May 18, 2004

Warranty Claims:

While some U.S. manufacturers are still preparing their latest financial statements, most of the largest warranty providers have already announced their first quarter claims and accruals. Half of the top 50 are spending more on warranty than a year ago while half are spending less.

Warranty continues to increase in importance, not only as a marketing tool and an indicator of product quality, but also as a benchmark of the financial and engineering health of a company. Thanks to late 2002 rulemaking by the Financial Accounting Standards Board, the first quarter of 2004 was the fifth quarter in a row for which detailed warranty account balances were provided by some 750 of America's largest manufacturers. This also means that the first quarter signals the beginning of meaningful year-over-year comparisons. For while a select few manufacturers have provided details on their 2002 warranty accounts, compliance back then was not required.

Unfortunately, in our rush to publish some of these numbers as soon as possible, we're a few weeks ahead of the reporting schedules for roughly 15% of these manufacturers. By late May or early June, most will have filed their Form 10-Q statements with the U.S. Securities and Exchange Commission. At that point, we'll be able to total up the numbers for warranty claims and accruals and break them down industry by industry. For now, all we can report is the very top of the pyramid, where 48 of the 50 largest and most important warranty providers have already filed their financial statements.

Dollar Comparisons

We took the list of the top 50 warranty providers, most of them repeats from the year-end 2003 charts, with a few new arrivals included, and ranked them based on the observed change in the size of their warranty claims between the first quarter of 2003 and the first quarter of 2004. Note that what was compared were the dollar amounts, not the percentage of sales. This is very important, because the percentages involve a comparison with sales figures, which themselves fluctuate from year to year.

In other words, claims might have soared simply because sales are soaring too. More products sold means more products repaired. Less products sold would be a disappointment, but it also would likely mean less warranty claims. Then again, there is a definite lag between when a product is sold and when, if ever, it needs repairs. So strictly speaking, comparing products sold and claims adjusted for the same quarter can produce misleading results.

Fortunately, only six of the companies saw product sales decline. That list included Seagate Technology, General Electric Co., Sun Microsystems, Boeing Co., Textron Inc., and Lucent Technologies. Equally fortunately, two of those companies -- GE and Textron -- did not provide warranty claims reports for either the first quarter of 2003 or 2004, so comparisons aren't possible. Of the four remaining companies, Seagate saw claims remain exactly the same year-over-year, while Sun, Boeing, and Lucent saw claims plunge by double-digit rates while sales declined by more gentle single-digit rates.

Sales Are Way Up for Some

A total of 39 companies saw product sales increase year-over-year. Among the biggest gainers were Applied Materials Inc. (+48%); AGCO Corp. (+47%); Motorola Inc. (42%); Caterpillar Inc. (36%); Pulte Homes Inc. (+32%); Paccar Inc. (+32%); EMC Corp. (+31%); Brunswick Corp. (+28%); Deere & Co. (+28%); and Cummins Inc. (+28%). Of those ten, only Pulte saw claims rise faster than sales (although there was no claims comparison available for Motorola). In fact, Applied Materials and Cummins saw sales rise and claims fall -- the best of both worlds.

What follows is a ranking of the top 50 warranty providers by the percent change in the amount of claims, in dollar terms. Warranty Week has received a fair amount of criticism from readers for always ranking based on claims as a percent of sales, and always placing those with the highest claims rates at the top of the chart. Some readers worry that marketing types will equate high rates with bad products, and low rates with good products. Setting aside the obvious differences in product type, materials, longevity, and durability, there are numerous other good reasons why claims and accrual rates are not directly comparable between companies.

In the automotive market, for instance, it seems that the manufacturers closest to the end user frequently are left holding the bag when it comes to warranty. Their suppliers may supply them with junk, but it's the OEMs that eat the cost of the recalls. In the computer industry, printer companies make all their money from sales of non-warranted supplies, while disk drive companies live and die on the quality of their products. Like photographic film and letters from home, the contents of a failed disk drive are rarely rectified by a mere replacement of the materials. So for a printer company, 8% or 9% claims rates are no big deal, while for a disk drive company, every failure turns the victim customer into an enemy for life.

