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Edited Transcript of NX earnings conference call or presentation 6-Mar-19 4:00pm GMT

Q1 2019 Quanex Building Products Corp Earnings Call

HOUSTON Mar 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Quanex Building Products Corp earnings conference call or presentation Wednesday, March 6, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brent L. Korb

Quanex Building Products Corporation - Senior VP of Finance & CFO

* Scott M. Zuehlke

Quanex Building Products Corporation - VP of IR & Treasurer

* William C. Griffiths

Quanex Building Products Corporation - Chairman of the Board, President & CEO

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Conference Call Participants

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* Brendan Asher Cutler

KeyBanc Capital Markets Inc., Research Division - Associate

* Daniel Joseph Moore

CJS Securities, Inc. - Director of Research

* Julio Alberto Romero

Sidoti & Company, LLC - Equity Analyst

* Steven Ramsey

Thompson Research Group, LLC - Associate Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the First Quarter 2019 Quanex Building Products Corporation Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

I'd now like to introduce your host for today's conference, Mr. Scott Zuehlke, Vice President, Investor Relations and Treasurer. Please go ahead.

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Scott M. Zuehlke, Quanex Building Products Corporation - VP of IR & Treasurer [2]

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Thanks for joining the call this morning. On the call with me today is Bill Griffiths, our Chairman, President, CEO; Brent Korb, our CFO; and George Wilson, our COO. This conference call will contain forward-looking statements and some discussion of non-GAAP measures. Forward-looking statements and guidance discussed on this call and in our earnings release are based on current expectations. Actual results or events may differ materially from such statements and guidance, and Quanex undertakes no obligation to update or revise any forward-looking statement to reflect new information or events. For more detailed description of our forward-looking statement disclaimer and a reconciliation of non-GAAP measure to the most directly comparable GAAP measures, please see our earnings release issued yesterday and posted to our website.

I'll now turn the call over to Brent to discuss the financial results.

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Brent L. Korb, Quanex Building Products Corporation - Senior VP of Finance & CFO [3]

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Thank you, Scott. I'll start with the review of the income statement and finish with comments on cash flow and the balance sheet. After my prepared remarks, I will hand the call over to Bill, who will provide comments about our performance and expectations going forward. Before I begin, note that we have made a small name change to the 2 window and door-related segments such that the term Engineered Components has been replaced by fenestration to more accurately reflect the primary end market. You will now see us using the names North American Fenestration and European Fenestration with no change to the North American Cabinet component's name.

We generated net sales of $196.8 million during the first quarter of 2019 compared to $191.7 million for the first quarter of 2018. The increase was mainly due to the healthy revenue growth of more than 6% in our North American Fenestration segment that was driven by market growth, combined with new business wins and some favorable pricing late in the quarter. We reported a net loss of $3.6 million or $0.11 per diluted share for the 3 months ended January 31, 2019 compared to net income of $4.9 million or $0.14 per diluted share during the same period of 2018. The EPS driver in the first quarter of last year was a $6.5 million or $0.19 per diluted share net tax benefit related to the Tax Cuts and Jobs Act that was enacted on December 22, 2017.

On an adjusted basis, we had a net loss of $2.3 million or $0.07 per diluted share during the first quarter of 2019 compared to a net loss of $1.5 million or $0.04 per diluted share during the first quarter of 2018. The adjustments being made for EPS are restructuring and related severance expense, transaction and advisory fees, foreign currency transaction impacts, along with the net tax benefit related to the Tax Cuts and Jobs Act.

On an adjusted basis, EBITDA for the quarter was $12.1 million, a $1 million reduction from $13.1 million in the first quarter of last year. The decrease in adjusted earnings was primarily attributable to an increase in SG&A expense driven by elevated medical cost.

Now let's move on to cash flow and the balance sheet. Cash used for operating activities was $20.2 million for the 3 months ended January 31, 2019 compared to cash provided by operating activities of $8.2 million for the 3 months ended January 31, 2018. Cash receipts were unfavorably impacted by a reduction in net income as well as unfavorable working capital changes, including a higher payout of accrued incentives, higher spending on the seasonal inventory build and a reduction in cash collected from accounts receivables compared to 2018.

Regarding the share repurchase program, we had approximately $26 million remaining as of January 31, 2019. This is after repurchasing 144,030 shares of common stock during the quarter for a total of approximately $2 million at an average price of $13.98 per share. Largely as a result of borrowing to fund incentive payouts and share repurchases, our leverage ratio of net debt to adjusted EBITDA increased to 2.4x as of January 31, 2019.

