September 22, 2003

Warranty in the IT Industry:

Spending on warranty claims for everything from handheld computers to television transmitters showed a very slight increase during the second quarter, while both claims rates and reserve fund balances were down. Collectively, some 259 IT equipment manufacturers spent almost $2 billion honoring warranty claims during the period.

Besides automotive, one of the largest sectors of the warranty claims business is the information technology industry, made up of separate-but-related segments such as computers, telecommunications equipment, and semiconductors. During the second quarter of 2003, these three sectors of the IT industry accounted for $1.987 billion in warranty claims, an increase of 2.04% from the first quarter's $1.947 billion total.

According to the Form 10-Q and 10-K reports of some 259 information technology manufacturers filed with the Securities and Exchange Commission during the months of June, July, or August, warranty claims consumed roughly 2.5% of these manufacturers' IT product sales (service, finance, and consumables revenue not included). That represents a slight increase from the 2.4% claims rate seen during the first quarter.

Meanwhile, warranty accruals -- the money put aside by information technology manufacturers to pay for future claims -- totaled $1.96 billion for the quarter. After a few more adjustments to account for changes of estimate and currency fluctuations, IT manufacturers ended the quarter with just over $8.3 billion in their reserve funds as of June 30. That represented a net decrease of $32 million from the reserve fund levels seen on March 30.

Five Segments

As mentioned, we're cramming 259 manufacturers into a category broadly defined as information technology equipment. Within that heading, there are numerous segments, of which we've defined five: computers, telecommunications equipment, semiconductors, data storage systems, and peripherals/other.

One of the biggest challenges was deciding where a given company fit best. Hewlett-Packard, for instance, would be at home among either the computer systems manufacturers, the data storage vendors, or the printer makers listed under peripherals. Had they not spun off their semiconductor operations as Agilent Technologies, they'd be at home in that category as well. But on the flip of a coin, they ended up with IBM, Gateway, and Dell in the computer category, although undoubtedly a large portion of their warranty claims spending came out of the printer division.

A bigger problem was deciding what to do with all the medical and scientific instrument manufacturers. Some of these systems look and feel like computers with their keyboards, screens and disk drives, and of course they're filled with semiconductors. In fact, an anti-epilepsy system sold by Cyberonics Inc. is first programmed by a computer and then surgically implanted into the patient, who can control it by use of a magnet.

Numerous modern medical devices are more like computers than hand tools. Companies such as Analogic Corp.; Bruker AXS Inc.; Planar Systems Inc.; Intuitive Surgical Inc.; and Versus Technology Inc. have divisions that make commercial semiconductors and/or computer peripherals. However, in each of these cases, all five were counted in the medical category, which will be considered separately in the Sept. 29 column. For now, suffice it to say there were around 100 medical device manufacturers reporting $122 million in claims, which was roughly 1.1% of their product sales.

With HP having a home and our appointment with medical equipment postponed until next week, it was still difficult to segment the information technology industry into just a handful of segments. Computers is perhaps too broad a term, if it includes everything from the PDAs of Palm Inc. and the iPods of Apple Computer to the supercomputers and animation workstations of Cray and Silicon Graphics. One reader suggested dividing the market into sectors for consumer and business computing. Unfortunately, the market segment information currently available from the computer manufacturers makes this impractical.

Data storage systems sounds a bit vague unless the definition is narrowed to include just makers of disk drives, tape backup systems, storage-area networks, flash memory, and one-of-a-kind gadgets like Zip drives. Of course, HP, Dell, IBM, and Sun also sell data storage systems, but there are roughly a dozen companies that make nothing but data storage systems. Those are what's grouped into this segment in the following chart.

Warranty in the Information Technology Industry
Claims by Industry Sector,
Second Quarter, 2003

  Warranty Claims as Warranty-
  Claims % of Product Months in
  Industry Sector 2Q ($m)  Sales   Reserves 
  Computers & Servers $1,248 3.6% 11
  Telecom Carrier Equip $250 2.0% 18
  Semiconductors & PCBs $192 1.5% 12
  Data Storage Systems $141 2.0% 15
  Peripherals & Other $156 1.1% 16
  Total $1,987 2.5% 13

Key: increases in black,
decreases in red.