In the consumer electronics industry, warranty claims are no big deal, and warranty work is becoming something of an anachronism. Some manufacturers throw the returns away, not even bothering to repackage or even test them. In the heating, air conditioning, power generation, and aerospace industries, product failures are events and sometimes news. In the automobile industry, it's becoming difficult not to notice how prominently-featured those longish warranties have become. Even on Wall Street, the ups and downs of quality and warranty are becoming leading indicators of future sales and earnings growth. Bottom line, warranty matters more for some companies, and less for others.

Most Improved List

With that having been said, here is another in our periodic lists of the top providers of warranty. This time, we're ranking the companies in descending order from most improved to least improved, based on dollar amounts spent on claims. But even this measure could unfairly penalize companies for which the importance of warranty is increasing. For if a year ago a company was getting by with 90-day warranties and now they're providing three-year terms, would not their expenses naturally increase? Fortunately, most companies have held steady on the breadth of their warranty programs over the past year. So this is merely a measure of changes in their depth:

America's Top Warranty Providers
Claims in $ Millions and Percent of Sales
First Quarter 2004

  Warranty Claims as  Increase or 
  Claims Percent of Decrease
  Company in 1Q '04  Prod Sales   Since 1Q '03 
  Gateway Inc. $18.9m 2.4% -60%
  Lucent Technologies Inc. $19.0m 1.0% -57%
  Tyco International Ltd. $35.7m 0.4% -21%
  Sun Microsystems Inc. $86.0m 4.9% -19%
  Boeing Co. $58.0m 1.1% -16%
  Applied Materials Inc. $35.2m 2.3% -11%
  Cummins Inc. $44.0m 2.5% -10%
  Cisco Systems Inc. $84.0m 1.8% -9.7%
  Champion Enterprises Inc. $14.3m 6.8% -9.4%
  American Standard Cos. $25.7m 1.2% -7.9%
  Fleetwood Enterprises Inc. $18.3m 3.1% 7.1%
  Rockwell Collins Inc. $16.0m 2.4% -5.9%
  Lexmark International Inc. $42.7m 8.7% -5.1%
  Navistar International $42.0m 2.8% -4.5%
  United Technologies Corp. $111m 1.9% -1.8%
  Hewlett-Packard Co. $576m 3.6% -0.9%
  Seagate Technology $33.0m 2.4% ±0%
  Agilent Technologies Inc. $19.0m 1.3% ±0%
  General Motors Corp. $1,131m 2.8% +3.2%
  Danaher Corp. $13.8m 0.9% +3.3%
  Whirlpool Corp. $79.0m 2.9% +3.9%
  EMC Corp. $19.8m 1.4% +4.2%
  Beckman Coulter Inc. $14.6m 2.7% +4.3%
  Ford Motor Co. $871m 2.2% +4.4
  Caterpillar Inc. $125m 2.1% +6.8%
  Brunswick Corp. $23.0m 1.9% +8.0%
  IBM Corp. $207m 3.1% +8.9%
  Maytag Corp. $35.5m 3.2% +13%
  Maxtor Corp. $56.5m 5.5% +15%
  Dell Inc. $257m 2.6% +18%
  Deere & Co. $81.0m 2.8% +19%
  Paccar Inc. $52.2m 2.2% +23%
  ArvinMeritor Inc. $21.0m 0.8% +24%
  Terex Corp. $17.9m 1.7% +26%
  Johnson Controls Inc. $11.1m 0.2% +26%
  York International Corp. $17.6m 2.1% +34%
  Pulte Homes Inc. $21.6m 1.1% +37%
  AGCO Corp. $19.4m 1.7% +39%
  Ingersoll-Rand Co. Ltd. $29.8m 1.4% +41%
  Honeywell International $55.0m 1.0% +57
  Apple Computer Inc. $27.0m 1.6% +59%
  Lennar Corp. $32.2m 1.8% +102%
  General Electric Co. (1) $187m 2.8% na
  Motorola Inc. (1) $44.5m 2.3% na
  Nortel Networks Inc. (1) $42.3m 1.0% na
  Textron Inc. (1) $37.8m 0.7% na
  Delphi Corp. (1) $29.6m 0.4% na
  Black & Decker Corp. (1) $21.4m 0.3% na
  Eaton Corp. (1) $20.5m 1.5% na
  Exide Technologies (1) $17.9m 2.3% na

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

Note: (1) -- Warranty Week estimate based on 2003 data.

