Brandon Gall: Yeah. We’re very pleased with the performance of Penelope, and relative to our underwriting assumptions, it continues to perform in line or better than those next expectations. And so, as we look at the guide for this year, it too incorporates those expectations that the brand continues to perform as we, in fact, hope for better.
Ben Klieve: Okay. Great. Thanks, Brandon. And then one more from me, Brandon. In your prepared remarks, you noted within the ingredients segment some challenges internationally. I’m wondering if you can comment on that qualitatively or quantitatively at all to kind of help us understand how significant this is?
Brandon Gall: Yeah. It’s near-term something that we’re looking at, but mid-to-long term, full confidence in Mike Buttshaw and that team to find a solution. But what I was highlighting in my prepared remarks were really two things. So, firstly, we’ve begun seeing increases in imports of commodity starches from Canada, Australia, and the EU, which is, for now resulting in some pricing pressure for our own clean-label commodity wheat starches, which represented at about 12% of segment sales in 2023. So that’s one of the headwinds. The second international headwind is, we’re also seeing some export headwinds of our specialty protein products into Japan, due mostly to unfavorable currency exchange rates. So what we’re doing to counter these challenges is really focusing on our domestic commercial efforts to maximize our specialty wheat starch and protein sales here in the U.S. So we are seeing some early signs of success here and we’re confident it’s going to work out over the course of the year, but it will take a little bit of time.
David Bratcher: Yeah. And I’ll add to that, we continue to focus on what we do well in our Ingredient business, and that is our Premium type of products with the specialty products. Those are the things that we focus on. Commodity starch is obviously a piece of our business, but it’s really more of a subset of what we do and really what we want to sell is our specialty type of products. The model we run for Ingredients is very similar to the model we run for Branded Spirits. We want to focus on those upside, upper and higher-end margin-type of brands. And commodity starch or clean-label commodity starches are exactly that. They’re commodity-driven. It works by supply and demand. And yes, this year, as we look at imports and stuff coming in, it’s created pricing pressure.
Ben Klieve: Got it. No, that makes sense. Very good, I appreciate you both answering my questions. I’ll jump back in queue.
Brandon Gall: Thanks, Klieve.
Operator: The next question is from Robert Moskow with TD Cowen. Please go ahead.
Seamus Cassidy: Hi. This is Seamus Cassidy on for Rob Moskow, and thanks for the question. I just wanted to drill a little bit deeper on brown goods volumes. So you mentioned that they were up for the full year, but for the first three quarters you called out negative brown volumes, which, as you mentioned, was driven by sort of being more selective around the selling of aged barrels, given better contract visibility on the new side. So there wasn’t pull-forward, but maybe higher than expected spot sales in 4Q, that maybe drove the sales beat. And if you could just offer any commentary on sort of your outlook for that in 2024 and how we should think about embedding that in Distilling Solutions’ mid-single-digit growth as you called out? Thank you.
Brandon Gall: Yeah. And thanks for the question, Seamus. And, yeah, so in 2023, Q4 volumes were a big part of it of our sales in Q4, especially the growth. And volume did play a role throughout the course of the earlier quarters, although less so than price and so that was the point we were making in a lot of the quarters. As we look to ’24, though, we do expect volume to play a larger role. And a lot of that is because we’re moving more towards new distillate in that type of model. So while we expect to see good pricing at the new distillate and aged level continue into this year, 2024, that is, we do expect volume to be the main driver of the sales growth we see in this year.
David Bratcher: Yeah. I’d add to that, too, that the other piece of that is the, other distillery coming online, the expansion on capacity. And as we look at our guidance and the numbers we provided, they’re Q2 through Q4 focused because of that additional capacity that we’ll have available. The other thing I would add in general is, our new distillate business, especially as we go into 2024 is really a model of the brand experience category. The people we’re selling to are the people that are putting it in brands and putting it on the shelves. And traditionally in the industry, Q1 on average tends to be a slower quarter than the other quarters. And as we look at everything that we’ve talked about there, if you were to subtract our capacity, expansions, and stuff on the backside, it might look a little more normalized.
But when we start to factor in everything going on with a lot of the craft customers, the aged that Brandon mentioned, and we look at the back half of this with our margin expansion, our numbers we anticipate should be better as Brandon indicated in two, three quarters.
