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Kaydon (NYSE:KDN)

Q4 2012 Earnings Call

February 21, 2013 11:00 am ET

Executives

Rick Mosteller - Assistant Corporate Controller

James O'Leary - Executive Chairman, Chief Executive Officer and President

Timothy J. Heasley - Chief Financial Officer and Senior Vice President

Analysts

Eli S. Lustgarten - Longbow Research LLC

Edward Marshall - Sidoti & Company, LLC

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Rick Mosteller

Welcome to the Kaydon Corporation Fourth Quarter and Full Year 2012 Earnings Conference Call. Before the conference begins, the company would like to make the legal disclaimer that certain information in this formal discussion, and that may be included in the question-and-answer session, is forward-looking within the meaning of the federal securities laws. These forward-looking statements are only predictions based on the company's current expectations about future events.

While the company believes any forward-looking statements made are reasonable, actual results could differ materially since the statements are based on the company's current expectations and are subject to risks and uncertainties beyond the control of the company. Listeners are cautioned to refer to the company's 2011 Form 10-K and the upcoming 2012 Form 10-K for a list of risk factors that could cause its results to differ from those anticipated in any forward-looking statement.

The company does not undertake and expressly disclaims any obligation to update or alter its forward-looking statements whether as a result of new information, future events or otherwise, except as required by applicable law.

During this conference call, Kaydon spokespersons will refer to certain non-GAAP measures, including adjusted net income, adjusted earnings per share, adjusted EBITDA and free cash flow. To assist you in understanding these non-GAAP measures, as well as to comply with SEC requirements, the company has included in its press release a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures.

Participating in today's call are Mr. Jim O'Leary, Chairman and Chief Executive Officer of Kaydon Corporation; Tim Heasley, our Chief Financial Officer; Laura Kowalchik, our Chief Accounting Officer; and Therese Houlahan, our Treasurer. Today's conference is being recorded. Now I'd like to turn the call over to Jim O'Leary, Chairman and Chief Executive Officer.

Jim, please go ahead.

James O'Leary

Great. Thanks, Rick, and thanks all for joining us today. And I'm going to do one of the things you're never supposed to do before a presentation, which is start off with an apology, or actually apologies. If my voice is a bit more sedate than usual, it is the cold and flu season everywhere, but particularly in Michigan, so to try to conserve some energy for the Q&A, I'll apologize in advance if -- it's not a lack of enthusiasm. It's a lack of horsepower.

And the second thing is the prepared remarks are a little bit longer than usual this time. It was a eventful year to say the least. And what we'd like to do is anticipate as many of the questions. There were a lot of unusual nuances to last year and into the upcoming year. Not many of you guys on the sell side have quarterly numbers out there yet because of the wind comparisons and the way the year builds up. There are some nuances to the year, which we're going to try to lay out for you, still leave plenty of time for Q&A, but we appreciate the fact that this is a tough year to analyze and an interesting year ahead of us.

Before we get into the prepared remarks, a couple of anecdotal musings. This year, particularly this quarter, was about repositioning, about repositioning the company for post-wind in a more -- less up, more, I'd say, diversified and steady military environment than we've seen in a while, hopefully, and we'll talk about sequestration later in on the questions. We've spent the last year and the last quarter positioning ourselves for that post-wind and more muted military environment than I think we've seen in a while.

The year was also about controlling the controllables. And a lot of you guys, I believe, do give us high marks and I'd like to give the guys in our divisions high marks for controlling the controllables, managing the things that are under our control, not just this quarter, but this year. And if you look over the past few years, we took advantage of a phenomenal opportunity with wind, but we didn't bet all our chips on it. We probably got all of our cash and then some out of it the last few years. But when we recognize that the wind environment post the 2009 financial crisis was not going to be what we'd originally anticipated, we took the actions necessary. We rightsized the operations and we're positioning ourselves, again controlling the controllables, for future years for hopefully much better times maybe as early as the end of this year, but getting ourselves in shape, working on the things we can control. And to quote an old English song, and you'll have to Google Ian Dury if you don't know the name, there were plenty of reasons to be cheerful in this quarter. I wouldn't say ecstatic yet because the environment, and particularly the macroeconomic environment is so uncertain, but our order book is coming along probably a little bit better than we had hoped for. Right through last week, we're up over 20% x wind and now wind dollars will be much lesser a part of the comparisons. But the order book is building a little bit better than we anticipated.

