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Operator
Good day, and thank you for standing by. Welcome to the A.O. 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. Please 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, Patricia Ackerman. Please go ahead.
Patricia Ackerman
Thank you, Shannon. Good morning and welcome to the A.O. Smith fourth quarter and full year 2021 conference call. I'm Pat Ackerman, Senior Vice President, Investor Relations and Corporate Responsibility and Sustainability. Joining me today are Kevin Wheeler, Chairman and Chief Executive Officer, Chuck Lauber, Chief Financial Officer, and Helen Gerholt, 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 per turn. If 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.aosmith.com. I will now turn the call over to Kevin to begin our prepared remarks. Please turn to slide four.
Pat Ackerman
Thank you, Pat, and good morning, everyone. Thank you for joining us today. I'm on slide four in 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, a water heater manufacturer in Canada, expanding our market share in North America, and welcoming a talented group of employees to the A.O. Smith family. With our dividend and share repurchases, we returned $537 million of capital to our shareholders. Please turn to slide five. Our global A.O. Smith team delivered record 2021 EPS of $3.02, 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 geographies. We achieved a strong performance as 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 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. Commercial and industry demand increased approximately 11%, due to the resumption of new construction and replacements in the hospitality market segment. Residential unit 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, And January continues to generate strong water rates for these market-leading, energy-efficient boilers, providing confidence in our outlook for the coming year. Our strategy to focus on innovation and decarbonization 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 addressable 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. In China, four-year sales increased 24% in 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. Reduction in energy use and greenhouse gas emissions are often top priorities for both consumers and contractors. As a result, adoption of sustainable building guidelines such as LEED and well building certifications continue to increase. I'd like to highlight some of our products that contribute to sustainable building practices and decarbonization efforts. Heat pump technology is a key consideration for many customers looking for a smart solution in both commercial and residential projects. A heat pump water heater 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 heater leaders in North America. and are well-positioned to help our customers reduce their carbon footprints through innovative products. Adopting commercial and residential ENERGY STAR certified products can contribute to lowering greenhouse gas emissions and reducing negative environmental impact. A.O. Smith is proud to manufacture more than 1,000 models 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, as it enhances the energy efficiency of our existing highly efficient Crest condensing boiler. Crest boilers with Hellcat technology reduce startup, maintenance, and operating costs 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.
Pat
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 to 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 segment sales growth. acquired on October 19, 2021, added $23 million to 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. 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 were being 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 operating margin improved to 8.8 percent compared to 2020, primarily as a result of improved operating leverage from higher volumes. Please turn to slide nine. Turning to the 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 87 cents per share, which is an 18% increase compared with earnings of 74 cents per share in the fourth quarter of 2020. Please turn to slide 10. Fourth quarter sales in North America segment rose to $715 million, a 27% increase compared against the 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 volumes were strong relative to historical fourth quarter volumes, our 2020 fourth 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 was somewhat offset by higher material and freight costs and lower volumes. Pricing actions trailed rapidly rising steel costs, which resulted in a lower segment operating margin of 23.3% compared with the 2020 segment margin 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 pent-up demand in China's 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 of 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 is 9.7% 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 return cash to shareholders. Earlier this month, our board approved our next quarterly dividend of $0.28 per share, which represents our 82nd consecutive year of dividend payments. We repurchased approximately 5.1 million shares of common stock in 2021 for a total of $367 million. Let's now turn to slide 13. In addition 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 with a focus on water heating and water treating assets. that meet our financial metrics of accretive to earnings in the first year and return our cost to capital in three years. Please turn to slide 14 in our 2020 earnings guidance and outlook. Adjusted EPS is introduced as a result of our termination of our defined benefit pension plan. The termination follows a strategy and measured glide path to de-risk our fully funded exposure to pension liabilities. The plan, which was previously sunset for benefits earned on December 31, 2014, represents over 95% of the company's pension liability. The terminated plan's pension liability is expected to be annuitized in 2022. The pension plan settlement, which we expect will occur during the fourth quarter, will accelerate the recognition of a projected $445 million of non-cash pre-tax pension expenses, or an EPS impact of $1.73. In addition, in order to protect our pension plan's 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 investments and, accordingly, higher pension expenses in 2020 compared to previous years. 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 exclude the impact of non-cash 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 that the Omicron COVID-19 variant, which is currently surging and impacting our production due to labor constraints, we currently have approximately 7% of our North America workforce out due to COVID-19 surge. Our outlook assumes that the variant subsides in 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 2021 price increases, which had a cumulative 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 and 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 logistic providers to troubleshoot, manage, and resolve bottlenecks as the environment remains unpredictable, particularly with the current surge in the Omicron variant of COVID-19. 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 $0.01 to EPS in 2021, net of customary purchase accounting adjustments and one-time transaction expenses. We reaffirm from our third quarter call that the acquisition is projected to add between $0.06 and $0.08 to 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 and $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 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 top-line growth assumption outlook and segment expectations for 2022, while staying on slide 14. Kevin? Thank you, Chuck.
