Windfall for Warranty Managers:
FASB requires U.S. manufacturers to include never-before-seen details on product warranty costs and reserve fund balances.
American manufacturers spent over $5.7 billion honoring their product warranties during the first quarter of 2003, meaning that the warranty business is perhaps now around $23.5 billion in size annually. The aggregate of some 750 manufacturing companies' warranty reserve funds topped $32.9 billion as of March 31, the amount taken out of these funds during the first three months of the year to satisfy warranty claims exceeded $5.7 billion, and the amount added to the funds to provide for newly-issued warranties topped $6 billion.
General Motors Corp. is by far the biggest warranty spender, followed by Ford Motor Co., Hewlett-Packard Co., Dell Inc., IBM Corp., and Caterpillar Inc. Together the top 25 spent a net amount just over $4.24 billion on warranty claims during the first quarter, while the other 650 companies on the list so far spent $1.46 billion.
Here, for the first time, is a chart of the top of the pyramid: a list of the top 25 U.S.-based warranty providers, ranked by the dollar amounts they spent satisfying warranty claims during the first quarter of 2003.
Top U.S.-Based Warranty Spenders
First Quarter, 2003
(all figures in $US millions)
|Parent Company||Revenue||Claims||of Sales|
|General Motors Co.||$38,777||$1,096||2.8% (4)|
|Ford Motor Co.||$34,200||$834||2.4% (4)|
|Hewlett-Packard Co.||$14,446||$581||4.0% (4)|
|Dell Inc. (1)||$8,851||$217||2.7%|
|IBM Corp.||$5,808||$190||3.3% (4)|
|Caterpillar Inc.||$4,424||$117||2.6% (4)|
|United Technologies||$4,864||$113||2.3% (4)|
|Sun Microsystems (3)||$1,930||$106||5.2% (4)|
|Cisco Systems (3)||$3,901||$80||2.3% (4)|
|Lucent Technologies (2)||$1,798||$44||3.5% (4)|
|Deere & Co. (2)||$3,071||$58||2.1% (4)|
|Navistar International||$1,481||$44||3.0% (4)|
|Paccar Inc.||$1,789||$42||2.4% (4)|
|Applied Materials Inc.||$1,000||$40||4.0%|
|American Standard Cos.||$1,951||$28||1.5%|
|AutoZone Inc. (2)||$1,121||$20||1.8%|
| All U.S. Manufacturers:
& Warranty Claims
|$425 B||$5.7 B||1.9%|
|Source: SEC Filings|
Notes:(1) Fiscal Year figures ÷ 4
(2) Six month figures ÷ 2
(3) Nine month figures ÷ 3
(4) Percent of warranted product revenue only, no finance, software or service revenue
(5) As a percent of total revenue, the ratio was 1.3%
Steady readers will note that seven companies were added to the chart after it was first published in the June 2 email edition of Warranty Week. Seagate Technology was suggested by a subscriber as a major player missing from the first edition of the list. The other six new entrants are companies that reported either whole fiscal year figures in a 10-K report (Dell), or either six-month or nine-month figures in a 10-Q report (Sun, Cisco, Lucent, AutoZone, and John Deere). The figures listed for their first quarter revenue and warranty claims spending is a Warranty Week estimate, derived proportionally from their reported results for the longer time periods. This revision also changed the industry-wide totals as first reported.
General Electric Co., a huge manufacturer with $131.7 billion in revenue during 2002, is the company most obviously missing from the list above. GE did not report its warranty activity during the first quarter. However, it did make a disclosure in its 2002 annual statement, listing a beginning balance for the year of $968 million, and an ending balance of $918 million. It also disclosed spending $694 million on warranty claims during the year, primarily for products coming out of the Power Systems sector.
If we were to carry forward that spending at the same rate into the first quarter, one could estimate that GE Power Systems spent $173.5 million on warranty claims during the period. That would place them sixth on the list above, between IBM and Caterpillar. However, it also would make GE the only member of the top 25 with no actual information on its warranty experience during the first quarter. The company said that while the 2002 Form 10-K annual report contained all the FASB-required details about the warranty fund balance, it does not plan to disclose this information going forward in its quarterly Form 10-Q reports. Therefore, for the moment, we will defer adding them to the list, until better information can be located. However, we are adding a placeholder estimate of $173.5 million for GE to the industry totals used elsewhere in this report.
In addition, upon the advice of several readers, Warranty Week revisited the percent of sales calculations. The problem, readers said, was that a simple division of warranty cost by total revenue was of limited value in the case of companies that had an appreciable presence in the mortgage, finance, software, consulting, and other non-warranted industries. Therefore, we recalculated the percentages, using the most restrictive numbers available for revenue segments, so as to count only sales of warranted products.
