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Tempur Sealy International Inc
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Good day, ladies and gentlemen, and welcome to the Tempur Sealy First Quarter 2018 Earnings Conference Call. I would now like to introduce your host for today's conference call, Ms. Aubrey Moore. You may begin, ma'am.
Thank you, operator. Good morning, everyone, and thank you for participating in today's call. Joining me in our Lexington headquarters are Scott Thompson, Chairman, President and CEO; and Bhaskar Rao, Executive Vice President and Chief Financial Officer. After prepared remarks, we will open the call for questions.
Forward-looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities and Litigation Reform Act of 1995. Investors are cautioned that these forward-looking statements, including the company's expectations regarding sales, earnings, net income, and adjusted EBITDA, and anticipated performance for 2018 and subsequent periods, involve uncertainties. Actual results may differ due to a variety of factors that could adversely affect the company's business.
The factors that could cause actual results to differ materially from those identified include economic, regulatory, competitive, operating, and other factors discussed in the press release issued today. These factors are also discussed in the company's SEC filings, including but not limited to, Annual Reports on the Form 10-K, the company's Quarterly Reports on 10-Q under the headings Special Note Regarding Forward-Looking Statements and/or Risk Factors. Any forward-looking statement speaks only as of the date on which it is made. The company undertakes no obligation to update any forward-looking statements.
This morning's commentary will include non-GAAP financial information. The press release contains reconciliations of these non-GAAP financial information to the most directly comparable GAAP information, except as otherwise discussed in the press release as well as information regarding the methodology used in our constant currency presentations. We have posted the press release on the company's investor website at investor.tempursealy.com and have also filed it with the SEC. Our comments will supplement the detailed information provided in the press release.
And now, with that introduction, it is my pleasure to turn the call over to Scott.
Thank you, Aubrey. Good morning, and thank you for joining us on our 2018 first quarter earnings call. In a few minutes Bhaskar will review our quarterly financial performance with you in detail. I would like to reflect on the progress the team has made in resetting the foundation of the company following the termination of our supply agreement with Mattress Firm approximately a year ago. I'm very proud of what's been accomplished as an organization in the face of an unexpected challenge.
While there's still more work to be done, I'd like to highlight four key items. First highlight is that we are making progress balancing our distribution model. Our primary focus will always be third-party retail distribution as the vast majority of consumers still prefer to try out mattresses in well-run local stores before purchasing. However, with the termination of our supply agreement with Mattress Firm, our domestic doors declined by 3,500 locations, leaving us gaps in our retail network. We have worked to address this issue in two ways. First, we've bolstered our relationship with supportive retail partners and those retailers are enjoying success with higher ASP and strong closing rates.
Second, we've begun to fill some of the more significant gaps in our retail network by selectively opening our own stores. This quarter, we opened 16 new Tempur-Pedic stores, bringing our total North American store count up to 29 at the end of the quarter.
These stores are performing ahead of expectations. And based on our early analysis, we believe they are generating incremental sales and likely increasing Tempur-Pedic's brand awareness in the local market, which should aid all retailers. As I have mentioned before, each of these high-touch customer-focused stores are designed to have about the same economics to us as 20 Mattress Firm stores.
Additionally, as certain consumers prefer to shop from home, we continue to be focused on enhancing our online business to enable us to be everywhere customers want to shop. As Bhaskar will highlight in a minute, the result of our efforts in North America drove a 29% growth rate in our direct-to-consumer business.
Today, we have a more balanced distribution footprint in North America than we did 12 months ago, led by a diversified group of strong retail partners and support by a growing direct business. While I'm pleased with our initial progress on managing this balanced omni-channel approach, this transformation doesn't happen overnight and we still have ways to go.
The second highlight is that we have meaningfully enhanced our product portfolio in North America, further elevating our brands in the marketplace. Our new Sealy Hybrid line has been successfully launched and very well received by our retail partners. It is performing above our expectations.