Pat Ackerman
As Chuck noted, our outlook assumes the current surge of the Omicron variant 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 the 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 that commercial water heating 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. We expect China's sales to grow approximately 5% in local currency in 2022. driven by demand of our residential and commercial water treatment products, including our replacement filters, as well as range hoods and cooktops. 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. An industry growth of 3% to 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 were approximately 30 to 35 percent 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 percent of the total market over time, 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 Hellcat technology, and the introduction of a 1 million BTU light-duty condensing commercial night FTXL. We project 13% to 14% growth in sales for North America water treatment. We believe the megatrends 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-use 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 22.25% and 22.75%, excluding pension expenses, and rest of the world segment margins to be approximately 10%, or 100 basis points higher than 2021. Slide 15, please. As we begin 2022, I'm focusing on key strategic priorities to advance our position as a leader in heating and treating water around the world. First, innovate and expand our DCAR portfolio, including heat pumps for space and water heating. Expand our global water treatment capabilities by investing in technologies, people, and distribution deploy capital effectively by investing in ourselves, acquisitions, and returning capital to shareholders. Thanks to the tremendous effort by our procurement and operation teams and their commitment to operational excellence, which is part of our DNA, as nearly a 150-year-old technology leader and innovative manufacturer, our supply chain is stabilizing and our manufacturing lead times remain consistent. Through our focus and determination to serve our customers, We closed out the year on a high note and remain strong entering 2022. Our strong brands across the portfolio combined with harnessing of 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, I have a bittersweet announcement. Pat Ackerman shared her plans to retire from her position as Senior Vice President, Investor Relations, Treasurer in Corporate Responsibility and 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, her leadership, and her steadfast commitment to the values and principles of our organization. Pat's many contributions and impact will be long-lasting. Please join me and Chuck and the rest of the A.O. Smith family in wishing Pat the very best in her well-earned retirement.
Patricia Ackerman
Thank you, Kevin, for your kind words. I am fortunate to have spent my entire 39-year career at a terrific company in A.O. 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 Gergold. With over two decades of progressively increasing finance experience at A.O. Smith, Helen most recently was vice president and controller and led our SEC reporting. You will find Helen to be knowledgeable and personable, and I know you will enjoy working with Helen as much as I have. With that, we conclude our prepared remarks, and we are now available for your questions.
Operator
Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Matt Somerville with DA Davidson. Your line is open.
Matt Somerville
Thanks and congrats, Pat. Um, a couple of questions. How should we be thinking about North America in particular, kind of the quarterly revenue and earnings cadence, given what's a pretty significant number of moving pieces, how you have incremental price rolling through, how you're thinking about volume across the different product lines. How should we be thinking about that? Um, for 2022?
