1989 年伯克希尔完整年报

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BERKSHIRE HATHAWAY INC. 1989 ANNUAL REPORT

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business activities. The most important of these is the property and casualts ostrance BERKSHIRE HATHAWAY INC. and its subsidiaries engage in a number or aiverse and reinsurance business conducted nationwide through a number of subsidiaries. ages of other publicly traded companies. Investment portfolios of insurance subsidiaries include meaningful ownership percent- newspaper circulated in upstate New York, and a number of Berkshire subsidiaries Additionally, Berkshire Hathaway publishes the Buffalo News. a daily and Sunday conduct substantial business activities unrelated to the insurance business. These include: systems and of See's fine chocolate candy: also, the publication and distribution of World the manufacture and distribution of Fechheimer Bros. uniforms, of Kirby home cleaning the retailing of fine jewelry. A savings and loan business is conducted in Pasadena, Book encyclopedias and other reference materials: the retailing of home furnishings and owned subsidiary of Berkshire. The Scott Fetzer Financial Group, 100% owned by California by a subsidiary of Wesco Financial Corporation, a publicly traded and 80.1% Berkshire, provides financing for buyers of World Book and Kirby products. managers. Investment decisions and all other capital allocation decisions are made for Operating decisions for the various Berkshire business units are made by unit Berkshire and its subsidiaries by Warren E. Buffett, in consultation with Charles T. Munger. Mr. Buffett is Chairman and Mr. Munger is Vice Chairman of Berkshire's Board

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BERKSHIRE HATHAWAY INC. 1989 ANNUAL REPORT TABLE OF CONTENTS Business Activities Of The Company.. ...Inside Front Cover Owner-Related Business Principles ..2 Selected Financial Data At Five Year Intervals ..4 Chairman's Letter* ..... ..5 Independent Auditor's Report... . 26 Consolidated Financial Statements.. 27 Management's Discussion 40 Combined Financial Statements - Unaudited - for Berkshire's Business Groups 45 Shareholder-Designated Contributions ..52 Annual Report Letter - Wesco Financial Corporation. ..54 Mutual Savings' letter of resignation from U.S. League of Savings Institutions ...71 Selected Financial Data For The Past Five Years....... ...72 Common Stock Data........................ .........72 Directors and Officers of the Company ...Inside Back Cover *Copyright © 1990 By Warren E. Buffett All Rights Reserved

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Certain OWNER-RELATED BUSINESS PRINCIPLES were included in the Chairman's letter* to Shareholders of Berkshire Hathaway Inc. in the 1983 Annual Report. Because the material remains topical, it is reproduced on this and the following page. With so many new shareholders, it's appropriate to summarize the major business principles we follow that pertain to the manager-owner relationship: 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 shareholdings we also are, for better or worse, controlling partners.) We do not view the company itself as the ultimate owner of our business assets but, instead, view the company as a conduit through which our shareholders own the assets. In the case of at least four, over 50% of family net worth is represented by holdings of Berkshire. We • In line with this owner-orientation, our directors are major shareholders of Berkshire Hathaway. eat our own cooking. average annual rate of gain in intrinsic business value on a per-share basis. We do not measure the economic • Our long-term economic goal (subject to some qualifications mentioned later) is to maximize the significance or performance of Berkshire by its size; we measure by per-share progress. We are certain that the rate of per-share progress will diminish in the future — a greatly enlarged capital base will see to that. But we will be disappointed if our rate does not exceed that of the average large American corporation. that generate cash and consistently earn above-average returns on capital. Our second choice is to own • Our preference would be to reach this goal by directly owning a diversified group of businesses insurance subsidiaries. The price and availability of businesses and the need for insurance capital determine parts ot similar businesses, attained primarily through purchases of marketable common stocks by our any given year's capital allocation. conventional accounting, consolidated reported earnings may reveal relatively little about our true economic • Because of this two-pronged approach to business ownership and because of the limitations of performance. Charlie and I, both as owners and managers, virtually ignore such consolidated numbers. However, we will also report to you the earnings of each major business we control, numbers we consider of great importance. These figures, along with other information we will supply about the individual businesses, should generally aid you in making judgments about them. acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under • Accounting consequences do not influence our operating or capital-allocation decisions. When standard accounting principles than to purchase $1 of earnings that is reportable. This is precisely the choice that often faces us since entire businesses (whose earnings will be fully reportable) frequently sell for double the pro-rata price of small portions (whose earnings will be largely unreportable). In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic business value through capital gains. oasis. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatisn • We rarely use much debt and, when we do, we attempt to structure it on a long-term fixed-rate has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary large portions of their net worth to our care. (As one of the Indianapolis "500" winners said: "To finish obligations to policyholders, depositors, lenders and the many equity holders who have committed unusually first, you must first finish.") *Copyright © 1984 by Warren E. Buffett All Rights Reserved 2

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entire businesses at control prices that ignore long-term economic consequences to our shareholders. We • A managerial "wish list" will not be filled at shareholder expense. We will not diversify by purchasing by diversifying your own portfolios through direct purchases in the stock market. will only do with your money what we would do with our own, weighing fully the values you can obtain • We feel noble intentions should be checked periodically against results. We test the wisdom of rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely. value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year • We will issue common stock only when we receive as much in business value as we give. This rule applies to all forms of issuance — not only mergers or public stock offerings, but stock-for-debt swaps, stock options, and convertible securities as well. We will not sell small portions of your company - and that is what the issuance of shares amounts to - on a basis inconsistent with the value of the entire enterprise. • You should be fully aware of one attitude Charlie and I share that hurts our financial performance: regardless of price, we have no interest at all in selling any good businesses that Berkshire owns, and are very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital- that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy projections will be dazzling — the advocates will be sincere — but, in the end, major additional investment managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in it. business value. Our guideline is to tell you the business facts that we would want to know if our positions • We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising in private. candor benefits us as managers: the CEO who misleads others in public may eventually mislead himself extent legally required. Good investment ideas are rare, valuable and subject to competitive appropriation • Despite our policy of candor, we will discuss our activities in marketable securities only to the just as good product or business acquisition ideas are. Therefore, we normally will not talk about our and to stocks we are incorrectly rumored to be buying. If we deny those reports but say "no comment" investment ideas. This ban extends even to securities we have sold (because we may purchase them again) on other occasions, the no-comments become confirmation. 3

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BERKSHIRE HATHAWAY INC. Selected Financial Data at Five Year Intervals (dollars in thousands, except per share amounts) 1964 1969 1974 1979 1984 1989 Revenues: Insurance premiums earned Sales and service revenues. $ 49,983 $ 25,258 40,427 $ 32,592 5,722 2,017 60,574 $ 286,493 181,949 $ 496,971 $ 1,526,459 Realized investment gain (loss). Investment income, insurance group - (1,908) 7,916 24,747 140,242 394,279 10,769 114,136 69,281 250,723 $ 560,381 $ 861,388 $2,483,892 223,810 Earnings (loss): Total revenues $ 49,983 $ 73,424 $ 100,384 Before realized investment gain (2,824) $ 3,863 (2,824) $ 7,953 4,090 (1,340) 8,383 $ 35,921 $ 42,817 6,896 $ 70,201 78,694 $ 299,902 Net earnings (loss) ... Realized investment gain (loss) 7,043 $ 148,895 $ 447,477 147,575 Earnings (loss) per share: Before realized investment gain Net earnings (loss).. Realized investment gain (loss) $ (2.41) $ 3.92 $ $ (2.11) $ 4.15 8.56 $ 34.97 41.68 6.71 $ 61.21 $ 129.82 68.61 $ 262.46 8.07 $ (1.37) Year-end data: 7.19 $ 127.55 390.01 Total assets. 27,887 $ 22,139 2,500 95,746 216,214 Shareholders' equity Term debt and other borrowings..... 43,918 7,419 88,199 21,830 $ 1,433,863 134,416 $2,297,516 1,271,761 127,104 $ 9,459,594 344,962 4,925,126 1,007,516 Common shares outstanding, Shareholders' equity per in thousands … 1,138 980 980 1,027 1,147 1,146 outstanding share..... $ 19.46 $ 44.83 $ 90.04 $ 335.85 $1,108.77 $ 4,296.01 The 1964 fiscal year was the 52 week period ended October 3, 1964. The years 1969, 1974, 1979 and 1984 were fiscal years that ended on Saturday nearest December 31. and accounting practices; accordingly, certain prior year data have been restated. Data are presented in conformity with 1989 consolidation 4

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BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc.: is, since present management took over) our per-share book value has grown from $19.46 to $4,296.01, Our gain in net worth during 1989 was $1.515 billion, or 44.4%. Over the last 25 years (that or at a rate of 23.8% compounded annually. businesses are rationally worth. With perfect foresight, this number can be calculated by taking What counts, however, is intrinsic value - the figure indicating what all of our constituent rates. So valued, all businesses, from manufacturers of buggy whips to operators of cellular phones, all future cash flows of a business - in and out - and discounting them at prevailing interest become economic equals. Back when Berkshire's book value was $19.46, intrinsic value was somewhat less because the book value was entirely tied up in a textile business not worth the figure at which it was carried from a discount to a premium means that Berkshire's intrinsic business Now most of our businesses are worth far more than their carrying values. This agreeable evolution at a rate that somewhat exceeds our 23.8% annual growth in book value. value has compounded is represented by equity securities that, with minor exceptions, are carried on The rear-view mirror is one thing; the windshield is another. A large portion of our book value at current market values. At yearend these securities were valued at higher prices, relative to their own intrinsic business values, than has been the case in the past. One reason is the buoyant 1989 once their stock prices were inappropriately low, they are not now. stock market. More important, the virtues of these businesses have been widely recognized. Whereas business value. This 'til-death-do-us-part attitude, combined with the full prices these holdings command, We will keep most of our major holdings, regardless of how they are priced relative to intrinsic the past. In other words, our performance to date has benefited from a double-dip: (1) the exceptional means that they cannot be expected to push up Berkshire's value in the future as sharply as in gains in intrinsic value that our portfolio companies have achieved; (2) the additional bonus we in relation to those of the average business. We will continue to benefit from good gains in business value that we feel confident our portfolio companies will make. But our "catch-up" rewards have been realized, which means we'll have to settle for a single-dip in the future. We face another obstacle: In a finite world, high growth rates must self-destruct. If the base from which the growth is taking place is tiny, this law may not operate for a time. But when the base balloons, the party ends: A high growth rate eventually forges its own anchor. overly ages to on at that reproduce by dividing into two every 15 minutes. Says Sagan: Carl Sagan has entertainingly described this phenomenon, musing about the destiny of bacteria an hour, and 96 doublings a day. Although a bacterium weighs only about a trillionth of a gram, "That means four doublings its descendants, after a day of wild asexual abandon, will collectively weigh as much as a mountain...in think of Berkshire as a bacterium. Nor, to our unending sorrow, have we found a way to Even on bad days, Charlie Munger (Berkshire's Vice Chairman and my partner) and I do not its net worth every 15 minutes. Furthermore, we are not the least bit shy about reproducing — double $4.9 billion in net worth, we will find it much more difficult to average 15% annual growth in financially — in public. Nevertheless, Sagan's observations apply. From Berkshire's present base of book value than we did to average 23.8% from the $22 million we began with. 5

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Taxes income taxes. in addition, Berkshire's share of the income taxes paid by its five major investees Our 1989 gain of $1.5 billion was achieved after we took a charge of about $712 million for totaled about $175 million.

• carry reserves booked at the 28% tax rate that then prevailed.

all gains at the current tax rate, whatever it may be. With the rate at 34%, such a rule would A new accounting rule is likely to be adopted that will require companies to reserve against increase our deferred tax liability, and decrease our net worth, by about $71 million - the result has sparked widespread controversy and its final form is unclear, we have not yet made this change. of raising the reserve on our pre-1987 gain by six percentage points. Because the proposed rule As you can see from our balance sheet on page 27, we would owe taxes of more than $1.1 effect on audited net worth, reducing it by $1.1 billion. its payment can be triggered only by the sale of stocks that, in very large part, we have no intention On the other hand, is this liability for deferred taxes a meaningless accounting fiction because of selling? Again, the answer is no. due only at our election (unless, of course, Congress moves to tax gains before they are realized). In economic terms, the liability resembles an interest-free loan from the U.S. Treasury that comes This "loan" is peculiar in other respects as well: It can be used only to finance the ownership of the particular, appreciated stocks and it fluctuates in size — daily as market prices change and transfer tax that is payable only if we elect to move from one asset to another. Indeed, we sold periodically if tax rates change. In effect, this deferred tax liability is equivalent to a very large of gains. some relatively small holdings in 1989, incurring about $76 million of "transfer" tax on $224 million

• if

look at an extreme comparison. was then sold. Imagine further that we used the after-tax proceeds to repeat this process in each Imagine that Berkshire had only $1, which we put in a security that doubled by yearend and gains tax that we would have paid on the profits from each sale would have delivered about $13.000 next 19 years, scoring a double each time. At the end of the 20 years, the 34% capital to the single fantastic investment that itself doubled 20 times during the 20 years, our dollar would grow government and we would be left with about $25,250. Not bad. If, however, we made a left with about $692,000. to $1,048,576. Were we then to cash out, we would pay a 34% tax of roughly $356,500 and be Interestingly, the government would The sole reason for this staggering difference in results would be the timing of tax payments.

• taking in taxes of $356,500 vs. $13,000 — though, admittedly, it would have to wait for its

gain from Scenario 2 in exactly the same 27:1 ratio as we money. because of these mathematics. Indeed, it is possible we could earn greater after-tax returns by moving We have not, we should stress, adopted our strategy favoring long-term investment commitments rather frequently from one investment to another. Many years ago, that's exactly what Charlie and 6

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We have found splendid business Now we would rather stay put, even if that means slightly lower returns. Our reason is simple: retain all we develop. This decision is particularly easy for us because we feel that these relationships relationships to be so rare and so enjoyable that we want to will produce good - though perhaps not optimal - financial results. Considering that, we think it makes little sense for us to give up time with people we know to be interesting and admirable for time with others we do not know and who are likely to have human qualities far closer to if one is already rich. average. That would be akin to marrying for money - a mistake under most circumstances, insanity Sources of Reported Earnings amortization of Goodwill and other major purchase-price accounting adjustments are not charged The table below shows the major sources of Berkshire's reported earnings. In this presentation, against the specific businesses to which they apply, but are instead aggregated and shown separately. had we not purchased them. I've explained in past reports why this form of presentation seems This procedure lets you view the earnings of our businesses as they would have been reported to us to be more useful to investors and managers than one utilizing generally accepted accounting principles (GAAP), which require purchase-price adjustments to be made on a business-by-business in our audited financial basis. The total net earnings we show in the table are, of course, identical to the GAAP total statements. 37-39, and in the Management's Discussion section on pages 40-44. In these sections you also will Further information about these businesses is given in the Business Segment section on pages urge you to read Charlie Munger's letter, which starts on page 54. In addition, we have reprinted on a GAAP basis. For information on Wesco's businesses, I on page 71 Charlie's May 30, 1989 letter to the U.S. League of Savings Institutions, which conveyed (000s omitted) Berkshire's Share of Net Earnings 1989 Pre-Tax Earnings after taxes and 1988 minority interests) Operating Earnings: 1989 1988 Insurance Group: Underwriting Net Investment Income.. $ (24,400) 243,599 $ (11,081) $ 231,250 213,642 (12,259) $ 197,779 (1,045) Fechheimer.... Buffalo News... 12,621 46,047 14,152 42,429 27,771 6,789 25,462 Kirby. 26,114 26,891 16,803 17,842 7,720 Nebraska Furniture Mart. 17,070 8,441 9,099 Scott Fetzer Manufacturing Group 33,165 28,542 18,439 See's Candies.. 34,235 32,473 19,996 20,626 19,671 17,640 Wesco - other than Insurance 13,008 16,133 World Book 25,583 27,890 9,810 16,372 10,650 18,021 Omer uticase Cice counting Charges.. (5,740) (3,387) (6,342) (2,806) (6,668) (3,372) (2,806) Interest Expense*…. Shareholder-Designated Contributions (42,389) (5,867) (35,613) (27,098) (23,212) (7,340) Other 23,755 41,059 (4,966) 12,863 (3,814) (3,217) perating Earning 393,414 418,450 27,177 ales of Securitie 223,810 131,671 299,902 147,575 313,441 Total Earnings - All Entities 617.224 $ 550,121 $ 447,477 $ 85,829 399,270 *Excludes interest expense of Scott Fetzer Financial Group and Mutual Savings & Loan. 7

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four segments. Ve reter vou also to pages 45-51 These correspond he way ha he and rained Berkshies finesian datainto statements for: (1) our insurance operations, with their major investment positions itemized; (2) our help you calculate Berkshire's intrinsic value. Shown on these pages are balance sheets and earnings manufacturing, publishing and retailing businesses, leaving aside certain non-operating assets and are Mutual Savings and Scott Fetzer Financial; and (4) an all-other category that includes the non- purchase-price accounting adjustments; (3) our subsidiaries engaged in finance-type operations, which operating assets (primarily marketable securities) held by the companies in segment (2), all purchase- price accounting adjustments, and various assets and debts of the Wesco and Berkshire parent companies. matching those shown on our GAAP statements. However, I want to emphasize that this four-category If you combine the earnings and net worths of these four segments, you will derive totals presentation does not fall within the purview of our auditors, who in no way bless it. standard accounting rules do not permit us to report. On page 15, we list five major investees from In addition to our reported earnings, we also benefit from significant earnings of investees that which we received dividends in 1989 of about $45 retained earnings of these investees totaled about $212 million last year, not counting large capital million, after taxes. However, our share of the gains realized by GEICO and Coca-Cola. If this $212 million had been distributed to us, our own rather than the $300 million shown in the table. operating earnings, after the payment of additional taxes, would have been close to $500 million as those we report. We believe they are - and even think they may be more valuable. The reason The question you must decide is whether these undistributed earnings are as valuable to us for this a-bird-in-the-bush-may-be-worth-two-in-the-hand conclusion is that earnings retained by these investees will be deployed by talented, owner-oriented managers who sometimes have better uses for these funds in their own businesses than we would have in ours. I would not make such assessment of most managements, but it is appropriate in these cases. in which we append our share of the operating earnings retained by our investees to our own In our view, Berkshire's fundamental earning power is best measured by a "look-through" approach, value to grow at an average of 15% per year, our "look-through" earnings must grow at about reported operating earnings, excluding capital gains in both instances. For our intrinsic business the same pace. We'll need plenty of help from our present investees, and also need to add a new one from time to time, in order to reach this 15% goal. Non-Insurance Operations In the past, we have labeled our major manufacturing, publishing and retail operations "The new title both alliterative and appropriate. We failed: Let's call the group "The Sainted Seven Plus Sainted Seven." With our acquisition of Borsheim's early in 1989, the challenge was to find a One." Furniture Mart, Scott Fetzer Manufacturing Group, See's Candies, World Book - is a collection This divine assemblage — Borsheim's, The Buffalo News, Fechheimer Bros., Kirby, Nebraska of businesses with economic characteristics that range from good to superb. Its managers range from superb to superb. they like to hit home runs. And that's exactly what they do. Their combined financial statements Most of these managers have no need to work for a living; they show up at the ballpark because (including those of some smaller operations), shown on page 49, illustrate just how outstanding their performance is. On an historical accounting basis, after-tax earnings of these operations were have matched funded debt. When I call off the names of our managers - the Blumkin, Friedman 57% on average equity capital. Moreover, this return was achieved with no net leverage: Cash equivalents and Heldman families, Chuck Huggins, Stan Lipsey, and Ralph Schey - I feel the same glow that Miller Huggins must have experienced when he announced the lineup of his 1927 New York Yankees. 8

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Let's take a look, business by business: • In its first year with Berkshire, Borsheim's met all expectations. Sales rose significantly and to its present location. In the six years are now considerably better than twice what they were four years ago when the company moved Borsheim's managing genius - and I mean that - has only one speed: fast-forward. prior to the move, sales had also doubled. Ike Friedman, huge volume it does If you haven't been there, you've never seen a jewelry store like Borsheim's. Because of the ranges. For the same at one location, the store can maintain an enormous selection across all price jewelry stores offering comparable merchandise. The reason, it can hold its expense ratio to about one-third that prevailing at by its unusual buying power, enable it to offer prices far lower than those of other jewelers. These store's tight control of expenses, accompanied result is store traffic as high as 4,000 people on seasonally-busy days. prices, in turn, generate even more volume, and so the circle goes 'round and 'round. The end We bought the business without an audit, Ike Friedman is not only a superb businessman and a great showman but also a man of integrity. "If you don't know jewelry, know your jeweler" makes sense whether you are buying the whole all of our surprises have been on the plus side. business or a tiny diamond. that gathers to have fun and explore a few subjects. Last September, meeting at Bishop's Lodge A story will illustrate why I enjoy Ike so much: Every two years I'm part of an informal group in Santa Fe, we asked Ike, his wife Roz, and his son Alan to come by and educate us on jewels and the jewelry business. fancy merchandise. I was somewhat apprehensive - Bishop's Lodge is no Fort Knox - and I Ike decided to dazzle the group, so he brought from Omaha about $20 million of particularly me aside. "See that safe?" he said. "This afternoon we changed the combination and now even mentioned my concern to Ike at our opening party the evening before his presentation. Ike took the hotel management doesn't know what it is." I breathed easier. Ike went on: "See those two big fellows with guns on their hips? They'll be guarding the safe all night." I now was ready to rejoin the party. But Ike leaned closer: "And besides, Warren," he confided, "the jewels aren't in the safe." talented and energetic family, Alan, Marvin Cohn, and Don Yale. How can we miss with a fellow like that — particularly when he comes equipped with a • At See's Candies we had an 8% increase in pounds sold, even though 1988 was itself a record year. Included in the 1989 performance were excellent same-store poundage gains, our first in many years. tising expenditures from $4 million to $5 million and also got copy from our agency, Hal Riney Advertising played an important role in this outstanding performance. We increased total adver- & Partners, Inc., that was 100% on the money in conveying the qualities that make See's special. Pao he, that was 10%, In our media businesses, such as the Buffalo News, we sell advertising. In other businesses, such as See's, we are buyers. When At See's, we more than tripled our expenditures on newspaper advertising last year, to the highest we buy, we practice exactly what we preach when we sell. percentage of sales that I can remember. The payoff was terrific, and we thank both Hal Riney and the power of well-directed newspaper advertising for this result. of Chuck Huggins: His daily involvement with all aspects of production and sales imparts a quality- See's splendid performances have become routine. But there is nothing routine about the management and-service message to the thousands of employees we need to produce and distribute over 27 phone business, it is no small trick to run things so that virtually every customer leaves happy. million pounds of candy annually. In a company with 225 shops and a massive mail order and Chuck makes it look easy. • The Nebraska Furniture Mart had record sales and excellent earnings in 1989, but there was in May, after disagreeing with other members of the Blumkin family/management about the one sad note. Mrs. B- Rose Blumkin, who started the company 52 years ago with $500 - quit remodeling and operation of the carpet department. 9

