Blount International's CEO Discusses 2013 Guidance and 2014 Outlook Conference Call (Transcript)

Feb.11.14 | About: Blount International (BLT)

Blount International, Inc (NYSE:BLT)

2013 Guidance and 2014 Outlook Conference Call

February 11, 2014 1:00 PM ET

Executives

David Dugan - Director, Corporate Communications and IR

Josh Collins - Chairman and CEO

Calvin Jenness - Senior Vice President and CFO

Analyst

Steve Barger - KeyBanc Capital Markets

Rob Kosowsky - Sidoti & Company

Larry De Maria - William Blair

Arthur Roulac - Three Court

Operator

Good morning or afternoon as the case maybe for each of you and welcome to the Blount International Incorporated Teleconference with Mr. Josh Collins, Chairman and Chief Executive Officer; Mr. David Willmott, President and Chief Operating Officer; Mr. Calvin Jenness, Senior Vice President and Chief Financial Officer; and Mr. David Dugan, Director of Corporate Communications and Investor Relations.

My name is Chad and I will be your facilitator today. The conference will begin with a brief overview of updated 2013 guidance, the Company's preliminary outlook for 2014 and other news followed by a question-and-answer session. All lines have been placed on mute to prevent any background noise. (Operator Instructions) At this time, I would like to turn the call over to Mr. Dugan. Mr. Dugan, you may begin.

David Dugan

Thank you Chad and good day everyone. Before we summarize the Company's performance, I would like to remind everyone that the statements made in the course of this conference call regarding the Company's or management's intentions, hopes, beliefs, guidance ranges or other expectations for the future are forward-looking statements. Those statements involve risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements detailed in this morning's press release and our Form 8-K and other SEC filings.

Additionally, we have supplemented our news release with a presentation that can be found along with the news release on our website at www.blount.com. At this time, Josh and Cal will provide an overview of the updated 2013 guidance and the Company’s preliminary outlook for 2014 and comment briefly on other topics covered in yesterday’s new release.

Josh Collins

Thanks, David and thank you all for joining us on today’s call. In addition to our updated 2013 guidance and our 2014 outlook, we will discuss our new supply agreement with Husqvarna, our plant consolidations, our agreement to become exclusive distributor of Pentruder high-performance concrete cutting systems in the Americas and a recent update to our strategic plans and long-term targets.

Throughout 2013 our business results were mixed. In our FLAG business, our estimated results were below our latest guidance for 2013. Our FRAG and concrete cutting and finishing businesses performed well throughout 2013 with increased sales compared to 2012. Our FLAG business was somewhat softer than expected. Despite the soft results, we continued to generate significant cash flow through the fourth quarter. Cal will address in more detail.

Our estimated full year results for 2013 were down 3% compared to 2012. Our FLAG segment estimated sales were down about 6% and our FRAG segment estimated sales were up nearly 4% compared to 2012. Our FLAG sales in Asia and Europe which includes Russia continue to be soft. Asian demand was impacted by currency rates and commodity prices with reduced channel and end-user demand. Estimated North American FLAG sales also ended the year soft, we were down 3% for the year versus 2012.

Overall demand in 2013 was driven by fueled inventory levels that were higher on entry and took longer than anticipated to normalize. While we expect modest improvement in 2014, the turn did not come by the end of 2013.

Our December 31, 2013 on order position reflects the soft demand. Our total on order position of $183 million compares to nearly 200 million at December 31, 2012 and 148 million in September 30, 2013. FLAG orders at the end of 2013 were $151 million, down about 10% compared to 2012 and this represented approximately 83% of the total on order at year-end. At year-end 2013, the FRAG on order position remained flat compared to December 31, 2012.

Estimated operating income for 2013 declined by $16 million compared to 2012. The decline was primarily driven by soft sales volumes in the FLAG business along with accompanying negative overhead impact of lower volumes. We’ve taken action to reduce our manufacturing cost in the FLAG business as we discussed in the new release this morning. We expect those actions to provide significant benefit in 2014.

I’ll now turn the call over to Cal to cover some specifics related to the financial performance of the Company. After that I will wrap-up with our 2014 outlook.

Calvin Jenness

Thanks, Josh. As a reminder, we posted a presentation to our website this morning in addition to our press release that outlined profit and cash flow drivers for 2013 compared to 2012 along with other operating metrics. From a profit perspective, the FLAG segment estimated contribution to operating income in 2013 climbed by about $22 million compared to 2012. About half of the climb was a result of reduced sales volumes.

