Q4 2021 A O Smith Corp Earnings Call
Good day and thank you for standing by welcome to the Smith Corporation fourth quarter 2021 earnings call. At this time, all participants are in a listen only mode.
After the speaker's presentation, there will be a question and answer session to ask a question. During the session you will need to press star one on your telephone.
Be advised that today's conference is being recorded if you require any further assistance. Please press star zero I would now like to hand, the conference over to your speaker today Patrick.
Tricia Ackerman. Please go ahead.
Shannon Good morning, and welcome to the a O Smith fourth quarter and full year 2021 conference call I Am Pat Ackerman, Senior Vice President Investor Relations and corporate responsibility and sustainability joining.
Joining me today are Kevin Wheeler, Chairman and Chief Executive Officer, Chuck Lauber, Chief Financial Officer, and Helen Gerhold, Vice President financial planning and analysis.
A friendly reminder, that some of our comments and answers. During this conference call will be forward looking statements that are subject to risks that could cause actual results to be materially different.
Those risks include matters that we have described in this morning's press release among others.
Also as a courtesy to others in the question queue. Please limit yourself to one question and one follow up question for churn.
Do you have multiple questions. Please rejoin the queue.
We will be using slides as we move through today's call you can access them on our website at investor Dot a O Smith's dot com.
I will now turn the call over to Kevin to begin our prepared remarks, please turn to slide four.
Thank you Pat and good morning, everyone. Thank you for joining us today.
I'm on slide four and our full year results our team delivered record setting sales and EPS performance, despite a turbulent macro environment.
Demand for our products in North America was strong and unprecedented inflation related pricing actions.
Drove sales, 19% higher over 2020.
The rest of the World segment performed well in 2021, China improved its operating margins to over 9%.
We successfully navigated supply chain and transportation challenges and improved our delivery performance since the first quarter.
We acquired giant water heater manufacturer in Canada, expanding our market share in North America, and welcoming a talented group of employees to the Ao Smith family.
With our dividend and share repurchases, we returned $537 million of capital to our shareholders.
Please turn to slide five.
Our global Ao Smith team delivered record 2021, EPS of $3 two a 42% increase that was driven in part by a record 22% increase in sales compared with 2020.
Demand for our products was robust across geographic geographically geographies.
We achieved this strong performance is a result of continued outstanding operational and sales execution from our team.
Despite the challenging environment of component shortages, logistical bottlenecks and material and transportation cost inflation.
I want to take the opportunity to thank my fellow a O Smith's employees for their ongoing dedication and creativity as we work to overcome these challenges to meet strong market demand and deliver for our valued customers.
North America water heater sales grew 21% in 2021.
Due to pricing actions implemented in response to rising material and logistic costs and strong demand for our products.
Commercially in industry demand increased approximately 11% due to the resumption of new construction replacements in the hospitality market segment.
Resident Judah industry demand increased by approximately 8% in 2021 due to strength in new construction and strong replacement demand.
Our North America boiler sales grew 13% driven by new construction and replacement demand as well as the launch of new products.
We ended 2021 with a record backlog largely composed of commercial condensing boilers.
In January continues to generate strong order rates for these market leading energy efficient boilers.
<unk> confidence in our outlook for the coming year.
Our strategy to focus on innovation and de carbonization contribute to strong demand for our high efficiency condensing boilers.
North America water treatment sales grew 14% in 2021 as we continue to pursue additional market share in this attractive fragmented market with a total adjustable market value that we estimate to be $2 6 billion.
Our strategy to pursue this market with an Omnichannel approach has worked to grow our share through innovation product development and acquisition opportunities.
We believe our independent water quality dealers have been outperforming the market and gaining market share.
And China full year sales increased 24% local currency compared to 2020, which was significantly impacted by the pandemic.
Each of our major product categories grew year over year, including electric gas Tankless water heaters, and residential and commercial water treatment products along with replacement filters.
Our water treatment business comprised of residential commercial and filter replacement consumables now represents approximately 30% of our overall business with repeatable consumable filter sales representing over 20% of overall water treatment sales.
I'm now on slide six.
We know the efficient operation of water heaters and boilers can make a significant impact on mitigating climate change we are committed to doing our part.
<unk> and energy use and greenhouse gas emissions are often top priorities for both consumers and contractors.
As a result of adoption of sustainable building guidelines, such as lead and well build these certifications continue to increase.
I'd like to highlight some of our products that contribute to sustainable building practices and de carbonization efforts.
The pump technology is a key consideration for many customers looking for a smart solution in both commercial and residential projects.
Water meter harnesses the heat in the ambient air and transfers it to the water in the tank.
We believe we are one of the technology and market share heat pump water heaters leaders in North America, and are well positioned to help our customers reduce their carbon footprint through innovative products.
Adapting commercial and residential energy star certified products can contribute to lowering greenhouse gas emissions and reduce the negative environmental impact.
<unk> is proud to manufacture more than 1000 miles of energy star certified products, many of which are eligible for incentives via national Eco rebates programs.
The launch of our newest crest commercial boiler with Hellcat combustion Smart technology is a significant achievement for us.
Is it enhances the energy efficiency of our existing highly efficient crest condensing boiler.
Crest boilers, with <unk> technology reduced startup maintenance and operating cost for our customers.
I'll now turn the call over to Chuck who will provide more details on the full year and fourth quarter performance.
