EXECUTIVE OVERVIEW
Results for the year ended December 31, 2012 were strong with increases in net sales, earnings per share and profitability despite continued macroeconomic challenges. Net sales increased 9.3% compared with 2011 due to net price realization and volume increases in the United States and key international markets as we continued our focus on core brands and innovation. Advertising expense increased 15.9% for the year supporting core brands along with new product launches. Net income and earnings per share-diluted also increased at greater rates than our long-term growth targets. The investments we have made in both productivity and cost savings resulted in a business model that is more efficient and effective, enabling us to deliver predictable, consistent and achievable marketplace and financial performance. We continue to generate strong cash flow from operations and our financial position remains solid. Adjusted Non-GAAP Financial Measures
Our "Management's Discussion and Analysis of Financial Condition and Results of Operations" section includes certain measures of financial performance that are not defined by U.S. generally accepted accounting principles ("GAAP"). For each of these non-GAAP financial measures, we are providing below (1) the most directly comparable GAAP measure; (2) a reconciliation of the differences between the non-GAAP measure and the most directly comparable GAAP measure;
(3) an explanation of why our management believes these non-GAAP measures provide useful information to investors; and (4) additional purposes for which we use these non-GAAP measures. We believe that the disclosure of these non-GAAP measures provides investors with a better comparison of our year-to-year operating results. We exclude the effects of certain items from Income before Interest and Income Taxes ("EBIT"), Net Income and Income per Share-Diluted-Common Stock ("EPS") when we evaluate key measures of our performance internally, and in assessing the impact of known trends and uncertainties on our business. We also believe that excluding the effects of these items provides a more balanced view of the underlying dynamics of our business. Adjusted non-GAAP financial measures exclude the impacts of charges or credits recorded during the last four years associated with our business realignment initiatives and impairment charges related to goodwill and certain trademarks. Non-service-related pension expenses are also excluded for each of the last four years, along with acquisition closing and integration costs, primarily associated with the acquisition of Brookside in 2012, and a gain on the sale of certain non-core trademark licensing rights in 2011. Non-service-related pension expenses include interest costs, the expected return on pension plan assets, the amortization of actuarial gains and losses, and certain curtailment and settlement losses or credits. Non-service-related pension expenses may be very volatile from year-to-year as a result of changes in interest rates and market returns on pension plan assets. Therefore, we have excluded non-service-related pension expense from our results in accordance with GAAP. We believe that non-GAAP financial results excluding non-service-related pension expenses will provide investors with a better understanding of the underlying profitability of our ongoing business. We believe that the service cost component of our total pension benefit costs closely reflects the operating costs of our business and provides for a better comparison of our operating results from year-to-year. Our most significant defined benefit pension plans were closed to most new participants after 2007, resulting in ongoing service costs that are stable and predictable.

For the years ended December 31,                     2012                                  2011
                                                       Net                                   Net
                                         EBIT        Income        EPS         EBIT        Income       EPS
In millions of dollars except per
share amounts

Results in accordance with GAAP       $ 1,111.1     $  660.9     $ 2.89     $ 1,055.0     $ 628.9     $ 2.74
Adjustments:
Business realignment charges
included in cost of sales ("COS")          36.4         23.7       0.10          45.1        28.4       0.12
Non-service-related pension expense
included in COS                             8.6          5.3       0.03             -           -          -
Acquisition integration costs
included in COS                             4.1          3.0       0.01             -           -          -
Business realignment charges
included in selling, marketing and
administrative ("SM&A")                     2.4          1.6       0.01           5.0         3.0       0.01
Non-service-related pension expense
included in SM&A                           12.0          7.4       0.03           2.8         2.0       0.01
Acquisition integration costs
included in SM&A                            9.3          6.2       0.03             -           -          -
Gain on sale of trademark licensing
rights included in SM&A                       -            -          -         (17.0 )     (11.1 )    (0.05 )
Business realignment and impairment
charges(credits) , net                     45.0         31.9       0.14          (0.9 )      (0.5 )        -

Adjusted non-GAAP results             $ 1,228.9     $  740.0     $ 3.24     $ 1,090.0     $ 650.7     $ 2.83



