Leslie's, Inc. 10-K

Item 8. Financial Statements and Supplementary Data. 46 LESLIE’S, INC. INDEX TO Consolidated Financial Statements Audited Consolidated Financial Statements for the fiscal years ended October 3, 2020, September 28, 2019 and September 29, 2018 Report of Independent Registered Public Accounting Firm 48 Consolidated Balance Sheets 49 Consolidated Statements of Operations 50 Consolidated Statements of Stockholders’ Deficit 51 Consolidated Statements of Cash Flows 52 Notes to Consolidated Financial Statements 53 47 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 3, 2020 and September 28, 2019, the related consolidated statements of operations, stockholders’ deficit and cash flows for each of the three years in the period ended October 3, 2020, 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 3, 2020 and September 28, 2019, and the results of its operations and its cash flows for each of the three years in the period ended October 3, 2020, in conformity with U.S. generally accepted accounting principles. Adoption of New Accounting Standard As discussed in Notes 2 and 9 to the consolidated financial statements, the Company changed its method for accounting for leases in the year ended October 3, 2020 due to the adoption of ASU No. 2016-02, Leases. 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 Public Company Accounting Oversight Board (United States) (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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. 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. /s/ Ernst & Young LLP We have served as the Company’s auditor since 2000. Phoenix, Arizona December 23, 2020 48 LESLIE’S, INC. CONSOLIDATED BALANCE SHEETS (Amounts in Thousands, Except Share and Per Share Amounts) As of October 3, 2020 September 28, 2019 Assets Current assets Cash and cash equivalents $ 157,072 $ 90,899 Accounts and other receivables, net 31,481 33,872 Inventories, net 148,966 149,729 Prepaid expenses and other current assets 34,614 7,589 Total current assets 372,133 282,089 Property and equipment, net 66,391 78,506 Operating lease right-of-use assets 177,655 — Goodwill and other intangibles, net 121,186 117,724 Deferred tax assets 6,583 — Other assets 2,490 1,402 Total assets $ 746,438 $ 479,721 Liabilities and stockholders’ deficit Current liabilities Accounts payable $ 92,372 $ 68,347 Accrued expenses 101,167 82,121 Operating lease liabilities 54,459 — Income taxes payable 1,857 6,713 Current portion of long-term debt 8,341 8,341 Total current liabilities 258,196 165,522 Deferred tax liabilities — 1,240 Operating lease liabilities, noncurrent 130,234 — Long-term debt, net 1,179,550 1,186,493 Other long-term liabilities 5,457 13,823 Total liabilities 1,573,437 1,367,078 Commitments and contingencies Stockholders’ deficit Common stock, $0.001 par value, 156,500,000 shares authorized, issued, and outstanding at October 3, 2020 and September 28, 2019 157 157 Capital deficit (278,063 ) (279,848 ) Retained deficit (549,093 ) (607,666 ) Total stockholders’ deficit (826,999 ) (887,357 ) Total liabilities and stockholders’ deficit $ 746,438 $ 479,721 See accompanying notes which are an integral part of these consolidated financial statements. 49 LESLIE’S, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in Thousands, Except Share and Per Share Amounts) Fiscal Year Ended October 3, 2020 September 28, 2019 September 29, 2018 Sales $ 1,112,229 $ 928,203 $ 892,600 Cost of merchandise and services sold 651,516 548,463 535,464 Gross profit 460,713 379,740 357,136 Selling, general and administrative expenses 314,338 258,152 241,669 Operating income 146,375 121,588 115,467 Other expense: Interest expense 84,098 98,578 91,656 Other expenses, net 1,089 7,453 1,759 Total other expense 85,187 106,031 93,415 Income before taxes 61,188 15,557 22,052 Income tax expense 2,627 14,855 4,926 Net income $ 58,561 $ 702 $ 17,126 Net income per share Basic and diluted $ 0.37 $ 0.00 $ 0.11 Weighted average shares outstanding Basic and diluted 156,500,000 156,500,000 156,500,000 See accompanying notes which are an integral part of these consolidated financial statements. 50 LESLIE’S, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT (Amounts in Thousands, Except Share Amounts) Common Stock Capital Retained Shares Amount Deficit Deficit Totals Balance, September 30, 2017 156,500,000 $ 157 $ (283,763 ) $ (624,395 ) $ (908,001 ) Equity-based compensation — — 1,785 — 1,785 Recovery of deemed distributions — — — 141 141 Net income — — — 17,126 17,126 Balance, September 29, 2018 156,500,000 $ 157 (281,978 ) (607,128 ) (888,949 ) Equity-based compensation — — 2,130 — 2,130 Payment of dividend — — — (1,240 ) (1,240 ) Net income — — — 702 702 Balance, September 28, 2019 156,500,000 $ 157 $ (279,848 ) $ (607,666 ) $ (887,357 ) Impact of adoption of new accounting pronouncements — — — 12 12 Equity-based compensation — — 1,785 — 1,785 Net income — — — 58,561 58,561 Balance, October 3, 2020 156,500,000 $ 157 $ (278,063 ) $ (549,093 ) $ (826,999 ) See accompanying notes which are an integral part of these consolidated financial statements. 