Pat
Matt, this is Chuck. Good morning. So as we kind of look at 2022, overall, the cadence, when we look at the first quarter, it's going to probably be the most challenging from a margin and perhaps a volume quarter. As you know, China is always weakest in the first quarter with the festival, gains momentum for the second and third quarter, and then the fourth quarter is the strongest. You should think of it very similar that way. Less moving parts in China, perhaps, because price and cost have not been that much of a move. Back to your North America focus, though. 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. If you look at steel, steel costs mentioned that we're going to still see 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 in North America a bit. Though we do have our price increase offsetting that. So we have pricing coming in, get a little bit higher steel. And so Q1 would be our most challenged on the margin side. Two through three as you roll out the rest, and four as you roll out the rest of the year in North America, we do expect steel to moderate just a bit. You've seen the index come down. And so we expect margins to be a little bit stronger on the back three-quarters in North America with the price increase in full for really all of the year. So that's basically the roll forward, you know, kind of how to look at 2022 from North America perspective. And, you know, we've got pricing I mentioned is about 45%, we believe, on the water heating side, effective that we've already seen. And so, you know, we've got 55% of that rolling in for 2022. Hope that provides a little better color on how it rolls out.
Matt Somerville
Yeah, it does. And just as a follow-up, you'd mentioned that inventory levels in China stand at the lowest level you've 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?
Pat
Yeah, you know, our goal is to always keep it at the leanest level that's appropriate to serve our customers in China. You know, it's at a low water mark. We wouldn't expect it to go lower than that, you know, at the end of 2021. So, you know, as we've said before, we keep a close watch on it. You know, 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.
Operator
Thank you. Our next question comes from Scott Graham with Loop Capital Markets. Your line is open.
Scott Graham
Yes. Hi. Good morning. And a hearty congratulations to you, Pat. You've been phenomenal in your job.
Patricia Ackerman
Thanks, Scott.
Scott Graham
I have a couple of questions for you all. I guess the first one is on the North American business. It looked like the first two months of industry shipments and resi war heaters were up, and your chart shows volumes down in North America for the quarter. Could you maybe give us a little more color on that?
Pat Ackerman
Hi, this is Kevin Scott. As we discussed on our Q3 call, we had a challenging Q1, and we had been making progress through Q2 and Q3, and we fully expected that to carry over into Q4. It lagged a little bit, and so that's what you're 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. And, you know, I guess the comment I would make is our customer bases are solid. 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 our supply chain started to stabilize and so forth, we had some allocations out there for most of the year, and 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, and As the industry normalizes and gets out of this turbulent sector, I think everything will move back to a much more of a normal cadence and a normal share output for us.
Scott Graham
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're coming from on that one, because, you know, we're still kind of, I guess, you know, I'm a problematic part of that, but it just feels like, you know, we're going to have a full year of, you know, reopenings, possibly even incremental reopenings versus 21, and just, you know, just sort of wondering why you would think that that would be a flat market for you.
Pat Ackerman
Well, I'll touch on that and then maybe have Chuck jump in as well. When you look at it, we had a lot of reopenings in 2021. We had a very strong market. And as we go forward, it's a forecast. We believe that things will be a bit more normalized. Probably some of the proactive replacements won't be there. And so as we look out, 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.
Operator
Thank you. Our next question comes from Susan McElroy with Goldman Sachs. Your line is open.
Susan McElroy
Thank you. Good morning, everyone. And, Pat, I'd like to add my congratulations as well to you. Thanks, Sue. Good morning. Good morning. My first question is, you know, 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 inventories sit and, you know, how do you expect that your order rates could trend as those allocations have been removed?
Pat Ackerman
Well, let me touch on that one as well. One, we're very specific on our order, our inventories in China because we have 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, the inventories are basically in line. There's probably some gaps here and there. For the most part, I think the allocation just frees up maybe some orders. I'm not going to put a number on it, quite frankly. But I do think we have limited some of our customers and try to be predictable for them, giving the right products to them, making sure that their deliveries were on time. So, again, I think it's a positive thing for our organization as we enter into 2022, removing the allocation and kind of getting back to business as normal. And so... That's kind of where we're at. No specific number, I think, I would want to add to that.
Susan McElroy
Gotcha. Okay, that's helpful. And then, you know, as we do think about steel perhaps moderating or sort of coming off of this peak as we move through the year, 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?
