As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 2/28/06  Kellogg Co                        10-K       12/31/05    9:996K                                   Bowne - Bde

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report for Fiscal Year Ended 12/31/2005      HTML    767K 
 2: EX-10.42    Executive Survivor Income Plan                      HTML     36K 
 3: EX-21.01    Domestic and Foreign Subsidiaries of the Company    HTML     45K 
 4: EX-23.01    Consent of Independent Registered Public            HTML      8K 
                          Accounting Firm                                        
 5: EX-24.01    Powers of Attorney                                  HTML     30K 
 6: EX-31.1     Rule 13A-14(A)/15D-14(A) Certification by James M.  HTML     13K 
                          Jenness                                                
 7: EX-31.2     Rule 13A-14(A)/15D-14(A) Certification by Jeffrey   HTML     13K 
                          Boromisa                                               
 8: EX-32.1     Section 1350 Certification by James M. Jenness      HTML      9K 
 9: EX-32.2     Section 1350 Certification by Jeffrey Boromisa      HTML      9K 

The Company. Kellogg Company, incorporated in Delaware in 1922, and its subsidiaries are engaged in the manufacture and marketing of ready-to-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 Creek 49016-3599. Unless otherwise specified or indicated by the context, the term “Company” as used in this report means 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 to the Consolidated Financial Statements which are included herein under Part II, Item 8.

Principal Products. The principal products of the Company are ready-to-eat cereals and convenience foods, such as cookies, crackers, toaster pastries, cereal bars, frozen waffles and meat alternatives. These products were, as of December 31, 2005, manufactured by the Company in 17 countries and marketed in more than 180 countries. The Company’s cereal products are generally marketed under the Kellogg’s name and are sold principally to the grocery trade through direct sales forces for resale to consumers. The Company uses broker and distribution arrangements for certain products. It also generally uses these, or similar arrangements, in less-developed market areas or in those market areas outside of its focus.

The Company also markets cookies, crackers, and other convenience foods, under brands such as Kellogg’s, Keebler, Cheez-It, Murray, Austin and Famous 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’s products for the years 2003 through 2005 is located in Note 14 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’s products. Cartonboard, corrugated, and plastic are the principal packaging materials used by the Company. 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’s short-term and long-term requirements.

The principal ingredients in the products produced by the Company 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 into long-term contracts for the commodities described in this section and purchases these items on the open market, depending on the Company’s view of possible price fluctuations, supply levels, and the Company’s relative negotiating power. While the cost of some of these commodities has, and may continue to, increase over time, the Company believes that it will be able to purchase an adequate supply of these items as needed. The Company also uses commodity futures and options to hedge some of its 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.

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 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’s products.

Trademarks and Technology. Generally, the Company’s products are marketed under trademarks it owns. The Company’s principal trademarks are its housemarks, brand names, slogans, and designs related to cereals and convenience foods manufactured and marketed by the Company, with the Company also licensing third parties to use these

The Company also markets convenience foods under trademarks and tradenames which include Keebler, Cheez-It, E. L. Fudge, Murray, Famous Amos, Austin, Ready Crust, Chips Deluxe, Club, Fudge Shoppe, Hi-Ho, Sunshine, Munch’Ems, Sandies, Soft Batch, Toasteds, Town House, Vienna Fingers, Wheatables, and Zesta. One of its subsidiaries is also the exclusive licensee of the Carr’s brand name in the United States.

Company trademarks also include logos and depictions of certain animated characters in conjunction with the Company’s products, including Snap!Crackle!Pop! for Rice Krispies cereals and Rice Krispies Treats convenience foods; Tony the Tiger for Kellogg’s Frosted Flakes, Zucaritas, Sucrilhos and Frosties cereals and convenience foods; Ernie Keebler for cookies, convenience foods and other products; the Hollow Tree logo for certain convenience foods; Toucan Sam for Froot Loops; Dig ‘Em for Smacks; Coco the Monkey for Cocoa Krispies and Coco Pops; Cornelius for Kellogg’s Corn Flakes; Melvin the elephant for certain cereal and convenience foods; Chocos the Bear and Kobi the Bear for certain cereal products.

The slogans The Best To You Each Morning, The Original and Best and They’re Gr-r-reat!, used in connection with the Company’s ready-to-eat cereals, along with L’ Eggo my Eggo, used in connection with the Company’s frozen waffles and pancakes, and Elfin Magic used in connection with convenience food products are also important Company trademarks.