Thank you, Kevin and good morning, everyone I'm on slide seven.
Full year sales in North America segment Rose to $2 5 billion, a 19% increase compared with 2020 pricing actions largely on water heaters represented approximately 70% of the increase higher volumes of water heaters and boilers were driven by strong replacement and new construction demand and higher volumes of water.
Treatment products added to the segment sales growth giant.
Wired on October 19, 2021 added $23 million in North America sales.
North America segment earnings of $591 million increased 17% compared with 2020, the earnings benefit of inflation related price increases and higher volumes was somewhat offset by higher material and freight costs.
Segment operating margin of 23, 4% was a modest decline compared with the 2020 segment margin despite significant cost headwinds.
Moving on to slide eight.
Rest of the World segment sales of $1 billion increased 30% year over year with approximately 60% of that increase attributed to higher volumes.
Our sales increase was positively impacted by lower channel inventory reductions in 2021 as compared to 2020 Chan.
Channel inventory levels at the end 2021 were at the lowest level in five years.
Currency translation of China sales favorably impacted sales by approximately $58 million.
Growth in each of our major product categories in China contributed to local currency growth of 24% in 2021.
New product introductions in the premium segment of the market, particularly our slimline electric wall hung water heaters and water treatment products that deliver hot and ambient filtered water contributed to sales gains.
India sales grew 31% in 2021 compared to 2020.
We remain committed to India as a long term growth opportunity given its attractive growth characteristics and changes in demographics.
Rest of the World segment earnings of $91 million increased significantly over breakeven results in 2020, which were adversely impacted by the pandemic.
In China, the benefits from higher volumes and favorable mix were partially offset by employee incentives and higher advertising as well as the absence of social insurance waivers that were received in 2020.
Segment segment operating margin improved to eight 8% compared to 2020, primarily as a result of improved operating leverage from higher volumes.
Please turn to slide nine.
Turning to the quarter fourth quarter performance, we delivered record sales of $996 million in the fourth quarter of 2021 up 19% year over year, driven by inflation related pricing actions, primarily in North America.
Earnings in the fourth quarter were <unk> 87 per share, which is an 18% increase compared with earnings of <unk> 74 per share in the fourth quarter of 2020.
Please turn to slide 10.
Fourth quarter sales in North America segment rose to $715 million or 27% increase compared against a strong comp in the fourth quarter of 2020 pricing actions largely on water heaters and sales from giant represented almost all of the increase while.
While volumes were strong relative to historical fourth quarter volumes, our 2024th quarter was exceptionally strong creating a difficult comp.
North America segment earnings of $167 million increased 21% compared with 2020.
The earnings benefit of inflation related price increases were somewhat offset by higher material and freight costs and lower volumes.
Pricing actions trailed rapidly rising steel costs, which resulted in lower segment operating margin of 23, 3% compared with the 2020 segment margins of 24, 6%.
Moving to slide 11.
Fourth quarter rest of the World segment sales of $288 million increased 3% year over year, primarily driven by favorable mix in China as consumers purchased our new higher priced products with more features and benefits, which was offset by lower China volumes compared to the fourth quarter of 2020, which benefited from.
Hence up demand in Chinas economy emerging from the pandemic.
Currency translation of China sales favorably impacted sales by approximately $9 million.
Rest of the World segment earnings of $31 million were in line with Q4 2020 segment earnings in China favorable mix offset lower volumes.
Segment operating margin was 10, 6% compared with 11, 2% in the fourth quarter of 2020, primarily due to lower volumes.
Please turn to slide 12.
We generated strong free cash flow of $566 million during 2021 higher than 2020 due to higher earnings that were partially offset by a larger investment in working capital to support demand levels.
Free cash flow conversion was 116%.
Our cash balances totaled $631 million at the end of December and our net cash position was $435 million.
Our leverage ratio was nine 7% as measured by total debt to total capital.
Our strong free cash flow and solid balance sheet enables us to focus on capital allocation priorities and returning cash to shareholders.
Earlier this month, our board approved our next quarterly dividend of 28 per share which represents our 82nd.
Consecutive year of dividend payments.
We repurchased approximately five 1 million shares of common stock in 2021 for a total of $367 million.
Let's now turn to slide 13.
To returning capital to shareholders, we continue to see opportunities for organic growth innovation and new product development across all of our product lines and geographies. We continue to target strategic acquisitions as a focused on water heating and water treating assets that meet our financial metrics are accretive to earnings in the first year and return our cost of cap.
And three years.
Please turn to slide 14, and our 2020 earnings guidance and outlook.
Adjusted EPS is introduced as a result of our termination of our defined benefit pension plan. The termination the termination follows the strategy and measured glidepath to de risk our fully funded exposure to pension liabilities.
Plan, which was previously sunset prevent <unk> earned on December 31, 2014 represents over 95% of the company's pension liabilities.
Terminated plans pension liability is expected to be <unk> in 2022.
The pension plan settlement, which we expect will occur during the fourth quarter, we will accelerate the recognition of a projected $445 million of non cash pre tax pension expenses or an EPS impact of the $1 73.
In addition in order to protect our pension plans funded status. During 2021, we transitioned our pension plan assets to lower risk investments. The impact of this transition will result in a lower rate of return on pension and Thats investments and accordingly, higher pension expenses in 2020 compared to.
Previous years and.
