UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

KELLOGG COMPANY

Delaware State of Incorporation		38-0710690 IRS Employer Identification No.

One Kellogg Square, P.O. Box 3599, Battle Creek, MI 49016-3599

Registrant’s telephone number: 269-961-2000

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 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” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer þ      Accelerated filero     Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Common Stock outstanding as of July 27, 2007 – 395,733,185 shares

 

 

KELLOGG COMPANY

INDEX

		Page
PART I — Financial Information
Item 1:
Consolidated Balance Sheet – June 30, 2007 and December 30, 2006		2
Consolidated Statement of Earnings – quarters and year-to-date periods ended June 30, 2007 and July 1, 2006		3
Consolidated Statement of Cash Flows – year-to-date periods ended June 30, 2007 and July 1, 2006		4
Notes to Consolidated Financial Statements		5-17
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations		18-26
Item 3: Quantitative and Qualitative Disclosures about Market Risk		27
Item 4: Controls and Procedures		27
PART II — Other Information
Item 1A: Risk Factors		28
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds		28
Item 6: Exhibits		29
Signatures		30
Exhibit Index		31
364-Day Credit Agreement dated as of June 13, 2007 with JPMorgan Chase Bank, N.A.
Rule 13a-14(e)/15d-14(a) Certification from A.D. David Mackay
Rule 13a-14(e)/15d-14(a) Certification from John A. Bryant
Section 1350 Certification from A.D. David Mackay
Section 1350 Certification from John A. Bryant
364-Day Credit Agreement
Certification
Certification
Section 1350 Certification
Section 1350 Certification

Kellogg Company and Subsidiaries

CONSOLIDATED BALANCE SHEET
(millions, except per share data)

		June 30,				December 30,
		2007				2006
		(unaudited)				*
Current assets
Cash and cash equivalents		$	574			$	411
Accounts receivable, net			1,118				945
Inventories:
Raw materials and supplies			219				201
Finished goods and materials in process			596				623
Deferred income taxes			149				116
Other prepaid assets			125				131
Total current assets			2,781				2,427
Property, net of accumulated depreciation of $4,310 and $4,102			2,845				2,816
Goodwill			3,448				3,448
Other intangibles, net of accumulated amortization of $41 and $49			1,412				1,420
Pension			383				353
Other assets			254				250
Total assets		$	11,123			$	10,714
Current liabilities
Current maturities of long-term debt		$	466			$	723
Notes payable			1,969				1,268
Accounts payable			971				910
Accrued advertising and promotion			398				338
Accrued income taxes			92				152
Accrued salaries and wages			225				311
Other current liabilities			341				318
Total current liabilities			4,462				4,020
Long-term debt			2,588				3,053
Deferred income taxes			572				619
Other liabilities			1,100				953
Shareholders’ equity
Common stock, $.25 par value			105				105
Capital in excess of par value			329				292
Retained earnings			4,011				3,630
Treasury stock, at cost			(1,044	)			(912	)
Accumulated other comprehensive income (loss)			(1,000	)			(1,046	)
Total shareholders’ equity			2,401				2,069
Total liabilities and shareholders’ equity		$	11,123			$	10,714

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF EARNINGS
(millions, except per share data)

		Quarter ended								Year-to-date period ended
		June 30,				July 1,				June 30,				July 1,
(Results are unaudited)		2007				2006				2007				2006
Net sales		$	3,015			$	2,773			$	5,978			$	5,500
Cost of goods sold			1,638				1,538				3,337				3,068
Selling, general, and administrative expense			859				774				1,624				1,498
Operating profit			518				461				1,017				934
Interest expense			76				77				154				152
Other income (expense), net			—				4				2				9
Earnings before income taxes			442				388				865				791
Income taxes			141				121				243				250
Net earnings		$	301			$	267			$	622			$	541
Net earnings per share:
Basic		$	.76			$	.68			$	1.56			$	1.36
Diluted		$	.75			$	.67			$	1.55			$	1.35
Dividends per share		$	.2910			$	.2775			$	.5820			$	.5550
Average shares outstanding:
Basic			397				394				397				396
Diluted			401				397				401				399
Actual shares outstanding at period end											396				396

Refer to Notes to Consolidated Financial Statements.

Kellogg Company and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS
(millions)

		Year-to-date period ended
		June 30,				July 1,
(unaudited)		2007				2006
Operating activities
Net earnings		$	622			$	541
Adjustments to reconcile net earnings to operating cash flows:
Depreciation and amortization			185				173
Deferred income taxes			(92	)			(2	)
Other (a)			79				74
Postretirement benefit plan contributions			(34	)			(30	)
Changes in operating assets and liabilities			(10	)			(254	)
Net cash provided by operating activities			750				502
Investing activities
Additions to properties			(181	)			(162	)
Investments in joint ventures and other			(4	)			(1	)
Net cash used in investing activities			(185	)			(163	)
Financing activities
Net issuances of notes payable			699				433
Reductions of long-term debt			(729	)			—
Issuances of common stock			100				116
Common stock repurchases			(264	)			(580	)
Cash dividends			(232	)			(218	)
Other			10				7
Net cash used in financing activities			(416	)			(242	)
Effect of exchange rate changes on cash			14				(1	)
Increase in cash and cash equivalents			163				96
Cash and cash equivalents at beginning of period			411				219
Cash and cash equivalents at end of period		$	574			$	315

Refer to Notes to Consolidated Financial Statements.

Notes to Consolidated Financial Statements
for the quarter and year-to-date periods ended June 30, 2007 (unaudited)

Note 1 Accounting policies

Basis of presentation

The unaudited interim financial information included in this report reflects normal recurring adjustments that management believes are necessary for a fair statement of the results of operations, financial position, and cash flows for the periods presented. This interim information should be read in conjunction with the financial statements and accompanying notes contained on pages 27 to 56 of the Company’s 2006 Annual Report on Form 10-K.

The condensed balance sheet data at December 30, 2006 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. The results of operations for the quarterly and year-to-date periods ended June 30, 2007 are not necessarily indicative of the results to be expected for other interim periods or the full year.

The Company’s fiscal year normally ends on the Saturday closest to December 31 and as a result, a 53^rd week is added approximately every sixth year. Under this convention, the Company’s 2006 fiscal year ended on December 30 and its 2007 fiscal year will end on December 29, 2007. Each quarterly period in 2006 and 2007 includes thirteen weeks.

