November 7, 2007
sponsored by Tavant
ISSN 1550-9214         

Dell's Warranty Accounting:

While it came up short in terms of scandal and financial impact, Dell's accounting investigation did produce one benefit. At long last, the company separated its basic and extended warranty programs. And it turns out that extended warranty was even bigger than we thought.

It took more than a year to complete and required hundreds of people to complete it, but at long last Dell Inc. has released the results of its internal investigation into various accounting scandals. And the results are underwhelming in almost every respect but one: Finally, now we can see the exact numbers and separate balances for product warranty and extended warranty that we could only estimate a year or two ago.

Basically, this investigation came about after Dell was caught manipulating its accruals so that certain sectors of the company could "make their numbers" at the end of each quarter. But the restated numbers from those irregularities and others produced only minor changes to net income and earnings per share. They were a little larger than rounding errors but a lot smaller than the numbers coming out of the sub-prime mortgage mess. So if on a scale of 1 to 10 Enron and WorldCom were a 10, this was more like a 2.

Investors justifiably shrugged it off. Shares closed up 35 cents per share on the day of the announcement, and went up a bit further on unusually high trading volume the following day. There were the obligatory articles in the financial press, but the whole matter was largely forgotten by the weekend. Still, there were the predictable apologies and promises that it will never happen again.

Dell Statement

"We are disappointed that these errors and irregularities occurred," wrote chairman Michael Dell in an online statement. "But we also believe that the rigorous examination of our accounting and finance processes, along with the remedial actions taken and planned, have made and will continue to make Dell a far stronger company and provide a solid foundation on which to move the business forward and focus our energy on serving our customers. And we have a renewed focus on achieving and maintaining a strong control environment, high ethical standards and financial reporting integrity."

In Dell's annual report for the fiscal year ended Feb. 2, 2007, the company explained the investigation and its findings. Some highlights:

"The scope of the investigation was determined by Willkie Farr, in consultation with the Audit Committee and KPMG," Dell's statement said. "Willkie Farr and KPMG assembled an investigative team that ultimately consisted of more than 375 professionals, including more than 125 lawyers and 250 accountants. Investigative teams were deployed in our three geographic regions � Americas (including our corporate functions), EMEA, and APJ. Information and documents were gathered from company personnel worldwide. Using proprietary search software, the investigative team evaluated over five million documents. Investigative counsel also conducted over 200 interviews of approximately 150 individuals..."

In a section entitled, "Summary of Investigation Findings," Dell describes what its investigation uncovered:

"The investigation raised questions relating to numerous accounting issues, most of which involved adjustments to various reserve and accrued liability accounts, and identified evidence that certain adjustments appear to have been motivated by the objective of attaining financial targets. According to the investigation, these activities typically occurred in the days immediately following the end of a quarter, when the accounting books were being closed and the results of the quarter were being compiled. The investigation found evidence that, in that timeframe, account balances were reviewed, sometimes at the request or with the knowledge of senior executives, with the goal of seeking adjustments so that quarterly performance objectives could be met. The investigation concluded that a number of these adjustments were improper, including the creation and release of accruals and reserves that appear to have been made for the purpose of enhancing internal performance measures or reported results, as well as the transfer of excess accruals from one liability account to another and the use of the excess balances to offset unrelated expenses in later periods. The investigation found that sometimes business unit personnel did not provide complete information to corporate headquarters and, in a number of instances, purposefully incorrect or incomplete information about these activities was provided to internal or external auditors."

Down a bit, in a section entitled "Warranty Liabilities," Dell included more specific information:

"The issues related to Dell�s warranty liabilities include situations where certain vendor reimbursement agreements were incorrectly accounted for as a reduction in the estimate of the outstanding warranty liabilities. There were also instances where warranty reserves in excess of the estimated warranty liability, as calculated by the warranty liability estimation process, were retained and not released to the income statement as appropriate. Additionally, certain adjustments in the warranty liability estimation process were identified where expected future costs or estimated failure rates were not accurate."