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more merchandise than any other salesperson in the store). victims of tired blood. At age 96 she has started a new business selling - what else? - carpet You will be pleased to know that Mrs. B continues to make Horatio Alger's heroes look like and furniture. And as always, she works seven days a week. most successful home furnishings store in the country. They are outstanding merchants, outstanding At the Mart Louie, Ron, and Irv Blumkin continue to propel what is by far the largest and of 1989, the carpet department registered a 75.3% consumer share in the Omaha market, up from managers, and a joy to be associated with. One reading on their acumen: In the fourth quarter breadth of merchandise at one location; (2) the lowest operating costs in the business; (3) the shrewdest NFM and Borsheim's follow precisely the same formula for success: (1) unparalleled depth and of buying, made possible in part by the huge volumes purchased; (4) gross margins, and therefore prices, far below competitors'; and (5) friendly personalized service with family members on hand at all times. is the only city in which a home furnishings store is the advertising leader. Many retailers cut space purchases in 1989; our experience at See's and NFM would indicate they made a major • The Buffalo News continued to star in 1989 in three important ways: First, among major metropolitan papers, both daily and Sunday, the News is number one in household penetration - the percentage of local households that purchase it each day. Second, in "news hole" - the portion of the paper it more news-rich than any comparable American paper. Third, in a year that saw profits slip at many major papers, the News set its seventh consecutive profit record. To some extent, these three factors are related, though obviously a high-percentage news hole, by itself, reduces profits significantly. A large and intelligently-utilized news hole, however, attracts a wide spectrum of readers and thereby boosts penetration. High penetration, in turn, makes a newspaper particularly valuable to retailers since it allows them to talk to the entire community through a and will eventually suffer in both ad rates and profits. single "megaphone." A low-penetration paper is a far less compelling purchase for many advertisers The population of Erie County, home territory of the News, has been falling - from 1,113,000 It should be emphasized that our excellent penetration is neither an accident nor automatic. in 1970 to 1,015,000 in 1980 to an story. In 1975, shortly before we started our Sunday edition, the Courier-Express, a long-established estimated 966,000 in 1988. Circulation figures tell a different Buffalo paper, was selling 207,500 Sunday copies in Erie County. Last year - with population at least 5% lower - the News sold an average of 292,700 copies. I believe that in no other major Sunday market has there been anything close to that increase in penetration. in its home town - someone is doing something right. In this case major credit clearly belongs When this kind of gain is made - and when a paper attains an unequaled degree of acceptance to Murray Light, our long-time editor who daily creates an informative, useful, and interesting product. late, because of production problems or distribution weaknesses, will lose customers, no matter how Credit should go also to the Circulation and Production Departments: A paper that is frequently its editorial content. 10

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I believe Stan's managerial skills deliver at least five extra percentage points in profit margin compared Stan Lipsey, publisher of the News, has produced profits fully up to the strength of our product. to the earnings that would be achieved by an average manager given the same circumstances. is an amazing performance, and one that could only be produced by a talented manager who knows

• and cares - about every nut and bolt of the business.

early years in the business were Stan's knowledge and talents, it should be emphasized, extend to the editorial product. His and editing a series of stories that in 1972 won a Pulitzer Prize for the Sun Newspaper of Omaha. spent on the news side and he played a key role in developing I could not ask for a better partner. Stan and I have worked together for over 20 years, through some bad times as well as good, and • At Fechheimer, the Heldman clan - Bob, George, Garv, Roger and Fred - continue their ex experienced aordinary pertormance. Pronts in 1989 were down somewhat because of problems the busines. Meanwhile, return on invested capital in integrating a major 1988 acquisition. These problems will be ironed out in time. at Fechheimer remains splendid. business. At last year's annual meeting I mentioned that when a prisoner enters San Quentin, Bob Like all of our managers, the Heldmans have an exceptional command of the details of their of the country is being discussed, they know exactly what is going on with major customers and and George probably know his shirt size. That's only a slight exaggeration: No matter what area with the competition. plants or the home office in Cincinnati. We're much like the lonesome Maytag repairman: The Though we purchased Fechheimer four years ago, Charlie and I have never visited any of its Heldman managerial product is so good that a service call is never needed. • Ralph Schey continues to do a superb job in managing our largest group — World Book, Kirby, and the Scott Fetzer Manufacturing Companies. Aggregate earnings of these businesses have increased is running an enterprise large enough, were it standing alone, to be on the Fortune 500. And he's every year since our purchase and returns on invested capital continue to be exceptional. Ralph running it in a fashion that would put him high in the top decile, measured by return on equity. Mart. Anticipating the imminent expiration of its lease, the business is now decentralizing into For some years, World Book has operated out of a single location in Chicago's Merchandise well. It will be another year before costs of the move are fully behind us. four locations. The expenses of this transition are significant; nevertheless profits in 1989 held up business has more than doubled in the last two years and quintupled in the past four; its share Kirby's business was particularly strong last year, featuring large gains in export sales. International of unit sales has risen from 5% to 20%. Our largest capital expenditures in 1989 were at Kirby, in preparation for a major model change in 1990. have produced funds for Berkshire that, in turn, have allowed us to make many other profitable And that completes our answer to the 1927 Yankees. 11

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Insurance Operations casually insurance industry: Shown below is an updated version of our usual table presenting key figures for the property- Yearly Change Statutory in Premiums Combined Ratio Yearly Change Written (%) After Policyholder Dividends in Incurred Inflation Rate Losses (%) GNP Deflator (%) Measured by 1982 1981 3.8 1984 1983 3.7 106.0 5.0 109.6 6.5 1986 1985 22.1 8.5 112.0 8.4 9.6 118.0 6.8 3.8 6.5 1988 1987 22.2 116.3 16.9 3.8 9.4 108.0 16.1 1989 (Est.). 4.4 104.6 13.5 2.6 3.0 2.1 110.4 105.4 7.8 8.7 5.5 3.3 3.1 4.2 Source: A.M. Best Co. to 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 funds ("the float") is taken into account, a combined ratio in the 107-111 range typically produces indicates a loss. When the investment income that an insurer earns from holding policyholders' an overall breakeven result, exclusive of earnings on the funds provided by shareholders. by about 10% annually, even in years when general For the reasons laid out in previous reports, we expect the industry's incurred losses to grow over the last 25 years, incurred losses have grown at a still faster rate, 11%.) If premium growth inflation runs considerably lower. (Actually, to under-reserve when business turns bad may obscure meanwhile materially lags that 10% rate, underwriting losses will mount, though the industry's tendency Last year we said the climb in the combined ratio probably will accelerate — for at least two more years." This year we will not predict accel- was "almost certain to continue - and eration, but otherwise must repeat last year's forecast. Premium growth 10% required annually. Remember also that a 10% rate would only stabilize the combined ratio, 1s running far below the not bring it down. catastrophes (led by Hurricane Hugo) were unusually severe. These abnormalities probably accounted The increase in the combined ratio in 1989 was a little more than we had expected because for about two points of the increase. If 1990 is more of a "normal" year, the combined ratio should to climb by a greater degree. rise only minimally from the catastrophe-swollen base of 1989. In 1991, though, the ratio is apt If that men to us fd to enly die is the guderesit is in and spears amer that let du o Commentators frequently discuss faulty thinking about the industry's fundamental economics. conduct the business in cartel fashion. At that time, the combined ratio fluctuated rhythmically The term was appropriate some decades ago when the industry and regulators cooperated to for two that it took a considerable time for mispriced policies to expire - delayed the impact of new 12

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averaged out current. Meanwhile, the absence of over the cycle, would be satisfactory. significant price competition guaranteed that industry profits, like product at independently-established prices. Such a configuration - whether the product being The cartel period is long gone. Now the industry has hundreds of participants selling a commodity- sold is steel or insurance policies — is certain to cause subnormal profitability in all circumstances determines the but one: a shortage of usable capacity. Just how often these periods occur and how long they last average profitability of the industry in question. In most industries, capacity is described in physical terms. In the insurance world, however, to write no more than X dollars of business if it has Y dollars of net worth. In practice, however, capacity is customarily described in financial terms; that is, it's considered appropriate for a company all slow to discipline companies that strain their resources. constraints of this sort have proven ineffective. Regulators, insurance brokers, and customers are grossly overstate their true capital. Hence, a company can write a great deal of business with very They also acquiesce when companies will be realized only when there is a shortage of capacity. Shortages will occur only when insurers All this understood, it is not very difficult to prognosticate the industry's profits. Good profits are frightened. That happens rarely - and most assuredly is not happening now. and 1989's catastrophes — Hurricane Hugo and the California earthquake — will cause prices to Some analysts have argued that the more onerous taxes recently imposed on the insurance industry strengthen significantly. We disagree. These adversities have not destroyed the eagerness of insurers to write business at present prices. Therefore, premium volume won't grow by 10% in 1990, which means the negative underwriting trend will not reverse. a orde higher to to shee potably sa ching the turning away business despite higher prices. And we're a long way from that point. determine are in 1986), partly because our traditional business continues to shrink and partly because the contract Berkshire's premium volume may drop to $150 million or so in 1990 (from a high of $1 billion under which we received 7% of the business of Fireman's Fund expired last August. Whatever believe to carry an expectation of profit. a mathematical expectation of loss; we experience enough disappointments doing transactions we tell. It concerns "CAT covers," which are reinsurance contracts that primary insurance companies However, our appetite for appropriately-priced business is ample, as one tale from 1989 will buying various layers of reinsurance above that level. When losses exceed the retained amount, payıng the remainder. (By requiring the primary insurer to keep 5% of each layer, the reinsurer the reinsurer typically pays 95% of the excess up to its contractual limit, with the primary insurer leaves him with a financial stake in each loss settlement and guards against his throwing away india fake in each lass intume te the reinsurer's money.) requires a primary insurer whose coverage has been exhausted by a catastrophe to buy a second CAT covers are usually one-year policies that also provide for one automatic reinstatement, which cover for the balance of the year in question by paying another premium. This provision protects the primary company from being "bare" for even a brief period after a first catastrophic event. the primary company. Under this definition, a wide-spread storm, causing damage for three days, The duration of "an event" is usually limited by contract to any span of 72 hours designated by will be classified as a single event if it arises from a single climatic cause. If the storm lasts four days, however, the primary company will file a claim carving out the 72 consecutive hours during 13

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which it suffered the greatest damage. Losses that occurred outside that period will be treated as arising from a separate event. insured loss, at a pace, however, that caused the vast damage in the Carolinas to occur slightly In 1989, two unusual things happened. First, Hurricane Hugo generated $4 billion or more of more than 72 hours quake hit within weeks, causing insured damage that was difficult to after the equally severe damage in the Caribbean. Second, the California earth- event. Slammed by these two - or possibly three - major catastrophes, some primary insurers, estimate, even well after the second cover or became uncertain as to whether they had done so. and also many reinsurers that had themselves bought CAT protection, either used up their automatic At that point sellers of CAT policies had lost a huge amount of money - perhaps twice because a CAT premium some years, we've thought premiums of that kind inadequate and have stayed away from the business. left most CAT writers licking their wounds, there was an immediate shortage after the earthquake But because the 1989 disasters left many insurers either actually or possibly bare, and also that CAT writers themselves buy. Just as instantly, Berkshire Hathaway offered to write up to $250 of much-needed catastrophe coverage. Prices instantly became attractive, particularly for the reinsurance million of catastrophe coverage, advertising that proposition in trade publications. Though we did not write all the business we sought, we did in a busy ten days book a substantial amount. sets us apart from any reinsurer Our willingness to put such a huge sum on the line for a loss that could occur tomorrow write $250 million or even far more of catastrophe coverage. But they do so only when they can, in the world. There are, of course, companies that sometimes off" in size, they disappear from the market. in turn, reinsure a large percentage of the business with other companies. When they can't "lay rates carry an expectation of profit, we want to assume as much risk as is prudent. And in our Berkshire's policy, conversely, is to retain the business we write rather than lay it off. When case, that's a lot. companies of about $6 billion — the second highest amount in the United States; and (2) we simply to those earnings (or losses) were reached intelligently. don't care what earnings we report quarterly, or even annually, just as long as the decisions leading is some probability that we will lose the full $250 million in a single quarter. That probability Obviously, if we write $250 million of catastrophe coverage and retain it all ourselves, there is low, but it is not zero. If we had a loss of that magnitude, our after-tax cost would be about be a blow only to our pride, not to our well-being. $165 million. Though that is far more than Berkshire normally earns in a quarter, the damage would write scads of business on terms that almost guarantee them mediocre returns on equity. But they This posture is one few insurance managements will assume. Typically, they are willing to do not want to expose themselves to an embarrassing single-quarter loss, even if the managerial their thinking: What is best for their owners is not necessarily best for the managers. Fortunately strategy that causes the loss promises, over time, to produce superior results. I can understand Charlie and I have both total job security and financial interests that are identical with those of our shareholders. We are willing to look foolish as long as we don't feel we have acted foolishly. huge capacity when capacity is short and we become less competitive only when capacity is abundant. Our method of operation, incidentally, makes us a stabilizing force in the industry. We add believe it to be the most sensible and profitable course of action. Nevertheless, our behavior steadies Of course, we don't follow this policy in the interest of stabilization — we follow it because we the market. In this case, Adam Smith's invisible hand works as advertised. 14

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should produce quite favorable insurance results Currently, we hold an exceptional amount of float compared to premium volume. This circumstance 1989. Our underwriting losses should be tolerable and our investment income from policyholder for us during the next few years as it did in funds large. This pleasant situation, however, will gradually deteriorate as our float runs off. usiness. Mike Goldberg and his management team of Rod Eldred, Dinos lordanou, Ajit Jain, Phi t some point, however, there will be an opportunity for us to write large amounts of profitabl Urban, and Don Wurster continue to position us well for this eventuality. Marketable Securities major categories: (1) long-term common stock investments, (2) medium-term fixed-income securities, In selecting marketable securities for our insurance companies, we generally choose among five (3) long-term commitments. fixed-income securities, (4) short-term cash equivalents, and (5) short-term arbitrage net worth. to do with maximizing immediately reportable earnings; our goal, rather, is to maximize eventual • Below we list our common stock holdings having a value of over $100 million. A small portio f these investments belongs to subsidiaries of which Berkshire owns less than 100% Shares Company Cost 12/31/89 Market 23,350,000 3,000,000 Capital Cities/ABC, Inc. 2,400,000 Federal Home Loan Mortgage Corp The Coca-Cola Co.. $ 517,500 (000s omitted) 1,023,920 $1,692,375 71,729 1,803,787 1,727,765 The Washington Post Company.... 6,850,000 GEICO Corp........ 45,713 1,044,625 161,100 9,731 486,366 shares changed: Our holdings of Coca-Cola increased from 14,172,500 shares at the end of 1988 This list of companies is the same as last year's and in only one case has the number of to 23,350,000. that I started buying Cokes at the rate of six for 25¢ from Buffett & Son, the family grocery store, to sell around the neighborhood for 5¢ each. In this excursion into high-margin retailing, I duly observed the extraordinary consumer attractiveness and commercial possibilities of the product. this period, however, I carefully avoided buying even a single share, instead allocating major portions I continued to note these qualities for the next 52 years as Coke blanketed the world. During businesses, trading-stamp issuers, and the like. (If you think I'm making this up, I can supply the of my net worth to street railway companies, windmill manufacturers, anthracite producers, textile names.) Only in the summer of 1988 did my brain finally establish contact with my eyes. Coca-Cola had in 1981 become a new company with the move of Roberto Goizueta to CEO. Roberto, What I then perceived was both clear and fascinating. After drifting somewhat in the 1970's, along with Don Keough, once my across-the-street neighbor in Omaha, first rethought and focused the company's policies and then energetically carried them out. What was already the world's most ubiquitous product gained new momentum, with sales overseas virtually exploding. 15

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growth of his product and the rewards that this growth brings to shareholders. Normally, the CEO Through a truly rare blend of marketing and financial skills, Roberto has maximized both the either marketing or finance to dominate the business at the expense of the other discipline. With of a consumer products company, drawing on his natural inclinations or experience, will cause Roberto, the mesh of marketing and finance is perfect and the result is a shareholder's dream. running things. In fact, if I had been thinking straight I would have persuaded my grandtather Of course, we should have started buying Coke much earlier, soon after Roberto and Don began to sell the grocery store back in 1936 and put all of the proceeds into Coca-Cola stock. I've learned my lesson: My response time to the next glaringly attractive idea will be slashed to well under As I mentioned earlier, the yearend prices of our major investees were much higher relative are clearly vulnerable to a general market decline. A drop in their prices would not disturb us to their intrinsic values than theretofore. While those prices may not yet cause nosebleeds, they reduction in Berkshire's net worth. We think such a reduction is almost certain in at least one at all — it might in fact work to our eventual benefit - but it would cause at least a one-year of the next three years. Indeed, it would take only about a 10% year-to-year decline in the aggregate value of our portfolio investments to send Berkshire's net worth down. We continue to be blessed with extraordinary managers at our portfolio companies. They are high-grade, talented, and shareholder-oriented. The exceptional results we have achieved while investing with them accurately reflect their exceptional personal qualities. way it turned out. Arbitrage positions are a substitute for short-term cash equivalents, and during We told you last year that we expected to do little in arbitrage during 1989, and that's the part of the year we held relatively low levels of cash. In the rest of the year we had a fairly transactions that made no economic sense to us; arbitraging such deals comes too close to playing good-sized cash position and even so chose not to engage in arbitrage. The main reason was corporate the greater-fool game. (As Wall Streeter Ray DeVoe says: "Fools rush in where angels fear to trade.") We will engage in arbitrage from time to time — sometimes on a large scale - but only when we like the odds. • Leaving aside the three convertible preferreds discussed in the next section, we substantially just about our only holdings have been Washington Public Power Supply Systems (WPPSS) bonds reduced our holdings in both medium- and long-term fixed-income securities. In the long-terms, carrying coupons ranging from low to high. During the year we sold a number of the low-coupon issues, which we originally bought at very large discounts. Many of these issues had approximately doubled in price since we purchased them and in addition had paid us 15%-17% annually, tax- free. Our prices upon sale were only slightly cheaper than typical high-grade tax-exempts then commanded. We have kept all of our high-coupon WPPSS issues. Some have been called for redemption in 1991 and 1992, and we expect the rest to be called in the early to mid-1990s. We also sold said we would be happy to sell them - regardless of whether they were higher many of our medium-term tax-exempt bonds during the year. When we bought or lower than at our time of purchase — if something we liked better came along. Something did - and concurrently we unloaded most of these issues at modest gains. Overall, our 1989 profit from the sale of tax-exempt bonds was about $51 million pre-tax. • The proceeds from our bond sales, along with our excess cash at the beginning of the yea and that generated later through stocks. In the first transaction, which took place in July, we purchased $600 million of The Gillette went into the purchase ot three convertible preterre Co. preferred with an 8 3/4% dividend, a mandatory redemption in ten years, and the right to convert into common at $50 per share. preferred stock with mandatory redemption in ten years, a dividend of 9 1/4%, and the right to $358 million of USAir Group, Inc. convert into common at $60 per share. Finally, late in the year we purchased $300 million of Champion International Corp. preferred with mandatory redemption in ten years, a 9 1/4% dividend, and the right to convert into common at $38 per 16

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convertible for considerable periods of time and there is consequently no way we can gain from Unlike standard convertible preferred stocks, the issues we own are either non-salable or non- short-term price blips in the common on the board of USAir or Champion. (I thoroughly enjoy the boards I am on, but can't handle stock. I have gone on the board of Gillette, but I am not any more.) economics Gillette's business is very much the kind we like. Charlie and I think we understand the company's you haven't tried Gillette's new Sensor razor, go right out and get one.) However, we have no and therefore believe we can make a reasonably intelligent guess about its future. (If ability to forecast the economics of the investment banking business (in which we have a position industry. This does not mean that we predict a negative future for these industries: we're agnostics, of Salomon convertible preferred), the airline industry, or the paper we must structure our investments in them differently from what we do when we invest in a not atheists. Our businesses, however, means that business appearing to have splendid economic characteristics. with people whom we like, admire, and trust. John Gutfreund at Salomon, Colman Mockler, Jr. In one major respect, however, these purchases are not different: We only want to link up at Gillette, Ed Colony at USAir, and Andy Sigler at Champion meet this test in spades. They in turn have demonstrated some confidence in us, insisting in each case that our preferreds in corporate finance. In effect they are trusting us to be intelligent owners, thinking about tomorrow voting rights on a fully-converted basis, an arrangement that is far from standard instead of today, just as we are trusting them to be intelligent managers, thinking about tomorrow as well as today. economics hinder the performance of our investees, but will produce reasonably attractive results The preferred-stock structures we have negotiated will provide a mediocre return for us if industry for us if they can earn a return comparable to that of American industry in general. We believe and Andy will reach it unless industry conditions are harsh. that Gillette, under Colman's management, will far exceed that return and believe that John, Ed, If that is all we get, though, the result will be disappointing, because we will have given up flexibility Under almost any conditions, we expect these preferreds to return us our money plus dividends. and consequently will have missed some significant opportunities that are bound to present themselves during the decade. Under that scenario, we will have obtained only a preferred-stock yield during way Berkshire can achieve satisfactory results from its four preferred issues is to have the common a period when the typical preferred stock will have held no appeal for us whatsoever. The only stocks of the investee companies do well. But we believe Berkshire's investment will also help and that the other shareholders of each investee Good management and at least tolerable industry conditions will be needed if that is to happen. will profit over the years ahead from our preferred-stock purchase. The help will come from the fact that each company now has a major, stable, and interested shareholder whose Chairman and of their own money to these undertakings. In dealing with our investees, Charlie and I will be Vice Chairman have, through Berkshire's investments, indirectly committed a very large amount supportive, analytical, and objective. We recognize that we are working with experienced CEOs who are very much in command of appreciate the chance to test their thinking on someone without ties to their industry or to decisions their own businesses but who nevertheless, at certain moments, of the past. As a group, these convertible preferreds will not produce the returns we can achieve when we find a business with wonderful economic prospects that is unappreciated by the market. Nor will the returns be deployment, the acquisition of 80% or more of a fine business with a fine management. But both attractive as those produced when we make our favorite form of capital opportunities are rare, particularly in a size befitting our present and anticipated resources. In summation, Charlie and I feel that our preferred stock investments should produce returns moderately above those achieved by most fixed-income portfolios and that we can play a minor but enjoyable and constructive role in the investee companies. 17

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Zero-Coupon Securities Subordinated Debentures, which are now listed on the New York Stock Exchange. Salomon Brothers In September, Berkshire issued $902.6 million principal amount of Zero-Coupon Convertible handled the underwriting in superb fashion, providing us helpful advice and a flawless execution. bond, conversely, requires no current interest payments; instead, the investor receives his yield by Most bonds, of course, require regular payments of interest, usually semi-annually. A zero-coupon is determined by the original issue price, the maturity value, and the amount of time between purchasing the security at a significant discount from maturity value. The effective interest rate issuance and maturity. In our case, the bonds were issued For investors purchasing the bonds, that is the mathematical equivalent of a 5.5% current payment at 44.314% of maturity value and are due in 15 years. offering were $400 million (less about $9.5 million of offering expenses). compounded semi-annually. Because we received only 44.31g on the dollar, our proceeds from this shares of Berkshire Hathaway. Because a $10,000 bond cost $4,431, this means that the conversion The bonds were issued in denominations of $10,000 and each bond is convertible into .4515 can call the bonds at any time after September 28, 1992 at their accreted value (the original issue price was $9,815 per Berkshire share, a 15% premium to the market price then existing. Berkshire price plus 5.5% compounded semi-annually) and on two specified days, September 28 of 1994 and 1999, the bondholders can require Berkshire to buy the securities at their accreted value. we make no payments to the bondholders. Thus the net effect to us, resulting from the reduced For tax purposes, Berkshire is entitled to deduct the 5.5% interest accrual each year, even though taxes, is positive cash flow. That is a very significant benefit. Some unknowable variables prevent below 5.5%. There is meanwhile a symmetry to the tax law: Any taxable holder of the bonds us from calculating our exact effective rate of interest, but under all circumstances it will be well must pay tax each year on the 5.5% interest, even though he receives no cash. (notably Loews and Motorola) resemble the great bulk of zero-coupon bonds that have been issued Neither our bonds nor those of certain other companies that issued similar bonds last in recent years. Of these, Charlie and I have been, and will continue to be, outspoken critics. As I will later explain, such bonds have often been used in the most deceptive of ways and with a time when the apple had not yet been bitten. deadly consequences to investors. But before we tackle that subject, let's travel back to Eden, to the famous Series E U. S. Savings Bond, the most widely-sold bond issue in history. (After the If you're my age you bought your first zero-coupon bonds during World War II, by purchasing war, these bonds were held by one out of two U. S. households.) Nobody, of course, called the what the Series E was. Series E a zero-coupon bond, a term in fact that I doubt had been invented. But that's precisely of the United States government due in 10 years, terms that gave the buyer a compounded annual These bonds came in denominations as small as $18.75. That amount purchased a $25 obligation return of 2.9%. At the time, this was an attractive offer: the 2.9% rate was higher than that generally available on Government bonds and at any time cash in his bonds with only a minor reduction in interest. the holder faced no market-fluctuation risk, since he could last decade. One problem A second form of zero-coupon U. S. Treasury issue, also benign and useful, surfaced in the