The balance was a result of increased cost and mostly driven by the negative leverage and overhead costs that comes with lower traction volumes. FRAG estimated sales for 2013 were up about 4% compared to 2012, as we experienced increased sales in agricultural attachments, tractor parts and log splitter product lines. Increased volume represents a recovery from the weather related soft demand and integration difficulties in the prior year. Additionally we experienced some improvement in average pricing.

Adjusted EBITDA for the FRAG business estimated was 21 million in 2013 compared to 10 million for the full year 2012. The improvement to estimated FRAG profit was driven mostly by an improved cost profile compared to 2012. Increased volumes and better prices add to the cost improvement to increased profit.

In total estimated adjusted EBITDA for 2013 was 125 million compared to 136 million for the full year of 2012. The reduction in adjusted EBITDA reflects improved FRAG results which were more than offset by the decline in FLAG results. Including those results was approximately $3 million of increased audit related administrative expenses we expect to incur in connection with the audit of our 2013 financial statements.

Net debt was an estimated 395 million at the end of 2013, down about 71 million from December 31, 2012. Our estimated ratio of net debt-to-adjusted EBITDA was 3.2 times at the end of 2013. The decrease in leverage from the end of 2012 is primarily a result of improved free cash flow and the result in net debt reduction, partially offset by lower estimated adjusted EBITDA for 2013 compared to 2012.

Net debt decreased in 2013 mostly as a result of approximately 67 million of free cash flow compared to nearly zero in 2012. As discussed in our news release our working capital profile improved significantly in 2013 compared to 2012, as we managed through soft market environment and targeted cash flow generation throughout the year. As we entered 2014, we have substantially completed our previous announced consolidation of saw chain manufacturing facilities in Portland, Oregon into one location. Also in the first half of 2014 we’re closing on one more blade manufacturing plant in Mexico that came with the PBL acquisition in 2011.

We will consolidate our North American production into our Kansas City, Missouri blade plant. In combination these actions are expected to improve our cost profile for the FLAG business by about $8 million to $10 million annually once fully rolled in. In calendar year 2014 we expect to realize $7 million to $9 million of that savings excluding the transition cost that have to be incurred.

As we mentioned in the news release the Company has continued to remediate the internal control weaknesses identified in the December 31, 2012 Form 10-K/A. However due to the timing of identification of certain of these controlled weaknesses we do not expect that we will conclude our full remediation was accomplished by the end of 2013. Consequently we will likely disclose some material control weaknesses in our Form 10-K for December 31, 2013.

Further we expect that non-cash impairment charge will be recorded to goodwill and certain other indefinite intangible assets, both related to acquisitions made in recent years. Accounting for intangible assets recorded upon acquisition of business is a complex topic; our accounting team is working through the details of the potential non-cash impairment charges expected for goodwill and other intangible assets.

We believe that the SpeeCo and PBL businesses are most likely to trigger non-cash impairment charges for 2013, the factor that’s driving impairments for these businesses our recent results and expected near-term management of those businesses as we reinvest for future profitability. As we concluded the reassessment, controls, conclusions in our December 31, 2012 Form 10-K/A, our independent registered public accounting firm notified the Company that completion of the 2013 audit is unlucky to occur prior to the deadline for filing the Company’s Form 10-K for 2013.

Additionally estimated fees to complete the audit increased by approximately $3 million compared to the rate previously communicated, which resulted in unanticipated increase in administrative expense of approximately $3 million in the fourth quarter of 2013. Our auditors are working diligently through the 2013 audit and we expect to keep our investors updated as we progress through the filing of our 2013 Form 10-K.

That covers the specifics related to 2013. So now I would like to turn the call back over to Josh.

Josh Collins

Thanks Cal. I will wrap-up today’s call by highlighting recent agreements reached pertaining to our FLAG and CCF businesses. And I’ll provide an update to our strategic plan and long-term targets, as well as estimated outlook for 2014. Then after that we will open the line for questions.

We’re pleased to announce that we have recently entered into a new long-term supply agreement with Husqvarna our largest customer. Blount has been a strategic supplier of saw chain and other products to Husqvarna for several decades. These supply agreement expires at the end of 2017 and replaces the existing agreement would have expired at the end of 2015.

Under the terms of the agreement Blount would be exclusive supplier to Husqvarna except for their own production capabilities from saw chain products as well as laminated and guide bars and certain other chain related parts. The supply agreement also provides a mechanism to extend the contract further into the future, should both companies would like to do so. We also recently announced an agreement with Tractive AB of Sweden and Pentruder Inc. of Chandler Arizona becoming exclusive distributor of Pentruder, high-performance concrete cutting systems in the Americas.

Our concrete cutting and finishing brand ICS will market sell and support the Pentruder line of wall saws, wire saws, core drills and all parts and accessories in the Americas. The transaction provides us with a greater assortment of products to offer to ICS customers.