In some cases, such as IBM, this radically reduced the size of the denominator, and raised the percentage proportionally. Using total revenue as the denominator, $190m / $20,065m equals only 0.9% -- below the industry average. But using just hardware revenue, $190m / $5,808m equals 3.3% -- closer to the experience of their competitors who don't have as much service or finance revenue in their financial statements. Readers are cautioned that these "warranty relevant" revenue numbers are under review, and as the denominators continue to shrink in the weeks ahead, further increases in the percentages are likely. The stated total revenue and warranty cost figures, however, will remain as they are now. At the end of this process, we will hopefully have estimates very close to the real percent-of-warranted-sales figures of the vendors in question.
As a percentage of product sales, American manufacturers that issue product warranties spent around 1.9% of their first quarter revenue on warranty claims. However, at least five companies were over 5%, including Lexmark International (9.7%), Fedders Corp. (7.1%), Handspring Inc. (6.5%), Gateway Inc. (6.2%), and Novellus Systems Inc. (5.6%). Looking at just product revenue (and excluding service revenue from the calculation), Sun Microsystems and Palm Inc. also stood above 5%.
These relatively high percentages do not always signal a manufacturing problem; high rates of warranty claims could be normal for their industries or for their product types. Some companies incur a high warranty expense which they immediately bill back to their component suppliers, and therefore they report only the net amount. Many other companies make a significant percentage of their revenue from services, financial investments, consumables, raw materials, and non-warranted products, so their ratio of sales to warranty cost appears deceptively low (see Part Four). Also, because of lag time, what we list as warranty costs incurred during the first quarter are most likely attributable to manufacturing defects in products sold in the third quarter of 2002 or before, which means that companies experiencing a seasonal or cyclical downturn in sales now are incurring warranty costs from periods in which sales volumes might have been significantly higher.
The Enron Effect
Anybody wondering whether any good would come out of the last few years of corporate financial scandals need look no further than FASB Interpretation No. 45. A publication of the Financial Accounting Standards Board, the interpretation now requires public companies to reveal details about all the guarantees they've made, including the size of their warranty reserves at the beginning and end of each financial period, as well as the amount of funds transferred into and out of the reserve during the period.
Gone are the days when manufacturers made the slimmest of disclosures, if any, about their warranty costs. Beginning with the 10-Q quarterly financial statements filed with the Securities and Exchange Commission over the past few weeks, many manufacturers are for the first time revealing not only the size of their warranty reserve, but also the exact costs they incurred.
Officially entitled "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," FASB Interpretation No. 45 is more concerned with guarantees of leases, stock prices, letters of credit, and other financial matters than it is with product warranties. All public companies that make guarantees must now reveal to their shareholders the maximum amount for which they might one day be liable should things go wrong.
Product warranties are an exception, in that while some disclosures are required, companies need not bother computing the maximum -- the amount it would cost them if each and every unit they sold was defective and returned for adjustment. Rather, they must now make disclosures about how they plan to finance their future warranty costs, and what amounts they actually spent financing warranty costs in the current fiscal period. In paragraph 14 the document makes clear what is expected of manufacturers:
- 14. For product warranties ... a guarantor is not required to disclose the maximum potential amount of future payments specified in paragraph 13(d) above. Instead, the guarantor is required to disclose for those product warranties the following information:
- a. The guarantor's accounting policy and methodology used in determining its liability for product warranties (including any liability [such as deferred revenue] associated with extended warranties).
b. A tabular reconciliation of the charges in the guarantor's aggregate product warranty liability for the reporting period. That reconciliation should present the beginning balance of the aggregate product warranty liability, the aggregate reductions in that liability for payments made (in cash or in kind) under the warranty, the aggregate changes in the liability for accruals related to product warranties issued during the reporting period, the aggregate changes in the liability for accruals related to preexisting warranties (including adjustments related to changes in estimates), and the ending balance of the aggregate product warranty liability.
While the interpretation was supposed to be implemented for all interim and annual reports covering periods ending after Dec. 15, 2002, in reality most companies didn't get around to inserting a paragraph 14(b) warranty table into their 10-Q or 10-K filings until April or May 2003 (most of them were for quarters or fiscal years ending on March 31). At least 40 manufacturing companies have still not gotten around to it, filing 2002 annual reports and 2003 first quarter reports with the SEC that continue the old ways of saying little or nothing about warranties.
Although the battle over disclosures of warranty costs doesn't make the headlines as often as the accounting controversies surrounding employee stock options, it nevertheless remains a somewhat sensitive topic. However, if we're not mistaken in counting the 675 companies who have and the 40 who haven't published 14(b) tables, we can conclude that more than 90% of manufacturing companies are in compliance on the first go-round.
