The Warranty Week 500
Most of the major players in warranty claims management recently reported details about their warranty reserve funds, claims and accruals during the second quarter. Here are the summary results.
Warranty claims during the second quarter topped $5.767 billion, a figure only about one percent higher than the first quarter's revised total of $5.7 billion. Though the aggregate for all US manufacturers was up only slightly, individual companies showed quite a bit of fluctuation.
Around 289 companies registered increases in their warranty claims rates as a percentage of product sales, while 332 registered decreases. An additional 43 reported no change in claims rate from the first to second quarter.
Twelve companies, including Handspring Inc., AAON Inc., and Mattson Technology Inc., saw claims rates rise dramatically in the second quarter, while ten companies saw claims rates fall by more than three percentage points since the first quarter. Of these ten, only Bruker AXS Inc. and Fedders Corp. paid more than $300,000 in second-quarter claims.
The list of medium-to-large companies showing mild increases in their claims rates included Boeing Co.; Deere & Co.; Exide Technologies; Ford Motor Co.; Gateway Inc.; General Dynamics Corp.; Hewlett-Packard Co.; Honeywell International; Johnson Controls Inc.; KLA-Tencor Corp.; Lennar Corp.; Lexmark International; Novellus Systems Inc.; Paccar Inc.; Terex Corp.; and Tyco International Ltd.
Medium-to-large companies showing mild decreases in their claims rates included AGCO Corp.; Agilent Technologies Inc.; American Standard Cos.; Apple Computer Inc.; Applied Materials Inc.; ArvinMeritor Inc.; AutoZone Inc.; Avaya Inc.; Beckman Coulter Inc.; Brunswick Corp.; Caterpillar Inc.; Champion Enterprises Inc.; Cisco Systems; Cummins Inc.; Dana Corp.; Dell Inc.; EMC Corp.; Fleetwood Enterprises Inc.; General Motors Corp.; IBM Corp.; Ingersoll-Rand Co. Ltd.; Lucent Technologies; Maxtor Corp.; Maytag Corp.; Mohawk Industries Inc.; Navistar International; Pulte Homes Inc.; Rockwell Collins Inc.; Seagate Technology; Sun Microsystems Inc.; United Technologies; Whirlpool Corp.; and York International Corp.
Handspring deserves special mention. For its fiscal year ended June 30, Handspring spent nearly 10% of product sales on warranty claims, which represents a dramatic rise even from rates seen earlier in the company's fiscal year. Part of the reason is falling sales volumes. However, in Handspring's case the primary reason seems to be a more than doubling of claims rates late in the year. During the first nine months of its fiscal year, claims rates remained below $1 million a month. But by the fiscal year's end, claims had risen above $2 million a month.
Among all companies spending at least $5 million per quarter satisfying warranty claims, only one company spent a higher percentage of product revenue on warranty than Handspring. For clues to this company's identity, look at the chart below.
Top U.S.-Based Warranty Spenders
Second Quarter, 2003
|Reserve||Percent of||Months in|
|Company||2Q 2003||Prod Sales (2)||Reserves|
|Champion Enterprises Inc.||$47m||6.4%||10|
|Novellus Systems Inc.||$28m||5.6%||6|
|Applied Materials Inc.||$143m||3.7%||11|
|Fleetwood Enterprises Inc.||$62m||3.6%||10|
|General Electric Co. (1)||$1,304m||3.0%||21|
|Rockwell Collins Inc.||$134m||2.8%||31|
|General Motors Corp.||$8,765m||2.8%||25|
|Beckman Coulter Inc.||$12m||2.7%||3|
|Ford Motor Co.||$5,400m||2.5%||19|
|Deere & Co.||$387m||2.1%||15|
|Nortel Networks Corp.||$248m||1.7%||24|
|York International Corp.||$93m||1.5%||17|
|Mohawk Industries Inc.||$6m||1.4%||1|
|Apple Computer Inc.||$67m||1.3%||11|
|American Standard Cos.||$327m||1.2%||39|
|Pulte Homes Inc.||$50m||1.0%||8|
|Ingersoll-Rand Co. Ltd.||$134m||0.9%||23|
|Tyco International Ltd.||$426m||0.6%||27|
|General Dynamics Corp.||$217m||0.4%||34|
|Johnson Controls Inc.||$71m||0.2%||16|
Source: SEC Form 10-Q & Form 10-K
- GE has not reported on its warranty activity since the end of 2002; fourth quarter figures are used here as placeholder estimates.
- Because segment data was not available, estimates for product sales were used for Dell, Gateway, Whirlpool, Maytag, American Standard Cos., Brunswick, and Ingersoll-Rand.
