1985 年伯克希尔完整年报

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Item 601 Reg. S-K Exhibit 13 Prem Jain 38 BERKSHIRE HATHAWAY ING ANNUAL REPORT TO THE STOCKHOLDERS 1985

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BERKSHIRE HATHAWAY INC. 1985 ANNUAL REPORT TABLE OF CONTENTS Selected Financial Data At Five-Year Intervals Inside Front Cover Owner-Related Business Principles .............. 2 Chairman's Letter* ............ 4 Accountants' Certificate .....24 Consolidated Financial Statements ..25 Summarized Financial Statements — Parent Company Only .43 Business Activities of The Company . 44 Managements' Discussion . 49 Annual Report Letter - Wesco Financial Corporation .56 Shareholder-Designated Contributions . 66 Changing Price Data .68 Shareholders' Views re. Advisory Matters .69 Common Stock Data ..70 Selected Financial Data For The Past Five Years ........71 Directors, Officers and Operating Managers . Inside Back Cover PURDUE UNIVERSITY]

• Copyright 0) RigHt BY Warren E. Buffett

SEP < 7 1986 1

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BERKSHIRE HATHAWAY INC. OWNER-RELATED BUSINESS PRINCIPLES Reproduced from Chairman's letter in 1983 Annual Peport follow that pertain io : ." manager-owner relationship. With so many new shareholders. it's appropriate to summarize the major business principles we shareholders as owner-partners, and of ourselves as managing partners. (Because of the size of our • Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our itself as the ultimate owner of our business assets but, instead, view the company as a conduit through shareholdings we also are, for better or worse, controlling partners.) We do not view the company which our sharaholders own the assets. In the case of at least four of the five, over 50% of family net worth is represented by holdings of • In line with this owner-orientation, our directors are all major shareholders of Berkshire Hathaway. Berkshire. We eat our own cooking. the average annual rate of gain in intrinsic business value on a per-share basis. We do not measure • Our long-term economic goal (subject to some qualifications mentioned laier) is to maximize We are certain that the rate of per-share progress will diminish in the future - a greatly enlarged the economic significance or performance of Berkshire by its size: we measure by per-share progress. average large American corporation. capital base will sec to that. But we will be disappointed if our rate does not exceed tha! of the that generate cash and consistently earn above-average returns on capital. Our second choice is to • Our preference would be to reach this goal by directly owning a diversified group of businesses capital determine any given year's capital allocation. conventional accounting, consolidated reported earnings may reveal relatively little about our true • Because of this two-pronged approach to business ownership and because of the limitations of numbers. However, we will also report to you the earnings of each major business we control, numbers economic performance. Charlie and 1, both as owners and managers, virtua!ly ignore such consolidated the individun! businesses, should generally aid you in making judgments about them. we consider of great importance. These figures, along with other information we will supply about acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us • Accounting consequences de not influence our operating or capital-allocation decisions. When precisely the choice that often faces us since entire businesses (whose earnings will be fully reportable) under standard accounting principles than to purchase $1 of earnings that is reportable. This is In aggregate and over time, we expect the unreported garnings to be fully reflected in our intrinsic frequently sell for double the pro-rata price of small portions (whose earnings will be largely unreportable). business value through capital gains. rate basis. We will reject interesting opportunities rather than • We rarely use much debt and, when we do, we attempi to structure it on e long-term fixed- conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering over-leveroge our balance sheet. This committed unusually large portions of their net worth to our care. (As one of the Indianapolis "500" our fiduciary obligations to policyholders, depositors, lenders and the many equity holders who have winners said: "To finish first, you must first finish.") 128) 2

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purchasing entire businesses at control prices that ignore long-term economic consequences to our • A managerial "wisalist" will not be filled at shareholder expense. We will not diversify by the values you can obtain by diversifying your own portfolios through direct purchases in the stock shareholders. We will only do with your money what 1. would do with our own, weighing fully oi retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of • We feel noble intentions should be checked periodically against results. We test the wisdom market value for each S1 retained. To date, this test has been met. We will continue to apply it on This rule applies to all forms of issuance — not only mergers or public stock offerings, but stock- • We will issue common stock only when we receive as much in business value as we give. for-debt swaps, slock options, and convertible securities as weil. We will not sell small portions of the value of the entire enterprise. your company — ind that is what the issuance of shares amounts to - on a basis inconsistent with regarless of price, we have no interest at all in selling any good businesses that Berkshire owns, • You should be fully aware of one attitude Charlie and I share that hurts our financial performance: and are very reluctan! to sell sub-par businesses as long as we expect them to generate at least some the capital-allocation mistakes that led us into such sub-par businesses. And we react with great cash and as long as we feel good about their managers and labor relations. We hope not to repeat caution to suggestions that our poor businesses can be restored to satisfactory profitability by major end. major additional investment in a terrible industry usually is about as rewarding as struggling in capital expenditures. (The projections will be dazzling - the advocates will be sincere - but, in the each turn) is not our style. We would rather have our overall results penalized a bit than engage quicksand.) Nevertheless. gin rummy managerial behavior (discord your least promising business at in it. appraising business value. Our guideline is to tell you the business facts that we would want to knew • We will be candid in our reporting to you, emphasizing the pluses and minuses important in business. it would be inexcusable for us to apply lesser standards of accuracy, balance and incisiveness if our positions were raversed. We owe you no less. Morenver, as a company with a major communications when reperting on ourselves than we would expect our news people to apply when reporting on others. We also believe condor benefits us as manager: the CEO who misleads others in public may eventually mislead himself in privata. the extent legally required. Good investment ideas • Despite our policy of cander, we will discuss our activities in marketable securities only to approriation just as good product or business acquisition ideas are. Therefore, we normally will not are rare, valuable and subject Ir rompetitive purchase them again) and to stocks we are incorrectly rumored to be buying. If we deny those reports talk about our investment ideas. This ban extends even to securities we have sold (because we may but say "no comment" on other occasions, the no-comments become confirmation. That completes the catechism... 3

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BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc.: General Foods. term participation in the insurance business of Fireman's Fund, and (d) our sale of our stock in Our gain in net worth during the year was $613.6 million, or 48.2%. It is fitting that the visit of gain in per-share book value over the last twenty-one years (that is, since present management took Hally Comet coincided with this percentage gain: neither will be seen again in my lifetime. Our not be repeated. over) has been from $19.46 to $1643.71, or 23.2% compounded annually, another percentage that will Two factors make anything approaching this rate of gain unachievable in the future. One factor that prevailed throughout much of the 1964-1984 period. Today we cannot find significantly-undervalued

• probably transitory — is a stock market that offers very little opportunity compared to the markets

from that existing about a decade ago, when the only question was which bargain to choose. equities to purchase for our insurance company portfolios. The current situation is 180 degrees removed annual report I could say: "We consider several of our major holdings to have great potential for This change in the market also has negative implications for our present portfolio. In our 1974 significantly increased values in future years." I can't say that now. It's true that our insurance companies currently hold major positions in companies with exceptional underlying economics and these attributes, whereas they were ignored in 1974. Today's valuations mean that our insurance outstanding managements, just as they did in 1974. But current market prices generously appraise companies have no chance for future portfolio gains on the scale of those achieved in the past. times what it was only ten years ago. And an iron law of business is that growth eventually dampens The second negative factor, far more telling, is our size. Our equity capital is more than twenty exceptional economics. Just look at the records of high-return companies once they have amassed even $1 billion of equity capital. None that I know of has managed subsequently, over a ten-year earnings. Instead, to sustain their high returns, such companies have needed to shed a lot of capital period, to keep on earning 20% or more on equity while reinvesting all or substantially all of its by way of either dividends or repurchases of stock. Their shareholders would have been far better off if all earnings could have been reinvested at the fat returns earned by these exceptional businesses. But the companies simply couldn't turn up enough high-return opportunities to make that possible. in our capital base during 1985. (Here's a little perspective: leaving aside oil companies, only about 15 U.S. businesses have managed to earn over $5.7 billion during the past ten years.) ability to earn returns superior to those earned by corporate America generally, and you will benefit Charlie Munger, my partner in managing Berkshire, and I are reasonably optimistic about Berkshire's from the company's retention of all earnings as long as those returns are forthcoming. We have several things going for us: (1) we don't have to worry about quarterly or annual figures but, instead, can focus on whatever actions will maximize long-term value; (2) we can expand the business into any areas that make sense — our scope is not circumscribed by history, structure, or concept; and (3) we love our work. All of these help. Even so, we will also need a full measure of good fortune to average our hoped-for 15% — far more good fortune than was required for our past 23.2%. 4

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We need to mention one further item in the investment equation that could affect recent purchasers of our stock. Historically, Berkshire shares have sold modestly below intrinsic business value. With the price there, purchasers could be certain (as long as they did not experience a widening of this the business. But recently the discount has disappeared, and occasionally a modest premium has discount) that their personal investment experience would at least equal the financial experience of prevailed. The elimination of the discount means that Berkshire's market value increased even faster than business value (which, itself, grew at a pleasing pace). That was good news for any owner holding experience of new owners of Berkshire is merely to match the future financial experience of the while that move took place, but it is bad news for the new or prospective owner. If the financial company, any premium of market value over intrinsic business value that they pay must be maintained. Management cannot determine market prices, although it can, by its disclosures and policies, encourage rational behavior by market participants. My own preference, as perhaps you'd guess, is for a market price that consistently approximates business value. Given that relationship, all owners prices far above and below business value do not change the final gains for owners in aggregate; in prosper precisely as the business prospers during their period of ownership. Wild swings in market the end, investor gains must equal business gains. But long periods of substantial undervaluation and/ or overvaluation will cause the gains of the business to be inequitably distributed among various owners, with the investment result of any given owner largely depending upon how lucky, shrewd, or foolish he happens to be. Over the long term there has been a more consistent relationship between Berkshire's market value and business value than has existed for any other publicly-traded equity with which I am the market price for Berkshire stock has almost always been sensible. This unusual result has been familiar. This is a tribute to you. Because you have been rational, interested, and investment-oriented, achieved by a shareholder group with unusual demographics: virtually all of our shareholders are individuals, not institutions. No other public company our size can claim the same. professionals, would be a force for stability and reason in financial markets. They are not: stocks You might think that institutions, with their large staffs of highly-paid and experienced investment heavily owned and constantly monitored by institutions have often been among the most inappropriately Ben Graham told a story 40 years ago that illustrates why investment professionals behave as "You're qualified for residence", said St. Peter, "but, as you can see, the compound reserved for oil they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. he might say just four words to the present occupants. That seemed harmless to St. Peter, so the men is packed. There's no way to squeeze you in." After thinking a moment, the prospector asked if prospector cupped his hands and yelled, "Oil discovered in hell." Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. "No," he said, "I think I'll go along with the rest of the boys. There might be some truth to that rumor after all." Sources of Reported Earnings numbers, along with far more detailed sub-segment numbers, are the ones that Charlie and I focus The table on the next page shows the major sources of Berkshire's reported earnings. These upon. We do not find consolidated figures an aid in either managing or evaluating Berkshire and, in fact, never prepare them for internal use. multi-line business. Corporate managers always have insisted upon such information before making Segment information is equally essential for investors wanting to know what is going on in a acquisition decisions but, until a few years ago, seldom made it available to investors faced with acquisition and disposition decisions of their own. Instead, when owners wishing to understand the economic realities of their business asked for data, managers usually gave them a we-can't-tell-you- 5

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what-is-going-on-because-it-would-hurt-the-company answer. Ultimately the SEC ordered disclosure of segment data and management began supplying real answers. The change in their behavior recalls an insight of Al Capone: "You can get much further with a kind word and a gun than you can with outlined in the Appendix to my letter in the 1983 annual report, is aggregated as a separate item. (A In the table, amortization of Goodwill is not charged against the specific businesses but, for reasons compendium of the 1977-1984 letters is available upon request.) In the Business Segment Data and Management's Discussion sections on pages 39-41 and 49-55, much additional information regarding our businesses is provided, including Goodwill and Goodwill Amortization figures for each of the which starts on page 56. segments. I urge you to read those sections as well as Charlie Munger's letter to Wesco shareholders, (000s omitted) Berkshire's Share of Net Earnings Pre-Tax Earnings (after taxes and minority interests) Operating Earnings: 1985 1984 1985 1984 Insurance Group: Underwriting Net Investment Income $ (44,230) $ (48,060) Associated Retail Stores 95,217 $(23,569) 270 68,903 79,716 $ (25,955) Buffalo News Blue Chip Stamps (1,072) 134 62,059 5,763 (1,843) 2,813 (579) Nebraska Furniture Mart Mutual Savings and Loan 29,921 27,328 (899) 2,622 1,456 14,580 13,317 Precision Steel 12,686 14,511 4,016 3,151 See's Candies 3,896 4,092 1,477 5,181 5,917 Textiles 28,989 26,644 1,696 418 14,558 Wesco Financial (2,395) 13,380 9,500 9,777 (1,324) 226 Interest on Debt Amortization of Goodwill (1,475) (14,734) (1,434) 4,191 (1,475) 4,828 Shareholder-Designated Contributions (14,415) (7,288) (7,452) (1,434) Other (4,006) (3,179) Operating Earnings 3,106 (2,164) 4,932 2,102 (1,716) 3,475 Special General Foods Distribution 125,449 Special Washington Post Distribution 4,127 87,739 92,948 8,111 3,779 70,014 Sales of Securities 468,903 14,877 7,294 104,699 - 13,851 - Total Earnings — all entities ....... $613,356 325,237 71,587 $200,549 $435,815 $148,895 Our 1985 results include unusually large earnings from the sale of securities. This fact, in itself, does not mean that we had a particularly good year (though, of course, we did). Security profits in four years is recognized on a day when nothing further is learned. We may hold a stock for a decade a given year bear similarities to a college graduation ceremony in which the knowledge gained over or more, and during that period it may grow quite consistently in both business and market value. In the year in which we finally sell it there may be no increase in value, or there may even be a decrease. But all growth in value since purchase will be reflected in the accounting earnings of the year of sale. (If the stock owned is in our insurance subsidiaries, however, any gain or loss in market year are meaningless as a measure of how well we have done in the current year. value will be reflected in net worth annually.) Thus, reported capital gains or losses in any given came about through the sale of our General Foods shares. We held most of these shares since 1980, A large portion of the realized gain in 1985 ($338 million pre-tax out of a total of $488 million) 6

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when we had purchased them at a price far below what we felt was their per/share business value. Year by year, the managerial efforts of Jim Ferguson and Phil Smith substantially increased General Foods' business value and, last fall, Philip Morris made an offer for the company that reflected the increase. We thus benefited from four factors: a bargain purchase price, a business with fine underlying economics, an able management concentrating on the interests of shareholders, and a buyer willing to pay full business value. While that last factor is the only one that produces reported earnings, we ….. consider identification of the first three to be the key to building value for Berkshire shareholders. In selecting common stocks, we devote our attention to attractive purchases, not to the possibility of We have again reported substantial income from special distributions, this year from Washington Post and General Foods. (The General Foods transactions obviously took place well before the Philip back to it simultaneously with its purchase of shares from other shareholders. The number of shares Morris offer.) Distributions of this kind occur when we sell a portion of our shares in a company we sell is contractually set so as to leave our percentage ownership in the company precisely the same after the sale as before. Such a transaction is quite properly regarded by the IRS as substantially equivalent to a dividend since we, as a shareholder, receive cash while maintaining an unchanged ownership interest. This tax treatment benefits us because corporate taxpayers, unlike individual taxpayers, incur much lower taxes on dividend income than on income from long-term capital gains. (This difference will be widened further if the House-passed tax bill becomes law: under its provisions, capital gains realized by corporations will be taxed at the same rate as ordinary income.) However, accounting rules are unclear as to proper treatment for shareholder reporting. To conform with last year's treatment, we have shown these transactions as capital gains. Though we have not sought out such transactions, we have agreed to them on several occasions when managements initiated the idea. In each case we have felt that non-selling shareholders (all of made their repurchases at prices below intrinsic business value. The tax advantages we receive and whom had an opportunity to sell at the same price we received) benefited because the companies our wish to cooperate with managements that are increasing values for all shareholders have sometimes led us to sell - but only to the extent that our proportional share of the business was undiminished. At this point we usually turn to a discussion of some of our major business units. Before doing so, however, we should first look at a failure at one of our smaller businesses. Our Vice Chairman, Charlie Munger, has always emphasized the study of mistakes rather than successes, both in business and other aspects of life. He does so in the spirit of the man who said: "All I want to know is where I'm going to die so I'll never go there." You'll immediately see why we make a good team: Charlie insurance businesses. Shutdown of Textile Business In July we decided to close our textile operation, and by yearend this unpleasant job was largely completed. The history of this business is instructive. control of Berkshire Hathaway 21 years ago, it had an accounting net worth of $22 million, all devoted When Buffett Partnership, Ltd., an investment partnership of which I was general partner, bought to the textile business. The company's intrinsic business value, however, was considerably less because the textile assets were unable to earn returns commensurate with their accounting value. Indeed, during the previous nine years (the period in which Berkshire and Hathaway operated as a merged company) aggregate sales of $530 million had produced an aggregate loss of $10 million. Profits had been reported from time to time but the net effect was always one step forward, two steps back. At the time we made our purchase, southern textile plants - largely non-union - were believed to have an important competitive advantage. Most northern textile operations had closed and many people thought we would liquidate our business as well.

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(9) (10 wo immediately selected to be president, Ken Chace. In this respect we were 100% correct: Ken and We fell, however, that the business would be run much better by a long-time employee whom at our more profitable businesses. his recent successor, Garry Morrison, have been excellent managers, every bit the equal of managers via the purchase of National Indemnity Company. Some of the money came from earnings and some In early 1967 cash generated by the textile operation was used to fund our entry into insurance from reduced investment in lextile inventories, receivebles, and fixed assets. This pullback proved no! even in cyclical upturns. wise: although much improved by Ken's management, the textile business never became a good earner, effect on our overall return diminished as the business became a progressively smaller portion of the Further diversification for Berkshire followed, and gradually the textile operation's depressing summarized at other times also): "(1) our extile businesses are very important employers in their corporation. We remained in the business for reasons that I sisted in the 1978 annual report (and long as these conditions prevail - and we expect that they will - we intend to continue to support our textile business despite more attractive alternative uses for capital." thereafter consumed It turned out that I was very wrong about (4). Though 1979 was moderately profitable, the business condition was almost sure to continue. Could we have found a buyer who would continue operations, major amounts of cash. By mid-1985 it became clear, even to me, that this to others, and interest was nil. our corporate rate of return. However, I also feel it inappropriate for even an exceptionally profitable I won't close down businesses of sub-normal profitability merely to add a fraction of a point to would disagreo with my first proposition, and Kail Marx would disagree with my second; the middle company to fund an operation once it appears to have unending losses in prospect. Adam Smith ground is the only position that leaves me comfortable. attempting to make our textile operalion a success. Trying to achieve sustainable profitability, they I should reemphasize that Ken and Garry have been resourceful, energetic and imaginative in reworked product lines. machinery configurations and distribution arrangements. We also made a business to axplain an acquisition thai otherwise makes no sense). But in the end nothing worked major acquisition, Waumbec Mills, with the expectation of important synergy (a term widely used in mills have closed since 1990. Their owners were not privy to any information that was unknown to and I should be faulted for not quitting sooner. A recent Business Week article stated that 250 textile i no is live a leone has preced the neil in which substantial excess capucity exists. Much The domestic textile industry operates in a commodity business. competing in a world market both directly and indirectly, to competition from loreign countries whose workers are paid a small of the trouble we experienced was attributable, blame for our closing. In faci, in comparison with employees of American industry generally, our fraction of the U.S. minimum wage. But that in no way means that our labor force deserves any workers were poorly paid, as has been the case throughout the textile business. In contract negotiations. sing a ta be he ase there for unrealistic wage increases or unproductive work practices. union leaders and members were sensitive to our disadvantageous cost position and did not push as we did to keep us competitive. Even during our liquidation period they performed superbly. To the contrary, they tried just as hard (Ironically, we would have been better off financially if our union hed behaved unreasonably some and avoided significant future losses.) years ago: we then would have recognized the impossible future that we faced, promptly closed down, 8 Notes to Consolidated Financial Statements (Continued)