In order to provide transparency to the operating results of our business in 2022, we will provide non-GAAP measures adjusted net earnings adjusted earnings per share and adjusted segment earnings that excludes the impact of noncash pension pension income and expenses.
Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of the presentation and also on our website.
We are pleased to introduce our 2022 outlook with an expected EPS range of $1 56, and $1 76 per share and our adjusted EPS range of $3 35.
And $3 55 per share.
The midpoint of our adjusted EPS range represents an increase of 17% compared with 2021.
Our outlook is based on a number of key assumptions, including at the Omicron COVID-19 variant, which is currently surging and impacting our production due to labor constraints. We currently have approximately 7% 7% of our North America workforce out due to COVID-19 surge.
Our outlook assumes that the variance subsides from the first quarter and we return to the productivity levels that we operated at during the majority of 2021.
Steel indices began to stabilize at the end of 2021, and we started to see the full benefit of our five announced price 2021 price increases.
Each had an accumulative effect on water heating prices of approximately 50%.
Our guidance assumes that steel prices in 2022 on an annual basis will approximate steel market pricing at the end of 2021.
We continue to see increases in non steel materials and transportation costs.
Multiple 2021 price increases compounding to approximately 50% for water heaters as we exit 2021.
We assume that approximately 45% of the cumulative announced price increase was realized in 2021 and the remainder will be realized in 2022.
Previously announced mid to high single digit inflation related price increases in the remainder of our global portfolio.
Continued strength in demand and backlog in North America for all of our water heating product categories, driven by growth in replacement demand and new construction spending.
While supply chain challenges have moderated as we move into 2022, we remain in close contact with our suppliers and logistics providers to troubleshoot manage and resolve bottlenecks as the environment remains unpredictable particular with the current surge and omicron by experience with COVID-19.
<unk>.
The integration of giant, which we acquired in the fourth quarter of 2021 is on track and customer and employee feedback is positive.
We project the acquisition to achieve annual synergies of approximately $5 million over a two year period.
Giant added <unk> <unk> to EPS in 2021 net of customary purchase accounting adjustments and onetime transaction expenses.
We reaffirm from our third quarter call that the acquisition is projected to add between between six and eight.
The EPS in 2022.
As for other housekeeping assumptions, we expect to generate strong free cash flow of between $500 million and $525 million for the year Capex is projected to be between $75 million $80 million corporate and other expenses are expected to be approximately $55 million.
Our effective tax rate is estimated to be between 23, 5% to 24%.
And we expect to repurchase approximately $400 million of share shares of our stock, resulting in outstanding diluted shares of $157 million at the end of 2022.
Based on these assumptions the midpoint of our adjusted EPS range represents an increase of 17% compared to 2021.
I'll now turn the call back over to Kevin who will provide a little bit more color on our key markets and topline growth assumption outlook and segment expectations for 2022, while staying on slide 14, Kevin.
Thank you Chuck.
As Chuck noted our outlook assumes the current surge of the omicron various subsides during the first quarter. It does not significantly impact productivity or significantly impact the end markets that we serve.
With the assumption as a backdrop to 2022, we project revenue growth for 2022 of 16% to 18% which includes the following assumptions.
After approximately 8% growth in each of the last two years, which is well above historical average growth rate, we estimate U S residential water industry unit volumes will be down approximately 2% from last year as industry demand normalizes.
We believe the commercial water heater industry volumes to be flat to slightly down as new construction and replacement installations level off.
Our China business performance was strong and stable in 2021, and we expect China sales to grow approximately 5% in local currency in 2022.
Driven by demand of our residential and commercial water treatment products, including a replacement filters as well as range hoods and could cost we.
We expect that sales of our residential water heaters in China will be flat to slightly down compared to 2021.
We expect our North America boiler sales will increase approximately 10% in 2022.
Our expectations are based on several growth drivers.
And the industry growth of 3%, 4%, we believe replacement demand is 85% the transition to higher energy efficient boilers will continue, particularly as commercial buildings improve their overall carbon footprint.
In 2021, condensing boilers, where approximately 30% to 35% of the commercial boiler industry that represents our addressable market.
We believe the potential for the condensing boiler market is to represent 60% to 65% of the total market overtime.
Which provides continued opportunity for our leading market share commercial condensing boilers.
And new product launches, including a full year of our improved flagship crest commercial condensing boiler with healthcare technology and the introduction of a 1 million Btu light duty condensing commercial night ft XL.
We project, 13% to 14% growth in sales for North America water treatment.
We believe the mega trends of healthy and safe drinking water as well as reduction of single use plastic bottles will continue to drive consumer demand for our point of views and point of entry water treatment systems.
We expect margins to improve by approximately 100 basis points in 2022 compared to last year.
Based on these factors along with the full impact of our 2021 price increases we expect our North America segment margin to be between 22, and a quarter in 'twenty, two and three quarter percent excluding pension expenses.
In rest of World segment margins to be approximately 10% or 100 basis points higher than 2021.
Slide 15 please.
As we begin 2022 and focusing on our key strategic priorities to advance our position as a leader in TV and treating water around the world.
First innovate and expand our D card portfolio, including heat pumps per space and water heating.
Expand our global water treatment capabilities by investing in technologies people in distribution.
Capital effectively by investing in ourselves acquisitions, and returning capital to shareholders.