We are confident in our ability to generate strong free cash flow in the second half of the year, and expect to pay down debt while opportunistically buying back stock. We also expect to exit fiscal 2019 with a net leverage ratio of between 1.5 to 2x.

I will now turn the call over to Bill.

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [4]

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Thanks, Brent. When we issued guidance for fiscal 2019 back in early December, there was some skepticism around our ability to achieve revenue growth of 4% to 6% in light of all the negative rhetoric around home building and the building product sectors generally. As we complete the end of our first fiscal quarter, which is typically our most challenging due to seasonality and weather, we are reporting consolidated revenue growth of approximately 4%, excluding the foreign exchange impact. This was driven by above-market growth in our fenestration businesses, both in Europe and North America.

In Europe revenues grew at 10.5%, excluding the foreign exchange impact and in North America, revenues grew 6.2%. In our European Fenestration segment, price increases implemented late last year accounted for about 50% of the revenue growth and helped boost margins by almost 300 basis points as prices finally caught up with inflationary costs.

Similarly in our North American Fenestration segment, price increases accounted for a little over 25% of the revenue increase. But because those increases only went into effect in January, we did not see the full effect in the quarter, the margins actually shrank by 80 basis points. Looking ahead, however, we expect to see the full benefit of price increases in Q2 and would expect slight margin expansion in this segment for the remainder of the year.

Our North American Cabinet Component segment had a challenging quarter with revenues down almost 4% compared to the prior year. This was a result of a number of factors: first and foremost, overall industry cabinet shipments, specifically, in the semi-custom segment were down by about 5% year-over-year when compared to the first quarter of 2018. It's worth mentioning that cabinet shipments were strong in our fiscal fourth quarter last year, which may help explain why many customers shuttered production over the December holidays for extended periods. The number of unplanned down days was then exacerbated by plant closures in January due to extreme weather in the upper Midwest. Those unplanned down days caused production inefficiencies and excessive overtime, which negatively impacted margins. Volumes started to recover in February, however, and we expect this positive trend to continue through the year.

Overall, despite the softness in our North American Cabinet Components segment in Q1, we are confident in reaffirming our prior fiscal 2019 guidance of 4% to 6% consolidated revenue growth, $97 million to $107 million in adjusted EBITDA and $50 million to $55 million in free cash flow.

As a reminder, we generate nearly all of our cash in the second half of our fiscal year. In addition, as Brent said, even though we were a net borrower in Q1, which increased our leverage ratio to 2.4x. We fully expect to close the year with a leverage ratio of between 1.5 and 2x, while still opportunistically buying back stock over the balance of the year.

You heard Brent talk about renaming our fenestration segments. In conjunction with this and in an effort to be more efficient as an organization, we consolidated leadership, sales, finance, IT and accounting in North America from 3 business units into 1. This is a forward-looking approach designed to streamline our organization so that we can better meet the needs of our customers, employees and shareholders. These moves resulted in severance and restructuring costs of approximately $1.25 million in the first quarter. Consolidation took place at the end of January but was incorporated into our 2019 operating plan, and therefore, into our guidance for this year. On an annualized basis, the cost savings are expected to be between $2.5 million and $3 million, approximately $2 million of which should be realized this year and was built into our guidance for fiscal 2019. This consolidation will also facilitate our ongoing commitment to reduce and maintain lower working capital levels as we progress through the year.

And on a separate note, I'd like to take the opportunity publicly to thank LeRoy Nosbaum for his valued contributions to our board as an independent director since 2010. Under our corporate governance guidelines, Mr. Nosbaum will not stand for reelection at our annual meeting of stockholders on March 22. Don Maier, who is currently the CEO of Armstrong Flooring is standing for election in LeRoy's place. As a matter of good governance, we will continue to refresh the composition of our board as appropriate.

And now operator, we're ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Daniel Moore with CJS Securities.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [2]

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You started to -- and gave pretty good color, Bill, but maybe just elaborate a little bit on those -- the customer, the North American Cabinets, some of the customers that took a little bit more extended downtime around the holidays, are those back up to running at full schedule? You alluded to February volumes starting to come back, maybe anymore color there would be great.

