If all industries were impacted as badly by the pandemic and the lockdowns that followed as the passenger car industry was, we'd all be in big trouble. But in an effort to point out that not everything was that apocalyptic last year, we present to you the warranty expense reports of four corners of the electronics industry: computers, data storage, peripherals, and semiconductors.

We began with a list of 281 U.S.-based manufacturers of high-tech electronics equipment that report their warranty expenses in their financial statements. Of those, 24 are manufacturers of desktop computers, mainframes, laptops, tablets, and smart phones. A total of 154 of those companies make semiconductors, printed circuit boards, or the tools, test equipment, and manufacturing systems used for their production. Forty-four make data storage systems for computers. And the remaining 59 make computer peripherals of one sort or another.

From each of their annual reports and quarterly financial statements, we extracted three essential warranty metrics: the amount of claims paid, the amount of accruals made, and the closing balance in their warranty reserve funds at the end of each period. We also gathered product sales revenue data, and we used that to calculate the percentage of sales going toward paying claims (the claims rate) and the percentage of sales going toward making accruals (the accrual rate).

Warranty Claims Totals

In Figure 1, we're looking at the past 20 quarters of claims payments by companies in the four industry segments. As is obvious, the computer manufacturers pay the vast majority of the claims, even though they are the fewest in number. In fact, most of the claims are paid by just one company: Apple Inc., makers of the Macintosh, iPad, and iPhone. But there are other major contributors in there as well, including both HP Inc. and Hewlett Packard Enterprise Co., as well as International Business Machines Corp.

The semiconductor industry is unusual in that many of its largest manufacturers do not report any warranty expenses, as they should if they were following U.S. accounting rules. The list of non-reporters includes Intel Corp. and Texas Instruments Inc., as well as Analog Devices Inc., Broadcom Inc., Jabil Inc., Micron Technology Inc., and Sanmina Corp., among others.

The list of warranty expense reporters is much longer, but the major players are much smaller than those above. Those who do report their warranty expenses include Advanced Micro Devices Inc., Applied Materials Inc., Coherent Inc., Lam Research Corp., and Nvidia Corp., among others.

In the data storage area, the top remaining warranty providers are NetApp Inc., Seagate Technology, and Western Digital Corp., with many of the former market leaders, such as EMC, Iomega, Maxtor, SanDisk, and StorageTek, having been acquired years ago. And then in the peripherals category, the leaders are companies such as Daktronics Inc., Diebold Nixdorf Inc., NCR Corp., Xerox Corp., and Zebra Technologies Corp.

In the industry as a whole, claims payments were down -21% last year to $4.98 billion, from $6.29 billion in 2019. Claims were down -22% for the computer manufacturers, down -20% for the data storage companies, down -12% for the semiconductor makers, and down -15% for the peripherals companies.

As we have seen in other industries, claims were particularly depressed during the second quarter of 2020, in the worst days of the pandemic lockdowns. During that quarter, claims payments were down by -32% for the computer makers, down -28% for the semi makers, and down -31% for the data storage companies. But claims were down by only -3.9% for the peripherals makers.

By the end of the year, the semiconductor companies' claims had bounced back and were up +24% in the fourth quarter. But the computer makers' claims never recovered, nor did the data storage companies. And for some reason, the peripherals companies saw their claims payments plummet in the fourth quarter of 2020.

Warranty Accrual Totals

In Figure 2, the most obvious feature is the one- or two-quarter spikes in accrual totals each year. As we explained in the November 5 newsletter last year, that is almost entirely due to Apple's peculiar habit of packing most of its accruals into those quarters of the year. And because they are one of the world's largest warranty providers in any industry, what they do can easily move the totals and averages for any group they're in.

Accruals overall were down by $920 million to $5.36 billion, a -15% decline. But even the bulk of this metric's movement can be traced back to Apple. In calendar 2020 (which is different from Apple's fiscal year), Apple's accruals were down by $815 million, or -21%.

Elsewhere, IBM's accruals fell -25%, and HP's accruals were down -7.0%. In the semiconductor category, Lam Research's accruals were down -4.6%, AMD was up +165%, and Applied Materials was up +11%. In data storage, Western Digital's accruals were down -16% while Seagate's were down -17%. And in peripherals, NCR was down -19%; Diebold Nixdorf was down -45%; but Zebra Technologies was up +20%.

Theoretically, accruals should remain proportional to sales, unless there has been a noticeable change in failure rates or repair costs. For the year as a whole, computer hardware sales revenue was up +8.9%, but accruals were down -17%, so there was a mismatch. But for semiconductors, sales were up +29% while accruals were up +14%, so there was at least an agreement on direction. For data storage, sales were down -5.1% and accruals were down -17%. And for peripherals, both sales and accruals were down -10%, suggesting that perhaps there's something to that proportionality theory.

