Kellogg Company and Subsidiaries

RESULTS OF OPERATIONS

Overview

The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand Kellogg Company, our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes thereto contained in Item 8 of this report.

For more than 100 years, consumers have counted on Kellogg for great-tasting, high-quality and nutritious foods. Kellogg is the world's leading producer of cereal, second largest producer of cookies and crackers, and a leading producer of savory snacks and frozen foods. Additional product offerings include toaster pastries, cereal bars, fruit-flavored snacks and veggie foods. Kellogg products are manufactured and marketed globally.

We manage our operations through nine operating segments that are based on product category or geographic location. These operating segments are evaluated for similarity with regards to economic characteristics, products, production processes, types or classes of customers, distribution methods and regulatory environments to determine if they can be aggregated into reportable segments. We report results of operations in the following reportable segments: U.S. Morning Foods & Kashi; U.S. Snacks; U.S. Specialty; North America Other; Europe; Latin America; and Asia Pacific. The reportable segments are discussed in greater detail in Note 16 within Notes to Consolidated Financial Statements.

We manage our company for sustainable performance defined by our long-term annual growth targets. These targets are 3 to 4% for internal net sales, mid-single-digit (4 to 6%) for underlying operating profit, and high-single-digit (7 to 9%) for currency neutral underlying diluted net earnings per share.

Internal net sales growth and internal operating profit growth exclude the impact of foreign currency translation and, if applicable, acquisitions, dispositions and transaction and integration costs associated with the acquisition of the PringlesŪ business (Pringles). In addition to these items, internal operating profit growth also includes the benefit of allocating a portion of costs related to our support functions that are now being leveraged to provide support to the Pringles business.

As a result of adopting the accounting change discussed below, comparability of certain financial measures is impacted significantly by the mark-to-market adjustments that are recorded annually, or more frequently if a re-measurement event occurs. To provide increased transparency and assist in understanding our underlying operating performance we use non-GAAP financial measures within the MD&A that exclude the impact of mark-to-market adjustments. These non-GAAP financial measures include underlying gross margin, underlying gross profit, underlying SGA%, underlying operating margin, underlying operating profit, underlying operating profit growth, underlying income taxes, underlying net income attributable to Kellogg Company, underlying basic earnings per share (EPS), underlying diluted EPS, and underlying diluted EPS growth. Underlying operating profit growth excludes the impact of foreign currency translation, mark-to-market adjustments, and, if applicable, acquisitions, dispositions, and transaction and integration costs associated with the acquisition of the Pringles business.

During 2012 we completed the acquisition of the Pringles business from The Procter & Gamble Company (P&G) for $2.668 billion, including working capital adjustments, which was funded from cash-on-hand and the issuance of $2.3 billion of short and long-term debt.

In the fourth quarter of 2012 we changed our accounting for recognizing expense for our pension and post-retirement benefit plans. Historically we deferred actuarial gains and losses from these plans and recognized the financial impact to the income statement over several years. Under the new accounting method, gains and losses from these plans are recognized in an annual mark-to-market adjustment that is recorded in the fourth quarter of each year, or more frequently if a re-measurement event occurs earlier in the year.

Concurrent with the accounting change, we have elected to modify the allocation of pension and post-retirement benefit plan costs to reportable segments. Historically all costs for these plans were allocated to reportable segments for management evaluation and reporting purposes. Beginning in the fourth quarter of 2012, we have included the service cost of these plans within the financial results of the reportable segments. All other costs related to these plans, such as interest cost, expected return on plan assets, and the annual mark-to-market adjustment will be reported in Corporate.

These changes have been applied retrospectively. Financial results from prior periods have been recast to include the impact as if the changes had been in place during those periods. Refer to Note 1 within Notes to

For the full year 2012, our reported net sales, which includes the impact of the operating results of the Pringles business since the acquisition on May 31, 2012, increased by 7.6% and internal net sales increased by 2.5%, in line with our expectations. We experienced solid growth in North America, Latin America, and most of Asia Pacific. Operating environments in Europe continued to be difficult, although we are seeing continued improvement in sales trends for the segment. Reported operating profit, which includes the impact of the accounting change, the operating results of the Pringles business, and transaction and integration costs related to the acquisition of Pringles, increased by 9.5%. Underlying operating profit declined by 5.7%, in line with our expectations, and was unfavorably impacted by anticipated cost inflation, the impact of the third quarter's limited recall, and increased brand-building investment. Diluted EPS of $2.67, was up 12.2% compared to the prior year EPS of $2.38. Underlying EPS of $3.52 was in line with our expectations.

