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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes, which are included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Actual results or outcomes may differ materially from those anticipated in these forward-looking statements, which are subject to risks, uncertainties, and other factors, including those described in Part I, Item 1A, “Risk Factors” of this Annual Report on Form 10-K for the fiscal year ended October 1, 2022.

We operate on a fiscal calendar that results in a fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to September 30th. In a 52-week fiscal year, each quarter contains 13 weeks of operations; in a 53-week fiscal year, each of the first, second and third quarters includes 13 weeks of operations and the fourth quarter includes 14 weeks of operations. References to fiscal 2022, 2021, and 2020 refer to the fiscal years ended October 1, 2022, October 2, 2021, and October 3, 2020, respectively. Fiscal 2022 and 2021 included 52 weeks of operations. Fiscal 2020 included 53 weeks of operations.

Our Company

We are the largest and most trusted direct-to-consumer brand in the $15 billion United States pool and spa care industry, serving residential and professional consumers. Founded in 1963, we are the only direct-to-consumer pool and spa care brand with national scale, operating an integrated marketing and distribution ecosystem powered by a physical network of 990 branded locations and a robust digital platform. We offer an extensive assortment of professional-grade products, the majority of which are exclusive to Leslie’s, as well as certified installation and repair services, all of which are essential to the ongoing maintenance of pools and spas. Our dedicated team of associates, pool and spa care experts, and experienced service technicians are passionate about empowering our consumers with the knowledge, products, and solutions necessary to confidently maintain and enjoy their pools and spas. The considerable scale of our integrated marketing and distribution ecosystem, which is powered by our direct-to-consumer network, uniquely enables us to efficiently reach and service every pool and spa in the continental United States.

We operate primarily in the pool and spa aftermarket industry, which is one of the most fundamentally attractive consumer categories given its scale, predictability, and growth outlook. We have a highly predictable, recurring revenue model, as evidenced by our 59 consecutive years of sales growth. Approximately 80% of our assortment is comprised of non-discretionary products essential to the care of residential and commercial pools and spas. Our assortment includes chemicals, equipment and parts, cleaning and maintenance equipment, and safety, recreational, and fitness-related products. We also offer important essential services, such as equipment installation and repair for residential consumers and professional pool operators. Consumers receive the benefit of extended vendor warranties on purchased products from our locations and on installations or repairs from our certified in-field technicians. We offer complimentary, commercial-grade in-store water testing and analysis via our proprietary AccuBlue® system, which increases consumer engagement, conversion, basket size, and loyalty, resulting in higher lifetime value. Our water treatment expertise is powered by data and intelligence accumulated from the millions of water tests we have performed over the years, positioning us as the most trusted water treatment service provider in the industry. Due to the non-discretionary nature of our products and services, our business has historically delivered strong, uninterrupted growth and profitability in all market environments, including through the Great Recession and the ongoing COVID-19 pandemic.

We have a legacy of leadership and disruptive innovation. Since our founding in 1963, we have been the leading innovator in our category and have provided our consumers with the most advanced pool and spa care available. As we have scaled, we have leveraged our competitive advantages to strategically reinvest in our business and intellectual property to develop new value-added capabilities. Over the course of our history, we have pioneered complimentary in-store water testing, offered complimentary in-store equipment repair services, introduced the industry’s first loyalty program, and developed an expansive platform of owned and exclusive brands. These differentiated capabilities allow us to meet the needs of any pool and spa owner, whether they care for their pool or spa themselves or rely on a professional, whenever, wherever, and however they choose to engage with us.

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Key Factors and Measures We Use to Evaluate Our Business

We consider a variety of financial and operating measures in assessing the performance of our business. The key measures we use under United States generally accepted accounting principles (“GAAP”) are sales, gross profit and gross margin, selling, general, and administrative expenses (“SG&A”), and operating income (loss). The key non-GAAP measures and other operating measures we use are comparable sales, comparable sales growth, Adjusted EBITDA, Adjusted net income (loss), and Adjusted earnings per share.

Sales

We offer a broad range of products that consists of regularly purchased, non-discretionary pool and spa maintenance items such as chemicals, equipment, cleaning accessories and parts, as well as installation and repair services for pool and spa equipment. Our offering of proprietary, owned, and third-party brands across diverse product categories drives sales growth by attracting new consumers and encouraging repeat visits from our existing consumers. Revenue from merchandise sales at retail locations is recognized at the point of sale, revenue from services is recognized when the services are rendered, and revenue from e-commerce merchandise sales is generally recognized upon shipment of the merchandise. Revenue is recorded net of related discounts and sales tax. Payment from retail customers is generally at the point of sale and payment terms for professional pool operator customers are based on our credit requirements and generally have terms of less than 60 days. When we receive payment from a consumer before the consumer has taken possession of the merchandise or the service has been performed, the amount received is recorded as deferred revenue or as a customer deposit until the sale or service is complete. Sales are impacted by product mix and availability, as well as promotional and competitive activities and the spending habits of our consumers. Growth of our sales is primarily driven by comparable sales growth and expansion of our locations in existing and new markets.

Comparable Sales and Comparable Sales Growth

We measure comparable sales growth as the increase or decrease in sales recorded by the comparable base in any reporting period, compared to sales recorded by the comparable base in the prior reporting period. The comparable base includes sales through our locations and through our e-commerce websites and third-party marketplaces. Comparable sales growth is a key measure used by management and our board of directors to assess our financial performance.

We consider a new or acquired location comparable in the first full month after it has completed one year of sales. Closed locations become non-comparable during their last partial month of operation. Locations that are relocated are considered comparable at the time the relocation is complete. Comparable sales is not calculated in the same manner by all companies, and accordingly, is not necessarily comparable to similarly titled measures of other companies and may not be an appropriate measure for performance relative to other companies.

The number of new locations reflects the number of locations opened during a particular reporting period. New locations require an initial capital investment in location build-outs, fixtures, and equipment, which we amortize over time as well as cash required for inventory.

As of October 1, 2022, we operated 990 retail locations in 39 states across the United States. We owned 27 locations and leased the remainder of our locations. Our initial lease terms are typically five years with options to renew for multiple successive five-year periods. We evaluate new opportunities in new and existing markets based on the number of pools and spas in the market, competition, our existing locations, availability and cost of real estate, and distribution and operating costs of our locations. We review performance of our locations on a regular basis and evaluate opportunities to strategically close locations to improve our profitability. Our limited investment costs in individual locations and our ability to transfer sales to our extensive network of remaining locations and e-commerce websites allows us to improve profitability as a result of any strategic closures.

Gross Profit and Gross Margin

Gross profit is equal to our sales less our cost of merchandise and services sold. Cost of merchandise and services sold reflects the direct cost of purchased merchandise, costs to package certain chemical products, including direct materials and labor, costs to provide services, including labor and materials, as well as distribution and occupancy costs. The direct cost of purchased merchandise includes vendor rebates, which are generally treated as a reduction of merchandise costs. We recognize such vendor rebates at the time the obligations to purchase products or perform services have been completed, and the related inventory has been sold. Distribution costs include warehousing and transportation expenses, including costs associated with third-party fulfillment centers used to ship merchandise to our e-commerce consumers. Occupancy costs include the rent, common area maintenance, real estate taxes, and depreciation and amortization costs of all retail locations. These costs are significant and are expected to continue to increase proportionate to our growth.

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Gross margin is gross profit as a percentage of our sales. Gross margin is impacted by merchandise costs, pricing and promotions, product mix and availability, inflation, and service costs, which can vary. Our proprietary brands, custom-formulated products, and vertical integration provide us with cost savings, as well as greater control over product availability and quality as compared to other companies in the industry. Gross margin is also impacted by the costs of distribution and occupancy costs, which can vary.

Our gross profit is variable in nature and generally follows changes in sales. The components of our cost of merchandise and services sold may not be comparable to the components of cost of sales or similar measures of other companies. As a result, our gross profit and gross margin may not be comparable to similar data made available by other companies.

Selling, General and Administrative Expenses

Our SG&A includes selling and operating expenses across our retail locations and digital platform, and our corporate-level general and administrative expenses. Selling and operating expenses at retail locations include payroll, bonus and benefit costs for personnel, supplies, and credit and debit card processing costs. Corporate expenses include payroll, bonus, and benefit costs for our corporate and field support functions, equity-based compensation, marketing and advertising, insurance, utilities, occupancy costs related to our corporate office facilities, professional services, and depreciation and amortization for all assets, except those related to our retail locations and distribution operations, which are included in cost of merchandise and services sold. Selling and operating expenses generally vary proportionately with sales and the change in the number of locations. In contrast, general and administrative expenses are generally not directly proportional to sales and the change in the number of locations but are expected to increase over time to support our growth and public company obligations. The components of our SG&A may not be comparable to the components of similar measures of other companies.

Operating Income (Loss)

Operating income (loss) is gross profit less SG&A. Operating income (loss) excludes interest expense, loss on debt extinguishment, income tax expense (benefit), and other (income) expenses, net. We use operating income (loss) as an indicator of the productivity of our business and our ability to manage expenses.

Adjusted EBITDA

Adjusted EBITDA is defined as earnings before interest (including amortization of debt issuance costs), taxes, depreciation and amortization, management fees, equity-based compensation expense, loss on debt extinguishment, costs related to equity offerings, strategic project costs, executive transition costs, loss (gain) on disposition of assets, mark-to-market on interest rate cap and other non-recurring, non-cash or discrete items. Adjusted EBITDA is a key measure used by management and our board of directors to assess our financial performance. Adjusted EBITDA is also frequently used by analysts, investors and other interested parties to evaluate companies in our industry, when considered alongside other GAAP measures. We use Adjusted EBITDA to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions and to compare our performance against that of other companies using similar measures.