If you look at last quarter and last year, we had a phenomenal track record in terms of free cash flow. But I think an important thing and something, I think, demonstrates our commitment to shareholder value from our board down, we're not just generating free cash flow and building it anymore. We generated free cash flow and we returned it to you. When we look at our quarterly numbers on how much cash flow is returned in the form of dividends to you in what's essentially a yield-starved environment, this year was staggering. When you look back over the last 5 years, the amount of cash returned to you in the form of dividends, both the special dividend and increased dividends year-after-year, coupled with the share repurchases, it's been well over $0.5 billion. And when you look at our market capitalization and the general peer group, I'd say on a pound-for-pound basis, in terms of actually returning cash flow to you, we've done a really, really good job. Not just at controlling the controllables, but putting our money where the mouth is.

Now, we'll get into the prepared remarks as quickly as possible and then turn it over to you guys for Q&A.

Fiscal 2012 was an important transition year for Kaydon during which we proactively and actively managed our business in response to evolving business conditions in many of our key end markets, generating significant free cash flow and returning that cash flow to our shareholders as we returned $368 million to you in 2012, adding to the nearly $460 million in the past 5 years, and in share repurchases well over $0.5 billion.

After a period of exceptional growth in our military and wind energy businesses that spanned much of the decade preceding the global recession and financial crisis of 2009, recent years saw declines in both of these markets as the aftershocks and the resultant steep recession that created new market realities, notably, fiscal austerity in most of the developed nations and generally fragile and uncertain economic conditions worldwide, not just here -- well, we'll talk about sequestration later, but still in Europe.

In September, we initiated a comprehensive restructuring of our bearing business to align capacity with the current market needs while maintaining our leadership positions in these markets. By rightsizing to reflect the current market realities, we adjusted manufacturing capacity, lowered fixed operating costs, and increased operating leverage to position ourselves for margin expansion when business conditions return to more consistently robust levels.

With much of the revenue decline related to wind energy already replaced by acquisitions made over the past 2 years in our Velocity Controls segment -- remember, controlling the controllables, we look forward to accelerating profitable growth across the product portfolio, but particularly within Friction Controls now that the restructuring process is close to complete. Within our Friction Controls segment, we remain focused on developing profitable expansion opportunities, particularly in underserved international markets and in our traditional distribution channels and what historically have been our critical industrial end markets. With operating leverage largely restored within the core Kaydon businesses, investments made in operational initiatives and sales and marketing efforts throughout the company over the past 5 years will make a more pronounced and noticeable impact when the eventual improvement of the economy occurs.

As well-publicized in recent months, the fourth quarter saw relatively high levels of uncertainty in the United States with the election and fiscal cliff concerns prevalent, and in Europe where recent relative economic stability is yet to translate into a real improved industrial activity.

While there continues to be notable uncertainty in many of our markets, incoming orders during the fourth quarter of 2012 and through mid-February 2013 were healthy as many of our traditional markets served experienced gains relative to prior year. Through February, orders are running over 20% ahead of prior year's levels. Although the first half, and particularly first quarter of 2013, will be impacted by challenging comparisons of wind performance against 2012 and some further inventory reduction across our industrial customer base, we expect favorable results in comparison to prior periods in the second half of the year, assuming the economy continues to improve and as tougher wind comparisons dissipate, and more importantly, the actions we took in 2012 to restore operating leverage take effect.

While we wait for more balanced and sustained improvement in business conditions, a reprioritized focus on our powerful industrial brands and the critical industries they serve, coupled with the enhanced operating leverage post-restructuring, should serve as well.

With manufacturing capacity and working capital levels now better reflective of the current environment, we're well positioned for gradual economic improvements as the year progresses.