The accounting policies used in preparing these financial statements are the same as those applied in the prior year, except that the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes,” as of the beginning of its 2007 fiscal year, which is discussed in Note 10. Additionally, the Company adopted FASB Statement of Financial Accounting Standard (SFAS) No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” as of the end of its 2006 fiscal year, which affected only the year-end balance sheet presentation of postretirement and postemployment benefit obligations. Accordingly, the Company’s 2007 fiscal year (and interim periods within that year) is the first reporting period for which total comprehensive income will be affected by the adoption of this standard. Refer to page 33 of the Company’s 2006 Annual Report on Form 10-K for further information on SFAS No. 158. Lastly, the Company is continuing to evaluate the impact of adopting SFAS No. 157 “Fair Value Measurements” in the first quarter of its 2008 fiscal year. Refer to page 34 of the Company’s 2006 Annual Report on Form 10-K for further information on SFAS No. 157.

Note 2 Acquisitions, other investments, and intangibles

Joint venture arrangement

During the quarter ended June 30, 2007, the Company contributed an additional $4 million in cash to its Turkish joint venture, in which it owns a 50% equity interest, bringing the total cumulative investment to approximately $7 million. Refer to page 35 of the Company’s 2006 Annual Report on Form 10-K for further information on this arrangement.

Goodwill and other intangible assets

For the quarter ended June 30, 2007, the Company recorded impairment losses of $7 million in corporate selling, general, and administrative expense to write off the remaining carrying value of several individually-insignificant trademarks, which were abandoned as of June 30, 2007. As presented in the following table, associated gross

carrying amounts and accumulated amortization of $16 million were retired from the Company’s balance sheet during the second quarter of 2007.

Intangible assets subject to amortization

		Gross carrying amount								Accumulated amortization
		June 30,				December 30,				June 30,				December 30,
(millions)		2007				2006				2007				2006
Trademarks		$	14			$	30			$	13			$	22
Other			29				29				28				27
Total		$	43			$	59			$	41			$	49

		June 30,				July 1,
Amortization expense		2007				2006
Year-to-date		$	8			$	1

For intangible assets in the preceding table, amortization (excluding the aforementioned impairment losses) was less than $1 million for each of the current and prior-year quarterly periods. The currently-estimated aggregate amortization expense for full-year 2007 and each of the three succeeding fiscal years is approximately $1 million per year and less than $1 million per year for the fourth and fifth succeeding years.

Intangible assets not subject to amortization

		Total carrying amount
		June 30,				December 30,
(million)		2007				2006
Trademarks		$	1,410			$	1,410

There were no changes in the carrying amount of goodwill for the year-to-date period ended June 30, 2007.

Carrying amount of goodwill

														Asia Pacific
(millions)		United States				Europe				Latin America				(a)				Consolidated
December 30, 2006 and June 30, 2007		$	3,446				—				—			$	2			$	3,448

Note 3 Exit or disposal plans

The Company views its continued spending on cost-reduction initiatives as part of its ongoing operating principles to reinvest earnings so as to provide greater visibility in meeting long-term growth targets. Initiatives undertaken are currently expected to recover cash implementation costs within a five-year period of completion (“expected pay-back target”). 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 multi-year programs), the project begins to deliver cash savings and/or reduced depreciation, which is then used to fund new initiatives. Certain of these initiatives represent exit or disposal plans for which material charges will be incurred.

In 2006, the Company commenced 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 project costs (including those already incurred in 2006), largely comprised of voluntary early retirement and severance benefits to eliminate approximately 220 hourly and salaried employee positions from the Manchester facility by the end of 2008. For 2006, the Company incurred approximately $28 million of total project costs and currently expects to incur approximately $17 million in 2007, with the remainder to be incurred in 2008. (Refer to page 36 of the Company’s 2006 Annual Report on Form 10-K for further information on this initiative.)

All of the costs for the European manufacturing optimization plan have been recorded in cost of goods sold within the Company’s European operating segment. The following tables present total project costs to date and a reconciliation of employee severance reserves for this initiative. All other cash costs were paid in the period incurred.

		Employee				Other cash				Asset write-				Retirement
Project costs to date (in millions)		severance				costs (a)				offs				benefits (b)				Total
Year ended December 30, 2006		$	12			$	2			$	5			$	9			$	28
Quarter ended March 30, 2007			3				1				1								5
Quarter ended June 30, 2007			4				1				2								7
Total project to date		$	19			$	4			$	8			$	9			$	40

Employee severance reserves to date		Beginning												End of
(in millions)		of period				Accruals				Payments				period
Year ended December 30, 2006		$	—			$	12			$	—			$	12
Quarter ended March 30, 2007			12				3				(9	)			6
Quarter ended June 30, 2007			6				4				(5	)			5
Total project to date						$	19			$	(14	)

On June 27, 2007, the Company began to extend offers to exit approximately 517 distribution route franchise agreements with independent contractors, which were substantially accepted as of July 13, 2007. Based on these acceptances, management then commenced a plan to reorganize the Company’s direct store-door delivery (DSD) operations in the southeastern United States by the end of 2007. Certain elements of this plan are conditional, pending the completion of consultations with union representatives at certain facilities. This DSD reorganization plan is intended to integrate the Company’s southeastern sales and distribution regions with the rest of its U.S. direct store-door operations, resulting in greater efficiency across the nationwide network. The plan is expected to result in the involuntary termination or relocation of approximately 300 employee positions. To complete this initiative, management currently expects to incur $75-$85 million of total project costs, principally consisting of cash expenditures for route franchise settlements and to a lesser extent, for employee separation, relocation, and reorganization. Based on acceptances received through June 30, 2007, the Company accrued $38 million of charges for route franchise settlements during the second quarter of 2007, which were in reserve as of quarter end. These charges were recorded in selling, general, and administrative expense within the Company’s North America operating segment.

In summary, operating profit for the quarter ended June 30, 2007 included total exit plan-related charges of $45 million, comprised of $7 million recorded in cost of goods sold and $38 million recorded in selling, general, and administrative expense. The operating segment impact of these costs was (in millions): North America-$38; Europe-$7. On a year-to-date basis, operating profit included total exit plan-related charges of $50 million, comprised of $12 million recorded in cost of goods sold and $38 million recorded in selling, general, and administrative expense. The operating segment impact of these costs was (in millions): North America-$38; Europe-$12.