51 LESLIE’S, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar Amounts in Thousands) Fiscal Year Ended October 3, 2020 September 28, 2019 September 29, 2018 Operating activities Net income $ 58,561 $ 702 $ 17,126 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 28,925 30,424 31,611 Equity-based compensation 1,785 2,130 1,785 Amortization of deferred financing costs and debt discounts 3,489 3,240 3,013 Provision for doubtful accounts 577 463 259 Deferred income taxes (7,823 ) (754 ) 1,405 Loss on disposition of assets 785 1,751 1,057 Loss on extinguishment of debt — — 488 Changes in operating assets and liabilities: Accounts and other receivables 1,813 (5,632 ) (4,304 ) Inventories 1,762 (3,797 ) (4,920 ) Prepaid expenses and other current assets (26,912 ) (1,670 ) 289 Other assets (1,070 ) 4,518 (2,759 ) Accounts payable and accrued expenses 39,336 23,832 2,039 Income taxes payable (4,856 ) 2,614 (3,809 ) Operating lease assets and liabilities, net 7,037 — — Net cash provided by operating activities 103,409 57,821 43,280 Investing activities Purchases of property and equipment (20,630 ) (27,444 ) (28,786 ) Acquisitions, net of cash acquired (6,188 ) (9,616 ) (11,758 ) Proceeds from disposition of fixed assets 7 64 325 Net cash used in investing activities (26,811 ) (36,996 ) (40,219 ) Financing activities Borrowings on revolving commitment 238,750 190,900 148,400 Repayments to revolving commitment (238,750 ) (190,900 ) (148,400 ) Principal payments on Term Loan (10,425 ) (6,255 ) (23,662 ) Recovery of deemed distribution — — 141 Payment of dividend — (1,240 ) — Payment of deferred financing costs — — (865 ) Net cash used in financing activities (10,425 ) (7,495 ) (24,386 ) Net increase (decrease) in cash and cash equivalents 66,173 13,330 (21,325 ) Cash and cash equivalents, beginning of period 90,899 77,569 98,894 Cash and cash equivalents, end of period $ 157,072 $ 90,899 $ 77,569 Supplemental disclosure of cash payments for: Interest $ 88,678 $ 90,478 $ 90,055 Income taxes 15,305 12,944 7,329 See accompanying notes which are an integral part of these consolidated financial statements. 52 LESLIE’S, INC. NOTES TO 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, cleaning accessories, as well as safety, recreational, and fitness-related products. We currently market our products through 936 company-operated locations in 37 states and e-commerce websites. Note 2—Summary of Significant Accounting Policies Basis of Presentation and Principles of Consolidation We prepared the consolidated financial statements following U.S. generally accepted accounting principles (“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 2020, fiscal 2019 and fiscal 2018 refer to the 53 weeks ended October 3, 2020, 52 weeks ended September 28, 2019 and 52 weeks ended September 29, 2018, respectively. Use of Estimates in the Preparation of Financial Statements To prepare financial statements that conform to GAAP, we make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Our most significant estimates relate to the allowance for doubtful accounts, inventory obsolescence reserves, vendor programs, income taxes, self-insurance, and goodwill impairment evaluations. We continually review our estimates and make adjustments as necessary, but actual results could be significantly different from what we expected when we made these estimates. 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. The amounts due from financial intermediaries for these transactions classified as cash and cash equivalents totaled $157.1 million and $90.9 million at October 3, 2020 and September 28, 2019. Fair Value Measurements We measure certain financial instruments and other items at fair value. 53 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 3, 2020 and September 28, 2019, we held zero and $85.5 million, respectively, in money market funds that are required to be measured at fair value on a recurring basis. These assets were determined to be Level 1 assets as they are actively traded and are classified as cash and cash equivalents. Fair Value of Financial Instruments We evaluate our financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level of classification for each reporting period within the fair value hierarchy. The fair value of the Term Loan due in 2023 (see Note 8), was determined to be $796.5 million at October 3, 2020 and $783.6 million at September 28, 2019. Fair value of the Senior Unsecured Notes (see Note 8) at October 3, 2020 and September 28, 2019 was estimated to be $390.0 million. 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 fair value of the interest rate cap agreements (see Note 8), determined to be Level 2, and is included in other assets on the consolidated balance sheets as of October 3, 2020 and September 28, 2019. Changes in fair value of the interest rate cap are recorded in other expenses in the consolidated statement of operations. The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate fair value due to the short-term maturity of these instruments. There were no transfers between levels in the fair value hierarchy during the fiscal years ended October 3, 2020 and September 28, 2019 respectively. 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 statement of operations. Certain programs offering advertising support are recorded as a reduction to selling, general and administrative expenses in the consolidated statement of operations. Accounts and other receivables include vendor rebate receivables of $15.9 million and $16.7 million as of October 3, 2020 and September 28, 2019, respectively. 54 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 and was not material in fiscal 2020 or 2019. Inventories, Net Inventories are stated at the lower of cost or market. 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 historical purchase cost, selling price, margin, and current business trends. When an inventory item is sold or disposed, the associated reserve is released at that time. 