Adjusted EBITDA is not a recognized measure of financial performance under GAAP but is used by some investors to determine a company’s ability to service or incur indebtedness. Adjusted EBITDA is not calculated in the same manner by all companies, and accordingly, is not necessarily comparable to similarly titled measures of other companies and may not be an appropriate measure for performance relative to other companies. Adjusted EBITDA should not be construed as an indicator of a company’s operating performance in isolation from, or as a substitute for, net income (loss), cash flows from operations or cash flow data, all of which are prepared in accordance with GAAP. We have presented Adjusted EBITDA solely as supplemental disclosure because we believe it allows for a more complete analysis of results of operations. Adjusted EBITDA is not intended to represent, and should not be considered more meaningful than, or as an alternative to, measures of operating performance as determined in accordance with GAAP. In the future, we may incur expenses or charges such as those added back to calculate Adjusted EBITDA. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by these items.

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Adjusted Net Income (Loss) and Adjusted Earnings per Share

Adjusted net income (loss) and Adjusted earnings per share are additional key measures used by management and our board of directors to assess our financial performance. Adjusted net income (loss) and Adjusted earnings per share are also frequently used by analysts, investors, and other interested parties to evaluate companies in our industry, when considered alongside other GAAP measures.

Adjusted net income (loss) is defined as net income (loss) adjusted to exclude management fees, equity-based compensation expense, loss on debt extinguishment, costs related to equity offerings, strategic project costs, executive transition costs, loss (gain) on disposition of assets, mark-to-market on interest rate cap, and other non-recurring, non-cash or discrete items. Adjusted diluted earnings per share is defined as Adjusted net income (loss) divided by the diluted weighted average number of common shares outstanding.

Factors Affecting the Comparability of our Results of Operations

Our reported results have been affected by, among other events, the following events, which must be understood in order to assess the comparability of our period-to-period financial performance and condition.

Impact of Macroeconomic Events and Uncertainties

Our financial performance and condition may be impacted to varying extents from period to period by macroeconomic and geopolitical developments, including the ongoing COVID-19 pandemic, escalating global conflicts, supply chain disruptions, labor market constraints, rising rates of inflation, and rising interest rates. The extent of the impact of COVID-19 on our financial and operating performance depends significantly on the duration and severity of the pandemic, the actions taken to contain or mitigate its impact, and any changes in consumer behaviors. While it is not possible to predict the likelihood, timing, or severity of future direct and indirect impacts of COVID-19 on our business, due to the non-discretionary nature of our products and services, our business has delivered strong growth and profitability thus far throughout the pandemic, despite restrictions on the operation of our locations and distribution facilities. Significant disruption to our supply chain for products we sell, as a result of COVID-19, geopolitical conflict or otherwise, could have a material impact on our sales and earnings.

Business Acquisitions

See Note 3—Business Combinations to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for information regarding our business acquisitions.

Incremental Public Company Expenses

As a newly public company we will incur significant expenses on an ongoing basis that we did not incur as a private company. Those costs include additional director compensation and director and officer liability insurance expenses, as well as third-party and internal resources related to accounting, auditing, Sarbanes-Oxley Act compliance, legal, and investor and public relations expenses. These costs will generally be included in SG&A in our consolidated statements of operations.

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Results of Operations

We derived our consolidated statements of operations for fiscal 2022, 2021, and 2020 from our consolidated financial statements. Our historical results are not necessarily indicative of the results that may be expected in the future. The following table summarizes key components of our results of operations for the periods indicated, both in dollars and as a percentage of our sales (in thousands, except per share amounts).

Year Ended

Statements of Operations data: October 1, 2022 October 2, 2021 October 3, 2020

Other expense:

Loss on debt extinguishment — 9,169 —

Earnings per share

Weighted average shares outstanding

Percentage of Sales(1) (%) (%) (%)

Cost of merchandise and services sold 56.9 55.7 58.6

Selling, general and administrative expenses 27.8 28.7 28.3

Other expense:

Loss on debt extinguishment — 0.7 —

Other expenses, net 0.1 0.2 0.1

Total other expense 2.0 3.4 7.7

Other Financial and Operations data:

Number of new and acquired locations, net 38 17 10

Number of locations open at end of period 990 952 936

Adjusted EBITDA as a percentage of sales(3) 18.7 % 20.2 % 16.4 %

Adjusted diluted earnings per share $ 0.95 $ 0.85 $ 0.42

(1)

Components may not add to totals due to rounding.

(2)

See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors and Measures We Use to Evaluate Our Business.”

(3)

The tables below provide a reconciliation from our net income to Adjusted EBITDA and net income to Adjusted net income for fiscal 2022, 2021, and 2020 (in thousands).

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Year Ended

Loss on debt extinguishment(4) — 9,169 —

Costs related to equity offerings(5) 550 10,444 —

Strategic project costs(6) 4,960 — —

Year Ended

Loss on debt extinguishment(4) — 9,169 —

Costs related to equity offerings(5) 550 10,444 —

Strategic project costs(6) 4,960 — —

(1)

Includes depreciation related to our distribution centers and locations, which is reported in cost of merchandise and services sold in our consolidated statements of operations.

(2)

Represents amounts paid or accrued in connection with our management services agreement, which was terminated upon the completion of our IPO in November 2020 and are reported in SG&A in our consolidated statements of operations.

(3)

Represents charges related to equity-based compensation and the related Company payroll tax expense, which are reported in SG&A in our consolidated statements of operations.

(4)

Represents non-cash expense due to the write-off of deferred financing costs related to the Term Loan modification and the repayment of our senior unsecured notes in fiscal 2021, which are reported in loss on debt extinguishment in our consolidated statements of operations.

(5)

Includes one-time payments of contractual amounts incurred in connection with our IPO that was completed in November 2020, which are reported in SG&A, and costs incurred for follow on equity offerings, which are reported in other (income) expenses, net in our consolidated statements of operations.

(6)

Represents non-recurring costs, such as third-party consulting costs, which are not part of our ongoing operations and are incurred to execute differentiated, strategic projects, and are reported in SG&A in our consolidated statements of operations.

(7)

Includes executive transition costs, losses (gains) on disposition of fixed assets, merger and acquisition costs and other non-recurring, non-cash or discrete items as determined by management. Amounts are reported in SG&A and other (income) expenses, net in our consolidated statements of operations.

(8)

Represents the tax effect of the total adjustments based on our actual statutory tax rate. Amounts are reported in income tax expense in our consolidated statements of operations.

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Comparison of Fiscal 2022 and 2021

Sales

Sales increased to $1,562.1 million in fiscal 2022 from $1,342.9 million in fiscal 2021, an increase of $219.2 million or 16.3%. The increase was primarily driven by comparable sales growth of $143.1 million, or 10.6%, in the current fiscal year as well as non-comparable sales of $76.1 million, driven by acquisitions and new locations open for less than 52 weeks.

Gross Profit and Gross Margin

Gross profit increased to $673.7 million in fiscal 2022 from $595.2 million in fiscal 2021, an increase of $78.5 million or 13.2%. Gross margin decreased to 43.1% compared to 44.3% in fiscal 2021, a decrease of 120 basis points. The increase in gross profit was primarily due to increased sales. The decrease in gross margin was primarily due to shifts in business mix, decreased product margin related to promotions and higher product cost, partially offset by distribution and occupancy leverage.

Selling, General and Administrative Expenses

SG&A increased to $435.0 million in fiscal 2022 from $386.1 million in fiscal 2021, an increase of $48.9 million or 12.7%. This increase in SG&A was primarily related to a $57.0 million increase associated with higher sales, inflationary costs associated with payroll and digital marketing expenses and non-comparable SG&A associated with our acquisitions; a $5.0 million increase related to strategic project costs incurred during fiscal 2022; a $4.9 million increase associated with executive transition costs, losses (gains) on disposition of fixed assets, merger and acquisition costs and other non-recurring, non-cash or discrete items; and a $3.9 million increase associated with higher depreciation and amortization expense. These increases were offset by lower non-cash equity-based compensation expense of $13.7 million compared to fiscal 2021 and certain one-time payments of contractual amounts of $8.2 million made in fiscal 2021, both of which were primarily incurred in connection with our IPO.

Total Other Expense

Total other expenses decreased to $30.6 million in fiscal 2022 from $46.0 million in fiscal 2021, a decrease of $15.4 million. The decrease in other expenses was primarily related to a $9.2 million non-cash loss on debt extinguishment related to the refinancing of the Term Loan and repayment of our senior unsecured notes during fiscal 2021, a decrease in interest expense of $4.2 million in fiscal 2022 due to the repayment of our senior unsecured notes with the proceeds of our IPO and $2.0 million of follow-on offering costs incurred in fiscal 2021.

Income Taxes

Income tax expense increased to $49.1 million in fiscal 2022 from $36.5 million in fiscal 2021, an increase of $12.6 million. Our effective tax rate was 23.6% compared to 22.4% for fiscal 2022 and fiscal 2021, respectively, reflecting lower income tax benefits attributable to equity-based compensation awards and research and development credits.

Net Income and Earnings per Share

Net income increased to $159.0 million in fiscal 2022 from $126.6 million in fiscal 2021, an increase of $32.4 million. Diluted earnings per share increased to $0.85 in fiscal 2022 from $0.67 in fiscal 2021.

Adjusted net income increased to $176.4 million in fiscal 2022 from $161.5 million in fiscal 2021, an increase of $14.9 million. Adjusted diluted earnings per share increased to $0.95 in fiscal 2022 compared to $0.85 in fiscal 2021.

Adjusted EBITDA

Adjusted EBITDA increased to $292.3 million in fiscal 2022 from $270.6 million fiscal 2021, an increase of $21.7 million or 8.0%. This increase was due primarily to the increase in comparable sales and gross profit.

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Comparison of Fiscal 2021 and 2020

Impact of 53rd week

Fiscal 2020 included a 53rd week, which added approximately $18.0 million in sales, $1.5 million in net income, and $3.0 million in Adjusted EBITDA.

Sales

Sales increased to $1,342.9 million in fiscal 2021 from $1,112.2 million in fiscal 2020, an increase of $230.7 million or 20.7%. The increase was primarily the result of an increase in comparable sales on a reported basis of 21.5% or $235.2 million, driven by an increase in consumer demand and elevated retail price inflation in the core sanitizer and equipment product categories.