Thanks to the tremendous effort by our procurement and operations teams and their commitment to operational excellence, which is part of our DNA as nearly 150 year old technology leader in innovative manufacturer or supply chain is stabilizing and our manufacturing lead times remained consistent.
Through our focus and determination to serve our customers we closed out the year on a high note remains strong entering 2022.
Our strong brands across the portfolio combined with harnessing technology to drive innovation and new product development will enhance our market leadership.
We are confident in our ability to capitalize on opportunities as we continue to execute our strategy.
And finally.
A bittersweet announcement.
Pat Ackerman shared her plans to retire from her position as senior Vice President Investor Relations Treasurer, and corporate responsibility sustainability effective March 31 2022.
In addition to her many responsibilities Pat has been a key contact for new and existing investors since 2008.
Coordinating communication and effectively delivering our message to our investor base.
We thank Pat for her dedication to a O Smith <unk>.
Her leadership and our steadfast commitment to the values and principles of our organization.
Perhaps many contributions and impact will be long lasting.
Please join me.
And Chuck and the rest of the Ao Smith family and wishing Pat the very best in her well earned retirement.
Thank you Kevin for your kind words.
I'm fortunate to have spent my entire 39 year career at a terrific company enabled Smith.
And working alongside Great people like many of you on this call today.
I'm enthusiastic about retirement and one of the key reasons why is my Investor Relations successor, Helen careful.
With over two decades of progressively increasing finance experience at a O Smith.
Helen Most recently was vice President and controller and let our SEC reporting you.
You will find Helen to be knowledgeable and personable and I know you will enjoy working with talent as much as I have.
With that we conclude our prepared remarks, and we are now available for your questions.
Thank you as a reminder to ask a question you will need to press star one on your telephone withdraw your question press the pound key.
Please standby, while we compile the Q&A roster.
Our first question comes from Matt Summerville with D. A Davidson your line is open.
Thanks, and congrats on that.
Yes.
Couple of questions, how should we be thinking about North America in particular kind of the quarterly revenue and earnings cadence given whats pretty significant number of moving pieces. How you have incremental price rolling through how youre thinking about volume across the different product lines, how should we be thinking about that.
For 2022.
Matt This is Chuck good morning.
So as we kind of look at 2022 overall.
Cadence and when we look at the first quarter, it's going to probably be the most challenging from a margin and perhaps the volume quarter. As you know China is always a weakest in the first quarter with the festival gains momentum for the second and third quarter than the fourth quarter is the strongest you should think of it very similar to that way.
Less moving parts in China, perhaps because the price pricing cost has not been that much of a move back.
Back to your North America focused there on North America.
A little lighter on the volume in Q1, there are some disruptions omicron has as I mentioned a bit of our labor force out.
And we're going to look at steel steel costs mentioned that we're going to still see in.
In the first quarter, we're going to have our highest steel cost that we've experienced as steel has been rising we as you know have a lag when we see the steel. So our Q3 to Q4 steel cost is going to be rising maybe 15% to 20% compared to Q4. So Q1 will certainly be challenged on the margin on the margin in north.
America a bit.
We do have our price increase offsetting that so pricing coming in and get a little bit higher steel.
And so Q1 Q1 has to be our most challenged on the margin side.
<unk> three as you rollout the rest of <unk> and <unk> relative to rest of the year in North America we.
We do expect steel to moderate just a bit you've seen the index come down.
And so we would expect margins to be a little bit stronger on the back three quarters in North America was the price increase in full for all.
Really all all of the all of the year.
That's basically the roll forward kind of how to look at 2022 from North America perspective.
And we've got.
Pricing I mentioned is about 45%, we believe on the water heating side.
Effective that we've already seen and so we've got 55% of that rolling in for 2022.
I hope that provides a little better color on how it rolls out.
Yes, Doug and just as a follow up you had mentioned that inventory levels in China stand at the lowest level <unk> seen in five years.
I guess do you feel or do you expect to see inventory start to bleed higher or is a O. Smith's objective going forward to really drive that number as low as possible. So as to not have a repeat of some of the challenges you had in recent years.
Our goal is to always keep it at the leanest level thats appropriate to serve our customers in China and it's at a low watermark, we wouldn't expect it to go lower than that.
We ended 2021 so.
As we've said before we keep a close watch on it.
It's at a level, where we feel is about as low as it's going to go to make sure we're serving our customers.
Thank you. Our next question comes from Scott Graham with Loop capital markets. Your line is open.
Yes, hi, good morning.
Hearty congratulations to you Pat you've been phenomenal thing your job.
Thanks Scott.
I have a couple of questions.
I guess the first one is on the North American business. It looked like the first two months of industry shipments in Resi award, here's where up and your.
Your chart shows.
Volume was down in North America for the quarter could you maybe give.
Just a little more color on that.
Yes, Hi, this is Kevin Scott.
As we discussed.
On our Q3 call we.
H, a challenging Q1, and we had been making progress.
Through Q2, and Q3, we fully expected that the carryover into Q4, it lagged a little bit and so thats what youre seeing.
That is not indicative of order rates, that's not indicative of customers.
But it did lag a little bit we expect to pick that up as we get into 2022.
<unk>.
I guess the comment I would make is our customer basis are solid we've had we've had no issues no losses.
And I believe based on customer feedback, we really serviced our customers well throughout this pandemic and made sure they had the right products they needed.