Cost of goods sold for the quarter and year-to-date periods ended July 1, 2006, included total exit plan-related charges of approximately $20 million and $27 million, respectively. The total year-to-date amount for 2006 was comprised of $12 million of asset write-offs, $4 million attributable to a multiemployer pension plan withdrawal liability, and $11 million of cash expenditures, which consisted principally of production relocation and severance costs. These costs were recorded in the Company’s North America operating segment and related to a U.S. bakery consolidation initiative, which was completed in 2006. The details of this initiative are provided on page 37 of the Company’s 2006 Annual Report on Form 10-K.

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 gains (losses) recognized were ($7) million, for both the quarter and year-to-date periods ended June 30, 2007, as compared to $2 million and $4 million, respectively, for the quarter and year-to-date periods ended July 1, 2006.

Note 5 Equity

Earnings per share

Basic net earnings per share is determined by dividing net earnings by the weighted 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, and to a lesser extent, certain contingently issuable performance shares. Basic net earnings per share is reconciled to diluted net earnings per share in the following table. The total number of anti-dilutive potential common shares excluded from the reconciliation was 5 million and 4 million, respectively, for the quarter and year-to-date periods ended June 30, 2007, as compared to 10 million for both the quarter and year-to-date periods ended July 1, 2006.

Quarter						Average				Net
(millions, except		Net				shares				earnings
per share data)		earnings				outstanding				per share
2007
Basic		$	301				397			$	.76
Dilutive potential common shares			—				4				(.01	)
Diluted		$	301				401			$	.75
2006
Basic		$	267				394			$	.68
Dilutive potential common shares			—				3				(.01	)
Diluted		$	267				397			$	.67

Year-to-date						Average				Net
(millions, except		Net				shares				earnings
per share data)		earnings				outstanding				per share
2007
Basic		$	622				397			$	1.56
Dilutive potential common shares			—				4				(.01	)
Diluted		$	622				401			$	1.55
2006
Basic		$	541				396			$	1.36
Dilutive potential common shares			—				3				(.01	)
Diluted		$	541				399			$	1.35

During the year-to-date period ended June 30, 2007, the Company issued 2 million shares to employees and directors under various benefit plans and stock purchase programs, as further discussed in Note 8. To offset these issuances and for general corporate purposes, the Company’s Board of Directors has authorized management to repurchase up to $650 million of the Company’s common stock during 2007. In connection with this authorization, during the year-to-date period ended June 30, 2007, the Company spent $264 million to repurchase approximately 5 million shares.

Comprehensive Income
Comprehensive income includes net earnings and all other changes in equity during a period except those resulting from investments by or distributions to shareholders. Other comprehensive income for all periods presented consists of foreign currency translation adjustments pursuant to SFAS No. 52 “Foreign Currency Translation” and fair value adjustments associated with cash flow hedges pursuant to SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities.” Additionally, other comprehensive income for 2007 includes adjustments for net experience losses and prior service cost pursuant to SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” The Company adopted SFAS No. 158 as of the end of its 2006 fiscal year; however, comprehensive income for interim periods of 2006 continued to include minimum pension liability adjustments pursuant to SFAS No. 87 “Employers’ Accounting for Pensions.”

Pursuant to SFAS No. 158, during the second quarter of 2007, the Company recorded an increase to its defined benefit pension and postretirement plan obligations of $40 million, comprised of $27 million for a census-related valuation update and $13 million for foreign currency remeasurement. As presented in the following schedule, this resulted in a corresponding net-of-tax increase in net experience loss of $26 million and prior service cost of $1 million within other comprehensive income. The year-to-date impact on other comprehensive income was similar.

Quarter

		Pre-tax				Tax (expense)				After-tax
(millions)		amount				or benefit				amount
2007
Net earnings										$	301
Other comprehensive income:
Foreign currency translation adjustments			34				—				34
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges			—				—				—
Reclassification to net earnings			—				—				—
Postretirement and postemployment benefits:
Amounts arising during the period:
Net experience loss			(39	)			13				(26	)
Prior service cost			(1	)			—				(1	)
Reclassification to net earnings:
Net experience loss			23				(8	)			15
Prior service cost			3				(1	)			2
			20				4				24
Total comprehensive income										$	325

		Pre-tax				Tax (expense)				After-tax
(millions)		amount				or benefit				amount
2006
Net earnings										$	267
Other comprehensive income:
Foreign currency translation adjustments			(24	)			—				(24	)
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges			2				(1	)			1
Reclassification to net earnings			3				(1	)			2
Minimum pension liability adjustments			—				—				—
			(19	)			(2	)			(21	)
Total comprehensive income										$	246

Year-to-date

		Pre-tax				Tax (expense)				After-tax
(millions)		amount				or benefit				amount
2007
Net earnings										$	622
Other comprehensive income:
Foreign currency translation adjustments			27				—				27
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges			17				(6	)			11
Reclassification to net earnings			1				—				1
Postretirement and postemployment benefits:
Amounts arising during the period:
Net experience loss			(38	)			13				(25	)
Prior service cost			(1	)			—				(1	)
Reclassification to net earnings:
Net experience loss			45				(15	)			30
Prior service cost			5				(2	)			3
			56				(10	)			46
Total comprehensive income										$	668

		Pre-tax				Tax (expense)				After-tax
(millions)		amount				or benefit				amount
2006
Net earnings										$	541
Other comprehensive income:
Foreign currency translation adjustments			(38	)			—				(38	)
Cash flow hedges:
Unrealized gain (loss) on cash flow hedges			5				(2	)			3
Reclassification to net earnings			5				(2	)			3
Minimum pension liability adjustments			—				—				—
			(28	)			(4	)			(32	)
Total comprehensive income										$	509

Accumulated other comprehensive income (loss) as of June 30, 2007 and December 30, 2006 consisted of the following:

		June 30,				December 30,
(millions)		2007				2006
Foreign currency translation adjustments		$	(382	)		$	(409	)
Cash flow hedges — unrealized net loss			(21	)			(33	)
Postretirement and postemployment benefits:
Net experience loss			(535	)			(540	)
Prior service cost			(62	)			(64	)
Total accumulated other comprehensive income (loss)		$	(1,000	)		$	(1,046	)

Note 6 Leases and other commitments

The Company was subject to a maximum residual value guarantee on one operating lease of a snacks manufacturing facility in Chicago, Illinois, for approximately $13 million, which was scheduled to expire in July 2007. During the first quarter of 2007, the Company recognized a liability in connection with this guarantee of approximately $5 million, which was recorded in cost of goods sold within the Company’s North America operating segment. During the second quarter of 2007, the Company terminated the lease agreement and purchased the facility for approximately $16 million, which discharged the residual value guarantee obligation.