Pat
Yeah, we've never had these sort of price increases like we've seen in this last year, of course, so it's a little bit difficult to predict. We can 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 it's been hard to see how it plays out. We've got non-field costs in logistics and freight, that even as steel costs have come down since our last call, we've only seen pressure and increase on all other non-steel costs. We really have seen those surge a bit in the last quarter. So those somewhat offset some of the relief, perhaps, that might be happening on a bit of moderation on the steel side.
Operator
Our next question comes from Damian Karras with UBS. Your line is open.
Damian Karras
Hey, good morning, everyone. Congrats on the year, and Pat, best of luck in your retirement. Thanks, Damian. So I wanted to ask you about some of your comments on China. So you're expecting 5% sales growth there, but you mentioned water heater volumes flat to slightly down. Could you just talk a little bit about your key assumptions driving your forecast there?
Pat
Sure, sure. Yeah, I mean, water heater volumes in China have been flat to down. You know, when we look at the full year demand, and I'll just kind of talk about what the overall 2021, you know, consumer demand as best, you know, we measure through our channel, it probably was up 1% to 2%, you know, the demand itself. So underlying demand, when we get to the 5%, you can kind of think of it as 1% to 2%. There's a bit of pricing in China. We haven't nearly seen the cost pressures as we've seen in North America, but You know, that's perhaps another percent. And then when we think about kind of the new products, you know, we've got some new products we've introduced. We've got the products I mentioned earlier in the statement on electric that are doing well and the gas products that are doing well, you know, range hoods, cooktops, commercial water treatment, and water treatment overall we feel pretty positive about, which kind of fills that gap to get you 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 up to that 5%.
Damian Karras
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 mix is today, you know, compared to the, you know, pre-2019 peak levels, if you will. Obviously, kind of you mix down, you know, after that, but... Maybe any color around kind of the, you know, the mid to premium price mix today relative to the past would be helpful. Thanks.
Pat
Yeah, so we're not at the peak where we were at max in the peak 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, you know. So we've got a year-over-year improvement index planned in 2022 quarter. Q4 was positive on mix. And, you know, the introduction of a couple of the new products we've just put out there help our mix because they're in the premium segment. So, you know, 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.
Pat Ackerman
Yeah, I would just add, I mean, it's new products across our electric line, our gas tankless line, our water treatment that has done substantially well and continues to grow. And so, and then the kind of what I would call the newer segments. Our commercial water treatment continues to do well and close to over the $40-plus million. And then Chuck mentioned range hoods and cooktops, which are gaining momentum. So, you know, overall, there's still going to be a COVID issue that we'll have to work through there and some spotty shutdowns that happen. And, you know, that may be, we'll say, a setback. There's still some de-risking. But you put it all together, we came out of fourth quarter pretty well. We have some really good products on the premium side that are just getting into the markets fully. So we feel real good about the mix and where it's going and hope to get back to those 19 levels soon.
Operator
Thank you. Our next question comes from Nathan Jones with Stifel. Your line is open.
spk08
Good morning, everyone. i'll add my congratulations to pat and welcome to this part of the team to helen um i did want to uh 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 have actually come down pretty substantially 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 steel in inventory? And how is that balancing off against the inflation that you're continuing to see in other inputs?
Pat
Yeah, I mean, our input on steel is about 70% cold roll, 30% hot roll. So 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 there. 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, you know, 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 costs, components, logistics. We really haven't seen any relief on that. You know, if we just kind of look through the rest of the year, our best projection would be, you know, if there is some moderation in steel on the index, we have seen a bit. you know, that the offset is largely in the non-steel components. And so, you know, we're not in our outlook calling for any, you know, we're calling for in our outlook when we look at it, the Q1 is probably the most challenge. And then it really, the margins sort of flatten out after that, after we get over that, you know, kind of one quarter where steel's the highest. Thanks.
spk08
I guess my follow-up then around the margin guidance for North America, which is down a little bit from 2021 is, I think given, you know, you were 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 into seeing margins a little bit lower in North America in 2022? Thanks. Sure, sure.
