September 29, 2003

Warranty in the Air, Sea, and Ground:

Compliance with FASB FIN 45 rules concerning product warranty disclosures has spread tremendously in just the first two quarters of 2003, making it possible to find ranges and averages for warranty accrual and claims rates in numerous market segments. In addition to the automotive and IT industry sectors detailed in the past two issues, here are charts for six more market segments.

Warranties are everywhere. Product warranties are issued for everything from satellite communications systems to mining equipment. This year, thanks to the efforts of the Financial Accounting Standards Board and FASB Interpretation No. 45, never-before seen details about what those warranties actually cost manufacturers are becoming available in their quarterly Form 10-Q statements and their Form 10-K annual reports.

The great thing about having detailed warranty data available from more than 750 manufacturers is that it enables analyses of markets as narrow as, say, golf clubs, or as broad as telecommunications equipment. With the reporting season for second quarter financials now coming to a close, we're still making adjustments to the industry categories, and to the total warranty claims and accruals figures reported for each industry. Sorry to make it seem as if the numbers change every week, but in fact that's exactly what's happening.

Silicon Graphics and Sun Microsystems filed their Form 10-K reports just today, and several other top manufacturers filed their 10-K reports late last week. Therefore, our PlaceHolder estimates are being replaced by actual reported numbers. The only large (+$1m) warranty spenders that haven't yet filed their second quarter statements are Advance Stores Co. Inc., Astrocom Corp., Baldwin Technology Co. Inc., and Read-Rite Corp., so within a week or two that process of replacing the estimates with actual data should come to an end. Interestingly, Applera Corp. and Harman International Industries Inc. are among the companies that filed their 10-K reports last week, but both companies apparently forgot to include any warranty data at all in those annual reports, despite them both having made full disclosures during the first quarter.

With all the new information, the Warranty Week estimate for total warranty claims paid during the second quarter expands to $5.767 billion, up 1.1% from the revised first quarter total of $5.703 billion. The warranty reserves of the 750 manufacturers who have now fully disclosed their fund details stands at $32.955 billion as of June 30, up roughly $86 million from the $32.869 billion total counted as of March 31. The Warranty Week estimate for total claims expected for all of 2003 remains in a range of $23 to $24 billion, although this may turn out to be low.

Retroactive Revisions

Keep in mind that numerous companies decided to disclose their warranty accruals and claims totals for the first time in the second quarter, and many of them released six-month data covering the period from January to June. If this catch-up trend accelerates, and a crowd of manufacturers who haven't yet shared their warranty data decide to release nine-month data in the coming quarter, this will raise the estimates for not only spending in the first and second quarter, but also for the full year.

Every few weeks, the online editions of the Warranty Week columns from both June and September are revised and corrected to reflect the latest available data. While on the one hand this sounds like an activity that would make George Orwell proud -- revising the past to fit with the present -- on the other hand these FASB FIN 45 warranty disclosures are so new that many manufacturers have yet to comply. As they do so, we're going to add their data to the industry totals. After all, the money was spent, even if the reports weren't timely.

What follows below is an attempt to take a snapshot of warranty activity in six different industry segments. Readers will notice that some of the companies mentioned were previously included in either the automotive or the information technology industry data delivered over the past few weeks. In fact, because of their diverse product lines, certain companies such as Manitowoc, Honeywell, General Electric, Caterpillar, and United Technologies make more than one of the six lists below.

Rest assured that there's no double-counting taking place. We're sticking to previous estimates that half of all warranty claims spending comes from the automotive sector, and roughly 35% comes from the information technology segment. This isn't a report on the remaining 15%. In fact, in some respects these six industry segments borrow heavily from both the automotive and the IT sectors. But because without additional (and unavailable) data it's impossible to split a given company's warranty claims and accrual totals between, say, air conditioning and aerospace, we're left with two choices: 1) put the company in just one category and leave them there, or 2) put each company into whichever categories in which it belongs. In this round, we did the latter.

Industry Crossovers

What you see, therefore, is a constant reuse of the same data. For instance, United Technologies' Carrier air conditioning business unit gets them into the HVAC category below. Its Pratt & Whitney, Hamilton Sundstrand, and Sikorsky business units qualify as aerospace operations. Therefore, United Technologies belongs in both categories. What immediately becomes apparent, however, is that while United Technologies' aggregate 2.2% claims rate looks high in the HVAC segment, it's about average in the aerospace segment. But keep in mind that other units within United Technologies sell warranted products such as elevators and turbines. We're not saying that all those product lines experience a 2.2% claims rate. Indeed, none may be precisely at that figure. Rather, the 2.2% rate is an average of all the company's product lines. It's the same situation at Manitowoc, Honeywell, General Electric, and Caterpillar.

