I would now like to call over to Mr. Bhaskar Rao, Chief Financial Officer.
You may begin.
Thank you, operator. Good morning, and thank you for joining us on today's call. Joining me today is Scott Thompson, Chairman, President and CEO. After prepared remarks, we will open the call for Q and A. Remarks made today concerning future expectations, events, objectives, strategies, trends or results constitute forward looking statements.
Actual results or events may differ materially due to a number of risks and uncertainties, and the company undertakes no obligation to update or revise these statements. For a summary of risk factors and additional information, please refer to the press release and 8 ks, along with sections of our 10 ks, 10 Q entitled Forward Looking Statements and Risk Factors. This morning's commentary will include forward looking non GAAP financial information. The press release contains an explanation as to why the company is unable to reconcile this information to its most comparable GAAP financial measure without unreasonable efforts. We have posted the press release on the company's investor website and have also filed it with the SEC.
Our comments will supplement the detailed information provided in the press release. Today's call will be limited to covering the items in yesterday's press release. We will not discuss items outside the release and are looking forward to updating you on current earnings and operating trends at an appropriate time after the close of the Q2. And now with that introduction, it's my pleasure to turn the call over to Scott.
Thank you, Bhaskar. Good morning, and thank you for joining us today on our call to discuss our recently signed supply agreements. Clearly, we are making significant progress on making sure our products are where customers wish to shop. Starting in North America, first with Mattress Firm. As way of background, Tempur Sealy products were successfully distributed through Mattress Firm for many years.
This benefited both companies. In fact, Mattress Firm represented 21% of Tempur Sealy's global sales in 2016, of which more than half were sales of our high margin Tempur Pedic products. Then in early 2017, the relationship was terminated when the former Mattress Firm management team and the Steinhoff Organization demanded economics, which we believed would put our other retailers at a competitive disadvantage in the marketplace. This termination was highly disruptive for Mattress Firm, Tempur Sealy and the broader bedding industry. There were really no winners in this unfortunate situation.
The results were the largest bedding manufacturer in the world was no longer doing business with the largest bedding retailer in North America. Post termination, we remained focused on our long term initiatives and were successful at recapturing a good bit of lost business through our 3rd party retailers and our direct to consumer business. But certainly, we did not recapture all of the lost business. Our Tempur Pedic, Sealy and Sturm and Foster products were not available at the largest bedding retailer in the U. S, which is counter to our global strategy to be wherever the consumer wishes to shop.
It is for this reason, we believe it is better for the companies to work together rather than as competitors. We also believe that resolving this matter in a way that maintains the competitive balance between retailers and at the same time allows Mattress Firm access to high end brands will help bring stability to the U. S. Bedding industry, benefiting all retailers and the global supply chain overall. As you know, we have 4 guiding principles when considering business with any potential retailer.
These include being financially viable counterparty, having alignment in our go to market strategy, trusting in and having confidence in their business plan as well as their leadership and finally, believing that the relationship is durable and long term. Throughout our conversations with Mattress Firm, during the past 6 months, our Board of Directors and management team have been committed to these standard principles. We are pleased to announce this week that we have officially entered into a new evergreen supply agreement with Mattress Firm. We focused on creating a win win relationship, not only one for the 2 companies, but one that will also help North America bedding industry overall. We've performed our due diligence, and we believe we're doing business with a new, different and greatly improved Mattress Firm.
We understand the new leadership team at Mattress Firm is driving towards a customer centric strategy based on quality of service and providing true value to the customer, while moving away from the failed relative market share strategy that resulted in excess real estate investments and pressured their business model. We believe this new agreement represents a significant opportunity for both companies. This expands our distribution network. This expansion of our distribution network is a true testament to the strength of our brands, our reliable manufacturing and high quality service. Our premium brand and innovative products have allowed us to service a growing customer base.
We expect this agreement to have a positive impact on expanding our brand's share of voice in the marketplace in North America as co op spending rises. Additionally, the incremental sales growth will support increased brand advertising spend, which we expect will benefit all retailers of our products. This agreement reunites some of the strongest bedding brands with more than 3,000,000 people a year that find the right sleep solution at Mattress Firm Stores. Beginning in the Q4 of 2019, our complete portfolio of brands will be reintroduced to approximately 2,500 mattress room stores across the country, with the expectation of completing launch in the Q1 of 2020. This timing allows us to maintain the quality of our products and excellent service levels to our existing third party retailers.