For the years ended December 31,                     2010                                 2009
                                                       Net                                  Net
                                         EBIT        Income        EPS        EBIT        Income       EPS
In millions of dollars except per
share amounts

Results in accordance with GAAP       $   905.3     $  509.8     $ 2.21     $  761.6     $ 436.0     $ 1.90
Adjustments:
Business realignment charges
included in COS                            13.7          8.4       0.04         10.1         6.3       0.03
Non-service-related pension expense
included in COS                             0.9          0.6          -         14.7         9.1       0.04
Business realignment charges
included in SM&A                            1.5          0.9          -          6.1         3.8       0.02
Non-service-related pension expense
included in SM&A                            5.0          3.2       0.02          6.8         4.2       0.02
Business realignment and impairment
charges, net                               83.4         68.6       0.30         82.9        50.7       0.22

Adjusted non-GAAP results             $ 1,009.8     $  591.5     $ 2.57     $  882.2     $ 510.1     $ 2.23



                                                            Adjusted Non-GAAP Results
Key Annual Performance Measures                          2012          2011         2010
Increase in Net Sales                                      9.3 %         7.2 %        7.0 %
Increase in adjusted EBIT                                 12.7 %         7.9 %       14.5 %
Improvement in adjusted EBIT Margin in basis points
("bps")                                                  60bps         10bps       110bps
Increase in adjusted EPS                                  14.5 %        10.1 %       15.2 %

SUMMARY OF OPERATING RESULTS
Analysis of Selected Items from Our GAAP Income Statement
                                                                                Percent Change
                                                                             Increase (Decrease)
For the years ended
December 31,                       2012          2011          2010       2012-2011      2011-2010
In millions of dollars except per share amounts

Net Sales                       $ 6,644.3     $ 6,080.8     $ 5,671.0         9.3 %           7.2  %
Cost of Sales                     3,784.4       3,548.9       3,255.8         6.6             9.0

Gross Profit                      2,859.9       2,531.9       2,415.2        13.0             4.8

Gross Margin                         43.0 %        41.6 %        42.6 %

SM&A Expense                      1,703.8       1,477.8       1,426.5        15.3             3.6

SM&A Expense as a percent of
sales                                25.6 %        24.3 %        25.2 %

Business Realignment and
Impairment
  Charges (Credits), Net             45.0          (0.9 )        83.4         N/A          (101.1 )

EBIT                              1,111.1       1,055.0         905.3         5.3            16.5
EBIT Margin                          16.7 %        17.4 %        16.0 %

Interest Expense, Net                95.6          92.2          96.4         3.7            (4.4 )
Provision for Income Taxes          354.6         333.9         299.1         6.2            11.6

Effective Income Tax Rate            34.9 %        34.7 %        37.0 %

Net Income                      $   660.9     $   628.9     $   509.8         5.1            23.4

Net Income Per Share-Diluted    $    2.89     $    2.74     $    2.21         5.5            24.0


Net Sales
2012 compared with 2011

Key U.S. Marketplace Metrics
For the 52 weeks ended December 31, 2012 2011 2010 Consumer Takeaway Increase 5.7 % 7.8 % 5.3 % Market Share Increase 0.6 0.8 0.3