Warranty Expense Rates

Although we have warranty expense data going back to 2003, we're showing only the last five years in order to make it easier to see what happened to manufacturers last year. In Figures 3 through 6, what we've done is to take the data from Figures 1 and 2 and divide each total by total product sales figures, in order to calculate the percentage of sales going towards claims and accruals.

Theoretically, the two metrics should remain close to each other, because accruals are what you think your warranties will cost you in the future while claims are what they actually do end up costing you. If you over-estimate future costs, the green line will rise above the red line, and excess warranty reserves will accumulate. And if you under-estimate, the red line will be on top and your warranty reserve will be depleted.

Also, the direction of the lines over time is important. In Figure 3, the seemingly seasonal swings of the lines within each year are caused primarily by Apple's habit of stuffing accruals into its warranty reserve in specific quarters. But over time, the averages do seem to drop, from around three percent in 2016 to around 1.5% in 2020. In previous decade, these metrics both dropped from the four percent range, thanks to a constant effort among the manufacturers to reduce their warranty expenses through automation and better management.

What you don't seen in Figure 3 is a pandemic-related spike in either the claims rate or the accrual rate. That's because manufacturers for the most part kept their warranty expenses proportional to sales revenue, so they both rose or fell together.

Semiconductor Warranty Expense Rates

As we mentioned, semiconductor claims fell -12% last year while accruals rose +14% and sales jumped +29%. But as we can see in Figure 4, while this caused the expense rates to rise in the second quarter and remain elevated in the third and fourth quarters, the big story is whatever happened in the second quarter of 2019.

Unlike in the computer segment, no one company is big enough to move the averages like that all by itself. And indeed, if we look back we find that Applied Materials, Lam Research and Coherent Inc. all had bad second quarters in 2019. Lam Research saw its claims rate jump from 1.8% to 3.2%. Coherent's claims rate rose from 2.7% to 3.8%. And Applied Materials saw its claims rate rise from 1.0% to 1.7%.

Even some of the smaller players had a hard time. Kulicke and Soffa Industries Inc. raised its accrual rate from 1.4% in the second quarter of 2018 to 3.5% in the second quarter of 2019. And Brooks Automation Inc. raised its accrual rate from 1.1% to 1.8% over the same period. Both returned to their baseline expense rates by 2020.

In Figure 5, we see something similar happening in the data storage industry. Accruals spiked right at the end of 2019, before falling back to their usual one-percent range in 2020. Most of that came from Seagate, which raised its accrual rate to 1.7% after its claims rate rose to 1.6% in late 2019.

Over the long term, this group's average claims rate is 1.4% while its average accrual rate is 1.3%. Obviously, both those metrics have been below-average for most of the past five years. Meanwhile, the computer group is up around 2.6% for its long-term average claims and accrual rates, while the semiconductor group is around 0.8% for both metrics.

The peripheral group, whose expense rates are detailed in Figure 6, has an average claims rate of nearly 1.2% and an average accrual rate of just over 1.1%. It ended 2020 with both those metrics just under 1.1%, so this group also is below its long-term average.

Note that there was nothing unusual about the 2020 data. In fact, of the four groups, the only one whose 2020 data was somewhat concerning was the semiconductor group. And with them, the 2019 data, by being even more concerning, negated the 2020 concerns. The bottom line is that while 2020 was a down year, warranty expenses were managed well enough that it didn't show up in any of these charts.

Warranty Reserve Totals

There was, however, a predictable downturn in warranty reserves. At the end of 2020, these 281 manufacturers reported a combined $6.85 billion in their warranty reserve funds, up by $291 million or +4.4% from the end of 2019. However, in the third quarter of 2020, their warranty reserves briefly dipped below $6 billion, as they did in mid-2019. Before that, reserves hadn't fallen below $6 billion since the depths of the Great Recession in 2009.

The computer group raised its reserve levels by $282 million or +5.3% in 2020. The semiconductor group raised its reserve level by $58 million, or +12%. But the data storage group cut its reserves by $51 million or -8.7%, and the peripherals group kept its reserve levels more or less the same from the end of 2019 to the end of 2020.

Looking at the quarterly comparisons, there were only a couple of surprises. From June 2019 to June 2020, the computer group's reserves grew by +17%. From March 2019 to March 2020, the peripherals group let their reserve balances fall by -16%. And from December 2019 to December 2020, the semiconductor group's reserves grew by +12%. Except for these, all the other year-over-year comparisons changed up or down by less than 10%.