• say 10% - the holder cannot be assured that a compounded 10% return will be realized. For

with a normal bond is that even though it pays a given interest rate that rate to materialize, each If current interest rates are, say, only 6% or 7% when these coupons come due, the holder will semi-annual coupon must be reinvested at 10% as it is received. be unable to compound his money over the life of the bond at the advertised rate. For pension problem. Savings Bonds might have solved it, except that they are issued only to individuals and funds or other investors with long-term liabilities, are unavailable in large denominations. What big buyers needed was huge quantities of "Savings Bond Equivalents." 18

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say, by Salomon Brothers). They created the instrument desired by "stripping" the semi-annual coupons some ingenious and, in this case, highly useful investment bankers (led, I'm happy to of a Savings Bond since it represents standard Government issues. Each coupon, once detached, takes on the essential character you strip the 40 semi-annual coupons from a U. S. Government Bond due in the year 2010, you a single sum due sometime in the future. For example, if then be bundled with other coupons of like maturity will have 40 zero-coupon bonds, with maturities from six months to 20 years, each of which say, 10% for all maturities, the six-month issue will sell for 95.24% of maturity value and the and marketed. If current interest rates are, 20-year issue will sell for 14.20%. The purchaser of any given maturity is thus guaranteed a com- on a large scale in recent rate of 10% for his entire holding period. Stripping of government bonds has occurred IRA accounts, recognized these high-grade, zero-coupon issues to be well suited to their needs. as long-term investors, ranging from pension funds to individual the end. In the last few years zero-coupon bonds (and their functional equivalent, pay-in-kind bonds, But as happens in Wall Street all too often, what the wise do in the beginning, fools do in issued in enormous quantities by ever-junkier credits. To these issuers, zero (or PIK) bonds offer which distribute additional PIK bonds semi-annually as interest instead of paying cash) have been one overwhelming advantage: It is impossible to default on a promise to pay nothing. Indeed, if they would now have a spotless record LDC governments had issued no debt in the 1970's other than long-term zero-coupon obligations, to pay nothing for a long time - has not been lost on promoters and investment bankers seeking This principle at work - that you need not default for a long time if you solemnly promise to finance ever-shakier deals. But its acceptance by lenders took a while: When the leveraged buy- 222242 which conservatively-estimated free cash flow - that is, operating earnings plus depreciation and out craze began some years back, purchasers could borrow only on a reasonably sound basis, in reductions in debt. amortization less normalized capital expenditures — was adequate to cover both interest and modest high that Later, as the adrenalin of deal-makers surged, businesses began to be purchased at prices so nothing for the paydown of debt. In effect, a Scarlett O'Hara "I'll think about it tomorrow" position all free cash flow necessarily had to be allocated to the payment of interest. That left in respect to principal payments was taken by borrowers and accepted by a new breed of lender, repaid. The change brings to mind a New Yorker cartoon in which the grateful borrower rises to the buyer of original-issue junk bonds. Debt now became something to be refinanced rather than shake the hand of the bank's lending officer and gushes: "I don't know how I'll ever repay you." finance even sillier transactions, they introduced an abomination, EBDIT - Earnings Before Soon borrowers found even the new, lax standards intolerably binding. To induce lenders to sawed-off yardstick, the borrower ignored depreciation as an expense on the theory that it did not Depreciation, Interest and Taxes — as the test of a company's ability to pay interest. Using this that over time roughly approximate depreciation are a necessity and are every bit as real an expense Such an attitude is clearly delusional. At 95% of American businesses, capital expenditures income that covers not only interest and operating expenses, but also realistically-calculated depre- as labor or utility costs. Even a high school dropout knows that to finance a car he must have ciation. He would be laughed out of the bank if he started talking about EBDIT. Capital outlays at a business can be skipped, of course, in any given month, just as a human can skip a day or even a week of eating. up, the body weakens and eventually dies. Furthermore, a start-and-stop feeding policy will over But if the skipping becomes routine and is not made time produce a less healthy organism, human or corporate, than that produced by a steady diet. As businessmen, Charlie and I relish having competitors who are unable to fund capital expenditures. You might think that waving away a major expense such as depreciation in an attempt to make with more "imagination." 19

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nough he doing last a teres and yeir in many are procained on zero-coupon or PIK bonds could be ignored when the financial feasibility of a transaction was being assessed. This approach not only relegated depreciation expense to the let's-ignore-it corner, but gave similar treatment to what was usually a significant portion of interest expense. To their shame, many professional investment managers went along with this nonsense, though they usually is actually too kind; they should be designated "promotees.") were careful to do so only with clients' money, not their own. (Calling these managers "professionals" which $90 million of interest must be paid currently, might use a zero-coupon or PIK issue to Under this new standard, a business earning, say, $100 million pre-tax and having debt on incur another $60 million of annual interest that would accrue and compound but not come due for some years. The rate on these issues would typically be very high, which means that the situation in year 2 might be $90 million cash interest plus $69 million accrued interest, and so on compounding proceeds. Such high-rate reborrowing schemes, which a few years ago were appro- as the investment banking houses. priately confined to the waterfront, soon became models of modern finance at virtually all major income and balance sheet projections extending five or more years into the future for companies When they make these offerings, investment bankers display their humorous side: They dispense you join in the fun: Ask the investment banker for the one-year budgets that his own firm prepared term: "the bezzle," defined as the current amount of undiscovered embezzlement. This financial Some time ago Ken Galbraith, in his witty and insightful The Great Crash, coined a new economic creature has a magical quality: The embezzlers are richer by the amount of the bezzle, while the embezzlees do not yet feel so that we might know the Psychic National Wealth. Logically, a society that wanted to feel enormously Professor Galbraith astutely pointed out that this sum should be added to the National Wealth prosperous would both encourage its citizens to embezzle and try not to detect the crime. By this means, "wealth" would balloon though not an erg of productive work had been done. bond. With zeros, one party to a contract can experience "income" without his opposite experiencing The satirical nonsense of the bezzle is dwarfed by the real-world nonsense of the zero-coupon the pain of expenditure. In our illustration, a company capable of earning only $100 million dollars for bondholders of $150 million. As long as major investors willingly don their Peter Pan wings annually - and therefore capable of paying only that much in interest - magically creates "earnings" and repeatedly say "I believe," there is no limit to how much "income" can be created by the zero-coupon bond. for the strel orele mod here, ventily, was an enentimens that enlid her ed folk might reserve at prices no longer limited by actual earning power. The result, obviously, would be more transactions: finally, was an instrument that would let the Street make deals the mother's milk of finance. Silly prices will always attract sellers. And, as Jesse Unruh might have put it, transactions are banker, which is that the time elapsing The zero-coupon or PIK bond possesses one additional attraction for the promoter and investment between folly and failure can be stretched out. This is no small benefit. If the period before all costs must be faced is long, promoters can create a string earlier ventures. ot foolish deals - and take in lots of fees - before any chickens come home to roost from their not be transformed But in the end, alchemy, whether it is metallurgical or financial, fails. A base business can claiming to be a financial alchemist may become rich. But gullible investors rather than business into a golden business by tricks of accounting or capital structure. The man achievements will usually be the source of his wealth. 20

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We have in fact owned some and may buy more if their market becomes sufficiently distressed Whatever their weaknesses, we should add, many zero-coupon and PIK bonds will not default. is evil per se; it's just that some variations have far more potential for mischief than others. (We've not, however, even considered buying a new issue from a weak credit.) No financial instrument The blue ribbon for mischief-making a current basis. Our advice: Whenever an investment banker starts talking should go to the zero-coupon issuer unable to make its both payable and accrued, to be comfortably met out of current cash flow net of ample capital someone creates a capital structure that does not allow all interest, expenditures — zip up your wallet. Turn the tables by suggesting that the promoter and his high- their take until the zero-coupon bonds have old-fashioned way — believe that they should perform a gatekeeping role, guarding investors against Our comments about investment bankers may seem harsh. But Charlie and I - in our hopelessly the same judgment and restraint in accepting money that alcoholics have exercised in accepting the promoter's propensity to indulge in excess. Promoters, after all, have throughout time exercised liquor. At a minimum, therefore, the banker's conduct should rise to that of a responsible bartender who, when necessary, refuses the profit from the next drink to avoid sending a drunk out on the to be an intolerably restrictive standard. Lately, those who have traveled the high road in Wall highway. In recent years, unfortunately, many leading investment firms have found bartender morality Street have not encountered heavy traffic. direct participants. Certain savings and loan associations were heavy buyers of such bonds, using One distressing footnote: The cost of the zero-coupon folly will not be borne solely by the cash that came from FSLIC-insured deposits. Straining to show splendid earnings, these buyers recorded are now in major trouble. Had their loans to shaky credits worked, the owners of the associations

• but did not receive - ultra-high interest income on these issues. Many of these associations

will pick up the bill. To paraphrase Jackie Mason, at these associations it was the managers who would have pocketed the profits. In the many cases in which the loans will fail, the taxpayer should have been wearing the ski masks. Mistakes of the First Twenty-five Years (A Condensed Version) To quote Robert Benchley, "Having a dog teaches a boy fidelity, perseverance, and to turn around idea to review past mistakes before committing new ones. So let's take a quick look at the last three times before lying down." Such are the shortcomings of experience. Nevertheless, it's a good • My first mistake, of course, was in buying control of Berkshire. Though I knew its business 25 years.

• textile manufacturing — to be unpromising, I was enticed to buy because the price looked cheap.

Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the strategy was not ideal. If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the "cigar butt" approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the "bargain purchase" will make that puff all profit. original "bargain" price probably will not turn out to be such a steal after all. In a difficult business, Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the no sooner is one problem solved than another surfaces — never is there just one cockroach in that the business earns. For example, if you buy a business for $8 million that can be sold or the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return liquidated for $10 million and promptly take either course, you can realize a high return. But the has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful investment will disappoint if the business is sold for $10 million in ten years and in the interim business, the enemy of the mediocre. 21

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You might think this principle is obvious, but I had to learn it the hard way - in fact, I had to learn it several times over. Shortly after purchasing Berkshire, I acquired a Baltimore department store, Hochschild, Kohn, buying through a company called Diversified Retailing that later merged with Berkshire. I bought at a substantial discount from book value, the people were first-class, and the deal included some extras - unrecorded real estate values and a significant LIFO inventory cushion. How could I miss? So-o-o - three years later I was lucky to sell the business for about Miss Him a Lot." give you other personal examples of "bargain-purchase" folly but I'm sure you get the picture: It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. common stocks, we look for first-class businesses accompanied by first-class But now, when buying companies or managements. • That leads right into a related lesson: Good jockeys will do well on good horses, but not on broken-down nags. Both Berkshire's textile business and Hochschild, Kohn had able and honest people running them. The same managers employed in a business with good economic characteristics in quicksand. would have achieved fine records. But they were never going to make any progress while running I've said many times that when a management with a reputation for brilliance tackles a business just wish hadnt been so econgetic in ireating examples. My behavior nas matched that admitted the reputation of the business that remains intact. l by Mae West: "I was Snow White, but I drifted." • A further related lesson: Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated to clear seven-footers. on identifying one-foot hurdles that we could step over rather than because we acquired any ability to simply stick with the easy The finding may seem unfair, but in both business and investments it is usually far more profitable problems must be tackled as was the case when we started our Sunday paper in Buffalo. In other and obvious than it is to resolve the difficult. On occasion, tough instances, a great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem as was the case many years back at both American Express and GEICO. Overall, however, we've done better by avoiding dragons than by slaying them. • My most surprising discovery: the overwhelming importance in business of an unseen force imperative's existence and I did not intuitively understand it when I entered the business world. that we might call "the institutional imperative." In business school, I was given no hint of the I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn't so. Instead, rationality frequently wilts when the institutional imperative comes into play. any change in its current direction; (2) Just as work expands to fill available time, corporate projects For example: (1) As if governed by Newton's First Law of Motion, an institution will resist however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, by his troops; setting executive compensation or whatever, will be mindlessly imitated. and (4) The behavior of peer companies, whether they are expanding, acquiring, too often misguided. After Institutional dynamics, not venality making some expensive mistakes because I ignored the power of the stupidity, set businesses on these courses, which are Furthermore, Charlie and 1 have attempted to concentrate our investments in companies that appear imperative, I have tried to organize and manage Berkshire in ways that minimize its influence. alert to the problem. 22

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• After some other mistakes, I learned to go into business only with people whom I like, trust, and admire. or department-store company won't prosper simply because its managers are men that you would As I noted before, this policy of itself will not ensure success: A second-class textile if he manages to be pleased to see your daughter marry. However, an owner — or investor — can accomplish wonders associate himself characteristics. Conversely, we do not wish to join with managers who lack admirable qualities, such people in businesses that possess decent economic deal with a bad no matter how attractive the prospects of their business. We've never succeeded in making a good • Some of my worst mistakes were not publicly visible. These were stock and business purchases one's area of competence. But I have passed on a couple of really big purchases that were served whose virtues I understood and yet didn't make. It's no sin to miss a great opportunity outside myself included, the cost of this thumb-sucking has been huge. up to me on a platter and that I was fully capable of understanding. For Berkshire's shareholders, view were not. In retrospect, it is clear that significantly higher, though still conventional, leverage • Our consistently-conservative financial policies may appear to have been a mistake, but in my have actually averaged. Even in 1965, perhaps we could have judged there to be a 99% probability ratios at Berkshire would have produced considerably better returns on equity than the 23.8% we that higher leverage would lead to nothing but good. Correspondingly, we might have seen only to produce a result falling somewhere between temporary anguish and default. a 1% chance that some shock factor, external or internal, would cause a conventional debt ratio disgrace cannot, in our view, be offset by a large chance of extra returns. If your actions are sensible, We wouldn't have liked those 99:1 odds — and never will. A small chance of distress or you are certain to get good results; in most such cases, leverage just moves things along faster.

• though we have learned to live with those also.

Charlie and 1 have never been in a big hurry: We enjoy the process far more than the proceeds

• * * * *

*

• * * *

2015 to do that, you can count on this section occupying many more pages than it does here. We hope in another 25 years to report on the mistakes of the first 50. If we are around in Miscellaneous help. If you have a business that fits the following criteria, call me or, preferably, write. We hope to buy more businesses that are similar to the ones we have, and we can use some Here's what we're looking for: (1) Large purchases (at least $10 million of after-tax earnings), (2) demonstrated consistent earning power (future projections are of little interest to us, nor are "turnaround" situations), (3) businesses earning good returns on equity while employing little or no debt, (4) management in place (we can't supply it), (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). very fast answer — customarily within five minutes — as to whether we're interested. We prefer We will not engage in unfriendly takeovers. We can promise complete confidentiality and a o buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. 23

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these, the company's owner-managers Our favorite form of purchase is one fitting the Blumkin-Friedman-Heldman mold. In cases like wish to generate significant amounts of cash, sometimes for themselves, but often for their families or inactive shareholders. At the same time, these managers past. We think we offer a particularly good fit for owners with such objectives. We invite potential wish to remain significant owners who continue to run their companies just as they have in the sellers to check us out by contacting people with whom we have done business in the past. our tests: Charlie and I frequently get approached about acquisitions that don't come close to meeting call hoping to sell you their cocker spaniels. Our interest in new ventures, turnarounds, or auction- We've found that if you advertise an interest in buying collies, a lot of people will like sales can best be expressed by a Goldwynism: "Please include me out." in the negotiated purchase Besides being interested in the purchase of businesses as described above, we are also interested of large, but not controlling, blocks of stock comparable to those we interest in large purchases of convertible preferreds. We still have hold in Capital Cities, Salomon, Gillette, USAir and Champion. Last year we said we had a special it is limited since we now are close to the maximum position we feel appropriate for this category of that kind, but of investment. * * * * * * * * mess at Two years ago, I told you about Harry Bottle, who in 1962 quickly cured a major business "bargain" purchases) and who 24 years later had reappeared to again rescue me, this time from first industrial company I controlled, Dempster Mill Manufacturing (one of my I reported, in short order Harry reduced capital employed at K&W, rationalized production, cut problems at K&W Products, a small Berkshire subsidiary that produces automotive compounds. As costs, and quadrupled profits. You might think he would then have paused for breath. But last year Harry, now 70, attended a bankruptcy auction and, for a pittance, acquired a product line Watch this space for future bulletins on Harry's triumphs. that is a natural for K&W. That company's profitability may well be increased 50% by this coup. *

* With more than a year behind him of trading Berkshire's stock on the New York Stock Exchange, our specialist, Jim Maguire of Henderson Brothers, Inc. ("HBI"), continues his outstanding maintained the spread at 50 points or less, which at current prices is well under 1%. Shareholders performance. Before we listed, dealer spreads often were 3% or more of market price. Jim has who buy or sell benefit significantly from this reduction in transaction costs. in ads that have been run in ecause we are delighted by our experience with Jim, HBI and the NYSE, I said as mur series placed by the NYSE. Normally I shun testimonials, but was pleased in this instance to publicly compliment the Exchange.

• * *
• *
• *

* * bought another used jet for $6.7 million. Last summer we sold the corporate jet that we purchased for $850,000 three years ago and plying bacteria on page 5 will understandably panic: If our net worth continues to increase at Those of you who recall the mathematics of the multi current rates, and the cost of replacing planes also continues to rise at the now-established rate by its jet. of 100% compounded annually, it will not be long before Berkshire's entire net worth is consumed His idea of traveling in style is an air-conditioned bus, a luxury he steps up to only when bargain Charlie doesn't like it when I equate the jet with bacteria; he feels it's degrading to the bacteria. fares are in effect. My own attitude toward the jet can be summarized by the prayer attributed, 24

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apocryphally I'm sure, to St. Augustine as he contemplated leaving a life of secular pleasures to to become chaste - but not become a priest. Battling the conflict between intellect and glands, he pled: "Help me, Oh Lord, countered with Naming the plane has not been easy. I initially suggested "The Charles T. Munger." Charlie "The Aberration." We finally selled on "The Indefensible."

• * * * * *

** * * ** ontributions program. Contributions made through the program were $5.9 million, and 2.550 charitie bout 96.9% of all eligible shares participated in Berkshire's 1989 shareholder-designate were recipients. program that appears on pages 52-53. If you wish to participate in future programs, we strongly We urge new shareholders to read the description of our shareholder-designated contributions urge that you immediately make sure your shares are registered in the name of the actual owner, 1990 will be ineligible for the 1990 program. not in the nominee name of a broker, bank or depository. Shares not so registered on August 31, * * * * * * * * grew last year to about 1,000, very close to the seating capacity of the Witherspoon Hall at Joslyn The annual meeting this year will take place at 9:30 a.m. on Monday, April 30, 1990. Attendance Museum. So this year's meeting will be moved to the Orpheum Theatre, which is in downtown smaller but nice hotel, is located across the street from the Orpheum. Or you may wish to stay Omaha, about one-quarter of a mile from the Red Lion Hotel. The Radisson-Redick Tower, a much at the Marriott that will leave at 8:30 and 8:45 for the meeting and return after it ends. at the Marriott, which is in west Omaha, about 100 yards from Borsheim's. We will have buses shareholders is reflected in the quality of the questions we get: We have never attended an annual Charlie and I always enjoy the meeting, and we hope you can make it. The quality of our meeting anywhere that features such a consistently high level of intelligent, owner-related questions. for admission to the meeting. Because weekday parking can be tight around the Orpheum, we have An attachment to our proxy material explains how you can obtain the card you will need about them. lined up a number of nearby lots for our shareholders to use. The attachment also contains information the meeting and to take you to downtown hotels or to the airport later. I hope that you will allow As usual, we will have buses to take you to Nebraska Furniture Mart and Borsheim's after plenty of time to fully explore the attractions of both stores. the Furniture Mart any day of the week; it is open from 10 a.m. to 5:30 p.m. on Saturdays, and Those of you arriving early can visit from noon to 5:30 p.m. on Sundays. from noon to 6 p.m. on Sunday, April 29th. Ike likes to put on a show, and you can rely on Borsheim's normally is closed on Sunday, but we will open for shareholders and their guests him to produce something very special for our shareholders. own rate turn negative for a day — not a pretty thought, I admit - visit Ike on the 29th. In this letter we've had a lot to say about rates of compounding. If you can bear having your Warren E. Buffett March 2, 1990 Chairman of the Board 25

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Deloitte & Touche Omaha, Nebraska 68102-1678 2000 First National Center Telex: 6716075 TROSS UW Telephone: (402) 346-7788 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders Berkshire Hathaway Inc. Hathaway Inc. We have audited the accompanying consolidated balance sheets of Berkshire related consolidated statements of earnings and cash flows for each of the subsidiaries of December 31, 1989 and 1988, and the three years in the period ended December 31, 1989. These financial statements are the responsibility of the Company's management. express an opinion on these financial statements based on our audits. Our responsibility is to standards. We conducted our audits in accordance with generally accepted auditing obtain reasonable assurance about whether the financial statements are free of Those standards require that we plan to material misstatement. supporting the amounts and disclosures in the financial statements. An audit includes examining, on a test basis, evidence includes assessing accounting principles and significant An audit statement presentation. estimates made by management, We believe that our audits provide a reasonable basis as well as evaluating the overall financial for our opinion. present fairly, in all material respects, the financial position of Berkshire In our opinion, the consolidated financial statements referred to above Hathaway Inc. and subsidiaries results of their operations and their cash flows for each of the three years as of December 31, 1989 and 1988, and the in the period ended December 31, 1989, in conformity with generally accepted accounting principles. retroactive effect to the Company's adoption in 1989 of Statement of Financial Note 1, the consolidated financial statements give Accounting for Certain Long-Duration Contracts and for Standards "Accounting Reporting Realized Insurance Losses from the Sale of Investments." March 7, 1990 26

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BERKSHIRE HATHAWAY INC. CONSOLIDATED BALANCE SHEETS and Subsidiaries (dollars in thousands except per share amounts) December 31, Cash and cash equivalents.. ASSETS 1989 1988 Investments: $ 205,127 $ 265,081 Obligations with fixed maturities Loans and accounts receivable.... Marketable equity securities....... 2,795,588 5,261,598 1,815,321 3,558,724 Inventories. 554,763 579,910 Properties and equipment. 195,927 207,432 194,390 167,293 Other assets 239,159 236,129 $ 9,459,594 $ 6,816.848 Losses and loss adjustment expenses LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,436,311 $ 1,407,189 Savings accounts Unearned premiums... 143,631 241,818 443,602 291,592 286,909 Accounts payable, accruals and other liabilities 325,514 Income taxes 1,129,038 1,007,516 598,905 Term debt and other borrowings 480.009 4,451,690 3.340,344 Minority shareholders' interests 82,778 66,396 Shareholders' equity: Common stock of $5 par value. Authorized 1,500,000 shares; issued 1,375,202 shares, including shares held in treasury. 157,377 6,876 157,377 6,876 Capital in excess of par value.. Unrealized appreciation of marketable equity securities, net 2,460.968 2,342,198 2.013.491 1,274,657 Retained earnings 4,967,419 3,452,401 Less common stock in treasury, at cost (228,761 shares) 4.925.126 42,293 3.410,108 42.293 Total shareholders' equity $ 9,459.594 $ 6.816.848 See accompanying Notes to Consolidated Financial Statements 27

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BERKSHIRE HATHAWAY INC. CONSOLIDATED STATEMENTS OF EARNINGS and Subsidiaries (dollars in thousands except per share amounts) 1989 Year Ended December 31, 1988* 1987* Revenues: Sales and service revenues interest and dividend incom nsurance premiums earne .... .... $1,526,459 394,279 $1,407,642 584,235 $1,326,829 Sundry income. Realized investment gain ... 223,810 331,452 314,251 824,895 237,319 .... 7,892 131,671 27,094 13.901 28,838 2,483,892 2,464,893 2.431.782 Cost and expenses: Insurance losses and loss adjustment expenses.. Cost of products and services sold 844,056 Insurance underwriting expenses... 309,391 753,845 437,695 705,203 Interest expense Selling, general and administrative expenses 109,288 495,331 157,621 661,146 526,359 219,178 1,866.668 77,574 70,280 488,307 1.914.772 2,121.271 47.437 Earnings before income taxes •..• 617,224 550,121 310,511 Income taxes. ..•• 159,287 140,791 69,539 Minority interest. 457,937 10,460 409,330 10,060 240,972 Net earnings 6,420 Net earnings per share ... $ 447,477 $ 399,270 $ 234.552 390.01 348.23 $ *Restated — See Note 1(b) 204.51 See accompanying Notes to Consolidated Financial Statements 28