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 the 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: Buildings and improvements 5–39 years Vehicles, machinery, and equipment 3–10 years Office furniture and equipment 3–7 years Leasehold improvements 5–10 years, not to exceed the lease life We evaluate events and changes in circumstances that could indicate carrying amounts of long-lived assets, including property and equipment, may not be recoverable. When such events or changes in circumstances occur, we assess the recoverability of long-lived assets by determining whether or not the carrying value of such assets will be recovered through undiscounted future cash flows derived from their use and eventual disposition. For purposes of this assessment, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If the sum of the undiscounted future cash flows is less than the carrying amount of an asset, we record an impairment loss for the amount by which the carrying amount of the assets exceeds its fair value. We recorded an impairment charge of $0.2 million, $1.2 million and $0.7 million in fiscal 2020, 2019 and 2018, respectively. The impairment charge is recorded in selling, general and administrative expenses in the consolidated statements of operations. Internal Use Software Expenditures for software developed for internal use are capitalized and amortized over the estimated useful life of the asset. Our policy provides for the capitalization of external direct costs of materials and services associated with developing or obtaining internal use computer software. In addition, we also capitalize certain payroll and payroll-related costs for employees who are directly associated with internal use computer software development projects. The amount of payroll costs capitalized with respect to these employees is limited to the time directly spent on such projects. Costs associated with preliminary project stage activities, training, maintenance and all other post-implementation stage activities are expensed as incurred. Capitalized software additions placed into service were $3.0 million and $4.0 million in fiscal 2020 and 2019, respectively. Capitalized software accumulated amortization totaled approximately $11.1 million and $8.7 million as of October 3, 2020 and September 28, 2019, respectively. Capitalized software and development costs remaining to be amortized were approximately $7.0 million and $6.4 million, as of October 3, 2020 and September 28, 2019, respectively. 55 Goodwill and Other Intangibles, net Goodwill and intangible assets are recorded at cost or 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 on an interim basis whenever events or changes in circumstances indicate the fair value of such assets may be below their carrying amount. We may first make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying value. The qualitative impairment assessment includes considering various factors including macroeconomic conditions, industry and market conditions, cost factors, a sustained share price or market capitalization decrease, and any reporting unit specific events. If it is determined through the qualitative assessment that a reporting unit’s fair value is more likely than not greater than its carrying value, the quantitative impairment assessment is not required. If the qualitative assessment indicates it is more likely than not that a reporting unit’s fair value is not greater than its carrying value, we must perform a quantitative impairment assessment. If it is determined a quantitative assessment is necessary, we would compare the fair value of the reporting unit to the respective carrying value, which includes goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired. If the carrying value is higher than the fair value, the difference would be recognized as an impairment loss. Similar to our test for impairment of goodwill, we may first make a qualitative assessment of whether it is more likely than not that an indefinite lived intangible assets’ fair value is less than its carrying value to determine whether it is necessary to perform a quantitative impairment assessment. If it is determined a quantitative assessment is necessary, we would compare their estimated fair values to their carrying values. We would recognize an impairment charge when the estimated fair value of the indefinite lived intangible asset is less than its carrying value. We annually evaluate whether the trade names continue to have an indefinite life. 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. After we made our qualitative assessments it was determined that there were no impairment charges related to goodwill or other indefinite lived intangible assets during the years ended October 3, 2020 and September 28, 2019. 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 became 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, as well as to the expiration of statutes of limitations in the numerous and varied jurisdictions in which we operate. Our judgments and estimates may change as a result of the evaluation of new information, such as the outcome 56 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 3, 2020 and September 28, 2019. 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 the Company expects 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, revenue from services are 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 commercial customers are based on the Company’s 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. We do not provide an estimated allowance for sales returns or chargebacks, as they have been determined to be immaterial. Shipping and handling are treated as costs to fulfill the contract and not a separate performance obligation. We include shipping and handling fees billed to customers as freight out income within net sales and those costs are charged to cost of merchandise and services sold. The Company offers a customer loyalty program that provides customers with the ability to earn reward points based on their purchases. Loyalty rewards are accounted for as a separate performance obligation and deferred revenue is recorded in the amount of the transaction price allocated to the rewards, inclusive of the impact of estimated breakage. The estimated breakage of loyalty rewards is based on historical redemption rates experienced under the loyalty program. Revenue is recognized when the rewards are redeemed, expire or based on estimated breakage. The amount of deferred revenue related to the loyalty program is included in accrued expenses and other current liabilities on the balance sheet and is not material. Prior to fiscal 2020, loyalty program revenue was recorded using the incremental cost method within cost of sales on the consolidated statements of income. 