Adjustments were made to the relevant accounts, which also required a restatement of revenue, expenses and net income. In the end, the effect were minor. For instance, in the fiscal year ended Feb. 3, 2006, restated revenue decreased by 0.2%, restated net income increased by 0.8%, and earnings per share went from $1.49 to $1.50.

Separate Basic & Extended Warranty

There was, however, one very important aspect to all the restatements. At long last, Dell has separated its basic and extended warranty accounting! And what a surprise it contains. It turns out that basic warranty expenses are much smaller, and extended warranty revenues are much larger, than anyone outside the company ever imagined.

Let's start with a revisit to past articles about Dell. In a January 9 newsletter from earlier this year, we looked at one possible scenario for separating Dell's basic product warranty and extended warranty accounting. Two years ago, in an October 15 newsletter, we looked at another possible scenario for separating the two, which even took a stab at figuring out what percentage of Dell's operating income came from extended warranties.

In Figure 1 below, we're summarizing what we believed to be true until we were proven so very wrong last week. We formerly believed that Dell's extended warranty program was growing so fast that it eclipsed the basic product warranty program two or three years ago. As it turns out, extended warranty has been massively much larger since at least the beginning of 2004, if not longer. They were never of comparable size.

The Old Estimates

Figure 1, based on previously filed financial reports, estimated that Dell began 2004 with a basic product warranty reserve of $1.669 billion and a pool of $1.025 billion in deferred extended warranty revenue. For anyone keeping track, that's a ratio of 62% to 38% on a combined balance of $2.694 billion.

By early 2006, we had estimated that the ratio had swung the other way, with 48% of $4.572 billion held as product warranty accruals and 52% as extended warranty deferred revenue. Boy were we wrong!


Figure 1
Dell's Basic vs. Extended Warranties:
Relative Reserve Fund Balances, 2004-2007
(estimated before the revisions)

Figure 1


Just for giggles, we carried our assumptions through to the end of the most recent fiscal year, where we estimated 44% of $5.179 billion to be held for product warranty and 56% for extended warranty.

The New Estimates

When Dell released its restated financials, it eliminated the need to estimate the separations. Now we know them for sure. Figure 2 includes the actual fund balances held for product warranty and extended warranty from Jan. 30, 2004 to Feb. 2, 2007. As is obvious, extended warranty funds have never been close to equal with product warranty funds.

As of Jan. 30, 2004, the ratio was 24% to 76%. By Feb. 2, 2007 it was 18% to 82%. In other words, it was never either slightly above or slightly below 50/50. It was never even close. Instead, the extended warranty fund went from three times larger to more than four times larger.


Figure 2
Dell's Basic vs. Extended Warranties:
Relative Reserve Fund Balances, 2004-2007
(estimated after the revisions)

Figure 2


The combined balances had also changed in the restatements, but only slightly. As of Jan. 30, 2004, the combined balances decreased by $8 million to $2.686 billion. The combined balances a year later were revised up by $32 million. As of Feb. 3, 2006, the combined balances had increased by $86 million. And of course, the combined balances as of Feb. 2, 2007 had never before been announced, so there was no revision required.

Traditionally, manufacturers have kept basic and extended warranty in separate accounts. For instance, in that Oct. 25, 2005 newsletter, the basic and extended warranty operations of Apple Inc. and Gateway Inc. were also profiled, based on the way they disclosed their separate accounts. In fact, of the 900 manufacturers tracked by Warranty Week, only Dell, Cummins Inc. and American Standard have ever combined their basic and extended warranty fund balances.

Still No Comment

Dell declined to comment back in 2005 upon our estimates of how its accounts should be separated. This week, the company once again declined to comment upon our analysis. If at some future point they should choose to confirm or refute these conclusions, their input will be welcome.

Then again, while the company had the opportunity to correct our mistaken estimates two years ago, what we're presenting here is more fact-based. The problem is that Dell's revision and separation of its warranty accounts went only as far back as early 2004, and did not cover 2003. In addition, the revisions for 2004 came only in the annual statement, and not any of the individual quarterly reports. So we still need to make some estimates.

