Seven other companies that made the top ten list in Figure 2 also made at least one other top ten list, which suggests that some of these adjustments are overly large no matter what's used as a base for comparison. For instance, that same acquisition by White made two other top ten lists.

Repeat Appearances

In this newsletter, there are five top ten lists for a total of 50 entries. But all 50 entries are accounted for by only 23 companies, some of which have multiple entries on multiple lists. In fact, while White made three lists, two companies made four lists. And in one of those cases, the cause was a massive product failure.

In the White case, the adjustment was caused by a divestiture. Sometimes, however, the adjustment is caused by an acquisition. Take the case of solar manufacturer Energy Conversion Devices Inc., which made four lists. On August 19, 2009, the company acquired Solar Integrated Technologies Inc. And then in its financial statement for the quarter ended September 30, 2009, the company reported a $33.7 million increase in its warranty liability. The thing is, the company had only $5.9 million in its warranty reserve at the time, so this acquisition drove that balance up significantly.

And then there are the adjustments that are caused by product disasters. Mohawk Industries Inc., a floor tile and carpet manufacturer, always kept its warranty reserve fund balance as low as possible. Up until 2008, it rarely kept more than a seven-month supply of funds in the reserve, essentially a pay-as-you-go system with a slight financial cushion.

But then the company launched a new line of commercial carpet tiles, which had a new type of adhesive on the bottom to keep them in place. And the new adhesive didn't seem to be working. Basically, the entire product line was coming back defective.

In the first quarter of 2009, the company had to add $110 million to its warranty reserve fund to cover the cost of these claims. In the fourth quarter, it had to add another $15 million to the fund, bringing the year's total warranty adjustment to $125 million. That was more than twice the balance the company's warranty reserve carried at the beginning of that fiscal year. And it was large enough to get Mohawk onto four of the five lists in this newsletter.

Relative Comparisons

As was seen in Figure 1, that $125 million adjustment was the eighth biggest seen in the ten quarters between Jan. 1, 2009 and June 30, 2011. And it was the third largest boost to the warranty reserve balance, as listed in Figure 2. So it should come as no surprise that it's also among the largest adjustments when compared to warranty accruals (Figure 3).

Warranty claims are what you pay. Warranty accruals are what you expect to pay. Therefore, what Figure 3 is really measuring is the difference between what was expected to happen and what really happened. However, Mohawk barely makes the list in Figure 3 because its $125 million adjustment was only 2.4 times as large as its $52 million regular accrual total for the year. In other words, the adhesive disaster was only 2.4 times as large as the rest of the company's warranty budget was that year.

And that means there have been nine instances since 2009 where the upwards adjustment in warranty reserves was more than 2.4 times accruals. We've already attributed the Energy Conversion Devices and White Electronic Designs to an acquisition and a divestiture, respectively. But what about the two Itron adjustments?

We should mention that we tried to eliminate all duplications on our list by taking only one upward adjustment per company per fiscal year. So, over the course of ten quarters spanning at most three fiscal years, a company could make the raw list no more than three times.

Amazingly, 36 companies made the raw list three times each. Of course, not every one of those adjustments made a top ten list. The only company whose maximum of three adjustments each made a top ten list was General Motors. And all three of those made only the largest-dollar-amount list in Figure 1. GM made no other appearances.

Only three companies saw two out of their maximum of three adjustments make a top ten list. Those three companies were Boeing Co., Itron Inc., and ThermoGenesis Corp. And again, one of Boeing's entries made only the largest-dollar-amount list in Figure 1.

Six companies had the maximum of three adjustments, of which only one made any top ten lists. Those companies were Daktronics Inc.; Harris Corp.; Lennar Corp.; Modine Manufacturing Co.; Mohawk Industries Inc.; and Symmetricom Inc.

Annual Adjustments

And then there were 26 companies that made an upwards adjustment at least once in each of the past three fiscal years, but did not make any top ten list at all. In other words, their warranty reserves fell short, but not so short that they were proportionally among the largest.

Those 26 companies were; Astec Industries Inc.; Cascade Corp.; Dana Holding Corp.; First Solar Inc.; FMC Technologies Inc.; Graco Inc.; Harley-Davidson Inc.; IBM Corp.; Invacare Corp.; Lennox International Inc.; Lexmark International Inc.; LSI Corp.; M/I Homes Inc.; Masco Corp.; Moog Inc.; Oplink Communications Inc.; Quantum Corp.; Quantum Fuel Systems Technologies Worldwide Inc.; Ryland Group Inc.; Teleflex Inc.; Terex Corp.; Toll Brothers Inc.; Toro Co.; VeriFone Systems Inc.; Whirlpool Corp.; and William Lyon Homes.

So in a very roundabout way, what we've found is that only GM had three adjustments that all made it onto a top ten list, and only two companies had two out of three of their adjustments on a top ten list.

For instance, utility meter manufacturer Itron is both third and fourth on the list in Figure 3. In the quarter ended June 30, 2010, the company listed $14.4 million in "Other changes/adjustments to warranties." And then in the quarter ended March 31, 2011, it made a $9.0 million adjustment. Each was in a different fiscal year, so we counted both. And then Itron also made a $7.6 million upwards adjustment in 2009, but that didn't make any top ten lists.

The 2010 adjustment was the result of an arbitration between Itron's UK subsidiary and Cinclus Technology. The customer alleged that the meters it bought from Itron in 2007 ended up all being defective, because they were susceptible to electromagnetic interference produced by other household electronics. And the customer demanded not only their complete replacement, but also the cost of labor associated with this demand.

The cause of the more recent adjustment is unclear, but Itron noted in its 2011 financial statement that its gross margins "were impacted unfavorably by a warranty charge of $7.7 million related to certain products in Brazil." And that's all it had to say about it. But as this Zacks investment research bulletin details, it hasn't gone unnoticed by Wall Street analysts.

These adjustments were multiple times larger than Itron's accruals during the same periods. And in fact each was several times larger than regular claims during the same periods. In other words, they were significant budget items. And one was so large it actually exceeded half the company's sales, which landed it on the list in Figure 5.

Warranty Arbitration Adjustments

The largest adjustment on the list in Figure 3 belongs to Boeing, however. In the quarter ending March 31, 2009, the company made a $108 million change of estimate, which was more than twice as much as its regular accruals and 1.7 times its claims payments. It was also equal to nearly 18% of the company's profits that quarter. The cause was an arbitration decision over a satellite that failed in 2004.

  Source: Warranty Week