We believe that COVID-19 has accelerated secular trends in consumer behavior and has favorably impacted our sales. While the duration and effects of the ongoing COVID-19 pandemic are uncertain, we anticipate that the changes in consumer behavior will continue for the foreseeable future.

Gross Profit and Gross Margin

Gross profit increased to $595.2 million in fiscal 2021 from $460.7 million in fiscal 2020, an increase of $134.5 million or 29.2%. Gross margin increased to 44.3% compared to 41.4% in fiscal 2020, an increase of 290 basis points. The increase in gross profit was primarily due to increased sales and gross margin improvements. The increase in gross margin was primarily due to product margin improvements and occupancy leverage, partially offset by business mix.

Selling, General and Administrative Expenses

SG&A increased to $386.1 million in fiscal 2021 from $314.3 million in fiscal 2020, an increase of $71.8 million or 22.8%. The increase in SG&A was primarily due to $55.2 million attributable to the increase in overall sales and our continued investments to support Company growth, $23.8 million related to non-cash equity-based compensation charges for the conversion of performance-based equity units and other equity awards granted at the time of IPO, and $8.2 million of one-time contractual amounts incurred in connection with the IPO, partially offset by lower costs of $6.4 million associated with COVID-19, a reduction in sponsor management fees of $4.5 million due to the termination of our sponsor management agreement at the time of our IPO, lower physical location closure costs of $3.6 million related to the strategic consolidation of certain locations during the first quarter of fiscal 2020, and lower executive transition and other costs of $0.9 million.

Total Other Expense

Total other expense decreased to $46.0 million in fiscal 2021 from $85.2 million in fiscal 2020, a decrease of $39.2 million. This decrease was primarily due to lower interest expense of $49.7 million, due to a reduction in interest rates and the repayment of our senior unsecured notes with the proceeds of our IPO in November 2020, partially offset by a $9.2 million non-cash loss on debt extinguishment related to the repayment of our senior unsecured notes and amendment to the Term Loan during fiscal 2021.

Income Taxes

Income tax expense increased to $36.5 million in fiscal 2021 from $2.6 million in fiscal 2020, an increase of $33.9 million. This increase was primarily attributable to higher income before taxes.

Our effective tax rate was 22.4% in fiscal 2021 and reflects the reversal of a valuation allowance for our interest limitation carryforward as a result of our IPO and subsequent paydown of debt, as well as income tax benefits attributable to equity-based compensation awards. Our effective tax rate was 4.3% in fiscal 2020, reflecting a decrease in the valuation allowance for our interest limitation carryforward due to favorable provisions of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which increased the interest limitation from 30% to 50% of adjusted taxable income and allowed for the utilization of interest deduction carryforwards during fiscal 2020.

Net Income and Earnings per Share

Net income increased to $126.6 million in fiscal 2021 from $58.6 million in fiscal 2020, an increase of $68.0 million. Diluted earnings per share increased to $0.67 in fiscal 2021 from $0.37 in fiscal 2020.

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Adjusted net income increased to $161.5 million in fiscal 2021 from $65.0 million in fiscal 2020, an increase of $96.5 million. Adjusted diluted earnings per share increased to $0.85 in fiscal 2021 compared to $0.42 in fiscal 2020.

Adjusted EBITDA

Adjusted EBITDA increased to $270.6 million fiscal 2021 from $182.8 million in fiscal 2020, an increase of $87.8 million or 48.0%. This increase was due primarily to our increase in comparable sales, an improvement in gross margin, and cost leverage.

Seasonality and Quarterly Fluctuations

Our business is highly seasonal. Sales and earnings are highest during the third and fourth fiscal quarters, which include April through September, and represent the peak months of swimming pool use. In fiscal 2022, we generated approximately 75% of our sales and 95% of our Adjusted EBITDA in the third and fourth quarters of our fiscal year. Sales are substantially lower during our first and second fiscal quarters. We have a long track record of investing in our business throughout the year, including in operating expenses, working capital, and capital expenditures related to new locations and other growth initiatives. While these investments drive performance during the primary selling season in our third and fourth fiscal quarters, they have a negative impact during our first and second fiscal quarters.

We typically experience a build-up of inventory and accounts payable during the first and second fiscal quarters in anticipation of the peak swimming pool supply selling season. We negotiate extended payment terms with certain of our primary suppliers as we receive merchandise in December through March, and we pay for merchandise in April through July.

The principal external factor affecting our business is weather. Hot weather can increase purchases of chemicals and other non-discretionary products as well as purchases of discretionary products and can drive increased purchases of installation and repair services. Unseasonably cool weather or significant amounts of rainfall during the peak sales season can reduce chemical consumption in pools and spas and decrease consumer purchases of our products and services. In addition, unseasonably early or late warming trends can increase or decrease the length of the pool season and impact timing around pool openings and closings and, therefore, our total sales and timing of our sales.

We generally open new locations before our peak selling season begins and we close locations after our peak selling season ends. We expect that our quarterly results of operations will fluctuate depending on the timing and amount of sales contributed by new locations.

Liquidity and Capital Resources

Overview

Our primary sources of liquidity are net cash provided by operating activities and borrowing availability under our Revolving Credit Facility. Historically, we have funded working capital requirements, capital expenditures, payments related to acquisitions, debt service requirements, and repurchases of shares of our common stock with internally generated cash on hand and through our Revolving Credit Facility.

Cash and cash equivalents consist primarily of cash on deposit with banks. Cash and cash equivalents totaled $112.3 million and $343.5 million as of October 1, 2022 and October 2, 2021, respectively. As of October 1, 2022 and October 2, 2021, we did not have any outstanding borrowings under our Revolving Credit Facility.

Our primary working capital requirements are for the purchase of inventory, payroll, rent, other facility costs, distribution costs, and general and administrative costs. Our working capital requirements fluctuate during the year, driven primarily by seasonality and the timing of inventory purchases.

Our capital expenditures are primarily related to infrastructure-related investments, including investments related to upgrading and maintaining our information technology systems, ongoing location improvements, expenditures related to our distribution centers, and new location openings. We expect to fund capital expenditures from net cash provided by operating activities.

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Based on our growth plans, we believe our cash and cash equivalents position, net cash provided by operating activities and borrowing availability under our Revolving Credit Facility will be adequate to finance our working capital requirements, planned capital expenditures, strategic acquisitions, share repurchases, and debt service over the next 12 months. If cash provided by operating activities and borrowings under our Revolving Credit Facility are not sufficient or available to meet our capital requirements, then we may need to obtain additional equity or debt financing. There can be no assurance that equity or debt financing will be available to us if we need it or, if available, whether the terms will be satisfactory to us.

As of October 1, 2022, outstanding standby letters of credit totaled $10.0 million, and after considering borrowing base restrictions, we had $190.0 million of available borrowing capacity under the terms of the Revolving Credit Facility. As of October 1, 2022, we were in compliance with the covenants under the Revolving Credit Facility and our Term Loan agreements.

Summary of Cash Flows

A summary of our cash flows from operating, investing, and financing activities is presented in the following table (in thousands):

Year Ended

Cash Provided by Operating Activities

Net cash provided by operating activities decreased to $66.6 million in fiscal 2022 from $169.3 million in fiscal 2021, a decrease of $102.7 million. This decrease was primarily driven by changes in working capital related to business acquisitions and strategic investment in product inventories to meet heightened customer demand across product categories.

Net cash provided by operating activities increased to $169.3 million in fiscal 2021 from $102.1 million in fiscal 2020, an increase of $67.2 million. This increase was primarily driven by the increase in net income related to our sales growth, partially offset by changes in working capital related to the strategic investment in product inventories to meet heightened customer demand across product categories.

Cash Used in Investing Activities

Net cash used in investing activities increased to $139.0 million in fiscal 2022 from $35.4 million in fiscal 2021, an increase of $103.6 million. This increase was primarily driven by higher investments for business acquisitions of $98.8 million and investments in property and equipment of $2.8 million, primarily related to new and existing retail locations and distribution centers, compared to fiscal 2021.

Net cash used in investing activities increased to $35.4 million in fiscal 2021 from $26.8 million in fiscal 2020, an increase of $8.6 million. This increase was primarily driven by an increase in investments in information technology initiatives.

Cash (Used in) Provided by Financing Activities

Net cash used in financing activities in fiscal 2022 of $158.9 million was primarily related to the repurchase and retirement of common stock of $152.1 million and net repayment of debt of $8.1 million, partially offset by proceeds from option exercises of $1.4 million.

Net cash provided by financing activities in fiscal 2021 of $53.8 million was primarily related to net proceeds raised during our IPO in November 2020 of $458.6 million, partially offset by a $396.1 million repayment of long-term debt. Net cash used in financing activities in fiscal 2020 of $10.4 million was related to the net paydown of long-term debt.

Share Repurchase Program

On December 3, 2021, the board of directors authorized a share repurchase program for up to an aggregate of $300 million of the Company’s outstanding shares of common stock over a period of three years, expiring December 31, 2024. As of October 1, 2022, approximately $148 million remained available for future purchases under our share repurchase program (see Note 16—Share Repurchase Program).

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Contractual Obligations and Other Commitments

The following table summarizes our contractual cash obligations as of October 1, 2022 (in thousands):

Payments Due By Period

Revolving Credit Facility (1) $ — $ — $ — $ — $ — $ — $ —

(1)

We are required to pay a commitment fee of 0.25% based on the unused portion of the Revolving Credit Facility.

(2)

Purchase obligations include all legally binding contracts and primarily relate to firm commitments for inventory purchases. Purchase orders that are not binding agreements are excluded from the table above.

(3)

Operating lease obligations relate to our locations, office, distribution, and manufacturing facilities. We are obligated to make cash payments in connection with various lease obligations and purchase commitments and all obligations require cash payments to be made by us over varying periods of time. Certain leases are renewable at our option typically for periods of five to more years and are cancelable on short notice and others require payments upon early termination.

Critical Accounting Estimates

The preparation of our consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of sales and expenses during the reported periods. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgements. Based on this definition, we have identified the critical accounting policies and judgements addressed below. We base these estimates on historical results and various other assumptions we believe to be reasonable, all of which form the basis for making estimates concerning the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates.