In Figure 3, we've attempted to track the balance in the basic product warranty reserve fund since early 2003. But, the first four quarters are still estimates based on inappropriately combined data, and the next four are quarterly estimates based on annual data. However, the most recent 11 quarters are based on the newly revised and separated accounting.

Figure 3 shows a warranty reserve that has slowly grown from $633 million as of Jan. 30, 2004 (1Q04 on this chart) to $722 million a year later (1Q05), to $951 million by Feb. 3, 2006 (1Q06), and finally $958 million by Feb. 2, 2007 (1Q07). It never exceeded $1 billion in size.


Figure 3
Dell's Warranty Reserves, 2003-2007
(in millions of dollars and months of capacity)

Figure 3


We'll spare you the old numbers we had before. Suffice it to say that we had assumed the warranty reserve was gradually increasing in size and had reached $2.2 billion by early 2005. In terms of capacity to pay claims, we had estimated that it peaked at 21 months in late 2004. As Figure 3 shows, it had never exceeded 12 months, meaning that Dell has always kept a bit under a year's worth of reserves on hand to pay future claims (about right given the average length of its warranties).

Revisions to Claims & Accrual Totals

The other major correction we need to make is to the figures for warranty claims and accruals. Dell restated its dollar figures for both metrics, and also restated its revenue figures, so the percentages calculated from those figures changed significantly.

Dell formerly published a combined figure for deferred extended warranty revenue and product warranty accruals. Now it publishes those figures separately. Dell formerly published a combined total for all claims paid, be they from product warranty or extended warranty policies. Now, we believe, the company publishes only the product warranty figures.

We specifically asked for clarification on this point but have not yet received a reply. But in comparing the old and the new figures, we noticed that claims for the year ended Jan. 28, 2005 dropped from $1.176 billion in the old report to $763 million in the new report. Does that mean $413 million of those were extended warranty claims? Likewise, in the following fiscal year claims were revised down by $489 million. Was this the extended warranty share?

In Figure 4, we're tracking just the now-separated product warranty figures for claims and accruals. As can be seen, the claims and accrual rates we used to think were closer to 4.0% have actually been below 3.0% most of the time, with the exception of the dramatic spike in the quarter covering August to October 2005 (4Q05).


Figure 4
Dell's Warranty Claims & Accruals, 2003-2007
(in percent of sales and millions of dollars)

Figure 4


As with Figure 3, the 2003 data is the same as before. It just goes to show how things looked when basic product warranty and extended warranty accounts were combined. And then the 2004 data is estimated based on a single annual report chopped into four pieces. But the most recent 11 quarters are derived from the restatements released by Dell last week.

There is one more dramatic effect that we're not going to reduce to graphs just yet. And that's got to do with the way that Dell's new accounting has revised the totals down for both the computer industry and for manufacturers in general. Already, we have revised the claims totals downward by some half a billion dollars per year for all U.S. manufacturers, to $27.6 billion in calendar 2006, and $26.9 billion for calendar 2005. But we'll leave the exact analysis until the end of this year, which has only eight weeks left to it.


Announcing a Global Automotive Warranty Survey

BearingPoint, the Automotive Industry Action Group (AIAG), the Original Equipment Suppliers Association (OESA), the European Association of Automotive Suppliers (CLEPA), and Warranty Week are jointly sponsoring a global automotive warranty survey.

Bob Baxendale, a senior manager in the automotive practice at BearingPoint, said that emails and news bulletins are now going out from key members of the various warranty councils and early warning standards teams of these sponsors, telling their co-workers that the survey is now available and will remain online throughout the month of November.

This survey will examine how automotive OEMs and suppliers are working together more effectively to deliver a higher quality experience for the consumer. More specifically, the survey will provide information and insight for OEMs and suppliers to:

  • Increase consumer satisfaction and loyalty,
  • Improve collaboration among supply chain partners,
  • Reduce incident rates and improve part and vehicle quality,
  • Reduce time to identify and correct concerns (detection-to-correction), and
  • Reduce overall cost of warranty.

