October 2, 2014

Mid-Year Warranty Expense Report:

By comparing each company to itself over time, and then comparing the size of the changes, we can spot the companies with the most improved warranty costs and those in the most trouble.

While warranty claims payments by U.S.-based companies are down in the first half of 2014, accruals are up. And while the expense rates for most companies have shifted only slightly in the past year, a few dozen manufacturers have seen massive recent changes in their claims and accrual rates.

We began this week's analysis with a list of all U.S.-based companies that reported paying warranty claims in both the first half of 2013 and 2014. We narrowed it down to just the 240 largest warranty providers by eliminating 1) all companies that paid less than $4 million in claims last year, 2) all that did not report their quarterly warranty expenses (annual-only reporters), and 3) all that have not yet fully reported their warranty expenses for the first half of 2014.

For each of those 240 companies, we calculated their claims and accrual rates for the middle of 2013 and for the middle of 2014. Then we compared the two pairs of percentages, looking for the biggest relative changes, up and down, over the past year.

The reason for doing it this way is our inability to compare all of these warranty providers directly to each other. A one percent accrual rate might be very high for a medical device manufacturer, but it would be very low for an automobile maker. Even within a single industry, there might be differences in the way companies account for parts costs and for indirect costs such as training and call center overhead.

Therefore, companies can't really be compared to one another. And it's not possible to make a list of the companies with the highest or the lowest warranty costs. Comparisons to industry averages might make sense, but with companies in at least 15 industries issuing warranties, and some companies in multiple industries, which average should we use?

Early Warning Signal

So if we can't compare them to each other, let's compare each company to itself, over time. Let's assume that each company is internally consistent in terms of how they segment their own revenue and how they count their warranty expenses. If we see a company whose expense rate doubles in a year, it's a clear sign of trouble. Something's wrong. Either repair costs are soaring or product sales are plummeting, or both.

Likewise, if a warranty provider's expense rate decline by half in a year, something very good must be happening. The decade-long baseline for each company is their "normal" expense rate; their deviance from normal is the measure we're using. And then we're comparing the relative sizes of the changes, and publishing the top ten.

What follows are the top ten gainers and decliners out of those 240 companies for the year between June 2013 and June 2014, first for warranty claims rates, and then for warranty accrual rates. The top ten increases are the companies experiencing the most pain, while the top ten decreases are the companies enjoying the most savings.

In Figure 1, for instance, American Axle & Manufacturing Holdings Inc. is the top company of all in terms of warranty claims rate declines. Back in the second quarter of 2013, it paid $1.3 million in claims on $800 million in sales. But in the second quarter of 2014, it paid only $200,000 in claims on $947 million in sales. So with that 18% sales gain also helping, its claims rate fell by almost nine-tenths, from 0.2% to 0.02%.

Figure 1
Top 240 U.S.-based Warranty Providers:
Top Ten Claims Rate Reductions,
June 2014 vs. June 2013
(claims as a % of product sales)

   Claims   Claims  Rate Now
  Rate Rate vs.
  Company  Dec '12   Dec '13   Year Ago 
  American Axle 0.16% 0.02% -0.14%
  Lindsay Corp. 0.6% 0.1% -0.5%
  ON Semiconductor 0.4% 0.1% -0.3%
  EnPro Industries 0.3% 0.1% -0.2%
  Plantronics Inc. 2.3% 0.6% -1.7%
  Alliant Techsystems 0.8% 0.2% -0.5%
  Foster Wheeler 0.5% 0.1% -0.4%
  First Solar Inc. 1.6% 0.6% -1.0%
  Park-Ohio Holdings 0.3% 0.2% -0.2%
  Babcock & Wilcox 0.7% 0.3% -0.4%

    Source: Warranty Week from SEC data

There were two top ten companies from the aerospace industry: Alliant Techsystems Inc. and Park-Ohio Holdings Corp. And there were two representatives of the power generating equipment industry: First Solar Inc. and Babcock & Wilcox Co. And besides American Axle, the other representative from the auto parts supplier industry was EnPro Industries Inc.

In the chart below, we've detailed the claims and accrual rates of the only representative from the telecommunications equipment industry. Plantronics Inc., a leading manufacturer of headsets and headphones, reduced its claims rate by more than two-thirds, from 2.3% in the middle of 2013 to 0.6% in the middle of 2014. It also reduced its accrual rate from 2.2% to 1.3% during the same period, but that wasn't a large enough decline to get it into the top ten in Figure 5.


Figure 2
Plantronics Inc.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 2


Even without the math it's easy to see why Plantronics would be one of the top warranty expense rate decliners. For the last four quarters its claims and accrual rates have been far below the 2003-2012 baseline. And in fact, its claims rate has never been lower than it is now. This is the kind of achievement that deserves both praise and additional compensation: a sustained decline in expense rates.

Rising Claims Costs

Conversely, the companies on the list in Figure 3 have some explaining to do to their shareholders. For they are the companies that saw their claims rate rise the most out of all 240 companies under examination. Some of the math may not work out because of rounding, but it's pretty clear that seven of these companies have seen their claims rate more than double in the past year.