And what we did at the end of this year as the as the our supply chain started to stabilize and so forth. We have some allocations to out there for the most of the year and we took we took those allocations off in December so that's going to help drive.
Maybe some additional orders as we get into Q1, but bottom line I think we're in good shape.
As the industry normalizes and gets out of this turbulent sector I think everything will move back to a much more of at a normal cadence in a number of share.
<unk> for us.
Okay. Thank you for that Kevin.
Two other questions really I know you have to start the year carefully with some of your estimates and certainly that seems to have read through to a couple of the line items I guess I'm thinking that when you say commercial flat to slightly down.
I guess I'm kind of wondering where you are coming from on that one since you know the.
Withheld.
I guess im trying not to be part of that but.
It just it feels like.
We're going to have a full year of.
Reopening as possibly even incremental reopening versus 'twenty wanted just.
Sort of wondering why you would think that that would be a flat market for you.
Well I'll touch on that and maybe have Chuck jump in as well.
When you look at we have a lot of re openings in 2021, we had a very strong market.
And as we as we go forward.
It's a forecast we believe that the.
Thanks.
More normalize probably some of the proactive replacements won't be there and so as we look out a very strong 2021, we think that's just going to Peel back in 2022.
But again flat coming off a very strong year, Scott is pretty positive.
Thank you. Our next question comes from Susan Mcclary with Goldman Sachs. Your line is open.
Thank you good morning, everyone and Pat I'd like to add my congratulations as well to you. Thanks, Tim Good morning.
Good morning.
Question is you mentioned that you have taken a lot of your customers off of allocation in North America. In December can you just give us some color on where you think channel inventory set.
How do you expect that your order rates could trend as those allocations have been removed.
Let me touch on that one as well.
One we're very specific on our order our inventories in China, we had really terrific visibility there.
North America, it's more of a.
We don't have the same visibility, but based on the input that we have from our customers and so forth that the inventories are basically in line, there's probably some gaps here and there but.
For the most part I think the allocation.
Just freeze up maybe some orders I am not going to put a number on it quite frankly, but I.
I do think.
We have limited some of our customers.
To be predictable for them getting the right products to them, making sure that they are.
<unk> deliveries were on time, so again I think it's a positive thing for our organization as we enter into 2020 to remove any allocation and kind of getting back to business as normal.
So.
That's kind of where we're at.
No specific number I think I would want to add to that.
Got you. Okay. That's helpful. And then as we do think about steel, perhaps moderating are sort of coming off of the peak as we move through the year, how should we be expect how should we expect price will sort of trend with that do you think that as the volumes come off on the residential side potentially you'll have to give back any of.
This price or do you expect that it'll be fairly sticky.
Yes.
We've never had these sort of price increases like we've seen in the last couple of in this last year of course, so it's a little bit difficult to predict.
Can you kind of look at historically what's happened.
Historically, we've generally been able to hold share and margin and we react to the cost changes as necessary. So.
A bit hard to see how it plays out.
We've got non steel cost and logistics and freight that even as steel costs have come down since our last call. We've only seen pressure an increase.
All other non steel costs were really we really are seeing those surge of it in the last in the last quarter. So those somewhat offset some of the relief perhaps that might be happening.
A bit of moderation on the steel side.
Our next question comes from Damian Karas with UBS. Your line is open.
Hey, good morning, everyone. Congrats on the year.
Best of luck in your retirement.
Hmm.
So I wanted to ask you about some of your comments on China.
So your <unk>.
Expecting 5% sales growth there, but you mentioned water heater volumes flat to slightly down could you just talk about little bit about your key assumptions driving your forecast there sure sure yes.
Water heater volumes in China have been flat to down.
When we look at the full year demand and I'll, just kind of talk about what the overall 2021 consumer demand as best we measure through our channel.
Probably was up 1% to 2%.
The demand itself, so underlying demand when we get to the five you can kind of think of it as 1% to 2% theres a bit of pricing in China, we haven't nearly seen that of cost pressures as we've seen in North America, but that's perhaps another percent and then when we think about kind of the new products. We've got some new products. We've introduced we've got the products I mentioned earlier in the state.
<unk>.
On electric that are doing well on the gas the gas gas products that are doing well range hoods Cook tops.
Marshall water treatment and water treatment overall, we feel pretty positive about which kind of filled that gap to continue to that 5% year over year currencies, we expect to be roughly flat equal year over year. So that's kind of the bridge to kind of get to get up to that 5%.
Okay, Great that's helpful.
And then on water heaters, specifically in China, maybe you could just help us understand a little kind of where our mix is today.
<unk> to the pre 2019 peak levels, if you will obviously.
Kind of your mix down shortly after that but maybe any any color around kind of.
The mid to premium price mix today relative to the past would be helpful. Thanks.
So we're not at the peak, where we were in mix in the peak years.
Years before 2019 premium segment of the market was higher percentage of the segment of the market as we measure it at that time, but we are coming out of the trough. So we've got a year over year improvement in mix planned in 2022 Corp, Q4 was positive on mix and the introduction of a couple of the new products. We've just put out there.
Help help our mix because they are in the premium segment. So we're not at the peak, we're certainly not at the trough, we feel really good about the momentum coming out of it and positive about the new products coming into the market. Yes, I would just add I mean, its new products across our electric line. Our guests Tankless line water treatment that is done substantially.
Well it continues to grow and so and then the kind of I would call the newer segments, our commercial water treatment continues to.