In the press release we issued yesterday, we outlined our preliminary outlook for 2014. We estimated the fiscal year 2014 sales will range from $925 million to $950 million. And our adjusted EBITDA will range from $130 million to $135 million. Our expectations for sales assumes high sales growth of approximately 4% and growth in FLAG segment sales were approximately 8% both compared to estimated full year 2013 levels.

2014 adjusted EBITDA levels reflect increased sales volumes in both the FLAG and FRAG segments partially offset by investment in important strategic initiatives. We are expected to yield benefits over the next five years. Free cash flow in 2014 is expected to be in the $35 million range that’s approximately $45 million of capital expenditures.

In 2013 we completed a strategic review of our businesses and shared services functions. A summary of our updated strategic plan is included in the Company overview presentation which is available on our website. To comment briefly on the plan, our mission is to create long-term value for our shareholders with profitable growth by building an enduring organization driven by performance-oriented culture of continuous improvement and a relentless focus on providing our customers with quality parts and equipment.

Our vision for 2018 is to be with supplier of choice with professional quality parts and equipment to help our customers get their job done right. Global and corporate strategy is comprised of four components; first, profitably growing our business by leveraging our channel and geographic resources to our existing and new innovative products; second, in support of this growth we must continue to build a high performance organization; third in support of growth and to maximize return to our shareholders we must prudently allocate capital. And lastly we will continue to opportunistically pursue acquisitions.

Each of four business units strategies are aligned with our corporate strategy. In our FLAG business we will focus on strengthening our core business and expanding to adjacent geographies and product categories. FRAG will become one integrated international business in concrete cutting and finishing, we will increase its scale and scope through new product categories and geographic expansion.

As an outcome of our strategic planning we’re targeting 2018 sales of more than 1.1 billion and adjusted EBITDA of approximately $175 million. Free cash flow generation over the strategic planning horizon would be primarily dedicated to repayment of debt and funding strategic initiatives. At lower leveraged levels we anticipate paying dividend. We are implementing a stock repurchasing program in order to return capital to shareholders.

Again additional details of our updated strategic plan are available in the Company overview and presentation on our website.

With that we would like to open the line for questions

Question-and-Answer Session

Operator

Certainly, we will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Steve Barger with KeyBanc Capital Markets

Steve Barger - KeyBanc Capital Markets

Hey good morning guys.

Josh Collins

Hey Steve.

Steve Barger - KeyBanc Capital Markets

I’d like to talk about capital allocation first as it relates to the long-term plan, the released cash flow will go toward debt repayment and funding strategic initiatives. So first just how should I think about maintenance CapEx in 2015 through ’18, and more importantly what do you see as the strategic initiatives, is it more internal investments or is it more acquisition focus?

Josh Collins

No. It's internally focused, organic growth focused, we’ll obviously continue to look at potential acquisitions, not to the strategy per se but in support of the strategies that we have laid out in the presentation, and whether it’s a buy versus build decision et cetera, I would say Pentruder is a really interesting example of that. It’s a relatively small acquisition. We’re not disclosing sort of levels but it’s a cost effective way to really accomplish what we’re trying to do strategically in concrete cutting and finishing and we think there is a lot upside around it.

In terms of CapEx and modeling if you will, the area of 4% to 5% of revenue, that’s not necessarily, that’s the way we look at it. But that’s a good way to model it, I would say. And now at $45 million for 2014, is what we have in the plan. That breaks down, call it $17 million to $20 million what we call maintenance CapEx typically. There’s about $15 million to $17 million of expansion capital, namely that $12 million with Fuzhou and call it $5 million or $7 million of solid bar expansion project that we are finishing up.

In addition we’ve got about $5 million of new product development, capital and IT spend is about $5 million which includes SAP integration at both in one of our small units we’re doing this year and getting ready for a large one next year.

I hope that gives you a sense of it, the capital allocations as we said we’ve got the investment business and after investment business we’re going to pay down debt and when the time is right, we will implement either a share buyback program and/or a small dividend.

Steve Barger - KeyBanc Capital Markets

And what do you think is an appropriate leverage ratio that you need to see before you would contemplate some of the other actions that could buyback?

Josh Collins

2 to 2.5 times net debt-to-EBITDA.

Steve Barger - KeyBanc Capital Markets

Okay. And for the Husqvarna deal did terms change from the prior agreement, you know this from an economic standpoint in order for you to get that extension?

