MGP Ingredients, Inc.
Q3 2016 Earnings Call Transcript

Published: 2 Nov 2016

[Operator:]

Good morning, and welcome to the MGP Ingredients Third Quarter 2016 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Bob Burton. Please go ahead.

[Bob Burton:]

Thank you, Gary. Good morning, everyone and thank you for joining the MGP Ingredients conference call and webcast to discuss the company’s financial results for the third quarter of 2016. I’m Bob Burton with Lambert, Edwards, MGP’s Investor Relations firm and joining me our members of their management team, including Gus Griffin, President and Chief Executive Officer; and Tom Pigott, Vice President of Finance and Chief Financial Officer. We will begin the call with management’s prepared remarks and then open the call up to questions. However, before we begin today’s call, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the company’s business. The company’s actual results could differ materially from any forward-looking statements made today due to a number of factors, including the risk factors described in the company’s most recent annual and quarterly reports filed with the Securities and Exchange Commission. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the press release issued by MGP today, you can access it at the company’s website www.mgpingredients.com. At this time, I would like to turn the call over to MGP’s President and Chief Executive Officer, Gus Griffin. Gus?

[Gus Griffin:]

Thank you, Bob and thank you all for joining us on this call. We are very pleased to take this step forward by providing our shareholders and interested parties with an earnings conference call, our first in recent company history. On this call, we expect to provide an overview of the quarter, updates on key metrics, a discussion of progress against our strategy, and then we would take your questions. We expect the call to run about 45 minutes. Before we discuss the quarter, we would like to take a moment to provide you an update on the accidental chemical release that occurred in our Atchison facility on Friday, October 21. The health and safety of our team and our community is of paramount importance and our company takes any risk to that health or safety very seriously. We are very glad to report that based on the information we have at this time, all people treated as a result of the incident have been released. MGP reported the event to the EPA, OSHA, and Kansas and local authorities on that date and is cooperating fully to investigate and ensure that all appropriate response actions are being taken. MGP has also engaged outside experts to assist with the investigation and response. In advance of the findings of this investigation, we are not providing further information into the details of the incident itself at this time. We are also pleased to report that there was no significant damage to the Atchison plant, which is operating normally. No other MGP facilities, including our distillery in Lawrenceburg, Indiana were affected by this incident. Now turning to results. We’re continuing to implement the long-term strategy that we announced at the start of 2015. The key components of that strategy include maximizing the value of our production, capturing a larger share of the value chain, investing for growth, strong risk management in building the MGP brand. We believe that successfully implementing these strategies should better position us for long-term growth and benefit all MGP shareholders. Our progress against these strategic initiatives was evident in the quarter just reported and our successes and challenges should be viewed in the context of these long-term goals. Our focus continues to be on implementation of our long-term strategic plan. Let me begin with an overview of the quarter. Overall, we were very pleased with results of the third quarter and the continued execution of our long-term strategy. Revenues were relatively flat, declining 50 basis points, as we continued to manage a very competitive pricing environment in industrial alcohol. In turn, the resulting mix shift resulted in a 27.5 gross profit improvement. We grew operating income by 81.1%, behind the improved gross profit performance in both segments, as well as some favorable one-time items that Tom will take you through. Looking at each segment individually at our Distillery Products segment, our focus is on migrating away from industrial alcohol by expanding our vodka and gin business and growing our whiskey business. The continued shift towards premium beverage alcohol should provide MGP and our investors a more stable and profitable revenue stream. While the industrial alcohol business continues to show softness, we are pleased with the pace of this migration. Segment gross profit grew by 19.2%, despite a slight decline in net sales. The 300 basis point margin expansion was driven by our continued emphasis on growing our more profitable beverage alcohol business, while managing against a decline in low margin industrial alcohol sales. Within food grade alcohol, we grew premium beverage alcohol net sales by 16.1% for the quarter and 16.7% year-to-date, as demand for our premium bourbon and rye whiskeys continues to outpace category trends. As I mentioned, pricing conditions in the industrial alcohol industry have been difficult all year as this market is oversupplied, and we did not meet our topline expectations. During the third quarter as in the first two quarters of the year, we managed volumes against these difficult conditions, and as a result, industrial alcohol revenue declined 21.8%. Turning to Ingredient Solutions, we also showed strong improvement against the soft quarter last year. Gross profit grew by 85%, driven by improved plant performance and lower input costs. We expect pricing headwinds to continue as we work to strengthen our position against long-term macro trends. We continue to expect this business to return to its historic low growth profile. The strong results of both segments produced a gross profit increase of 27.5% and margin expansion of over 400 basis points. That concludes my initial remarks. Let me now turn things over to CFO, Tom Pigott for review of the key metrics and numbers. Tom?