Pat
So they are lower in our guidance. Let me just do a little reconciliation because if you exclude, and I mentioned the non-cash pension adjustment, that's about $10 million that you'll see in our gap to non-gap 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 two really get us back to adjusted margins that are flat compared to 2021. So 2022 North America is roughly flat compared to 2021. And that's 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 are really filling that gap.
Operator
Thank you. Our next question comes from Mike Halloran with Baird. Your line is open.
Mike Halloran
Hey, good morning, everyone, and congrats, Pat. It's been an enjoyable, what, decade plus, I guess, but I've really enjoyed the relationship, so thank you. Thanks, Mike. So maybe a similar line of question on China. Chuck, maybe just could you give the bridge on the China margins and obviously 10% is a nice increase here, but what are the puts and takes going from this year's to next year's margin levels?
Pat
Yeah, I could do that. I mean, it's really up about 100 basis points, so we're looking to expand from 9% to 10%, mostly on volume, mostly on volume and mix. You know, we got the products that we mentioned earlier, and they came into play in volume and mix. We overcame a bit in 2021 to 2020. I mentioned the social insurance. That's about $12 million per year. So we like the progress that we made in 2021 to get us to $9 million, and then it's really volume and mix and leverage on the top line that gets us to $10 million.
Mike Halloran
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, Any movement as you think about it through this year and how you're thinking about it through last year, excuse me, how you're 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?
Pat Ackerman
I would say on the residential side, probably not any tank momentum, I think, Heat pumps have been growing year over year, becoming more popular. Obviously, there's more incentives out there, and 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 up there. But let's step back. We still have a great decarbing footprint called condensing water heaters and condensing boilers. And That's also trending well because there's so many applications that you really need the output and the heat of a gas-fired product. And being able to provide condensing boilers and condensing commercial water heaters also provides opportunities. So commercial, I think you're going to continue to see just high efficiency growing on both gas and on the heat pump side.
Operator
Thank you. Our next question comes from Jeff Hammond with KeyBank Capital Markets. Your line is open.
Jeff Hammond
Hey, good morning, everyone. Best of luck, Pat. Thanks, Jeff. Just first on supply chain, you mentioned a couple times stabilization, moderation, and the headwinds. Can you just speak specifically to what you see as getting better here near term?
Pat Ackerman
Just overall, you know, You can't make any of our products without every component. And so it's – and I say that while I'm smiling here, but overall, as you start to become a bit more predictable, as our suppliers become a bit more predictable. And so that's what's been – and then just some of the volumes coming up. We came out of a big freeze that impacted foam and oil-based products, and then steel was running behind. But we're starting to see all these key components moving in the right directions. 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, you know, overall that's what stabilization looks like. That's why we were able to remove the allocation from our supply chain. And then I'm going to tell you we're going to have pockets of disruption occasionally here and there. 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 in production and deliveries. But it's incremental, and we feel, as we enter 2022, we're in better shape than 2021, albeit we'll have to see how the Omicron surge impacts that. But as of right now, that hasn't been a large issue for us.
Jeff Hammond
Okay, and then just back on this kind of steel and pricing dynamic, it seems like cold roll, which I think is your biggest input, is down like 15% off of year-end pricing. And just, you know, if that sticks, when do you start to see, one, the benefit of that? And just remind us how the material price formulas work with, you know, the DIY customers where some of that pricing, you know, when some of that pricing might roll off. Thanks. Thanks.
Pat
Yeah, so the decrease we've seen so far, you know, that it still has come down. We probably, we will not see that until you get it, you know, probably into the middle of the second quarter. So that's, you know, from a cost perspective. And then who knows where it will go from there, right? So it's gone down a bit. I'm not sure, you know, our assumption is that it kind of stays at that level for the rest of the year. We have certain customers that have pricing formula that represents maybe 25% of our water heater volume. And so the cadence on that follows similarly to kind of when you see steel indexes move.
Operator
Thank you. Our next question comes from David McGregor with Longbow Research. Your line is open.