Let's start this analysis in the air and work our way below ground. Warranty Week found 55 manufacturers reporting warranty expense in aerospace, satellite communications, airport operations, shipbuilding, and smaller boats. Initially, we were going to report the air and sea segments separately, but this category we envision to be the future home of defense contractors such as Lockheed Martin Corp. and Northrop Grumman Corp. who so far have not yet made any warranty disclosures regarding their aircraft and watercraft.

What's below are the ten largest spenders on warranty claims in the second quarter, ranked in descending order by the percentage of product revenue those claims represent. As mentioned, these claims rates do not represent just the aerospace and nautical product lines. They are aggregates for the company's whole product line, which in several cases is quite diverse.


Warranty in the Air, Sea & Space Industries
Top Spenders on Claims,
Second Quarter, 2003


  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  General Electric Co. (1) $174 3.0% 23
  Rockwell Collins Inc. $13 2.8% 31
  General Motors Corp. $1,036 2.8% 25
  United Technologies $125 2.2% 27
  Brunswick Corp. $23 2.2% 23
  Goodrich Corp. $12 1.0% 16
  Honeywell International $45 0.8% 17
  Boeing Co. $79 0.6% 33
  L-3 Communications $7.1 0.6% 26
  General Dynamics $19 0.4% 34
  Other $44    
  Total $1,576 2.1% 25

Key: increases in black,
decreases in red.

    (1)  GE has chosen to disclose warranty claims data just once a year,
    so estimates derived from 2002 data were used.


Source: SEC Form 10-Q & Form 10-K



General Electric is on top of this list, though it probably doesn't belong there. The company reported $694 million in warranty claims for 2002, most of which it said arose in its GE Power Systems turbine business unit, not its appliance or aerospace units. However, the company has not provided any warranty data so far in 2003, and won't do so until it files its next annual report. So it won't be known until early in 2004 whether the company experiences any warranty claims for the aircraft engines it sold in 2003.

Rockwell Collins is a prominent maker of avionics systems for both commercial and military aircraft. General Motors is in this category by virtue of its ownership of Hughes Electronics, which is being sold to News Corp. Brunswick is here for its Mercury boat engines and its Sea Ray, Bayliner, Maxum, Hatteras, Meridian and Sealine pleasure boats. Besides boats, the company's other divisions are market leaders in billiards and bowling.

Goodrich makes jet airplane parts, avionics, and landing gear, among other items. Despite its name being associated with car tires, it's largely out of the automotive business. Honeywell, which is included in the HVAC category thanks to its leadership in thermostats and other controls, is in the aerospace category thanks to its manufacture of turboprop aircraft engines.

Noteworthy Anomalies

L-3 Communications is best-known as a manufacturer of military avionics and satellite communications systems, but it also is the maker of the "black box" flight data recorders loaded into all large commercial aircraft. Its warranty claims jumped from $4.1 million in the first quarter to $7.1 million in the second quarter. Its accruals, meanwhile, fell from $7.9 million to $1.3 million over the same period. That left the company with a warranty reserve fund large enough to pay the next 26 months of claims, down from the 44 warranty-months it held in reserve at the end of the first quarter. Obviously, we need a few more quarters of data to make sense of these curious oscillations.

Speaking of curious data, General Dynamics reported $9 million in claims during the first quarter, and $19 million in claims during the second quarter. The company made an upwards $81 million change of estimate during the first quarter, and another upwards $65 million change of estimate in the second quarter. So far in 2003, its warranty reserves have grown from $137 million to $217 million, while claims have edged up from 0.3% to 0.4% of sales. To understand how peculiar this is, consider that only 20 companies now have a larger warranty reserve than General Dynamics, and only two of them experience claims of less than $40 million per quarter.

There are 45 other companies on the list, including several that, like GE, also make it onto the electrical power generation list below. But before we get to that, let's take a look at the HVAC industry. Covered in detail in the June 30 edition of Warranty Week, this is the home of not only the window-mounted air conditioners and central heating/cooling units, but also all of the commercial freezers, refrigerators, beverage dispensers, and ice machines used by restaurants, food markets, and perishable freight haulers.