[Tom Pigott:]

Thanks, Gus. As Gus discussed, we had a strong gross profit performance for the quarter. On a consolidated basis, net sales were relatively flat, decreasing 50 basis points to $80 million. However, gross profit increased 27.5% to $50 million for the quarter, resulting in over 400 basis points of gross margin improvement. The margin growth was driven by favorable mix, improved plant efficiencies, and lower input costs. For the third quarter, SG&A expense was up $1.5 million due to higher professional and personnel costs and advertising and promotion expense as we continued to invest for future growth. In addition, there were two favorable items that were recorded in other operating income this quarter. First, the company recorded at $2.6 million favorable legal settlement; and second, the company recorded a gain on sale of long-lived asset. These two items provided additional $3.4 million of income for the quarter. The strong gross profit performance combined with the favorable other operating income drove our reported operating income up 81.1% versus the prior year to $11.5 million. Of the 81% growth, 53% was driven by the other operating income items I mentioned, and the business drove a 28% increase over the prior year. Our ICP joint venture made a modest contribution of $700,000 to this quarter’s results. This joint venture continues to experience difficult conditions in the ethanol market. Our tax rate was 19.5% for the quarter as we benefited from the implementation of ASU 2016-09, which simplifies the accounting for share-based payments. The implementation of this new standard combined with some new tax planning strategies will bring our full year tax rate down to 31%. Net income for the 2016 quarter increased 40.8% to $9.5 million, and earnings per share increased 44.7% to $0.55 behind the strong operating performance and the special items I mentioned. MGP’s balance sheet remained strong, allowing us to continue to invest to grow as well as return funds to shareholder. Recently, the Board authorized our fourth quarter dividend of $0.02 per share payable on December 8. So, overall you could see that the execution of our strategy has led to strong financial results despite the changing market conditions. Now turning to our guidance. Our 2016 net sales percentage growth projection has been revised downward to reflect the year-to-date sales declines. And as I mentioned, the anticipated tax rate has improved. The three-year operating income guidance is unchanged and excludes the favorable legal settlement and assets sale gain. We project full year operating income to increase by a compound annual growth rate in the 10% to 15% range through fiscal 2018. 2016 net sales are expected to decline in low single-digits. 2016 gross margin gains are expected to be moderate following the strong 2015 improvement. The 2016 effective tax rate is forecast to be 31%, reflecting the adoption of the new accounting standard and shares outstanding are expected to be approximately 16.7 million. Last, due to the challenging and volatile conditions in the fuel ethanol market, ICP’s level of profitability is expected to be modest in 2016. Now let me turn things back over to Gus for his concluding remarks.

[Gus Griffin:]

Thanks, Tom. We have discussed in some detail how our overall strategy is evolving in MGP. And while we have made much progress in 2015 and 2016, we believe that MGP can further enhance performance going forward. While we may experience continued volatility in our quarterly results, we remain focused on progress over the long-term. Since our last earnings announcement, we have initiated a number of activities in line with our strategy. We recently announced introduction of a new series of gin flavors that we believe will allow our customers to take advantage of the current growth in the super premium gin segment and we will continue to maximize the value of our production. During the third quarter, we continue to invest in aggressively laying down whiskey, adding $4.7 million to our inventory of barreled whiskey which now totals $45 million. Our view of the long-term demand for these products continues to be very positive as growth of the bourbon category remained strong. Turning to our other strategic initiatives. We continue to invest to support our longer-term growth. This quarter, our Board approved an additional $9 million on our warehouse expansion plan, taking the total project up to $29 million. This most recent appropriation will allow us to meet the demands of our growing customers and for our own needs for the foreseeable future. Also, we continue to carefully develop our own portfolio of premium beverage brands. Till American Wheat Vodka is being well received by consumers and is gaining volume in the Kansas and Missouri markets. We have expanded our distribution of Till to the Iowa and Indiana markets as well. That concludes our prepared remarks. Operator, we are ready to begin the question-and-answer portion of the call.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bill Chappell with SunTrust. Please go ahead.

[Bill Chappell:]

Thanks. Good morning.

