General Mills
Annual Report 2006

Plain-text annual report

General Mills 2006 Annual Report GENERAL MILLS AT A GLANCE U.S. Retail International Bakeries and Foodservice Joint Ventures Net Sales by Division $8.02 billion in total 23% Big G Cereals 22% Meals 19% Pillsbury USA 14% Yoplait 12% Snacks 8% Baking Products 2% Other Net Sales by Region $1.84 billion in total 34% Europe 31% Canada 22% Asia/Pacific 13% Latin America Net Sales by Customer Segment $1.78 billion in total 49% Distributors/ Restaurants 39% Bakery Channels 12% Convenience Stores/Vending Net Sales by Joint Venture $894 million proportionate share 78% Cereal Partners Worldwide (CPW) 20% Häagen-Dazs 2% 8th Continent U.S. RETAIL Our U.S. Retail business segment includes the major market- ing divisions listed to the left. We market our products in a variety of domestic retail outlets including traditional grocery stores, natural food chains, mass merchandisers and member- ship stores. This segment accounts for 69 percent of total company sales. INTERNATIONAL We market our products in more than 100 countries outside the United States. Our largest international brands are Häagen-Dazs ice cream, Green Giant vegetables, Old El Paso Mexican foods and Pillsbury dough products. This business segment accounts for 16 percent of total company sales. BAKERIES AND FOODSERVICE This segment of our business generates nearly $1.8 billion in sales. We customize packaging of our retail products and mar- ket them to convenience stores and foodservice outlets such as schools, restaurants and hotels. We sell baking mixes and frozen dough-based products to supermarket, retail and wholesale bakeries. We also sell branded food products to food- service operators, wholesale distributors and bakeries. JOINT VENTURES We are partners in several joint ventures around the world. Cereal Partners Worldwide is our joint venture with Nestlé S.A. We participate in several Häagen-Dazs joint ventures, the largest of which is in Japan. And we are partners with DuPont in 8th Continent, which produces soy beverages in the United States. CONTENTS LETTER TO SHAREHOLDERS _ 02 A NEW PHASE OF GROWTH _ 07 CORPORATE DIRECTORY _ 16 SELECTED FINANCIAL INFORMATION _ 17 ANNUAL REPORT ON FORM 10-K _ 21 2006 Financial Highlights In Millions, Except per Share Data Fiscal Year Ended Net Sales Segment Operating Profit Net Earnings Diluted Earnings per Share Average Diluted Common Shares Outstanding Dividends per Share May 28, 2006 $ 11,640 2,119 1,090 2.90 379 1.34 $ May 29, 2005 $ 11,244 2,024 1,240 3.08 409 $ 1.24 Change 4% 5 –12 –6 –7 8 Net Sales (dollars in millions) Segment Operating Profit† (dollars in millions) 11,070 11,244 11,640 10,506 2,001 2,060 2,024 2,119 7,949 1,257 02 03 04 05 06 02 03 04 05 06 Diluted Earnings per Share (dollars) 2.60 5 7 . 2 2.35 3 4 . 2 3.08 5 7 . 2 2.90 8 9 . 2 1.34 4 3 . 1 Return on Average Total Capital† (percent) 10.0 10.0 10.6 9.5 8.5 02 03 04 05 06 02 03 04 05* 06* Excluding accounting impact of contingently convertible debt and 2005 net gain from divestitures and bond buyback † *Excluding 2005 net gain from divestitures and bond buyback Fiscal 2004 included 53 weeks. All other fiscal periods shown included 52 weeks. †See page 24 of the 2006 Annual Report on Form 10-K for discussion of these non-GAAP measures. page _ 1 TO OUR SHAREHOLDERS Fiscal 2006 marked the beginning of a new phase in General Mills’ long-term growth, and we’re off to a good start: • • Net sales rose 4 percent to exceed $11.6 billion worldwide. • • Despite significant input cost inflation, our gross mar- gin increased 90 basis points to exceed 40 percent, and seg- ment operating profits grew faster than sales, increasing 5 percent to more than $2.1 billion. • • Net earnings and diluted earnings per share (EPS) were below last year’s reported results, which included a $284 million after-tax gain from the divestiture of two businesses. But EPS of $2.90 in 2006 was slightly above our targeted range for the year, and represented good growth from last year’s results excluding the one-time gain. • • Dividends grew 8 percent to $1.34 per share, repre- senting a payout of 46 percent of diluted EPS to our share- holders. We also invested approximately $900 million to repurchase 19 million shares of General Mills common stock at an average price of approximately $47 per share. • • We coupled our sales and earnings growth with disci- plined cash use and drove a 60 basis point improvement in return on capital (ROC). We have a goal of increasing our ROC by 50 basis points a year, so this put us slightly ahead of our targeted pace. We believe increases in net sales, segment operating profit, earnings per share and return on capital are the key measures of financial performance for our business, and we recorded gains on each of these metrics in 2006. The market price of General Mills shares increased 4 per- cent over the fiscal year. Total return to General Mills shareholders, including dividends, was 7 percent. This com- pares to a negative 2 percent return for our food company peer group and a 9 percent return for the broader S&P 500. 20 06 O PER AT ING PE R FOR M ANC E General Mills has three operating segments: U.S. Retail, International, and Bakeries and Foodservice. In 2006, all three of these segments achieved growth in net sales and faster growth in operating profits. For U.S. Retail, net sales grew 3 percent to $8.0 billion. This included gains of 14 percent for the Yoplait division, 7 percent for the Meals division, 6 percent for Baking Products, 5 percent for the Snacks division and 27 percent for our small but fast-growing organic business, Small Planet Foods. Two divisions – Big G cereals and Pillsbury USA – posted sales declines of 1 percent. Operating profits for U.S. Retail grew slightly faster than net sales to reach nearly $1.8 billion, as pricing and productivity offset higher input costs and increased investment in advertising to sup- port the long-term growth of our brands. page _ 2 U.S. Retail Leading Market Positions Margin Expansion Dollars in Millions, Fiscal 2006 Ready-to-eat Cereals Refrigerated Yogurt Frozen Vegetables Ready-to-serve Soup Mexican Products Granola Bars/Grain Snacks Refrigerated Dough Dessert Mixes Frozen Hot Snacks Frozen Baked Goods Microwave Popcorn Fruit Snacks Dry Dinners Category Sales $7,750 3,690 2,320 1,800 1,780 1,760 1,670 1,510 1,020 940 820 650 580 Our Dollar Share 29% 38 22 30 19 21 69 40 27 19 21 50 72 Rank 2 1 1 2 2 2 1 1 2 1 2 1 1 Gross Margin Segment Operating Margin* 39.2% 40.1% 18.0% 18.2% 05 06 05 06 Channels include ACNielsen measured outlets and Wal-Mart * Based on total segment operating profit. See page 25 of the Annual Report on Form 10-K for discussion of this non-GAAP measure. International segment net sales grew 6 percent to $1.8 bil- lion, and operating profit grew 18 percent to surpass the $200 million mark. This was the fourth consecutive year of double-digit profit growth for our International operations. Bakeries and Foodservice net sales grew 2 percent in 2006 to reach $1.8 billion, and operating profit grew 4 percent to $139 million. This represents renewed growth after several years when manufacturing reconfiguration and weak indus- try conditions depressed results for this segment. Joint ventures generated $64 million in after-tax earnings for General Mills in 2006. This was below last year’s results, which included $28 million in earnings from the Snack Ventures Europe (SVE) partnership that ended in February 2005. But earnings from ongoing joint ventures grew 5 percent. Our Cereal Partners Worldwide venture with Nestlé S.A. led this performance, posting good sales and profit gains for the year. We reinvested some of our earnings in 2006 to fund con- tinued innovation and consumer-directed marketing. Advertising spending increased 8 percent to $515 million overall, including a strong increase in second-half media support for our U.S. Retail business. And we invested $360 million in capital projects to support future business growth and productivity initiatives. We believe these investments will help sustain our momentum in fiscal 2007 and will underpin consistent good growth and returns in the years ahead. GR OWT H OU TL OOK As noted at the top of this letter, we see 2006 as the begin- ning of a new period of growth for General Mills. Over the next three to five years, we believe our company is well- positioned to deliver low single-digit growth in net sales, mid single-digit growth in operating profit, and high sin- gle-digit growth in earnings per share. And we think that this financial performance – coupled with an attractive div- idend yield – should result in consistent, double-digit returns to our shareholders. General Mills Long-term Growth Objectives Net Sales Growth Operating Profit Growth Diluted Earnings per Share Growth + Dividend Yield Targeted Compound Annual Growth Rate Low single-digit Mid single-digit High single-digit Total Shareholder Return Double-digit page _ 3 Dividends per Share (dollars) Total Shareholder Return, Fiscal 2006 (price appreciation plus reinvested dividends) 1.24 1.34 1.10 + 8.8% + 7.2% SHAREHOLDER RETURNS Dividends per share grew 8 percent in fiscal 2006, and the market price of General Mills shares rose 4 percent. Total return to General Mills share- holders exceeded 7 percent. 04 05 06 -1.8% S&P Packaged Foods Index S&P 500 Index General Mills What’s new about this chapter of our long-term growth? To begin with, for most of our history we’ve been essentially a U.S. food company. Today we have 32 plants, more than 9,000 talented people and nearly $2 billion in sales outside the United States. And we’re just getting started. So inter- national business expansion will be an increasingly important driver of our growth going forward. Here’s another change: Our food sales used to be highly concentrated in traditional supermarkets. Today, we are a major supplier to a wide variety of retail outlets, ranging from convenience stores to natural and organic food store chains. And we are a major player in the foodservice industry, too, with sales to schools, hotel operators, restau- rants and foodservice distributors. These faster-growing channels offer great new opportunities for us. One further difference we see in this new phase of growth is our profit base. In the past, General Mills’ overall profit per- formance was highly dependent on the U.S. cereal business. The Big G division will still be an important source of sales and profit growth in our future, but today our portfolio includes a broad base of established, profitable businesses. And we have several newer businesses with compelling mar- gin expansion potential. We see our business portfolio as a strategic advantage, which can enable us to deliver consis- tent growth in sales and earnings going forward. We expect our worldwide food businesses to achieve another year of good sales and operating profit growth in 2007. We have a well-stocked pipeline of new products – you’ll see a number of them on the following pages of this report. And our established brands have started the year with good momentum. We anticipate that these positive factors will be partially offset by higher input costs, higher interest and tax rates, and expensing of stock-based com- pensation, but still result in another year of earnings per share growth. A S TR ONG ORG ANI ZATI ON Winning in the packaged foods business is all about inno- vation and execution, so the key to success is great people. Our 28,100 employees delivered terrific results in 2006. We’ll continue to invest in initiatives that help ensure our people see General Mills as a great place to work and grow throughout their careers. In June, we implemented a new senior leadership struc- ture for our organization. Ken Powell is now President and Chief Operating Officer of General Mills and has joined the board of directors. In this role, Ken oversees all com- pany operating activities worldwide. Reporting to him are Ian Friendly, Executive Vice President, Chief Operating Officer, U.S. Retail; Chris O’Leary, Executive Vice President, page _ 4 From left: Steve Sanger, Ken Powell, Jim Lawrence Chief Operating Officer, International; Marc Belton, Executive Vice President, Worldwide Health, Brand and New Business Development; Randy Darcy, Executive Vice President, Worldwide Operations and Technology; and Jeff Rotsch, Executive Vice President, Worldwide Sales and Channel Development. Jim Lawrence is now Vice Chairman of General Mills and continues to serve as Chief Financial Officer. Several other senior leaders also have taken on important new roles. A complete listing of our senior leadership team appears on page 16 of this report. General Mills has a long history of achieving good growth and returns, and our new team is committed to delivering continued strong performance for shareholders in this new phase of growth. Stephen W. Sanger Chairman of the Board and Chief Executive Officer Kendall J. Powell President and Chief Operating Officer James A. Lawrence Vice Chairman and Chief Financial Officer July 28, 2006 page _ 5 WE’RE IN A NEW PHASE OF GROWTH WHAT’S NEW ABOUT IT? We’ve got exciting new products. We’ve gone global, building brands around the world. We’re in new places where people buy food. In short, we see exciting new opportunities to drive profitable growth. page _ 7 YOPLAIT YOGURT – IT IS SO GOOD! An advertising campaign emphasizing the weight-loss benefits of calcium helped drive 14 percent retail sales growth for our Yoplait yogurt line in 2006. Wh a t’s New ? WE’VE GOT INNOVATIVE NEW PRODUCTS In 2006, we introduced more than 300 new food products around the world, designed to make consumers’ lives healthier and easier. We’ll keep the innovation coming in 2007, with 100 new products from our U.S. Retail businesses launching in the first half alone. Here are some examples. Nature Valley granola bars are a nutritious and convenient snack. Retail sales have been growing at a double- digit pace, up 29 percent in fiscal 2006. We’re now expanding the brand with new Nature Valley Fruit Crisps. These single-serving pouches of baked apple chips contain just 50 calories each. Progresso ready-to-serve soup is another quick and nutritious food choice. Retail sales for Progresso grew 12 percent in 2006 due in part to effective advertising, highlighting the fact that 25 of our soup varieties contain 100 calories or less per serving. In 2007, Progresso will offer a new line of soups con- Our Big G division has a number of taining 50 percent less sodium than regular varieties. wholesome new breakfast cereals planned for the year. New Fruity Cheerios cereal contains at least 16 grams of whole grain and 12 essential vitamins and minerals per serving, making it a healthy option for kids and adults. Other new items include La Lechera Flakes and Dora the Explorer cereal, We’re also innovating which is lower in sugar and higher in fiber than most children’s cereals. page _ 8 1 3 2 4 FRESH OFF THE SHELF 1_ New flavors of Progresso soup include several varieties with 50 percent less sodium. 2_ Hamburger Helper casseroles and Green Giant vegetables are ready in minutes with these new single-serving versions. 3_ Each pouch of new Nature Valley Fruit Crisps contains baked apple chips equal to one serving of fruit. 4_ Yogurt Burst Cheerios helped drive 5 percent retail sales growth for the Cheerios franchise in 2006. Oatmeal Crisp Maple Brown Sugar is one of the new cereals we’re introducing in 2007. Media Spending (dollars in millions) 477 515 Yoplait/Colombo Yogurt Retail Sales (dollars in millions) 1,450 1,275 1,175 1,100 Progresso Soup Retail Sales (dollars in millions) 550 490 440 390 INVESTING IN OUR BRANDS Effective consumer advertising messages drove strong sales gains for a number of our businesses last year, including Yoplait yogurt and Progresso soup. Our plans for 2007 call for even higher levels of adver- tising support for our businesses. 05 06 03 04 05 06 03 04 05 06 Yogurt and soup retail sales in ACNielsen measured outlets and Wal-Mart in ways that add new levels of convenience to our portfolio. Last year, we introduced Betty Crocker Warm Delights microwaveable desserts. Their popularity helped drive 7 percent retail sales growth for our Betty Crocker desserts business in 2006. This year, we’re introducing several more new products that can be made in the microwave. With Hamburger Helper Microwave Singles, an individual serving of your favorite casserole is ready in less than 10 minutes. All you add is water – the meat is already included. New Green Giant Just for One! frozen vegetables are single servings in microwaveable trays, for warm vegetables and sauce in just two minutes. Baked goods are quick and easy to prepare with Pillsbury refrigerated dough, the leading brand in the $1.7 billion refrigerated dough category. Our newest additions to this line include Flaky Supreme Grands! cinnamon rolls and garlic We’re investing in our new products and our estab- flavored crescent rolls and breadsticks. lished brands with increased advertising support. Companywide media spending in 2006 grew by nearly $40 million, or 8 percent, to reach $515 million. We expect our investment level to grow again in 2007, in part to support our year-long lineup of new product introductions. page _ 9 Our products are marketed in more than 100 countries today, and that number will continue to grow as we increase our presence around the world. Since 2001, sales for our International business segment have increased fivefold, reaching $1.8 billion in 2006. Our largest international brands – Häagen-Dazs, Green Giant and Old El Paso – hold premium, niche positions in their categories. And we have a number of strong regional and local brands that broaden our worldwide reach. We’re building our international business in several ways. First, we’re bringing U.S. Retail brands to global markets. For example, we launched Nature Valley granola bars in India and several European markets in fiscal 2006, and we’ll be adding distribution this year. Betty Crocker is a popular brand in the baking mix category in Australia and has been gaining market share in the United Kingdom, too. And last fall, we brought our Trix fruit snacks to China. We’re borrowing products and brands from other countries, too. Wanchai Ferry frozen dumplings originated in China. This year, we’ll introduce this convenient heat-and-eat line in Taiwan. We’ll also be launching an entire line of We’re expanding our international Wanchai Ferry shelf-stable Chinese dinner kits in France. W hat’s New? WE’RE TAPPING NEW MARKETS AROUND THE GLOBE NATURAL ENERGY FOR AN ACTIVE LIFE – WORLDWIDE Consumers from Brazil to Spain, and 60 more markets around the world, have discovered the natural goodness of Nature Valley granola bars. page _ 10 business by entering new markets. We’ve got a small but fast-growing business in India that began with whole wheat flour for traditional Indian breads. We have been adding to our product line, most recently with new Pillsbury Sweet Variety Mix for desserts. And last December, we launched Dip Trix cookie snacks, designed to appeal to India’s 300 million kids. We also participate in several international joint ventures. The largest of these is Cereal Partners Worldwide (CPW), which gener- ated net sales of $1.4 billion in 2006. CPW competes in over 130 markets and holds a 24 percent composite share of cereal category sales in those markets. In July 2006, CPW acquired Uncle Tobys cereals in Australia, where the ready-to-eat cereal market generates annual retail sales of more than $600 million. With this acquisition, Australia becomes the second-largest market for CPW, just behind the United Kingdom. Our opportunity for international growth has never been better. We expect our wholly owned businesses to be increasingly important contributors to companywide sales and profit growth. And our international joint ventures will make growing contributions to our after-tax earnings. Net Sales International Segment (dollars in millions) Operating Profit International Segment (dollars in millions) 1,837 1,725 201 171 1,550 1,300 119 91 Ongoing Joint Venture Earnings (dollars in millions, after tax) 61 64 48 40 03 04 05 06 03 04 05 06 03 04 05 06 See page 26 of the 2006 Annual Report on Form 10-K for discussion of this non-GAAP measure. 1 3 2 4 INTERNATIONAL GROWTH Our international businesses are becoming increasingly important contributors to overall company performance. Operating profits for our wholly owned businesses have been growing at a double-digit pace for the past several years. And earnings from ongoing joint ventures, primarily international, reached $64 million in 2006. A SPIN AROUND THE WORLD 1_ The latest new products from Cereal Partners Worldwide include Chocapic Duo in France, Trix &Yoghurt in Latin America, and now Uncle Tobys cereals in Australia. 2_ Häagen-Dazs ice cream sandwiches continue to be a big hit in Japan and Europe. New flavors coming in 2007 include Summer Berries & Cream. 3_ Our business in India is grow- ing with new Dip Trix cookie snacks and Pillsbury Sweet Variety Mix for traditional Indian desserts. 4_ This line of Wanchai Ferry Chinese dinner kits is being intro- duced in France this fall. page _ 11 EVERY DAY IN THE UNITED STATES, 35 MILLION BREAKFASTS are purchased away from home. We’re making sure consumers can find our cereals wherever they buy breakfast – whether it’s in a cafeteria or a quick-service restaurant. Wh a t’s Ne w? OUR PRODUCTS ARE SELLING IN NEW CHANNELS According to the United States Department of Agriculture, 2004 sales for food eaten away from home totaled $475 billion, surpassing sales for food eaten at home for the first time. Foodservice industry sales are expected to continue to grow, fueled by consumers’ busy lives and their need for convenient eating options. Our Bakeries and Foodservice business generated nearly $1.8 billion in sales in 2006. One of our largest customer segments is foodservice distributors, who carry a wide assort- ment of our branded products. Volume for Big G cereals was up 10 percent last year, and Yoplait yogurt grew 6 percent as we gained distribution in outlets such as hotels, restaurants and college cafeterias. We include sales to convenience stores in our Bakeries and Foodservice segment. In 2006, our volume in this channel grew 11 percent led by snacks such as Nature Valley Sweet & Salty Nut bars and Chocolate Chex Mix. This year, we’re introducing several new grab-and-go treats, including Caribou Coffee bars and Caramel Bugles. In our U.S. Retail segment, traditional gro- cery stores still account for the majority of sales for food eaten at home. But there are many more unique retail outlets selling food today. For example, our Cascadian Farm and Muir Glen brands are available in both traditional grocery stores and natural and organic food outlets. Net sales for these page _ 12 1 3 2 4 Retail Outlet Food Sales Growth (three-year compound growth through December 2005) 15% 14% 10% 8% 6% 1% Grocery Stores Mass Merchandisers & Supercenters Natural/ Organic Stores Club Stores Drug and Dollar Stores Convenience Stores ACNielsen Household Panel Data brands combined grew 27 percent in 2006, as we expanded their presence in both of these channels. Food And we’ve got a variety of new organic products, from cereal to soup, coming in 2007. sales at mass merchandisers and supercenters have grown at a 15 percent compound rate over the past three years. We’re increasing our sales in this fast-growing channel with products that are partic- ularly well-suited to these outlets, such as Betty Crocker baking mixes that leverage popular candy bar At drug and dollar stores, food sales are growing at an 8 percent pace. Our sales are flavors. growing even faster in these outlets as we’ve gained distribution with customized packaging of our products, including fruit snacks and Hamburger Helper dinner mixes. Our sales at club stores are growing, too, as we leverage the popularity of many of our brands, putting them in unique packaging formats to meet the special needs of club store shoppers. And we have a sales team dedicated to each of these channels, which will allow us to put increased focus on these growing outlets in 2007. As consumers enjoy more meals away from home and purchase food in a wider variety of retail out- lets, we see new sales and distribution opportunities for our products. COMING TO ALL KINDS OF STORES NEAR YOU 1_ Our newest organic foods include Vanilla Almond Crunch cereal from Cascadian Farm and Southwest Black Bean soup from Muir Glen. 2_ These Betty Crocker dessert mixes were featured at mass merchandisers. 3_ Sales for our products with food- service distributors grew 3 percent in fiscal 2006. 4_ Our snacks are popular in convenience stores, where food sales have been growing at a 6 percent rate in recent years. FOOD SHOPPING IN NEW PLACES Consumers are buying food in a wide variety of channels today. Food sales in these retail outlets have been growing faster than sales in traditional grocery stores. We see exciting opportunities for our brands in all of these channels. page _ 13 Our long-term growth model calls for segment operating profit to grow faster than sales, creating margin expansion over time. We’re finding new opportunities across our business portfolio to drive profit growth. For example, we simplified the Hamburger Helper line of dinner mixes, reducing the number of flavors and the variety of ingredients in each box. This led to production cost savings, which we reinvested in increased advertising, ultimately driving 7 percent retail sales growth for Hamburger Helper in fiscal 2006. We took similar actions in our Betty Crocker dessert busi- ness, eliminating the slowest selling flavors of cake and frosting. We also made our promotional spending more efficient, resulting in cost savings that allowed us to launch new items such as Betty Crocker Warm Delights desserts. As a result, retail sales for Betty Crocker dessert mixes grew 7 percent in fiscal 2006, and we gained more than 2 points of market share in the $1.5 billion dessert mix cate- gory. Margins for our baking business also improved due to the more profitable mix of products in our portfolio. In our Bakeries and Foodservice division, foodservice distributors represent one of our fastest-growing segments. Our branded businesses – cereal, yogurt and snacks – showed W hat’s New? WE SEE NEW OPPORTUNITIES FOR PROFITABLE GROWTH HOW DO YOU GROW A 35-YEAR-OLD BRAND? By focusing on what consumers really want. We eliminated the slow-selling flavors and reduced the number of ingredient pouches and pasta varieties in our Hamburger Helper line. We realized significant production cost savings, reinvested in brand-building initiatives and saw retail sales grow 7 percent in 2006. page _ 14 solid growth in fiscal 2006, which helped drive overall operating profit growth for this division. We’re building on this momentum with the first-quarter introduction of 12 new items targeted to foodser- vice distributors. Our initiatives to increase profitability aren’t limited to our domestic busi- nesses. Internationally, we’re improving productivity on several large brands. In fiscal 2006, we consolidated manufacturing of our European Old El Paso products into one state-of-the-art facility in Spain. We’ve also automated key portions of the packaging process for frozen dough at a manufac- turing site in the United Kingdom, and for Häagen-Dazs ice cream at a facility in France. These cost- savings initiatives contributed to 18 percent operating profit growth for our International division in Across the company, our profit base is changing. In the past, our overall profit perform- 2006. ance was highly dependent on our U.S. cereal business. Today, our portfolio includes a broader base of high-margin businesses. And we have a number of businesses with great potential for further margin expansion as they grow and gain the advantage of scale. These include Small Planet Foods organic products and our International businesses. Segment Operating Profit Margins U.S. Retail International Bakeries and Foodservice 22.1% 22.2% 9.9% 10.9% 7.7% 7.8% 05 06 05 06 05 06 1 3 2 4 PORTFOLIO STRENGTH Our operating profit growth is coming from a wider variety of businesses today. While the U.S. Retail segment is still our largest profit driver, the International and Bakeries and Foodservice segments are becoming bigger contributors to overall profit growth. GROWING PROFITS AROUND THE WORLD 1_ Attractive price points on Betty Crocker Warm Delights con- tributed to sales and profit growth for our baking products portfolio. We’ve recently added two new flavors to this line of microwaveable desserts. 2_ Pillsbury refrigerated dough products and Totino’s hot snacks hold leading market posi- tions in attractive categories. 3_ European Old El Paso products are produced in one plant, driving productivity savings on this popu- lar line of Mexican foods. 4_ We’ve increased our profitability in China with new products, such as Trix fruit snacks, and the expansion of established lines such as Wanchai Ferry dumplings. page _ 15 C OR PORAT E DIR E C TORY We have a long-standing commitment to strong corporate governance. The cornerstone of our practices is an independent board of directors. All directors stand annually for election by shareholders, and all board committees are composed entirely of independent directors. In addition, our management practices demand high standards of ethics as described by our Employee Code of Conduct. For more information on our governance practices, see our 2006 Proxy Statement. BOARD OF DIRECTORS (as of July 28, 2006) Paul Danos Dean, Tuck School of Business and Laurence F. Whittemore Professor of Business Administration, Dartmouth College (1,5) Hanover, New Hampshire Judith Richards Hope Distinguished Visitor from Practice and Adjunct Professor, Georgetown University Law Center (1*,5) Washington, D.C. William T. Esrey Chairman Emeritus, Sprint Corporation (telecommunication systems) (1,3*) Vail, Colorado Raymond V. Gilmartin Retired Chairman, President and Chief Executive Officer, Merck & Company, Inc. (pharmaceuticals) (2,4*) Woodcliff Lake, New Jersey Heidi G. Miller Executive Vice President and chief executive officer, Treasury & Security Services, J.P. Morgan Chase & Co. (2,3) New York, New York Hilda Ochoa-Brillembourg Founder, President and Chief Executive Officer, Strategic Investment Group (investment management) (3,5) Arlington, Virginia Board Committees: 1. Audit 4. Corporate Governance 2. Compensation 3. Finance 5. Public Responsibility * Denotes Committee Chair SENIOR MANAGEME NT (as of July 28, 2006) Y. Marc Belton Executive Vice President, Worldwide Health, Brand and New Business Development Ian R. Friendly Executive Vice President; Chief Operating Officer, U.S. Retail Peter J. Capell Senior Vice President; President, Big G Cereals Gary Chu Senior Vice President; President, Greater China Juliana L. Chugg Senior Vice President; President, Pillsbury USA Giuseppe A. D’Angelo Senior Vice President; President, Europe, Latin America and Africa Randy G. Darcy Executive Vice President, Worldwide Operations and Technology David P. Homer Vice President; President, General Mills Canada James A. Lawrence Vice Chairman and Chief Financial Officer John T. Machuzick Senior Vice President; President, Bakeries and Foodservice Siri S. Marshall Senior Vice President, General Counsel, Chief Governance and Compliance Officer and Secretary Maria S. Morgan Vice President; President, Small Planet Foods Rory A.M. Delaney Senior Vice President, Strategic Technology Development Donal L. Mulligan Vice President, Treasurer page _ 16 Steve Odland Chairman and Chief Executive Officer, Office Depot, Inc. (office products retailer) (3,4) Delray Beach, Florida Kendall J. Powell President and Chief Operating Officer, General Mills, Inc. Michael D. Rose Retired Chairman of the Board, Gaylord Entertainment Company (diversified entertainment) (2*,4) Memphis, Tennessee Robert L. Ryan Retired Senior Vice President and Chief Financial Officer, Medtronic, Inc. (medical technology) (1,3) Minneapolis, Minnesota James H. Murphy Vice President; President, Meals Kimberly A. Nelson Vice President; President, Snacks Unlimited Christopher D. O’Leary Executive Vice President; Chief Operating Officer, International Michael A. Peel Senior Vice President, Human Resources and Corporate Services Kendall J. Powell President and Chief Operating Officer Jeffrey J. Rotsch Executive Vice President, Worldwide Sales and Channel Development Stephen W. Sanger Chairman of the Board and Chief Executive Officer, General Mills, Inc. A. Michael Spence Partner, Oak Hill Venture Partners; Professor Emeritus and Former Dean, Graduate School of Business, Stanford University (2,4) Stanford, California Dorothy A. Terrell President and Chief Executive Officer, Initiative for a Competitive Inner City (nonprofit organization); Limited Partner, First Light Capital (venture capital) (1,5*) Boston, Massachusetts Stephen W. Sanger Chairman of the Board and Chief Executive Officer Christina L. Shea Senior Vice President, External Relations and President, General Mills Foundation Ann W.H. Simonds Vice President; President, Baking Products Christi L. Strauss Senior Vice President; Chief Executive Officer, Cereal Partners Worldwide Kenneth L. Thome Senior Vice President, Financial Operations Robert F. Waldron Senior Vice President; President, Yoplait-Colombo Selected Financial Information This section highlights selected information on our financial performance and future expectations. For a complete pre- sentation of General Mills’ financial results, refer to the 2006 Annual Report on Form 10-K, which follows this section. Aug. 1, 2006, payment. It is our goal to continue paying attractive dividends roughly in line with the payout ratios of our peer group, and to increase dividends over time as our earnings grow. We view repurchase of General Mills common stock as a component of our earnings per share growth. In 2006, we repurchased nearly 19 million shares of General Mills stock at an average price of $47.35 per share. Over the next several years, we expect share repurchases to reduce total shares outstanding by a net of 2 percent per year – not nec- essarily each and every year, but on average. C A S H F L O W O V E R V I E W In fiscal 2006, our cash flow from operations increased 4 per- cent to reach nearly $1.8 billion. We reinvested a portion of this cash in capital projects designed to support the growth of our businesses worldwide and to increase productivity. And we returned nearly $1.4 billion in cash to General Mills shareholders through dividends and share repurchases. Our investments in capital projects totaled $360 million in 2006, or approximately 3 percent of net sales. We added manufacturing capacity for several growing businesses, including Nature Valley bars and Yoplait yogurt. And we completed numerous projects designed to generate cost savings in 2007 and beyond. Over the next several years, we expect our capital investments to remain roughly in line with our depreciation and amortization expense, and total less than 4 percent of annual net sales. In 2007, our current plans call for capital investments of approximately $425 million. In summary, we intend to remain disciplined on our capital investment and continue returning significant cash to shareholders through dividends and share repurchases. We expect these actions, coupled with the growth in earnings that we have targeted, to result in improving return on capi- tal (ROC). In 2006, our ROC increased by 60 basis points from 2005 results. Our goal is to improve our return on cap- ital by an average of 50 basis points a year. We view dividends as an important component of share- holder return. In fact, General Mills and its predecessor firm have paid regular dividends without interruption or reduction for 108 years. During 2006, we made two increases to the quarterly dividend rate. Total dividends of $1.34 per share paid during the year represented an 8 per- cent increase from the 2005 rate. As 2007 began, the board of directors approved a further 1-cent increase in the quarterly dividend to 35 cents per share, effective with the page _ 17 Selected Financial Information Continued Reconciliation of Diluted EPS to Non-GAAP EPS Diluted EPS Effect of accounting for contingently convertible (CoCo) debt EPS excluding CoCo accounting Divestitures – gain Debt repurchase costs Diluted EPS excluding CoCos, divestiture gain and bond buyback 2006 $2.90 (.08) 2.98 – _ $2.98 2005 $3.08 (.19) 3.27 .75 (.23) 2004 $2.60 (.15) 2.75 – _ 2003 $2.35 (.08) 2.43 – _ $2.75 $2.75 $2.43 A C C O U N T I N G F O R S T O C K - B A S E D C O M P E N S AT I O N C E R T I F I C AT I O N S The most recent certifications by our Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act are filed as exhibits to our Annual Report on Form 10-K. We also have filed with the New York Stock Exchange the most recent Annual CEO Certification as required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual. General Mills will adopt the new accounting standard for stock-based compensation beginning in the first quarter of fiscal 2007. We expect this new accounting standard to rep- resent incremental noncash expense of approximately 11 to 12 cents per share for the year. We further expect about half of the total expense to fall in the first quarter of 2007, due to the accelerated expensing of awards to retirement- eligible employees. F O R W A R D - L O O K I N G S TAT E M E N T S This report to shareholders contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on manage- ment’s current expectations and assumptions. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our expectations. For a full disclosure of the risks and uncer- tainties that could cause actual results to differ from those contained in the forward-looking statements, refer to the information set forth under the heading “Cautionary Statement Relevant to Forward-looking Information for the Purpose of ‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of 1995” in Item One of our 2006 Annual Report on Form 10-K. page _ 18 page _ 18 Six-year Financial Summary In Millions, Except per Share Data and Number of Employees FINANCIAL RESULTS Earnings per share – basic Earnings per share – diluted Dividends per share Return on average total capital1 Net sales Costs and expenses: Cost of sales Selling, general and administrative Interest, net Restructuring and other exit costs Divestitures (gain) Debt repurchase costs Earnings before income taxes and after-tax earnings from joint ventures Income taxes After-tax earnings from joint ventures Earnings before accounting changes Accounting changes Net earnings Net earnings as a percent of sales Average common shares: Basic Diluted FINANCIAL POSITION AT YEAR-END Total assets Land, buildings and equipment, net Total debt (notes payable and long-term debt, including current portion) Stockholders’ equity OTHER STATISTICS Total dividends paid Purchases of land, buildings and equipment Research and development Advertising and media expenditures Wages, salaries and employee benefits Number of full- and part-time employees Common stock price: High for year Low for year Year-end May 28, 2006 May 29, 2005 May 30, 2004 May 25, 2003 May 26, 2002 May 27, 2001 $ 3.05 2.90 1.34 10.6% $ 3.34 3.08 1.24 10.0% $ 2.82 2.60 1.10 10.0% $ 2.49 2.35 1.10 9.5% $ 1.38 1.34 1.10 8.5% $ 2.34 2.28 1.10 24.1% 11,640 11,244 11,070 10,506 6,966 2,678 399 30 – – 1,567 541 64 1,090 – 1,090 6,834 2,418 455 84 (499) 137 1,815 664 89 1,240 – 1,240 6,584 2,443 508 26 – – 1,509 528 74 1,055 – 1,055 9.4% 11.0% 9.5% 358 379 18,207 2,997 6,049 5,772 485 360 173 515 1,624 28,147 52.16 44.67 51.79 371 409 18,066 3,111 6,192 5,676 461 434 168 477 1,492 27,804 53.89 43.01 49.68 375 413 18,448 3,197 8,226 5,248 413 653 158 512 1,494 27,580 49.66 43.75 46.05 6,109 2,472 547 62 – – 1,316 460 61 917 – 917 8.7% 369 395 18,227 3,087 8,857 4,175 406 750 149 519 1,395 27,338 48.18 37.38 46.56 7,949 4,662 2,070 416 134 – – 667 239 33 461 (3) 458 5.8% 331 342 16,540 2,842 9,439 3,576 358 540 131 489 1,105 28,519 52.86 41.61 45.10 5,450 2,841 1,393 206 12 – – 998 350 17 665 – 665 12.2% 284 292 5,091 1,551 3,428 52 312 337 83 358 666 11,001 46.35 31.38 42.20 1 Excludes effects of the divestitures of our 40.5% interest in SVE and the Lloyd’s barbecue business, and the loss from debt repurchases. Return on average total capital including these items was 10.5% in fiscal 2006 and 11.4% in fiscal 2005. See page 25 of the 2006 Annual Report on Form 10-K for discussion of this non-GAAP measure. Diluted earnings per share and diluted share data for fiscal 2004 and 2003 have been restated for the adoption of EITF Issue 04-8. Certain items reported as unusual items prior to fiscal 2003 have been reclassified to restructuring and other exit costs, to selling, general and administrative expense, and to cost of sales. All sales-related and selling, general and administrative information prior to fiscal 2002 has been restated for the adoption of EITF Issue 01-09. Purchases of land, buildings, and equipment for fiscal years 2005 and prior have been restated to include capitalized software. Fiscal 2004 was a 53-week year; all other fiscal years were 52 weeks. Our acquisition of Pillsbury on October 31, 2001, significantly affected our financial condition and results of operations beginning in fiscal 2002. page _ 19 page _ 20 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MAY 28, 2006 Commission File Number 1-1185 GENERAL MILLS, INC. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) Number One General Mills Boulevard Minneapolis, Minnesota (Mail: P.O. Box 1113) (Address of principal executive offices) 41-0274440 (IRS Employer Identification No.) 55426 (Mail: 55440) (Zip Code) (763) 764-7600 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, $.10 par value Name of each exchange on which registered New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes A No u Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes u No A 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 A No u Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. u 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 Act. (Check one) Large accelerated filer A Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes u No A Aggregate market value of Common Stock held by non-affiliates of the registrant, based on the closing price of $48.10 per share as reported on the New York Stock Exchange on November 25, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter): $17,078 million. Number of shares of Common Stock outstanding as of July 14, 2006: 352,811,767 (excluding 149,494,897 shares held in the treasury). Non-accelerated filer u Accelerated filer u DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant’s Proxy Statement for its 2006 Annual Meeting of Stockholders are incorporated by reference into Part III. TABLE OF CONTENTS Part I Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. Part II Item 5. Item 6. Item 7. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 8. Item 9. Item 9A. Item 9B. Part III Item 10. Item 11. Item 12. Item 13. Item 14. Part IV Item 15. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Principal Accounting Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 1 7 10 10 11 11 11 12 12 27 28 54 54 54 54 54 54 54 55 55 59 Part I ITEM 1 BUSINESS COMPANY OVERVIEW General Mills, Inc. was incorporated in Delaware in 1928. The terms “General Mills,” “Company,” “Registrant,” “we,” “us” and “our” mean General Mills, Inc. and all subsid- iaries included in the consolidated financial statements unless the context indicates otherwise. We are a leading producer of packaged consumer foods and operate exclusively in the consumer foods industry. We have multiple operating segments organized generally by product categories. We aggregate our operating segments into three reportable segments by type of customer and geographic region as follows: • • • U.S. Retail; International; and Bakeries and Foodservice. U.S. Retail reflects business with a wide variety of grocery stores, mass merchandisers, club stores, specialty stores and drug, dollar and discount chains operating throughout the United States. Our major product categories in this business segment are: ready-to-eat cereals, meals, refriger- ated and frozen dough products, baking products, snacks, yogurt and organic foods. Our International segment includes a retail business in Canada that largely mirrors our U.S. Retail product mix, along with retail and foodservice businesses competing in key markets in Europe, Latin America and the Asia/Pacific region. Our Bakeries and Foodservice segment consists of products marketed throughout the United States and Canada to retail and wholesale bakeries, commercial and noncommercial foodservice distributors and operators, restaurants, and convenience stores. A more detailed description of the product categories for each reportable segment appears below. For financial information by business segment and geographic area, refer to Note Sixteen to the Consolidated Financial Statements on pages 51 through 52 in Item Eight of this report. REPORTABLE SEGMENTS U.S. RETAIL In the United States, we market our retail products primarily through our own sales organization, supported by advertising and other promotional activities. Our products primarily are distributed directly to retail food chains, cooperatives, membership stores and wholesalers. Certain food products also are sold through distributors and brokers. Our principal product categories in the U.S. Retail segment are as follows: Big G Cereals We produce and sell a number of ready- to-eat cereals, including such brands as: Cheerios, Honey Nut Cheerios, Frosted Cheerios, Apple Cinnamon Cheerios, MultiGrain Cheerios, Berry Burst Cheerios, Yogurt Burst Cheerios, Wheaties, Lucky Charms, Total with strawberries, Whole Grain Total, Total Raisin Bran, Total Honey Clusters, Trix, Golden Grahams, Wheat Chex, Corn Chex, Rice Chex, Multi-Bran Chex, Honey Nut Chex, Kix, Berry Berry Kix, Fiber One, Reese’s Puffs, Cocoa Puffs, Cookie Crisp, Cinnamon Toast Crunch, French Toast Crunch, Peanut Butter Toast Crunch, Clusters, Oatmeal Crisp, Basic 4 and Raisin Nut Bran. Meals We manufacture and sell several lines of conve- nient dinner products, including Betty Crocker dry packaged dinner mixes under the Hamburger Helper, Tuna Helper and Chicken Helper trademarks; Old El Paso Mexican foods and dinner kits; Progresso soups and ingredients; and Green Giant canned and frozen vegetables and meal starters. Also under the Betty Crocker trademark, we sell dry packaged specialty potatoes, Potato Buds instant mashed potatoes, Suddenly Salad salad mix and Bac*O’s salad topping. We manufacture and market shelf-stable microwave meals under the Betty Crocker Bowl Appetit! trademark and pack- aged meals under the Betty Crocker Complete Meals trademark. Pillsbury USA We manufacture and sell refrigerated and frozen dough products, frozen breakfast products, and frozen pizza and snack products. Refrigerated dough prod- ucts marketed under the Pillsbury brand include Grands! biscuits and sweet rolls, Golden Layers biscuits, Perfect Portions biscuits, Pillsbury Ready To Bake! and Big Deluxe Classics cookies, and Pillsbury cookies, crescent rolls, sweet rolls, breads, biscuits and pie crust. Frozen dough product offerings include Oven Baked biscuits, rolls and other bakery goods. Breakfast products sold under the Pillsbury trademark include Toaster Strudel pastries, Toaster Scram- bles pastries and Pillsbury frozen pancakes, waffles and waffle sticks. All the breakfast and refrigerated and frozen dough products incorporate the well-known Doughboy logo. Frozen pizza and snack products are marketed under the Totino’s and Jeno’s trademarks. Baking Products We make and sell a line of dessert mixes under the Betty Crocker trademark, including SuperMoist cake mixes, Rich & Creamy and Whipped ready-to-spread frostings, Supreme brownie and dessert bar mixes, muffin mixes, Warm Delights microwaveable desserts and other mixes used to prepare dessert and baking items. We market a variety of baking mixes under the Bisquick trademark, sell pouch mixes under the Betty Crocker name and produce family flour under the Gold Medal brand introduced in 1880. Snacks We market and produce Pop•Secret microwave popcorn; a line of grain snacks including Nature Valley granola bars and Milk n’Cereal bars; a line of fruit snacks _ 1 including Fruit Roll-Ups, Fruit By The Foot and Gushers; a line of snack mix products including Chex Mix and Gardet- to’s; and Bugles savory snacks. DuPont to develop and market soy-based products. This venture began marketing a line of 8th Continent soymilk in July 2001. Yoplait We manufacture and sell yogurt products, including Yoplait Original, Yoplait Light, Yoplait Thick and Creamy, Trix, Yumsters, Go-GURT - yogurt-in-a-tube, Yoplait Whips! - a mousse-like yogurt, Yoplait Nouriche - a meal replacement yogurt drink, Go-GURT Smoothie - a yogurt beverage for kids, and Yoplait Smoothie - an all-family snack size smoothie. We also manufacture and sell a variety of cup yogurt products under the Colombo brand name. Organic We market organic frozen fruits and vegetables, a wide variety of canned tomato products including toma- toes and spaghetti sauce, salsa, ketchup, soup, frozen juice concentrates, pickles, fruit spreads, granola bars and cereal under our Cascadian Farm and Muir Glen trademarks. INTERNATIONAL Our international businesses consist of operations and sales in Canada, Latin America, Europe and the Asia/Pacific region. Outside the United States, we manufacture our products in 17 countries and distribute them in over 100 countries. In Canada, we market products in many categories, including cereals, meals, refrigerated dough products, baking products and snacks. Outside of North America, we offer numerous local brands in addition to such internationally recognized brands as Häagen-Dazs ice cream, Old El Paso Mexican foods, Green Giant vegeta- bles, Pillsbury dough products and mixes, Betty Crocker mixes, Bugles snacks and Nature Valley granola bars. We manufacture certain products in the United States for export internationally, primarily in Caribbean and Latin American markets. We also sell mixes and dough products to bakery and foodservice customers outside of the United States and Canada. These international businesses are managed through 34 sales and marketing offices. BAKERIES AND FOODSERVICE We market mixes and unbaked, par-baked and fully baked frozen dough products to retail, supermarket and wholesale bakeries under the Pillsbury and Gold Medal trademarks. In addition, we sell flour to bakery, foodservice and manufacturing customers. We also market frozen dough products, branded baking mixes, cereals, snacks, dinner and side dish products, refrig- erated and soft-serve frozen yogurt, and custom food items to quick service chains and other restaurants, business and school cafeterias, convenience stores and vending companies. JOINT VENTURES In addition to our consolidated operations, we manufacture and sell products through several joint ventures. Domestic Joint Venture We have a 50 percent equity interest in 8th Continent, LLC, a joint venture formed with _ 2 International Joint Ventures We have a 50 percent equity interest in Cereal Partners Worldwide (CPW), a joint venture with Nestlé S.A. (Nestlé) that manufactures and markets ready-to-eat cereal products in more than 130 coun- tries and republics outside the United States and Canada. The cereal products marketed by CPW under the umbrella Nestlé trademark in fiscal 2006 include: Chocapic, Cini Minis, Cookie Crisp, Corn Flakes, Crunch, Fitness, Fitness and Fruit, Honey Nut Cheerios, Cheerios, Nesquik, Shredded Wheat and Shreddies. CPW also markets cereal bars in several Euro- pean countries and manufactures private label cereals for customers in the United Kingdom. On July 14, 2006, CPW acquired the Uncle Tobys cereal business in Australia for approximately $385 million. This business had revenues of approximately $100 million for the fiscal year ended June 30, 2006. We funded our 50 percent share of the purchase price by making an additional equity contribution in CPW from cash generated from our international oper- ations, including our international joint ventures. We have 50 percent equity interests in the following joint ventures for the manufacture, distribution and marketing of Häagen-Dazs frozen ice cream products and novelties: Häagen-Dazs Japan K.K., Häagen-Dazs Korea Company Limited and Häagen-Dazs Marketing & Distribution (Phil- ippines) Inc. We have a 49 percent equity interest in Häagen-Dazs Distributors (Thailand) Company Limited. We also have a 50 percent equity interest in Seretram, a joint venture with Co-op de Pau for the production of Green Giant canned corn in France. In May 2006, we acquired a controlling financial interest in our Häagen-Dazs joint venture in the Philippines for less than $1 million. COMPETITION The consumer foods market is highly competitive, with numerous manufacturers of varying sizes in the United States and throughout the world. The food categories in which we participate are very competitive. Our principal competitors in these categories all have substantial finan- cial, marketing and other resources. We also compete with private label products offered by supermarkets, mass merchants and other retailers such as club stores. Compe- tition in our product categories is based on product innovation, product quality, price, brand recognition and loyalty, effectiveness of marketing, promotional activity and the ability to identify and satisfy consumer preferences. Our principal strategies for competing in each of our segments include superior product quality, innovative adver- tising, product promotion, product innovation and price. In most product categories, we compete not only with other widely advertised branded products, but also with generic and private label products, which are generally sold at lower prices. Internationally, we compete with both multi-national and local manufacturers, and each country includes a unique group of competitors. CUSTOMERS During fiscal 2006, one customer, Wal-Mart Stores, Inc. (Wal-Mart), accounted for approximately 18 percent of our consolidated net sales and 24 percent of our sales in the U.S. Retail segment. No other customer accounted for 10 percent or more of our consolidated net sales. At May 28, 2006, Wal-Mart accounted for 17 percent of our trade receiv- ables invoiced in the U.S. Retail segment. The top five customers in our U.S. Retail segment accounted for approx- imately 47 percent of its fiscal 2006 net sales, and the top five customers in our Bakeries and Foodservice segment accounted for approximately 36 percent of its fiscal 2006 net sales. SEASONALITY In general, demand for our products is evenly balanced throughout the year. However, within our U.S. Retail segment demand for refrigerated dough, frozen baked goods and baking products is stronger in the fourth calendar quarter. Demand for Progresso soup and Green Giant canned and frozen vegetables is higher during the fall and winter months. Internationally, demand for Häagen-Dazs ice cream is higher during the summer months and demand for baking mix and dough products increases during winter months. Due to the offsetting impact of these demand trends, as well as the different seasons in the northern and southern hemispheres, our international net sales are generally evenly balanced throughout the year. TRADEMARKS AND PATENTS Trademarks and service marks are vital to our businesses. Our products are marketed under trademarks and service marks that are owned by or licensed to us. The most signif- icant trademarks and service marks used in our businesses are set forth in italics in this report. These marks include the trademarks used in our international joint ventures that are owned by or licensed to the joint ventures. In addition, some of our products are marketed under or in combina- tion with trademarks that have been licensed from others, including Reese’s Puffs cereal, Hershey’s chocolate included with a variety of products, Dora the Explorer for yogurt and cereal, and a variety of characters and brands used on fruit snacks, including Sunkist, My Little Pony, Animal Planet, Care Bears and various Warner Bros. characters. We use the Yoplait trademark in connection with our yogurt business in the United States under the terms of a license agreement with a third party licensor. U.S. trademark and service mark registrations are generally for a term of 10 years, renewable every 10 years as long as the trademark is used in the regular course of trade. We own the Häagen-Dazs trademark and have the right to use the trademark outside of the United States and Canada. We use the trademark internationally through Company-owned operations, a franchise system and joint ventures in the Asia/Pacific region. Nestlé has an exclusive royalty-free license to use the trademark in the United States and Canada. J. M. Smucker Company (Smucker) holds an exclusive royalty-free license to use the Doughboy trademark and Pillsbury brand in the dessert mix and baking mix catego- ries. The license is renewable without cost in 20-year increments at Smucker’s discretion. Given our focus on developing and marketing innova- tive, proprietary products, we consider the collective rights under our various patents, which expire from time to time, a valuable asset, but we do not believe that our businesses are materially dependent upon any single patent or group of related patents. BACKLOG Orders are generally filled within a few days of receipt and are subject to cancellation at any time prior to shipment. The backlog of any unfilled orders at May 28, 2006, was not material. RAW MATERIALS AND SUPPLIES The principal raw materials that we use are cereal grains, sugar, dairy products, vegetables, fruits, meats, vegetable oils, and other agricultural products as well as paper and plastic packaging materials, operating supplies and energy. We have some long-term fixed price contracts, but the majority of our raw materials are purchased on the open market. We believe that we will be able to obtain an adequate supply of needed ingredients and packaging materials. Occasionally and where possible, we make advance purchases of items significant to our business in order to ensure continuity of operations. Our objective is to procure materials meeting both our quality standards and our production needs at price levels that allow a targeted profit margin. Since commodities generally represent the largest variable cost in manufacturing our products, to the extent possible, we hedge the risk associated with adverse price movements using exchange-traded futures and options, forward cash contracts and over-the-counter derivatives. See also Note Six to the Consolidated Financial Statements on pages 40 through 42 in Item Eight of this report and Item Seven A on page 27 of this report. _ 3 CAPITAL EXPENDITURES ENVIRONMENTAL MATTERS During the fiscal year ended May 28, 2006, our aggregate capital expenditures for land, buildings and equipment were $360 million. We expect to spend approximately $425 million for capital projects in fiscal 2007, primarily for fixed assets to support further growth and increase supply chain productivity. RESEARCH AND DEVELOPMENT Major research and development facilities are located at the Riverside Technical Center in Minneapolis, Minnesota and the James Ford Bell Technical Center in Golden Valley (suburban Minneapolis), Minnesota. Our research and development resources are focused on new product devel- improvement, process design and opment, product improvement, packaging and exploratory research in new business areas. Research and development expenditures amounted to $173 million in fiscal 2006, $168 million in fiscal 2005 and $158 million in fiscal 2004. EMPLOYEES At May 28, 2006, we had approximately 28,100 full- and part-time employees. FOOD QUALITY AND SAFETY REGULATION The manufacture and sale of consumer food products is highly regulated. In the United States, our activities are subject to regulation by various government agencies, including the Food and Drug Administration, Department of Agriculture, Federal Trade Commission, Department of Commerce and Environmental Protection Agency, as well as various state and local agencies. Our business is also regulated by similar agencies outside of the United States. _ 4 As of July 27, 2006, we were involved with the following active cleanup sites associated with the alleged release or threatened release of hazardous substances or wastes: Site Central Steel Drum, Newark, New Jersey East Hennepin, Minneapolis, Minnesota Vallejo, California King’s Road Landfill, Toledo, Ohio Kipp, Kansas Northside Sanitary Landfill, Zionsville, Indiana Operating Industries, Los Angeles, California Sauget Landfill, Sauget, Illinois Safer Textiles, Moonachie, New Jersey Stuckey’s, Doolittle, Missouri Chemical of Concern No single hazardous material specified Trichloroethylene Petroleum fuel products No single hazardous material specified Carbon tetrachloride No single hazardous material specified No single hazardous material specified No single hazardous material specified Tetrachloroethylene Petroleum fuel products These matters involve several different actions, including administrative proceedings commenced by regulatory agen- cies and demand letters by regulatory agencies and private parties. We recognize that our potential exposure with respect to any of these sites may be joint and several, but have concluded that our probable aggregate exposure is not mate- rial. This conclusion is based upon, among other things: our payments and accruals with respect to each site; the number, ranking and financial strength of other potentially responsible parties identified at each of the sites; the status of the proceedings, including various settlement agree- ments, consent decrees or court orders; allocations of volumetric waste contributions and allocations of relative responsibility among potentially responsible parties devel- oped by regulatory agencies and by private parties; remediation cost estimates prepared by governmental authorities or private technical consultants; and our histor- ical experience in negotiating and settling disputes with respect to similar sites. Our operations are subject to the Clean Air Act, Clean Water Act, Resource Conservation and Recovery Act, Comprehensive Environmental Response, Compensation and Liability Act, and the Federal Insecticide, Fungicide and Rodenticide Act, and all similar state environmental laws applicable to the jurisdictions in which we operate. Based on current facts and circumstances, we believe that neither the results of our environmental proceedings nor our compliance in general with environmental laws or regulations will have a material adverse effect upon our capital expenditures, earnings or competitive position. EXECUTIVE OFFICERS The section below provides information regarding our exec- utive officers, together with their ages and business experience as of July 14, 2006: Y. Marc Belton, age 47, is Executive Vice President, World- wide Health, Brand and New Business Development. Mr. Belton joined General Mills in 1983 and has held various positions throughout General Mills, including Pres- ident of Snacks Unlimited from 1994 to 1997, New Ventures from 1997 to 1999 and Big G Cereals from 1999 to 2002. Mr. Belton had oversight responsibility for Yoplait, General Mills Canada and New Business Development from 2002 to May 2005, and has had oversight responsibility for World- wide Health, Brand and New Business Development since May 2005. Mr. Belton was elected a Vice President of General Mills in 1991, a Senior Vice President in 1994 and an Executive Vice President in June 2006. Mr. Belton is a director of Navistar International Corporation. Randy G. Darcy, age 55, is Executive Vice President, World- wide Operations and Technology. Mr. Darcy joined General Mills in 1987, was named Vice President, Director of Manu- facturing, Technology and Operations in 1989, served as Senior Vice President, Supply Chain from 1994 to 2003 and Senior Vice President, Chief Technical Officer with respon- sibilities for Supply Chain, Research and Development, and Quality and Regulatory Operations from 2003 to 2005. He was named to his present position in May 2005. Mr. Darcy was employed by The Procter & Gamble Company from 1973 to 1987, serving in a variety of management positions. Rory A. M. Delaney, age 61, is Senior Vice President, Stra- tegic Technology Development. Mr. Delaney joined General Mills in this position in 2001 from The Pillsbury Company (Pillsbury) where he spent a total of eight years, last serving as Senior Vice President of Technology, responsible for the development and application of food technologies for Pillsbury’s global operations. Prior to joining Pillsbury, Mr. Delaney spent 18 years with PepsiCo, Inc., last serving as Senior Vice President of Technology for Frito-Lay North America. Ian R. Friendly, age 46, is Executive Vice President and Chief Operating Officer, U.S. Retail. Mr. Friendly joined General Mills in 1983 and held various positions before becoming Vice President of Cereal Partners Worldwide in 1994, Pres- ident of Yoplait in 1998, a Senior Vice President of General Mills in 2000 and President of the Big G Cereals division in 2002. In May 2004, Mr. Friendly was named Chief Execu- tive Officer of Cereal Partners Worldwide. He was named to his present position in June 2006. James A. Lawrence, age 53, is Vice Chairman and Chief Financial Officer. Mr. Lawrence joined General Mills as Chief Financial Officer in 1998 from Northwest Airlines where he was Executive Vice President, Chief Financial Officer. Prior to joining Northwest Airlines in 1996, he was at Pepsi-Cola International, serving as President and Chief Executive Officer for its operations in Asia, the Middle East and Africa. He was elected Vice Chairman of General Mills in June 2006. Mr. Lawrence is a director of Avnet, Inc. Siri S. Marshall, age 58, is Senior Vice President, General Counsel, Chief Governance and Compliance Officer and Secretary. Ms. Marshall joined General Mills in 1994 as Senior Vice President, General Counsel and Secretary from Avon Products, Inc. where she spent 15 years, last serving as Senior Vice President, General Counsel and Secretary. Ms. Marshall was named Chief Governance and Compli- ance Officer in May 2005. Ms. Marshall is a director of Ameriprise Financial, Inc. Christopher D. O’Leary, age 47, is Executive Vice President and Chief Operating Officer, International. Mr. O’Leary joined General Mills in 1997 as Vice President, Corporate Growth. He was elected a Senior Vice President in 1999 and President of the Meals division in 2001. Mr. O’Leary was named to his present position in June 2006. Prior to joining General Mills, he spent 17 years at PepsiCo, Inc., last serving as President and Chief Executive Officer of the Hostess Frito-Lay business in Canada. Mr. O’Leary is a director of Telephone & Data Systems, Inc. Michael A. Peel, age 56, is Senior Vice President, Human Resources and Corporate Services. Mr. Peel joined General Mills in this position in 1991 from PepsiCo, Inc. where he spent 14 years, last serving as Senior Vice President, Human Resources, responsible for PepsiCo Worldwide Foods. Mr. Peel is a director of Select Comfort Corporation. Kendall J. Powell, age 52, is President, Chief Operating Officer and a director of General Mills. Mr. Powell joined General Mills in 1979 and held various positions before becoming Vice President, Marketing Director of Cereal Part- ners Worldwide in 1990. He was named President of Yoplait in 1996, President of the Big G Cereals division in 1997 and Senior Vice President of General Mills in 1998. From 1999 to 2004, he was Chief Executive Officer of Cereal Partners Worldwide. He was elected Executive Vice President of General Mills in 2004 with responsibility for our Meals, Pillsbury USA, Baking Products and Bakeries and Foodservice divisions. Mr. Powell was named Executive Vice President and Chief Operating Officer, U.S. Retail in May 2005, and was named to his present position in June 2006. Jeffrey J. Rotsch, age 55, is Executive Vice President, World- wide Sales and Channel Development. Mr. Rotsch joined General Mills in 1974 and served as the President of several divisions, including Betty Crocker and Big G Cereals. He served as Senior Vice President from 1993 to 2005 and as _ 5 President, Consumer Foods Sales, from 1997 to 2005. Mr. Rotsch was named to his present position in May 2005. Stephen W. Sanger, age 60, has been Chairman of the Board and Chief Executive Officer of General Mills since 1995. Mr. Sanger joined General Mills in 1974 and served as the head of several business units, including Yoplait and Big G Cereals. He was elected a Senior Vice President in 1989, an Executive Vice President in 1991, Vice Chairman in 1992 and President in 1993. He is a director of Target Corpora- tion and Wells Fargo & Company. Christina L. Shea, age 53, is Senior Vice President, External Relations and President, General Mills Foundation. Ms. Shea joined General Mills in 1977 and has held various positions in the Big G Cereals, Yoplait, Gold Medal, Snacks and Betty Crocker divisions. From 1994 to 1999, she was President of the Betty Crocker division and was named a Senior Vice President of General Mills in 1998. She became President of General Mills Community Action and the General Mills Foundation in 2002 and was named to her current position in May 2005. Kenneth L. Thome, age 58, is Senior Vice President, Finan- cial Operations. Mr. Thome joined General Mills in 1969 and was named Vice President, Controller for the Conve- nience and International Foods Group in 1985, Vice President, Controller for International Foods in 1989, Vice President, Director of Information Systems in 1991 and was elected to his present position in 1993. AVAILABLE INFORMATION Availability of Reports We are a reporting company under the Securities Exchange Act of 1934, as amended (1934 Act), and file reports, proxy statements and other informa- tion with the Securities and Exchange Commission (SEC). The public may read and copy any of our filings at the SEC’s Public Reference Room at 100 F Street N.E., Wash- ington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at (800) 732-0330. Because we make filings to the SEC elec- tronically, you may access this information at the SEC’s internet website: www.sec.gov. This site contains reports, proxies and information statements and other information regarding issuers that file electronically with the SEC. Website Access Our website is www.generalmills.com. We make available, free of charge at the “Investors” portion of this website, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amend- ments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the 1934 Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Reports of beneficial ownership filed pursuant to Section 16(a) of the 1934 Act are also available on our website. _ 6 CAUTIONARY STATEMENT RELEVANT TO FORWARD- LOOKING INFORMATION FOR THE PURPOSE OF “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This report contains or incorporates by reference forward- looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on our management’s current expectations and assumptions. We and our representatives also may from time to time make written or oral forward-looking statements, including statements contained in our filings with the SEC and in our reports to stockholders. The words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “plan,” “project” or similar expressions identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results and those currently anticipated or projected. We wish to caution you not to place undue reliance on any such forward-looking statements, which speak only as of the date made. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that could affect our financial performance and could cause our actual results for future periods to differ materially from any opinions or state- ments expressed with respect to future periods in any current statements. Our future results could be affected by a variety of factors, such as: competitive dynamics in the consumer foods industry and the markets for our products, including new product introductions, advertising activities, pricing actions and promotional activities of our competitors; economic conditions, including changes in inflation rates, interest rates or tax rates; product development and innovation; consumer acceptance of new products and product improvements; consumer reaction to pricing actions and changes in promotion levels; acquisitions or dispositions of businesses or assets; changes in capital structure; changes in laws and regulations, including labeling and advertising regulations; changes in accounting standards and the impact of significant accounting estimates; product quality and safety issues, including recalls and product liability; changes in customer demand for our products; effective- ness of advertising, marketing and promotional programs; changes in consumer behavior, trends and preferences, including weight loss trends; consumer perception of health-related issues, including obesity; consolidation in the retail environment; changes in purchasing and inventory levels of significant customers; fluctuations in the cost and availability of supply chain resources, including raw mate- rials, packaging and energy; disruptions or inefficiencies in the supply chain; benefit plan expenses due to changes in plan asset values and discount rates used to determine plan liabilities; resolution of uncertain income tax matters; foreign economic conditions, including currency rate fluc- tuations; and political unrest in foreign markets and economic uncertainty due to terrorism or war. You should also consider the risk factors that we identify on pages 7 through 10 in Item One A of this report, which could also affect our future results. We undertake no obligation to publicly revise any future events forward-looking statements to reflect or circumstances. ITEM 1A RISK FACTORS Various risks and uncertainties could affect our business. Any of the risks described below or elsewhere in this report or our other filings with the SEC could materially adversely affect our business, financial condition and results of oper- ations. It is not possible to predict or identify all risk factors. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely affect our business, financial condition and results of operations in the future. Therefore, the following is not intended to be a complete discussion of all potential risks or uncertainties. The food categories in which we participate are very competitive, and if we are not able to compete effectively, our results of operations would be adversely affected. The food categories in which we participate are very compet- itive. Our principal competitors in these categories all have substantial financial, marketing and other resources. We also compete with private label products offered by super- markets, mass merchants and other retailers such as club stores. Competition in our product categories is based on product innovation, product quality, price, brand recogni- tion and loyalty, effectiveness of marketing, promotional activity and the ability to identify and satisfy consumer pref- erences. If our large competitors were to decrease their pricing or were to increase their promotional spending, we could choose to do the same, which could adversely affect our margins and profitability. If we did not do the same, our revenues and market share could be adversely affected. Our market share and revenue growth could also be adversely impacted if we are not successful in introducing innovative products in response to changing consumer demands or by new product introductions of our competi- tors. If we are unable to build and sustain brand equity by offering recognizably superior product quality, we may be unable to maintain premium pricing over private label products. We may be unable to maintain our profit margins in the face of a consolidating retail environment. Our five largest customers in our U.S. Retail segment together accounted for approximately 47 percent of that segment’s net sales for fiscal 2006. The loss of any large customer for an extended length of time could adversely affect our sales and profits. In addition, as the retail grocery trade continues to consolidate and mass market retailers become larger, our large retail customers may seek to use their position to improve their profitability through improved efficiency, lower pricing and increased promo- tional programs. If we are unable to use our scale, marketing expertise, product innovation and category lead- ership positions to respond to these demands, our profitability or volume growth could be negatively impacted. Price changes for the commodities we depend on for raw materials and packaging may adversely affect our profitability. The raw materials used in our business include cereal grains, sugar, dairy products, vegetables, fruits, meats, vege- table oils, and other agricultural products as well as paper and plastic packaging materials, operating supplies and energy. These items are largely commodities that experi- ence price volatility caused by external conditions such as weather and product scarcity, commodity market fluctua- tions, currency fluctuations and changes in governmental agricultural programs. Commodity price changes may result in unexpected increases in raw material, packaging and energy costs. If we are unable to increase productivity to offset these increased costs or increase our prices as a result of consumer sensitivity to pricing or otherwise, we may experience reduced margins and profitability. We do not fully hedge against changes in commodity prices and the hedging procedures that we do use may not always work as we intend. If we are not efficient in our production, our profitability could suffer as a result of the highly competitive environment in which we operate. Our future success and earnings growth depends in part on our ability to be efficient in the production and manufac- ture of our products in highly competitive markets. Our ability to gain additional efficiencies may become more diffi- time as we take advantage of existing cult over opportunities. Our failure to reduce costs through produc- tivity gains or by eliminating redundant costs resulting from acquisitions could adversely affect our profitability and also weaken our competitive position. Further, many produc- reorganization of involve complex tivity initiatives _ 7 manufacturing facilities and production lines. Such manu- facturing realignment may result in the interruption of production which may negatively impact product volume and margins. Customer demand for our products may be limited in future periods as a result of increased purchases in response to promotional activity. Disruption of our supply chain could adversely affect our business. Our ability to make, move and sell products is critical to our success. Damage or disruption to our manufacturing or distribution capabilities due to weather, natural disaster, fire, terrorism, pandemic, strikes or other reasons could impair our ability to manufacture or sell our products. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, particularly when a product is sourced from a single location, could adversely affect our business and results of operations, as well as require addi- tional resources to restore our supply chain. We may be unable to anticipate changes in consumer preferences and trends, which may result in decreased demand for our products. Our success depends in part on our ability to anticipate the tastes and eating habits of consumers and to offer products that appeal to their preferences. Consumer preferences change from time to time and can be affected by a number of different trends. Our failure to anticipate, identify or react to these changes and trends, and to introduce new and improved products on a timely basis, could result in reduced demand for our products, which would in turn cause our revenues and profitability to suffer. Similarly, demand for our products could be affected by consumer concerns regarding the health effects of ingredients such as trans fats, sugar, processed wheat or other product ingredi- ents or attributes. We may be unable to grow our market share or add products that are in faster growing and more profitable categories. The food industry’s growth potential is constrained by popu- lation growth. Our success depends in part on our ability to grow our business faster than populations are growing in the markets that we serve. One way to achieve that growth is to enhance our portfolio by adding innovative new prod- ucts in faster growing and more profitable categories. Our future results will also depend on our ability to increase market share in our existing product categories. If we do not succeed in developing innovative products for new and existing categories, our growth may slow, which could adversely affect our profitability. _ 8 Our unit volume in the last week of each quarter is consis- tently higher than the average for the preceding weeks of the quarter. In comparison to the average daily shipments in the first 12 weeks of a quarter, the final week of each quarter has approximately two to four days’ worth of incre- mental shipments (based on a five-day week), reflecting increased promotional activity at the end of the quarter. This increased activity includes promotions to assure that our customers have sufficient inventory on hand to support major marketing events or increased seasonal demand early in the next quarter, as well as promotions intended to help achieve interim unit volume targets. If, due to quarter-end promotions or other reasons, our customers purchase more product in any reporting period than end-consumer demand will require in future periods, our sales level in future reporting periods could be adversely affected. Economic downturns could cause consumers to shift their food purchases from our higher priced premium products to lower priced items, which could adversely affect our results of operations. The willingness of consumers to purchase premium branded food products depends in part on local economic conditions. In periods of economic uncertainty, consumers tend to purchase more private label or other economy brands. In those circumstances, we could experience a reduction in sales of higher margin products or a shift in our product mix to lower margin offerings. In addition, as a result of economic conditions or otherwise, we may be unable to raise our prices as a result of increased consumer sensitivity to pricing. Any of these events could have an adverse effect on our results of operations. Our international operations are subject to political and economic risks. In fiscal 2006, approximately 16 percent of our consolidated net sales were generated outside of the United States. We are accordingly subject to a number of risks relating to doing business internationally, any of which could signifi- cantly harm our business. These risks include: • • • • political and economic instability; exchange controls and currency exchange rates; foreign tax treaties and policies; and restrictions on the transfer of funds to and from foreign countries. Our financial performance on a U.S. dollar denominated basis is subject to fluctuations in currency exchange rates. These fluctuations could cause our results of operations to vary materially from period to period. From time to time, we enter into agreements that are intended to reduce the effects of our exposure to currency fluctuations, but these agreements may not be effective in significantly reducing our exposure. Concerns with the safety and quality of food products could cause consumers to avoid our products. We could be adversely affected if consumers in our prin- cipal markets lose confidence in the safety and quality of certain food products or ingredients. Adverse publicity about these types of concerns, whether or not valid, may discourage consumers from buying our products or cause production and delivery disruptions. If our food products become adulterated or misbranded, we might need to recall those items and may experience product liability claims if consumers are injured. We may need to recall some of our products if they become adulterated or misbranded. We may also be liable if the consumption of any of our products causes injury. A wide- spread product recall could result in significant losses due to the costs of a recall, the destruction of product inventory and lost sales due to the unavailability of product for a period of time. We could also suffer losses from a signifi- cant product liability judgment against us. A significant product recall or product liability case could also result in adverse publicity, damage to our reputation and a loss of consumer confidence in our food products, which could have a material adverse effect on our business results and the value of our brands. New regulations or regulatory-based claims could adversely affect our business. we have issued indebtedness do not prevent us from incur- ring additional unsecured indebtedness in the future. Our level of indebtedness may limit our: • • ability to obtain additional financing for working capital, capital expenditures or general corporate purposes, particularly if the ratings assigned to our debt securities by rating organizations were revised downward; and flexibility to adjust to changing business and market conditions and may make us more vulnerable to a downturn in general economic conditions. There are various financial covenants and other restric- tions in our debt instruments and minority interests. If we fail to comply with any of these requirements, the related indebtedness and minority interests (and other unrelated indebtedness) could become due and payable prior to its stated maturity. A default under our debt instruments and minority interests may also significantly affect our ability to obtain additional or alternative financing. If our subsidiary General Mills Cereals, LLC (GMC) fails to make required distributions to the holders of the B-1 interests of GMC, we will be restricted from paying any dividends (other than dividends in the form of shares of common stock) or other distributions on shares of our common stock and may not repurchase or redeem shares of our common stock until such distributions are paid. Our ability to make scheduled payments on or to refi- nance our debt and other obligations will depend on our operating and financial performance, which in turn is subject to prevailing economic conditions and to financial, business and other factors beyond our control. Volatility in the securities markets, interest rates and other factors or changes in our employee base could substantially increase our pension and postretirement costs. Food production and marketing are highly regulated by a variety of federal, state, local and foreign agencies. Changes in laws or regulations that impose additional regulatory requirements on us could increase our cost of doing busi- ness or restrict our actions, causing our results of operations to be adversely affected. In addition, we advertise our prod- ucts and could be the target of claims relating to false or deceptive advertising under federal, state and foreign laws and regulations. We have a substantial amount of indebtedness, which could limit financing and other options and in some cases adversely affect our ability to pay dividends. As of May 28, 2006, we had total debt and minority interests of approximately $7.2 billion. The agreements under which We sponsor a number of defined benefit plans for employees in the United States, Canada and various foreign locations, including pension, retiree health and welfare, severance and other post-employment plans. Our major pension plans are funded, with trust assets invested in a diversified portfolio. Changes in interest rates, mortality rates, health care costs, early retirement rates, investment returns and the market value of plan assets can affect the funded status of our pension and postretirement plans and cause volatility in the net periodic benefit cost and future funding requirements of the plans. Although the aggregate fair value of our pension and postretirement plan assets exceeded the aggregate pension and postretirement benefit obligations as of May 28, 2006, a significant increase in future funding requirements could have a negative impact on our results of operations or cash flows from operations. _ 9 If other potentially responsible parties (PRPs) are unable to contribute to remediation costs at certain contaminated sites, our costs for remediation could be material. We are subject to various federal, state, local and foreign environmental and health and safety laws and regulations. Under certain of these laws, namely the Comprehensive Environmental Response, Compensation and Liability Act and its state counterparts, liability for investigation and remediation of hazardous substance contamination at currently or formerly owned or operated facilities or at third- party waste disposal sites is joint and several. We currently are involved in active remediation efforts at certain sites where we have been named a PRP. If other PRPs at these sites are unable to contribute to remediation costs, we could be held responsible for all or their portion of the remedia- tion costs, and those costs could be material. We cannot assure you that our costs in relation to these environmental matters or compliance with environmental laws in general will not exceed our reserves or otherwise have an adverse effect on our business and results of operations. An impairment in the carrying value of goodwill or other intangibles could negatively affect our consolidated results of operations and net worth. Goodwill represents the difference between the purchase prices of acquired companies and the related fair values of net assets acquired. Goodwill is not subject to amortization and is tested for impairment annually and whenever events or changes in circumstances indicate that an impairment may have occurred. Impairment testing is performed for each of our reporting units. We compare the carrying amount of goodwill for a reporting unit with its fair value and if the carrying amount of goodwill exceeds its fair value, an impairment has occurred. The costs of patents, copyrights and other intangible assets with finite lives are amortized over their estimated useful lives. Intangibles with indefinite lives, principally brands, are carried at cost. Finite and indefinite-lived intan- gible assets are tested for impairment annually and whenever events or changes in circumstances indicate that their carrying value may not be recoverable. An impair- ment loss would be recognized when fair value is less than the carrying amount of the intangible. Our estimates of fair value are determined based on a discounted cash flow model using inputs from our annual long-range planning process. We also make estimates of discount rates, perpetuity growth assumptions and other factors. As of May 28, 2006, we had $10.3 billion of goodwill and other intangible assets. Events and conditions that could result in an impairment include changes in the industries in which we operate, including competition and advances in technology; a significant product liability or intellectual _ 10 property claim; or other factors leading to reduction in expected sales or profitability. Should the value of goodwill or other intangible assets become impaired, our consoli- dated net earnings and net worth may be materially adversely affected by a non-cash charge. Resolution of uncertain income tax matters could adversely affect our cash flows from operations. We accrue income tax liabilities for potential assessments related to uncertain tax positions in a variety of taxing juris- dictions. An unfavorable resolution of these matters, including the accounting for losses recorded as part of the Pillsbury transaction, could have a material adverse effect on our cash flows from operations. ITEM 1B UNRESOLVED STAFF COMMENTS None. ITEM 2 PROPERTIES We own our principal executive offices and main research facilities, which are located in the Minneapolis, Minnesota metropolitan area. We operate numerous manufacturing facilities and maintain many sales and administrative offices and warehouses, mainly in the United States. Other facili- ties are operated in Canada and elsewhere around the world. As of July 27, 2006, we operated 66 facilities for the production of a wide variety of food products. Of these plants, 34 are located in the United States (one of which is leased), 15 in the Asia/Pacific region (10 of which are leased), six in Canada (two of which are leased), five in Europe (one of which is leased), five in Latin America and Mexico, and one in South Africa. The following table lists the locations of our principal production facilities, all of which are owned by us, that principally support our U.S. Retail segment unless otherwise noted: • • • • • • • Arras, France – International segment Irapuato, Mexico Trenton, Ontario – Bakeries & Foodservice segment Carson, California Lodi, California Covington, Georgia Belvidere, Illinois • West Chicago, Illinois • • New Albany, Indiana Cedar Rapids, Iowa • • Reed City, Michigan Chanhassen, Minnesota – Bakeries & Foodservice segment Part II • Hannibal, Missouri • • • • Joplin, Missouri – Bakeries & Foodservice segment Vineland, New Jersey Albuquerque, New Mexico Buffalo, New York • Martel, Ohio – Bakeries & Foodservice segment • Wellston, Ohio • Murfreesboro, Tennessee • Milwaukee, Wisconsin We own flour mills at eight locations: Vallejo, California (not currently operating); Vernon, California; Avon, Iowa; Minneapolis, Minnesota (2); Kansas City, Missouri; Great Falls, Montana; and Buffalo, New York. We also operate six terminal grain elevators (in Minnesota and Wisconsin, two of which are leased), and have country grain elevators in seven locations (primarily in Idaho), plus additional seasonal elevators (primarily in Idaho). We also own or lease warehouse space aggregating approximately 12.2 million square feet, of which approxi- mately 9.6 million square feet are leased. We lease a number of sales and administrative offices in the United States, Canada and elsewhere around the world, totaling approxi- mately 2.8 million square feet. ITEM 3 LEGAL PROCEEDINGS We are the subject of various pending or threatened legal actions in the ordinary course of our business. All such matters are subject to many uncertainties and outcomes that are not predictable with assurance. In our manage- ment’s opinion, there were no claims or litigation pending as of May 28, 2006, that are reasonably likely to have a material adverse effect on our consolidated financial posi- tion or results of operations. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock is listed on the New York Stock Exchange. On July 14, 2006, there were approximately 34,675 record holders of our common stock. Information regarding the market prices for our common stock and dividend payments for the two most recent fiscal years is set forth in Note Eighteen to the Consolidated Financial Statements on page 53 in Item Eight of this report. Infor- mation regarding restrictions on our ability to pay dividends in certain situations is set forth in Note Eight to the Consol- idated Financial Statements on pages 43 and 44 in Item Eight of this report. The following table sets forth information with respect to shares of our common stock that we purchased during the three fiscal months ended May 28, 2006: Issuer Purchases of Equity Securities Total Number of Shares Purchased(a) Average Price Paid Per Share 111,772 $49.55 445,466 $49.06 1,182,100 1,739,338 $49.79 $49.59 Period February 27, 2006 through April 2, 2006 April 3, 2006 through April 30, 2006 May 1, 2006 through May 28, 2006 Total Total Number of Shares Purchased as Part of a Publicly Announced Program Maximum Number of Shares that may yet be Purchased Under the Program(b) – – – – – – – – (a) The total number of shares purchased includes: (i) 231,500 shares purchased from the ESOP fund of our 401(k) savings plan; (ii) 8,338 shares of restricted stock withheld for the payment of with- holding taxes upon vesting of restricted stock; and (iii) 1,499,500 shares purchased in the open market. (b) On February 21, 2000, we announced that our Board of Directors autho- rized us to repurchase up to 170 million shares of our common stock to be held in our treasury. The Board did not specify a time period or an expiration date for the authorization. _ 11 ITEM 6 SELECTED FINANCIAL DATA ITEM 7 MANAGEMENT’S May 28, 2006 May 29, 2005 May 30, 2004 May 25, 2003 May 26, 2002 EXECUTIVE OVERVIEW The following table sets forth selected financial data for each of the fiscal years in the five-year period ended May 28, 2006: In Millions, Except per Share Data Fiscal Year Ended Operating data: Net sales Gross margin Gross margin as a percentage of net sales Interest, net Net earnings Financial position at year-end: Land, buildings and equipment Total assets Long-term debt, excluding current portion Stockholders’ equity Average shares outstanding (diluted) Cash flow data: Net cash provided by operating activities Capital expenditures Net cash provided (used) by investing activities Net cash provided (used) by financing activities Per share data: Net earnings — basic Net earnings — diluted Dividends $11,640 $11,244 $11,070 $10,506 $ 7,949 3,287 4,486 4,674 4,397 4,410 40.1% 39.2% 40.5% 41.9% 41.4% 399 508 1,055 1,090 455 1,240 547 917 416 458 2,997 18,207 3,111 18,066 3,197 18,448 3,087 18,227 2,842 16,540 2,415 5,772 4,255 5,676 7,410 5,248 7,516 4,175 5,591 3,576 379 409 413 395 342 1,771 360 1,711 434 1,461 653 1,631 750 913 540 (292) 496 (470) (1,018) (3,271) (1,405) (2,385) (943) (885) 3,269 3.05 3.34 2.82 2.49 1.38 2.90 1.34 3.08 1.24 2.60 1.10 2.35 1.10 1.34 1.10 Gross margin is defined as net sales less cost of sales. Fiscal 2004 was a 53-week year; all other fiscal years were 52 weeks. Diluted earnings per share for fiscal 2004 and 2003 have been restated for the adoption of EITF Issue 04-8. Our acquisition of Pillsbury on October 31, 2001, significantly affected our financial condition and results of operations beginning in fiscal 2002. _ 12 DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We are a global consumer foods company. We develop differentiated food products and market these value-added products under unique brand names. We work continu- ously on product innovation to improve our established brands and to create new products that meet consumers’ evolving needs and preferences. In addition, we build the equity of our brands over time with strong consumer- directed marketing and innovative merchandising. We believe our brand-building strategy is the key to winning and sustaining leading share positions in markets around the globe. Our businesses are organized into three reportable segments. U.S. Retail reflects business with a wide variety of grocery stores, mass merchandisers, club stores, specialty stores and drug, dollar and discount chains operating throughout the United States. Our major product catego- ries in this business segment are ready-to-eat cereals, meals, refrigerated and frozen dough products, baking products, snacks, yogurt and organic foods. Our International segment is made up of retail businesses outside of the United States, including a retail business in Canada that largely mirrors our U.S. Retail product mix, and foodservice businesses outside of the United States and Canada. Our Bakeries and Foodservice segment consists of products marketed throughout the United States and Canada to retail and wholesale bakeries, commercial and noncommercial foodservice distributors and operators, restaurants, and convenience stores. Our fundamental business goal is to generate superior returns for our stockholders over the long term. In the most recent fiscal year, our total return to stockholders, including stock price appreciation and dividends, was 7.2 percent, while the S&P 500 Index returned 8.8 percent; from fiscal 2001 to 2006, our total return to stockholders averaged 6.8 percent per year while the S&P 500 Index posted a 1.8 percent average annual return over the same period. Our long-term growth objectives are: • low single-digit average annual growth in net sales; • mid-single-digit average annual growth in total segment operating profit (see page 25 for our discus- sion of this measure not defined by generally accepted accounting principles (GAAP)); and • high single-digit average annual growth in earnings per share (EPS). These measures, combined with an attractive dividend yield and improvement in return on capital, drive the management of our business. For the fiscal year ended May 28, 2006, our net sales grew 4 percent and total segment operating profit grew 5 percent, in line with our long-term goals. Diluted EPS decreased 6 percent in fiscal 2006; however, excluding the EPS effects of our convertible debentures in both fiscal years and the fiscal 2005 net benefit of gains on divestitures and debt repur- chase costs, our diluted EPS grew 8 percent, in line with our long-term goal (see page 24 for our discussion of this measure not defined by GAAP). Our net cash provided by operations increased to nearly $1.8 billion in 2006, enabling us to: increase our annual dividend payments by 8 percent from fiscal 2005; continue to return cash to stockholders via share repurchases, which totaled $885 million in fiscal 2006; and repay $189 million of debt. We continued to rein- vest in the long-term growth in our brands, increasing advertising by 8 percent from fiscal 2005, and we also continued to make significant capital investments to support future growth and productivity, as we spent $360 million in capital expenditures in fiscal 2006. Finally, our return on average total capital improved by 60 basis points (see page 25 for our discussion of this measure not defined by GAAP). Results for fiscal 2006 were negatively impacted by increased fuel and commodity costs and higher advertising spending. Details of our financial results are provided in the “Fiscal 2006 Consolidated Results of Operations” section below. As we begin fiscal 2007, we have momentum in several of our key businesses. We must sustain that momentum and restore net sales growth in two operating units that did not grow in fiscal 2006 – Big G cereals and Pillsbury USA. We plan to launch new products, achieve competitive levels of retailer merchandising activity and increase advertising in Big G cereals in fiscal 2007. In Pillsbury USA, we plan to launch new products and focus consumer marketing support to improve product mix. We expect our worldwide food business to achieve another year of good sales and operating profit growth. We also intend to deliver more growth from new products and accelerate our performance in fast-growing channels such as drug stores, dollar stores and club formats. Finally, we plan to expand our margins by focusing on realizing price increases, managing our input costs, and achieving productivity through supply chain and administrative cost-saving efforts. We expect our fiscal 2007 interest expense to be $40 million higher than in fiscal 2006, primarily due to higher interest rates. We also expect the impact of the adoption of a new accounting standard for stock-based compensation to reduce earnings by $0.11 to $0.12 per diluted share in fiscal 2007, and we expect our effective tax rate to increase 75 to 125 basis points over the fiscal 2006 effective rate of 34.5 percent. FISCAL 2006 CONSOLIDATED RESULTS OF OPERATIONS For fiscal 2006, we reported diluted EPS of $2.90, down 6 percent from $3.08 per share earned in fiscal 2005. Excluding the effects of our convertible debentures in both fiscal years and excluding the fiscal 2005 net benefit of gains on divestitures and debt repurchase costs, diluted EPS increased 8 percent from $2.75 in fiscal 2005 to $2.98 in fiscal 2006. Earnings after tax were $1,090 million in fiscal 2006, down 12 percent from $1,240 million in fiscal 2005, reflecting the net benefit of gains on divestitures and debt repurchase costs in fiscal 2005. Net sales for fiscal 2006 grew 4 percent to $11.6 billion, driven by 2 percentage points of unit volume growth, prima- rily in U.S. Retail and International, and 1 percentage point of growth from pricing and product mix across many of our businesses. Promotional spending and foreign currency exchange effects were flat compared to fiscal 2005. The components of net sales growth are shown in the following table: Components of Net Sales Growth Unit Volume Growth Price/Product Mix/Foreign Currency Exchange Trade and Coupon Promotion Expense Net Sales Growth Table does not add due to rounding. Fiscal 2006 vs. 2005 +2 pts +1 pt Flat +4% Cost of sales was up $132 million in fiscal 2006 versus fiscal 2005, primarily due to unit volume increases, as manufacturing efficiencies largely offset cost increases due to inflation. Also, the year-over-year change in cost of sales was favorably impacted by the following costs incurred in fiscal 2005: $18 million in expense from accelerated depre- ciation associated with exit activities, as described below; and $5 million of product recall costs. Cost of sales as a percent of net sales decreased from 60.8 percent in fiscal 2005 to 59.9 percent in fiscal 2006. Selling, general and administrative (SG&A) expense increased by $260 million in fiscal 2006 versus fiscal 2005. SG&A as a percent of net sales increased from 21.5 percent in fiscal 2005 to 23.0 percent in fiscal 2006. The increase in SG&A from fiscal 2005 was largely the result of a $97 million increase in domestic employee benefit costs, including incentives; an $86 million increase in customer freight expense, primarily due to increased fuel costs; a $46 million increase in consumer marketing spending; and $23 million of increases in our environmental reserves. Net interest expense for fiscal 2006 totaled $399 million, lower than interest expense for fiscal 2005 of $455 million, primarily as the result of debt pay down and the maturation of interest rate swaps. Interest expense includes preferred _ 13 our after-tax earnings from joint ventures in fiscal 2007 and fiscal 2008. Net sales for our Häagen-Dazs joint ventures in Asia declined 7 percent from fiscal 2005 due to an unsea- sonably cold winter and increased competitive pressure in Japan. 