In recent weeks, we have begun to roll out our entirely new Tempur-Pedic bedding system, including the Adapt and the ProAdapt mattresses, a refreshed line of pillows, and a home and family of adjustable bases. As a reminder, the Adapt and ProAdapt models represent the first phase of our all new Tempur mattress rollout, with the new premium models set to be introduced in late 2018 or early 2019. The new Tempur-Pedic products have been well received by our retail partners and to-date, orders have been strong and in line with our expectation.
The third highlight is the solid growth we have seen in our international business. International sales grew 17%, and on a constant currency basis, 8%. We realized growth on a constant currency basis in all three major geographic areas: Europe, Asia-Pacific, and Latin America. As a reminder, in 2017, we launched new Tempur-Pedic products internationally. Our growth this year has been driven by the success of the 2017 rollout.
The fourth and final highlight I'd like to cover, the resilience of our gross margin. This quarter, our gross margins were meaningfully impacted, as compared to first quarter last year by the operating deleverage associated with the termination of Mattress Firm business, which was heavily weighted towards higher-margin Tempur-Pedic products.
We also absorbed $12 million of commodity cost inflation during the quarter as our price increase did not take effect until mid-March. Despite these significant headwinds, our gross margins were consistent with the first quarter last year. With the Mattress Firm comparison period behind us, and our new Tempur-Pedic product launching, we expect to drive EBITDA growth in future quarters.
While it's been a challenging 12 months for the team, we have put our company on a stronger footing with a diversified third-party retailer base, a rapidly growing direct-to-consumer business, and enhanced product portfolio. We believe that supporting our strong portfolio of brands with significant advertising spend, properly servicing customers, launching innovative products, manufacturing them effectively, and making them available where the consumers want to shop is a winning strategy and the path to creating meaningful shareholder value over the long term.
With that, I'll turn the call over to Bhaskar to walk us through the first quarter financial results.
Thank you, Scott. Before going into details, a few key financial highlights from the first quarter. Global net sales were $648 million, a decrease of $74 million versus the prior year. Gross margin was consistent with the prior year, 41.3%. Operating margin was 8.3% of net sales, and EBITDA was $83 million. Earnings per share for the quarter was $0.42. And lastly, I'm pleased to report there were no pro-forma adjustments this quarter.
Our leverage ratio was 4.3 times. As we communicated on our last earnings call, we expected to be slightly over our target leverage ratio range of 3 to 4 times. Going forward, we expect to lower the ratio over time through earnings growth and debt pay-down to be back within our target range during 2018. Then we expect to be in a position to consider other alternatives and allocations of capital, including the resumption of our share repurchase program.
My comments going forward on net sales will be excluding Mattress Firm from the prior year. I should also mention that we had a change in classification required by the new revenue recognition accounting standard that shifted royalty income to the revenue line, increasing net sales by $5 million with the corresponding increase in expenses, resulting in no impact to EBITDA. This change in the accounting standard will impact our comparisons in each quarter this year.
On a segment basis, sales in North America were consistent with the prior year, with Tempur increasing low-single digits and Sealy being down low-single digits. As we disclosed earlier, orders started out a little bit slow in January but Presidents' Day weekend was solid. Subsequently, the orders weakened.
North America sales trends were unfavorably impacted by three factors. One, a highly promotional environment in the quarter, including heavy discounting at Mattress Firm. It was our strategy not to follow short-term follies to drive low profitability unit growth. This costs us some units in the quarter. Two, continued weakness in certain department store counts. And three, the planned transition of legacy products including the sell-off of adjustable bases with our retail partners.
As previously discussed, we expect a certain amount of noise during launches and we believe this is be a temporary headwind as we start to ship new products. Our North American wholesale channel decreased 2% and the direct channel increased a robust 29% in the quarter. North American gross margin declined 90 basis points to 37.9% as compared to the prior year. This was driven by commodity cost inflation, fixed cost deleverage on lower unit volume, and unfavorable brand mix. These headwinds were partially offset by improved channel mix, operational improvements, and favorable product mix. We expect the brand mix headwind to lessen starting in the second quarter as new Tempur products ship in North America.
North American operating margins declined 330 basis points to 11.1% as compared to the prior year. This was driven by operating expense deleverage including start-up expenses associated with store openings and the change in gross margin. As a reminder, we opened 16 stores during the quarter, which have some start-up expenses and have a bit of a ramp-up period, both of which are short-term headwinds to operating margin.