Note 7 Debt

On February 28, 2007, a subsidiary of the Company redeemed Euro 550 million of Guaranteed Floating Rate Notes otherwise due May 2007 for $728 million. 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 are senior unsecured obligations of the applicable Issuer. Notes issued by subsidiary Issuers are 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. On June 13, 2007, management also increased the aggregate principal amount of notes that may be outstanding at any time under the Company’s U.S. commercial paper program from $2.0 billion to $2.5 billion.

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 $3.3 billion at June 30, 2007. This increase was achieved via a $400 million unsecured 364-Day Credit Agreement effective January 31, 2007 and a $700 million 364-Day Credit Agreement effective June 13, 2007. These 364-Day Agreements contain customary covenants, warranties, and restrictions similar to those described for the Five-Year Credit Agreement on page 41 of the Company’s 2006 Annual Report on Form 10-K. The Company’s credit facilities are available for general corporate purposes, including commercial paper back-up, although management does not currently anticipate any draw-down of the facilities.

As of June 30, 2007, notes outstanding under the Company’s commercial paper programs were (in millions): U.S.-$1,796; Europe-$127; Canada-$0. Refer to page 40 of the Company’s 2006 annual report on Form 10-K for comparable information as of December 30, 2006.

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. Additionally, the Company awards stock options and restricted stock to its outside directors. These awards are administered through several plans, as described on pages 41 to 44 of the Company’s 2006 Annual Report on Form 10-K.

Beginning in 2006, the Company has followed SFAS No. 123(R) “Share-Based Payment” to account for its equity-based compensation programs. For the periods presented, the Company classified pre-tax stock compensation expense in selling, general, and administrative expense principally within its corporate operations. For further information on the Company’s stock compensation accounting methods, refer to pages 32 and 33 of the Company’s 2006 Annual Report on Form 10-K.

For the quarter ended June 30, 2007, compensation expense for all types of equity-based programs and the related income tax benefit recognized were $22 million and $8 million, respectively. Year-to-date, pre-tax stock- based compensation expense was $47 million and the related tax benefit was $17 million. For the quarter ended July 1, 2006, compensation expense for all types of equity-based programs and the related income tax benefit recognized were $23 million and $8 million, respectively. Year-to-date, pre-tax stock-based compensation expense was $45 million and the related tax benefit was $16 million.

As of June 30, 2007, total stock-based compensation cost related to nonvested awards not yet recognized was approximately $54 million and the weighted-average period over which this amount is expected to be recognized was approximately 1.4 years.

Stock Options
During the year-to-date periods ended June 30, 2007 and July 1, 2006, the Company granted non-qualified stock options to eligible employees and outside directors as presented in the following activity tables. Terms of these grants and the Company’s methods for determining grant-date fair value of the awards were consistent with that described on page 43 of the Company’s 2006 Annual Report on Form 10-K.

Year-to-date period ended June 30, 2007:

										Weighted-
						Weighted-				average				Aggregate
						average				remaining				intrinsic
Employee and director		Shares				exercise				contractual				value
stock options		(millions)				price				term (yrs.)				(millions)
Outstanding, beginning of period			27			$	41
Granted			6				50
Exercised			(5	)			41
Forfeitures and expirations			—				—
Outstanding, end of period			28			$	43				6.4			$	252
Exercisable, end of period			22			$	42				5.5			$	220

Year-to-date period ended July 1, 2006:

										Weighted-
						Weighted-				average				Aggregate
						average				remaining				intrinsic
Employee and director		Shares				exercise				contractual				value
stock options		(millions)				price				term (yrs.)				(millions)
Outstanding, beginning of period			29			$	38
Granted			7				45
Exercised			(5	)			36
Forfeitures and expirations			—				—
Outstanding, end of period			31			$	40				6.4			$	246
Exercisable, end of period			23			$	39				5.5			$	209

The weighted-average fair value of options granted was $7.52 per share for the year-to-date period ended June 30, 2007 and $7.14 per share for the year-to-date period ended July 1, 2006. The total intrinsic value of options exercised was $56 million for the year-to-date period ended June 30, 2007 and $48 million for the year-to-date period ended July 1, 2006.

Other stock-based awards
During the periods presented, other stock-based awards consisted principally of executive performance shares granted under the Company's 2003 Long-Term Incentive Plan.

In the first quarter of 2007, the Company granted performance shares to a limited number of senior executive-level employees, which entitle these employees to receive a specified number of shares of the Company’s common stock on the vesting date, provided cumulative three-year cash flow targets are achieved. The 2007 target grant currently corresponds to approximately 206,000 shares, with a grant-date fair value of approximately $46 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. For information on similar performance share awards in 2005 and 2006, refer to page 44 of the Company’s 2006 Annual Report on Form 10-K. Based on the market price of the Company’s common stock at June 30, 2007, the maximum future value that could be awarded to employees on the vesting date is (in millions): 2005 award-$28; 2006 award-$26; and 2007 award-$21.

Note 9 Employee benefits

The Company sponsors a number of U.S. and foreign pension, other postretirement and postemployment plans to provide various benefits for its employees. These plans are described on pages 44 to 48 of the Company’s 2006 Annual Report on Form 10-K. Components of Company plan benefit expense for the periods presented are included in the tables below.