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BERKSHIRE HATHAWAY INC. CONSOLIDATED STATEMENTS OF CASH FLOWS and Subsidiaries (dollars in thousands) 1989 Year Ended December 31, 1988 1987 Cash flows from operating activities: Net income... Adjustments to reconcile net income to cash flows .... $ 447,477 $ 399,270 $ 234,552 from operating activities: Depreciation and amortization.............. Realized investment gain (223,810) 32,107 29,808 29,683 Minority interests. 131,671 0,060 (28,838) Increase (decrease) in income taxes payable (22,181) 10,460 6,420 146,767 3,643 400,194 (30,937) Increase in losses and loss adjustment expenses...... Decrease in unearned premiums ... (98,187) 29,122 Other ... Decrease in deferred acquisition costs... (99,526) (6,253) 11,783 (73,642) 124,737 30,481 47,401 21,907 Net cash flows from operating activities 330,206 363,881 606.740 Cash flows from investing activities: Purchases of fixed maturity investments. (1,468,157) Proceeds on sales of fixed maturity investments Purchases of marketable equity securities (739,932) (1,708,971) (109,245) (1,229,290) 519,470 345,351 (550,112) 205,110 Proceeds from maturities of fixed Proceeds on sales of marketable equity securities......... maturity investments.... 821,656 28,985 878,228 46,104 607,080 92,873 Principal collection on loans Loans originated in finance businesses.. (133,546) _(57,174) 109,830 (103,602) 21,144 111,745 (177,840) _(15,351) 123,297 Other Net cash flows from investing activities.... (918,868) (519,246) (944,233) Cash flows from financing activities: Repayments of borrowings.... Proceeds from borrowings .. 1,172,356 (650,019) 250,000 (59,877) (111,359) 141,075 Net increase in savings account...... 1,688 4,683 (2,33Z) 698 (4,393) 3,853 Other.. Net cash flows from financing activities... 528,708 188,484 29,176 Cash and cash equivalents at beginning of year. Increase (decrease) in cash and cash equivalents.. 265,081 (59,954) 33,119 540,279 (308,317) 231,962 Cash and cash equivalents at end of year. .. . . $205,127 $ 265,081 $231.962 Other cash flow information: Interest paid Income taxes paid. ..... $ 181,468 70,191 $ 137,148 61,798 $ 100,778 46,067 See accompanying Notes to Consolidated Financial Statements 29 -

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BERKSHIRE HATHAWAY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and Subsidiaries December 31, 1989 (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 its su sidiaries. Intercompany accounts and transactions have been eliminated. (b) Restatements Berkshire's prior period consolidated financial statements are restated to reflect the applicabl statement of earnings in which pre-tax realized investment gains and losses are reported as rovisions of Statement of Financial Accounting Standards No. 97 which require a one-ste replaces the previously utilized form in which net-after-tax earnings as restated are unchanged from the amounts originally reported. operating earnings were shown separately from net-after-tax realized investment gains. Net (c) Cash Cash equivalents consist of funds invested in money market accounts and in investments with equivalents a maturity of three months or less when purchased. (d) Investments Investments in obligations with fixed maturities are carried at cost or adjusted cost. Marketable equity securities held by members of the Berkshire Hathaway Insurance Group are carried at market value. Marketable equity securities held by the Company and by non-insurance subsidiaries Note 4. are carried cost, which in the aggregate is less than market value. See (e) Investments - sales 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 taxes, identified cost is used. Goodwill and negative goodwill of acquired businesses The difference between purchase cost and the fair value of the net assets of acquired businesses is amortized on a straight line basis over forty years. The net unamortized balance is carried in other assets. (g) Insurance premium acquisition costs 'or financial reporting purposes, certain costs of acquiring insurance premiums are deferred suoject to ultimate recoverability, and charged to income as the premiums are earned. With cation of ultimate recoverability of the directly related acquisition cost takes into account espect to premiums received under major quota-share reinsurance contracts, the compu investment income anticipated to be earned on funds held subject to the contracts. Other- investment income. wise, ultimate recoverability of premium acquisition costs is determined without regard to 30

[PAGE 33]

(1) Significant accounting policies and practices (Continued) (h) Losses and loss adjustment expenses Liability for losses and loss adjustment expenses is determined on the basis of estimates of are intended to cover ultimate payment amounts less amounts recoverable on account of unpaid amounts with respect to both reported and incurred but not reported losses. Provisions are established at discounted present value of expected ultimate payment amounts reinsurance, except that provisions for periodic payment obligations ("structured settlements" Present value of expected ultimate payment amounts for structured settlements was determined for financial reporting purposes to be $197,090,000 as of December 31, 1989 applying, as average of which was 9% as of December 31, 1989. Present value of net liabilities for structured present value discount rates, the market interest rates at contract inception dates - the weighted settlements was determined for statutory and tax reporting purposes to be $277,744,000 as

• 5% for contracts incepting after 1986, and 7% with respect to contracts dated prior to 1987.

of December 31, 1989 applying discount rates prescribed by insurance regulatory authority (j) 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 unearned premiums ceded to reinsurers. Policyholder dividends, immaterial in amount (less than $5,000,000 per year for each of the past three years), incurred with respect to participating policies are reflected in the accom- panying Consolidated Statements of Earnings as a deduction from earned premiums. (k) Income taxes Certain items of income and deductions are recognized in the financial statements in time periods income tax returns, giving rise to recognition in the financial statements to deferred and prepaid that differ from those in which they are recognized in the Company's consolidated Federal The liability for income taxes in the Consolidated Balance Sheets includes deferred taxes deemed income taxes. securities. Such taxes were accrued at a rate of 34% relative to increases in unrealized applicable to unrealized appreciation included in carrying value of marketable equity appreciation that arose subsequent to 1986 and at the rate of 28% relative to appreciation that arose in years prior to 1987. In 1987, the Financial Accounting Standards Board ("FASB") issued Statement No. 96 " Accounting for Income Taxes" and required its implementation in financial statements issued for years its effective date. Implementation is now required in financial statements for years beginning beginning after December 15, 1988. Subsequently, the FASB issued statements twice deferring after December 15, 1991. The statement requires the "liability method" of accounting for for Income Taxes" requiring the "deferred method", with an earnings statement focus. Although income taxes, with a balance sheet focus. It supersedes APB Opinion No. 11 "Accounting If change to the "liability method" were to have been reflected in Berkshire's consolidated early adoption is permitted, the Company has not yet implemented the statement's provisions. resulted. The approximate range of reduction would have been from $35,000,000 to balance sheet as of December 31, 1989, a reduction to total shareholders' equity would have $70,000,000, with the precise amount dependent upon Berkshire's selection between per- mitted alternative means of implementation. 31

[PAGE 34]

Notes to Consolidated Financial Statements (Continued) (2) Investment in obligations with fixed maturities Assets comprising this account at December 31, 1989 and 1988 were as follows: Cumulative convertible preferred stocks: 1989 1988 The Gillette Company.. Champion International Corporation. $ 300,000,000 600,000,000 $ Salomon Inc USAir Group, Inc. 700,000,000 358,000,000 700,000,000 Bonds Other preferred stocks 832,397,000 5,191,000 15,072,000 $2,795,588,000 $1,815,321,000 1,100,249,000 the Champion, Gillette, Salomon Inc and USAir preferred shares nor for some of the bond issues represented There is no regular trading market from which quotations of market value might be obtained for in the portfolio; but Berkshire management believes that aggregate market value of the consolidated portfolio of fixed maturity obligations exceeded aggregate cost at both December 31, 1989 and 1988. Investments in cumulative convertible preferred stocks Salomon Inc On October 1, 1987, subsidiaries of Berkshire purchased a new issue of 700.000 shares of 9% Cumulative Convertible Preferred Stock of Salomon Inc ("Salomon"). These shares were purchased for cash at their par value of $1,000 per share and $700,000,000 in the aggregate. shareholders. At December 31, 1989, the preferred shares possessed approximately 13% of Each share is entitled to 26.31579 votes on all matters submitted to a vote of Salomon total Salomon voting rights. On October 31, 1990, each preferred share becomes convertible commencing in 1995, Salomon will redeem, at cost, 140,000 of the shares or such fewer into 26.31579 fully paid common shares of Salomon. Annually on each October 31, The Gillette Company number as are then outstanding. On July 20, 1989, subsidiaries of Berkshire purchased an issue of 600,000 shares of Series B of $1,000 per share - $600,000,000 in the aggregate - with respect to which dividends accrue Cumulative Convertible Preferred Stock of The Gillette Company ("Gillette") at a cash price to a vote of Gillette shareholders and at December 31, 1989 the preferred shares possessed at the annual rate of $87.50 per share. Each share is entitled to 20 votes on all matters submitted approximately 11% of total Gillette voting rights. On July 20, 1991 and until July 20, 1999, may call the shares for redemption at $1,100 per share. If neither called nor converted then each share may be converted into 20 shares of common stock. Also during this period, Gillette USAir Group, Inc. Gillette must redeem the shares on July 20, 1999 at $1,000 per share. On August 7, 1989, subsidiaries of Berkshire purchased 358,000 shares of newly issued Series A Convertible Preferred Stock of USAir Group, Inc. ("USAir") at a cash price of $1,000 per Each of these shares is entitled to 16 2/3 votes on all matters submitted to a vote of USAir share -$358,000,000 in the aggregate. Dividends accrue at an annual rate of $92.50 per share. of total USAir voting rights. During the eight years beginning August 7, 1991 each preferred shareholders. At December 31, 1989 the aggregate voting rights of the issue represented 11% redemption at $1,100 per share. If neither called nor converted, the shares must be redeemed share will be convertible into 16 2/3 common shares and USAir may call the shares for (d) Champion International Corporation on August 7, 1999 at their issue price. On December 6, 1989, subsidiaries of Berkshire purchased a new issue of 300,000 shares of purchased for cash at a price of $1,000 per share - $300,000,000 in the aggregate. The annual Preference Stock of Champion International Corporation ("Champion"). These shares were dividend accrual rate is $92.50 per share and each share is entitled to 26.31579 votes on aggregate voting rights of the issue represented approximately 8% of total Champion voting all matters submitted to a vote of shareholders of Champion. At December 31, 1989, the of Champion. Champion has the right to redeem the shares at any time prior to December rights. Each preference share may be converted at any time into 26.31579 common shares redeem them on December 6, 1999 at their issue price. 6, 1999 at $1,150 per share. If the shares are not called or converted, then Champion must

[PAGE 35]

(4) Investments in marketable equity securities securities. elow so the dates indicated to No consolated investment in a deal guy scurie hom December 31, 1989 Common stock of: Cost Unrealized Gain Market Carrying Value Capital Cities/ABC, Inc.. GEICO Corporation. The Coca-Cola Company. $ 1,023,919,000 517,500,000 $ 1,174,875,000 779,868,000 $ 1,692,375,000 $ 1,672,794,000 All other marketable equity securities The Washington Post Company.... 45,713,000 9,731,000 998,912,000 476,635,000 486,366,000 1,044,625,000 217,797,000 136,008,000 353,805,000 255,818,000 486,366,000 $1,814,660,000 $3,566,298,000 $5,380,958.000 $5,261,598,000 December 31, 1988 Cost Unrealized Gain Market Carrying Common stock of: Value Capital Cities/ABC, Inc. GEICO Corporation. The Coca-Cola Company.. $ 517,500,000 592,540,000 $ 569,250,000 281,765,000 45,713,000 803,687,000 39,908,000 $ 1,086,750,000 $ 1,077,262,000 632,448,000 632,448,000 The Washington Post Company ..... RJR Nabisco Inc. .... 288,000,000 9,731,000 354,395,000 22,775,000 849,400,000 304,540,000 849,400,000 304,180,000 All other marketable equity securities 97,653,000 385,653,000 364,126,000 331,308,000 364,126,000 $1,735,249,000 $1,887,668,000 $3,622,917,000 $3,558,724,000 category captioned "All other marketable equity securities." Unrealized gain is shown net of nominal unrealized loss as to certain stocks included above in the (5) Investment in shares of Capital Cities/ABC, Inc. Common shares of Capital Cities/ABC, Inc. ("Capital Cities") owned by Berkshire subsidiaries 31, 1989. The shares are held subject to an Agreement the terms of which grant to Capital Cities a right possessed approximately 17% of the voting rights of all Capital Cities shares outstanding at December the shares may be sold or transferred. Also, Berkshire and its subsidiaries have delivered to Capital Cities of first refusal to purchase the shares and otherwise govern until January 3, 1997 the manner by which irrevocable proxies with respect to these shares in favor of Thomas S. Murphy so long as he shall be the chief executive officer of Capital Cities, or Daniel B. Burke so long as he shall be the chief executive proxies expire on January 2, 1997 or at the earlier date when neither of such persons is chief executive officer of Capital Cities, to vote the shares at any and all meetings of shareholders of Capital Cities. The officer of Capital Cities. (6) Investment in GEICO Corporation shares of common stock of GEICO Corporation. The shares possessed approximately 45% of the voting Subsidiaries of Berkshire, at both December 31, 1989 and at December 31, 1988, owned 6,850,000 proxy arrangement for voting of the shares as required by Order of GEICO's domiciliary insurance super- rights of all GEICO shares outstanding at December 31, 1989, but Berkshire maintains an independent visory authority. The Order, dating from Berkshire subsidiaries' major purchase of the shares in 1976, no officer or director of Berkshire or of any affiliate or subsidiary of Berkshire is permitted to serve as prohibits Berkshire from seeking or causing to change the independent proxy. Also, under the Order, a director of GEICO. Because the Order divests Berkshire of its voting rights with respect to the shares, Berkshire does not use the equity method of accounting for its investment in GEICO. 33

[PAGE 36]

Notes to Consolidated Financial Statements (Continued) (7) Loans and accounts receivable Loans and accounts receivable represent the following: Dec. 31, 1989 Dec. 31, Trade accounts receivable. 1988 Loans of Mutual Savings and Loan Association ("Mutual"), $257,776,000 $234,009,000 stallment receivables purchased 1 rincipally real estate. 153,755,000 136,970,000 Due Insurance Group members, principally premiums.. Scott Fetzer Financial Group ("SFF") 69,479,000 Investment income due and accrued 42,583,000 69,229,000 Amounts due from sales of securities 31,170,000 43,168,000 63,275,000 33,259,000 (8) Income taxes $554,763.000 $579,910,000 represent estimates of liabilities as follows: The liability for income taxes as reflected in the accompanying Consolidated Balance Sheets Dec. 31, 36,906,000 1989 Dec. 31, ( Payable currently Deferred, relating to unrealized appreciation $ $ 46,758,000 1988 Deferred (prepaid arising from of marketable equity securities... 1,100,784,000 548,470,000 timing difference (8,652,000) 3,677,000 $1,129,038,000 $ 598,905,000 The Consolidated Statements of Earnings reflect charges for income taxes as shown below: Federal 1989 State .. $ 142,996,000 $ 122,492,000 1988 $ 1987 Foreign 15,514,000 15,871,000 56,597,000 777,000 2,428,000 11,551,000 $159,287,000 1,391,000 Taxes payable currently... $140,791,000 $ 69,539,000 Increase (decrease) in net deferred taxes .. $ 171,616,000 (12,329,000) $ 149,835,000 (9,044,000) $ 122,351,000 $159,287,000 52,812,000) $140,791,000 The increase (decrease) in net deferred taxes represent the tax effects of timing differences as follows: $69,539,000 Deferred insurance premium acquisition costs........ Applicable to: ... $ (10,363,000) 1989 $(7,377,000) 1988 1987 Structured settlement liabilities... 5,607,000 $ (13,577,000) Discounting of losses and loss adjustment expense reserves 6,902,000 4,714,000 Deferred gross profit on installment receivables.... (7,752,000) (3,588,000) (10,988,000) (4,610,000) (37,692,000) Other, net 3,767,000 7,029,000 2,488,000 (8,745,000) $(12,329,000) $(9,044,000) Charges for income taxes are reconciled in the table which follows to hypothetical amounts computed $(52,812,000) at the Federal statutory rate: Net earnings before income taxes..... .... $617,224,000 1989 $550,121,000 1988 $310,511,000 1987 Hypothetical amounts applicable to above computed at the Federal statutory rate Decreases, resulting from: (34% in 1989 and 1988, 40% in 1987) ... $ 209,856,000 $ 187,041,000 $ 124,204,000 Dividends received deduction Tax-exempt interest income .. (26,735,000) Net other differences. State income taxes, less Federal income tax benefit... (36,065,000) 33,477,000) 1,991,000 10,240,000 (21,461,000) (40,501,000) 10,597,000 10,830,000) Total income taxes (1,909,000) 6,931,000 .... $159,287,000 $140,791,000 (10,265,000) $ 69,539,000 34

[PAGE 37]

(9) Term debt and other borrowings at December 31, 1989 and 1988. The following table sets forth the term debt and other borrowings of the Company and its subsidiaries 1989 1988 10% Debentures due January 1, 2018, redeemable Zero Coupon Convertible Subordinated Notes Due 2004... $ 405,683,000 $ annual repayments of $7,500,000 beginning in 1999 through operation of a sinking fund which calls for 9 3/4% Debentures due January 15, 2018, redeemable 150,000,000 150,000,000 through operation of sinking fund which calls for .7% Loan repayable August 1, 1993 or at earlier deman‹ nnual repayments of $5,000,000 beginning in 1999 ... 100,000,000 Other notes, payable through 1993 .. 109,120,000 100,000,000 9,396,000 Subsidiaries 774,199,000 11,316,000 261,316,000 10% Notes, payable in annual installments of $2,625,000 8.125% Notes, payable in 1996 120,000,000 120,000,000 on August 31, 1998 through 1997 with a final payment of $2,750,000 9 1/2% Notes, payable in annual installments of $2,500,000 23,750,000 26,375,000 8 7/8% Notes, payable in 1999..... through 1998. 30,000,000 22,500,000 25,000,000 Federal Home Loan Bank advance, due August 1994, 10 1/8% Notes, originally due in 1991, refunded in 1989.. 25,000,000 Other notes maturing through 2014 bearing interest at 8.73%... _ 20,167,000 16,900,000 22,318.000 $1,007,516,000 $480,009,000 at 44.314% of their face value which totaled $902,640,000. The issue price reflected an original issue The Zero Coupon Convertible Subordinated Notes Due 2004 were issued on September 28, 1989 discount rate and yield to maturity of 5.5% per annum; there will be no periodic payments of interest. Company into 0.4515 shares of common stock. A holder entitled upon conversion to a fractional share Each $10,000 face amount note may be converted at any time prior to redemption or purchase by the of common stock shall receive cash equal to the then current market value of such fractional share. The conversion rate will be adjusted only upon occurrence of certain dilutive events affecting the common require the Company to purchase any of its holdings on September 28, 1994 and again on September stock. The Company may redeem the notes for cash at any time after September 28, 1992. A holder may 28, 1999. The price at which notes will be purchased or redeemed will be issue price plus accrued original No materially restrictive covenants are included in any of the various borrowing Agreements. ive years as shown in the table immediately below. Amounts have been determined without regard t Principal payments on borrowings outstanding at December 31, 1989 are required during the succeeding optional repayment provisions of the governing instruments. 1991 1990 $ 11,731,000 8,028,000 1992 8,043,000 1993. 118,860,000 1994. 22,892,000 35

[PAGE 38]

Notes to Consolidated Financial Statements (Continued) (10) Shareholders' equity accounts Changes in Shareholders' Equity accounts during the most recent three years were as follows: Net Unrealized Retained Appreciation Earnings Treasury Stock Balance at December 31, 1986..... ... $ 874,813,000 $ 1,379,669,000 $ 40,938,000 349,147,000 Net earnings 1987 income taxes '.... (119,837,000) Balance at December 31, 1987... .... ... 1,104,123,000 1,614,221,000 234,552,000 .. L 40,938,000 Increase during 1988 in unrealized appreciation included in carrying value of marketable Change during 1988 in deemed applicable equity securities.. •... 259,486,000 Increase in minority shareholders' interest income taxes... ••.. (88,763,000) Net earnings 1988 in unrealized appreciation (189,000) Value of Berkshire stock received in connection 399,270,000 with termination of pension plans (note 12).. ....• 1,355,000 Increase during 1989 in unrealized Balance at December 31, 1988. appreciation .... 1,274,657,000 2,013,491,000 42,293,000 equity securities.. included in carrying value of marketable Change during 1989 in deemed applicable ...... 1,623,462,000 Increase in minority shareholders' interest income taxes …... ..... (552,314,000) Net earnings 1989 ... in unrealized appreciation .... .... (3,607,000) 447,477,000 Balance December 31, 1989 $2,342,198,000 $2,460,968,000 (11) Interest and dividend income $ 42,293,000 Interest and dividend income for each of the past three years were comprised of the following: Interest earned with respect to: 1989 1988 1987 Investment securities... Loans and financed receivables $ 114,928,000 50,904,000 $ 164,499,000 51,135,000 $ 149,534,000 51,271,000 102,181,000 63,439,000 34,965,000 63,652,000 17,241,000 19,273,000 $331,452,000 (12) Sundry income for 1989 and 1988 includes approximately $53,000 and 516,366,000 respectively. $314,251,000 $237,319,000 which represents the approximate fair value of cash and securities that reverted to the Company and to certain of its subsidiaries upon termination of overfunded pension plans. (13) Interest expense follows: Interest expense is comprised of interest on savings accounts of Mutual plus interest on debt as Savings accounts of Mutua 1989 1988 Debt of SFFG. Debt of Mutua $ 21,261,000 1987 599,000 $ 20,579,000 $ 20,903,000 Other debt ... 42,389,000 13,325,000 35,613,000 14,088,000 11,474,000 15,060,000 36 $77,574,000 $70,280,000 $47,437,000

[PAGE 39]

(14) Dividend restrictions - insurance subsidiaries Without prior regulatory approval in 1990, Berkshire can receive up to approximately $580,900,000 as Payments of dividends by Insurance Group members are restricted by insurance statutes and regulations. dividends from insurance subsidiaries. rules (Statutory Surplus as Regards Policyholders) was approximately $6,000,000,000 at December 31, Combined shareholder's equity of insurance subsidiaries determined pursuant to statutory accounting on the basis of generally accepted accounting principles; the difference is principally represented by deferred 1989. This amount exceeded by approximately $1,000,000,000 the corresponding amounts determined .. L income tax liabilities recognized for financial reporting purposes but not for statutory reporting purposes. (15) Business segment data Board Statement No. 14. This is unchanged from 1988. The principle activity/product/service of each In 1989, Berkshire had seven reportable business segments as defined in Financial Accounting Standards Segment Activity/product/service Insurance Property/casualty insurance and reinsurance. Candy Boxed chocolates and other confectionery products. Newspaper Publication of the Buffalo News, a daily and Sunday newspaper. Retailing of home furnishings products. Carpet, furniture, appliances, electronics and related Encyclopedias, other reference materials encyclopedias and other educational and reference works. Composition, publication and marketing of World Book Home cleaning systems Manufacture and distribution of principally Kirby branded home cleaning systems and products. Uniform manufacturing and distribution jackets, shirts, and caps. Manufacture and distribution of uniforms, trousers, The tables which follow reflect data for those segments for each of the three most recent years. Revenues 1989 1988 1987 Insurance ... $ 865,026,000 Candy ..... 186,053,000 $ 943,873,000 135,647,000 168,166,000 $ 1,003,821,000 338,397,000 156,762,000 131,664,000 157,391,000 152,541,000 122,955,000 Home cleaning systems.. 158,959,000 337,990,000 145,997,000 Karents a tan to aid ego. ... 549,118,000 93,930,000 144,145,000 325,772,000 494,000,000 92,514,000 129,678,000 471,434,000 74,734,000 $2,483,892,000 $2,464,893,000 $2,431,782,000 37