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(11) that would have allowed us to somewhat reduce variable costs. Each proposal to do so looked like Over the years, we had the option of making large capital expenditurs in the textile operation promised greater economic benehts than would have resulted from comparable expenditures in our an immediate winner. Measured by standard return-on-investment tests, in fact, these proposals usually highly-profitable candy and newspaper businesses. both domestic and foreign, were stepping up to the same kind of expenditures and, once enough But the promised benefits from these textile investments were illusory. Many of our competitors, individually, each company's capital invesiment decision appeared cost-effective and rational; viewed companies did so, their reduced costs became the ba. "ine for reduced prices industrywide. Viewed person watching a parade decides he can see a little better if he stands on tiptoes). After each round collectively, the decisions neutralized each other and were irrational (just as happens when each business alive, but would have left us with terrible returns on ever-growing amounts of capital. After Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile advantage in labor costs. A refusal to invest, however, would make us increasingly non-competitive, the investment, moreover, the foreign competition would still have relained a major, continuing by Woody Allen in one of his movies: "More than any other time in history, mankind faces a crossroads. even measured against domestic textile manufacturers. I always thought myself in the position described the wisdom to choose correctly." One path leads to despair and utter hopelessness, the other to total extinction. Let us pray we have business, it is instructive to look at Burlington Industries, by far the largest U.S. textile company both For an underslanding of how the to-inves!-or-not-to-invest dilemma plays out in a commodity 21 years ago and now. In 1964 Burlington had sales of $1.2 billion against our $50 million. It had strengths in both distribution and production that we could never hope to match and also, of course, had an earnings record far superior to ours. Its stock soid at 60 at the end of 1964: ours was 13. billion. During the 1964-85 period, the company made capital expenditures of aboul $3 billion, far Burlington made a decision to stick to the textile business, and in 1985 had sales of about $2.8 more than any other U.S. textile company and more than $200-per-share on that $60 stock. A very large part of the expenditures, I am sure, was devoted to cost improvement and expansion. Given decisions were quite rational. Burlington's basic commitment to stay in textiles. I would also surmise that the company's capital and equity now than 20 years ago. Split 2-for-1 in 1965, the stock now sells at 34 - on an adjusted Nevertheless, Burlington has lost sales volume in real dollars and has far lower returns on sales basis. just a little over its $60 price in 1964. Meanwhile, the CPI has more than tripled. Therefore, have been paid but they, too, have shrunk significantly in purchasing power. each share commands about one-third the purchasing power it did at the end of 1964. Regular dividends and energy are applied to a faulty premise. The situation is suggestive of Samuel Johnson's horse: "A This devastating outcome for the shareholders indicates what can happen when much brain power horse thai can count to ten is e remarkable horse - not a remarkable mathematician." Likewise, a textile company that allocates capital brilliantly within its industry is a remarkable textile company

• but not a remarkable business.

a good managerial record (measured by economic returns) is far more a function of what business My conclusion from my own experiences and from much observation of other businesses is that of course, in any business, good or bad). Some years ago I wrote: "When a managerent with a boat you get into than it is of how effectively you row (though intelligence and effort help considerably. the reputation of the business that remains intact." Nothing has since changed my point of view on reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is is likely to be more productive than energy devoted to patching leaks. that matter. Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels ••• 9 35

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in their stock-buying decisions (as I, in my early years, did myself). And some economists and There is an investment postscript in our textile saga. Some investors weight book value heavily academicians believe replacement values are of considerable importance in calculating an appropriate price level for the stock market as a whole. Those of both persuasions would have received an education at the auction we held in early 1986 to dispose of our textile machinery. The equipment sold (including some disposed of in the few months prior to the auction) took up about 750,000 square feet of factory space in New Bedford and was eminently usable. It originally cost us about $13 million, including $2 million spent in 1980-84, and had a current book value of the equipment could have been replaced new for perhaps $30-$50 million. $866,000 (after accelerated depreciation). Though no sane management would have made the investment, Gross proceeds from our sale of this equipment came to $163,122. Allowing for necessary pre- and post-sale costs, our net was less than zero. Relatively modern looms that we bought for $5,000 apiece in 1981 found no takers at $50. We finally sold them for scrap at $26 each, a sum less than removal costs. candy store — considerably exceeds the proceeds we received from this massive collection of tangible Ponder this: the economic goodwill attributable to two paper routes in Buffalo - or a single See's assets that not too many years ago, under different competitive conditions, was able to employ over 1,000 people. Three Very Good Businesses (and a Few Thoughts About Incentive Compensation) also working on a book and each night he dictated a few pages to me. The title — brace yourself — When I was 12, I lived with my grandfather for about four months. A grocer by trade, he was was sure that interest in these two subjects was universal and that the world awaited his views. You was "How to Run a Grocery Store and a Few Things I Have Learned About Fishing". My grandfather (and personality). may conclude from this section's title and contents that I was overexposed to Grandpa's literary style News here because the economic strengths, weaknesses, and prospects of these businesses have changed I am merging the discussion of Nebraska Furniture Mart, See's Candy Shops, and Buffalo Evening little since I reported to you a year ago. The shortness of this discussion, however, is in no way meant to minimize the importance of these businesses to us: in 1985 they earned an aggregate of $72 about $8 million pre-tax. million pre-tax. Fifteen years ago, before we had acquired any of them, their aggregate earnings were While an increase in earnings from $8 million to $72 million sounds terrific — and usually is — you should not automatically assume that to be the case. You must first make sure that earnings were not severely depressed in the base year. If they were instead substantial in relation to capital to produce the additional earnings? employed, an even more important point must be examined: how much additional capital was required In both respects, our group of three scores well. First, earnings 15 years ago were excellent compared to capital then employed in the businesses. Second, although annual earnings are now $64 was the case then. million greater, the businesses require only about $40 million more in invested capital to operate than only minor amounts of capital, illustrates very well the power of economic goodwill during an The dramatic growth in earning power of these three businesses, accompanied by their need for inflationary period (a phenomenon explained in detail in the 1983 annual report). The financial characteristics of these businesses have allowed us to use a very large portion of the earnings they generate elsewhere. Corporate America, however, has had a different experience: in order to increase earnings significantly, most companies have needed to increase capital significantly also. The average American business has required about $5 of additional capital to generate an additional $1 of annual from its owners in order to achieve an earnings performance equal to our group of three. pre-tax earnings. That business, therefore, would have required over $300 million in additional capital 10

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When returns on capital are ordinary, an earn-more-by-putting-up-more record is no great managerial achievement. You can get the same result personally while operating from your rocking chair. Just quadruple the capital you commit to a savings account and you will quadruple your earnings. You would hardly expect hosannas for that particular accomplishment. Yet, retirement announcements their reign - with no one examining whether this gain was attributable simply to many years of regularly sing the praises of CEOs who have, say, quadrupled earnings of their widget company during retained earnings and the workings of compound interest. if capital employed only doubled during the CEO's reign, the praise for him may be well deserved If the widget company consistently earned a superior return on capital throughout the period, or But if return on capital was lackluster and capital employed increased in pace with earnings, applause should be withheld. A savings account in which interest was reinvested would achieve the same year- by-year increase in earnings — and, at only 8% interest, would quadruple its annual earnings in 18 years. The power of this simple math is often ignored by companies to the detriment of their shareholders. Many corporate compensation plans reward managers handsomely for earnings increases produced solely, or in large part, by retained earnings — i.e., earnings withheld from owners. For example, ten- year, fixed-price stock options are granted routinely, often by companies whose dividends are only a small percentage of earnings. you had a $100,000 savings account earning 8% interest and "managed" by a trustee who could An example will illustrate the inequities possible under such circumstances. Let's suppose that decide each year what portion of the interest you were to be paid in cash. Interest not paid out would in his superior wisdom, set the "pay-out ratio" at one-quarter of the annual earnings. be "retained earnings" added to the savings account to compound. And let's suppose that your trustee, Additionally, your annual earnings would have increased about 70% from $8,000 to $13,515 under Under these assumptions, your account would be worth $179,084 at the end of ten years. this inspired management. And, finally, your "dividends" would have increased commensurately, rising regularly from $2,000 in the first year to $3,378 in the tenth year. Each year, when your manager's public relations firm prepared his annual report to you, all of the charts would have had lines marching skyward. Now, just for fun, let's push our scenario one notch further and give your trustee-manager a ten- in the first year. With such an option, your manager would reap a substantial profit at your expense year fixed-price option on part of your "business" (i.e., your savings account) based on its fair value — just from having held on to most of your earnings. If he were both Machiavellian and a bit of a mathematician, your manager might also have cut the pay-out ratio once he was firmly entrenched. This scenario is not as farfetched as you might think. Many stock options in the corporate world have worked in exactly that fashion: they have gained in value simply because management retained earnings, not because it did well with the capital in its hands. issuing corporation immediate and substantial compensation), I believe it is fair to say that nowhere Managers actually apply a double standard to options. Leaving aside warrants (which deliver the in the business world are ten-year fixed-price options on all or a portion of a business granted to outsiders. Ten months, in fact, would be regarded as extreme. It would be particularly unthinkable outsider wanting to secure such an option would be required to pay fully for capital added during for managers to grant a long-term option on a business that was regularly adding to its capital. Any the option period. to do-unto-themselves. (Negotiating with one's self seldom produces a barroom brawl.) Managers The unwillingness of managers to do-unto-outsiders, however, is not matched by an unwillingness regularly engineer ten-year, fixed-price options for themselves and associates that, first, totally ignore the fact that retained earnings automatically build value and, second, ignore the carrying cost of capital. As a result, these managers end up profiting much as they would have had they had an option on that savings account that was automatically building up in value. 11

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Of course, stock options often go to talented, value-adding managers and sometimes deliver them rewards that are perfectly appropriate. (Indeed, managers who are really exceptional almost always get far less than they should.) But when the result is equitable, it is accidental. Once granted, the option is blind to individual performance. Because it is irrevocable and unconditional (so long as a manager stays in the company), the sluggard receives rewards from his options precisely as does the system. star. A managerial Rip Van Winkle, ready to doze for ten years, could not wish for a better "incentive" Government on Chrysler shares as partial consideration for the government's guarantee of some life- (I can't resist commenting on one long-term option given an "outsider": that granted the U.S. saving loans. When these options worked out well for the government, Chrysler sought to modify the in relation to its contribution to Chrysler's recovery. The company's anguish over what it saw as an payoff, arguing that the rewards to the government were both far greater than intended and outsize imbalance between payoff and performance made national news. That anguish may well be unique: to my knowledge, no managers — anywhere — have been similarly offended by unwarranted payoffs arising from options granted to themselves or their colleagues.) managers and owners in the same financial boat. In reality, the boats are far different. No owner has Ironically, the rhetoric about options frequently describes them as desirable because they put • ever escaped the burden of capital costs, whereas a holder of a fixed-price option bears no capital costs at all. An owner must weigh upside potential against downside risk; an option holder has no downside. In fact, the business project in which you would wish to have an option frequently is a I'll never buy one.) project in which you would reject ownership. (I'll be happy to accept a lottery ticket as a gift - but serve the owner. Think back to the savings account example. The trustee, holding his option, would In dividend policy also, the option holders' interests are best served by a policy that may ill benefit from a no-dividend policy. Conversely, the owner of the account should lean to a total payout so that he can prevent the option-holding manager from sharing in the account's retained earnings. relates to their indiscriminate use and, in that connection, I would like to emphasize three points: Despite their shortcomings, options can be appropriate under some circumstances. My criticism therefore, they should be awarded only to those managers with overall responsibility. Managers with First, stock options are inevitably tied to the overall performance of a corporation. Logically, limited areas of responsibility should have incentives that pay off in relation to results under their plays for a cellar-dwelling team. And the .150 hitter should get no reward - even if he plays for a control. The .350 hitter expects, and also deserves, a big payoff for his performance — even if he pennant winner. Only those with overall responsibility for the team should have their rewards tied into them a retained-earnings or carrying-cost factor. Equally important, they should be priced realistically. Second, options should be structured carefully. Absent special factors, they should have built When managers are faced with offers for their companies, they unfailingly point out how unrealistic be the valuations at which managers sell portions of their businesses to themselves? (They may go market prices can be as an index of real value. But why, then, should these same depressed prices further: officers and directors sometimes consult the Tax Code to determine the lowest prices at which they can, in effect, sell part of the business to insiders. While they're at it, they often elect plans that produce the worst tax result for the company.) Except in highly unusual cases, owners are not well served by the sale of part of their business at a bargain price - whether the sale is to outsiders or to insiders. The obvious conclusion: options should be priced at true business value. Third, I want to emphasize that some managers whom I admire enormously — and whose operating records are far better than mine — disagree with me regarding fixed-price options. They have built leadership and example, and by the use of options as incentives, these managers have taught their corporate cultures that work, and fixed-price options have been a tool that helped them. By their colleagues to think like owners. Such a culture is rare and when it exists should perhaps be left 12

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intact - despite inefficiencies and inequities that may infest the option program. "If it ain't broke, don't fix it" is preferable to "purity at any price". At Berkshire, however, we use an incentive-compensation system that rewards key managers for meeting targets in their own bailiwicks. If See's does well, that does not produce incentive compensation at the News — nor vice versa. Neither do we look at the price of Berkshire stock when we write falls, or stays even. Similarly, we think average performance should earn no special rewards even if bonus checks. We believe good unit performance should be rewarded whether Berkshire stock rises, our stock should soar. "Performance", furthermore, is defined in different ways depending upon the underlying economics of the business: in some our managers enjoy tailwinds not of their own making, in others they fight unavoidable headwinds. The rewards that go with this system can be large. At our various business units, top managers sometimes receive incentive bonuses of five times their base salary, or more, and it would appear on bonuses, and the potential for rewards is not hierarchical. The manager of a relatively small unit possible that one manager's bonus could top $2 million in 1986. (I hope so.) We do not put a cap can earn far more than the manager of a larger unit if results indicate he should. We believe, further, that such factors as seniority and age should not affect incentive compensation (though they sometimes influence basic compensation). A 20-year-old who can hit .300 is as valuable to us as a 40-year-old performing as well. Obviously, all Berkshire managers can use their bonus money (or other funds, including borrowed holdings. By accepting both the risks and the carrying costs that go with outright purchases, these money) to buy our stock in the market. Many have done just that - and some now have large managers truly walk in the shoes of owners. Now let's get back — at long last - to our three businesses: the business to regularly offer customers the best values available in home furnishings. NFM is the At Nebraska Furniture Mart our basic strength is an exceptionally low-cost operation that allows largest store of its kind in the country. Although the already-depressed farm economy worsened considerably in 1985, the store easily set a new sales record. I also am happy to report that NFM's none of us can keep up with. She's there wheeling and dealing seven days a week, and I hope that Chairman, Rose Blumkin (the legendary "Mrs. B"), continues at age 92 to set a pace at the store that does me. any of you who visit Omaha will go out to the Mart and see her in action. It will inspire you, as it we know of. Despite the unmatched consumer acceptance we enjoy, industry trends are not good, At See's we continue to get store volumes that are far beyond those achieved by any competitor on per-pound costs. We now are willing to increase prices only modestly and, unless we can stabilize and we continue to experience slippage in poundage sales on a same-store basis. This puts pressure per-shop poundage, profit margins will narrow. gain was more than accounted for by preprints. ROP linage (advertising printed on our own pages) At the News volume gains are also difficult to achieve. Though linage increased during 1985, the declined. Preprints are far less profitable than ROP ads, and also more vulnerable to competition. In 1985, the News again controlled costs well and our household penetration continues to be exceptional. One problem these three operations do not have is management. At See's we have Chuck Huggins, the man we put in charge the day we bought the business. Selecting him remains one of our best business decisions. At the News we have Stan Lipsey, a manager of equal caliber. Stan has been with us 17 years, and his unusual business talents have become more evident with every additional level of responsibility he has tackled. And, at the Mart, we have the amazing Blumkins — Mrs. B, Louie, Ron, Irv, and Steve — a three-generation miracle of management. them personally as much as I admire them professionally. I consider myself extraordinarily lucky to be able to work with managers such as these. I like 13

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Insurance Operations industry: Shown below is an updated version of our usual table, listing two key figures for the insurance Yearly Change Combined Ratio in Premiums after Policyholder Written (%) Dividends 1972 1973 ... 10.2 1974 .... 8.0 99.2 96.2 1975 6.2 105.4 1976 11.0 1977 21.9 107.9 102.4 1978 19.8 97.2 1979 12.8 1980 10.3 97.5 100.6 1981 6.0 1982 3.9 103.1 1983 4.4 106.0 4.5 111.9 109.7 1984 (Revised) 1985 (Estimated) 9.2 117.9 20.9 118.0 Source: Best's Aggregates and Averages revenue from premiums: a ratio below 100 indicates an underwriting profit, and one above 100 The combined ratio represents total insurance costs (losses incurred plus expenses) compared to indicates a loss. insured losses grown at their normal rate of most recent years - that is, a few points above the The industry's 1985 results were highly unusual. The revenue gain was exceptional, and had inflation rate — a significant drop in the combined ratio would have occurred. But losses in 1985 didn't cooperate, as they did not in 1984. Though inflation slowed considerably in these years, insured losses perversely accelerated, growing by 16% in 1984 and by an even more startling 17% in 1985. record. The year's growth in losses therefore exceeds the inflation rate by over 13 percentage points, a modern Catastrophes were not the culprit in this explosion of loss cost. True, there were an unusual was about 2% of premium volume, a not unusual proportion. Nor was there any burst in the number number of hurricanes in 1985, but the aggregate damage caused by all catastrophes in 1984 and 1985 of insured autos, houses, employers, or other kinds of "exposure units". A partial explanation for the surge in the loss figures is all the additions to reserves that the industry made in 1985. As results for the year were reported, the scene resembled a revival meeting: shouting "I've sinned, I've sinned", insurance managers rushed forward to confess they had underreserved in earlier years. Their corrections significantly affected 1985 loss numbers. The insurer's ability A more disturbing ingredient in the loss surge is the acceleration in "social" or "judicial" inflation. to pay has assumed overwhelming importance with juries and judges in the found, no matter what the policy wording, the facts, or the precedents. assessment of both liability and damages. More and more, "the deep pocket" is being sought and This judicial inflation represents a wild card in the industry's future, and makes forecasting (quarterly gains were difficult. Nevertheless, the short-term outlook is good. Premium growth improved as 1985 went along industry's combined ratio should fall sharply in 1986. an estimated 15%, 19%, 24% and 22%) and, barring a supercatastrophe, the see to that. First, commodity businesses achieve good levels of profitability only when prices are fixed The profit improvement, however, is likely to be of short duration. Two economic principles will 14

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in some manner or when capacity is short. Second, managers quickly add to capacity when prospects start to improve and capital is available. In my 1982 report to you, I discussed the commodity nature of the insurance industry extensively. The typical policyholder does not differentiate between products but concentrates instead on price. good. The insurance product now is priced as any other commodity for which a free market exists: For many decades a cartel-like procedure kept prices up, but this arrangement has disappeared for when capacity is tight, prices will be set remuneratively; otherwise, they will not be. capacity is an attitudinal concept, not a physical fact. Insurance managers can write whatever amount Capacity currently is tight in many lines of insurance — though in this industry, unlike most, of business they feel comfortable writing, subject only to pressures applied by regulators and Best's, the industry's authoritative rating service. The comfort level of both managers and regulators is tied commodity business, furthermore, such as aluminum or steel, a long gestation precedes the birth of to capital. More capital means more comfort, which in turn means more capacity. In the typical additional capacity. In the insurance industry, capital can be secured instantly. Thus, any capacity shortage can be eliminated in short order. piling up capital so that they can write all the business possible at the better prices now available. That's exactly what's going on right now. In 1985, about 15 insurers raised well over $3 billion, The capital-raising trend has accelerated dramatically so far in 1986. and next a fall in profitability. When the fall comes, it will be the fault of the capital-raisers of 1985 If capacity additions continue at this rate, it won't be long before serious price-cutting appears in our textile example, the dynamics of capitalism cause each insurer to make decisions that for itself and 1986, not the price-cutters of 198X. (Critics should be understanding, however: as was the case appear sensible, but that collectively slash profitability.)