Josh Collins

I mean terms always change and these agreements are very complex. We’re not going to go into details of it but it’s primarily the same economically. And we are very happy about this, we are dedicated to being the best supplier that we possibly can for Husqvarna. Obviously, our long-term plan through -- I know you are down at ARA and I hope you get a chance to spend some time with our guys down there. But -- so you probably haven’t had a chance to really dig into that strategic plan summary that’s in the presentation but when you do you’re going see that it looks like on the FLAG side growth is lower than we’ve talked about in the past and a big chunk of that is in assumption just an implicit assumption in over the five year period of time that we will lose some portion of that Husqvarna business. We are obviously going to be fighting as hard as we can to retain as much as we can and as a good amount is at risk as well in a very competitive industry as you know both other competitors in the industry in China et cetera. And there is still uncertainty around that but we feel very good that we’ve dedicated beyond this long-term agreement and they have as well.

Steve Barger - KeyBanc Capital Markets

Got it. Thank you. And you’re right I did talk to your CCF guys, good showing down here at ARA right now. In terms of -- can you tell me what the growth rate is, because you’re right I haven’t seen the slides yet I mean how much -- what is the expected decline from Husqvarna specifically as you think about the saw chain growth rate going forward?

Josh Collins

Yes. Implicit in there is losing about half of the Husqvarna business. Once again, that’s a wet finger in the air. There is risk around that and we know that their dedicated to building high-end professional chain and at the same time we are dedicated to try and keeping as much as of that business with them as possible and we will to that by providing great service, quality and innovative products.

Steve Barger - KeyBanc Capital Markets

Okay. Great. And one more and I’ll get back in the line as you look at that long-term forecast, how much price if any is in there or is that more based on volume assumptions?

Josh Collins

Yes, we’ve got very modest pricing effectively assuming pricing is about flat and it’s based on margin, I mean they’re plus and minuses all over the place but in aggregate that’s about right on FLAG side.

Steve Barger - KeyBanc Capital Markets

Great. Good, I’ll hop back in line. Thanks.

Josh Collins

Okay. Thank you.

Operator

Our next question comes from Rob Kosowsky with Sidoti.

Rob Kosowsky - Sidoti & Company

Good morning guys. How are you doing?

Josh Collins

Very well, how are you Rob?

Rob Kosowsky - Sidoti & Company

I was wondering just looking at I guess into the 2014 outlook on the FRAG side, you saw margins on FRAG in 2013 EBITDA margins, expanded nicely but we are still shy of the 15% goal so -- or at least what it was back in one point in time. What level of margin expansion could we expect to see kind of going into 2014 from this segment and is it still on the table to get to that kind of mid double-digit profitability level and also kind of what kind of growth investments you got in there?

Josh Collins

Yes. On the FRAG side for ’14 we’re not going to see margin expansion in ’14. ’14 for FRAG is a year of investment and while both on the supply chain side, product development side we’re going to see an increase in SG&A there of about $3 million so that’s about half open positions and wage and bonus normalization et cetera and half dedicated to new product development. I think we got five real new products coming out, plan for this year is 9 refresh products at FRAG.

We’re not going to get into the details of those but I will say that it’s across the board what we used to call the business units. The log splitter aside, the cutter side, the ag turf side and skidder. So, we’ve got a lot planned there and there is a lot of investment in those numbers we think there is an opportunity there for further performing in the markets there, performing on what we’re expecting for margin but we’re not expecting margin increases. We’re seeing -- we are expecting some top-line increase that’s pretty significant and as I said a year, ’14 is a year for investment in FRAG.

We do see long-term in our strategic plans as we’re laying it out. We do see EBITDA margins approaching 15%, I think it’s just north of 14% in our outlook and a lot of this is going to be top-line dependent. I mean if you get it I think there is probably some upside there. Does that answer your question?

Rob Kosowsky - Sidoti & Company

Okay. Yes, yes so it’s kind of just like a big year of investment this year, I mean obviously your 8% growth rate is a lot better than what we are seeing from ag in general, so some of that’s kind of the early fruit coming sort of efficiency better kind of leverage I guess further out down the road I guess.

Josh Collins

Yes.

Rob Kosowsky - Sidoti & Company

Okay. And then and now have just kind of like a broader question on 2018 goal is that way back in time there was like a another long-term outlook and so your EBITDA estimate is less than what that was and if I look at back at the longer term, your 2011 results you had about 169 million of EBITDA. And I am just wondering why 175 million seems kind of like low I guess or you seem like you should be able to attain it or kind of, what were some of the assumptions that changed to kind of get to that number, you know given the, you did show that earnings slide previously and also kind of what you won’t stop the earnings power of the Company.