Reconciliation of certain non-GAAP Financial Measures

Consolidated results
(dollars in millions, except

per share data)                                            2012               2011               2010
Net sales                                                $ 14,197           $ 13,198           $ 12,397
Net sales growth:           As reported                       7.6 %              6.5 %             (1.4 )%
                            Internal (a)                      2.5 %              4.5 %             (1.3 )%
Reported operating profit                                $  1,562           $  1,427           $  2,037
Mark-to-market (b)                                           (452 )             (682 )               (9 )
Underlying operating profit (c)                          $  2,014           $  2,109           $  2,046
Operating profit
growth:                     As reported                       9.5 %            (30.0 )%            (4.5 )%
                            Mark-to-market (b)               15.2 %            (30.7 )%            (9.6 )%
                            Underlying (c)                   (5.7 )%             0.7 %              5.1 %
Reported income taxes                                    $    363           $    320           $    510
Mark-to-market (b)                                           (148 )             (227 )              (10 )
Underlying income taxes (c)                              $    511           $    547           $    520
Reported net income attributable to Kellogg
Company                                                  $    961           $    866           $  1,287
Mark-to-market (b)                                           (304 )             (455 )                1
Underlying net income attributable to Kellogg
Company (c)                                              $  1,265           $  1,321           $  1,286
Reported basic EPS                                       $   2.68           $   2.39           $   3.43
Mark-to-market (b)                                          (0.85 )            (1.25 )             0.01
Underlying basic EPS (c)                                 $   3.53           $   3.64           $   3.42
Underlying basic EPS growth (c)                              (3.0 )%             6.4 %             10.3 %
Reported diluted EPS                                     $   2.67           $   2.38           $   3.40
Mark-to-market (b)                                          (0.85 )            (1.24 )                -
Underlying diluted EPS (c)                               $   3.52           $   3.62           $   3.40
Underlying diluted EPS growth (c)                            (2.8 )%             6.5 %             10.0 %

(a) Internal net sales growth for 2012 excludes the impact of acquisitions, divestitures, integration costs, and currency. Internal net sales growth for 2011 excludes the impact of currency. Internal net sales growth is a non-GAAP financial measure further discussed and reconciled to the directly comparable measure in accordance with U.S. GAAP in the net sales and operating profit section.

(b) Actuarial gains/losses are recognized in the year they occur. In 2012, asset returns exceeded expectations but discount rates fell almost 100 basis points resulting in a net loss. The loss in 2011 resulted from actual asset returns being less than expected and a decline in discount rates. The loss in 2010 resulted from a decline in discount rates which was partially offset by better than expected asset returns.

(c) Underlying operating profit, underlying operating profit growth, underlying income taxes, underlying net income attributable to Kellogg Company, underlying basic EPS, underlying basic EPS growth, underlying diluted EPS, and underlying diluted EPS growth are non-GAAP measures that exclude the impact of pension and post-retirement benefit plans mark-to-market adjustments. Underlying operating profit growth excludes the impact of foreign currency translation, mark-to-market adjustments, and, if applicable, acquisitions, dispositions, and transaction and integration costs associated with the acquisition of Pringles. We believe the use of such non-GAAP measures provides increased transparency and assists in understanding our underlying operating performance. These non-GAAP measures are reconciled to the directly comparable measures in accordance with U.S. GAAP within this table.