Consumer takeaway and the change in market share for 2012 are provided for measured channels of distribution accounting for approximately 90% of our U.S. confectionery retail business. These channels of distribution primarily include food, drug, mass merchandisers, including Wal-Mart Stores, Inc., and convenience stores.
Consumer takeaway for 2011 and 2010 is provided for channels of distribution accounting for approximately 80% of our U.S. confectionery retail business. These channels of distribution include food, drug, mass merchandisers, including Wal-Mart Stores, Inc., and convenience stores. The change in market share for 2011 and 2010 is provided for channels measured by syndicated data which include sales in the food, drug, convenience store and mass merchandiser classes of trade, excluding sales of Wal-Mart Stores, Inc. Cost of Sales and Gross Margin
2012 compared with 2011
The cost of sales increase of 6.6% in 2012 compared with 2011 was primarily due to higher input costs, the impact of sales volume increases and higher supply chain costs which together increased cost of sales by approximately 7.1%. An increase in cost of sales of 2.0% resulted from the Brookside acquisition. Supply chain productivity improvements reduced cost of sales by approximately 2.5%. Business realignment and impairment charges of $36.4 million were included in cost of sales in 2012, compared with $45.1 million in the prior year. Gross margin increased by 1.4 percentage points in 2012 compared with 2011, primarily as a result of price realization and supply chain productivity improvements which together improved gross margin by 4.1 percentage points. These improvements were substantially offset by higher input and supply chain costs which reduced gross margin by a total of 2.9 percentage points. The impact of lower business realignment and impairment charges recorded in 2012 compared with 2011 increased gross margin by 0.2 percentage points. 2011 compared with 2010
The cost of sales increase of 9.0% in 2011 compared with 2010 was primarily associated with higher sales volume and significantly higher commodity costs which together increased cost of sales by approximately 8.0%, each contributing about half of the increase. Increases in other supply chain costs were essentially offset by productivity improvements. Business realignment and impairment charges of $45.1 million were included in cost of sales in 2011, compared with $13.7 million in the prior year, contributing approximately 1.0% of the cost of sales increase.
Gross margin decreased by 1.0 percentage point in 2011 compared with 2010. Higher commodity and other supply chain costs reduced gross margin by about 3.2 percentage points, substantially offset by productivity improvements and price realization of approximately 2.8 percentage points. Supply chain productivity and net price realization each contributed approximately half of this gross margin improvement. The impact of higher business realignment and impairment charges recorded in 2011 compared with 2010 reduced gross margin by 0.6 percentage points.
Selling, Marketing and Administrative
2012 compared with 2011
Selling, marketing and administrative expenses increased $226.0 million or 15.3% in 2012. The increase was primarily a result of increased advertising, marketing research and consumer promotion expenses, higher employee-related expenses, increased incentive compensation costs and expenses associated with the Brookside acquisition. In addition, selling, marketing and administrative costs were reduced in 2011 by a $17.0 million gain on the sale of non-core trademark licensing rights. Advertising expense increased approximately 15.9% compared with 2011. Business realignment charges of $2.5 million were included in selling, marketing and administrative expenses in 2012 compared with $5.0 million in 2011.
2011 compared with 2010
Selling, marketing and administrative expenses increased $51.3 million or 3.6% in 2011. The increase was primarily a result of higher marketing and employee-related expenses, offset somewhat by the $17.0 million gain on the sale of non-core

trademark licensing rights as well as lower costs related to the consideration of potential acquisitions and divestitures in 2011. Advertising expense increased approximately 5.9% compared with 2010. Selling and administrative expenses increased approximately 6.6%, reflecting investments in enhancing and executing our global go-to-market strategies, including increases in selling, marketing and certain administrative staff levels. Business realignment charges of $5.0 million were included in selling, marketing and administrative expenses in 2011 compared with $1.5 million in 2010. Business Realignment and Impairment Charges In June 2010, we announced Project Next Century (the "Next Century program") as part of our ongoing efforts to create an advantaged supply chain and competitive cost structure. As part of the program, production was to transition from the Company's century-old facility at 19 East Chocolate Avenue in Hershey, Pennsylvania, to an expanded West Hershey facility, which was built in 1992. Production from the 19 East Chocolate Avenue plant, as well as a portion of the workforce, was fully transitioned to the West Hershey facility during 2012. We estimate that the Next Century program will incur pre-tax charges and non-recurring project implementation costs of $190 million to $200 million. This estimate includes $170 million to $180 million in pre-tax business realignment and impairment charges and approximately $20 million in project implementation and start-up costs, in addition to pension settlement losses of $15.8 million which were recorded in 2012. As of December 31, 2012, total costs of $173.6 million have been recorded over the last three years for the Next Century program. Total costs of $76.3 million were recorded during 2012. Total costs of $43.4 million were recorded in 2011 and total costs of $53.9 million were recorded in 2010.
In September 2011, we entered into a sale and leasing agreement for the 19 East Chocolate Avenue manufacturing facility with Chocolate Realty DST, a Delaware Statutory Trust. Chocolate Realty DST is not affiliated with the Milton Hershey School Trust. We are leasing a portion of the building for administrative office space under the agreement. As a result of our continuing involvement and use of the property, we are deemed to be the owner of the property for accounting purposes. We received net proceeds of $47.6 million and recorded a lease financing obligation of $50.0 million under the leasing agreement in 2011. The initial term of the agreement expires in 2041.
In December 2012, the Board of Directors of Tri-US, Inc. decided to immediately cease operations and dissolve the company as a result of operational difficulties, quality issues and competitive constraints. In December 2012, the Company recorded non-cash asset impairment charges of approximately $7.5 million, primarily associated with the write off of goodwill and other intangible assets, including a reduction to reflect the share of the charges associated with the noncontrolling interests.
During the second quarter of 2010 we completed an impairment evaluation of goodwill and other intangible assets associated with Godrej Hershey Ltd. Based on this evaluation, we recorded a non-cash goodwill impairment charge of $44.7 million, including a reduction to reflect the share of the charge associated with the noncontrolling interests.
During 2009, we completed our comprehensive, three-year supply chain transformation program (the "global supply chain transformation program").