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 selling, general and administrative expenses include 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, 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 2020, 2019 and 2018 were approximately $19.4 million, $18.0 million and $21.9 million, respectively, and are shown net of cooperative advertising of $1.6 million, $1.6 million and $1.4 million for these periods, respectively. 57 Equity-Based Compensation We recognize equity-based compensation expense based on the fair value of the awards at the grant date. We use the Black-Scholes model, which uses certain subjective assumptions in determining the fair value of the awards. Compensation cost is recognized ratably over the vesting period of the related equity-based compensation award. For performance based vesting awards, compensation cost is recognized taking into account the probability of our achievement of such performance targets. Forfeitures are accounted for as they occur. 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. Self-insured liabilities include our estimates of the aggregate ultimate losses and claims incurred but not reported using historical experience. 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. 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 the consolidated statements of operations. Our consolidated financial statements include the results of operations from the date of acquisition for each business combination. We expense all acquisition-related costs as incurred in selling, general and administrative expenses in the consolidated statements of operations. 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. Net Income per Share We calculate net income per share by dividing the net income or loss by the weighted average number of common shares outstanding. We had no potentially dilutive securities for any periods presented. Recent Accounting Pronouncements In March 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2020-04”). This ASU provides temporary optional expedients and exceptions to the GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates. This ASU is effective for all entities beginning as of its date of effectiveness, March 12, 2020. The guidance is temporary and can be applied through December 31, 2022. This ASU did not have a material impact on our consolidated financial statements. 58 In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This ASU amends the Accounting Standards Codification (“ASC”) 820, Fair Value Measurement to add, remove, and modify fair value measurement disclosure requirements. The adoption of this ASU did not have a material impact on our consolidated financial statements. In May 2017, the FASB issued ASU 2018-07, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, which amends the scope of modification accounting for share-based payment arrangements. The adoption of this ASU did not have a material impact on our consolidated financial statements. In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which will require entities to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial instruments measured at amortized cost and also applies to some off-balance sheet credit exposures. The adoption of this ASU as of the first day of our fiscal year ending October 3, 2020 did not have a material impact on our consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires that lessees recognize lease assets and lease liabilities on the balance sheet with an option to exclude short-term leases (leases with terms of 12 months or less). The guidance also requires disclosures about the amount, timing, and uncertainty of cash flows arising from leases. As of the first day of our fiscal year 2020, we adopted ASU No. 2016-02 using the modified retrospective approach and elected the package of practical expedients to use in transition, which permitted us not to reassess, under the new standard, our prior conclusions about lease identification and lease classification. Additionally, we separate lease and non-lease components of contracts. The adoption resulted in the addition of $177.7 million of operating lease right-of-use assets and a corresponding $184.7 million of operating lease liabilities to our balance sheet, while eliminating deferred rent and tenant improvement allowances. The adoption but did not have a material impact on the Company’s Consolidated Statements of Operations, Consolidated Statements of Stockholders’ Deficit or Consolidated Statements of Cash Flows. See Note 9, “Leases” for additional information related to the Company’s leases. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. In adopting ASU 2014-09 companies may use either a full retrospective or a modified retrospective approach. We adopted this ASU, under the modified retrospective approach, as of the first day of fiscal year 2020. The cumulative effect of adoption was primarily related to the change in accounting for the loyalty program, and was not material. Note 3—Business Combinations Fiscal 2020 Acquisition In October 2019, we acquired the assets of a retailer of supplies and services for hot tubs, swim spas and saunas. The acquisition included six locations in the Portland area of Oregon and expanded our retail presence to 37 states. The acquisition did not have a material impact on our financial position or results of operations. Our consolidated financial statements include the results of operations of the acquisition from the date of acquisition. The goodwill resulting from the acquisition is deductible for income tax purposes. The purchase accounting for this acquisition is complete. 