2005 Annual Letter

--- Page 1 --- Note: The following table appears in the printed Annual Report on the facing page of the Chairman's Letter 2 Berkshire’s Corporate Performance vs. the S&P 500 Annual Percentage Change in Per-Share in S&P 500 Book Value of with Dividends Relative Berkshire Included Results Year (1) (2) (1)-(2) 1965 .................................................. 23.8 10.0 13.8 1966 .................................................. 20.3 (11.7) 32.0 1967 .................................................. 11.0 30.9 (19.9) 1968 .................................................. 19.0 11.0 8.0 1969 .................................................. 16.2 (8.4) 24.6 1970 .................................................. 12.0 3.9 8.1 1971 .................................................. 16.4 14.6 1.8 1972 .................................................. 21.7 18.9 2.8 1973 .................................................. 4.7 (14.8) 19.5 1974 .................................................. 5.5 (26.4) 31.9 1975 .................................................. 21.9 37.2 (15.3) 1976 .................................................. 59.3 23.6 35.7 1977 .................................................. 31.9 (7.4) 39.3 1978 .................................................. 24.0 6.4 17.6 1979 .................................................. 35.7 18.2 17.5 1980 .................................................. 19.3 32.3 (13.0) 1981 .................................................. 31.4 (5.0) 36.4 1982 .................................................. 40.0 21.4 18.6 1983 .................................................. 32.3 22.4 9.9 1984 .................................................. 13.6 6.1 7.5 1985 .................................................. 48.2 31.6 16.6 1986 .................................................. 26.1 18.6 7.5 1987 .................................................. 19.5 5.1 14.4 1988 .................................................. 20.1 16.6 3.5 1989 .................................................. 44.4 31.7 12.7 1990 .................................................. 7.4 (3.1) 10.5 1991 .................................................. 39.6 30.5 9.1 1992 .................................................. 20.3 7.6 12.7 1993 .................................................. 14.3 10.1 4.2 1994 .................................................. 13.9 1.3 12.6 1995 .................................................. 43.1 37.6 5.5 1996 .................................................. 31.8 23.0 8.8 1997 .................................................. 34.1 33.4 .7 1998 .................................................. 48.3 28.6 19.7 1999 .................................................. .5 21.0 (20.5) 2000 .................................................. 6.5 (9.1) 15.6 2001 .................................................. (6.2) (11.9) 5.7 2002 .................................................. 10.0 (22.1) 32.1 2003 .................................................. 21.0 28.7 (7.7) 2004 .................................................. 10.5 10.9 (.4) 2005 .................................................. 6.4 4.9 1.5 Average Annual Gain — 1965-2005 21.5 10.3 11.2 Overall Gain — 1964-2005 305,134 5,583 Notes: Data are for calendar years with these exceptions: 1965 and 1966, year ended 9/30; 1967, 15 months ended 12/31. Starting in 1979, accounting rules required insurance companie s to value the equity securities they hold at market rather than at the lower of cost or market, which was prev iously the requirement. In this table, Berkshire’s results through 1978 have been restated to conform to the changed rule s. In all other respects, the results are calculated using the numbers originally reported. The S&P 500 numbers are pre-tax whereas the Berkshire numbers are after-tax . If a corporation such as Berkshire were simply to have owned the S&P 500 and accrued the appr opriate taxes, its results would have lagged the S&P 500 in years when that index showed a positive return, but would have exceeded the S&P 500 in years when the index showed a negative return. Over the years, the tax cost s would have caused the aggregate lag to be substantial. --- Page 2 --- BER KSHIR E HATHAWAY INC. To the Shareholders of Berkshire Hath away Inc. : Our gain in net worth du ring 2005 was $5.6 billion, which increased the per-share book value of both our Class A an d Class B stock by 6.4%. Over the last 41 y ears (that is, since present managem ent took over) book value has grown from $19 t o $59,377, a rate of 21.5% c ompounded annually.* Berkshire ha d a decent year in 2005. We initiated five acquisitions (two of whic h have yet to close) an d most of ou r operating su bsidiaries pros pered. Even o ur insurance b usiness in its entirety did well, th ough Hurrican e Kat rina in flicted record losses on both Berk shire an d the indu stry. We estim ate our loss fro m Katrin a at $2.5 billion – and her ugly sisters, Rit a and Wilma, co st us an additional $.9 billion. Cred it GEICO – and its brillian t CEO, To ny Nicely – for our stellar in surance resu lts in a d isaster- ridden year. One statistic stan ds out: In just two years, GEICO im proved its p roductivity b y 32%. Remarkabl y, employment fell by 4% eve n as pol icy count grew by 26% – an d more gai ns are i n store. When we dri ve un it co sts d own in such a dram atic manner, we can offer ever-greater value to our customers. The payoff: Last year, GEICO gained market-share, earned commenda ble profits and strengthened its brand. If you have a new son or grandson in 2006, name him Tony . * * * * * * * * * * * * My g oal in writin g this report is to give you the info rmatio n you need to estimate Berk shire’s intrinsic value . I say “estimate” becaus e calculations of intrinsic value, t hough all-im porta nt, are necessa rily impreci se and often seriously wrong. The more unce rtain the future of a business, the more possibility th ere is th at the calculation will b e wild ly off-base. (Fo r an explanation of intrinsic v alue, see page s 77 – 78.) Here B erkshire has s ome adva ntages: a wide vari ety of relatively-stable earni ngs streams, combined with great liquidity and minimum debt. These factors m ean that Berks hire’s in trinsic v alue can be m ore precis ely calculated than can th e intrinsic value of m ost companies. Yet if preci sion is aided by Berkshire’s financial ch aracteristics, th e job o f calcu lating in trinsic value has bee n made more com plex by the mere prese nce of s o many earni ngs st reams. Back i n 1965, when we own ed only a sm all textile o peration , the task of calcu lating intrinsic v alue was a sn ap. No w we own 68 distinct businesses with widely disparat e operating and financial charact eristics. T his array of unrelated enterprises, coupled with our massive invest ment holdings, makes i t impossi ble for you to simply examine our consolidated financial state ments and arriv e at an informed estimate of intrinsic value. We h ave at tempted to ease t his problem by clustering our businesses into four logical groups, each of which we discu ss later in this repo rt. In th ese d iscussions, we will p rovide the key figures for bo th the group and its important com ponents. Of course, the value of B erkshire may be ei ther great er or less than the sum of these fo ur parts. The o utcome depen ds on whether o ur many units function better or worse by being part of a larger e nterprise and whether capi tal allocation improves or deteriorates wh en it is un der the direction of a holding company. In other words, does Berkshire ownership bring anything to the party, or would our s harehol ders be better off if they directly owne d sha res in each of our 68 busi nesses ? These are important questio ns but ones that you will h ave to answer for you rself. Before we look at our individual businesses, however, let’s review two sets of figures that show where we ’ve c ome from and whe re we are now. The fi rst set is the am ount of invest ments (including cash and cash-equivalents) we o wn on a per-share basi s. In making this calculation, we excl ude investments held in our fina nce ope ration because these are largely offs et by borrowi ngs: * All fi gures used in t his report ap ply to Berkshi re’s A shares, the successor to the only stock that the company had outstan ding before 1996. The B shares hav e an econ omic interest equal to 1/30th that of the A. 3 --- Page 3 --- Year Per-Sha re Inve stments* 1965 ..................................................................... $ 4 1975 ..................................................................... 159 1985 ..................................................................... 2,407 1995 ..................................................................... 21,817 2005 ..................................................................... $74,129 Com pound G rowth Rate 1965 -2005.................... 28.0% Com pound G rowth Rate 1995 -2005.................... 13.0% * Net of minority interests In add ition to th ese m arketable securities, wh ich with m inor exceptions are held in our insurance companies, w e own a w ide variety o f non- insurance bu sinesses. Belo w, we show the pre-tax earn ings (excluding good will am ortization) of these businesses, ag ain on a per-share b asis: Year Per-Sha re Earnings * 1965 ..................................................................... $ 4 1975 ..................................................................... 4 1985 ..................................................................... 52 1995 ..................................................................... 175 2005 ..................................................................... $2,441 Com pound G rowth Rate 1965 -2005.................... 17.2% Com pound G rowth Rate 1995 -2005.................... 30.2% *Pre-tax and net of minority interests When growth rates are un der discussion , it will pay you to be suspicious as to why the beginning and term inal years h ave been selected . If eith er year was aberratio nal, an y calcu lation of growth will be distorted. In part icular, a base y ear i n whi ch ear nings were poor can produce a breat htaking, but meaningless, growth rate. In the table above, however, the base year of 1965 was abnormally good; Berk shire earned more money in that year th an it d id in all bu t one of the previous ten. As you can see f rom the two tab les, the com parative growth rates of Berkshire’s two elements of value have change d in the last decade, a result re flecting our e ver-increasi ng em phasis on business acquisition s. Nev ertheless, Ch arlie Mu nger, Berk shire’s Vice Ch airman and my p artner, and I wan t to increase t he figures i n both tables. In this ambition, we hope – metaphori cally – to avoid the fate of the elderly couple who had been rom antically challenged for some time. As they finished dinner on their 50th anniversa ry, however, the wife – st imulated by soft music, wi ne and candlelight – felt a long-absent tickle and demurely suggested to her husband that they go u pstairs and m ake love. He ag onized f or a m oment and then replied, “I can do one or the other, but not both.” Acquisiti ons Over the years, our current businesses, in aggregate, should del iver modest growth in operating earnings. Bu t they will n ot in themselves produce tru ly satisfacto ry gains. We will n eed major acq uisitions to get that job done. In this quest, 2005 was encouraging. We agreed to five purch ases: two that were co mpleted last year, one that closed after ye arend a nd two others that we expect to cl ose soon. None of the deals invo lve the issuance of Berkshi re sha res. That ’s a c rucial, but often ignored, point: Whe n a managem ent proudly acqui res a nother company for stock, the shareholders of the acquirer are concurrently selling part of their interest in everyth ing they own. I’ve made this kind of deal a few times myse lf – and, on balance, my actions have cost you money . 