Charges (credits) associated with business realignment initiatives and impairment recorded during 2012, 2011 and 2010 were as follows:

For the years ended December 31,                        2012          2011          2010
In thousands of dollars

Cost of sales
Next Century program                                 $  36,383     $  39,280     $  13,644
Global supply chain transformation program                   -         5,816             -

Total cost of sales                                     36,383        45,096        13,644

Selling, marketing and administrative - Next
Century program                                          2,446         4,961         1,493

Business realignment and impairment charges, net
Next Century program:
Pension settlement loss                                 15,787             -             -
Plant closure expenses and fixed asset impairment       20,780         8,620         5,516
Employee separation costs (credits)                        914        (9,506 )      33,225
Tri-US, Inc. asset impairment charges                    7,457             -             -
Godrej Hershey Ltd. goodwill impairment                      -             -        44,692

Total business realignment and impairment charges
(credits), net                                          44,938          (886 )      83,433

Total net charges associated with business
realignment initiatives and impairment               $  83,767     $  49,171     $  98,570

Next Century Program
The charge of $36.4 million recorded in cost of sales during 2012 related primarily to start-up costs and accelerated depreciation of fixed assets over a reduced estimated remaining useful life associated with the Next Century program. A charge of $2.4 million was recorded in selling, marketing and administrative expenses during 2012 for project administration related to the Next Century program. The level of lump sum withdrawals during 2012 from one of the Company's pension plans by employees retiring or leaving the Company, primarily under the Next Century program, resulted in a non-cash pension settlement loss of $15.8 million. Expenses of $20.8 million were recorded in 2012 primarily related to costs associated with the closure of a manufacturing facility and the relocation of production lines.
The charge of $39.3 million recorded in cost of sales during 2011 related primarily to accelerated depreciation of fixed assets over a reduced estimated remaining useful life associated with the Next Century program. A charge of $5.0 million was recorded in selling, marketing and administrative expenses during 2011 for project administration related to the Next Century program. Plant closure expenses of $8.6 million were recorded in 2011 primarily related to costs associated with the relocation of production lines. Employee separation costs were reduced by $9.5 million during 2011, which consisted of an $11.2 million credit reflecting lower expected costs related to voluntary and involuntary terminations at the two manufacturing facilities and a net benefits curtailment loss of $1.7 million also related to the employee terminations. The charge of $13.6 million recorded in cost of sales during 2010 related primarily to accelerated depreciation of fixed assets over a reduced estimated remaining useful life associated with the Next Century program. A charge of $1.5 million was recorded in selling, marketing and administrative expenses during 2010 for project administration. Fixed asset impairment charges of $5.5 million were recorded during 2010. In determining the costs related to fixed asset impairments, fair value was estimated based on the expected sales proceeds. Employee separation costs of $33.2 million during 2010 were related to expected voluntary and involuntary terminations at the two manufacturing facilities. Global Supply Chain Transformation Program The charge of $5.8 million recorded in 2011 was due to a decline in the estimated net realizable value of two properties being held for sale.