8th Continent, our joint venture with DuPont, achieved 14 percent net sales growth in fiscal 2006. Average diluted shares outstanding decreased by 30 million from fiscal 2005. This was due primarily to the repurchase of a significant portion of our contingently convertible debentures in October 2005 and the completion of a consent solicitation related to the remaining convert- ible debentures in December 2005, actions that ended the dilutive accounting effect of these debentures in our EPS calculations. In addition, we repurchased 19 million shares of our stock during fiscal 2006, partially offset by the issu- ance of shares upon stock option exercises. FISCAL 2005 CONSOLIDATED RESULTS OF OPERATIONS Earnings per diluted share of $3.08 in fiscal 2005 were up 18 percent from $2.60 in fiscal 2004 primarily due to the gain from the redemption of our SVE interest and the reduc- tion in interest expense. Earnings after tax increased to $1,240 million, up 18 percent from $1,055 million in fiscal 2004. Our cash flow in 2005 was strong, enabling us to increase our dividend payments, continue to make signifi- cant fixed asset investments to support future growth and productivity, and reduce our total debt (notes payable and long-term debt, including current portion) by $2.0 billion. Our net sales for fiscal 2005 were $11.2 billion, an increase of 2 percent for the year compared to sales in fiscal 2004. Excluding the effect of the 53rd week in 2004, net sales increased 3 percent (see page 26 for our discussion of this measure not defined by GAAP). Net sales growth was primarily driven by 2 percentage points of unit volume growth on a 52 vs. 52-week basis, primarily in U.S. Retail and International. Pricing and product mix across many of our businesses contributed 3 percentage points of growth, however increases in promotional spending, primarily in U.S. Retail, offset that effect. Foreign currency exchange effects contributed 1 percentage point of growth. The components of net sales growth are shown in the following table. distributions paid on subsidiary minority interests. We have in place an amount of interest rate swaps that convert $500 million of fixed-rate debt to floating rates. Taking into account the effect of our interest rate swaps, the average interest rate on our total outstanding debt and subsidiary minority interests was 6.4 percent at May 28, 2006, compared to 5.4 percent at May 29, 2005. In fiscal 2006, we recorded restructuring and other exit costs of $30 million, consisting of $13 million related to the closure of our Swedesboro, New Jersey frozen dough plant; $6 million primarily for severance costs associated with the restructuring of our frozen dough plant in Montreal, Quebec; $4 million of restructuring costs at our Allentown, Pennsylvania frozen waffle plant, primarily related to product and production realignment; $3 million associated with an asset impairment charge in one of our plants; and $4 million primarily associated with fiscal 2005 supply chain initiatives. In fiscal 2005, we recorded restructuring and other exit costs of $84 million, consisting of $44 million of charges associated with fiscal 2005 supply chain initiatives; $30 million of charges related to relocating our frozen baked goods line from our Boston plant; $3 million of charges primarily associated with Bakeries and Foodservice sever- ance; and $7 million of charges associated with restructuring actions prior to fiscal 2005. The fiscal 2005 supply chain initiatives were undertaken to further increase asset utilization and reduce manufacturing and sourcing costs, resulting in decisions regarding plant closures and production realignment. The actions included decisions to: close our flour milling plant in Vallejo, California; close our par-baked bread plant in Medley, Florida; relocate bread production from our Swedesboro, New Jersey plant; relo- cate a portion of our cereal production from Cincinnati, Ohio; close our snacks foods plant in Iowa City, Iowa; and close our dry mix production at Trenton, Ontario. The effective income tax rate was 34.5 percent for fiscal 2006, reflecting the benefit of $11 million of adjustments to deferred tax liabilities associated with our International segment’s brand intangibles. In fiscal 2005 our effective income tax rate was 36.6 percent, driven primarily by the tax impacts of our fiscal 2005 divestitures. Earnings after tax from joint ventures totaled $64 million in fiscal 2006, compared to $89 million in fiscal 2005. Earn- ings from joint ventures in fiscal 2005 included $28 million from our Snack Ventures Europe (SVE) joint venture with PepsiCo, Inc., which was divested on February 28, 2005. In fiscal 2006, unit volume for Cereal Partners Worldwide (CPW), our joint venture with Nestlé S.A., grew 6 percent and net sales were up 4 percent. In February 2006, CPW announced a restructuring of its manufacturing plants in the United Kingdom. Our after-tax earnings from joint ventures was reduced by $8 million for our share of the restructuring costs, primarily accelerated depreciation and incurred in fiscal 2006. Our share of the severance, remainder of CPW’s restructuring costs is expected to affect _ 14 Components of Net Sales Growth Unit Volume Growth: 52 vs. 52-week Basis (as if fiscal 2004 contained 52 weeks) Absence of 53rd week Price/Product Mix/Foreign Currency Exchange Trade and Coupon Promotion Expense Net Sales Growth Fiscal 2005 vs. 2004 +2 pts –1 pt +4 pts –3 pts +2% Average diluted shares outstanding were 409 million in fiscal 2005, down 1 percent from 413 million in fiscal 2004 as the repurchase of 17 million shares from Diageo was partially offset by stock option exercises. RESULTS OF SEGMENT OPERATIONS The following tables provide the dollar amount and percentage of net sales and operating profit from each reportable segment for fiscal 2006, 2005 and 2004: Cost of sales increased by $250 million to $6,834 million, primarily driven by unit volume increases and $170 million in commodity cost increases. SG&A costs decreased by $25 million from fiscal 2004 to fiscal 2005, primarily driven by four factors: a $54 million decrease in consumer marketing expense; a $37 million increase in distribution costs; a $34 million decrease in merger-related costs for the planning and execution of the integration of Pillsbury; and a $32 million increase in unal- located corporate items. As detailed above in “Fiscal 2006 Consolidated Results of Operations,” restructuring and other exit costs were $84 million in fiscal 2005, compared to $26 million in 2004. On March 23, 2005, we commenced a cash tender offer for our outstanding 6 percent notes due in 2012. The tender offer resulted in the purchase of $500 million principal amount of the notes. Subsequent to the expiration of the tender offer, we purchased an additional $260 million prin- cipal amount of the notes in the open market. The aggregate purchases resulted in debt repurchase costs of $137 million, consisting of $73 million of non-cash interest rate swap losses reclassified from Accumulated Other Comprehen- sive Income, $59 million of purchase premium and $5 million of noncash unamortized cost of issuance expense. On February 28, 2005, SVE was terminated and our 40.5 percent interest was redeemed. On April 4, 2005, we sold our Lloyd’s barbecue business to Hormel Foods Corpora- tion. We received $799 million in cash proceeds from these dispositions and recorded $499 million in gains in fiscal 2005. Net interest expense decreased 10 percent from $508 million in fiscal 2004 to $455 million in fiscal 2005, prima- rily due to a reduction of our debt levels. In fiscal 2005 our effective income tax rate increased to 36.6 percent, driven primarily by the tax impacts of our fiscal 2005 divestitures. The higher book tax expense related to the fiscal 2005 divestitures did not result in the payment of significant cash taxes. Our effective income tax rate was 35.0 percent in fiscal 2004. After-tax earnings from joint venture operations grew 20 percent to reach $89 million in fiscal 2005, compared with $74 million reported a year earlier. This increase was primarily due to unit volume gains by our continuing joint ventures. Net Sales In Millions, Fiscal Year U.S. Retail International Bakeries and 2006 2005 2004 Net Sales $ 8,024 1,837 Percent Net of Net Sales Sales 69% $ 7,779 1,725 16 Percent Net of Net Sales Sales 69% $ 7,763 1,550 15 Percent of Net Sales 70% 14 Foodservice Total 1,779 $11,640 15 1,740 100% $11,244 16 1,757 100% $11,070 16 100% Segment Operating Profit 2006 2005 2004 Segment Operating Profit $1,779 201 Percent of Segment Segment Operating Operating Profit Profit 84% $1,719 171 9 Percent of Segment Segment Operating Operating Profit Profit 85% $1,809 119 8 Percent of Segment Operating Profit 88% 6 In Millions, Fiscal Year U.S. Retail International Bakeries and Foodservice Total 139 $2,119 7 134 100% $2,024 7 132 100% $2,060 6 100% We review operating results to evaluate segment perfor- mance. Operating profit for the reportable segments excludes: unallocated corporate items of $123 million for fiscal 2006, $32 million for fiscal 2005, and $17 million for fiscal 2004 (including a foreign currency transaction gain of $2 million in fiscal 2006 and foreign currency transaction losses of $6 million and $2 million in fiscal 2005 and 2004, respectively); net interest; restructuring and other exit costs; gains on divestitures; debt repurchase costs; income taxes; and after-tax earnings from joint ventures as these items are centrally managed at the corporate level and are excluded from the measure of segment profitability reviewed by management. Under our supply chain organi- zation, our manufacturing, warehouse and distribution activities are substantially integrated across our operations in order to maximize efficiency and productivity. As a result, fixed assets, capital expenditures for long-lived assets, and depreciation and amortization expenses are neither main- tained nor available by operating segment. See Note Sixteen to the Consolidated Financial Statements on pages 51 and 52 in Item Eight of this report for a reconciliation of segment operating profits and net earnings. _ 15 U.S. Retail Segment Results For fiscal 2006, net sales for our U.S. Retail operations were $8.0 billion, up 3 percent from fiscal 2005. Net sales totaled $7.8 billion in both fiscal 2005 and fiscal 2004. The compo- nents of the changes in net sales are shown in the following table: Components of U.S Retail Change in Net Sales Unit Volume Growth: 52 vs. 52-week Basis (as if fiscal 2004 contained 52 weeks) Absence of 53rd week Price/Product Mix Trade and Coupon Promotion Expense Change in Net Sales Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 +2 pts N/A Flat +1 pt +3% +3 pts –2 pts +2 pts –3 pts Flat Unit volume increased 2 points in fiscal 2006 versus fiscal 2005, led by strong growth in our Yoplait business and volume increases in our Meals, Baking Products and Snacks operating units. Favorable trade and coupon spending also contributed 1 point to the fiscal 2006 increase in net sales, as the rate of promotional activity decreased on a year over year basis, largely the result of narrowing price gaps between our products and competitors’ products in several heavily promoted categories. Unit volume grew 1 percent in fiscal 2005 versus fiscal 2004, or 3 percent on a compa- rable 52–week basis, with growth in all divisions except Big G cereals. All of our U.S. Retail divisions with the exception of Big G cereals and Pillsbury USA experienced net sales growth in fiscal 2006 as shown in the table below: U.S. Retail Change in Net Sales Yoplait Meals Baking Products Snacks Big G Cereals Pillsbury USA Total U.S. Retail Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 +14% +7 +6 +5 –1 –1 +3% +8% Flat +4 Flat –6 +2 Flat For fiscal 2006, net sales for the Yoplait division grew 14 percent over fiscal 2005 primarily due to growth in estab- lished cup yogurt lines. The Meals division’s net sales grew by 7 percent during fiscal 2006 led by Progresso soup and Hamburger Helper. Baking Products net sales grew 6 percent over fiscal 2005 reflecting the introduction of Warm Delights microwaveable desserts and strong performance during the holiday baking season. Net sales for the Snacks division grew 5 percent led by our Nature Valley granola bars and Chex Mix product lines. Big G cereals net sales declined 1 percent as our merchandising activity lagged competitors’ _ 16 levels, particularly in the first half of the year. Pillsbury USA net sales also declined 1 percent due to weakness in frozen breakfast items, frozen baked goods, and refriger- ated cookies. For fiscal 2005, Yoplait division net sales increased 8 percent with continued growth from established cup yogurt lines. Meals division net sales were flat with growth in our Progresso, Hamburger Helper and Old El Paso busi- nesses offset by declines in shelf-stable vegetables. Baking Products division net sales increased 4 percent behind growth in mass merchandising channels. Snacks division net sales were flat. Big G cereals net sales fell 6 percent with contributions from new products including reduced-sugar versions of Cinnamon Toast Crunch, Trix and Cocoa Puffs, more than offset by the loss of volume associated with merchandising activity. Net sales growth of 2 percent for Pillsbury USA reflected gains for refrigerated cookies and bread and Totino’s pizza and hot snacks. Consumer retail purchases of our products were up 4 percent for fiscal 2006 as compared to fiscal 2005 in ACNielsen measured outlets and Wal-Mart. In fiscal 2005, retail dollar sales for our major brands grew 3 percent overall. The table below provides our retail dollar sales growth for major products for the past two years: Retail Dollar Sales Growth Composite Retail Sales Granola Bars/Grain Snacks Refrigerated Yogurt Ready-to-serve Soup Hot Snacks Dessert Mixes Refrigerated Dough Frozen Vegetables Ready-to-eat Cereals Microwave Popcorn Dry Dinners Fruit Snacks Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 +4% +15% +14 +12 +8 +7 +3 +2 Flat –1 –1 –6 +3% +2% +9 +12 +14 +6 +4 +5 –1 +4 +2 –3 Channels include ACNielsen measured outlets and Wal-Mart. Operating profit of $1.78 billion in fiscal 2006 improved $60 million, or 3 percent, over fiscal 2005. Unit volume increases accounted for approximately $83 million of the improvement. Net pricing realization (defined as the impact of list and promoted price increases net of trade and other promotion costs) and product mix of $90 million exceeded manufacturing and distribution rate increases of $62 million. Increases in consumer marketing spending of $28 million accounted for a majority of the remainder of the change. Fiscal 2005 operating profit was $1.72 billion, down $90 million, or 5 percent, versus fiscal 2004. Unit volume growth contributed approximately $13 million. Cost of sales increased by $161 million, driven primarily by commodity cost increases, and net pricing realization did not contribute to offset those increased costs. SG&A costs decreased by $54 million, primarily due to decreases in consumer marketing spending. International Segment Results For fiscal 2006, net sales for our International segment were $1.84 billion, up 6 percent. Net sales totaled $1.72 billion in fiscal 2005 compared to $1.55 billion in 2004. The compo- nents of net sales growth are shown in the following table: Bakeries and Foodservice Segment Results For fiscal 2006, net sales for our Bakeries and Foodservice segment increased 2 percent to $1.78 billion. Net sales decreased slightly to $1.74 billion in fiscal 2005 compared to $1.76 billion in fiscal 2004. The components of the change in net sales are shown in the following table: Components of Bakeries and Foodservice Change in Net Sales Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 Components of International Change in Net Sales Unit Volume Growth: Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 Unit Volume Growth: 52 vs. 52-week Basis (as if fiscal 2004 +4 pts +6 pts contained 52 weeks) Absence of 53rd week Price/Product Mix Foreign Currency Exchange Trade and Coupon Promotion Expense Change in Net Sales N/A +2 pts +1 pt –1 pt +6% –1 pt +3 pts +6 pts –3 pts +11% For fiscal 2006 versus fiscal 2005, unit volume grew 4 percent, driven by a 6 percent increase in the Asia/Pacific region. For fiscal 2005 versus fiscal 2004, unit volume grew 5 percent for the year and comparable 52-week volume was up 6 percent, driven by 12 percent growth in the Asia/Pacific region. Net sales growth for our International segment by geographic region is shown in the following table: International Change in Net Sales Canada Asia/Pacific Latin America/Other Europe Total International Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 +10% +9 +9 +1 +6% +9% +14 +10 +12 +11% Operating profits for fiscal 2006 grew to $201 million, up 18 percent from the prior year, with foreign currency exchange effects contributing 2 percentage points of that growth. Improvement in unit volume contributed $24 million; net pricing realization of $46 million more than offset the effects of supply chain cost changes; and consumer marketing spending increased $24 million. Operating profits grew to $171 million in fiscal 2005, 44 percent above fiscal 2004’s $119 million. Foreign currency exchange effects contributed 9 percentage points of that growth. The unit volume increase in fiscal 2005 contrib- uted approximately $27 million; net price realization more than offset increases in cost of sales; and SG&A costs increased $29 million. 52 vs. 52-week Basis (as if fiscal 2004 Flat –3 pts contained 52 weeks) Absence of 53rd week Price/Product Mix Trade and Coupon Promotion Expense Change in Net Sales N/A +3 pts –1 pt +2% –2 pts +4 pts Flat –1% Fiscal 2006 unit volume was flat as compared to fiscal 2005, with net price realization and product mix making up the primary increase in net sales growth for the fiscal year. In fiscal 2005, unit volume was down 5 percent compared with fiscal 2004, or down 3 percent on a comparable 52-week basis, reflecting softness in shipments to our foodservice distributors and bakery customers that was partially offset by growth in sales to convenience stores. The change in net sales by major customer category is set forth in the following table: Bakeries and Foodservice Change in Net Sales Convenience Stores/Vending Wholesale/In-store Bakery Distributors/Restaurants Total Bakeries and Foodservice Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 +5% +5 Flat +2% +21% –3 –3 –1% Operating profits for the segment were $139 million in fiscal 2006, up 4 percent from $134 million in fiscal 2005. Unit volume was flat, and pricing actions essentially covered manufacturing and distribution rate increases of $39 million. Fiscal 2005 operating profits were up slightly at $134 million versus $132 million in fiscal 2004. The unit volume decline reduced earnings by $22 million, but $70 million of net pricing realization more than offset manufacturing and distribution rate increases. Unallocated Corporate Items For fiscal 2006, unallocated corporate expenses were $123 million compared to $32 million in fiscal 2005. Fiscal 2006 included: higher domestic employee benefit expense, including incentives, that increased by $61 million over _ 17 increases in environmental reserves of fiscal 2005; $23 million; and a $10 million write-down of the asset value of a low-income housing investment. Unallocated corporate expenses in fiscal 2005 included $18 million in costs (classified as cost of sales) associated with restructuring and other exit activities. Fiscal 2004 expense was $17 million, including merger-related costs of $34 million. Joint Ventures Net sales growth for CPW in fiscal 2006 was restrained by unfavorable foreign currency effects. Our share of after-tax joint venture earnings decreased from $89 million in fiscal 2005 to $64 million in fiscal 2006. As noted above, this reflects the absence of SVE earnings and the inclusion of $8 million of restructuring costs for CPW in fiscal 2006. Joint Venture Change in Net Sales CPW Häagen-Dazs 8th Continent Ongoing Joint Ventures Fiscal 2006 vs. 2005 Fiscal 2005 vs. 2004 +4% –7 +14 +2% +13% +6 +37 +12% Our interest in SVE was redeemed in February 2005, and therefore is excluded from the table above. See page 26 for our discussion of this measure not defined by GAAP. Our share of after-tax joint venture earnings increased from $74 million in fiscal 2004 to $89 million in fiscal 2005, primarily due to unit volume gains in our continuing ventures. IMPACT OF INFLATION It is our view that changes in the general rate of inflation have not had a significant effect on profitability over the three most recent fiscal years other than as noted above related to commodities and employee benefit costs. We attempt to minimize the effects of inflation through appro- risk priate planning and operating practices. Our management practices are discussed on pages 7 through 10 in Item Seven A of this report. _ 18 LIQUIDITY AND CAPITAL RESOURCES Sources and uses of cash in the past three fiscal years are shown in the following table. Over the most recent three- year period, our operations have generated $4.9 billion in cash. In fiscal 2006, cash flow from operations totaled nearly $1.8 billion. The increase in cash flows from operations from fiscal 2005 to fiscal 2006 was primarily the result of increases in accrued compensation and accrued income taxes. The increase in cash flows from operations from fiscal 2004 to fiscal 2005 was primarily the result of increases in accrued income taxes resulting from cash benefits from the utilization of capital losses for tax purposes. Cash Sources (Uses) In Millions, for Fiscal Year Ended Net cash provided by May 28, 2006 May 29, 2005 May 30, 2004 operations $1,771 $ 1,711 $1,461 Purchases of land, buildings and equipment (360) (434) (653) Proceeds from disposal of land, buildings and equipment Investments in businesses and affiliates, net Change in marketable securities Proceeds from disposition of businesses Other investing activities, net Payment of outstanding debt, 11 52 1 – 4 24 84 32 799 (9) 36 (22) 122 – 2 net (189) (2,170) (695) Proceeds from minority interest investors Common stock issued Treasury stock purchases Dividends paid Other financing activities, net Increase (Decrease) in Cash and Cash Equivalents – 157 (885) (485) (3) 835 195 (771) (461) (13) – 192 (24) (413) (3) $ 74 $ (178) $ 48 In fiscal 2006, capital investment for land, buildings and equipment decreased to $360 million from $434 million in fiscal 2005. We expect capital expenditures of approxi- mately $425 million in fiscal 2007. Dividends paid in fiscal 2006 totaled $485 million, or $1.34 per share, an 8 percent increase from fiscal 2005 dividends of $1.24 per share. Our Board of Directors announced a quarterly dividend increase from $0.31 per share to $0.33 per share effective with the dividend paid on August 1, 2005, a quarterly dividend increase to $0.34 per share effective with the dividend paid on February 1, 2006, and another quarterly dividend increase to $0.35 per share effective with the dividend payable on August 1, 2006. Our Board of Directors has authorized the repurchase from time to time of shares of our common stock subject to a maximum of 170 million shares held in our treasury. During fiscal 2006, we repurchased 19 million shares of common stock for an aggregate purchase price of $892 million, of which $7 million settled after the end of our fiscal year. In fiscal 2005, we repurchased 17 million shares of common stock for an aggregate purchase price of $771 million. A total of 146 million shares were held in treasury at May 28, 2006. We also used cash from operations to repay $189 million in outstanding debt in fiscal 2006. In fiscal 2005, we repaid nearly $2.2 billion of debt, including the purchase of $760 million principal amount of our 6 percent notes due in 2012. Fiscal 2005 debt repurchase costs were $137 million, consisting of $73 million of noncash interest rate swap losses reclassified from Accumulated Other Comprehen- sive Income, $59 million of purchase premium and $5 million of noncash unamortized cost of issuance expense. Capital Structure In Millions Notes payable Current portion of long-term debt Long-term debt Total debt Minority interests Stockholders’ equity Total Capital May 28, 2006 $ 1,503 2,131 2,415 6,049 1,136 5,772 $12,957 $ May 29, 2005 299 1,638 4,255 6,192 1,133 5,676 $13,001 We have $2.1 billion of long-term debt maturing in the next 12 months and classified as current, including $131 million that may mature in fiscal 2007 based on the put rights of those note holders. We believe that cash flows from operations, together with available short- and long- term debt financing, will be adequate to meet our liquidity and capital needs for at least the next 12 months. On October 28, 2005, we repurchased a significant portion of our zero coupon convertible debentures pursuant to put rights of the holders for an aggregate purchase price of $1.33 billion, including $77 million of accreted original issue discount. These debentures had an aggregate prin- cipal amount at maturity of $1.86 billion. We incurred no gain or loss from this repurchase. As of May 28, 2006, there were $371 million in aggregate principal amount at matu- rity of the debentures outstanding, or $268 million of accreted value. We used proceeds from the issuance of commercial paper to fund the purchase price of the deben- tures. We also have reclassified the remaining zero coupon convertible debentures to long-term debt based on the October 2008 put rights of the holders. On March 23, 2005, we commenced a cash tender offer for our outstanding 6 percent notes due in 2012. The tender offer resulted in the purchase of $500 million principal amount of the notes. Subsequent to the expiration of the tender offer, we purchased an additional $260 million prin- cipal amount of the notes in the open market. The aggregate purchases resulted in the debt repurchase costs as discussed above. Our minority interests consist of interests in certain of our subsidiaries that are held by third parties. General Mills Cereals, LLC (GMC), our subsidiary, holds the manufac- turing assets and intellectual property associated with the production and retail sale of Big G ready-to-eat cereals, Progresso soups and Old El Paso products. In May 2002, one of our wholly owned subsidiaries sold 150,000 Class A preferred membership interests in GMC to an unrelated third-party investor in exchange for $150 million, and in October 2004, another of our wholly owned subsidiaries sold 835,000 Series B-1 preferred membership interests in GMC in exchange for $835 million. All interests in GMC, other than the 150,000 Class A interests and 835,000 Series B-1 interests, but including all managing member inter- ests, are held by our wholly owned subsidiaries. In fiscal 2003, General Mills Capital, Inc. (GM Capital), a subsidiary formed for the purpose of purchasing and collecting our receivables, sold $150 million of its Series A preferred stock to an unrelated third-party investor. The Class A interests of GMC receive quarterly preferred distributions at a floating rate equal to (i) the sum of three- month LIBOR plus 90 basis points, divided by (ii) 0.965. This rate will be adjusted by agreement between the third- party investor holding the Class A interests and GMC every five years, beginning in June 2007. Under certain circum- stances, GMC also may be required to be dissolved and liquidated, including, without limitation, the bankruptcy of GMC or its subsidiaries, failure to deliver the preferred distributions, failure to comply with portfolio requirements, breaches of certain covenants, lowering of our senior debt rating below either Baa3 by Moody’s or BBB by Standard & Poor’s, and a failed attempt to remarket the Class A inter- ests as a result of a breach of GMC’s obligations to assist in such remarketing. In the event of a liquidation of GMC, each member of GMC would receive the amount of its then current capital account balance. The managing member may avoid liquidation in most circumstances by exercising an option to purchase the Class A interests. The Series B-1 interests of GMC are entitled to receive quarterly preferred distributions at a fixed rate of 4.5 percent per year, which is scheduled to be reset to a new fixed rate through a remarketing in October 2007. Beginning in October 2007, the managing member of GMC may elect to repurchase the Series B-1 interests for an amount equal to the holder’s then current capital account balance plus any applicable make-whole amount. GMC is not required to purchase the Series B-1 interests nor may these investors put these interests to us. The Series B-1 interests will be exchanged for shares of our perpetual preferred stock upon the occurrence of any of the following events: our senior unsecured debt rating falling below either Ba3 as rated by Moody’s or BB- as rated by Standard & Poor’s or Fitch, Inc., _ 19 our bankruptcy or liquidation, a default on any of our senior indebtedness resulting in an acceleration of indebtedness having an outstanding principal balance in excess of $50 million, failing to pay a dividend on our common stock in any fiscal quarter, or certain liquidating events. If GMC fails to make a required distribution to the holders of Series B-1 interests when due, we will be restricted from paying any dividend (other than dividends in the form of shares of common stock) or other distributions on shares of our common or preferred stock, and may not repurchase or redeem shares of our common or preferred stock, until all such accrued and undistributed distributions are paid to the holders of the Series B-1 interests. For financial reporting purposes, the assets, liabilities, results of operations and cash flows of GMC and GM Capital are included in our consolidated financial state- ments. The third-party investors’ Class A and Series B-1 interests in GMC and the preferred stock of GM Capital are reflected as minority interests on our consolidated balance sheets, and the return to the third party investors is reflected in interest expense, net, in the consolidated statements of earnings. See Note Eight to the Consolidated Financial Statements on pages 43 and 44 in Item Eight for more information regarding our minority interests. At May 28, 2006, our cash and cash equivalents included $11 million in GMC and $21 million in GM Capital that are restricted from use for our general corporate purposes pursuant to the terms of our agreements with third-party minority interest investors. In October 2004, we entered into a forward purchase contract under which we are obligated to deliver between approximately 14 million and 17 million shares of our common stock in October 2007, subject to adjustment under certain circumstances, in exchange for $750 million of cash or, in certain circumstances, securities of an affiliate of the forward counterparty. The following table, when reviewed in conjunction with the capital structure table above, shows the composition of our debt structure including the impact of using derivative instruments: Debt Structure In Millions Floating-rate Fixed-rate Total Debt May 28, 2006 May 29, 2005 $2,228 3,821 $6,049 37% $1,049 63% 5,143 100% $6,192 17% 83% 100% Commercial paper is a continuing source of short-term financing. We can issue commercial paper in the United States, Canada and Europe. Our commercial paper borrow- ings are supported by $2.95 billion of fee-paid committed credit lines and $335 million in uncommitted lines. On October 21, 2005, we entered into a new $1.1 billion 364-day credit facility expiring in October 2006 and a new $1.1 billion five-year credit facility expiring in October 2010. These new facilities replaced our $1.1 billion credit facility _ 20 that would have expired in January 2006 and our $750 million credit facility that would have expired in April 2006. We also have a $750 million five-year credit facility that will expire in January 2009. Our credit facilities, certain of our long-term debt agreements and our minority interests contain restrictive covenants. At May 28, 2006, we were in compliance with all of these covenants. The following table details the fee-paid committed credit lines we had available as of May 28, 2006: Committed Credit Facilities Credit facility maturing: October 2006 January 2009 October 2010 Total Committed Credit Facilities Amount $1.10 billion 0.75 billion 1.10 billion $2.95 billion We have an effective shelf registration statement on file with the SEC covering the sale of debt securities, common stock, preference stock, depository shares, securities warrants, purchase contracts, purchase units and units. As of May 28, 2006, approximately $5.1 billion remained avail- able under the shelf registration for future use. We believe that two important measures of financial strength are the ratio of fixed charge coverage and the ratio of operating cash flow (defined as net cash provided by operating activities) to debt (defined as notes payable plus long-term debt, including current portion). Our fixed charge coverage in fiscal 2006 was 4.6 compared to 4.7 in fiscal 2005. Fiscal 2005 was favorably impacted by the gain on our disposition of our 40.5 percent equity interest in SVE. Our operating cash flow to debt ratio increased to 29 percent in fiscal 2006 from 28 percent in fiscal 2005. Currently, Stan- dard and Poor’s Corporation has ratings of BBB+ on our publicly held long-term debt and A-2 on our commercial paper. Moody’s Investors Services, Inc. has ratings of Baa2 for our long-term debt and P-2 for our commercial paper. Fitch Ratings, Inc. rates our long-term debt BBB+ and our commercial paper F-2. Dominion Bond Rating Service in Canada currently rates General Mills as A-low. These ratings are not a recommendation to buy, sell or hold securities, are subject to revision or withdrawal at any time by the rating organization and should be evaluated independently of any other rating. We also believe that growth in return on average capital is a key measure, and it is used for management perfor- mance ratings. Return on average capital increased from 10.0 percent in 2005 to 10.6 percent in 2006 due to earnings growth and disciplined use of cash. OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS It is not our general business practice to enter into off-balance sheet arrangements nor is it our policy to issue guarantees to third parties. We have, however, issued guar- antees and comfort letters of $171 million for the debt and other obligations of unconsolidated affiliates, primarily for CPW. In addition, off-balance sheet arrangements are gener- ally limited to the future payments under noncancelable operating leases, which totaled $408 million at May 28, 2006. At May 28, 2006, we had invested in four variable interest entities (VIEs). We are the primary beneficiary (PB) of General Mills Capital, Inc. (GM Capital), a subsidiary that we consolidate as set forth in Note Eight to the Consoli- dated Financial Statements appearing on pages 43 and 44 in Item Eight of this report. We also have an interest in a contract manufacturer at our former facility in Geneva, Illi- nois. Even though we are the PB, we have not consolidated this entity because it is not material to our results of oper- ations, financial condition, or liquidity at May 28, 2006. This entity had property and equipment of $50 million and long-term debt of $50 million at May 28, 2006. We are not the PB of the remaining two VIEs. Our maximum exposure to loss from these VIEs is limited to the $150 million minority interest in GM Capital, the contract manufactur- er’s debt and our $6 million of equity investments in the two remaining VIEs. The following table summarizes our future estimated cash payments under existing contractual obligations, including payments due by period. The majority of the purchase obligations represent commitments for raw mate- rial and packaging to be utilized in the normal course of business and for consumer-directed marketing commit- ments that support our brands. The net fair value of our interest rate and equity swaps was $159 million at May 28, 2006, based on market values as of that date. Future changes in market values will impact the amount of cash ultimately paid or received to settle those instruments in the future. Other long-term obligations primarily consist of income taxes, accrued compensation and benefits, and miscella- neous liabilities. We are unable to estimate the timing of the payments for these items. We do not have significant statutory or contractual funding requirements for our defined-benefit retirement and other postretirement benefit plans. Further information on these plans, including our expected contributions for fiscal 2007, is set forth in Note Thirteen to the Consolidated Financial Statements appearing on pages 47 through 50 in Item Eight of this report. In Millions, Payments Due by Fiscal Year Long-term debt Accrued interest Operating leases Purchase obligations Total Total $4,546 152 408 2007 $2,131 152 92 2008-09 $ 971 – 142 2010-11 $ 55 – 89 2012 and Thereafter $1,389 – 85 2,351 $7,457 2,068 $4,443 144 $1,257 75 $219 64 $1,538 SIGNIFICANT ACCOUNTING