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [3]

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Yes, as we sort of closed out the calendar year, a number of customers actually took extra days out of production over the holidays. And then January, with the extreme weather in the upper Midwest caused some plant closures. But mostly a lot of absenteeism, a lot of trucking companies came off the road for a number of days because of the weather conditions. And as a result of that ended up having to work excessive overtime, and obviously, very inefficient for production through month of January, hence the margin shrinkage. Volumes have started to bounce back pretty nicely in the month of February and are up year-over-year, even though it's still early yet.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [4]

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Got it. And then maybe a step back, in North American Fenestration, after a couple of years of some pretty good competitive pressures, it seems like things have stabilized. Do you see -- you're seeing an opportunity to win back some of the business that may be you walked away from previously given your price discipline?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [5]

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Yes, so in the first quarter, we started production with some new business in our vinyl extrusion business. That contract was signed late last year, but as you know, it's a long lead time to get into production. We have a second piece of new business where the contract has been signed. We'll start production in our second quarter, and -- but it won't fully ramp up until the second half of the year. And then also in Q1, we actually started some new screen business as well. So yes, we are winning back some business, which is encouraging. And the reason for the consolidation is, I think, we're at a stage in our life cycle now with the 3 primary fenestration businesses that linking them together on the one set of leadership, one set of back office and one sales force now makes sense. And we'll continue to see efficiencies improve as we go through the year.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [6]

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Helpful. And lastly for me, on the EU side of the house, may be just talk about crosscurrents, Brexit concerns, what you're seeing there? And outlook for growth both in terms of underlying and then on FX adjusted basis for the remainder of the year?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [7]

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Yes, realistically, I don't think that growth rate is sustainable. We clearly did see some customers building inventory. And I'm sure, as you read in the popular press, everybody seems to be doing that whether it's stockpiling food at home or product in the event of some form of border closure. I think at this point, nobody really knows what's going to happen. Our belief is that growth rates will slow down to a more normalized low single-digit number as we go through the year. I think a lot of the great growth was attributable to Brexit stockpiling. We also stockpiled some inventory as well for the same reasons. But still feel very good about the jurisdiction and still feel confident that this will get resolved in a manner that won't be overly disruptive to trade.

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Operator [8]

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Our next question is from Steven Ramsey with Thompson Research Group.

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Steven Ramsey, Thompson Research Group, LLC - Associate Research Analyst [9]

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I guess starting with the business that you have won back. I guess kind of is there a way to ballpark the percentage that you won back from what was lost? And is there any way to kind of have a read on in the next -- even in the fiscal '20 if there is opportunity to win more back?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [10]

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Yes, so we lost -- my recollection is $70 million, $75 million in total between a number of the businesses. We do not expect to get all of that back in what we've been awarded so far. And not all of this is coming from customers where we lost business. Some of this, our existing customers where we're getting new contracts or new customers. So it's not all a return of business we lost. But it is on an annualized basis less than $20 million across the business.

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Steven Ramsey, Thompson Research Group, LLC - Associate Research Analyst [11]

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Helpful. But...

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [12]

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But our expectation is though, we will continue to win new business based on the quotation pipeline we have. And as I've mentioned earlier, a lot of this is long-cycle business that from negotiation and contract signing to being in production, it can often be a couple of quarters.

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Steven Ramsey, Thompson Research Group, LLC - Associate Research Analyst [13]

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Right. Okay. Helpful. Thinking about the spacer business and the investments you've been making. I guess can you update us on if demand is still strong in that segment? And where you are with investments and adding new lines to meet the demand?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [14]

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Yes, demand is still strong. But as I've mentioned before, the inhibitor is really the ability of the equipment manufacturers to supply our customers with those lines and they are being added at the rate of about 3 a year across the customer base. Still strong interest, and obviously, still helps the spacer business but not a step change in volumes.

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Steven Ramsey, Thompson Research Group, LLC - Associate Research Analyst [15]

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Great. And then lastly, on cabinets, just a lot of shifting parts in that business with imports and how the market is segmenting on the low end and the high end. Can you may be talk to consolidation in the space or recent acquisition or proposed acquisition activity? Kind of along with the tariffs. Kind of how those moving parts impact cabinet business going forward?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [16]

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I think the real answer is, it's still too soon to tell. There was clearly an announcement from one of our larger customers this week about a strategic review of their businesses. There is no certainty that, that will be consummated in a transaction and no certainty that, that will result in any consolidation. And as we've seen in the window space through some recent acquisitions, most of the acquisitions are to access new markets or new territories and typically don't result in a consolidation of production. And so thus far, our expectation is and with conversations with customers that are directly involved in this, the word thus far is, business as usual, we don't expect to see any change. All of the players that are moving parts, are current customers, and at this point, we would expect that to continue.