Turning to our International segment, on a reported basis, net sales increased a very robust 17%; and on a constant currency basis, sales increased a solid 8%. On a reported basis, the wholesale channel increased 18%, and the direct channel increased 12%. As Scott mentioned, all geographies were up on a year-over-year basis.
International gross margin was 51.5%, similar with the first quarter of 2017. International operating margin declined 260 basis points to 16.5%. This was primarily due to a significant investment in advertising in Germany and Asia-Pacific, as well as the modest impact from the change in the accounting standard.
Now, turning back to the company's global performance, operating income was $54 million and included investments in advertising and expansion of our company-owned stores around the world. I'm pleased to report, after normalizing for the termination costs in the prior year, as well as the change in the accounting reclassification mentioned earlier, our operating expenses were essentially flat.
EBITDA was $83 million, down $38 million from last year. EBITDA was impacted by fixed cost deleverage, increased commodity cost, and lapping the $9.5 million one-time payment by Mattress Firm in the prior year. This was partially offset by favorable channel mix and operational improvements. The tax rate was 30%, interest expense was $23 million, and EPS for the quarter was $0.42.
Now, moving on to the balance sheet and cash flow items. As planned, we used operating cash flow of $10 million in the first quarter. Cash cycle was unfavorable by four days versus the first quarter of 2017. This was principally driven by higher inventory levels to support the launch of our new Tempur-Pedic products in North America. The first quarter is normally our high watermark for debt during the year. And at the end of the first quarter, net debt was $1.8 billion. Today, we reaffirm our 2018 adjusted EBITDA guidance of $450 million to $500 million.
Before I turn the call back over to Scott, I want to flag a few items for modeling purposes. For the full-year 2018, we currently expect D&A of $110 million to $120 million, CapEx of $65 million to $75 million, and interest expense of $90 million to $95 million. We expect the tax rate to be between 26% and 28%, and the share count to be 55 million.
And now, I'll turn the call back over to Scott.
Thank you, Bhaskar. Great job. Now, turning to our long-term corporate initiatives. First, developing the most innovative bedding products in all the markets we serve. As I mentioned previously in North America, we launched our new and improved Sealy Hybrid product and are currently launching our full line-up of new Tempur mattresses, pillows and bases.
We invested heavily in these new lines, both from an R&D standpoint and in terms of higher quality components to deliver true quality to the marketplace. The new Sealy Hybrid line has a substantially improved feel and aesthetics, which is resonating with both retailers and customers.
This product launch is the third and final piece of our North America Sealy masterbrand offering, which was introduced last year to simplify the selling process for retailers and to drive improved product quality and efficiency. The new Tempur-Pedic product have just started launch in April and feature Tempur APR, advanced pressure relief technology, a breakthrough formulation that we've been working on for over three years.
The new improved Tempur material delivers two times the pressure relief benefits of ordinary memory foam, while also unlocking a broader range of feels for the customer. Although rollout is still ongoing, the initial response at retail where the new Tempur-Pedic products have been floored, has been outstanding. Many of our retail partners consider it to be the best Tempur-Pedic product in the company's history.
The second long-term initiative is to invest significant marketing dollars to promote our worldwide brands. Our direct advertising spend was up worldwide, as we support our brands and retailers. This year in North America, we have faced the weighting of our advertising spend towards the latter part of the year in order to drive customers into the market. At the same time, our new Tempur-Pedic products will be widely available. We expect for the full-year total direct advertising spend will be up versus 2017, demonstrating our commitment for the long term.
The third long-term initiative: to optimize worldwide distribution to make sure our products are properly represented in all channels. We're letting customers choose where they want to shop and are not trying to influence which channel they choose. That means our products need to be available through every distribution channel. As we mentioned earlier on the call, we are making progress in advancing our third-party retail relationships but are also focused on offering a premium shopping experience through our company-owned stores, as well as growing our online presence.
This omni-channel strategy will create a company that is better positioned to succeed in the future. We'll be more diverse and be better able to control our brand story and have closer relationship with our customers.