Now sales in the fourth quarter of 2012 were $110.5 million, compared to $108.1 million in the fourth quarter of last year. During the fourth quarter, we incurred $600,000 of nonrecurring costs and $1.3 million of noncash amortization of previously incurred actuarial losses. During the third quarter, the company offered former non-retiree employees with vested pension benefits the option of receiving a lump sum payment or an immediate annuity in settlement of all future pension obligations. This derisking of our pension obligations reduced future pension liabilities by $9.2 million, resulting in a fourth quarter noncash settlement charge of $2.9 million, resulting from the acceleration of associated unrecognized actuarial losses previously being amortized.

I noticed a couple of the comments that were put out this morning said it was a little bit bigger than was expected. I would say the bigger that number was, the better for future periods. Remember, we're removing liabilities for dollar-per-dollar basis from the balance sheet with cash that's in the pension plan and appropriately earmarked for that. We're reducing future amortization of losses that will come in over the quarter as the pension accounting dictates. So honestly, the bigger that number was, the better. That means more people took us up on the opportunity. And again, we're derisking future liabilities that introduce volatility into the P&L.

This discrete nonrecurring item is included in the fourth quarter SG&A. So there's a little bit of a bump in 2012 SG&A that you probably weren't anticipating, that's all that $2.9 million of actuarial losses. There was no impact on our cash position as the distributions totaling about $7.3 million were funded out of the assets of the pension plan.

On a GAAP basis, net income for the fourth quarter of 2012 was $8 million, compared to $8.7 million last year. GAAP EPS totaled $0.25, compared to $0.27 in the prior year. Adjusting for these items, adjusted operating income was $16.6 million in the fourth quarter of 2012 compared to $18.2 million last year. Adjusted EPS was $0.36 on a diluted basis, compared to $0.41 on a diluted basis as adjusted last year.

Finally, adjusted EBITDA was $22.4 million in the fourth quarter of 2012 compared to $25.5 million in the fourth quarter of 2011.

Adjusted gross margin increased to 36.8% in the fourth quarter of 2012 compared to 34.9% in the third quarter as reduced shipments of wind energy bearings began to benefit product mix. Adjusted gross margin decreased slightly to 36.8% from 37.1% in the fourth quarter of 2011 as successful efforts to reduce inventories, ring cash out of working capital resulted in lower manufacturing activity, which negatively impacted gross margins best. As general economic activity improves later in the year, which should result in increased manufacturing activity and the actions we took last year to reduce capacity, gross margins should be expected to improve.

Free cash flow for the quarter, a real positive, was $33.4 million compared to $16.6 million in the fourth quarter of last year. A $26 million net reduction in receivables, inventories and payables, it was the strongest free cash flow we've had in over 3 years.

Orders were $102.6 million in the fourth quarter, compared to $84.6 million last year, reflecting strength in the industrial markets and the contribution of Fabreeka's operations. As noted before, new orders through mid-February are in excess of 20% above prior year's levels.

Turning to the segments. Friction Control sales in the fourth quarter of 2012 were $53.9 million, compared to $58.5 million in 2011. Wind revenues were $1.9 million, compared to $9.6 million last year, so we'll still have a couple of quarters of comparisons that we'll have to call out. But excluding wind, Friction Control Products were 6.5% higher than last year. Fourth quarter Friction Control Products operating income was $7.1 million compared to $4.9 million in the fourth quarter of last year with the increase largely attributable to the absence of a $5.2 million arbitration cost offset somewhat by lower wind energy sales and lost absorption again as we brought down production to ring more cash flow out of the operations.

Velocity Control Products sales in the fourth quarter were $27.9 million, compared to $20.4 million the fourth quarter of last year with operating income equaling $4.5 million, compared to $3.4 million in the fourth quarter of last year.

Other Industrial Products sales in the fourth quarter equaled $28.7 million, compared to $29.2 million last year with operating income increasing to $4.1 million from $3.8 million.

Now, I'll turn it over to Tim to cover some additional financial items.