59 Fiscal 2019 Acquisition In January 2019, we acquired a retailer of supplies and services for swimming pools, hot tubs, barbecues and fireplaces. The acquisition included nine locations in the Pacific Northwest and expanded our presence to 36 states. The acquisition did not have a material impact on our financial position or results of operations. Our consolidated financial statements include the results of operations of the acquisition from the date of acquisition. The goodwill resulting from the acquisition is deductible for income tax purposes. The purchase accounting for this acquisition is complete. Fiscal 2018 Acquisitions In January 2018, we completed the acquisition of a retailer of swimming pool and spa supplies, spas and above-ground pools, and related equipment. The acquisition included five locations in Pennsylvania and related warehouses and a corporate office. We also acquired the real estate related to two locations. In May 2018, we acquired a pool and spa parts distributor in Arizona. The acquisition included inventory and assets at leased facilities located in Arizona and Tennessee. The acquisitions did not have a material impact on our financial position or results of operations, either individually or in the aggregate. Our consolidated financial statements included the results of operations for the acquisitions from the date of each acquisition. The goodwill resulting from these acquisitions are deductible for income tax purposes. The purchase accounting for these acquisitions is complete. Note 4—Goodwill and Other Intangibles, Net Goodwill The changes in the carrying amount of goodwill for fiscal 2020 and 2019 are as follows (in thousands): Balance, September 29, 2018 $ 84,518 Acquisitions 4,283 Other adjustments 938 Balance, September 28, 2019 89,739 Acquisitions 3,556 Balance, October 3, 2020 $ 93,295 Other Intangible Assets Our other intangible assets are as follows as of October 3, 2020: Weighted Average Useful Life Gross Carrying Value Accumulated Amortization Net Carrying Amount (In years) (In thousands) Trade name and trademarks (finite life) 2.6 $ 5,540 $ (5,139 ) $ 401 Trade name and trademarks (indefinite life) Indefinite 17,750 — 17,750 Non-compete 4.9 8,633 (6,872 ) 1,761 Consumer relationships 3.8 17,200 (10,118 ) 7,082 Internally developed software 2.9 4,000 (3,434 ) 566 Other 1.6 1,000 (958 ) 42 Total $ 54,123 $ (26,521 ) $ 27,602 60 Our other intangible assets are as follows as of September 28, 2019: Gross Carrying Value Accumulated Amortization Net Carrying Amount (In thousands) Trade name and trademarks (finite life) $ 5,540 $ (5,026 ) $ 514 Trade name and trademarks (indefinite life) 17,150 — 17,150 Non-compete 7,733 (6,181 ) 1,552 Consumer relationships 16,200 (8,655 ) 7,545 Internally developed software 4,000 (3,180 ) 820 Other 1,000 (925 ) 75 Total $ 51,623 $ (23,967 ) $ 27,656 Other intangible assets amortization expense was $2.6 million, $2.5 million and $3.8 million in fiscal 2020, 2019 and 2018, respectively. Estimated future amortization of the other intangible assets for the next five years as of October 3, 2020 is as follows (in thousands): Fiscal Year Ended Amount 2021 $ 1,892 2022 1,936 2023 1,703 2024 1,065 2025 968 Thereafter 2,122 Total $ 9,686 Intangible assets also include costs associated with acquiring mailing lists for our proprietary database. As of October 3, 2020 and September 28, 2019 the gross amounts capitalized on the consolidated balance sheets for mailing lists were $1.6 million. Note 5—Inventories, Net (In thousands) As of October 3, 2020 September 28, 2019 Raw materials $ 1,967 $ 1,768 Finished goods 146,999 147,961 Total inventories, net $ 148,966 $ 149,729 Changes in inventory excess and obsolescence reserves were as follows: Additions Deductions Balance at Beginning of Period Charged to Costs and Expenses Sale or Disposal of Inventories Balance at End of Period (In Thousands) 2018 $ 3,382 $ 1,019 $ (856 ) $ 3,545 2019 $ 3,545 $ 1,345 $ (1,268 ) $ 3,622 2020 $ 3,622 $ 2,659 $ (1,342 ) $ 4,939 61 Note 6—Property and Equipment Property and equipment consist of the following: (In thousands) As of October 3, 2020 September 28, 2019 Land $ 5,813 $ 5,813 Buildings and improvements 16,148 15,976 Vehicles, machinery, and equipment 34,639 34,831 Leasehold improvements 164,501 166,640 Office furniture, equipment, and other 154,570 146,455 Software and construction in process 9,960 6,769 385,631 376,484 Less: accumulated depreciation and amortization (319,240 ) (297,978 ) Total $ 66,391 $ 78,506 Depreciation and amortization expense on property and equipment was $28.9 million, $27.9 million and $27.7 million in fiscal 2020, 2019 and 2018, respectively. Software and construction in process is primarily composed of internal use software currently being developed and leasehold improvements related to new or remodeled locations where construction had not been completed by the end of the period. Note 7—Accrued Expenses Accrued expenses consist of the following (in thousands): As of October 3, 2020 September 28, 2019 Accrued payroll and employee benefits $ 32,420 $ 14,694 Occupancy expenses 3,573 14,669 Interest 9,377 17,520 Sales taxes 11,164 9,045 Self-insurance reserves 6,518 6,242 Customer deposits 13,286 6,246 All other current liabilities 24,829 13,705 Total accrued expenses $ 101,167 $ 82,121 Note 8—Long-Term Debt The table below presents our debt obligations as of the periods presented (in thousands): As of Effective Interest Rate(1) October 3, 2020 September 28, 2019 Term Loan—due on August 16, 2023 3.65%(2) $ 811,178 $ 821,605 Senior Unsecured Notes—due on August 16, 2024 9.50%(3) 390,000 390,000 ABL Credit Facility 1.89%(4) — — Total long-term debt 1,201,178 1,211,605 Less: current portion of long-term debt (8,341 ) (8,341 ) Less: unamortized discount (9,348 ) (11,589 ) Less: deferred financing charges (3,939 ) (5,182 ) Long-term debt, net $ 1,179,550 $ 1,186,493 (1) Effective interest rates as of October 3, 2020. 