Vendor Rebates

Many of our vendor arrangements provide for us to receive specified amounts of consideration when we achieve various measures. These measures generally relate to the volume level of purchases. We estimate the amount recorded, generally as a reduction of the prices of the vendor’s products and therefore a reduction of inventory at the end of each period based on a detailed analysis of inventory and of the facts and circumstances of various contractual agreements with vendors. Once we sell the product we recognize such consideration as a reduction of cost of merchandise and services sold in our consolidated statements of operations. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions we use to calculate our reduction of inventory.

Inventories

Inventories are stated at the lower of cost or market or net realizable value. We value inventory using the weighted-average cost method. We evaluate inventory for excess and obsolescence and record necessary reserves. We provide provisions for losses related to inventories based on management’s judgement regarding historical purchase cost, selling price, margin, and current business trends. If actual demand or market conditions are different than those projected by management, future margins may be unfavorably or favorably affected by adjustments to these estimates. When an inventory item is sold or disposed, the associated reserve is released at that time. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions used to calculate our inventory reserve.

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Business Combinations

We account for business combinations using the acquisition method of accounting. This method requires that the purchase price of the acquisition be allocated to the assets acquired and liabilities assumed using the fair values determined by management as of the acquisition date. The excess of the purchase price over the amounts allocated to assets acquired and liabilities assumed is recorded as goodwill.

The accounting for business combinations requires us to make estimates and assumptions at the acquisition date with respect to the fair value of assets acquired and liabilities assumed as well as the useful lives of those acquired intangible assets. Critical estimates in valuing certain of the intangible assets and goodwill we have acquired include but are not limited to; future expected cash flows, historical and expected customer attribution rates and royalty and discount rates. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results.

In addition, the consideration for an acquisition may include future payments that are contingent upon the occurrence of a particular event. We record a contingent consideration at fair value on the acquisition date. We estimate the fair values through valuation models that incorporate probability adjusted assumptions related to the achievement of the milestones and the likelihood of making related payments. The fair value is remeasured at the end of each period and changes in fair value are recorded in within SG&A in the consolidated statements of operations. Determining the fair value of the contingent consideration requires management to make assumptions and judgements. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions used to calculate the values of our acquired intangible assets contingent considerations liabilities.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements, see Note 2—Summary of Significant Accounting Policies to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

Our operating results are subject to risk from interest rate fluctuations on our borrowings, which carry variable interest rates. Our borrowings include our Revolving Credit Facility and Term Loan. Our Revolving Credit Facility provides for revolving loans of up to $200.0 million, with a sub-commitment for issuance of letters of credit of $25.0 million. Because our borrowings bear interest at a variable rate, we are exposed to market risks relating to changes in interest rates. As of October 1, 2022, we had variable rate debt outstanding of $797.9 million under our Term Loan. No amounts were outstanding under our Revolving Credit Facility as of October 1, 2022. Based on the outstanding variable rate loan balance for the Term Loan, an increase or decrease of 1% in the effective interest rate would cause an increase or decrease in interest cost of approximately $8.0 million over the next 12 months. From time-to-time, we may enter into interest rate hedges or cap agreements to manage interest rate risk.

The United Kingdom’s Financial Conduct Authority announced the phased cessation of the publication of LIBOR beginning after 2021 and continuing through 2023. When LIBOR is discontinued, we may need to change the terms of certain of our floating rate notes, interest rate cap agreements, and credit instruments which utilize LIBOR as a benchmark in determining the interest rate, to replace LIBOR with the new standard that is established. As a result, we may incur incremental costs in the transition to a new standard, and interest rates on our current or future indebtedness may be adversely affected by the new standard. A decision has not been finalized regarding the replacement rates. As such, the potential effect of any such event on our cost of capital cannot yet be determined, but we do not expect it to have a material impact to our consolidated financial condition, results of operations, or cash flows.

Impact of Inflation

We experience inflation and deflation related to our purchase of certain products. This price volatility could potentially have a material impact on our financial condition and/or our results of operations. We actively manage the impact of inflation, including tariffs, through strong relationships with our diverse supplier base, vendor negotiation, and promotion management. We also strategically invest through inventory purchases in order to obtain favorable pricing ahead of any vendor price increases. In order to mitigate price volatility, we monitor price fluctuations and may adjust our selling prices accordingly; however, our ability to recover higher costs through increased pricing may be limited by the competitive environment in which we operate. Although we may experience periodic effects on sales, gross profit, gross margins, and cash flows as a result of changing prices, including most recently from inflationary pressures due primarily to supply chain disruptions complicated by the ongoing COVID-19 pandemic, we do not expect the effect of inflation or deflation to have a material impact on our ability to execute our long-term business strategy. We currently do not use derivative instruments to manage these risks.

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Item 8. Financial Statements and Supplementary Data.

LESLIE’S, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Audited Consolidated Financial Statements for the fiscal years ended October 1, 2022, October 2, 2021, and October 3, 2020

Page

Report of Independent Registered Public Accounting Firm (PCAOB ID: 42) 46

Consolidated Balance Sheets 48

Consolidated Statements of Operations 49

Consolidated Statements of Stockholders’ Deficit 50

Consolidated Statements of Cash Flow 51

Notes to Consolidated Financial Statements 52

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Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors of Leslie’s, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Leslie’s, Inc. (the Company) as of October 1, 2022 and October 2, 2021, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for each of the three years in the period ended October 1, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at October 1, 2022 and October 2, 2021, and the results of its operations and its cash flows for each of the three years in the period ended October 1, 2022, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of October 1, 2022, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated November 30, 2022 expressed an adverse opinion thereon.

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Vendor Rebates

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/s/ Ernst & Young LLP

We have served as the Company’s auditor since 2000.

Phoenix, Arizona

November 30, 2022

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LESLIE’S, INC.

Consolidated Balance Sheets

(Amounts in Thousands, Except Share and Per Share Amounts)

Assets

Current assets

Prepaid expenses and other current assets 23,104 20,564

Liabilities and stockholders’ deficit

Current liabilities

Current portion of long-term debt 8,100 8,100

Other long-term liabilities 65 3,915

Commitments and contingencies

Stockholders’ deficit

See accompanying notes which are an integral part of these consolidated financial statements.

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LESLIE’S, INC.

Consolidated Statements of Operations

(Amounts in Thousands, Except Per Share Amounts)

Year Ended

Other expense:

Loss on debt extinguishment — 9,169 —

Earnings per share:

Weighted average shares outstanding:

See accompanying notes which are an integral part of these consolidated financial statements.

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LESLIE’S, INC.

Consolidated Statements of Stockholders’ Deficit

(Amounts in Thousands)

Common Stock AdditionalPaid inCapital Retained Total Stockholders’

Shares Amount (Deficit) Deficit Deficit

Impact of adoption of new accounting pronouncements — — — 12 12

Equity-based compensation — — 1,785 — 1,785

Issuance of common stock under the Plan 3,321 3 — — 3

See accompanying notes which are an integral part of these consolidated financial statements.

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LESLIE’S, INC.

Consolidated Statements of Cash Flows

(Amounts in Thousands)

Year Ended

Operating Activities

Amortization of deferred financing costs and debt discounts 1,982 2,483 3,489

Loss (gain) on disposition of assets 466 (1,606 ) 785

Loss on debt extinguishment — 9,169 —

Changes in operating assets and liabilities:

Prepaid expenses and other current assets (1,476 ) 2,674 (14,959 )

Operating lease assets and liabilities, net (5,093 ) 1,786 7,037

Investing Activities

Business acquisitions, net of cash acquired (107,663 ) (8,868 ) (6,188 )

Proceeds from disposition of fixed assets 408 2,444 7

Financing Activities

Borrowings on Revolving Credit Facility 45,000 — 238,750

Payments on Revolving Credit Facility (45,000 ) — (238,750 )

Issuance of long-term debt — 907 —

Payment of deferred financing costs — (9,579 ) —

Proceeds from options exercised 1,378 — —

Repurchase and retirement of common stock (152,146 ) — —

Supplemental Information:

See accompanying notes which are an integral part of these consolidated financial statements.

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LESLIE’S, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 1—Business and Operations

Leslie’s, Inc. (“Leslie’s,” “we,” “our,” “us,” “its,” or the “Company”) is the leading direct-to-consumer pool and spa care brand. We market and sell pool and spa supplies and related products and services, which primarily consist of maintenance items such as chemicals, equipment and parts, and cleaning accessories, as well as safety, recreational, and fitness-related products. We currently market our products through990 Company-operated locations in 39 states and e-commerce websites.

Initial Public Offering

In November 2020, we completed an IPO of 30.0 million shares of common stock at a public offering price of $17.00 per share for net proceeds of $458.6 million, after deducting underwriting discounts and commissions of $45.0 million and offering costs of $6.3 million. We used the net proceeds from the IPO to repay the entire outstanding amount related to our $390.0 million senior unsecured notes. The remaining proceeds were used for working capital and general corporate purposes.

Note 2—Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

We prepared the accompanying consolidated financial statements following GAAP. The financial statements include all normal and recurring adjustments that are necessary for a fair presentation of our financial position and operating results. The consolidated financial statements include the accounts of Leslie’s, Inc. and our subsidiaries. All significant intercompany accounts and transactions have been eliminated.

All share and per share information included in the accompanying consolidated financial statements has been retroactively adjusted to reflect a 156,500-for-1 stock split which was effected on October 23, 2020. The par value of the common stock was not adjusted as the result of the stock split.

Fiscal Periods

We operate on a fiscal calendar that results in a fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to September 30th. In a 52-week fiscal year, each quarter contains 13 weeks of operations; in a 53-week fiscal year, each of the first, second and third quarters includes 13 weeks of operations and the fourth quarter includes 14 weeks of operations. References to fiscal 2022, 2021, and 2020 refer to the 52 weeks ended October 1, 2022 and October 2, 2021, respectively, and 53 weeks ended October 3, 2020.