To do well and.
Post over the 40 plus million dollars and then Chuck.
Chuck mentioned ranges and Cook tops, which are gaining momentum. So overall there is still going to be a COVID-19 issue that we'll have to work through there in some spotty shutdowns that happened in <unk>.
<unk>.
That may be we'll see a setback there is still some derisking, but you put it all together we came out of fourth quarter pretty well, we have some really good products on the on the premium side that are just getting into the market fully so we feel real good about the mix and where it's going and hope to get back to those 19.
Levels soon.
Thank you. Our next question comes from Nathan Jones with Stifel. Your line is open.
Good morning, everyone.
Add my congratulations to Pat and welcome to this part of the James Allen.
Yes.
I did want to follow up on steel prices. I know you guys are talking about steel indices flattening out, but I think you have more exposure to coil steel prices, which has actually come down pretty substantially.
Speaker 1: I know you guys are talking about steel indices flattening out, but I think you have more exposure to coil steel prices, which have actually come down pretty substantially.
Speaker 1: Is that a potential significant tailwind for margins as we get into maybe the second half of the year once you've run through the higher cost spiel in inventory? And how is that balancing off against the inflation that you're continuing to see in other inputs?
Is that a potential significant tailwind for margins as we get into maybe the second half of the once you've run through the higher cost scaling inventory and how is that balancing off against the inflation that you're continuing to see and other inputs.
Yes.
Speaker 2: Yeah, I mean, our input on steel is about 70% cold rolled, 30% hot rolled. So those are, those are the industries we're really tracking. And there we've seen some moderation, we haven't seen it come down a great deal, but we've seen some moderation. You know, year over year, our steel is going to be up 50% in 2022, on average, compared to 2021. So we still have that.
<unk> still has about 70% coal roll, 30% hot rolled so those are those are the industries, we're really tracking in there we've seen some moderation we haven't seen it come down a great deal, but we've seen some moderation year over year, our skill is going to be up 50% in 2022 on average compared to 2021, So we still have them.
At that steel pressure there.
Right now I mean, it's early in the year right. So we're looking at the increase of non steel cost components logistics.
We haven't seen any relief on that.
If we just kind of look through the rest of the year, our best projection would be if there is some moderation in steel on the index that we have seen a bit that the offset is largely in the non steel components and so we're not in our outlook, calling for any we're calling for in our outlook. When we look at it that Q1 is probably the most challenging.
It really the margins sort of flattened out after that after we get over that kind of one quarter, where steel is the eyes.
Thanks, I guess my follow up data around the margin guidance for North America, which is down a little bit from 2021.
I think given you are chasing costs up last year, you had some disruption in your manufacturing processes early in the year last year.
I might have expected a little margin expansion in 2022 can you maybe just discuss the puts and takes that are going to see margins a little bit larger in North America 22, Thanks sure sure. So.
They are lower than our guidance and what let me just do a little reconciliation because if you exclude and I mentioned the noncash pension.
Adjustments thats about $10 million that youll see in our in our GAAP to non-GAAP reconciliations that will affect the margins a bit and if you look at the giant acquisition, which is performing great as we expected performing well, but it doesn't have quite the same margin as the rest of the North America business reconciling for those.
To really get us back to adjusted margins that are flat compared to 2021. So 2022, North America is roughly flat compared to 2021 and Thats, Yes, Thats with continued growth in North America water treatment and some of those other businesses that we're looking to expand our margin year over year. So.
The kind of expectation it may gone up.
We're really looking at flat and some of those other non steel costs that we're seeing.
We're really filling that gap.
Thank you. Our next question comes from Mike Halloran with Baird. Your line is open.
Hey, good morning, everyone and.
Congrats patents been an enjoyable.
Decade, plus I guess, but I've really enjoyed the relationships. So thank you.
So so maybe a similar line of question on China, Chuck maybe just could you give the bridge on the China margins.
Obviously, 10% so nice increase here, but what are the puts and takes going from this year's to next year's margin levels.
Yes, I can do that.
It's really.
It's up about 100 basis points. So we're kind of look we're looking to expand from 9% to 10%.
Mostly on volume, mostly on volume and mix, we've got the products that we mentioned earlier and they came into play in volume and mix. So we overcame a bit in 2021% to 2020 I mentioned, the social insurance, that's about $12 million for the year. So we like the progress that we made in 'twenty, one to get us to nine.
And then.
It's really volume and mix and leverage on the top line that gets us to 10.
That makes sense and then shifting gears to North America.
When you think about the tank Tankless heat pump dynamic in the water heater side, the residential water heater side.
And any movement as you think about it through this year and how youre thinking about through last year excuse me, how youre thinking about it this year.
Any real change in the momentum that you've been seeing in any of those business lines relative to each other.
I would say on the residential side, probably not any tank momentum.
Heat pumps have been growing year over year, becoming more popular obviously theres more incentives out there.
That's moving in the right direction. So we're in good position there.
And I would say maybe on the commercial side, we're starting to see a bit more commercial heat pump that up there but.
Let's step back we still have a great day car being footprint called.
Condensing water heaters, and condensing boilers and that is also trending well because theres. So many applications that you really need the output.
Keith.
Our gas fire product and being able to provide.
Condensing boilers and condensing commercial water heaters also prized opportunity. So commercially I think youre going to continue to see high efficiency growing.