62 (2) Carries interest at a specified margin over LIBOR of 3.50% with a minimum rate of 0.00%. Prior to February 27, 2018, the Term Loan carried interest with a specified margin over LIBOR of 3.75% with a minimum rate of 1.00%. (3) Carries interest at a specified margin over LIBOR of 8.50% with a minimum rate of 1.00%. (4) Carries interest at a specific margin of 0.75% and 1.00% with respect to Base Rate loans and between 1.75% and 2.00% with respect to Eurodollar Rate loans. Prior to August 13, 2020, the ABL Credit Facility carried interest at a specific margin of 0.25% and 0.75% with respect to Base Rate loans and between 1.25% and 1.75% with respect to Eurodollar Rate loans. Loss on extinguishment/modification of debt— On February 27, 2018, we amended the Term Loan including the incremental term loan, which resulted in a $0.5 million loss on debt extinguishment related to the underlying loan tranches repaid in connection with the amendment. We capitalize financing costs we incur related to implementing and in certain circumstances, amending our debt arrangements. We record any financing costs associated with our Term Loan and Senior Unsecured Notes as a reduction of long-term debt, net on our consolidated balance sheet and amortize them over the contractual life of the related debt arrangements. The table below summarizes changes in deferred financing costs associated with our Term Loan and Senior Unsecured Notes for the periods presented (in thousands): As of October 3, 2020 September 28, 2019 Deferred financing costs Balance, beginning of year $ 5,182 $ 6,356 Financing costs deferred 5 10 Less: amortization expense (1,248 ) (1,184 ) Deferred financing costs, net of accumulated amortization $ 3,939 $ 5,182 We record any financing costs associated with our ABL Credit Facility in other assets on our consolidated balance sheets and amortize them over the contractual life of the related debt arrangement. Repayment of the Term Loan— We are required to make principal repayments equal to 0.25% of the Term Loan principal amount as stated in the third amendment executed February 27, 2018 on the last day of December, March, June, and September. We are also required to repay the term loan based on an annual calculation of excess cash flow, as defined in the agreement. As of October 3, 2020, no amount of excess cash flows was required to be repaid. The Term Loan does not require us to comply with any financial covenants. The Term Loan contains customary events of default, including default upon the nonpayment of principal, interest, fees or other amounts, or the occurrence of a change of control. No event of default had occurred under the Term Loan as of October 3, 2020 or September 28, 2019. Principal maturities for the Term Loan are as follows as of October 3, 2020 (in thousands): 2021 $ 8,341 2022 8,341 2023 794,496 Total $ 811,178 Repayment of the ABL Credit Facility —We are obligated to pay the lender a commitment fee of 0.375% per annum, payable quarterly in arrears. 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. No amounts are outstanding on the $200.0 million and $150.0 million ABL Credit Facility as of October 3, 2020 and September 28, 2019, respectively. The amount available is reduced by $11.6 million and $10.6 million of existing standby letters of credit as of October 3, 2020 and September 28, 2019, respectively. 63 The ABL Credit Facility does not require us to comply with any financial covenants. The ABL Credit Facility contains customary events of default, including default upon the nonpayment of principal, interest, fees or other amounts, or the occurrence of a change of control. No event of default had occurred under the ABL Credit Facility as of October 3, 2020 or September 28, 2019. Repayment of the Senior Unsecured Notes—The Senior Unsecured Notes are guaranteed on a senior basis by us and all our present and future domestic wholly owned subsidiaries. Interest-only payments on the Senior Unsecured Notes are payable quarterly on January 10, April 10, July 10, and October 10 of each year. The Senior Unsecured Notes bear interest of 8.50% plus LIBOR, subject to a minimum rate of 1.00%. The Senior Unsecured Notes have restrictive covenants that limit the ability to, among other things, incur or guarantee additional indebtedness or issue preferred stock; pay dividends and make other restricted payments; incur restrictions on the payment of dividends or other distributions; create or incur certain liens; make certain investments; transfer or sell assets; engage in transactions with affiliates; and merge or consolidate with other companies or transfer all or substantially all of our assets. The entire maturity of the Senior Unsecured Notes is due in 2024. Representations and covenants— The Term Loan, Senior Unsecured Notes, and ABL Credit Facility contain customary representations and warranties, covenants, and conditions to borrowing. No event of default had occurred as of October 3, 2020 or September 28, 2019. Substantially all of our assets are pledged as collateral to secure our indebtedness under our long-term debt agreements. 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 have capped LIBOR at 3.00% with respect to the aggregate notional amount of $750.0 million through the expiration of the agreements in March 2021. In the event LIBOR exceeds 3.00% we will pay interest at the capped rate plus the applicable margin. In the event LIBOR is less than 3.00%, we will pay interest at the prevailing LIBOR rate plus the applicable margin. The fair value of the interest rate cap agreements was zero, zero and $4.3 million as of October 3, 2020, September 28, 2019 and September 29, 2018 respectively, and is recorded in other assets on the consolidated balance sheets. We recognized a (loss) gain related to the interest rate cap agreements of zero, $(4.3) million and $3.0 million in fiscal 2020, 2019 and 2018, respectively, which is recorded in other expenses in the consolidated statement of operations. Note 9—Leases The majority of our long-term operating lease agreements are for our corporate office, retail locations, and distribution centers, which expire in various years through 2031. The initial lease terms for these facilities range