[PAGE 40]

Notes to Consolidated Financial Statements (Continued) (15) Business segment data (continued) Operating profit before taxes 1989 1988 1987 Candy.... Insurance. $ 439,223,000 Retailing of home furnishings .. Newspaper. 45,448,000 33,260,000 $ 347,900,000 31,498,000 $ 122,985,000 Encyclopedias, other reference materials 16,624,000 41,830,000 30,718,000 Home cleaning systems .... 25,332,000 17,994,000 38,811,000 Pre-tax operating profits not identified with Uniform manufacturing and distribution... 26,188,000 27,639,000 16,328,000 11,899,000 27,210,000 25,494,000 13,425,000 23,325,000 12,613,000 Unallocated corporate costs segments (a)... 70,798,000 Interest on debt (a). (42,389,000) (9,159,000) 86,958,000 (35,613,000) (8,720,000) 60,029,000 (11,474,000) (8,318,000) $617,224,000 $550,121,000 $310,511,000 (a) Interest expense of finance and savings and loan operations has been deducted in determining pre-tax profits not identified with segments. Accordingly, such interest is not included in interest on debt. Capital expenditures 1989 1988 1987 Insurance Newspaper Candy. $ 3,882,000 525,000 $ 838,000 Retailing of home furnishings... 971,000 3,509,000 $ 804,000 Home cleaning systems.. Encyclopedias, other reference materials 2,247,000 988,000 4,758,000 3,552,000 2,037,000 1,266,000 Uniform manufacturing and distribution 11,191,000 329,000 3,103,000 Other 17,897,000 2,272,000 2,370,000 1,320,000 376,000 5,418,000 2,203,000 5,155,000 981,000 $ 42,537,000 $17,692,000 $17,763,000 Depreciation and amortization of tangible assets 1989 1988 1987 Insurance $ 3,574,000 918,000 $ 722,000 Encyclopedias, other reference materials Retailing of home furnishings.... 1,745,000 2,757,000 2,836,000 3,392,000 3,200,000 648,000 Home cleaning systems.. 749,000 1,612,000 2,909,000 Other Uniform manufacturing and distribution 2,115,000 3,274,000 2,575,000 746,000 1,515,000 770,000 13,589,000 13,421,000 1,698,000 2,627,000 13,960,000 1,192,000 $ 28,721,000 $ 27,002,000 $.26,821,000 Identifiable assets at year-end Dec. 31, 1989 Dec. 31, 1988 Dec. 31, 1987 Insurance $ 7,871,097,000 Newspaper Candy. 66,278,000 $ 5,421,195,000 48,917,000 64,304,000 $ 4,519,657,000 Encyclopedias, other reference materials Retailing of home furnishings.. 103,159,000 71,107,000 50,755,000 64,742,000 70,660,000 54,326,000 Home cleaning systems.. Uniform manufacturing and distribution. 70,597,000 60,147,000 45,675,000 85,675,000 71,461,000 80,318,000 Other... 1,168,292,000 1,005,575,000 73,009,000 61,595,000 46,191,000 964,945.000 $9,459,594,000 $6,816,848,000 $5,863,235,000 38

[PAGE 41]

(15) Business segment data (continued) Revenues of the insurance segment Premiums written. 1989 1988 1987 $296,092,000 $484,709,000 $ 751,253,000 Premiums earned: Primary or direct insurance. A Reinsurance assumed excluding structured $ 188,920,000 $ 292,309,000 441,635,000 settlements and portfolio reinsurance. Subtotal. 146,827,000 structured settlements and portfolio reinsurance 335,747,000 229,323,000 Investment income Total premiums earned 58,532,000 521,632,000 372,763,000 394,279,000 62,603,000 814,398,000 Realized investment gain 220,024,000 250,723,000 584,235,000 824,895,000 10,497,000 231,907,000 $865,026,000 $943,873,000 127,731,000 152,995,000 $1,003,821,000 25,931,000 Insurance segment operating profit before taxes 1989 1988 1987 Underwriting gain (loss): rimary or direct insurance grationed $ 4,243,000 $ 17,466,000 $ (2,715,000) settlements and portfolio reinsurance .... (11,204,000) Structured settlements and portfolio reinsuranc... (6,961,000) (14,472,000) Net investment income.... Total underwriting (loss).. -(17,439,000) 2,994,000 (27,745,000) (24,400,000) (14,075,000) (24,969,000) (30,460,000) Realized investment gain 220,024,000 243,599,000 231,250,000 (11,081,000) 152,483,000 (55,429,000) 127,731,000 25,931,000 $439,223,000 $ 347,900,000 $ 122,985,000 (16) Quarterly data following table. This information is unaudited. Dollars are in thousands, except per share amounts. A summary of revenues and earnings by quarter for each of the last two years is presented in the 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER 1989 1988 1989 1988 1989

• 1988

19891988 Revenues $Z01,707 $641,678 $564,214 $576,374 $597,143 $583,949 $620,828 $662,892 Earnings excluding realized investment gain $ 72,241 $ 77,835 $ 62,424 $ 69,506 $ 70,932 $ 75,961

• per share

63.01 - 67.87 54.45 - 60.62 61.87 66.26 $ 94,305 82.49 $ 90,139 78.62

• per share

Realized investment gain 54,813 $ 21,222 $ 25,011 $ 24,939 $ 17,028 $ 31,104 47.81 21.82 21.75 27.13 • per share Net earnings $ 127,054 $ 99,057 $ 87,435 $ 94,445 $ 121,655 $ 84,525 $ 111,333 $ 121,243 110.82 86.38 76.27 _ 82.37 -106.12 _ 73.73 96.83 105.75 See's Candy sales peak at Easter and more notably so in the fourth quarter when more than one-half of Revenues and earnings from marketing of World Book products are concentrated in the first quarter. determining liabilities for unpaid losses of insurance subsidiaries, can be relatively more significant to Berkshire's interim consolidated financial statements is that estimation error, inherent to the process of securities gains or losses cause significant variations in periodic net earnings. results of interim periods than to results for a full year. Variations in amount and timing of realized 39

[PAGE 42]

BERKSHIRE HATHAWAY INC. Financial Condition and Results of Operations Management's Discussion and Analysis of Results of Operations in thousands, and each figure is income tax-effected. Net earnings for each of the past three years are disaggregated in the table that follows. Amounts are Insurance underwriting... Activity or Item Contribution to Net Earnings Insurance segment investment income. ..... ..... $ (12,259) 1989 $ (1,045) 1988_ $ (20,659) 1987 Manufacturing, merchandising, and services.. 11021 _197,779 196,734 136,621 115,962 Pension plan asset reversions* 135,652 109,681 Interest on dated corporate cost .... (27,098) (23,212) 9,983 (6,102) (5,905) Earnings before realized investment gain. ........ 299,902 313,441 -(5,716) 214,746 (4,992) Realized investment gain.... Net earnings ... $ 447,477 147,575 $ 399,270 85,829 $234,552 19,806 ermination of overfunded pension plans are set out separately because of their comparativ Net earnings that resulted from asset reversions to the Company and certain subsidiaries upo significance. Berkshire has adopted Financial Accounting Standards Board Statement No. 97. The Statement requires of Earnings no longer reflect net-after-tax investment gains separately from net-after-tax operating earnings pre-tax realized investment gains to be shown as a component of revenues. As a result, Berkshire's Statements contribution to earnings of those differing components. However, in our discussions of Berkshire's results, we expect to continue to show separately the net the individual Berkshire businesses and should be read in conjunction with this discussion. Note 15 to the consolidated financial statements ("the Segment Note") shows data for a number of Insurance Underwriting The after-tax figures shown above for the Insurance underwriting segment derive from the following: 000s Omitted Underwriting gain (loss): 1989 1988 1987 Primary or Direct Insurance Operations..... Reinsurance Assumed, excluding Structured ....• $ 4,243 $ 17,466 $ (2,715) Structured Settlements and Portfolio Reinsurance. Settlements and Portfolio Reinsurance ...... (11,204) Applicable income tax credit* Underwriting loss - pre-tax (17,439) (14,472) .... After-tax underwriting loss... Applicable minority interest.. ....•• (24,400) (14.075) (27,745) ..... ....•• 11,781 (11,081) (24,969) $(12,259) 360 9,670 (55,429) $(1,045) 366 34,461 $(20,659) 309 of approximately $3 million for 1989, $5 million for 1988 and $8 million for 1987. *Income tax credits applicable to underwriting losses include a "fresh start" tax benefit 40

[PAGE 43]

Insurance Underwriting (continued) Primary or Direct Insurance Underwriting accepted accounting principles ("GAAP"), of the Berkshire Hathaway Insurance Group's primary or direct A summary follows of the combined underwriting results, determined on the basis of generally insurance operations. Dollars are in thousands. 1989 Premiums earned Premiums written.... $ 169,661 Amount % Amount 1988 Losses and loss expenses 188,920 Total losses and expenses... Underwriting expenses.... 125,873 100.0 Es 218,838 % Amount 1987 58,804 66.6 292,309 Underwriting gain (loss) - pre-tax 184,677 31.1 196,165 100.0 $ 412,748 4,243 97.7 274,843 78,678 26.9 67.1 441,635 338,575 100.0 17,466 94.0 105,775 76.7 HA 414,350 23.9 (2,715) 100.6 in 1988 from 1987 by about 34%. During the 1987-1989 period, a continuously decreasing number of Premiums earned from primary or direct operations decreased in 1989 from 1988 by about 35% and policies were issued from each of the separately-focused underwriting areas that make up Berkshire's since inception in 1985 through 1989. They peaked at $93 million for 1987, then declined to $54.1 million the Professional Liability and Special Risks Divisions, both in New York City, have been $241.4 million primary or direct business. Earned premiums from business produced by the Commercial Casualty and and successively fewer favorably priced insuring opportunities have been presented since 1986. for 1988 and to $20.2 million for 1989. Competition for insurance business has significantly eroded prices evident in the above table, are the result of the declining level of premiums, in two ways. First, the business The increases from year to year in percent of earned premiums represented by underwriting expenses, produced by the New York City divisions has historically carried a lower than group average underwriting premiums represented by this business has declined from 21% in 1987 to 18% in 1988 and 11% in the expense rate (8.8% inception-to-date), and the proportion of the Group's total primary or direct earned most recent year. Secondly, costs of providing underwriting support, particularly personnel costs, for traditional business have decreased at a slower rate than have earned premiums from such business. Summarized below is loss and loss expense data from primary or direct underwriting: $667,592 1989 000s Omitted $628,077 1988 Incurred losses recorded: Unpaid losses and loss expenses at beginning of year.. $429,505 1987 Current year occurrences..... All prior years' occurrences .... ..... (20,034) 145,907 225,309 125,873 196,165 (29,144) 348,010 338,575 (9,435) Payments with respect to: Current year occurrences.... 27,645 All prior years' occurrences 154,319 126,674 117.387 39,263 44,856 _156,650 95,147 Unpaid losses and loss expenses at end of year... $639,146 $667,592 140,003 $628.071 favorable developments of loss reserves have been recorded for this business in each of the past three As indicated above by the credits shown for incurred losses recorded for all prior years occurrences, earned in those respective years. The bulk of favorable loss development recorded in 1989 related to years. The credits represent 10.6% - 1989, 10.0% — 1988, and 2.1% — 1987, of direct or primary premiums National Indemnity Company's traditional liability coverages for bus and truck operators. 41

[PAGE 44]

Management's Discussion (continued) Insurance Underwriting (continued) Reinsurance Assumed excluding Structured Settlements and Portfolio Reinsurance assumed business, other than structured settlements and portfolio reinsurance, are summarized in the The combined underwriting results, determined on a GAAP basis, with respect to the reinsurance following table, with dollars in thousands. 1989 Premiums earned Premiums written $ Amount 65,954 % Amount 1988 1987 Losses and loss expenses 146,827 Underwriting expenses... 109,419 100.0 $ 203,268 Amount Total losses and expenses ... 48.612 74.5 229,323 Underwriting (loss) - pre-tax $ (11,204) 158,031 107.6 33.1 170,492 100.0 $ 328,011 % 243,795 73.303 32.0 74.3 372,763 112,870 287,638 100.0 77.2 $ (14,472) 106.3 $ (27,745) 400,508 107.4 30.2 of expiration of the quota-share reinsurance arrangement under which National Indemnity Company The significant decreases reflected above for both written and earned premiums in 1989 are the result four years from September 1, 1985 to August 31, 1989. Premiums earned from that arrangement during assumed 7% of the business written by the Fireman's Fund Insurance Companies ("FF") during the $131,000,000 in 1989. In mid-September 1989, National Indemnity returned to FFC approximately $55 years covered by the above table were approximately $254,000,000 in 1987, $216,000,000 in 1988 and Hathaway Insurance Group remains liable for run-off of its share of the losses and loss expenses covered million of premiums, net of ceding commissions, unearned at contract expiration date. The Berkshire many years hence. by the contract, and will continue to invest funds offsetting the reserves until the run-off is complete past three years. Loss and loss expense data with respect to this reinsurance business is summarized below for the Incurred losses recorded: Unpaid losses and loss expenses at beginning of year... .... $531,334 1989 000s Omitted $488,098 1988 $319,989 1987 All prior years' occurrences.. Current year occurrences...... 109,231 109.119 188 169,688 804 283,151 Payments with respect to: 170,492 287,638 4,487 All prior years' occurrences Current year occurrences... 97,392 31,983 35,474 Unpaid losses and loss expenses at end of year .... . . . . $511,378 129,375 127,256 91,782 74,328 45,201 $531,334 $488,098 119,529 Unpaid losses and loss expenses from major quota share reinsurance arrangements were $412 million, 2222 may be significant. Analyses of loss developments for the Structured Settlements and Portfolio Reinsurance business are Structured Settlements and Portfolio Reinsurance losses will result in varying amounts that are reasonably estimable. Acceptance of the business nevertheless not meaningful because, at inception of these contracts, it is predictable that subsequent underwriting occurs after appraisal on a proposal-by-proposal basis of the value of funds expected to be generated thereby. 42

[PAGE 45]

Insurance Segment Investment Income Approximately $200 million was added in 1987, $275 million in 1988 and $415 million in 1989. The Berkshire contributed additional capital to the Insurance Group in each of the past three years. added capital together with reinvested earnings and increased float increased the total invested assets of the Group. Meaningful year-to-year increases resulted in investment income, summarized below for Investment 000s Omitted Income Investment Before Applicable Applicable Income After 1989 Taxes Income Minority Taxes and 1988 $243,599 Taxes 1987 231,250 $ 26,756 $ 3,201 Interest Minority Int. $213,642 152,483 30,698 13,670 2,192 2,773 197,779 136,621 1986 - three years ago - to approximately $1,541,000,000 at December 31, 1989. The term denotes the "Float" from policyholder funds has increased from approximately $1,078,000,000 at December 31, agents balances receivable, amounts recoverable as reinsurance on paid losses and deferred policy sum of unpaid losses, unpaid loss adjustment expenses and unearned premiums, less the aggregate of acquisition costs. Of the 1989 year-end total float, structured settlement and portfolio reinsurance liabilities amounted to approximately $285,000,000. Manufacturing, Merchandising and Services summarized in the following table, in thousands of dollars: Results of operations for the past three years of Berkshire's diverse non-insurance businesses are 1989 Revenues .... Amount % Amount 1988 1987 Earnings before income taxes Costs and expenses $ 1,613,474 100.0 $ 1,500,724 % Amount 85,876 14.0 1,274,466 100.0 6,830 0.4 5.4 226,258 84.9 $1,425,054 % _1,389,317 86.0 1,220,643 100.0 Applicable minority interest Applicable income taxes.. 224,157 84,231 15.1 204,411 85.7 6 131.451 8.2 135,652 6,375 0.4 5.6 90,114 14.3 9.1 $• 109,681 4,616 0.3 6.3 Net earnings .. 7.2 in each of the three years, data are included with respect to moderate scale real estate management activities Operations summarized above numbered twenty five in 1989, two more than in 1988 and 1987, plus, of Berkshire and Wesco. The operations added in 1989 were (i) retailing of jewelry — in February, Berkshire purchased for cash 80% of Borsheim's Fine Jewelry and Gifts, and (ii) the manufacturing of electrical equipment by New America Electric — 80% purchased for cash by Wesco at the end of 1988. However, for each of the three years, the same six businesses constituted Berkshire's non-insurance "reportable business segments," a standing determined by relative size. The six are: (i) See's candy business, (ii) publication daily and Sunday of The Buffalo News, (iii) retailing of home furnishings by The Nebraska Furniture Mart, (iv) composing, publishing and marketing of World Book encyclopedias and other reference works, (vi) manufacture and distribution of Fechheimer uniforms. (v) manufacture and distribution of home cleaning systems - principally Kirby branded products and than in 1988. And, in the prior year, aggregate revenues of the six were more by approximately $70 million, Revenues of those six segments were greater in 1989 by approximately $42 million, or about 4%, or 7%, than in 1987. As shown in the table of revenues in the Segment Note, revenue increases from home cleaning systems business each recorded about 10% higher sales than in 1988, while the aggregate 1987 to 1988 were at a fairly even rate among the six. In 1989, however, the candy business and the revenues of the other four increased about 1%. 43

[PAGE 46]

Management's Discussion (continued) Manufacturing, Merchandising, and Services (continued) See's increased sales were accompanied by increased advertising costs, but of a lesser dollar magnitude, so the business contributed about one million dollars more to 1989 than to 1988 net earnings of Berkshire. products. Strengthened distribution for those products was evident from results in Scandinavia, West The increased sales of home cleaning systems were led by a 32% increase in unit foreign sales of Kirby Germany, Australia, Italy and Japan. Improved earnings, however, did not follow this segment's improved revenues, principally because of significant start-up costs incurred with respect to production for marketing in the 90's of a new model Kirby machine. Interest on debt increased in both 1989 and 1988, reflecting increased outstanding borrowings in Interest Expense each year. The 1989 increase over 1988 reflects the expense recorded for accretion of the zero coupon convertible subordinated notes issued on September 28, 1989. The 1988 increase over 1987 reflects the added borrowing costs from Berkshire's $250 million face amount of debentures due 2018, issued in January 1988 Realized Investment Gain The amount - recorded by Berkshire when appreciated securities are sold — tends to fluctuate significantly Realized investment gain has been a recurring element in Berkshire's net earnings for many years. from period to period, with a meaningfully varying effect upon Berkshire's consolidated net earnings. amount from period to period have no practical analytical value, given the pre-existence of substantial But, the amount of realized investment gain for any period has no predictive value, and variations in unrealized price appreciation in Berkshire's consolidated investment portfolio. Liquidity and Capital Resources Berkshire's Consolidated Balance Sheet as of December 31, 1989, reflects continuing capital strength. approximately $4.93 billion at December 31, 1989. In that three-year period, realized and unrealized Berkshire shareholders' equity has increased from approximately $2.38 billion at December 31, 1986 to securities gains increased equity capital by approximately $1.72 billion. Reinvested earnings, other than realized securities gains, were approximately $828 million for the three years. through sinking funds commencing in 1999 with final maturity in 2018. In September 1989, Berkshire In January 1988 Berkshire issued $250,000,000 face amount of 30 year debentures, redeemable received approximately $400 million proceeds from issuance of zero coupon convertible subordinated equity capital of the Insurance Group. Berkshire borrowed the funds not with a view to any immediate notes maturing in 2004 at approximately $903 million. Proceeds from the issues were contributed to the cash needs but rather to increase its already substantial liquidity. Somewhat improved ability to respon o future business acquisition opportunities also resulted In early 1989, Standard and Poor's Corporation announced its assignment of a AAA credit rating o Berkshire senior debt. Creditors' indebtedness that is subordinated normally receives a rating one gradatio ower than is received for their senior indebtedness. Accordinelv. Berkshire's issue of zero coupo subordinated notes received an AA+ rating from that rating agency, when issued in September 1989. 44

[PAGE 47]

BERKSHIRE HATHAWAY INC. INSURANCE GROUP Berkshire's insurance business is conducted by 12 separate subsidiaries, Special Risk Division, each with offices in New York City, solicit and underwrite risks. The Commercial Casualty Division and the Professional Liability and the latter. Members domiciled in the states of Colorado, Kansas and Nebraska provide standard multiple-line property/casualty insurance to "homestate" residents. A California domiciled member provides principally workers' com- in New York City, treaties of reinsurance are offered to other insurers. pensation insurance to employers in that state. Also, from a Reinsurance Division unparalleled high levels, significantly higher than normal in the industry. This The Berkshire Hathaway Insurance Group maintains capital strength at strength differentiates Group members from their competitors. For example, the Group's net premiums written in 1989 were approximately 5.5% of the Group's year-end statutory surplus. That compares to an industry average premiums-to- surplus ratio of about 170% (for 1988). The obvious margins of safety thus provided to insureds of the Group are particularly persuasive in marketing of ing liability assumptions with respect to loss portfolios and with respect to individually negotiated financial insurance and reinsurance contracts, includ- periodic payment contracts (structured settlements). Group - unaudited and not fully adjusted to conform to Generally Accepted Combined financial statements of the Berkshire Hathaway Inc. Insurance Accounting Principles - are presented on the following two pages. - 45

[PAGE 48]

BERKSHIRE HATHAWAY INC. INSURANCE GROUP (dollars in thousands) Balance Sheets 1989 December 31, 1988 Assets Investments: Fixed maturities at amortized cost: Bonds: Other Wash. Pub. Power Supply System $ 194,004 545,943 $ 246,982 802,916 Redeemable preferred stocks: Champion International... 279,000 Salomon Inc Gillette 600,000 624,000 USAir. 348,000 624,000 Equity Securities at market: Other. 668 10,548 Common stocks: Coca-Cola Company Capital Cities/ABC, Inc.. 1,799,152 1,664,169 1,068,637 1,044,625 632,448 GEICO 486,366 849,400 Other Washington Post 123,728 364,126 23,509 498,614 Nonredeemable preferred stocks 8.606 7,733,164 5,106,277 Receivables. Cash and cash equivalents 70,998 45,390 121,614 2,328 14,975 139,702 Other Deferred insurance premium acquisition costs 45,456 3,299 Liabilities $7.866,855 $5.416.348 Loss and loss adjustment expenses $ 1,436,311 201,008 143,631 $ 1,407,189 Unearned premiums... 241,818 Income taxes (Deferred: $1,095,300, 1989; $547,635, 1988) Accounts payable, accruals and other 1,136,174 565,310 85,387 2,917,124 2,299,704 Equity Minority shareholders' _4,914,563 35,168 _ 3,091,687 24,957 Berkshire shareholders'. 4,949,731 3,116,644 $7,866,855 $5,416,348 These stalements do not conform to GAAP in all respects These statements are unandited 46

[PAGE 49]

BERKSHIRE HATHAWAY INC. INSURANCE GROUP Statements of Earnings (dollars in thousands) Premiums written. $ 296,092 1989 1988 $ 484,709 $ 751,253 1987 Premiums earned Underwriting expenses.. osses and loss expenses $ 394,279 309,391 $ 584,235 $ 824,895 Underwriting loss - pre-tax Total losses and expenses... 418,679 157,621 219,178 Net investment income.. (24,400) (11.081) 880,324 152,483 (55,429) Realized investment gain.... Income taxes - credit (expense) Earnings from operations before income taxes (88,902) 440,067 Minority interest 351,165 136,575 Net earnings. $ 347,148 1,884 $ 280,680 $ 134,691 Statements of Net Investment Income (dollars in thousands) 1989 1988 1987 Interest: ubstantially exempt from Federal income taxes Other Vash. Pub. Power Supply Syster $ 52,623 26,268 $ 34,615 46,701 64,545 $ 68,310 32,293 Taxable 100,839 21,948 145,861 121,780 21.177 Dividends: Capital Cities/ABC, Inc. 590 Champion International 1,864 590 590 GEICO . Coca-Cola Company 12,330 31,322 11,234 4.393 9,316 Salomon Inc. Gillette 56,160 23,479 12,876 56,160 14,040 USAir.... Other Washington Post 8.084 3,179 10,974 2,695 2.212 5.057 250,723 .. ... $ 243.876 (6,847) 231.907 $ 231,250 (657) 152,995 Investment expenses.. $ 152,483 (512) Net investment income These statements do not conform to GAAP in all respects These statements are unaudited 47

