commission file number1-4171.*  IBRF 
 10.02 Kellogg Company Supplemental Retirement Plan, incorporated by reference to Exhibit 10.05 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1990, Commission file number1-4171.*  IBRF 
 10.03 Kellogg Company Supplemental Savings and Investment Plan, as amended and restated as of January 1, 2003, incorporated by reference to Exhibit 10.03 to our Annual Report onForm 10-K for the fiscal year ended December 28, 2002, Commission file number1-4171.*  IBRF 
 10.04 Kellogg Company International Retirement Plan, incorporated by reference to Exhibit 10.05 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1997, Commission file number1-4171.*  IBRF 
 10.05 Kellogg Company Executive Survivor Income Plan, incorporated by reference to Exhibit 10.06 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1985, Commission file number1-4171.*  IBRF 


61

         
    Electronic(E),
    Paper(P) or
Exhibit
   Incorp. By
No.
 
Description
 
Ref.(IBRF)
 
 10.06 Kellogg Company Key Executive Benefits Plan, incorporated by reference to Exhibit 10.09 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1991, Commission file number 1-4171.*  IBRF 
 10.07 Kellogg Company Key Employee Long Term Incentive Plan, incorporated by reference to Exhibit 10.08 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1997, Commission file number 1-4171.*  IBRF 
 10.08 Amended and Restated Deferred Compensation Plan for Non-Employee Directors, incorporated by reference to Exhibit 10.1 to our Quarterly Report onForm 10-Q for the fiscal quarter ended March 29, 2003, Commission file number1-4171.*  IBRF 
 10.09 Kellogg Company Senior Executive Officer Performance Bonus Plan, incorporated by reference to Exhibit 10.10 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1995, Commission file number1-4171.*  IBRF 
 10.10 Kellogg Company 2000 Non-Employee Director Stock Plan, incorporated by reference to Exhibit 4.3 to our Registration Statement onForm S-8, filenumber 333-56536.*  IBRF 
 10.11 Kellogg Company 2001 Long-Term Incentive Plan, as amended and restated as of February 20, 2003, incorporated by reference to Exhibit 10.11 to our Annual Report onForm 10-K for the fiscal year ended December 28, 2002.*  IBRF 
 10.12 Kellogg Company Bonus Replacement Stock Option Plan, incorporated by reference to Exhibit 10.12 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1997, Commission file number1-4171.*  IBRF 
 10.13 Kellogg Company Executive Compensation Deferral Plan incorporated by reference to Exhibit 10.13 to our Annual Report onForm 10-K for the fiscal year ended December 31, 1997, Commission file number1-4171.*  IBRF 
 10.14 Agreement between us and Alan F. Harris, incorporated by reference to Exhibit 10.2 to our Quarterly Report onForm 10-Q for the fiscal quarter ended September 27, 2003, Commission file number1-4171.*  IBRF 
 10.15 Amendment to Agreement between us and Alan F. Harris, incorporated by reference to Exhibit 10.2 to our Quarterly Report onForm 10-Q for the fiscal quarter ended September 25, 2004, Commission file number1-4171.*  IBRF 
 10.16 Agreement between us and David Mackay, incorporated by reference to Exhibit 10.1 to our Quarterly Report onForm 10-Q for the fiscal quarter ended September 27, 2003, Commission file number1-4171.*  IBRF 
 10.17 Retention Agreement between us and David Mackay, incorporated by reference to Exhibit 10.3 to our Quarterly Report onForm 10-Q for the fiscal period ended September 25, 2004, Commission file number1-4171.*  IBRF 
 10.18 Employment Letter between us and James M. Jenness, incorporated by reference to Exhibit 10.18 to our Annual Report inForm 10-K for the fiscal year ended January 1, 2005, Commission file number1-4171.*  IBRF 
 10.19 Separation Agreement between us and Carlos M. Gutierrez, incorporated by reference to Exhibit 10.19 of our Annual Report inForm 10-K for our fiscal year ended January 1, 2005, Commission file number1-4171.  IBRF 
 10.20 Agreement between us and other executives, incorporated by reference to Exhibit 10.05 of our Quarterly Report onForm 10-Q for the quarter ended June 30, 2000, Commission file number1-4171.*  IBRF 
 10.21 Stock Option Agreement between us and James Jenness, incorporated by reference to Exhibit 4.4 to our Registration Statement onForm S-8, filenumber 333-56536.*  IBRF 
 10.22 Kellogg Company 2002 Employee Stock Purchase Plan, as amended and restated as of December 5, 2002, incorporated by reference to Exhibit 10.21 of our Annual Report onForm 10-K for the fiscal year ended December 28, 2002, Commission file number1-4171.*  IBRF 
 10.23 Kellogg Company Executive Stock Purchase Plan, incorporated by reference to Exhibit 10.25 to our Annual Report onForm 10-K for the fiscal year ended December 31, 2001, Commission file number1-4171.*  IBRF 