• should one day allow us to claim a distinct competitive advantage in the insurance market. With

In past reports, I have told you that Berkshire's strong capital position - the best in the industry the tightening of the market, that day arrived. Our premium volume more than tripled last year, following a long period of stagnation. Berkshire's financial strength (and our record of maintaining unusual strength through thick and thin) is now a major asset for us in securing good business. We correctly foresaw. a flight to quality by many large buyers of insurance and reinsurance who belatedly recognized that a policy is only an IOU - and who, in 1985, could not collect on many But, in a development we did not foresee, we also are finding buyers drawn to us because our ability of their IOUs. These buyers today are attracted to Berkshire because of its strong capital position. to insure substantial risks sets us apart from the crowd. insurers have wanted to write this kind of business. However, their willingness to do so has been To understand this point, you need a few background facts about large risks. Traditionally, many almost always based upon reinsurance arrangements that allow the insurer to keep just a small portion a directors and officers ("D & O") liability policy providing $25 million of coverage. By various "excess- of the risk itself while passing on ("laying off") most of the risk to its reinsurers. Imagine, for example, of-loss" reinsurance contracts, the company issuing that policy might keep the liability for only the would be borne by the reinsurers of the issuing insurer. In trade parlance, a company that issues first $1 million of any loss that occurs. The liability for any loss above that amount up to $24 million large policies but retains relatively little of the risk for its own account writes a large gross line but a small net line. be divided among the various "layers" of risk. In our D & O policy, for example, what part of the In any reinsurance arrangement, a key question is how the premiums paid for the policy should $1 million of risk and how much should be passed on to the reinsurers to compensate them fairly premium received should be kept by the issuing company to compensate it fairly for taking the first for taking the risk between $1 million and $25 million? lamp by which my feet are guided, and that is the lamp of experience." In other words, how much One way to solve this problem might be deemed the Patrick Henry approach: "I have but one 15

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Fireman's Fund Quota-Share Contract where he is Chairman and CEO of the holding company. Never one to let go of a meal ticket, we have followed Jack Byrne to Fireman's Fund ("FFIC") On September 1, 1985 we became a 7% participant in all of the business in force of the FFIC four years, and provides that our losses and costs will be proportionate to theirs throughout the group, with the exception of reinsurance they write for unaffiliated companies. Our contract runs for contract period. If there is no extension, we will thereafter have no participation in any ongoing the losses that occurred in the September 1, 1985 — August 31, 1989 period. business. However, for a great many years in the future, we will be reimbursing FFIC for our 7% of Under the contract FFIC remits premiums to us promptly and we reimburse FFIC promptly for or investment. As part of the deal, I'm available to FFIC for consultation about general investmen xpenses and losses it has paid. Thus, funds generated by our share of the business are held by u: in any aspect of the company's underwriting activities. strategy. I'm not involved, however, in specific investment decisions of FFIC, nor is Berkshire involved The company's September 1, 1985 unearned premium reserve was $1.324 billion, and it therefore Currently FFIC is doing about $3 billion of business, and it will probably do more as rates rise. transferred 7% of this, or $92.7 million, to us at initiation of the contract. We concurrently paid them $29.4 million representing the underwriting expenses that they had incurred on the transferred premium. along to Wesco-Financial Insurance Company ("Wes-FIC"), a new company organized by our 80%- All of the FFIC business is written by National Indemnity Company, but two-sevenths of it is passed Wes-FIC and the reinsurance business on pages 60-62. owned subsidiary, Wesco Financial Corporation. Charlie Munger has some interesting comments about Share Contracts. The 1985 results of the FFIC contract are reported there, though the newness of the To the Insurance Segment tables on page 41, we have added a new line, labeled Major Quota- arrangement makes these results only very rough approximations. be over $50 million. We hope to develop more of this business, and industry conditions suggest that After the end of the year, we secured another quota-share contract, whose 1986 volume should prudently handle. Our financial strength makes us an attractive partner for such companies. we could: a significant number of companies are generating more business than they themselves can Marketable Securities value over $25 million are listed, and the interests attributable to minority shareholders of Wesco We show below our 1985 yearend net holdings in marketable equities. All positions with a market and Nebraska Furniture Mart are excluded. No. of Shares Cost Market 1,036,461 Affiliated Publications, Inc. …....... (000s omitted) 2,350,922 900,800 Beatrice Companies, Inc. . American Broadcasting Companies, Inc. $ 3,516 $ 54,435 108,997 55,710 6,850,000 2,379,200 Handy & Harman GEICO Corporation …...... 106,811 45,713 595,950 108,142 1,727,765 847,788 Time, Inc. .. 27,318 43,718 The Washington Post Company 20,385 9,731 205,172 52,669 All Other Common Stockholdings 267,909 1,170,358 Total Common Stocks 7,201 27,963 $275,110 $1,198,321 18

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We mentioned earlier that in the past decade the investment environment has changed from one in which great businesses were totally unappreciated to one in which they are appropriately recognized. The Washington Post Company ("WPC") provides an excellent example. then per-share business value of the enterprise. Calculating the price/value ratio required no unusual We bought all of our WPC holdings in mid-1973 at a price of not more than one-fourth of the intrinsic business value at $400 to $500 million just as we did. And its $100 million stock market insights. Most security analysts, media brokers, and media executives would have estimated PC's valuation was published daily for all to see. Our advantage, rather, was attitude: we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values. Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious and therefore calculations of business value - and even thought, itself — were of no importance in business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest - whether it be bridge, chess, or stock selection - than to have opponents who have been taught that thinking is a waste of energy?) Through 1973 and 1974, WPC continued to do fine as a business, and intrinsic value grew. Nevertheless, by yearend 1974 our WPC holding showed a loss of about 25%, with market value at had become a good bit cheaper as the market, in its infinite wisdom, marked WPC stock down to $8 million against our cost of $10.6 million. What we had thought ridiculously cheap a year earlier well below 20¢ on the dollar of intrinsic value. You know the happy outcome. Kay Graham, CEO of WPC, had the brains and courage to repurchase large quantities of stock for the company at those bargain prices, as well as the managerial skills necessary to dramatically increase business values. Meanwhile, investors began to recognize the we experienced a triple dip: the company's business value soared upward, per-share business value exceptional economics of the business and the stock price moved closer to underlying value. Thus, increased considerably faster because of stock repurchases and, with a narrowing of the discount, the stock price outpaced the gain in per-share business value. We hold all of the WPC shares we bought in 1973, except for those sold back to the company in 1985's proportionate redemption. Proceeds from the redemption plus yearend market value of our holdings total $221 million. If we had invested our $10.6 million in any of a half-dozen media companies that were investment favorites in mid-1973, the value of our holdings at yearend would have been in the area of $40 - $60 million. Our gain would have far exceeded the gain in the general market, an outcome reflecting ownership of WPC came, in very large part, from the superior nature of the managerial decisions the exceptional economics of the media business. The extra $160 million or so we gained through made by Kay as compared to those made by managers of most media companies. Her stunning business success has in large part gone unreported but among Berkshire shareholders it should not go unappreciated. Our Capital Cities purchase, described in the next section, required me to leave the WPC Board early in 1986. But we intend to hold indefinitely whatever WPC stock FCC rules allow us to. We expect WC's business values to grow at a reasonable rate, and we know that management is both able and shareholder-oriented. However, the market now values the company at over $1.8 billion, and there is no way that the value can progress from that level at a rate anywhere close to the rate possible when the company's valuation was only $100 million. Because market prices have also been bid up for our other holdings, we face the same vastly-reduced potential throughout our portfolio. You will notice that we had a significant holding in Beatrice Companies at yearend. This is a short-term arbitrage holding - in effect, a parking place for money (though not a totally safe one, 19

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since deals sometimes fall through and create substantial losses). We sometimes enter the arbitrage We would be a lot happier if the funds currently employed on this short-term basis found a long- field when we have more money than ideas, but only to participate in announced mergers and sales. term home. At the moment, however, prospects are bleak. $194 million at amortized cost were issues of Washington Public Power Supply System ("WPPSS") At yearend our insurance subsidiaries had about $400 million in tax-exempt bonds, of which Projects 1, 2, and 3. I discussed this position fully last year, and explained why we would not disclose further purchases or sales until well after the fact (adhering to the policy we follow on stocks). Our unrealized gain on the WPPSS bonds at yearend was $62 million, perhaps one-third arising from the upward movement of bonds generally, and the remainder from a more positive investor view toward WPPSS 1, 2, and 3s. Annual tax-exempt income from our WPPSS issues is about $30 million. Capital Cities/ABC, Inc. at $172.50 per share, the market price of such shares at the time the commitment was made early in Right after yearend, Berkshire purchased 3 million shares of Capital Cities/ABC, Inc. ("'Cap Cities") the best of any publicly-owned company in the country. And Tom Murphy and Dan Burke are not March, 1985. I've been on record for many years about the management of Cap Cities: I think it is only great managers, they are precisely the sort of fellows that you would want your daughter to them will understand marry. It is a privilege to be associated with them — and also a lot of fun, as any of you who know Our purchase of stock helped Cap Cities finance the $3.5 billion acquisition of American Broadcasting over the next few years. This bothers us not an iota; we can be very patient. (No matter how great Companies. For Cap Cities, ABC is a major undertaking whose economics are likely to be unexciting the talent or effort, some things just take time: you can't produce a baby in one month by getting nine women pregnant.) Tom, as CEO (or Dan, should he be CEO) votes our stock. This arrangement was initiated by Charlie As evidence of our confidence, we have executed an unusual agreement: for an extended period The object of these restrictions is to make sure that our block does not get sold to anyone who is a and me, not by Tom. We also have restricted ourselves in various ways regarding sale of our shares. large holder (or intends to become a large holder) without the approval of management, an arrangement similar to ones we initiated some years ago at GEICO and Washington Post. Since large blocks frequently command premium prices, some might think we have injured term economic prospects for these businesses — and, thus, for ourselves as owners — are enhanced Berkshire financially by creating such restrictions. Our view is just the opposite. We feel the long- by the arrangements. With them in place, the first-class managers with whom we have aligned ourselves can focus their efforts entirely upon running the businesses and maximizing long-term values for owners. Certainly this is much better than having those managers distracted by "revolving-door capitalists" hoping to put the company "in play". (Of course, some managers place their own interests above those of the company and its owners and deserve to be shaken up — but, in making investments, we try to steer clear of this type.) stock. At any time a major holder can surface, usually mouthing reassuring rhetoric but frequently Today, corporate instability is an inevitable consequence of widely-diffused ownership of voting harboring uncivil intentions. By circumscribing our blocks of stock as we often do, we intend to promote stability where it otherwise might be lacking. That kind of certainty, combined with a good case for our arrangements. manager and a good business, provides excellent soil for a rich financial harvest. That's the economic have welcomed a major financial commitment by us — to ever lose any sleep wondering whether The human side is just as important. We don't want managers we like and admire - and who surprises might occur because of our large ownership. I have told them there will be no surprises, and these agreements put Berkshire's signature where my mouth is. That signature also means the 20

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managers have a corporate commitment and therefore need not worry if my personal participation in Berkshire's affairs ends prematurely (a term I define as any age short of three digits). for both media stocks and media properties that has developed in recent years (and that, in the case Our Cap Cities purchase was made at a full price, reflecting the very considerable enthusiasm of some property purchases, has approached a mania). It's no field for bargains. However, our Cap Cities investment allies us with an exceptional combination of properties and people - and we like the opportunity to participate in size. Of course, some of you probably wonder why we are now buying Cap Cities at $172.50 per share company at $43 per share in 1978-80. Anticipating your question, I spent much of 1985 working on given that your Chairman, in a characteristic burst of brilliance, sold Berkshire's holdings in the same a snappy answer that would reconcile these acts. A little more time, please. Acquisition of Scott & Fetzer Right after yearend we acquired The Scott & Fetzer Company ("Scott Fetzer") of Cleveland for about $320 million. (In addition, about $90 million of pre-existing Scott Fetzer debt remains in place.) In the next section of this report I describe the sort of businesses that we wish to buy for Berkshire. Scott Fetzer is a prototype - understandable, large, well-managed, a good earner. The company has sales of about $700 million derived from 17 businesses, many leaders in their fields. Return on invested capital is good to excellent for most of these businesses. Some well-known products are Kirby home-care systems, Campbell Hausfeld air compressors, and Wayne burners and water pumps. World Book, Inc. - accounting for about 40% of Scott Fetzer's sales and a bit more of its income — is by far the company's largest operation. It also is by far the leader in its industry, selling more in the U.S. than its four biggest competitors combined. than twice as many encyclopedia sets annually as its nearest competitor. In fact, it sells more sets encylopedia as something special. I've been a fan (and user) for 25 years, and now have grandchildren Charlie and I have a particular interest in the World Book operation because we regard its consulting the sets just as my children did. World Book is regularly rated the most useful encyclopedia by teachers, librarians and consumer buying guides. Yet it sells for less than any of its major competitors. Childcraft, another World Book, Inc. product, offers similar value. This combination of exceptional for Scott Fetzer, despite declining results for many companies in the direct-selling industry. products and modest prices at World Book, Inc. helped make us willing to pay the price demanded charge, the company had 31 businesses, the result of an acquisition spree in the 1960s. He disposed An equal attraction at Scott Fetzer is Ralph Schey, its CEO for nine years. When Ralph took of many that did not fit or had limited profit potential, but his focus on rationalizing the original in 1978. Ralph's operating and capital-allocation record is superb, and we are delighted to be associated potpourri was not so intense that he passed by World Book when it became available for purchase with him. The history of the Scott Fetzer acquisition is interesting, marked by some zigs and zags before we became involved. The company had been an announced candidate for purchase since early 1984. A major investment banking firm spent many months canvassing scores of prospects, evoking interest from several. Finally, in mid-1985 a plan of sale, featuring heavy participation by an ESOP (Employee Stock Ownership Plan), was approved by shareholders. However, as difficulty in closing followed, the plan was scuttled I had followed this corporate odyssey through the newspapers. On October 10, well after the the company's record and asked if he might like to talk. Charlie and I met Ralph for dinner in Chicago ESOP deal had fallen through, I wrote a short letter to Ralph, whom I did not know. I said we admired on October 22 and signed an acquisition contract the following week. 21

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above $2 billion in 1986, more than double those of 1985. The Scott Fetzer acquisition, plus major growth in our insurance business, should push revenues Miscellaneous The Scott Fetzer purchase illustrates our somewhat haphazard approach to acquisitions. We have staff to investigate a multitude of ideas presented by promoters and intermediaries. Instead, we simply no master strategy, no corporate planners delivering us insights about socioeconomic trends, and no hope that something sensible comes along - and, when it does, we act. from last year's copy is in (1): because we continue to want any acquisition we make to have a To give fate a helping hand, we again repeat our regular "business wanted" ad. The only change measurable impact on Berkshire's financial results, we have raised our minimum profit requirement. Here's what we're looking for: (2) demonstrated consistent earning power (future projections are of little interest to us, nor are (1) large purchases (at least $10 million of after-tax earnings), /turn-around situations), (4) management in place (we can't supply it), (3) businesses earning good returns on equity while employing little or no debt, (5) simple businesses (if there's lots of technology, we won't understand it), (6) an offering price (we don't want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown). fast answer — customarily within five minutes — as to whether we're interested. We prefer to buy We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very for cash, but will consider issuance of stock when we receive as much in intrinsic business value as we give. Indeed, following recent advances in the price of Berkshire stock, transactions involving with whom we have done business in the past. For the right business — and the right people - we stock issuance may be quite feasible. We invite potential sellers to check us out by contacting people can provide a good home. On the other hand, we frequently get approached about acquisitions that don't come close to "I'm-sure-something-will-work-out-if-you-people-get-to-know-each-other". None of these attracts us in meeting our tests: new ventures, turn-arounds, auction-like sales, and the ever-popular (among brokers) the least. Besides being interested in the purchases of entire businesses as described above, we are also interested in the negotiated purchase of large, but not controlling, blocks of stock, as in our Cap Cities purchase. Such purchases appeal to us only when we are very comfortable with both the economics of the business and the ability and integrity of the people running the operation. We prefer large but our preference is for commitments many times that size. transactions: in the unusual case we might do something as small as $50 million (or even smaller), program. Total contributions made through the program were $4 million, and 1,724 charities were About 96.8% of all eligible shares participated in Berkshire's 1985 shareholder-designated contributions recipients. We conducted a plebiscite last year in order to get your views about this program, as well as about our dividend policy. (Recognizing that it's possible to influence the answers to à question by the framing of it, we attempted to make the wording of ours as neutral as possible.) We present the ballot and the results in the Appendix on page 69. I think it's fair to summarize your response as highly supportive of present policies and your group preference — allowing for the tendency of asset values build. people to vote for the status quo - to be for increasing the annual charitable commitment as our 22

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We urge new shareholders to read the description of our shareholder-designated contributions urge that you immediately make sure that your shares are registered in the name of the actual owner, program that appears on pages 66 and 67. If you wish to participate in future programs, we strongly not in "street" name or nominee name. Shares not so registered on September 30, 1986 will be ineligible for the 1986 program.

• * *

holdings in The Illinois National Bank and Trust Company of Rockford, Illinois. Our method of doing Five years ago we were required by the Bank Holding Company Act of 1969 to dispose of our so was unusual: we announced an exchange ratio between stock of Rockford Bancorp Inc. (the Illinois National's holding company) and stock of Berkshire, and then let each of our shareholders - except me - make the decision as to whether to exchange all, part, or none of his Berkshire shares for Rockford shares. I took the Rockford stock that was left over and thus my own holding in Rockford and most elementary system of fairly dividing an object. Just as when you were a child and one Last fall Illinois National was sold. When Rockford's liquidation is completed, its shareholders will have received per-share proceeds about equal to Berkshire's per-share intrinsic value at the time of the bank's sale. I'm pleased that this five-year result indicates that the division of the cake was reasonably equitable.

• *

* Last year I put in a plug for our annual meeting, and you took me up on the invitation. Over 250 of our more than 3,000 registered shareholders showed up. Those attending behaved just as those present in previous years, asking the sort of questions you would expect from intelligent and interested Maddox, when Governor of Georgia, was criticized regarding the state's abysmal prison system. "The owners. You can attend a great many annual meetings without running into a crowd like ours. (Lester solution", he said, "is simple. All we need is a better class of prisoners." Upgrading annual meetings works the same way.) I hope you come to this year's meeting, which will be held on May 20 in Omaha. There will be only one change: after 48 years of allegiance to another soft drink, your Chairman, in an unprecedented display of behavioral flexibility, has converted to the new Cherry Coke. Henceforth, it will be the Official Drink of the Berkshire Hathaway Annual Meeting. And bring money: Mrs. B promises to have bargains galore if you will pay her a visit at The Nebraska Furniture Mart after the meeting. Warren E. Buffett Chairman of the Board March 4, 1986 23

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24 Torche Ross & Co. March 10, 1986 To the Board of Directors and Stockholders Berksaiie Hathauzy Inc. and We have examined the consolidated balance sheet of Berkshire Hathaway consolidaied staterents of earninga and changes in financial position for the consolidated subsidiaries as of Decerber 28, 1985, und the related year then accepted auditing standards examination yas made in accordance with generally accounting accordingly, included such tests of the песеввату the circumstances. procedurea considered Berkshire Hathaway The consolidated financial s-ltesents of report dated Deceaber 29, 1984 and Deceaber 31, 1983, vere examined by other auditors whose and consolidated subsidiaries for 21222 the years ended statementa which was as of March 18, 1985, expressed an unqualitied opinion on as to Note 21 to the 1984 financial those statements. In our opinion, the 1985 consolidated financial statecenta referred to consolidated subsidiaries as of December 28, present fairly che financial parition of Berkshire Hathaway Inc. and aperations and the changes in their financial position 1985, and the resulta of ended, in confornity with the year then = basis consistent with that of the preceding year. generally accepted accounting principles applied on Sanche and lo. Jour Fardl 2000 FIAST NATIONAL CENTER. ОЫЛН, NEBRASKA 68102: (402) 340-7765

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Д. BERKSHIRE HATHAWAY INC. CONSOLIDATED BALANCE SHEETS and Consolidated Subsidiaries (dollars in thousands) Dit. 28, Cash and lemporary cash Investments ASSETS 1985 Dec. 29, 1984 Investments, other than investmants in affiliates: $1,017,667 $ 173,721 Obligations with fixod maturities, principally bonds - at cost (market value: Doc. 28, 1985 — $543,101, Marketable equity securities (Notes 3 and 4) Doc. 29, 1984 - 5317,734) 475,216 Investment in The Scott & Fetzer Company (Note 18) Investment in Mutual Savings ard Loan Association (Note 5) 1,183,476 1,235,903 303,928 29,810 Inventories Accounts roceivable from customers, agents and others (Note 6) 156,362 57,215 32,927 Real estate, equipment, furniture and leasehold 37,386 88,489 Deferred insurance premium acquisition costs improvements (Note 7) 41,332 69,369 Other assets Goodwill of acquired businesses 75,169 51,368 67,919 7.444 27,680 77,269 53.180,718 6,271 $2,035,203 = 00 Lossos and loss adjustment expenses LIABILITIES AND STOCKHOLDERS' EQUITY Unearned premiums .. $ 411,305 229,440 $ 247,298 Liability for unredeemed trading stamp: (Note 8) 72,636 48,187 49.099 Current income laxes Accounts payable, accruals and other liabilities 58,957 Term debt and other borrowings (Note 10) Deferred income taxes (Note 0) 284.401 97.180 73,346 11,432 117,879 177.907 1,261,028 127,104 741,143 Minority shareholders' interests 34,360 22,299 Stockholders equity (Notes 11 and 12): Common stock of 55 par value. Authorized 1,500.000 held in treasury .... shares: issued 1,375,183 shares, including shares Unrealized appraciation of marketable equity securities, net Capital in excess of par value 157,377 6.876 6.876 Retained earnings 1,097,308 664.707 157,377 486,953 1,926,268 661,493 Loss commun siock in treasury, el cost (228,274 shares) 40,938 1,312,699 Tetal stockholders' equity Commitments and subsequent events (Note 18) ... 1,885,330 40,938 1,271,761 $3,180,718 $2,035,203 See accompanying Notes to Consolidated Financial Statemenis 25