[Gus Griffin:]

Good morning.

[Bill Chappell:]

Gus, I guess first, thank you for doing the call and thank you for more transparency on the financial that’s really helpful. Can you talk a little bit -- clearly the Brown Spirits business is doing well but can you talk a little bit about the outlook for vodka and gin in terms of how you see that playing out? Is it growing now, how long does it take to kind of convert more of the capacity to that? Is that quarters away, is that years away? Just trying to understand how we should we be looking at that business over the next 12 months?

[Gus Griffin:]

Sure. Thanks, Bill. Let’s talk about the white goods first. The category itself -- so vodka is the largest category. Flavors have started -- have been declining. You are still seeing low levels of growth in the unflavored category. But I think you are going to continue to see more brands come in. Our business is based on both the category growth and the number of brands that come in. Likewise on the gin category, the excitement is at the super premium level where you’re seeing a number of new brands come in and a lot more interest from other brand builders and developing brands. So, while the overall category may be declining, that particular segment is growing and the number of entrants coming into it is growing. So, we think both those trends bode well for us. In terms of when you’ll start seeing it play out for us, we have to basically develop new products with our customers, partner with them to help on the R&D side, and then those products have to go to market in a substantial way to drive that volume. So it won’t be a linear progression. It will be a steady long-term effort on our part to work with our customers and to gain new customers and to benefit from that trend.

[Bill Chappell:]

Okay. So it’s probably a few quarters away before we see some real growth.

[Gus Griffin:]

Yes. I think what we can promise is a continued long-term effort and it may be a little choppy in how it actually plays out.

[Bill Chappell:]

Got it. And then in terms of industrial alcohol on the quarter, I’m just trying to understand what was the surprise, was it you lost business or the pricing got even worse than you expected? I’m just trying to understand. I know it tripped up. It’s tripped up the business all year in terms of the new players coming into the market. Just trying to understand what was incremental.

[Gus Griffin:]

Yes. Bill, that industry, that segment continues to be oversupplied and unfortunately, it just continues to get more and more price competitive, and so business that we might have thought we are interested in got even more price competitive. It moved away from us and we choose not to -- at some point we choose not to chase it.

[Bill Chappell:]

Got it. And last one for me. On the warehouse, so I just want to make sure I understood the incremental $9 million. I thought you had kind of signed off and finished in terms of doubling the warehouse capacity, is this incremental to that or is the $9 million is just finishing that out?

[Gus Griffin:]

No, it’s incremental to that. When we announced the initial plan based on our forecast of our customers’ business and our own internal needs, we thought that would be sufficient. From what we see in the market, from what we see from our customers and what we see with our own needs, we thought we needed an incremental step and that’s what this is for.

[Bill Chappell:]

Got it. Thanks so much.

[Gus Griffin:]

Thank you.

[Operator:]

Excuse me. The next question comes from Alex Fuhrman with Craig-Hallum Capital Group. Please go ahead.

[Alex Fuhrman:]

Hey guys. Congratulations on a strong quarter here on the bottom line. Definitely, was pleased to see some of the more disclosures here around beverage versus industrial alcohol. I guess my first question would be, obviously growing 16% on the beverage side here in the third quarter, seems like that’s been -- the growth rate pretty consistently throughout the year. Roughly, how long has the beverage business been growing at a nice pace like that? And do you think that’s something that’s sustainable and then obviously there is less visibility into the industrial side of the business? I mean big picture over a multiyear horizon, is it it reasonable to think that the beverage alcohol side of the business could continue to grow at a double-digit pace? And then thinking about longer-term, potentially retooling some of that industrial alcohol capacity more towards some of the white beverage alcohols? Can you just give us a little bit of an overview and how expensive is that process and is that a very time-consuming process? Just trying to understand some of the dynamics at play there.

[Gus Griffin:]

Okay. Thanks for the question, Alex. First of all, let’s talk about the migration from industrial to premium beverage alcohol. So, when I got here in 2014, it was about a 50-50 split between the industrial alcohol and premium beverage alcohol. In 2015, we were able to shift that to 57% being in premium beverage alcohol; and year-to-date, we are at 65%. So, we’ve made some big steps. Again that won’t be a linear progression, but it will be continued long-term effort. In terms of what’s going to drive that growth, it’s how fast we are able to work with customers develop new products on the white goods side, the gin and vodka side, and it will also depend a little bit on the actual growth of those categories. On the whiskey side, we’ve said that we plan to grow share of growing category, and we are outpacing the trend for the overall bourbon category. And we think we will be able to continue to do that. So, we think that those factors will continue to drive that change.