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

Within these five somewhat arbitrary sectors of the IT industry, there's quite a bit of variance with respect to warranty claims rates and reserve fund-to-claims ratios. Among all 259 IT manufacturers who reported warranty activity during the second quarter, the average claims rate is 2.45% of product sales and the average warranty reserve fund is equal to around 12.5 months' worth of claims. But computer vendors typically experience a higher claims rate, and telecom equipment makers tend to keep a higher level of reserves, as the chart above shows.

The telecom carrier equipment sector includes all the networking gear used by telephone companies, Internet service providers, television and radio broadcasters, cable TV networks, mobile phone service providers, and local-area networks for computers. In this instance, it does not include the televisions themselves, nor does it include the radios, stereos, and other audio/video equipment used to receive programming, which is more properly accounted for as consumer electronics. But it does include mobile phone handsets and the set-top boxes used for cable TV reception. It also includes all the network cards, modems, and computer-fax systems inserted into PCs for data communications purposes.

Semiconductors and printed circuit boards is a somewhat self-explanatory industry segment. However, in this instance it also includes not only the actual wafer production equipment, but also the test equipment and ancillary systems such as those that filter the air and water used during production. As mentioned, some of the medical equipment makers whose pumping and filtering systems purify air and water for pharmaceuticals and lab tests also sell their systems to semiconductor manufacturers. But for now, we'll keep them on the medical equipment list.

Finally, there's the all-encompassing "other" category. This sweeps in all the printer and scanner makers, as well as all the laptop battery makers and the security and access control system manufacturers (but not the firewall vendors, who are in the datacom networking sector). Computer-based gambling systems also are included here. Automated teller machines, currency counting machines, counterfeit detection systems, point-of-sale terminals, and other computer-like money-handling apparatus are included here as well. The list even includes a maker of digital computer screen projectors.

Several manufacturers are blurring the line between office equipment and computer peripherals with all-in-one units that include a laser printer, a fax machine, a copier, and a scanner. Fortunately, all but those sold by Xerox and Pitney Bowes are covered by manufacturer's warranties issued by foreign companies, which are not included here. So we dodged that bullet. Both of those companies are included in the "other" category.

What's Not Here

Excluded in this go-round are all the electrical power equipment manufacturers, who were lumped into the "network equipment" category for the first quarter report delivered in the June 9 issue of Warranty Week. After some subscriber complaints, we've reconsidered and realized that there's a world of difference between steam-powered turbines that generate electricity and TV transmitters that generate RF waves. Electrical power generation equipment will be included in the Sept. 29 report, although it's still an open question what to do with the diesel-powered portable generator manufacturers. Their products don't have wheels so they're not automotive. But several of the most successful diesel engine manufacturers make units for both vehicular and stationary power generation applications.

Still, there is the nagging question of what to do with battery manufacturers. Some batteries are clearly aimed at consumer electronics equipment. They're even sold in shrink-wrap and blister packs. Others belong in automobiles. Then there are the battery backup systems that tried and mostly failed to keep wireless telecom services up and running during the two recent East Coast blackouts. And of course, there are the batteries that power laptop computers, iPods, and PDAs.

We're stumped, and need advice. Do all the AC power equipment vendors and all the DC battery makers belong in the same category? Or should car battery makers be treated as automotive and laptop battery makers counted as computer? For now, we're throwing all the computer and telecom battery makers into the "other" category. Automotive battery makers were counted last week, but clearly there's some overlap.

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

  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Handspring Inc. $6 10% 6
  Cray Inc. $1 7.4% 18
  Gateway Inc. $51 6.6% 2
  Sun Microsystems $92 5.0% 9
  Palm Inc. $9 4.7% 6
  Hewlett-Packard Co. $626 4.2% 10
  IBM Corp. $206 3.2% 9
  Dell Inc. $232 2.7% 18
  Silicon Graphics $3 2.4% 7
  Apple Computer Inc. $18 1.3% 11
  Other $5    
  Subtotal $1,248 3.6% 11

Key: increases in black,
decreases in red.