4 --- Page 4 --- Here are last y ear’s purchases : • On June 3 0 we bo ught Medical Protective Com pany (“MedPro”), a 106-year- old medical malp ractice insurer b ased in Fort Wayne. Malp ractice insura nce is tough to underwri te and has proved to be a graveyard for many insurers. Med Pro nevertheless shou ld do well. It will h ave the attitu dinal advantage that all Berk shire in surers share, wherein underwri ting discipline trumps all other goals. Additionally, as part of Berk shire, MedPro has financial streng th far ex ceeding that of its co mpetitors, a quality assu ring doctors t hat lon g-to-set tle clai ms will not end up back on their doorstep because their ins urer failed. Fi nally, the com pany has a sm art and e nergetic CEO, Tim Kenesey, who instinctively thin ks like a Berk shire manager. • Forest Riv er, our seco nd acquisition , closed on Augu st 31. A co uple of months earlier, on June 21, I recei ved a two-pa ge fa x telling me – point by point – why Forest River m et the ac quisition criteria we set fort h on page 25 o f this report. I ha d not before he ard of the co mpany, a recreation al vehicle manufacturer with $1.6 billion of sales, nor of Pete Lieg l, its owner and manager . But the fax made sense, a nd I immediately asked for m ore figures. T hese ca me the next morning, and that afternoon I made Pet e an offer. On June 28, we shook hands on a deal. Pete is a remarkable en trepreneur. So me years back, he sold his business, then far smaller than today, to a n LBO operat or who prom ptly bega n telling him how to run th e place. Before long, Pete left, and the business soon sunk into bankruptcy. Pete then repurchased i t. You can be sure that I won’t be telling Pet e how to manage hi s operation. Forest River has 60 plants, 5,400 em ployees and has c onsistently gained share in the RV business, while also e xpandi ng into other areas s uch as boats . Pete is 61 – and definitely in an acceleration mode. Read the piece from RV Business that accom panies this report , and you’ll see why Pete and Berks hire are made for ea ch other. • On November 12, 2005, an article ran in The Wall Street Journal deal ing with Berkshire’s unusual acquisition and managerial practices. In it Pete d eclared, “It was easier to sell my b usiness th an to renew my driver’s license.” In New Yo rk, Cath y Baro n Tamraz read the article, and it struc k a chord. On Novem ber 21, she sent m e a letter that began, “As president of Business Wire, I’d lik e to introduce you to my company, as I believe it fits th e profile o f Berkshire Hath away sub sidiary companies as d etailed in a recen t Wall Street Jou rnal article.” By th e time I finished Cathy’s two-p age letter, I felt Busi ness Wire and Berk shire were a fit. I particula rly lik ed her penultimate paragra ph: “We run a tight shi p and keep unnecessary spendi ng under wraps. No secret aries or m anagem ent layers he re. Yet we’ll invest big dollars to gain a technological a dvantage and move the busi ness forward.” I prom ptly gave Cathy a call, and before l ong Berks hire had reache d agreem ent with Busi ness Wire’s controlling shareholder, Lorry Lokey, who founded the com pany in 1961 (and who had just made Cathy CEO). I love success st ories like Lorry’s. Today 78, he has built a com pany t hat dissem inates inf ormation in 150 co untries for 25,000 clients. Hi s story, like those of m any entrepreneurs who have sel ected B erkshire as a hom e for their life’s work, is an exam ple of what can happe n when a good i dea, a talented individual and hard work converge. • In Decem ber we agreed to buy 81% of Applied Underwriters, a com pany that offe rs a combination of pay roll services a nd workers’ compensation insurance to small businesses. A majority of Applied’s c ustomers are located in Californ ia. 5 --- Page 5 --- In 1998, though, when the company had 12 em ployees, it acqui red a n Om aha-base d operation with 24 em ployees that offe red a som ewhat-similar service. Sid Ferenc and St eve Menzies, wh o have built App lied’s remarkable bu siness, co ncluded that O maha had many advantages as an operation al base – a brillia nt insight, I might add – and tod ay 400 of the co mpany’s 479 employees are located here . Less than a year ago, Appl ied entere d into a large rein suran ce con tract with Ajit Jain , the extraordinary manager of Natio nal Ind emnity’s re insuran ce division. Ajit was im pressed by Sid and Steve, a nd they liked Berk shire’s method of operation. So we decide d to join forces . We are pleased that Si d and Steve retain 19% of Applied. They started on a s hoestring only 12 years ago , and it will b e fun to see what they can accom plish with Berk shire’s backing. • Last spri ng, MidAm erican Ener gy, our 80.5% owned subsidiary, agreed t o buy PacifiCorp, a major electric u tility serv ing six Western states. An acquisition of this so rt requires m any regulatory approvals, bu t we’ve now obtained these and expect to close this tran sactio n soon . Berk shire will then buy $3.4 billion of MidAm erican ’s commo n stock, which MidAmerican will supplement with $1.7 billion of borro wing to complete th e purchase. You can’t ex pect to earn outsized profits in regulated utilities, b ut the in dustry offers own ers the opportun ity to deploy large sums at fai r returns – an d therefore, it makes go od se nse for Berks hire. A few years back, I said that we hoped to make some very larg e purchases in the utility field . No te the plural – we’ll b e looking for more. In addition to buying these new op eration s, we co ntinue to make “bolt-on” acquisition s. So me aren’t so sm all: Sh aw, our carpet operation , spent abou t $550 million last year on two pu rchases that furth ered its vertical in tegration and shou ld improve its profit m argin in th e future. XTRA and Clayto n Hom es also m ade value-enhancing acquisitions. Unlike many business buyers, Berkshire has no “exi t strategy.” We buy to keep . We do, though, have an entrance strateg y, look ing for businesses in this coun try or abroad that meet our s ix criteria and are availab le at a p rice th at will p roduce a reaso nable return. If you have a business that fits, g ive me a call. Like a hopeful teenage girl, I’ll b e waitin g by the phone. Insur ance Let’s now talk abo ut our four sector s and start with insuran ce, our core business. What coun ts here is the am ount of “fl oat” and its cost over tim e. For new rea ders, let m e explain. “Floa t” is money that do esn’t belo ng to us but that we temporarily hold. Most of our fl oat arises because (1) pre miums are pa id upfront though the servic e we provide – insurance protection – i s delivered over a pe riod that usual ly cove rs a y ear and; (2) loss events that occur toda y do not always resu lt in our immediately p aying claim s, because it sometim es takes many years for lo sses to be repo rted (asb estos lo sses wou ld be an example), negotiated and settled . Th e $20 million of flo at that ca me with our 1967 entry in to insurance has n ow increased – both by way of internal growth and acquisition s – to $49 billion. Float is wonderful – if it doesn’t come at a high price. Its co st is d etermined by underwritin g results, m eaning how th e expen ses an d losses we will ultimatel y pay com pare with the premiums we h ave receive d. Whe n an insurer earns a n unde rwriting profit – as has been t he case at Be rkshire in a bout hal f of the 39 y ears we ha ve bee n in the insurance b usiness – float is b etter th an free. In su ch years, we are actually paid for holding other people’s money . Fo r most insure rs, howeve r, life has bee n far more diffic ult: In aggre gate, the prope rty-casualty indust ry alm ost inva riably operates at an underwriting l oss. When that loss is larg e, float becomes exp ensive, sometimes devastatin gly so. 6 --- Page 6 --- In 2004 our float cost us less than nothing, and I told you that we had a chance – absent a mega- catastrophe – of no-cost float in 200 5. B ut we had the mega-cat, and as a specialis t in that coverage, Berk shire suffered hurrican e losses o f $3.4 billion. Nev ertheless, o ur float was costless in 2005 because of the superb results we had in our other insurance activ ities, particularly at GEIC O. * * * * * * * * * * * * Auto policies in force gre w by 12.1% at GE ICO, a gain i ncreasing its m arket s hare of U.S. private passe nger aut o busi ness f rom about 5.6% t o about 6.1%. Aut o insurance is a bi g business: Each s hare- point equates to $1.6 billion in sales. While ou r brand streng th is not quantifiab le, I b elieve it also grew sign ifican tly. W hen Berk shire acqui red c ontrol of GEICO in 1996, its annual advertising expenditures were $31 m illion. Last year we were up to $502 million. And I can ’t wait to spend more. Our adve rtising works because we ha ve a great story to tell: More pe ople can sa ve money by insuring with us than is th e case with any other national carrier offering policies to all co mers. (So me specialized aut o insure rs do partic ularly well for a pplicants fitting i nto their niches; also, because our national competitors use rati ng system s that differ from ours, they will so metimes b eat o ur price.) Last year, we ac hieved by far the highest conversion rate – the perce ntage of internet and phone quotes turned into sales – in ou r history. This is po werfu l evidence that our prices a re more attract ive relativ e to the competitio n than ever before. Test us by going to GEIC O.co m or by callin g 800-847-7536. Be su re to indicate you are a sh areholder because that fact will o ften qualify you for a discount. I told you last year abo ut GEICO’s en try into New Jersey in August, 2004. Drivers in that state love us. Our retention rate there for new policyholders is running higher than in any other state, an d by sometime in 2007, GEIC O is likely to become the third largest au to insu rer in New Jersey. There, as elsewh ere, our low co sts allow low prices that lead