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BERKSHIRE HATHAWAY INC. and Consolidated Subsidiaries CONSOLIDATED STATEMENTS OF EARNINGS (dollars in thousands except per share amounts) Fiscal Year Ended Saturday Nearest December 31 Income items: 1985 1984 1983 Insurance premiums earned Sales and service revenues ... $ 317,059 $ 140,242 $ 152,480 interest and dividend income (Note 13) Equity in earnings excluding realized investment ... 508,764 500,219 107,662 84,161 381,674 64,903 gain of unconsolidated subsidiaries .. ... 6,379 4,557 3,669 Cost and expense items: 939,864 729,179 602,726 Insurance losses and loss adjustment expenses Cost of products and services sold 280,249 141,550 Insurance underwriting expenses 285,925 296,770 134,109 Interest and financing costs Selling, general and administrative expenses 150,423 81,040 46,752 214,362 138,875 122,023 52,243 14,415 14,734 15,104 812,052 638,681 Earnings from operations including minority 537,841 interest in consolidated subsidiaries, realized investment gain before applicable income taxes and before Income taxes applicable to above (Note 14) 127,812 90,498 64,885 31,271 16,420 Minority interest applicable to above 96,541 8,904 74,078 3,593 3.877 55,981 Realized investment gain, net (Note 15) Earnings before realized investment gain 92,948 70,201 7,337 342,867 48,644 Net earnings 78,694 63,522 $ 435,815 Average shares outstanding $ 148,895 $ 112,166 Per share: 1,146,909 1,146,909 1,066,709 Net earnings Earnings before realized investment gain $ 81.04 $ 61.21 379.99 129.82 $ 45.60 105.15 See accompanying Notes to Consolidated Financial Statements 26

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BERKSHIRE HATHAWAY INC. CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION and Consolidated Subsidiaries (dollars in thousands) December 28, 1985 Fiscal Year Ended Saturday Nearest December 31 1985 1984 1983 Consolidated assets at beginning of year .. $2,035,203 $1,837,543 $1,514,431 Changes during the year resulted from: Net earnings Net increase in losses, loss adjustment expenses and 435,815 148,895 112,166 348,348 23,908 16,598 Vet increase (decrease) in other consolidatec appreciation of securities ...... 35,277 3,355 (4,420) liabilities Increases essentially from operations....... 65,043 14,581 (46,488) 884,483 190,739 77,856 Increase (decrease) in deferred income taxes, relating to unrealized appreciation of securities .... Net increase, reflected in stockholders' equity, in 71,217 (1,061) 48,899 unrealized appreciation of securities Net increase (decrease) in minority interests 177,754 12,061 4,309 3,673 (83,187)* 125,159 Purchase of treasury stock Issuance of capital stock 154,665* Total changes (280) Consolidated assets at end of year 1,145,515 197,660 323,112 $3,180,718 $2,035,203 $1,837,543 *The minority interest in net assets of Blue Chip Stamps at the beginning of 1983 was $88,234. On July 28, 1983, Berkshire acquired that minority interest in exchange for its stock, resulting in a net decrease during the year in the aggregate interest of minority shareholders in the net assets of consolidated subsidiaries. The presentation format of this statement differs from that of prior years. It is the view of Berkshire's management that the revised presentation provides disclosures regarding changes in the Company's consolidated resources in a more meaningful manner. See accompanying Notes to Consolidated Financial Statements

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BERKSHIRE HATHAWAY INC. and Consolidated Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 28, 1985 (dollars in thousands except per share amounts) (1) Significant Accounting Policies and Practices (a) Basis of Consolidation The accompanying Consolidated Financial Statements include the accounts of Berkshire Hathaway Inc. (the "Company" or "Berkshire") consolidated with accounts of all of its subsidiaries except Mutual Savings and Loan Association ("Mutual") and a wholly-owned aggregate investment is minor. Berkshire accounts for its investments in non-consolidater subsidiary of Mutual, and except certain other subsidiaries in which the Company' Consolidated financial position and results reflect those of companies engaged in a number of diverse businesses. See Note 16. (b) Corporate Changes in 1983 Influencing Comparability of Earnings Merger of Blue Chip Stamps For part of 1983, Berkshire owned 59.6% of Blue Chip Stamps ("Blue Chip") and, accordingly, there was a charge to Berkshire's consolidated net earnings applicable to the 40.4% outstanding minority interest in Blue Chip. That charge was eliminated for periods after July 28, 1983 when, in a merger transaction that was accounted for by Berkshire as a purchase, Berkshire acquired the interests of the minority shareholders in exchange for its issuance of 160,900 shares of its common stock plus its payment of cash in lieu of issuance of fractional common shares. Blue Chip operated a promotional services business, it owned 100% of See's Candy Shops, Incorporated, 100% of the Buffalo News, and 80.1% of Wesco Financial Corporation. Purchase of Majority Interest in Nebraska Furniture Mart, Inc. On September 30, 1983, Berkshire purchased for cash the majority of the outstanding capital stock of Nebraska Furniture Mart, Inc., a corporation engaged in the business of retailing of home furnishings. Results of operations of the business from the date of purchase are reflected in the accompanying Consolidated Statements of Earnings. (c) Accounting Period Accounts of Berkshire and certain of its subsidiaries are maintained on the basis of a 52- for See's candy business consisted of 53 weeks. The calendar year is the annual accounting 53 week fiscal year ending with respect to December 31. For 1983, the accounting period subsidiary and certain other of the consolidated companies. period of the insurance subsidiaries, the newspaper subsidiary, the home furnishings (d) Investments in Securities, Other Than Affiliates Investments in obligations with fixed dates of maturity — bonds and redeemable preferred stocks — are stated at cost, adjusted where appropriate for accretion of discount or amortization of premium. Investments in marketable equity securities held by members of the Insurance Group are carried at market value. Investments in marketable equity securities held by Berkshire and by consolidated subsidiaries which are not members of the Insurance Group are carried at the lower of aggregate cost or market. Cost of securities sold is usually determined on a first-in, first-out basis. Occasionally, when specific identification of securities sold results in lower applicable income tax, identified 28

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(1) Significant Accounting Policies and Practices (Continued) Inventories Inventories are stated at cost, determined principally using the first-in, first-out ("FIFO"), or average cost method. Inventory costs that were determined using the last-in, first-out ("LIFO") method comprised 26% of inventory carrying value in the consolidated balance inventory layers had the effect of increasing 1985 income before taxes by approximately sheet at December 28, 1985 (41% at December 29, 1984). Liquidation of prior years' LIFO inventories of the Company's textile division. Variations in LIFO layers in 1983 and 1984 $3,098. Of such amount, $2,602 relates to liquidation or write-off in 1985 of domestic were not significant. (f) Real Estate, Equipment, Furniture and Leasehold Improvements These items of property (including significant betterments and renewals) are carried at cost, depreciated principally on a straight line basis over their useful lives estimated at the charged to operations as incurred. date of acquisition. Maintenance, repairs and renewals of a minor nature are generally (g) Goodwill and Negative Goodwill of Acquired Businesses The difference between purchase cost and fair value of net assets of acquired businesses is amortized on a straight line basis over forty years. (h) Insurance Premium Acquisition Costs For financial reporting purposes, costs of acquiring insurance premiums are deferred, subject to ultimate recoverability, and charged to income as the premiums are earned. With respect ultimate recoverability of the directly related acquisition costs takes into account investment to premiums received under major quota-share reinsurance contracts, the computation of recoverabilty of premium acquisition costs is determined without regard to investment income anticipated to be earned on funds held subject to the contracts. Otherwise, ultimate acquisition costs are charged to income when incurred. income. For statutory insurance accounting and income tax reporting purposes, premium (i) Losses and Loss Adjustment Expenses The Insurance Group provides for losses and loss adjustment expenses for unsettled cases based on estimates of ultimate liability with respect to reported cases, plus estimates of aggregate liability with respect to incurred but not reported losses. Estimates of liability relating to assumed reinsurance are based on loss reports received from the primary insurers. The liability provision is reduced for amounts recoverable on account of reinsurance respectively. ceded; these reductions amounted to $16,157 and $10,531 at December 31, 1985 and 1984, An aggregate liability amounting to $40,841 and $15,944 at December 31, 1985 and 1984, with respect to periodic payment obligations ("Structured respectively, was additionally established at present value on a contract-by-contract basis Settlements") assumed by a given contract is dependent upon market interest rates at the contract inception date. members of the Insurance Group. The specific present value discount rate applicable to reporting purposes was approximately 11.5%. For statutory insurance accounting and tax The weighted average discount rate for all such contracts at December 31, 1985 for financial reporting purposes, these liabilities were discounted at a rate of 7% as prescribed by regulatory authority. 29

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Notes to Consolidated Financial Statements — Continued (1) Significant Accounting Policies and Practices (Continued) (i) Losses and Loss Adjustment Expenses (Continued) Additionally at December 31, 1985 and 1984, an aggregate liability amounting to $47,036 and $14,712, respectively, was established with respect to portfolio reinsurance obligations dates at amounts approximately equal to the consideration then received, and thereafter of the Insurance Group. Liabilities under these contracts are established at their inception at experience-modified amounts. relating principally to automobile physical damage coverages, are not recognized as they are considered immaterial in the aggregate. (k) Insurance Premiums Insurance premiums are recognized as revenues ratably over the terms of the policies. Unearned premiums are computed on a monthly or daily pro rata basis and are stated after deduction of premiums for reinsurance placed with reinsurers in the amount of Dividends to policyholders, primarily relating to workers' compensation coverages, are reflected in the accompanying Consolidated Statements of Earnings as a deduction from earned premiums. This reduction amounted to $5,243 for 1985, $3,110 for 1984, and $4,955 for 1983. (m) Stamp Service Accounting Trading stamp revenues and related redemption costs of Blue Chip Stamps, a consolidated subsidiary engaged in the promotional services business, are recognized upon issuance the liability for unredeemed trading stamps, an account for which is maintained based of the trading stamps. Period redemption costs reflect any change during the period in on estimates of the future cost of redemption merchandise and service. The estimates are periodically revised to take into account the effect of changing facts and circumstances. (n) Income Taxes The carrying value of investments in, and equity in earnings of the non-consolidated subsidiaries are determined on an after-tax basis. Thus, income taxes reflected in the subsidiaries that are consolidated therein. Consolidated Financial Statements represent those of the Company and those of its Certain items of income and deductions are recognized in the financial statements in time periods that differ from those in which they are recognized in the income tax returns filed for the companies. Recording the tax effects of these "timing differences" gives rise to recognition in the financial statements of net deferred income taxes. (2) Acquisition of Businesses of The Scott & Fetzer Company in January, 1986 ("Scott Fetzer") subject to all of Scott Fetzer's liabilities in a merger whereby Scott Fetzer became an On January 6, 1986, Berkshire succeeded to all of the assets of The Scott & Fetzer Company indirectly wholly-owned subsidiary of Berkshire. The resulting business combination will be accounted for as a purchase by Berkshire of Scott Fetzer's assets. terms, at the beginning of 1985. Revenues ... $1,642,990 Net earnings $ 448,815 Net earnings per share $ 391.33 See also Note 18. 30

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(3) Investments in Marketable Equity Securities Aggregate data with respect to the consolidated investment in marketable equity securities is shown below as of the dates for which consolidated balance sheets are presented herein. See Note 1(d) as to methods applied to determine carrying value of these securities. All of these investments at December 31, 1985 were held by members of the Insurance Group. December 31, 1985 Unrealized Cost Gain Market Carrying Value Common stock of: American Broadcasting Companies, Inc. ..... GEICO Corporation $54,435 $ 54,562 $ 108,997 All Others ..... The Washington Post Company ............... 45,713 9,731 550,237 $ 108,997 195,441 595,950 595,950 205,172 .... 150,558 122,799 273,357 205,172 273,357 $260,437 $923,039 $1,183,476 $1,183,476 There were no unrealized losses with respect to these securities at December 31, 1985. December 29, 1984 Unrealized Cost Carrying Gain Market Value Common stock of: Exxon Corporation GEICO Corporation $150,370 $ 1,586 $ 151,956 General Foods Corporation 45,713 351,587 $ 151,959 397,300 All Others The Washington Post Company 153,964 78,914 232,878 397,300 10,628 139,327 149,955 149,955 221,189 201,168 114,670 315,838 315,500 $561,843 $686,084 $1,247,927 $1,235,903 $438 in determining net unrealized gain of $686,084 as reflected above. As of December 29, 1984, gross unrealized gain of $686,522 was reduced by unrealized loss of Investment in shares of Capital Cities Communications, Inc. On January 2, 1986, subsidiaries of Berkshire purchased for cash three million common shares of Capital Cities/ABC Inc. ("Capital Cities") pursuant to a Letter Agreement between Berkshire and Capital Cities dated March 18, 1985. The shares represented approximately 18.7% of the total outstanding the aggregate cost was $517,500. Berkshire subsidiaries hold the shares subject to an agreement the shares of Capital Cities immediately after the transaction. The purchase price was $172.50 per share; terms of which, among other provisions, grant to Capital Cities a right of first refusal to purchase the shares and otherwise govern until January 3, 1997 the manner by which the shares may be sold or transferred. Also, Berkshire and its subsidiaries have delivered to Capital Cities irrevocable proxies officer of Capital Cities, or Daniel B. Burke, so long as he shall be the chief executive officer of Capital with respect to these shares in favor of Thomas S. Murphy so long as he shall be the chief executive Cities, to vote the shares at any and all meetings of shareholders of Capital Cities. The proxies expire Capital Cities. on January 2, 1997 or at the earlier date when neither of such persons is chief executive officer of See also Note 18. 31

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Notes io Consolidated Financial Statements (Continued) (4) Investmeni in GEICO Corporation shares of common stock of GEICO Corporation. The shares possessed approximately 38%% of the Subsidiaries of Berkshire, at both December 28, 1985 and at December 29, 1984, owned 6,850,000 voting rights of all GEICO shares outstanding a: December 28, 1985 (36½% at December 29, 1984). of Columbia, the corporate domicile of GEICO, which prohibits Berkshire from exercising such rights. but Berkshire holds the shares subject to an Order of the Superintendent of Insurance of the District these shares and prohibits Berkshire from seeking or causing to change the independent proxy. Also, The Order provides that Berkshire must maintain an independent proxy arrangement for voting of permitted to serve as a director of GEICO. As a result of the Order, which divests Berkshire of its under the Order, no officer or director of Berkshire or of any affiliate or subsidiary of Berkshire is for its investment in GEICO. voting rights with respect to its GEICO holdings. Berkshire does not use the equity method of accounting (5) Investment in Mutual Savings and Loan Association of Berkshire. Mutual is wholly owned by Wesco Financial Corporation, an 80.1% beneficially owned subsidiary represents the original cost assigned to the asset, adjusted for amortization of negative goodwill that The carrying value of the investment in Mutual in the accompanying Consolidated Balance Sheets periods. 80.1% of Mutual's stated net book value at December 31, 1985 is $46,120. The excess of such arose at the various dates of acquisition and for equity in Mutual's undistributed earnings of ensuing figure over Berkshire's $29,810 carrying value of its investment in Mutual is $16,310, representing Summarized consolideted financial information of Mutual is as follows: Balance Sheet Data 1985 December 31 1984 Cash and marketable securities ... Assets $235,969 12,203 83.425 $188,851 Other assets Loans receivable. not 11.071 95,120 $331,597 $295,042 Savings accounts Liabilities and Shareholder's Equity $269,313 $227,585 Other liabilities 274,018 4,705 5,906 Total liabilities 57,579 233,491 Shareholder's oquity, substantinlly restricted 61.551 5331,597 5295.042 Earnings Statement Data 1985 1984 Total revenues 538,798 _526,887 Net income _S 9,330 _S 6,844 Cash dividends paid lo Wesco _$14,000 32

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(6) Accounts Receivable Accounts receivable from customers, agents and others were made up of the following: Dec. 28, 1985 Dec. 29, 1984 Trade accounts receivable, net of allowances for Agents' balences and premiums in courte of collection doubtful accounts $ 48,322 74,001 $ 47,647 Investment income due end accrued Reinsurance recoverable on loss payments 32,060 490 19,935 522 Amounts due from sales of securities 1,489 18,342 2,043 5156,362 5 88,489 (7) Real Estate, Equipment, Furniture and Leasehold Improvements The composition of property, plant and equipment, on a consolidated basis, at the end of the past two years is shown below; Dec. 28. 1985 Dec. 29. 1984 Buildings Land $ 7,455 65,810 40,708 39,418 7,486 Furniture, fixtures and leasehold improvements Machinery and aquipment 60,821 33,760 32,040 147.733 139,765 Less accumulated depreciation and amortization $ 69,369 78,364 71,846 5 67,919 (8) Liability for Unredeemed Trading Stamps that must be eslimated and taken into account in computing The probability for ultimate redemption of trading stamps issued by Blue Chip Stamps is a factor Blue Chip's liability for issued but trended downward in recent years, as Blue Chip's volume of stamp issuances steadily declined. The unredeemed stamps (the "unredeemed liability"), Management's estimata of that probability factor has earnings for those years. During 1985, in order to provide uniform, improved service to all of its revisions of the redemption-probability factor in 1983 and 1984 did not appreciably affect Berkshire's on a postage-collect basis and merchardise . shipped from its distribution center to redeemers on a stamp savers, Blue Chip commenced a centralized program whereby orders are received at its headquarters freight-prepaid basis. The outlying redemp/in outlets (22 at the beginning of the year) were closed. probability used in the computation of the 1985 year-end unredeemed liability was revised further A notable reduction in redemption activity followed the clesings, and the factor for redemption- and Berkshire's 1985 cost of services sold, by approximately $10,800. The after-fax effect was to downward. The revision had the offect of reducing the unredeemed liability at December 28, 1985, 33

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[PAGE 43]

Notes to Consolidated Financial Statements (Continued) Deferred Income Taxes The liability for deferred income taxes shown in the Consolidated Balance Sheets includes $258,164 at December 28, 1985, and $186,198 at December 29, 1984, which amounts are deemed applicable to unrealized appreciation of marketable equity securities carried at market value. That liability is increased by deferred taxes, and reduced by prepaid taxes, arising from timing differences. Such differences arise because certain items of income and deductions are recognized for financial reporting purposes in time periods different from those in which they are recognized for income tax reporting purposes. A summary follows of deferred and prepaid income taxes arising from timing differences. Dec. 28, Dec. 29, 1985 1984 Deferred taxes relating to timing differences in accounting for: Structured settlements and portfolio Deferred insurance premium acquisition costs reinsurance liabilities ... $13,111 Depreciation of property, plant & equipment 23,630 $ 5,471 2,862 3,423 39,603 1,622 10,516 Prepaid taxes relating to timing differences in accounting for: Trading stamp liability State income and franchise taxes 9,797 15,839 All other Unearned carrying charges 2,755 ... 170 644 1,008 950 1,010 13,366 Net deferred at December 28, 1985 18,807 $26,237 Net prepaid at December 29, 1984 $ 8,291 (10) Term Debt and Other Borrowings Consolidated term debt and other borrowings were as follows: Dec. 28, Dec. 29, Berkshire: 1985 1984 124% debentures maturing from August 1, 1991 through Other notes, debentures and capitalized lease August 1, 2005 at $4,004 annually $ 60,000 $ 60,000 obligations maturing through 1993 in varying annual installments, with interest at rates varying principally from 8% to 9% 19,261 28,066 Consolidated Subsidiaries: 79,261 88,066 10% notes maturing in June, 1991 Notes and capitalized lease obligations maturing through 2007* 25,000 25,000 from 6% to 10% in varying installments, with interest at rates varying principally Total consolidated term debt 13,618 14,038 $117,879 $127,104 34