Timothy J. Heasley

Thanks, Jim, and good morning, everyone. Capital expenditures in the fourth quarter were $4.4 million compared to $3.1 million in the prior year fourth quarter. For the full year of 2012, capital expenditures totaled $17.4 million, compared to $14.9 million in the prior year.

For 2013, we expect capital expenditures to be in the $15 million to $20 million range.

As Jim mentioned, we had another strong cash flow quarter. Free cash flow was $33.4 million or 30% of revenues, compared to $16.6 million or 15% of revenues in the prior year fourth quarter. For the total year, free cash flow of $71.6 million, or 15% of revenues, was up 78% from $40.2 million or 9% of revenues in 2011.

During the quarter, we paid cash dividends totaling $12.6 million, which included the payment of dividends declared in both the third and fourth quarters. For the full year, dividends paid, including the special dividends totaled $367.9 million.

Cash and cash equivalents totaled $53.6 million at the end of the fourth quarter of 2012, compared to $225.2 million at the end of the fourth quarter of 2011. As we've discussed previously, $186 million of the first quarter special dividend was funded from existing cash balances.

Also as discussed previously, during the second quarter of 2012, we completed the acquisition of Fabreeka for $53 million, which was financed with borrowings under our existing $250 million credit facility.

During the fourth quarter, we paid down approximately $20 million of debt. As of year-end, we had $32 million of borrowings outstanding under our revolving credit facility and $144.4 million outstanding under our term loan facility.

Net debt was $122.8 million. Our current cash position, along with $215 million of unused credit, under the revolving credit facility, provides us with adequate financial flexibility to take advantage of additional internal and external growth opportunities for the foreseeable future.

We had a strong quarter of working capital reductions. Net inventories decreased $10.2 million during the quarter with year-end inventory turns improving to 2.9 versus 2.6 turns in the prior year.

Net receivables decreased $22 million during the quarter and DSO decreased 10 days from the third quarter to 59 days.

The effective tax rate for the fourth quarter was 26.2%, compared to 27.5% for the fourth quarter of 2011. Excluding the impact of charges related to the restructuring of the company's wind energy bearings business, effective tax rate for the year was approximately 28%. The balance of the quarter-over-quarter difference, as well as the full year difference, is in both instances largely due to a decrease in taxes on foreign earnings.

For the full year 2013, we expect our effective tax rate to be approximately 29%.

As discussed on our last call, during 2013 we expect to complete our wind energy restructuring with the consolidation of 1 of 3 facilities in Sumter, South Carolina into other Kaydon operations. Nonrecurring costs associated with finalizing this project will be approximately $800,000 in Q1, $1.7 million in Q2, $700,000 in Q3 and roughly $300,000 in Q4.

Now I'd like to turn the call back over to Jim.

James O'Leary

Great. Thanks, Tim. Although we've been necessarily been patient while wind unfolded, while the actions and restructuring that we were waiting to do needed to be done after customer obligations and the like were satisfied and while we wait for the economic improvements expected later in 2013, please don't confuse patience with complacence. In 2012, in addition to initiating the restructuring actions we've already discussed, completing one acquisition in Velocity Controls and integrating another, we provided ample evidence of our ability to generate strong levels of free cash flow, particularly this quarter, while providing meaningful returns to our shareholders in a yield-starved environment as demonstrated by our special dividend earlier this year and our ongoing commitment to our regular dividend. Our ability to generate consistently strong levels of free cash flow and our willingness to provide meaningful cash returns to our shareholders in a still volatile investing environment remains a hallmark of Kaydon as we've managed both cyclical and secular challenges over the last few years. The solid cash flow ability -- excuse me, the solid cash flow performance and ability to provide cash returns to our shareholders regardless of the economic environment while we wait for a more consistently strong economy is a hallmark of Kaydon.