to steady g ains in profitab le business. That simple form ula im mediately impressed m e 55 y ears ago when I first discovered GEIC O. Indeed, at age 21, I wrote an article about the company – it’s reproduced on page 24 – when its market value was $ 7 million. As y ou can see , I cal led GE ICO “T he Sec urity I Like B est.” An d that’s what I still call it. * * * * * * * * * * * * We ha ve m ajor reins urance operatio ns at G eneral Re and National Indemnity. The fo rmer is run by Joe Brandon and Tad Montross, the latter by Ajit Jain. Bo th un its performed well in 2005 considering the extraordinary hu rrican e losses th at battered the ind ustry. It’s a n open question whet her atm ospheric, ocea nic or other causal factors ha ve dra matically change d the freque ncy or int ensity of hurri canes. R ecent expe rience is worris ome. We know, for ins tance, that in the 100 year s before 2004, abou t 59 hurricanes of Catego ry 3 strength, or greater , hit th e Southeastern a nd Gulf Coast states, and that only three of these we re Catego ry 5s. We f urther k now that in 2004 there were three C ategory 3 storms that ham mered those areas and that these were foll owed by four more in 2005, one of them, Katrina, the most destructive hurricane in industry history. Mor eover, there were th ree Categ ory 5s near th e coast last ye ar that fortunat ely weak ened before landfall. Was t his on slaught of more frequ ent and more in tense sto rms merely an anomaly? Or was it cause d by changes in climate, wat er temperature or other variables we don’t fully understand? And could these fact ors be d eveloping in a manner that will soo n prod uce disasters dwarfing Katrina? Joe, Ajit and I don’t know the an swer t o these all-i mportant questio ns. What we do k now is that our ign orance means we must fo llow th e course prescrib ed by Pascal in his fam ous wag er abou t the existence o f God. As y ou may recal l, he concl uded that since he di dn’t know the answer, his per sonal gain/loss ratio dictated an affirmative conclusion. 7 --- Page 7 --- So guided, we’ve concluded that we s hould now write mega-cat policies onl y at prices f ar higher than prev ailed last year – and then only with an aggregate expos ure that woul d not cau se us distres s if shifts in some important variable produ ce far m ore co stly sto rms in the near future. To a lesser d egree, we felt this way after 2004 – and cut back our writings when prices didn’t move. No w our caution has i ntensified. If prices seem appropriate, howev er, we contin ue to have both the ability an d the app etite to be the larges t writer of mega-cat coverage in the world. * * * * * * * * * * * * Our sm aller in surers, with MedPro added to the fold, delivered truly outstan ding results last year. Howe ver, what you see in the table be low does not do full jus tice to their perform ance. That’s because we increased the l oss reserv es of MedPro by about $125 million immed iately after our purchase. No one knows with any precisio n what amo unt will be required to pay the claim s we in herited. Medical malpractice insura nce is a “l ong-tai l” line, meaning that claim s often take m any years to settle. In addition, there are o ther losses th at have occurred, but that we won ’t even hear abou t for some time. On e thing, though, we h ave learn ed – the hard way – after m any years in the business: Su rprises in insuran ce are far from symmetr ical. Y ou ar e lucky if yo u get one that is pleasan t for ev ery ten th at go the other way. Too often, howeve r, insurers react to loom ing loss proble ms with optim ism. They be have like the fellow in a swi tchblade fight who, after his opponent has t aken a mighty swipe at his throat, excl aimed, “Y ou never touched me.” H is adversary ’s rep ly: “Ju st wait until yo u try to shake your head.” Excluding the reser ves we a dded for prior periods, MedPro wrote at an underwriting profit. And our other primary com panies, in aggregate, had a n underwriting profit of $324 million on $1,270 m illion of volume. Th is is an extraordinary result, and ou r thanks go to Rod Eldred of Berk shire Hathaway Homestate Co mpanies, Joh n Kizer of Cen tral States In demnity, To m Nern ey of U. S. Liability, Don Towle of Kansas B ankers Surety and Don Wurster of National Indemnity. Here ’s the overall tally on our underwriting and float for each m ajor sector of insurance: (in $ millio ns) Underwriting Profit (Loss) Yearend Float Insurance Ope rations 2005 2004 2005 2004 Gene ral Re ....................... $( 334) $ 3 $22,920 $23,120 B-H Rei nsurance.............. (1,069) 417 16,233 15,278 GEIC O............................. 1,221 970 6,692 5,960 Othe r Primary................... 235* 161 3,442 1,736 Total ................................. $ 53 $1,551 $49,287 $46,094 *Includes M edPro from June 30, 2005. Regulated Uti lity Business We ha ve an 80.5% (fully diluted) interest in MidAm erican Ene rgy Holdings, which owns a wide variety o f utility o peration s. The larg est of these are (1 ) Yorkshire Electricity and Northern Electric, wh ose 3.7 million electric cu stomers m ake it t he third larg est d istribu tor of electricity in the U.K.; (2) MidAm erican Energy, whic h serves 706,000 electric customers, primarily in Iowa; an d (3) Kern River and Northern Natural pipelines, w hich car ry 7.8% of the natural gas co nsum ed in the U.S. Whe n our Paci fiCorp acquisition closes, we will ad d 1.6 million electric cu stomers in six Western states, with Orego n and Utah providing us the most business. Th is tran sactio n will increase Mid American ’s rev enues by $3.3 billion and its assets b y $14.1 billion. 8 --- Page 8 --- The Pub lic Utili ty Ho lding Co mpany Act (“PUHC A”) was rep ealed o n Aug ust 8, 2 005, a milesto ne that allo wed Berk shire to convert its Mid American p referred stock i nto voting com mon share s on February 9, 2 006. Thi s conversion ended a con voluted corporate arrangem ent that PUHC A ha d forced upon us. No w we have 83.4% of b oth the com mon st ock and t he votes at MidAm erican, w hich allows us to cons olidate the com pany’s inc ome for fina ncial accounting a nd tax purposes . Our true ec onom ic interest, howe ver, is the aforem entioned 80.5%, since t here are options outstanding that are sure t o be exercised within a few years an d that upon exercise will d ilute our ownership. Though our voting pow er has in creased dramatically, the dynamics of our four-party ownership have not changed at all. We view M idAm erican as a partnership am ong Berkshire, Walter Scott, and two terrific m anagers, Dave Sokol and Greg Abel. It’s unimportant how many votes each party has; we will make major m oves only whe n we a re unanimous i n thinking them wise. Five years o f working with Dave , Greg and Walter have underscored my original belief: Berkshire couldn’t have better partners. You will n otice th at this year we h ave provided you with two balance sheets, o ne representing our actual figures per GAAP on Decem ber 31, 2005 (which does not consolidate MidAm erican) a nd one that reflects th e sub sequent conversion of our preferred . All fu ture fin ancial repo rts of Berk shire will in clude MidAm erican’s figures. Somewhat incongruously, Mid American owns the seco nd largest real estate b rokerage firm in the U.S. And it’s a gem . The parent com pany’s nam e is HomeServices of America, bu t our 19,200 agen ts operate through 18 locally-branded firms. Aided by three small acqui sitions, we participated in $64 billion of transactions last year, u p 6.5% from 2004. Currently, th e white-ho t market in residential real estate of rece nt years i s cool ing down, and that should lead to ad ditional acqu isition possibilities fo r us. Both we and Ron Peltier, t he company’s CEO, expect Hom eServices to be fa r larger a deca de from now. Here are some key fi gures on MidAm erican’s operations: Earnings (in $ millio ns) 2005 2004 U.K. utilitie s....................................................................................................... $ 308 $ 326 Iowa u tility ......................................................................................................... 288 268 Pipelines ............................................................................................................. 309 288 Hom eServices ..................................................................................................... 148 130 Othe r (net).......................................................................................................... 107 172 Income (loss) from discontinued zi nc project .................................................... 8 (579) Earni ngs before corporate i nterest and ta xes...................................................... 1,168 605 Intere st, other than to Berkshi re......................................................................... (200) (212) Intere st on Be rkshire junior debt ........................................................................ (157) (170) Income tax.......................................................................................................... (248) (53) Net ear nings........................................................................................................ $ 563 $ 170 Earni ngs applicable to Be rkshire*...................................................................... $ 523 $ 237 Debt owed to others ............................................................................................ 10,296 10,528 Debt owed to Berks hire...................................................................................... 1,289 1,478 *Includes interest earne d by Berkshire (net of related income taxes) of $102 in 2005 and $110 in 2004. 