As we have pointed out is the case with several industries, warranty expenses in the medical and scientific equipment industry seem to have stopped declining. Though it's not yet a massive upturn, warranty costs have begun climbing again for at least one segment of the industry: companies whose equipment makes use of lasers and/or X-rays.

To reach this conclusion, we began with a list of 196 U.S.-based manufacturers of medical and scientific equipment, borrowing a handful of companies that would ordinarily be classified in other industries such as semiconductors, furniture, or telecom equipment. For instance, custom printed circuit board manufacturer Plexus Corp., specializes in manufacturing highly complex products for customers in the healthcare and life sciences industries. Laser system manufacturer Coherent Inc. offers products used for everything from DNA sequencing to glaucoma surgery.

From each company we collected four essential metrics: warranty claims paid, accruals made, reserves held, and products sold. We tried our best to exclude non-warranted products such as consumables and basic materials, but some companies do a better job than others of segmenting their revenue sources. With the claims, accrual, and product sales data, we calculated an additional pair of ratios: claims as a percentage of sales (the claims rate) and accruals as a percentage of sales (the accrual rate).

Two Groups

As we have done in past years, we separated the 196 companies into two groups: those that manufacture instruments and equipment that uses lasers or X-rays, and those that do not. The reason is to see if the laser and X-ray companies continue to spend a far higher percentage of their sales revenue on warranty expenses than do other medical and scientific equipment makers.

As can be seen in Figure 1, the 24 laser and X-ray equipment makers that we identified account for only a small portion of the industry's total claims paid. In 2017, they accounted for only 18% of the $719 million total. However, that was actually their highest share of the total in the last 15 years. Back in 2004 and 2005, they accounted for only 12% of the total.

The big reason for their increased share is simple: their warranty expenses rose last year while the warranty costs of other medical and scientific equipment makers dropped. Laser and X-ray equipment makers paid $25 million more in 2017 than they did in 2016, while other medical and scientific equipment makers paid $73 million less.

Test equipment maker Danaher Corp. saw one of the largest drops, cutting its claims cost from $90.3 million in 2016 to $56.6 million in 2017. Percentage-wise, Bio-Rad Laboratories Inc. reported an even deeper cut, bringing its 2016 bill of $33.2 million down by more than 40% in 2017. Boston Scientific Corp., Roper Technologies Inc., and Invacare Corp. were among the other medical and scientific equipment makers that reduced their claims costs by big percentages.

At the other extreme, Dentsply Sirona Inc., deeply involved with X-ray machines used by dentists, and Coherent Inc., makers of the laser systems used for laser vision correction, skin treatments, and other medical and scientific applications, saw some of the largest increases in claims costs. Coherent's claims cost jumped by $15.4 million or 69%, while Dentsply's rose by $7.3 million or 41%. The year before, Dentsply's claims costs soared more than tenfold, but that was caused primarily by the February 2016 merger between Dentsply International and Sirona Dental Systems. Dentsply was primarily a manufacturer of dental consumables, while Sirona made the capital equipment used by dentists.

And then there were a handful of companies that went against the trend. For instance, on the X-ray side, Varian Medical Systems Inc. cut its claims cost by $11.8 million or 22%. And on the other side, ResMed Inc., which makes systems used to treat sleep apnea and other airflow problems, saw its claims cost rise by $4.6 million or 37%. But these were the exceptions to the rule.

Warranty Accruals

It was much the same pattern with warranty accruals. The laser and X-ray equipment makers increased their accruals by $28 million last year, while the other medical and scientific equipment makers reduced their accruals by $60 million. And because of those shifts, the overall share of accruals made by the laser and X-ray equipment makers rose above 20% for the first time ever. Long-term, their average annual share has been closer to 15%, and was as low as 11%, in 2005.

Danaher and Bio-Rad Laboratories once again led the declines, reducing their accrual totals by $33 million and $13 million, respectively. Invacare, Roper Technologies, and Boston Scientific once again were also near the top of the list. But they were joined by glucose monitor manufacturer Dexcom Inc., which cut its accrual total by more than a quarter last year.

Coherent was once again one of the laser and X-ray equipment makers that vastly increased their accruals last year. But it was joined by medical X-ray imaging systems maker Hologic Inc., which in March 2017 acquired Cynosure Inc., manufacturers of laser-based hair and tattoo removal systems. Due to that acquisition, Hologic's accruals more than doubled in 2017.

And then there were a handful of companies that went against the trend. Once again, Varian Medical Systems was one of the few laser and X-ray system makers to see its accrual total drop. Its accrual decrease was $8.7 million or 15%. Surprisingly, Dentsply Sirona's accruals rose by only 2%, despite the big jump in claims. Among the other manufacturers, hospital bed maker Hill-Rom Holdings Inc. reported one of the biggest increases in accruals, followed by genetic sequencing systems maker Illumina Inc. and scientific equipment maker Thermo Fisher Scientific Inc.