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Operator [17]

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Our next question is from Ken Zener with KeyBanc.

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Brendan Asher Cutler, KeyBanc Capital Markets Inc., Research Division - Associate [18]

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This is actually Brendan on Ken. So as cabinets improve, should we be expecting a similar margin profile relative to '18? Just trying to figure out the cadence of margin expansion there as we go forward relative to '18.

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [19]

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Yes, we certainly expect to see significant margin expansion simply by virtue of volumes. It is back-end loaded. But we fully expect the year to finish at better overall margins than last year.

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Brendan Asher Cutler, KeyBanc Capital Markets Inc., Research Division - Associate [20]

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Great. And then given Europe Engineered Components did very well with EBIT margin going up almost 400 bps year-over-year. How should we be thinking about the cadence for margins for the remainder of the year given you had guided to '19 margins being flat to slightly down year-over-year?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [21]

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Yes, I think, for North American Fenestration, we will see slight margin expansion. We did guide to flat, we may see slight margin expansion as we progress through the year based on what we can see right now.

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Brendan Asher Cutler, KeyBanc Capital Markets Inc., Research Division - Associate [22]

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I was thinking about Europe Engineered Components, not North America.

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [23]

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Sorry, European?

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Brendan Asher Cutler, KeyBanc Capital Markets Inc., Research Division - Associate [24]

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Yes, yes. European, please.

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [25]

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Yes, that margin profile clearly was assisted by the increase in volumes. I think if our thinking is correct, the volumes will start to or growth rates will subside somewhat in the second half of the year. I wouldn't expect that level of margin expansion to continue. But I would expect to see some margin expansion as we go through the next 3 quarters.

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Brendan Asher Cutler, KeyBanc Capital Markets Inc., Research Division - Associate [26]

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Okay. So for the year, you're saying margins could be flat to slightly up now instead of flat to slightly down?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [27]

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Yes.

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Brendan Asher Cutler, KeyBanc Capital Markets Inc., Research Division - Associate [28]

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Okay, great. And then just my final question. 6% growth in North America Engineered Components was very good. Can you just talk about how you would rank the growth between the businesses there between the warm edge spacer, screens and extrusion and why, please?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [29]

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We're seeing steady growth in the spacer business, primarily as a result of the high-speed line installations that we talked about earlier. We're seeing growth in screens as a result of new business, and we're starting to see potentially the highest growth in our extrusion business as we get awarded new contracts there.

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Operator [30]

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Our next question is from Julio Romero of Sidoti.

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Julio Alberto Romero, Sidoti & Company, LLC - Equity Analyst [31]

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Just to piggyback on Steven's question earlier, if that large customer does spin out that cabinet and windows business, how do you guys think about that scenario where the remaining OEMs would potentially get a little more bargaining power? Is there anything that could potentially get in front of that today and potentially offset that? Just how do you guys think about that?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [32]

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No, I think based on what we know and in conversations with that customer, I think the most likely outcome is business as usual.

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Julio Alberto Romero, Sidoti & Company, LLC - Equity Analyst [33]

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Okay. That's helpful. And you mentioned in the press release and obviously in the numbers, inventories definitely stepped up in preparation for the spring, summer season, can you just talk about what volumes are expected for Cabinet Components in the spring? I know that there's been some promotional activity in the home center. So just trying to think about what to expect during the current spring season?

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [34]

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Yes, so far, I mean the early indications are after what was a pretty tough first quarter, not just for us, I mean if you look at the industry statistics for cabinets in that semi-custom space they went down as opposed to any kind of growth. I think the expectation right now both for us and for the industry is low single-digit growth as we progress through the spring and summer here.

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Operator [35]

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And that concludes our Q&A session for today. I'd like to turn the call back over to Mr. Bill Griffiths for any further remarks.

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William C. Griffiths, Quanex Building Products Corporation - Chairman of the Board, President & CEO [36]

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Thanks, everyone. I appreciate you joining the call, and we look forward to updating you next quarter. And we'll be seeing some of you shortly at various conferences and roadshows. Thank you.

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Operator [37]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a great day.