Josh Collins

Yes, we are personally when you state, there were some notes that came out this morning, we really appreciate our equity research analysts being on top of this and you get notes after right away. One of the two folks had a term in there the 2018 outlook or targets were stretched targets and that’s not true and not what it’s meant to be. The strategic plan in process is an in-depth literally a year long process for us and a very good process in which we evaluated our industries -- our various industries, and competitive dynamics, our strengths, weaknesses, capabilities and how we could best take advantage of where we believe that that industry is going.

And in the light of all the dynamics from a macro level, from a competitive level, from regulatory and technological change that’s occurring. We could best be positioned to take advantage of where we believe it is going. There is obviously since we came out in 2010 with that five year plan, and absolutely we are not denying, when we came out with that there has been a meaningful change in the FLAG industry in and life happens and it makes sense to update as we go along.

Likewise a year from now, or 18 months from now we will very well update those longer-term targets. Now if we blow this year out of the water, we will likely update those targets. It would make sense. And yet so we wouldn’t think of it as a stretched target. I think that term was in there it’s not -- this is an internal target which is meant to be achievable. And you give people a vision for how we are persuading the important thing in that target plan for us internally is the assumptions that we have laid out and the initiatives that we are laying out and have laid out in order to drive growth and profit growth into the future.

It’s not about five year budget clearly, okay. In fact we backup for a second, nobody has mentioned this but obviously a little bit unusual to come out with this press release and conference call, now versus the first week of March when we normally do, there is a lot of stuff going on. And one of the primary things that’s going on is we were beginning to rollout our communication of our strategic plan, internally, to 4,200 people around the globe. As we were doing that, we’ve got okay we have got these financial targets that are out there, and if you’re reasonable investor you are going to want that you hear something around that or see the numbers, it’s obviously non-public I would say that it’s not a budget and arguable whether it’s material. But we certainly think that it is good disclosure, we got advice so there is probably not an FD issue but we think it is good disclosure and we always want to provide good disclosure.

We obviously also had a lot of other things going on whether it’s Husqvarna and Pentruder our guidance or updated guidance, tightened guidance for 2013, what’s going on with the audit and that Cal was talking about, and we thought okay let’s get as much insight there as we can and then we will find as we go. Alright, so we really want to be talking about this five year strategic plan internally in getting enterprise alignment around the globe around our strategic initiatives and behind each one of these divisions, strategic plans where we have got four or five bullet points laid out.

There are 15 to 20 initiatives in major projects that drive in those directions, so rather than focusing on 1.1 billion five years from now, and $175 million, directionally, it’s the right direction and we see good growth opportunities and expansion opportunities around FRAG. We have very bold numbers out there around and assumptions out there around, what we can do, around concrete cutting and finishing where we’re scaling that business, and we know that we will have challenges in Husqvarna’s market and as our other competitors continue to operate in that industry.

And we know that for us to succeed we have to strengthen our core and grow our adjacencies both in terms of product development and in terms of strengthening and some of the emerging markets where we frankly don’t get a fair share. One of the key to our FLAG is we have to build the best bar and chain in the world.

We need to continue to do that around quality, performance, innovation, voice of the customer, understanding what our customer needs and providing it to them. And you will see in the ’14 numbers we have some real dollars and time invested in new product development that is going to come out at the end of the year. We’re not going to get revenue from it this year but it’s absolutely essential in order to maintain the strength of that business. Okay, so last one hope that answers your question Rob?

Rob Kosowsky - Sidoti & Company

Okay. Now that was a great timeframe and everything and I think you’ve stretched goal so sorry about that using the wrong term. And then I guess just one other thing on the 2018 target, I mean how big of a push do you think international is going to be in kind of getting this growth that you want to see? Is it going to be substantially more international?

Josh Collins

No, we have got somewhere around 15 million of FRAG international today somewhere around there. And we think that probably grows to 40 or 50. We’ve got a foothold right now in Europe and initially through the PBL acquisition and really sort of integrating that within FRAG now and it’s going well, and we think there is opportunity there, and we will spend a lot of time this year in investing, investing time not a lot of dollars this year at least that we see but setting up for entering with FRAG into Brazil and South America and so 40 to 50 roughly half in Europe, half in South America is what we’re expecting probably a little bit here and there.

Rob Kosowsky - Sidoti & Company

Okay. Alright thank you very much and good luck.

Josh Collins

Thank you, Rob.

Operator

Our next question is from Larry De Maria with William Blair.

Larry De Maria - William Blair

Okay, thanks. Good morning, guys.

Josh Collins

Go ahead.