Pension

		Quarter ended								Year-to-date period ended
(millions)		June 30, 2007				July 1, 2006				June 30, 2007				July 1, 2006
Service cost		$	24			$	22			$	48			$	46
Interest cost			46				43				92				84
Expected return on plan assets			(69	)			(63	)			(138	)			(125	)
Amortization of unrecognized prior service cost			3				3				5				6
Recognized net loss			16				20				32				39
Total pension expense — Company plans		$	20			$	25			$	39			$	50

Other nonpension postretirement

		Quarter ended								Year-to-date period ended
(millions)		June 30, 2007				July 1, 2006				June 30, 2007				July 1, 2006
Service cost		$	4			$	4			$	8			$	9
Interest cost			17				16				34				32
Expected return on plan assets			(15	)			(14	)			(30	)			(29	)
Amortization of unrecognized prior service cost			—				(1	)			—				(2	)
Recognized net loss			6				8				12				16
Postretirement benefit expense		$	12			$	13			$	24			$	26

Postemployment

		Quarter ended								Year-to-date period ended
(millions)		June 30, 2007				July 1, 2006				June 30, 2007				July 1, 2006
Service cost		$	1			$	1			$	2			$	2
Interest cost			1				—				2				1
Recognized net loss			1				1				1				2
Postemployment benefit expense		$	3			$	2			$	5			$	5

Management currently plans to contribute approximately $33 million to its defined benefit pension plans and $15 million to its retiree health and welfare benefit plans during 2007, for a total of $48 million. During 2006, the Company contributed approximately $86 million to defined benefit pension plans and $13 million to retiree health and welfare benefit plans, for a total of $99 million. Plan funding strategies are periodically modified to reflect management’s current evaluation of tax deductibility, market conditions, and competing investment alternatives.

Note 10 Income taxes

Effective income tax rate
The consolidated effective income tax rate was 32% for the quarter ended June 30, 2007, as compared to 31% for the quarter ended July 1, 2006. The second quarter 2006 provision for income taxes included two significant, but partially-offsetting, discrete adjustments. First, during that period, the Company revised its repatriation plan for certain foreign earnings, giving rise to an incremental net tax cost of $18 million. Secondly, the Company reduced its reserves for uncertain tax positions by $25 million, related principally to closure of several domestic tax audits.

For the year-to-date period ended June 30, 2007, the consolidated effective income tax rate was 28%, as compared to approximately 32% for the comparable prior year-to-date period. During the first quarter of 2007, management implemented an international restructuring initiative, which eliminated a foreign tax liability of approximately $40 million. Accordingly, the first quarter reversal is reflected in the Company’s consolidated income tax provision for the year-to-date period ended June 30, 2007.

In July 2007, the government of the United Kingdom enacted a statutory rate reduction of two percentage points, applicable from April 1, 2008. During the third quarter of 2007, management also expects the government of Germany to enact a federal statutory income tax rate reduction of ten percentage points effective in 2008, partially offset by the effect of other German tax law changes. Accordingly, during the third quarter of 2007, management plans to reduce the Company’s net deferred income tax liabilities in these jurisdictions to reflect the lower rates; the current estimate of the resulting earnings benefit is approximately $16 million.

Uncertain tax positions
The Company adopted Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (FIN No. 48) as of the beginning of its 2007 fiscal year. This interpretation clarifies 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.

Prior to adopting FIN No. 48, the Company’s policy was to establish reserves that reflected the probable outcome of known tax contingencies. Favorable resolution was recognized as a reduction to the effective income tax rate in the period of resolution. As compared to a contingency approach, FIN No. 48 is based on a benefit recognition model. 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. The initial application of FIN No. 48 resulted in a net decrease to the Company’s consolidated accrued income tax and related interest liabilities of approximately $2 million, with an offsetting increase to retained earnings.

The Company files income taxes in the U.S. federal jurisdiction, and in various state, local, and foreign jurisdictions. The Company’s annual provision for U.S. federal income taxes has recently represented approximately 70% of the Company’s consolidated income tax provision. With limited exceptions, the Company is no longer subject to U.S. federal examinations by the Internal Revenue Service (IRS) for years prior to 2004. During the first quarter of 2007, the IRS commenced an examination of the Company’s 2004 and 2005 U.S. federal income tax returns, which is anticipated to be completed during the second half of 2008. The Company is also under examination for income and non-income tax filings in various state and foreign jurisdictions, most notably: 1) a U.S.-Canadian transfer pricing issue pending international arbitration (“Competent Authority”) with a related advanced pricing agreement for years 1997-2008; and 2) an on-going examination of 2002-2004 U.K. income tax filings, with an examination of the 2005 filing, which began in July 2007.

As of June 30, 2007, the Company has classified approximately $24 million of unrecognized tax benefits as a current liability, representing several individually insignificant income tax positions under examination in various jurisdictions. Management’s estimate of reasonably possible changes in unrecognized tax benefits during the next twelve months is comprised of the aforementioned current liability balance expected to be settled within one year, offset by approximately $25 million of projected additions related primarily to ongoing intercompany transfer pricing activity. Management is currently unaware of any issues under review that could result in significant additional payments, accruals, or other material deviation in this estimate.

Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the year-to-date period ended June 30, 2007. Approximately $145 million of this total represents the amount that, if recognized, would affect the Company’s effective income tax rate in future periods. This amount differs from the gross unrecognized tax benefits presented in the table due to the decrease in U.S. federal income taxes which would occur upon recognition of the state tax benefits included therein.

(millions)
Balance at December 31, 2006		$	143
Tax positions related to current year:
Additions			15
Reductions			—
Tax positions related to prior years:
Additions			8
Reductions			(1	)
Settlements			—
Lapses in statutes of limitation			—
Balance at June 30, 2007		$	165

The current portion of the Company’s unrecognized tax benefits is presented in the balance sheet within accrued income taxes and the amount expected to be settled after one year is recorded in other noncurrent liabilities.

The Company classifies income tax-related interest and penalties as interest expense and selling, general, and administrative expense, respectively. For the year-to-date period ended June 30, 2007, the Company recognized $4 million of tax-related interest and penalties and had approximately $24 million accrued at June 30, 2007.

Note 11 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 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 in four geographic operating segments, comprised of North America and the three International operating segments of Europe, Latin America, and Asia Pacific. Prior to 2007, the Asia Pacific operating segment included Australia and Asian markets. Beginning in 2007, this segment also includes South Africa, which was formerly a part of Europe. Prior-year periods have been restated.