9 --- Page 9 --- Finance and F inancial Prod ucts The st ar of our finance s ector is Clayton Homes, masterful ly run by Kevin Clayton. He does not owe his brillian t reco rd to a rising tide: The manufactured-housing business has been disappo inting since Berks hire purc hased Clayton in 2003. Indus try sales have stagnate d at 40-year lows, a nd the recent uptick from Katrina-related dem and will alm ost certainly be short-live d. In rece nt years, m any industry participants have suffered losses, and only Clayton ha s earned significant money . In this brutal e nvironm ent Clayton has bought a large am ount of manufac tured-housi ng loans from major banks that found them unp rofitable and difficult to servi ce. Clayton’s operating ex pertise and Berkshire’s financi al resources have m ade this an exce llent busi ness fo r us a nd one in whi ch we are preeminent. We presen tly serv ice $17 billion of loans, com pared to $5.4 billon at th e time o f our purchase. Moreover, Clayto n now own s $9.6 billion of its serv icing portfolio, a position built up almost entirely sin ce Berk shire en tered the picture. To finance th is portfolio, Clayto n borrows money fro m Berkshire, wh ich in turn borrows th e sam e amount publicly. For t he use of its credit, Berkshire charges Clayton a o ne percent age-point markup on its borrowing cos t. In 2 005, the cost to Clayton for this arrangem ent was $ 83 million. That amount is included in “Other” income in the table on t he faci ng page, and C layton’s earni ngs of $416 m illion are aft er deducting this payment. On the manufacturing side, Clayton has also b een activ e. To its o riginal base of twen ty plants, it first added twelve more in 2004 by way of the ban kruptcy purchase of O akwood, which just a few years earlier wa s one of the la rgest companies in t he business. Then in 2005 Clayton purchased Karst en, a four- plant operation th at greatly stren gthens Clayto n’s position on the West Co ast. * * * * * * * * * * * * Long ago, Mark Twain said: “A m an who tries to carry a cat h ome by its tail will lear n a lesso n that can be learned in no other way.” If Twain were around now, he might try winding up a der ivativ es business. After a few days, he would opt for cats. We lo st $1 04 million pre-tax last year in our con tinuing atte mpt to exit Gen Re’s derivative operation. Our aggregate losses since we began this endeavor total $404 million. Originally w e had 23,218 contracts ou tstand ing. By th e start of 2005 we were dow n to 2,890. You might expect th at ou r losses wou ld have been stemme d by this point, but the blood h as kept flowing. Reducing our inventory to 741 contracts last y ear co st us the $1 04 million men tioned above. Remember th at th e rationale fo r estab lishing this un it in 19 90 was Gen Re’s wish to meet th e need s of insurance cl ients. Yet one of the cont racts we liquidated in 2005 had a t erm of 1 00 years! It ’s diffic ult to im agine what “nee d” such a contract coul d fulfill except, perhaps, the nee d of a compensation- consciou s trader to h ave a lon g-dated contract o n his book s. Long contracts, or alter natively th ose with multiple variables, are the m ost difficult to mark to m arket (the stan dard proce dure use d in accounting for derivatives) and provide the most opportunity fo r “imagination” when trad ers are estimatin g their v alue. Small wo nder that trad ers prom ote them. A business in which huge amounts of compensat ion flow from assum ed numbers is obviously fraught with danger. When t wo traders execute a transact ion that has se veral, som etimes esot eric, variables and a far-o ff settle ment date, th eir resp ective firm s must subsequently value these co ntracts wh enever they calculate their earni ngs. A gi ven c ontract may be val ued at one price by Firm A and at anot her by Firm B. You can bet that the val uation differences – and I’m personally fam iliar with several that were huge – ten d to be tilted in a direction fa voring hi gher e arnings at each firm . It’s a st range worl d in which two pa rties can ca rry out a paper transaction that each can promptly report as profitable. I dwell on our expe rience in derivative s each year for two reas ons. One is pe rsonal and unpleasant. The hard fact is that I have c ost you a l ot of money by not moving immediately to close do wn 10 --- Page 10 --- Gen Re’s trad ing operation . Both Charlie an d I knew at the time of the Gen Re pu rchase th at it was a problem an d told its management that we wan ted to exit the business. It was my resp onsibility to mak e sure t hat happened. Rather than address t he situation hea d on, however, I wast ed se veral years w hile we attempted to sell the operat ion. That was a doom ed en deav or beca use no real istic solution could have extricated us from the maze of liab ilities th at was go ing to ex ist fo r decades. Our obligation s were particula rly worrisom e because thei r pote ntial to explode could not be measured. More over, if s evere trouble occurred, we knew it was lik ely to co rrelat e with prob lems elsewh ere in financial markets. So I failed in my atte mpt to exit painlessly, and in the mean time more trad es were put on the books. Fau lt me fo r dithering. (Charlie calls it thumb-suc king.) When a problem exists, whet her in personnel or in bu siness operations, the tim e to act is now. The seco nd reason I reg ularly d escrib e our prob lems in this area lies in the ho pe th at our expe riences may prove instructive for m anagers , auditors and re gulators. In a sense , we are a canary in this business co al mine and should sing a son g of warning as we expire. The nu mber and value of derivativ e contracts out standing in the world continues to mushroom and i s now a m ultiple of wh at existed in 1998, the last ti me that fin ancial ch aos erup ted. Our e xperie nce should be particularly sobering because we we re a better-tha n-ave rage candidate to exit gracefully. Ge n Re was a relativel y minor operat or in t he derivatives field. It has had the good fortune to unwind its supposedly liquid positions i n a benign market, all the whi le free of financial or other press ures t hat might have forced it to conduct the liquidation in a less-than-efficient manner. Our accounting in the past was conventiona l and actually thought to be conser vative. Additionally, we know of no bad behavior by anyone involved. It co uld be a differen t story for others in the future. Imag ine, if yo u will, o ne or more fir ms (troub les o ften spread) with positions that are many multiples of ours atte mpting to liquidate in ch aotic markets and unde r extrem e, and well-publicized, press ures. Th is is a s cenario to which much atten tion should be gi ven now rather than aft er the fact. The t ime to have c onsidered – an d improved – t he reliability of New Orlea ns’ levee s was before Katrin a. When we finally win d up Gen Re Securities, m y feelin gs about its d eparture will b e akin to tho se expressed in a country son g, “My w ife ran aw ay w ith m y best friend, an d I sure miss him a lo t.” * * * * * * * * * * * * Belo w are th e resu lts of our various finance an d financial products activ ities: (in $ millio ns) Pre-Tax E arnings Interest-Bea ring Liabilities 2005 2004 2005 2004 Tradi ng – ordinary i ncome............................ $ 200 $ 264 $1,061 $5,751 Gen Re Sec urities (loss )................................. (104) (44) 2,617* 5,437* Life and a nnuity operation ............................. 11 (57) 2,461 2,467 Value Ca pital ( loss) ....................................... (33) 30 N/A N/A Leasing ope rations ......................................... 173 92 370 391 Manufactured- housing fina nce (Clayton) ....... 416 192 9,299 3,636 Othe r............................................................... 159 107 N/A N/A Income before capital gains ............................ 822 584 Tradi ng – capit al gains (losses ) ..................... (234) 1,750 Total .............................................................. $ 588 $2,334 *Includes all li abilities 11 --- Page 11 --- Manufa cturing , Serv ice a nd Reta iling Opera tions Our activ ities in this part of Berk shire cover th e waterfro nt. Let’s look , tho ugh, at a su mmary balance sheet a nd earnings statement for the entire group. Balance Sh eet 1 2/31/05 (in $ millio ns) Assets Liabilities an d Equity Cash a nd equi valents .............................. $ 1,004 Notes paya ble............................ $ 1,469 Accounts a nd notes receivabl e............... 3,287 Othe r current l iabilities .............. 5,371 Inventory ................................................ 4,143 Total curre nt liabilities .............. 6,840 Othe r current a ssets ................................ 342 Total curre nt assets ................................. 8,776 Goodwill and other inta ngibles............... 9,260 Deferred taxes............................ 338 Fixed assets ............................................. 7,148 Term debt a nd other liabilities ... 2,188 Othe r assets ............................................. 1,021 Equity ........................................ 16,839 $26,205 $26,205 Earnings Statemen t (in $ millio ns) 2005 2004 200 3 Revenues .................................................................................... $46,896 $44,142 $32,106 Operating expenses (including depreci ation of $699 in 2005, $676 in 2004 a nd $605 in 2003) .......................................... 44,190 41,604 29,885 Intere st expe nse (net).................................................................. 83 57 64 Pre-ta x earnings.......................................................................... 2,623 2,481 2,157 Income taxes ............................................................................... 977 941 813 Net inc ome................................................................................. $ 1,646 $ 1,540 $ 1,344 This eclectic co llectio n, which sells produ cts ra nging from Dilly Bars to fraction al interests in Boeing 737s, e arned a very respectab le 22.2% on a verage tangible net worth last year. It ’s noteworthy also that these ope rations use d only minor fi nancial leverage i n achi eving that return. Clearly, we o wn some terrific businesses. We purchased m any of them , howe ver, at subst antial prem iums to net wort h – a p oint reflected in the g oodwill ite m sh own on the balance sheet – and that fact red uces th e earn ings on our avera ge carrying value to 10.1%. Here are t he pre-tax ea rnings for the larger categories or units. Pre-Tax E arnings (in $ millio ns) 2005 2004 Building Pr oducts .................................................................................................... $ 751 $ 643 Shaw Industri es....................................................................................................... 485 466 Appa rel & Footw ear................................................................................................ 348 325 Retailing of Je welry, Home Furnishings a nd Candy ............................................... 257 215 Flight Se rvices......................................................................................................... 120 191 McLane .................................................................................................................... 217 228 Othe r busi nesses...................................................................................................... 