The trademarks listed above, among others, when taken as a whole, are important to the Company’s business. Certain individual trademarks are also important to the Company’s business. Depending on the jurisdiction, trademarks are generally valid as long as they are in use and/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 that, taken as a whole, the rights under its various patents, which expire from time to time, are a valuable asset, but the Company does not believe that its businesses are materially dependent on any single patent or group of related patents. The Company’s activities under licenses or other franchises or concessions which it holds are similarly a valuable asset, but are not believed to be material.

Seasonality. Demand for the Company’s products has generally been approximately level throughout the year, although some of the Company’s convenience foods have a bias for stronger demand in the second half of the year due to events and holidays. The Company also custom-bakes cookies for the Girl Scouts of the U.S.A., which are principally sold in the first quarter of the year.

Working Capital. Although terms vary around the world and by business types, 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. Receipts from goods sold, supplemented as required by borrowings, provide for the Company’s payment of dividends, capital expansion, and for other operating expenses and working capital needs.

Customers. The Company’s largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 17% of consolidated net sales during 2005, comprised principally of sales within the United States. At December 31, 2005, approximately 12% of the Company’s consolidated receivables balance and 17% of the Company’s U.S. receivables balance was comprised of amounts owed by Wal-Mart Stores, Inc. and its affiliates. During 2005, the Company’s top five customers, collectively, accounted for approximately 31% of the Company’s 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 believes 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’s sales and profits, the Company does not anticipate that this will occur to a significant extent due to the consumer demand for the Company’s products and the Company’s relationships with its customers. Products of the Company have been generally sold through its 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, 2005 and January 1, 2005, was not material to the Company.

Competition. The Company has experienced, and expects to continue to experience, intense competition for sales of all of its principal products in its major product categories, both domestically and internationally. The Company’s 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’s 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’s expenditures for research and development were approximately $181.0 million in 2005, $148.9 million in 2004 and $126.7 million in 2003.

Regulation. The Company’s 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’s 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’s activities.

Environmental Matters. The Company’s 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 is not a party to any material proceedings arising under these regulations. The Company believes that compliance with existing environmental laws and regulations will not materially affect the consolidated financial condition or the competitive position of the Company. The Company is currently in substantial compliance with all material environmental regulations affecting the Company and its properties.

Employees. At December 31, 2005, the Company had approximately 25,600 employees.

Financial Information About Geographic Areas. Information on geographic areas is located in Note 14 to the Consolidated Financial Statements, which are included herein under Part II, Item 8.

Executive Officers. The names, ages, and positions of the executive officers of the Company (as of February 15, 2006) 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.

James M. Jenness
Chairman of the Board and
Chief Executive Officer           59

A. D. David Mackay
President and Chief Operating Officer           50

John A. Bryant
Executive Vice President and President,
Kellogg International           40

Alan F. Harris
Executive Vice President and Chief Marketing
and Customer Officer           51

Jeffrey W. Montie
Executive Vice President and President,
Kellogg North America           44

Donna J. Banks
Senior Vice President, Global Supply Chain           49

Jeffrey M. Boromisa
Senior Vice President and Chief Financial Officer           50

Celeste Clark
Senior Vice President, Corporate Affairs           52

Gary H. Pilnick
Senior Vice President, General Counsel,
Corporate Development and Secretary           41

Kathleen Wilson-Thompson
Senior Vice President,
Global Human Resources           48

Alan R. Andrews
Vice President and Corporate Controller           50

Availability of Reports; Website Access; Other Information. Our internet address is http://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 on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 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 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 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information about the Public Reference Room by contacting the SEC at 1-800-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 Company will provide copies of any of these documents to any Share Owner upon request.

Forward-Looking Statements. This Report contains “forward-looking statements” with projections concerning, among other things, the Company’s 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’s 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’s actual results or activities may differ materially from these predictions. The Company’s 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 undertakes no obligation to publicly update them.

In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially adversely affect the Company’s business, financial condition and results of operations. Additional risks and uncertainties not presently known to the Company or that the Company currently deems immaterial also may impair the Company’s business operations and financial condition.

The Company’s performance is affected by general economic and political conditions and taxation policies.