ESTIMATES For a complete description of our significant accounting policies, please see Note One to the Consolidated Financial Statements appearing on pages 35 through 37 in Item Eight of this report. Our significant accounting estimates are those that have meaningful impact on the reporting of our financial condition and results of operations. These poli- cies include our accounting for trade and consumer promotion activities; goodwill and other intangible asset impairments; income taxes; and pension and other postretirement benefits. Trade and Consumer Promotion Activities We report sales net of certain coupon and trade promotion costs. The consumer coupon costs recorded as a reduction of sales are based on the estimated redemption value of those coupons, as determined by historical patterns of coupon redemption and consideration of current market conditions such as competitive activity in those product categories. The trade promotion costs include payments to customers to perform merchandising activities on our behalf, such as advertising or in-store displays, discounts to our list prices to lower retail shelf prices, and payments to gain distribution of new products. The cost of these activi- ties is recognized as the related revenue is recorded, which generally precedes the actual cash expenditure. The recog- nition of these costs requires estimation of customer participation and performance levels. These estimates are made based on the quantity of customer sales, the timing and forecasted costs of promotional activities, and other factors. Differences between estimated expenses and actual costs are normally insignificant and are recognized as a change in management estimate in a subsequent period. Our accrued trade and consumer promotion liability was $339 million as of May 28, 2006, and $283 million as of May 29, 2005. Our unit volume in the last week of each quarter is consis- tently higher than the average for the preceding weeks of the quarter. In comparison to the average daily shipments in the first 12 weeks of a quarter, the final week of each quarter has approximately two to four days’ worth of incre- mental shipments (based on a five-day week), reflecting increased promotional activity at the end of the quarter. This increased activity includes promotions to assure that our customers have sufficient inventory on hand to support major marketing events or increased seasonal demand early in the next quarter, as well as promotions intended to help achieve interim unit volume targets. If, due to quarter-end promotions or other reasons, our customers purchase more product in any reporting period than end-consumer demand will require in future periods, our sales level in future reporting periods could be adversely affected. _ 21 Goodwill and Other Intangible Asset Impairments Goodwill represents the difference between the purchase prices of acquired companies and the related fair values of net assets acquired. Goodwill is not subject to amortization and is tested for impairment annually and whenever events or changes in circumstances indicate that an impairment may have occurred. Impairment testing is performed for each of our reporting units. We compare the carrying amount of goodwill for a reporting unit with its fair value and if the carrying amount of goodwill exceeds its fair value, an impairment has occurred. Finite and indefinite-lived intangible assets, primarily brands, are also tested for impairment annually and when- ever events or changes in circumstances indicate that their carrying value may not be recoverable. An impairment loss would be recognized when fair value is less than the carrying amount of the intangible. Our estimates of fair value are determined based on a discounted cash flow model using inputs from our annual long-range planning process. We also make estimates of discount rates, perpetuity growth assumptions and other factors. We have completed our annual impairment testing and determined none of our goodwill or other intangible assets was impaired. Income Taxes Our consolidated effective income tax rate is influenced by tax planning opportunities available to us in the various jurisdictions in which we operate and involves manage- ment judgment as to the ultimate resolution of any tax issues. We accrue liabilities in current income taxes payable for potential assessments related to uncertain tax positions in a variety of taxing jurisdictions. Historically, our assess- ments of the ultimate resolution of tax issues have been reasonably accurate. The current open tax issues are not dissimilar in size or substance from historical items, except for the accounting for losses recorded as part of the Pillsbury transaction. Management currently believes that the ulti- mate resolution of these matters, including the accounting for losses recorded as part of the Pillsbury transaction, will not have a material effect on our business, financial condi- tion, results of operations or liquidity. Pension and Other Postretirement Benefits We have defined-benefit retirement plans covering most U.S., Canadian and United Kingdom employees. Benefits for salaried employees are based on length of service and final average compensation. The hourly plans include various monthly amounts for each year of credited service. Our funding policy is consistent with the requirements of applicable laws. Our principal retirement plan covering domestic salaried employees has a provision that any excess _ 22 pension assets would vest in plan participants if the plan is terminated within five years of a change in control. We also sponsor plans that provide health care benefits to the majority of our U.S. and Canadian retirees. The sala- ried health care benefit plan is contributory, with retiree contributions based on years of service. We fund related trusts for certain employees and retirees on an annual basis and made $95 million of voluntary contributions to these plans in fiscal 2006. Actuarial Assumptions We recognize benefits provided during retirement over the plan participants’ active working life. Accordingly, we must use various actuarial assump- tions to predict and measure costs and obligations many years prior to the settlement of our obligations. Actuarial assumptions that require significant management judg- ment and have a material impact on the measurement of our net periodic benefit expense or income and accumu- lated benefit obligations include the long-term rates of return on plan assets, the interest rates used to discount the obligations for our benefit plans, how we derive the market- related values of assets and the health care cost trend rates. Expected Rate of Return on Plan Assets Our expected rate of return on plan assets is determined by our asset alloca- tion, our historical long-term investment performance, our estimate of future long-term returns by asset class (using input from our actuaries, investment services and invest- ment managers), and long-term inflation assumptions. The investment objective for our pension and other postretirement benefit plans is to secure the benefit obliga- tions to participants at a reasonable cost to us. The goal is to optimize the long-term return on plan assets at a moderate level of risk. The pension and postretirement portfolios are broadly diversified across asset classes. Within asset classes, the portfolios are further diversified across investment styles and investment organizations. For the pension and other postretirement plans, the long-term investment policy allo- cations are: 30 percent to U.S. equities; 20 percent to international equities; 10 percent to private equi- ties; 30 percent to fixed income; and 10 percent to real assets (real estate, energy and timber). The actual allocations to these asset classes may vary tactically around the long-term policy allocations based on relative market valuations. Our historical investment returns (compound annual growth rates) were 16 percent, 9 percent, 11 percent, 12 percent and 12 percent for the 1, 5, 10, 15 and 20 year periods ended May 28, 2006. For fiscal 2006, 2005 and 2004, we assumed a rate of return of 9.6 percent on our pension plan assets and our other postretirement plan assets. Lowering the expected long-term rate of return on assets by 50 basis points would increase our net pension and postretirement expense for fiscal 2007 by approximately $18 million. Discount Rates Our discount rate assumptions are deter- mined annually as of the last day of our fiscal year for our pension and other postretirement obligations. Those same discount rates also are used to determine pension and other postretirement income and expense for the following fiscal year. We work with our actuaries to determine the timing and amount of expected future cash outflows to plan partic- ipants and, using high-quality corporate bond yields, to develop a forward interest rate curve, including a margin to that index based on our credit risk. This forward interest rate curve is applied to our expected future cash outflows to determine our discount rate assumptions. The discount rates used in our pension and other postretirement assump- tions were 5.55 percent and 5.5 percent, respectively, for the obligations as of May 29, 2005, and for our fiscal 2006 income and expense, and 6.65 percent for the obligations as of May 30, 2004, and for our fiscal 2005 income and expense. Lowering the discount rate by 50 basis points would increase our net pension and postretirement expense for fiscal 2007 by approximately $24 million. Market-Related Value We base our determination of pension expense or income on a market-related valuation of assets which reduces year-to-year volatility. This market- related valuation recognizes investment gains or losses over a five-year period from the year in which they occur. Invest- ment gains or losses for this purpose are the difference between the expected return calculated using the market- related value of assets and the actual return based on the market-related value of assets. Since the market-related value of assets recognizes gains or losses over a five-year period, the future value of assets will be impacted as previ- ously deferred gains or losses are recorded. Health Care Cost Trend Rates We review our health care trend rates annually. Our review is based on data and infor- mation we collect about our health care claims experience and information provided by our actuaries. This informa- tion includes recent plan experience, plan design, overall industry experience and projections, and assumptions used by other similar organizations. Our initial health care cost trend rate is adjusted as necessary to remain consistent with this review, recent experiences, and short term expec- tations. Our current health care cost trend rate assumption is 11 percent for retirees age 65 and over and 10 percent for retirees under age 65. These rates are graded down annu- ally until the ultimate trend rate of 5.2 percent is reached in 2013 for retirees over age 65 and 2014 for retirees under age 65. The trend rates are applicable for calculations only if the retirees’ benefits increase as a result of health care inflation. The ultimate trend rate is adjusted annually, as necessary, to approximate the current economic view on the rate of long-term inflation plus an appropriate health care cost premium. Assumed trend rates for health care costs have an important effect on the amounts reported for the postretirement benefit plans. If the health care cost trend rate increased by 1 percentage point in each future year, the aggregate of the service and interest cost components of postretirement expense for fiscal 2007 would increase by $7 million, and the postretire- ment accumulated benefit obligation as of May 28, 2006, would increase by $90 million. Financial Statement Impact In fiscal 2006, we recorded net pension and postretirement expense of $25 million compared to $6 million in fiscal 2005 and $5 million in fiscal 2004. As of May 28, 2006, we had cumulative unrecognized actuarial net losses of $464 million on our pension plans and $317 million on our postretirement plans, primarily as the result of decreases in our discount rate assumptions. These unrecognized actuarial net losses will result in decreases in our future pension income and increases in postretirement expense since they currently exceed the corridors defined by GAAP. For our fiscal 2007 pension and other postretirement income and expense estimate, we have increased the discount rate to 6.55 percent for our pension liabilities and 6.5 percent for our other postretirement liabilities, based on interest rates and our credit spread as of May 28, 2006. The expected rate of return on plan assets remains 9.6 percent. Actual future net pension and postretirement income or expense will depend on investment performance, changes in future discount rates and various other factors related to the populations participating in our pension and postretirement plans. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123(Revised) “Share-Based Payment” (SFAS 123R), which generally requires public companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value and to recognize this cost over the period during which the employee is required to provide service in exchange for the award. The standard is effective for public companies for annual periods beginning after June 15, 2005, with several transition options regarding prospective versus retrospective application. We will adopt SFAS 123R in the first quarter of fiscal 2007, using the modified prospective method. Accordingly, prior year results will not be restated, but fiscal 2007 results will be presented as if we had applied the fair value method of accounting for stock-based compensation from the beginning of fiscal 1997. We currently expect the impact of adopting the fair value method of valuing stock awards to be approximately $0.11 to $0.12 per diluted share for fiscal 2007. However, the actual impact on fiscal 2007 will be largely dependent _ 23 on the particular structure of stock-based awards granted during fiscal 2007 and various market factors that affect the fair value of awards. We are evaluating whether to allocate these costs to our operating segments. SFAS 123R also requires the benefits of tax deductions in excess of recog- nized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required, thereby reducing net operating cash flows and increasing net financing cash flows in periods following adoption. While those amounts cannot be estimated for future periods, the amount of operating cash flows gener- ated in prior periods for such excess tax deductions was $41 million for fiscal 2006, $62 million for fiscal 2005 and $63 million for fiscal 2004. See Note One to the Consolidated Financial Statements on pages 35 through 37 in Item Eight of this report. In November 2004, the FASB issued SFAS No. 151, “Inventory Costs – An Amendment of ARB No. 43, Chapter 4.” SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS No. 151 is effec- tive for us in the first quarter of fiscal 2007. We do not expect SFAS No. 151 to have a material impact on our results of operations or financial condition. In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies when tax benefits should be recorded in financial statements, requires certain disclosures of uncertain tax matters and indicates how any tax reserves should be classified in a balance sheet. FIN 48 is effective for us in the first quarter of fiscal 2008. We are evaluating the impact of FIN 48 on our results of operations and finan- cial condition. NON-GAAP MEASURES We have included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations measures of financial performance that are not defined by GAAP. For each of these non-GAAP financial measures, we are providing below a reconciliation of the differences between the non-GAAP measure and the most directly comparable GAAP measure, an explanation of why our management believes the non-GAAP measure provides useful information to investors and any additional purposes for which our management or Board of Directors uses the non-GAAP measure. These non-GAAP measures should be viewed in addition to, and not in lieu of, the comparable GAAP measure. Fiscal years prior to 2004 are presented in support of our discussion of these measures outside of this Annual Report on Form 10-K. Diluted EPS excluding the effects of our convertible debentures and the net benefit of gains on divestitures and debt repur- chase costs: This non-GAAP measure is used in internal management reporting and as a component of the Board of Directors’ rating of our performance for management and employee incentive compensation. Management and the Board of Directors believe that this measure provides useful infor- mation to investors as it eliminates the effects of infrequently occurring events, thereby improving the comparability of year-to-year results of operations. In Millions, Except Per Share Data, Fiscal Year Net earnings for EPS calculation Deduct: Interest on contingently convertible debentures, after-tax Deduct: Divestitures gain, after-tax Add: Debt repurchase costs, after-tax Net earnings excluding after-tax effect of accounting for contingently convertible debentures, divestitures gain and debt repurchase costs Average number of common shares outstanding for EPS calculation Deduct: Incremental share effect from contingently convertible debentures Average number of common shares outstanding excluding effect of accounting for contingently convertible debentures Diluted EPS excluding after-tax effect of accounting for contingently convertible debentures, divestitures gain and debt repurchase costs 2006 2005 2004 2003 $1,099 $1,260 $1,075 $ 928 (9) (20) (20) (11) — — (284) 87 — — — — $1,090 $1,043 $1,055 $ 917 379 409 413 395 (13) (29) (29) (17) 366 380 384 378 $ 2.98 $ 2.75 $ 2.75 $2.43 _ 24 Total segment operating profit: This non-GAAP measure is used in internal management reporting and as a component of the Board of Directors’ rating of our performance for management and employee incentive compensation. Management and the Board of Directors believe that this measure provides useful infor- mation to investors because it is the profitability measure we use to evaluate segment performance. Operating profit In Millions, Fiscal Year Segment Operating Profit: U.S. Retail International Bakeries and Foodservice Total segment operating profit Unallocated corporate items Interest, net Restructuring and other exit costs Divestitures – gain Debt repurchase costs for the reportable segments and total segment operating profit exclude unallocated corporate items; net interest; restructuring and other exit costs; gains on divestitures; debt repurchase costs; income taxes; and after-tax earnings from joint ventures as these items are centrally managed at the corporate level. See Note Sixteen to the Consolidated Financial Statements on pages 51 and 52 in Item Eight of this report for a reconciliation of segment operating profits and net earnings. 2006 2005 2004 2003 2002 $1,779 201 139 2,119 (123) (399) (30) – – $1,719 171 134 2,024 (32) (455) (84) 499 (137) $1,809 119 132 2,060 (17) (508) (26) – – $1,754 91 156 2,001 (76) (547) (62) – – $1,057 45 155 1,257 (40) (416) (134) – – Earnings before income taxes and after-tax earnings from joint ventures $1,567 $1,815 $1,509 $1,316 $ 667 Return on average total capital: This non-GAAP measure is used in internal management reporting and as a component of the Board of Directors’ rating of our performance for management and employee incentive compensation. Management and the Board of Directors believe that this measure provides useful infor- mation to investors because it is important for assessing the utilization of capital and it eliminates the effects of infrequently occurring events, thereby improving the year- to-year comparability. In Millions, Fiscal Year Net earnings Interest, net, after-tax Divestitures gain, after-tax Debt repurchase costs, after-tax Earnings before interest, after-tax (adjusted) Current portion of long-term debt Notes payable Long-term debt Total debt Minority interests Stockholders’ equity Total capital Less: 2005 Divestitures gain, net of debt 2006 $ 1,090 261 – – $ 1,351 $ 2,131 1,503 2,415 6,049 1,136 5,772 12,957 2005 $ 1,240 289 (284) 87 $ 1,332 $ 1,638 299 4,255 6,192 1,133 5,676 13,001 2004 $ 1,055 330 – – $ 1,385 233 $ 583 7,410 8,226 299 5,248 13,773 $ 2003 917 378 – – $ 1,295 105 $ 1,236 7,516 8,857 300 4,175 13,332 $ $ $ 2002 458 267 – – 725 248 3,600 5,591 9,439 153 3,576 13,168 2001 $ 665 134 – – $ 799 $ 349 858 2,221 3,428 – 52 3,480 2000 $ 414 1,086 1,760 3,260 – (289) 2,971 repurchase costs, after-tax (197) (197) – – – – – Less: Accumulated other comprehensive (income) loss Adjusted total capital Adjusted average total capital Return on average total capital (125) $12,635 $12,716 (8) $12,796 $13,356 144 $13,917 $13,796 342 $13,674 $13,609 376 $13,544 $ 8,559 93 $3,573 $3,315 86 $3,057 10.6% 10.0% 10.0% 9.5% 8.5% 24.1% _ 25 Change in net sales excluding the effect of the 53rd week: Ongoing joint ventures: Our interest in SVE was redeemed in February 2005. To view the performance of our joint ventures on an ongoing basis, we have provided certain information excluding SVE. In Millions, Fiscal Year After-tax earnings from joint ventures: As reported Less: SVE Ongoing joint ventures Net sales of joint ventures (100% basis): As reported Less: SVE Ongoing joint ventures Fiscal Year Change in net sales of joint ventures (100% basis): As reported Ongoing joint ventures 2006 2005 2004 2003 $ 64 – $ 89 (28) $ 74 (26) $ 61 (21) $ 64 $ 61 $ 48 $ 40 $1,796 – $2,652 (896) $ 2,625 (1,055) $2,159 (870) $1,796 $1,756 $ 1,570 $1,289 2006 vs. 2005 2005 vs. 2004 2004 vs. 2003 –32% +2% +1% +12% +22% +22% Our fiscal year ends on the last Sunday of May. While our typical fiscal year includes 52 weeks, every 5 or 6 years our fiscal year includes a 53rd week, as it did in the fiscal year ended May 30, 2004. That 53rd week impacts the compara- bility of annual results. To view our results on a comparable basis, we have provided net sales growth information on a comparable 52-week basis. The effect of the 53rd week was determined using one-fifth of the values of the five-week month of May 2004. In Millions, Fiscal Year As reported (including the effect of the 53rd week): U.S. Retail International Bakeries and Foodservice Total Effect of 53rd week in fiscal 2004: U.S. Retail International Bakeries and Foodservice Total Net sales excluding the effect of the 53rd week: U.S. Retail International Bakeries and Foodservice Total Growth rate, including the effect of the 53rd week: U.S. Retail International Bakeries and Foodservice Total Growth rate, excluding the effect of the 53rd week: U.S. Retail International Bakeries and Foodservice Total Net Sales 2005 2004 $ 7,763 1,550 1,757 $11,070 $ $ 140 7 33 180 $ 7,623 1,543 1,724 $10,890 $ 7,779 1,725 1,740 $11,244 $ 7,779 1,725 1,740 $11,244 0% 11% -1% 2% 2% 12% 1% 3% _ 26 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risk stemming from changes in interest rates, foreign exchange rates, commodity prices and equity prices. Changes in these factors could cause fluctuations in our earnings and cash flows. In the normal course of business, we actively manage our exposure to these market risks by entering into various hedging trans- actions, authorized under our policies that place clear controls on these activities. The counterparties in these transactions are generally highly rated institutions. We establish credit limits for each counterparty. Our hedging transactions include but are not limited to a variety of deriv- ative financial instruments. Interest Rates We manage our debt structure and our interest rate risk through the use of fixed- and floating-rate debt and derivatives. We use interest rate swaps and forward-starting interest rate swaps to hedge our exposure to interest rate changes and to reduce volatility of our financing costs. Generally under these swaps, we agree with a counterparty to exchange the difference between fixed- rate and floating-rate interest amounts based on an agreed notional principal amount. Our primary exposure is to U.S. interest rates. As of May 28, 2006, we had $7.0 billion of aggregate notional principal amount (the principal amount on which the fixed or floating interest rate is calculated) outstanding. This includes notional amounts of offsetting swaps that neutralize our exposure to interest rates on other interest rate swaps. See Note Six to the Consolidated Finan- cial Statements on pages 40 through 42 in Item Eight of this report. Foreign Currency Rates Foreign currency fluctuations can affect our net investments and earnings denominated in foreign currencies. We primarily use foreign currency forward contracts and option contracts to selectively hedge our cash flow exposure to changes in exchange rates. These contracts function as hedges, since they change in value inversely to the change created in the underlying exposure as foreign exchange rates fluctuate. Our primary U.S. dollar exchange rate exposures are with the Canadian dollar, the euro, the Australian dollar, the Mexican peso and the British pound. Commodities Many commodities we use in the produc- tion and distribution of our products are exposed to market price risks. We manage this market risk through an inte- grated set of financial instruments, including purchase orders, noncancelable contracts, futures contracts, options and swaps. Our primary commodity price exposures are to cereal grains, sugar, dairy products, vegetables, fruits, meats, vegetable oils, and other agricultural products, as well as paper and plastic packaging materials, operating supplies and energy. Equity Instruments Equity price movements affect our compensation expense as certain investments owned by our employees are revalued. We use equity swaps to manage this market risk. Value at Risk These estimates are intended to measure the maximum potential fair value we could lose in one day from adverse changes in market interest rates, foreign exchange rates, commodity prices, or equity prices under normal market conditions. A Monte Carlo (VAR) method- ology was used to quantify the market risk for our exposures. The models assumed normal market conditions and used a 95 percent confidence level. The VAR calculation used historical interest rates, foreign exchange rates and commodity and equity prices from the past year to estimate the potential volatility and correlation of these rates in the future. The market data were drawn from the RiskMetricsTM data set. The calculations are not intended to represent actual losses in fair value that we expect to incur. Further, since the hedging instrument (the derivative) inversely correlates with the underlying expo- sure, we would expect that any loss or gain in the fair value of our derivatives would be generally offset by an increase or decrease in the fair value of the underlying exposures. The positions included in the calculations were: debt; invest- ments; interest rate swaps; foreign exchange forwards; commodity swaps, futures and options; and equity instru- ments. The calculations do not include the underlying foreign exchange and commodities-related positions that are hedged by these market-risk-sensitive instruments. The table below presents the estimated maximum poten- tial one-day loss in fair value for our interest rate, foreign currency, commodity and equity market-risk-sensitive instruments outstanding on May 28, 2006 and May 29, 2005, and the average amount outstanding during the year ended May 28, 2006. The amounts were calculated using the VAR methodology described above. In Millions Interest rate instruments Foreign currency instruments Commodity instruments Equity instruments Fair Value Impact Average during 2006 $10 1 2 1 May 29, 2005 $18 1 1 – May 28, 2006 $8 2 2 1 _ 27 ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of General Mills, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control system was designed to provide reasonable assurance to our management and the Board of Directors regarding the preparation and fair presentation of published financial statements. Under the supervision and with the participation of management, including our Chief Execu- tive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of May 28, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on our assessment using the criteria set forth by COSO in Internal Control—Integrated Framework, management concluded that our internal control over finan- cial reporting was effective as of May 28, 2006. KPMG LLP, an independent registered public accounting firm, has issued an audit report on management’s assess- ment of the Company’s internal control over financial reporting. S. W. Sanger Chairman of the Board and Chief Executive Officer July 27, 2006 J. A. Lawrence Vice Chairman and Chief Financial Officer REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM REGARDING INTERNAL CONTROL OVER FINANCIAL REPORTING The Board of Directors and Stockholders General Mills, Inc.: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that General Mills, Inc. and subsidiaries maintained effective internal control over financial reporting as of May 28, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). General Mills’ manage- ment is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on manage- ment’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the stan- dards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over finan- cial reporting, evaluating management’s assessment, testing and evaluating the design and operating effective- ness of internal control, and performing such other procedures as we considered necessary in the circum- stances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A compa- ny’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transac- tions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. _ 28 Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstate- ments. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or proce- dures may deteriorate. In our opinion, management’s assessment that General Mills maintained effective internal control over financial reporting as of May 28, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by COSO. Also, in our opinion, General Mills maintained, in all material respects, effective internal control over financial reporting as of May 28, 2006, based on criteria established in Internal Control—Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of General Mills, Inc. and subsidiaries as of May 28, 2006 and May 29, 2005, and the related consolidated statements of earnings, stock- holders’ equity and comprehensive income, and cash flows, for each of the fiscal years in the three-year period ended May 28, 2006, and our report dated July 27, 2006 expressed an unqualified opinion on those consolidated financial statements. Minneapolis, Minnesota July 27, 2006 REPORT OF MANAGEMENT RESPONSIBILITIES The management of General Mills, Inc. is responsible for the fairness and accuracy of the consolidated financial state- ments. The statements have been prepared in accordance with accounting principles that are generally accepted in the United States, using management’s best estimates and judgments where appropriate. The financial information throughout this Annual Report on Form 10-K is consistent with our consolidated financial statements. respects, Management has established a system of internal controls that provides reasonable assurance that assets are adequately safeguarded and transactions are recorded accu- rately in all material in accordance with management’s authorization. We maintain a strong audit program that independently evaluates the adequacy and effectiveness of internal controls. Our internal controls provide for appropriate separation of duties and responsi- bilities, and there are documented policies regarding use of our assets and proper financial reporting. These formally stated and regularly communicated policies demand highly ethical conduct from all employees. The Audit Committee of the Board of Directors meets regularly with management, internal auditors and our inde- pendent auditors to review internal control, auditing and financial reporting matters. The independent auditors, internal auditors and employees have full and free access to the Audit Committee at any time. The Audit Committee reviewed and approved the Compa- ny’s annual financial statements and recommended to the full Board of Directors that they be included in the Annual Report. The Audit Committee also recommended to the Board of Directors that the independent auditors be reap- pointed for fiscal 2007, subject to ratification by the stockholders at the annual meeting. S. W. Sanger Chairman of the Board and Chief Executive Officer July 27, 2006 J. A. Lawrence Vice Chairman and Chief Financial Officer _ 29 We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of General Mills’ internal control over financial reporting as of May 28, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated July 27, 2006 expressed an unqualified opinion on manage- ment’s assessment of, and the effective operation of, internal control over financial reporting. Minneapolis, Minnesota July 27, 2006 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON THE CONSOLIDATED FINANCIAL STATEMENTS AND RELATED FINANCIAL STATEMENT SCHEDULE The Board of Directors and Stockholders General Mills, Inc.: We have audited the accompanying consolidated balance sheets of General Mills, Inc. and subsidiaries as of May 28, 2006 and May 29, 2005, and the related consolidated state- ments of earnings, stockholders’ equity and comprehensive income, and cash flows for each of the fiscal years in the three-year period ended May 28, 2006. In connection with our audits of the consolidated financial statements we also have audited the accompanying financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the stan- dards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of General Mills, Inc. and subsidiaries as of May 28, 2006 and May 29, 2005, and the results of their operations and their cash flows for each of the fiscal years in the three-year period ended May 28, 2006 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the accompanying financial statement schedule, when considered in relation to the basic consoli- dated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. _ 30 G E N E R A L M I L L S , I N C . A N D S U B S I D I A R I E S C O N S O L I D AT E D S TAT E M E N T S O F E A R N I N G S In Millions, Except per Share Data Fiscal Year Ended Net Sales Costs and Expenses: Cost of sales Selling, general and administrative Interest, net Restructuring and other exit costs Divestitures (gain) Debt repurchase costs Total Costs and Expenses Earnings before Income Taxes and After-tax Earnings from Joint Ventures Income Taxes After-tax Earnings from Joint Ventures Net Earnings Earnings per Share – Basic Earnings per Share – Diluted Dividends per Share See accompanying notes to consolidated financial statements. May 28, 2006 $11,640 May 29, 2005 $11,244 May 30, 2004 $11,070 6,966 2,678 399 30 – – 10,073 1,567 541 64 $ 1,090 $ $ $ 3.05 2.90 1.34 6,834 2,418 455 84 (499) 137 9,429 1,815 664 89 $ 1,240 $ $ $ 3.34 3.08 1.24 6,584 2,443 508 26 – – 9,561 1,509 528 74 $ 1,055 $ $ $ 2.82 2.60 1.10 _ 31 May 28, 2006 May 29, 2005 $ 647 1,076 1,055 216 182 3,176 2,997 6,652 3,607 1,775 $18,207 $ 1,151 2,131 1,503 1,353 6,138 2,415 1,822 924 11,299 1,136 – 50 5,737 5,107 (5,163) (84) 125 5,772 $18,207 $ 573 1,034 1,037 203 208 3,055 3,111 6,684 3,532 1,684 $18,066 $ 1,136 1,638 299 1,111 4,184 4,255 1,851 967 11,257 1,133 – 50 5,691 4,501 (4,460) (114) 8 5,676 $18,066 G E N E R A L M I L L S , I N C . A N D S U B S I D I A R I E S C O N S O L I D AT E D B A L A N C E S H E E T S In Millions ASSETS Current Assets: Cash and cash equivalents Receivables Inventories Prepaid expenses and other current assets Deferred income taxes Total Current Assets Land, Buildings and Equipment Goodwill Other Intangible Assets Other Assets Total Assets LIABILITIES AND EQUITY Current Liabilities: Accounts payable Current portion of long-term debt Notes payable Other current liabilities Total Current Liabilities Long-term Debt Deferred Income Taxes Other Liabilities Total Liabilities Minority Interests Stockholders’ Equity: Cumulative preference stock, none issued Common stock, 502 shares issued Additional paid-in capital Retained earnings Common stock in treasury, at cost, shares of 146 in 2006 and 133 in 2005 Unearned compensation Accumulated other comprehensive income Total Stockholders’ Equity Total Liabilities and Equity See accompanying notes to consolidated financial statements. _ 32 G E N E R A L M I L L S , I N C . A N D S U B S I D I A R I E S C O N S O L I D AT E D S TAT E M E N T S O F S T O C K H O L D E R S ’ E Q U I T Y A N D C O M P R E H E N S I V E I N C O M E In Millions, Except per Share Data Balance at May 25, 2003 Comprehensive Income: Net earnings Other comprehensive income, net of tax: Net change on hedge derivatives Net change on securities Foreign currency translation Minimum pension liability adjustment Other comprehensive income Total comprehensive income Cash dividends declared ($1.10 per share) Stock compensation plans (includes income tax benefits of $5) Shares purchased Unearned compensation related to restricted stock awards Earned compensation and other Balance at May 30, 2004 Comprehensive Income: Net earnings Other comprehensive income, net of tax: Net change on hedge derivatives Foreign currency translation Minimum pension liability adjustment Other comprehensive income Total comprehensive income Cash dividends declared ($1.24 per share) Stock compensation plans (includes income tax benefits of $62) Shares purchased Forward purchase contract fees Unearned compensation related to restricted stock awards Earned compensation and other Balance at May 29, 2005 Comprehensive Income: Net earnings Other comprehensive income, net of tax: Net change on hedge derivatives Foreign currency translation Minimum pension liability adjustment Other comprehensive income Total comprehensive income Cash dividends declared ($1.34 per share) Stock compensation plans (includes income tax benefits of $41) Shares purchased Unearned compensation related to restricted stock awards Earned compensation and other Balance at May 28, 2006 $.10 Par Value Common Stock (One Billion Shares Authorized) Issued Treasury Shares 502 Amount $5,684 Shares (132) Amount $(4,203) Unearned Compensation $ (43) Retained Earnings $3,079 1,055 (412) – (4) 10 (1) 306 (24) Accumulated Other Comprehensive Income (Loss) $(342) 101 (10) 75 32 198 Total $4,175 1,055 101 (10) 75 32 198 1,253 (412) 302 (24) 502 $5,680 (123) $(3,921) $3,722 (77) 31 $ (89) (77) 31 $5,248 $(144) 1,240 (461) – – 104 (43) 7 (17) 232 (771) 502 $5,741 (133) $(4,460) $4,501 (66) 41 $(114) 1,090 (484) 99 75 (22) 152 $ 8 20 73 24 117 – 46 6 (19) 189 (892) 502 $5,787 (146) $(5,163) $5,107 (17) 47 $ (84) $ 125 See accompanying notes to consolidated financial statements. 