[PAGE 50]

BERKSHIRE HATHAWAY INC. MANUFACTURING, PUBLISHING AND RETAILING BUSINESSES and not fully adjusted to conform to Generally Accepted Accounting Principles - are presented on the following page. Combined financial statements of Berkshire's Manufacturing, Publishing and Retailing businesses - unaudited The operations whose data have been combined in these presentations include Berkshire's six non-insurance "reportable business segments," as well as the following: Operation Adalet Activity/product/service Blue Chip Stamps. Conduit fittings, explosion proof fittings, junction boxes Borsheim's Retailing of fine jewelry Trading stamps Carefree.. Campbell Hausfeld Air compressors, airless paint sprayers France .. Appliance timing controls, ignition transformers Roll-up awnings, other RV accessories Haler KEW Products Zinc and aluminum die cast fittings Meriom... Pressure and flow measurement devices Automotive compounds Northland New America Electric Fractional horsepower motors Manufacturer of electrical equipment Precision.... Powerwinch Steel service center Boat winches, windlasses Scot Labs.. Quikut..... Varieties of cutlery Stahl..... Maintenance chemicals Wayne Home Equipment Furnace burners; sump, utility & sewage pumps Custom steel bodies for truck chassis Western Enterprises Western Plastics .... Molded plastic parts Gas transmission line fittings The six non-insurance "reportable business segments" are more fully described below. weekday. It is the only metropolitan newspaper published daily within a ten county upstate New York distribution area Newspaper — The Buffalo News, a division of Berkshire, publishes a Sunday edition and seven editions each that comprises one of the nation's 50 largest primary market areas. 1986. Fechheimers manufactures its products at plants in Kentucky, Ohio, Tennessee and Texas, for marketing through Uniform Manufacturing and Distribution — Berkshire acquired its 85% ownership interest of Fechheimers in mid- approximately three dozen company-owned retail distribution centers and by independent dealers who together serve more than 200 of the country's major metropolitan areas. systems and products, sold to approximately 600 factory distributors who in turn sell them to a network of area Home Cleaning Systems - This segment of Berkshire's business is principally represented by Kirby cleaning distributors and dealers. Independent dealers employ in-the-home demonstrations for direct resale to consumers. distributed through department stores, catalogue showrooms and hardware stores. Data with respect to Cleveland Wood Douglas Products Company manufacturers specialty vacuum cleaners such as hand-held electric and cordless units Products Company, a manufacturer of vacuum cleaner brushes, is also reported within this segment. very large - over 200,000 square feet - retail outlet and sizable warehouse facilities in Omaha, Nebraska. It serves a trade Retailing of Home Furnishings — The Nebraska Furniture Mart operates a home furnishing retail business from a area with a radius around Omaha of approximately 300 miles. Berkshire owns 80% of this business: key managers own large kitchens in California. See's distributes its candies through its own retail stores - over 200 in number - located in Candy - See's produces boxed chocolates and other confectionary products with an emphasis on quality in two shipments made nationwide from a seasonally-varying number of quantity order distribution centers. 12 western and midwestern states, including Hawaii. A meaningful volume of candy business is also recorded for direct earning, a preschool educational program, are among the products of this segment. Revised editions of the encyclope- Encyclopedias, Other Reference Materials — World Book encyclopedias as well as Childeraft and Early World of dia are composed and published annually. In the first quarter of each year an updating yearbook is published and to schools, libraries and individual households by a commissioned sales force of thousands located throughout the marketed by mail to owners of earlier editions. Otherwise, products are marketed primarily by the direct sales method United States, Canada, Australia and the British Isles. 48

[PAGE 51]

BERKSHIRE HATHAWAY INC. MANUFACTURING, PUBLISHING and RETAILING BUSINESSES (dollars in thousands) Balance Sheets Assets 1989 December 31, 1988 Cash and cash equivalents........ Accounts receivable 25,165 Inventories. 175,629 43,376 Properties and equipment 165,751 150,394 Other 141,935 133,762 18,363 130,363 Liabilities $ 526,843 $ 473,565 15,670 Income taxes... Accounts payable, accruals and other $ 214,152 Term debt and other borrowings 38,046 37,948 $ 179,301 47,738 Equity 290,146 264,743 37,704 Berkshire shareholders' Minority shareholders 211,531 25,166 18,999 $ 526.843 236,697 189,823 $ 473.565 208.822 Statements of Earnings (dollars in thousands) 1989 1988 1987 Revenues: Sales and service revenues terest income $ 1,526,458 8,405 $1,407,642 .. . . 1,537,442 2,579 2,472 6,724 $1,326,829 undry incom 6,789 1.416,838 722 Costs and expenses: 1.334,340 Soline, gendal add denisestle. 838,741 487,664 747,831 Interest on debt. 6,197 461,783 699,730 Income tax expense Earnings from operations before income taxes .... 1,332,602 4,955 445,970 204,840 1,214,569 6,730 125,863 78.977 202,269 1,152,430 76.216 181,910 Net earnings... Minority interest. $ 120,881 4,982 126,053 79,588 $121,700 4,353 102,322 98,839 3,483 repare in es comes but at cute entert rit on ereie urine apions are not These statements do not conform to GAAP in all respects These statements are unaudited 49

[PAGE 52]

BERKSHIRE HATHAWAY INC. FINANCE-TYPE BUSINESSES up Berkshire's finance-type operations. Mutual Savings and Loan Association and its subsidiary and Scott Fetzer Financial Group, Inc. and its subsidiaries make (dollars in thousands) Balance Sheets 1989 December 31, 1988 Assets Cash and cash equivalents Investments at cost: $ 40,035 $ 63,193 Fixed maturies: Equity securities: Redeemable preferred stocks 30,524 17,473 30,524 48,013 Nonredeemable preferred stocks FHLMC common stock.... 36,852 71,729 152,807 136,970 36,852 71,729 Collateralized loans receivable (1). Prepaid income taxes Installment and other receivables 173,214 153,755 Other 17,183 12,864 14.375 13,558 Liabilities $ 553,629 $ 568,021 Savings accounts Income taxes Accounts payable, accruals and other $ 293,073 18,432 $ 288,522 159,593 1,481 32,759 Term debt and other borrowings 150.202 1,807 Equity 472,579 473,290 Minority shareholders Berkshire shareholders' 71,329 9,721 9,882 $ 553.629 81,050 - 84,849 $ 568.021 94.731 Statements of Earnings (dollars in thousands) Revenues: 1989 1988 1987 Interest and dividends on investment securities ... Interest and fees on loans and financed receivables ..... $ 49,421 Sundry income. 19,230 $ 50,230 20,842 $ 47,858 68,914 263 71,710 638 22,708 72,340 1,774 Expenses: Interest on debt Interest on savings accounts 21,530 General and administrative 20,753 13,924 20,840 23,313 14.088 15,060 20,944 Income tax expense Earnings from operations before income taxes _56,207 58.241 29,493(2) 12,707 13,469 65,497 1,237 11,458 2,011 6,843 linority interes 11,470 6,298 545 et earning $ 10,036 _ 834 $ 10,483 _ 975 $ 5.941 357 (1) Includes mortgage-backed securities of $34,316, 1989 and $45.367, 1988. (2) Includes $3,618 write off of prepaid FSLJC insurance premiums. hese statements do not conform to GAAP in all respect hese statements are unaudite 50

[PAGE 53]

BERKSHIRE HATHAWAY INC. NON-OPERATING ACTIVITIES revenues and expenses that were not assigned to any Berkshire operating group in the unaudited, and not fully GAY. These statements reflect the consolidated financial statement values for assets liabilities, shareholders' equity, adjusted group financial statements heretofore presented (pages 45 to 50). Statements of Net Assets (dollars in thousands) Assets 1989 December 31, 1988 Investments: Cash and cash equivalents $ 96,018 $ 38,511 Fixed maturities: Bonds. Common stocks. Redeemable preferred stocks. 81,000 74,977 50,000 2,338 Property account adjustments (1) 11,468 Prepaid income taxes Unamortized goodwill (1) 140,544 79,524 28,312 117,970 83,348 Other 64,681 8,985 53,606 9,983 Liabilities $ 557.197 $ 384.068 Accounts payable, accruals and other ncome taxes $ 31,610 Term debt and other borrowings 809,877 (24,716) $ 28,067 292,103 7,591 Equity 816,771 327,761 Minority shareholders' Berkshire shareholders' (272,297) 12,723 43,749 12,558 $ 557,197 (259,574) $ 384,068 56,307 Statements of Earnings (dollars in thousands) Revenues: 1989 1988 1987 Sundry income. Interest and dividend income 7,256 16,513 9,257 _ 35,907 28,503(2) 7,404 $ 14,823 6,969 Expenses: 21,792 Corporate administration.... 5,867 3,382 4,966 3,754 Shareholder designated contributions 3,380 Property account adjustments (1) Amortization of goodwill (1)....... 3,371 5,987 6,937 2,719 4,938 5,546 2,862 Interest on debt ...... 37,350 946 30,658 Other costs and expenses 56,903 49,572 538 1,754 4,930 Income tax credit (expense) Excess of expenses before income taxes (40,390) 9,829 (13,665) 23.410 (30,561) (12,475) 1,190 (2,605) (1,618) 627 1,118 (4,223) Minority interest Net loss $ (31,188) $ (13,593) $ (4,919) 696 11) Pouts so ever im so 0 ai am to counting bust eruption plans., These statements do not conform to GAP in all respects These statements are unaudited 51

[PAGE 54]

BERKSHIRE HATHAWAY INC. SHAREHOLDER-DESIGNATED CONTRIBUTIONS On October 14, 1981, the Chairman sent to the shareholders a letter* explaining the program. Portions The Company has conducted this program of corporate giving during each of the past nine years. of that letter follow: that, 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 "Each Berkshire shareholder — on a basis proportional to the number of shares of Berkshire You'll name the charity; Berkshire will write the check. The ruling states that there will be no exercised by the owners in closely-held businesses, is almost exclusively exercised by the managers "Thus, our approximately 1500 owners now can exercise a perquisite that, although routinely in more widely-held businesses. no input at all from shareholders, in two main categories: "In a widely-held corporation the executives ordinarily arrange all charitable donations, with (1) Donations considered to benefit the corporation directly in an amount roughly (2) Donations considered to benefit the corporation indirectly through hard-to-measure, commensurate with the cost of the donation; and long-delayed feedback effects of various kinds. all charitable donations in the first category. However, the aggregate level of giving in such category "I and other Berkshire executives have arranged in the past, as we will arrange in the future, to produce roughly commensurate direct benefits to Berkshire. has been quite low, and very likely will remain quite low, because not many gifts can be shown not comfortable with ordinary corporate practice and had no better practice to substitute. What "In the second category, Berkshire's charitable gifts have been virtually nil, because I am bothers me about ordinary corporate practice is the way gifts tend to be made based more on of the donee's activities. Conventionality often overpowers rationality. who does the asking and how corporate peers are responding than on an objective evaluation of the corporate manager, who usually is heavily influenced by specific social pressures on him. "A common result is the use of the stockholder's money to implement the charitable inclinations Frequently there is an added incongruity; many corporate managers deplore governmental allocation dollar. of the taxpayer's dollar but embrace enthusiastically their own allocation of the shareholder's your personal judgments by writing checks on my bank account for charities of your choice, "For Berkshire, a different model seems appropriate. Just as I wouldn't want you to implement I feel it inappropriate to write checks on your corporate "bank account" for charities of my choice. foster charitable interests in a tax-deductible manner reside largely at the corporate level rather Your charitable preferences are as good as mine and, for both you and me, funds available to than in our own hands. "Under such circumstances, I believe Berkshire should imitate more closely-held companies, not larger public companies. If you and I each own 50% of a corporation, our charitable decision have first claim on our available charitable funds. Any balance available after the "operations- making would be simple. Charities very directly related to the operations of the business would related" contributions would be divided among various charitable interests of the two of us, some suggestions, we would listen carefully - but the final decision would be ours. Despite on a basis roughly proportional to our ownership interest. If the manager of our company had partnership. our corporate form, in this aspect of the business we probably would behave as if we were a *Copyright © 1981 By Warren E. Buffett All Rights Reserved 52

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we operate through a large, fairly widely-held corporation. Our Treasury ruling will allow such "Wherever feasible, I believe in maintaining such a partnership frame of mind, even though partnership-like behavior in this area ... "I am pleased that Berkshire donations can become owner-directed. understandable, that a large and growing number of major corporations have charitable policies It is ironic, but this one - many even match gifts made by directors) but none, to my knowledge, has a plan pursuant to which they will match gifts made by their employees (and - brace yourself for matching charitable gifts by owners. I say 'understandable' because much of the stock of many investment horizons, and that lack a long-term owner's perspective... large corporations is owned on a revolving door' basis by institutions that have short-term at the end of each year more than 98% of our shares are owned by people who were shareholders "Our own shareholders are a different breed. As 1 mentioned in the 1979 annual report, at the beginning of the year. This long-term commitment to the business reflects an owner mentality which, as your manager, l intend to acknowledge in all feasible ways. The designated contributions * * The history of contributions made pursuant to this program since its inception follows: Specified Amount Eligible* Shares Percent of Year per Share Participating Contributed Amount Charities No. of 1982 1981 $2 95.8% 95.6% $1,783,655 1983 $3 $1 96.4% $3,066,501 $ 890,948 675 1,353 704 1985 1984 $4 $3 96.8% 97.2% $3,179,049 97.1% $3,996,820 $4,006,260 1,724 1,519 1986 16:87 1988 $5 $4 97.2% $5 97.4% $4,965,665 $4,937,574 2,050 1,934 1989 $6 96.9% $5,867,254 2,319 2,550

• Shares registered in street name are not eligible to participate.

In addition to the shareholder-designated contributions summarized above, Berkshire and its sub- sidiaries have made certain contributions pursuant to local level decisions of operating managers of the businesses.

• *

* produce substandard or no tax deductions. In other years Berkshire expects to intorm shareholders of The program may not be conducted in the occasional year, if any, when the contributions would the amount per share that may be designated, and a reply form will accompany the notice allowing be mailed on or about September 15 to shareholders of record reflected in our Registrar's records as shareholders to respond with their designations. If the program is conducted in 1990, the notice will of the close of business August 31, 1990, and shareholders will be given until November 15 to respond. the corresponding of-record date used in past years. The required response date is also fifteen days earlier. Shareholders should note that the end-of-August record date is one month earlier in the year than in the program. To qualify, shares must be registered on August 31 in the owner's individual name(s) Shareholders should also note the fact that shares held in street name are not eligible to participate or the name of an owning trust, corporation, partnership or estate, as applicable. 53

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stockholders from the Chairman of the Company. The 1989 Annual Report of Wesco Financial Corporation included the following letter to Wesco WESCO FINANCIAL CORPORATION LETTER TO SHAREHOLDERS To Our Shareholders: Consolidated "normal" operating income (i.e., before all unusual operating income and all net gains from sales of securities) for the calendar year 1989 increased to $24,414,000 ($3.43 per share) from $23,564,000 ($3.31 per share) in the previous year. securities) increased to $30,334,000 ($4.26 per share) from $30,089,000 ($4.22 per share) in the Consolidated net income (i.e., after unusual operating items and all net gains from sales of previous year. Company, headquartered in Omaha and currently engaged principally in the reinsurance business, Wesco has three major subsidiaries, Mutual Savings, in Pasadena, Wesco-Financial Insurance metal products businesses. Consolidated net income for the two years just ended breaks down as and Precision Steel, headquartered in Chicago and engaged in the steel warehousing and specialty follows (in 000s except for per-share amounts) (1): December 31, 1989 December 31, 1988 Per "Normal" net operating income of: Amount Wesco Per Share Amount Share Wesco Mutual Savings ... $ 4,191 $ .59 $ 4,694 $ .66 Wesco-Financial Insurance business 14,276 2.00 12,094 1.70 Precision Steel's businesses (...•• 2,769 .39 3,167 44 All other "normal" net operating income (2) 24,414 3,178 45 3.43 3,609 .51 23,564 3.31 Gain on sale of interest in Bowery Savings Bank. 4,836 .68 Wesco consolidated net income Net gains on sales of marketable securities.................. 5,920 $30,334 .83 $4.26 $30,089 1,689 .23 $4.22 (1) All figures are net of income taxes. (2) After deduction of interest and other This supplementary breakdown of earnings differs somewhat from that used in audited financial statements which follow standard accounting convention. The supplementary breakdown is fur- nished because it is considered useful to shareholders. 54

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Reproduced from 1989 Annual Report of Wesco Financial Corporation Mutual Savings of 11% from the $4,694,000 figure the previous year. Mutual Savings' "normal" net operating income of $4,191,000 in 1989 represented a decrease cost of holding savings increased more than yield on loans and investments. The decrease in 1989 was primarily attributable to a less favorable interest rate "spread" as association. As usual, these "normal-income" figures come from a decidedly abnormal savings and loan this annual report. They show (1) total savings accounts rising to $293 million from $289 million the Separate balance Sheets of Mutual Savings at yearend 1988 and 1989 are set forth at the end of year before, (2) a very high ratio of shareholders' equity to savings account liabilities (near the account liabilities offset by cash equivalents and marketable securities, and (4) a loan portfolio highest for any mature U.S. savings and loan association), (3) a substantial portion of savings (mostly real estate mortgages) of about $154 million at the end of 1989, up slightly from $137 million at the end of 1988. bore an average interest rate of only 9.23%, probably near the lowest among U.S. savings and loan The loan portfolio at the end of 1989, although containing almost no risk of loss from defaults, entirely made up of instruments of short maturity or bearing interest rates that adjust automatically associations, but up moderately from 8.70% at the end of 1988. Because the loan portfolio is almost with the market, there is now much less unrealized depreciation in the loan portfolio than the net unrealized appreciation in Mutual Savings' interest-bearing stocks. That appreciation at December 31, 1989 was about $11.3 million. securities and public utility preferred received on loans remains too low to provide respectable profits, this "spread" improved again last While the "spread" between Mutual Savings' average interest rates paid on savings and by the effect of various forms of tax-advantaged investment, primarily preferred stock and municipal year. Moreover, the disadvantage from inadequate "spread" has been reduced in each recent year loans is the risk that preferred stock and municipal bonds, with their fixed yield and long life, will bonds. The negative side of this tax-advantaged antidote to inadequate interest rate margin on decline in value and not provide enough income to cover Mutual Savings' interest and other costs, if the general level of interest rates should sharply rise. In view of this risk, Mutual Savings' total commitment has been kept conservative, relative to the amount of its net worth. Mutual Savings remains a "qualified thrift lender" under the old federal regulatory definition to continue keeping substantially all loans receivable either with short expected lives or with interest (which ends june 30, 1991) requiring 60% of assets in various housing related categories. it planes rates that fluctuate with the market. All new variable-rate loans are "capped" at the 25% per annum level, which is over ten percentage points higher than the common 2½-points-over-market "cap" offered by competing associations. Naturally, to gain this extra protection from interest rate increase, Mutual Savings "pays" by (1) getting lower "spreads" over an interest rate index, and (2) not being able to make loans in amounts desired. As pointed out in Note 10 to the accompanying financial statements, the book value of Wesco's after taxes, from sale or liquidation at book value. If all Mutual Savings' assets, net of liabilities, were equity in Mutual Savings ($48.9 million at December 31, 1989) overstates the amount realizable, less than $48.9 million after substantial income taxation imposed because about $47 million of what to be sold for the $48.9 million reported as book value, the parent corporation would receive much Is designated shareholders' equity for accounting purposes is considered bad debt reserves for most tax purposes. 55

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Reproduced from 1989 Annual Report of Wesco Financial Corporation buried value in real estate. The foreclosed property on hand (mostly 22 acres at or near the Mutual Savings has not only a buried value in unrealized appreciation of securities but also a oceanfront in Santa Barbara, acquired in 1966) has become worth over a long holding period sensitive development of this property has been delayed over 14 years in the course of administra- considerably more than its $8.4 million balance sheet carrying cost. Reasonable, community- various stages of completion on the property as part of an authorized development into 32 houses tion of land-use laws. But, miraculous to report, eight houses, plus recreation facilities, are in 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. The buried value in real estate is limited by the small number of houses allowed (32) and by the fact that only about half of such houses will have a significant ocean view. Additional limitation will come from high cost of private streets, sewage and utility improvements and connections, landscap- ing, and non-standardized, environmentally sensitive adaptation of housing to the site. Also, various will drastically reduce our potential recovery from what it would have been had the zoning and charges and burdens, including heavy archaeological obligations imposed by governmental bodies, development climate of the early 1970s continued into the present era. We have "given" a very large fraction of the value of our land to the County of Santa Barbara in exchange for permission to use it at all. The savings and loan association described in the foregoing paragraphs, quite different from Savings increased its position in stock of Federal Home Loan Mortgage Corporation (widely known most other associations for a long time, added a significant new abnormality during 1988. Mutual as "Freddie Mac") to 2,400,000 shares. This is 4% of the total shares outstanding, the legal limit for share, compared to a price of $67.12 per share in trading on the New York Stock Exchange at the any one holder at the time the shares were purchased. Mutual Savings' average cost is $29.89 per end of 1989. Thus, based on 1989 yearend trading prices, Mutual Savings had an unrealized pre-tax is about $52.6 million, or $7.39 per Wesco share outstanding. profit in Freddie Mac shares of about $89.4 million. At current tax rates the potential after-tax profit Freddie Mac, formerly created and long run by a federal agency (the Federal Home Loan Bank independent board of directors. Freddie Mac supports housing primarily by purchasing housing Board), is now owned privately, largely by institutional investors and is now governed by an mortgage loans for immediate transmutation into mortgage-backed securities that it guarantees and rate-change risk. This is a much better business than that carried on by most (or indeed most of the promptly sells. In the process Freddie Mac earns fees and "spreads" while avoiding most interest- top 10% of) savings and loan associations, as demonstrated by Freddie Mac's high percentage returns earned on equity capital in recent years. One ironic cause of the high returns is that this function of the savings and loan industry. creation of federal regulators pays no deposit-insurance premiums as it replaces much of the former At Freddie Mac's current dividend rate ($1.60 per annum per share), Mutual Savings' pre-tax yield is only 5.35% on its $29.89 average cost per share. Post-tax, the dividend yield is only 4.4%, but this amounts to about 75% of the current after-tax yield from very high grade mortgages. Moreover, Freddie Mac has a very creditable history of avoiding significant loan losses and increasing its earnings and dividend rate, thus contributing to increases in the market price of its stock. Following are figures for 1985-1989: 56

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Reproduced from 1989 Annual Report of Wesco Financial Corporation Mariot Free reddie Mac Year Ended 12/31: etum Earne _por Share Average Equity 1985 $2.98 $.53 $ 9.19 1986 3.72 30.0% 1.13 15.17 1987 4.53 28.5 1.10 12.12 1988 5.73 282 1.25 50.50 27.5 1989 6.57 1.60 67.12 25.0 revisions to the savings and loan laws. But it was clear that associations were shortly to be "re- When Wesco's annual report went to press last year. Congress was midcourse in considering regulated" into some mode less likely to cause a fresh torrent of deposit-insurance losses, borne by taxpayers. Provoking that legislative action was a previous torrent of losses which now seems likely to exceed $150 billion. These losses were caused by a combination of (1) competitive pressure on the "spread" between interest paid and interest received put on associations and banks when attract deposits, (2) loose asset deployment rules for associations, (3) admission and retention of federal deposit insurance is provided to entities free to pay any interest rates they wish in order to crooks and fools as managers of associations without regulatory objection, (4) general real estate unsoundness by the savings and loan lobby and certain members of Congress beholden to the most calamities in certain big regions, and (5) continuous irresponsible protection and enhancement of despicable savings and loan operators. The new laws, under the acronym FIRREA, were composed and enacted with a speed caused comparisons, is provided by the words of Congressman Jim Leach: "[If certain allegations are true] by congressional indignation. (A recent example of such indignation, employing remarkable commerce, given a license to steal by a bank board headed by the Neville Chamberlain of regulation Charles Keating is a financiopath of obscene proportions - the Reverend Jim Bakker of American

• a cheerleader who saw little evil and thus spoke little truth.")