American Superconductor Corp. had the compound misfortune of seeing claims almost quadruple from $74,000 in the second quarter of 2013 to $280,000 in the second quarter of 2014, just as sales fell by almost half from $23.1 million to $11.7 million. The result is a claims rate that soared from 0.3% to 2.4%.

Figure 3
Top 240 U.S.-based Warranty Providers:
Top Ten Claims Rate Increases,
June 2014 vs. June 2013
(claims as a % of product sales)

   Claims   Claims  Rate Now
  Rate Rate vs.
  Company  Dec '12   Dec '13   Year Ago 
  American Superconductor 0.3% 2.4% +2.1%
  SunPower Corp. 0.2% 1.0% +0.8%
  Tecumseh Products 0.7% 2.2% +1.5%
  Tesla Motors Inc. 0.4% 1.2% +0.8%
  Generac Holdings 0.5% 1.1% +0.7%
  Bio-Rad Laboratories 0.5% 1.0% +0.5%
  Woodward Inc. 0.2% 0.4% +0.2%
  St. Jude Medical 0.1% 0.3% +0.1%
  Invacare Corp. 0.9% 1.7% +0.8%
  Rofin-Sinar 0.6% 1.2% +0.5%

    Source: Warranty Week from SEC data

American Superconductor was one of three representatives from the power generating equipment industry. SunPower Corp. and Generac Holdings Inc. were the other two. There was only one company from the automotive industry: electric car manufacturer Tesla Motors Inc., which ran into increased expense rates caused by rising safety recall costs.

And then there were three companies from the medical device and scientific equipment industry: Bio-Rad Laboratories Inc., Invacare Corp., and St. Jude Medical Inc. Bio-Rad makes laboratory instruments and imaging equipment. Invacare makes crutches, wheelchairs and motorized scooters. And St. Jude manufactures artificial heart valves, pacemakers, and defibrillators, among other products.

Volatile Expense Rates

As can be seen in Figure 4, the heart monitoring equipment business is quite volatile. In fact, St. Jude also makes it onto the top ten list in Figure 7 for its rapidly increasing accrual rate, which almost doubled along with its claims rate from June 2013 to June 2014. But back in 2011, expense rates were somewhat higher, due to a defibrillator safety recall ordered by Food and Drug Administration. And its claims rate spiked abruptly in 2004, while its accrual rate spiked in 2005, for unknown reasons.


Figure 4
St. Jude Medical Inc.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 4


The point is, St. Jude Medical is in a volatile business when it comes to warranty costs. And it just so happens to now be at the peak of yet another upswing. It's not unlikely that a year from now, the company will be on the top ten decliner lists, as expense rates dive back to the near-zero levels that frequently appear in the baseline seen in Figure 4. So it's merely a matter of unfortunate timing to see them on the "pain" lists this year.

Declining Accrual Rates

In Figure 5, we're tracking the biggest declines in warranty accrual rates from June 2013 to June 2014. The largest possible decline would be 100%, if a company's accrual rate for some reason fell to 0%. Amazingly, this happened to two different companies: American Superconductor and EnPro Industries.

Do those names sound familiar? EnPro was also among the top decliners on the Figure 1 list, which makes perfect sense: if your claims rate falls by almost three-quarters, you'll want to reduce your accrual rate too. However, American Superconductor was on the "bad" list in Figure 3: top ten claims rate increases.

So what do you do when your claims rate soars seven-fold and your sales fall by half? You discontinue making warranty accruals, and hope that nobody notices. Not only that, but American Superconductor also removed $72,000 from its warranty reserve fund due to a change in estimate. So its accruals were actually less than zero.

Figure 5
Top 240 U.S.-based Warranty Providers:
Top Ten Accrual Rate Reductions,
June 2014 vs. June 2013
(claims as a % of product sales)

   Claims   Claims  Rate Now
  Rate Rate vs.
  Company  Dec '12   Dec '13   Year Ago 
  American Superconductor 0.7% 0% -0.7%
  EnPro Industries Inc. 0.3% 0% -0.3%
  Hill-Rom Holdings Inc. 2.7% 0.2% -2.5%
  Greenbrier Companies 0.23% 0.04% -0.19%
  ResMed Inc. 0.8% 0.2% -0.5%
  Teledyne Technologies 0.4% 0.1% -0.2%
  Boston Scientific Corp. 0.14% 0.05% -0.09%
  Roper Industries Inc. 1.0% 0.4% -0.6%
  Donaldson Company 0.3% 0.1% -0.2%
  Titan International 2.1% 0.9% -1.2%

    Source: Warranty Week from SEC data

There were three medical device companies on the top ten list of Figure 5: Hill-Rom Holdings Inc., ResMed Inc., and Boston Scientific Corp. And besides EnPro, there were two other automotive parts suppliers on the list too: Donaldson Company Inc. and Titan International Inc.