David McGregor
Yes, good morning, everyone. And Pat, thanks for all the help along the way. It's been great working with you. I wish you all the best in your retirement. Thanks, Dave. I guess I just wanted to build on a couple of other questions that have been asked at this point. And maybe for starters, go back to the discussion around China and mix. And you talked about the fact you were seeing a stronger mix with the premium product. it clearly that's a reflection of new product that you've introduced out there, but are you seeing a similar trend across the broader market? In other words, is the Chinese consumer mixing up again? Uh, or is this really AOS specific?
Pat Ackerman
Yeah. Based on the data that we've seen in, and again, I'm going to relate it to more of the appliance side of the business. We see almost every category, um, on a year on year basis mixing up. So that's a positive trend that says a lot, maybe consumer confidence and so forth. Um, in China. But yeah, we are seeing it. It's not just in our categories, but others that we don't participate in.
Pat
Yeah, it's not back to the peak, but it's a couple quarters now where I think we can start calling it a trend because we've seen an uptick.
David McGregor
Yeah, that's encouraging. And just on China, can you update us in terms of how you're approaching distribution and the growth of distribution in terms of 2022? What should we expect there in terms of new doors?
Pat
Yeah, so we really are focusing on two pieces, really, when you think about kind of the Tier 1 and Tier 2 cities. We are, you know, we're really looking at store efficiencies there. So we're continuing to be focused on store efficiencies. We're probably, you know, we're probably going to take out a bit more stores in 2022. We're at that pace. We've been on that pace. For a number of years now, we're probably, you know, in the 200 to 300 store, you know, taking out in 2022 compared to where we're ending the year in 2021, just not quite 6,000 outlets. On the other side, we're really looking to grow geography on the Tier 3 to Tier 6 cities. So, you know, think of that as low-cost counters. We're just, you know, we're not having a promoter. It's very opportunistic. And those footprints, you know, that's growing in the neighborhood of maybe 500. But don't do the math equal to the Tier 1 and Tier 2. But it's certainly opportunistic, and it's where we're really looking to continue to expand.
Operator
Thank you. Our next question comes from Andy Kaplowitz with Citigroup. Your line is open.
Andy Kaplowitz
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 you've also been aggressively raising price, and 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?
Pat Ackerman
Well, I worry every day. So, and I'm not being flippant. I mean, 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 A.O. Smith and A.O. Smith's customers and our brands. And so there are clearly some kind of competitors coming into the market. We're going to continue to focus on what we do best, and that's bringing innovative products to 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 taken care of our customers in a professional way and managed their expectations. And again, I always go back to this industry isn't about residential. Gas and electric isn't about just standard commercial. It's about bringing a portfolio of products 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 the market. Perfect example is Hellcat 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. that meets our customers' expectations and helps them grow their business.
Pat
And the only additional comment I'll make to that is, and we called it out on our slides, is that our R&D spend is over $90 million, and that's on water heating, water treating, and we're really focused on those markets and, as Kevin said, being the leader in product technologies.
Andy Kaplowitz
Thanks for that. And maybe for my follow-up, North American boiler sales, you talked about them up 10% in 22 after a good year in 21. 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 you'll see any direct impacts from the infrastructure bill? And if so, when could they begin to occur?
Pat Ackerman
Well, I can tell you we've seen certain segments. We talked about the educational segment last quarter that's certainly been helping us in providing opportunity. We're seeing more government institutional segments start to grow. So we are seeing some of that, maybe that stimulus that we're talking about in the marketplace. That's what's led to our record backlog that we have today. And that's going to stay with us, I think, at least through 2022. I mean, we're looking at a 10% growth rate. And so, yeah, overall, there's some stimulus out there. There's also just some pent-up demand that may go back to the pandemic that we're filling that gap as well. And again, the replacement market is 85%. So you're going to have that natural replacement market continue. So Overall, the boiler market looks strong. Orders are still good. Quoting activity is still good. So overall, entering 2022 in a really good position in the boiler segment.