And on both gas and on the kind of the heat pump side.
Thank you. Our next question comes from Jeff Hammond with Keybanc capital markets. Your line is open.
Hey, good morning, everyone and best of luck Pat.
Thanks, Jeff.
Just first on supply chain, you mentioned, a couple of times stabilization moderation in the headwinds can you just speak specifically to what you see is getting better here near term.
Just just overall.
Yeah.
You can't make any of our products without every component and so.
And I say that I'm smiling here, but overall as you start to become a bit more predictable as our suppliers become a bit more predictable.
So that's what's been and then just some of the volumes coming up we came out of a big freeze that impacted volume in oil based products. So then.
<unk> was was running behind but we're starting to see all these key components moving in the right direction.
And so that's the stabilization.
We're still very tactical tracking orders and making sure. We're looking for alternatives, but we've been doing that for a year and it's worked out pretty well for our team.
So overall, that's what's that's what stabilization looks like that's why we were able to move the location.
From our supply chain, and then I'm going to tell you we're going to have pockets of disruption occasionally here and there and we'll have to keep working through that.
But that's where it's at it's getting incrementally better it's getting incrementally more predictable.
Our suppliers just like us are stepping up their game.
Production and deliveries.
It's incremental and we feel as we enter 2022 were in better shape in 2021, albeit we'll have to see how the Amazon shirts impacts that but as of right now that hasnt been a large large issue for us.
Okay, and then just back on this kind of deal and pricing dynamic it seems like cold roll.
Is your biggest input is down like 15% off of year end.
Pricing and just if that sticks when do you start to see one the benefit of that.
And just to remind us how the material price formulas work.
With the DIY customers, where some of that pricing when that some of that pricing might roll off. Thanks.
Yes.
So the decrease we have seen so far.
It still has come down we probably we will not see that until we get probably into the middle of the second quarter.
So that's from a cost perspective, and then who knows where it'll go from there. So it has gone down a bit.
Not sure our assumption is that it kind of stays at that level for the rest of the year.
We've got we have certain customers that have pricing formula that represents maybe 25% of our water our water heater volume.
And so the cadence on that follows similarly to kind of when you see steel indexes.
Thank you. Our next question comes from David Macgregor with Longbow Research. Your line is open.
Good morning, everyone and thanks for all the help along the way and great working with you and wish you all the best in your retirement.
Right.
I guess I just wanted to build on a couple of other questions that have been asked at this point.
Have you started to go back to the discussion around China mix and you talked about that.
Youre seeing the stronger mix with premium product.
Clearly that's a reflection of new products that you've introduced that would do it but are you seeing a similar trend across the broader market in other words is the Chinese consumer mixing up again.
Or is this really specific.
Based on the data that we've seen in the game.
Weighted to more of the appliance side of the business, we see almost every category on a year on year basis mixing up so that's a positive trend that says a lot maybe consumer confidence and so forth.
In China, but yes, we are seeing it it's not just in our categories, but others that we don't participate in.
Yes.
Back to the peak, but it's a couple of quarters now.
We can start calling it a trend because we've seen an uptick.
Yes, that's encouraging.
Just on China can you update us in terms of how youre approaching distribution and the growth of distribution in terms of 2022, what should we expect there in terms of new doors.
Yes, so we really are focusing on two pieces really when you think about kind of the tier one tier two cities.
We are.
We're really looking at store efficiencies there. So we're continue to be focused on store efficiencies.
Probably.
We're probably going to take out a bit more stores in 2022 were at that pace, we've been on that pace.
For a number of years now.
Probably in the 200 to 300 store.
Take taking out in 2022 compared to where we are ending the year in 2021, just not quite 6000 outlets on.
On the other side, we're really looking to grow geography on the tier three to tier six cities. So.
Think of that as low cost counters, where just.
We're not having a promoter is very opportunistic and those footprints that's growing in the neighborhood of maybe 500, but don't do the math equal to the tier one and tier two but it's certainly it's certainly opportunistic and that's where we're really looking to continue to expand.
Okay.
Thank you. Our next question comes from Andy Kaplowitz with Citigroup.
Your line is open.
Good morning, everyone best of luck Pat.
Thanks, Andy.
Can you talk a little bit more about the competitive environment, you're seeing in North America, you, obviously have a very strong positioning in the core water heater market here, but <unk> also been aggressively raising pricing you do have some competition ramping up their own capacity now so how sticky can your.
Pricing be as inflation starts to normalize a bit and should we be at all worried about competitors ramping up their own capacity.
Right.
Every day, so I am not being flip if you look at our business we've been competing.
For 70 years in this industry, we continue to get up every day and focus on.
On a O Smith and <unk> customers in our brands.
And so there clearly some competitors coming into the market.
We're going to continue to focus on what we do best and that's bringing innovative products markets high service levels.
And making sure that we grow profitable with our customers and I'll go back to recent statements that we just really talked about is we've had no customer loss I really believe that we've really we've taken care of our customers in a professional manager management.
Professional way and manage your expectations in.
And again.
Let's go back to this industry using about residential gas and electric isn't about just standard commercial it's about bringing a portfolio of products to our to our customers.
And not only residential and commercial but the high technology newer products like heat pumps and condensing products that we continue to bring to market perfect. Examples healthcare technology on our crest boiler all those things matter and we package that up together, we believe when we compete in the market we have a value proposition.