		Quarter ended								Year-to-date period ended
(millions)		June 30,				July 1,				June 30,				July 1,
(Results are unaudited)		2007				2006				2007				2006
Net sales
North America		$	1,980			$	1,859			$	3,982			$	3,724
Europe			623				538				1,197				1,028
Latin America			253				225				482				440
Asia Pacific (a)			159				151				317				308
Consolidated		$	3,015			$	2,773			$	5,978			$	5,500
Segment operating profit
North America		$	365			$	327			$	726			$	679
Europe			127				97				235				181
Latin America			55				58				102				113
Asia Pacific (a)			20				24				47				49
Corporate			(49	)			(45	)			(93	)			(88	)
Consolidated		$	518			$	461			$	1,017			$	934

Note 12 Supplemental cash flow data

(millions)

		Year-to-date period ended
		June 30,				July 1,
Changes in operating assets and liabilities		2007				2006
Trade receivables		$	(189	)		$	(170	)
Inventories			9				(3	)
Accounts payable			61				(5	)
Accrued income taxes			45				(14	)
Accrued interest expense			1				1
Accrued and prepaid advertising, promotion and trade allowances			66				12
Accrued salaries and wages			(86	)			(74	)
Exit plan-related reserves (a)			43				3
All other current assets and liabilities			40				(4	)
		$	(10	)		$	(254	)

KELLOGG COMPANY

PART I — FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and 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 veggie foods. Kellogg products are manufactured and marketed globally. Principal markets for these products include the United States and United Kingdom. We currently manage our operations in four geographic operating segments, comprised of North America and the three International operating segments of Europe, Latin America, and Asia Pacific. Prior to 2007, the Asia Pacific operating segment included Australia and Asian markets. Beginning in 2007, this segment also includes South Africa, which was formerly a part of Europe. Prior-year periods have been restated.

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 diluted net earnings per share. (Our measure of internal growth rates excludes the impact of currency, and if applicable, acquisitions, dispositions, and shipping day differences.) We believe our strong financial performance for the first half of the year provides momentum for achieving or exceeding these annual growth targets for the full year of 2007. For the year-to-date period ended June 30, 2007, we reported consolidated net sales growth of 9% with internal growth of 6%. Consolidated operating profit also increased 9% on internal growth of 6%. Diluted net earnings per share grew 15%, from $1.35 in the first half of 2006 to $1.55 in the current year-to-date period. Similarly, for the second quarter of 2007, we reported consolidated net sales growth of 9% with internal growth of 6%. Consolidated operating profit increased 12% on internal growth of 9%. Diluted net earnings per share grew 12%, from $.67 in the second quarter of 2006 to $.75 in the current period.

Net sales and operating profit
The following table provides an analysis of net sales and operating profit performance for the second quarter of 2007 versus 2006:

		North								Latin				Asia Pacific								Consoli-
(dollars in millions)		America				Europe				America				(a)				Corporate				dated
2007 net sales		$	1,980			$	623			$	253			$	159			$	—			$	3,015
2006 net sales		$	1,859			$	538			$	225			$	151			$	—			$	2,773
% change - 2007 vs. 2006:
Volume (tonnage) (b)			1.4	%			3.1	%			6.3	%			-1.5	%			—				2.0	%
Pricing/mix			4.9	%			3.9	%			1.6	%			1.0	%			—				4.2	%
Subtotal — internal business			6.3	%			7.0	%			7.9	%			-.5	%			—				6.2	%
Foreign currency impact			.2	%			8.6	%			4.6	%			5.8	%			—				2.5	%
Total change			6.5	%			15.6	%			12.5	%			5.3	%			—				8.7	%

		North								Latin				Asia Pacific								Consoli-
(dollars in millions)		America				Europe				America				(a)				Corporate				dated
2007 operating profit		$	365			$	127			$	55			$	20			$	(49	)		$	518
2006 operating profit		$	327			$	97			$	58			$	24			$	(45	)		$	461
% change - 2007 vs. 2006:
Internal business			11.3	%			19.4	%			-7.6	%			-25.8	%			-6.6	%			9.1	%
Foreign currency impact			.3	%			10.4	%			3.9	%			5.4	%			—				3.3	%
Total change			11.6	%			29.8	%			-3.7	%			-20.4	%			-6.6	%			12.4	%

 

Our strong consolidated net sales performance for the second quarter of 2007 reflects the continuation of broad-based successful innovation, brand-building (advertising and consumer promotion) investment, and in-store execution.

For the quarter, our North America operating segment reported internal net sales growth of 6%, with each major product group contributing as follows: retail cereal +3%; retail snacks (wholesome snacks, cookies, crackers, toaster pastries, fruit snacks) +9%; frozen and specialty (food service, vending, convenience, drug stores, custom manufacturing) channels +8%. Notably, this quarter’s performance represents five consecutive years of quarter-over-quarter internal net sales growth for each of the three product groups within North America.

Our International operating segments collectively reported internal net sales growth of approximately 6% with leading dollar contributions from our UK, France, Mexico, and Venezuela business units. The internal sales decline in our Asia Pacific operating segment (which represents only about 5% of our consolidated results) was attributable to continuing weak performance in our Australian business due to competitive pressures, which offset strong sales growth in our Asian and S. Africa markets.

For the quarter, our consolidated operating profit increased 12% on a reported basis and 9% on an internal basis. This high single-digit internal operating profit growth primarily reflects strong top-line performance coupled with gross margin improvement, as further discussed in the next section entitled “Margin performance.” For the quarter, our consolidated operating profit continued to reflect double-digit growth in advertising investment and good cost containment on promotional expenditures.

As discussed in the section herein entitled “Exit or disposal plans,” this quarter’s operating profit included $25 million of incremental exit plan-related charges as compared to the second quarter of 2006. The total incremental amount was allocated to our operating segments as follows (in millions): North America-$18; Europe-$7. The allocation of the net incremental amount within operating profit resulted in a favorable year-over-year impact on cost of goods sold of $13 million and an unfavorable impact on selling, general, and administrative expense of $38 million. Our current-period corporate operating profit also included intangible impairment losses of $7 million. Refer to Note 2 within Notes to Consolidated Financial Statements for further information.