Pat
Yeah, and I think I'll add on to that. I mean, that 10% growth, there was some pricing that we did do on the boiler side of the business also. So there's a bit of carryover pricing that helps us a little bit. But we still see growth in the boiler market.
Operator
Thank you. Our next question comes from Brian Blair with Oppenheimer. Your line is open.
Brian Blair
Good morning, everyone. Pat, thank you very much for your help over the years. It's been a pleasure working with you.
Patricia Ackerman
Thanks, Brian. Good morning.
Brian Blair
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 in 2020?
Pat
Yeah, we haven't, I don't think, but margins are around 11%. They were approaching 11% in 2021, so we're pleased with the progress that we made. Leverage and volume, the acquisitions have continued to move forward on that, and we're expecting about 100 basis points expansion in 2022.
Brian Blair
Okay, appreciate that. And circling back to commercial boilers, any feedback you can offer on uh, on the reception acceptance of your Hellcat technology since that that's been out there and how that factors into the backlog build that you've had and, um, you know, how we should think about the, I guess the cadence of first, first, second half growth netting to that 10% range that you've guided, uh, given your backlog position, uh, bidding activity, et cetera.
Pat Ackerman
Well, the Hellcat, um, Technology has been accepted and received very well by our contractor mechanical base. But 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. Maintenance, it helps us get through the maintenance. It adjusts so you don't have to go out there and do manual adjustments. And the overall cost, so we're excited about it. It's a first-to-market, a first-mover. It's truly technology different than what's in the market today. You bolted on a terrific product like the Crest, and we just see that continuing to grow and gain momentum, particularly in the specified side of the business.
Pat
Yeah, not specific to growth, but the cadence of the boiler business is, you know, typically Q3 and Q4 are the strongest quarters. And we still expect that in 2022.
Operator
Thank you. Our next question comes from Larry DiMario with William Blair. Your line is open.
Larry DiMario
Thanks. Good morning, everybody, and certainly congratulations. Best of luck to Pat. Thank you. Yeah, we won't get to see you one last time for a field trip. So I was kind of curious, I know you touched on this, but it relates to China with inventory at a five-year low, I believe you said, but only looking up 5% for the market. I mean, I know there's comps and stuff, but can you delineate between consumer demand and channel fill, and are we holding the channel back at all from refilling? It just seems like there might be some potential upside there.
Pat
Good question. We don't believe we're holding the channel back. I mean, I will say we had a strong order rate at the end of December that we – You know, we certainly did get out in January, but we're not, you know, it may go up a bit. We don't expect it to go lower. So as we kind of think about 2022, you know, channel inventories do get a bit lumpy, but they've been really honed down to a pretty lean level. And, you know, if anything, we expect it to slightly go up, but we're, you know, we're going to keep that in a close watch.
Larry DiMario
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 North America is a little bit in China also. And, you know, how meaningful is that impact?
Pat Ackerman
Yeah, it's primary. It's almost exclusively North America, uh, particularly with the number of people that we have out. So, uh, China, again, um, very little, but again, that's spotty depends on the region. Um, India is the same way, but really the Omicron surge has really impacted our North America businesses, and we're working through it. It hasn't peaked yet, but we hope that we'll start to see a peak, and it'll come down, and we'll get through it the first quarter and kind of put this phase of COVID in the rearview mirror.
Operator
Thank you, and I'm currently showing no further questions at this time. I'd like to turn the call back over to Helen Gerholt for closing remarks.
Patricia Ackerman
Thank you for joining us today. Let me conclude by reminding you that our global A.O. Smith team delivered strong sales and earnings despite many challenges in 2021. We are optimistic about our results in future periods based on a durable strategy, robust demand for our products, as well as strong execution of our strategy despite an environment challenged by component shortages, logistical bottlenecks, inflation in both materials and transportation costs, and pandemic-related surges. 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 Barrett on February 22nd, Citi on February 23rd, and Barclays on February 24th. Thank you, and have a great rest of your day.
Operator
That concludes today's conference call. Thank you for participating. You may now disconnect.
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