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(10) Term Debt and Other Borrowings (Continued) Various covenants of borrowing Agreements to which the Company or its subsidiaries are parties are not materially restrictive as to the Company's current or prospective actions and activities. Principal payments on term debt outstanding at December 28, 1985 are required during the succeeding five years as follows: 1986 $2,867 1987 2,756 1988 1989 2,788 2,448 1990 2,456 Revolving Credit and Term Loan Agreements between Berkshire and certain banks, which made available up to $175,000 in borrowings by Berkshire, were in effect from February, 1984 until October, 1985, when Berkshire exercised its option to terminate the Agreements. (11) Stockholders' Equity Accounts Changes in Stockholders' Equity accounts during the most recent three years were as follows: Net Unrealized Appreciation Retained Earnings Treasury Stock Balance at January 1, 1983 $358,121 $ 400,432 $40,658 Increase during 1983 in unrealized appreciation included in carrying value of marketable equity securities 174,058 Change during 1983 in deemed applicable income taxes (48,899) Net earnings 1983 112,166 Value of 500 treasury shares acquired in Blue Chip merger 280 Increase during 1984 in unrealized appreciation included Balance at December 31, 1983 483,280 512,598 40,938 in carrying value of marketable equity securities 2,612 Change during 1984 in deemed applicable income taxes 1,061 Net earnings 1984 148,895 Balance at December 29, 1984 486,953 Increase during 1985 in unrealized appreciation included 661,493 40,938 Change during 1985 in deemed applicable in carrying value of marketable equity securities 248,978 income taxes (71,217) Minority shareholders' interest (7) Net earnings 1985 435,815 Balance at December 28, 1985 $664,707 $1,097,308 $40,938 On July 28, 1983, Berkshire increased by $805 its issued common stock when it exchanged 160,900 shares of its $5 par value shares for the 40.4% in Blue Chip's net assets that it did not already own. Additionally, in recording this transaction $153,860 was credited to capital in excess of par value. (12) Dividend Restrictions - Insurance Subsidiaries Payments of dividends by Insurance Group members are restricted by insurance statutes and regulations. In early January, 1986, dividends of approximately $205,000 were paid by Insurance Group members to Berkshire after necessary approvals were obtained from the Nebraska Department of Insurance. Payment to Berkshire by Insurance Group members of additional dividends in 1986 which exceed $43,137 would require approval of regulatory authorities. Combined stockholders' equity of insurance subsidiaries, determined pursuant to statutory accounting amounts determined on the basis of generally accepted accounting principles were $1,410,976 and rules, was $1,681,874 and $1,291,103 at December 31, 1985 and 1984, respectively. Corresponding $1,101,947. 35

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Notes to Consolidated Financial Statements (Continued) (13) Interest and Dividend Income Investment income for each of the past three years was comprised of the following: 1985 1984 1983 Dividends: Exxon Corporation American Broadcasting Companies .. $ 1,441 General Foods Corporation GEICO Corporation 5,588 $ - 6,850 2,585 $ = All Others The Washington Post Company 7,727 6,028 9,428 5,121 1,726 10,923 1,495 10,786 1,233 20,933 29,151 Interest exempt from Federal income taxes Total dividends 34,118 Other interest 36,965 36,579 23,896 41,964 44,933 9,677 Interest and dividend income. 18,301 10,293 $107,662 $84,161 $64,903 (14) Income Taxes earnings and to realized investment gain as shown below: The Consolidated Statements of Earnings reflect charges for income taxes applicable to operating Applicable to Applicable income taxes 1985 1984 1983 Operating earnings Realized investment gain of consolidated companies $ 31,271 140,946 $ 16,420 31,221 $ 8,904 21,849 $172,217 $ 47,641 $ 30,753 These taxes are comprised of: Federal State $158,603 $ 39,128 Foreign 13,593 $ 26,728 21 8,455 58 3,920 105 Taxes payable currently $172,217 $ 47,641 $ 30,753 Changes in prepaid/deferred taxes $137,689 34,528 $ 44,286 3,355 $ 35,173 (4,420) $172,217 $ 47,641 $ 30,753 computed at the Federal statutory rate: Charges for income taxes are reconciled in the table which follows to hypothetical amounts 1985 1984 1983 Net earnings including minority interest, before applicable income taxes .. $620,035 $203,031 $151,720 Hypothetical amounts applicable to above computed at the Federal statutory rate (46%) Decreases, resulting from: $285,216 $ 93,394 $ 69,791 Tax-exempt interest income .. 85% dividends received deduction relating to (16,826) (10,992) (4,310) dividend income reported herein Rate differentials relating to realized (13,340) (16,408) (17,714) State income taxes, less Federal income investment gains (86,828) (21,209) (19,391) tax benefit Net other differences 7,340 Total income taxes (3,345) 4,636 2,117 (1,780) 260 $172,217 $ 47,641 $ 30,753 36

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(15) Realized Investment Gain A summary of net realized investment gain for each of the past three years is presented in the following table: 1985 1984 1983 Special share redemption proceeds*: From General Foods Corporation ... $ 8,845 $ 21,844 $- From The Washington Post Company 15,774 From GEICO Corporation 21,000 24,619 21,844 21,000 Less: Cost of shares redeemed 5,615 13,733 1,425 Pre-tax gain realized from special share Pre-tax gain realized on sale of General Foods stock** redemption transactions 333,479 19,004 8,111 19,575 Pre-tax net gain realized on other sales of securities by consolidated companies . 135,424 Applicable income taxes (140,946) 101,692 (31,221) (21,849) 67,260 Applicable minority interest (7,551) (2,035) (1,464) 339,410 76,547 63,522 Equity in after-tax gain realized by Mutual Savings and Loan Association, an unconsolidated subsidiary 3,457 2,147 Realized investment gain, net $342,867 $ 78,694 $63,522 *Share redemption proceeds were received in transactions that resulted in no change therefrom, in Berkshire's percentage ownership of investees and are therefore viewed by management as equivalent to dividend income. Generally accepted accounting principles require that the proceeds be reflected in realized investment gain and that in determining income from the transactions, the proceeds must be reduced for the cost of the shares redeemed. Income taxes applicable to the resulting net gain are reflected at the rate (6.9%) applicable to dividend income. Stated on after-tax basis, the per share for those respective years. applicable minority interests, Berkshire's gain from this transaction amounted to $227,797 ($198.62 per share). 37

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Notes to Consolidated Financial Statements (Continued) (16) Quarterly Data information is unaudited. A summary of earnings by quarter for the past two years is presented in the following table. This 1985 Ist 2nd Income items Quarter Quarter 3rd 4th Quarter Quarteral Earnings before realized investment gain $178,693 $190,116 $227,761 Realized investment gain …... 22,708 $343,294 Net earnings .... 22,289 18,696 48,065 18,253 37,200 33,291 235,313 Per average outstanding share ...... $ 44,997 $ 66,761 $ 55,453 $268,604 Net earnings Earnings before realized investment gain ….. $ 19.80 39.23 $ 16.30 58.21 $ 15.91 $ 29.03 48.35 234.20 Income items ….... 1984 $164,580 Earnings before realized investment gain $179,208 $160,509 Realized investment gain .. . ......... 13,001 14,648 $224,882 21,446 13,870 Net earnings 21,670 17,654 28,682 17,924 $ 34,447 Per average outstanding share: $ 36,318 $ 31,524 $ 46,606 Net earnings Earnings before realized investment gain $ 11.34 $ 12.77 30.03 31.67 $ 12.09 $ 25.01 27.49 40.63 10) Candy business revenues and earnings are significantly higher in the fourth quarter of the year compared to earlier quarters. More than half of See's Candies annual sales are normally recorded in the fourth quarter. Newspaper revenues and earnings also peak in the fourth quarter of the year. 38

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(17) Business Segment Data The tables below reflect data for each of the three most recent fiscal years, broken down as to business segments. Revenues 1985 1984 1983 Insurance $412,481 Newspaper Candy 145,103 $209,523 136,053 $196,729 107,864 Steel service cente Retailing of home furnishing 123,292 101,639 133,616 118,176 90,161 28,910 51,305 55,305 46,266 Retailing of apparel 43,115 Textiles ….... 25,696 32,444 41,966 26,611 41,997 Revenues not identified with segments. 31,008 34,073 38,436 $939,864 $729,179 $602,726 Operating Profit Before Taxes 1985 1984 1983 Insurance $ 50,987 $ 20,843 Candy 28,014 25,669 $ 26,697 9,938 Newspaper 29,322 26,729 19,039 Steel service center Retailing of home furnishings 12,177 14,044 3,642 3,896 4,092 3,241 Retailing of apparel 270 (1,072) 697 Textiles (2,395) 418 (100) Pre-tax operating profits not identified with segments 25,687 19,230 21,173 Shareholder designated contributions Corporate expenses (1,725) (1,543) (1,272) (4,006) (3,178) (3,066) Interest expense (14,415) (14,734) (15,104) $127,812 $ 90,498 $ 64,885 Amounts are stated before deduction of any applicable minority interest. Charges or credits for depreciation and amortization of tangible and intangible assets have been taken into account. See below. Realized investment gains are not reflected. Capital Expenditures 1985 1984 1983 Insurance $ 623 3,756 $ 441 3,727 $ 282 Newspaper Candy 3,602 734 2106 Retailing of home furnishings 1,665 623 Steel service center 492 409 159 Textiles Retailing of apparel 285 628 612 320 1,269 470 Other 672 720 972 $11,723 $ 7,586 $ 6,346 Expenditures which were part of business acquisitions are excluded. 39

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... Notes to Consolidated Financial Statements (Continued) (17) Business Segment Data (Continued) Depreciation and Amortization of Tangible Assets Insurance 1985 1984 1983 Candy $ 531 $ Newspaper 2,613 492 $ 550 Retailing of home furnishings 1,098 2,762 2,592 2,386 2,264 922 2,557 Steel service center Textiles Retailing of apparel 673 633 228 698 538 457 633 662 400 Other 689 679 620 632 $ 9,592 $ 8,764 $ 7,953 Amortization of Intangible Assets 1985 Candy 1984 1983 Newspaper $ 975 Retailing of home furnishings 599 $ 975 599 $ 714 Other Mutual 509 467 314 (624) (624) 128 (624) 16 17 $ 1,475 $ 1,434 $ 532 Identifiable Assets At Year-End 1985 Identified with segments: 1984 1983 Insurance Candy - other than goodwill $2,627,957

• goodwill

34,606 $1,615,274 28,631 $1,322,160 Newspaper — other than goodwill 33,523 34,497 27,791

• goodwill

37,515 22,907 37,653 35,472 Retailing of home furnishings 22,307 37,292 23,506

• other than goodwill

Steel service center goodwill 19,298 45,319 40,560 19,807 35,165 Retailing of apparel 18,608 18,182 20,274 Textiles 15,163 13,186 17,672 Other ... 6,465 16,085 13,435 14,789 9,264 9,487 10,575 Not identified with segments: 2,870,025 1,856,269 1,558,131 Investment in unconsolidated subsidiaries Corporate cash and marketable securities of 31,027 33,235 27,216 parent and non-insurance subsidiaries .. 279,666 145,699 252,196 $3,180,718 $2,035,203 $1,837,543 40

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(17) Business Segment Data (Continued) Revenues of the Insurance Segment 1985 1984 1983 Premiums written .. $497,400 $133,558 $149,849 Premiums earned: Workers' compensation* Specialized auto and general liability ... 123,410 64,003 68,148 17,715 22,665 19,278 Home-state multiple lines... 43,208 32,598 35,328 Subtotal - excludes reinsurance assumed 184,333 119,266 122,754 Major quota-share reinsurance** Reinsurance ................. 12,616 16,066 70,261 - 26,460 Structured settlements and portfolio reinsurance... 49,849 4,910 3,266 Total premiums earned 317,059 140,242 152,480 Investment income …........ 95,422 69,281 44,249 $412,481 $209,523 $196,729 *Workers' Compensation coverage written by the Home State Companies, as part of their multiple line business, is not disaggregated from their total earned premiums. Seven percent (7%) of business of Fireman's Fund Insurance Companies from September 1, 1985 to December 31, 1985. Insurance Segment Operating Profit Before Taxes 1985 1984 1983 Underwriting (loss): Specialized auto and general liability $ (2,950) $(16,049) Workers' compensation (2,406) (12,703) $(14,880) (1,406) Home-state multiple lines (2,791) (4,101) (8,834) Subtotal - excludes reinsurance assumed (8,147) (32,853) (25,120) Major quota-share reinsurance Reinsurance (19,712) (12,560) (8,072) (10,261) Structured settlements and portfolio reinsurance (6,110) (2,647) (680) Total underwriting (loss) (44,230) (48,060) (33,872) Net investment income 95,217 68,903 43,810 $ 50,987 $ 20,843 $ 9,938 Portfolio reinsurance obligations were first assumed near the end of 1983 and no gain or loss from such transactions was recorded until 1984. **Seven percent (7%) of business of Fireman's Fund Insurance Companies from September 1, 1985 to December 31, 1985. 41

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Notes to Consolidated Financial Statements (Continued) (18) Commitments and Subsequent Events On January 2, 1986, Berkshire subsidiaries purchased, for $517,500 cash, three million shares of common stock of Capital Cities Communications, Inc. See the preceding Note 3. Additionally, on January 6, 1986, the businesses of Scott Fetzer were acquired. See the preceding note 2. In that merger transaction, Berkshire contributed on the merger date approximately $260,000 cash consideration for the merger, and Berkshire thereby succeeded to the assets, subject to the liabilities, of Scott Fetzer. These transactions had significant impact on Berkshire's consolidated balance sheet, including, among other things, a large reduction in cash. of (a) Scott Fetzer's historical condensed consolidated balance sheet as of November 30, 1985 with The following unaudited pro forma condensed consolidated balance sheet results from combination (b) Berkshire's condensed consolidated balance sheet as of December 28, 1985, as if the business combination had occurred, on its same terms, at the close of business on December 28, 1985. Also given pro forma effect is the January 2, 1986 purchase of the Capital Cities shares. Pro forma assets Cash and temporary cash investments Securities with fixed maturities $ 247,498 Accounts receivable …...... Marketable equity securities .... 1,849,951 475,216 Inventories 247,457 Goodwill Property, plant and equipment, net 212,256 150,630 Other assets 94,418 209,154 $3,486,580 Pro forma liabilities and stockholders' equity Losses, loss adjustment expenses and unearned premium of insurance subsidiaries Deferred income taxes ...... Accounts payable, accruals and similar liabilities $ 640,745 335,574 Term debt and other borrowings 326,114 157,195 Minority shareholders' interests 1,459,628 Stockholders' equity ... 34,360 1,992,592 $3,486,580 Pro forma stockholders' equity exceeds by $107,262 that reflected in Berkshire's consolidated investment by Berkshire's insurance subsidiaries in Capital Cities shares at their market value on the balance sheet as of December 28, 1985. This is the result of including, in the pro forma data, the date of acquisition. The then market value of the shares exceeded the purchase price, which was contractually fixed on March 18, 1985. Certain estimates, using tentative and preliminary data, were required for the making of the pro forma adjustments, the effects of which are reflected above, relating to the Scott Fetzer acquisition. Data recorded by Berkshire in its actual accounting for the Scott Fetzer merger will differ immaterially. Among other differences, Scott Fetzer's data as of the actual merger date will be the basis for the purchase accounting, as opposed to November 30, 1985 data used for purposes of the above pro forma balance sheet. 42

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[PAGE 53]

BUSINESS ACTIVITIES OF THE COMPANY AND ITS SUBSIDIARIES BERKSHIRE HATHAWAY INC. December 28, 1985 reincorporated in Delaware in 1973, were originally centered in New England and for several decades The activities of the Parent company, which was incorporated in Massachusetts in 1889 and onsisted of the manufacture and sale of woven textile products. Reductions in scope of Berkshire entirely ceased its manufacture of textile products. extile activities occurred from time to time, albeit irregularlv, after about 1960. In 1985. Berkshir Berkshire and its subsidiaries by Warren E. Buffett in consultation with Charles T. Munger, Chairman Investment activities and decisions and all other major capital allocation decisions are made for are made by the managers of Berkshire's operating units. and Vice Chairman, respectively, of Berkshire's Board of Directors. Operating decisions, by contrast,

• * *

entities that were engaged in the property and casualty insurance business. Thereafter, insurance In 1967, redeploying capital from the Company's textile business, the Company acquired two operations were expanded and controlling interests in several other businesses were acquired. At the wholly-owned subsidiaries. Four major business activities so conducted were: end of 1985, Berkshire's diverse activities were conducted through wholly-owned or substantially- (a) Underwriting of property and casualty insurance (b) Candy production and sale at retail (c) Newspaper publishing (d) Retailing of home furnishings A description of these major business activities and others of Berkshire appears below and on the following pages. The businesses of The Scott & Fetzer Company acquired shortly after the end of 1985 (on January 6, 1986) are also briefly described. (a) Underwriting of Property and Casualty Insurance. Several Berkshire subsidiaries, collectively referred to in this report as the "Berkshire Hathaway Insurance Group", provide insurance coverages reinsurance basis ("Direct" in this context refers to an insurance company's issuance of policies in with respect to property and casualty insurance risks. Coverages are provided on both a direct and insured risks between insurance companies.) the names of persons directly subject to risk of loss, whereas "reinsurance" refers to transfers of been divided into six subsegments, as follows: For descriptive and reporting purposes, the underwriting activities of the Insurance Group have (ii) Reinsurance, (i) Specialized automobile and general liability insurance, (iii) Major quota-share reinsurance, (iv) Structured settlements and portfolio reinsurance, (vi) Workers' compensation (v) Home-state multiple lines, and office in Omaha, Nebraska are National Indemnity Company ("NICO"), National Fire and Marine Members of the Berkshire Hathaway Insurance Group with a common staff and sharing a home Insurance Company and Columbia Insurance Company, each a wholly-owned, Nebraska chartered subsidiary of Berkshire. Also now sharing that staff and home office is Wesco-Financial Insurance Company (Wes-FIC), also Nebraska chartered, formed in 1985 as a wholly-owned subsidiary of Berkshire's 80.1%-owned Wesco Financial Corporation ("Wesco" — see below). As an initial insurance transaction, Wes-FIC assumed a portion of a major quota-share reinsurance contract entered into by Insurance NICO. These companies, in differing degrees by each, share the business of the Berkshire Hathaway Group that is categorized in Berkshire's segment data (note 17 to Berkshire's consolidated financial reinsurance, and (iv) structured settlements and portfolio reinsurance. statements) as (i) specialized automobile and general liability, (ii) reinsurance, (iii) major quota-share 44

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from "non-standard" risks. Herein we refer to "non-standard" risks as those that involve some type of unusual exposure for which premium charges may be higher than for those that are not perceived to involve distinguishing unusual exposure. Risks viewed by industry participants as "standard" when insurance coverages are readily available come to be viewed as "non-standard" when industry insuring increased sharply in 1985, resulting in a greatly increased number of non-standard risk offerings to, capacity decreases. Public and industry perceptions of lack of insuring capacity appear to have and acceptances by, the Berkshire Hathaway Insurance Group. A separate division was established in 1985 within the Berkshire Hathaway Insurance Group to efforts, although 1985 earned premiums of about $8 million was less than the $40 million volume underwrite large-premium risk offerings. Some business was written as a result of this new division's of premiums written. are expected to increase in 1986 over 1985, following a 93% increase in 1985 over the 1984 figure. Earned premiums from this subsegment of the business that writes specialized liability insurance The tail (claim reporting and settlement period) of this type of business is long, so that it will be years before the degree of profitability or unprofitability of the business will be fully known. reinsurance. The division which manages this business was established in 1969 and is currently (ii) The Berkshire Hathaway Insurance Group underwrites various types of property/casualty treaty located in Philadelphia. The volume generated by this subsegment has been limited in recent years but could increase significantly as a result of the reduction of insuring capacity in the reinsurance marketplace. (iii) As of September 1, 1985, NICO entered into a major quota-share reinsurance arrangement with the Fireman's Fund Insurance Companies ("FF"), whereby it will, for a four-year period, receive 7% of all the property and casualty insurance premiums written by FFC and will, in turn, pay 7% with Wes-FIC, is expected to generate in 1986 more than $200 million in premium volume for the of all costs incurred by FFC related to this 7% of their business. This arrangement, shared by NICO Berkshire Hathaway Insurance Group. reinsurance arrangement with another major company. This one-year renewable term arrangement will In January, 1986, The Berkshire Hathaway Insurance Group entered into another quota-share generate earned premiums for 1986 estimated at about $50 million. While the terms of these treaties are similar to some classified in (ii) as "reinsurance", the significant volume of business anticipated from these major contracts has motivated the reporting of results therefrom as a separate subsegment of the business. (iv) Assumption by members of the Berkshire Hathaway Insurance Group of liabilities of other insurance companies for periodic payments of settled claims ("structured settlements") and portfolio risk assumptions was incepted in 1982. The number of periodic payment obligations assumed in 1985 increased significantly over the number of assumptions in 1984. Additionally, earned premiums in assumption activity. 45

[PAGE 55]