2012 compared to 2011

The following table provides an analysis of net sales and operating profit performance for 2012 versus 2011 for our reportable segments:

U.S

                                      Morning Foods           U.S.              U.S.                 North                               Latin             Asia
(dollars in millions)                    & Kashi             Snacks           Specialty          America Other          Europe          America          Pacific
2012 net sales *                     $         3,707         $ 3,226         $     1,121        $         1,485         $ 2,527         $  1,121         $  1,010
2011 net sales *                     $         3,611         $ 2,883         $     1,008        $         1,371         $ 2,334         $  1,049         $    942
% change - 2012 vs. 2011:
Internal business (a)                            2.7 %           1.9 %               7.4 %                  7.0  %         (3.8 )%           6.7  %           2.7  %
Acquisitions (b)                                   - %          10.0 %               3.8 %                  1.8  %        16.6  %            4.2  %          10.9  %
Dispositions (c)                                   - %             - %                 - %                    -  %           -  %              -  %          (3.4 )%
Integration impact (d)                             - %             - %                 - %                    -  %           -  %              -  %           (.1 )%
Foreign currency impact                            - %             - %                 - %                  (.5 )%         (4.5 )%          (4.1 )%          (2.8 )%
Total change                                     2.7 %          11.9 %              11.2 %                  8.3 %          8.3  %            6.8  %          7.3  %

                                           U.S
                                      Morning Foods           U.S.              U.S.                 North                               Latin             Asia
(dollars in millions)                    & Kashi             Snacks           Specialty          America Other          Europe          America          Pacific
2012 operating profit (e)*           $           595         $   469         $       241        $           265         $   261         $    167         $     85
2011 operating profit (f)*           $           611         $   437         $       231        $           250         $   302         $    176         $    104
% change - 2012 vs. 2011:
Internal business (a)                           (2.7 )%          (.8 )%              1.2 %                 5.2  %         (15.8 )%          (3.7 )%         (28.7 )%
Acquisitions (b)                                   -  %         12.4  %              3.1 %                 1.7  %          12.6  %           2.6  %           7.6  %
Dispositions (c)                                   -  %            -  %                - %                   -  %             -  %             -  %           9.7  %
Integration impact (d)                             -  %         (4.3 )%                - %                   -  %          (8.0 )%           (.4 )%          (4.5 )%
Foreign currency impact                            -  %            -  %                - %                  (.7 )%         (2.3 )%          (3.5 )%          (2.5 )%
Total change                                    (2.7 )%          7.3  %              4.3 %                  6.2  %        (13.5 )%          (5.0 )%         (18.4 )%

(a) Internal net sales and operating profit growth for 2012, exclude the impact of acquisitions, divestitures, integration costs and the impact of currency. Internal net sales and operating profit growth are non-GAAP financial measures which are reconciled to the directly comparable measures in accordance with U.S. GAAP within these tables.

(b) Impact of results for year ended December 29, 2012 from the acquisition of Pringles.

(c) Impact of results for year ended December 29, 2012 from the divestiture of Navigable Foods.

(d) Includes impact of integration costs associated with the Pringles acquisition.

(e) Financial results for the year ended December 29, 2012 include the impact of adopting new pension and post-retirement benefit plan accounting.

(f) Financial results for the year ended December 31, 2011 have been re-cast to include the impact of adopting new pension and post-retirement benefit plan accounting.

* Net sales and operating profit for reportable segments are reconciled to Consolidated in Note 16 within Notes to Consolidated Financial Statements.

Internal net sales for U.S. Morning Foods & Kashi increased 2.7% as a result of favorable pricing/mix and approximately flat volume. This business has two product groups: cereal and select snacks. Cereal's internal net sales increased by 2.4% resulting from strong innovation launches and increased investment in brand-building supporting brands such as Frosted FlakesŪ. Snacks (toaster pastries, Kashi-branded cereal bars, crackers, cookies, Stretch Island fruit snacks, and health and wellness products) internal net sales increased by 3.4% as a result of solid growth in the toaster pastries and health and wellness businesses.

Internal net sales in U.S. Snacks increased by 1.9% as a result of favorable pricing/mix and a slight decline in volume. This business consists of cookies, crackers, cereal bars, fruit-flavored snacks and Pringles. The sales growth was the result of strong crackers consumption behind the launch of Special K Cracker ChipsŪ and Cheez-itŪ innovation. Sales declined in cereal bars versus a difficult year-ago comparison while Special KŪ bars continued strong growth behind innovations. Cookies sales were flat versus a difficult year-ago comparison.