Our last initiative is to drive increased EBITDA. With the anniversary of Mattress Firm termination and a full suite of new exciting products, we expect to begin to report increasing EBITDA going forward. With iconic brands, some of the most innovative products in the mattress industry, and a talented worldwide workforce, Tempur Sealy is well-positioned to improve customers' lives and create significant shareholder value.
Operator, will you please open the call up for questions?
Our first question comes from Bobby Griffin with Raymond James.
Good morning, Bobby.
One moment.
And congrats on getting through the last challenging year-over-year comparison quarter.
Thank you.
I was just curious. Can you maybe clear up some of the comments about the progression that you mentioned during the quarter? January started off soft, Presidents' Day was better and then it kind of tailed off after that. Is that how the quarter ended or is that – or how should we think about how it played through after Presidents' Day?
Yeah. Kind of ground everybody. As we said on the year-end call, and I think it's consistent with what other industry participants have said, January was soft, and then we went into Presidents' Day weekend and it was solid and we've said that on the earnings call at year end, and then it tailed off. And if you heard me talk about before, we hit this kind of air pockets on sales. And it was slow.
Then towards – look, towards the end of the quarter or really more into April, things have picked up. And I think that's also consistent with what I've heard from some other industry participants. So, yeah. I don't know. Some of it was probably promotional activity in the marketplace. Some of it was clearly some weather, which you always hate to call out that we have first quarter. But in the second quarter, the order bank looks very solid going into the second quarter.
Thank you. Our next question comes from Bob Drbul with Guggenheim Securities.
Hi. Good morning. I guess just on the distribution plans, ex-Mattress Firm, with those guys being out of the equation, you talked about the department store channel. You've had some issues with one of those or two of those. Can you just talk about the relationship that you have today with various department stores, and just in terms of like trying to replace the door count at the Mattress Firm, where the opportunities lie for you?
Sure. There's a couple of questions in there, but let me see if I can kind of address them. I mean first, just relationship-wise, a very strong relationship with the department stores. They're very important to us. They're very good customers. And from a relationship standpoint, I would say that in all the department stores, we have a very good relationship. What we're feeling, and what you were pointing out in the numbers is, some of the department stores are having some traffic issues and some sales issues, and they're closing some stores, and they're dealing with their reality, and that has created some pressure on our numbers. So, that's not a relationship issue. That's just what I'll call, we'll call that a brick-and-mortar retail issue.
Your second question that was embedded in there is what are we doing to replace those doors. We do have some people who are setting up some new distribution. We call them greenfielders. They're opening up some new stores. We're obviously opening up some of our own Tempur-Pedic stores. But we're looking – and we're doing some online, direct-to-customer through the online, but we're also working with the other brick-and-mortar retailers to increase velocity of our slots as we look to see where those customers who are migrating from, we'll call it closed department stores, where that business is going. Consistent with our strategy is we're really following the customer and making sure our product is properly presented everywhere the customer wants to shop.
Thank you. Our next question comes from Peter Keith with Piper Jaffray.
Hey. Thanks. Good morning, everyone. Just a two-part question on some of the product launches. So last quarter you had mentioned, you thought there'd be a $10 million EBITDA shift out of Q1 into Q2. Wondering if you can frame up what that actually turned out to be.
And then secondly, there is some chatter on the Tempur app just having some very minor slight delays that could cause some flooring issues going into Memorial Day. Could you give us some color around that dynamic?
Sure. You were able to squeeze two questions into a one-question call. I'm going to let Bhaskar do the numbers. But let me talk about our launches. We had two launches. We obviously had the Sealy launch, the Hybrid launch. That was completed within the first quarter. It's gone very well and the Sealy Hybrid is performing over our expectation.
The other launch is the Tempur launch, and as I called out at the end of the third quarter, if my memory serves me, that the Tempur launch was going to be large, complex, and it would be kind of difficult from a modeling standpoint for a little while as we try to work through replacing all of the Tempur product in North America. Again, one of the more complicated launches.
