-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SvlIdsjd95AuXSUYT0Vng66EG9nmblKoWsPqC83kCqlHkokz+3GcvFrpZjqz8R2v pjESBKr44kcv9Ys8pK1PfA== 0000898430-98-004493.txt : 19981228 0000898430-98-004493.hdr.sgml : 19981228 ACCESSION NUMBER: 0000898430-98-004493 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981003 FILED AS OF DATE: 19981222 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LESLIES POOLMART INC CENTRAL INDEX KEY: 0000866048 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-RETAIL STORES, NEC [5990] IRS NUMBER: 954620298 STATE OF INCORPORATION: DE FISCAL YEAR END: 0927 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-18741 FILM NUMBER: 98773222 BUSINESS ADDRESS: STREET 1: 20630 PLUMMER ST CITY: CHATSWORTH STATE: CA ZIP: 91311 BUSINESS PHONE: 8189934212 MAIL ADDRESS: STREET 1: 20222 PLUMMER ST CITY: CHATSWORTH STATE: CA ZIP: 91311 10-K405 1 ANNUAL REPORT ON FORM 10-K405 - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------- Form 10-K ------- (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD FROM SEPTEMBER 28, 1997 TO OCTOBER 3, 1998 COMMISSION FILE NUMBER 0-18741 LESLIE'S POOLMART, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4620298 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 20630 PLUMMER STREET, CHATSWORTH, CALIFORNIA 91311 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 993-4212 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK: NONE Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: [X] The aggregate value of the voting stock held by non-affiliates of the Registrant on December 18, 1998 was $1,062,040. APPLICABLE ONLY TO CORPORATE REGISTRANTS: The number of outstanding shares of the Registrant's Common Stock on December 18, 1998 was 1,433,643. - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS Leslie's Poolmart, Inc. ("Leslie's" or the "Company") is the leading national specialty retailer of swimming pool supplies and related products. These products primarily consist of regularly purchased, non-discretionary pool maintenance items such as chemicals, equipment, cleaning accessories and parts, and also include fun, safety and fitness-oriented recreational items. The Company currently markets its products under the trade name Leslie's Swimming Pool Supplies through 316 company-owned retail stores in 28 states and through mail order catalogs sent to selected pool owners nationwide. The Company provides its customers a comprehensive selection of high quality products, competitive every day low prices ("EDLP") and superior customer service through knowledgeable and responsive sales personnel who offer a high level of technical assistance at convenient store locations. The EDLP offered by the Company are comparable to or better than those offered by any of its competitors, including mass merchandisers and home centers. The typical Leslie's store contains 4,000 square feet of space, is located either in a strip center or on a freestanding site in an area of heavy retail activity, and draws its customers primarily from an approximately three-mile trade area. The Company maintains a proprietary mailing list of approximately 4.9 million addresses, including approximately 90% of the residential in-ground pools in the U.S. This highly focused list of target customers is central to the Company's direct mail marketing efforts, which support both its retail store and mail order operations. Management believes that the Leslie's name is one of the most recognized brands in pool supplies and represents an image of quality to consumers. In fiscal 1998, Leslie's brand name products accounted for approximately 60% of the Company's total sales. Leslie's successful execution of its business strategy has generated a 35-year history of consistently increasing sales. Management intends to continue increasing sales and profits by further expanding its store base at the rate of 12% to 15% annually and continuing to achieve positive comparable store sales increases. The Company attributes its strong historical results and its positive outlook for growth and profitability to the following factors: Leadership Position in a Highly Fragmented Market. Leslie's current store count of 316 locations is greater than the sum of the next fifteen largest specialty retail competitors combined. However, despite its large relative size, Leslie's presently accounts for only approximately 7% of the estimated $3.7 billion annual pool and spa supply market. Since 1989, Leslie's has accelerated the pace of its new store openings and consequently has gained market share. Management believes that this growth has come primarily at the expense of independent local and regional pool supply retailers, which accounted for about two-thirds of industry sales in 1998. Attractive Store Economics. Leslie's results reflect extremely attractive store-level economics. The Company estimates that the capital expenditure required to open each new store currently averages approximately $125,000. Based upon the Company's past experience, new stores generally break even in their first year of operation, pay back their initial investments after three years, and in their fifth year of operation, contribute approximately $181,000 of store operating profit, yielding an annual return of 145% on the average capital expenditures. Growth Potential of Recently Opened Stores. Leslie's new stores have historically grown dramatically in sales and store operating profit during their first five years of operation. Since the end of 1994, Leslie's has opened 148 new stores. Management expects these stores generally to follow the Company's historical pattern of maturation and believes there exists a large potential for sales and store operating profit increases from these nonmature stores. Large Sales Volume of Non-Discretionary Products. The consistency of Leslie's sales growth and profitability is due in large part to the sale of non- discretionary and regularly consumed products such as pool chemicals, cleaning accessories, major pool equipment (pumps and heaters) and replacement parts. Pool owners must purchase such products to maintain their pools' water quality and physical appearance and, in the Company's experience, do so regardless of the economic environment. In 1998, non-discretionary and regularly consumed products comprised approximately 75% of the Company's sales, with pool chemicals representing approximately 44% of the Company's product sales. Proprietary Database of Pool Locations. Through ongoing research as well as the conduct of its retail and mail order business, Leslie's has developed a proprietary database of about 4.9 million addresses. The list includes 1 approximately 90% of the residential in-ground pools in the U.S. This proprietary database allows Leslie's to execute cost-effective and highly targeted direct mail marketing. When combined with the Company's mail order sales results and computerized mapping capability, this database also gives Leslie's a sophisticated store site selection capability. Management believes that the scope and accuracy of its proprietary database is unique in the pool supply industry. Purchasing Power and Vertical Integration. Due to its size, Leslie's purchases more chemicals and other pool supplies than any other specialty retailer. In addition, Leslie's operates a repackaging facility which provides the Company with significant cost savings, greater control over product availability and quality, greater flexibility when sourcing products, and vital information when negotiating with third-party providers. Further, unlike most of its competitors, the Company does not rely upon third-party distribution, but has it own highly efficient distribution system. Management believes that these factors permit Leslie's to achieve a lower cost of goods than any of its competitors, including mass merchandisers and home centers. Superior Level of Customer Service. Leslie's believes that its superior level of customer service, including its comprehensive product selection, gives it a significant advantage over its competitors in winning the loyalty of customers. Due to the complicated nature of pool chemistry and pool equipment maintenance, and consistent with its philosophy of being a full service swimming pool supply retailer, Leslie's offers a high level of technical assistance to its customers. The Company has developed a comprehensive training program educating all store employees on the subjects of maintenance techniques, water chemistry and equipment testing and repair. As part of its regular customer service program, the Company offers free detailed water testing, pamphlets on pool maintenance, and in-store equipment repairs, generally free of labor or bench charges. HISTORY The Company is a successor to the original Leslie's Poolmart founded in 1963. From its inception in 1963 through the end of 1987, Leslie's Poolmart grew steadily in sales and number of stores. In September 1988, Leslie's Poolmart was purchased in a highly leveraged transaction by an investment group led by Hancock Park Associates ("HPA"). The purchase was accomplished by means of a merger, with Leslie's Poolmart, a California corporation ("Leslie's California") as the surviving entity. Leslie's California completed an initial public offering in April 1991 and in August 1992 added 14 stores through the acquisition of a competitor. In June 1997, Leslie's California reincorporated in Delaware by merger into a wholly-owned Delaware subsidiary and completed an additional recapitalization merger (the "Mergers"). The transactions were led by Green Equity Investors, II, L.P. ("GEI") and HPA, together with certain members of management and associates of HPA (collectively, the "HPA Group"). As a result of the Mergers, the Company's common stock is no longer publicly-traded. Unless otherwise referred to herein or the context otherwise requires, references to "Leslie's" or the "Company" shall mean Leslie's Poolmart, Inc., its predecessors by merger, Poolmart and Leslie's California, and the predecessor of Leslie's California. Leslie's has opened 148 new stores during the past four years. Leslie's intends to continue to grow by opening additional retail stores in both new and existing markets. 2 SWIMMING POOL SUPPLY INDUSTRY Regardless of the type or size of a swimming pool, there are numerous ongoing maintenance and repair requirements associated with pool ownership. In order to keep a pool safe and sanitized, chemical treatment is required to maintain proper chemical balance, particularly in response to variables such as pool usage, precipitation and temperature. A swimming pool is chemically balanced when the disinfectant, pH, alkalinity, hardness and dissolved solids are at the desired levels. The majority of swimming pool owners use chlorine to disinfect their pools. When the pool is chemically balanced, problems such as algae, mineral and salt saturation, corrosive water, staining, eye irritation and strong chlorine smell are less likely to occur. A regular testing and maintenance routine will result in a stable and more easily maintained pool. However, regardless of how well appropriate levels of chlorine are maintained, "shocking" is periodically required to break up the contaminants which invariably build up in the pool water. To accomplish this, the pool owner can either superchlorinate the pool or use a nonchlorinated oxidizing compound. The maintenance of proper chemical balance and the related upkeep and repair of swimming pool equipment, such as pumps, heaters, and filters, create a non- discretionary demand for pool chemicals and other swimming pool supplies and services. Further, even non-usage considerations such as a pool's appearance and the overall look of a household and yard create an ongoing demand for these maintenance related supplies. In addition, pool usage creates demand for discretionary items such as floats, games and accessories. The swimming pool supply industry can be divided into four major segments by pool type: residential in-ground swimming pools, residential above-ground swimming pools (usually 12 to 24 feet in diameter), commercial swimming pools and spas or hot tubs. The Company's historical strategy was to focus primarily on the residential in-ground pool owner. In recent years the Company has expanded its activities to more aggressively address the commercial and above-ground markets as well. In the residential categories, the Company markets its products primarily to the "do-it-yourself" market as opposed to those pool owners who hire pool servicers. Through its rapidly growing commercial business, products and services are offered to all non-residential pool installations as well as to pool service companies which maintain either residential or commercial pools. The Company's uninterrupted growth through three recessionary periods suggests that due to the ongoing maintenance and repair needs of existing swimming pools, the Company would not be significantly affected by a decline in swimming pool installation. However, there can be no assurance that a prolonged severe economic downturn and resulting decline in new housing construction or swimming pool installation would not adversely affect the Company's long-term expansion plans. SEASONALITY The Company's business exhibits substantial seasonality, which the Company believes is typical of the swimming pool supply industry. In general, sales and net income are highest during the quarters ended June and September which represent the peak months of swimming pool use. Sales are substantially lower during the quarters ended December and March when the Company typically incurs net losses. The principal external factor affecting the Company's business is weather. Hot weather and the higher frequency of pool usage in such weather create a need for more pool chemicals and supplies. Unseasonably early or late warming trends can increase or decrease the length of the pool season. In addition, unseasonably cool weather and/or extraordinary amounts of rainfall in the peak season (such as that experienced in much of the U.S. in the spring and early summer of 1995) will tend to decrease swimming pool use. The likelihood that unusual weather patterns will severely impact the Company's results is lessened by the geographical diversification of the Company's store locations. The Company also expects that its quarterly results of operations will fluctuate depending on the timing and amount of revenue contributed by new stores and, to a lesser degree, the timing of costs associated with the opening of new stores. The Company attempts to open its new stores primarily in the quarter ending March in order to position itself for the following peak season. 3 PRODUCTS Leslie's offers its customers a comprehensive selection of products necessary to satisfy their swimming pool supply needs. During 1998, the Company stocked approximately 3,000 items in each store, with more than 15,000 additional items available through its Xpress Parts program and special order processes. In 1998, approximately 500 items were displayed in the Company's residential mail order catalogs and 1,200 items were in the commercial catalog, although special order procedures make nearly all Leslie's products available to mail order customers as well. The Company's major product categories are pool chemicals; major equipment; cleaning and testing equipment; pool covers, reels, and liners; in a limited number of stores, above-ground pools; and recreational items (which include swimming pool floats, games, lounges, masks, fins, snorkels and other "impulse" items). The following table shows the approximate percentage of sales and primary function for each of the Company's major product categories for the fiscal year ended October 3, 1998:
Product Line Percentage Purpose ------------ ---------- ------- Pool Chemicals........................ 44% Cleanliness, appearance, health Major Equipment and Parts............. 31% Pumps and heaters for cleaning and temperature maintenance; automatic pool cleaners for ease of maintenance Cleaning and Testing Equipment........ 8% Water evaluation, cleanliness and appearance Covers, Reels, Liners and Pools....... 8% Safety, cleanliness and temperature maintenance for above-ground pools Recreational Items.................... 9% Pool enjoyment, swim aids
Non-discretionary and regularly consumed products such as pool chemicals, major equipment and parts represented approximately 75% of total sales in fiscal 1998. The Company's non-discretionary products have long shelf lives and are not prone to either obsolescence or shrinkage due to the high percentage of Leslie's business which is attributable to non-discretionary products. The Company believes that product quality and availability are key attributes considered by consumers when shopping for pool supplies and that the Company's ability to provide a high quality, in-stock product offering is fundamental to its concept of value leadership. In addition to third-party brand names, Leslie's carries a broad selection of products under the Leslie's brand name. Marketing studies have shown that the Leslie's brand name is one of the three most recognized brands in pool supplies and represents an image of quality to consumers. In fiscal 1998, Leslie's brand name products accounted for approximately 60% of the Company's total sales. CHANNELS OF DISTRIBUTION Retail Store Operations. At the end of fiscal 1998, Leslie's marketed its products through 316 retail stores in 28 states under the trade name Leslie's Swimming Pool Supplies. California represents its single largest concentration of stores with 91, while 51 stores are located in Texas, and 78 stores are in the northeast/mid-Atlantic area. Leslie's retail stores are located in areas with high concentrations of swimming pools and typically are approximately 4,000 square feet in size. In addition to the store manager, the typical Leslie's store employs two assistant managers, both of whom are generally full-time employees. Additionally, Leslie's makes frequent use of part-time and temporary employees to support its full-time employees during peak seasons. During 1998, the Company had 21 regional supervisors, each of whom was responsible for approximately 15 stores. Mail Order Catalog. Leslie's mail order catalogs provide an extension of its service philosophies and products to those areas not currently served by a retail store and allow the scope of the Company's business to be truly nationwide. The Company believes that it operates one of the largest pool supply mail order businesses in the country, with annual sales for the year ended October 3, 1998 of approximately $5.5 million. Further, the Company believes that its mail order catalogs build awareness of the Leslie's name, provide it with buying efficiencies and, when coupled with information from its retail stores, are instrumental in determining site selection for new stores. 4 CUSTOMER SERVICE Due to the complicated nature of pool chemistry and equipment maintenance and consistent with its philosophy of being a full service swimming pool supply retailer, Leslie's offers a high level of technical assistance to support its customers. The Company considers its training of store personnel to be an integral part of its service philosophy. Leslie's extensive training program for all full-time and part-time store employees includes courses in water chemistry, water testing, trouble shooting on equipment, equipment sizing and parts replacement. The Company maintains the same high customer service standards for its mail order business as it does for its retail stores. During fiscal 1997, Leslie's stores in Northern California; Dallas and Houston, Texas; and Las Vegas, Nevada, were supported by the Leslie's Service Department, which offers poolside equipment installation and repair, leak detection and repair, and seasonal opening and closing services. The Service Department utilizes both Company employees and subcontractors to perform these services. In Southern California in 1997, the Company tested the operation of its service technicians out of the local stores as compared to the service department organization described above. This operating structure proved very successful and as a result, in late 1997 and early 1998 Leslie's converted all of its service departments to store-based service operations and added service capabilities in selected other markets. In 1998, approximately 169 stores were supported by service technicians. The Company anticipates a nationwide expansion of the store-based service operations over the next several years. MARKETING Substantially all the Company's marketing is done on a direct mail basis through its proprietary mailing list of approximately 4.9 million addresses at which, primarily, residential pools are located. Leslie's has found that its ability to mail directly to this highly focused group is an effective and efficient way to conduct its marketing activities to both retail store and mail order customers. The Company constantly updates its address list through primary research techniques and in-store customer sign-ups. Addresses on the Company's proprietary list that are located within a specified service area of a retail store receive circulars once or twice per month from late March or early April through September or, selectively, through October. As a regular part of Leslie's promotional activities, each mailer highlights specific items which are intended to increase store traffic, and reinforces to the customer the advantages of shopping at Leslie's, which include everyday low pricing, a high level of customer service, and the broad selection of high quality products. Addresses outside the Company's store service areas, and recently active mail order customers within those service areas, receive the Company's mail order catalogs. Occasionally, the Company will utilize local print media when it enters a new market, and is doing so in connection with its above-ground pool sales test markets. New store openings typically involve additional advertising pieces in the first two to three months of operation. PURCHASING Leslie's management believes that because it is one of the largest purchasers of swimming pool supplies for retail sales in the United States, the Company is able to obtain very favorable pricing on its purchases from outside suppliers. Nearly all raw materials and those products not repackaged by the Company are purchased directly from manufacturers. It is common in the swimming pool supply industry for certain manufacturers to offer extended dating terms on certain products to quantity purchasers such as Leslie's. These dating terms are typically available to the Company for pre-season or early season purchases. The Company's principal chemical raw materials and granular chlorine compounds are purchased primarily from three suppliers. At the end of fiscal 1997, the Company entered into a multi-year product purchase agreement with a major producer of one of the principal chlorine compounds, the chlorinated isocyanurates. The Company believes that there are several other reliable suppliers of chlorine products in the marketplace today. Although the Company has one sole source supplier for a nonchlorine shocking compound, termination of supply would not pose any significant problems for the Company because substitute chemicals and alternate shocking techniques are available. The Company believes that reliable alternative sources of supply are available for all of its raw materials and finished products. 5 VERTICAL INTEGRATION Leslie's operates a plant in the Los Angeles area where it converts dry granular chlorine into tablet form and repackages a variety of bulk chemicals into various sized containers suitable for retail sales. Leslie's also formulates a variety of specialty liquids, including water clarifiers, tile cleaners, algaecides and stain preventives. The chemicals that the Company processes have a relatively long shelf life. Leslie's believes that supplying its stores with chemicals from its own repackaging plant provides it with cost savings, as well as greater control over product availability and quality, as compared to non-integrated pool supply retailers. It also offers the Company greater flexibility of sourcing and vital information when negotiating with third-party repackagers and chemical providers. The Leslie's brand name appears on all products processed at its repackaging plant, and on the significant majority of all its chemical products. The Company believes that it is among the largest processors of chlorine products for the swimming pool supply industry. The total output of Leslie's repackaging plant is utilized by the Company and is not sold or distributed to other retailers. Leslie's currently does not intend to sell any significant amount of chemicals from its Los Angeles area facility to other retailers or distributors. In connection with the operation of its second Distribution Center in Dallas, Texas, and third Distribution Center in Bridgeport, New Jersey, the Company has expanded its use of third-party chemical repackagers and its purchase of products already in end-use configurations. These products are also generally packaged under the Leslie's brand name. The Company continually evaluates the cost effectiveness of third-party sourcing versus internal manufacturing in order to minimize its cost of goods. Leslie's will also continue to evaluate the establishment of additional chemical repackaging capabilities, though there are currently no plans for such an investment. In addition to chemicals, a variety of the Company's products are packaged under the Leslie's brand name. DISTRIBUTION In 1998, the Company distributed all of its products to its retail stores and to its catalog customers through its leased distribution facilities in Ontario, California; Dallas, Texas; and Bridgeport, New Jersey. Leslie's relocated and consolidated its West coast distribution operation, along with the Los Angeles repackaging operation, into a 183,000 square foot facility in Ontario, California in early 1997. Leslie's opened its 100,000 square foot Dallas facility in November 1990 and relocated its Bridgeport, New Jersey operations to a new 119,000 square foot facility in March of 1998. In the summer of 1998, the Company signed a lease for a 146,000 square foot build-to-suit distribution center in Covington, Kentucky, which it expects to be operating in the 1999 season. The Company is now purchasing the majority of the chemicals to be distributed from the Dallas, Bridgeport and Covington distribution centers from outside manufacturers rather than obtaining them through its repackaging facility in Southern California. During the height of its seasonal activities, each of the Company's retail stores is generally replenished every 5 to 10 days. The Company utilizes company-owned and operated equipment, supplemented by additional equipment leased during the busy season, to transport its goods to stores within an approximately 350-mile radius of a distribution center. Other stores receive deliveries via common carriers. 6 COMPETITION Primary elements of competition in the retail swimming pool supply industry are price, technical assistance, customer service, product selection and product availability. Most of the Company's competition comes from local stores or regional chains which do not repackage or manufacture products and which generally buy products in smaller quantities. The Company believes that its vertical integration, varied sourcing strategy, and large volume purchasing enable it to maintain attractive margins as well as competitive price leadership relative to the smaller operators, and that its position is strengthened by its merchandising and marketing emphasis. The chain store competitors include a large franchise operator of approximately 110 retail outlets in the Florida market and a limited number of other retail chains of approximately 15 to 30 stores. The Company competes on selected principal products such as chlorine with large volume, mass merchant and home center retailers. While the ability of these merchants to accept low margins on the limited number of items they offer makes them aggressive price competitors of the Company, they are not generally priced below Leslie's and do not offer the level of customer service or wide selection of swimming pool supplies available at Leslie's. EMPLOYEES As of October 3, 1998, Leslie's employed 1,906 persons. During the height of the Company's seasonal activities in 1998, it employed 2,442 persons, including seasonal and part-time store employees who generally are not employed during the off season. The Company is not subject to any collective bargaining agreements and believes that its relationships with its employees are excellent. TRADEMARKS In the course of its business, Leslie's employs various trademarks, trade names and service marks as well as its logo in packaging and advertising its products. The Company has registered trademarks and trade names for several of its major products on the Principal Register of the United States Patent and Trademark Office. The Company distinguishes the products produced in its chemical repackaging operation or by third party repackagers at its direction through the use of the Leslie's brand name and logo and the trademarks and trade names of the individual items, none of which is patented, licensed, or otherwise restricted to or by the Company. The Company believes the strength of its trademarks and trade names has been beneficial to its business and intends to continue to protect and promote its marks in appropriate circumstances. 7 ITEM 2. PROPERTIES As of October 3, 1998, the Company operated 316 stores in 28 states. The following table sets forth information concerning the Company's stores:
State Number of Stores State Number of Stores ----- ---------------- ----- ---------------- Alabama............... 4 Missouri.................... 3 Arizona ............. 18 Nevada...................... 7 California............ 91 New Hampshire............... 1 Connecticut........... 9 New Jersey.................. 16 Delaware.............. 2 New Mexico.................. 1 Florida............... 17 New York .................. 21 Georgia............... 11 North Carolina.............. 1 Indiana............... 3 Ohio........................ 10 Kansas................ 1 Oklahoma.................... 5 Kentucky.............. 2 Pennsylvania................ 13 Louisiana............. 4 Rhode Island................ 1 Maryland ............ 5 Tennessee ................. 3 Massachusetts ........ 7 Texas....................... 51 Michigan ............ 6 Virginia.................... 3 ----- Total Stores .............. 316 =====
Except for 25 owned stores, all of its retail stores are leased by the Company with lease terms expiring between 1998 and 2010. The Company's typical lease term is five years, and in the majority of instances, the Company has renewal options at increased rents. Five leases provide for rent contingent on sales exceeding specific amounts. No other leases require payment of percentage rent. In January and February of 1997, the Company relocated its corporate offices, the Southern California distribution center and the chemical repackaging operation. The corporate offices were relocated to another location in Chatsworth, California. The new 38,000 square foot office building has been leased for five years and the lease has three five-year renewal options. The Southern California distribution center (previously located in Chatsworth, California) and the chemical repackaging operations (previously located in Los Angeles) were moved and consolidated into a 183,000 square foot facility located in Ontario, California. The Ontario facility was leased for 10 years and the lease has two five-year renewal options. The Company's distribution facility in Dallas, Texas, consists of 100,000 square feet, with a lease term expiring in 2000. This lease includes options to renew for two additional five-year periods. The 119,000 square foot distribution facility in Bridgeport, New Jersey is leased for a 10-year term, expiring in 2008. The lease includes options to renew for two five-year periods. In 1998, the Company signed a lease for a new 146,000 square foot build-to- suit distribution center in Covington, Kentucky. The lease will commence in December 1998, for a 12 year term and provides for two five year renewal options. ITEM 3. LEGAL PROCEEDINGS The Company is routinely involved in legal proceedings related to the ordinary course of its business. Management does not believe any such matters will have a material adverse effect on the Company. 8 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no public trading market for the Company's common stock. There are 11 holders of the Company's common stock. The Company has not paid any dividends on its common stock, and does not anticipate doing so in the foreseeable future. SALES OF UNREGISTERED SECURITIES On June 11, 1997, the Company made the following sales or exchanges of its securities. The following shares of common stock were issued upon conversion of a like number of shares of Leslie's California common stock:
Holder Number of Shares ------------------------- ---------------- Michael J. Fourticq 160,539 Brian P. McDermott 166,552 Richard H. Hillman 22,414 Gregory Fourticq 10,000
The following shares of common stock were issued by the Company for consideration of $14.50 per share, cash:
Purchaser Number of Shares ------------------------- ---------------- GEI 1,055,172 Robert D. Olsen 16,966 Cynthia G. Watts 2,000
In addition, 28,000 shares of the Company's Series A Preferred Stock together with warrants to purchase 252,996 shares of common stock (subject to adjustment), were issued to Occidental Petroleum Corporation for $28,000,000. All such transactions were exempt pursuant to Section 4(2) of the Securities Act of 1933, as a transaction not involving a public offering. All offerees and purchasers were either affiliates of the Company or continuing securities holders. SENIOR NOTES: USE OF PROCEEDS An S-1 Registration Statement covering the Company's 10.375 percent Senior Notes due 2004, in principal amount of $90,000,000 was declared effective on July 21, 1997. Commission file number 333-30305 was assigned to the registration statement. The offering, which was an exchange offer open to holders of the Company's notes issued June 11, 1997 pursuant to a transaction exempt from registration under Rule 144 A of the Securities Act, commenced on July 21, 1997, and terminated on November 28, 1997. The managing underwriter of the original offering was BT Securities. All offered securities were sold. The proceeds were 100% used in the payment of the Cash Merger Consideration. Fees and expenses of the original offering, together with the filing of the Registration Statement and the Exchange offer were approximately $3,449,000, distributed as follows: Underwriting Discounts and Commissions $2,700,000 Expenses Paid to or for Underwriters 210,000 Other Expenses 539,000 ---------- Total Expenses: $3,449,000
The net proceeds to the Company were $86,551,000. 10 ITEM 6. SELECTED FINANCIAL DATA SELECTED CONSOLIDATED FINANCIAL DATA The following table presents selected consolidated financial data of the Company as of and for the fiscal year ended October 3, 1998 (53 weeks), the twelve months ended September 27, 1997 (unaudited), the nine months ended September 27, 1997 (transition period) and the three fiscal years in the period ended December 28, 1996. This financial data was derived from the audited historical consolidated financial statements of the Company (with the exception of the twelve months ended September 27, 1997) and should be read in conjunction with the financial statements of the Company and "Management's Discussion and Analysis of Financial Condition and Results of Operations" elsewhere in this Annual Report.
Twelve Nine Year Months Months Years Ended Ended Ended Ended ------------------------------------------ October 3, September 27, September 27, December 28, December 30, December 31, 1998 1997 1997 1996 1995 1994 ---------- ------------- ------------- ------------ ------------ ------------ (53 weeks) (52 weeks) (transition (unaudited) period) Net Sales $252,923 $217,109 $196,025 $191,640 $162,456 $141,553 Gross Profit 99,358 81,761 77,365 72,760 60,399 55,469 Gross Margin 39.3% 37.7% 39.5% 38.0% 37.2% 39.2% Loss (Gain) on Disposition of Fixed Assets 334 1,112 457 750 27 (106) Depreciation and Amortization 7,223 5,429 4,207 4,326 3,374 2,393 Income from Operations 15,536 11,021 17,989 9,400 6,691 9,569 Interest Expense, net 10,513 4,842 4,220 2,786 2,708 1,733 Net Income 2,790 4,343 8,783 3,869 3,407 4,584 Balance Sheet Data: Working Capital $ 36,102 $ 36,711 $ 36,711 $ 12,718 $ 13,007 $ 8,072 Total Assets 121,286 113,252 113,252 83,157 79,529 61,717 Current Ratio 2.13 2.29 2.29 1.45 1.47 1.38 Long-term Debt 91,195 91,290 91,290 15,581 17,843 11,272 Stockholders' (Deficit) Equity (34,915) (35,845) (35,845) 36,315 31,921 26,339 Selected Operating Data: Capital Expenditures $ 10,519 $ 9,885 $ 7,917 $ 8,807 $ 9,550 $ 7,394 EBITDA(1) 22,537 18,318 23,247 14,960 10,472 11,476 EBITDA Margin(2) 8.91% 8.44% 11.86% 7.81% 6.45% 8.11% Number of Employees at Year-end 1,906 1,767 1,767 1,055 780 678 Stores Operated at Year-end 316 278 278 259 224 180 Comparable Store Sales Growth 10.3% 10.1% 10.4% 9.9% 6.0% 12.9%
- ------------------------- (1) Earnings before interest, taxes, depreciation, amortization, loss/(gain) on disposition of fixed assets, Recapitalization costs and LIFO adjustments. EBITDA is a measurement that is used by the financial community. It is not a substitute for the statement of cash flows prepared in accordance with Generally Accepted Accounting Principles but is a factor that is widely used and accepted by the investment community. (2) EBITDA Margin represents EBITDA as a percentage of sales. 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information included in this document (as well as information included in oral statements or other written statements made or to be made by the Company) contains statements that are forward-looking, such as statements relating to plans for future activities. Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to domestic economic conditions, activities of competitors, changes in federal or state tax laws and of the administration of such laws and the general condition of the economy and its effect on the securities market. THE TRANSACTIONS On June 11, 1997, Leslie's California reincorporated in Delaware by merger into a wholly-owned Delaware subsidiary (the "Reincorporation"), and merged Poolmart USA Inc., a newly-formed corporation, with and into the Company (the "Recapitalization"). As a result of the Recapitalization, (i) each outstanding share of common stock of Leslie's California (other than 359,505 shares owned primarily by members of management, including Michael Fourticq and Brian McDermott, the President and CEO of the Company) was converted into $14.50 cash (the "Cash Merger Consideration"); and (ii) outstanding options covering approximately 830,000 shares of common stock, including those not yet vested, were exercised and retired upon for payment of the difference between the exercise price and $14.50 per share. The total value of the shares and options approximated $100,000,000. In order to finance the repurchase of the outstanding common shares and options, the Company issued $90,000,000 of its 10.375% Senior Notes and sold 1,074,138 shares of its common stock for net proceeds of $15,575,000. As indicated above, certain directors and members of management converted some of the Leslie's California common shares which they owned into shares of the Company's common stock. Also in connection with the Recapitalization, the Company issued 28,000 shares of its Series A Preferred Stock of the Company, par value $0.001 per share, at $1,000 per share for a total consideration of $28,000,000 consisting of cash and an exchange of the $10,000,000 principal amount of Convertible Subordinated Debentures of Leslie's California held by Occidental Petroleum Corporation. In connection with this transaction, Occidental received warrants to purchase up to 15.0% of the shares of the Company's common stock at a purchase price of $0.01 per share (subject to adjustment) for a period of ten years. (The transactions described in the foregoing paragraphs are sometimes collectively referred to as the "Transactions.") FISCAL PERIOD CHANGE In 1997, the Company changed its fiscal year end from the Saturday closest to December 31 to the Saturday closest to September 30. The 1998 fiscal year ended on October 3, 1998, and included 53 weeks. The 1996 fiscal year ended on December 28, 1996 included 52 weeks, while the nine month transition period ended September 27, 1997 included 39 weeks. RESULTS OF OPERATIONS The Company is the leading specialty retailer of swimming pool supplies and related products in the United States. At October 3, 1998, the Company marketed its products through 316 Company-owned retail stores in 28 states and through a nationwide mail order catalog. The Company is vertically integrated, operating a chemical repackaging facility in Ontario, California. In 1998, the Company supplied its retail stores from three distribution facilities, located in Ontario, California; Dallas, Texas; and Bridgeport, New Jersey. 12 1998 compared to 1997: The Company's 1998 fiscal year includes 53 weeks. The unaudited twelve month period ended September 27, 1997 (used for comparative purposes) includes 52 weeks. For the twelve months ended October 3, 1998, sales increased 16.5% to $252,923,000 from $217,109,000 in the same twelve months of the prior year. The sales increase is primarily attributable to comparable store sales growth (over the comparable 53 weeks) of 10.3% and 38 (net) new store additions in 1998. EBITDA for the period increased 23.0% to $22,537,000 or 8.9% of sales, from $18,319,000 or 8.4% of sales in the same twelve months of 1997. Net income for 1998 decreased to $2,790,000 as compared to $4,343,000 in 1997 due to higher interest expense in 1998 resulting from the Recapitalization transaction. During 1998, the Company expanded its business by opening 36 new stores and acquiring five from a competitor. Additionally, three stores were closed and six relocated in 1998. This resulted in a net increase of 38 stores as of October 3, 1998 as compared to September 27, 1997.