[Alex Fuhrman:]

Great. That’s helpful. And then as you think about potentially launching or acquiring some more brands following American Till, is there kind of a timeline that you are thinking about for that and any particular categories within the beverages that you are making that seem more attractive than the others, perhaps coming out with a gin to follow some of the new formulations that you come out with or is it maybe more attractive to look at whiskey brands given your expertise there? When should we be -- would it be reasonable to think that in 2017, there’ll be more brands coming to market?

[Gus Griffin:]

Yes. Well, I think first of all, it is important to understand that our core business will always be supplying other people. But that said we do think there’s room for us to develop our own portfolio of premium beverage brands. Right now we have defined that as premium and super premium brands and brands that we either do or can supply ourselves. So that sort of limits it to vodka, gin, bourbon and rye. We are aggressively and proactively evaluating brands but we are not at a panic. We don’t need to acquire something to drive our growth but we think there are attractive targets out there and we are aggressively evaluating it. We haven’t put a timetable on that but we have said that we plan to develop and build our platform, both our portfolio of brands in our sales and marketing platform. And so, we are evaluating brands along those lines.

[Alex Fuhrman:]

That’s terrific. Thank you very much.

[Gus Griffin:]

Thanks, Alex.

[Operator:]

The next question comes from Bill Dezellem with Tieton Capital Management. Please go ahead.

[Bill Dezellem:]

Thank you. Group of questions. First of all, the most basic level, why are you growing your beverage alcohol business so much faster than the industry?

[Gus Griffin:]

Thanks, Bill. I think the key driver there is our unique position within the industry both in terms of our capabilities and our capacity. So, we are a very large supplier of vodka. We are a very large supplier of gin and of course, we are very large supplier of bourbons and ryes. Then on top of that is our unique position within the whiskey category itself. We have worked very well with our customers to partner, to meet the demands, to make sure we can meet the quality, the consistency and the costs that they need to build their brands with the overall growth of the category. So, I think it is really due to our positioning within the overall premium beverage alcohol business, the range of products we can supply and the way that we have worked with our customers for mutual benefit.

[Bill Dezellem:]

And to what degree over the course of your year three-year plan, are you believing that you can continue to grow the beverage alcohol business at 15% or greater?

[Gus Griffin:]

We have not defined exactly how fast we will grow that. And again, I don’t think it will be linear. We think we have much more confidence in our ability to outpace the bourbon category with our whiskey sales. But then the migration from industrial alcohol into premium gins and vodkas will be a little bit more choppy. But I think combined we feel very good about our verdict to not only continue that migration but on the whiskey side to continue to outperform that category.

[Bill Dezellem:]

That’s helpful. And I would like to actually beat the industrial alcohol, of course a little bit more here. It sounds like you for -- did not take some business in the industrial alcohol arena because it was such a low price. But are you finding the prices are so low that they don’t even meet your variable costs and you’d actually lose money by producing? Or did you just choose not to take that lower margin?

[Tom Pigott:]

Hey, Bill. This is Tom. So, overall, as we’ve discussed, industrial is not strategic for us. And longer-term that business tends to be choppy in terms of customers always looking for the lowest bid. There’s not necessarily a competitive advantage that we can provide that we do in other places like in vodka and gin. So in the bidding situation, yes, there are some business that actually are just very marginally profitable that we are not pursuing for two reasons. One, it’s not strategic and two, the very limited profits we can get by pursuing it.

[Bill Dezellem:]

All right. Part of what I was just trying in my mind sort out is whether because it’s a commoditized and it is not strategic that if you had the capacity, even if you just made a very small margin it’s at least money in your pocket?

[Tom Pigott:]

Yes. Certainly, Bill, we do look at that and we do try to make sure we keep that in plant optimally run. So that does factor into our pricing for industrial.

[Bill Dezellem:]

Understood. Thank you. And if I may switch to the ethanol market quickly, with crude oil prices increasing, how does that tend to affect ethanol business?

[Gus Griffin:]

Bill, this is Gus. In general, it should improve ethanol margins but that’s a very complex market. It involves international customers. It involves international sources of supply and then as you highlighted also the correlation to oil prices. But in general as oil prices go up, historically ethanol prices -- ethanol margins have gone up.