Where I would give our Sealy launch, an A, and it is complete at this point. On Tempur, I'd probably give us a B. As you mentioned, there's a little bit of chatter out there. And we had a supplier capacity issue down in Tempur and that did slow the launch somewhat and disrupted a little bit. But I'd call it minor, and just to kind of frame it, where we'd originally planned to probably be 80% to 85% floored by Memorial Day, I think we'll be more like 70% floored by Memorial Day.
So it's probably going to cost us a little bit of sales activity in the second quarter, but I think the important thing to really focus on in the launch is the quality of the product, which is very good. The response from the retailers who have it has been outstanding. And more importantly, customers who've bought it.
But yeah, there's a little bit of indigestion. But to be frankly honest, probably from our perspective not unexpected. And that's why I called out in the third quarter how big and how complicated this launch would be. So overall, I'm going to give us a B on the Tempur launch. And Bhaskar, you want to go now on the question on the $10 million that was talked about earlier?
Absolutely. Just building off the launch discussion. Any time you have a significant launch, there is going to be a certain amount of noise that happens from a quarter and into another quarter. So, what we experienced in the first quarter is we did experience the impact associated with the transition. Now as I step back from it, is we will not understand the full impact until I get out of the second quarter. However that said, from a magnitude standpoint, it's not going to be any larger than what I previously communicated, was $10 million of EBITDA out of Q1 into Q2.
Thank you. Our next question comes from Laura Champine with Loop Capital Markets.
Good morning. Just wanted to ask about what's happening in the retail channel. It looks like Macy's pulled Tempur out of their line-up. Is that a negative impact for the rest of the year? And if so, could you help us quantify that?
No. First of all, you're accurate in your comment, is that they are not selling Tempur at Macy's currently. They did not sell very much Tempur, to be frankly honest. And that would be immaterial and insignificant to the company. And what they're replacing those slots with, are more productive SKUs, which will include some (27:27 – 28:09)
Operator?
Our next question comes from Brad Thomas with KeyBanc Capital Markets.
Thank you.
Yeah. Hi. Good morning. Can you guys hear me?
Yeah.
Sorry. You guys died out a bit, I think, on the last question there.
Excuse me. Did I give an answer in on that question or did I go silent?
You went silent about halfway through it. So...
Okay. Let me...
...maybe you want to answer that question first.
Yeah. Let me answer that question first so that we don't lose that question.
Perfect.
The question related to Macy's and Tempur. Macy's have moved away from Tempur. They didn't sell much Tempur historically. That is relatively insignificant for them and for us. And in looking at the productivity of their slots, they're going to move in another direction, which will include some Sealy beds. So, we're very supportive of what they're doing in that area. And, again, I don't think it's material one way or the other to Tempur Sealy.
Great. Thanks, Scott. And so, my question was just on the Tempur and the Sealy brands, if you could just give us a little bit more color about how each of those performed in 1Q? And how you we're thinking about the trajectory of those brands as we move into 2Q and the back half of the year?
Sure. Obviously, there was a lot of noise in the first quarter between, we still had Mattress Firm numbers out there. We had highly promotional environment driven by kind of a wounded retailer. Quite frankly, probably our media mix, we probably leaned a little heavy into digital in the first quarter. We spent all the money, but we probably leaned a little heavy into digital and probably need to lean a little bit more on television. So, there's a lot of stuff. And of course, we have a launch going on.
But just in general, the Sealy Hybrid has been probably one of the best products Sealy has ever launched, and we feel good about the Sealy brand overall. As we've talked about in the past, there is pressure on the Sealy brand. It's a below $1,000. We continue to feel that, and we're moving price point up, and working at the high end, and we're so far working very successfully in that area.
Just to touch briefly, because we're kind of focused on North America and my comments were on North America, I do have to give a call out to the International group. 8% growth constant currency is a big number, but I wanted to point out if you take our Asian joint venture, which is primarily Sealy product, and you are asking about brand, and if you were to consolidate our Asian joint venture, which again is mainly Sealy product, our international growth rate on the revenue line would be 12%. So, if I look – kind of answer your question more broadly worldwide, gees, that's strong. And so, we feel very good there.