Sales ---------------------------- Twelve Months Ended ---------------------------- Oct. 3, 1998 Sep. 27, 1997 ------------ ------------- (unaudited) (in thousands) Retail Stores.................... $246,506 $205,879 Mail Order Catalog............... 5,521 6,428 Service Departments.............. 896 4,802 -------- -------- $252,923 $217,109 ======== ========
Sales for the twelve months ended October 3, 1998 increased 16.5% over the same period in 1997. Retail store sales, which are comprised of residential sales and commercial sales, grew 19.7%, reflecting an extra sales week in fiscal 1998, increases in comparable store sales (over the comparable 53 weeks) of 10.3% and an increase in the total number of stores in operation from 278 in 1997 to 316 at the end of 1998. The increase in comparable store sales resulted from the maturing of new stores opened over the last several years, from continued growth of commercial sales, and from the addition of service sales to selected retail stores. In total, commercial sales grew by approximately 22% in the twelve month period as compared to last year, increasing comparable store sales growth by about 2.0%. Additionally, in 1998, the Company converted Service Department operations into a store-based format, and as a result, reflected these service sales in the retail store sales total. The inclusion of service increased the comparable store sales gains by approximately 4.0% in the year-to-date period. Mail order catalog sales declined 14.1% to $5,521,000 from $6,428,000 in the comparable period of 1997. New store openings in a number of strong mail order markets continued to cannibalize mail order sales. Service department sales declined versus the same period in 1997 reflecting the transition to store-based service operations. Gross profit for the twelve months ended October 3, 1998 increased to 39.3% of sales, from 37.7% in 1997. Gross profit represents sales less the cost of services and purchased goods, chemical repackaging costs, and non-administrative occupancy costs. The gross margin increase in 1998 reflects higher average retail pricing, some lower product acquisition costs, lower inventory shrinkage expense and a decrease in store rent expense as a percentage of sales due to the slightly reduced rate of new store openings in the last two years. 13 In 1998, selling, general and administrative expenses equaled $82,908,000, versus $68,580,000 in 1997, an increase of 20.9%, largely the result of the increase in the number of stores in operation at the end of 1998. EBITDA was $22,537,000 in the twelve months of 1998, representing an increase of $4,218,000, or 23.0%, as compared to $18,319,000 for the same period of 1997. The EBITDA margin increased to 8.9% of sales in the twelve months of 1998 from 8.4% of sales in the same period of 1997. The increase in EBITDA was primarily the result of the Company's sales growth combined with increased gross margins. Amortization expense for the twelve months ended October 3, 1998 increased to $580,000 from $254,000 in the same period of 1997 due to higher goodwill amortization and the amortization of non competition agreements associated with the Marlin acquisition. (See Note 2(g) of the Financial Statements.) For the twelve months ended October 3, 1998, the Company recognized losses on the disposition of fixed assets totaling approximately $334,000. This was primarily associated with the closure or relocation of several stores in 1998. Income from operations for the period increased 41.0% to $15,536,000 or 6.1% of sales, from $11,021,000 or 5.1% of sales in the same twelve months of 1997. Interest expense equaled $10,513,000 in 1998, up from $4,842,000 in 1997. The increase was primarily the result of increased borrowings subsequent to June 11, 1997 resulting from the completion of the Recapitalization transaction and related issuance of the $90,000,000 in Senior Notes. The tax provision increased to $2,233,000 in 1998, an effective tax rate of 44.5%, from $1,836,000 and an effective tax rate of 29.7% in 1997. The lower effective tax rate in 1997 as compared to 1998 reflects the reversal in 1997 of certain tax reserves which were no longer needed. 1997 compared to 1996:
Sales ----------------------------- Nine Months Ended ----------------------------- Sep. 27, 1997 Sep. 28, 1996 ------------- ------------- (transition period) (unaudited) (in thousands) Retail Stores.................................. $186,641 $159,881 Mail Order Catalog............................. 5,508 6,803 Service Departments............................ 3,876 3,871 -------- -------- $196,025 $170,555 ======== ========
Sales for the nine months ended September 27, 1997 (transition period) increased 14.9% over the same period in 1996. Retail store sales, which are comprised of residential sales and commercial sales, grew 16.7%, reflecting increases in comparable store sales of 10.4% as well as an increase in the total number of stores in operation from 259 in 1996 to 278 for most of the 1997 selling season. The increase in comparable store sales resulted from the maturing of new stores opened over the last several years, from continued growth of commercial sales, and from the addition of service sales to selected retail stores. In total, commercial sales grew by 20.9% in the nine month period as compared to last year increasing comparable store sales growth by approximately .5%. Additionally, in the Southern California market, the Company tested the operations of its service technicians out of the local stores, and as a result, reflected these service sales in the retail store sales total. This increased the comparable store sales gains by approximately 1.0% in the year-to-date period. 14 Mail order catalog sales declined 19.0% to $5,508,000 from $6,803,000 in the comparable period of 1996. New store openings in a number of strong mail order markets continued to cannibalize mail order sales. Service department sales were flat as compared to the same period in 1996 reflecting solid growth in the Texas service centers, offset by the reclassification of the Southern California service sales to the retail store sales. Gross profit for the nine months ended September 27, 1997 decreased to 39.5% of sales, from 40.1% in 1996. Gross profit represents sales less the cost of services and purchased goods, chemical repackaging costs, and non- administrative occupancy costs. The gross margin decrease in 1997 reflects increased promotional activity, including increased retail price discounting in 1997 associated with the grand opening of new stores, as well as an increase in store rent expense as a percentage of sales due to continued new store openings. In 1997, selling, general and administrative expenses equaled $57,934,000, versus $51,709,000 in 1996, an increase of 12.0%, largely the result of the increase in the number of stores. As a percentage of sales, selling, general and administrative expenses decreased 0.7% to 29.6%, compared to 30.3% of sales in 1996, due to the continued comparable store sales growth in 1997. EBITDA was $23,247,000 in the nine months of 1997, representing an increase of $3,358,000, or 16.9%, as compared to $19,889,000 for the same period of 1996. The EBITDA margin increased to 11.9% of sales in the nine months of 1997 from 11.7% of sales in the same period of 1996. The increase in the EBITDA margin was the result of the Company's solid sales growth which leveraged expenses as a percentage of sales, partially offset by lower gross margins. Amortization of acquisition costs, which represents the amortization of goodwill, equaled $191,000 in the nine months of 1997, essentially flat as compared to the same period in 1996. In 1997, the Company recognized losses on the disposition of fixed assets totaling approximately $457,000. This was primarily associated with the closure or relocation of several stores in 1997 as well as the sale and leaseback of a company-owned property. Income from operations for the period increased 9.9% to $17,989,000 or 9.2% of sales, from $16,367,000 or 9.6% of sales in 1996. Interest expense equaled $4,220,000 in 1997, up from $2,164,000 in 1996. The increase was primarily the result of increased borrowings subsequent to June 11, 1997 resulting from the completion of the Recapitalization transaction and related issuance of the $90,000,000 in Senior Notes. The tax provision decreased to $4,986,000 in 1997, an effective rate of 36.2%, from $5,894,000 and an effective tax rate of 41.5% in 1996. The lower effective tax rate in 1997 as compared to 1996 reflects the reversal in 1997 of certain tax reserves which were no longer needed. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES Changes in Financial Condition. From September 27, 1997 to October 3, 1998, total current assets increased $2,856,000 from $65,272,000 to $68,128,000. The increase in current assets results mainly from increases in inventories partially offset by reductions in cash. The principal component of current assets is inventory, which increased $7,201,000 from $40,239,000 to $47,440,000. The inventory increase results primarily from the increased number of stores in operation in 1998. Total current liabilities increased $3,465,000 between September 27, 1997 and October 3, 1998. Increased accounts payable and accrued liabilities, resulting primarily from the continued growth of the business, were partially offset by lower income taxes payable. 15 Liquidity and Capital Resources. For the twelve months ended October 3, 1998, net cash provided by operating activities was $7,737,000 compared to $17,071,000 in the twelve months of the prior year. Increased working capital requirements, in particular inventory, produced the decreased cash flow from operations in 1998. Inventories increased $7,201,000 year-over-year, due primarily to the additional stores opened in 1998 and a large early-buy of product (for sale in 1999) made prior to year-end. In the twelve months of fiscal 1998, cash used in investing activities was $12,915,000 compared with $8,672,000 in the same period of the prior year. Increased capital expenditures in 1998 were the result of the larger number of new stores opened this year. In addition, the Company purchased a small Atlanta, Georgia competitor, Marlin Pool Supply, in 1998. Cash used in financing activities was $87,000 in the twelve months of 1998 compared with cash provided by financing activities of $6,306,000 in the same period of 1997. In June 1997, the Recapitalization transaction was completed creating a new and significantly different capital structure for the Company. The cash provided by financing activities in 1997 reflects this change. The Company believes that its internally generated funds, as well as its borrowing capacity, are adequate to meet its working capital needs, maturing obligations and capital expenditure requirements, including those relating to the opening of new stores. Seasonality and Quarterly Fluctuations. The Company's business exhibits substantial seasonality which the Company believes is typical of the swimming pool supply industry. In general, sales and net income are highest during the quarters ended June and September, which represent the peak months of swimming pool use. Sales are substantially lower during the quarters ended December and March when the Company will typically incur net losses. The principal external factor affecting the Company's business is weather. Hot weather and the higher frequency of pool usage in such weather create a need for more pool chemicals and supplies. Unseasonably early or late warming trends can increase or decrease the length of the pool season. In addition, unseasonably cool weather and/or extraordinary amounts of rainfall in the peak season decrease swimming pool use. The likelihood that unusual weather patterns will severely impact the Company's results is lessened by the geographical diversification of the Company's store locations. The Company expects that its quarterly results of operations will fluctuate depending on the timing and amount of revenue contributed by new stores and, to a lesser degree, the timing of costs associated with the opening of new stores. The Company attempts to open its new stores primarily in the quarter ending March in order to position itself for the following peak season. As additional stores and the resultant operating expenses are added, the Company expects its usual losses incurred in the quarters ended December and March to increase. 16 SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS)
13 Weeks Ended 14 Weeks --------------------------------- Ended Dec. 27 March 28 June 27 Oct. 3 ------- -------- -------- -------- 1998 Sales............................. $24,238 $ 24,403 $110,851 $93,431 Gross Profit...................... 6,726 5,736 46,309 40,587 (Loss)Income from Operations...... (6,767) (12,280) 18,805 15,778 Net (Loss) Income................. (5,382) (8,504) 9,095 7,581 EBITDA(1)......................... $(5,225) $(10,709) $ 20,595 $17,876 Comparable Store Sales Growth..... 16.2% 0.0% 7.8% 15.0% 13 Weeks Transition Period Ended --------------------------------- Dec. 28 March 29 June 28 Sept. 27 ------- -------- -------- -------- 1997 Sales............................. $21,084 $ 23,816 $ 98,034 $74,175 Gross Profit...................... 4,398 5,562 40,858 30,945 (Loss)Income from Operations...... (6,967) (9,628) 16,012 11,605 Net (Loss) Income................. (4,440) (6,101) 8,776 6,108 EBITDA(1)......................... $(4,929) $ (8,243) $ 18,367 $13,123 Comparable Store Sales Growth..... 6.4% 20.8% 6.6% 13.6%