The Company’s 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 conducts business, the financial markets through which the Company accesses capital and currency, political unrest and terrorist acts in the United States or other countries in which the Company carries 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 is currently active or may be active in the future, or on specific products that it sells or with which its products compete, may have an adverse effect on its business or on its results of operations.

The Company operates in the highly competitive food industry.

The Company faces competition across its product lines, including ready-to-eat cereals and convenience foods, from other companies which have varying abilities to withstand changes in market conditions. Some of the Company’s competitors have substantial financial, marketing and other resources, and competition with them in the Company’s various markets and product lines could cause the Company to reduce prices, increase capital, marketing or other expenditures, or lose category share, any of which could have a material adverse effect on the business and financial results of the Company. Category share and growth could also be adversely impacted if the Company is not successful in introducing new products.

The Company’s consolidated financial results and demand for the Company’s 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 Company and the industry as a whole. These include changing consumer dietary trends and the availability of substitute products.

The Company’s 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 aims 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 devotes significant focus to the development of new products and to the research, development and technology process functions of its business, it may not be successful in developing new products or its new products may not be commercially successful. The Company’s future results and its ability to maintain or improve its competitive position will depend on its capacity to gauge the direction of its key markets and upon its 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’s consolidated operating results and net worth.

The carrying value of goodwill represents the fair value of acquired business 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 the 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, 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’s consolidated earnings and net worth may be materially adversely affected.

As of December 31, 2005, the carrying value of intangible assets totaled approximately $4.9 billion, of which $3.5 billion was goodwill and $1.4 billion represented trademarks, trade names, and other acquired intangibles compared to total assets of $10.6 billion and shareholders’ equity of $2.3 billion.

The Company may not achieve its targeted cost savings from cost reduction initiatives.

The Company’s success depends in part on its ability to be an efficient producer in a highly competitive industry. The Company has invested a significant amount in capital expenditure to improve its 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 Company to achieve its planned cost savings could have a material adverse effect on its business and consolidated financial position and on the consolidated results of its operations and profitability.

The Company has a substantial amount of indebtedness.

The Company has indebtedness that is substantial in relation to its shareholders’ equity. As of December 31, 2005, the Company had total debt of approximately $4.9 billion and shareholders’ equity of $2.3 billion.

The Company’s substantial indebtedness could have important consequences, including:

The Company’s ability to make scheduled payments or to refinance its obligations with respect to indebtedness will depend on the Company’s financial and operating performance, which in turn, is subject to prevailing economic conditions, the availability of, and interest rates on, short term financing, and to financial, business and other factors beyond the Company’s control.

The 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’s products. Cartonboard, corrugated, and plastic are the principal packaging materials used by the Company. 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 is unable to increase its prices or adequately hedge against such changes in prices in a manner that offsets such changes, the results of its 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 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’s 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’s 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’s consolidated operating results or financial conditions.

Additionally, the Company’s labor costs include the cost of providing benefits for employees. The Company sponsors 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 Company also participates in a number of multiemployer pension plans for certain of its manufacturing locations. The Company’s 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 change in the assumed and actual rate of return on major plan assets, a change in the weighted-average discount rate used to measure obligations, the rate of health care cost inflation, and the outcome of collectively bargained wage and benefit agreements.

The Company may be unable to maintain its profit margins in the face of a consolidating retail environment. In addition, the loss of one of the Company’s largest customers could negatively impact its sales and profits.

The Company’s largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 17% of consolidated net sales during 2005, comprised principally of sales within the United States. At December 31, 2005, approximately 12% of the Company’s consolidated receivables balance and 17% of the Company’s U.S. receivables balance was comprised of amounts owed by Wal-Mart Stores, Inc. and its affiliates. During 2005, the Company’s top five

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’s consolidated financial condition.

The Company’s 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’s 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 is 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’s business and results of operations.

The Company’s operations face significant foreign currency exchange rate exposure which could negatively impact its operating results.

The Company holds assets and incurs liabilities, earns revenue and pays 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’s consolidated financial statements are presented in U.S. dollars, the Company must translate its 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’s consolidated financial statements, even if their value has not changed in their original currency. To the extent the Company fails to manage its foreign currency exposure adequately, the Company’s consolidated results of operations may be negatively affected.

If the Company’s food products become adulterated or misbranded, it might need to recall those items and may experience product liability if consumers are injured as a result.