445 413 $2,623 $2,481 12 --- Page 12 --- • In both our building-products companies and at Shaw, we continue to be hit by rising cos ts for raw materials and energy. Most of these operations a re sign ificant users of oil (o r more sp ecifically, petrochemicals) and natural gas. And prices fo r these co mmodities h ave soared. We, l ikewise, have raised prices on m any products, but there are often l ags be fore inc reases be- come effect ive. Nevertheless, both our building-products operations and Shaw delivered respect- able resu lts in 2005, a fact att ributable to th eir strong business franc hises and able managements. • In apparel, ou r larg est u nit, Fru it of the Lo om, again incre ased earnings and m arket-s hare. You know, of course, of our leadersh ip position in men’s and boys’ unde rwear, in which we account for about 48.7% of the sales recorde d by mass-m arketers (Wal-Mart, Ta rget, etc.). T hat’s up from 44.2% in 2002, whe n we ac quired the com pany. Operating from a sm aller base, we have m ade still g reater g ains in intimate apparel fo r women and girls that is so ld by the mass-mark eters, climbing fr om 13.7% of t heir sales in 2002 to 24.7% in 2005. A gai n like that in a major cat egory doesn’t com e easy . Thank John Holland, Fruit’s extraordinary CEO, for making this happen. • I told you last year th at Ben Brid ge (jewelry) a nd R. C. Willey (ho me furnishings) had same-store sales gai ns far above the average o f their industries. You might think that blow-out figures in one year wo uld mak e comparison s difficu lt in the following year. Bu t Ed and Jon Bridge at th eir operation and Scott Hym as at R. C. Willey were m ore than up to th is challen ge. Ben Bridge had a 6.6% same-store gain in 2005, and R. C. Willey ca me in at 9.9%. Our never-on-Sun day app roach at R. C. Willey co ntinues to overwh elm seven-day competitors as we roll out stores in new m arkets. The Bois e store, about which I was such a skeptic a few ye ars back , had a 21% gai n in 2005, coming of f a 10% gain in 2004. Our new Reno store, opened in Novem ber, broke out of the gate fast with sales that exc eeded Boise’s early pace, a nd we will begin busine ss in Sacram ento in June . If thi s store succeeds as I expect it to, Californians will see many more R. C. Willey sto res in the years to come. • In flight services, ea rnings improve d at FlightSafety as c orporate aviation continued its rebound. To support growth, we invest h eavily in ne w sim ulators. Our m ost recent expansi on, bri nging us to 42 training cen ters, is a major facility at Farn borough, Eng land that opened in September. When it is fully built ou t in 2007, we will h ave invested more th an $100 million in the building and its 15 simu lators. Bru ce Whitman, Flig htSafety’s ab le CEO, m akes sure th at no competitor comes close to offering the breadth and depth of services that we do. Operating res ults at NetJets were a di fferent story . I sai d last year th at this business would earn money in 2005 – and I was dead wrong. Our European operat ion, it should be not ed, showed both excel lent growth and a reduce d loss. Custom er cont racts there inc reased by 37% . We are t he only fractional-ownership operation of any size in Euro pe, a nd our now-pervasive prese nce there is a key factor i n making NetJets the worldwid e lead er in this ind ustry. Despite a la rge increase in c ustom ers, however, our U.S. operation dipped far into the red . Its efficien cy fell, and costs soared. We b elieve that our three la rgest co mpetitors suffered similar problem s, but each is owne d by ai rcraft m anufact urers that may thi nk differently than we do a bout the necessi ty of m aking ade quate profits. The combi ned value of the fleets managed by these three c ompetitors , in any ca se, continues t o be less valua ble than the fleet that we operate. Rich Santulli, one of the most dynamic managers I’v e ever m et, will so lve our rev enue/expense problem. He won ’t do it, howev er, in a manner that impairs th e quality o f the NetJets ex perience. Both he and I are co mmitted to a lev el of service, secu rity and safety t hat can ’t be match ed by others. 13 --- Page 13 --- • Our retailing category includes See’s Candies, a c ompany we bought early in 1972 (a date making it our oldest non-insurance business). At that time, Charlie and I immediately deci ded to put Chuck Huggins, th en 46, in charge. Thoug h we were new at th e game o f selectin g managers, Charlie and I hit a h ome run with this appo intment. Ch uck’s love for the cu stomer and the brand perm eated the organization, which in his 34-year tenure produced a m ore-than-tenfold increase i n profits. Th is gain was ach ieved in an indu stry growing at b est slowly an d perhaps no t at all. (Volume figures in this industry are hard to pin down.) At yeare nd, Chuck turned the reins at See ’s over to Brad K instler , who pr eviously had served Berkshire well while running Cypress Insurance a nd Fec hheimer’s. It’s unusual for us to move managers a round, but Brad’s reco rd m ade hi m an obvi ous choice for the See’s j ob. I h ope C huck and his wife, Donna, a re at the annual m eeting. If they are, sha reholders can join Cha rlie and m e in giving America’s n umber one candy maker a richly-deserved round of applause. * * * * * * * * * * * * Every day, in countless ways, th e competitiv e position of each of our businesses grows eith er weake r or stronger. If we a re del ighting customers, el iminating u nnecessary cost s and i mproving our products and services, we gain strength. B ut if we t reat customers wi th indifference or tolerate bloat, our businesses will with er. On a daily basis, th e effects of our actio ns are im perceptible; cum ulatively, th ough, their consequences a re enormous. Whe n our l ong-term com petitive position improves as a result of these almost unnoticeable actions, we des cribe the phenomenon as “wi dening the moat.” An d doing that is essent ial if we are t o have the kind of bus iness we want a decade or two from now . We always, of course, hope t o earn m ore money in the sho rt-term. But when short-term and long-term conflict, wid ening the moat must take precede nce. If a managem ent makes bad d ecisions i n order t o hit short-term earni ngs targets, and co nsequently gets behind the eight-ball in terms of cost s, customer sat isfaction or brand strength, no am ount of s ubsequent brillian ce will o vercome the damage that has b een inflicted . Tak e a look at th e dilemmas o f managers in the au to and airlin e industries to day as th ey strugg le with the hug e problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin’s “An ounce of preventi on is worth a pound of cure.” B ut someti mes n o amount of cure will o vercome the mistak es of t he past. Our m anagers focus on moat-wid ening – and are brillian t at it. Quite sim ply, they are p assion ate about their businesses. Usually, they were ru nning those long before we cam e along; our only function since has bee n to stay out of the way . If y ou see t hese her oes – an d our four heroines as wel l – at the annual meetin g, thank them for th e job they do for you . * * * * * * * * * * * * The attitu de of ou r managers vividly contrasts with that of the you ng man who married a tyco on’s only child, a decidedly homely and dul l lass. R elieved, the fath er called in his new so n-in-law after th e wedding and began to discuss the future: “Son , you ’re the boy I always w anted and n ever had. H ere’s a stoc k certificate for 50% of the company. You’re m y equal partner from now on.” “Tha nks, dad .” “Now, what would you like to run? How about sales?” “I’m afraid I couldn’t sell wa ter to a man crawlin g in the Sah ara.” “Well then, how about heading human relatio ns?” “I really don’t care for people .” “No problem, we have lots of other spots in the business. What would you like to do?” “Actually, no thing appeals to m e. Why don’t you just buy me o ut?” 14 --- Page 14 --- Inves tments We sh ow below our common st ock i nvestments. Th ose that had a m arket value of more than $700 million at th e end of 2005 are itemized . 12/31/05 Percent age of Shares Company Company Owned Cost* Market (in $ millio ns) 151,610,700 American Expr ess Co mpany................... 12.2 $1,287 $ 7,802 30,322,137 Ameriprise Finan cial, In c..................... 12.1 183 1,243 43,854,200 Anheuser-Busch Cos., In c.................... 5.6 2,133 1,884 200,000,000 The C oca-C ola Com pany........................ 8.4 1,299 8,062 6,708,760 M&T Bank C orporation .......................... 6.0 103 732 48,000, 000 Moody’s Corporation .............................. 16.2 499 2,948 2,338,961,000 PetroChina “H” sh ares (or equivalents)... 1.3 488 1,915 100,000,000 The Pro cter & G amble Company.......... 3.0 940 5,788 19,944,300 Wal-Mart Stores, Inc.......................... 0.5 944 933 1,727,765 The Washington Post Company.............. 18.0 11 1,322 95,092, 200 Wells Far go & Com pany......................... 5.7 2,754 5,975 1,724,200 White Mountains Insurance ..................... 16.0 369 963 Others...................................................... 4,937 7,154 Total Com mon Stoc ks............................. $15,947 $46,721 *This is our actual purchase price and al so our tax basis; GAAP “c ost” differs in a few case s because of write-ups or write-downs that ha ve bee n require d. A couple of la st year’s cha nges in our portfolio occurred because of c orporate e vents: Gillette was merg ed into Procter & Gam ble, an d American Exp ress s pun off Am eriprise. In addition, we sub stantially increased our holdings in Wells Farg o, a co mpany that Dick Kov acevich runs brillian tly, an d estab lished positions in Anheuser-Bu sch and Wal-Mart. Expect no miracles fr om our equi ty portfolio. T hough we own major interests in a number of strong, highly-profitable businesses, t hey are not selling at anything like bargain prices. As a g roup, they may d ouble in value in ten years. Th e likelihood is th at their p er-share earn ings, in aggregate, will g row 6- 8% per year o ver the decade and that their sto ck prices will more or less match that growth . (Th eir managers , of course, think my expect ations are too modest – and I hope they’re right.) * * * * * * * * * * * * The P&G-Gillette merger, cl osing in the fourth qu arter o f 2005, requ ired Berk shire to record a $5.0 billion pre-tax capital g ain. Th is bookkeeping entry, d ictated by GAAP, is mean ingless from an econ omic standp oint, and you should ignore it when you are eval uating Berkshire’s 2005 ea rnings. We didn’t intend to sell o ur Gillette sh ares b efore th e merger; we do n’t in tend to sell o ur P&G sh ares now; an d we inc urred no tax when the merger t ook place. It’s h ard to overem phasize th e importance of who is CEO o f a co mpany. Befo re Jim Kilts arriv ed at Gillette in 2001, the com pany was strugg ling, having particularly suffered from cap ital-allo catio n blunde rs. In the m ajor exa mple, Gillette’ s acquisiti on of Duracell cost Gillette sharehol ders billions of dollars, a loss never m ade visible by conventional accounting. Quite simply, what Gillette received in business value in this acquisition was not equi valent to what it gave u p. (Amazingly, this most fundamental of yardsticks is alm ost always i gnored by both managem ents and their investment bankers when acqu isitio ns are und er discu ssion .) 