- -------- (1) EBITDA represents income before interest, taxes, depreciation, amortization, loss/(gain) on disposition of fixed assets, Recapitalization costs and LIFO adjustments. YEAR 2000 ISSUES General. The computer systems issue relating to dates beyond 1999 is the result of many computer programs being written to use and store dates with only the last two digits of the applicable year. As a result, these programs may assume that all two digit dates are twentieth century dates. This could result in system failure, anomalous system behavior or incorrect system reporting. System failure could, in turn, temporarily affect the Company's ability to process customer transactions, interface with vendors and engage in similar normal business activities. The Company has assessed how it may be impacted. The Company has formulated and begun implementation of a plan to address all known aspects of the issue. The company has already completed a substantial portion of this plan and is on schedule to fully complete the plan by August of 1999. Overview of the Plan. The Company's plan addresses internal software information systems, vendor provided computer hardware and operating systems, communications systems, suppliers and other business partners. The plan identifies a four step process for each of these areas-- 1) Initial Assessment of Exposure 2) Development of a Plan to Further Identify All Necessary Costs/Steps to Address Issues 3) Plan Implementation and Testing 4) Contingency Planning 17 Internal Software Information Systems. Internal software information systems include our base financial and merchandising system (Alliance), our distribution package (CAMBAR), our point of sale system (POS 98) and other smaller scale systems developed internally. The company is now at planning step three (Plan Implementation and Testing) for each of these major system areas. The Alliance system was found to be substantially non-compliant. The initial assessment identified high costs to re-engineer this system for compliance. For this reason, and for other business-related reasons, the company plans to replace the Alliance system with a new package. This package (JDA) has been chosen, acquired and installed for test purposes. The vendor has done extensive year 2000 development and testing and has guaranteed year 2000 compliance. The Company's internal testing of the JDA system has initially confirmed year 2000 readiness. It is expected the capital cost to acquire and install the JDA system will be approximately $1,100,000. Current implementation plans call for the system to be fully installed and operational no later than August of 1999. The CAMBAR system was found to be substantially non-compliant. The initial assessment identified relatively low costs to internally re-engineer the system for compliance. The development of this year 2000 compliance code has been completed. The estimated costs to develop, test and install these changes is less than $20,000. The full test of CAMBAR year 2000 compliant code is to be completed by January of 1999. The POS 98 application system was found to be fully year 2000 compliant. Changes to support year 2000 dates in other smaller scale internal systems have been identified. In particular, Sales Audit and Mail Order systems will need to be modified and/or replaced in order to comply. Modifications to the Sales Audit system and to other small scale systems that will need modification are expected to cost less than $40,000 to develop, test and install. These changes are planned to be operational no later than June of 1999. The Mail Order system will be fully replaced by a new system currently in development. This new system will cost approximately $90,000-$120,000 to develop, test and install. The new system is planned to be installed no later than August of 1999. Vendor Provided Computer Hardware and Operating Systems. Vendor provided computer hardware and operating systems includes all data center equipment (IBM AS-400 systems), all store POS equipment (Various Intel-Based Microcomputer Systems), embedded systems in corporate environmental equipment, and corporate/field management microcomputer systems. The Company is now at planning step three (Plan Implementation and Testing) or planning step four (Contingency Planning) for these systems. All of these systems were found to be substantially year 2000 compliant with the exception of store POS systems. A limited number of store systems will be replaced by June of 1999 with an estimated cost of less than $30,000. An in- store procedure may also be necessary in a limited number of stores to manually set the date on January 1, 2000. Communications Systems. Communications systems includes all data center equipment and software systems used to support external communications with the field and with business partners and all corporate equipment and software systems used to support internal business management communications. All of these systems have been recently replaced and/or upgraded. Each significant component of these communications systems has been tested and all were found to be substantially year 2000 compliant. 18 Suppliers and Other Business Partners. This area of the plan called for all significant suppliers and other business partners to be surveyed for year 2000 readiness. Most of the significant trade vendors have already been contacted. The Company anticipates that these activities will continue in the first quarter of 1999. The Company is not currently aware of any single vendor or business partner with year 2000 compliance issues that could have a material impact on the Company. Year 2000 business transaction tests of all direct interfaces with vendors and other business partners will be completed by the second quarter of 1999. The Company can provide no assurance that year 2000 compliance will be successfully implemented by all of its suppliers. Contingency Planning. The Company has not yet developed a comprehensive contingency plan to address the risks of operational problems and costs likely to result from a failure by the Company or by a supplier or business partner to address year 2000 readiness. This plan will be developed by the end of the first quarter of 1999. It will list specific action plans for failure in any of the identified areas of the year 2000 compliance plan. The Company believes that failure to complete any of the remaining work to be done will not alone adversely affect the continuity of the core retail business. The Company believes its current state of readiness is on schedule with a conservative plan to be fully year 2000 compliant by August of 1999 and that business risks have been minimized. However, there can be no guarantee that year 2000 compliance issues not yet identified or fully addressed will not materially affect the Company's operations or expose it to third party liability. Recent Accounting Pronouncement. In June 1997, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures About Segments of an Enterprise and Related Information," which requires a new model of segment reporting called the "management approach." In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures about Pensions and Other Postretirement Benefits," which increases the disclosure requirements for public companies. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments. In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which provides guidance on accounting for the costs of computer software developed or obtained for internal use. In April 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of Start-Up Activities," which requires start-up activities and organization costs to be expenses as incurred. All standards, to the extent applicable, will be adopted in the first quarter of fiscal 1999. Management does not expect the adoption of these standards to have a material effect on the Company's financial position or results of operations. 19 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
Page ---- Report of Independent Public Accountants............................. 21 Management's Report.................................................. 22 Consolidated Balance Sheets--October 3, 1998 and September 27, 1997.. 23 Consolidated Statements of Operations--Years Ended October 3, 1998 and September 27, 1997 (unaudited), the Nine Months Ended September 27, 1997 (transition period) and September 28, 1996 (unaudited) and Year Ended December 28, 1996....................... 24 Consolidated Statements of Shareholders' Equity (Deficit)--Year Ended October 3, 1998, the Nine Months Ended September 27, 1997 and the Year Ended December 28, 1996....................................... 25 Consolidated Statements of Cash Flows--Year Ended October 3, 1998 and September 27, 1997 (unaudited), the Nine Months Ended September 27, 1997 and September 28, 1996 (unaudited) and the Year Ended December 28, 1996....................................... 26 Notes to Consolidated Financial Statements........................... 27
20 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Leslie's Poolmart, Inc.: We have audited the accompanying consolidated balance sheets of Leslie's Poolmart, Inc. (a Delaware corporation) and subsidiaries as of October 3, 1998 and September 27, 1997 and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for the fiscal year ended October 3, 1998, the nine months ended September 27, 1997 (transition period) and the fiscal year ended December 28, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Leslie's Poolmart, Inc. and subsidiaries as of October 3, 1998 and September 27, 1997 and the results of their operations and their cash flows for the fiscal year ended October 3, 1998, the nine months ended September 27, 1997 and the fiscal year ended December 28, 1996, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Los Angeles, California November 18, 1998 21 MANAGEMENT'S REPORT Management is responsible for the preparation and integrity of the financial statements appearing in this Form 10-K. The financial statements were prepared in accordance with generally accepted accounting principles and include certain amounts based on management's best estimates and judgments. The Company maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that transactions are executed as authorized and are recorded and reported properly. Management believes that existing internal accounting control systems are achieving their objectives and that they provide reasonable assurance concerning the accuracy of the financial statements. Arthur Andersen LLP, independent public accountants, has audited the Company's financial statements and their report is presented herein. Arthur Andersen LLP has direct access to the Board of Directors and periodically meets with the Board to discuss accounting, auditing and financial reporting matters. Robert D. Olsen Chief Financial Officer 22 LESLIE'S POOLMART, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
ASSETS ------ Oct. 3, 1998 Sep. 27, 1997 ------------ ------------- CURRENT ASSETS: Cash ........................................................... $ 9,564 $ 14,829 Accounts and other receivables, not............................. 5,270 4,368 Inventories..................................................... 47,440 40,239 Prepaid expenses and other...................................... 1,583 1,523 Deferred tax assets............................................. 4,271 4,313 -------- ---------- Total current assets........................................ 68,128 65,272 -------- ---------- PROPERTY, PLANT AND EQUIPMENT:..................................... 61,744 52,102 Less--Accumulated depreciation and amortization.................... 21,902 16,408 -------- ---------- Net property, plant and equipment.................................. 39,842 35,694 -------- ---------- OTHER ASSETS: Goodwill, net................................................... 8,699 8,051 Non-compete covenant, net....................................... 1,091 - Deferred financing costs, net................................... 3,007 3,564 Other........................................................... 519 671 -------- ---------- Total other assets.......................................... 13,316 12,286 -------- ---------- $121,286 $ 113,252 ======== ========== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) --------------------------------------------- CURRENT LIABILITIES: Accounts payable................................................. $ 14,692 $ 11,838 Accrued liabilities.............................................. 12,559 10,544 Current portion of long-term debt................................ 94 87 Income taxes..................................................... 4,681 6,092 -------- ---------- Total current liabilities................................... 32,026 28,561 -------- ---------- DEFERRED TAX LIABILITIES........................................... 3,619 3,393 LONG-TERM DEBT, net of current portion............................. 1,195 1,290 SENIOR NOTES....................................................... 90,000 90,000 PREFERRED STOCK, $0.001 par value; Authorized--2,000,000 shares; Issued and outstanding--28,000 Series A at Oct. 3, 1998 and Sep. 27, 1997; liquidation preference $28,000,000................ 29,361 25,853 COMMITMENTS AND CONTINGENCIES...................................... - - SHAREHOLDERS' EQUITY (DEFICIT): Common stock, $0.001 par value; Authorized--12,000,000 shares; ssued and outstanding--1,433,643 at Oct. 3, 1998 and Sep. 27, 1997 1 1 Additional paid-in capital....................................... (45,702) (47,350) Retained earnings............................................... 10,786 11,504 -------- ---------- Total shareholders' deficit................................. (34,915) (35,845) -------- ---------- $121,286 $ 113,252 ======== ==========
The accompanying notes are an integral part of these consolidated balance sheets. 23 LESLIE'S POOLMART, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands)