The Company may need to recall some of its products if they become adulterated or misbranded. The Company may also be liable if the consumption of any of its products cause 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 Company could also suffer losses from a significant product liability judgment against it. A significant product recall or product liability case could also result in a loss of consumer confidence in the Company’s food products, which could have a material adverse effect on its business results and the value of its brands.

None.

The Company’s corporate headquarters and principal research and development facilities are located in Battle Creek, Michigan.

The Company operated, as of December 31, 2005, 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’s plants have been designed and constructed to meet its specific production requirements, and the Company periodically invests 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 other Company plants producing similar products, and other factors. 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

Outside the United States, the Company had, as of December 31, 2005, additional manufacturing locations, some with warehousing facilities, in Australia, Brazil, Canada, Colombia, Ecuador, Germany, Great Britain, Guatemala, India, Japan, Mexico, South Africa, South Korea, Spain, Thailand, and Venezuela.

The principal properties of the Company, including its 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 its facilities, taken as a whole, to be suitable, adequate, and of sufficient capacity for its current operations.

The Company is not a party to any pending legal proceedings which could reasonably be expected to have a material adverse effect on the Company and its subsidiaries, considered on a consolidated basis, nor are any of the Company’s properties or subsidiaries subject to any such proceedings.

Not applicable.

The following table provides information with respect to acquisitions by the Company of shares of its common stock during the quarter ended December 31, 2005.

(millions, except per share data)

ISSUER PURCHASES OF EQUITY SECURITIES

Kellogg Company and Subsidiaries

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, frozen waffles, and meat alternatives. Kellogg products are manufactured and marketed globally. We currently manage our operations based on the geographic regions of North America, Europe, Latin America, and Asia Pacific. This organizational structure is the basis of the operating segment data presented in this report.

2005 compared to 2004

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 compared to 2003

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, corporate 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 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 profit for each of fiscal 2003 and 2004 includes 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 comprised of $7.9 million to write off the remaining value of this same contract-based intangible asset in North America and $2.5 million to write off goodwill in Latin America.

Margin performance is presented in the following table.

Our long-term goal is to achieve annual improvements in gross margin and to reinvest this growth in brand-building and innovation expenditures, so as to maintain a relatively steady operating margin. Our strategy for expanding our gross margin is to manage external cost pressures through sales-driven operating leverage, mix improvements, productivity savings, and technological initiatives to reduce the cost of product ingredients and packaging. In 2004, our consolidated gross margin increased by 50 basis points to 44.9%. For 2005, we were able to maintain our consolidated gross margin at this level, overcoming the impact of several significant cost factors as discussed in the following paragraphs. Supported by late 2005 price increases in various markets 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

Employee benefit costs (the majority of which is recorded in cost of goods sold) also increased for both 2004 and 2005, with total active and retired employee benefits expense reaching nearly $300 million in 2005 versus approximately $260 million in 2004 and $240 million in 2003. Our profitability projections for 2006 currently include incremental employee benefits expense of $20-$40 million.

In addition to external cost pressures, our discretionary investment in cost reduction initiatives (refer to following section) has placed short-term pressure on our gross margin performance during the periods presented. The portion of total program-related charges recorded in cost of goods sold was (in millions): 2005-$90; 2004-$46; 2003-$67. 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.

We view our continued spending on cost-reduction initiatives as part of our sustainable growth model of earnings reinvestment for 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 of relatively short duration (normally one year or less), and begins to deliver cash savings and/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” section beginning on page 11.

In 2005, we undertook an initiative to consolidate U.S. snacks bakery capacity, resulting in the closure 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 alternatives 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, 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 efficiency initiatives primarily in our North American and European operating segments, as well as the 2003 disposal of a manufacturing facility in China. Details of each initiative are described in Note 3 to Consolidated Financial Statements.

Related to the aforementioned U.S. snacks bakery consolidation, we expect to incur approximately $30 million of project costs 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 versus SGA impact of the remaining $60 million has not yet been determined.

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, and $30 million for severance and other cash expenditures. All of the charges were recorded in cost of goods sold within the Company’s North American 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) expense. The 2004 charges impacted our operating segments as follows (in millions): North America-$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 severance and other cash exit costs. Approximately $67 million of the total 2003 charges were recorded in cost of

Exit cost reserves were approximately $13 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, exit cost reserves were approximately $11 million, representing severance costs that were substantially paid out in 2005.