The Product Warranty Table
Here's an example of a 14(b) product warranty liability table, taken from Note 4 in the SEC Form 10-Q filed for the first quarter by General Motors:
March 31, 2003
| Beginning balance
| Increase in liability
(warranties issued during period)
| Adjustments to liability
| Effect of foreign currency translation
All figures for GM's 14(b) warranty table are in $ millions. As mentioned, at least 675 manufacturing companies have included these brand new FASB FIN 45 14(b) warranty tables in their latest filings. Together, these companies increased their warranty reserves from approximately $32.2 billion on Dec. 31, 2002, to more than $32.9 billion on March 31, 2003 -- the first quarter of 2003. During that period they spent around $5.52 billion honoring warranty claims (payments), and replenished their warranty reserves with around $5.93 billion (increases in liability). Add to that a net +$193 million increase in adjustments of estimate and a positive effect of currency translations of around $103 million, and you have the ingredients needed to assemble a 14(b) table of total U.S. warranty claims management spending during the first quarter of 2003.
Companies are most certainly missing from version 1.0 of the list. Readers are encouraged to send in names, which we will add to the list. We need help identifying all the publicly-traded companies that issue product warranties, especially the smaller manufacturers. As newly-found companies are added, these totals will be revised and amended in the online copies of this report. We also expect that later in the year, currently non-compliant companies will make FASB FIN 45-compliant disclosures that are retroactive to Dec. 15, 2002. As they do so, the totals in these charts will be revised as required.
The major problem encountered when trying to find the missing companies is that not all companies issue warranties. If they're a bank, a restaurant chain, an electrical company, a phone company, a brokerage house, or an insurance company, they most probably have no warranty matters to disclose (although they most likely have made other types of guarantees covered by FASB FIN 45). Therefore, the absence of a warranty disclosure in a financial statement does not in and of itself mean a company is flouting FASB FIN 45 requirements. They simply might have no warranties to disclose. And telling the difference between a company that doesn't provide product warranties and a company that issues them but doesn't talk about it is not so simple. Because warranty disclosures didn't begin in earnest until first quarter 10-Q statements were filed in early May 2003, there is as yet no master list -- no Fortune 500 of warranted product manufacturers -- to use as a reference.
In addition, these are net figures -- payments minus reimbursements -- so one warranty claim could involve money passed between, say, an axle manufacturer, an auto manufacturer, and a dealer. If the company is a retailer or a wholesaler, they might very well deal with warranties somewhere in their supply chains on a pass-through basis, but they would not typically issue those warranties themselves. Merely selling or distributing a product covered by a manufacturer's warranty does not invoke the disclosure requirements of the interpretation. It remains unclear whether overhead -- the paper-shuffling costs incurred by a retailer or a dealer in their handling of claims -- is in and of itself a disclosure required by FASB FIN 45.
Then again, some retailers also sell their own extended warranty plans, and some businesses such as automobile service stations might also warrant the repairs they make, using not only the warranted parts of a manufacturer but also their own warranted labor. Retailers, wholesalers, and OEM manufacturers could report just the net amount they pay in overhead as they pass warranty matters through to their suppliers and subcontractors. Others might elevate the warranty of the parts and components they sell above and beyond what the supplier itself offers, for instance issuing a one-year warranty for an item covered by only a 90-day manufacturer's warranty (or no warranty at all).
International Laissez Faire?
If the manufacturer is a subsidiary of a company based in another country, however, they can continue making little or no warranty disclosures. For instance, Electrolux on the appliance side, Chrysler in the automotive segment, and virtually the entire consumer electronics industry are ultimately owned by entities based in Europe or Japan. Warranty Week found a handful of Canadian companies following the FASB warranty disclosure rules in their filings, but for the most part the non-American manufacturers took full advantage of their immunity from persecution (see Part Four for a list of the top 50 foreign warranty issuers).
This puts U.S.-based manufacturers at somewhat of a disadvantage. For while it can now be said with certainty that warranty costs during the first quarter equaled 2.83% of auto sales at General Motors and 2.44% at Ford, there is no comparable public information for Chrysler, or for all the other automobile manufacturers based outside the 50 states -- even those that operate "transplant" factories within the U.S. This makes it almost impossible to analyze industries such as consumer electronics, where it seems like all but a handful of speaker and jukebox manufacturers are ultimately based abroad.
Even among U.S.-based manufacturing companies, however, product warranties are not a requirement. In many states it is perfectly acceptable to sell a manufactured product "as is" and without a warranty. In manufacturing industries such as petroleum, chemicals and paper, for instance, product warranties are virtually unknown. However, there is always the implied warranty of fitness for a particular purpose, meaning an oil company cannot sell kerosene and call it diesel. And there is the implied warranty of merchantability, meaning a paper company cannot sell drinking cups with holes in the bottom. But implied warranties are not covered by FASB disclosure requirements.