Mattress Firm stores will carry a broad offering of Tempur Pedic and Stearns and Foster products and select Sealy products. Ultimately, our share of the business will be based on the strength of our products and services as retail customers determine our success. Turning to Big Lots. We're very pleased to announce that we've recently expanded our long term supply agreement with Big Lots. This agreement is expected to grow the sales of the entry level Sealy product and drive unit volume, primarily in the previously pressured below 1,000 retail price points.
The quality of our product and service was key to growing this partnership between Big Lots and the Sealy brand. We see their Store of the Future concept, which they are currently rolling out as a very compelling retail format in the value space and are thrilled to be a part of it. This is a significant win for the Sealy business as we launch incremental product into 1400 Big Lots stores with the expectation to complete the launch by year end 2019. Finally, turning to Better Bed and international expansion. As previously announced, we've also extended our European distribution network by reaching a supply agreement with Better Bet Holding, one of Europe's leading bedding retailers.
Their stores in Netherlands, Belgium and Sweden will begin carrying our Tempur brand. This is a significant opportunity for our European business in 2020. As we will complete the rollout of 100 stores by the end of 2019, approximately 10% of the total store base controlled by Better Bed. While the most important aspect of our worldwide omni distribution strategy is 3rd party retail, we continue to pursue our highly successful direct to consumer initiative, both online and through company owned retail stores. We continue to operate this portion of our business in a very profitable manner, keeping our customer acquisition costs low, while matching high end customers with high end product.
I think you can easily see our distribution is now more diverse and balanced than it has ever been. We will continue to be wherever the retail customer wishes to shop. Regarding current year expectations, as we bring on higher volume of Mattress Firm as well as Big Lots into our North American operations, We believe we have the appropriate operational controls in place to maintain the highest quality with both our existing and new accounts. Combined, the two accounts are of such a size, we anticipate some unique investments during the launch. During the back half of twenty nineteen, we expect to incur onetime cost while ramping up and that production cost will not be optimized until 2020 excuse me, until mid-twenty 20.
Let there be no question, quality of product and service are more important than short term margins. The incremental net sales in the Q4 associated with these new accounts is expected to fully cover launch cost and initial inefficiencies. Thus, these new agreements in aggregate are not expected to have a material impact on adjusted EBITDA in 2019, but we fully expect significant net sales and EBITDA benefits to accrue in 2020 beyond. The aggregate net sales from these new supply agreements is expected to exceed $400,000,000 on an annual run rate basis once products are launched and launch is completed and RSAs are fully trained. Additionally, in 2020, as we become fully ramped up and optimized, we estimate we'll generate incremental annual adjusted EBITDA in the range of $75,000,000 to 100,000,000 Finally, in short, we believe over the long term, the combination of our innovative new premium product, our expanding powerful omni distribution platform, our anticipated increase in share voice, our internal productivity and quality service levels will all help drive future profit and cash flow, thus creating meaningful shareholder value in the future.
With that operator, please open up the call for questions today.
Thank you. Our first question comes from the line of Seth Basham of Wedbush Securities. Your line is open.
Thanks a lot. Good morning and congratulations on the deal with Mattress Firm.
Thank you.
Scott, if you could provide a little bit more color on the breakdown of the value of the deals between those 3 retailers that would be helpful.
Yes, it probably would be helpful, but I'm not going to give you a lot of detail. Clearly Mattress Firm is the most significant from a revenue standpoint and EBITDA standpoint. And the Big Lots transaction is certainly significant to the Sealy brand and certainly fills in a hole, where we had a little bit of problem in the below 1,000 market. And Better Bed is considerably smaller, as it's only 100 stores in Europe, but is very material to the European operation as far as an opportunity in the long term because Better Bed has control of more stores than where we are that we're starting out at. And if we do a good job, we would hope to be able to grow that relationship.
The one
thing I would want to highlight, as Scott said, is as it relates to Big Lots is it's a very nice opportunity for us and it is in that below $1,000 space, which does fill in the units that we have lost over the last couple of years. So it's a good opportunity, but it is in that below $1,000 space.
Our next question comes from the line of Curtis Nagle of Bank of America Merrill Lynch.
Taking the question.
Good morning.
Good morning, Scott. How are you doing?
Good.