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

As was mentioned in the Sept. 15 issue of Warranty Week, Handspring's 10% claims rate is far above the norm for manufacturers. Here we demonstrate that it's also above the claims rates experienced by not only arch-rival (and future acquirer) Palm Inc., but also the whole class of computer system makers. The sector average is closer to 3.6%, though that number is heavily weighted by the claims experience of HP, IBM, and Dell.

As of the end of the third quarter, a handful of companies had yet to file their Form 10-K reports with the SEC for the second quarter. That group includes include Read-Rite Corp.; DT Industries Inc.; and Asante Technologies Inc. In each case, estimates derived from the first quarter reports of each respective company were inserted as placeholders. Their warranty reserve fund balances, for the time being, were assumed to have remained unchanged since March 30, i.e. claims were matched by accruals. For this reason, there are no up or down movements in any of their statistics. As these companies file their reports in the next three or four weeks, the correct information will be inserted into the online edition of this column, and therefore the totals also may change very slightly.

Warranty in the Telecom/Datacom Sectors
Top Spenders on Claims,
Second Quarter, 2003

  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Juniper Networks Inc. $7 5.0% 13
  3Com Corp. $8 4.6% 17
  Lucent Technologies $49 3.5% 21
  Avaya Inc. $14 2.3% 9
  Cisco Systems $72 2.2% 10
  UTStarcom Inc. $5 2.0% 11
  Nortel Networks Corp. $32 1.7% 24
  Scientific-Atlanta $6 1.5% 20
  Corning Inc. $4 1.1% 38
  SPX Corp. $10 0.9% 21
  Other $54    
  Subtotal $250 2.0% 18

Key: increases in black,
decreases in red.

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

The telecom equipment market could easily be subdivided into carrier-specific segments. There could be segments for traditional telephone companies, for cable TV networks, for wireless phone services, and for TV and radio broadcasters. And of course there could be segments for both wide-area and local-area datacom network equipment providers.

Right now, we're jamming 112 manufacturers into one all-encompassing "telecom" category. Together, these manufacturers spent a collective $250 million on warranty during the second quarter, which was roughly 2% of their product sales. Of course, telecom services are not covered by warranties, and where applicable, services revenue was excluded from the above calculations.

There are really no surprises in the chart above. Except for the unusually large reserve fund kept by optical equipment maker Corning Inc., nothing seems out of the ordinary. You'd have to go all the way down the list to First Virtual Communications Inc. to find a company with a claims rate over 10% ($179,000 in claims against $1.4 million in product sales so far this year).

Besides Corning, telecom network and carrier equipment companies with unusually large warranty reserves include Avanex Corp.; Communications Systems Inc.; Crossroads Systems Inc.; Pinnacle Systems Inc.; and Verilink Corp. But that's more a function of their low claims rates than any huge fund balances.

Among larger companies, Qualcomm and Broadcom are towards the high end with respective reserve-to-claims ratios of 45 and 91 warranty-months. Cisco and Avaya are towards the low end, with ratios of 10 and 9 warranty-months, respectively. The median in this sector, by the way, is 21 warranty-months -- enough to pay the current claims rate for the next seven quarters.

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

  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Axcelis Technologies Inc. $5 7.8% 9
  Cymer Inc. $5 6.3% 16
  Novellus Systems Inc. $14 5.6% 6
  FEI Company $4 5.5% 9
  Advanced Energy Industries $4 4.6% 5
  KLA-Tencor Corp. $12 4.4% 9
  Applied Materials Inc. $41 3.7% 11
  Lam Research Corp. $4 2.4% 12
  Agilent Technologies $18 1.5% 12
  Advanced Micro Devices $7 1.1% 9
  Other $79    
  Subtotal $192 1.5% 12

Key: increases in black,
decreases in red.