Mutual Savings modestly contributed to tough legislative action by resigning from the U.S. despite its understated criticism. A copy of this letter of resignation is appended at the end of this League of Savings Institutions, using a letter of resignation which drew widespread media attention letter to shareholders. FIRREA, even though many of them will hurt Mutual Savings' profits. Mutual Savings, desiring to act responsibly, supported virtually all the law revisions made by For example: (1) In stages, by July 1, 1994, Mutual Savings (and its service corporation subsidiary) must dispose of: (a) High-quality public utility preferred stocks, having tax-advantaged dividend rates 1989, and a market value then higher by about $8.7 million; and averaging about 10.8% per annum, with a carrying value of $41.4 million at yearend (b) High-quality convertible preferred stock of Salomon Inc, bearing a tax-advantaged below the amount which could be realized in the event of sale. dividend rate of 9% per annum, with a carrying value of $26 million, belleved to be (2) In stages, by the same date, July 1, 1994, Mutual Savings must write down to zero, in computing net worth for regulatory purposes, its 2,400.000 shares of Freddie Mac, which 57

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Reproduced from 1989 Annual Report of Wesco Financial Corporation had a carrying value of $71.7 million at yearend 1989, and, as reported above, a market value then higher by about $89.4 million. (3) All new asset commitments, fitting Mutual Savings' proclivities and tax position, are pretty well restricted to (a) housing loans (including indirect loans in the form of mortgage- backed securities) and (b) debt instruments of the U.S. Government or its agencies. (4) In stages, designed to create compliance during a two-year period commencing July 1, 1991, Mutual Savings will have to increase "qualified thrift lender" assets by 10 percentage thrift lender" assets which, to our surprise, does not include Freddie Mac stock. If the new points to a 70%-of-assets level, using a new and more limited definition of such "qualified test had been in full effect at December 31, 1989, Mutual Savings would have complied by disposing of about $74 million of non-home-loan assets (including some cash equivalents) and placing the proceeds in home loans (including indirect home loans in the form of short- term mortgage-backed securities). (5) Deposit-insurance premiums have been increased. Short term, Mutual Savings is protected by credits of a nonrecurring nature. But by the mid 1990s the new premium rates will reduce Mutual Savings' annual earning power by about $200,000 from the level which would have occurred if it were still paying at the 0.083%-of-deposits rate which was in insurance costs on percentage return on shareholders' equity is much lower at Mutual effect for years, instead of the new rate of 0.23%. The adverse effect of the higher deposit Savings than at almost all other associations, which suffer substantially. The cause of This is a "one-time" advantage related to one ratio; on an incremental dollar of savings Mutual Savings' advantage is its much larger percentage of equity, compared to deposits. Mutual Savings faces the same damage as everyone else. These combined effects will reduce Mutual Savings' normal earning power. While conservatively operated, Mutual Savings has been scrambling through recent years in its own way, obtaining a under pre-FIRREA law. Consequently, FIRREA will adversely affect Mutual Savings, however wise modest success made possible largely by the wide variety of asset-deployment options available the new restrictions, public needs considered. Nevertheless, it is probable that Mutual Savings' normal earning power will not be much reduced in 1990 and 1991. We predict this deferment of decline in normal earnings because: (1) FIRREA's asset-mix effects are phased in, subject to wide regulatory discretion; and (2) We anticipate that regulators will be wise enough to exercise their discretion to allow extra- to weak associations with hard-to-sell assets. strong associations, with easy-to-sell assets, the same forbearance which will be granted If we prove wrong in our prediction about regulators, Mutual Savings' wisest alternative will probably insurance premiums. be withdrawal from the savings and loan business and the related obligation to pay deposit- If, as seems likely, Mutual Savings stays in the savings and loan business, it will retain a business even more mediocre than before, with only two interesting near-term prospects: (1) During the next few years, Mutual Savings is almost certain to make a pre-tax profit of a foreclosure in 1966; and nonrecurring nature as it disposes of the Santa Barbara property it acquired through (2) Mutual Savings will retain prospects for gain from its Freddie Mac stock if, as anticipated, Freddie Mac pays ever-higher dividends and the price of the stock also rises. 58

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Reproduced from 1989 Annual Report of Wesco Financial Corporation Long term, Mutual Savings hopes to find within the savings and loan business some constructive, continuing role which is not dependent on either of the foregoing anticipated near-term prospects. Until the right long-term role is found, our policy is simply to "stagger through." taxpayers' point of view, took an approach which can fairly be described as "all stick and no carrot." The FIRREA law revision, while greatly improving the savings and loan system from the This is no way to create felicity for the donkey, but we deserve our share of the beating because we were previously so passive in the presence of obvious error and evil. Moreover, the safety- under pressure: banks and associations remain free, within wide limits, to attract government- enhancing features of the law revision fell short in one fundamental respect which leaves profits insured deposits at any interest rate they wish, while they must resell the ultimate fungible rate "spread" safely attainable, combined with normal competitive disadvantages of associations, commodity, the use of money, into a brutally competitive market. The resulting squeeze on interest- leaves the average well-run association with a likely future which should not excite its owners. bank, now include the following: higher deposit-insurance costs, more confusing new regulation, The normal competitive disadvantages of the average association, compared with the average and less experience and momentum in various important remunerative activities. As a result, even a stock market at a much lower price-to-book-value ratio than a superbly run bank. And the average superbly run conventional association, like the one owned by H. F. Ahmanson & Co., sells in the savings and loan branch office probably now offers more incremental value to an experienced bank than it provides to its present owner. "deposits" are the money-market funds which: Moreover, the average association does not now compete only with banks. Also gathering (1) pay no deposit-insurance premiums, saving 0.23% of deposits each year, compared to associations; (2) are required to employ exactly no capital from profit-earning proprietors ("management raised; companies" in fund parlance), while capital requirements for associations have been (3) have lower-cost regulation (from an understaffed SEC) than associations; (4) maintain no expensive branch offices, although they provide check-writing privileges and ways to the new order than the systems of the average association; and, accept frequent deposits, using fast, low-cost systems which are better adapted in many (5) as a result of all the foregoing advantages, have total annual costs (before proprietors' profits), as a percentage of assets, which are more than 50% lower than annual costs of the most efficient association. Thus, the natural "almost-no-brainer," non-home-mortgage, deposit-gathering niche is now some large, extremely efficient loan originators like Home Savings, but, as we seem to say each introduced into Australia. The adjustable-home-mortgage niche may now provide a decent home for year, we have not yet found for Mutual Savings a permanent lending niche which is attractive, as son's observation that: "'Life is a state in which much is to be endured and little to be enjoyed." distinguished from bearable. In the mortgage business we thus constantly confirm Samuel John- Structural risk for the federal government as deposit insurer. Associations retain a considerable Left in place in the revised savings and loan system is a significant (although much reduced) residue of temptation to act imprudently. The temptation, in response to the profit-pressure which is a natural consequence of the structure of the system, is the same one which caused troubles in the 59

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Reproduced from 1989 Annual Report of Wesco Financial Corporation bearing undue risk from either (1) mismatched maturities of loans and deposits or (2) losses past: the temptation to seek an acceptable interest rate "spread," not available any other way, by through defaults of a gamier class of borrowers willing to promise extra-high interest rates. It is almost impossible to have asset deployment controls so tough that a bank or association can't look good for a while (and give the appearance of justifying higher compensation of management) as it takes risks which will in due course destroy its owners' equity and also cause deposit insurance losses. The "all stick" method of control is much better than nothing, but it is far from ideal when it is ago, the federal deposit insurer had low losses, the savings and loan system used both carrots and the exclusive method for prevention of losses borne by the deposit insurer. In contrast, when, lona stick, so that the average savings and loan operator could do well without exceptional luck or ability. (The carrots were very low income taxation plus interest-rate controls which reduced cost of holding deposits while giving an advantage over banks in attracting deposits.) We think the present, revised system continues to impose more risk than taxpayers should bear, with high deposit- insurance costs contributing to the risk as well as compensating for it. Housing is now less assisted than before by the existence of savings and loan associations. An example of the drift away from housing assistance is provided by FIRREA's new restriction more than 15% of owners' equity to one customer, with exceptions permitted up to 30% for preventing large loans to any one house builder. The new requirement is that an association loan no reduced the profits and housing contributions of Mutual Savings in its early days when it concen- adequately capitalized associations with good records. The new requirement would have greatly trated resources in development loans while trusting only a few house-builders. And the new requirement now has the same general effect. It will significantly restrict availability of house- complex system without undesired "by-product" effects. The first law of ecology and the first law of building loans in many regions of the country. This result demonstrates the impossibility of revising a legislation are one and the same: "You can never do merely one thing." a market. New "risk-based" capital requirements under FIRREA have such an effect, as they give Of course, a "by-product" of law revision sometimes helps, instead of hurts, some participant in associations new incentives to transfer monies they otherwise would have earned to Freddie Mac, through exchange of mortgages for credit-enhanced, mortgage-backed securities. (Although the securities then provide less income, they help satisfy regulatory capital requirements, because the securities require less owners' equity to hold.) This income-transfer effect should help Mutual Savings, through its large shareholding position in Freddie Mac. Precision Steel Franklin Park, Illinois, contributed $2,769,000 to normal net operating income in 1989, down 13% The businesses of Wesco's Precision Steel subsidiary, located in the outskirts of Chicago at compared with $3,167,000 in 1988. The decrease in 1989 profit occurred as pounds of product sold declined by 12%. Revenues were down less, by 5% to $59,440,000. under the skilled leadership of David Hillstrom, Precision Steel's businesses in 1989 continued to provide an extraordinary return on resources employed. one strong enough to cause the results achieved in the absence of superb management. Precision As we never tire of saying, the good financial results have an underlying reason, although not Steel's businesses, despite their mundane nomenclature, are stens advanced on the quality scale from mere commodity-type businesses. Many customers of Precision Steel. needina dependable prices, technical excellence in cutting to order, and remembrance when supplies are short, rightly supply on short notice of specialized grades of high-quality, cold-rolled strip steel, reasonable believe that they have no fully comparable alternative in Precision Steel's market area. Indeed. many 60

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Reproduced from 1989 Annual Report of Wesco Financial Corporation service. customers at locations remote from Chicago (for instance, Los Angeles) seek out Precision Steel's after year, under David Hillstrom's leadership is boring, repetitive excellence as he remembers a It is not common that steel warehouses have results like Precision Steel's. What we see, year long time. basic catechism emphasizing service of the highest quality. We hope to be associated with him for a Wesco-Financial Insurance Company and ultimate parent corporation, Berkshire Hathaway Inc. A new business was added to the Wesco group in 1985, in co-venture with Wesco's 80% owner ers in the Peters and Caspers families, without whose approval such action would not have been With the enthusiastic approval of all Wesco's directors, including substantial Wesco sharehold- insurance company, Wesco-Financial Insurance Company ("Wes-FIC"'). Another $58 million was taken, Wesco in 1985 invested $45 million in cash equivalents in a newly organized, wholly owned invested in 1986, 1987 and 1989. company subsidiary as intermediary-without-profit, 2% of the entire book of insurance business of The new subsidiary, Wes-FIC, reinsured, through another Berkshire Hathaway insurance the long-established Fireman's Fund Group. Wes-FIC thereby assumed the benefits and burdens of by Fireman's Fund during a four-year period ending August 31, 1989. The arrangement put Wes-FIC Fireman's Fund's prices, costs and losses under a contract covering all insurance premiums earned written 2% of the business. Differences in results occurred only from the investment side of in almost exactly the position it would have been in if it, instead of Fireman's Fund, had directly FIC's share of premiums earned in 1989, before contract termination, exceeded $37 million. insurance, as Wes-FIC, instead of Fireman's Fund, invested funds from "float" generated. Wes- premiums, net of related ceding commissions, and retained assets of about $91 million offset by Upon contract termination, Wes-FIC returned to Fireman's Fund $15.6 million in unearned Wesco's four-year participation in the Fireman's Fund reinsurance contract as having excellent claims reserves which will be exhausted slowly over many future years. We regard the totality of prospects, all future claim payments considered. Wesco's ultimate parent corporation (and 80% time. owner) almost certainly did Wesco a favor in allowing Wesco's participation, as was planned at the Fund contract. The date, August 31, 1989, happened to be just before occurrence of both Hurricane There was some good luck in the selection, years ago, of a termination date for the Fireman's Hugo and the San Francisco earthquake. There was some heavenly justice in this outcome, because Wes-FIC caught a share of hurricane losses within hours after the inception of the contract in 1985. licensed in Nebraska, Utah and lowa, but it wrote only $183,000 in direct premiums, almost all Wes-FIC in 1988 began to write direct business, as distinguished from reinsurance. It is now were $438,000. surplus lines coverage (permitted for non-admitted insurers) in Alabama. Earned direct premiums net "normal" income figures excluded securities gains, net of income taxes, of $5,910,000 in 1989, Wes-FIC's "normal" net income for 1989 was $14,276,000, versus $12,094,000 for 1988. The Bowery Savings Bank) in 1988. These items are reported as "Net Gains on Sales of Securities," compared with $6,071,000 (including $4,836,000 realized on sale of Wes-FIC's 9% equity interest in because of an unusual adjustment to its income tax provision caused by the Tax Reform Act of below. Wes-FIC's net income benefitted by about $215,000 in 1989, versus $260,000 in 1988, 61

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Reproduced from 1989 Annual Report of Wesco Financial Corporation It is in the nature of even the finest casualtv insurance businesses that in keepina their accounte uncertainties inherent in this undertakino make financial statements more mere *hect honest they must estimate and deduct all future costs and losses from premiums already earned reinsurance portion of the casualty insurance business, because it contains one or more extra links guesses" than is typically the case with accounts of non-insurance-writing corporations. And the in the loss-reporting chain, usually creates more accounting uncertainty than the non-reinsurance portion. Wesco shareholders should remain aware of the inherent imperfections of Wes-FIC's accounting, based as it is on forecasts of outcomes in many future years. Wes-FIC retains a "longage" of capital and a shortage of good insurance business. We see few present opportunities for sound expansion, but we expect more insurance writing in due course, made possible by fear that other insurers will become unable or unwilling to pay fair claims. Effective January 1, 1990, Wes-FIC has begun to reinsure 50% of the book of insurance business (largely workers' compensation insurance) of Cypress Insurance Company, a wholly owned subsidiary of Berkshire Hathaway. Wes-FIC's share of premiums written is expected to is not nearly as promising, per dollar of insurance written, as was the Fireman's Fund contract. approximate $8 million in 1990. We regard this reinsurance contract as worth having at Wesco, but it All Other "Normal" Net Operating Income All other "normal" net operating income, net of interest paid and general corporate expenses, decreased to $3,178,000 in 1989 from $3,609,000 in 1988. Sources were (1) rents ($2,518,000 nantly leased to outsiders although Mutual Savings is the ground floor tenant), (2) interest and gross, excluding rent from Mutual Savings) from Wesco's Pasadena office building block (predomi- dividends from cash equivalents and marketable securities held outside the savings and loan and insurance subsidiaries, and (3) earnings of New America Electrical Corporation. The decrease in this "all other" component of earnings in 1989 resulted primarily from transfer of assets, with their related incomes, to Wesco's insurance subsidiary to augment its capital position. Net Gains On Sales Of Securities Wesco's aggregate net gains on sales of securities, combined, after income taxes, decreased to $5,920,000 in 1989 from $6,525,000 in 1988. As noted above, $5,910,000 of these gains were realized in the Wes-FIC insurance subsidiary in 1989, versus $6,071,000 realized in 1988. Convertible Preferred Stock of Salomon Inc newly issued shares of Series A Cumulative Convertible Preferred Stock, without par value, of On October 1, 1987 Wesco and certain of its wholly owned subsidiaries purchased 100,000 its subsidiary, Salomon Brothers, a leading securities firm. Our investment was part of a $700 million Salomon Inc ("Salomon"'), at a cost of $100 million. Salomon's primary business is transacted by transaction in which other subsidiaries of Berkshire Hathawav Inc.. Wesco's parent, invested $600 dividends at the annual rate of 9%; (2) each preferred share, purchased at a cost of $1,000, will be million. Principal terms of the transaction included the following: (1) the preferred stock pays convertible into 26.31579 shares of Salomon common stock on or after October 31, 1990, or earier if certain extraordinary events occur; and (3) the preferred stock is subject to mandatory redemption provisions requirina the retirement, at $1,000 ner share plus accrued dividends. of 20% outstanding. of the issue on each October 31, beginning in 1995, so long as any shares of preferred stock remain requirements) will be realizable whenever, after October 31. 1990, the common stock of Salomon At the stated conversion price of the preferred stock, a profit (subiect to certain procedural (listed on the New York Stock Exchange) trades at over $38 per share. At the time of our 62

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Reproduced from 1989 Annual Report of Wesco Financial Corporation However, shortly after Wesco acquired its new stock certificates, the October 19, 1987 "Black commitment to buy the new preferred, the common stock of Salomon was selling in the low 30s. Monday" stock market crash occurred, which caused temporary but substantial operating losses rough share of the general debacle, its common stock at one time after the crash traded as low as plus a lowered credit rating at Salomon. Although Salomon, among securities firms, suffered only its end of 1988, after much constructive adjustment of Salomon's business to new conditions. At the end of 1989 Salomon common stock was trading at $23%, compared with $24 at the Salomon's credit as a potential source of preferred dividends and stock redemptions improved during its 1988 recovery, when generally available dividend rates on preferred stock were roughly stable. And during 1989 Salomon was a star performer, compared to most other securities firms. enhanced in value during the last two years, we believe that the fair market value of Wesco's With Wesco's preferred stock now shorter in contractual duration, and its conversion privilege investment was somewhat in excess of its cost, and that the aggregate amount of any such excess was not material to Wesco, at December 31, 1989. Salomon on October 28, 1987, and are very pleased with the association. Berkshire Hathaway's Chairman, Warren Buffett, and the undersigned joined the board of Other Convertible Preferred Stocks In transactions similar to that which created our Salomon investment, Wesco and its subsidiar- ies during 1989 invested a total of $75 million in several new issues of convertible preferred stock. The common stock of all issuers is listed on the New York Stock Exchange. These transactions are briefly summarized below: (1) The Gillette Company On July 20, 1989, Wesco's Wes-FIC subsidiary invested $40 million in newly issued shares of convertible preferred stock of The Gillette Company ("Gillette"). The stock provides an 84% common stock at $50 per share. Warren Buffett, Chairman of Wesco's parent company, has annual dividend, must be redeemed by Gillette in 10 years, and is convertible into Gillette joined Gillette's board of directors. Gillette has just introduced a new product, the Sensor razor, which will sell well because it provides significant improvements to the wet-shaving process. (2) USAir Group, Inc. stock of USAir Group, Inc. ("USAir"). The stock provides an annual 94% dividend, must be On August 7, 1989, Wes-FIC invested $12 million in the newly issued convertible preferred redeemed by USAir in 10 years, and is convertible into USAir common stock at 560 per share. (3) Champion International Corporation of convertible preferred stock of Champion International Corporation (Champion"). The On December 6, 1989, Wesco and certain of its subsidiaries invested $23 million in a new issue stock provides an annual 9/4% dividend, must be redeemed by Champion in 10 years, and is convertible into Champion common stock at $38 per share. aggregate as sound but not exciting. Few, if any, investors have ever prospered mightily from While we admire the corporations and managements involved, we regard these investments in the investing in convertible preferred stocks of leading corporations. Considering alternatives available When the investments were made, we were pleased to buy the stocks, but Wesco shareholders should expect no bonanza. 63

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Reproduced from 1989 Annual Report of Wesco Financial Corporation New America Electrical Corporation ("'New America Electric"') for a price of $8,200,000. Of this price $7,165,000 was cash paid to a At the close of 1988, Wesco acquired 80% of the stock of New America Electrical Corporation liquidating trust for the former shareholders of New America Fund and $1,035,000 was a ten-year, America Electric not acquired by Wesco. The pattern of this acquisition is a common one within the 10% note payable to Glen Mitchel, CEO of New America Electric, who retains the 20% of New Berkshire Hathaway group, where we are willing to be an 80% owner in many a business we would not be in if we did continue to operate the business, with little help and no hindrance from us. not admire and trust people who retain the other 20% and are expected to Glen Mitchel is a long-time friend and trusted and admired business associate of the under- signed, Wesco's CEO. Indeed, because Wesco's CEO and his family owned a higher percentage of New America Electric than Wesco, our whole transaction was approved by the Wesco board with the recommendation and participation of Warren Buffett, CEO and major shareholder of Berkshire Hathaway, Wesco's parent company. Mr. Buffett had no financial interest in New America Electric, of New America Electric at yearend 1988. and he, plus Messrs. Munger and Mitchel, all believed that $10,250,000 was a fair valuation for 100% This acquisition became available to Wesco because Glen Mitchel preferred minority (20%) America Electric, with all other New America Electric stock pretty well scattered through a new ownership of a Berkshire Hathaway group subsidiary instead of dominant 30% ownership in New public offering, which was the alternative offered. We like causing such confidence and try always to deserve it. New America Electric is a manufacturer of various electrical products including switchgear, and recreational vehicle parks. Its facilities are in Orange County, California. circuit breakers, lighting ballasts and starters and electrical equipment for marinas and mobile home When Wesco purchased its 80% interest, New America Electric had a book net worth of about $6,400,000, including approximately $2,500,000 in cash and equivalents, and a long history of earning high returns on capital, but with current earnings reduced by an industry-wide price war. Unfortunately, financial results in New America Electric's first year after acquisition are an embarrassment to us. In 1989, New America Electric earned only $168,000, after taxes (before adjustments under consolidated accounting convention incident to our purchase of stock), which is (1) only 2.6% on historical book value of shareholders' equity, and (2) only 1.6% on the price Wesco paid. After consolidated accounting adjustments, the total contribution of New America breakdown in the "all other normal net operating income" category). Electric to Wesco's 1989 earnings was even lower: only $59,000 (included in our earnings The year-to-year earnings decline at New America Electric was a stunning 77%. Part of the earnings decline was caused by high expense incurred in consolidating previously scattered operations in a large, newly leased building. Other factors were (1) escalation of the price war (3) at least one decision which, with hindsight, looks like an error. accompanied by a 2.5% year-to-year decline in sales, (2) a ridiculous, unfair result in a lawsuit, and New America Electric's 1989 troubles were limited to the income statement. Its balance sheet remained strong. For instance, at yearend 1989, despite major improvements of facilities and of the year: $2.5 million. purchase of new equipment, the same amount of cash and equivalents was on hand as at the start problems with his usual skill and diligence. We are impressed with the new building and new We appraise the 1989 earnings decline as temporary. We think Glen Mitchel is tackling the equipment, which will both reduce costs and improve quality of products and service. And we 64