EnPro Sees Warranty Costs Dive

In Figure 6, we've charted the past 11-1/2 years of warranty expense rates for EnPro. That data series begins soon after the company was spun off from Goodrich Corp., which in turn was acquired two years ago by United Technologies Corp. EnPro has made its own series of acquisitions, which have taken it deeper into the trucking, aerospace, power generation, and oil & gas mining industries.


Figure 6
EnPro Industries Inc.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 6


The data in Figure 6 looks a bit volatile at first glance. But notice that the vertical scale is much smaller than is used in either Figures 2, 4 or 8. On those charts, a half-percentage-point move looks steady. Here, it looks like a massive change. Still, it's obvious from the chart why EnPro made it onto both the top claims and accrual rate decline charts. Its claims rate went from above 0.3% to below 0.1%, while its accrual rate fell to zero.

Top Ten Accrual Increases

And then, if you thought that being on the Figure 3 list was bad, imagine being on both that and the list below. Figure 7 is the one that hurts the most, because warranty accrual expenses directly and immediately reduce net income. So when they double, it really hurts.

Of the ten companies on the list in Figure 7, five saw their accrual rates double, three saw their accrual rates quintuple or more, and two were just a shade under doubling. And that's in only a year. A case can be made for some that their accrual rates were artificially low a year ago and are simply now returning to normal levels. But whatever the excuse, there are 230 companies that either saw their accrual rates go down (149 companies) or go up by less than 100% (the other 81 companies).

Figure 7
Top 240 U.S.-based Warranty Providers:
Top Ten Accrual Rate Increases,
June 2014 vs. June 2013
(claims as a % of product sales)

   Claims   Claims  Rate Now
  Rate Rate vs.
  Company  Dec '12   Dec '13   Year Ago 
  Alliant Techsystems 0.04% 0.34% +0.31%
  Raytheon Co. 0.1% 0.4% +0.3%
  Woodward Inc. 0.1% 0.5% +0.4%
  Arris Group Inc. 0.3% 0.8% +0.5%
  Bio-Rad Laboratories 0.4% 1.0% +0.6%
  OSI Systems Inc. 0.3% 0.8% +0.5%
  Powell Industries 0.2% 0.6% +0.3%
  General Motors Co. 2.1% 5.1% +2.9%
  St. Jude Medical 0.14% 0.27% +0.13%
  Diebold Inc. 3.0% 5.7% +2.8%

    Source: Warranty Week from SEC data

Amazingly, three companies made it onto both of the top ten "pain" lists: Bio-Rad Laboratories, St. Jude Medical, and Woodward Inc. are listed in both Figure 3 and Figure 7. All three saw sales levels remain relatively unchanged, so these top ten outcomes really are the result of massive increases in warranty expenses.

And then there's Alliant Techsystems Inc., an aerospace supplier that made it onto the "good" list of Figure 1, yet still found a reason to raise its accrual rate from 0.04% a year ago to 0.34% in the second quarter of 2014. The truth is, from 2003 to 2011 the company had negligible claims and very low accrual rates. It's only in the past ten quarters that the company's warranty expense rates have become somewhat unpredictable.

Of the 34 companies that made it onto one of our four lists, 27 are what we'll call medium-sized warranty providers, paying out between $4 million and $20 million a year in claims. And then seven are what we'll call large warranty providers. Those paying out between $20 million and $100 million a year include Arris Group Inc.; Babcock & Wilcox; Diebold Inc.; First Solar; Hill-Rom Holdings; and Titan International.

Billions of Dollars of Pain

And then there was only one company paying out more than $100 million a year. Actually, it's one of only a handful of companies that have ever paid out more than one billion dollars a year in warranty claims. General Motors Co., which lost its title as America's largest warranty provider last year to Apple Inc., has grabbed it back in the first half of 2014.

But that's not the worst of it. GM is only number 8 on the "pain" list of Figure 7. But that's because its accrual rate soared from 2.1% in the first half of 2013 to 5.1% in the first half of 2014. They say a picture's worth a thousand words. Here's the executive summary:


Figure 8
General Motors Co.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2014)

Figure 8


It's almost entirely due to some well-publicized recall expenses, which really kicked in during the spring months. Notably, in its financial statements GM is now breaking out its warranty accruals into two different categories: "Warranties issued and assumed in period -- policy and warranty," and a new item called "Warranties issued and assumed in period -- recall campaigns and courtesy transportation."

A year ago, the recall accruals comprised only 20% of the total. Now they represent almost two-thirds of the total. Moreover, GM had to add another $889 million to cover under-accruals in previous periods. In all, GM had to set aside nearly $4.7 billion in the first half of 2014 to cover both its usual warranty costs and these recent recalls.

Earlier this week came the news that the same thing is happening to Ford Motor Co., though on a much smaller scale. And a few years ago, it was Toyota's turn to see its warranty and recall costs soar because of well-publicized problems. So maybe it's just GM's turn? Or maybe the expense rates seen at the end of 2013 and the beginning of 2014 are too low to last? Time will tell us the answer.





GWSCA First Annual Conference on Service Contracts
AMT Warranty Corp.
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