<unk>.
Meets our customers' expectations and helps them grow their business.
Alright.
Only additional comment I'll make to that is and we called it out on our slides is that.
R&D spend is over $90 million, that's not water heating water treating and we're really focused on those markets and as Kevin said being the leader in the product technology.
Thanks for that and maybe for my follow up North American boiler sales you can you talk about him up 10% and 22 after a good year in 'twenty. One. So maybe you can talk a little bit more about the sustainability of the growth trends that are helping you in that business I think historically, it's been more of a mid single digit grower and do you think youll see any direct impacts from the infrastructure Bill.
If so when could they begin to occur.
Well I can tell you we've seen certain segments, we talked about the the educational segment last quarter that's been.
<unk>, certainly been helping us and providing opportunity we're seeing more government institutional segments start to start to grow. So we are seeing some of that maybe that stimulus or that we're talking about in the marketplace.
What's led to a record backlog that we have today.
And that's going to stay with us I think at least through 2022.
We're looking at a 10% growth rate.
So overall there are some stimulus out there. There's also just some pent up demand that may go back to the pandemic that we are.
Filling that gap as well and again the replacement market is 85%, so youre going to have.
That natural replacement market continue so overall the boarder market looks looks strong orders are still.
Good.
Quoting activity is still good so overall entering 2022 and a really good position in the boiler segment.
I think I'll add on to that is that 10% growth. There was some pricing that we did do on the boiler side of the business also so theres a bit of carryover pricing that helps us a little bit, but we still see growth in the boiler market.
Thank you our next.
Next question comes from Bryan Blair with Oppenheimer. Your line is open.
Good morning, everyone and thank you very much for your help over the years, it's been a pleasure working with you.
Good morning.
I apologize if I missed this did you cite run rate North American water treatment margins or the expected.
Margin step up as that business continues to scale double digits since 2010.
Yes, we havent I don't think but margins are around 11% there were approaching 11% in 2021. So we're pleased with the progress that we've made.
Leverage and volume the acquisitions to continue to move forward on that and we're expecting about 100 basis points expansion in 2022.
Okay I appreciate that.
Circling back to commercial boilers any feedback you can offer on.
The reception acceptance of your health technology. Since then that's been out there and how that factors into the backlog build that you've had.
And how we should think about the I guess the cadence so first versus second half growth netting to that 10% range that you've guided given your backlog position bidding activity et cetera.
The haircut.
Technology has been accepted received very well by our contract with mechanical base.
But that was that was at the later part of the year. So we really look forward into 2022 of having a full year with this new technology.
And just to go back to it.
We stated in our remarks, but it's not only higher efficiency, but startup that could take two to three hours takes 20 minutes, sometimes now maybe.
Maintenance.
It helps us get through the maintenance. It just so you don't have to go out there and do manual adjustments and the overall cost. So we're excited about it its a first to market first mover, it's truly technology.
Different than what's in the market today, you bolted on a terrific product like the crest in and we just see that continuing to grow and gain momentum, particularly in the specified side of the business.
Yes.
Terrific to growth, but the cadence of the boiler business is.
Typically Q3, and Q4 are the strongest quarters, so and we still expect that it wanted to.
Thank you. Our next question comes from Larry de Maria with.
William Blair Your line is open.
Thanks, Good morning, everybody.
Best of luck to Pat.
Yes.
Thank you everyone lifestyle for field trip.
So I'm just kind of curious I know you touched on this but as it relates to China with inventory to five year low I believe you said, but only looking at 5% for the market.
I know theres constant stuff, but can you delineate between consumer demand and channel fill and are we holding the channel back at all from Refilling just seemed like there might be some potential upside there.
Good question.
We don't believe we are holding the channel back.
I will say, we had a strong order rate at the end of December that.
We certainly did get out in January but.
We're not.
It may go up a bit we don't expect it to go lower so as we kind of think about 2022.
Channel inventories do get a bit lumpy, but <unk> been really honed down to a pretty lean level and.
If anything we expect it to slightly go up but we are.
We're going to keep that.
A close watch.
Okay. Thank you and then you guys also mentioned impact of Omicron I think in the fourth quarter into the first quarter. If you could just kind of clarify that mostly in North America.
China also and how meaningful is that in fact, it's primarily almost exclusively in North America, particularly with the number of people that we have out so China again.
Very little but again that spotty depends on the region.
And use the same way, but really on the current surge is really impacted our north America businesses and we're working through it hasn't peaked yet, but we hope that we will start to see it come down and we'll get through with the first quarter and kind of put this phase of Covid in the rearview mirror.
Thank you and I'm currently showing no further questions at this time I'd like to turn the call back over to Helen <unk> for closing remarks.
Thank you for joining US today, let me conclude by reminding you that our global <unk> team delivered strong sales and earnings despite many challenges in 2021.
We are optimistic about our results in future periods based on the durable strategy robust demand for our products as well as strong execution of our strategy. Despite an environment challenged by component shortages.
Sickle bottlenecks inflation in both materials and transportation costs and pandemic related surge we.
We look forward to updating you on our progress in the quarters to come. In addition, please mark your calendars to join our presentations at three conferences next month RW Baird on February 22nd City.
February 23rd and Barclays on February 24th Thank you and have a great rest of your day.
Okay.
This concludes today's conference call. Thank you for participating you may now disconnect.
Okay.
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