from 5-10 years with the exception of the lease for our corporate headquarters which is 13 years. The majority of our building leases also include options to extend, which are not factored into the recognition of their respective assets and liabilities based on management’s assessment of the probability that the options will be exercised as they are written in the lease. We sublease real estate for five locations to third parties. Many of our lease agreements include escalating rents over the lease terms which, under Topic 842, results in rent being expensed on a straight-line basis over the life of the lease that commences on the date we have the right to control the property. Our lease agreements do not contain any residual value guarantees or restrictive covenants that would reasonably be expected to have a material impact on our business. When readily determinable, the rate implicit in the lease is used to discount lease payments to present value; however, substantially all of our leases do not provide a readily determinable implicit rate. If the rate implicit in the lease is not readily determinable, we use an estimate comparable to a secured incremental borrowing rate, determined on a collateralized basis, to discount lease payments based on information available at lease commencement. 64 The following table presents the weighted-average remaining lease term, and discount rate for operating leases as of October 3, 2020: Weighted-average remaining lease term 4.2 years Weighted-average discount rate 5.9 % Future annual minimum lease payments as of October 3, 2020, are as follows (in thousands): 2021 $ 68,036 2022 59,097 2023 46,874 2024 33,956 2025 19,864 Thereafter 15,328 Total $ 243,155 Less: amount of lease payments representing imputed interest 58,462 Present value of future minimum lease payments 184,693 Less: current operating lease liabilities 54,459 Operating lease liabilities, noncurrent $ 130,234 Operating lease expense totaled $66.6 million in fiscal 2020, and rent expense was $63.6 million and $59.9 million in fiscal 2019 and 2018, respectively. Note 10—Income Taxes The provision for income taxes comprises the following: (In thousands) Fiscal 2020 Fiscal 2019 Fiscal 2018 Current: Federal $ 8,188 $ 14,072 $ 966 State (5,844 ) 1,537 2,555 Total Current 2,344 15,609 3,521 Deferred: Federal 2,260 (418 ) 2,752 State (1,977 ) (336 ) (1,347 ) Total Deferred 283 (754 ) 1,405 Total income tax provision $ 2,627 $ 14,855 $ 4,926 A reconciliation of the provision for income taxes to the amount computed at the federal statutory rate is as follows: (In thousands) Fiscal 2020 Fiscal 2019 Fiscal 2018 Federal income tax at statutory rate $ 12,851 $ 3,198 $ (190 ) Permanent differences 464 286 27 Change in valuation allowance (11,373 ) 11,060 5,738 State taxes, net of federal benefit 2,503 208 891 Federal rate change — — (1,540 ) Other (1,818 ) 103 — Total income tax provision $ 2,627 $ 14,855 $ 4,926 65 Our effective rate for fiscal 2020 was 4.3%. The decrease in valuation allowance accounts for (18.6)% of the overall effective rate. This decrease is related to utilization of interest limitation carryforwards related to the impact of U.S. Tax Reform and the new provision of Internal Revenue Code Section 163(j). The Coronavirus Aid, Relief, and Economic Security (CARES) Act increased the interest limitation from 30% to 50% of adjusted taxable income which allowed for the utilization of interest deduction carryforwards during fiscal 2020. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are summarized below. (In thousands) As of October 3, 2020 September 28, 2019 Deferred tax assets: Compensation accruals $ 5,433 $ 948 Deferred rent — 1,228 Inventory 1,053 681 Interest limitation 6,919 17,886 Lease liabilities 46,644 — Property and equipment — 590 Reserves and other accruals 354 — Total deferred tax assets 60,403 21,333 Deferred tax liabilities: Property, plant, and equipment (611 ) — Intangibles (3,258 ) (2,456 ) Reserves and other accruals — (2,673 ) Leased assets (44,014 ) — Deferred financing cost (512 ) (646 ) Total deferred tax liabilities (48,395 ) (5,775 ) Valuation allowance (5,425 ) (16,798 ) Deferred tax assets (liabilities), net $ 6,583 $ (1,240 ) 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. We are projecting future taxable income, however, the interest expense limitation passed in the Act created a deferred tax asset for the years ended October 3, 2020 and September 28, 2019, that we do not anticipate realizing in the immediate future. As of October 3, 2020 and September 28, 2019, we recorded a valuation allowance of $5.4 million and $16.8 million, respectively, for our U.S. deferred tax asset related to our interest expense limitation only. Valuation Allowance consists of the following: Balance at Beginning of Period Additions Charged to Costs and Expenses Deductions Balance at End of Period (In Thousands) 2018 $ — $ 5,738 $ — $ 5,738 2019 $ 5,738 $ 11,060 $ — $ 16,798 2020 $ 16,798 $ — $ (11,373 ) $ 5,425 We are subject to U.S. federal and state taxes in the normal course of business and our income tax returns are subject examination by the relevant tax authorities. With few exceptions, we are no longer subject to U.S. federal examinations by taxing authorities for calendar years before 2017 and no longer subject to state examinations for calendar years before 2016. We have not identified any material uncertain tax positions. 