As a testament to our confidence, our Board of Directors declared a quarterly dividend of $0.20 per share in the first quarter, which will be payable on March 28. Now, normally this wouldn't be the type of thing I call out on a quarterly call, but I think it merits mention. Last year, we accelerated a dividend into 2012 because we're recognizing that for many of our investors, the tax consequences did matter. At our board meeting the other day, one of our directors highlighted the fact that this would leave you with 5 payments last year, 3 this year, and to many of our investors that would be a total return decrement if you were focused on yield or the consistent return you look to for Kaydon. And we made the decision to accelerate the payment of the declaration of the dividend into the March quarter and then we'll do the same in June, September and December, effectively normalizing the dividend payments again. While you could argue that's timing, and many of you will, I think it was a thoughtful approach to making sure we were delivering to you the same amount at least next year that we committed to as part of our normal policy. And in my view, it ends up giving you an extra payment last year, if you've been a holder, in addition to the special dividend. And that's the type of shareholder-friendly consistent cash flow and consistently thinking about ways to return to you in the optimal way. Again, it's a hallmark of Kaydon.

That concludes the formal presentation. I'd like to thank our associates out there for their hard work this year.

And Brian, we'd be glad to turn it over to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Eli Lustgarten with Longbow Securities.

Eli S. Lustgarten - Longbow Research LLC

Can we -- so just on the fourth quarter, the operating margin in Friction, as reported, I understand it was 13-something. Can you give us -- there's got to be some inefficiencies from the inventory reduction. I don't know whether any of the charges for the restructuring of wind is in the operating number, though? Can you give us a breakdown of what a more normalized margin might have been for that sector?

James O'Leary

Yes, it should be mid-teens and start building to mid- to high teens as the year progresses. It was -- we've adjusted out -- you can see the adjustments that impacted Friction Controls in the segment data. So we've adjusted out some of the unusual items, but it was unquestionably impacted by our decision to focus on cash flow, make sure we got inventories in line. But also a lot of our customers are doing the same thing. If you listen to a number of peer press releases and a lot of the same guys who are our customers, we were anticipatory in bringing our own inventories down. But as the year progressed, a lot of our customers were doing the same. So where we would have been and expect to be producing for them that impacted margins, but did benefit cash flow. You'll start to see that build again mid-teens and then towards high teens as the year progresses if, and again, the big if, is if the economy continues to recover the way, I think, most economic pundits expect, barring some catastrophic result from sequestration or another black swan that wanders across the street.

Eli S. Lustgarten - Longbow Research LLC

No, I get it. So again, beside the inventory stuff, some of the wind restructuring within that number, so the number was adjusted. Instead of being 13%, it would have been even closer to about 15%, 16%. I mean, I'm just trying to ...

James O'Leary

That sounds about right, but we'll confirm that for you, as well.

Eli S. Lustgarten - Longbow Research LLC

Okay. And you sort of gave us the improvements in margins you expect for the rest of as you go through '13 in Friction, might as well do it for Velocity, too.

James O'Leary

Velocity will be pretty consistent. I mean, remember that's largely unaffected by restructuring activities. It was impacted a little bit by inventory, but I don't think it's meaningful enough to really call out. It's low 20s and if it stayed like that forever, I think I'd be a pretty happy guy, as long as we can grow the top line.

Eli S. Lustgarten - Longbow Research LLC

And I think you indicated, you'll be taking some more inventory out in the first half of this year, also with a more reduced production in the first part of the year, I think, in your comments?

James O'Leary

Well we should see a little bit -- we should continue to see some benefits as we work down day- sales in inventory. We should still see some benefit on working capital assets. It won't be as pronounced as the fourth quarter. Production will be relatively flat until releases start coming later in the year. And I'm glad you asked the question. Wind -- remember, last year wind was about $18 million in the first quarter. This year, it's going to be less than $5 million. In fact -- I want to get out of doing this, but I think we owe it to you for one -- at least 1 last year. We hope we'll be somewhere in the high teens, low 20s next year, a lot depends on how quickly our customers and their customers -- our customers' customers kind of return post the PTC party that we had at the end of last year. So wind with $18 million in the first quarter of last year. It'll be less than $5 million this year. It was $20 million in the second quarter of last year. It might be $5 million or a little bit better this year. And it was $16 million in the third quarter. And again, there's where we hope it'll be, a little bit north of $5 million in the third and fourth quarter. So when you look at the first quarter of this year, it's going to look an awful lot like the fourth quarter of last year. Sequentially, it'll be pretty much like the fourth quarter and then that will build -- and this is not a cyclical issue because Kaydon historically hasn't been particularly cyclical, particularly pre-wind. But based on, again, what most people feel about the economy, what most of our customers are saying in both their press releases and in their conference calls, we expect the back half to be better. Not a cyclical issue. Really, as the improvement of the economy takes hold, as they start producing and accepting deliveries themselves, we'll see what's essentially a replay of the fourth quarter in terms of revenue and adjusted margins. Hopefully, we'll have less adjustments in the first quarter. The second gets a little better. The third and fourth both sequentially get better.