[Bill Dezellem:]

Okay. So the increase in oil prices that we’ve seen this year should be a benefit with time but maybe not immediate in terms of the benefit?

[Gus Griffin:]

Yes. And much as you see in oil prices bounce around, it can be pretty -- the correlation can be pretty choppy and the timing can be relatively short too.

[Bill Dezellem:]

That’s helpful. And one last one before I go, please. Relative to the ingredients business, what are the trends that you were referring to in the press release there?

[Gus Griffin:]

Yes. Really four of them, high-fiber, enhanced proteins, increased dietary fiber, increased protein both for muscle recovery and then just as humans age, Non-GMO. Of course, all wheat is Non-GMO and then plant-based proteins, which is people getting a bigger piece of their overall protein intake from non-animal sources.

[Bill Dezellem:]

Understood. Thank you very much.

[Operator:]

The next question comes from Jon Braatz with Kansas City Capital. Please go ahead.

[Jon Braatz:]

Good morning, Gus, Tom.

[Gus Griffin:]

Hey, Jon.

[Tom Pigott:]

Good morning, Jon.

[Jon Braatz:]

I’d like to maybe dig into the SG&A costs little bit. You had mentioned that there were up, higher professional fees and so on. But when you are -- and looking at the 10-Q, I see your corporate expenses were down $1.3 million versus $3.2 million and I don’t know if they are all in SG&A line. But can you give me a little bit more clarity on the higher SG&A costs and will they continue?

[Gus Griffin:]

Sure, Jon. Yes. So the increased SG&A is really people and professional fees as well as the A&P costs. So the investments we are making is really longer-term, building out our brands platform. So, we are investing both in people as well as advertising and promotion expenses for the Till launch. So, we do anticipate a continued invest to grow as we build out that platform. And in terms of the level, much of that is dependent on our brand launches and how they perform in the market. So, I don’t want to give you specifics in terms of how that will play through but overall, we realized we need to invest to execute this brand strategy and we are trying to make the appropriate and prudent investments to do that.

[Jon Braatz:]

And then in theory, those costs will be offset over the higher gross margin?

[Gus Griffin:]

Exactly. So, longer-term, we believe the brands platform will contribute some nice margin accretions for us and right now we are investing to build that out.

[Jon Braatz:]

And Tom, the decline in the corporate expenses from $3.2 million to $1.3 million, what does that reflect?

[Tom Pigott:]

I will have to get back to you on that specific one, Jon. I know on a year-to-date basis, our corporate expenses are down due to lower bonus accrual if you are referring to the year-to-date figures.

[Jon Braatz:]

Okay. All right. And then, Gus, obviously there has been a lot of craft distilleries opening up, how important are the craft distillers to your revenue stream? And then secondly, Gus, High West was acquired recently by Constellation and they are a customer of yours. Have you been in any conversations with Constellation about what they are thinking they’re going to do with High West?

[Gus Griffin:]

Jon, let me take the first part of that in terms of the craft distillers. Craft distillers and the growth in craft distillers has been very important to the growth of the overall category, not only in volume but in terms of interest. So the more craft distillers there are, the more brands -- some more investment there is and then more consumer interest. So, I think they have been very important in that. We have great partnerships with a number of craft distillers that are important piece of our business. We don’t single out or we don’t discuss any of our specific customers. But I think in general, we play a very important role with those customers. And I think they are pleased with how we play that role. They are pleased with the quality, the consistency, the customer support, the R&D that we supply them. We’ve always said we plan to grow along with our customers over the long-term and we believe as long as we do a good job of playing our role and we provide them with what we need, we will continue that partnership.

[Jon Braatz:]

Okay. In fact most of the craft distillers, are they actual distillers or they blender so to speak?

[Gus Griffin:]

I think that probably the best way to look at that is they all add value. Some of them distill all their own products. Some distill a portion of their own product. Some do blending and it’s been fishing. But they all add a degree of value to the product that we sell them and then it into our higher value product. We always say we sell them products and they turn them into brands.

[Jon Braatz:]

Okay. All right. Thank you, Gus.

[Gus Griffin:]

Hey, Jon, I just want to get back to you. I think what you are looking for -- looking at in that footnote combines the income we got from the special items and that’s the reduction you are seeing.

[Jon Braatz:]

Okay. All right. Thank you.

[Gus Griffin:]

Yes. Sure.