Good. So yes, I just wanted to work through the math in the $400,000,000 I guess at least of additional revenue. So I understand that firm is a smaller retailer, right, when it was almost $700,000,000 in revenues. But arguably the stores should be more productive given that you've taken out the underperformers. Stearns and Foster is now in there when it wasn't before.
You've got 2 other contracts, which at least by my estimate could be something like $100,000,000 in business. So how is the $400,000,000 not conservative? And with sealing out being covered by big lots, it just seems like the number, I guess, could be bigger.
Yes. I mean, first of all, there's no question that it could be bigger and there's no question that internal targets are higher, both for Tempur Sealy and for the retailers. But I think you also have to just stop and look. Mattress Firm is a new entity. They've done a great job in the reorganization, but they're only 6 months out of the reorganization.
As you mentioned, the store base is down 20%. They've got a new Board, a new CEO, working new merchandising plan. They're moving more to a customer centric approach. All those changes of which we fully support, it just makes making an estimate very difficult. And so I'm hopeful that that's a conservative estimate.
But I think with the totality of change that they're looking at and the working through the size of the launch, that's probably a good number. I hope in the future we're able to say, yes, that's conservative. Certainly, the internal targets are to get Mattress Firm from a revenue and sales standpoint back to where they used to be. And I think ultimately that will happen. I just don't know what the time period is, but it's not in 2020 in my estimation.
Thank you. Our next question comes from the line of Bobby Clifton of Raymond James. And your line is open.
Good morning, Scott and Boster. Hope everything's going well. Thank you for taking my question.
You
bet. First, I just wanted to see, could you provide us a little color on the current capacity utilization for both Tempur Pedic in the U. S. And Sealy? And are there going to be any needs for new capital investments or 3rd party sourcing for this new volume in 2020?
Yes. Great question, Bobby. No. We've got the capacity to do the business that's in that release plus additional capacity. Kind of give you a little more granular data from a temper standpoint, the 2 North American plants can easily lever up and no issues there, and they've got excess capacity for a number of years.
On the Sealy side of the house, it's a little more complex as the construction of those beds is a little more complex and more labor intense. We have the plant capacity. As you remember, we've only closed one very small plant in the last 5 years. We've done more volume than we've projected historically. We do have to hire some people, but from a facility standpoint, we're in good shape.
And over the last few years, we've continued to invest in our plants, having opened recently a state of the art plant in LA, along with numerous improvements in the base. So in a lot of ways, we've kind of been preparing for this, and never stopped investing in our plants. If we had not done that and if we had taken the short term approach to trying to squeeze dollars out because we had a little disruption in our sales, we would not have been in a position today to handle this volume. But no, we're not expecting any significant incremental capital expenditures other than we need to hire some people. I would point out that one of the great things about this business model is we it's built to kind of lever up and down from a personnel standpoint.
It's just the nature of the business. So we're executing under that strategy.
Thank you. And our next question comes from the line of Keith Hughes of SunTrust. Your line is open.
Thank you. You referred in the opening statement about when you'd left Mattress Firm, you would reclaim some of those sales through 3rd party or other retail channels of distribution. In the estimate you gave in the press release, have you assumed that some of those the same sort of cannibalization occurs in those numbers? And I don't even know how to figure that out. How would you estimate that?
Yes. That is a net number. And you're right to think about trying to compute that is difficult. Look, and I think that net number could be anything from 0 to up a little bit. And quite frankly, may not even be we shouldn't maybe even net it.
If we get a lot of lift from a positive share of voice, then we're going to find out that computation was overly conservative. But it's a difficult estimate. When I look at it and talk to various retailers, I mean, look, they're selling our products because our products are very strong in the marketplace, and they're making good money on them. And we've clearly worked through this situation over a 6 month period, and we've clearly worked through it in a way to keep competitive balance in the marketplace. So yes, that is a net number, but I'm not expecting anything significant from the non mattress room retailers.
And if we are correct that it helps bring stability to the marketplace from a pricing standpoint and some of the other issues we've worked through over the last couple of years that this should be a net net benefit to everybody.
Our next question comes from the line of Peter Keith of Piper Jaffray.
To follow-up a bit on that topic around share of voice, Scott, if we look at the sales contribution versus the expected EBITDA contribution, in the ballpark it implies roughly about a 25% contribution margin overall, which seems a little bit low, even taking into account that Big Lots would be sub-one thousand. So what I'm wondering is, does that $75,000,000 to $100,000,000 include what seems to be an anticipated step up in advertising overall? Or is there something else we should be aware of that keeps that contribution margin a little bit depressed?