A few of these comparisons were dramatic enough to make us go back and double-check our figures. And we are happy to report that yes, Gateway and Lucent did indeed see dramatic declines in warranty claims. We're less happy to report that Lennar, Apple, and Honeywell did indeed see dramatic increases in first quarter claims.

Among the big five -- GM, Ford, HP, Dell, and IBM -- only HP saw claims fall at all in aggregate dollar terms. GM and Ford saw modest increases of 3.2% and 4.4%, respectively. IBM saw an 8.9% increase, and Dell saw an 18.4% increase in claims (almost equally matched by its 17% rise in sales).

Welcome Delphi

Among the top 50 overall, the only real new entrant is Delphi Corp., which joins in a somewhat sideways fashion. The company does not yet provide details of its warranty accounting, but it did let slip that claims were only 0.4% of sales. With a few clicks of the calculator, we extrapolated a likely quarterly claims total of $29.6 million for the auto parts giant, which we will use for now as a placeholder estimate. Anonymous corrections are welcome.

Further down the list, some of the top 50 for 2003 slipped below the cutoff for the first quarter, displaced by a few manufacturers that were bubbling under three months ago. The exits include General Dynamics, Avaya, and Dana Corp., while the new entrants include Beckman Coulter and Western Digital.

Among companies with extremely low claims rates as a percentage of sales in early 2003, most saw large increases in claims, at least in dollar terms if not also in percentage terms. For instance, Johnson Controls saw claims rise from $8.8 million to $11.1 million, and the claims rate rise from 0.15% to 0.18%. At Tyco, however, claims fell from $45 million to $35.7 million, while the claims rate fell from 0.63% to 0.45%. At ArvinMeritor, claims rose from $17 million to $21 million, but because sales rose at a faster pace, the claims rate actually fell from 0.85% to 0.78%.

Among companies with unusually high claims rates a year ago, Lexmark saw claims fall and sales rise, leading to a decrease in its claims rate from 9.7% to 8.7%. However, keep in mind that the company has now ceased to break out its printer hardware and consumables into separate segments, so Warranty Week had to extrapolate the former at a rate of 40% of total revenue -- the average ratio in 2003.

Extrapolated Segment Data

For several other companies, notably Dell, Gateway, Whirlpool, and Maytag, Warranty Week also had to extrapolate to derive segment data for (warranted) hardware and (non-warranted) software, service, and finance revenue. In most cases, total revenue was simply deflated by 10%, based on ratios seen at similar companies.

At Dell, a future complication was thrown into the mix. The company has decided to begin mixing product warranty and extended warranty fund balances, which will make it increasingly difficult to ascertain its warranty accruals and warranty reserve fund balances. Warranty Week asked if perhaps the company could provide unbundled numbers, but that request was politely declined. In this week's calculations, however, this development has no effect.

Of the top 50, only Exide Technologies and Nortel Networks have yet to file their financial statements for the first quarter. Meanwhile, GE, Motorola, Textron, Black & Decker, and Eaton have returned to their schedule of providing detailed warranty accounting only once a year. Of those five, however, Motorola is providing at least beginning and ending balances for their warranty reserve fund.

Outside of the top 50, quite a number of companies have yet to report. As of close of business on May 18, only 85% of the 750 manufacturers we're tracking have filed their Form 10-Q or 10-K statements with the SEC. For some of the 15%, it's simply a matter of habit to wait for late May or early June to file their quarterly statements. For others, we're awaiting their annual reports for fiscal years ending in March, and we may be waiting until late June for some of those. For an unfortunate few such as Nortel, however, internal accounting chaos will make the wait much longer. Overall, in another week or two we should have closer to 95% of all the reports on file, making industry comparisons and other analyses possible.

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