Business Activities of the Company and its Subsidiaries (Continued) (a) Underwriting of Property and Casualty Insurance (Continued) (v) Home-state subsidiaries were formed, in the 1970s, by Berkshire (as NICO subsidiaries) in domiciliary states. Their underwriting operations are locally managed and conducted with a view to certain states to write standard multiple line property and casualty insurance principally in their providing to agents and policyholders service that is competitively-superior because of their proximity to the Home-state companies' headquarters. Home-state subsidiaries presently include Cornhusker Continental Divide Insurance Company in Inglewood, Colorado. Casualty Company in Omaha, Nebraska, Kansas Fire & Casualty Company in Topeka, Kansas, and Insurance Company, a Berkshire subsidiary located in Pasadena, California. (vi) Workers' compensation insurance operations are conducted as a specialty business of Cypress In recent years, financial failures in the insurance industry have received considerable attention c been made mone ivan of rainergent derived from de, industry participant an financial resources supported, with significant margins of safety against adversity, their promises. In this respect Berkshire Hathaway Insurance Group members are competitively well positioned. They feature significantly extended claims settlement periods. That feature is integral to most of the businesses possess notable above-average financial strength, particularly of benefit in areas of insurance that businesses. of the Berkshire Hathaway Insurance Group, with the possible exception of the Home-state companies' * December 31, 1985. Approximately 600 employees were engaged in the conduct of Berkshire's insurance business at * 1983 through the merger of Blue Chip Stamps. See's produces boxed chocolates and other confectionery (b) The Candy Business. See's Candy Shops, Incorporated became wholly-owned by Berkshire in the largest candy manufacturers distributing at retail through its own chain of stores. It now has 215 products of high quality in two large kitchen facilities in California. See's is believed to be one of retail shops in twelve western and midwestern states including Hawaii. Additional retailing activities are conducted from five of seven full-time quantity order centers that were in operation in 1985; in the fourth quarter of 1985. fifteen additional quantity order centers were in temporary operation to serve peak seasonal requirements volume is generated during the last two months of the year, when quantity sales at reduced prices A significant degree of seasonality exists in this business. About 50% of each year's unit sales the number of See's employees peaks at about three times the full-time base of approximately 1,500. to businesses and other organizations augment the extremely high December shop volume. At Christmas, (c) The Newspaper Business. This business is operated by the Buffalo Evening News, Inc., which is in its 105th year of publishing in Buffalo, New York. It presently publishes the Buffalo News, an all-day newspaper published seven days a week, with seven editions printed each weekday. It is the only metropolitan newspaper published daily within its ten-county distribution area. The Buffalo News is number one in penetration among newspapers in the top 50 primary market areas in the 24th among the nation's daily newspapers in daily circulation. United States, with 79% penetration on weekdays and 82% penetration on Sundays. It currently ranks It became wholly owned by Berkshire in 1983 through Berkshire's merger of Blue Chip. The assets of the Buffalo Evening News, Inc. were purchased by Blue Chip Stamps in April, 1977. The News employs about 970 persons on a full-time basis. 46

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(d) Retailing of Home Furnishings. This business is conducted by Nebraska Furniture Mart, Inc., Nebraska is believed by Berkshire management to be the largest single home furnishings retail store 90% ownership of which was acquired by Berkshire on September 30, 1983. Its store in Omaha, in the United States. It has sizable warehousing facilities near its retail outlet permitting it to serve a trade area within a radius of about 300 miles from Omaha. Local consumer preference studies indicate Nebraska Furniture Mart to be the leading retailer of its products in its marketing area. The business is operated by members of the family from whom Berkshire purchased its interest therein, and who retain a minority ownership interest. As stated, Berkshire's ownership interest in the business in the earnings of the business is 80%. An important feature of the business is its ability to control is 90%, but as a result of options outstanding to key managers of the operation, Berkshire's interest its costs and realize highly satisfactory earnings while offering significant value to its customers. At the end of 1985, Nebraska Furniture Mart employed about 600 persons.

• * *

WESCO FINANCIAL CORPORATION is a savings and loan and insurance holding company, 80.1% beneficially owned by Berkshire. It owns, operates and receives income with respect to a downtown business block in Pasadena, California with improvements including a nine-story office building, commercial store buildings and a multi-story parking garage. Wholly-owned subsidiaries of Wesco include Mutual Savings and Loan Association, Pasadena, California, a state chartered savings and loan company (with savings account deposits of approximately $269 million and 60 employees at December 31, 1985) and Precision Steel Warehouse Inc., Franklin Park, Illinois and Charlotte, North Carolina. Precision operates a metals service center business and employs about 265 persons. In September, 1985, Wesco invested $45 million in cash equivalents in a newly organized, wholly-owned, Nebraska chartered insurance company, Wesco-Financial Insurance Company ("Wes-FIC"'). Wes-FIC is accounted for in Berkshire's consolidated financial statements as a member of the Berkshire Hathaway Insurance Group. See above. Its business in 1985 consisted of accepting, as a retrocession from National Indemnity Company, a portion (two sevenths) of the business that NICO wrote with the Fireman's Fund Insurance Companies under arrangements heretofore described. is a wholly-owned subsidiary of Berkshire. Associated operates a chain of about 90 retail apparel Associated Retail Stores, Inc., with headquarters and warehouse in Long Island City, New York, stores located in New York City, Chicago, Philadelphia and at various other locations in midwest and northeast states. It employs approximately 1,000 persons on a full-time basis. Berkshire. It operates a west coast trading stamp business from its Los Angeles headquarters. Blue Chip Stamps, with about 90 employees at December 31, 1985, is also wholly-owned by * Berkshire is also engaged in the manufacture and sale of branded ('K & W") chemical products used in the automotive after-market. This business employs 35 persons and operates from Los Angeles, California and Bloomington, Indiana. Berkshire owns real property and about 15 acres of land with building improvements, in New Berkshire is currently holding this property for prospective lease to others Bedford, Massachusetts, principally occupied until recently by its discontinued textile weaving operations.

• * *

47

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Business Activities of the Company and its Subsidiaries (Continued) Businesses of The Scott & Fetzer Company, acquired January 6, 1986 stock of The Scott & Fetzer Company ("Scott Fetzer"). Scott Fetzer, headquartered in Westlake, Ohio, On January 6, 1986, Berkshire acquired to beneficial ownership of all of the outstanding capital lines are vacuum cleaners and related accessories primarily for home use sold under the Kirby and conducts diversified manufacturing and marketing activities. Two of Scott Fetzer's principal product other brand names, and encyclopedias and related education products sold under the World Book name. Scott Fetzer also manufactures through its Campbell Hausfeld division a variety of products related to transmission of air and other fluids, such as air compressors, units for the spraying of Home Equipment name, Scott Fetzer assembles and sells domestically water circulation pumps, sump paints and other liquids, air receivers and high pressure sprayers and washers. Under the Wayne and other pumps, and power oil and gas burners. Scott Fetzer's 17 operating units are located in 12 states, and their businesses involve manufacture and sale of a variety of other products and services. Berkshire paid approximately $320 million (of which approximately $260 million was paid in cash on January 6, 1986) to acquire Scott Fetzer. Scott Fetzer's revenues in its fiscal year ended derived from World Book products, 17% — Kirby and related private label products, 12% - Campbell November 30, 1985 were approximately $690 million. Of those revenues, approximately 41% were Hausfeld products, and 6% - Wayne home equipment products. Various other products contributed about 24% of Scott Fetzer's fiscal 1985 revenues. Scott Fetzer employed about 21,000 persons at December 31, 1985. Investments and Investment Income of the Berkshire Hathaway Insurance Group. Investable funds of the Insurance Group derive from Significant amounts of investment income are generated by investments in securities by members extensive capital funds committed to the operations, and from policyholder funds derived from unearned premium and loss reserves. Also, additional investment income, varying in amount from year to year, the Insurance Group. Additional information regarding investments in securities, investment income derives from securities held from time to time by Berkshire and by Berkshire subsidiaries outside of and realized gains from securities transactions is reflected in the accompanying consolidated financial statements and notes thereto. Berkshire's executive offices are in Omaha, Nebraska.

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48

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BERKSHIRE HATHAWAY INC. Financial Condition and Results of Operations Management's Discussion and Analysis of Results of Operations Berkshire's operations are diverse. For purposes of this discussion, results are disaggregated to to the various Berkshire operations appears in Note 17 (the "Segment Note") to the Consolidated permit separate discussion of the more significant sources of net earnings. Extensive data with respect Financial Statements appearing elsewhere herein. This discussion should be read in conjunction with that data. The section of this report relating to "Business Activities of the Company..." at pages 44 to 48 is also pertinent. detailed. The impact of income taxes is somewhat uneven as to the various line items. Consolidated In the Segment Note, the operating profit before taxes of the various Berkshire businesses is after-tax earnings for the past three years are summarized by principal source in the following table: Net After-Tax Earnings (Loss) Source 000s Omitted 1985 1984 1983 Insurance underwriting $ (23,569) $ (25,955) Candy business 13,583 12,406 $ (18,400) 11,498 Newspaper business 13,980 Retailing of home furnishings Interest and dividend income .... 4,672 12,717 8,518 86,204 71,0177 5,451 1,352 Interest and financing costs (7,288) (7,452) 53,341 Other operating items, net 5,366 2,017 (7,346) (319) Earnings before realized investment gain 92,948 Realized investment gain, net 342,867 70,201 78,694 63,522 48,644 Net earnings $435,815 $148,895 $112,166 Insurance underwriting below, on the basis of generally accepted accounting principles ("GAAP"), for the past three years, A summary of the underwriting results of the Berkshire Hathaway Insurance Group is presented with dollars in thousands: 1985 1984 1983 Amount % Amount % Amount % Premiums written $497,400 $133,558 $149,849 Premiums earned 317,059 100.0 140,242 100.0 152,480 100.0 Losses and loss expenses 280,249 88.4 141,550 100.9 Underwriting expenses Total losses and expenses 81,040 25.6 46,752 33.4 134,109 87.9 52,243 34.3 361,289 114.0 188,302 134.3 186,352 122.2 Underwriting loss - pre-tax (44,230) (48,060) (33,872) Applicable income tax credit 20,346 22,105 15,472 Applicable minority interest 315 After-tax loss $(23,569) $ (25,955) $(18,400) to premiums earned (hereafter, the "loss and expense ratio") is comparable but not identical to the The percentage figures shown in the above table representing the ratio of total losses and expenses "combined ratio" that is computed for companies in the industry based on data assembled for statutory reporting purposes. Of course, underwriting results, computed on a GAAP basis, are profitable to the extent that the loss and expense ratio is less than 100% and unprofitable to the extent that the ratio exceeds 100%. 49

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Management's Discussion •.. (Continued) Insurance Underwriting (Continued) For a period of several years prior to 1985, the insurance industry's prices (premium rates) were The extensive financial resources of the Berkshire Hathaway Insurance Group permitted it to significantly increase its volume of business in 1985, as the number of business offerings to the group, at higher prices, increased for the past three years are shown in the following table. Summaries of aggregate loss and loss expense data for the Berkshire Hathaway Insurance Group 000s Omitted Unpaid losses and loss expense at beginning of year 1985 1984 1983 Incurred losses recorded: . . . $243,298 $212,706 $193,477 Current year occurrences All prior years' occurrences 257,384 22,865 122,043 19,507 130,101 4,008 Payments with respect to: 280,249 141,550 134,109 Current year occurrences All prior years' occurrences 36,439 75,803 32,648 78,310 43,062 112,242 71,818 Unpaid losses and loss expense at end of year 110,958 $411,305 114,880 $243,298 $212,706 years' occurrences" ($22,865,000 for 1985, $19,507,000 for 1984, and $4,008,000 for 1983). These Adverse loss development is represented by the figures for incurred losses captioned "All prior figures represent increases in the given year to the estimates of prior years' loss occurrences, based on information that came to light in that given year with respect to such prior occurrences. If the prior year-end estimation processes would have been perfect, all of the costs related to prior years' recorded in a given year is an indication of the estimation error that resulted when the prior year- end liability for unpaid losses additional information will become available and events will subsequently occur that influence the because even though one additional year's hindsight is employed in making the revised estimate, actual loss amounts ultimately incurred with respect to the prior years' occurrences. It literally takes years to determine the precise amount of estimation error that existed in an original estimate. One- of any given year of the estimation error recognized in that year. year developments, as presented above, have the advantage of revealing the effect on reported income

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Aggregation of underwriting data of the Berkshire Hathaway Insurance Group serves a purpose in any broad analysis of Berkshire's total operations. However, analysis and discussion that deals only sub-groupings are possible, one of which is reflected in the last two tables of the Segment Note with Berkshire's insurance operations requires further disaggregation of Insurance Group data. Various appearing at page 41. That breakdown aligns with managements' view of the components of Berkshire's (i) business other than reinsurance assumed, and (ii) reinsurance assumed. insurance business. The balance of this discussion centers around that breakdown, summarized as to 50

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Insurance Operations Excluding Reinsurance Assumed Business Insurance Underwriting (Continued) A summary follows of the combined underwriting results of the Berkshire Hathaway Insurance Group, excluding reinsurance assumed business. Dollars are in thousands. 1985 1984 1983 Amount % Amount % Amount % Premiums written $269,057 $118,090 $119,809 Premiums earned 184,333 100.0 119,266 100.0 122,754 100.0 Losses and loss expenses 140,029 76.0 Underwriting expenses 52,451 28.4 110,491 92.6 102,880 83.8 41,628 34.9 44,994 36.7 Total losses and expenses 192,480 104.4 152,119 127.5 147,874 120.5 Underwriting loss — pre-tax (8,147) (32,853) (25,120) Applicable income tax credit 3,748 15,110 11,474 After-tax loss $ (4,399) $(17,743) $ (13,646) Administrative costs, largely charged to underwriting expenses, did not increase in proportion to the increase in premiums written, with the result that a meaningful decrease, from 34.9% in 1984 to 28.4% in 1985, is reflected for premium acquisition costs. It amounted to $8,105,000 and it contributed 6.8 points to the 1984 loss and loss expense ratio. In Significant adverse loss development in these businesses was recorded in 1984, as shown below. contrast, adverse loss development in 1985 was only nominal. Summarized below is loss and loss expense data for the Berkshire Hathaway Insurance Group's business, excluding reinsurance assumed business, for the past three years. 000s Omitted 1985 1984 1983 Unpaid losses and loss expense at beginning of year .. $164,776 $150,804 $144,091 Incurred losses recorded: Current year occurrences 139,966 All prior years' occurrences 63 102,386 103,861 8,105 (981) 140,029 110,491 102,880 Payments with respect to: Current year occurrences 35,419 36,608 40,553 All prior years' occurrences 60,150 59,911 55,614 95,569 96,519 96,167 Unpaid losses and loss expense at end of year $209,236 $164,776 $150,804 51

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Management's Discussion ... (Continued) Reinsurance Assumed Activities Insurance Underwriting (Continued) of the business involving reinsurance assumed, other than Structured settlements and portfolio The combined underwriting results of the Berkshire Hathaway Insurance Group for subsegments reinsurance, are summarized in the following table, with dollars in thousands. 1985 1984 Premiums written Amount % 1983 Amount % Amount % Premiums earned $178,502 $ 10,542 $ 26,774 Losses and loss expenses 82,877 100.0 Underwriting expenses 85,670 16,066 100.0 103.4 26,460 Total losses and expenses 27,180 23,720• 147.6 100.0 32.8 4,906 30.5 27,358 103.4 7,174 27.1 ... Applicable income tax credit Underwriting loss - pre-tax 112,850 136.2 28,626 178.1 34,532 130.5 (29,973) (12,560) Applicable minority interest 13,788 5,777 (8,072) 315 3,687 After-tax loss $ (15,870) $ (6,783) $(4,385) business for the past three years. Summarized below is loss and loss expense data with respect to the above summarized assumed 000s Omitted Unpaid losses and loss expense at beginning of year 1985 1984 1983 Incurred losses recorded: $ 47,867 $ 45,664 $ 45,820 Current year occurrences All prior years' occurrences 66,228 14,055 19,442 22,773 9,665 4,585 Payments with respect to: 85,670 23,720 27,358 Current year occurrences All prior years' occurrences 5,155 4,212 14,191 17,305 11,687 15,827 Unpaid losses and loss expense at end of year 19,346 21,517 27,514 $114,191 $ 47,867 $ 45,664 arrangement involving 7% of the post 8/31/85 business of Fireman's Fund Insurance Companies ("FFC"). The above data includes the significant amounts that resulted from the quota-share reinsurance (See the Segment Note.) None of the adverse development ("All prior years' occurrences") reflected involve assumption of any FFC's prior occurrence liabilities. All of the adverse development reflected in the immediately preceding table relates to the FFC arrangements since those arrangements did not in the preceding table relates to other reinsurance contracts written in earlier years. Significant adverse development in reinsurance assumed business has been common to the reinsurance industry in recent in the reinsurance market. years. Its revelation has been a major contributing cause to the shrinkage in capacity that has occurred Comparable summaries of the Structured settlements and portfolio subsegment of the reinsurance business are not informative, since different ratio analyses are applicable, depending on the varying to the Segment Note which reflects this subsegment's premium and pre-tax loss information. nature of the several different arrangements included in this very specialized area. Reference is made 52

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Candy Business follows: A summary of results to Berkshire from its See's candy business for the past three years is as 000s omitted Profit Applicable income Applicable minority Net before taxes taxes interest earnings 1985….. $28,014 $14,431 $ $13,583 1984 .... 25,670 13,264 1983 ..... 26,697 12,406 13,712 1,487 11,498 Stamps. For some time prior to that merger, See's was approximately 60% beneficially owned by This business became wholly-owned by Berkshire in 1983 as a result of the merger of Blue Chip Berkshire. Unit volume (pounds of candy sold) has been relatively static in the past three years, actually declining somewhat on a store-for-store basis. In 1984, a nominal percentage increase in selling price was somewhat less than the percentage increases in yearly costs, so that profit before taxes in 1984 declined slightly from 1983. A somewhat higher percentage increase in 1985 selling prices — about 6% — overcame the percentage increase in costs, permitting increased 1985 profit. Newspaper Business Berkshire's results from operation of the Buffalo News for the past three years is as follows: 000s omitted Profit Applicable income Applicable minority Net before taxes taxes interest earnings 1985 $29,321 1984 26,728 $15,341 $13,980 14,011 12,7177 1983 19,039 9,000 1,521 8,518 The News was 59.6% beneficially owned by Berkshire in earlier years and until the mid-1983 merger of Blue Chip Stamps. It is now 100% owned by Berkshire. In both 1985 and 1984 advertising and circulation revenues each increased from the immediately increased 12% over 1983. A lesser rate of increase in costs in each of the two most recent years preceding year. Total revenues in 1985 increased about 6% over 1984 amounts. Revenues in 1984 permitted the News' profit betore taxes to increase as shown above. Only nominal state income taxes were incurred in 1983 as a result of applicable net operating loss carryovers. In both 1985 and 1984, income of the News was fully subject to both state and federal income taxes. 53

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Management's Discussion ... (Continued) Retailing of Home Furnishings after Berkshire's purchase on September 30, 1983. The table below reflects data with respect to the Nebraska Furniture Mart's operations for periods 000s omitted Profit before Applicable Applicable taxes income taxes minority interest Net 1985 $12,177 earnings 1984 14,044 $6,210 $1,295 $4,672 1983 (3 months) ... 3,642 7,064 1,909 1,529 381 5,451 1,352 and operating costs increased moderately. The latter reflected higher costs incurred with respect to Revenues in 1985 were about 4% greater than in 1983. However, gross margins declined moderately, computerized systems for inventory location and control and in other areas of costs relating to customer service. Interest and Dividend Income This income is largely earned by the Insurance Group. Wesco and certain other consolidated issued by non-affiliates. subsidiaries and, from time to time, Berkshire also retain investments in income producing securities A summary of this category of income for the past three years follows: 000s omitted Profit Applicable income Applicable before taxes taxes minority Net 1985 interest earnings 1983 1984 $107,662 $19,865 84,161 11,802 $1,593 1,342 $86,204 64,903 8,018 3,544 53,341 71,017 portion represents dividend income of which only 15% is taxable at the full Federal corporate rate A portion of this income is received with respect to tax-exempt obligations, and a significan as the amount of investments has increased. Tax-exempt interest income increased significantly from See Note 13 to the accompanying financial statements. Total interest and dividend income has increased increased investment in Washington Public Power Supply System bonds. $9,677,000 in 1983 to $23,896,000 in 1984 and to $36,579,000 in 1985. The increases resulted from Realized Investment Gain This part of the discussion in past years has included a recitation that a significant component of Berkshire's net earnings has historically resulted from gains recorded when appreciated securities were sold; that management's decision to sell any of Berkshire's investments is based on a number of factors, but the impact of the decision on reported earnings is not a consideration; and that the amount of earnings that Berkshire may derive from realized investment gains, if any, tends to fluctuate significantly from period to period. That recitation was and still is totally appropriate. In 1985, realized investment gain was unusually high because of the sale by Berkshire subsidiaries to Philip Morris Company, in response to a tender offer at a large premium over the then prevailing about two thirds of the 1985 realized investment gain. See also Note 15 to the Consolidated Financial market price, of their significant investment in General Foods Corporation. That transaction contributed 54

