May 3, 2012

Semiconductor Warranties:

The companies that make the equipment that makes the semiconductors pay for more than half of the industry's warranty costs, even though their sales are less than a quarter of the total. But they've also done the most to cut their costs since 2003.

In order to complete our report on the new 2011 claims and accrual data for the high tech sector of the warranty industry, following computer, telecom, and medical equipment reports, we go even further up the supply chain, to their suppliers: the semiconductor and printed circuit board makers, and to their suppliers' suppliers: the makers of semiconductor production and test equipment.

As in with the medical and scientific equipment industry report last week, we found a clear separation between the types of companies within the semiconductor industry, in terms of warranty expense rates. But in the medical field, the split was between equipment that either did or did not use lasers or X-rays in their operations. This week, the split is between the chip makers and their suppliers.

An Industry Where Suppliers Pay the Most

The companies that manufacture the equipment that actually makes the semiconductors and printed circuit boards spend a significantly higher proportion of their revenue on warranty expenses than do the makers of the chips, boards, and devices. In other words, those who supply the manufacturing equipment to the factory are paying for the defects, not the factories themselves.

Last year, for instance, the capital equipment manufacturers accounted for a little less than 22% of the semiconductor industry's total warranted product revenue, but ended up paying 51% of the industry's claims. And this pattern has endured for most of the last nine years. The suppliers pay more than their customers in terms of warranty costs.

Since 2003 we've been tracking 147 companies whose primary business is in the semiconductor and printed circuit board industry. There were 20 that make the manufacturing equipment, and 127 which use that equipment to make the boards, circuits, chips, components and devices. So there are 20 capital equipment makers, and more than six times as many customers.

The manufacturing equipment makers reported revenue of roughly $21.1 billion in 2011, while the device makers reported around $75.6 billion in revenue. But the equipment makers reported $371 million in warranty claims, while the device makers reported only $334 million. So the ratio was 53%/47% last year.

Semiconductor Device Fabrication

The claims payments of the two groups are detailed in the charts below. In Figure 1, we've assigned a yellow color to the semiconductor equipment makers, and a green color to their customers, the board and device makers. Except for the recessionary years of 2009-2010, the equipment makers have always paid more than half the total industry's claims.

Figure 1
Semiconductor & Printed Circuit Board Warranties
Claims Paid by U.S.-based Companies
(in US$ millions, 2003-2011)

Figure 1

The leading equipment makers on our list of 20 include Applied Materials Inc., Lam Research Corp., Novellus Systems Inc., KLA-Tencor Corp., and Cymer Inc. As the chart shows, from 2003 to 2008 this relatively small group accounted for almost 60% of the industry's total claims. But their share fell below 40% in 2009 and 2010, before bouncing back to a 53% share in 2011.

Missing Companies

The leading device makers, to be frank, aren't even on the chart. Top U.S.-based semiconductor manufacturers such as Intel Corp. and Texas Instruments Inc. state that their warranty costs are immaterial and therefore don't need to be reported in their financial statements.

Many of their competitors disagree, as evidenced by their decision to continuously report their warranty expenses -- as small as they might be. Sanmina-SCI Corp., for instance, most recently had an 0.13% claims rate, but it still reported its expenses in its annual report. Cypress Semiconductor Corp. reported a 0.23% claims rate. Marvell Technology reported a 0.05% claims rate. And then some of the largest warranty providers among the 127 device makers in terms of dollars spent are Nvidia Corp., Advanced Micro Devices Inc., First Solar Inc., and Teradyne Inc. (see Figure 6 below).

There are also numerous semiconductor manufacturers that we've counted in the telecom, computer, medical, and aerospace industries, which we won't repeat here. For instance, IBM manufactures a vast amount of semiconductors, but uses most of them itself within its own computers. Motorola uses many of its semiconductors within its own phones and other telecom gear. But they've already been covered in past weeks' industry reports.

And then there are the numerous non-U.S.-based semiconductor manufacturers who either import their products into the U.S. market, or operate their own fabrication plants within its borders. We're not counting them this week either. They usually don't make their annual warranty reports to the SEC until June or later.

Equipment Makers Dominate Accruals Too

With accruals, the same pattern holds, more or less. In six out of the nine years charted in Figure 2, the equipment makers accounted for 60% of the accruals, while their customers accounted for the rest. But this pattern reversed itself in the recessionary years of 2008-2010, in which the equipment makers cut their accruals much more rapidly than did their customers the device makers.

Figure 2
Semiconductor & Printed Circuit Board Warranties
Accruals Made by U.S.-based Companies
(in US$ millions, 2003-2011)

Figure 2

We cannot fully explain why the pattern reversed itself during the recession. However, it probably has something to do with the speed at which different groups felt the effects of the downturn. It's likely that the capital equipment makers were the first to see sales fall, while the device makers saw a much more gradual downturn in demand.

And we cannot explain why the equipment makers' share of accruals fell all the way from 60% in 2007 to just 30% in 2009, or why it snapped back to 60% so quickly in 2011. This recession broke a few patterns and started a few new ones. And every sector suffered at different times and to different degrees.

As a Percentage of Sales

The best way to spotlight the difference between the equipment and device makers is to look not so much at their outlays, but at the percentage of revenues that those outlays represent. In Figures 3 and 4, we've taken the data in Figures 1 and 2 and divided it by sales data.

Figure 3 shows the claims and accrual rates of all 147 manufacturers over the past nine years. Figure 4 compares the claims and accrual rates of the 20 equipment makers and the 120 device makers.

After a quick glance at Figure 3, you'd be hard-pressed to find any evidence of a recession. Yes, the data becomes more volatile after 2009 begins, but no, there is no soaring claims rates as we saw with the automotive industry in the April 5 newsletter.