Segment Reporting

Our Chief Operating Decision Maker is our Chief Executive Officer, who reviews financial information presented on a consolidated basis for purposes of allocating resources and assessing performance. We operate all of our locations in the United States and offer consumers similar products, services, and methods of distribution through our retail locations and e-commerce websites. As a result, we have a single reportable segment.

Seasonality

Our business is highly seasonal. Sales and earnings are highest during our third and fourth fiscal quarters, being April through September, which represent the peak months of swimming pool use. Sales are substantially lower during our first and second fiscal quarters.

Prior Period Reclassifications

Reclassifications of certain immaterial prior period amounts have been made to conform to current period presentation.

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Use of Estimates

Management is required to make certain estimates and assumptions during the preparation of the consolidated financial statements in accordance with GAAP. These estimates and assumptions impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. They also impact the reported amount of net income during any period. Actual results could differ from those estimates.

Significant estimates underlying the accompanying consolidated financial statements include inventory reserves, lease assumptions, vendor rebate programs, our loyalty program, the determination of income taxes payable and deferred income taxes, sales returns reserve, self-insurance liabilities, the recoverability of intangible assets and goodwill, fair value of assets acquired in a business combination; and contingent consideration related to business combinations.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, demand deposits, money market funds and credit and debit card transactions. Our cash balance at financial institutions may exceed the FDIC insurance coverage limit. We consider all investments with an original maturity of three months or less and money market funds to be cash equivalents. All credit card and debit card transactions that process in less than seven days are classified as cash and cash equivalents.

Fair Value Measurements

We use fair value measurements to record the fair value of certain assets and to estimate the fair value of financial instruments not recorded at fair value but required to be disclosed at fair value.

To determine the fair value, we maximize the use of observable inputs and minimize the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use to value an asset or liability and are developed based on market data obtained from independent sources. Unobservable inputs are inputs based on assumptions about the factors market participants would use to value an asset or liability.

The fair value hierarchy is as follows, of which the first two are considered observable and the last unobservable:

•

Level 1—Quoted prices in active markets for identical assets or liabilities.

•

Level 2—Inputs other than Level 1 that are observable for the asset or liability, either directly or indirectly, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data by correlation or other means.

•

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Value is determined using pricing models, discounted cash flow methodologies, or similar techniques and also includes instruments for which the determination of fair value requires significant judgment or estimation.

As of October 1, 2022 and October 2, 2021, we held no assets that were required to be measured at fair value on a recurring basis. There were no transfers between levels in the fair value hierarchy during fiscal 2022, 2021, and 2020, respectively.

The fair value of our amended and restated term loan credit agreement (“Term Loan”) due in 2028 was determined to be $760.0 million and $802.9 million as of October 1, 2022 and October 2, 2021, respectively. These fair value estimates, determined to be Level 2, are subjective in nature and involve uncertainties and matters of judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates.

The carrying amounts of cash, cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value due to the short-term maturity of these instruments.

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Vendor Rebates

Many of our vendor arrangements provide for us to receive specified amounts of consideration when we achieve various measures. These measures generally relate to the volume level of purchases from our vendors. We generally account for vendor programs as a reduction of the prices of the vendor’s products and therefore a reduction of inventory until we sell the product, at which time we recognize such consideration as a reduction of cost of merchandise and services sold in our consolidated statements of operations. Accounts and other receivables include vendor rebate receivables of $19.5 million and $20.2 million as of October 1, 2022 and October 2, 2021, respectively.

Allowance for Doubtful Accounts

Allowance for doubtful accounts is calculated based on historical experience, counterparty credit risk, consumer credit risk and application of the specific identification method.

Inventories

Business Combinations

We use our best estimates and assumptions as part of the purchase price allocation process to accurately value assets acquired and liabilities assumed as of the acquisition date. Our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill to the extent we identify adjustments to the preliminary purchase price allocation. Upon the conclusion of the measurement period or final determination of the fair values of the assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in our consolidated statements of operations. Our consolidated financial statements include the results of operations from the date of acquisition for each business combination.

The consideration for an acquisition may include future payments that are contingent upon the occurrence of a particular event. We record a contingent consideration at fair value on the acquisition date. We estimate the fair values through valuation models that incorporate probability adjusted assumptions related to the achievement of the milestones and the likelihood of making related payments. The fair value is remeasured at each reporting date and changes in fair value are recorded in within SG&A in the consolidated statements of operations. Determining the fair value of the contingent consideration requires management to make assumptions and judgements.

We expense all acquisition-related costs as incurred in SG&A expenses in our consolidated statements of operations.

Property and Equipment, Net

Property and equipment are stated at cost, less accumulated depreciation and amortization. Costs of normal maintenance and repairs are charged to expense as incurred. Major replacements or improvements of property and equipment are capitalized. When items are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is included in our consolidated statements of operations.

Depreciation and amortization are computed using the straight-line method. These charges are based on the following range of useful lives:

Building and improvements 5-39 years

Vehicles, machinery and equipment 3-10 years

Office furniture, computers and software 3-7 years

Leasehold improvements 5-10 years, not to exceed the lease life

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We evaluate our long-lived assets for potential impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. The evaluation for long-lived assets (asset group) is performed at the lowest level of identifiable cash flows, which, for location assets, is the individual location level. The assets of a physical location with indicators of impairment are evaluated for recoverability by comparing its undiscounted future cash flows with its carrying value. If the carrying value is greater than the undiscounted future cash flows, we then measure the asset’s fair value to determine whether an impairment loss should be recognized. If the resulting fair value is less than the carrying value, an impairment loss is recognized for the difference between the carrying value and the estimated fair value. There was no impairment charge in fiscal 2022 or 2021. The impairment charges for long-lived assets were not material to our consolidated financial statements in fiscal 2020. Impairment charges are recorded in SG&A in our consolidated statements of operations.

Cloud Computing Arrangements

From time-to-time, we enter into various agreements with unaffiliated third parties for assistance with technical development work related to our security-related software and systems and other ongoing projects. Expenditures for implementation, set-up, and other upfront costs incurred in a cloud computing arrangement that is hosted by the vendor are capitalized generally in the same manner as internal use software and are recorded as other assets in our consolidated balance sheets. Such costs are amortized over the life of the related cloud computing arrangement. As of October 1, 2022 and October 2, 2021, approximately $9.7 million and $5.2 million associated with these agreements are included in prepaid expenses and other current assets in our consolidated balance sheets, respectively. In addition, as of October 1, 2022 and October 2, 2021, approximately $35.7 million and $23.1 million associated with these agreements are included in other assets in our consolidated balance sheets, respectively.

Goodwill and Other Intangibles, Net

Goodwill and intangible assets are recorded at their estimated fair values at the date of acquisition. We review goodwill and indefinite-lived intangible assets for impairment annually (in the fourth quarter) or more frequently if impairment indicators arise. Goodwill can be evaluated for impairment, at our option, by first performing a qualitative assessment to determine whether a quantitative goodwill test is necessary. If it is determined, based on qualitative factors, the fair value of the reporting unit may be more likely than not less than the carrying amount, a quantitative goodwill impairment test would be required. Additionally, we can elect to forgo a qualitative assessment and perform a quantitative test. The quantitative test is to identify if a potential impairment exists by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds the fair value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of goodwill.

If a quantitative test is performed, we would estimate the value considering the use of various valuation techniques which may use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. We include assumptions about sales growth, operating margins, discount rates and valuations multiples which consider our budgets, business plans, economic projections and marketplace data, and are believed to reflect market participant views which would exist in an exit transaction. Some of the inherent estimates and assumptions used in this analysis are outside the control of management, including cost of capital, tax rates and market EBITDA comparables.

Finite-lived intangible assets are amortized to reflect the pattern of economic benefits consumed. We evaluate amortizable intangible assets for potential impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. Intangible assets useful lives are reviewed annually.

For our indefinite life intangible assets, a qualitative assessment can also be performed to determine whether the existence of events and circumstances indicates it is more likely than not the intangible asset is impaired. Similar to goodwill, we can also elect to forgo a qualitative test for indefinite life intangible assets and perform a quantitative test. Upon performing the quantitative test, if the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. We evaluate whether certain trade names continue to have an indefinite life annually.

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After we made our assessments, it was determined that there was no impairment related to goodwill or other intangible assets during fiscal 2022, 2021, and 2020.

Leases

We enter into contractual arrangements for the utilization of certain non-owned assets which are evaluated as finance or operating leases upon commencement and are accounted for accordingly. Specifically, a contract is or contains a lease when (1) the contract contains an explicitly or implicitly identified asset and (2) we obtain substantially all of the economic benefits from the use of that underlying asset and direct how and for what purpose the asset is used during the term of the contract in exchange for consideration. We assess whether an arrangement is or contains a lease at inception of the contract.

