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Evaluating the efficacy of Industrial Aftermarket strategy based on SEC 10K Filing

As industrials are preparing for an economic slowdown, they are also looking for aftermarket strategies that will help them maintain a steady aftermarket growth. Industrials and industrial management alike are trying to figure out how best to benchmark their performance against industry giants.

Here’s a timely post by Ron Giuntini recreated from LinkedIn, where he lays down the basics of how to evaluate an Industrial OEM based on publically available information.

What to look for in order to ascertain the level of leadership engagement in supplying solutions that impact the periodic expenditures incurred by end-users in managing the availability, productivity, and accessibility of their machines.

For those of us focused on the B2B Aftermarket, the opaqueness of financial reporting by OEMs on this subject is often truly ‘bizarre.’ So, how can you better understand which OEMs ‘get-it’ regarding the Aftermarket and which remain ‘clueless’?

Here is a listing of 12 factors to review in which the Aftermarket transparency or opaqueness on a 10K SEC filing will indicate leadership’s ‘seriousness’ in the mining of their installed base.  


Focus of Reporting

10K Filing Level of Detail

So What?


Aftermarket/parts segment reporting of revenues/costs

Primarily revenues and COGs of parts, and in turn, profitability for the segment. Can also comingle short- term service agreements. Can describe the type of parts supplied: proprietary, COTS, white label for other manufacturers, remanufactured, reversed engineered competitor parts, and others. The supply of parts can either be employed for maintaining or improving the availability or productivity of an asset. Important for investors to understand the materiality of the recurring profits of parts. The valuation of an OEM is primarily driven by the forecasted recurring profitability of an enterprise, with parts often generating 12-18% of revenues but 30-35% of profits, and during cyclical economic downturns, the vast majority of an OEM’s profits.


Distribution channels for parts

Various channels can be identified: direct-to-end-user, authorized distributors of machines, other manufacturers, and independent distributors. Having a diverse customer base for parts demand can often minimize major unfavorable changes in demand and assist the OEM in maintaining profitability during down-cycles.


Size of installed base

Overall size with further details on product lines, geography, and age. Further detail can include the installed base of machine models that an OEM does not produce. The installed base is the ultimate driver of all Aftermarket/Advanced- Services [A/AS] demand


Existence of a captive financial subsidiary

Availability of operating leases to obtain accessibility to their machines, versus only finance leases(i.e., loans) A major enabler to engage in Machine-as-a-Service offerings; without such an entity, the balance sheet issues of an operating lease embedded in an A/AS offering are much more challenging


OEM-managed parts distribution centers

Global location of centers and their square footage. The footprint indicates the overall parts investment committed to supporting the installed base in managing the availability of their machines.


Limited warranty for machines sold

Account balance sheet accrued liabilities and actual expenses incurred are required to be reported by the SEC in 10K filings. The amount of warranty claim recoveries to be received from suppliers can also be reported. New product launches require greater use of judgment in developing estimates until the historical experience becomes available. Given the relatively ‘slim’ profit margins derived from the sale of machines, the limited warranty expenditures can indeed be material, often running 2-4% of enterprise revenues, and if only focused upon product sales, can be 3-5%. Based upon the net profit margin of 7-8% for product sales, Limited warranties can reduce product profitability by 20%-30%; a major impact upon the valuation of an OEM.


Recalls of machines and/or parts in the installed base

Decouples recalls from limited warranties. Initiated as the retrieval of a product/part or an initiative performed at the customer’s site. Typically no accrual is established for the recall; strictly actual costs incurred during the period. Can be highly detrimental to the value of a brand and very costly. Some voluntary recalls can be somewhat immaterial, such as early stages of rust on a structure, but others can be mandatory/government-imposed, usually related to safety/environmental issues.


Extended warranties/service contracts

Extended warranty/service contracts can be delivered during a period of 1 year or > 1 year. Note that multi-year contracts may be simply a series of 1-year renewable contracts versus a contractual obligation of multi-years. Accrued revenues and costs for >1-year contract are reflected on the balance sheet as long-term assets/liabilities. The contracts are pooled to determine financial performance. Note that a traditional service agreement may or may not employ performance assurances or be customized for the buyer. A source of predictable recurring profits for the OEM if the portfolio is properly overseen by the OEM. If not, major losses can occur over the life of the portfolio.


Restoration of machines and parts

Remanufacturing/Overhaul/Rebuild/Other programs for both machines and parts to reduce the expenditures incurred by end-users in managing the availability, productivity, and accessibility of their machines. Can be employed in Like-Kind Exchange [LKE] programs, used machine sales, machine rental programs, safety requirements and others. A major impact source of profits. As a group, often achieve the highest profit margins for an OEM. They are also a major contributor to meeting the Environmental ‘E’ of ESG.


Segmented parts Inventory

Parts can be classified as either current asset inventory or fixed assets. Parts asset turnover can be calculated if the COG of parts is available, in turn providing the efficiency of the management of their parts investment.


Goodwill intangibles

The balance sheet reporting the premium paid as a result of an M&A activity; for ‘customer relationship’. A plurality of this account is for the ‘stickiness’ of the relationship with the installed base and its recurring revenue/profit streams from primarily parts.


New solutions enhancing the success of the installed base

Leveraging of e-commerce, improved data analytic tools, robotic enhancements employed in maintenance tasks, Advanced-Services and more. Indicates shift to digitalized solutions; OEM obtaining more and more of their revenues from highly profitable firmware and application software.


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