The questions are in English, but to encourage more people in Europe and Asia to take the survey, it has also been translated into Chinese, French, Japanese, and Portuguese, with additional translations expected soon into Spanish and German.

Baxendale said the survey should take around 20 or 30 minutes to complete. If that can't be done in one sitting, it can be split up into multiple sessions. All respondents who complete the survey and include their contact info will receive a copy of the results, and will be entered into a contest to win a Garmin nüvi GPS receiver. The names of all participants will remain confidential.

Results are expected in January. BearingPoint will present the results at the next Warranty Chain Management Conference in San Diego. OESA and AIAG may sponsor additional breakfast meetings where their members can discuss the results with the BearingPoint team, Baxendale said. "We've also talked about setting up a Webinar for people who are not local," he added. "And we've been asked by CLEPA to do a meeting with their members, and to do a separate report on the European suppliers."


The IWCM Launches a Best Paper Award for 2008

IWCMThe Institute of Warranty Chain Management (IWCM) is pleased to launch a contest to encourage the creation and documentation of ideas and best practices in the warranty industry. Authors are invited to submit papers on warranty-related subjects which encompass the whole warranty value chain.

Glen Griffiths, president of the Institute, said it's part of an effort to generate content, which in turn will be offered to members. "We want to encourage people to write papers about warranty," he said. Basically, there are numerous PowerPoint slide decks floating around, but not a whole lot of Word documents.

Papers must be written in English and should contain a minimum of 5,000 and a maximum of 10,000 words and must include an executive summary and/or abstract as part of the word count. Papers must be submitted to the IWCM via email to Alison.Griffiths@iwcm.org by 5pm PST on Wednesday, January 16, 2008. The winner of the competition will be informed via email by Thursday, January 31, 2008, and will be announced publicly at the WCM Conference.

Papers will be judged on relevance and comprehensiveness of subject content, originality and contribution to warranty thinking. The paper determined by the IWCM review committee as winning this competition, based on the above criteria, will be invited to present their paper at the Warranty Chain Management Conference in San Diego. The winner will qualify for a round trip coach class ticket to San Diego (up to $1,000), three nights hotel accommodation at the Hyatt Regency and entrance to the WCM Conference itself (total value of $2,900).

Subjects eligible for the award include, but are not restricted to:

  • Warranty Management,
  • Warranty Management Systems,
  • Managing the End-to-end Warranty Chain,
  • Warranty Policy,
  • Warranty Administration and Registration,
  • Warranty Tools and Techniques,
  • Early Warning Systems,
  • Warranty Service and Support Chain,
  • Warranty Logistics and Supply Chain,
  • Extended Warranties,
  • Warranty Benchmarking and Metrics,
  • Warranty Cost reduction,
  • Design for Warranty, and
  • Finance aspects of Warranty.

All decisions by the IWCM review committee on the winner of the competition are considered final. This prize is not transferable. A substitute cash prize of $750 will be available if the winner is unable to attend or present at the WCM conference.

Tavant

 

This Week’s Warranty Week Headlines

Tasmanian government to drop mandatory home owners' warranty insurance system, sources say.
Australian Broadcasting Corporation, November 8, 2007
General Motors reports a net loss of $39 billion but sees better warranty performance.
Press Release, November 7, 2007
Virginia judge says state's lemon law alpplies to recreational vehicles.
WDBJ-TV Roanoke, November 7, 2007
ServicePower Technologies plc appoints Mark Duffin to be new CEO.
Press Release, November 7, 2007
EU clears Advent International takeover of Domestic & General Group LLC.
International Herald Tribune, November 6, 2007
 

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Mize Warranty Connect

 

Warranty Headlines (cont’d)