We lease certain retail locations, warehouse and distribution space, office space, equipment, and vehicles. A substantial majority of our leases have an initial lease term of five years, typically with the option to extend the lease for at least one additional five-year term. Some of our leases may include the option to terminate in less than five years. The lease term used to calculate the right-of-use asset and lease liability at commencement includes the impacts of options to extend or terminate the lease when it is reasonably certain that we will exercise that option. When determining whether it is reasonably certain that we will exercise an option at commencement, we consider various existing economic factors, including market conditions, real estate strategies, the nature, length, and terms of the agreement, as well as the uncertainty of the condition of leased equipment at the end of the lease term. Based on these considerations, we generally conclude that the exercise of renewal options would not be reasonably certain in calculating our operating lease liability at commencement. The discount rate used to calculate the present value of lease payments is the rate implicit in the lease, when readily determinable. As the rate implicit in the lease is rarely readily determinable, we use a secured incremental borrowing rate, which is updated on a periodic basis as the discount rate for the present value of lease payments. Real estate taxes, insurance, maintenance, and operating expenses applicable to the leased property are generally our obligations under our lease agreements. In instances where these payments are fixed, they are included in the measurement of our lease liabilities, and when variable, are excluded and recognized in the period in which the obligation for those payments is incurred. For variable payments dependent upon an index or rate, we apply the active index or rate as of the lease commencement date. Variable lease payments not based on an index or rate are not included in the measurement of our operating lease liabilities as they cannot be reasonably estimated and are recognized in the period in which the obligation for those payments is incurred. Leases that have a term of 12 months or less upon commencement are considered short-term in nature and as such are not included in the measurement of our operating lease right-of-use assets and operating lease liabilities on the consolidated balance sheets and are expensed on a straight-line basis over the lease term. In addition, we do separate lease and non-lease components (e.g., common area maintenance). Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Revenue Recognition

Revenue is recognized when control of the promised goods or services is transferred to our customer, in an amount that reflects the consideration we expect to be entitled to in exchange for such goods or services. Revenue from merchandise sales at retail locations is recognized at the point of sale and revenue from services is recognized when the services are rendered. Revenue from e-commerce merchandise sales is recognized either at the time of pick-up at one of our locations or at the time of shipment, depending on the customer’s order designation. Revenue is recorded net of related discounts, loyalty point deferrals, and sales tax. Payment from retail customers is generally at the point of sale and payment terms for professional pool operators are based on our credit requirements and generally have terms of less than 60 days. When we receive payment from a consumer before the consumer has taken possession of the merchandise or the service has been performed, the amount received is recorded as deferred revenue or as a customer deposit until the sale or service is complete. Shipping and handling are treated as costs to fulfill the contract and not a separate performance obligation.

We estimate a liability for sales returns based on current sales levels and historical return trends. At each financial reporting date, we assess our estimates of expected returns, and a corresponding adjustment to cost of sales for our right to recover the goods returned by the customer, net of any expected recovery cost. Adjustments related to changes in return estimates were immaterial in all periods presented.

Our loyalty program, Pool PerksTM, allows members to earn reward points based on their purchases. Once a loyalty member achieves a certain point level, the member earns an award that may be used on future purchases. Points are valid for 12 months from issuance. We defer revenue related to earned points that have not yet been redeemed. The amount of deferred revenue is based on the estimated standalone selling price of points earned by members and reduced by the percentage of points expected to be redeemed. The estimated redemption percentage is based on historical redemption trends, current trends, and other relevant factors. Revenue is recognized when the rewards are redeemed, expired, or based on estimated breakage. As of October 1, 2022 and October 2, 2021, deferred revenue related to the loyalty program was $4.6 million and $5.9 million, respectively, and is included in accounts payable and accrued expenses in our consolidated balance sheets.

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Cost of Merchandise and Services Sold

Cost of merchandise and services sold reflects the direct cost of purchased merchandise, costs to package certain chemical products, including direct materials and labor, costs to provide services, including labor and materials, as well as distribution and occupancy costs. Distribution costs include warehousing and transportation expenses, including costs associated with third-party fulfillment centers. Occupancy costs include the rent, common area maintenance, real estate taxes, and depreciation and amortization costs of all retail locations.

Selling, General and Administrative Expenses

Our SG&A includes selling and operating expenses at our retail locations and corporate level general and administrative expenses. Selling and operating expenses at retail locations include payroll, bonus and benefit costs for personnel, supplies, and credit and debit card processing costs. Corporate expenses include payroll, bonus, and benefit costs for our corporate and field support functions, equity-based compensation, marketing and advertising, insurance, utilities, occupancy costs related to our corporate office facilities, professional services, and depreciation and amortization for all assets, except those related to our retail locations and distribution operations, which are included in cost of merchandise and services sold.

Advertising

We expense advertising costs as incurred. Advertising costs for fiscal 2022, 2021, and 2020 were approximately $38.0 million, $25.4 million, and $19.4 million, respectively.

Income Taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts and tax bases of existing assets and liabilities. Deferred tax assets, including the benefit of net operating loss and tax credit carryforwards, are evaluated based on the guidelines for realization and are reduced by a valuation allowance if it is deemed more likely than not that such assets will not be realized. We consider several factors in evaluating the realizability of our deferred tax assets, including the nature, frequency and severity of recent losses, the remaining years available for carryforwards, changes in tax laws, the future profitability of the operations in the jurisdiction, and tax planning strategies. Our judgments and estimates concerning realizability of deferred tax assets could change if any of the evaluation factors change, resulting in an increase or decrease to income tax expense in any period.

The ultimate realization of deferred tax assets can be dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. On a quarterly basis, we evaluate whether it is more likely than not that our deferred tax assets will be realized in the future and conclude whether a valuation allowance must be established.

We record a liability for uncertain tax positions to the extent a tax position taken or expected to be taken in a tax return does not meet certain recognition or measurement criteria. Considerable management judgment is necessary to assess the inherent uncertainties related to the interpretations of complex tax laws, regulations and taxing authority rulings. Our judgments and estimates may change as a result of the evaluation of new information, such as the outcome of tax audits or changes to or further interpretations of tax laws and regulations, resulting in an increase or decrease to income tax expense in any period. Interest and penalties accrued, if any, relating to uncertain tax positions will be recognized as a component of the income tax provision.

We determined there were no material uncertain tax positions as of October 1, 2022 and October 2, 2021.

Equity-Based Compensation

Stock-based compensation expense is measured at grant date, based on the fair value of the award, and is recognized on a straight-line basis over the requisite service period for awards expected to vest. See Note 17—Equity-Based Compensation for further discussion.

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Self-Insurance Reserves

We are self-insured for losses relating to workers’ compensation, general liability, and employee medical. Stop-loss coverage has been purchased to limit exposure to any material level of claims. Liabilities for self-insurance reserves are estimated based on independent actuarial estimates, which are based on historical information and assumptions about future events. We utilize various techniques, including analysis of historical trends and actuarial valuation methods, to estimate the cost to settle reported claims and claims incurred but not yet reported as of the balance sheet date. The actuarial valuation methods consider loss development factors, which include the development time frame and expected claim reporting and settlement patterns, and expected loss costs, which include the expected frequency and severity of claim activity.

Earnings per Share

Basic earnings per share is calculated by dividing net income by the weighted average number of shares outstanding during the period. Dilutive earnings per share is computed giving effect to all potentially dilutive shares, unless their effect is antidilutive. We apply the treasury stock method for dilutive share-based awards. Performance-based share-based awards are included in diluted shares only if the related performance conditions have been considered satisfied as of the end of the reporting period.

Recent Accounting Pronouncements

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes (“Topic 740”): Simplifying the Accounting for Income Taxes. ASU 2019-12 removes certain exceptions related to intraperiod tax allocations, foreign subsidiaries, and interim reporting that are present within existing GAAP rules. The ASU also provides updated guidance regarding the tax treatment of certain franchise taxes, goodwill and nontaxable entities, among other items. In addition, ASU 2019-12 clarifies that the effect of a change in tax laws or rates should be reflected in the annual effective tax rate computation during the interim period that includes the enactment date. We adopted ASU 2019-12 as of October 3, 2021, (as of the beginning of fiscal 2022) and its adoption did not have a material impact on our consolidated financial statements.

In March 2020 and January 2021, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting and ASU No. 2021-01, Reference Rate Reform (Topic 848): Scope, respectively. This collective guidance is in response to accounting concerns regarding contract modifications and hedge accounting because of impending rate reform associated with structural risks of interbank offered rates, and particularly, the risk of cessation of the London Inter-Bank Offer Rate (“LIBOR”) related to regulators in several jurisdictions around the world having undertaken reference rate reform initiatives to identify alternative reference rates. The guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The guidance is effective upon issuance and may be applied through December 31, 2022. In anticipation of the adoption and based on management’s initial evaluation of the projected impact to our consolidated financial statements, we do not estimate there to be a material impact.

In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (“Topic 805”): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which includes certain amendments to improve, simplify, and provide consistency for recognition and measurement of acquired contract assets and contract liabilities from revenue contracts in a business combination. The amendments require that an acquirer recognize and measure such contract assets and contract liabilities under Topic 606, Revenue from Contracts with Customers, as if it had originated the contracts. The amendments also allow for election of certain practical expedients, which are applied on an acquisition-by-acquisition basis. The ASU is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted, including for any interim period, and if so elected, the amendments are applied retrospectively for any acquisitions that occurred in the fiscal year of interim adoption. We adopted ASU 2021-08 during the second quarter of fiscal 2022, and its adoption did not have a material impact on our consolidated financial statements.

Note 3—Business Combinations

Our consolidated financial statements include the results of operations of these acquisitions from the date of acquisition. The total purchase consideration was allocated to the tangible and intangible assets acquired and the liabilities assumed at their estimated fair values as of each acquisition date, with the excess recorded to goodwill. The goodwill resulting from these acquisitions is expected to be deductible for income tax purposes. During the measurement periods, which will not exceed one year from each closing, we will continue to obtain information to assist us in finalizing the acquisition date fair values. Any qualifying changes to our preliminary estimates will be recorded as adjustments to the respective assets and liabilities, with any residual amounts allocated to goodwill.

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Fiscal 2022 Acquisitions

In fiscal 2022, we acquired six businesses for an aggregate purchase price of $107.7 million, inclusive of contingent consideration of up $4.0 million if certain performance metrics are achieved within one to three years of the respective closing dates. These acquisitions expanded our pool and spa footprint and added 27 new retail locations as well as expanded our manufacturing capabilities. The following table sets forth the preliminary purchase price allocation of these acquisitions, net of immaterial measurement period adjustments, in the aggregate (in thousands). The purchase accounting for two of the six acquisitions is complete.

Total

Total purchase consideration, net of cash acquired $ 107,663

Fair value of assets acquired and liabilities assumed:

Finite-lived intangible assets 15,200

Other assets and liabilities, net 1,692

Total assets acquired, net of liabilities assumed 36,942

Fiscal 2021 Acquisitions

In fiscal 2021, we acquired three businesses for an aggregate purchase price of $8.9 million. These acquisitions consisted of retailers of supplies and services for hot tubs and swim spas and added eight locations. During fiscal 2022, we recorded measurement period adjustments resulting in an increase in goodwill of $1.7 million related to these acquisitions. The purchase accounting for these acquisitions is complete.