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Liquidity and Capital Resources Berkshire maintains liquidity beyond industry norms. But, the amount of cash and temporary cash investments held by Berkshire at year-end 1985 was abnormally high, even for Berkshire, because of significant commitments that then existed against those funds. In March, 1985, Berkshire committed itself to purchase for $517,500,000 cash, the three million shares of Capital Cities that it purchased just a few days after 1985 year-end. Further, the Scott Fetzer merger, effected with cash, occurred to the Consolidated Financial Statements herein. It reflects what Berkshire's financial condition would early in January, 1986. An unaudited pro forma balance sheet of Berkshire is presented in Note 18 did, just after year-end. have been if those two transactions would have occurred at year-end instead of occurring, as they financial strength and liquidity enabled it to respond quickly to the opportunity to acquire Scott That pro forma balance sheet reflects continuing significant capital strength and liquidity. Berkshire's Fetzer. The sale of the General Foods stock made funds available that otherwise would have been required from other of Berkshire's resources; it also permitted Berkshire to cancel, on October 18, 1985, its $175 million line-of-credit arrangements with banks. Berkshire's equity capital, as reflected in its year-end consolidated balance sheets, has increased at the end of 1985. Berkshire's obligations continue to include those of a fiduciary nature, to policyholders $1,157,847,000 in the past three years, from $727,483,000 at the beginning of 1983, to $1,885,330,000 of its insurance subsidiaries, to savers of Blue Chip trading stamps, and to others. Management expects Berkshire to maintain significant margin of safety for meeting those obligations. Inflation Berkshire's management does not believe that, to date, inflation has seriously affected Berkshire's businesses. Generally, Berkshire receives current revenues in any year which have substantially the same purchasing power as the dollars which represent its current costs. Very few of Berkshire's costs are stated in dollars which are other than current dollars. This is not expected to change appreciably as the result of the Scott Fetzer merger. Berkshire's insurance business, particularly since premium rates are established well in advance of Very large changes in the rate of inflation that were not anticipated could seriously impact incurrence of the related costs. Management believes that to date, however, underwriting results have not been impacted materially by inflation or changes in inflation rates. 55

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The 1985 Annual Report of Wesco Financial Corporation included the following letter to Wesco stockholders from the Chairman of the Company. WESCO FINANCIAL CORPORATION LETTER TO SHAREHOLDERS To Our Shareholders: income and all net gains from sales of securities) for the calendar year 1985 decreased to Consolidated "normal" operating income (i.e., before all unusual operating $8,347,000 ($1.17 per share) from $10,060,000 ($1.42 per share) in the previous year. from sales of securities) increased to $51,541,000 ($7.24 per share) from $23,656,000 Consolidated net income (i.e., after unusual operating income and all net gains ($3.32 per share) in the previous year. A highly unusual capital gain, of a not-likely-to-recur type, from disposition of General Foods stock caused most of the net income in 1985. The table below gives particulars. Wesco has three major subsidiaries, Mutual Savings, in Pasadena, Precision Steel, neadquartered in Chicago and engaged in the steel warehousing and specialty metal products businesses, and Wesco-Financial Insurance Company, headquartered in Omaha and currently engaged in the reinsurance business. Consolidated net income for the two years just ended breaks down as follows (in 000s except for per-share amounts) '): Year Ended December 31, 1985 Per December 31, 1984 Wesco Wesco Per "Normal" net operating income (loss) of: Amount Share Amount Share Mutual Savings Precision Steel businesses ... $ 3,342 $ .47 $ 3,476 $.49 Wesco-Financial Insurance business— 2,010 .28 2,034 .29 Underwriting ............... Investment activity ........... (1,584) 1,225 (.22) .17 - - (359) (.05) All other "normal" net operating income(2) 3,354 .47 4,550 .64 Fluctuation in market value of GNMA futures contract .. 8,347 1.17 10,060 1.42 Net gains on sales of securities(3) .... 1,671 .24 458 .06 ... 41,523 5.83 Wesco consolidated net income ...: 13,138 1.84 ... $51,541 $7.24 $23,656 $3.32 (1) All figures are net of income taxes. (2) After deduction of interest and other corporate expenses. Income was from ownership of the Mutual Savings headquarters office building, primarily leased to outside tenants, and interest and dividend income from cash equivalents and marketable (3) The 1985 figure includes a $34,363,000 ($4.83 per share) gain realized by Wesco on the sale of its General Foods Corporation securities owned outside the savings and loan and insurance subsidiaries. Sales of Securities" below. common stock to Philip Morris Company in connection with the latter's publicly announced tender offer. See "Net Gains on This supplementary breakdown of earnings differs somewhat from that used in audited financial statements which follow standard accounting convention. The supple- mentary breakdown is furnished because it is considered useful to shareholders. 56

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Reproduced from 1985 Annual Report of Wesco Financial Corporation Mutual Savings Mutual Savings' "normal" net operating income of $3,342,000 in 1985 represented a decrease of 4% from the $3,476,000 figure the previous year. Separate balance sheets of Mutual Savings at yearend 1984 and 1985 are set forth at the end of this annual report. They show (1) total savings accounts rising to $269 million from $228 million the year before, (2) a very high ratio of shareholders' equity to savings account liabilities (probably the highest for any mature U.S. savings and loan associa- tion), (3) a substantial portion of savings account liabilities offset by cash equivalents and marketable securities, (4) a loan portfolio (mostly real estate mortgages) of about $83 million at the end of 1985, down 12% from the $95 million at the end of 1984, and (5) favorable effects of securities gains and other unusual gains and fluctuations, which caused net worth to decline only $4 million in 1985 despite payment of a dividend of $14 million to the parent corporation. The loan portfolio at the end of 1985, although containing almost no risk of loss from defaults, bore a fixed average interest rate of only 7.60%, probably the lowest for any U.S. savings and loan association and far below the average interest rate which now must be paid to hold savings accounts. However, as the loan payoff pace intensified and interest rates declined sharply in 1985, the unrealized depreciation in the loan portfolio became approximately offset by unrealized appreciation in Mutual Savings' interest- bearing securities and preferred stocks. As pointed out in tootnote 13 to the accompanying tinancial statements, the book value of Wesco's equity in Mutual Savings ($57.6 million at December 31, 1985) over- states the amount realizable, after taxes, from sale or liquidation at book value. If all Mutual Savings' assets, net of liabilities, were to be sold, even pursuant to a plan of complete liquidation, for the $57.6 million in book value reported under applicable accounting convention, the parent corporation would receive much less than $57.6 million after substantial income taxation imposed because about $47 million of what is designated shareholders' equity for accounting purposes is considered bad debt reserves for most tax purposes. There is, however, a buried plus value in Mutual Savings. The foreclosed property on hand (mostly 22 largely oceanfront acres in Santa Barbara) has become worth over a long holding period much more than its $1.5 million balance sheet carrying cost. Reasonable, community-sensitive development of this property has been delayed over end to the delay is near and that the Santa Barbara and Montecito communities will be 10 years in the course of administration of land-use laws. But we are optimistic that an very pleased with the development now likely to go forward. This development will contain 32 houses interspersed with large open areas. Mutual Savings plans to make the development first rate in every respect, and unique in the quality of its landscaping. Balancing all merits and demerits, Mutual Savings, as it has been managed under present conditions by the writer and others, is no jewel ot a business trom the share- holders' point of view. Mutual Savings' good points are: (1) high asset quality and sound balance sheet; (2) a maturity match of interest-bearing assets and liabilities which makes risk of insolvency near zero, whatever happens to interest rates; and (3) a deserved reputation for high quality service to account holders, achieved at below-average cost to the institution in an efficient one-large-office operation, as distinguished from a 57

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Reproduced from 1985 Annual Report of Wesco Financial Corporation many-small-branch-offices operation. Mutual Savings' bad points are: (1) all recent growth in savings accounts, considered on an incremental effects basis, has been loss business because interest and other costs incurred exceed income obtained by employ- ing proceeds in short-term interest-bearing assets; (2) a burdensome position under the FSLIC account-insurance system causes payments of ever-higher amounts into the system to help bail out more venturesome savings and loan associations which become insolvent, with the payments being required despite the fact that Mutual Savings imposes almost no risk on FSLIC; (3) "normal" net operating income is below an acceptable rate of return on present book value of shareholders' equity, with such return reaching an acceptable level over recent years only with help trom securities gains ano other unusual items; (4) it would not be easy to leave the savings and loan business should this course of action ever be desired, without a large income tax burden of a type not applied to corporations other than savings and loan associations; (5) the regulatory structure of the savings and loan business creates a competitive situation in which it is hard to make respectable profits through careful operations; and (6) management has years of trying. not yet found an acceptable remedy for any of the previously listed bad points, despite Moreover, comparisons of post-1984 financial results for Mutual Savings with results for many other and more typical savings and loan associations in California leave Mutual Savings looking inferior, to put it mildly. As interest rates went down these other associations, which have greater financial leverage and operated less fearfully than Mutual Savings during former high-interest periods, came to have loan and investment portfolios which (1) now are worth more on average than book value and (2) now produce a high return on book value of shareholders' equity, after deduction of operating expenses and interest to account holders at present rates. Any Wesco share- interest rate changes can look at the 1985 record and despair. holder who thinks Mutual Savings has any expertise in predicting and profiting from Despite the fact that some other savings and loan associations did much better after 1984 than Mutual Savings, and are now much better poised to report good figures for 1986, we plan to continue operating only in ways acceptable in our own judgment, anticipating as a consequence widely fluctuating and sometimes inadequate returns. In the future, however, Mutual Savings will make and purchase more loans. Now that Mutual Savings' old mortgage loans have declined in amount and increased in market value (the market value increase being caused both by a decline in generally prevailing interest rates and by a shortening of remaining loan life), new loans will be added as seems wise, with a target that 60% of assets be in housing-related loans. The first new direct loan in some time, an adjustable rate mortgage with no cap on future interest rate changes but with an extremely low "spread" for the lender, will shortly be closed. We are not at all excited by our prospects as we now make housing loans of this type, but we wish to get some renewal of direct mortgage lending under way. With assets not employed in direct real-estate lending, Mutual Savings continues not only to make payments to FSLIC far in excess of fair charges for risks imposed on FSLIC but also to employ a large part of total assets in short-term loans to the Federal Home Loan Bank. These practices are pro-social but will continue to reduce profits. Mutual Savings also continues to support the Federal Home Loan Bank Board in its efforts to change the present rules of the savings and loan business to augment average 58

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Reproduced from 1985 Annual Report of Wesco Financial Corporation soundness of FSLIC-insured associations. We retain our opinion that the present rules, despite some improvement in 1985 through wise efforts of the Federal Home Loan Bank Board, are unsound, from the country's point of view. Too much latitude is allowed financial "swingers" to grow as they gamble, through use of account guarantees from FSLIC, an agency of the U.S. Government, while they offer whatever it takes in interest rates to attract more accounts. With money being the ultimate fungible commodity, it seems to us that the rules create a super-competitive, commodity-type business, in which (1) economic law realize very modest returns on shareholders' equity over extended time periods, yet (2) probably destines most careful associations, like other tungible-commodity dealers, to good financial results can nonetheless usually be reported in each near-term period by managers-in-charge through aggressive deposit-expanding, lending and investing mea- sures which increase risk, while (3) the importance and rewards of managers, who usually have little downside risk as owners, are tied mostly to institutional size and recently reported numbers. With managers mostly being non-owners, a sort of Gresham's law of competitive-yet-deposit-insured banking, "bad loans drive out good," reason for assuming that ethical, intelligent managers in the savings and loan industry are immune from effects similar to those which caused similar managers of all major U.S. banks to place significant portions of assets in now-regretted foreign loans, rather than stand apart from the crowd. If our diagnosis is correct, a lot of serious trouble lies ahead (perhaps far ahead) for U.S. savings and loan associations. While present rules and practices have a positive side in causing satisfaction of almost 100% of demand for those housing loans which are sound at the prevailing interest rate, this accomplishment is accompanied by much unsound housing and other lending and by much unsound investment in "junk bonds" and other assets unsuitable for highly leveraged, federally insured, deposit-taking institutions. The system design in place would probably be a flunking design in an engineering course, where the empha- sound credit extension and (2) forced more conservative conduct on banks and savings and loan associations. The present design, we think, would probably also be a flunking design in a surgery course, where the wise practice is to remove some healthy cells along with cancerous cells, based on margin-of-safety principles. We hope we are wrong about the present design of the savings and loan system, but we fear increased, widespread adversity, ultimately reaching housing borrowers and would-be housing borrowers, whose inter- ests we consider important. Any such adversity would probably be followed by changes in the rules. No doubt, our judgment as to the probable temporary nature of present savings and loan industry structure and practices has helped deter us from direct lending of a conventional sort which otherwise would have occurred. Our attitude, right or wrong, during recent tumultuous changes in the savings and loan industry, has been 59

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Reproduced from 1985 Annual Report of Wesco Financial Corporation Precision Steel Wesco's Precision Steel subsidiary, located in the outskirts of Chicago at Franklin Park, Illinois, was acquired for approximately $15 million on February 28, 1979. The price was roughly book value for a company which carried its inventories on a con- servative LIFO accounting basis and which contained significant cash balances. More important, the company had reached its position from a modest beginning through by a gifted founder and his successors. Precision Steel owns a well-established steel maintenance of sound, customer-oriented business values inculcated over a long time ! toof room supplies and other specialty metal products. service center business and a subsidiary engaged in the manufacture and distribution of Precision Steel's businesses contributed $2,010,000 to "normal" net operating income in 1985, down 1% compared with $2,034, 000 in 1984. Such a modest decrease in 1985 profit was achieved in spite of decreased sales (down 7% to $51,124,000). Under the skilled leadership of David Hillstrom, Precision Steel's businesses are consolidated picture incident to their acquisition. now quite satisfactory, taking into account the financial leverage put into Wesco's Shortly after Wesco's purchase of Precision Steel, a substantial physical expansion of steel warehousing facilities was authorized, involving a new building in Charlotte, North Carolina. The new building and the whole North Carolina operation are now very successful, contributing $9,140,000 to 1985 sales at a profit margin higher than has prevailed in the long-established Chicago headquarters' facility. Precision Steel's businesses, despite their mundane nomenclature, are steps advanced on the quality scale from mere commodity-type businesses. Many customers of Precision Steel, needing dependable supply on short notice of specialized grades of high-quality, cold-rolled strip steel, reasonable prices, technical excellence in cutting to order, and remembrance when supplies are short, rightly believe that they have no fully comparable alternative in Precision Steel's market area. Indeed, many customers at locations remote from Chicago and Charlotte (for instance, Los Angeles) seek out Precision Steel's service. available liquid assets. Wesco remains interested in logical expansion of Precision Steel's businesses, using Wesco-Financial Insurance Company 80% owner and ultimate parent corporation, Berkshire Hathaway Inc. A new business was added to the Wesco group in 1985, in co-venture with Wesco's With the enthusiastic approval of all Wesco's directors, including substantial Wesco shareholders in the Peters and Caspers families, without whose approval such action would not have been taken, Wesco invested $45,000,000 in cash equivalents in a newly Insurance Company ("Wes-FIC"'). organized, wholly owned, Nebraska-chartered insurance company, Wesco-Financial The new subsidiary, Wes-FIC, then reinsured, through another Berkshire Hathaway insurance company subsidiary as intermediary-without-profit, 2% of the entire book of insurance business of the long-established Fireman's Fund Corp. (listed on the NYSE). 60

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Reproduced from 1985 Annual Report of Wesco Financial Corporation Wes-FIC thereby assumed the benefits and burdens of Fireman's Fund's prices, costs and losses under a contract covering all insurance premiums earned by Fireman's Fund during a four-year period commencing September 1, 1985. The arrangement puts Wes- FIC in almost exactly the position it would have been in if it, instead of Fireman's Fund, had directly written 2% of the business. Differences in results should occur only from the investment side of insurance, as Wes-FIC, instead of Fireman's Fund, invests funds from "float" generated. Wes-FIC's share of premiums earned in 1986 is expected to be over $60 million. Wes-FIC's separate financial statements, covering the brief period of its existence, September 1, 1985, to December 31, 1985, are included on pages 29 and 30 of this Annual Report, and show that Wes-FIC experienced a small 1985 reduction in net worth, from $45,000,000 to $44,676,000. We do not consider this four-month result to have significant predictive value with respect to the future. The price of insurance is rising, with price increases not yet fully reflected in 1985 numbers. Moreover, the financial statements are of questionable accuracy and could be wrong in either direction. It is in the nature of even the finest casualty insurance businesses that in keeping their accounts they must estimate and deduct all future costs and losses from premiums already earned. Uncertainties inherent in this undertaking make financial statements more mere "best honest guesses" than is typically the case with accounts of non-insurance-writing corporations. And the rein- surance portion of the casualty insurance business, because it contains one or more extra links in the loss-reporting chain, usually creates more accounting uncertainty than the non-reinsurance portion. Finally, Wes-FIC's initial financial statements have a disad- vantage in that the period covered is short, making any use of the reported past cost- price ratio extra dubious as an indicator of any probable future cost-price ratio, due to the small size of the sample forming a base for projection. It is entirely too soon to forecast future results for Wes-FIC, but Wesco hopes for: (1) a reasonable return on its investment over the four years of the Fireman's Fund rein- surance contract, and (2) possible future reinsurance contracts with other insurers. Wesco has high regard for John Byrne, newly appointed CEO and also a large enormously during his stewardship. Fireman's Fund's insurance business is intrinsically more cyclical and less-advantaged than GEICO's core insurance business, which has lower distribution costs from a different, "direct-writing" distribution system. Thus Fireman's Fund's business will almost surely be much more difficult to improve perma- nently than was the case at GEICO. However, Mr. Byrne and other Fireman's Fund executives know all this very well, and, with improvement less spectacular than previous improvement at GEICO, Fireman's Fund and Wes-FIC could both prosper. Industry-wide conditions, as well as managerial excellence, affect Wes-FIC's pros- pects under the reinsurance contract with Fireman's Fund. Large premium increases now going into effect throughout the casualty insurance business could provide some welcome tailwind effects, instead of the headwind effects of the period just ended, which was one of the worst in history. 61

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Lia. Reproduced from 1985 Annual Report of Wesco Financial Corporation We are pleased with our relationship with Fireman's Fund, which has a long and distinguished record, going all the way back to superb performance after the great San Francisco earthquake and fire, and which is affiliated with the even longer established American Express Company, one of the premier corporations in the United States. However, Wesco's optimism about quality of Fireman's Fund, quality of this rein- surance contract, and possible short-term, industry-wide cyclical improvement, is tem- pered by a larger and longer view of the reinsurance business. That business has the defect of being too attractive-looking to new entrants for its own good and therefore will always tend to be more or less the opposite of, say, the old business of gathering and rendering dead horses, which tended to contain few and prosperous participants. Troubles, losses, and insolvencies can come fast as the apparent attractions of the reinsurance business, including its seductive receive-pay-in-advance aspects, lure new entrants and encourage expansions by old occupants. The business was a disaster area in recent years, adversely affected by prices which would have been too low in a stable world, plus inflation, new judicial notions tending to augment insurance coverage beyond limits contemplated when policies were issued, and not-minor degradation of commercial behavior. No doubt recent commercial behavior degradation, particularly noticeable in the reinsurance business on both sides of the purchase counter, was accelerated by general for an empty sack to stand upright." hardship, demonstrating once again the wisdom of Poor Richard's Almanac: "It is hard Insurance company subsidiaries of Wesco's parent corporation, Berkshire Hathaway, long active in reinsurance, did continue proper commercial behavior during the recent period of industry-wide problems, but financial results from reinsurance were terrible. Thus Wesco shareholders are being led not only into an extra-hazardous place but also by people who met severe reverses on the last trip. Is there any reasonable hope for Wesco shareholders that its reinsurance business, whatever its short-term merits, will provide an advantageous long-term journey? Yes, one reason for long-term optimism is present. With recent defaults by reinsurers causing everyone to worry more about quality in promisors, Wes-FIC and Berkshire Hathaway expect that their old-fashioned, engineering-type attitudes and financial practices will help create for Wes-FIC an unusual, commercially-useful reputation for issuing trust- worthy promises in one or more markets or submarkets wherein most buyers will accept nothing less. Thus, the absence of federal insurance for reinsurance liabilities may create for Wes-FIC a reputation-based competitive advantage which is denied to their accounts. Mutual Savings by FSLIC's support of all Mutual Savings' competitors through insuring All Other "Normal" Net Operating Income All other "normal" net operating income, net of interest paid and general corporate expenses, decreased to $3,354,000 in 1985 from $4,550,000 in 1984. Sources were (1) rents ($2,219,000 gross, excluding rent from Mutual Savings) from Wesco's Pasadena office building block (predominantly leased to outsiders although Mutual Savings is the ground floor tenant) and (2) interest and dividends from cash equivalents and 62