On the Tempur side of the house, again, obviously, internationally, we're benefiting from the second-year launch of the new Tempur product internationally, and I called out the international numbers just a second ago. We came off a 19% growth rate in the fourth quarter, and then, in the first quarter, look, it's a little slow. We were a little light on the revenue at wholesale, but again, in the promotional environment we're talking about and with the merchant, with the mix changing, and the floors changing, it's pretty hard to get much of a read there.
So, I think in general, we feel very good, but I expect going forward from probably the second quarter on, that Tempur will be more of a story, because we've made significant investment in new product. And I would expect for the next couple of years that Tempur is going to be probably the big story between the two brands. But I think Sealy is going to be solid.
Thank you. Our next question comes from Carla Casella with JPMorgan.
Hi. Some of my questions have already been answered. But can you just talk about – you mentioned the gross margins in the U.S. and the puts and takes in terms of the increased cost. Can you just give us a sense for how much of the gross cost increases are coming from transportation versus materials, or give us any kind of barometers, what percentage of your COGS are transportation or steel or any of the key materials?
Sure. I'll let Bhaskar kind of go through that in detail. But look, we were really happy with the gross margin performance, considering the headwinds that we had in the quarter and you mentioned a couple of them, transportation for sure and commodities. And we had to eat those costs before our price increase really came in to help offset them. But Bhaskar, you want to help her kind of drill down on it a little bit?
Sure. Sure. So, as we think about commodities, as we called out, we experienced commodity cost inflation in the quarter and that did put pressure on us, on the gross margin line, both from a Tempur Sealy, and as well as, International. We called out approximately $12 million impact in the quarter from commodities. And as we think about the rest of the year, if I were to digress for a moment, is that the industry typically has been very successful at passing along commodity cost increases in the form of price with a bit of a lag. As we – now turning back – as we talked about commodities for the full-year going into the year, we quantified it in around $30 million. And as we sit here today, we have seen commodity cost inflation. And we're thinking about it more in the $45 million range. So, we've seen a bit of an increase. But now, turning back to what I led off with is that, as we always do when we face this type of conditions, we are evaluating price.
Yeah. I'd just kind of add on a little bit there. What we're seeing right now in commodities and, really, in all the areas, I think it's very likely that the industry is going to need another price increase before the end of the year.
Thank you. Our next question comes from John Baugh with Stifel.
Good morning. And I guess, Scott, maybe following up on that inflation question. So, you've seen an escalation, I guess, of $15 million and now the input inflation forecast. I guess and, I think, if I'm not mistaken, Sealy raised prices in March and with the launch of Tempur, there's the plan to capture margin or pricing, I guess, through that. So, just a clarification if I understand that right, how has the Sealy price increase gone? SSB is not doing well from what we hear. I'm just curious how easy or difficult? I know pricing is never easy, but it's going to be prospectively as well with what you've seen so far year-to-date. Thank you.
Sure. First off, let me confirm. What you said is basically accurate that Sealy took pricing on a like-for-like basis and then Tempur, there's some embedded pricing in the new launched product, which is not inconsistent with normal strategy. You asked about how did the Sealy pricing go. Look, it went very well. We got pricing everywhere. And you're right, it's never easy, but as you remember, we ate quite a bit commodity costs before we went to the retailers and pushed the price increase through. And our position is – look, when commodity prices come through, we will try to offset them with efficiencies. But there is, at some point, we need to pass them through. Others in the industry, from a component standpoint, also passed through price increases. And so, I think that went fine.
As far as you mentioned a competitor and how their price increase went, I'm not familiar with how their pricing went, or what their pricing strategy is, or what their issues are? So, I can't really comment on that. But from our standpoint, pricing went in very well and relatively speaking, I would say probably not easy but went very well.
The other thing I'd point out on the commodity issue is that, although, we're not thrilled about having it and having to deal with it, I will tell you that I think Tempur Sealy, based on our size and our expertise in this area and our contracts with our suppliers, we're in the best position probably in the industry to deal with it. And so, from a competitive analysis standpoint, I think we're better positioned and certainly bed-in-a-box companies, and certainly smaller manufacturers because of the nature of our critical mass.