On the flip side, there are also no plunging claims or accrual rates, as we saw in the computer industry as detailed in the April 12 newsletter. However, there is a bit of a decrease in the averages, from the 1.0% to 1.1% range in 2003-2005 to around 0.9% in 2006-2008 and 0.7% to 0.8% in 2009-2011.

Figure 3
Semiconductor & PC Board Manufacturers
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2011)

Figure 3

It's not until you separate the equipment makers from the device makers, as has been done in Figure 4, that two trends become clear. First, the equipment makers have almost always had higher claims and accrual rates than their customers. The only exception is that first quarter of 2010, when the equipment makers' average claims rate plummeted, primarily because of big and sudden claims reductions reported by Applied Materials, Novellus, and Cymer.

And second, those same equipment makers have done the most over the years to refine and improve their warranty processes, raise their product reliability, and cut their warranty costs. The equipment makers have cut their average claims rate from 3.5% in 2003 to 2.5% by 2007 and close to 2.0% for most of the last three years.

Yes, they suffered a deep downturn in sales. But they also came out of that trough with lower expense rates than they had going in. The most amazing thing about that 1.3% claims rate reduction between the fourth quarter of 2009 and the first quarter of 2010 is that it became the new normal. The equipment sector's claims rate, though slowly climbing, has remained below two percent for two years. And now their accrual rate is there as well.

Figure 4
Semiconductor & PC Board Manufacturers
Average Warranty Claims & Accrual Rates
Manufacturing Equipment vs. Chips & PCBs
(as a % of product sales, 2003-2011)

Figure 4

One might say the device makers already had cut their warranty costs to a minimum, and so they simply couldn't go any lower. Indeed, the companies that did report their warranty expense rates have kept them close to 0.5% for most of the past nine years. And in the middle quarters of 2011 they cut their average accrual rates to under 0.3%. No wonder Intel and TI don't consider warranty costs to be worth reporting.

The thing is, the reason the device makers have such low warranty expense rates is because the equipment they use is so precise. Think about it. In the automobile industry, when a defect is found, you fix the vehicle. And maybe if it happens often enough, you go looking for a reason back in manufacturing, perhaps even by using the warranty data to spot a pattern. But in the semiconductor industry, however, you blame every defect on the equipment used to manufacture it.

Warranty Reserves Keep Rising

The other warranty metric that we track is the beginning and ending balance in the warranty reserve funds of the 147 semiconductor and printed circuit board companies that report their warranty expenses. In Figure 5, we've charted the year-ending balances for the past nine years. And the surprise is that except for the downturn of 2009, the combined balance has been increasing since 2005.

Figure 5
Semiconductor & Printed Circuit Board Warranties
Reserves Held by U.S.-based Companies
(in US$ millions, 2003-2011)

Figure 5

Warranty reserves shrank for both equipment and device makers in 2004-2005. And they fell by dramatic proportions for the equipment makers in 2007-08 and again in 2008-09. But except for a relatively small reduction by the device makers in 2008-09, that's it for the decreases. In 2009-10 there were large increases reported by both groups, followed by somewhat smaller increases in 2010-11.

The most amazing aspect of the data in Figure 5, however, is the changing proportion between the equipment and device segments. From 2003 until 2007, the ratio was close to 60/40, in favor of the equipment makers. But in 2008-2011, it's been closer to 40/60, the reverse. We think that's a sign that the equipment makers are doing more to reduce their warranty expense rates.

Top Warranty Providers

Finally, we wanted to include a semiconductor industry "market share" chart for claims paid by the dozen largest warranty providers in the industry. In this chart, the totals in Figure 1 are set to equal 100%, and each company that reported claims payments gets a "market share" based on their contribution to that total.

The top 12 of 2011 are listed below, with the largest warranty providers as of last year at the bottom of the chart. Applied Materials is #1 with a 22% ($157 million) share. Graphics board maker Nvidia has risen to second with 16%, followed by Lam Research and Novellus, then KLA-Tencor. Eight of the top 12 are from the equipment side of the house. AMD and Teradyne have been in the top lists for years. But Nvidia and the other new arrival in the top 12 come from the device side of the house, where the warranty events can be both costly and unexpected.

Figure 6
Semiconductor & PC Board Manufacturers
Claims Paid per Year
(as a % share of the total in Figure 1)

Figure 6

The narrowing of the Novellus band in this chart and the dip in the Applied Materials 2010 "share" are graphic proof that the equipment makers have done the most in recent years to reduce their warranty expenses. We'd add Lam Research and KLA-Tencor to that trend, but their warranty claims "market shares" actually rose in 2011. And LAM Research previously had escalated warranty costs back in 2007-08, as the chart above shows.

Manufacturing Crises

Nvidia Corp. had a well-publicized manufacturing problem with its graphics boards back in July 2008, which in the chart above can be seen as the red bulge in the recent data. And First Solar, which manufacturers solar panels, is currently dealing with the double whammy of an increase in defects and a downturn in sales. Its emergence as a significant claims payer, however, began more than two years ago, as the sudden appearance of the bright green band suggests.

We don't point these out to add to their misery. But it could serve as a caution and a reminder to the semiconductor companies that don't consider warranty expenses to be worth reporting in their financial statements, that when it rains, it pours.

Ninth Annual Product Warranty Reports

As we continue with our annual survey of U.S.-based warranty providers, here are the links to the online editions of all the other parts of this series:

Readers needing more detailed snapshots of individual companies in either a PowerPoint or Excel format are invited to view the list of charts and spreadsheets available on the Warranty Statistics page.

PCMI - Your technology partner
Mize Warranty Connect
ServiceBench for Service Administrators
After Warranty Analytics
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