In the chart above, each company is measured based on three data points, representing weight, rate, and capacity. The warranty reserve is the weight. The bigger the number, the more the company has put aside to fund future warranty claims. GM, Ford, GE, HP, United Technologies, and Dell are therefore the heavyweights, each having more than a billion dollars on reserve.
The second column lists each company's warranty reserve fund balance as of the end of their respective quarter. For most companies, this means June 30, 2003. However, several companies are on different scheduled for their fiscal years involved, so in their cases the date is the last day of the fiscal quarter that ended in either April, May, or June.
The 50 companies are listed in descending order based upon the percentage of product sales they spent during the period satisfying warranty claims. This is the measure of rate. The higher the number, the greater the percentage of current sales is spent to satisfy warranty claims. Depending on the company and the manner in which they make their report, the period involved could be one quarter, six months, nine months, or in some cases, a full year.
The average claims rate for all manufacturers is around 1.9% of product sales, but figures vary tremendously between different industries. So while it may be normal for most automobile and computer manufacturers to be above 1.9%, this is certainly not the case in new home sales or medical instruments, where 1% is closer to the norm. Even within companies, different product lines experience different claims rates. Therefore, the 1.9% average should be seen more as a mathematical statistic and less as an industry benchmark. In general, anything under 5% is sustainable, especially for larger manufacturers, although half of all manufacturers reported claims rates below 1%. The median rate was, in fact, 0.97% among 667 manufacturers.
The fourth column measures capacity. Given current spending rates, how many months would the warranty reserve last if no additional money was added to the fund? Anything between 10 and 20 months can be considered normal. Anything under 10 months reflects a high degree of optimism, while anything over 20 months represents a highly conservative outlook regarding future claims. During the latest round of reports, 50% of manufacturers became more conservative, while 46% became more optimistic. In other words, half allowed the capacity of their reserve funds to grow, while just under half allowed the number of warranty-months in their reserve funds to shrink. Only 4% kept the ratio between claims and reserves constant.
However, even this measure of the ratio between claims and reserves varies by industry, primarily because of the varying length of warranties customary within each industry. For instance, three of the biggest players in air conditioning -- United Technologies, York International, and American Standard -- carry reserves the size of 27, 17, and 39 warranty-months, respectively. At first glance, this suggests they're being conservative. But it also could be due to the fact that warranties of five, 10, or even 15 years are the norm in that industry. Likewise, automobile manufacturers might seem to be somewhat on the conservative side in terms of reserve fund capacity, given that three- or four-year warranties are the norm in their industry. But given the legacy of Firestone and the possibility of an expensive product recall, who can fault them for having a thicker cushion than most?
No doubt, there is some seasonality to these figures as well, for instance with appliances and home computers given as Christmas gifts late last year showing up as warranty claims in March and April. No doubt, there also is a high degree of seasonality in claims related to sales of warm weather products such as air conditioners and lawn equipment. And even if there is no seasonality to claims, there is probably a seasonal pattern to the product sales themselves.
Bottom line: don't read too much into the quarterly fluctuations of the data. It's still early in terms of disclosures, and a handful of data points don't make a trend. Once we have a full year's worth of warranty disclosures for the more than 600 companies we're tracking, it will become clearer what's normal and seasonal and typical for a given industry, and what represents a manufacturing crisis. All we can do now is point to cases such as Handspring's and suggest that something's not right there.
With $11.47 billion in claims registered so far during the first half of 2003, it is safe to assume that the eventual full-year figure for warranty claims made against US manufacturers will be in a range of $23 to $24 billion. Once all the placeholder estimates are converted into actuals, and once all the non-complying product warranty issuers begin making the disclosures now expected from all public companies, the "size" of the warranty industry for US manufacturers is likely to end up in the neighborhood of $25 to $26 billion in claims per year.
However, keep in mind that both the first- and second-quarter reports are constantly under revision as new information becomes available. So before you make a report to your own internal warranty team, please check back to see if any of the totals have changed. For instance, we are now able to report that Cummins Inc. spent $49 million satisfying warranty claims during the first quarter. That represented 3.5% of the company's product revenue. During the second quarter, the engine maker spent $43 million on claims. That was 3.1% of sales. These figures are now available because Cummins has at long last resolved some unrelated accounting problems, which prevented publication of their Form 10-Q statements for the past few quarters.
The other new arrival among the top 50 warranty spenders is Nortel Networks Corp., which last quarter published only its warranty reserve fund balance but which this quarter published full details in a warranty table covering the first six months of the year. During that six-month period, the company spent around 1% of product sales satisfying current warranty claims, while accruing funds to pay future claims at a 1.1% rate.