Warranty Expense Rates

In Figure 3, we've taken the claims and accrual totals from Figures 1 and 2, and divided them by corresponding product sales totals, to calculate two pair of warranty expense rates. In Figures 1 and 2, the expenses of the laser and X-ray system makers comprised roughly 15% to 20% of the total. But in Figure 3, their expense rates are 2-1/2 to 3 times higher than those of the other medical and scientific equipment makers.

Both pairs of expense rates are subject to seasonal changes, which industry experts have said are related to the procurement patterns caused by the school year and budgetary cycles. And both pairs of expense rates have been generally decreasing since 2003. Also, the gap between them has gradually narrowed as well, from as high as two percent back in 2003 and 2004 to as low as 0.5% in 2015 and 2016.

However, the gap widened in 2017 as the expense rates of the laser and X-ray system makers rose slightly for the first time in years, and those of the other manufacturers continued to drift lower. Interestingly, some of the biggest percentage rate increases were reported by the laser and X-ray system makers. Varian Medical Systems boosted its accrual rate from 2.3% at the end of calendar 2016 to 3.9% at the end of 2017. Coherent raised its accrual rate from 2.5% to 3.0%. And Hologic raised its accrual rate from 0.4% to 0.7%. The latter two saw their claims rate rise even faster, though Varian saw an 0.7% reduction in its claims rate.

Out of all the large companies on the list, Varian and Coherent had the highest accrual rates of all, at 3.9% and 3.0%, respectively. Dentsply and Hologic were towards the middle of the list, as was Illumina, Bruker Corp., and Invacare.

Also, Dexcom, Invacare, ResMed, and Roper Technologies turned in some of the largest warranty expense rate reductions of the year. Dexcom did best, reducing its claims rate by 0.5% and its accrual rate by 1.8%. Meanwhile, Dentsply Sirona was one of the few large laser and X-ray system makers to see any expense rate reductions, and it was only an 0.1% decline to a 1.3% rate.

Warranty Reserves

Our final warranty metric is the year-ending balance in the warranty reserve funds of the 24 laser and X-ray system makers and the 172 other medical and scientific equipment makers. Once again, this metric followed the same pattern as claims and accruals: the balance was up for the laser and X-ray companies and down for the others.

The 24 laser and X-ray companies saw their year-ending balance rise from $110 million in 2016 to $127 million in 2017. The 172 other medical and scientific equipment makers saw their reserves drop from $636 million to $628 million. On a net basis, reserve balances in the entire industry rose by $9 million, a one percent increase. It was a small increase, but it was the first since 2010-11 and the only one last year among the industry totals tabulated in Figures 1, 2 or 4.

We should also note that the $127 million total for laser and X-ray companies in 2017 represents a new record high for this group, surpassing the 2007 total by $2 million. And the laser and X-ray companies' share of the total hit a new high of 17%. Also, the balances reported by the 172 other medical and scientific equipment makers hit a new low, falling below the previous low water marks of 2016 and 2003.

Among individual companies, laser and X-ray companies were at both ends of the largest rise and largest decline lists. Following its Cynosure acquisition, Hologic boosted its reserve balance by $10.3 million, or 175%, while Varian cut its reserve balance by $4.3 million or 8%. Coherent raised its reserve balance by about a third, while Dentsply ended up with only a $600,000 increase.

The other medical and scientific equipment makers were also split between the rise and decline lists. Illumina raised its reserve balance by $3.8 million or 28%, and ResMed raised its reserve balance by $3.9 million or 23%. Pacemaker manufacturer Medtronic cut its reserves by $7.0 million or 7%, and Hill-Rom cut its reserve balance by $1.0 million or 4%.

Entrances and Exits

One feature that the list of U.S.-based medical and scientific equipment industry shares with other industries is the large amount of attrition. Out of the 196 companies on our list as warranty providers in any year, 115 were no longer active by the end of 2017 because of mergers, acquisitions, going private, or going out of business.

Besides Cynosure and Sirona, some of the other notable recent exits from the list of warranty-reporting companies last year include St. Jude Medical Inc. (acquired by Abbot Laboratories), Thoratec Corp. (acquired by St. Jude Medical in 2015), and Cepheid Inc. (acquired by Danaher).

At the same time, however, numerous new companies have joined the list since 2003, including Dexcom, ResMed, Allergan plc, Cardiovascular Systems Inc., Electromed Inc., ICU Medical Inc., Insulet Corp., Stereotaxis Inc., and Vocera Communications Inc. So it's not all market exits.

One thing we haven't seen in any of this data is evidence of a recession. Unlike the automotive, computer, and telecom businesses, there is no deep notch in the 2008 or 2009 data, and no recessionary spikes in the claims rates caused by massive sales declines. No, this is a business-to-business market, and business has been relatively steady for most of the past 15 years, except for the annual back-to-school sales spikes that cause the seasonal pattern.

This concludes our tour of the high-tech and electronics sector of the warranty-providing list of industries. We completed the vehicular sector in April, though we will revisit the international portion of those industries in July. Until then, we have a few warranty-providing industries in the building trades sector to cover in the coming weeks, such as new homes, appliances, HVAC systems, fixtures, furniture, and building materials.