I mean, in some of its merchandising mix, as you pointed out. And then you should expect that we're going to drive some direct advertising with the incremental sales that we should achieve from Mattress Firm and Big Lots.
Thank you. Our next question comes from the line of Brad Thomas of KeyBanc Capital Markets. Your line is open.
Hey, thanks. Good morning. Congratulations. Just to ask maybe in a little bit more detail, I guess, Scott, can you contrast at all what the current relationship and assortment and strategic priorities are with Mattress Firm today versus what that relationship had been 3 years ago when you had been partnered?
Yes. I can try. I think we were in the previous relationship thought of as a supplier. And I think in this relationship starting at the Board level, much higher level than we ever interfaced with Mattress Firm, I think we really are more considered a strategic partner. I think we've all kind of looked at least from my perspective, I think some others, where relative market share was good at driving sales, it probably wasn't good at driving return on invested capital for retailers.
And that's a broad statement. That's not an Atris firm specific. We see it throughout the industry that that strategy got some retailers in trouble. Probably also wasn't the greatest strategy for manufacturers. It's more difficult to service multiple stores.
We need productive boxes and we need high SKU velocity. So I think we're from a strategy standpoint, we're much more aligned. I was never a fan of relative market share, which you can probably tell. So I think from just a broad strategy standpoint, I think the companies are more aligned. And so I think it's a very, very different situation than what we had under the previous relationship.
Thank you. And our next question comes from the line of Michael Lasser of UBS. Your line is open.
Good morning. Thanks a lot for taking my questions. Scott, can you clarify those comments? More specifically, how do the terms of this deal compare to the prior arrangement you had with Mattress Firm? And second, in the last 24 hours in the recent months as this deal has come closer to fruition, what has been sorry, what has been the response from other retail partners on the prospect of you returning to Mattress Firm?
Sure. Let me do the last one first, because I think I kind of answered it already. We've communicated with other retailers. They're not surprised. Nobody's shocked.
And there's been fair communication. They've expressed concerns and some of them have expressed support. So I think the issue is how it's executed in the future is more the issue with the other retailers than the actual getting together. And this is structured in a way that should be good for the other retailers also. As to specific terms of any individual deal, we're not going to talk about individual terms of a deal other than to tell you, look, we feel very comfortable with the terms of this deal, the economics of this deal, the strategy consistency between the companies.
And it was designed to be a win win deal for the long term. And I think the Mattress Firm team is also very comfortable with the relationship. But it is structured differently, but it's in a way that I think will benefit both parties. Thank
you. Our next question comes from the line of Laura Champine of Loop Capital. Your line is open.
Thanks for taking my question. In this new arrangement, what's the role in Mattress Firm Stores of its private label product, which I know had expanded under the prior management?
Yes. Now look, we're and this again, this isn't a Mattress Firm answer. This is just an industry question. There is a place with some retailers for private label, which we're supportive of. At Mattress Firm, they've got private label.
I expect them to continue to have private label. And it fits very nicely in a merchandising plan with our high end product. So I mean, we've got a broad array of Tempur product on the floor. We've got a broad array of Stearns and Foster and Selective Sealy. Frankly speaking, we got the products that we wanted and needed on the floor.
We expect Mattress Firm to have a healthy dose of private label at the appropriate price points.
Thank you. Our next question comes from the line of William Rutter of Bank of America. Your line is open.
Good morning. Just in terms of mix, how does the mix of Tempur, Sealy and Stearns and Foster that are going to be on the floor compare with the previous mix under the old arrangement?
I'm trying to think through this. We did not have a full mix of Stearns on mattress rooms floor all the time. We did at some points and at some points we were off the floor. We did have some select Sealy on the floor. Then we probably had more tempered beds on the floor that were a little bit overlap.
So the way I'd look at it, it's a complete Tempur line and then probably more Stearns and Foster for sure, and then about the same, I guess, give or take. But it's a full offering of our family of brands, which is what we think is appropriate in the situation.
Thank you. Our next question comes from the line of Carla Casella of JPMorgan. Your line is open.
Hi. I'm wondering if you look at the numbers you gave, the $400,000,000 for revenue and $75,000,000 to $100,000,000 for EBITDA, How much of that is Mattress Firm versus big? And should we assume that in the near term, we could as the big rollout is before Mattress Firm that we could see gross margin dilution and then ultimately pick up in next year? And is that why it's a back end loaded profitability?