Internal net sales in U.S. Specialty increased by 7.4% as a result of favorable pricing/mix and volume. Sales growth was due to strong results from innovation launches and expanded points of distribution.

Europe's internal net sales declined 3.8% for the year driven by a decline in volume, partially offset by favorable pricing/mix. The operating environment in Europe continued to be difficult as a result of economic conditions and competitive activity although we are experiencing continued improvement in sales trends. Latin America's internal net sales growth was 6.7% due to a strong increase in pricing/mix partially offset by a decline in volume. Latin America experienced growth in both cereal and snacks behind an increase in brand-building investment to support innovations. Growth was broad-based across nearly every market in the segment. Internal net sales in Asia Pacific grew 2.7% as a result of favorable volume partially offset by unfavorable pricing/mix. Asia Pacific's growth was driven by solid performance across most of Asia, as well as South Africa. Australia posted a slight decline in sales, but experienced continued improvement throughout the year, while gaining share in both the cereal and snacks categories.

The third quarter recall impacted internal operating profit growth as follows:
Kellogg Consolidated - (1.8%), U.S. Morning Foods & Kashi - (3.1%), U.S.

Specialty - (1.6%), North America Other - (1.4%).

Internal operating profit in U.S. Morning Foods & Kashi declined by 2.7%, U.S. Snacks declined by 0.8%, U.S. Specialty increased by 1.2%, North America Other grew by 5.2%, Europe declined by 15.8%, Latin America declined by 3.7% and Asia Pacific declined by 28.7%. U.S. Morning Foods & Kashi's decline was attributable to the impact of the third-quarter recall and increased commodity costs, partially offset by sales growth in cereal and snacks. U.S. Snacks' decline was attributable to cost inflation and a double-digit increase in brand-building investments. U.S. Specialty's increase was attributable to strong sales growth being partially offset by increased commodity costs and a double-digit increase in brand-building investment. North America Other's increase was attributable to strong sales growth being partially offset by increased commodity costs and a double-digit increase in brand-building investment. Europe's operating profit declined due to lower sales resulting from the continued difficult operating environment and increased commodity costs, partially offset by reduced brand-building investment. The decline in Latin America's operating profit was due to cost inflation and increased brand-building investment more than offsetting the impact of higher sales. Asia Pacific's operating profit decline was due to cost inflation, charges related to the closure of a plant in Australia, and increased brand-building investment more than offsetting the impact of higher sales. Refer to Note 2 within Notes to Consolidated Financial Statements for further information on the Australian plant closure.

2011 compared to 2010

The following table provides an analysis of net sales and operating profit performance for 2011 versus 2010 for our reportable segments:

U.S

                                      Morning Foods           U.S.             U.S.                 North                             Latin           Asia
(dollars in millions)                    & Kashi             Snacks          Specialty          America Other         Europe         America         Pacific
2011 net sales *                              $3,611          $2,883             $1,008                 $1,371         $2,334          $1,049            $942
2010 net sales *                              $3,463          $2,704               $975                 $1,260         $2,230           $ 923           $ 842
 % change - 2011 vs. 2010:
Internal business (a)                            4.3 %           6.6 %              3.4 %                  6.4 %          (.7 )%         10.3 %           4.1 %
Foreign currency impact                            - %             - %                - %                  2.4 %          5.3  %          3.4 %           7.7 %
Total change                                     4.3 %           6.6 %              3.4 %                  8.8 %          4.6  %         13.7 %          11.8 %

                                           U.S
                                      Morning Foods           U.S.             U.S.                 North                             Latin           Asia
(dollars in millions)                    & Kashi             Snacks          Specialty          America Other         Europe         America         Pacific
2011 operating profit (b)*                      $611            $437               $231                   $250           $302            $176            $104
2010 operating profit (b)*                      $622            $475               $253                   $222           $338            $153             $72
 % change - 2011 vs. 2010:
Internal business (a)                           (1.6 )%         (8.1 )%            (8.7 )%                 9.5 %        (16.1 )%          8.5 %          34.8 %
Foreign currency impact                          (.2 )%            -  %               -  %                 3.4 %          5.5  %          6.1 %          10.4 %
Total change                                    (1.8 )%         (8.1 )%            (8.7 )%                12.9 %        (10.6 )%         14.6 %          45.2 %

(a) Internal net sales and operating profit growth for 2011 and 2010 exclude the impact of currency. Internal net sales and operating profit growth are non-GAAP financial measures which are reconciled to the directly comparable measures in accordance with U.S. GAAP within these tables.