15 --- Page 15 --- Upon taking office at Gillett e, Jim quickly in stilled fiscal d iscipline, tig htened operations and energized marketing, m oves that dramatically in creas ed th e intrinsic v alue of the company. Gillette’s merger with P&G the n expa nded the potential of bot h com panies. For his accom plishments, Jim was paid very well – but he earned e very pe nny. (This is no acade mic evaluati on: As a 9.7% owne r of Gillette, Berk shire in effect paid th at propo rtion of his compensatio n.) Indeed, it’s difficu lt to overpay th e truly extraordinary CEO of a giant enterprise. B ut this species is rare. Too often, executive compensatio n in the U.S. is ridiculously o ut of lin e with perform ance. That won’t change, moreover , because t he deck is stacked against investors when it comes to the CEO’s pay. The u pshot is that a mediocre- or-worse CEO – ai ded by his handpicked VP of human rel ations and a consultant from the ever-acc omm odating fi rm of Ratche t, Ratchet and B ingo – all too often receive s gobs of money fro m an ill-d esigned compensation arran gement. Take, for instance, ten year, fixed-price options (and who wo uldn’t?). If Fred Futile, CEO of Stagnant, Inc., receives a bundle of these – let’s say enough to give him an opti on on 1% of t he com pany – his self-in terest is clear: He sh ould sk ip dividends entirely and instea d use all of t he company’s earnings to repurchase stock. Let’s ass ume that under Fre d’s leade rship Stagna nt lives up to its n ame. In each of the ten years after th e option grant, it earns $1 billion on $10 billion of net worth, which initially comes to $10 per share on the 100 m illion sha res then outstanding. Fred esc hews dividends and regularly uses al l earni ngs to repurchase sh ares. If th e stock constan tly sells at ten times earn ings per share, it will h ave appreciated 158% by t he end of t he option period. T hat’s because repurchases would reduce t he number of s hares to 38.7 million by that time, and earnings per share would ther eby increase to $25.80. Simply by withho lding earni ngs f rom owners, Fre d gets very rich, m aking a cool $158 m illion, des pite the business i tself improving not at all. Astonishingly, Fred coul d have m ade more than $100 million if Stagna nt’s ea rnings had declined by 20% during the ten-year period. Fred can also get a splendid resul t for himself by paying no dividends and deploying the earnings he withholds from share holders into a variety of disappointing projects and acquisitions. Even if these initiativ es deliver a paltry 5% return , Fred will still make a bundle. Specifically – with Stagn ant’s p/e ratio remaining unc hange d at ten – Fre d’s option will deliv er him $63 m illion. Meanwh ile, his share holders will wonder what happened to the “alignment of interests” that was s uppose d to occur when Fred was issued options. A “n ormal” divi dend policy, of co urse – one-third of ear nings pai d out, for e xample – pro duces less ex treme resu lts bu t still can provide lush rewards for managers who achieve nothing. CEOs understan d this math and kno w that ev ery dime paid out in dividends reduces th e value of all outstanding options. I’ve neve r, however, seen this manager -owner conflict refe rence d in proxy materials that request a pproval of a fixed-pri ced option plan. Though CEOs invariably preac h interna lly that capital comes at a cost, they so mehow forget to tell share holders that fixed-price opt ions give them capital th at is free. It does n’t have to be this way : It’s chi ld’s play for a b oard to desi gn options that give effect to the automatic build-up in valu e that occurs when ea rnings are retaine d. But – surprise, surprise – options of that kind are almost never issu ed. Indeed, the very though t of options with strike prices th at are adj usted for retained earni ngs seem s forei gn to com pensation “e xperts,” who are nevert heless ency clopedic about every manage ment-frie ndly plan t hat exists. (“Whose bre ad I eat, his song I sing.”) Getting fired can produce a par ticularly boun tiful payday fo r a CEO . Indeed , he can “ear n” more in that sin gle day, wh ile clean ing out his desk, than an American worker ea rns in a lifetim e of cle aning toilets. Forget the old m axim abou t nothi ng succee ding like success: T oday, in the e xecutive s uite, the all- too-prevale nt rule is th at nothing succee ds like failure . 16 --- Page 16 --- Huge severance pay ments, lavish perks and outsized payments for ho-hum perf ormance often occur b ecause comp committees h ave become slav es to comparativ e data. Th e drill is simple: Th ree o r so directors – not chose n by chance – are bombarded for a few hours before a b oard meeting wi th pay statistics th at perp etually ratch et upward s. Additionally, t he committee i s told abou t new perks that other managers a re receiving. In this manner, outlandis h “goodies” are showere d upon CEOs simply becaus e of a cor porate version of the argument we al l used when children: “But, Mom, all the other ki ds ha ve one.” When comp commi ttees fo llow th is “log ic,” yesterd ay’s m ost egre gious excess bec omes today ’s baseline. Comp commit tees shou ld adop t the attitu de of Hank Greenb erg, the Detroit slu gger and a boyhood hero of mine. Hank’s son, Steve, at one time was a player’s a gent. Repr esenting an outfielder in negotiations with a major league cl ub, Steve sou nded out his dad about the size of t he signing bonus he should ask f or. Hank , a true pay-for-performance guy , got straight to the point, “What did he hit last year?” When Steve answered “.246,” Hank’s comeback was imm ediate: “As k for a uniform .” (Let me pause for a brief con fession: In criticizin g comp commit tee behavior, I do n’t speak as a true insider. Though I have served as a director of twenty public companies, only one CEO has put me on his comp commit tee. Hmmmm . . .) * * * * * * * * * * * * My views on America’s long-term problem in resp ect to trade imbalances, which I have laid ou t in previous reports, rem ain unchange d. My conviction, however, cost Berkshire $955 million pre-tax in 2005. That amount is included in our earni ngs statement, a fact that illustrates the differing ways in which GAAP treats g ains and losses. When we have a lo ng-term position in stocks or bond s, year- to-year changes in value a re reflected in our bal ance s heet but, as long as the asset is not s old, are rarely re flected in ea rnings. For example, our Coca-Co la holdings wen t from $1 billion in value early o n to $13.4 billion at yearen d 1998 and have since declin ed to $8.1 billion – with none of th ese m oves affecting our earn ings statemen t. Long-term currency positions, however, are d aily m arked to m arket an d therefo re hav e an effect on earni ngs i n every reporting period. From the dat e we fi rst entered into currency contracts, we are $2.0 billion in th e black. We re duced our direct position in c urrencies so mewhat during 200 5. We p artially o ffset th is change, however, by purchasing equities who se prices are denominated in a variety of foreign currencies and that earn a large part of their profits internationally. Charlie and I prefer this method of acquiring non- dollar exposure. T hat’s largely because of cha nges in interest rates: As U.S. rates ha ve risen relative to those of the rest of the world, holding most foreign currencies now involves a si gnificant negative “ca rry.” The ca rry aspect of our direct currency position indee d cost us m oney in 2005 and is likely to do so again in 2006. In contrast, th e ownership of fo reign equities is lik ely, o ver time, to create a p ositive carry – perhaps a sub stantial one. The underlying factors affecting the U.S. c urrent account deficit continue to worse n, and no letup is in sight. Not only did our trade deficit – the large st and most familiar item in the current account – hit an all-time high in 2005, but we also can e xpect a secon d item – the bal ance of i nvestment income – to soon turn negative. As f oreigners increase t heir ownership of U.S. assets (or of claim s against us) relative to U.S. inv estments abro ad, these in vestors will b egin earning more on their ho ldings than we do on ours. Finally, th e third co mponent of the current acco unt, unilateral transfers, is always negative. The U.S., it sho uld be emphasized , is ex traord inarily rich an d will g et richer. As a resu lt, the huge imbalances in its curre nt account m ay continue for a long time without their ha ving noticeable deleterious effects on the U.S. eco nomy or on markets. I doubt, however, that the situation will forev er rem ain benign. Either Am erican s add ress the p roblem soon in a way we select, o r at so me point the problem will likely address us in an unpleasant way of its own. 17 --- Page 17 --- How to Mini mize Investme nt Returns It’s b een an easy matter for Berk shire an d other own ers of Am erican equities to prosper ov er the years. Bet ween Decem ber 31, 1899 a nd Dece mber 31, 1999, to give a really lo ng-term example, the Dow rose from 66 to 11,497. (Guess wh at annual g rowth rate is requ ired to produce this resu lt; th e surpri sing answ er is at the end of this sect ion.) This huge rise ca me about for a simple reason: Over the century American busi nesses di d ext raordinarily well and i nvest ors rode the wav e of their prosperity. Businesses continue to do well. Bu t now sh areho lders, th rough a series o f self-in flicted wounds, are in a major way cutting the return s they will realize fro m their inv estments. The exp lanation of how th is is h appening b egins with a fu ndamental tru th: With unimportant exceptions , such as ba nkruptcies in whic h some of a com pany’s los ses are borne by cre ditors, the most that owners in aggregate can earn between now and Judgment Day is what their businesse s in aggregate earn. True , by buying and selling that is clever or lucky, investor A m ay take m ore than his share of the pie at the expe nse of investor B. And, yes, all invest ors feel richer when st ocks soa r. But an owner can exit only by having someone take hi s place. If one investor sel ls high, another m ust buy high. For owners as a whole, there is sim ply no m agic – no showe r of m oney from outer space – that will enable them to extract wealth from their companies beyond that cr eated by the com panies them selves. Indee d, owners must earn les s than their businesse s earn because of “fric tiona l” costs. And that’s my point: These costs are now being inc urred in amounts that will cause share holders t o earn far less th an they historically h ave. To understand h ow this toll has ballooned, imagine for a moment that all Am erican corporation s are, and always will b e, owned by a sin gle fam ily. We’ll call th em the Gotrocks. After p aying taxes on dividends, this family – ge neration after generation – becomes richer by the aggregate amount earned by its companies. Today that am ount is about $700 billion a nnually. Naturally, the family spends s ome of these dollars. B ut the portio n it sav es stead ily co mpounds for its benefit. In the Go trocks ho usehold everyone grows wealthier at the same pace, and all is harm onious. But let’s now assum e that a few fast-talki ng Help ers approach the fam ily and persuade each of its members to try to outsmart his relativ es by buying certa in of th eir holdings and sellin g them certain others. The