Satisfaction Not Guaranteed
Intellectual properties such as books, compact discs, and motion pictures are typically not covered by product warranties, although some might be subject to satisfaction guarantees or some other type of return policy. Of course, they're all subject to the implied warranties listed above, but the bottom line is that the companies which manufacture those products do not have to make any FASB-mandated warranty disclosures. Simply put, the FASB rule is if you provide a warranty, you must disclose its finances.
For the most part, shrink-wrapped computer software makers are not issuers of warranties, and what little software is warranted is usually covered for 90 days or less, and only for the replacement of defective software. Monetarily, claims are insignificant, typically involving nothing more than the mailing of a replacement CD and perhaps some labor costs for online or on-the-phone support. Therefore, most software makers generally don't keep a warranty reserve fund, and don't report upon their warranty activities. However, some computer vendors sell a mixture of software, hardware, and consulting services, so a portion of their revenue is covered by a warranty. Depending on the size of that hardware product business, they may or may not decide to keep a warranty reserve fund on the books. They can always expense it as the need arises, taking the chance that a major mess-up could bankrupt the company.
Interestingly, Microsoft Corp. did make a warranty disclosure in its latest 10-Q, but it came in reference to its new line of Xbox game consoles, not its core Windows or Office product lines. Having launched the warranted Xbox, Microsoft has become a hardware manufacturer required to make FASB 45 disclosures. Even more interestingly, Microsoft reported spending exactly $0 servicing the warranty claims of its Xbox customers over the past nine months, although the company nevertheless increased the reserve from $8 million to $18 million. While that's insignificant compared to Microsoft's quarterly revenue, it's a good percentage of its $2.28 billion in game box revenue.
Common sense would suggest that companies such as Motorola Inc., General Electric Co., and Masco Corp. are manufacturers that sell at least some products covered by warranty, be they pagers, plane engines, or plumbing fixtures. However, they and at least a hundred other large manufacturing companies continue to make little or no warranty disclosures in their most recent financial reports filed through May 2003. Some simply state that their warranty costs are within expectations, without providing additional details. Others describe their products and associated warranty programs in detail, and then forget to include a 14(b) table. See Part Four for a list of the top 15 manufacturers missing from the ranks of FASB-compliant companies.
Under the heading of "new accounting pronouncements," a few manufacturing companies stated that they have fully implemented FASB Interpretation No. 45, despite the absence of 14(b) warranty tables elsewhere in their filings. Some continue to provide only beginning and ending fund balances for their warranty reserves within the accrued liabilities section of their balance sheets, without providing any figures at all for the inputs and outputs to the fund over the course of the quarter. Others say their warranty costs are very slight, or in legal wording, "immaterial," and therefore they do not require disclosure. We're not lawyers or accountants, but we read FASB Interpretation No. 45 in its entirety, and nowhere does it provide such a loophole based upon dollar amount or percentage.
In fact, companies that sell products whose warranty costs are "immaterial" should be proud to disclose such facts. If warranty costs eat up only 0.1% of sales or even 0.01% of sales, such a disclosure would suggest that a manufacturer's products are made very well (or their warranty policies are extremely restrictive). The smallest quarterly claims total yet reported was for $392 by a homebuilder, for whom that amount represented 0.01% of product sales. However, one company with no claims and no warranty reserve fund at all noted that management had concluded it didn't need one -- because the company had yet to sell any products. Also, companies remain free to expose themselves to risk by expensing warranty claims as they arise, without the buffer of a reserve fund. They still, however, must disclose the amount of the expense and how warranty claims are financed. It's not the presence of a reserve fund that triggers FASB FIN 45; it's the presence of a guarantee.
But before we get too deep into naming names, we are asking for all readers to help us make the Warranty Week 500 list as complete as possible. We've already included the companies of all registered Warranty Week subscribers on the list, so there's no need to send in your own company's name. You're included. But who are your competitors? Give us their names and we'll give you their warranty costs, compared to your own.
In the June 9 issue we will attempt to provide meaningful industry averages as well as high/low ranges, as soon as we're confident that the list of warranty-issuing companies is as complete as possible. For while in this edition we're providing a short list just of the 25 companies at the top, in reality it makes little sense to compare the warranty costs of a golf club to a jet plane, even if they're both made out of steel (or titanium).
Please take a moment to send us an email, listing a few of the companies you are certain are business units of U.S.-based manufacturers selling products covered by warranties. No company is too small -- the smallest company on the list so far reported sales of just $390,000 during the first quarter. And no warranty reserve is too small -- 20 companies reported reserve funds smaller than $100,000 as of March 31.
And once again, thank you Enron, thank you Bernie Ebbers, and thank you to all the book-cooking chefs who've ever listed the proceeds from a bank loan as revenue from a product sale, and to those who've ever called a secretly-owned offshore subsidiary an unrelated third party. Without your efforts, and the accounting reforms they inspired, warranty costs and warranty reserve fund balances might not have become public information.
|Go to Part Two|