62

         
    Electronic(E),
    Paper(P) or
Exhibit
   Incorp. By
No.
 
Description
 
Ref.(IBRF)
 
 10.24 Kellogg Company Senior Executive Annual Incentive Plan, incorporated by reference to Exhibit 10.26 to our Annual Report onForm 10-K for the fiscal year ended December 31, 2001, Commission file number1-4171.*  IBRF 
 10.25 Kellogg Company 2003 Long-Term Incentive Plan, as amended and restated as of December 8, 2006.*  E 
 10.26 Kellogg Company Senior Executive Annual Incentive Plan, incorporated by reference to Annex II of our Board of Directors’ proxy statement for the annual meeting of shareholders to be held on April 21, 2006.*  IBRF 
 10.27 Kellogg Company Severance Plan, incorporated by reference to Exhibit 10.25 of our Annual Report onForm 10-K for the fiscal year ended December 28, 2002, Commission file number1-4171.*  IBRF 
 10.28 Form of Non-Qualified Option Agreement for Senior Executives under 2003 Long-Term Incentive Plan, incorporated by reference to Exhibit 10.4 to our Quarterly Report onForm 10-Q for the fiscal period ended September 25, 2004, Commission file number1-4171.*  IBRF 
 10.29 Form of Restricted Stock Grant Award under 2003 Long-Term Incentive Plan, incorporated by reference to Exhibit 10.5 to our Quarterly Report onForm 10-Q for the fiscal period ended September 25, 2004, Commission file number1-4171.*  IBRF 
 10.30 Form of Non-Qualified Option Agreement for Non-Employee Director under 2000 Non-Employee Director Stock Plan, incorporated by reference to Exhibit 10.6 to our Quarterly Report onForm 10-Q for the fiscal period ended September 25, 2004, Commission file number1-4171.*  IBRF 
 10.31 Description of 2004 Senior Executive Annual Incentive Plan factors, incorporated by reference to our Current Report onForm 8-K dated February 4, 2005, Commission file number1-4171 (the “2005Form 8-K”).*  IBRF 
 10.32 Annual Incentive Plan, incorporated by reference to Exhibit 10.34 of our Annual Report inForm 10-K for our fiscal year ended January 1, 2005, Commission file number1-4171.*  IBRF 
 10.33 Description of Annual Incentive Plan factors, incorporated by reference to the 2005Form 8-K.*  IBRF 
 10.34 2005-2007 Executive Performance Plan, incorporated by reference to Exhibit 10.36 of our Annual Report inForm 10-K for our fiscal year ended January 1, 2005, Commission file number1-4171.*  IBRF 
 10.35 Description of Changes to the Compensation of Non-Employee Directors, incorporated by reference to the 2005Form 8-K.*  IBRF 
 10.36 2003-2005 Executive Performance Plan, incorporated by reference to Exhibit 10.38 of our Annual Report inForm 10-K for our fiscal year ended January 1, 2005, Commission file number1-4171.*  IBRF 
 10.37 First Amendment to the Key Executive Benefits Plan, incorporated by reference to Exhibit 10.39 of our Annual Report inForm 10-K for our fiscal year ended January 1, 2005, Commission file number1-4171.*  IBRF 
 10.38 2006-2008 Executive Performance Plan, incorporated by reference to Exhibit 10.1 of our Current Report onForm 8-K dated February 17, 2006, Commission file number1-4171 (the “2006Form 8-K”).*  IBRF 
 10.39 Compensation changes for named executive officers, incorporated by reference to the 2006Form 8-K.  IBRF 
 10.40 Restricted Stock Grant/Non-Compete Agreement between us and John Bryant, incorporated by reference to Exhibit 10.1 of our Quarterly Report onForm 10-Q for the period ended April 2, 2005, Commission file number 1-4171 (the “2005 Q1Form 10-Q”).*  IBRF 
 10.41 Restricted Stock Grant/Non-Compete Agreement between us and Jeff Montie, incorporated by reference to Exhibit 10.2 of the 2005 Q1Form 10-Q.*  IBRF 
 10.42 Executive Survivor Income Plan, incorporated by reference to Exhibit 10.42 of our Annual Report inForm 10-K for our fiscal year ended December 31, 2005, Commission file number1-4171.*  IBRF 
 10.43 Purchase and Sale Agreement between us and W. K. Kellogg Foundation Trust, incorporated by reference to Exhibit 10.1 to our Current Report onForm 8-K/A dated November 8, 2005, Commission file number1-4171.  IBRF 
 10.44 Purchase and Sale Agreement between us and W. K. Kellogg Foundation Trust, incorporated by reference to Exhibit 10.1 to our Current Report onForm 8-K dated February 16, 2006, Commission file number1-4171.  IBRF 
 10.45 Agreement between us and A.D. David Mackay, incorporated by reference to Exhibit 10.1 to our Current Report onForm 8-K dated October 20, 2006, Commission file number1-4171.*  IBRF 