Seamus Cassidy: That’s helpful. Thank you. And then just one more for me. Given that you’re moving more towards sort of this new distillate model, and you called out that inflation costs for a lot of your core commodities remain elevated, could you just offer us a little bit more detail on how that sort of flows through, given that a lot more of these volumes will be contracted and sort of how you connect with your customers on that side? Thank you.
Brandon Gall: Yeah. And that’s another advantage of having the longer-term agreements in place because they are — the pricing is input-based. And so, in addition to having a typical inflation factor year-over-year, what we also incorporate into our contracts and do distillate is pricing based off of raw material inputs, whether it’s corn whether it’s rye, malt, natural gas, the barrel, etc. So there are those mechanisms within our contract to help insulate us in our margins as we go forward in that type of environment.
David Bratcher: Yeah. Especially true on the new distillate, because as Brandon alluded, the contracts when we go out multi-years, they’re all based on that. People want to reflect whatever that current grain commodity may be, including the price of a barrel. As we look at our aged and our putaway, obviously those are impacting our future inventory costs and stuff, but in the big picture of things on aged, when the commodities vary like they have, it’s not super significant on the overall margin capability, because at those point of age, as you guys alluded to, we can reflect that in the pricing as well in the future.
Operator: The next question is from Mitch Pinheiro with Sturdivant. Please go ahead.
Mitchell Pinheiro: Yeah. Good morning. Just a couple of follow-up questions. One is, if the customers are kind of leaning into the new distillate, what does that — how should we interpret that related to their own inventory levels of age? Do they have ample aged, at this point?
Brandon Gall: Well, I would say that, yes, I would think that they’re managing their aged imbalance. Our strategy, MGP strategy for a long time has always been taking a new customer that wants to be an entrant into the Branded Spirits category in American whiskey and bridging them to new distillate. This isn’t really a brand new strategy, it’s an evolution over time. And so as those customers build those age, they will naturally go to new discipline and they’re going to be in a better financial shape to carry the own inventory costs as well. But it doesn’t preclude that those same customers get additional sales in their products and need more aged to be able to make that transition to new discipline, which is what happens on a lot of the customers on the aged market.
It’s also a reflection of why it’s easier to contract on the new distillate side because you’re going to be doing it with larger customers that have larger brands. And on the aged side, they’re able to come in because of our putaway plan and pick and choose what they need when they need it.
Mitchell Pinheiro: Okay. And then, when I look at your barrel distillate increasing, it gets us up 26% year-over-year. Some of that’s obviously is Penelope. But I would imagine that as that barrel distillate grows, that growth is really earmarked for your own brands, Lux Row, Remus, Penelope, etc., is that correct?
Brandon Gall: Yeah. It’s both. So, to date, it’s been more outweighed for Distilling Solutions and our own brands. But as we go forward, Mitch, that is going to evolve and part of the benefit of selling more new distillate with our capacity is the cash flow impact. And so as we move forward, and this year is a good example, that net putaway at cost will be less than the $51 million we experienced last year. We’re going to continue to invest in our putaway to line up with future demand for both of our segments, but that is one of the benefits we’ll see this year.
Mitchell Pinheiro: Okay. And then just final question, you talked about wholesaler inventory destocking. Where have you seen — have you seen any studies, your own surveys on cut consumer pantry destocking, that seems to me to be a significant event?
Brandon Gall: Yeah. No specific surveys to speak of on that. A lot of that, Mitch, as you know, is probably pretty anecdotal. And — but what we have seen is resilient growth in American whiskey, despite the broader industry being flattish in 2023 and we expect that to continue.
David Bratcher: Yeah. I would agree. Again, I haven’t seen any set data on pantry destocking to be honest with you. I think that’s a speculation of what can — what we can understand is retail emphasis on that. And they’ve had the same pressure that you’ve seen at the wholesale level. I mean, they’re carrying it at even higher costs than our wholesalers and when you’re dealing with big retailers, they’re watching their dollars as well. So I do think that as an industry, that is something that still we’re going to continue to see in 2024. But as you look at our own business, it’s what I said earlier, it’s that compared to our peers, the opportunity to increase our points of distribution is reflective and is our guidance.
Mitchell Pinheiro: Okay. All right, well, very helpful. Thank you very much.