[Operator:]

Pardon me for any mispronunciations. The next question comes from Howie Xia with BeaconLight Capital. Please go ahead.

[Howie Xia:]

Hi. Good morning, Tom and Gus.

[Gus Griffin:]

Good morning, Howie.

[Howie Xia:]

Two questions for me. One is clearly, longer-term you guys have a desire to go into branded brown goods. I’m sure given that’s kind of your bread and butter. So, I just want to understand early you mentioned you guys have started making interesting investment to build brand, while there was only one brand that you guys have launched on the brown good side, the Metze’s which was kind of limited edition range. Longer-term, if you guys want to build out another whiskey brand of your own, can you just walk me through what type of -- what are the most important structure investment elements that you need to make, whether it’s personnel or distribution, or logistics or what not?

[Gus Griffin:]

Yes. This is Gus. I think first of all as I said before, our core business will always be supplying other people. But we are committed to developing a portfolio of our own premium beverage brands. We are going to do that through internal development and acquisition. I think the most important thing to understand there is that we are always looking for white space with the consumers. So, we are always looking for brands, whether we develop them internally or acquire them that are unique in the marketplace and relevant with consumers. That’s the white space we are looking for. In terms of the investments required, obviously, if we acquire a brand that’s an investment. But in terms of building out our platform, ourselves and marketing platform to support those brands we will do as we need it. So as the development and expansion of the brands or the acquisition of brands dictate it. We are committed to building it out to the degree necessary to support the long-term growth of those brands. But we don’t have a set plan. It would depend on both development and acquisition.

[Howie Xia:]

Right. Got it. And then the follow-up for me. Just trying to get some comments on the general competition environment. Are there much other capacity coming on line that’s competing with you guys and trying to sell bulk whiskey to craft producers, or more mainstream producers?

[Gus Griffin:]

Yes. Obviously, the whiskey categories are obviously very robust category right now. You see expansion from brand owners. You see investment by small craft distillers, expanding their capabilities and you see a range in between. We are very conscious of our role within the industry and how we can best serve our customers and how can we have the strongest position within there. So between ensuring that we -- distillations are scale game, we are very large supplier. So, we are able to provide high-quality consistent product at a good price and that’s obviously a big advantage to us. We also have a large inventory of aged whiskey that we are putting down. It will help solidify our positioning in the market long-term and we think that will be very valuable to our customers and strengthen our position in the market.

[Howie Xia:]

Got it. Thank you.

[Operator:]

The next question comes from Brian Rath with Walthausen & Co. Please go ahead.

[Brian Rath:]

Hey guys. Thanks for taking my questions this morning. Just first one, looking at the gross margin improvement in distillery segment, how much of that was mix shift versus what you mentioned, plant efficiencies and lower input costs?

[Gus Griffin:]

Yes. Within distillery, the vast majority of that was the mix shift in the premium beverage alcohol. There was just a modest amount of favorable input costs and plant efficiencies in distillery.

[Brian Rath:]

Okay. And then coming back to just your longer-term goals on growing the branded whiskey portfolio and I know you’ve talked on it little bit. Just wondering how much of the gating factor is just waiting for that distillate that you’ve laid down really more aggressively since Q1 of ‘15 to age more if you are look to stay in super premium category? Does it need to get to say four years of aging is a sweet spot and that’s over kind of two years away from hitting that and that’s really the gating item?

[Gus Griffin:]

No, we did started aggressively putting it away in ’14 and then really ramped it up in 15’ and 16 but we had some aged whiskey. So, we certainly feel we have the whiskey to start our brands. The real driver on the timing of those introductions is the development of brand concepts and brand architecture to support long-term growth. So, we’ve always, we’ve said we knew we are in this for the long-term so we want to make sure any brand that we introduce has the potential to grow long-term to be a part of the industry for the very long-term. And that takes time to develop your brand concepts, your brand architecture, your packaging and so forth. And that’s what the real drivers are just doing that work.

[Brian Rath:]

Okay. And then looking at the increase in SG&A, I think you mentioned some of it was higher marketing spend. I wonder if you can break out how much that was and then tied to that just thinking about, as you are looking to build brands and invest upfront in the marketing and advertising, are brands profitable at launch or does it takes some time to turn profitable given that you have the frontload, that investment to build around the brand?