1,240 99 75 (22) 152 1,392 (461) 336 (771) (43) (66) 41 $5,676 1,090 20 73 24 117 1,207 (484) 235 (892) (17) 47 $5,772 _ 33 G E N E R A L M I L L S , I N C . A N D S U B S I D I A R I E S C O N S O L I D AT E D S TAT E M E N T S O F C A S H F L O W S In Millions Fiscal Year Ended Cash Flows – Operating Activities Net earnings Adjustments to reconcile net earnings to net cash provided by May 28, 2006 May 29, 2005 May 30, 2004 $ 1,090 $ 1,240 $ 1,055 operating activities: Depreciation and amortization Deferred income taxes Changes in current assets and liabilities Tax benefit on exercised options Pension and other postretirement costs Restructuring and other exit costs Divestitures (gain) Debt repurchase costs Other, net Net Cash Provided by Operating Activities Cash Flows – Investing Activities Purchases of land, buildings and equipment Investments in businesses Investments in affiliates, net of investment returns and dividends Purchases of marketable securities Proceeds from sale of marketable securities Proceeds from disposal of land, buildings and equipment Proceeds from disposition of businesses Other, net Net Cash Provided (Used) by Investing Activities Cash Flows – Financing Activities Change in notes payable Issuance of long-term debt Payment of long-term debt Proceeds from issuance of preferred membership interests of subsidiary Common stock issued Purchases of common stock for treasury Dividends paid Other, net Net Cash Used by Financing Activities Increase (Decrease) in Cash and Cash Equivalents Cash and Cash Equivalents – Beginning of Year Cash and Cash Equivalents – End of Year Cash Flow from Changes in Current Assets and Liabilities: Receivables Inventories Prepaid expenses and other current assets Accounts payable Other current liabilities 424 26 184 41 (74) 30 – – 50 1,771 (360) (26) 78 – 1 11 – 4 (292) 1,197 – (1,386) – 157 (885) (485) (3) (1,405) 74 573 647 $ $ (18) (6) (7) 14 201 443 9 258 62 (70) 84 (499) 137 47 1,711 (434) – 84 (1) 33 24 799 (9) 496 (1,057) 2 (1,115) 835 195 (771) (461) (13) (2,385) (178) 751 573 (9) 30 9 (19) 247 $ $ 399 109 (186) 63 (21) 26 – – 16 1,461 (653) (10) 32 (7) 129 36 – 2 (470) (1,023) 576 (248) – 192 (24) (413) (3) (943) 48 703 751 (22) 24 (15) (161) (12) $ $ Changes in Current Assets and Liabilities $ 184 $ 258 $ (186) See accompanying notes to consolidated financial statements. _ 34 G E N E R A L M I L L S , I N C . A N D S U B S I D I A R I E S N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 1. Summary of Significant Accounting Policies Basis of Presentation Our consolidated financial state- ments include the accounts of General Mills, Inc. and all subsidiaries in which it has a controlling financial interest. Intercompany transactions and accounts are eliminated in consolidation. Certain prior years’ amounts have been reclassified to conform to the current year presentation. Our fiscal year ends on the last Sunday in May. Fiscal years 2006 and 2005 each consisted of 52 weeks, and fiscal 2004 consisted of 53 weeks. Our International segment, with the exception of Canada and our export operations, is reported for the 12 calendar months ended April 30. Cash and Cash Equivalents We consider all investments purchased with an original maturity of three months or less to be cash equivalents. Inventories Most U.S. inventories are valued at the lower of cost, using the last-in, first-out (LIFO) method, or market. Grain inventories are valued at market. The balance of the U.S. inventories and inventories of consolidated operations outside of the U.S. are valued at the lower of cost, using the first-in, first-out (FIFO) method, or market. Shipping costs associated with the distribution of finished product to our customers are recorded as selling, general and administrative expense and are recognized when the related finished product is shipped to the customer. Land, Buildings, Equipment and Depreciation Land is recorded at historical cost. Buildings and equipment are recorded at historical cost and depreciated over estimated useful lives, primarily using the straight-line method. Ordi- nary maintenance and repairs are charged to operating costs. Buildings are usually depreciated over 40 to 50 years, and equipment is usually depreciated over three to 15 years. Accelerated depreciation methods generally are used for income tax purposes. When an item is sold or retired, the accounts are relieved of its cost and related accumulated depreciation; the resulting gains and losses, if any, are recog- nized in earnings. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows from the operation and disposition of the asset group are less than the carrying amount of the asset group. Asset groups are identifiable and largely indepen- dent of other asset groups. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Fair value is measured using discounted cash flows or independent appraisals as appropriate. Goodwill and Other Intangible Assets Goodwill represents the difference between the purchase prices of acquired companies and the related fair values of net assets acquired. Goodwill is not subject to amortization and is tested for impairment annually for each of our reporting units and whenever events or changes in circumstances indicate that an impairment may have occurred. Impairment testing compares the carrying amount of goodwill for a reporting unit with its fair value. Fair value is estimated based on discounted cash flows. When the carrying amount of good- will exceeds its fair value, an impairment has occurred. We have completed our annual impairment testing and deter- mined none of our goodwill is impaired. The costs of patents, copyrights and other intangible assets with finite lives are amortized over their estimated useful lives. Intangibles with indefinite lives, principally brands, are carried at cost. Finite and indefinite-lived intan- gible assets are also tested for impairment annually and whenever events or changes in circumstances indicate that their carrying value may not be recoverable. An impair- ment recognized when estimated undiscounted future cash flows are less than the carrying amount of the intangible. Measurement of an impairment loss would be based on the excess of the carrying amount of the intangible over its fair value. We have completed our annual impairment testing and determined none of our other intangible assets are impaired. loss would be Investments in Joint Ventures Our investments in compa- nies over which we have the ability to exercise significant influence are stated at cost plus our share of undistributed earnings or losses. We also receive royalty income from certain joint ventures, incur various expenses (primarily research and development) and record the tax impact of certain joint venture operations that are structured as part- nerships. Variable Interest Entities At May 28, 2006, we had invested in four variable interest entities (VIEs). We are the primary beneficiary (PB) of General Mills Capital, Inc. (GM Capital), a subsidiary that we consolidate as set forth in Note Eight. We also have an interest in a contract manufacturer at our former facility in Geneva, Illinois. Even though we are the PB, we have not consolidated this entity because it is not material to our results of operations, financial condition, or liquidity at May 28, 2006. This entity had property and equipment of $50 million and long-term debt of $50 million at May 28, 2006. We are not the PB of the remaining two VIEs. Our maximum exposure to loss from these VIEs is limited to the $150 million minority interest in GM Capital, the contract manufacturer’s debt and our $6 million equity investments in the remaining two VIEs. Revenue Recognition We recognize sales revenue upon acceptance of the shipment by our customers. Sales are reported net of consumer coupon, trade promotion and other costs, including estimated returns. Coupons are _ 35 are expensed when distributed based on estimated redemp- tions. Trade promotions expensed based on estimated participation and performance levels for offered programs. We generally do not allow a right of return. However, on a limited case-by-case basis with prior approval, we may allow customers to return product in saleable condi- tion for redistribution to other customers or outlets. Returns are expensed as reductions of net sales. Advertising Production Costs We expense the production costs of advertising the first time that the advertising takes place. Research and Development All expenditures for research and development are charged against earnings in the year incurred. Foreign Currency Translation Results of foreign opera- tions are translated into U.S. dollars using the average exchange rates each month. Assets and liabilities of these operations are translated at the period-end exchange rates, and the differences from historical exchange rates are reflected within Accumulated Other Comprehensive Income in Stockholders’ Equity as cumulative translation adjustments. Derivative Instruments We use derivatives primarily to hedge our exposure to changes in foreign exchange rates, interest rates and commodity prices. All derivatives are recognized on the Consolidated Balance Sheets at fair value based on quoted market prices or management’s estimate of their fair value and are recorded in either current or noncurrent assets or liabilities based on their maturity. Changes in the fair values of derivatives are recorded in earnings or other comprehensive income, based on whether the instrument is designated as a hedge transaction and, if so, the type of hedge transaction. Gains or losses on deriv- ative instruments reported in other comprehensive income are reclassified to earnings in the period the hedged item affects earnings. If the underlying hedged transaction ceases to exist, any associated amounts reported in other compre- hensive income are reclassified to earnings at that time. Any ineffectiveness is recognized in earnings in the current period. Stock-based Compensation We use the intrinsic value method for measuring the cost of compensation paid in our common stock. This method defines our cost as the excess of the stock’s market value at the time of the grant over the amount that the employee is required to pay. Our stock option plans require that the employee’s payment (i.e., exercise price) be at least the market value as of the grant date. Restricted share awards, including restricted stock and restricted stock units, are measured at the fair market value of our stock on the date of the award, and are initially _ 36 recorded in Stockholders’ Equity as unearned compensa- tion, net of estimated forfeitures. Unearned compensation is amortized to compensation expense on a straight-line basis over the requisite service period. The following table illustrates the pro forma effect on net earnings and earnings per share if we had applied the fair value recognition provisions of Statement of Financial Accounting Standard (SFAS) No. 123, (SFAS 123) “Accounting for Stock-Based Compensation,” to all employee stock-based compensation, net of estimated forfeitures. In Millions, Except per Share Data, Fiscal Year Ended Net earnings, as reported May 28, 2006 $1,090 May 29, 2005 $1,240 May 30, 2004 $1,055 Add: After-tax stock-based employee compensation expense included in reported net earnings Deduct: After-tax stock-based employee compensation expense determined under fair value requirements of SFAS 123 Pro forma net earnings Earnings per share: Basic – as reported Basic – pro forma Diluted – as reported Diluted – pro forma 28 24 17 (48) $1,070 (62) $1,202 (67) $1,005 $ 3.05 $ 2.99 $ 2.90 $ 2.84 $ 3.34 $ 3.24 $ 3.08 $ 2.99 $ 2.82 $ 2.68 $ 2.60 $ 2.49 The weighted-average grant date fair values of the employee stock options granted were estimated as $8.04 in fiscal 2006, $8.32 in fiscal 2005, and $8.54 in fiscal 2004 using the Black-Scholes option-pricing model with the following assumptions: Fiscal Year Risk-free interest rate Expected life Expected volatility Expected dividend growth rate 2006 4.3% 7 years 20.0% 10.2% 2005 4.0% 7 years 21.0% 9.8% 2004 3.9% 7 years 21.0% 10.0% In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(Revised) “Share-Based Payment” (SFAS 123R), which generally requires public companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value and to recognize this cost over the period during which the employee is required to provide service in exchange for the award. The standard is effective for public companies for annual periods begin- ning after June 15, 2005, with several transition options regarding prospective versus retrospective application. We will adopt SFAS 123R in the first quarter of fiscal 2007, using the modified prospective method. Accordingly, prior year results will not be restated, but fiscal 2007 results will be presented as if we had applied the fair value method of accounting for stock-based compensation from the begin- ning of fiscal 1997. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required, thereby reducing net operating cash flows and increasing net financing cash flows in periods following adoption. While those amounts cannot be estimated for future periods, the amount of oper- ating cash flows generated in prior periods for such excess tax deductions was $41 million for fiscal 2006, $62 million for fiscal 2005 and $63 million for fiscal 2004. Certain equity-based compensation plans contain provi- sions that accelerate vesting of awards upon retirement, disability or death of eligible employees and directors. For the periods presented, we generally recognized stock compensation expense over the stated vesting period of the award, with any unamortized expense recognized immedi- ately if an acceleration event occurred. SFAS No. 123R specifies that a stock-based award is vested when the employee’s retention of the award is no longer contingent on providing subsequent service. Accordingly, beginning in fiscal 2007, we will prospectively revise our expense attri- bution method so that the related compensation cost is recognized immediately for awards granted to retirement- eligible individuals or over the period from the grant date to the date retirement eligibility is achieved, if less than the stated vesting period. Use of Estimates Preparing our consolidated financial statements in conformity with accounting principles gener- ally accepted in the United States requires us to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the could differ from our estimates. reporting period. Actual results New Accounting Standards The FASB ratified in October 2004, Emerging Issues Task Force Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earn- ings per Share” (EITF 04-8). EITF 04-8 was effective for us in the third quarter of fiscal 2005. The adoption of EITF 04-8 increased diluted shares outstanding to give effect to shares that were contingently issuable related to our zero coupon convertible debentures issued in October 2002. Also, net earnings used for earnings per share calculations were adjusted, using the if-converted method. See Note Eleven. In the second quarter of fiscal 2006, we adopted SFAS No. 153, “Exchanges of Nonmonetary Assets – An Amend- ment of APB Opinion No. 29.” SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets and replaces it with an exception for exchanges that do not have commercial substance. The adoption of SFAS 153 did not have any impact on our results of operations or financial condition. In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obli- gations” (FIN 47). FIN 47 requires that liabilities be recognized for the fair value of a legal obligation to perform asset retirement activities that are conditional on a future event if the amount can be reasonably estimated. We adopted FIN 47 in the fourth quarter of fiscal 2006 and it did not have a material impact on our results of operations or financial condition. 2. Acquisitions and Divestitures On March 3, 2006, we acquired Elysées Consult S.A., the franchise operator of a Häagen-Dazs shop in France. On November 21, 2005, we acquired Croissant King, a producer of frozen pastry products in Australia. On October 31, 2005, we acquired a controlling financial interest in Pinedale Holdings Pte. Limited, an operator of Häagen-Dazs cafes in Singapore and Malaysia. The aggregate purchase price of our fiscal 2006 acquisitions was $26 million. The pro forma effect of these acquisitions was not material. On February 28, 2005, Snack Ventures Europe (SVE), our snacks joint venture with PepsiCo, Inc., was termi- nated and our 40.5 percent interest was redeemed. On April 4, 2005, we sold our Lloyd’s barbecue business to Hormel Foods Corporation. We received $799 million in cash proceeds from these dispositions and recorded $499 million in gains in fiscal 2005. 3. Restructuring and Other Exit Costs In fiscal 2006, we recorded restructuring and other exit costs of $30 million pursuant to approved plans consisting of: $13 million related to the closure of our Swedesboro, New Jersey plant; $6 million related to the closure of a production line at our Montreal, Quebec plant; $4 million related to restructuring actions at our Allentown, Pennsyl- vania plant; $3 million of asset impairment charges for one of our plants; and $4 million related primarily to fiscal 2005 initiatives. The fiscal 2006 restructuring charges included $17 million to write down assets to fair value, $7 million of severance costs for 425 employees being terminated, and $6 million of other exit costs. The carrying value of the assets written down was $18 million.The fair values of the assets written down were determined using discounted cash flows. The fiscal 2006 initiatives were undertaken to increase asset utilization and reduce manufacturing costs. The actions included decisions to: close our leased frozen dough foodservice plant in Swedesboro, New Jersey, affecting 101 employees; shut down a portion of our frozen dough in Montreal, Quebec, affecting 77 foodservice plant employees; realign and modify product and manufacturing _ 37 These fiscal 2005 supply chain actions also resulted in certain associated expenses in fiscal 2005, primarily resulting from adjustments to the depreciable life of the assets necessary to reflect the shortened asset lives which coincided with the final production dates at the Cincinnati and Iowa City plants. These associated expenses were recorded as cost of sales and totaled $18 million. In fiscal 2004, we recorded restructuring and other exit costs of $26 million pursuant to approved plans. These costs included: a severance charge for 142 employees being terminated as a result of a plant closure in the Netherlands; costs related to a plant closure in Brazil, including a sever- ance charge for 201 employees; costs for the closure of our tomato canning facility in Atwater, California, including severance costs for 47 employees; adjustments of costs asso- ciated with of manufacturing facilities; and a severance charge for 132 employees, related primarily to actions in our Bakeries and Foodservice organization. The carrying value of the assets written down was $3 million. announced previously closures capabilities at our frozen waffle plant in Allentown, Penn- sylvania, affecting 72 employees; and complete the fiscal 2005 initiative to relocate our frozen baked goods line from our plant in Chelsea, Massachusetts, to another facility, affecting 175 employees. In fiscal 2005, we recorded restructuring and other exit costs of $84 million pursuant to approved plans, consisting of: $74 million of charges associated with fiscal 2005 supply chain initiatives; $3 million of charges associated with Bakeries and Foodservice severance charges resulting from fiscal 2004 decisions; and $7 million of charges associated with restructuring actions prior to fiscal 2005. The charges from the fiscal 2005 initiatives included severance and pension and postretirement curtailment costs of $14 million for 551 employees being terminated, $20 million to write off assets, $30 million for the write-down of assets to their net realizable value and $10 million of other exit costs. The carrying value of the assets written down was $36 million. Net realizable value was determined by independent market analysis. The fiscal 2005 initiatives were undertaken to further increase asset utilization and reduce manufacturing and sourcing costs, resulting in decisions regarding plant closures and production realignment. The actions included decisions to: close our flour milling plant in Vallejo, Cali- fornia, affecting 43 employees; close our par-baked bread plant in Medley, Florida, affecting 42 employees; relocate bread production from our Swedesboro, New Jersey plant, affecting 110 employees; relocate a portion of our cereal production from Cincinnati, Ohio, affecting 45 employees; close our snacks foods plant in Iowa City, Iowa, affecting 83 employees; close our dry mix production at Trenton, Ontario, affecting 53 employees; and relocate our frozen baked goods line from our plant in Chelsea, Massachusetts to another facility. _ 38 The analysis of our restructuring and other exit costs is as follows: In Millions Reserve balance at May 25, 2003 2004 Charges Utilized in 2004 Reserve balance at May 30, 2004 2005 Charges Utilized in 2005 Reserve Balance at May 29, 2005 2006 Charges Utilized in 2006 Reserve Balance at May 28, 2006 Severance $ 10 16 (13) 13 12 (16) 9 7 (8) $ 8 Asset Write-down $ 16 4 (18) 2 51 (53) – 17 (17) $ – Pension and Postretirement Curtailment Cost $ – – – – 4 (4) – – – $ – Other $ 11 6 (9) 8 17 (16) 9 6 (8) $ 7 Total $ 37 26 (40) 23 84 (89) 18 30 (33) $ 15 4. Investments in Joint Ventures We have a 50 percent equity interest in Cereal Partners Worldwide (CPW), a joint venture with Nestlé S.A. that manufactures and markets cereal products outside the United States and Canada. We have guaranteed a portion of CPW’s debt. See Note Fifteen. We have a 50 percent equity interest in 8th Continent, LLC, a domestic joint venture with DuPont to develop and market soy-based products. We have 50 percent equity interests in the following joint ventures for the manufacture, distribution and marketing of Häagen-Dazs frozen ice cream products and novelties: Häagen-Dazs Japan K.K.; Häagen-Dazs Korea Company Limited; and Häagen-Dazs Marketing & Distribution (Phil- ippines) Inc. We have a 49 percent equity interest in Häagen-Dazs Distributors (Thailand) Company Limited. We also have a 50 percent equity interest in Seretram, a joint venture with Co-op de Pau for the production of Green Giant canned corn in France. In May 2006, we acquired a control- ling financial interest in our Häagen-Dazs joint venture in the Philippines for less than $1 million. Fiscal 2005 and fiscal 2004 results of operations include our share of the after-tax earnings of SVE through the date of its termination on February 28, 2005. On July 14, 2006, CPW acquired the Uncle Tobys cereal business in Australia for approximately $385 million. This business had revenues of approximately $100 million for the fiscal year ended June 30, 2006. We funded our 50 percent share of the purchase price by making an addi- tional equity contribution in CPW from cash generated from our international operations, including our interna- tional joint ventures. In February 2006, CPW announced a restructuring of its manufacturing plants in the United Kingdom. Our after-tax earnings from joint ventures were reduced by $8 million for our share of the restructuring costs, primarily acceler- ated depreciation and severance, incurred in fiscal 2006. Our cumulative investment in these joint ventures was $186 million at the end of fiscal 2006 and $211 million at the end of fiscal 2005. We made aggregate investments in the joint ventures of $7 million in fiscal 2006, $15 million in fiscal 2005 and $31 million in fiscal 2004. We received aggregate dividends from the joint ventures of $77 million in fiscal 2006, $83 million in fiscal 2005 and $60 million in fiscal 2004. Results from our CPW joint venture are reported as of and for the twelve months ended March 31. The Häagen- Dazs and Seretram joint venture results are reported as of and for the twelve months ended April 30. 8th Continent’s results are presented on the same basis as our fiscal year. Summary combined financial information for the joint ventures (including SVE through the date of its termina- tion on February 28, 2005) on a 100 percent basis follows: In Millions, Fiscal Year Ended Net Sales Gross Margin Earnings before Income Taxes Earnings after Income Taxes 2006 $1,796 770 157 120 2005 $2,652 1,184 231 184 2004 $2,625 1,180 205 153 Gross margin is defined as net sales less cost of sales. In Millions, At End of Fiscal Year Current Assets Noncurrent Assets Current Liabilities Noncurrent Liabilities 2006 $634 578 756 6 2005 $604 612 695 7 _ 39 5. Goodwill and Intangible Assets The components of goodwill and other intangible assets are as follows: In Millions Goodwill Other Intangible Assets: Intangible assets not subject to amortization: Brands Pension intangible Total intangible assets not subject to amortization Intangible assets subject to amortization: Patents, trademarks and other finite-lived intangibles Less accumulated amortization Total intangible assets subject to amortization Total Other Intangible Assets Total Goodwill and Other Intangible May 28, 2006 $ 6,652 May 29, 2005 $ 6,684 3,595 – 3,595 19 (7) 12 3,607 3,516 3 3,519 19 (6) 13 3,532 Assets $10,259 $10,216 Brand intangibles increased by $79 million, as a result of foreign currency translation. The changes in the carrying amount of goodwill for fiscal 2004, 2005 and 2006 are as follows: U.S. Retail $5,024 – International $421 14 Bakeries and Foodservice Total $1,205 $6,650 14 – 6. Financial Instruments and Risk Management Activities Financial Instruments The carrying values of cash and cash equivalents, receivables, accounts payable, other current liabilities and notes payable approximate fair value. Marketable securities are carried at fair value. As of May 28, 2006, a comparison of cost and market values of our market- able debt and equity securities is as follows: In Millions Held to maturity: Equity securities Total Available for sale: Debt securities Equity securities Total Cost $ 2 $ 2 $20 4 $24 Market Value Gross Gains Gross Losses $ 2 $ 2 $20 8 $28 $ – $ – $ – 4 $ 4 $ – $ – $ – – $ – Earnings include realized gains from sales of available- for-sale marketable securities of less than $1 million in fiscal 2006, $2 million in fiscal 2005 and $20 million in fiscal 2004. Gains and losses are determined by specific identification. The aggregate unrealized gains and losses on available-for-sale securities, net of tax effects, are classi- fied in Accumulated Other Comprehensive Income within Stockholders’ Equity. At May 28, 2006, we owned twenty marketable securities with a fair market value less than cost. The fair market value of these securities was $0.3 million below their cost. Scheduled maturities of our marketable securities are as follows: Held to Maturity Available for Sale – 5,024 – (22) 5,002 – 20 455 1 25 481 15 – 1,205 – 20 6,684 1 (4) 1,201 – (1) 6,684 15 In Millions Under one year (current) From 1 to 3 years From 4 to 7 years Over 7 years Equity securities Total Cost $ – – – – 2 $ 2 Market Value $ – – – – 2 $ 2 Cost $ 5 5 2 8 4 $24 Market Value $ 5 5 2 8 8 $28 In Millions Balance at May 25, 2003 Goodwill acquired Other activity, including translation Balance at May 30, 2004 Goodwill acquired Other activity, including translation Balance at May 29, 2005 Goodwill acquired Deferred tax adjustment related to Pillsbury acquisition Other activity, Cash, cash equivalents and marketable securities totaling $48 million as of May 28, 2006, and $63 million as of May 29, 2005, were pledged as collateral. These assets are primarily pledged as collateral for certain derivative contracts. The fair values and carrying amounts of long-term debt, including the current portion, were $4,566 million and $4,546 million at May 28, 2006, and $6,074 million and $5,893 million at May 29, 2005. The fair value of long-term debt was estimated using discounted cash flows based on our current incremental borrowing rates for similar types of instruments. Risk Management Activities As a part of our ongoing busi- ness operations, we are exposed to market risks such as (42) – – (42) including translation Balance at May 28, 2006 – $4,960 (5) $491 – (5) $1,201 $6,652 Future purchase price adjustments to goodwill may occur upon the resolution of certain income tax accounting matters. See Note Fourteen. _ 40 changes in interest rates, foreign currency exchange rates and commodity prices. To manage these risks, we may enter into various derivative transactions (e.g., futures, options and swaps) pursuant to our established policies. Interest Rate Risk We are exposed to interest rate vola- tility with regard to existing variable-rate debt and planned future issuances of fixed-rate debt. We use a combination of interest rate swaps and forward-starting swaps to reduce interest rate volatility and to achieve a desired proportion of variable versus fixed-rate debt, based on current and projected market conditions. Variable Interest Rate Exposures – Except as discussed below, variable-to-fixed interest rate swaps are accounted for as cash flow hedges, as are all hedges of forecasted issuances of debt. Effectiveness is assessed based on either the perfectly effective hypothetical derivative method or changes in the present value of interest payments on the underlying debt. Amounts deferred to Accumulated Other Comprehensive Income are reclassified into earnings over the life of the associated debt. The amount of hedge inef- fectiveness was less than $1 million in fiscal 2006, 2005 and 2004. Fixed Interest Rate Exposures – Fixed-to-variable interest rate swaps are accounted for as fair value hedges with effec- tiveness assessed based on changes in the fair value of the underlying debt, using incremental borrowing rates currently available on loans with similar terms and maturi- ties. Effective gains and losses on these derivatives and the underlying hedged items are recorded as interest expense. The amount of hedge ineffectiveness was less than $1 million in fiscal 2006, 2005 and 2004. In anticipation of the Pillsbury acquisition and other financing needs, we entered into pay-fixed interest rate swap contracts during fiscal 2001 and fiscal 2002 totaling $7.1 billion to lock in our interest payments on the associ- ated debt. During fiscal 2004, $750 million of these swaps matured. In fiscal 2005, $2 billion of these swaps matured. At May 28, 2006, we still owned $3.15 billion of Pillsbury- related pay-fixed swaps that were previously neutralized with offsetting pay-floating swaps in fiscal 2002. At May 28, 2006, $500 million of our pay-floating interest rate swaps were designated as a fair value hedge of our 2.625 percent notes due October 2006. In May 2006, we entered into a $100 million pay-fixed, forward-starting interest rate swap with a fixed rate of 5.7 percent in anticipation of fixed-rate debt refinancing probable of occurring in fiscal 2007. Subsequent to May 28, 2006, we entered into an additional $600 million of pay-fixed, forward-starting interest rate swaps with an average fixed rate of 5.7 percent. The following table summarizes the notional amounts and weighted average interest rates of our interest rate swaps. As discussed above, we have neutralized all of our pay-fixed swaps with pay-floating swaps; however, we cannot present them on a net basis in the following table because the offsetting occurred with different counterparties. Average variable rates are based on rates as of the end of the reporting period. In Millions Pay-floating swaps – notional amount Average receive rate Average pay rate May 28, 2006 $3,770 4.8% 5.1% May 29, 2005 $3,795 4.8% 3.1% Pay-fixed swaps – notional amount $3,250 $3,150 Average receive rate Average pay rate 5.1% 6.8% 3.1% 6.9% The swap contracts mature at various dates from 2007 to 2015, as follows: In Millions Fiscal Year Maturity Date 2007 2008 2009 2010 2011 Beyond 2011 Total Pay Floating $1,923 22 20 20 18 1,767 $3,770 Pay Fixed $1,400 – – – – 1,850 $3,250 Foreign Exchange Transaction Risk We are exposed to fluctuations in foreign currency cash flows related prima- rily to third-party purchases, intercompany product shipments and intercompany loans. Our primary U.S. dollar exchange rate exposures are with the Canadian dollar, the euro, the Australian dollar, the Mexican peso and the British pound. Forward contracts of generally less than 12 months duration are used to hedge some of these risks. Hedge effectiveness is assessed based on changes in forward rates. The amount of hedge ineffectiveness was $1 million or less in fiscal 2006, 2005 and 2004. Commodity Price Risk We are exposed to price fluctua- tions primarily as a result of anticipated purchases of ingredient and packaging materials. The principal raw materials that we use are cereal grains, sugar, dairy prod- ucts, vegetables, fruits, meats, vegetable oils, and other agricultural products as well as paper and plastic packaging materials, operating supplies and energy. We use a combi- nation of long cash positions with suppliers, exchange- traded futures and option contracts and over-the-counter hedging mechanisms to reduce price fluctuations in a desired percentage of forecasted purchases over a period of less than two years. Except as discussed below, commodity derivatives are accounted for as cash flow hedges, with effec- tiveness assessed based on changes in futures prices. The amount of hedge ineffectiveness was a gain of $3 million in fiscal 2006, and were losses of $1 million or less in fiscal 2005 and 2004. _ 41 Other Risk Management Activities We enter into certain derivative contracts in accordance with our risk manage- ment strategy that do not meet the criteria for hedge accounting, including those in our grain merchandising operation, certain foreign currency derivatives and offset- ting interest rate swaps as discussed above. Even though they may not qualify as hedges, these derivatives have the economic impact of largely mitigating the associated risks. These derivatives were not acquired for trading purposes and are recorded at fair value with changes in fair value recognized in earnings each period. Our grain merchandising operation provides us efficient access to and more informed knowledge of various commodities markets. This operation uses futures and options to hedge its net inventory position to minimize market exposure. As of May 28, 2006, our grain merchan- dising operation had futures and options contracts that essentially hedged its net inventory position. None of the contracts extended beyond May 2007. All futures contracts and options are exchange-based instruments with ready liquidity and determinable market values. Neither the results of operations nor the year-end positions of our grain merchandising operation were material. Unrealized losses from cash flow hedges recorded in Accumulated Other Comprehensive Income as of May 28, 2006, totaled $92 million, primarily related to interest rate swaps we entered into in contemplation of future borrowings and other financing requirements (primarily related to the Pillsbury acquisition), which are being reclassified into interest expense over the lives of the hedged forecasted transactions. The majority of the remaining gains and losses from cash flow hedges recorded in Accumulated Other Comprehensive Income as of May 28, 2006, were related to foreign currency contracts. The net amount of the gains and losses in Accumulated Other Comprehensive Income as of May 28, 2006, that is expected to be reclassified into earnings within the next twelve months is $39 million in expense. See Note Seven for the impact of these reclassifications on interest expense. Concentrations of Credit Risk We enter into interest rate, foreign exchange, and certain commodity and equity deriv- atives primarily with a diversified group of highly rated counterparties. We continually monitor our positions and the credit ratings of the counterparties involved and, by policy, limit the amount of credit exposure to any one party. These transactions may expose us to potential losses due to the credit risk of nonperformance by these counterparties; however, we have not incurred a material loss nor are losses anticipated. We also enter into commodity futures transac- tions through various regulated exchanges. Our top five customers in the U.S. Retail segment account for 47 percent of the segment’s net sales. Payment terms vary depending on product categories and markets. We establish and monitor credit limits to manage our credit _ 42 risk. We have not incurred a material loss nor are any such losses anticipated. 