The one thing I would like to highlight is specifically on the Sealy side, the price increase went into effect later in the quarter. So, we'd expect to see a better – a bigger benefit of price as we progress through the year.
Thank you. Our next question comes from Seth Basham with Wedbush Securities.
Thanks a lot, and good morning.
Good morning.
My question is on the sales outlook. I know you don't provide specific guidance as it relates to sales. In North America this quarter, ex-Mattress Firm, you're flattish. How should we think about your ability to drive volume and drive top-line for the balance of the year?
Yeah. I mean, first of all just as background information. One of the reason we don't give sales guidance is because it's very volatile and I kind of walk people through that at times that sales can be up or down literally 25% to 30% in a given week. So, it's difficult from that standpoint. And then it's a little inconsistent with our strategy, which is to manage contribution profit. If you just want to generate top line, it really is not that difficult. It's just called discounting and promotion. And that's not consistent with our strategy. So, we have a tendency to focus on the net contribution as opposed to the top line.
Having said that, okay, and kind of hedge those words, when I look across the world, clearly the international group is performing well with new product that was launched last year. The worldwide economy feels generally pretty good. There's a country here or there that we're watching closely. But in general, worldwide, the consumer feels pretty good.
We've got a hot product in Sealy with the Hybrid. We've got some pressure below $1,000 which we've talked about. And then we've got the main asset in North America with new Tempur product coming. And we would expect that it will over-perform last year's Tempur products, so we'd expect that to be some sales growth.
But having said all that again, in the framework of our strategy, which is we're not going to go out and buy business. And in a highly promotional environment, at times we might lose some units if people want to do what I'll call irrational pricing. So, I can't really tell you more because I really don't know what some people's pricing policies are going to be going forward, and that's primarily pointed at a large retailer who's been very promotional this year.
Thank you. Our next question comes from Curtis Nagle with Bank of America Merrill Lynch.
Great. Thanks very much for taking the question. I just wanted to follow-up a little more on North America gross margin. So, I think I see it going forward, as you'd mentioned, you're going to have pricing offsetting commodities. You should have leverage or unit leverage with Firm no longer in the comparisons, the launches of the Hybrid, Tempur, pillows, all that stuff that should be accretive and then, a direct business, which at least on a store basis is much larger and, by your own comments is extremely profitable. I guess why couldn't or why shouldn't this lead to significantly better gross margins through the year and beyond?
Okay. Let me help on one of those I'll let Bhaskar clean it up for me. As I listened to your list, I ticked them off, yeah I agree, I agree, I agree, except for one. Remember, on the Tempur brand, we're launching the low end first, okay. And so, to the extent that the low end one is successful, there's going to be a merchandising, natural merchandising mix pull-down because the new product – because we're launching the low-end would have a lower margin.
Then, as we've talked about before, there should be some cannibalization from the higher-end Tempur product into the lower-end product until we get what we call the Tier 3 and new breeze out so that you've got the full suite of products on the floor. Those will be coming late fourth quarter, early first quarter. So, you're going to have a little bit of merchandising mix pressure in the Tempur brand because of the pacing of the rollout. Anything else Bhaskar?
No. The only other item I would like to highlight is from a brand mix standpoint, Tempur versus Sealy. We would expect that Tempur grows faster than Sealy and therefore, get some positivity across the North American gross margin profile.
And you'd have a little bit of lag time possibly on price adjustments and commodity hits.
That's correct.
So, other than that, what he said would be positive to margin.
Correct.
Thank you. Our next question comes from Keith Hughes with SunTrust
Thank you. Bhaskar, you gave some good commentary on raw materials moving forward. I just want a couple of items, clarify the $45 million, is that a price cost mix number? And what quarter do you think where you stand today will that all sort of peak out as a negative for you?
I think, if I understood the question, you're asking kind of what is the $45 million. And correct me if I'm wrong, Bhaskar, I believe that's the negative impact on this year's EBITDA.
Correct, commodities.
And it's not a net number. That's a gross number before any pricing adjustments, right?