Taking into account the aforementioned year-over-year segment impact of exit plan-related charges, our North American and European operating segments performed very strongly at the operating profit line, with the pace of profit growth exceeding sales growth. This was primarily due to gross margin expansion in both regions and to a lesser extent, timing of brand-building expenditures in North America. As previously predicted, our Latin America operating segment continued to be impacted by corn price inflation and other cost factors, resulting in a reported

operating profit decline of approximately $3 million for the quarter. Our reported Asia Pacific operating profit also declined by approximately $4 million, largely related to the sales decline in that segment, significant investment in brand-building, and costs associated with an overhead streamlining initiative in Australia. Nevertheless, the combined operating profit decline for our Latin America and Asia Pacific segments reduced our internal operating profit growth for the quarter by only two percentage points. Although we do expect some stabilization and recovery for these regions in the second half of the year, we do not currently believe our Latin America and Asia Pacific segments’ full-year 2007 operating profit will exceed the 2006 level.

The following table provides an analysis of net sales and operating profit performance for the year-to-date periods of 2007 versus 2006. On a year-to-date basis, incremental exit-plan-related charges were $23 million and were allocated to segments as follows (in millions): North America-$11; Europe-$12. The allocation of the net incremental amount within operating profit resulted in a favorable year-over-year impact on cost of goods sold of $15 million and an unfavorable impact on selling, general, and administrative expense of $38 million. Our year-to-date North America operating profit also included a charge of $5 million related to a lease residual value guarantee. Refer to Note 6 within Notes to Consolidated Financial Statements for further information.

		North								Latin				Asia Pacific								Consoli-
(dollars in millions)		America				Europe				America				(a)				Corporate				dated
2007 net sales		$	3,982			$	1,197			$	482			$	317			$	—			$	5,978
2006 net sales		$	3,724			$	1,028			$	440			$	308			$	—			$	5,500
% change - 2007 vs. 2006:
Volume (tonnage) (b)			2.2	%			3.2	%			7.4	%			-2.9	%			—				2.6	%
Pricing/mix			4.6	%			3.6	%			.7	%			1.7	%			—				3.9	%
Subtotal — internal business			6.8	%			6.8	%			8.1	%			-1.2	%			—				6.5	%
Foreign currency impact			.1	%			9.6	%			1.6	%			4.1	%			—				2.2	%
Total change			6.9	%			16.4	%			9.7	%			2.9	%			—				8.7	%
		North								Latin				Asia Pacific								Consoli-
(dollars in millions)		America				Europe				America				(a)				Corporate				dated
2007 operating profit		$	726			$	235			$	102			$	47			$	(93	)		$	1,017
2006 operating profit		$	679			$	181			$	113			$	49			$	(88	)		$	934
% change - 2007 vs. 2006:
Internal business			6.9	%			18.6	%			-11.1	%			-10.4	%			-5.3	%			6.2	%
Foreign currency impact			.1	%			11.4	%			1.4	%			4.8	%			—				2.7	%
Total change			7.0	%			30.0	%			-9.7	%			-5.6	%			-5.3	%			8.9	%

Margin performance

Margin performance for the second quarter and year-to-date periods of 2007 versus 2006 is presented in the following table:

										Change
										vs. prior
Quarter		2007				2006				year (pts.)
Gross margin			45.7	%			44.5	%			1.2
SGA% (a)			-28.5	%			-27.9	%			(.6)
Operating margin			17.2	%			16.6	%			0.6

Year-to-date		2007				2006				Change
Gross margin			44.2	%			44.2	%			—
SGA% (a)			-27.2	%			-27.2	%			—
Operating margin			17.0	%			17.0	%			—

Our consolidated gross margin increased 120 basis points for the quarter, bringing our year-to-date results in line with the prior-year period. Following a number of periods of quarter-over-quarter decline, we believe this improved gross margin performance largely reflects savings from cost-reduction initiatives, price/mix improvements, and operating leverage, which more than offset continuing commodity, fuel, and energy price inflation. As discussed in the preceding section, a year-over-year shift in earnings caption allocation of exit plan-related charges also favorably impacted gross margin by 40 basis points in the quarter and 30 basis points in the year-to-date period. Lastly, our ongoing focus on package insert and other promotional efficiencies resulted in gross margin improvement of 60 basis points in the quarter and 30 basis points in the year-to-date period. Based on our first-half performance, we currently expect that our full-year 2007 consolidated gross margin will decline by approximately 50 basis points. This forecast incorporates approximately $150-$170 million of year-over-year commodity, fuel, and energy price inflation, net of a modest reduction in employee benefit costs. Approximately one-third of this price inflation was absorbed in the first half of 2007. As compared to our original 2007 price inflation forecast of $110-$130 million (discussed on page 14 of our 2006 Annual Report on Form 10-K), our most recent projection incorporates higher, current market prices for packaging and ingredient purchases, primarily dairy, eggs and wheat.

Despite the full-year 2007 forecasted gross margin decline, we use incremental gross profit dollars to fund investment in innovation and brand-building to drive future business growth. For the year-to-date period, we achieved incremental gross profit of $209 million.

Exit or disposal plans

As discussed on pages 14-15 of our 2006 Annual Report on Form 10-K, we view our continued spending on cost-reduction initiatives as part of our ongoing operating principles to reinvest earnings so as to provide greater visibility in meeting long-term growth targets. Initiatives undertaken are currently expected to recover cash implementation costs within a five-year period of completion (“expected pay-back target”). Upon completion (or as each major stage is completed in the case of multi-year programs), the project begins to deliver cash savings and/or reduced depreciation, which is then used to fund new initiatives. Certain of these initiatives represent exit or disposal plans for which material charges will be incurred. We include these charges in our measure or operating segment profitability.

We are currently committed to exit plans that are expected to generate up to $102 million of related charges for the full year of 2007 as compared to $82 million in 2006. The 2007 total is approximately allocated as follows (in millions): European manufacturing optimization-$17; U.S. DSD reorganization-$85. (The details of each of these initiatives are discussed in the following paragraphs of this section.) Additionally, we currently expect full-year 2007 cash requirements for these projects to approximate our forecast of exit plan-related charges. We expect these cash requirements to be funded by operating cash flow. These forecasted charges and cash requirements are incorporated in our communicated expectations for 2007 earnings and cash flow performance.