7. Debt Notes Payable The components of notes payable and their respective weighted average interest rates at the end of the periods were as follows: May 28, 2006 May 29, 2005 Dollars In Millions U.S. commercial paper Euro commercial paper Financial institutions Total Notes Payable Notes Payable $ 713 462 328 $1,503 Weighted Average Interest Notes Rate Payable 5.1% $125 – 5.1 5.7 174 5.2% $299 Weighted Average Interest Rate 3.1% – 7.2 5.5% To ensure availability of funds, we maintain bank credit lines sufficient to cover our outstanding short-term borrow- ings. As of May 28, 2006, we had $2.95 billion in committed lines and $335 million in uncommitted lines. Our committed lines consist of a $750 million five-year credit facility expiring in January 2009, a $1.1 billion 364-day credit facility expiring in October 2006 and a new $1.1 billion five-year credit facility expiring in October 2010. Long-term Debt On October 28, 2005, we repurchased a significant portion of our zero coupon convertible deben- tures pursuant to the put rights of the holders for an aggregate purchase price of $1.33 billion, including $77 million of accreted original issue discount classified within financing cash flows in the Consolidated Statement of Cash Flows. These debentures had an aggregate principal amount at maturity of $1.86 billion. We incurred no gain or loss from this repurchase. As of May 28, 2006, there were $371 million in aggregate principal amount at maturity of the debentures outstanding, or $268 million of accreted value. We used proceeds from the issuance of commercial paper to fund our repurchase of the debentures. We have also reclassified the remaining zero coupon convertible deben- tures to long-term debt based on the put rights of the holders. Our credit facilities, certain of our long-term debt agree- ments and our minority interests contain restrictive debt covenants. At May 28, 2006, we were in compliance with all of these covenants. On March 23, 2005, we commenced a cash tender offer for our outstanding 6 percent notes due in 2012. The tender offer resulted in the purchase of $500 million principal amount of the notes. Subsequent to the expiration of the tender offer, we purchased an additional $260 million prin- cipal amount of the notes in the open market. The aggregate purchases resulted in debt repurchase costs of $137 million, consisting of $73 million of noncash interest rate swap losses reclassified from Accumulated Other Comprehen- sive Income, $59 million of purchase premium and $5 million of noncash unamortized cost of issuance expense. As of May 28, 2006, the $86 million recorded in Accumu- lated Other Comprehensive Income associated with our previously designated interest rate swaps will be reclassi- fied to interest expense over the remaining lives of the hedged forecasted transaction. The amount expected to be reclassified from Accumulated Other Comprehensive Income to interest expense in fiscal 2007 is $33 million. The amount reclassified from Accumulated Other Compre- hensive Income in fiscal 2006 was $33 million. A summary of our long-term debt is as follows: In Millions 51/8% notes due February 15, 2007 6% notes due February 15, 2012 2.625% notes due October 24, 2006 Medium-term notes, 4.8% to 9.1%, due 2006 to 2078(a) 37/8% notes due November 30, 2007 Zero coupon convertible debentures yield 2.0%, $371 due October 28, 2022 3.901% notes due November 30, 2007 Zero coupon notes, yield 11.1%, $261 due August 15, 2013 Other, primarily due July 11, 2008 8.2% ESOP loan guaranty, due through June 30, 2007 Less amounts due within one year Total Long-term Debt May 28, 2006 $ 1,500 1,240 500 May 29, 2005 $ 1,500 1,240 500 362 350 268 135 121 66 413 350 1,579 135 108 62 4 4,546 (2,131) $ 2,415 6 5,893 (1,638) $ 4,255 (a) Medium-term notes of $131 million may mature in fiscal 2007 based on the put rights of these note holders. See Note Six for a description of related interest-rate deriv- ative instruments. We have guaranteed the debt of our Employee Stock Ownership Plan; therefore, the loan is reflected on our consolidated balance sheets as long-term debt with a related offset in Unearned Compensation in Stockholders’ Equity. Principal payments due on long-term debt in the next five years based on stated contractual maturities or put rights of certain note holders are (in millions) $2,131 in fiscal 2007, $854 in fiscal 2008, $117 in fiscal 2009, $55 in fiscal 2010 and $0 in fiscal 2011. 8. Minority Interests In April 2002, we and certain of our wholly owned subsid- iaries contributed assets with an aggregate fair market value of approximately $4 billion to another wholly owned subsid- iary, General Mills Cereals, LLC (GMC), a limited liability company. GMC is a separate and distinct legal entity from the Company and its subsidiaries, and has separate assets, liabilities, businesses and operations. The contributed assets consist primarily of manufacturing assets and intellectual property associated with the production and retail sale of Big G ready-to-eat cereals, Progresso soups and Old El Paso products. In exchange for the contribution of these assets, GMC issued the managing membership interest and preferred membership interests to our wholly owned subsidiaries. The managing member directs the business activities and operations of GMC and has fiduciary respon- sibilities to GMC and its members. Other than rights to vote on certain matters, holders of the preferred member- ship interests have no right to direct the management of GMC. In May 2002, one of our wholly owned subsidiaries sold 150,000 Class A preferred membership interests in GMC to an unrelated third-party investor in exchange for $150 million. On October 8, 2004, another of our wholly owned subsidiaries sold 835,000 Series B-1 preferred membership interests in GMC in exchange for $835 million. In connec- tion with the sale of the Series B-1 interests, GMC and its existing members entered into a Third Amended and Restated Limited Liability Company Agreement of GMC (the LLC Agreement), setting forth, among other things, the terms of the Series B-1 and Class A interests held by the third-party investors and the rights of those investors. Currently, all interests in GMC, other than the 150,000 Class A interests and 835,000 Series B-1 interests, but including all managing member interests, are held by our wholly owned subsidiaries. The Class A interests receive quarterly preferred distri- butions at a floating rate equal to (i) the sum of three- month LIBOR plus 90 basis points, divided by (ii) 0.965. The LLC Agreement requires that the rate of the distribu- tions on the Class A interests be adjusted by agreement between the third-party investor holding the Class A inter- ests and GMC every five years, beginning in June 2007. If GMC and the investor fail to mutually agree on a new rate of preferred distributions, GMC must remarket the Class A interests to set a new distribution rate. Upon a failed remarketing, the rate over LIBOR will be increased by 75 basis points until the next scheduled remarketing date. GMC, through its managing member, may elect to repur- chase all of the Class A interests at any time for an amount equal to the holder’s capital account, plus any applicable make-whole amount. Under certain circumstances, GMC also may be required to be dissolved and liquidated, including, without limitation, the bankruptcy of GMC or its subsidiaries, failure to deliver the preferred distributions, failure to comply with portfolio requirements, breaches of certain covenants, lowering of our senior debt rating below either Baa3 by Moody’s or BBB by Standard & Poor’s, and a failed attempt to remarket the Class A interests as a result of a breach of GMC’s obligations to assist in such remarketing. In the event of a liquidation of GMC, each member of GMC would receive the amount of its then capital account balance. The managing member may avoid liquidation in most circumstances by exercising an option _ 43 to an unrelated third-party investor. GM Capital regularly purchases our receivables. These receivables are included in the Consolidated Balance Sheets and the $150 million purchase price for the Series A preferred stock is reflected as minority interest on the Consolidated Balance Sheets. The proceeds from the issuance of the preferred stock were used to reduce short-term debt. The return to the third- party investor is reflected as interest expense, net, in the Consolidated Statements of Earnings. At May 28, 2006, our cash and cash equivalents included $11 million in GMC and $21 million in GM Capital that are restricted from use for our general corporate purposes pursuant to the terms of our agreements with third-party minority interest investors. 9. Stockholders’ Equity Cumulative preference stock of 5 million shares, without par value, is authorized but unissued. We had a stockholder rights plan that expired on February 1, 2006. The Board of Directors has authorized the repurchase, from time to time, of common stock for our treasury, provided that the number of treasury shares shall not exceed 170 million. In October 2004, we purchased 17 million shares of our common stock from Diageo plc (Diageo) for $750 million, or $45.20 per share. This share repurchase was made in conjunction with Diageo’s sale of 33 million additional shares of our common stock in an underwritten public offering. Concurrently in October 2004, Lehman Brothers Hold- ings Inc. issued $750 million of notes, which are mandatorily exchangeable for shares of our common stock. In connection with the issuance of those notes, an affiliate of Lehman Brothers entered into a forward purchase contract with us, under which we are obligated to deliver to such affiliate between 14 million and 17 million shares of our common stock, subject to adjustment under certain circumstances. These shares will generally be deliverable by us in October 2007, in exchange for $750 million in cash or, in certain circumstances, securities of an affiliate of Lehman Brothers. We recorded a $43 million fee for this forward purchase contract as an adjustment to Stockholders’ Equity. to purchase the Class A interests. An election to purchase the preferred membership interests could impact our liquidity by requiring us to refinance the purchase price. The Series B-1 interests are entitled to receive quarterly preferred distributions at a fixed rate of 4.5 percent per year, which is scheduled to be reset to a new fixed rate through a remarketing in October 2007. Beginning in October 2007, the managing member of GMC may elect to repurchase the Series B-1 interests for an amount equal to the holder’s then current capital account balance plus any applicable make-whole amount. GMC is not required to purchase the Series B-1 interests nor may these investors put these interests to us. Upon the occurrence of certain exchange events (as described below), the Series B-1 interests will be exchanged for shares of our perpetual preferred stock. An exchange will occur upon our senior unsecured debt rating falling below either Ba3 as rated by Moody’s Investors Service, Inc. or BB- as rated by Standard & Poor’s or Fitch, Inc., our bankruptcy or liquidation, a default on any of our senior indebtedness resulting in an acceleration of indebtedness having an outstanding principal balance in excess of $50 million, failing to pay a dividend on our common stock in any fiscal quarter, or certain liquidating events as set forth in the LLC Agreement. If GMC fails to make a required distribution to the holders of Series B-1 interests when due, we will be restricted from paying any dividend (other than dividends in the form of shares of common stock) or other distribu- tions on shares of our common or preferred stock, and may not repurchase or redeem shares of our common or preferred stock, until all such accrued and undistributed distributions are paid to the holders of the Series B-1 inter- ests. If the required distributions on the Series B-1 interests remain undistributed for six quarterly distribution periods, the managing member will form a nine-member board of directors to manage GMC. Under these circumstances, the holder of the Series B-1 interests will have the right to appoint one director. Upon the payment of the required distributions, the GMC board of directors will be dissolved. At May 28, 2006, we have made all required distributions to the Series B-1 interests. Upon the occurrence of certain events the Series B-1 interests will be included in our computation of diluted earnings per share as a partici- pating security. For financial reporting purposes, the assets, liabilities, results of operations and cash flows of GMC are included in our consolidated financial statements. The third-party investors’ Class A and Series B-1 interests in GMC are reflected as minority interests on our Consolidated Balance Sheets, and the return to the third party investors is reflected as interest expense, net, in the Consolidated Statements of Earnings. In fiscal 2003, General Mills Capital, Inc. (GM Capital), a subsidiary, sold $150 million of its Series A preferred stock _ 44 The following table provides details of Other Comprehen- 10. Stock Plans sive Income: We use broad-based stock plans to help ensure manage- ment’s alignment with our stockholders’ interests. As of May 28, 2006, a total of 15,021,864 shares were available for grant in the form of stock options, restricted shares, restricted stock units and shares of common stock under the 2005 Stock Compensation Plan (2005 Plan) through December 31, 2007, and the 2001 Compensation Plan for Nonemployee Directors (2001 Director Plan) through September 30, 2006. Restricted shares and restricted stock units may also be granted under the Executive Incentive Plan (EIP) through September 25, 2010. Stock-based awards now outstanding include some granted under the 1990, 1993, 1995, 1996, 1998 (senior management), 1998 (employee) and 2003 stock plans, under which no further awards may be granted. The stock plans provide for full vesting of options, restricted shares and restricted stock units upon completion of specified service periods or in the event of a change of control. On May 28, 2006, a total of 3,606,659 restricted shares and restricted stock units were outstanding under all plans. Stock Options Options may be priced at 100 percent or more of the fair market value on the date of grant, and generally vest four years after the date of grant. Options generally expire within 10 years and one month after the date of grant. The 2001 Director Plan allows each nonemployee director to receive upon election and re-election to the Board of Directors options to purchase 10,000 shares of common stock that generally vest one year, and expire within 10 years, after the date of grant. In Millions Fiscal 2004 Foreign currency translation Minimum pension liability Other fair value changes: Securities Hedge derivatives Reclassifications to earnings: Securities Hedge derivatives Other Comprehensive Income Fiscal 2005 Foreign currency translation Minimum pension liability Other fair value changes: Securities Hedge derivatives Reclassifications to earnings: Securities Hedge derivatives Other Comprehensive Income Fiscal 2006 Foreign currency translation Minimum pension liability Other fair value changes: Securities Hedge derivatives Reclassifications to earnings: Hedge derivatives Other Comprehensive Income Tax (Expense) Benefit Other Compre- hensive Income $ – (19) $ 75 32 Pretax Change $ 75 51 5 24 (20) 136 $271 $ 75 (35) 2 (30) (2) 187 $197 $ 73 38 2 (13) 44 $144 (2) (9) 7 (50) $(73) $ – 13 (1) 11 1 (69) $(45) 3 15 (13) 86 $198 $ 75 (22) 1 (19) (1) 118 $152 $ – (14) $ 73 24 (1) 5 1 (8) (17) $(27) 27 $117 Except for reclassifications to earnings, changes in Other Comprehensive Income are primarily noncash items. Accumulated Other Comprehensive Income balances, net of tax effects, were as follows: In Millions Foreign currency translation adjustments Unrealized gain (loss) from: Securities Hedge derivatives Minimum pension liability Accumulated Other Comprehensive May 28, 2006 May 29, 2005 $208 $135 2 (57) (28) 1 (76) (52) Income $125 $ 8 _ 45 Information on stock option activity follows: Balance at May 25, 2003 Granted Exercised Expired Options Exercisable (Thousands) 37,743 Weighted Average Exercise Price per Share $31.61 Balance at May 30, 2004 37,191 $33.73 Granted Exercised Expired Balance at May 29, 2005 36,506 $36.08 Granted(a) Exercised Expired Balance at May 28, 2006 42,071 $39.93 Options Outstanding (Thousands) 74,360 5,180 (9,316) (1,111) 69,113 4,544 (8,334) (1,064) 64,259 136 (5,572) (620) 58,203 Weighted Average Exercise Price per Share $37.07 46.12 27.27 43.06 $38.97 46.94 29.27 45.78 $40.68 46.56 32.99 45.67 $41.45 (a) In fiscal 2005 we changed the timing of our annual stock option grant from December to June. As a result, we did not make an annual stock option grant during fiscal 2006. On June 26, 2006, we granted (in thousands) 5,175 stock options at an exercise price of $51.26 per share. Range of Exercise Price per Share Under $30 $30 — $35 $35 — $40 $40 — $45 Over $45 Options Exercisable (Thousands) 233 13,915 6,625 10,730 10,569 42,071 Weighted Average Exercise Price per Share $26.85 33.45 37.42 41.33 48.91 $39.93 Options Outstanding (Thousands) 233 13,915 6,625 17,520 19,910 58,203 Weighted Average Exercise Price per Share $26.85 33.45 37.42 42.31 47.79 $41.45 Weighted Average Remaining Contractual Life (In Years) 0.16 2.77 2.26 5.19 6.85 4.83 Information on restricted stock activity follows: Fiscal Year Number of shares awarded(a) Weighted average price 2006 2005 2004 629,919 1,497,480 1,738,581 per share $ 49.75 $ 46.73 $ 46.35 (a) In fiscal 2005 we changed the timing of our annual restricted stock unit grant from December to June. As a result, we did not make an annual restricted stock unit grant during fiscal 2006. On June 26, 2006, we granted 1,614,338 restricted stock units at a price per share of $51.26. Stock-based compensation expense related to restricted stock awards was $45 million for fiscal 2006, $38 million for fiscal 2005 and $27 million for fiscal 2004. Restricted Stock Awards Stock and units settled in stock subject to a restricted period and a purchase price, if any (as determined by the Compensation Committee of the Board of Directors), may be granted to key employees under the 2005 Plan. Restricted shares and restricted stock units, up to 50 percent of the value of an individual’s cash incentive award, may also be granted through the EIP. Certain restricted share and restricted stock unit awards require the employee to deposit personally owned shares (on a one-for-one basis) with us during the restricted period. Restricted shares and restricted stock units generally vest and become unrestricted four years after the date of grant. Participants are entitled to cash dividends on such awarded shares and units, but the sale or transfer of these shares and units is restricted during the vesting period. Partici- pants holding restricted shares, but not restricted stock units, are also entitled to vote on matters submitted to holders of common stock for a vote. The 2001 Director Plan allows each nonemployee director to receive upon election and re-election to the Board 1,000 restricted stock units that generally vest one year after the date of grant. _ 46 11. Earnings Per Share 12. Interest, Net Basic and diluted earnings per share were calculated using the following: The components of interest, including distributions to minority interest holders, net are as follows: 2006 $1,090 2005 $1,240 2004 $1,055 In Millions, Fiscal Year Interest expense Distributions paid on preferred 2006 $367 2005 $449 2004 $529 In Millions, Except per Share Data, Fiscal Year Net earnings – as reported Interest on contingently convertible debentures, after tax(a) Net Earnings for Diluted Earnings per Share Calculation Average number of common shares – basic earnings per share Incremental share effect from: Stock options(b) Restricted stock, restricted stock units and other(b) Contingently convertible debentures(a) Average Number of Common Shares – Diluted Earnings per Share 9 20 20 $1,099 $1,260 $1,075 358 371 375 6 2 13 8 1 29 8 1 29 379 409 413 Earnings per Share – Basic Earnings per Share – Diluted $ 3.05 $ 2.90 $ 3.34 $ 3.08 $ 2.82 $ 2.60 (a) Shares from contingently convertible debentures are reflected using the if-converted method. On December 12, 2005, we completed a consent solicitation and entered into a supplemental indenture related to our zero coupon convertible debentures. We also made an irrevo- cable election: (i) to satisfy all future obligations to repurchase debentures solely in cash and (ii) to satisfy all future conversions of debentures (a) solely in cash up to an amount equal to the accreted value of the debentures and (b) at our discretion, in cash, stock or a combination of cash and stock to the extent the conversion value of the debentures exceeds the accreted value. As a result of these actions, no shares of common stock underlying the debentures were considered outstanding after December 12, 2005, for purposes of calculating our diluted earnings per share. (b) Incremental shares from stock options, restricted stock and restricted stock units are computed by the treasury stock method. The diluted EPS calculation does not include stock options for 8 million shares in fiscal 2006, 9 million shares in fiscal 2005 and 12 million shares in fiscal 2004 that were considered anti-dilutive because their exercise price was greater than the average market price of our stock during the period. stock and interests in subsidiaries Capitalized interest Interest income Interest, Net 60 (1) (27) $399 39 (3) (30) $455 8 (8) (21) $508 We made cash interest payments of $378 million in fiscal 2006, $450 million in fiscal 2005 and $497 million in fiscal 2004. 13. Retirement Benefits Pension Plans We have defined-benefit retirement plans covering most U.S., Canadian and United Kingdom employees. Benefits for salaried employees are based on length of service and final average compensation. The hourly plans include various monthly amounts for each year of credited service. Our funding policy is consistent with the requirements of applicable laws. Our principal domestic retirement plan covering salaried employees has a provision that any excess pension assets would vest in plan participants if the plan is terminated within five years of a change in control. Other Postretirement Benefit Plans We sponsor plans that provide health-care benefits to the majority of our U.S. and Canadian retirees. The salaried health care benefit plan is contributory, with retiree contributions based on years of service. We fund related trusts for certain employees and retirees on an annual basis and made $95 million of volun- tary contributions to these plans in fiscal 2006. Assumed health care cost trend rates are as follows: Fiscal Year Health care cost trend rate for next year (a) Rate to which the cost trend rate is assumed to decline (ultimate rate) Year that the rate reaches the ultimate 2006 2005 10.0% and 11.0% 9.0% 5.2% 5.2% trend rate 2013/2014 2010 (a) In fiscal 2006, we raised our health care cost trend rate for plan partic- ipants greater than 65 years of age to 10 percent and for those less than 65 years of age to 11 percent. The year the ultimate trend rate is reached is 2013 for plan participants greater than 65 years of age and 2014 for plan participants less than 65 years of age. We use our fiscal year-end as a measurement date for all our pension and postretirement benefit plans. Summarized financial information about pension and other postretirement benefit plans is presented below. For _ 47 fiscal 2006, the impact of plan amendments on the projected benefit obligation is primarily related to incremental bene- fits under agreements with the unions representing the hourly workers at certain of our U.S. cereal, dough and foodservice plants covering the four-year period ending April 25, 2010. In Millions, Fiscal Year End Change in Plan Assets: Fair value at beginning of year Actual return on assets Employer contributions Plan participant contributions Benefit payments Fair Value at End of Year Change in Projected Benefit Obligation: Benefit obligation at beginning of year Service cost Interest cost Plan amendment Curtailment/Other Plan participant contributions Actuarial loss (gain) Benefits payments from plans Projected Benefit Obligation at End of Year Funded Status: Plan assets in excess of (less than) benefit obligation Unrecognized net actuarial loss Unrecognized prior service costs (credits) Net Amount Recognized Amounts Recognized in Consolidated Balance Sheets: Prepaid benefit cost Accrued benefit cost Intangible asset Other comprehensive loss - minimum pension liability Net Amount Recognized Pension Plans Other Postretirement Benefit Plans 2006 2005 2006 2005 $3,237 502 8 1 (154) $3,594 $3,082 76 167 31 – 1 (315) (154) $2,888 $ 706 464 69 $1,239 $1,320 (131) – 50 $1,239 $2,850 486 46 1 (146) $3,237 $2,578 62 167 1 2 1 417 (146) $3,082 $ 155 993 43 $1,191 $1,239 (134) 3 83 $1,191 $ 242 38 95 9 (55) $ 329 $ 971 18 50 (4) 1 9 (43) (52) $ 950 $(621) 317 (14) $(318) $ – (318) – – $(318) $ 219 39 20 8 (44) $ 242 $ 826 15 53 – 2 8 116 (49) $ 971 $(729) 393 (11) $(347) $ – (347) – – $(347) The accumulated benefit obligation for all defined-benefit plans was $2,689 million at May 28, 2006, and $2,868 million at May 29, 2005. Plans with accumulated benefit obligations in excess of plan assets are as follows: Pension Plans Other Postretirement Benefit Plans In Millions, Fiscal Year End Projected benefit obligation Accumulated benefit obligation Plan assets at fair value 2006 $173 147 15 2005 $293 279 144 2006 N/A $ 950 329 Components of net periodic benefit (income) costs are as follows: In Millions, Fiscal Year Service cost Interest cost Expected return on plan assets Amortization of losses Amortization of prior service costs (credits) Settlement or curtailment losses Net periodic benefit (income) costs _ 48 2006 $ 76 167 (323) 37 5 – $ (38) Pension Plans 2005 $ 62 167 (301) 10 6 2 $ (54) 2004 $ 70 160 (300) 18 5 – $ (47) Other Postretirement Benefit Plans 2005 $ 15 53 (22) 14 (2) 2 $ 60 2006 $ 18 50 (24) 19 (2) 2 $ 63 2005 N/A $ 971 242 2004 $ 16 47 (22) 13 (2) – $ 52 Assumptions Weighted-average assumptions used to determine benefit obligations are as follows: Fiscal Year End Discount rate Rate of salary increases Pension Plans 2006 6.55% 4.4 2005 5.55% 4.4 Other Postretirement Benefit Plans 2006 6.50% – Weighted-average assumptions used to determine net periodic benefit (income) costs are as follows: Fiscal Year Discount rate Rate of salary increases Expected long-term rate of return on plan assets 2006 5.55% 4.4 9.6 Pension Plans 2005 6.65% 4.4 9.6 2004 6.00% 4.4 9.6 2006 5.50% – 9.6 Other Postretirement Benefit Plans 2005 6.65% – 9.6 2005 5.50% – 2004 6.00% – 9.6 Our expected rate of return on plan assets is determined by our asset allocation, our historical long-term investment performance, our estimate of future long-term returns by asset class (using input from our actuaries, investment services and investment managers), and long-term infla- tion assumptions. Weighted-average asset allocations for the past two fiscal years for our pension and other postretirement benefit plans are as follows: Fiscal Year Asset Category: U.S. equities International equities Private equities Fixed income Real assets Total Pension Plans Other Postretirement Benefit Plans 2006 2005 2006 2005 34% 20 10 22 14 100% 37% 18 7 26 12 100% 24% 16 7 43 10 100% 40% 17 5 28 10 100% The investment objective for the U.S. pension and other postretirement benefit plans is to secure the benefit obliga- tions to participants at a reasonable cost to us. The goal is to optimize the long-term return on plan assets at a moderate level of risk. The pension and postretirement portfolios are broadly diversified across asset classes. Within asset classes, the portfolios are further diversified across investment styles and investment organizations. For the pension and other postretirement plans, the long-term investment policy allo- cations are: 30 percent to U.S. equities, 20 percent to to private equi- international equities, 10 percent ties, 30 percent to fixed income and 10 percent to real assets (real estate, energy and timber). The actual allocations to these asset classes may vary tactically around the long-term policy allocations based on relative market valuations. Contributions and Future Benefit Payments We expect to contribute $15 million to our pension plans and other postretirement benefit plans in fiscal 2007. Estimated benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows: In Millions, Fiscal Year 2007 2008 2009 2010 2011 2012 – 2016 Pension Plans $ 157 161 165 171 177 1,011 Other Postretirement Benefit Plans Gross $ 54 56 59 62 66 367 Medicare Subsidy Receipts $ 6 7 7 8 8 49 Certain international operations have defined-benefit pension plans that are not presented in the tables above. These international operations had prepaid pension assets of less than $1 million at the end of fiscal 2006 and 2005, and they had accrued pension plan liabilities of $4 million at the end of fiscal 2006 and $7 million at the end of fiscal 2005. Pension expense associated with these plans was $3 million for fiscal 2006, $6 million for fiscal 2005 and $3 million for fiscal 2004. Defined Contribution Plans The General Mills Savings Plan is a defined contribution plan that covers salaried and nonunion employees. It had net assets of $2,031 million as of May 28, 2006, and $1,797 million as of May 29, 2005. This plan is a 401(k) savings plan that includes a number of investment funds and an Employee Stock Ownership Plan (ESOP). Our total expense related to defined-contribution plans recognized was $46 million in fiscal 2006, $17 million in fiscal 2005 and $20 million in fiscal 2004. The ESOP’s only assets are our common stock and temporary cash balances. The ESOP’s share of the total defined contribution expense was $38 million in fiscal 2006, $11 million in fiscal 2005 and $15 million in fiscal 2004. The ESOP’s expense is calculated by the “shares allocated” method. _ 49 14. Income Taxes The components of Earnings before Income Taxes and After-tax Earnings from Joint Ventures and the corre- sponding income taxes thereon are as follows: In Millions, Fiscal Year Earnings before Income Taxes and After-tax Earnings from Joint Ventures: U.S. Foreign Total Earnings before Income Taxes and After-tax Earnings from Joint Ventures Income taxes: Currently payable: Federal State and local Foreign Total Current Deferred: Federal State and local Foreign Total Deferred Total Income Taxes 2006 2005 2004 $1,380 187 $1,723 92 $1,408 101 $1,567 $1,815 $1,509 $ 395 56 64 515 38 (4) (8) 26 $ 541 $ 557 60 38 655 14 (3) (2) 9 $ 664 $ 366 31 22 419 85 7 17 109 $ 528 We paid income taxes of $321 million in fiscal 2006, $227 million in fiscal 2005 and $225 million in fiscal 2004. The following table reconciles the U.S. statutory income tax rate with our effective income tax rate: Fiscal Year U.S. statutory rate State and local income taxes, net of federal tax benefits Divestitures, net Other, net Effective Income Tax Rate 2006 35.0% 2.6 – (3.1) 34.5% 2005 35.0% 2.0 1.8 (2.2) 36.6% 2004 35.0% 1.6 – (1.6) 35.0% The ESOP uses our common stock to convey benefits to employees and, through increased stock ownership, to further align employee interests with those of stockholders. We match a percentage of employee contributions to the General Mills Savings Plan with a base match plus a vari- able year-end match that depends on annual results. Employees receive our match in the form of common stock. The ESOP originally purchased our common stock prin- cipally with funds borrowed from third parties and guaranteed by us. The ESOP shares are included in net shares outstanding for the purposes of calculating earnings per share. The ESOP’s third-party debt is described in Note Seven. We treat cash dividends paid to the ESOP the same as other dividends. Dividends received on leveraged shares (i.e., all shares originally purchased with the debt proceeds) are used for debt service, while dividends received on unleveraged shares are passed through to participants. Our cash contribution to the ESOP is calculated so as to pay off enough debt to release sufficient shares to make our match. The ESOP uses our cash contributions to the plan, plus the dividends received on the ESOP’s leveraged shares, to make principal and interest payments on the ESOP’s debt. As loan payments are made, shares become unencum- bered by debt and are committed to be allocated. The ESOP allocates shares to individual employee accounts on the basis of the match of employee payroll savings (contribu- tions), plus reinvested dividends received on previously allocated shares. The ESOP incurred interest expense of less than $1 million in fiscal 2006, 2005 and 2004. The ESOP used dividends of $4 million in fiscal 2006, $4 million in fiscal 2005 and $5 million in fiscal 2004, along with our contributions of less than $1 million in fiscal 2006, 2005 and 2004 to make interest and principal payments. The number of shares of our common stock in the ESOP is summarized as follows: Number of Shares, in Thousands, Fiscal Year Ended Unreleased shares Allocated to participants Total Shares May 28, 2006 150 5,187 5,337 May 29, 2005 280 5,334 5,614 Executive Incentive Plan Our Executive Incentive Plan provides incentives to key employees who have the greatest potential to contribute to current earnings and successful future operations. All employees at the level of vice presi- dent and above participate in the plan. These awards are approved by the Compensation Committee of the Board of Directors, which consists solely of independent, outside directors. Awards are based on performance against pre-established goals approved by the Committee. Profit- sharing expense was $23 million, $17 million and $16 million in fiscal 2006, 2005 and 2004, respectively. _ 50 The tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows: In Millions Accrued liabilities Restructuring and other exit charges Compensation and employee benefits Unrealized hedge losses Unrealized losses Tax credit carry forwards Other Gross deferred tax assets Valuation allowance Net deferred tax assets Brands Depreciation Prepaid pension asset Intangible assets Tax lease transactions Zero coupon convertible debentures Other Gross deferred tax liabilities Net Deferred Tax Liability May 28, 2006 $ 189 8 318 45 850 51 19 1,480 858 622 1,292 257 482 75 61 18 77 2,262 $1,640 May 29, 2005 $ 180 7 316 72 855 76 14 1,520 855 665 1,322 263 450 58 64 73 78 2,308 $1,643 Of the total valuation allowance of $858 million, $768 million relates to a deferred tax asset for losses recorded as part of the Pillsbury acquisition. In the future, when tax benefits related to these losses are finalized, the reduction in the valuation allowance will be allocated to reduce good- will. Of the remaining valuation allowance, $66 million relates to state and foreign operating loss carry forwards. In the future, if tax benefits are realized related to the oper- ating losses, the reduction in the valuation allowance will reduce tax expense. At May 28, 2006, we believe it is more likely than not that the remainder of our deferred tax asset is realizable. The carry forward period on the net tax benefited amounts of our foreign loss carry forwards are as follows: $20 million do not expire; $5 million will expire in 2007 and 2008; $21 million will expire between 2009 and 2014; and $16 million will expire in 2018. We have not recognized a deferred tax liability for unremitted earnings of $1.03 billion from our foreign oper- ations because we do not expect those earnings to become taxable to us in the foreseeable future. 