Correct. Correct. And as we pointed out, it's about a $50 million increase as we originally thought about it. What we would expect is that we would see the peak in the first quarter and it would tail off thereafter. However, where we're sitting at today is that we would expect the peak to happen sometime during the summer and then flatten out thereafter.
Thank you.
Our next question comes from Carla Casella with JPMorgan. One moment. Your line is now open, Carla.
Sorry about that. I just had a question on the inventory levels in the channel. And given the retailers' closing stores, are you – have you worked through that or could we see some additional bad debt, expense, or adjustments to inventories as the department store inventories worked their way up/down?
Yeah. I'll let Bhaskar help me with it, but I'm not expecting any significant bad debt relative to retailers worldwide as I sit here right now. And retailers who are closing stores generally would not have any significant inventory to work through. The inventory that we do have to work through, though, are the floor – old floor models of Tempur in, what I'll call, kind of a natural launch issue as they've got to sell off some of their floor models and usually have some delay in what our new Tempur sales as retailers are having to, what I'll call, naturally sell off the old product line. That would be the only inventory issue that I can see near term. Anything else, Bhaskar?
I would agree. Let me generally – we do a good job at managing our exposure as it relates to credit risk. I don't see anything out there that I'm overly concerned about. And just reiterating your point on inventory at our retailers. So, nothing more to add there.
Our next question comes from Michael Lasser with UBS.
Good morning. This is Atul Maheswari filling in for Michael Lasser. Thanks a lot for taking our questions. So, your new store openings accelerated significantly this quarter. I'm just wondering what's going to be the likely cadence for the rest of the year? And more longer term, where do you see your store count evolving over the next few years?
Great. Thank you for the question. Yeah. You're right. Probably the news to our store is probably we opened a few more than we probably expected to this quarter, but the team's done a good job of finding the proper locations. To kind of ground everybody, the plan was to open about 40 stores this year. Pause, look, and make sure that the stores are performing as expected.
And when I say performing as expected, that's of course based on sales and EBITDA, but it's also a detailed look to see where those sales are coming from, and seeing how impactful the stores are to our other customers. And we've carefully selected the sites and carefully devised the business plan for those sales to be incremental and not cannibalize other retailers.
And I think the two things I'm excited about is, one, the stores are open and I think we are probably – we probably have 30, 31 stores open today as I sit here. The stores are performing on an EBITDA and sales basis above our pro forma. But also, and just as importantly is that when you go through and look at the sales of other retailers in the areas where we sold stores, quite frankly they have performed better than in markets where we have not had the stores. So, that is giving us some more confidence that these sales are incremental and not cannibalizing, and that's something we'll continue to watch.
Having said all of that, probably the 40-store pause, as I've talked about in the past, that pause will probably be pretty short because we're not seeing any issues relative to personnel, finding good locations, cannibalization, or anything else. So, we'll probably north of our 40-store opening by the end of the year, and then we'll continue to look at it.
But, again, I don't think this particular channel is a huge number of stores. What we're looking for is some iconic stores that will drive brand awareness and give us some footprints in some markets that we're not performing as well as we'd like to. And so, I think maybe by the end of the year, maybe the number is 50 stores, and maybe we'll do maybe another 25 or something next year. But those are very soft numbers, again, dependent on the performance of the stores, both from an EBITDA standpoint and where we believe the sales are coming from.
The only incremental thing I would like to highlight there is, as you pointed out, we did open 16 stores during the quarter, and we did incur approximately $2 million of start-up expenses associated with that. And I would characterize that start-up as just the get-up-and-go type of cost, and also the ramps associated with sales before they get up to full speed. I would anticipate that impact to be – we'll see a bit of that in the second quarter, but then, thereafter, it will normalize itself out.
Good call out, Bhaskar.
Ladies and gentlemen, that does conclude the Q&A portion of today's conference. I'd like to turn the call back over to Scott for closing remarks.
Thank you, operator. To the almost 7,000 employees worldwide, thank you for what you do every day to make the company successful. To our retail partners, thank you for your outstanding representation of our brands. To our shareholders and lenders, thank you for your confidence in Tempur Sealy management and its board of directors. Operator, that ends the call for the day.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.