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Reproduced from 1985 Annual Report of Wesco Financial Corporation marketable securities held by Precision Steel and its subsidiaries and at the parent company level. Net Gains on Sales of Securities Wesco's aggregate net gains on sales of securities, combined, after income taxes, increased to $41,523,000 in 1985 from $13,138,000 in 1984. The 1985 figure includes a big after-tax gain ($34,363,000) from sale of General market at a conservative price relative to its value as a share of ownership in a presum- ably ever-continuing independent entity, it was unprecedented and virtually incon- ceivable that a corporation the size of General Foods would ever be "bear-hugged" into selling out at an immense premium over the then prevailing market price for its stock But that is what happened, wholly unpredicted by Wesco, in 1985 as old taboos eroded and the great American takeover game swept into new areas. Bowery Savings Bank In 1985 Wesco, in another co-venture with its parent corporation, approved by Wesco's directors in the same manner as the Wes-FIC co-venture, joined a group which invested $100,000,000 cash in a newly organized, New York-chartered savings bank. The new bank then took over the name, assets and liabilities of the insolvent Bowery Savings Bank in the city of New York. The takeover received (1) much needed assistance from FDIC, the federal agency, akin to FSLIC, which insures deposits in banks, and (2) the blessing of New York bank regulators. Wesco invested $9,000,000, other Berkshire Hathaway subsidiaries invested $12,384,000, and other unrelated investors invested the balance of the $100,000,000. The terms of the FDIC assistance, which include income-assistance payments over many years to the newly organized bank, are extremely complex but can be tairly summarized as far from adequate to assure that the investors will make a profit. This is as it should be when $100 million buys a highly-leveraged residual equity position in a $5 billion bank, albeit one with many sick assets. Any minority-position investment with such extreme financial leverage (in effect buying with a 2% down payment), involving a troubled company in a demanding environment, can fairly be called a venture-capital type investment for Wesco. In our judgment, the prospect for gain justitied the risk of loss. The investment involves a small portion (about 5%) of Wesco's consolidated net worth. We consider it financially conservative to risk 3½% of Wesco's net worth, which is roughly the after-tax exposure involved, if we believe a hundred similar bets would, in aggregate, be almost sure to work out successfully. Consolidated Balance Sheet and Related Discussion Wesco's consolidated balance sheet (1) retains a strength befitting a company whose consolidated net worth supports large outstanding promises to others and (2) reflects a continuing slow pace of acquisition of additional businesses because few are 63

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Reproduced from 1985 Annual Report of Wesco Financial Corporation found available, despite constant search, at prices deemed rational from the standpoint of Wesco shareholders. As indicated in Note 3 to the accompanying financial statements, the aggregate market value of Wesco's marketable equity securities was higher than their aggregate cost at December 31, 1985 by about $5 million, down sharply from about $13 million one year earlier. Wesco's Pasadena real estate, a full block (containing (1) about 125,000 first class net rentable square feet, including Mutual Savings' space, in a modern office building, plus (2) an additional net rentable 34,000 square feet of economically marginal space in old bu cares reain, expensive ted roy mo, age dark sale subs at 9ly i likes, against this real estate now exceeding its depreciated carrying value ($3,158,000) in Wesco's balance sheet at December 31, 1985, and (2) substantial current net cash flow (about $1 million per year) to Wesco after debt service on the mortgage. The modern office building is 96% rented, despite a glut of vacant office space in Pasadena. We charge just-below-standard rents and run the building as a sort of first-class club for tenants we admire. With these practices, a prime location and superior parking facili- inflation.: ties, we anticipate future increases in cash flow, but at no better rate than the rate of holders' equity and total liquid assets. Wesco's practice has been to do a certain amount Wesco remains in a prudent position when total debt is compared to total share- of long-term borrowing in advance of specific need, in order to have maximum financial flexibility to face both hazards and opportunities. It is expected that the balance sheet strength of the consolidated enterprise will in due course be used in one or more business extensions. The extension activity, however, requires some patience, as suitable opportunities are not always present. As indicated in Schedule I accompanying Wesco's financial statements, invest- ments, both those in the savings and loan and reinsurance subsidiaries and those held temporarily elsewhere pending sale to fund business extension, tend to be concen- trated in very few places. Through this practice of concentration of investments, better understanding is sought with respect to the few decisions made. The ratio of Wesco's annual reported consolidated net income to reported consoli- dated shareholders' equity, about 21% in 1983-85, was dependent to a very large extent on securities gains, irregular by nature. The recent ratio is almost certain to decline, quite probably very sharply. Neither possible future acquisitions of other businesses nor possible tuture securities gains appear likely to cause the recent ratio to continue. The business acquisition game is now crowded with optimistic players who usually torce prices for low-leverage acquirers like Wesco to levels where return-on-investment prospects are modest. And, as discussed earlier, the great contribution of 1985 securities gains to Wesco's recent return on shareholders' equity contained a big fluke element. Such fluke gain, rare in any event, tends to come to an investor like Wesco mostly as an unanticipated by-product of an obviously sound investment which does not require any fluke to work out well. Because securities generally traded lower several years ago than they do now, relative to the intrinsic values of the businesses represented by the securities, creating more obviously sound investments then than now, and because 64

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Reproduced from 1985 Annual Report of Wesco Financial Corporation prospects for above-average returns tend to go down as assets managed go up, it is now easy to predict less desirable future results. It is also easy for any sophisticated Wesco shareholder, reviewing Wesco marketable securities disclosed in the 1985 Annual Report, to diagnose (correctly) that the decision-makers are dry of good investment Wesco is trying more to profit from always remembering the obvious than from grasping the esoteric (including much modern "strategic planning" and "portfolio theory"). Such an approach, while it has worked fairly well on average in the past and will probably work fairly well over the long-term future, is bound to encounter periods of dullness and disadvantage as it limits action. Moreover, the approach is being applied to no great base position. Wesco is sort of scrambling through the years without owning a single business, even a small one, with enough commercial advantage in place to pretty well assure high future returns on its capital. In contrast, Berkshire Hathaway, Wesco's parent corporation, owns three such high-return businesses. On January 23, 1986, Wesco increased its regular quarterly dividend from 15½ cents per share to 16½ cents per share, payable March 6, 1986, to shareholders of record as of the close of business on February 17, 1986. This annual report contains Form 10-K, a report filed with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidi- aries as well as audited financial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charkes T manger Chairman of the Board Charles T. Munger February 13, 1986 65

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L.. BERKSHIRE HATHAWAY INC. SHAREHOLDER-DESIGNATED CONTRIBUTIONS the Chairman sent to the shareholders a letter giving the reasons for the program. Portions of that The Company has conducted this program of corporate giving for five years. On October 14, 1981, letter follow: in most years, should produce a significant benefit for charities of your choice. "On September 30, 1981 Berkshire received a tax ruling from the U.S. Treasury Department that, "Each Berkshire shareholder — on a basis proportional to the number of shares of Berkshire that name the charity; Berkshire will write the check. The ruling states that there will be no personal ta› ne owns — Will be able to designate recipients of charitable contributions by our company. You'll consequences to our shareholders from making such designations. exercised by the proxim in ely sell businesses, is aerost e a perquiy e thaised by ugh notinely in more widely-held businesses. input at all from shareholders, in two main categories: "In a widely-held corporation the executives ordinarily arrange all charitable donations, with no (1) Donations considered to benefit the corporation directly in an amount roughly commensurate with the cost of the donation; and (2) Donations considered to benefit the corporation indirectly through hard-to-measure, long- delayed feedback effects of various kinds. "I and other Berkshire executives have arranged in the past, as we will arrange in the future, all been quite low, and very likely will remain quite low, because not many gifts can be shown to produce charitable donations in the first category. However, the aggregate level of giving in such category has roughly commensurate direct benefits to Berkshire. comfortable with ordinary corporate practice and had no better practice to substitute. What bothers "In the second category, Berkshire's charitable gifts have been virtually nil, because I am not asking and how corporate peers are responding than on an objective evaluation of the donee's activities. me about ordinary corporate practice is the way gifts tend to be made based more on who does the Conventionality often overpowers rationality. "A common result is the use of the stockholder's money to implement the charitable inclinations of the corporate manager, who usually is heavily influenced by specific social pressures on him. of the taxpayer's dollar but embrace enthusiastically their own allocation of the shareholder's dollar. Frequently there is an added incongruity; many corporate managers deplore governmental allocation your personal judgments by writing checks on my bank account for charities of your choice, I feel "For Berkshire, a different model seems appropriate. Just as I wouldn't want you to implement it inappropriate to write checks on your corporate "bank account" for charities of my choice. Your interests in a tax-deductible manner reside largely at the corporate level rather than in our own hands. charitable preferences are as good as mine and, for both you and me, funds available to foster charitable "Under such circumstances, I believe Berkshire should imitate more closely-held companies, not larger public companies. If you and I each owned 50% of a corporation, our charitable decision making would be simple. Charities very directly related to the operations of the business would have first claim on our available charitable funds. Any balance available after the "operations-related' contributions business we probably would behave as if we were a partnership. "Wherever feasible, I believe in maintaining such a partnership frame of mind, even though we operate through a large, fairly widely-held corporation. Our Treasury ruling will allow such partnership- like behavior in this area ... 66

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"I am pleased that Berkshire donations can become owner-directed. It is ironic, but understandable, they will match gifts made by their employees (and — brace yourself for this one — many even that a large and growing number of major corporations have charitable policies pursuant to which match gifts made by directors) but none, to my knowledge, has a plan matching charitable gifts by owners. I say "understandable" because much of the stock of many large corporations is owned on a "revolving door" basis by institutions that have short-term investment horizons, and that lack a long-term owner's perspective ... "Our own shareholders are a different breed. As I mentioned in the 1979 annual report, at the end of each year more than 98% of our shares are owned by people who were shareholders at the beginning of the year. This long-term commitment to the business reflects an owner mentality which, as your manager, I intend to acknowledge in all feasible ways. The designated contributions policy is an example of that intent." * * The history of contributions made pursuant to this program since its inception follows: Percent of Specified Amount Eligible* Shares Year per Share Participating Amount No. of Contributed Charities 1981 $2 95.6% 1982 $1 1,783,655 675 95.8% 1984 1983 $3 96.4% 890,948 704 1985 $3 97.2% 3,179,049 3,066,501 1,353 1,519 $4 96.8% 4,006,260 1,724 *Shares registered in street name are not eligible to participate. In addition to the shareholder-designated contributions summarized above, Berkshire and its subsidiaries continue to make certain contributions pursuant to local level decisions of our operating * * * replies received after that deadline are not processed. 67

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BERKSHIRE HATHAWAY INC. SUPPLEMENTAL INFORMATION ON THE EFFECTS OF CHANGING PRICES (dollars in thousands except per share amounts) This information is unaudited. The Financial Accounting Standards Board ("FASB") requires disclosure by certain companies of supplementary data intended to reflect the effects of inflation on portions of the financial statements. Berkshire's management does not use this supplementary data in any of its decision-making activities. Readers' evaluation of the data should be made with caution and only with reference to other financial data. Selected Financial Data as Reported and as Adjusted for General Inflation constant dollars. The latter is determined by the Consumer Price Index. This table presents certain prescribed data as reported* and then as adjusted to average 1985 Fiscal Year Ended Saturday nearest December 31 1985 1984 1983 1982 Total revenues: 1981 As reported* As adjusted .... $ 939,864 $ 729,179 $ 602,726 939,864 755,196 650,799 $521,472 581,177 $529,234 626,218 operations before realized Earnings from continuing investment gain: Total as adjusted Total as reported* $ 92,948 $ 70,201 92,948 $ 48,644 $ 31,497 $ 39,723 72,706 52,524 35,103 47,002 Per share as reported* Per share as adjusted $ 81.04 81.04 $ 61.21 63.39 $ 45.60 $ 31.93 49.24 35.59 $ 40.27 47.65 Stockholders' equity: As adjusted As reported* $1,885,330 $1,271,761 $1,119,193 1,885,330 1,317,137 1,208,458 $727,483 $519,463 810,775 614,657 Market price per common share at year end: Historical amount As adjusted $ 2,430 $ 2,430 1,275 1,320 $ 1,310 $ 775 $ 560 1,414 864 663 Average consumer price index (1967 = 100) 322.2 311.1 298.4 289.1 272.3 *Or as would have been reported following current consolidation and presentation practices. Gain or Loss in Purchasing Power from Holding Net Monetary Items In general, assets or liabilities which are fixed in terms of the amount of cash held, receivable or payable are "monetary items". Hypothetical gain results from holding of net monetary liabilities, i.e., monetary items that are liabilities in excess of monetary items that are assets, since this calculation presumes that the net liabilities can be redeemed with dollars of lower value. The calculated purchasing of the past five years — stated in average 1985 dollars, is as follows: power gain resulting from this calculation, as to Berkshire and its consolidated subsidiaries for each 1985 1984 $4,786 1983 6,707 1982 6,991 8,810 1981 14,937 Additional FASB Requirements and depreciation thereon, and reporting the net effect on reported net income of these restatements. Another FASB requirement is for restating at "current cost" inventories, assets used in production Since these items are not relatively material to Berkshire's operating income or financial position, this information has been omitted. 68

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SHAREHOLDERS' VIEWS re. ADVISORY MATTERS BERKSHIRE HATHAWAY INC. May, 1985 SOLICITATION OF VIEWS shareholders' meeting. The following was distributed to shareholders of the company prior to the company's 1985 ADVISORY MATTERS — NOT FOR ACTION AT ANNUAL MEETING SHAREHOLDER DESIGNATED CONTRIBUTIONS PROGRAM mermens, by alou 5o0% dr the ape fled amount Do you favor (check one): • Discontinuation of the program • At the same $3 rate Continuation of the program: • At a higher ($4-7) rate • At a lower ($1-2) rate DIVIDEND POLICY earnings in is van us busine in the 1984 Annual Report the Company has, for some years, reinvested all of his Do you favor (check one): Cy cast divide the policy of reinvesting all earnings rather than payment of Payment annually of cash dividends at a modest rate (5%-15% of operatir arnings), with a corresponding reduction in reinvested earning TABULATION OF RESPONSES with respect to 541,285 shares. This tabulation excludes responses of Warren E. Buffett, Susan I. Buffett, and Charles I. Munger SHAREHOLDER DESIGNATED CONTRIBUTION PROGRAM Shares Represented Views Expressed No. of Percent of Discontinuation In Favor of Responses No. Responses 257 12,249 3.2% Continuation at: Same $3 rate per share 948 151,767 205,141 39.0% 52.7% Lower rate Higher rate 446 50 13,217 3.4% Continuation at "some" rate 23 6,532 1.7% 1,724 388,906 100.0% DIVIDEND POLICY Shares Represented Views Expressed No. of Percent of Responses No. Responses 1,441 342,611 87.8% 193 33,453 8.6% 149 9,218 2.4% 1 4,600 1.2% 1,784 389,882 100.0% 69

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BERKSHIRE HATHAWAY INC. COMMON STOCK DATA Shareholders The Company had approximately 3,800 recerd holders of its common stock at March 4, 1986. Market Prices quotations ara reported through the National Association of Securities Dealers Automated Quotation The common stock of Berkshire Hathaway Inc. is traded in the over the counter market and price National Market System ('NMS"). Thus, the following information includes bid quotations for 1984 System ("NASDAQ") under the symbol BKHT. On April 16, 1985, Berkshire was entered in NASDAQ's and for 1985 (through April 16) which represent prices between dealers which do not include retail markup, markdown or commission. They do not represent actual transactions. Quotations subsequent to Berkshiro's entry into the NMS are high and low selling prices. 1985- High Low 1984 High Low First Quarter Second Quarter ..$1,930 2.160 $1,275 1,725 Second Quarter ..... 1,345 First Quarter ........ $1,360 $1,240 Third Quarter 2,2.35 2,005 Third Quarter... 1,305 1,220 2,730 2,075 Fourth Quarter • 1,305 1,230 Fourth Quarter 1,265 Dividends Berkshire has not declared a cash dividend since 1967. Stock Transfer Agent the Company's common stock. Certificates to be transferred should be mailed directly to the Transfer The First National Bank of Boston, P.O. Box 644, Boston, MA 02102 serves as Transfer Agent for Agent, preferably by registored mail. Certificates to be transferred should not be mailed to the Company. 70

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(dollars in thousands - excepi per share amounts) Selected Financial Data for the Past Five Years BERKSHIRE HATHAWAY INC. 1981 1982 1983 1984 1985 Revenues of consolidated companies Sales and service revenues Insurance premiums earned ........ $ 159,013 § 152,945 $ 152,480 $ 140,242 Interest and dividend income 312,105 54,035 306,564 58.003 381,674 64,903 500,219 $ 317,059 84,161 508,764 107.662 Earnings Realized investment gain Before realized investment gain 39,723 $ 22,881 31,497 14,877 63,522 48,644 78,694 70,201 $ 92,948 342,867 Net earnings 62,604 S 46,374 ≤ 112,166 S 148,895 § 435,815 Common shares outstanding — average in thousands .. 986 987 1,067

• 1,147
• 1,147

Earnings per share Before realized investment gain Net earnings ........ 40.27$ 63.47 31.93 $ 45.60 $ 61.21$ 17.01 105.15 129.82 379.99 81.04 Year-ond data Term debt and other borrowings Total assets .. $1,199,837 $1,514,431 $1,837,543 $2,035,203 $3,180,718 Stockholders' equity - total Minority shareholders' interest 130,192 81,762 101,177 169,947 128,984 17,990 127,104 22,299 117,879 519,453 727,483 1,119,193 1,271,761 1,885,330 34,360 Shares of common stock outstanding - in thousands 987 987 1,147 1,147 1,147 Stockholders equity per o'istanding share .. 5 526.57 § 737.43 S 975.83 5.1,108.77 $ 1,643.71 71 Next Page 99 ask

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BERKSHIRE HATHAWAY INC. : DIRECTORS AND OFFICERS OF THE COMPANY " WARREN E. BUPPETT, Director und Chairman of the Board, Chief Executive Officer CHARLES I. Mungar, Director and l'ice Chairman of the Board KENNETH V. CHAcE, Director Retired, Former Chief Operating Officer of the Textile Operations MALCOLM G. CHACE, JR., Director Retired, Former Chairman of the Board of Directors J. VERNE MCKENZIE, Director Vico President, Secrotary and Treasurer ROBERT H. BIRD, Vice President MICHAEL A. GOLDBERG, Vice President DANIEL J. JAKSICH, Controller J. WILLIAM SCOTT, Vice President OPERATING MANAGERS INSURANCE GROUP Thomas A. Bolt Prosident ypross Insurance Compan mhuskor Casualty Compar 017 South Fair Oaks Avo., Pasadona, CA 9110 Josoph W. Elllott President Coinsuranco Division 40 Wost Dodge Rosd, Omaha, NE 681 Stovon Gluckstern Manager Goneral Nata Pean Contor Plaza Suy 1400 PhildrinciPA 18702 Robert A. Lauridson President Redwood Fire & Casualty Company lational Indemnity Company/National Firo & Marine Ins. Co 1111 Bayhill Drive, Sulte 180, San Bruno, CA 9406€ Roland D. Miller Prosident Thomas H. Rowley President ontinental Divide Insurance Compan 3C24 Harney Streat, Omaha, NE 68131 7935 Enst Prentice Ave., Bldg. 40 DTC. Englewood, CO 8011 Floyd V. Taylor Prosident Kansas Fire & Cesualty Company Donald F. Wurster General 400 Kansas Avenue, Topoka, KS 68801 Managar OTHER OPERATIONS Loula Blumkin Prosident Nobraska Furniture Mart, Inc. Prosident 00 South 72 Streot, Omaha, NE 68114 Harold R. Dettmann Mutual Sevia Folorsdo Blvd., Pesodena, CA 91109 315 East a Loan Association Paga E. Golsan, Iii Ka W Products Division 8319 So. Allport Avenuo, Santa Fe Springs, CA $0670 David G. Hillstrom Procision Steel Warehouse. Inc. 3500 North Wolf Rood, Franklin Park, IL 60131 Cherlen N. Huggins Soa's Candy Shope. Incorporalod 210 El Camino Real, South San Francisco, CA 94080 Doneld A. Kouppel Bluo Chip Stamps 5801 South Esstern Avenue, Los Angeles, CA 90040 Bernard C. Kyrouec Associated Rotall Stores, Inc Stanford Lipsny Publisher Buffalo News 50-01 Northern Bottlevard, Long Island City, NY 11101 Ono Nows Plaza, Buffalo, NY 14240

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BERKSHIre HATHAWAY INC. Executive Offices — 1440 Kiewit Plaza, Omaha, Nebraska 68131

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4 DO N