15. Leases and Other Commitments An analysis of rent expense by property leased follows: In Millions, Fiscal Year Warehouse space Equipment Other Total Rent Expense 2006 $ 44 27 35 $106 2005 $ 41 30 37 $108 2004 $42 20 34 $96 Some leases require payment of property taxes, insur- ance and maintenance costs in addition to the rent payments. Contingent and escalation rent in excess of minimum rent payments and sublease income netted in rent expense were insignificant. Noncancelable future lease commitments (in millions) are: $92 in fiscal 2007; $75 in fiscal 2008; $67 in fiscal 2009; $52 in fiscal 2010; $37 in fiscal 2011; and $85 after fiscal 2011, with a cumulative total of $408. These future lease commitments will be partially offset by estimated future sublease receipts of $55 million. We are contingently liable under guarantees and comfort letters for $171 million. The guarantees and comfort letters are principally issued to support borrowing arrangements, primarily for our joint ventures. We are involved in various claims, including environ- mental matters, arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters, either individually or in aggregate, will not have a material adverse effect on our financial position or results of operations. 16. Business Segment and Geographic Information We operate exclusively in the consumer foods industry, with multiple operating segments organized generally by product categories. We aggregate our operating segments into three reportable segments by type of customer and geographic region as follows: U.S. Retail, 69 percent of our fiscal 2006 consolidated net sales; International, 16 percent of our fiscal 2006 consolidated net sales; and Bakeries and Foodservice, 15 percent of our fiscal 2006 consolidated net sales. U.S. Retail reflects business with a wide variety of grocery stores, mass merchandisers, club stores, specialty stores and drug, dollar and discount chains operating throughout the United States. Our major product categories in this business segment are ready-to-eat cereals, meals, refriger- ated and frozen dough products, baking products, snacks, yogurt and organic foods. Our International segment is made up of retail businesses outside of the United States, including a retail business in Canada that largely mirrors our U.S. Retail product mix, and foodservice businesses outside of the United States and Canada. Our Bakeries and Foodservice segment consists of products marketed throughout the United States and Canada to retail and wholesale bakeries, commercial and noncommercial foodservice distributors and operators, restaurants, and convenience stores. During fiscal 2006, one customer, Wal-Mart Stores, Inc. (Wal-Mart), accounted for approximately 18 percent of our consolidated net sales and 24 percent of our sales in the U.S. Retail segment. No other customer accounted for 10 percent or more of our consolidated net sales. At May 28, _ 51 The following table provides net sales information for our reportable segments: In Millions, Fiscal Year U.S. Retail: Big G Cereals Meals Pillsbury USA Yoplait Snacks Baking Products Other Total U.S. Retail International: Europe Canada Asia/Pacific Latin America/Other Total International Bakeries and Foodservice Total 2006 2005 2004 $ 1,854 1,794 1,538 1,096 956 643 143 8,024 629 566 403 239 1,837 1,779 $11,640 $ 1,874 1,676 1,546 962 913 609 199 7,779 622 514 370 219 1,725 1,740 $11,244 $ 1,990 1,658 1,518 893 909 586 209 7,763 557 470 324 199 1,550 1,757 $11,070 The following table provides financial information iden- tified by geographic area: In Millions, Fiscal Year Net sales: U.S. Non-U.S. Total In Millions Long-lived assets: U.S. Non-U.S. Total 2006 2005 2004 $ 9,739 1,901 $11,640 $ 9,447 1,797 $11,244 $ 9,441 1,629 $11,070 May 28, 2006 $2,584 413 $2,997 May 29, 2005 $2,722 389 $3,111 17. Supplemental Information The components of certain balance sheet accounts are as follows: In Millions Receivables: From customers Other Less allowance for doubtful accounts May 28, 2006 May 29, 2005 $ 931 163 (18) $1,076 $ 910 143 (19) $1,034 2006, Wal-Mart accounted for 17 percent of our trade receiv- ables invoiced in the U.S. Retail segment. The top five customers in our U.S. Retail segment accounted for approx- imately 47 percent of its fiscal 2006 net sales, and the top five customers in our Bakeries and Foodservice segment accounted for approximately 36 percent of its fiscal 2006 net sales. Our management reviews operating results to evaluate segment performance. Operating profit for the reportable segments excludes unallocated corporate items (including a foreign currency transaction gain of $2 million in fiscal 2006 and foreign currency transaction losses of $6 million and $2 million in fiscal 2005 and 2004, respectively); net interest; restructuring and other exit costs; gain on divesti- tures; debt repurchase costs; income taxes; and after-tax earnings from joint ventures, as these items are centrally managed at the corporate level and are excluded from the measure of segment profitability reviewed by manage- ment. Under our chain organization, our manufacturing, warehouse and distribution activities are substantially integrated across our operations in order to maximize efficiency and productivity. As a result, fixed assets, capital expenditures for long-lived assets, and depre- ciation and amortization expenses are neither maintained nor available by operating segment. Transactions between reportable segments were not material in the periods presented. supply 2006 2005 2004 $ 8,024 1,837 1,779 $11,640 $ 7,779 1,725 1,740 $11,244 $ 7,763 1,550 1,757 $11,070 $ 1,779 201 139 2,119 (123) (399) $ 1,719 171 134 2,024 (32) (455) $ 1,809 119 132 2,060 (17) (508) (30) – – (84) 499 (137) (26) – – In Millions, Fiscal Year Net Sales: U.S. Retail International Bakeries and Foodservice Total Segment Operating Profit: U.S. Retail International Bakeries and Foodservice Total Unallocated corporate items Interest, net Restructuring and other exit costs Divestitures – gain Debt repurchase costs Earnings before income taxes and after-tax earnings from joint ventures Income taxes After-tax earnings from joint ventures Net Earnings 64 $ 1,090 89 $ 1,240 74 $ 1,055 _ 52 1,567 (541) 1,815 (664) 1,509 (528) Total In Millions Inventories: At the lower of cost, determined on the FIFO or weighted average cost methods, or market: Raw materials and packaging Finished goods Grain Excess of FIFO or weighted-average cost over LIFO cost Total May 28, 2006 May 29, 2005 In Millions Other Current Liabilities: Accrued payroll Accrued interest Accrued taxes Miscellaneous Total Other Noncurrent Liabilities: Interest rate swaps Accrued compensation and benefits Miscellaneous $ 226 813 78 $ 214 795 73 (62) $1,055 (45) $1,037 Inventories of $739 million at May 28, 2006, and $758 Total May 28, 2006 May 29, 2005 $ 308 152 743 150 $1,353 $ 196 638 90 $ 924 $ 240 134 588 149 $1,111 $ 221 658 88 $ 967 million at May 29, 2005, were valued at LIFO. Certain statement of earnings amounts are as follows: In Millions Land, Buildings and Equipment: Land Buildings Equipment Capitalized software Construction in progress Total land, buildings and equipment Less accumulated depreciation Total Other Assets: Prepaid pension Marketable securities, at market Investments in and advances to joint ventures Miscellaneous Total 18. Quarterly Data (Unaudited) May 28, 2006 May 29, 2005 $ 54 1,430 3,859 211 252 5,806 (2,809) $ 2,997 $ 54 1,396 3,722 196 302 5,670 (2,559) $ 3,111 $ 1,320 25 $ 1,239 24 186 244 $ 1,775 211 210 $ 1,684 In Millions, Fiscal Year Depreciation, including depreciation of capitalized software Shipping costs associated with the distribution of finished product to our customers (recorded in selling, general and administrative expense) Research and development Advertising (including production and communication costs) 2006 2005 2004 $424 $443 $399 474 173 388 168 352 158 515 477 512 Summarized quarterly data for fiscal 2006 and 2005 follows: In Millions, Except per Share and Market Price Amounts Net sales Gross margin Net earnings Net earnings per share: Basic Diluted Dividends per share Market price of common stock: High Low First Quarter Second Quarter Third Quarter Fourth Quarter 2006 $2,662 1,105 252 .69 .64 .33 2005 $2,585 1,004 183 .48 .45 .31 51.45 45.49 48.15 44.72 2006 $3,273 1,345 370 1.04 .97 .33 49.38 44.67 2005 $3,168 1,279 367 .99 .92 .31 2006 $2,860 1,114 246 .69 .68 .34 2005 $2,772 1,077 230 .63 .58 .34 2006 $2,845 1,110 222 .62 .61 .34 47.63 43.01 50.49 47.05 53.89 44.96 52.16 48.51 2005 $2,719 1,050 460(a) 1.25 1.14 .31 52.86 48.05 (a) Net earnings in the fourth quarter of fiscal 2005 include a pretax $499 million gain from the dispositions of our 40.5 percent interest in SVE and the Lloyd’s barbecue business, and $137 million of pretax debt repurchase expenses. See Notes Two and Seven. Gross margin is defined as net sales less cost of sales. _ 53 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A CONTROLS AND PROCEDURES We, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the 1934 Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of May 28, 2006, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. The annual report of our management on internal control over financial reporting is provided on page 28 in Item Eight of this report. The attestation report of KPMG LLP, our independent registered public accounting firm, regarding our internal control over financial reporting is provided on pages 28 and 29 in Item Eight of this report. There were no changes in our internal control over finan- cial reporting (as defined in Rule 13a-15(f) under the 1934 Act) during our fiscal quarter ended May 28, 2006, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B OTHER INFORMATION None. Part III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained in the sections entitled “Elec- tion of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” contained in our definitive Proxy Statement for our 2006 Annual Meeting of Stockholders is incorporated herein by reference. _ 54 Information regarding our executive officers is set forth on pages 5 and 6 in Item One of this report. The information regarding our Audit Committee, including the members of the Audit Committee and audit committee financial experts, set forth in the section entitled “Board Committees and Their Functions” contained in our definitive Proxy Statement for our 2006 Annual Meeting of Stockholders, is incorporated herein by reference. We have adopted a Code of Conduct applicable to all employees, including our principal executive officer, prin- cipal financial officer and principal accounting officer. A copy of the Code of Conduct is available on our website at www.generalmills.com. We intend to post on our website any amendments to our Code of Conduct within two days of any such amendment and to post waivers from our Code of Conduct for principal officers within two days of any such waiver. ITEM 11 EXECUTIVE COMPENSATION The information contained in the sections entitled “Execu- tive Compensation,” “Director Compensation and Benefits” and “Change of Control Arrangements” in our definitive Proxy Statement for our 2006 Annual Meeting of Stock- holders is incorporated herein by reference. ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information contained in the sections entitled “Owner- ship of General Mills Common Stock by Directors, Officers and Certain Beneficial Owners” and “Equity Compensation Plan Information” in our definitive Proxy Statement for our 2006 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth in the section entitled “Certain Relationships and Related Transactions” contained in our definitive Proxy Statement for our 2006 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES The information contained in the section entitled “Indepen- dent Registered Public Accounting Firm Fees” in our definitive Proxy Statement for our 2006 Annual Meeting of Stockholders is incorporated herein by reference. Part IV ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 1. Financial Statements: The following financial statements are included in this report under Item Eight: Consolidated Statements of Earnings for the Fiscal Years Ended May 28, 2006; May 29, 2005; and May 30, 2004. Consolidated Balance Sheets at May 28, 2006, and May 29, 2005. Consolidated Statements of Cash Flows for the Fiscal Years Ended May 28, 2006; May 29, 2005; and May 30, 2004. 3. Exhibits: Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the Fiscal Years Ended May 28, 2006; May 29, 2005; and May 30, 2004. Notes to Consolidated Financial Statements. Management’s Report on Internal Control Over Financial Reporting. Independent Registered Public Report of Accounting Firm Regarding Internal Control Over Financial Reporting. Report of Management Responsibilities. Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements and Related Financial Statement Schedule. 2. Financial Statement Schedule: For the Fiscal Years Ended May 28, 2006; May 29, 2005; and May 30, 2004: II — Valuation and Qualifying Accounts Exhibit No. 2.1 2.2 2.3 Description Agreement and Plan of Merger, dated as of July 16, 2000, by and among the Registrant, General Mills North American Businesses, Inc., Diageo plc and The Pillsbury Company (incorporated herein by reference to Exhibit 10.1 to Registrant’s Report on Form 8-K filed July 20, 2000). First Amendment to Agreement and Plan of Merger, dated as of April 12, 2001, by and among the Registrant, General Mills North American Businesses, Inc., Diageo plc and The Pillsbury Company (incorporated herein by reference to Exhibit 10.1 to Registrant’s Report on Form 8-K filed April 13, 2001). Second Amendment to Agreement and Plan of Merger, dated as of October 31, 2001, by and among the Registrant, General Mills North American Businesses, Inc., Diageo plc and The Pillsbury Company (incorporated herein by reference to Exhibit 10.1 to Registrant’s Report on Form 8-K filed November 2, 2001). Exhibit No. 3.1 3.2 4.1 4.2 Description Restated Certificate of Incorporation of the Registrant, as amended to date (incorporated herein by reference to Exhibit 3.1 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 26, 2002). By-Laws of the Registrant, as amended to date (incorporated herein by reference to Exhibit 3.1 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended November 28, 2004). Indenture, dated as of July 1, 1982, between the Registrant and U.S. Bank Trust National Association (f.k.a. Continental Illinois National Bank and Trust Company), as amended by Supplemental Indentures Nos. 1 through 8 (incorporated herein by reference to Exhibit 4.1 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 26, 2002). Indenture, dated as of February 1, 1996, between the Registrant and U.S. Bank Trust National Association (f.k.a. First Trust of Illinois, National Association) (incorporated herein by reference to Exhibit 4.1 to Registrant’s Registration Statement on Form S-3 filed February 6, 1996 (File no. 333-00745)). _ 55 Description Indenture, dated as of September 23, 1994, among Ralcorp Holdings, Inc., Beech-Nut Nutrition Corporation, Bremner, Inc., Keystone Resorts Management, Inc., Ralston Foods, Inc. and The First National Bank of Chicago, as amended by the First Supplemental Indenture, dated as of January 31, 1997, by and among Ralcorp Holdings, Inc., the Registrant and The First National Bank of Chicago (incorporated herein by reference to Exhibit 4.4 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 26, 2002). Indenture, dated as of October 28, 2002, between the Registrant and BNY Midwest Trust Company (incorporated herein by reference to Exhibit 4.2 to Registrant’s Report on Form 8-K filed November 12, 2002). Form of 51/8 percent Note due 2007 (incorporated herein by reference to Exhibit 4.1 to Registrant’s Report on Form 8-K filed February 21, 2002). Form of 6 percent Note due 2012 (incorporated herein by reference to Exhibit 4.2 to Registrant’s Report on Form 8-K filed February 21, 2002). Form of Zero Coupon Convertible Senior Debenture due 2022 (incorporated herein by reference to Exhibit 4.1 to Registrant’s Report on Form 8-K filed November 12, 2002). Third Amended and Restated Limited Liability Company Agreement of General Mills Cereals, LLC, dated as of October 8, 2004, by and among GM Cereals Operations, Inc., RBDB, INC., The Pillsbury Company, GM Class B, Inc. and GM Cereals Holdings, Inc. (incorporated herein by reference to Exhibit 4.1 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended November 28, 2004). Dividend Restriction Agreement, dated as of October 8, 2004, between the Registrant and Wells Fargo Bank, National Association (incorporated herein by reference to Exhibit 4.2 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended November 28, 2004). Amended and Restated Exchange Agreement, dated as of November 29, 2004, by and between the Registrant and Capital Trust (incorporated herein by reference to Exhibit 4.3 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended November 28, 2004). First Supplemental Indenture, dated as of September 14, 2005, between the Registrant and BNY Midwest Trust Company (incorporated herein by reference to Exhibit 4.1 to Registrant’s Report on Form 8-K filed September 15, 2005). Exhibit No. 4.12 4.13 10.1* 10.2* 10.3* 10.4* 10.5* 10.6* 10.7* 10.8* 10.9* Description Second Supplemental Indenture, dated as of December 12, 2005, between the Registrant and BNY Midwest Trust Company (incorporated herein by reference to Exhibit 4.1 to Registrant’s Report on Form 8-K filed December 13, 2005). Notice of Irrevocable Election, dated December 12, 2005, to Holders of the Registrant’s Zero Coupon Convertible Senior Debentures Due 2022 (incorporated herein by reference to Exhibit 4.2 to Registrant’s Report on Form 8-K filed December 13, 2005). Annual Retainer for Directors (incorporated herein by reference to Exhibit 10.1 to Registrant’s Report on Form 8-K filed December 16, 2005). 1998 Employee Stock Plan, as amended to date (incorporated herein by reference to Exhibit 10.3 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 26, 2002). Amended and Restated Executive Incentive Plan, as amended to date (incorporated herein by reference to Exhibit 10.3 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 29, 2005). Form of Management Continuity Agreement (incorporated herein by reference to Exhibit 10.5 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 27, 2001). Supplemental Retirement Plan, as amended (incorporated herein by reference to Exhibit 10.6 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 28, 2000). Executive Survivor Income Plan, as amended to date (incorporated herein by reference to Exhibit 10.6 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 29, 2005). Executive Health Plan, as amended to date (incorporated herein by reference to Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended February 24, 2002). Supplemental Savings Plan, as amended (incorporated herein by reference to Exhibit 10.9 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 28, 2000). 1996 Compensation Plan for Non-Employee Directors, as amended to date (incorporated herein by reference to Exhibit 10.10 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 30, 1999). 10.10* 1995 Salary Replacement Stock Option Plan, as amended to date (incorporated herein by reference to Exhibit 10.11 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 28, 2000). Exhibit No. 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 _ 56 Exhibit No. 10.11* 10.12* 10.13* 10.14 10.15 10.16 10.17 10.18* 10.19* 10.20* Description Deferred Compensation Plan, as amended to date (incorporated herein by reference to Exhibit 10.12 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 25, 2003). Supplemental Benefits Trust Agreement, amended and restated as of September 26, 1988, between the Registrant and Norwest Bank Minnesota, N.A. (incorporated herein by reference to Exhibit 10.12 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 29, 2005). Supplemental Benefits Trust Agreement, dated as of September 26, 1988, between the Registrant and Norwest Bank Minnesota, N.A. (incorporated herein by reference to Exhibit 10.13 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 29, 2005). Agreements, dated November 29, 1989, by and between the Registrant and Nestle S.A. (incorporated herein by reference to Exhibit 10.15 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 28, 2000). Protocol and Addendum No. 1 to Protocol of Cereal Partners Worldwide, dated November 21, 1989, between the Registrant and Nestle S.A. (incorporated herein by reference to Exhibit 10.16 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 27, 2001). Addendum No. 2 to the Protocol of Cereal Partners Worldwide, dated March 16, 1993, between the Registrant and Nestle S.A. (incorporated herein by reference to Exhibit 10.18 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 30, 2004). Addendum No. 3 to the Protocol of Cereal Partners Worldwide, effective as of March 15, 1993, between the Registrant and Nestle S.A. (incorporated herein by reference to Exhibit 10.2 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 28, 2000). 1990 Salary Replacement Stock Option Plan, as amended to date (incorporated herein by reference to Exhibit 10.18 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 29, 2005). Stock Option and Long-Term Incentive Plan of 1993, as amended to date (incorporated herein by reference to Exhibit 10.20 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 28, 2000). 1998 Senior Management Stock Plan, as amended to date (incorporated herein by reference to Exhibit 10.22 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 25, 2003). Exhibit No. 10.21* 10.22* 10.23 10.24 10.25 10.26 10.27* 10.28* 10.29* Description 2001 Compensation Plan for Non-Employee Directors, as amended to date (incorporated herein by reference to Exhibit 10.23 to Registrant’s Annual Report on Form 10-K for the fiscal year ended May 25, 2003). 2003 Stock Compensation Plan (incorporated herein by reference to Exhibit 4 to Registrant’s Form S-8 Registration Statement filed September 23, 2003 (File no. 333-109050)). Forward Purchase Contract, dated as of October 8, 2004, between the Registrant and Lehman Brothers OTC Derivatives Inc. (incorporated herein by reference to Exhibit 10.1 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended November 28, 2004). Five-Year Credit Agreement, dated as of January 20, 2004, among the Registrant, the several financial institutions from time to time party to the Agreement, JPMorgan Chase Bank, as Administrative Agent, Bank of America, N.A., as Syndication Agent, and Barclays Bank PLC and Citibank N.A., as Documentation Agents (incorporated herein by reference to Exhibit 99.2 to Registrant’s Report on Form 8-K filed February 12, 2004). 364-Day Credit Agreement, dated as of October 21, 2005, among the Registrant, the several financial institutions from time to time party to the agreement and JPMorgan Chase Bank, N.A., as Administrative Agent (incorporated herein by reference to Exhibit 10.1 to Registrant’s Report on Form 8-K filed October 25, 2005). Five-Year Credit Agreement, dated as of October 21, 2005, among the Registrant, the several financial institutions from time to time party to the agreement and JPMorgan Chase Bank, N.A., as Administrative Agent (incorporated herein by reference to Exhibit 10.2 to Registrant’s Report on Form 8-K filed October 25, 2005). 2005 Stock Compensation Plan (incorporated herein by reference to Exhibit 10.1 to Registrant’s Report on Form 8-K filed September 28, 2005). Amendment to General Mills, Inc. Supplemental Savings Plan (incorporated herein by reference to Exhibit 10.2 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended February 26, 2006). Amendment to General Mills, Inc. Supplemental Retirement Plan (incorporated herein by reference to Exhibit 10.3 to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended February 26, 2006). 12 Computation of Ratio of Earnings to Fixed Charges. _ 57 Exhibit No. 21 23 31.1 31.2 32.1 32.2 Description List of Subsidiaries of the Registrant. Consent of Independent Registered Public Accounting Firm. Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Items that are management contracts or compensatory plans or arrangements required to be filed as exhibits pursuant to Item 15 of Form 10-K. Pursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of certain instruments defining the rights of holders of our long-term debt are not filed and, in lieu thereof, we agree to furnish copies to the SEC upon request. _ 58 S I G N AT U R E S Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: July 27, 2006 GENERAL MILLS, INC. By: /s/ Siri S. Marshall Siri S. Marshall Senior Vice President, General Counsel and Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature /s/ Paul Danos Paul Danos /s/ William T. Esrey William T. Esrey /s/ Raymond V. Gilmartin Raymond V. Gilmartin /s/ Judith Richards Hope Judith Richards Hope /s/ Heidi G. Miller Heidi G. Miller Title Director Director Director Director Director /s/ Hilda Ochoa-Brillembourg Director Hilda Ochoa-Brillembourg Director Date July 20, 2006 July 24, 2006 July 21, 2006 July 21, 2006 July 21, 2006 July 20, 2006 July 24, 2006 /s/ Steve Odland Steve Odland /s/ Kendall J. Powell Kendall J. Powell /s/ Michael D. Rose Michael D. Rose /s/ Robert L. Ryan Robert L. Ryan /s/ Stephen W. Sanger Stephen W. Sanger /s/ A. Michael Spence A. Michael Spence President, Chief Operating Officer and Director July 21, 2006 Director Director Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer) Director July 24, 2006 July 24, 2006 July 20, 2006 July 21, 2006 _ 59 Signature Title /s/ Dorothy A. Terrell Dorothy A. Terrell /s/ James A. Lawrence James A. Lawrence /s/ Kenneth L. Thome Kenneth L. Thome Director Vice Chairman and Chief Financial Officer (Principal Financial Officer) Senior Vice President, Financial Operations (Principal Accounting Officer) Date July 20, 2006 July 20, 2006 July 24, 2006 _ 60 G E N E R A L M I L L S , I N C . A N D S U B S I D I A R I E S S C H E D U L E I I – VA L U AT I O N A N D Q U A L I F Y I N G A C C O U N T S In Millions Allowance for doubtful accounts: Balance at beginning of year Additions charged to expense Bad debt write-offs Other adjustments and reclassifications Balance at end of year Valuation allowance for deferred tax assets: Balance at beginning of year Additions charged to expense and deferred tax asset Adjustments to acquisition amounts Balance at end of year Reserve for restructuring and other exit charges: Balance at beginning of year Additions charged to expense Net amounts utilized for restructuring activities Balance at end of year Reserve for LIFO valuation: Balance at beginning of year Increment Balance at end of year May 28, 2006 Fiscal Year Ended May 29, 2005 May 30, 2004 $ 19 2 (3) – $ 18 $855 15 (12) $858 $ 18 30 (33) $ 15 $ 45 17 $ 62 $ 19 – (2) 2 $ 19 $809 31 15 $855 $ 23 84 (89) $ 18 $ 41 4 $ 45 $ 28 3 (13) 1 $ 19 $791 34 (16) $809 $ 37 26 (40) $ 23 $ 27 14 $ 41 _ 61 EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES In Millions Earnings before Income Taxes and After-tax Earnings from Joint Ventures Plus: Earnings from Joint Ventures before Income Taxes Plus: Fixed Charges (1) Less: Capitalized Interest Earnings Available to Cover Fixed Charges Ratio of Earnings to Fixed Charges (1) Fixed Charges: Interest and Minority Interest Expense, Gross Rentals (1/3) Total Fixed Charges May 28, 2006 $1,567 93 463 (1) $2,122 4.58 $ 428 35 $ 463 May 29, 2005 $1,815 121 524 (3) $2,457 4.69 $ 488 36 $ 524 Fiscal Year Ended May 30, 2004 $1,509 100 569 (8) $2,170 3.81 $ 537 32 $ 569 May 25, 2003 $1,316 81 619 (8) $2,008 3.24 $ 589 30 $ 619 May 26, 2002 $ 667 40 468 (3) $1,172 2.50 $ 445 23 $ 468 For purposes of computing the ratio of earnings to fixed charges, earnings represent earnings before taxes and after-tax earnings of joint ventures, plus pretax earnings or losses of joint ventures, fixed charges and less capitalized interest. Fixed charges represent gross interest expense and subsidiary preferred distributions to minority interest holders, plus one-third (the proportion deemed representative of the interest factor) of rent expense. _ 62 EXHIBIT 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Stephen W. Sanger, certify that: 1. I have reviewed this annual report on Form 10-K of General Mills, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: July 27, 2006 Stephen W. Sanger Chairman of the Board and Chief Executive Officer _ 63 EXHIBIT 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, James A. Lawrence, certify that: 1. I have reviewed this annual report on Form 10-K of General Mills, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: July 27, 2006 James A. Lawrence Vice Chairman and Chief Financial Officer _ 64 EXHIBIT 32.1 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Stephen W. Sanger, Chairman of the Board and Chief Executive Officer of General Mills, Inc. (the “Company”), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) the Annual Report on Form 10-K of the Company for the fiscal year ended May 28, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: July 27, 2006 Stephen W. Sanger Chairman of the Board and Chief Executive Officer EXHIBIT 32.2 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, James A. Lawrence, Vice Chairman and Chief Financial Officer of General Mills, Inc. (the “Company”), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: (1) the Annual Report on Form 10-K of the Company for the fiscal year ended May 28, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: July 27, 2006 James A. Lawrence Vice Chairman and Chief Financial Officer _ 65 Shareholder Information General Mills World Headquarters Number One General Mills Boulevard Minneapolis, MN 55426-1347 Phone: (763) 764-7600 Internet For corporate reports and company news, visit our Web site at www.generalmills.com Markets New York Stock Exchange Trading Symbol: GIS Independent Auditor KPMG LLP 4200 Wells Fargo Center 90 South Seventh Street Minneapolis, MN 55402-3900 Phone: (612) 305-5000 Investor Inquiries Contact the Investor Relations department at (800) 245-5703 or (763) 764-3202. Transfer Agent, Registrar, Dividend Payments and Dividend Reinvestment Plan Wells Fargo Bank, N.A. 161 North Concord Exchange P.O. Box 64854 St. Paul, MN 55164-0854 Phone: (800) 670-4763 or (651) 450-4084 E-mail access via: www.wellsfargo.com/ shareownerservices Account access via Web site: www.shareowneronline.com Corporate Social Responsibility Report Available As a global leader in the food industry, we are committed to making a difference in our con- sumers’ lives and in our communities. For more information about all aspects of our corporate citizenship, see our 2006 Corporate Social Responsibility Report available at www.generalmills.com Notice of Annual Meeting The annual meeting of General Mills shareholders will be held at 11 a.m., Central Daylight Time, Monday, Sept. 25, 2006, at the Children’s Theatre Company, 2400 Third Avenue South, Minneapolis, Minnesota. Electronic Access to General Mills Proxy Statement, Annual Report and Form 10-K General Mills offers shareholders access to its Proxy Statement, Annual Report and Form 10-K online as a convenient and cost-effective alternative to mailing the printed materials. Shareholders who have access to the Internet are encour- aged to enroll in the electronic access program. Please go to the Web site www.icsdelivery.com/gis and follow the instructions to enroll. If your General Mills shares are not registered in your name, contact your bank or broker to enroll in this program. . c n I o h t i L y b g n i t n i r P n o s i d d A y b n g i s e D © 2006 General Mills, Inc. Holiday Gift Boxes General Mills Gift Boxes are a part of many shareholders’ December holiday traditions. To request an order form, call us toll free at (800) 936-0327 or write, including your name, street address, city, state, zip code and phone number (including area code) to: 2006 General Mills Holiday Gift Box Department 4527 P.O. Box 5006 Stacy, MN 55078-5006 Or you can place an order online at www.gmiholidaygiftbox.com Please contact us after Oct. 1, 2006. General Mills P.O. Box 1113 Minneapolis, MN 55440 -1113 (763)764-7600 www.generalmills.com 

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