Note 4—Goodwill and Other Intangibles, Net

Goodwill

The following table details the changes in goodwill (in thousands):

Acquisitions, net of measurement period adjustments 72,399 7,819

Other Intangible Assets

Other intangible assets consisted of the following as of October 1, 2022 (in thousands, except weighted average remaining useful life):

Trade name and trademarks (indefinite life) Indefinite 9,350 — 9,350

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Other intangible assets consisted of the following as of October 2, 2021 (in thousands, except weighted average remaining useful life):

Trade name and trademarks (finite life) 6.6 $ 5,940 $ (5,274 ) $ 666

Trade name and trademarks (indefinite life) Indefinite 17,750 — 17,750

Other intangible assets consisted of the following as of October 3, 2020 (in thousands, except weighted average remaining useful life):

Trade name and trademarks (finite life) 3.6 $ 5,540 $ (5,139 ) $ 401

Trade name and trademarks (indefinite life) Indefinite 17,750 — 17,750

Amortization expense was $3.0 million, $2.2 million, and $2.6 million in fiscal 2022, 2021, and 2020, respectively. No impairment of goodwill or other intangible assets was recorded during fiscal 2022, 2021, and 2020.

In the fourth quarter of fiscal 2022, an $8.4 million indefinite-lived trade name intangible asset was reclassified to a finite-lived intangible asset due to a change in the way the asset will be utilized in the future. Prior to reclassifying the trade name to a finite-lived intangible asset, the Company tested it for impairment and determined that the fair value of the asset exceeded the carrying value. This trade name was assigned a 10-year estimated useful life and will be amortized over its useful life on a prospective basis.

The following table summarizes the estimated future amortization expense related to finite-lived intangible assets on our consolidated balance sheet as of October 1, 2022 (in thousands):

Amount

Note 5—Accounts and Other Receivables, Net

Accounts and other receivables, net consisted of the following (in thousands):

Vendor and other rebates receivable $ 24,546 $ 23,222

Allowance for doubtful accounts (1,512 ) (2,456 )

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Note 6—Inventories

Inventories consisted of the following (in thousands):

Changes in inventory excess and obsolescence reserves were as follows (in thousands):

Additions Deductions

Note 7—Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of the following (in thousands):

Note 8—Property and Equipment

Property and equipment consist of the following (in thousands):

Less: accumulated depreciation and amortization (342,860 ) (321,936 )

Depreciation and amortization expense on property and equipment was $27.8 million, $26.6 million, and $28.9 million in fiscal 2022, 2021, and 2020, respectively. Construction in process primarily consisted of leasehold improvements related to new or remodeled locations where construction had not been completed by the end of the period and internal use software as of October 1, 2022 and October 2, 2021, respectively.

Capitalized software additions placed into service were $6.5 million, $2.8 million, and $3.0 million in fiscal 2022, 2021, and 2020, respectively. Capitalized software accumulated amortization totaled approximately $20.9 million and $15.0 million as of October 1, 2022 and October 2, 2021, respectively. Capitalized software and development costs remaining to be amortized were approximately $7.6 million and $6.9 million as of October 1, 2022 and October 2, 2021, respectively.

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Note 9—Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consisted of the following (in thousands):

Accrued payroll and employee benefits 34,010 40,071

As of October 1, 2022, October 2, 2021, and October 3, 2020, approximately $1.1 million, $1.5 million, and $1.1 million of capital expenditures are included in other accrued liabilities, respectively.

Note 10—Long-Term Debt

Our long-term debt, net consisted of the following (in thousands, except interest rates):

EffectiveInterest Rate (1) October 1, 2022 October 2, 2021

Revolving Credit Facility 1.25 % (3) — —

Senior Unsecured Notes — —

Less: current portion of long-term debt (8,100 ) (8,100 )

Less: unamortized discount (2,805 ) (3,285 )

Less: deferred financing charges (7,219 ) (8,440 )

(1)

Effective interest rates as of October 1, 2022.

(2)

Carries interest at a specified margin over LIBOR between 2.50% and 2.75% with a minimum LIBOR of 0.50%.

(3)

Carries interest at a specific margin between 0.25% and 0.75% with respect to Base Rate loans and between 1.25% and 1.75% with respect to Eurodollar Rate loans.

Term Loan

In March 2021, we entered into an amendment to our Term Loan. The amended Term Loan provides for an $810.0 million secured term loan facility with a maturity date of March 9, 2028. Borrowings under the Term Loan have an initial applicable rate, at our option, of (i) 2.75% for loans that are LIBOR loans and (ii) 1.75% for loans that are ABR loans. The applicable rate of the Term Loan is based on our first lien leverage ratio as follows: (a) if the first lien leverage ratio is greater than 2.75 to 1.00, the applicable rate will be 2.75% for LIBOR loans and 1.75% for ABR loans and (b) the first lien leverage ratio is less than or equal to 2.75 to 1.00, the applicable rate will be 2.50% for LIBOR loans and 1.50% for ABR loans. For LIBOR loans, the loans will bear interest at the adjusted LIBOR rate plus the applicable rate, where the adjusted LIBOR rate will not be less than 0.50%. As a result of the amendment during the fiscal year ended October 2, 2021, we recognized a $1.9 million loss on debt extinguishment on our consolidated statements of operations.

Revolving Credit Facility

In April 2021, we entered into Amendment No. 5 to our $200.0 million Revolving Credit Facility maturing on August 13, 2025 (the “Amendment”). The Amendment has (i) an applicable margin on Base Rate loans with a range of 0.25% to 0.75%, (ii) an applicable margin on Eurodollar Rate loans with a range of 1.25% to 1.75%, (iii) a LIBOR floor of 0%, and (iv) a commitment fee rate of 0.25%.

We are also obligated to pay a commission on all outstanding letters of credit as well as customary administrative, issuance, fronting, amendment, payment, and negotiation fees. As of October 1, 2022 and October 2, 2021, no amounts were outstanding under the Revolving Credit Facility. The amount available was reduced by $10.0 million and $9.2 million of existing standby letters of credit as of October 1, 2022 and October 2, 2021, respectively.

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Senior Unsecured Notes

The senior unsecured notes principal of $390.0 million was paid in full on November 3, 2020, resulting in a loss on debt extinguishment of $7.3 million on our consolidated statements of operations for the fiscal year ended October 2, 2021.

Interest Rate Cap Agreements

In March 2017, we entered into interest rate cap agreements in order to manage the variability of cash flows related to a portion of our floating rate indebtedness. Pursuant to the agreements, we capped LIBOR at 3.00% with respect to the aggregate notional amount of $750.0 million. In March 2021, our interest rate cap agreements expired. The fair value of our interest rate cap agreements was zero as of October 2, 2021, and we did not recognize any gain or loss on our interest rate cap agreements in fiscal 2021.

Representations and Covenants

Substantially all of our assets are pledged as collateral to secure our indebtedness. The Term Loan and the Revolving Credit Facility do not require us to comply with any financial covenants. The Term Loan and the Revolving Credit Facility contain customary representations and warranties, covenants, and conditions to borrowing. No event of default occurred as of October 1, 2022 and October 2, 2021, respectively.

Future Debt Maturities

The following table summarizes the debt maturities and scheduled principal repayments of our indebtedness as of October 1, 2022 (in thousands):

Amount

Note 11—Leases

Operating Leases

We lease certain locations, office, distribution, and manufacturing facilities under operating leases that expire at various dates through December 2033. We are obligated to make cash payments in connection with various lease obligations and purchase commitments. All of these obligations require cash payments to be made by us over varying periods of time. Certain leases are renewable at our option typically for periods of five or more years. Certain of these arrangements are cancelable on short notice and others require payments upon early termination. We do not have any finance leases.

The following table summarizes the components of lease expense (in thousands):

Year Ended

As of October 1, 2022 and October 2, 2021, operating lease right-of-use assets obtained in exchange for operating lease liabilities totaled $32.6 million and $9.7 million, respectively.

The following table presents the weighted-average remaining lease term and discount rate for operating leases:

Weighted-average remaining lease term 4.4 years 4.3 years

Weighted-average discount rate 5.5 % 5.1 %

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The following table summarizes the future annual minimum lease payments as of October 1, 2022 (in thousands):

Amount

Less: amount of lease payments representing imputed interest 32,083

Present value of future minimum lease payments 240,208

Less: current operating lease liabilities 60,373

Operating lease liabilities, noncurrent $ 179,835

Note 12—Income Taxes

The provision for income taxes consists of the following (in thousands):

Year Ended

Current:

Deferred:

A reconciliation of the provision for income taxes to the amount computed at the federal statutory rate is as follows (in thousands):

Year Ended

Change in valuation allowance — (5,425 ) (11,373 )

Our effective income tax rate for fiscal 2022 was 23.6% as compared to 22.4% in fiscal 2021.

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The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are summarized below (in thousands):

Deferred tax assets:

Deferred tax liabilities:

Property, plant, and equipment (4,066 ) (1,392 )

Deferred financing cost (310 ) (399 )

Deferred tax assets (liabilities), net $ 1,268 $ 3,734

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. The interest expense limitation passed in the CARES Act created a deferred tax asset for the fiscal year ended October 3, 2020 that we did not anticipate realizing in the immediate future; as a result, a valuation allowance was recorded. The $5.4 million valuation allowance was removed during the first quarter of fiscal 2021 as the realization of the CARES Act deferred tax asset was deemed probable due to the Company’s paydown of debt with proceeds from the IPO, which decreased interest expense.

We are subject to United States federal and state taxes in the normal course of business and our income tax returns are subject to examination by the relevant tax authorities. We are no longer subject to United States federal examinations by taxing authorities for calendar years before 2018 and are no longer subject to state examinations for calendar years before 2017.

We have not identified any material uncertain tax positions.

In August 2022, the Inflation Reduction Act of 2022 was signed into law containing provisions effective January 1, 2023, including a 15% corporate minimum tax and a 1% excise tax on stock repurchases and several tax incentives to promote clean energy. The Company is evaluating the impact on future periods and at this time the Company does not expect it to have a material impact on its consolidated financial statements.