Help ers – for a fee, of cou rse – ob ligingly ag ree to handle these tran sactio ns. Th e Gotrocks still o wn all of c orporat e Am erica; the trades just rearrange who ow ns w hat. So the fam ily’s annual gain in wealth diminishes, e qualing the earnings of Am erican busi ness minus commissions paid. The more that family members trade , the sm aller their sha re of the pie a nd the larger t he slice received by the Helpers. This fact is no t lost upon th ese broker-Helpers: Activity is th eir friend and, in a wide variety o f ways, th ey urge it on . After a while, most of the family members realize that the y are not doing so well at th is new “b eat- my-brot her” game. Ent er another set of Helpers. These newcomers explain t o each m ember of the Gotrocks clan that by himself he’ll neve r outsmart the rest of the fam ily. The suggested cure: “Hire a manager – yes, us – an d get the job done professionally.” Th ese manager-Hel pers co ntinue to use th e broker-Hel pers to execute tra des; th e managers m ay even increase thei r activity so as to permit the brokers to prosper still m ore. Ov erall, a b igger slice of the pie now goes to th e two classes of Helpers. The family’s disappointment grows. Each of its members is now em ploying professionals. Yet overall, the group’s finances have taken a turn for the worse. Th e solution? More help, of co urse. It arri ves in the form of financial p lanners and institutional consultants, who weigh in to advise the Gotrocks on selecting m anager -Helpers. The be fuddled fam ily wel comes this assi stance. B y now its members know they ca n pick neither the right stocks nor the right stock-pickers. Why , one might ask, should they ex pect su ccess in picking the righ t con sultant? But this question does no t occur to the Gotrocks, and the consultant-Helpers certainly don’t suggest it to them. 18 --- Page 18 --- The Gotrocks, now supporting three cl asses of expensive Help ers, fi nd that their results get worse, and they si nk into despair. B ut just a s hope seem s lost, a fo urth group – we’ll call th em the hyper-Hel pers – appea rs. T hese friendly fol k explain t o the Gotrocks that their unsatisfactory re sults are occurrin g because the existing Helpers – brokers , managers , consultants – are not s ufficiently motivated and a re simply going through the motions. “ What,” the new Helpers as k, “ca n you ex pect from such a b unch of zombies?” The new arri vals offer a breath takingly simple so lution: Pay more money . Brimmin g with self- confide nce, the hyper-Hel pers assert that huge c ontinge nt paym ents – in addition to s tiff fixed fees – are what each family member must fork over in order to really outmaneuve r his relatives. The more observant members of the family see that some o f the hyper-Help ers are really ju st manager -Helpers weari ng n ew uni forms, beari ng sewn-on sexy nam es like HEDGE FUND or PRIVAT E EQUI TY. The new Helpers, however, assure the Gotrocks that this change of clothing is all-important, bestowing on its weare rs magical powers si milar to those acqui red by mild-mannere d Clark Kent when he chan ged into his Superm an costume. Calmed by this explanation, the family deci des to pay up. And that’s where we are today: A rec ord portion of the earnings that would go in their entirety to owners – if they all j ust stayed in their rocking chairs – is no w going to a swelling arm y of Helpers. Particularly expensive is the recen t pandemic of profit arrangem ents under whic h Helpers receive large portion s of the winn ings when they are sm art or lu cky, and leav e fam ily members with all o f the losses – and large fi xed fees t o boot – when the Helper s are dum b or unl ucky (o r occasionally crooke d). A su fficien t number of arran gements like this – heads, the Help er tak es much of the winn ings; tails, the Gotrocks lose a nd pay dear ly for the privilege of doi ng so – may make it more accurate to cal l the family the Ha drocks. Today, in fact, the family’s fri ctional cost s of al l sorts may well amount to 20% of the earnings of Am erican business. In ot her words, the burden of paying Helpe rs may cause Am erican equity in vestors, ov erall, t o earn only 80% or so of what they wou ld earn if they just sat still an d listen ed to no one. Long a go, Sir Isaac Newt on gave us t hree la ws of motion, whic h we re the work of genius. But Sir Isaac’s talents didn’t e xtend t o investing: He lost a bundle in the Sout h Sea Bubble, explaining later, “ I can calculate the movem ent of the stars, but not the madness of men.” If he had not been traumatized b y this loss, Sir Isaac might well have gone on to discover the Four th La w of Motion : For i nvestors as a whole, returns decrease as motion increa ses. * * * * * * * * * * * * Here ’s the ans wer to the question posed at the begi nning of this section: To get very specific, the Dow increase d from 65.73 to 11,497.12 in the 20th cent ury, and that amounts to a gain of 5.3% compounde d annually. (Inve stors woul d also have receive d dividends, of course.) T o achieve a n equal rate of gain in the 21st century, t he Dow will ha ve to rise by Dece mber 31, 2099 to – brace yourself – precisely 2,011,011.23. Bu t I’m willing to settle fo r 2,00 0,000 ; six years in to this cen tury, th e Dow h as gained not at all. Debt and Risk As we c onsolidate MidAm erican, o ur new balance s heet may suggest that Berkshi re has expa nded its tolerance for borrowing. But that’s not so. Exce pt for token am ounts, we shun debt, turning to it for only three purposes: 1) We occasional ly use re pos a s a part of ce rtain s hort-term investing st rategies that incorporate ownership of U.S. governmen t (or ag ency) secu rities. Pu rchases o f this kind are highly opportunistic and i nvolve only the most liquid of sec urities. A f ew years ag o, we e ntered i nto several interest ing transactio ns th at have since been unwound or are runn ing off. The offsettin g debt has likewise bee n cut substantially and before long may be gone. 19 --- Page 19 --- 2) We borrow money agai nst portfolio s of interest-bearing receivables whose risk cha racteristics we understand . We did this in 2001 when we gu aranteed $5.6 billion of bank debt to take over, in partnership wit h Leuca dia, a bankr upt Finova (which held a broa d range of receiva bles). All of that debt has been repaid. More rece ntly, we ha ve b orrowed to finance a wi dely-diversified, predictably-perform ing portfolio of m anufact ured-home receiva bles managed by Clayton. Alternatively, we c ould “ securitize” – that is, sell – these receiva bles, but re tain the servicing of them. If we fo llowed this pro cedure, which is co mmon in the industry, we wou ld not show th e debt that we do on our balance sheet, a nd we would als o accelerate the earni ngs we report. In the end, however, we w ould earn less m oney . Were market variables t o change s o as to fa vor securitizatio n (an unlikely ev ent), we cou ld sell p art of our portfolio and eliminate th e related debt. Until then, we prefer b etter pro fits to b etter co smetics. 3) At Mid American , we have substantial d ebt, but it is th at co mpany’s obligation only. Tho ugh it will appear on our consolidated balance sh eet, Berk shire does not guarantee it. Even so, this debt is unquestionabl y secure beca use i t is serviced by MidAm erican’s diversified stream of highly-stab le utility earn ings. If t here were to be so me bolt fro m the blue that hurt one of MidAmerican ’s utility p roperties, earn ings from the others wo uld still b e more th an am ple to cove r all debt requirements. M oreover, MidAm erican retain s all of its earn ings, an equity- building practice th at is rare i n the utility field . From a risk standpoint, it is far safer to have earn ings from ten diverse an d uncorrelated utility operations that cove r interest char ges by, say, a 2: 1 ratio than it is to have fa r greater cove rage provided by a single utility. A catastrop hic event can render a si ngle utility insolvent – witness what Kat rina did to the local electric u tility in New Orleans – no matter h ow conservative its d ebt policy. A ge ographical disaster – say , an e arthquake in a West ern state – can’t have the sam e effect on MidAm erican. And e ven a worrier lik e Ch arlie can ’t think of an event that wou ld syste mically decrease utility ear nings in any major way. Because of MidAm erican’s e ver- wide ning dive rsity of regulated earnings, it will always uti lize major am ounts of debt. And that’s abo ut it. We are no t interested in incurring an y significan t debt at Berk shire for acquisition s or operating purposes. Conv entional business wisd om, of cou rse, would argu e that we are being too conservat ive and that there are a dded profits that coul d be sa fely earned i f we injected m oderate leverage into our balance sh eet. Maybe so. B ut many of B erkshire’s hundreds of thousands of investors have a l arge portion of their net worth in our st ock (among t hem, it shoul d be em phasized, a l arge number of ou r board and key managers ) and a disaster for the com pany would be a disaster for them . Moreove r, there are pe ople who have been permanent ly injured to whom we o we insurance pay ments that stretch out for fi fty years or more. To these an d other con stituencies we h ave promised total secu rity, wh atever co mes: fin ancial panics, stock-exc hange closures (a n extended one occurre d in 1914) or even dom estic nuclear, chem ical or biological attacks. We a re quite willing to acce pt huge risks. Indeed , more tha n any other insure r, we write high-lim it policies th at are tied to sing le catastrop hic events. We also own a larg e investment portfolio whose mark et value cou ld fall d ramatically and quickly under certain conditions (as h appened on Octob er 19, 1987). Whatever occurs, tho ugh, Berkshire will h ave the net worth, th e earn ings stream s and the liq uidity to handle the prob lem with ease. Any other a pproach i s dangerous. Over the years, a n umber of very smart peo ple have learne d the hard way th at a long string of im pressiv e numbers m ultiplied by a single zero always eq uals zero . That is not an equation whose ef fects I wo uld like to experience pers onally, and I would like eve n less to be respon sible for imposing its penalties up on others. 