Operator: The next question is from Sean McGowan with ROTH MKM. Please go ahead.
Sean McGowan: Thank you. A couple of questions. So, in terms of margin, you’ve talked about some potential shifts to lower margin segments, etc., but at the same time, stripping out Atchison, the fourth quarter margins were at extremely high level. So can you give us some overall color on how you expect gross margins to trend in 2024?
Brandon Gall: Yeah. Thanks for the question, Sean. I’m glad we got to this. I thought we’d get to it earlier, actually, but, yeah, so, we got the closure of the Atchison Distillery. We anticipate it’s going to be very creative for our overall consolidated gross margin structure. So in the performance that we provided this morning for last year, as an example, consolidated margins would be 42.5% in 2023. Going forward this year, we expect margins to be right in there in that low-to-mid 40% on a consolidated basis. By segment Distilling Solutions on a pro forma basis, it’s a little bit north of 45%. We expect it to be in that low-to-mid 40s. The expansion is not going to be as strong as you might expect, but that’s partly due to the brown goods sales mix that we’ve described.
Within Branded Spirits, we do anticipate more expansion this year. So we finished the year in the mid-40s and we expect to be in the mid-to-upper 40s, potentially in 2024. Ingredients is going to be a little bit more challenged near-term, and there’s really two main reasons for that. Number one is, the additional $4 million to $6 million in cost of drying, the start slurry. That’s going to temporarily weigh on the segment this year until we get a longer-term solution in place to figure that out. But also, we’re ramping up our new Proterra facility commercially. And we’re not going to have it sold out in 2024. So, there’s going to be more overhead to absorb as part of that. So for those two reasons, we actually expect Ingredient solutions margins to be in the mid-20s for the year.
So hopefully, Mitch or I’m sorry, Sean, that answers your question.
Sean McGowan: Yeah. Very helpful. One other clarification and then a quick housekeeping one. When you talked about the first quarter being lower than the subsequent three quarters, I think that’s typically the case. But are you trying to imply that the first quarter could actually be below last year on a pro forma basis?
Brandon Gall: Yes. That is, what we’re implying. And there’s four main reasons to that, and it spans in all four segments, some of them we touched on. One of the bigger ones, in fact, the biggest driver in our look forward is in our Branded Spirit segment, excuse me. And that’s really the result of the timing and seasonality of our allocated and single barrel pick items within our Premium Plus brands. That usually is more weighted toward the back half over the last three quarters but this year it’s going to be even more so. And those items, as you can imagine come with a lot of gross profit attached to them. So even on a year-over-year basis, we’re going to do less in Q1 of this year than we did last year in Q1. And really the reason for that is, the ideal time to get those products out in the market is in Q3 and Q4.
And then last year, when we’re getting those products out, we experienced some delays operationally, and so some of them accidentally trickled out into Q1 of this year. So we’re going to be lapping that. Brown goods commitments were the second one, while we feel really good about having the vast majority of those committed. It’s not going to be equal across the year, as David alluded to and so that’s going to be more weighted towards Q2 through Q4. We also mentioned the Lux Row expansion, which is going to take off in Q2 of this year. That’s our American whiskey distillery in Kentucky. And so the new distillate sales we’ll get out of that facility, will not have a chance in Q1 to take place, but will for the remainder of the year. And then again for Ingredients, I mentioned the commercialization of Proterra, that’s going to ramp up as the year goes on.
And then as we handle these international headwinds we’re seeing, as we already discussed, we expect those to be offset, but not all at once in the first quarter, but as the year plays out as well.
Sean McGowan: Okay. Thank you. And then a quick housekeeping. What do you expect the effective tax rate to be for the year?
Brandon Gall: Yeah, between 24.5% and 25.5% this year. In another note, our A&P advertising promotion for Branded Spirits, while we’re clicking through here, Sean was about 15% — 15.5% in Q4. We expect that to be around the same in 2024. And the reason for that is again, flattish to low single-digit sales for Branded Spirits for the reasons I already described, but really ramping up our advertising and promotion investment into Penelope as the year goes on this year.
Sean McGowan: Okay. Thank you very much.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to David Bratcher for any closing remarks.
David Bratcher: Thank you for your interest in our company and for joining us today for our fourth quarter and full-year 2023 earnings call. We look forward to talking with you again after the first quarter.
Operator: The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