Consumer Reports finds rear-projection TVs to be much more repair prone than LCD or plasma sets.
Dealerscope, November 6, 2007
Rainmaker Systems Inc. signs new Fortune 500 client for its Post Warranty Services.
Press Release, November 6, 2007
Delphi reports net loss and $124 million in third quarter warranty accruals.
Press Release, November 6, 2007
TurboChef CEO notes lower warranty expenses in third quarter earnings announcement.
Press Release, November 6, 2007
Warranty work by Parsons subcontractor at Baghdad Police College fails to fix plumbing woes.
International Herald Tribune, November 6, 2007
 

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PCMI - Your technology partner

 

Warranty Headlines (cont’d)

National Auto Warranty Services buys fiber network from Qwest for its call center.
Press Release, November 6, 2007
New Holland's three-year tractor warranty helps seal the deal for a County Tipperary farmer.
Irish Independent, November 6, 2007
Chris U’dell is appointed commercial director of the UK's AA Warranty.
Insurance Daily, November 6, 2007
Bioscope shoots a time traveling TV ad for Kia touting its 10-year warranties.
Filmmaker South Africa, November 6, 2007
Leading extended warranty administrators explain how they price plans for new technologies.
This Week in Consumer Electronics, November 5, 2007
 

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After Warranty Analytics

 

Warranty Headlines (cont’d)

Economist likes to take risks while his wife prefers to buy extended warranties and insurance.
Sify Ltd., November 5, 2007
Columnist says length of water heater's warranty is an excellent method to compare quality
James Dulley Advice Column, November 4, 2007
John Deere lengthens warranties on Select Series tractors to four years.
Press Release, November 2, 2007
New Jersey levies $120k fine against Corfacts Inc., aka Metro Marketing, National Warranty Division, and Warranty Warehouse.
Asbury Park Press, November 2, 2007
Loser of file sharing lawsuit says Best Buy replaced her hard drive under extended warranty.
P2Pnet News, November 2, 2007
 

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Warranty Headlines (cont’d)

Force10 Networks adopts SigmaQuest's On-Demand suite of SigmaSure products.
Press Release, November 1, 2007
First American partially blames higher home warranty claims for drop in profits.
Press Release, November 1, 2007
In a possible dig at the locked iPhone, Nokia advertises its mobile phones as unlocked.
New York Times, November 1, 2007
Ontario Motor Vehicle Industry Council warns Canadians tempted by lower U.S. auto prices.
Press Release, November 1, 2007
Consumer Reports holiday shopping poll predicts 37% will buy extended warranties, down from 42% in 2006.
Consumer Affairs, November 1, 2007
 

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Entigo

 

Warranty Headlines (cont’d)