Note 13—Commitments & Contingencies

Contingencies

We are defendants in lawsuits or potential claims encountered in the normal course of business. When the potential liability from a matter can be estimated and the loss is considered probable, we record the estimated loss. Due to uncertainties related to the resolution of lawsuits, investigations and claims, the ultimate outcome may differ from the estimates. We do not expect that the resolutions of any of these matters will have a material effect to our consolidated financial position or results of operations. We did not record any material loss contingencies as of October 1, 2022, October 2, 2021, and October 3, 2020.

Our workers’ compensation insurance program, general liability insurance program, and employee group medical plan have self-insurance retention features of up to $0.4 million per event as of October 1, 2022 and October 2, 2021. We had standby letters of credit outstanding in the amounts of $10.0 and $9.2 million as of October 1, 2022 and October 2, 2021, respectively, for the purpose of securing such obligations under our workers’ compensation self-insurance programs.

Purchase Commitments

In addition to our lease obligations, we maintain future purchase commitments related to inventory and operational requirements.

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The following table summarizes the future minimum purchase commitments as of October 1, 2022 (in thousands):

Amount

Note 14—401(K) Plan

We provide for the benefit of our employees a voluntary defined contribution retirement plan under Section 401(k) of the Internal Revenue Code. The plan covers all eligible employees and provides for a matching contribution by us of 50% of each participant’s contribution of up to 4% of the individual’s compensation as defined. The expenses related to this plan were $1.4 million, $0.8 million, and $1.1 million in fiscal 2022, 2021, and 2020, respectively.

Note 15—Related Party Transactions

In February 2017, we entered into a management services agreement with our private equity sponsors in connection with our acquisition in February 2017. The management services agreement provided that we pay an annual fee for management and advisory services to us and our affiliates, including general management consulting services, support and analysis with respect to financing alternatives and strategic planning functions. The management services agreement terminated in October 2020 in connection with the completion of our IPO. During fiscal 2020, we paid or accrued management fees in the amount of $4.9 million.

On December 14, 2021, the Company entered into a share repurchase agreement with Bubbles Investor Aggregator, L.P. and Explorer Investment Pte. Ltd. (together, the “Selling Stockholders”), each a greater than 5% beneficial owner of the Company’s common stock, providing for the repurchase by the Company from the Selling Stockholders of an aggregate of 7.5 million shares of common stock, conditioned on the closing of a contemporaneous secondary public offering (the “Offering”). The price per share of repurchased common stock paid by the Company was $20.25, which represents the per share price at which shares of common stock were sold to the public in the Offering less the underwriting discount. The repurchase transaction closed on December 16, 2021. See Note 16—Share Repurchase Program for detailed information regarding our share repurchase program.

Note 16—Share Repurchase Program

On December 3, 2021, the board of directors authorized a share repurchase program for up to an aggregate of $300 million of the Company’s outstanding shares of common stock over a period of three years, expiring December 3, 2024. The amount, price, manner, and timing of repurchases are determined by the Company in its discretion and depends on a number of factors, including legal requirements, price, economic and market conditions, the Company’s financial condition, capital requirements, cash flows, results of operations, future business prospects, and other factors our management may deem relevant. The share repurchase program may be amended, suspended, or discontinued at any time. Shares may be repurchased from time-to-time using a variety of methods, including on the open market and/or in privately negotiated transactions, including under plans complying with Rule 10b5-1 under the Exchange Act, as part of accelerated share repurchases, and other methods.

On December 16, 2021, the Company repurchased and retired 7.5 million shares of common stock at a price per share of $20.25 under the program. The Company paid $151.9 million ($152.1 million including offering costs) to fund the share repurchase using existing cash on hand. The Company accounted for the share repurchase and retirement of shares under the cost method by deducting its par value from common stock, reducing additional paid-in-capital by $127.5 million (using the share price when the shares were originally issued), and increasing retained deficit by the remaining excess cost of $24.4 million.

As of October 1, 2022, approximately $148 million remained available for future purchases under our share repurchase program.

The following table presents information about our repurchases of common stock under our share repurchase program (in thousands):

Year Ended

Total number of shares repurchased 7,500 —

Total amount paid for shares repurchased $ 151,875 $ —

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Note 17—Equity-Based Compensation

Equity-Based Compensation

2020 Omnibus Incentive Plan

In October 2020, we adopted the Leslie’s, Inc. 2020 Omnibus Incentive Plan (the “Plan”). The Plan provides for the grant of awards such as non-qualified stock options to purchase Leslie’s common stock (each, a “Stock Option”) and restricted stock units (“RSUs”) which may settle in Leslie’s, Inc. common stock to our directors, executives and eligible employees of the Company. Stock Options granted under the Plan generally expire ten years from the date of grant and consist of Stock Options that vest upon the satisfaction of time-based requirements (“Service Stock Option”) and performance-based Stock Options that vest upon satisfaction of a performance-based requirement (“Performance Stock Options”). RSUs consist of grants that vest ratably upon the satisfaction of time-based requirements (“Service RSU”) and performance-based RSUs that vest upon satisfaction of performance-based requirements (“Performance RSU”). In each case, vesting of the Company’s outstanding and unvested Stock Options and RSUs is contingent upon the holder’s continued service through the date of each applicable vesting event. As of October 1, 2022, we had approximately 8.1 million shares of common stock available for future grants under the Plan.

As of October 1, 2022, the aggregate unamortized value of all outstanding equity-based compensation awards was approximately $29.1 million, which is expected to be recognized over a weighted average period of approximately 2.5 years.

Stock Options

The fair value of each Stock Option granted is estimated on the grant date using the Black-Scholes option pricing model. The expected life is based on the SEC simplified method and a mid-point assumption. Expected price volatility is determined based on the implied volatilities of comparable companies over a historical period that matches the expected life of the Stock Options. The risk-free interest rate is based on the expected United States Treasury rate over the expected life. The dividend yield is based on the expectation that no dividends will be paid.

During fiscal 2022, the Company did not grant any Stock Options. The following table summarizes the weighted average assumptions used for Stock Options granted during the year ended October 2, 2021:

Expected volatility 28.9 %

Risk-free interest rate 0.7 %

Dividend yield 0.0 %

Expected term (in years) 6.3

The following tables summarize our Stock Option activity under the Plan for the fiscal years ended (in thousands, except per share amounts):

Year Ended

Outstanding, Beginning 4,877 $ 18.22 — $ —

Vested and exercisable as of year-end 1,349 $ 18.28 — $ —

Aggregate intrinsic value of Stock Options outstanding $ —

Unamortized value of unvested Stock Options $ 9,477

Weighted average years that expense is expected to be recognized 1.8

Weighted average remaining contractual years outstanding 8.6

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Restricted Stock Units

The following table summarizes our RSU activity under the Plan for the fiscal years ended (in thousands, except per share amounts):

Year Ended

Outstanding, Beginning 3,135 $ 6.90 — $ —

Converted from Incentive Awards(1) — — 6,038 1.43

(1)

Represents approximately 4.8 million Service and Performance Incentive Awards converted to RSUs in connection with the IPO and adoption of the Plan during fiscal 2021.

(2)

RSUs that vested during the year ended October 2, 2021 includes RSUs that were issued in connection with the IPO that vest only upon achievement of volume weighted average price (“VWAP”) targets established by the compensation committee of the board of directors (Performance RSUs). The VWAP target was measured over rolling 20-day trading periods commencing on the six-month anniversary of the consummation of the IPO.

Unamortized value of unvested RSUs $ 19,622

Weighted average period (years) expense is expected to be recognized 2.8

During the fiscal year ended October 1, 2022, equity-based compensation expense was $11.3 million. During the fiscal year ended October 2, 2021, equity-based compensation expense was $25.6 million and approximately $10.7 million associated with the acceleration of certain Incentive Awards in connection with the completion of our IPO. Equity-based compensation expense was $1.8 million during the fiscal year ended October 3, 2020. Equity-based compensation expense is reported in SG&A in our consolidated statements of operations.

Incentive Grant Agreements

Prior to the IPO, our then parent company granted profits interests to our employees (“Incentive Awards”) through incentive unit grant agreements (“Incentive Agreements”). The Incentive Awards had economic characteristics similar to Stock Options and had the right to share in the appreciation of the equity value of our then parent company. The sole asset of our then parent company was indirect ownership of Leslie’s, Inc. We concluded such Incentive Awards were classified as equity awards. The Incentive Awards were spread over two tiers, a service-based (time) award tier (“Service Incentive Awards”) and a performance-based award tier (“Performance Incentive Awards”). The Service Incentive Awards vested over a four-year period at a rate of 25% annually on each anniversary of the date of grant. The Performance Incentive Awards vested based on performance conditions as defined in the Incentive Agreements. In connection with the IPO and adoption of the Plan, all Incentive Awards granted under Incentive Agreements were converted to RSUs under the Plan with substantially similar service and performance conditions as defined in the Incentive Agreements.

The fair value of the Incentive Awards was estimated on the date of grant using the Black-Scholes option pricing model, which treated the Incentive Unit Grant Agreements as implicit call options with exercise prices determined based on their respective rights to participate in distributions. The Black-Scholes option pricing model required the use of a number of assumptions, including expected volatility, risk-free interest rate, expected dividends, and expected term.

The following table summarizes the assumptions and fair value used for Incentive Awards for the fiscal year ended October 3, 2020:

Expected volatility 23.5 %

Risk-free interest rate 1.4 %

Dividend yield 0.0 %

Expected term (in years) 4.0

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The following table summarizes our Incentive Awards activity for the fiscal year ended (in thousands, except per share amounts):

Cancelled upon IPO (8,450 ) —

Converted to RSUs (4,817 ) —

Cancelled/forfeited — (2,976 )

Note 18—Earnings Per Share

LESL US Equity

LESL · 10-K · period ended 2022-10-01

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Item 8. Financial Statements and Supplementary Data.

LESL US Equity☆

LESL · 10-K · period ended 2022-10-01

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Item 8. Financial Statements and Supplementary Data.

LESL US Equity