Larry De Maria - William Blair

As far as Husqvarna I think you said you lose half of ’18 based into the plan, when do we think about starting to lose some, I would doubt that the cliff in ’18 is probably more of a ramp and how does that proceed? And also is there a mix impact here are they moving to the, maybe the higher end chain and then you guys continue to maybe consumer chain so is there a negative mix we should think about?

Josh Collins

If you listened to Husqvarna last week I think what they’re talking about is product by the end of 2015 for profitability in ’16. We think they may well be ahead of that schedule, it’s a great company and they know how to make stuff. So we’re planning on being flexible but wanted to provide them as much as we possibly can. I guess as we’ll start to see some impact by the end of next year into that that ramps through the end of the planning period through ’18 to the level that we’re talking about.

In terms of mix, there are enough variables I think that you don’t have to worry too much about that. There is a margin difference but such a wet finger in the air that that wouldn’t worry too much about it that way I mean obviously they’re very good customer with preferred terms and a very large customer for us with preferred terms and, it’s probably a difference but I actually don’t have the number on top of my head and it’s not digging up difference for modeling purposes, I don’t think. I think in terms of sensitivity if you talk volume numbers and capture the whole range of possibilities.

Larry De Maria - William Blair

Okay, thanks. I guess we were initially surprised that EBITDA guidance for the midpoint was only going to increase about $7.5 million given all the annualized cost cutting you guys are seeing? But is that impact really just because of the lack of margin expansion of FRAG given the investments? And then also as it relates FRAG, how should we model that kind on a quarterly basis as we think about the cadence going through 2013, as that’s going to have a similar kind of seasonal margin in the top-line interest here?

Josh Collins

Okay, both good questions, let’s start with the seasonality where we’re slightly -- we’re more than slightly seasonal to the second half and especially Q3 with FRAG and it’s I don’t know it’s probably like 28.52 and with first quarter probably the slowest and frankly we have had pretty good quarter last first quarter. We have got a month in the books, right, and you start out pretty good even though North America really not too much. You we had a lot of challengers around weather delivering stuff and nobody worked in half the country half the month.

But one month is not a year make by any means, doesn’t make a trend but we feel pretty about what we’ve seen so for albeit North America has been tough and obviously FRAG is more heavily weighted towards North America than FLAG or even CCF. So that sort of handles the seasonality question.

In terms of, yes, we’re set up pretty well. We had very painful point consolidation in terms of culturally and really good people there and we’ve executed on plan we had a few hiccup, but it’s like a few hiccups but probably a little bit in lined and just in terms moving equipment around and getting everything qualified etcetera but we’re certainly not and you saw that we’re not moving off with numbers we think will get in terms of costs.

Overall on FLAG and FRAG we expect gross margins increase of 100 to 150 basis points for the year, year-over-year and obviously we’ve got increased volume as well. So overall its substantial and begs the question expression will [indiscernible] than and the answer is investment. Okay. We are investing in the business and this is when you have to do it and yes you’re right, part of it is well we got, 20 million of increased at expected top line in FRAG and we’re basically flat on the profitability line there and that’s, once again, its investment and some pricing action et cetera this. It’s set up here for FRAG in ’14 and we need to skew it. Does that answer your question?

Larry De Maria - William Blair

It does. So it’s kind of a thought but just wanted to make sure, and you explained it well. Thank you. Maybe on the order board which, increased sequentially -- I guess it was down year-over-year. Is there much in the way of back orders in there? I know you work reduce those or they getting delayed or pushed out at all with the weather or just how do we think about even apples to apples number on the backlog.

Josh Collins

Well, last -- just year-over-year last year we had $25 million of back orders if you look. We’d sort of ballooned up and brought that down over the course of the year and probably 7 million or 8 million of back orders almost all within a week, by the end of third quarter and that came up to about $12 million. So that 5 million increase in Q3 but still 12 versus 25 the year prior. So on apple to apples basis it’s actually better in terms of forward order board than just looking to all numbers. We’re still a little behind last year. But a lot of that is -- it can move around. Order patterns can move around lot. Once again we feel pretty good -- it's January, right? End of January, I know. We’ve got a month to go and we feel good about why we’re out there. And in terms of what you get from 7 million to 12 million of back orders in three months, it really was, it’s a nail in the head. It is the end of December, we sort of shut down and we had some trouble getting stuff out and we can see a little bit of bump over into Q1 but we still feel good about it.