[Gus Griffin:]

We don’t break out exactly what we spend on that A&P. But what we will say is that we are committed to building these brands for the long-term. So to your question are they profitable on a gross profit basis? Yes, the brands profitable from the first case we sell. But as you highlighted, it obviously depends on the investment that we put behind it. So, as I said, we are committed for the long-term. So, we are going to make that upfront investment, which will exceed the gross profit on the initial volume and then we are going to reap the return on those investments over the longer term. So, net investment is both in advertising and promotion and in people.

[Brian Rath:]

Yes. How long is the -- I don’t know if there is a rule of thumb but that inflection point where you’re making is gross margin accretive but you are spending more below that. So, how long does it usually take to where you actually return net positive and the bottom line gets the benefit?

[Gus Griffin:]

We haven’t disclosed to set model. And that model will be a little bit variable depending on the initial results we get from the brands. So, if we see a brand really take off, we may decide to even invest more behind it to benefit from the long-term growth. So, we’ve modeled these brands out and we will continue to adjust those models based on the feedback from the market.

[Tom Pigott:]

It’s a little early for us in this transition to specifically provide you guidance in terms of the brand of business. But the way we look at the margin progression is really the aged inventory will be paramount in that. As we mentioned, four years is a sweet spot. Some of it, we will get accretion for that, before that some, potentially after that. And then longer-term the brands will be a more significant impact to MGP’s margin growth profile. But the specifics in terms of -- it's a little early for us to give specific guidance in that space.

[Brian Rath:]

Okay. And last few here. Few months now, several months past, Greg Metze leaving the company, just wondering has there been anything of note from his departure, kind of the face on that limited release? I know you have two other master distillers. Now that you are few months past, has there been any impact in any part of the business?

[Gus Griffin:]

Given our role within the industry and again, it’s not just whiskey but it is vodka and gin. The real strength of MGP is the depth and breadth of our fermentation and distillation expertise. And we had a good talent bench in place at the time and we continue to develop more people and focus very hard on that in terms of development and mentoring and retention. We really -- we were in position. Greg had done a great job of mentoring people and so we were in potion to continue on when he left. And we are going to make sure that we are in a position to continue on, no matter what personnel changes there may be. Again, the backbone of our business is distillation and fermentation and we’re making sure that we always have a good strong bench in terms of the depth and the breadth of our skills.

[Brian Rath:]

Great. Thanks. That’s all I have.

[Gus Griffin:]

Thank you.

[Operator:]

The next question comes from Chris Robertson with Cardinal Capital. Please go ahead.

[Chris Robertson:]

Hi. Just wanted to ask two questions. The first is on the inventory. Was pleased with the increase their, can you talk about how you think about that beyond ’16, whether there's a particular growth profile that you are looking to stick with?

[Gus Griffin:]

Yes. So, overall, on the inventory, we also are pleased to increase the put away and we are aggressively putting away today because right now, we’ve got low corn prices, low energy costs to run the plants and very low incremental cost to capital at 2.5%. In terms of the longer-term put away, we model out kind of our projected customer needs, our potential brand platform and we look at the overall category trends. And so, overall, you will see us to continue to put away inventory. We are not specific at this stage in terms of how much and we are going to put away each year. But right now the conditions are very favorable so we are putting away aggressively.

[Chris Robertson:]

Next question was just on the outside consultants that you said you were using for the investigation, just so that folks are prepared for fourth quarter numbers, is there any kind of expense at a time that we should be thinking about associated with that or anything related to slowdown for that week?

[Tom Pigott:]

Sure. So, overall, MGP has an active risk management program and it’s important to keep in mind there is no significant damage to the Atchison plant. The company's insurance is expected to provide coverage to any damages to private plaintiffs subject to a deductible $250,000. But there are certain regulatory fines or penalties that may not be covered and at this point we can’t -- given that the investigations are in the early stages, we can’t forecast out that aspect of it. The insurance that we have does cover some of the costs of legal and some of the additional expenses that we might incur.

[Gus Griffin:]

This is Gus. Let me just add. That incident also happened right as we were going into a regularly scheduled annual shut down for maintenance. So it really had minimal impact on our scheduled production.

[Chris Robertson:]

That’s great. I appreciate all the color there. The last thing I had was on the SG&A, I know you said you didn’t want to break out anything specifically for A&P or marketing. Can you give us sort of -- maybe coming out from the other side, the base level of SG&A to run the business disassociated with the growth that might be coming down the line and lumpy periods as you grow your brands? Or maybe thinking about it as a certain percentage of gross profit -- certain percentage of gross profit or revenue, just so that we can think about it almost in two different ways? One is running the base business and the second is, as you grow into the new company that you are creating.