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 the Liquidity and Capital Resources section 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.

Other income (expense), net includes non-operating items such as interest income, foreign exchange gains and losses, charitable donations, and gains on asset sales. Other income (expense) for 2005 includes charges of $16 million for contributions to the Kellogg’s Corporate Citizenship Fund, a private trust established for charitable giving, and 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, 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 investment in an e-commerce business venture.

The consolidated effective income tax rate for 2005 was approximately 31%, which was below both the 2004 rate of nearly 35% and 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 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 significantly affected by the implementation of tax-savings initiatives 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. We expect that any incremental benefits from such discrete events would be invested in cost-reduction initiatives and other growth opportunities.

During 2005, we 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.

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. As a result, the growth in our operating cash flow should generally reflect the growth in our net earnings over time. As presented in the schedule to the right, operating cash flow performance for 2004 generally reflects this principle, except for 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.

The increasing level of benefit plan contributions during the 2003-2005 timeframe primarily reflects our decisions to improve the funded position of several of our major pension and retiree health care plans, as influenced by tax strategies and market factors. We did not 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 benefit plan contributions for 2006 are currently expected to be approximately $59 million. Actual 2006 or future year’s contributions could exceed our current projections, as influenced by our decision to voluntarily pre-fund our obligations versus other competing investment priorities, future changes in government requirements, or renewals of union contracts.

For 2005, the net favorable movement in core working capital was related to increased 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 working capital as 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.

The unfavorable movements in other working capital for 2004, as presented in the preceding table, relate largely to higher income tax payments and faster payment of customer promotional incentives, as compared to prior years.

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 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:

Our 2005 cash flow (as defined) declined approximately 19% versus the prior year, attributable primarily to incremental benefit plan contributions as discussed on page 16 and increased spending for selected capacity expansions to accommodate our Company’s strong sales growth over the past several years. This increased capital spending represented 3.7% of net sales, which exceeds our recent historical spending level of approximately 3% of net sales for both 2004 and 2003. We expect this trend to continue in the near term, with projected 2006 property expenditures reaching approximately 4.0% 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.

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, 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. Pursuant to this authorization, in November 2005, we 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 combination with open market transactions completed prior to November 2005, we spent a total of $664 million to repurchase approximately 15.4 million shares during 2005. Pursuant to similar Board authorizations applicable to those years, we paid $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 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.

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 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 Note 7 within Notes to Consolidated Financial Statements for further information on these debt issuances.)

At December 31, 2005, our total debt was approximately $4.9 billion, approximately even with the balance at year-end 2004. As discussed in the Interest expense section 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%. Primarily due to the recent

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 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 market and/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 the outstanding short-term debt balance and debt principal repayments through 2006.

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.

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.

Our significant accounting policies are discussed in Note 1 within Notes to Consolidated Financial Statements. None of the pronouncements adopted during the periods presented have had or are expected to have a significant impact on our Company’s financial statements.

In December 2004, the FASB issued SFAS No. 123(Revised) “Share-Based Payment,” which we adopted as of the beginning of our 2006 fiscal year, using the modified prospective method. Accordingly,

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.

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 2005 net sales; the likelihood exists of materially different reported results if different assumptions or conditions were to prevail.

We follow SFAS No. 142 “Goodwill and Other Intangible Assets” in evaluating impairment of intangibles. Under this standard, 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 party valuation consultants to assist in this process. At December 31, 2005, intangible assets, net, were $4.9 billion, consisting primarily of goodwill and trademarks associated with the 2001 acquisition of Keebler Foods Company. While we currently believe that the fair value of all of our intangibles exceeds carrying value, materially different assumptions regarding future performance of our North American snacks business or the weighted average cost of capital used in the valuations could result in significant impairment losses.

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” for the measurement and recognition of obligations and expense related to our retiree benefit plans. Embodied in both of these standards is the concept that the cost of benefits

To conduct our annual review of the long-term rate of return on plan assets, we work with third party financial consultants to model expected returns over a 20-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 2005 of 8.9% equated to approximately the 50th percentile expectation of our 2005 model. Similar methods are used for various foreign plans with invested assets, reflecting local economic conditions. Foreign plan investments represent approximately 30% of our global benefit plan investments.