Tri-US, Inc. Impairment Charges
In February 2011, we acquired a 49% interest in Tri-US, Inc. of Boulder, Colorado, a company that manufactures, markets and sells nutritional beverages under the "mix1" brand name. We invested $5.8 million and accounted for this investment using the equity method until January 2012. In January 2012, we made an additional investment of $6.0 million in Tri-US, Inc., resulting in a controlling ownership interest of approximately 69%. In December 2012, the Board of Directors of Tri-US, Inc. decided to immediately cease operations and dissolve the company as a result of operational difficulties, quality issues and competitive constraints. It was determined that investments necessary to continue the business would not generate a sufficient return. Accordingly, in December 2012, the Company recorded non-cash asset impairment charges of approximately $7.5 million, primarily associated with the write off of goodwill and other intangible assets. These charges excluded the portion of the losses attributable to the noncontrolling interests. Godrej Hershey Ltd. Goodwill Impairment
As a result of operating performance that was below expectations, we completed an impairment evaluation of goodwill and other intangible assets of Godrej Hershey Ltd. during the second quarter of 2010. As a result of reduced expectations for future cash flows from lower than expected profitability, we determined that the carrying amount of Godrej Hershey Ltd. exceeded its fair value. As a result, we recorded a non-cash goodwill impairment charge of $44.7 million to reduce the carrying value of Godrej Hershey Ltd. to its fair value, including a reduction to reflect the share of the charge associated with the noncontrolling interests. There was no tax benefit associated with this charge. For more information on our accounting policies for goodwill and other intangible assets see pages 44 and 45.
Liabilities Associated with Business Realignment Initiatives As of December 31, 2012, the liability balance relating to the Next Century program was $7.6 million primarily for estimated employee separation costs which were recorded in 2011 and 2010. We made payments against the liabilities recorded for the Next Century program of $12.8 million in 2012 and $2.2 million in 2011 related to employee separation and project administration costs and the remainder will be paid in 2013.
Income Before Interest and Income Taxes and EBIT Margin 2012 compared with 2011
EBIT increased in 2012 compared with 2011 as a result of higher gross profit, substantially offset by higher selling, marketing and administrative expenses, and business realignment and impairment charges. Pre-tax net business realignment and impairment charges of $83.8 million were recorded in 2012 compared with $49.2 million recorded in 2011.
EBIT margin decreased from 17.4% in 2011 to 16.7% in 2012 primarily as a result of higher selling, marketing and administrative expenses as a percentage of sales and the impact of higher business realignment and impairment costs which more than offset the increase in gross margin. EBIT margin in 2012 was reduced by 0.3 percentage points compared with 2011 as a result of the gain on the sale of trademark licensing rights recorded in 2011. The net impact of business realignment, impairment and acquisition charges recorded in 2012 reduced EBIT margin by 1.3 percentage points. Net business realignment and impairment charges recorded in 2011 reduced EBIT margin by 0.8 percentage points. 2011 compared with 2010
EBIT increased in 2011 compared with 2010 as a result of higher gross profit and lower business realignment and impairment charges. Higher selling, marketing and administrative expenses were offset somewhat by the pre-tax gain of $17.0 million on the sale of trademark licensing rights. Pre-tax net business realignment and impairment charges of $49.2 million were recorded in 2011 compared with $98.6 million recorded in 2010.
EBIT margin increased from 16.0% in 2010 to 17.4% in 2011 primarily as a result of the impact of lower business realignment and impairment charges and lower selling, marketing and administrative expenses as a percentage of sales. The gain on the sale of trademark licensing rights increased EBIT margin by 0.3 percentage points in 2011. The net impact of business realignment and impairment charges recorded in 2011 reduced EBIT margin by 0.8 percentage points. Net business realignment and impairment charges recorded in 2010 reduced EBIT margin by 1.7 percentage points.
Interest Expense, Net
2012 compared with 2011 . . .