Zürich Beteiligungs acquires auto extended warranty company Real Garant Versicherung AG.
Insurance Journal, October 31, 2007
Service Net Solutions to administer service contracts for Trek Bicycle Corp.
Louisville Courier-Journal, October 31, 2007
Toronto law firm accuses automakers of collusion to protect Canada from cheaper iimports.
Barrie Advance, October 31, 2007
Dell files past-due financial reports with the SEC; reduces net income by $92 million.
Computer Reseller News, October 30, 2007
J.D. Power says high reliability of major appliance may reduce need for extended warranties.
Press Release, October 30, 2007
Tenacity helps Gateway customer get her cracked laptop screen fixed for half price.
Baltimore Sun, October 30, 2007
InFocus points to lower warranty costs as reason for improved gross margins.
Press Release, October 30, 2007
Vermeer Manufacturing to use 4CS iWarranty software for warranty claims processing.
Press Release, October 29, 2007
Datacom Warranty Corp. to administer extended warranties for Brookside Technology Holdings Corp.
Press Release, October 29, 2007
Assurant Solutions lists the values behind the purchase of a service plan.
Press Release, October 29, 2007
Omni Warranty Corp. appoints Vince Callaghan to head new Consumer Electronics Division.
Market News, October 29, 2007
Gamestop tells its cashiers to no longer offer Xbox 360 Product Replacement Plans.
Gamers Report, October 27, 2007
Welch Allyn Protocol Inc. recalls Automatic External Defibrillators made from March to Aug.
Press Release, October 26, 2007
Finbarr O’Neill leaves Reynolds and Reynolds one year after merger with Universal Computer Systems.
Press Release, October 26, 2007
Chevron and Cummins test B20 biodiesel fuel mix in a Bay Area bus fleet.
Industry Week, October 26, 2007
Navistar increases warranty reserves by $321 million, part of preliminary restatement of 2003-2005 results.
Press Release, October 25, 2007
Omni Warranty Corp. to administer service contracts for Volkswagen Canada.
Press Release, October 25, 2007
Metso Minerals’ profitability impacted by "exceptionally high" warranty repair costs.
Press Release, October 25, 2007
Anthony John Scott of Homesafe -- issuer of builders warranty bonds -- pleads guilty to fraud.
Money Management, October 25, 2007
Owner of closed puppy farm in UK cites 72-hour warranty as proof of good conditions.
Wiltshire Gazette & Herald, October 25, 2007
ServiceBench combines its Warranty solution with ClickSoftware’s ServiceOptimization suite.
Press Release, October 24, 2007
Rusted screws at Westpac Stadium in Wellington may be covered under warranty.
New Zealand Herald, October 24, 2007
Subcontractors take back parts as builder Neumann Homes files for bankruptcy.
Lake County News-Sun, October 24, 2007
Renault touts reliability by backing new Laguna with a three-year warranty.
Irish Independent, October 24, 2007
Dell & Sony start extended warranties when PC is ordered; HP starts when it arrives.
PC World, October 23, 2007
Apple and Lenovo/IBM get highest reliability scores in Rescuecom service call study.
Press Release, October 23, 2007
Logistics costs and delays can negate wage advantages of electronics manufacturing in China.
EMS Now, October 23, 2007
First American Home Buyers Protection Corp. allows out-of-network plumber to fix broken pipe.
Fort Worth Star-Telegram, October 23, 2007
As a goodwill gesture, Fidelity Warranty Services pays labor for leaking Saab.
Miami Herald, October 23, 2007
Toyota's "warranty enhancement" to pay for repairs to Sienna doors that close unexpectedly.
Milwaukee Journal-Sentinel, October 23, 2007
Mitsubishi Caterpillar Forklift America to use the 4CS Supplier Warranty application.
Press Release, October 23, 2007
Powertrain Engineering and Manufacturing Alliance gets $4.9 million grant to improve engine quality.
Press Release, October 22, 2007
MSX International Inc. acquires Actuate Business Solutions Ltd. for undisclosed price.
Press Release, October 22, 2007
Cisco Capital Remarketing fights counterfeits by selling used equipment with full warranties.
Network World, October 22, 2007
Study finds $3.5 billion sales of recycled handsets covered by like-new warranties.
Press Release, October 22, 2007
Cirrus Research plc lengthens warranty on doseBadge personal noise dosemeter system to 12 years.
Press Release, October 22, 2007 (Word file)
Airbags fail to deploy in two Dodge Caravan collisions, blamed on brass sensor corrosion.
Kansas City Star, October 20, 2007
Astar Electronics forced into liquidation after losing lawsuit, suspends warranty service.
This Week in Consumer Electronics, October 18, 2007
Suzuki offers five-year warranty on outboard engines bought before end of year.
Motor Boat & Yachting, October 18, 2007
Tasmanian politicians urge government to scrap the last resort Home Owners Warranty.
Press Release, October 18, 2007
Apple to release a mobile software development kit for iPhone developers in February.
IDG News Service, October 17, 2007
Toyota Tundra, Camry, and Lexus GS get below average ratings in Consumer Reports survey.
Chicago Tribune, October 17, 2007
Cross Country Home Services launches Green Network Solutions to tout energy efficient appliances.
Press Release, October 17, 2007
Leath Furniture and Modernage go under, taking their extended warranties with them.
Miami Herald, October 17, 2007
 

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