Larry De Maria - William Blair

Is there a right number where you want back orders? I would assume its zero but…

Josh Collins

Sarcastic zero. Zero, and we always give this back order and then you get full order board and total backlog right. Let’s talk about that that back order sort of driving ourselves crazy too. Some of that is very real and we just have to continue to improve our service levels and down from 32 million of back orders, we feel good about that, okay. But we’re not there yet. [indiscernible] zero, I will also tell you that another plus and a minus, some of that is where do we record it and the customer who back ordered – it’s really not. People on credit roles, for one reason or another, we’ve entered a delivery date, its almost fictitious, its tomorrow and it can’t possibly happen. [indiscernible] pick up, it’s a famous one. So we are being ourselves to that. So $5 million is okay but we’re still not satisfied. We’ve got to measure it better and then we got to deliver better. And then the thing about the other side of it is it doesn’t say anything about how long the lead times are. Right?

So if an order comes in and we say, well, I want it in a month, we say you’ll have in three months and then we deliver it on time, three months from now, that’s great, it’s not a back order, but it’s too crappy service three or four out months or whatever. So those are the things we’re working on and you’ll see in the strategic plan presentation, there is a bullet point, that I think was the first bullet point under the FLAG strategic plan which is improve the key operating processes of the business that’s QCDS [ph] right, and improving delivery and we’re spending a lot of time and effort around that. And we’re making strides but we’ve got ways to go.

Larry De Maria - William Blair

Okay. Can one more and I’ll get back in the queue. You said a couple of times I think that, you feel relatively good through the month of January, you feel okay I guess anyway. Maybe just give us a real time update, South America and Asia for [indiscernible] uncertainly there, is there any change in patterns or anything there that worries you, number one. And then secondly, obviously you’re tend to get pretty good color to your cost distribution in Europe. Maybe just update us on what you might be seeing there in real time and then I’ll get back.

Josh Collins

General around South America, I will tell you on Cox business in Europe. As we said before, started beginning of the year last year last year, we have started seen year-over-year growth and that sustained and broadened throughout the course of the year and we are really this watching closely at the beginning of this year because we are starting to have some decent months and the strength has continued. So, we are seeing, we continue to see year-over-year growth there and it does feel that that is moving through to our direct-to-dealer business at some level and once again we feel decent about where we are today. We are actually kind of lean over the skews, we don't have the data to lean forward with these skews but it definitely feels better than they have.

Operator

Our next question is from Arthur Roulac of Three Court.

Arthur Roulac - Three Court

I wanted to follow up on something just regard to the investment, sort of that’s going to be run through the income statement this year that we didn’t see last year. Can you quantify that to a certain extent? First is that like a $5 million or $10 million extra or what is that?

Cal Jenness

Yeah, in the investments into the business?

Arthur Roulac - Three Court

Yeah exactly. They weren’t there in 2013 but will be there in 2014. You are talking about the reinvestment that isn’t being run through CapEx?

Josh Collins

I am sorry. I’ve been tracking down where is the other part of this question and without going into specifics of it, Latin America, rest of the world feels like it’s starting actually pretty much everything outside of North America in general feels pretty strong. North America as I said weather has hampered, not so much demand as delivery but still I would say it’s too early, we’re far out of the skew but in general that's the real-time update. I am sorry I missed your question.

Arthur Roulac - Three Court

No worries. Just regarding the extra investment you called out in the business, that’s going to be run through the income statement this year. Can you give us sort of quantify what that is, sort of what’s going to be there this year that wasn’t there in 2013?

Josh Collins

Yes, so just kind of generally here, we are going to see improvement in gross margin that’s really meaningful and we expect to see that, roughly feels pretty good there and the investment will come through the SG&A line there obviously on CapEx should end up in our cost of goods sold but costs are still around SG&A and its -- roughly half is related to normal wage increase which is always a decent sized number, accrual of bonuses, which was lower last year, obviously in open positions, so that’s close to half of it. And the other half is related to strategic initiatives around supply chain, IT, quality, sales and marketing, product development and FLAG, FRAG and CCNL.

Arthur Roulac - Three Court

Got it. And is that half then like is in the sort of $5 million to $8 million range, something like that?

Josh Collins

$6 million to $7 million, somewhere in there, yes.

Arthur Roulac - Three Court

Okay. And would we expect that sort of same level investment to show up in 2015 or is that something that invest it once in these things and then you will be going back to more sort of normalized levels through the SG&A line barring the normal sort of let’s say 1% to 2% wage increases that you have?

Josh Collins

What we are hoping is that drives top line, okay, and you then get the leverage, that’s the theory right. And some of this was on, on share [indiscernible]. So it should drive cost savings as well. And if we’re successful there then you are going to see it both on the revenue side and on the cost side. And if it is successful there, then we will probably have a whole bunch of more new product development initiatives at a minimum.

Arthur Roulac - Three Court

Got it. And just a little -- as we model out for ‘14 what should we think about in terms of cash taxes and cash interest?