Based on consolidated benefit plan assets at December 31, 2005, a 100 basis point reduction in the assumed rate of return would increase 2006 benefits expense by approximately $36 million. Correspondingly, a 100 basis point shortfall between the assumed and actual rate of return on plan assets for 2006 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 12 years. Under this recognition method, a 100 basis point shortfall in actual versus assumed performance of all of our plan assets in 2006 would reduce pre-tax earnings by approximately $1 million in 2007, increasing to approximately $6 million in year 2011. For each of the three years ending December 31, 2005, our actual return on plan assets exceeded the recognized assumed return by the following amounts (in millions): 2005-$39.4; 2004-$95.6; 2003-$269.4.

To conduct our annual review of health care cost trend rates, we work with third 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 employee 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%, our initial trend rate for 2006 of 10.5% 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, a 100 basis point increase in the assumed health care cost trend rates would increase 2006 benefits expense by approximately $17 million. A 100 basis point excess of 2006 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 claims cost-related experience gain or loss is recognized in the calculated value of claims cost over a four-year period. Once recognized, experience gains and losses are amortized over the average remaining service period of active plan participants, which for U.S. plans is presently about 15 years. The combined net experience loss arising from recognition of all prior-years claims experience, together with the revised trend rate assumption, was approximately $129 million.

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 the Citigroup Pension Liability Index^® for our U.S. plans. To test the appropriateness of these indices, we

Despite the previously described rigorous policies for selecting major actuarial assumptions, we periodically experience material differences between assumed and actual experience. As of December 31, 2005, we had consolidated unamortized net experience losses of approximately $1.29 billion. Of this total, approximately 70% was related to discount rate reductions, 13% was 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. For 2006, we currently expect incremental amortization of experience losses of approximately $10 million. Assuming actual future experience is consistent with our current assumptions, annual amortization of accumulated experience losses during each of the next several years would remain approximately level with the 2006 amount.

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 difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. Favorable resolution would be recognized as a reduction to our effective tax rate in the period of resolution. Our tax reserves are presented in the balance sheet principally within accrued income taxes. 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.

Our long-term annual growth targets are low single-digit for internal net sales, mid single-digit for internal operating profit, and high single-digit for 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 growth 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 in cost-reduction initiatives and other growth opportunities.

The Company is exposed to certain market risks, which exist as a part of the ongoing business operations and management uses derivative financial and commodity instruments, where appropriate, to manage these risks. The Company, as a matter of policy, does not engage in trading or speculative transactions. Refer to Note 12 to the Consolidated Financial Statements, which are included herein under Part II, Item 8, for further information on accounting policies related to derivative financial and commodity instruments.

The Company is exposed to fluctuations in foreign currency cash flows related to third-party purchases,

The total notional amount of foreign currency derivative instruments at year-end 2005 was $467.3 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 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 million at year-end 2005 and $37.5 million at year-end 2004. These unfavorable changes would generally have been offset by favorable changes in the values of the underlying exposures.

The 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. Management periodically uses 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 to the Consolidated Financial Statements, which are included herein under Part II, Item 8, provides information on the Company’s significant debt issues. There were no interest rate derivatives outstanding at year-end 2005 and 2004. 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 million in 2005 and $2.3 million in 2004.

The 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 uses the combination of long cash positions with suppliers, and exchange-traded futures and option contracts to reduce price fluctuations in a desired percentage of forecasted purchases over a duration of generally less than one year. The total notional amount of commodity derivative instruments at year-end 2005 was $21.8 million, representing a settlement receivable of approximately $1.0 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 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 positions 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 the Company.

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 2005 and 2003 fiscal years ended on December 31 and 27, respectively. The Company’s 2004 fiscal year ended on January 1, 2005, and included a 53rd week.

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 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. 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-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 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,” 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 the Company’s pre-existing accounting policy for inventory valuation was generally consistent with this guidance and does not, therefore, currently expect the adoption of SFAS No. 151 to have a significant impact on 2006 financial results.

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. 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 2004 and 2005, the carrying value of assets held for sale was insignificant.

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

The Company recognizes sales upon delivery of its products to customers net of applicable provisions for discounts, returns, and allowances. 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.

The costs of advertising are generally expensed as incurred and are classified within SGA.

For the periods presented, the Company used the intrinsic value method prescribed by Accounting Principles Board Opinion (APB) No. 25 “Accounting for Stock Issued to Employees,” to account 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. Refer to Note 8 for further information on the Company’s stock compensation programs.