63

         
    Electronic(E),
    Paper(P) or
Exhibit
   Incorp. By
No.
 
Description
 
Ref.(IBRF)
 
 10.46 Agreement between us and James M. Jenness, incorporated by reference to Exhibit 10.2 to our Current Report onForm 8-K dated October 20, 2006, Commission file number1-4171.*  IBRF 
 10.47 Agreement between us and Jeffrey M Boromisa, incorporated by reference to Exhibit 10.1 to our Current Report onForm 8-K dated December 29, 2006, Commission file number1-4171.*  IBRF 
 10.48 2007-2009 Executive Performance Plan, incorporated by reference to Exhibit 10.1 of our Current Report onForm 8-K dated February 20, 2007, Commission file number1-4171.*  IBRF 
 21.01 Domestic and Foreign Subsidiaries of Kellogg.  E 
 23.01 Consent of Independent Registered Public Accounting Firm.  E 
 24.01 Powers of Attorney authorizing Gary H. Pilnick to execute our Annual Report onForm 10-K for the fiscal year ended December 30, 2006, on behalf of the Board of Directors, and each of them.  E 
 31.1 Rule 13a-14(a)/15d-14(a) Certification by A.D. David Mackay.  E 
 31.2 Rule 13a-14(a)/15d-14(a) Certification by John A. Bryant.  E 
 32.1 Section 1350 Certification by A.D. David Mackay.  E 
 32.2 Section 1350 Certification by John A. Bryant.  E 
*A management contract or compensatory plan required to be filed with this Report.
The Company agrees
We agree to furnish to the Securities and Exchange Commission, upon its request, a copy of any instrument defining the rights of holders of long-term debt of the CompanyKellogg and its Subsidiariesour subsidiaries and any of itsour unconsolidated Subsidiariessubsidiaries for which Financial Statements are required to be filed.
The Company
We will furnish any of its share ownersour shareowners a copy of any of the above Exhibits not included herein upon the written request of such share ownershareowner and the payment to the CompanyKellogg of the reasonable expenses incurred by the Company in furnishing such copy or copies.


64

55