[Gus Griffin:]

We have not broken that out and disclosed that yet. But I think it’s important to understand, is not only are we developing a brands company, so you have sales and marketing people to support the expansion and development of our portfolio of premium brands. But also as our core business, both on the ingredient solution side and the premium beverage alcohol side, we are expanding there both our capabilities and our capacity, our business is growing quite significantly in the last two years. So, sometimes you need more people just to handle the volume of the business and then also the sophistication of our business has increased and so we are building there. So it’s little hard to break out the baseline of our business with those two factors involved.

[Tom Pigott:]

Yes. What I would say, overall, our guidance or three-year operating income guidance that we provided, we did contemplate the necessary investments in SG&A and A&P to achieve those numbers.

[Chris Robertson:]

Fair enough. Thanks for the time.

[Gus Griffin:]

Thank you.

[Operator:]

The next question comes from Doug Cartwright with Kornitzer Capital Management. Please go ahead.

[Doug Cartwright:]

Hey guys. In the most recent quarter, the net addition to barrel distillate inventory was a little bit lower than it’s been in recent quarters. So, I just wanted to understand is that a function of lower gross additions or did you release some inventory that’s seasonal or driven by cash flow? And can you just update us on the philosophy surrounding barrel distillate and what drives the decision of what to hold, how much to hold, when to release and how much to release?

[Gus Griffin:]

Yes. The first thing I think you need to -- the driver of that is our actual production. So, when do we have availability in our production line to put away for ourselves first, fill customers orders? So that will build in some inherent choppiness in that stream. The way we look at is long-term as Tom highlighted a lot of favorable things going in our favor in terms of the input cost and so forth and older is always better than younger. So, we always try to put away as much we can given our production constraints. In terms of aged whiskey and how we will use it, we have stated strategically we are going to use it for three purposes. We are going to use it to support our own brands. We are going to use it to support strategic partnerships and we may at times sell it on the open-market. And sometimes as you have odds and ends, you have products that are not mainline products. We may need to reach their peak price before four years because of changes in the markets and so forth. We also -- we will look to see if we should sell product before four years to either gain or retain a long-term customer. So, we may be able to help a customer out and exchange. We may either bring them to our business or really build a much stronger longer-term partnership. So again that’s another use of it. I think the real focus should be on, are we continuing to grow that inventory and obviously, we were.

[Doug Cartwright:]

Okay. Great. Thank you.

[Operator:]

The next question is a follow-up from Bill Dezellem with Tieton Capital Management. Please go ahead.

[Bill Dezellem:]

Thank you. Two of them. First of all, Tom, the $800,000 gain on sale, would you please provide a little detail around that?

[Tom Pigott:]

Yes, Bill. That was just a one-time sale of a corporate asset that we experienced a gain on. So, I would peel that off as kind of a one-time item.

[Bill Dezellem:]

And the corporate asset was what?

[Tom Pigott:]

It was a non-core asset.

[Bill Dezellem:]

I will shift away from that in tax rate. Next year, 2017, is the 31% a good number?

[Tom Pigott:]

I will give you -- specifically when we provided our overall guidance but what I would tell you is that the benefit that we got from this accounting change will continue into next year at similar levels, so that will allow us to keep a fairly consistent rate. But I will have more detail when we update our overall annual guidance for next year.

[Bill Dezellem:]

Okay. Let me ask the question different because I’m a little bit confused. The 31% that you’ve referenced for this year, is that the overall year in total, or is that the remainder of the year after the implementation of the new accounting?

[Tom Pigott:]

So the implementation of the new accounting standard we did in this quarter, so that’s how we got to the 19.5% rate for the quarter. The full year guidance for 2016 is 31%. So, I think our previous guidance was 34%. So, we took it down to 31%, and the implementation of that new standard which was about 300 basis points of savings, we will still get -- we believe we will get a comparable amount of savings next year.

[Bill Dezellem:]

So, thank you. And so the fourth quarter of this year it should be around the 31%. Am I hearing you correctly?

[Tom Pigott:]

It should average into -- the projection is that we average into 31%.

[Bill Dezellem:]

All right. That is helpful. Thank you very much.

[Operator:]

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

[Gus Griffin:]

Thank you for interest in our company. We look forward to talking with you again at year end.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.