Warranty in the Heating, Ventilation,
Air Conditioning & Refrigeration Industry
Top Spenders on Claims,
Second Quarter, 2003


  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Whirlpool Corp. $48 2.4% 9
  United Technologies $125 2.2% 27
  Manitowoc Co. Inc. $7.9 1.7% 15
  York International Corp. $16 1.5% 17
  American Standard Cos. $25 1.2% 39
  Ingersoll-Rand Co. Ltd. $18 0.9% 23
  SPX Corp. $10 0.9% 21
  Honeywell International $45 0.8% 17
  Rockwell Automation $8.0 0.7% 12
  Johnson Controls Inc. $13 0.2% 16
  Other $43    
  Total $358 0.8% 23

Key: increases in black,
decreases in red.


Source: SEC Form 10-Q & Form 10-K



By virtue of the inclusion of manufacturers such as Fedders, Whirlpool, Maytag, and the Holmes Group Inc., this category also covers the consumer end of the heating, cooling, and ventilation industry. But most of the companies among the 35 that make up this category are decidedly aimed more at the commercial and construction ends of the business.

Not included in this go-round is General Electric, whose HVAC division was sold in 1982 to Trane (which itself was acquired by American Standard in 1984). Nortek Inc., which went private earlier this year, is still reporting its warranty details, but AAF-McQuay Inc., which was bought by a Malaysian company in February, is not. With a few more minor changes from the list used in the June 30 HVAC report, we're left with a market that reported $391 million in claims during the first quarter and $386 million in claims during the second quarter. Because reported product revenue for the 35 companies fell from $46.25 billion to $43.5 billion, however, the claims rate increased slightly from 0.8% to 0.9%. Obviously, seasonality is a big factor in both HVAC sales and claims, though, so don't read too much into these oscillations until we have at least a year's data.

Missing from the list are HVAC vendors such as Dectron Internationale Inc.; Eaton Corp.; Global Energy Group Inc.; Masco Corp.; Mestek Inc.; MFRI Inc.; Parker Hannafin Corp.; and Wabash National Corp. None have made any disclosures to date concerning their warranty claims and accruals. Emerson Electric Co. and TurboChef Technologies Inc., meanwhile, disclosed only the beginning and ending balance in their respective warranty reserve funds.

When the Lights Went Out

With all the blackouts that have plagued the eastern U.S. and western Europe in recent weeks, electrical power generation is suddenly something that a lot of people are thinking about. People not accustomed to having their lights go out are now thinking about backup power sources, be they of the battery type or the gasoline-powered generator type. And of course, all the hand-wringers are looking closely at the existing grids, wondering what can be done to make sure they don't fail again.

Warranty Week found 39 companies engaged in the electrical power generation business in some way who reported details about their warranty claims and accruals during the second quarter. We also fashioned a PlaceHolder estimate for GE Power Systems, based upon its 2002 claims data. Among the non-reporters are American companies such as Dewey Electronics Corp.; Roper Industries Inc.; Surge Technologies Corp.; and Telenetics Corp. Among the internationally-based power equipment manufacturers are ABB Ltd.; Alstom; Invensys plc; Mitsubishi Corp.; Schneider Electric SA; and Siemens AG. Those in the former group are supposed to comply with FIN 45. Those in the latter group don't have to file statements with the SEC.

The top ten manufacturers in the electrical power generation business are on the list below, ranked in descending order by their claims rates.


Warranty in the Electrical Power Industry
Top Spenders on Claims,
Second Quarter, 2003


  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Global Power Equipment $3.2 5.1% 18
  Cummins Inc. $43 3.1% 23
  General Electric Co. (1) $174 3.0% 23
  Exide Technologies $16 2.8% 11
  American Power Conv. $8.8 2.7% 6
  Caterpillar Inc. $115 2.3% 18
  Briggs & Stratton Corp. $7.2 1.8% 20
  Carlisle Cos. Inc. $4.7 0.9% 5
  SPX Corp. $10 0.9% 21
  Flowserve Corp. $4.4 0.7% 10
  Other $15    
  Total $400 2.0% 21

Key: increases in black,
decreases in red.

    (1)  GE has chosen to disclose warranty claims data just once a year,
    so estimates derived from 2002 data were used.


Source: SEC Form 10-Q & Form 10-K



What's remarkable is how there seems to be no pattern in the data. The highest claims rate is 5.1% and the lowest is 0.7%. In fact, the data for all 39 manufacturers ranges from 390% to 0%. We kid you not. During the first six months of 2003, fuel cell manufacturer Proton Energy Systems Inc. reported $1.36 million in warranty claims, and only $350,000 in product revenue. That means claims exceeded revenue by almost four-to-one -- a 390% claims rate. At the other end of the spectrum, Evergreen Solar Inc., a company that makes solar power packs for roadside callboxes and illuminated signs, reported no warranty claims, though it still accrued $50,000 to cover possible future claims. There's just no pattern to the data, although 23 of the 45 manufacturers experienced claims rates under 1%, and only four were over 5%.