Eli S. Lustgarten - Longbow Research LLC

So you're seeing some pickup in wind business from the passing of the PTC in the new environment, if it's the case?

James O'Leary

Based on what our customers are saying now. I mean, again there is a PTC. The actual mechanics of it change a little bit. There'll still be replacement bearings. There are still projects out there. We're hopeful, again, the target, and not a forecast I'd sign in blood on, but we're hoping it's around $20 million next year and it's based on existing healthy customers who still have business. It's just far less than they'd like it to be.

Eli S. Lustgarten - Longbow Research LLC

And can you get -- one final question.

James O'Leary

We've got -- you got to hop to the back of the line at some point, but we'll give you one more.

Eli S. Lustgarten - Longbow Research LLC

I was going to give you the sequester -- you brought up sequestration and what's going on and what are you seeing on the defense side and how does it affect you as you go through the quarters?

James O'Leary

This is the worst answer I can give you. Unfortunately, it's the answer we've gotten from the economic -- and there are specific guys in the military area that we use on a consultancy basis. It's the same thing most of our customers and our customers are saying, no one really knows. Two or 3 quarters ago, I would have said I think it's improbable, not impossible, that sequestration will happen. A quarter ago, I said possible but still unlikely. Based on the stuff you read in the papers every day, there's a lot of positioning going on. There's a lot of maneuvering going on. I think it's as likely as not now and the impact is unquantifiable today. What I hope doesn't happen is that people err on the side of conservatism, meaning people who cut POs and make business decisions and they slam the brakes a little bit harder. I wouldn't say that's impossible. I'm still very hopeful that it's more political gamesmanship and that people pull back at the last minute as they did with the fiscal cliff. They do think sequestration would be not a good thing. Forget about the Kaydon and the military angle. I don't think it's a good thing for our perception in the world. However, it's almost impossible to handicap and impossible to quantify. So the short answer to your question is right now we're banking on a military year. It's pretty flat compared to last year. The benefits of, the diversity of our program across not just ground vehicles, across helicopters, across a host of other military programs, we think it should be a mid-50s year. That does not assume that there's any catastrophic impact from sequestration because we can't guess and couldn't handicap it.

Operator

And we'll now take our next question from Edward Marshall with Sidoti & Company.

Edward Marshall - Sidoti & Company, LLC

SG&A, I think you answered the question. You said there was $2.9 million of -- is that the pension curtailment, I guess, in the quarter? Not repeatable. There was nothing else that brings your run rate down to about $21.1 million, $21.2 million, something around that line, is that about right going forward? Of course, with variations.

James O'Leary

Run rate of $21.2 million is what, Ed?

Edward Marshall - Sidoti & Company, LLC

21 -- between $21 million and $22 million, that's about your run rate going forward assuming the variability in sales is not accounted for?

James O'Leary

Yes, yes, yes. And just one thing, the $2.9 million, I think, is there a little bit of that in the first quarter as well?

Timothy J. Heasley

No, the $2.9 million was all in fourth quarter.