20 --- Page 20 --- Manageme nt Succession As owners, you are naturally concerned about whether I will in sist on continuing as C EO after I begin to fade and, if so , how the board will han dle that problem. Yo u also wan t to know what happens if I should die tonight. That second question is eas y to answer. Most of our many busi nesses ha ve st rong m arket positions, sign ifican t momentum, and terrifi c managers. The special Berk shire culture is deeply ingrained throughout our sub sidiaries, an d these op erations won’t m iss a beat whe n I die. Moreover, we have three m anage rs at Berkshire wh o are reason ably young and fully capable of being CEO. Any of the three w ould be much better at certain manage ment aspect s of my job t han I. On the minus si de, none has m y cross over e xperience t hat allows m e to be comfortable making deci sions in either th e business aren a or in investments. Th at problem will b e solved by having anoth er person in the organizatio n handle marketable securities. Th at’s an interestin g job at Berk shire, and th e new CEO wil l have no problem in hiring a talented individual to do it. Indeed , that’s what we have done at GEICO for 26 years, and our resu lts have been terrific. Berkshire’s board has fully discuss ed eac h of t he three CEO can didates and has unanimously agree d on the person who s hould succeed me if a repl acement were needed toda y. The directors stay updated on this subject and could alter their view as ci rcumstances cha nge – new m anage rial stars may emerge and presen t ones will ag e. Th e important point is th at the directors know now – and will always know in th e future – ex actly wh at they will do when the need arises. The other questio n that must be addressed is wh ether the Board will b e prepared to make a ch ange if that need should arise not from my death but rathe r from my decay, particularly if this decay is accom panied by my delusionally thi nking that I am reac hing ne w peaks of m anage rial brilliance. That problem woul d not be uni que to me. Charl ie and I have faced this situ ation from t ime to time at Berks hire’s subsidiaries . Humans age at greatly varyi ng rates – b ut sooner or later their talents and vigor declin e. Some managers remain effectiv e well in to their 80s – Charlie is a wo nder at 82 – and others noticeably fade in their 60s. When their abilities ebb, so usually do their powers of self-assessm ent. Someone el se often needs to blow the whistle. When that time co mes for me, o ur board will h ave to step up to the job. From a financial standpoint, its members are un usually m otivated to do so. I kno w of no other board in the coun try in which the financial interests of directors are s o completely aligned wi th those of shareholders. Few b oards even come close. On a personal level, howe ver, it is e xtraordinarily d ifficu lt for most people to tell so meone, particularly a fr iend, that he or she is no longer capable. If I become a candidate fo r that message, however, ou r board will be d oing me a favo r by delivering it. Every share of Berk shire th at I own is destined to go to philanthropies, and I want s ociety to reap t he maximum good from these gi fts and bequests. It woul d be a t ragedy if the philanthropic potential of my holdings was d iminished because my asso ciates shirked their respo nsibility t o (tend erly, I hope) show m e the door. B ut don’t worry ab out this. We have an outstan ding group of directo rs, an d they will alway s do what’s right for shareholders. And while we are on the s ubject, I feel terrific. The Annual Meeting Our m eeting this year will b e on Saturd ay, May 6 . As always, th e doo rs will o pen at th e Qwest Center at 7 a.m., and the latest Berk shire movie will b e shown at 8:30. At 9 :30 we will g o directly to the question-and-an swer p eriod, which (with a break for lunch at th e Qwest ’s stan ds) will last u ntil 3:00. Then, after a sho rt recess, Ch arlie an d I will co nvene the annu al meetin g at 3:15. Th is sch edule wo rked well las t year, because it let those who wante d to attend the form al session to do so, while freeing others to shop . 21 --- Page 21 --- You certain ly did your share in this resp ect last year. Th e 194,300 square fo ot hall adjo ining the meetin g area was filled with th e products of Berksh ire subsidiaries, and the 21,000 people wh o cam e to the meetin g allowed every locatio n to rack up sales record s. Kelly Bro z (neé Mu chemore), th e Flo Zieg feld of Berks hire, orc hestrates both this magnificent shopping extravaga nza and the m eeting itself. T he exhi bitors love her, and so do I. Kelly got married in October, and I gave her away. She asked me how I wanted to be listed in the wedding program. I replied “envious of the groom,” and t hat’s the way it went to press. This year we will showcase two Clayto n ho mes (featuring Acm e brick, Shaw carpet, John s Manville in sulation, MiTek fasten ers, Carefree awnings and NFM furnitu re). You will find that these homes, pri ced at $79,000 and $89,000, deliver excel lent value. In fact, three sha reholders cam e so fi rmly to that con clusion last year that th ey bought the $119,000 model we t hen showcased. Flanking the Cl ayton homes on the exhibition floor will b e RVs from Forest River. GEIC O will h ave a boo th staffed by a nu mber of its to p counselors from around the coun try, all of them read y to supply you with auto insuran ce quotes. In m ost cases, GEICO will b e able to give yo u a special shareholder discount (us ually 8%). This sp ecial offer is perm itted by 45 of the 50 jurisdictions in which we operate. (On e supplemental point: The discount is not additive if you qualify fo r ano ther, such as that given cert ain groups.) Bring the details of y our existing insurance a nd check out whet her we ca n save you m oney . For at least 50% of you, I believe we ca n. And while you’re at it, sign up for the new GEICO credit ca rd. It’s the one I now use . On Saturd ay, at the Omaha airpo rt, we will have the usual array of aircraft from NetJets® availab le for your insp ection . Stop by the NetJets boo th at the Qwest t o learn a bout view ing these planes. Come to Omaha by bus; leav e in your new plane. The Bookworm bouti que at the Qwest broke all rec ords last year selling Berk shire-related books . An amazing 3,500 of these were Poor Charlie’s Almanack , the collected wi sdom of my part ner. This mean s that a co py was so ld every 9 second s. And for good reaso n: You will never find a book with more useful ideas. Word-of-mouth recom menda tions have ca used Charlie’s first printing of 20,500 copies to sell out, and we wi ll therefore have a revi sed and expa nded edition on sale at our meeting. Among t he other 22 titles an d DVDs av ailab le last year at t he Book worm, 4,597 cop ies were so ld for $84,746 . Our share holders are a bookseller’s dream . An attachm ent to t he proxy material that is encl osed w ith th is report explains how you can obtain the cred ential yo u will n eed for ad mission to the meeting and other events. As fo r plane, ho tel and car reser vations, we have a gain signed up American Ex press (800-799-6634) to give you special help. Carol Pede rsen, who handles t hese matters, doe s a terrifi c job for us each year, a nd I tha nk her for it. At Ne braska Furniture Mart, located on a 77-ac re site on 72nd Street between Dodge and Pacific, we will ag ain be having “Berk shire Week end” pricing . We in itiated this special ev ent at NFM n ine years ago, and sales during the “Weeken d” grew from $5.3 m illion in 1997 to $27.4 million in 2005 (up 9% f rom a year earlier). I get goose bumps just thinking abou t this volume. To obtain th e discoun t, you must make your purchases betw een Thu rsday, May 4 and Mo nday, May 8 inclusive, an d also present your m eeting cred ential. Th e period’s sp ecial p ricing will ev en apply to the products of several prestigious m anufact urers that normally have i ronclad rules aga inst discounting but that, in the spirit of our shareholder week end, have made an exce ption for y ou. We a ppreciate their cooperation. NFM is open from 10 a.m. to 9 p.m . Monday through S aturday, and 10 a.m. to 6 p. m. on Sunday . On Saturday this year, from 5:30 p.m. to 8 p.m., we a re having a speci al affair for shareholders only. I’ll be there, eat ing barbeque, drinking Coke, and counting sales. Borsheim ’s again will have t wo shareholde r-only eve nts. The first will be a coc ktail reception from 6 p.m. to 10 p.m. on Frid ay, May 5 . The second , the main gala, will b e from 9 a.m. to 4 p.m. o n Sunday, May 7. On Saturd ay, we will b e open until 6 p.m . 22 --- Page 22 --- We w ill have h uge crow ds at Bo rsheim’s th roughout the weekend. Fo r your con venience, therefore, sh areholder prices will b e available fro m Monday, May 1 through Saturd ay, May 1 3. During that period, just identify yoursel f as a s hareholder through your m eeting c redentials or a brokerage statement. Borsheim’s op erates on a gross margin that, even before the share holders’ discount, is fully twenty perce ntage points below that of its major ri vals. Last year, our sha reholder-period business increased 9% from 2004, which cam e on t op of a 73% gain the year before. The store sold 5,000 Berkshire Monopoly games – and then ran ou t. We’ve learn ed: Plenty will b e in stock this year. In a ten t outside of Borsheim’s, Patrick Wolff, twice U.S. ch ess ch ampion, will tak e on all co mers in groups of six – blindfolded. Add itionally, we will h ave Bob Hamm an and Sh aron Osberg, two of th e world’s top bridge e xperts, available to play with our shareholders on Sunday afternoon. They plan to keep their eyes open – but Bob never sorts his cards, eve n when playing for a national champions hip. Gorat’s – my fav orite steak house – will again be open exclu sively for Berk shire sh areholders on Sunday, May 7, and will b e serv ing from 4 p.m. until 10 p.m. Please re member that to come to Gorat’s o n that day, you must have a reservation . To make one, call 4 02-551-3733 on April 1 (but not before). In this schoo l year, ab out 35 university classes will co me to Omaha for sessio ns with me. I tak e almost all – in aggregate, perhaps 2, 000 students – to lunch at Gorat’s. And they lov e it. To learn why, come join us on Sunday . We will again have a special r eception from 4:00 to 5: 30 on Saturd ay afternoon for sha reholde rs who have come from outside of North America. E very year our meeting dra ws many people from around the globe, and Charlie and I want to be sure we pe rsonally greet those who have come so fa r. Last year we enjoyed meeting m ore than 400 of you from many dozen s of c ountries. Any shareholder who comes from other than the U.S. or Canada will b e given a special cred ential an d instructio ns for attend ing this function. * * * * * * * * * * * * Charlie and I are ex traord inarily lu cky. We we re born in America; had terrific parents who saw that we go t goo d educatio ns; h ave enjoyed wond erful families an d great h ealth ; and came eq uipped with a “business” gene that allows us t o prosper in a m anner hugely disproportionate to other people who contribute as much or m ore to our society’s well-being. Moreover, we have l ong had jobs that we l ove, in which we are helped every day in countless ways b y talented and chee rful associ ates. No wonder we tap- dance t o work. But nothing is more fu n for us than getting together with our shareholder-partners at Berk shire’s annual meetin g. So join us on May 6th at the Qwest fo r our annual Wood stock for Capitalists. We’ll see y ou there. February 28, 2006 Warren E. Buff ett Chairm an of the Board 23