The industry average is 2.0%, though the median is only 0.9%. This, no doubt, is caused by the large skewing effect of the big diesel engine manufacturers Cummins and Caterpillar, as well as battery makers Exide Technologies and C&D Technologies. Possibly, much of their warranty claims volume arises from their automotive lines of business, where 2% is nothing unusual.

Medical Warranties

Warranty Week found 101 companies engaged in the manufacture of medical equipment and scientific instruments. They averaged only a 1.1% claims rate. The median also was close to that figure. Eight companies saw claims rates over 5% and nine were under 0.1%. This data set might make the perfect bell curve.


Warranty in the Medical Equipment
and Scientific Instrument Industries
Top Spenders on Claims,
Second Quarter, 2003


  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Candela Corp. $3.6 8.0% 6
  Varian Medical Systems $7.0 3.2% 15
  Beckman Coulter Inc. $14 2.7% 3
  Waters Corp. $4.7 2.1% 6
  Eastman Kodak Co. $11 1.8% 12
  Agilent Technologies Inc. $18 1.5% 12
  Hillenbrand Industries Inc. $5.0 1.3% 13
  Thermo Electron Corp. $5.1 1.0% 17
  La-Z-Boy Inc. $4.1 0.9% 14
  Baxter International Inc. $6.0 0.3% 26
  Other $44    
  Total $122 1.1% 13

Key: increases in black,
decreases in red.


Source: SEC Form 10-Q & Form 10-K



One could make a case that Agilent Technologies Inc. and Eastman Kodak Co. don't belong on a list of medical and laboratory equipment vendors. Further down the list, numerous X-ray and laser system vendors manufacture their products for both the traditional medical markets as well as new applications such as weld inspections and fiber-optic communications. In fact, at least seven companies on the list would be equally at home as semiconductor equipment manufacturers.

Warranty claims in this sector were down by $3 million, but the claims rate edged up from 0.8% because of falling product sales volumes. The reserve-to-claims ratio was up only slightly, from 12.8 to 13.3 warranty-months, reflecting accrual rates that closely matched product sales. Interestingly, three companies reported no claims, and four made no accruals during the second quarter.

Down on the Farm

While one could vigorously debate what is and isn't a medical/scientific company, there's no doubt about the list of farm equipment vendors. Or is there? We're including here not only the systems and machines that a production farmer might use, but also the lawn mowers and garden utensils that a weekend/backyard "gentleman farmer" might use. Thus, the list includes well-known farm equipment vendors such as Caterpillar Inc. and Deere & Co., as well as more suburban names such as Toro Co., Briggs & Stratton, and Stanley Works. Meanwhile, all but Stanley Works were counted two weeks ago in the Sept. 15 column as automotive vendors.

Confusing? It gets worse. Tecumseh Products Co. also qualifies as an HVAC vendor, and Twin Disc Inc. makes boats as well as farm tractors. Featherlite makes recreational vehicles as well as horse trailers. Park-Ohio Holdings Corp. makes aluminum castings for farm equipment as well as landing gear for airplanes. Briggs & Stratton also makes generators, and Caterpillar also makes electrical power equipment.

The only "pure play" farm equipment makers on the list of 20 are Ag-Bag International Ltd., makers of plastic agricultural feed bags, and Paul Mueller Co., makers of dairy farm equipment. The 20 farm equipment manufacturers identified so far generated $239 million in warranty claims during the second quarter, although nearly half that total came from just Caterpillar. Claims during the first quarter were around $225 million, though because of lower sales volumes the claims rate was also close to 2.0% back then. As with the HVAC industry, readers are cautioned that there is likely to be a high degree of seasonality around both sales and claims volumes in this industry segment.


Warranty in the Farm Equipment Industry
Top Spenders on Claims,
Second Quarter, 2003


  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Caterpillar Inc. $115 2.3% 18
  Toro Co. $7.6 2.1% 23
  Twin Disc Inc. $1.2 2.1% 15
  Deere & Co. $79 2.1% 15
  Briggs & Stratton Corp. $7.2 1.8% 20
  AGCO Corp. $16 1.8% 17
  Gehl Co. $0.9 1.3% 14
  Tecumseh Products Co. $3.8 0.8% 26
  Stanley Works $3.9 0.6% 5
  Park-Ohio Holdings $0.9 0.5% 7
  Other $2.7    
  Total $239 2.0% 17

Key: increases in black,
decreases in red.