James O'Leary

So the $2.9 million was from a discrete action. Someday -- we have a closed pension plan, the Interest rate environment has absolutely wreaked havoc on anybody who has defined benefit plan. Someday when interest rates go up, we would like to broaden this program, and again, further derisk it and kind of take that volatility out. But doing anything more than we do now -- again, remember, we satisfied pretty much dollar-per-dollar cash in the plan for liabilities in the plan. Someday, when interest rates are a little bit more favorable to be more aggressive with that, we'd probably broaden the plan. I don't expect that to happen this year. And unfortunately, if you're a saver or if you're cash-rich company, you're looking at interest rates that are going to be virtually nil for a while, which doesn't help real proactive planning on the pension front.

Edward Marshall - Sidoti & Company, LLC

That's about $0.06 of earnings, just out of curiosity. I know you didn't adjust that out, but that's about right, right? $0.06?

James O'Leary

Yes.

Edward Marshall - Sidoti & Company, LLC

Okay. You talked about an order book. Is there anything geographic or end-market specifically that you could point to, or is it really broad based that you're seeing a modest pickup, even an accelerating pickup into the February time frame, so far...

James O'Leary

I wouldn't say an accelerating pickup. North America stayed strong. There was a little bit of timing that benefited 2012. If I'm right, we've been replaced with North America. Europe, we had a little bit of an acceleration in orders based on some price increases. But into 2013, North America, a little bit stronger. Europe, a little bit weaker. Pretty broad based across everything except wind, obviously, and nothing, other than North America a little bit stronger than Europe both quantitatively and anecdotally, nothing really noteworthy to call out.

Edward Marshall - Sidoti & Company, LLC

And when you pointed to the order book, is the 20%, is that year-over-year or is that -- and therefore --

James O'Leary

It's year-over-year. I think coincidentally it ends up being pretty close to that sequentially, too. But...

Edward Marshall - Sidoti & Company, LLC

Okay. So the acquisition plays no role in that number?

James O'Leary

Year-over-year, the acquisition plays a little bit of a role. It would be -- it would still be very high teens x Fabreeka.

Edward Marshall - Sidoti & Company, LLC

Okay. And then you didn't give -- and I don't if you will any longer, but sales on the wind and the order book on the wind? Could you ...

James O'Leary

The order book isn't much, so we won't give that. Sales for the year, I think, were $55 million or $56 million?

Timothy J. Heasley

$55 million.

James O'Leary

Yes, $55 million. And as I've mentioned to Eli, we do want to get out of the habit of doing this, but I appreciate you guys have a tough job getting the quarters right for the first part of this year. We expect it'll be about $20 million next year. You could say a little less than $5 million the first 2 quarters, a little better than $5 million the last 2. And that compares to $18 million, $20 million, $16 million and $3 million in 2012. So you see, the comparisons they don't roll off meaningfully until the fourth quarter. But right now, we expect, we subscribe and we're hopeful that our year x wind continues to build and kind of backfill that loss in revenue as the year progresses.

Edward Marshall - Sidoti & Company, LLC

Last one before you yell at me, too. You pointed out that you're generating good cash flow. I'm curious about the balance and how you're looking at the returns. I know you talked a lot about returning cash to shareholders. I assume a lot of that was to do with the adjustments in taxes as well among other things including repositioning the balance sheet. But returns to shareholders, debt reduction and growth, I mean, how do you look at those 3 options and how do you allocate your cash accordingly? And you've given us a lot of information already, but if you could elaborate a little bit.

James O'Leary

It's still exactly the opposite of the way you ticked them off. Growth, and particularly growth through acquisition, has to be an important part of strategy. And you have to be, unfortunately, acquisitions are, by definition, opportunistic particularly for a company that's as diversified industrial as we are. We continue to look at a lot of things. I tell you, the environment is pretty quiet now because seller expectations and buyer expectations are a bit misaligned, but there are some very interesting things we're looking at. Acquisitions continue to be the priority. CapEx for our businesses continues to be a priority, but now x wind, that'll drop down to a more normal number not substantially but certainly less than $20 million and probably somewhere between $15 million and $20 million. So organic CapEx is important, but not a huge user of cash flow. We delevered pretty quickly already. We expect to continue to do that. We expect to be able to provide meaningful returns along the way. If the acquisitions don't come in a couple of years, if we remain in this 1% to 2%, I don't want to say economic hell, but it has been a kind of a dull grind the last year after the pop out of the 2009 recession. If that continues but we continue to throw up cash flow, I wouldn't rule out additional special dividends in the future if acquisitions aren't there.