(b) Results for 2011 and 2010 have been re-cast to include the impact of adopting new pension and post-retirement benefit plan accounting.

* Net sales and operating profit for reportable segments are reconciled to Consolidated in Note 16 within Notes to Consolidated Financial Statements.

Internal net sales in U.S. Snacks increased by 6.6% as a result of favorable pricing/mix and approximately flat volume. This business consists of cookies, crackers, cereal bars, and fruit-flavored snacks. The sales growth was the result of strong crackers consumption behind the launch of Special K Cracker ChipsŪ and Cheez-itŪ innovation which contributed to a solid improvement in our cracker category share. Sales also improved in wholesome snacks as a result of innovations in our Special KŪ and FiberPlusŪ cereal bars business. Cookies low-single digit sales growth was favorably impacted by the launch of the KeeblerŪ master brand initiative in the second quarter which aligned pricing, packaging and scale across the KeeblerŪ brand.

Internal net sales in U.S. Specialty increased by 3.4% as a result of favorable pricing/mix and approximately flat volume. Sales growth was due to frozen food innovation launches and cereal bar distribution gains.

Internal net sales in North America Other (U.S. Frozen and Canada) increased by 6.4% due to mid-single-digit volume growth and favorable pricing/mix. Sales growth was the result of our U.S. Frozen business posting double-digit growth for the year while gaining share as a result of increased brand-building support behind innovation activity.

Europe's internal net sales declined 0.7% for the year driven by a decline in volume, partially offset by favorable pricing/mix. The operating environment in Europe continued to be difficult as a result of economic conditions and competitive activity. Sales growth in Russia was solid, as we continue to transition from a non-branded to a branded product mix. Latin America's internal net sales growth was 10.3% due to a slight increase in volume and double-digit increase in pricing/mix. Latin America experienced growth in both cereal and snacks behind a mid-double-digit increase in brand-building investment to support innovations. Internal net sales in Asia Pacific grew 4.1% as a result of favorable pricing/mix and approximately flat volume. Asia Pacific's growth was driven by strong performance across most of Asia, as well as South Africa.

Internal operating profit in U.S. Morning Foods & Kashi declined by 1.6%, U.S. Snacks declined by 8.1%, U.S. Specialty declined by 8.7%, North America Other grew by 9.5%, Europe declined by 16.1%, Latin America increased by 8.5% and Asia Pacific increased by 34.8%. U.S. Morning Foods & Kashi's decline was attributable to strong sales in cereal and snacks, being offset by increased incentive compensation expense, increased commodity costs and investments in supply chain. U.S. Snacks' decline was attributable to investments in supply chain and increased incentive compensation expense. U.S. Specialty's decline was attributable to increased commodity costs and incentive compensation expense. Europe's operating profit declined due to lower sales resulting from the continued difficult operating environment and increased commodity costs. The increase in Latin America's operating profit is primarily a result of higher sales partially offset by increased brand-building investment. Asia Pacific's operating profit growth was positively impacted by the prior year impairment charges related to our business in China. Refer to Note 2 within Notes to Consolidated Financial Statements for further information on the China impairment.

Corporate Expense

(dollars in millions) 2012 2011 2010 Operating profit $ (521 ) $ (684 ) $ (98 )

Corporate expense is primarily the result of mark-to-market adjustments for our pension and non-pension post-retirement benefit plans. These adjustments were $(452), $(682), and $(9) in 2012, 2011, and 2010, respectively. The remaining changes were the result of impacts from compensation-related expense and pension-related interest cost and offsetting pension-related expected return on plan assets.

Margin performance

Margin performance was as follows:

                                                                                           Change vs.
                                                                                       prior year (pts.)
                                    2012           2011           2010               2012               2011
. . .