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

Semiconductor makers typically experience very low warranty claims rates. In fact, Intel Corp. is of the opinion that their claims experience is so insignificant that they don't even need to report it. But look at the bottom of the list above. There sits AMD, one of Intel's arch-rivals, with a small but not insignificant claims rate of 1.1%.

One reason we suspect the claims rates for the chip-makers are so low is because they transfer the burden (and the cost) of ensuring zero defects onto the fabrication equipment makers. In other words, companies like Novellus have a 5.8% claims rate so that companies like Intel can have a 0.0% rate.

Then again, with 64 semiconductor vendors on the list so far, there is quite a bit of variance between the top and the bottom. Six chip makers spent less than $10,000 on warranty claims, and 17 were below $100,000. Twenty-six spent more than $1 million on claims, of which five spent upwards of $10 million. One can only speculate what Intel, with $6.8 billion in quarterly product revenue, considers to be insignificant.

Disk Drives

Twenty-seven companies were found reporting warranty claims in the data storage sector, of which all but a handful were related to hard disk drives and the servers built around them. Iomega spent $2.4 million on claims related to its Zip drives and CD burners, while Overland Storage and Exabyte reported claims of $399,000 and $1.149 million, respectively, for their tape drive units.

Warranty in the Data Storage Industry Sector
Top Spenders on Claims,
Second Quarter, 2003

  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Quantum Corp. $12 7.3% 11
  Maxtor Corp. $41 4.4% 19
  Storage Technology Corp. $12 3.9% 11
  Iomega Corp. $2 2.4% 8
  Western Digital $12 2.0% 13
  Seagate Technology $32 1.9% 13
  EMC Corp. $18 1.6% 20
  Advanced Digital Information $2 1.4% 10
  Hutchinson Technology $2 1.4% 1
  SanDisk Corp. $1 0.7% 15
  Other $7    
  Subtotal $141 2.0% 15

Key: increases in black,
decreases in red.

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

One immediately notices in the chart above that while six of the top ten vendors are within half a percent of the industry average, three are far above it and one is considerably below it. Industry-wide, though, only six vendors are above the average while the rest are below it. One possible reason: differing product lines and customer types. For instance, SanDisk makes flash memory units for cameras and PDAs, in which there are no moving parts, hence less wear and tear. Quantum and Maxtor make hard drives for PCs, and they have some of the most demanding customers in the world: HP and Dell. Western Digital, Iomega, and some others are big players in the retail channel, where customers are more likely to fume in quiet desperation than they are in the OEM channel.

And finally, there is the "other" category. Initially, this was the sector for just PC peripheral makers, but as more and more IT companies piled up that didn't fit in anywhere else, its scope widened. For instance, what to do with ID card readers, access control systems, PC-controlled and wireless-assisted video camera aiming devices, or closed circuit security camera networks attached to tape or disk recording systems? They're technology systems that gather and distribute information, but nobody would call them either computers or telecom networks. They're not automotive, and they're certainly not aerospace. So what are they?

Currency Transactions

Forty-one vendors make up the chart below. What you see are the top ten in terms of claims volume, ranked by the percentage of sales those claims represent. Included in the totals but not listed on the chart are companies such as IPC Acquisition Corp., whose business is the manufacture of the trading turrets used by brokers on Wall Street. As mentioned, the makers of laptop batteries and the backup power systems for telecom switches and transmitters also are included here, although Exide and C&D are the only two to make the top ten.

Also not listed below are the computerized gaming vendors, such as International Game Technology and International Lottery & Totalizator Systems Inc., whose computer-based products relieve users of their excess currency. This category also includes all the bar code scanners, point-of-sale terminals, and ATMs of manufacturers such as NCR, Diebold, and others. You can't call them cash registers or cash machines any more. As evidenced by the virus attacks and other calamities of recent years that temporarily put these systems out of commission, these are very much computers connected to data networks. So what if they can't play Tetris?