Operator

And we'll now take our next question from Peter Lisnic with Robert W. Baird.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

I guess, the first question on the order book, the over plus 20% here into mid-February, can you give us a feel for kind of where the strength is and if you could parse out what impact from Fabreeka on that number might be, that would be helpful.

James O'Leary

I'll repeat what I just said. Pretty broad based, more North America than Europe in some respects. It's been consistently the same rate of increase over fourth quarter over fourth quarter as it continued through February first quarter over first quarter. X Fabreeka, orders would still be in the high teens. So it's a couple of million, the year-over-year comparisons, but it's still high teens. And sequentially, it's still low 20s because Fabreeka was in the fourth quarter and the first quarter.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Okay, all right. That's helpful. Sorry if I missed that. On the competitive side of things with currency doing what it's doing on a global basis, I'm just wondering if there's any sort of impact on your business from a competitive standpoint as you kind of see the Yen deflate and what that might mean for some of the export business out of Germany as an example?

James O'Leary

We don't call this out because, I mean, it's not a huge thing for us. I think currency cost is about $800,000 year-over-year. There was a negative impact of about $800,000 to EBIT year-over-year on currency. About half of our -- well, closer to half than a few years ago of our business has euro exposure. There was some British pound exposure. And not necessarily the translations, but the competitive aspects of it and that's really been problematic. Within the order book, yes, we had to call out strengths. The 2 areas of weakness, which I didn't call out, but I think they have more to do with the economies in China and the industrial machinery market in both Germany and Germany to China. Those were 2 notable weak points. Not continuing to weaken as we saw about a 1.5 years ago when Europe first got a little wobbly. And China, I think, has been stable but not at the levels it was back in '10 and early '11. But our shipments to those areas, particularly Far Eastern markets and some of the particularly industrialized side of the bearings business and on specialty machinery which, in our case, goes to Germany and then is exported from Germany from our German distributor elsewhere, those were 2 notable parts of weakness. And I think that's largely because of competitive issues in the economies but it could also be impacted by currency because the British pound, obviously, is an outlier and euro -- the euro may have some impact on it, and I suspect it has more to do with the actual end market dynamics that those businesses serve.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Okay, all right. That is perfect on that one. And just last question on the SG&A. I mean, if I adjust the numbers, you were at almost $28 million GAAP if I take out that $2.9 million and some of the other nonrecurring things that you've identified in the press release. You're at $24 million, which is a little bit of a step-up from the 3 quarters...

James O'Leary

I'm glad you asked. I'm glad you asked because this was something specifically we wanted to call out to you guys as well. Fabreeka, when we get to -- I am hopeful by the end of this year we got a couple of normal quarters. Our gross margin particularly within Friction -- excuse me, Velocity Controls is going to be a fair bit better because Fabreeka's gross margins are a fair bit better than the company average. That's more of a selling organization. So once you back out the $2.9 million pension and you look at where our normal run rate has been, the whole difference is attributable to Fabreeka, which is more -- has more of a sales and marketing. It's more sales and marketing cost-heavy in the P&L. It gets higher gross margins, but you do see a higher SG&A carry. And that's attributable almost the difference between what you've seen historically and where we are this year x the $2.9 million.

Operator

[Operator Instructions] And there are no more questions in the queue at this time. I'd like to turn it back to our speakers for any additional remarks.

James O'Leary

Okay. I think I'd like to thank Ed Marshall and Eli Lustgarten for clearing the decks and asking every question that could be asked. And I also apologize if we've droned on a little bit at the beginning, but that was mainly to, hopefully, to answer a lot of the questions. Tim and I will be around the balance of the day. Again, I understand it's a complicated quarter and getting it right going to next year is important to you guys all. So please feel free to call. Thanks for joining us the last hour. And again to employees and shareholders out there, thanks for your loyalty and patience.

Brian, we're done.

Operator

And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.

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