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Reproduced from 1989 Annual Report of Wesco Financial Corporation Vogele. admire not only Glen Mitchel but also his chief officers: Thomas Johnson, Jeff Mowry and Thomas irrational panic is an entitlement for people who choose to make these 80%-20% deals with us. But We will be very supportive as operations are fixed. Our sharing of disappointing times without we will not obscure, in reports to our shareholders, poor financial results, temporary or not, from any recent business acquisition. And we will be particularly anxious to highlight bad results, no in the business acquired. If Wesco's shareholders don't hear much about New America Electric in matter how "immaterial" (in accountingspeak), in a case where Wesco's Chairman had an interest the future, it will be success, not failure, which causes de-emphasis. Consolidated Balance Sheet and Related Discussion consolidated net worth supports large outstanding promises to others and (2) reflects a continuing Wesco's consolidated balance sheet (1) retains a strength befitting a company whose slow pace of acquisition of additional businesses because few are found available, despite constant search, at prices deemed rational from the standpoint of Wesco shareholders. As indicated in the accompanying financial statements, the aggregate market value of Wesco's marketable equity securities was higher than their aggregate carrying value at December 31, 1989 aggregate market value of all marketable securities, including bonds and other fixed-income by about $98 million, up significantly from about $54 million one year earlier. The consolidated securities, exceeded aggregate carrying value by about $103 million. As earlier emphasized, about $101 million of this unrealized appreciation lies within the savings and loan subsidiary, and includes unrealized appreciation in common stocks (mostly stock ot the coca cola company) held by $89.4 million of appreciation in stock of Freddie Mac. In addition, there is about $29 million of Wesco's insurance subsidiary. Under a peculiar accounting convention applicable only to insurance companies this appreciation, after deducting income taxes which would be due if the stocks were sold, is already included in Wesco's audited net worth, even though the gain has never passed through any audited report of income. net rentable square feet, including Mutual Savings' space, in a modern office building, plus (2) an Wesco's Pasadena real estate comprises a full block containing (1) about 125,000 first-class additional net rentable 34,000 square feet of economically marginal space in old buildings, which it would probably be wiser to destroy than improve. This real estate has a market value substantially in excess of carrying value. The existence of unrealized appreciation is demonstrated by (1) mort- gage debt ($4,643,000 at 9.25% fixed) against this real estate now exceeding its depreciated current net cash flow (about $1 million per year) to Wesco after debt service on the mortgage. The carrying value ($2,862,000) in Wesco's balance sheet at December 31, 1989, and (2) substantial just-below-standard rents and run the building as a sort of first-class club for tenants we admire. In modern office building is 97% rented, despite a glut of vacant office space in Pasadena. We charge fact, we are about to refurbish all the bathrooms, even though there is almost nothing wrong with them. (We have observed many recent instances of mismanagement at other buildings where lapse, to stay a long way removed from such conduct, considering it contrary to both implicit managers prefer to paint the financial record, instead of the building. We try, with an occasional superior parking facilities, we anticipate future increases in cash flow, but at no better rate than the obligation to tenants and long-run interest of the owner.) With these practices, a prime location and rate of inflation. and total liquid assets. Wesco's practice has been to do a certain amount of long-term borrowing in Wesco remains in a prudent position when total debt is compared to total shareholders' equity advance of specific need, in order to have maximum financial flexibility to face both hazards and opportunities. Following this practice, and to reduce interest costs, Wesco during 1989 paid off at 65

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Reproduced from 1989 Annual Report of Wesco Financial Corporation par its $25 million of 10%% debentures due in June 1991, and issued $30 million of new 8%% debentures due in November 1999. The low interest rate on the new debentures was made possible by Wesco's AA+ credit rating. be used in one or more business extensions. The extension activity requires patience, at least for It is expected that the balance sheet strength of the consolidated enterprise will in due course people like us, as explained below. It is assumed by many business school graduates, and by almost all consultants, that a nesses. According to this widely shared view, if only the obvious steps had been taken, if the right corporation can easily improve its outcome by purchasing unrelated or tenuously related busi- "mission statement" had been adopted and the right "experts" hired, then each railroad, instead of remaining bound in chains by new forms of competition and obsolete and hostile laws and union rules, would have become another Federal Express, another United Parcel Service, or even another brilliant performer in the mode of Emerson Electric. through business acquisition. We think undue optimism arises because successful records draw too Our experience, both actual and vicarious, makes us less optimistic about easy solutions tennis after observation limited to Ivan Lendl and Steffi Graf, or good prospects in the California much attention. Many people then reason as I would if I forecasted good prospects in big-time lottery after limiting observation to winners. The converse is also true, only more so. Far too little attention is given to the terrible effects on shareholders (or other owners) of the worst examples of corporate acquisitions such as CBS-DuMont, Xerox-Scientific Data Systems, General Electric-Utah International, Exxon-Reliance Electric, Sohio-Kennecott, First Interstate Bancorp-Allied Banc- Mobil Oil-Montgomery Ward, General Motors-Hughes Aircraft, and Avon Products-Practically shares, Arizona Public Service-MeraBank, USX-Texas Oil & Gas, Prudential Insurance-Bache, Anybody. The list ends here for want of space, not a shortage of additional examples. The acquiring utility as examples as they show how hard it is, even for managers promoted to power through corporations listed are great enterprises, honorably run. In fact, their greatness augments their meritocratic procedures at admired corporations, to advance by acquisition the interests of owners. corporate reporting cause managers to present data in a manner which obscures both facts and The full implications of the worst examples are lost, in part, because the conventions of implications. Horrible results are obscured, and mediocre results are made to look fine. Techniques for masking the truth include (1) mixing bad or mediocre results into other good results which would have been much better, absent the mixture, and (2) taking several poor results off the stage at once through the "big bath" technique. The "big bath" technique, in turn, is often accompanied by some extraordinary gain elsewhere which is cashed on a time schedule designed for obfuscation. Or a loss is mixed into a "restructuring," adopting word usage which would explain Napoleon'S outcome at Waterloo as a thoughtful strengthening of France. As we appraise it, the corporate mode of "solving your problems by acquisition" far more often ends in the mediocre "follow-the-fad-of-the-year" record of a Peter Grace than in the wonderful record of a Dover Corporation. Nor does the avoidance of dubious methodology guarantee success. acquisition "experts" paid per transaction recommended and closed, and (2) does not create the It is hard to win at the game, even if one (1) does not rely on the valuation judgment of outside in-house equivalent of the outside adviser who must buy to thrive, namely the internal department which has no function except acquisitions and often bears a label including "planning," or even "strategic planning." Perhaps more instructive than the rarity of good corporate acquisition records is the striking rarity of important acquisitions within the few good records. Most winners act as a wise baseball hitter would if permitted to pass as many pitches as he wished before swinging. 66

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Reproduced from 1989 Annual Report of Wesco Financial Corporation Capital Cities / ABC. Yet the major acquisitions, which accounted for more than 80% of ending For instance, among the best acquisition records is that of Tom Murphy and Dan Burke at economic value for continuing shareholders, occurred less often than once each two years. This learners and actors around, did all the important work themselves, and were located in the midst of slow pace occurred even though they were in full control, were (and are) two of the quickest change churned out opportunities for the acute at an above-normal rate. (The writer has to believe a profit-laden and long-lasting communications revolution (television broadcasting) wherein rapid from the writer's participation in rejecting a television-station opportunity, long ago given by Murphy that the opportunities seized by Murphy and Burke were recognizable only by the acute. This follows present-day value.) and Burke when they were barred by law from purchase. The price was less than one-tenth of business acquisition record of Wesco's ultimate parent, Berkshire Hathaway. Over 24 years, A particularly depressing lesson, for the action-prone, might also be extracted from the Berkshire transformed a small, doomed New England textile enterprise into a large and diversified Berkshire's record the six most significant acquisitions, extracting occurrences averaging one every company, without ending up with many more shares outstanding. Yet if you removed from four years, the record would not now be mentioned here, or anywhere else. business purchases in a hurry with corporate cash. And it has been even easier to cause It has always been easy (indeed, one attracts scores of helpers) to make disadvantageous Xerox in the merger with Scientific Data Systems, not to be super-sensitive to the probability that disadvantage if one is unwise enough, like General Electric in the Utah International merger, or any attainable stock-for-stock merger will transfer more intrinsic business value than is acquired. On the other hand, advantageous business purchases, not involving competitors or branded products which can be sold through the acquirer's present sales system, are difficult to find. although that Principle does especially intense damage in the acquisition field. (This occurs It is not just the Peter Principle which makes corporate acquisition records so bad, on average, because, when you promote the General Sales Manager to CEO making unrelated business substantive change by promoting the Sales Manager of some territory to General Sales Manager.) acquisitions, you naturally cause more trouble than you earlier did when you made a less Even a CEO with good acquisition judgment is lucky if, in his remaining career, he finds one large opportunity which tempts rational response. businesses are ever for sale. It is just that, in a finite, competitive world, no business is so wonderful The scarcity of good acquisition transactions, of course, does not imply that no wonderful corporations buy anyway, for reasons Columbia's great philosopher, Charles Frankel, so well that it can't be ruined as an acquisition candidate by increasing the price. When this happens, many manager gains even though the shareholder loses. (Incidentally, Frankel was mugged to death in a understood. The system is so constructed (irresponsibly, Frankel would say) that the corporate final inadvertent contribution to the study of irresponsible systems, reminding many conservative social critics of Socrates.) how does one explain the widespread recent success of most of the leveraged-buy-out ("LBO") At this point, a last question remains: If successful corporate business acquisition is so hard, operators who have purchased corporations? A huge part of the answer comes from income-tax effects and other simple effects. When, in a typical LBO, the typical mostly equity corporate capitalization was replaced by 90% debt plus a new 10%-of-capitalization common stock position: (1) the combined market value of all the new common stock plus all the new debt became existing stream of pre-tax earnings was no longer shared with corporate income tax much higher than the previous market value of all the old common stock, because the 67

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Reproduced from 1989 Annual Report of Wesco Financial Corporation shareholders; and collectors who, in many cases, had previously received more cash each year than (2) even after the value-enhancing effect of the corporate tax reduction was shared with former shareholders by paying them extra-high prices to leave, a retained residue of value- enhancing tax effect made the new common stock (which now became much like a on acquisition papers; and speculative warrant with good terms) worth considerably more than cost as the ink dried (3) the new "owners" then resorted to strategies, difficult neither to conceive nor implement, including the following: (a) they eliminated many of the easily removable costs (largely personnel costs) and sub-par segments which in some mix (i) bedevil successful corporations (including ours) with sloth and folly and (ii) create their humane grace and, through present sacrifice, good long-term prospects, justifying sacrifice endured; and (b) they sold off a few operations at super-high prices, sometimes exercising the easiest microeconomic insight by selling to a direct competitor and sometimes selling to a surprisingly easy-to-find non-competitive corporate buyer, not owned by its manag- ers, willing to pay almost as high a price as a competitor would; and (4) the new "owners" then profited, in due course, not only from the tax effect and other simple reshuffling activities described above, but also from the wonderful upside effects of extreme financial leverage during a long business boom accompanied by a rising stock market. extremely leveraged capitalizations, except through occasional adversity, presents interesting social Whether the country wants a large number (or even any) of its large corporations to have questions. Is one social function of corporations to be financially strong so that they act as shock implicit in capitalism? Was Ben Franklin right when he included the following folk wisdom in Poor absorbers, protecting dependent employees, suppliers and customers from part of the volatility Richard's Almanac: "It is hard for an empty sack to stand upright." Is a weak corporation, borrowed to the hilt, the social equivalent of a bridge with an inadequate reserve of structural strength? long term efficiency, how many thousands of able people do we wish to attract into promotional Granting that leveraged buy outs have some favorable effects (as well as unfavorable effects) on corporate recapitalization activity which (1) reduces corporate income taxes, (2) often tests the limits of antitrust law, and (3) focuses business attention on short-term cash generation to pay it (more or less): "Do we really want entire corporate businesses, as important social institutions, down oppressive levels of debt? Finally, as Columbia Law School's Professor Lou Lowenstein puts continuously traded like pork belly contracts?" First, the corporate tax effect is so large in LBO transactions that easy success in such transactions However the social questions are answered, three aspects of the present situation are clear. leveraged-buy-out operators now with us raise does not imply that success is easy in ordinary corporate acquisitions. Second, the hordes of detriment of other would-be acquirers, including Wesco, which are not willing to maximize tax the general level of acquisition prices to the benefits through maximized borrowing. And, third, the LBO operators will not go away so long as leaf aiding promotion. Even though failure and disgrace will reduce their number, and prices paid in present permissive laws last. The operators have a real advantage under such laws, not just a fig leveraged-buy-out transactions will fall, the capitalized value of reducing the corporate income tax will remain. Therefore, plenty of rational incentive will remain for transactions. The LBO genie will encounter reverses, but he is not going back in the bottle unless ordered to do so by new laws. 68

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Reproduced from 1989 Annual Report of Wesco Financial Corporation advantages derived from tax law and wilingness to reshuffle businesses with much speed and few It should also be noted that the LBO operators' incentives to bid high do not end with real of LBO partnerships risk little of their own money (often less than none after fees are taken into scruples. Additional incentives for high bids come from typical structures in which general partners account), yet share significantly in gains. Such arrangements are similar to the system of the race track tout. And who has ever seen a tout who didn't want his backer to make a lot of bets? ro Wesco, as a non-Lou operator, the good-corporate-acquisition game was always tough and that game in each recent year has become more like fishing for muskies at Leech Lake, ir Minnesota, where the writer's earliest business partner, Ed Hoskins, had the following conversation with his Indian guide: "Are any muskies caught in this lake?" "More muskies are caught in this lake than in any other lake in Minnesota. This lake is famous for muskies." "How long have you been fishing here?" "19 years." "And how many muskies have you caught?" "None." predicted. Whether this happens, as we like to believe, because the game is hard for almost When a management has our point of view, infrequency of business acquisition may safely be less worthwhile activity than we all would like. But there may be one consolation: A series of big, everyone, or merely because the game is hard for us, the result for Wesco shareholders is the same: incorrectable acquisition troubles, with no meaningful salvage, is seldom caused by people who of course, quite possible. For instance, Wesco would cheerfully invest $75 million tomorrow, with hink the acquisition game is like fishing for muskies at Leech Lake. One terrible acquisition result is, 60% chance of total loss, provided the pay-off for winning was large enough to cause statistical expectation to provide a handsome return. those in the savings and loan and insurance subsidiaries and those held temporarily elsewhere As indicated in Schedule accompanying Wesco's financial statements, investments, both pending sale to fund business extension, tend to be concentrated 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 consolidated Shareholders' equity, about 11% in 1987-89, was dependent to a significant extent on securities gains, irregular by nature. as this is written does not result from our forecast that business conditions are about to worsen, or The considerable, and higher than desired, liquidity of Wesco's consolidated financial position results, instead, from our simply not finding opportunities for more aggressive use of capital with that interest rates are about to rise, or that common stock prices are about to fall. Wesco's condition which we are comfortable. the esoteric. It is remarkable how much long-term advantage people like us have gotten by trying to Wesco continues to try more to profit from always remembering the obvious than from grasping folk saying: "It's the strong swimmers who drown". Our approach, while it has worked fairly well on be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the 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. 69

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Reproduced from 1989 Annual Report of Wesco Financial Corporation tiny fraction of its total intrinsic value in businesses with enough commercial advantage in place to Moreover, our approach continues to be applied to no great base position. Wesco has only a Wesco's parent corporation, has a much larger proportion of its intrinsic value in durable high-return assure permanent high future returns on capital employed. In contrast, Berkshire Hathaway, businesses. The foregoing description of attitude, as well as the following historical explanation of the designed to deter inappropriate optimism. When Wesco's parent corporation acquired control, current situation, is repeated in the annual report each year, accompanied by a standard disclaimer Wesco's activities were almost entirely limited to holding (1) some surplus cash, plus (2) a multi- branch savings and loan association which had many very long-term, fixed-rate mortgages, offset by interest-bearing demand deposits. The acquisition of this intrinsically disadvantageous position was unwisely made, alternative opportunities considered, because the acquirer (including the signer of this letter) was overly influenced by a price considered to be moderately below liquidating value. Under such circumstances, acquisitions have a way of producing, on average, for acquirers who are from a starting "bargain" not quick-turn operators, low to moderate long-term results. This happens because any advantage purchased business. Such normal effects have not been completely avoided at Wesco, despite gets swamped by effects from change-resistant mediocrity in the some successful activities, including a large gain in 1985 from an investment in General Foods. continues to be like a tortoise in a race of hares. And, as we have demonstrated in one more year, A corporation like Wesco, with no significant proportion of intrinsic value in great businesses, by remembrance of past new-activity outcomes which were at least as bad as those of the writer's this particular tortoise is not very sprightly. Moreover, what sprightliness remains is often deterred dog when it limped home from its first foray outside the yard both (1) injured by a car and (2) one such once-new activity: hillside subdivision in the place with the ironic name, "Friendly Valley.") bloated from overeating garbage. (Some long-time Wesco shareholders may painfully remember to 20½ cents per share, payable March 13, 1990, to shareholders of record as of the close of On January 25, 1990, Wesco increased its regular quarterly dividend from 19½ cents per share business on February 28, 1990. Commission, and includes detailed information about Wesco and its subsidiaries as well as audited This annual report contains Form 10-K, a report filed with the Securities and Exchange financial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charks T Manger Chairman of the Board Charles T. Munger March 5, 1990 70

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Association from United States League of Savings Institutions. Reproduced on this page is a copy of the May 30, 1989 letter of resignation of Mutual Savings and Loan LAGANINGS 315 EAST COLORADO BLVD. • PASADENA, CALIFORNIA 91101-1954 United States League of Savings Institutions, May 30, 1989 Washington, D. C. 20006 1709 New York Avenue N. W., Gentlemen: This letter is the formal resignation of Mutual Savings and Loan Association from the United States League of Savings which are no longer willing to be associated with the League. Mutual Savings is a subsidiary of Wesco Financial Corporation, listed ASE, and Berkshire Hathaway Inc., listed NYSE, current lobbying operations are so tlawed, indeed disgraceful, that we are not willing to maintain membership. Mutual Savings does not lightly resign after belonging to the League for many years. But we believe that the League's mess has many causes, which we tried to summarize fairly in our last annual report to stockholders, it was made much Our savings and loan industry has now created the largest mess in the history of U.S. financial institutions. While the to operations of a minority of insured institutions dominated by crooks and fools, (2) mickey-mouse accounting which worse by (1) constant and successful inhibition over many years, through League lobbying, of proper regulatory response underlying insured institutions' promises to holders of savings accounts. made many insured institutions look sounder than they really were, and (3) inadequate levels of real equity capital agent, And, like cancer, our present troubles will recur if Congress lacks the wisdom and courage to excise elements which It is not unfair to liken the situation now facing Congress to cancer and to liken the League to a significant carcinogenic helped cause the troubles. lobbying efforts regularly resist minimal reform. For instance, Moreover, despite the obvious need for real legislative reform, involving painful readjustment, the League's recent conventions allowing regulators and (2) minimization of the amount of real equity capital required as a condition of maintenance of full scale "goodwill" (in the financial institutions' context translate "air") to count as capital in relations with operations relying on federal deposit insurance. prescribing continuation of loose accounting principles, inadequate capital and, in effect, inadequate management at many In the face of a national disaster which League lobbying plainly helped cause, the League obdurately persists in from the Valdez if it had insisted thereafter on liberal use of whiskey by tanker captains. insured institutions. The League responds to the savings and loan mess as Exxon would have responded to the oil spill public apology to Congress. Because the League has clearly misied its government for a long time, to the taxpayers' great It would be much better if the League followed the wise example, in another era, of the manufacturer which made a detriment, a public apology is in order, not redoubled efforts to mislead further. We know that there is a school of thought that trade associations are to be held to no high standard, that they are reason or normal human courtesy following egregious fault, but merely to furnish self-serving nonsense and political In this view, each industry creates a trade association not to proffer truth.or industries' trade associations. But the evidence is now before us that this type of trade association conduct, when backed in the legislative milieu, the self-serving nonsense and political contributions of other as in the League's case by vocal and affluent constituents in every congressional district, has an immense capacity to do baseball reformed after the "Black Sox' harm to the country. Therefore, the League's public duty is to behave in an entirely different way, much as major-leaque the increased mess caused by League short-sightedness in the past, client institutions will later prove ill-served by present scandal. Moreover, just as client savings institutions are now worse off because of short-sightedness of the League. Savings Institutions; we are also, as one small measure of protest, releasing to the media, for such attention as may ensue, Believing this, Mr. Warren E. Buffett and I are not only causing Mutual Savings to resign from the U.S. League of copies of this letter of resignation. Truly yours, MUTUAL SAVINGS AND LOAN ASSOCIATION CharkesT manger Chairman of the Board Charles T. Munger 71

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BERKSHIRE HATHAWAY INC. Selected Financial Data for the Past Five Years (dollars in thousands, except per share data) 1985 1986 1987 1988 Revenues: 1989 Insurance premiums earned Sales and service revenues. $ 504,872 Realized investment gain Interest and dividend income 144,722 317,059 $ 1.219.252 823,884 $ 1,326,829 220,764 181,992 824.895 $ 1,407,642 $ 1.526,459 Total revenues Sundry ....... 495,055 237,319 584,235 314,251 394,279 1,930 $2,452,208 6,316 13,901 28,838 131,671 223,810 331.452 Earnings: $1,463,638 $2,431,782 $2,464,893 27,094 $2,483.892 7.892 Before realized investment gain Realized investment gain ...... $ 92,948 Earnings per share: Net earnings..... 342,867 $ 131,464 $ 282,361

• 150.897

214,746 $ 435,815 $ 234.552 19,806 $ 313,441 $ 399,270 85,829 S 147,575 299.902 Before realized investment gain $ 447,477 Net earnings Realized investment gain $ 298.95 81.04 $ 131.57 114.62 187.24 Year-end data: $ 379.99 246.19 $ 17.27 273.37 348.23 74.86 127.55 262.46 204.51 Total assets 390.01 Term debt and other borrowings $ 3,480,789 1,885,330 117,879 $ 4,931,354 2,377,797 260,170 $ 5,863.235 Common shares outstanding, Shareholders' equity 2,841,659 289,886 $ 6,816,848 480.009 $ 9,459,594 3,410,108 4,925,126 1,007.516 Shareholders' equity per in thousands.. 1,147 1,147 1,147 outstanding share... 1,146 1,146 1,644 2.073 $ 2.477 $ 2.975 4,296 COMMON STOCK Stock Transfer Agent Registrar for the Company's common stock. Correspondence with the Division may be directed to Customer Service The Bank of Boston Shareholder Services Division, P.O. Box 644, Boston, MA 02102 serves as Transfer Agent and Stop 45-01-05. Certificates should not be mailed to the Company. Section, Mail Stop 45-02-09. Certificates for re-issue or transfer should be directed to the Transfer Processing Section. Mail Shareholders included nominees holding at least 145,000 shares on behalf of beneficial-but-not-of-record owners. Management The Company had approximately 6,300 record holders of its common stock at March 1, 1990. Record owners believes that the Company has more than 13,000 beneficial owners. Price Range of Common Stock following table sets forth the high and low sales prices per share, as reported on the New York Stock Exchange Composite The Company's Common Stock is listed for trading on the New York Stock Exchange. trading symbol: BRK. The System/National Market System prior to that date, during the periods indicated: List since November 29, 1988, and as reported by the National Association of Securities Dealers Automated Quotation 1989 ... First Quarter..... High LOW $5,025 1988 ..... Second Quarter 7,000 $4,625 High Low Third Quarter.... 4,950 First Quarter Fourth Quarter 8,750 Second Quarter.. $3,500 8,900 6,600 Third Quarter... 4,150 $3,000 Dividends 7,950 Fourth Quarter 5,000 3,400 5,050 4,040 4,600 Berkshire has not declared a cash dividend since 1967. 72

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BERKSHIRE HATHAWAY INC. DIRECTORS WARREN E. BUFFETT. Chairman Chief Executive Officer of Berkshire CHARLES T. MUNGER, Vice Chairman Chairman of the Board of Directors of Daily Journal Corporation, publisher of KENNETH V. CHACE specialty newspapers in California Retired, Former Chief Operating Officer of Textile Operations of Berkshire MALCOLM G. CHACE, JR. Retired. Former Chairman of Berkshire's Board J. VERNE MCKENZIE Chief Financial Officer of Berkshire WALTER SCOTT, JR. Chairman and Chief Executive Officer of Peter Kiewit Sons', Inc., engaged worldwide in construction, mining, packaging and timberlands. OFFICERS CHARLES T. MUNGER, Vice Chairman WARREN E. BUFFETT, Chairman and CEO ROBERT H. BIRD, Vice President MICHAEL A. GOLDBERG, Vice President STANFORD LIPSEY, Vice President J. WILLIAM SCOTT, Vice President J. VERNE MCKENZIE, Vice President, Secretary MARC D. HAMBURG, Treasurer DANIEL J. JAKSICH, Controller Two compilations of letters from earlier Annual Reports are available upon 1988. Single copies are furnished without charge in response to requests received by the request. One is from reports for 1977 through 1983, the other, from reports for 1984 through Company at 3555 Farnam St., Suite 1440, Omaha, NE 68131.

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Executive Offices - 1440 Kiewit Plaza, Omaha, Nebraska 68131 BERKSHIRE HATHAWAY INC.