We're not going to break them up by account. But because of the timing of the launch, you are going to get a heavy load of Sealy in the Q4, which would be dilutive to the Tempur Sealy margins as the Tempur product carries a higher margin than Sealy. And then you would you're right, then you would pick it up as you rolled out Mattress Firm. Correct.
Thank you. Our next question is a follow-up question from the line of Seth Basham of Wedbush Securities. Your line is open.
Thanks. Just to follow-up on the incremental $75,000,000 to $100,000,000 of EBITDA that I expect on an annual basis. Is that number specific to 2020? Or is it sort of annual number going forward after that? In other words, are there still inefficiencies associated with the ramp of the relationships that could weigh up EBITDA in 2020 or not?
Yes. I would look at the estimates that we put in for 2020. And again, this is a little early for guidance for us on 2020, but we felt like we needed to give something some information. But that would we would expect in the out years for 1, the revenues to 1, the revenues to be significantly higher, but also the flow through to be significantly better. So yes, that would be the I'm going to call it the minimum for the relationship.
That's not the ongoing post 2020.
Thank you. Our next follow-up is from the line of Curtis Nagle of Bank of America Merrill Lynch. Your line is open.
Great. So I guess just how do we think about capital allocation post the deal? Arguably this puts you well, I think well past or into your comfort zone for leverage. So how should we think about buybacks going forward and kind of the more immediate future?
Sure, sure. First, obviously, the Board will determine capital allocation. It's a discussion at every Board meeting. And I don't think a transaction or 2 changes your overall capital allocation strategy. So I don't think there's any strategy change on capital allocation.
But I do think it is significant to the execution of that strategy. And when you think about it, what we've announced, I guess, yesterday, changes our future cash flows and free cash flow significantly. And so it gives the appetite for buyback goes up, timing moves up. Also, from the standpoint, we took a competitor, Mattress Firm, and we've changed a competitor to a top 5 customer. And we've jumped into 20% of the U.
S. Betting market that we were not in. So from an enterprise risk standpoint, you'd have to say that you're more comfortable from a leverage ratio standpoint. So when I look at those combined factors, where maybe I think probably last time we talked, I talked about maybe paying a little bit of debt down here or there. I think when you look at these transactions, there's absolutely no reason why we would need to be paying debt down at this point after you execute these transactions.
And so when you kind of put that in the model and you assume U. S. Economy and the world's economies are okay, you clearly end up with a good bit of excess cash flow within any kind of reasonable leverage target. So I expect that our buybacks over the next 18 months are going to be significantly higher than what we thought they were going to be probably 6 months ago.
Thank you. And our next follow-up is from the line of Brad Thomas of KeyBanc Capital Markets. Your line is open.
Hey, thanks for getting me back on. So when we look at the potential $100,000,000 in EBITDA and your guidance here for this year, it starts to really put the aspirational plan into range for next year. Could you just remind us if you are able to hit that $600,000,000 EBITDA number, how we would factor that into our models? Does it hit an expense line item? Does it hit the share count?
Just a refresher on that would be helpful.
Sure. Bhaskar, you want to kind of walk me through some of that? Sure, sure. So the way
to think about that is that let's just use, for example, the $600,000,000 When that becomes probable or likely that it would be hit, then what would happen is in that quarter, the shares would come in as well as the associated expense. So big round numbers is there's about 1,500,000 shares total outstanding under the if we were to hit $600,000,000 what the plan provides is there would be 1 third of a payout. So that proportion of shares, 1 third of 1.6 would come into that quarter. From an expense standpoint, what we would anticipate is it would be it's considered amortization and primarily it would go through OpEx and associated with about onethree, you'd see about $30,000,000 of amortization go into the P and L.
Thank you. And our next follow-up is from the line of Carla Casella of JPMorgan. Your line is open.
Hi. So just on the mattress, this goes back to the question that was asked earlier. The business from before you left Mattress Firm to today, how does it change how is it different in terms of just the number of doors?
But they're door count mattress firms? Yes. Door count mattress firms down 20% from where they were before, if I got the question right.
Thank you. And this does conclude our question and answer session for today. I'd like to turn the conference back over to Mr. Scott Thompson, Chief Executive Officer, for the closing remarks.
Thank you, everyone, for your support and look forward to reporting our Q2 call at the end of July.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.