Source: SEC Form 10-Q & Form 10-K



Finally, there's the mining industry. As with the farming sector, virtually none of the materials produced are warranted, though virtually all of the equipment used is warranted. This is certainly not the case in either the automotive or the IT industries, where sophisticated (and warranted) equipment is typically used to manufacture even more sophisticated (and warranted) products. But in the food growing and processing industry, as well as with the mining and processing of raw materials, generally all of the inputs are warranted but none of the outputs are.

We purposefully excluded Caterpillar from this segment, because with only $55 million in total claims among the 19 other vendors, the industry average would have otherwise in effect become Caterpillar's numbers. Perhaps that isn't fair, because companies such as Terex and Manitowoc that sell both construction and mining equipment are on the list below. If you must, add Caterpillar at the top of the list and cut Donaldson from the bottom.


Warranty in the Mining Industry
Top Spenders on Claims,
Second Quarter, 2003


  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Terex Corp. $22 1.9% 8
  Joy Global Inc. $5.6 1.9% 17
  Manitowoc Co. Inc. $7.9 1.7% 15
  NACCO Industries Inc. $8.0 1.6% 16
  Gardner Denver Inc. $1.5 1.3% 14
  Input/Output Inc. $0.5 0.9% 21
  FMC Technologies Inc. $5.0 0.8% 7
  Robbins & Myers Inc. $1.4 0.6% 19
  Lone Star Technologies $0.7 0.3% 10
  Donaldson Co. Inc. $0.5 0.1% 54
  Other $1.7    
  Total $55 0.9% 13

Key: increases in black,
decreases in red.


Source: SEC Form 10-Q & Form 10-K



Claims for these ten vendors plus the nine not on the chart came in at $55 million in the second quarter and $43 million in the first quarter. No doubt, some seasonality is to blame for the Spring spike in claims. Even though warranty claims were up 28% sequentially, the claims rate rose only from 0.8% to 0.9%, reflecting higher sales. Though only five of the 19 manufacturers saw claims rates fall, none saw it fall by more than 0.3%. Though 14 saw an increased rate of claims, only one increase was over 0.3%. In other words, both claims and sales rise proportionally with the increasingly warm weather. In future quarters we will see whether claims and sales also trail off together during the colder seasons.

No More Lists

So what's left? Virtually untouched is the whole home building and home furnishing industry, where everything from carpets and countertops to appliances and home entertainment systems are sold with product warranties. There also are a significant number of materials handling and heavy industry equipment makers who don't sell into the mining, farming, or air conditioning markets who didn't make any of these six lists. And there are numerous machine tool companies whose products don't find much use in either the medical field or the semiconductor industry, and who therefore aren't represented on any of these lists. But we'll save those for the third quarter reports, which by the way will begin arriving this week. Next week's column will take a look at manufacturers' warranty reserve funds, then we'll shift back to other topics.

As mentioned, we're tracking 750 companies that are now making the required FASB FIN 45 disclosures regarding product warranties. We're tracking at least 180 more who have made only partial disclosures, primarily of their reserve fund balance. Then there are countless others who are making no warranty disclosures at all. For instance, despite the fact that most wrist watches have warranties, not one watch manufacturer has made even the slightest bit of disclosure.

Together these manufacturers have reported nearly $1.7 trillion in revenue for the year so far, which means they represent roughly a third of U.S. GDP. If that sounds like a shockingly low percentage, remember that whole industries such as banking, insurance, food service, energy, and telecommunications services report almost no warranties at all. Even among these 750 firms, less than 70% of their total revenue came from warranted product sales.

What's remarkable is that of all the non-reporting manufacturers, only 19 had quarterly sales over $1 billion. At least among large companies, compliance is astonishingly high, given that this is only the second full quarter in which FASB FIN 45 rules applied. What's even more remarkable is the fact that 385 manufacturers reported less than $1 million in warranty claims per quarter. Of those, 58 reported less than $10,000 in claims. So despite the heavy weighting of these lists and the warranty industry in general to the top 50 or 100 manufacturers, this FASB FIN 45 compliance story is spreading throughout the ranks -- into the most unlikely market segments, and among the smallest firms.


Back to Part Three   Go to Part Five  





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