Josh Collins

$17 million of cash interest and $37 million, probably little bit less than this number, probably $26 million or so cash taxes. Yes, cash taxes $25 million, $27 million, it is kind of around that number there.

Arthur Roulac - Three Court

Got it. In the I guess, the free cash flow guidance $35 million for the year, then there is some cash charges associated with restructuring and it seems like we take like 133, CapEx of 45.

Josh Collins

The working capital increase was about $12 million, $13 million, and higher CapEx.

Arthur Roulac - Three Court

Working capital is different? Okay Well thank you very much.

Josh Collins

If we are not just we think we’ll be at, then it’s $30 million of capital increase and it could be managed a little bit better, maybe also -- probably there is a lot of sales increase. If we don’t get that sales increase we’re not going to have capital increase. We’re pretty good at managing that balance sheet and we’re successful last year obviously $67 million of cash flow was really strong.

Operator

(Operator Instructions) Our next question is a follow up from Steve Barger of KeyBanc Capital Markets.

Steve Barger - KeyBanc Capital Markets

Cal first one for you. Are the on-cash impairment charges that you could take, is that from booking some line items incorrectly or something or is it because the profitability of the deals was lower than expected?

Cal Jenness

No. Our financial statements have been correct to our reporting periods 2012, 2013. This is just the annual impairment test that we do for our intangible assets and it’s a complex as I said earlier modeling process with this kind of cash flows over time. So when you start looking at kind of our short term outlook for some of these businesses, we have the incremental investment came out of our strategic review, kind of makes the numbers not a lot pretty, all that great robust for first couple of years. So that has an impact on the cash flow. So it’s really just annual impairment test based on our most current short term projections and then estimated what we do beyond that.

Steve Barger - KeyBanc Capital Markets

And then Josh, obviously as you pointed unusually cold winter for a lot of people. Historically has that driven launch product sales in the following year or even in the current year?

Josh Collins

Yes, it should. We’re going to be watching. We had a great year last year to large quarter sales and feel really good about that obviously coming off with all that issues we had around that. The component gas prices were up.

Steve Barger - KeyBanc Capital Markets

Got it. And then I think you had mentioned that you expect CCF is going to be bigger and with the Pentruder deal you have expanded the product lines. [indiscernible] significant acquisition where you need it or – and I guess where do you see the opportunities from an end market standpoint, now that you got that broader product line.

Josh Collins

It’s a good point. I’m going to turn this around here. Have you had a chance to see the Pentruder product line?

Steve Barger - KeyBanc Capital Markets

No I have not.

Josh Collins

Okay. I’m sure….

Steve Barger - KeyBanc Capital Markets

It’s not there in store.

Josh Collins

When you see it, what you will see is that this is a really premium set of products and well the Pentruder group out of Arizona has done a really good job here in the States. That’s a relatively small group and just a couple of folks who are servicing and all of North America. And the fit is actually exceptional in that we’ve got a group of technical salesmen who go direct to heavy users in North America and this fits right in. So we’re completing training now and we’ll rule that out. We think there is a lot of opportunity there. Also South America and because we’re selling whole goods, it gives more of a reason -- you go into the whole goods and there is a good after market, and the aftermarket is very large in that, that market as you know.

As we do sell some blades today but we don’t sell whole goods there on those product lines. So we think that’s excellent. Additionally we’ll be coming out in partnership with Tractive in Sweden. We’ll be coming out with some additional products that fit right in to that portfolio. So we’ll be able to market on a global basis.

So that should help accelerate the growth. We think with that combination ought to be able to get us very close to what we’re talking about. Between that and the success we’ve seen in power grid, we do expect a market rebound in those yield construction market, commercial construction markets that ought to be able to get us close to are some very bold targets.

Steve Barger - KeyBanc Capital Markets

And when you are talking about whole goods, is that -- can you give me kind of a range of the price of the products that you are going to be selling, just because I haven’t seen the product line yet.

Josh Collins

We’re talking about wall saws, core saws, core drills, electric chain saws and we’re talking about anywhere from $5,000 to $50,000.

Steve Barger - KeyBanc Capital Markets

Are you going to have the product line at Conexpo?

Josh Collins

I’ll get back to you on that. I want to reiterate that we’re not talking about high volume. This is a very premium product line and with it -- during that falling [ph] installed base and so it’s an aftermarket that is very important to those end users.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Josh Collins for any closing remarks.

Josh Collins

Okay, thank you all very much. We appreciate you taking the time and we will give you an update as we get and close to and have some clarity around the ’13 audit and 10-K filing. We will talk to you all later. Thanks.

Operator

Thank you very much. The conference is now concluded. Thank you attending. You may now disconnect your line.

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