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, we currently expect to incur approximately $60 million in total project costs (including those already incurred in 2006), largely comprised of voluntary early retirement and severance benefits to eliminate approximately 220 hourly and salaried employee positions from the Manchester facility by the end of 2008. For 2006, we incurred approximately $28 million of total project costs and expect to incur approximately $17 million in

2007, with the remainder incurred in 2008. (Refer to page 36 of our 2006 Annual Report on Form 10-K for further information on this initiative.)

All of the costs for the European manufacturing optimization plan have been recorded in cost of goods sold within our European operating segment. The following tables present total project costs to date and a reconciliation of employee severance reserves for this initiative. All other cash costs were paid in the period incurred.

		Employee				Other cash				Asset write-				Retirement
Project costs to date (in millions)		severance				costs (a)				offs				benefits(b)				Total
Year ended December 30, 2006		$	12			$	2			$	5			$	9			$	28
Quarter ended March 30, 2007			3				1				1				—				5
Quarter ended June 30, 2007			4				1				2				—				7
Total project to date		$	19			$	4			$	8			$	9			$	40

Employee severance reserves to date		Beginning of												End of
(in millions)		period				Accruals				Payments				period
Year ended December 30, 2006		$	—			$	12			$	—			$	12
Quarter ended March 30, 2007			12				3				(9	)			6
Quarter ended June 30, 2007			6				4				(5	)			5
Total project to date						$	19			$	(14	)

On June 27, 2007, we began to extend offers to exit approximately 517 distribution route franchise agreements with independent contractors, which were substantially accepted as of July 13, 2007. Based on these acceptances, we then commenced a plan to reorganize our direct store-door delivery (DSD) operations in the southeastern United States by the end of 2007. Certain elements of this plan are conditional, pending the completion of consultations with union representatives at certain facilities. This DSD reorganization plan is intended to integrate our southeastern sales and distribution regions with the rest of our U.S. direct store-door operations, resulting in greater efficiency across the nationwide network. The plan is expected to result in the involuntary termination or relocation of approximately 300 employee positions. To complete this initiative, we currently expect to incur $75-$85 million of total project costs, principally consisting of cash expenditures for route franchise settlements and to a lesser extent, for employee separation, relocation, and reorganization. Based on acceptances received through June 30, 2007, we accrued $38 million of charges for route franchise settlements during the second quarter of 2007, which were in reserve as of quarter end. These charges were recorded in selling, general, and administrative expense within our North America operating segment.

In summary, operating profit for the quarter ended June 30, 2007 included total exit plan-related charges of $45 million, comprised of $7 million recorded in cost of goods sold and $38 million recorded in selling, general, and administrative expense. The operating segment impact of these costs was (in millions): North America-$38; Europe-$7. On a year-to-date basis, operating profit included total exit plan-related charges of $50 million, comprised of $12 million recorded in cost of goods sold and $38 million recorded in selling, general, and administrative expense. The operating segment impact of these costs was (in millions): North America-$38; Europe-$12.

Cost of goods sold for the quarter and year-to-date periods ended July 1, 2006, included total exit plan-related charges of approximately $20 million and $27 million, respectively. The total year-to-date amount for 2006 was comprised of $12 million of asset write-offs, $4 million attributable to a multiemployer pension plan withdrawal liability, and $11 million of cash expenditures, which consisted principally of production relocation and severance costs. These costs were recorded in our North America operating segment and related to a U.S. bakery consolidation initiative, which was completed in 2006. The details of this initiative are provided on page 37 of our 2006 Annual Report on Form 10-K.

Interest expense

For the first half of 2007, interest expense was $154 million and interest income (which is recorded within other income) was $8 million, as compared to first half 2006 interest expense of $152 million and interest income of $4 million. Accordingly, interest expense, net of interest income, for the year-to-date period of 2007 was within $2 million of the 2006 amount. For the full year of 2007, we currently expect interest expense, net of interest income, to approximate the 2006 level of $296 million.

Income taxes

The consolidated effective income tax rate was 32% for the quarter ended June 30, 2007, as compared to 31% for the quarter ended July 1, 2006. For the year-to-date period ended June 30, 2007, the consolidated effective income tax rate was 28%, as compared to approximately 32% for the comparable prior year-to-date period. During the first quarter of 2007, we implemented an international restructuring initiative, which eliminated a foreign tax liability of approximately $40 million. Accordingly, the first quarter reversal is reflected in our consolidated income tax provision for the year-to-date period ended June 30, 2007.

In July 2007, the government of the United Kingdom enacted a statutory rate reduction of two percentage points, applicable from April 1, 2008. During the third quarter of 2007, we also expect the government of Germany to enact a federal statutory income tax rate reduction of ten percentage points effective in 2008, partially offset by the effect of other German tax law changes. Accordingly, during the third quarter of 2007, we plan to reduce our net deferred income tax liabilities in these jurisdictions to reflect the lower rates; our current estimate of the resulting earnings benefit is approximately $16 million. Taking into account this discrete benefit, we currently believe that our full-year 2007 consolidated effective income tax rate will be approximately 30%. Our projection of effective income tax rate for any period is highly influenced by country mix of earnings, changes in statutory tax rates, timing of implementation of tax planning initiatives, and developments which affect our evaluation of uncertain tax positions. For further information on our uncertain tax positions, refer to Note 10 within Notes to Consolidated Financial Statements.

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 (defined as days of inventory and trade receivables outstanding less days of trade payables outstanding) is relatively short; equating to approximately 29 days for the trailing 365-day period ended June 30, 2007. As a result, our operating cash flow should generally reflect our net earnings performance over time, although, as illustrated in the following schedule, specific results for any particular period may be significantly affected by the level of benefit plan contributions, working capital movements (operating assets and liabilities) and other factors.

		Year-to-date period ended
		June 30,				July 1,				Change versus
(in millions)		2007				2006				prior year
Operating activities
Net earnings		$	622			$	541			$	81
Items in net earnings not requiring (providing) cash:
Depreciation and amortization			185				173				12
Deferred income taxes			(92	)			(2	)			(90	)
Other (a)			79				74				5
Pension and other postretirement benefit plan contributions			(34	)			(30	)			(4	)
Changes in operating assets and liabilities:
Core working capital (b)			(119	)			(178	)			59
Other working capital			109				(76	)			185
			(10	)			(254	)			244
Net cash provided by operating activities		$	750			$	502			$	248