Nortel's and Cummins' arrival in the top 50 push out aerospace company Goodrich Corp. and disk drive maker Quantum Corp. By the way, Nortel, Tyco International Ltd., Seagate, and Ingersoll-Rand Co. Ltd. are among the handful of reporting companies that are based outside the US, but which have nevertheless elected to file details about their warranty activity with the U.S. Securities and Exchange Commission.
Other new arrivals outside the top 50 who made first-time warranty disclosures include Dover Corp.; Standard Pacific Corp.; Tecumseh Products Co.; Palm Harbor Homes Inc.; Cavco Industries Inc.; Southern Energy Homes Inc.; Remington Arms Co. Inc.; and Anthony & Sylvan Pools Corp.
Because some of these companies' disclosures were for six-month periods, we also can retroactively add their first-quarter warranty activity to the list. That brings the number of reporting companies up to 750 for the first quarter, with an upward revision to $5.7 billion in claims, $5.9 billion in accruals, and a March 31 warranty reserve balance of $32.869 billion.
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, also known as FIN 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 both the size of their warranty reserves and the amount of funds transferred into and out of the fund during the period.
Officially entitled "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," FASB Interpretation No. 45 is less concerned with product warranties and more concerned with guarantees of leases, stock prices, letters of credit, and other items that could one day result in huge liabilities. However, within its 42 pages are a few choice paragraphs that outline rather precisely what's now expected of all warranty issuers:
- 2. This interpretation addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees.
- 14. For product warranties ... the guarantor is required to disclose ... 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.
Source: FASB FIN 45, pp. 1 & 9
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. That set of figures was summarized in issues of Warranty Week dated June 2 to July 7.
Companies repeating their first-quarter non-compliance include General Electric Co.; Emerson Electric Co.; Weyerhaeuser Co.; Lockheed Martin Corp.; Delphi Corp.; Intel Corp.; Northrop Grumman Corp.; Parker Hannafin Corp.; Motorola Inc.; Flextronics International Ltd.; Solectron Corp.; Sanmina-SCI Corp.; Textron Inc.; Eaton Corp.; and Federal-Mogul Corp.
GE made the required warranty disclosures at the end of 2002, but has made none so far in either of its 2003 interim reports. Emerson Electric and Weyerhaeuser once again disclosed just their warranty reserve fund balances, but did not include the required warranty tables detailing net accruals and claims. The other 12 either made no mention at all about their warranties, or stated that the monetary amounts involved were "not material."
Among smaller companies, Collins & Aikman Floorcoverings Inc. disclosed only their warranty reserve balance during the first quarter. In its latest report the company didn't even bother to disclose that. Cascade Corp., MITY Enterprises Inc., and Lincoln Logs Ltd. have gone from full compliance in the first quarter to complete non-compliance in the second quarter. During this round of interim reports, MITY disclosed only its reserve fund balance. Cascade and Lincoln Logs made no warranty disclosures at all in their latest Form 10-Q statements.
Gone But Not Forgotten
Royal Appliance Manufacturing Co. and AAF-McQuay Inc. are among the companies exiting the list because they were acquired by non-reporting companies. Because these companies are not likely to resume reporting any time soon, placeholder estimates were not used. Likewise, most of the consumer electronics manufacturers and a significant number of appliance and automobile manufacturers are ultimately based in Europe and Japan, and as such are not required to follow FASB FIN 45 disclosure requirements, even if their stock is traded on an American exchange.
Already, there seems to be some anomalies in the available data. Through a comparison of first- and second-quarter reports, Warranty Week has determined that Hubbell Inc., Fedders Corp., and Bruker AXS Inc. seem to have actually made money on their product warranty programs during the second quarter.
For instance, Fedders reported spending a net $7.8 million on warranty during the period covering the six months between October 2002 and March 2003. More recently, it reported spending a net $7.7 million during the nine months between October 2002 and June 2003. The only way that's possible is if the company experienced a net $100,000 gain during the most recent quarter.
We're going to spend the next week double-checking our math and contacting some of the companies whose figures seem peculiar in one respect or another. Then we'll launch a detailed look at warranty in both the automotive and the information technology industries, similar to what was done three months ago for both the new home and HVAC industries.
Some of this information will be discussed during the Sept. 16 Warranty Week Webinar, which by the way is free and open to all warranty professionals. Slides will be presented through a Web site and audio will be delivered through a teleconference call, so all you need to attend is an online connection and a phone line.
Readers who can't make it can still shape the delivery of all the details about second-quarter warranty spending by contacting the editor. Would you like to see detailed quarter-to-quarter comparisons, or is it too soon with only two quarters of data available? Would you like to see warranty charts for something as narrow as forklift manufacturers or for something as broad as all transportation vehicles? Would you like Warranty Week to post some downloadable industry trend slides in, say, a GIF or PowerPoint format? Please let us know. Assume your messages are private unless you specify otherwise.
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