Warranty in Other IT Industry Sectors
Top Spenders on Claims,
Second Quarter, 2003

  Warranty Claims as Warranty-
  Claims % of Product Months in
  Company 2Q ($m)  Sales   Reserves 
  Lexmark International $39 11% 12
  InFocus Corp. $7 3.9% 4
  C&D Technologies Inc. $2 2.9% 12
  Exide Technologies $16 2.8% 11
  NCR Corp. $11 1.7% 5
  Diebold Inc. $2 1.5% 19
  Gerber Scientific Inc. $1 1.3% 9
  Xerox Corp. $13 0.8% 6
  Tyco International Ltd. $47 0.6% 27
  Dover Corp. $5 0.5% 22
  Other $13    
  Subtotal $156 1.1% 16

Key: increases in black,
decreases in red.

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

We also lumped in here the digital projectors of InFocus Corp. and the special IMAX projectors of Ballantyne of Omaha Inc. because, frankly, we didn't know where else to put them. They're not professional TV broadcasting and editing systems like Avid Technology Inc., and they're not for the most part consumer electronics items. Yet they are electronics-based systems involved in the delivery of information (and entertainment).

In sum, there are 259 U.S. manufacturers providing warranties for telecom, datacom, broadcasting, and computing systems. More importantly, they're providing investors and researchers with the details now required of them by FASB Interpretation No. 45.

We found another 54 IT vendors who stated that they issue product warranties, but who then provided no details about them beyond perhaps their warranty reserve fund balance. And then there are literally hundreds more who made no mention at all of their warranties.


The most notable companies failing to comply with FASB FIN 45 include Intel; Delphi Corp.; Motorola Inc.; Flextronics International Ltd.; Solectron Corp.; Sanmina-SCI Corp.; Jabil Circuit Inc.; and Pitney Bowes Inc. The list of smaller companies not in compliance includes Roper Industries Inc.; Rockford Corp.; Emcore Corp.; and Intervoice Inc. Hopefully, it's just a temporary oversight on their part, and as soon as they understand the requirements of FIN 45, they'll bring themselves into compliance. After all, this is just the second round of quarterly reports for which warranty disclosures were expected.

Then there are the importers. Telecom, computer, information technology, and semiconductor manufacturers based outside the U.S. and others not reporting their warranty financials to the SEC include Acer Inc.; Alcatel; Canon Inc.; Ericsson LM Telephone Co.; Hitachi Ltd.; LG Group; Marconi Corp. plc; Matsushita Electric Industrial Co. Ltd.; NEC Corp.; Nintendo Co. Ltd.; Nokia Corp.; Philips Electronics N.V.; Pioneer Corp.; Ricoh Co. Ltd.; Samsung Group; Seiko Epson Corp.; Siemens AG; Sony Corp.; Thomson Multimedia; and Toshiba Corp.

We leave it up to others to formulate estimates of those companies' warranty activity. In the June 23 issue, we took a stab at quarterly claims estimates for 15 non-filers, and some of those estimates turned out to be off by 40% or more. Once bitten, twice shy, as the saying goes.

In total, we're tracking 750 manufacturing companies that are now making the required FASB FIN 45 disclosures regarding product warranties. These manufacturers reported nearly $1.7 trillion in revenue during the first half of 2003, which means they represent roughly a third of U.S. GDP. Make no mistake -- this is a manufacturing story. While businesses such as repair service centers and insurance companies are intimately involved in the warranty industry, at the end of the day only manufacturers issue product warranties.

What's remarkable is that of all the non-reporting U.S. manufacturers, only 19 had quarterly sales over $1 billion. At least among large companies, compliance with FIN 45 is astonishingly high, given that this is only the second full quarter in which the new rules applied. What's even more remarkable is the large number of smaller manufacturers that have complied with FIN 45. Well over half of the 750 manufacturers reported less than $1 million in warranty claims per quarter. So despite the heavy weighting of these lists and the warranty industry in general to the top 50 or 100 manufacturers, the FASB FIN 45 compliance story is spreading widely.

Back to Part Two   Go to Part Four  

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