66 Note 11—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 on our consolidated financial position or results of operations. We did not record any material loss contingencies as of October 3, 2020 or as of September 28, 2019. Our workers’ compensation insurance program, general liability insurance program, and employee group medical plan have self-insurance retention features of $0.4 million per event as of October 3, 2020 and September 28, 2019, respectively. We had standby letters of credit outstanding in the amounts of $11.6 million and $10.6 million as of October 3, 2020 and September 28, 2019, 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 for inventory and other operational requirements. Future minimum purchase commitments as of October 3, 2020 are as follows (in thousands): 2021 $ 112,551 2022 70,888 2023 67,229 2024 50,196 2025 33,900 Thereafter 5,687 Total $ 340,451 Note 12—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 up to 4% of the individual’s compensation as defined. The expenses related to this plan were $1.1 million, $1.0 million and $1.1 million in fiscal 2020, 2019 and 2018, respectively. Note 13—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 provides that we will pay an annual fee for them to provide 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. During fiscal 2020, 2019 and 2018, we paid or accrued management fees in the amount of $4.9 million, $4.5 million and $3.2 million, respectively. In March 2013, we entered into an operating lease for our corporate headquarters with DM Ventures I, LLC. The former Chairman of our Board of Directors is one of the principals of DM Ventures I, LLC and holds a significant ownership position in the lessor entity. Aggregate rents paid to DM Ventures I, LLC for Leslie’s corporate headquarters were $1.9 million, $1.6 million and $1.6 million in fiscal 2020, 2019 and 2018, respectively. 67 Note 14—Equity-Based Compensation Incentive Unit Grant Agreements Our Parent has granted profits interests to our employees through Incentive Unit Grant Agreements. The units have economic characteristics similar to stock options and have the right to share in the appreciation of the equity value of our Parent. The sole asset of our Parent is indirect ownership of Leslie’s, Inc. We concluded such units are classified as equity awards. The awards are spread over two tiers, a service-based (time) award tier and a performance-based award tier; the service-based awards vest over a four-year period at a rate of 25% annually on each anniversary of the date of grant. The performance-based awards vest based on performance conditions as defined in the Incentive Unit Grant Agreements. We recognized equity-based compensation on a straight-line basis for service-based awards. The fair value of the awards is estimated on the date of grant using the Black-Scholes option pricing model, which treats 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 requires the use of a number of assumptions, including expected volatility, risk-free interest rate, expected dividends, and expected term. Expected volatility is based on the historic volatility of a basket of certain publicly traded comparable companies. The expected term of the awards is equal to the vesting term and represents the estimated period of time until liquidity. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the unit. Our Parent does not intend to pay any dividends in the future to ultimate shareholders who hold the type of security subject to the unit arrangement. Due to the absence of a public market for our Parent’s equity, the fair value of the profit interests has historically been determined by the General Partner of our Parent on each grant date. For fiscal 2020, 2019 and 2018, we recognized $1.8 million, $2.1 million and $1.8 million in compensation expense related to service-based Incentive Unit Grants. The performance-based Incentive Unit Grants were not deemed probable of achievement as of October 3, 2020, September 28, 2019 or September 29, 2018 and no expense has been recorded. The fair value of Incentive Units granted was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions. A summary of Incentive Unit activity and assumptions are as follows: Fiscal Year Ended October 3, 2020 September 28, 2019 September 29, 2018 Expected volatility 23.5 % 22.9 % 21.0 % Risk-free interest rate 1.4 % 2.5 % 2.2 % Dividend yield 0.0 % 0.0 % 0.0 % Expected term (in years) 4.0 4.0 4.0 Weighted-average grant date fair value per Incentive Unit $ 1.87 $ 1.69 $ 1.54 We granted 3,111,783 service-based Incentive Units and 2,868,892 performance-based Incentive Units during fiscal 2020. We granted 2,040,923 service-based Incentive Units and 1,360,615 performance-based Incentive Units during fiscal 2019. We granted 612,000 service-based Incentive Units and 408,000 performance-based Incentive Units during fiscal 2018. 68 A summary of Incentive Unit activity is as follows: Number of Incentive Units Outstanding, September 30, 2017 7,841,743 Granted 1,020,000 Exercised — Forfeited (915,750 ) Outstanding, September 29, 2018 7,945,993 Granted 3,401,538 Exercised — Forfeited (1,084,750 ) Outstanding, September 28, 2019 10,262,781 Granted 5,980,675 Exercised — Forfeited (2,976,250 ) Outstanding, October 3, 2020 13,267,206 Vested, September 29, 2018 1,163,512 Vested, September 28, 2019 1,993,273 Vested, October 3, 2020 3,196,606 The amount of unrecognized equity-based compensation for unvested service-based Incentive Units was $6.7 million as of October 3, 2020, which is expected to be recognized over approximately four years. Note 15—Subsequent Events On November 2, 2020, the Company closed its IPO, pursuant to which it issued and sold an aggregate of 30.0 million shares of common stock at the IPO Price of $17.00 per share. The aggregate gross proceeds to the Company were $510.0 million, and the net proceeds were $458.7 million after deducting underwriting discounts and commissions of $45.0 million and other IPO expenses of $6.3 million. The Company used the net proceeds from the sale of shares in the IPO to repay the entire outstanding amount of its $390 million senior unsecured floating rate notes due 2024. The remaining proceeds will be used for working capital and general corporate purposes. In connection with its IPO, the Company issued 6.0 million restricted stock units and 4.6 million stock options exercisable at a price of $17.00 per share. 69 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. None.