Years Ended Nine Months Ended Year Ended ---------------------------- ----------------------------- ------------- Oct. 3, 1998 Sep. 27, 1997 Sep. 27, 1997 Sep. 28, 1996 Dec. 28, 1996 ------------ ------------- ------------- ------------- ------------- (transition (unaudited) period) (unaudited) Net sales......................... $ 252,923 $ 217,109 $ 196,025 $ 170,555 $ 191,640 Cost of sales...................... 153,565 135,348 118,660 102,193 118,880 --------- --------- --------- --------- --------- Gross profit....................... 99,358 81,761 77,365 68,362 72,760 Selling, general and administrative expenses........... 82,908 68,580 57,934 51,709 62,358 Amortization of acquisition costs.. 580 254 191 191 252 Recapitalization costs............. - 794 794 - - Loss on disposition of fixed assets............................ 334 1,112 457 95 750 --------- --------- --------- --------- --------- Income from operations............. 15,536 11,021 17,989 16,367 9,400 Interest expense, net.............. 10,513 4,842 4,220 2,164 2,786 --------- --------- --------- --------- --------- Income before taxes................ 5,023 6,179 13,769 14,203 6,614 Income tax provision............... 2,233 1,836 4,986 5,894 2,745 --------- --------- --------- --------- --------- Net income......................... 2,790 4,343 8,783 8,309 3,869 ========= ========= ========= ========= ========= Series A Preferred Stock dividends and accretion........... 3,508 969 969 - - --------- --------- --------- --------- --------- (Loss)/Income applicable to common shareholders............... $ (718) $ 3,374 $ 7,814 $ 8,309 $ 3,869 ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 24 LESLIE'S POOLMART, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Common Stock ------------------------ Additional Retained Total Number of Paid in (Deficit) Shareholders' Shares Amount Capital Earnings Equity/(Deficit) ----------- ---------- ------------- ----------- ------------------ Balance, at December 30, 1995............... 6,507,074 $ 6 $ 32,094 $ (179) $ 31,921 Issuance of common stock................... 50 - 1 - 1 Stock options exercised.................... 40,804 - 304 - 304 Tax benefit from stock options exercised... - - 220 - 220 Net income................................. - - - 3,869 3,869 --------- --------- ---------- --------- ---------- Balance, at December 28, 1996............... 6,547,928 6 32,619 3,690 36,315 Stock options exercised.................... 9,184 - 77 - 77 Repurchase of common stock................. (6,197,607) (6) (99,530) - (99,536) Issuance of common stock................... 1,074,138 1 15,574 - 15,575 Issuance of non-qualified stock options.... - - 794 - 794 Issuance of warrants....................... - - 3,116 - 3,116 Series A Preferred Stock Dividends and accretion................... - - - (969) (969) Net income................................. - - - 8,783 8,783 --------- --------- ---------- --------- ---------- Balance, at September 27, 1997.............. 1,433,643 1 (47,350) 11,504 (35,845) Series A Preferred Stock Dividends and accretion.................... - - - (3,508) (3,508) Tax benefit NQ stock options................ - - 1,648 - 1,648 Net income.................................. - - - 2,790 2,790 --------- --------- ---------- --------- ---------- Balance, at October 3, 1998................. 1,433,643 $ 1 $ (45,702) $ 10,786 $ (34,915) ========= ========= ========== ========= ==========
The accompanying notes are an integral part of these consolidated financial statements. 25 LESLIE'S POOLMART, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Years Ended Nine Months Ended ------------------------------ ------------------------------ Year Ended Oct. 3, 1998 Sep. 27, 1997 Sep. 27, 1997 Sep. 28, 1996 Dec. 28, 1996 ------------ ------------- ------------- ------------- ------------- (Unaudited) (Unaudited) OPERATING ACTIVITIES: Net income.................................... $ 2,790 $ 4,343 $ 8,783 $ 8,309 $ 3,869 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............. 7,223 5,428 4,207 3,227 4,326 Deferred income taxes..................... 268 (284) (1,417) - (282) Recapitalization costs.................... - 794 794 - - Loss on disposition of fixed assets....... 334 1,112 457 95 750 (Increase) decrease in: Accounts and other receivables............ (902) (1,281) (1,818) (852) (315) Inventories............................... (7,201) (370) (6,291) (5,566) 355 Prepaid expenses and other................ (60) 181 170 50 183 Other assets.............................. 96 (48) 56 (1) (47) Increase (decrease) in: Accounts payable and accrued liabilities.. 4,869 5,287 11,847 8,334 1,774 Income taxes.............................. 320 1,909 6,092 4,183 1,357 -------- -------- -------- -------- -------- Net cash provided by operating activities..... 7,737 17,071 22,880 17,779 11,970 -------- -------- -------- -------- -------- INVESTING ACTIVITIES: Purchase of property, plant and equipment..... (10,519) (9,885) (7,917) (6,737) (8,807) Proceeds from dispositions of property, plant and equipment....................... - 1,213 1,213 120 221 Business acquisitions......................... (2,396) - - - - -------- -------- -------- -------- -------- Net cash used in investing activities......... (12,915) (8,672) (6,704) (6,617) (8,586) -------- -------- -------- -------- -------- FINANCING ACTIVITIES: Net line-of-credit repayments................. - (7,263) (15,440) (9,693) (1,516) Issuance of Senior Notes...................... - 90,000 90,000 - - Payments of long-term debt.................... (87) (16,828) (16,391) (1,723) (2,160) Payment of deferred financing costs........... - (3,719) (3,719) - - Repurchase of common stock.................... - (99,536) (99,536) - - Proceeds from issuance of preferred stock..... - 28,000 28,000 - - Proceeds from issuance of common stock, net... - 15,652 15,652 304 305 -------- --------- -------- -------- -------- Net cash provided by (used in) financing activities.................................... (87) 6,306 (1,434) (11,112) (3,371) -------- --------- -------- -------- -------- NET (DECREASE) INCREASE IN CASH.................. (5,265) 14,705 14,742 50 13 CASH AT BEGINNING OF PERIOD...................... 14,829 124 87 74 74 -------- --------- -------- -------- -------- CASH AT END OF PERIOD............................ $ 9,564 $ 14,829 $ 14,829 $ 124 $ 87 ======== ========= ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 26 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND OPERATIONS Leslie's Poolmart, Inc. (the Company) is a specialty retailer of swimming pool supplies and related products. As of October 3, 1998, the Company marketed its products under the trade name Leslie's Swimming Pool Supplies through 316 retail stores in 28 states and through mail order catalogs sent to selected swimming pool owners nationwide. The Company also repackages certain bulk chemical products for retail sale. The Company's business is highly seasonal as the majority of its sales and all of its operating profits are generated in the quarters ending in June and September. On June 11, 1997, Leslie's Poolmart (a California corporation -- "Leslie's California") reincorporated in Delaware by merging into a wholly-owned Delaware subsidiary (the "Reincorporation"), changed its name to Leslie's Poolmart, Inc. and merged Poolmart USA Inc., a newly-formed corporation, with and into the Company (the "Recapitalization"). As a result of the Recapitalization, (i) each outstanding share of common stock of Leslie's California was converted into $14.50 cash (other than 359,505 shares owned primarily by members of management); and (ii) outstanding options covering approximately 830,000 shares of common stock, including those not yet vested, were exercised and retired for payment of the difference between the exercise price and $14.50 per share. The total value of the shares and options cashed out approximated $94,300,000, plus $5,229,000 in expenses associated with this transaction. These costs have been included in the cost to repurchase the common stock in the accompanying statement of shareholders' equity. In connection with the Recapitalization, the Company changed the authorized capital of the Company to 12,000,000 shares of common stock with a $0.001 par value and 2,000,000 shares of preferred stock with a $0.001 par value. In order to finance the repurchase of the outstanding common shares and options, the Company issued $90,000,000 of its 10.375% Senior Notes and sold 1,074,138 shares of its common stock for proceeds of $15,575,000. As indicated above, certain directors and members of management converted some of the Leslie's California common shares which they owned into shares of the Company's common stock. (See Note 7) Also in connection with the Recapitalization, the Company issued 28,000 shares of its Series A Preferred Stock of the Company, par value $0.001 per share, at $1,000 per share for a total consideration of $28,000,000, consisting of cash and an exchange of the $10,000,000 principal amount of Convertible Subordinated Debentures of Leslie's California held by a major supplier. In connection with this transaction, the holder of the Series A Preferred Stock received Warrants to purchase up to 15.0% of the shares of the Company's common stock at a purchase price of $0.01 per share (subject to adjustment) for a period of ten years. (See Note 12) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a. Principles of Consolidation The consolidated financial statements of the Company include Leslie's Poolmart, Inc., and its wholly-owned subsidiaries, Leslie's Pool Brite, Inc., Sandy's Pool Supply, Inc. and Blackwood & Simmons, Inc. All significant intercompany transactions and accounts have been eliminated. b. Fiscal Periods In 1997, the Company changed its fiscal year end from the Saturday closest to December 31 to the Saturday closest to September 30. The 1998 fiscal year ended on October 3, 1998, and included 53 weeks. The 1996 fiscal year ended on December 28, 1996 included 52 weeks, while the nine month transition period ended September 27, 1997 included 39 weeks. 27 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) c. Accounts and Other Receivables, Net Accounts and other receivables include allowances for doubtful accounts of $192,000 and $217,000 at October 3, 1998 and September 27, 1997, respectively. d. Inventories Inventories are stated at the lower of cost or market. In September 1997, the Company changed its inventory valuation method from last-in, first-out (LIFO) to first-in, first-out (FIFO). The effect of utilizing LIFO in prior years resulted in inventory balances which were $544,000 lower at December 28, 1996 than would have been reported under the first-in, first-out (FIFO) method. The effect of changing the inventory valuation method was immaterial to all periods presented. e. Property, Plant and Equipment Property, plant and equipment are stated at cost. Costs of normal maintenance and repairs are charged to expense as incurred. Major replacements or improvements of property, plant 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 statements of operations. Depreciation and amortization are computed using the straight-line method (considering appropriate salvage values) based on the following estimated average useful lives: Buildings and improvements................ 15-30 years Vehicles, machinery and equipment......... 3-10 years Office furniture and equipment............ 3-10 years Leasehold improvements.................... 4-10 years
f. Goodwill The excess of the acquisition price over the fair value of the net assets at the date of acquisition is included in the accompanying consolidated balance sheets as "Goodwill." Goodwill is being amortized (straight-line) over forty years. The Company continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. When factors indicate that goodwill should be evaluated for possible impairment, the Company uses an estimate of the related business segment's undiscounted net income over the remaining life of the goodwill in measuring whether the goodwill is recoverable. The balance recorded at October 3, 1998 and September 27, 1997 was net of accumulated amortization of $1,858,000 and $1,588,000, respectively. g. Business Acquisition In January 1998, the Company purchased the capital stock of Blackwood & Simons, Inc. (dba Marlin Pool Supply), an operator of six swimming pool supply stores located in the Atlanta, Georgia area, in a cash for stock transaction. The purchase price, net of excess cash on hand, was approximately $2,300,000. The covenant not-to-compete was valued at $1,200,000 and is being amortized over three years. The goodwill of $950,000 is being amortized over 40 years. The acquisition was immaterial to the financial statements presented. 28 LESLIE'S POOLMART INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) h. Deferred Financing Costs In connection with issuing the Senior Notes and signing the Credit Agreement, the Company paid $3,708,000 in financing costs that are being deferred and amortized over the lives of the corresponding agreements. The balance recorded at October 3, 1998 and September 27, 1997 was net of accumulated amortization of $701,000 and $144,000 respectively. i. Income Taxes The Company provides for deferred income taxes relating to timing differences in the recognition of income and expense items (primarily depreciation and amortization) for financial and tax reporting purposes. Also, differences between the tax basis and the financial reporting basis of various assets were created when the Company was acquired in 1988 and when the Company purchased Sandy's in 1992; deferred tax assets and liabilities were provided related to these differences. Deferred taxes at October 3, 1998 and September 27, 1997 include a provision for the differences between tax and financial asset values except that deferred taxes were not provided with respect to amounts allocated to goodwill. As the difference between tax and financial reporting basis changes, appropriate charges/credits are made to the deferred tax account. j. Mail Order Catalog Sales Revenue on mail order catalog sales is recognized at the time goods are shipped. k. Cost of Sales Included in cost of sales are the costs of services and purchased goods, chemical repackaging costs and non-administrative occupancy costs. l. Fair Value of Financial Statements The fair value of the $90,000,000 Senior Notes using quoted market prices as of October 3, 1998 is $91,434,000. The carrying amounts of other long-term debt approximate fair value because either the interest rate fluctuates based on market rates or interest rates appear to approximate market rates for similar instruments. The fair value estimates are subjective in nature and involve uncertainties and matters of judgement and therefore, cannot be determined with precision. Changes in assumptions could significantly affect these estimates. m. Use of Estimates in the Preparation of Consolidated Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. n. Recent Accounting Pronouncements In June 1997, the Financial Standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures About Segments of an Enterprise and Related Information," which requires a new mode of segment reporting called the "management approach." In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures about Pensions and Other Postretirement Benefits," which increases the disclosure requirements for public companies. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments. 29 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which provides guidance on accounting for the costs of computer software developed or obtained for internal use. In April 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of Start-Up Activities," which requires start-up activities and organization costs to be expenses as incurred. All standards, to the extent applicable, will be adopted in the first quarter of fiscal 1999. Management does not expect the adoption of these standards to have a material effect on the Company's financial position or results of operations. o. Reclassifications Certain prior period amounts in the consolidated financial statements have been reclassified to conform to the 1998 presentations. 3. INVENTORIES Inventories consist of the following:
October 3, September 27, 1998 1997 ----------- ------------ Raw materials and supplies......................... $ 591,000 $ l,l02,000 Finished goods..................................... 46,849,000 39,137,000 ----------- ----------- $47,440,000 $40,239,000 =========== ===========
4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following:
October 3, September 27, 1998 1997 ----------- ------------ Land............................................... 6,250,000 $ 6,122,000 Buildings and improvements......................... 7,423,000 6,280,000 Vehicles, machinery and equipment ................. 2,703,000 2,290,000 Leasehold improvements............................. 23,143,000 19,027,000 Office furniture, equipment and other.............. 21,909,000 17,767,000 Construction-in-process............................ 316,000 616,000 ----------- ----------- 61,744,000 52,102,000 Less--Accumulated depreciation and amortization.... 21,902,000 16,408,000 ----------- ----------- $39,842,000 $35,694,000 =========== ===========
5. BANK CREDIT AGREEMENT In connection with the Recapitalization, the Company entered into a five year Credit Agreement (the "Agreement") with Wells Fargo Bank including a line of credit, letters of credit and swingline loans. The maximum borrowings available under the Agreement is $35,000,000, subject to requirements that the level of outstanding borrowing be limited as a function of inventory and accounts receivable balances. The Agreement is collateralized by inventories, accounts receivables, equipment and other assets. On October 3, 1998, no balances were outstanding under this Agreement. 30 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Agreement accrues interest at the lender's reference rate (8.25 percent at October 3, 1998) plus the applicable Prime rate margin or at LIBOR plus the applicable LIBOR rate margin. The margins are determined by the EBITDA coverage ratios as defined in the Agreement. The Agreement contains certain financial covenants that include tangible net worth, funded debt ratio and EBITDA coverage ratio. As of October 3, 1998, the Company was in compliance with these covenants. 6. LONG-TERM DEBT Long-term debt consists of the following:
October 3, September 27, 1998 1997 ---------- ------------- Notes payable collateralized by security interests in certain assets, maturing September 2002. Interest accrues at the rate of 6.5%................................................................. $ 359,000 $ 432,000 Notes payable collateralized by security interest in various properties, due in monthly installments maturing December 2003. Interest accrues at the rate of 9.6%......................................... 930,000 945,000 ---------- ---------- 1,289,000 1,377,000 Less-Current portion........................................................... 94,000 87,000 ---------- ---------- $1,195,000 $1,290,000 ========== ==========
Principal maturities of long-term debt as of October 3, 1998 are as follows:
1999............................................. $ 94,000 2000............................................. 100,000 2001............................................. 108,000 2002............................................. 116,000 2003............................................. 37,000 Thereafter....................................... 834,000 ---------- $1,289,000 ==========
7. SENIOR NOTES On June 11, 1997, the Company issued $90,000,000 aggregate principal amount of its 10.375 percent Senior Notes due July 15, 2004 (the "Notes"). The Notes were issued under an indenture (the "Indenture") by and among the Company and U.S. Trust Company of California, N.A., as trustee. Interest on the Notes will accrue at the rate of 10.375 percent per annum and will be payable semi-annually in arrears on each January 15 and July 15 commencing on January 15, 1998. The Notes are redeemable, in whole or in part, at the option of the Company on or after July 15, 2001, at the specified redemption prices. In addition, at any time on or prior to July 15, 2000, the Company may redeem up to $25,000,000 of aggregate principal amount of the Notes with the net cash proceeds from one or more Public Equity Offerings at a specified redemption price. The Notes are generally unsecured obligations of the Company and will be subordinated to any secured indebtedness of the Company. In the event of a change of control, the Company will be required to make an offer to purchase all outstanding Notes at a price equal to 101 percent of the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase. 31 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Indenture contains certain covenants which include, among other matters, limitations on the incurrence of additional indebtedness and the payment of dividends. At October 3, 1998, the Company was in compliance with all covenants. 8. LEASES The Company leases certain store, office, distribution and manufacturing facilities under operating leases which expire at various dates through 2010. Lease agreements generally provide for increases related to cost of living indices and require the Company to pay for property taxes, repairs and insurance. Future minimum lease payments at October 3, 1998 are as follows: 1999............................ $15,705,000 2000............................ 13,284,000 2001............................ 10,873,000 2002............................ 8,414,000 2003............................ 5,237,000 Thereafter ..................... 12,814,000 ----------- $66,327,000 ===========
Certain leases are renewable at the option of the Company for periods of one to ten years. Rent expense charged against income totaled $20,448,000, $13,994,000 and $16,024,000 in 1998, 1997 (transition period) and 1996, respectively. 9. INCOME TAXES The provision for income taxes is comprised of the following:
Nine Months Year Ended Ended Year Ended October 3, September 27, December 28, 1998 1997 1996 ---------- ------------- ------------ (transition period) Federal: Current.................. $1,962,000 $ 5,505,000 $2,386,000 Deferred................. (202,000) (1,218,000) (222,000) ---------- ----------- ---------- 1,760,000 4,287,000 2,164,000 ---------- ----------- ---------- State: Current.................. 539,000 898,000 641,000 Deferred................. (66,000) (199,000) (60,000) ---------- ----------- ---------- 473,000 699,000 581,000 ---------- ----------- ---------- $2,233,000 $ 4,986,000 $2,745,000 ========== =========== ==========
32 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) A reconciliation of the provision for income taxes to the amount computed at the federal statutory rate is as follows:
Nine Months Year Ended Ended Year Ended October 3, September 27, December 28, 1998 1997 1996 ---------- ------------- ------------ (transition period) Federal income tax at statutory rate............................. $1,708,000 $4,681,000 $2,248,000 Reversal of tax reserves no longer needed........................ - (550,000) - Permanent differences............................................ 206,000 91,000 146,000 State taxes, net of federal benefit.............................. 319,000 764,000 351,000 ---------- ---------- ---------- $2,233,000 $4,986,000 $2,745,000 ========== ========== ==========
The tax effect of temporary differences which give rise to significant portions of the deferred tax asset and liability are summarized below.
1998 1997 ---------------------------- ---------------------------- Deferred Tax Deferred Tax Deferred Tax Deferred Tax Assets Liabilities Assets Liabilities ------------ ------------ ------------ ------------ Property, plant and equipment differences............... $ - $2,995,000 $ - $2,693,000 State income taxes...................................... 460,000 - 585,000 - Inventory overhead differences.......................... 1,634,000 - 2,108,000 - Difference in timing of certain deductions.............. 2,177,000 624,000 1,620,000 700,000 ---------- ---------- ---------- ---------- $4,271,000 $3,619,000 $4,313,000 $3,393,000 ========== ========== ========== ==========
The Company has net operating losses (NOL) available for offset against future tax liabilities, extending through 2007, limited to approximately $83,000 per year. As this NOL is utilized, such amounts will reduce goodwill. 10. CONTINGENCIES The Company is a defendant in lawsuits or potential claims encountered in the normal course of business, such matters are being vigorously defended. In the opinion of management, the resolutions of these matters will not have a material effect on the Company's financial position or results of operations. The Company's general liability insurance program and employee group medical plan have self-insurance retention features of $100,000 and $75,000 per incident, respectively. The Company's liability is limited to $600,000 per year for the general liability program. 11. 401(k) PLAN The Company provides for the benefit of its employees a voluntary retirement plan under Section 401(k) of the Internal Revenue Code. During 1998, the plan covered all eligible employees and provided for a matching contribution by the Company of 50% of each participant's contribution up to 4% of the individual's compensation as defined. The expenses related to this program were $387,000, $225,000 and $263,000 for 1998, 1997 (transition period) and 1996, respectively. 33 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 12. PREFERRED STOCK In connection with the Recapitalization transaction, the Company sold 28,000 shares of Preferred Stock for total consideration of $28,000,000. The Preferred Stockholder is entitled to an annual cumulative dividend (which is payable at the option of the Company either in cash or in additional shares of Preferred Stock for the first five years). The annual dividend is payable quarterly at the annual rate of 10.875 percent, compounded semi-annually. The Preferred Stockholder is entitled to elect 20 percent of the members of the Board of Directors of the Company. The Preferred Stock may be redeemed at the option of the Company at any time at $1.010 per share plus accumulated and unpaid dividends. The Company is required to redeem the Preferred Stock in three equal installments terminating on the tenth anniversary of the date of issuance of the Preferred Shares. In connection with the issuance of the Series A Preferred Stock, the Preferred Stockholder received 252,996 Warrants to purchase common stock. Of the $28,000,000 face value of the Preferred Stock, $3,116,000 was assigned to the value of these Warrants and reflected as a discount on the Preferred Stock. This discount will be accreted over the life of the Preferred Stock. The terms of the Warrant Agreement will provide for a proportionate adjustment of the warrants for stock splits and stock dividends and for additional warrant shares to be issuable in the event any of the NQ Options or ISO Options are exercised. Based on the number of options outstanding at October 3, 1998, an additional 63,018 warrants could be granted if the options were exercised. In the ordinary course of business, the Company purchases raw materials and finished goods pursuant to a multi-year purchase contract from the holder of the Series A Preferred Stock. Management believes these transactions were under terms no less favorable to the Company than those arranged with other parties. 13. STOCK BASED COMPENSATION PLANS In October 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based Compensation," which applies the fair value-based method of accounting for options granted under stock-based compensation plans. SFAS l23 allows companies to continue to account for stock options granted in accordance with Accounting Principles Board Opinion No. 25, if the Company discloses the results under SFAS 123. Had compensation cost for these plans been determined consistent with SFAS 123, the Company's net income would have been reduced to the following proforma amounts:
1998 1997 1996 ----------- ----------- ---------- (transition period) (Loss)/Income applicable to common shareholders As reported................................. $ (718,000) $7,814,000 $3,869,000 Pro forma................................... $(1,107,000) $7,202,000 $3,490,000
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1998, 1997 and 1996: risk free interest rates of 5.7%, 6.4% and 5.8%, respectively; expected volatility of 0%, 0% and 49%, respectively; expected lives of 7 years for all options and no expected divided yield. Based on these assumptions, the weighted average value of the options granted is $4.72, $5.18 and $7.55 in 1998, 1997 and 1996, respectively. In June 1997, the Company adopted a non-qualified common stock option plan (the "NQ Option Plan") and an incentive common stock option plan (the "ISO Option Plan") and reserved 83,599 and 273,946 shares, respectively. All of the NQ Option Plan options were granted at an exercise price of $5.00 per share and 248,000 options were granted under the ISO Option Plan at $14.50 per share. 34 LESLIE'S POOLMART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The difference between the NQ Option price of $5.00 per share and the fair market value of $14.50 at the date of issuance has been charged as Recapitalization costs in the consolidated income statements for the period ended September 27, 1997. NQ Options vest immediately. NQ Options have a term of ten years and remain exercisable without regard to any termination of the employment of the holder. The Company and its major shareholders have a right to repurchase ("Call Option") a portion of the NQ Options if the option holder ceases to provide services to the Company. This call option ceases in June, 1999. Under the ISO Option Plan, 206,000 options vest in one-third increments over three years. The balance of the ISO Options are subject to the Company achieving certain operating and store-opening goals. Vested ISO Options may be exercised for 90 days post termination of employment, except in the case of the death of the option holder, in which case the vested portion may be exercised within 12 months from the date of termination. ISO Options have a term of ten years. A summary of option activities for all plans is as follows:
1998 1997 1996 ------------------- ------------------- ------------------- (transition period) Wtd Avg Wtd Avg Wtd Avg Shares Ex Price Shares Ex Price Shares Ex Price ------- -------- ------- -------- ------- -------- Outstanding at beginning of year............. 331,599 $ 12.11 972,067 $ 8.62 833,166 $ 7.58 Granted...................................... 28,000 14.77 331,599 12.11 208,168 12.92 Exercised.................................... - - (830,048) (8.57) (40,804) (7.44) Cancelled.................................... (2,500) (14.50) (142,019) (8.91) (28,463) (11.68) ------- ------- -------- ------ ------- ------- Outstanding at end of year................... 357,099 $ 12.30 331,599 $12.11 972,067 $ 8.62 ======= ======= ======== ====== ======= ======= Exercisable at end of year................... 168,769 $ 9.79 83,599 $ 5.00 709,074 $ 9.94 ======= ======= ======== ====== ======= =======
The following table summarizes information about all stock options outstanding as of October 3, 1998:
Options Outstanding Options Exercisable ------------------------------------- ----------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Price Outstanding Life Price Exercisable Price - -------------- ----------- ----------- -------- ----------- -------- $5.00........................................ 83,599 8.7 years $ 5.00 83,599 $ 5.00 $14.50....................................... 271,000 8.7 years 14.50 85,170 14.50 $17.50....................................... 2,500 9.9 years 17.50 - 17.50 ------- ------ ------- ------ 357,099 $12.30 168,769 $ 9.79 ======= ====== ======= ======
14. SUPPLEMENTAL CASH FLOW DISCLOSURES The Company paid interest charges of $11,111,000, $l,660,000 and $2,835,000, in 1998, 1997 (transition period) and 1996, respectively. The Company paid income taxes of $2,486,000, $474,000 and $2,425,000, in 1998, 1997 (transition period) and 1996, respectively. The Series A Preferred Stock dividends and the accretion of the warrants are excluded from the statement of cash flows as non- cash transactions. The tax benefit for non-qualified stock options was excluded from the statement of cash flows as a non-cash transaction. 35 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 36 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and executive officers of the Company are as follows: Name Age Positions ---- --- --------- Michael J. Fourticq.... 54 Chairman of the Board of Directors Brian P. McDermott..... 41 Chief Executive Officer, President and Director Gregory J. Annick...... 34 Director John G. Danhakl........ 42 Director Dr. Dale R. Laurance... 52 Director Robert D. Olsen........ 45 Executive Vice President, Chief Financial Officer Cynthia G. Watts....... 36 Senior Vice President, General Counsel and Secretary John T. Ball........... 53 Senior Vice President, Merchandising and Marketing Michael J. Fourticq has been Chairman of the Board of Directors of the Company since May 1988. Between May 1988 and August 1992, he served as the Company's Chief Executive Officer. From 1986 to 1987, Mr. Fourticq was President and Chief Executive Officer of the Mortell Company, a manufacturer of specialty chemical products. Since 1985 he has been the sole general partner of Hancock Park Associates, which is the general partner and affiliate of several investment partnerships. Mr. Fourticq was the Chairman of the Board and Chief Executive Officer of Alliance Northwest Industries, Inc., a holding company, principally for a specialty lighting distributor and retailer, which filed a petition for reorganization under Chapter 11 of the Federal Bankruptcy Code in March 1996. Brian P. McDermott has been President and a Director of the Company since April 1989 and its Chief Executive Officer since August 1992. Between May 1988 and April 1989, he served as the Company's Executive Vice President of Operations and also was its Secretary from May 1988 until October 1989. From 1987 to 1988, Mr. McDermott served as Director of Acquisitions and Divestitures at Castle & Cooke, Inc., a publicly-held holding company with diverse real estate and corporate interests. Mr. McDermott is Chairman of the Board of Busybody, Inc., a privately held fitness equipment retailer, of which he was acting Chief Executive Officer from November 1994 through March 1996. Gregory J. Annick became a director of the Company in June 1997. He has been an executive officer and an equity owner, through a trust, of Leonard Green & Partners ("LGP"), a merchant banking firm which manages Green Equity Investors, II, LP ("GEI"), since the formation of LGP and GEI in 1994 by the principals of Leonard Green & Associates, LP ("LGA"). He joined LGA as an associate in 1989, became a principal in 1993, and through a corporation became a partner of LGA in 1994. From 1988 to 1989, he was an associate with the merchant banking firm of Gibbons, Green, van Amorongen. Before that time, Mr. Annick was a financial analyst in mergers and acquisitions with Goldman, Sachs & Co. Mr. Annick is also a director of Carr-Gottstein Foods Co., Communications & Power Industries, Inc., Hechinger Company and Liberty Group Publishing, Inc. John G. Danhakl became a director of the Company in June 1997. He has been an executive officer and an equity owner of LGP, a merchant banking firm which manages GEI, since 1995. Mr. Danhakl had previously been a Managing Director at Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") and had been with DLJ since 1990. Prior to joining DLJ, Mr. Danhakl was a Vice President at Drexel Burnham Lambert Incorporated. Mr. Danhakl is also a director of Big 5 Corp., Communications & Power Industries, Inc., Hechinger Company, Twinlab Corporation, The Arden Group, Inc. and Liberty Group Publishing, Inc. 37 Dr. Dale R. Laurance has been a Director of the Company since January 1996. He has been a Director of Occidental Petroleum Corporation since 1990 and its President since 1996. He was its Senior Operating Officer from l990 to 1996 and Vice President of Operations from 1984 to 1990. He is a Director of Canadian Occidental Petroleum Ltd., Jacobs Engineering Group Inc., The Armand Hammer Museum of Art and Cultural Center, Inc., Chemical Manufacturers Association, American Petroleum Institute, U.S.-Arab Chamber of Commerce, Boy Scouts of America-Western Los Angeles County Council and a member of the Advisory Board of the Chemical Heritage Foundation. He is a past Chairman of the Advisory Board for the Department of Chemical and Petroleum Engineering at the University of Kansas and is a recipient of the Distinguished Engineering Service Award from the School of Engineering at the University of Kansas. Dr. Laurance has served as a Managing Director of the Joffrey Ballet Company. Robert D. Olsen has been Executive Vice President and Chief Financial Officer of the Company since April 1993. From 1990 through April 1993 he was Executive Vice President and Chief Financial Officer of TuneUp Masters, a California-based chain of fast automotive tuneup and lube outlets, which filed a petition for reorganization under Chapter 11 of the Federal Bankruptcy laws in November 1994. From 1985 through 1989, Mr. Olsen held several positions with AutoZone, an automotive parts and accessories retailer, including Controller, Vice President--Finance, and Senior Vice President and Chief Financial Officer. From 1981 through 1984 he held a variety of positions with PepsiCo International and Pepsi Cola USA. Cynthia G. Watts has been Senior Vice President of the Company since June 1997. She has been General Counsel of the Company since February 1993 and its Secretary since March 1993. From February 1993 to June 1997, she was Vice President of the Company. Since July 1997, she has been Vice President and General Counsel to Hancock Park Associates, which is the general partner and affiliate of several investment partnerships. From 1988 to January 1993, Ms. Watts was an attorney at Paul, Hastings, Janofsky and Walker, a Los Angeles- based law firm, where her practice was concentrated in the areas of general corporate representation and corporate finance, including securities, venture capital and mergers and acquisitions. John T. Ball has been Senior Vice President, Merchandising and Marketing of the Company since November 1997. From March 1995 through October 1997, he was Senior Vice President, Merchandising at Universal Studios, Inc. based in Orlando, Florida. Mr. Ball oversaw all merchandising efforts related to Universal's theme parks located in California, Florida and Japan. From 1993 to 1995, Mr. Ball was Vice President, Merchandising, Men's at Eddie Bauer, Inc. in Redmond, Washington, and was Director of Outlet Stores for Eddie Bauer from 1990 to 1993. From l980 to l985, he held several merchandising management positions in divisions of the Carter Hawley Hale Stores. All executive officers of the Company are chosen by the Board of Directors and serve at the Board's discretion. No family relationships exist between any of the officers or directors of the Company. Messrs. Fourticq and McDermott are partners together in investment partnerships that do not own shares of the Company. Occidental holds Leslie's Series A Preferred Stock in the principal amount of $28.0 million, together with warrants to purchase common stock. Immediately prior to the consummation of the transactions, Leslie's, GEI, the members of the HPA Group, Brian P. McDermott and Manette J. McDermott, as Co-Trustees of the McDermott Family Trust, and Occidental and the holders of certain management options entered into a Stockholders Agreement. In the Stockholders Agreement, Michael Fourticq and Mr. McDermott were given certain rights to be elected as directors of the Company. In addition, Occidental, as owner of the Preferred Stock, was given the right to board representation. 38 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following summary compensation table sets forth for the fiscal year ended October 3, 1998, the nine months ended September 27, 1997 and the year December 28, 1996, the compensation for services to the Company of the Chief Executive Officer and the other executive officers of the Company as of October 3, 1998.
Long-Term All Other Fiscal Year Compensation Compensation Compensation ------------------------ ------------- ------------------- Salary Bonus Stock Options 401(k) Insurance Year ($)(1) ($)(2) (#)(3) ($)(4) ($)(5) ---- ------- ------ ------------ ------ --------- Michael J. Fourticq..................... 1998 200,000 - - - - Chairman of the Board 1997 150,000 - 4,976 - - 1996 157,500 - 3,308 - - Brian P. McDermott...................... 1998 412,885 76,875 - 3,200 - Chief Executive Officer, 1997 293,000 97,500 77,000 3,200 - President and Director 1996 367,500 - 30,000 3,000 204 Robert D. Olsen......................... 1998 277,089 51,563 - 3,200 - Executive Vice President 1997 192,000 63,750 102,761 3,200 - and Chief Financial Officer 1996 231,000 - 22,500 3,000 204 Cynthia G. Watt(6)...................... 1998 90,673 16,875 - 2,270 - Senior Vice President, General 1997 104,000 25,000 16,000 3,200 - Counsel and Secretary 1996 157,500 - 15,000 3,000 108 John T. Ball............................ 1998 203,265 42,188 23,000 3,200 - Senior Vice President, 1997 - - - - - Merchandising and Marketing 1996 - - - - -
- ------------ (1) Salary figures for 1997 reflect the nine month fiscal year. (2) Bonuses are attributed to the year earned, and are paid out after the conclusion of the fiscal year. Bonuses were paid on a twelve month basis for 1997, and a nine month basis for 1998. (3) All options were granted at their fair market value on the date of grant, except 52,761 options granted to Robert D. Olsen and 7,000 options granted to Cynthia G. Watts in 1997, which have an exercise price of $5.00 per share. (4) Represents expected Company matching contributions to individuals' 40l(k) accounts. (5) Represents premiums paid by the Company for life insurance not generally available to all Company employees. (6) Employed on a part-time basis since July 1, 1997. NQ OPTION PLAN AND ISO OPTION PLAN Leslie's has adopted a non-qualified common stock option plan (the "NQ Option Plan") and an incentive common stock option plan (the "ISO Option Plan") and has reserved 83,599 shares and 273,946 shares, respectively, of Leslie's common stock for issuance upon the exercise of options to be granted to certain employees of Leslie's thereunder. Options to purchase Leslie's common stock have been granted at an exercise price of $5.00 per share for options granted under the NQ Option Plan ("NQ Options") and $14.50 per share in the case of options granted under the ISO Option Plan. 39 Leslie's has reserved 83,599 shares of Leslie's common stock for the NQ Option Plan. NQ Options vest immediately. However, Leslie's (and in some instances GEI and certain members of the HPA Group) have a right ("Call Option") to repurchase a portion of each NQ Option (and a portion of any shares of Leslie's common stock issued upon the exercise of any NQ Option ("NQ Option Shares")) upon the option holder or stockholder ceasing to provide services to Leslie's. If the NQ Option holder's service termination occurs prior to the first anniversary of the consummation of the Transactions, two-thirds of the NQ Option and two-thirds of any NQ Option Shares may be repurchased; if the termination occurs on or after the first anniversary and before the second anniversary, the Call Option applies to one-third of the NQ Options and NQ Option Shares; and the Call Option will not apply to any NQ Options or NQ Option Shares if termination occurs on or after the second anniversary of the consummation of the Transactions. NQ Options have a term of ten years and remain exercisable without regard to any termination of employment of the holder, subject to the exercise of the Call Option as described above. Under the ISO Plan, as amended, ISO Options vest in one-third increments on the first, second and third anniversaries of the effective date of the merger, except for options to purchase 67,946 shares are also subject to a further vesting condition based upon Leslie's achieving certain operating and store- opening goals. Options intended to qualify as "incentive stock options" and options not intended to so qualify may be granted under the ISO Option Plan. Pursuant to law, options intended to qualify as "incentive stock options" are subject to limitations on aggregate amounts granted and must be issued to any holder of 10% or more of the issuer's outstanding common stock at 110% of fair market value. Vested ISO Options may be exercised for 90 days post termination of employment, except in the case of the death of the option holder, in which case the vested portion may be exercised within twelve months from the date of termination. ISO Options have a term of ten years. OPTION GRANTS IN 1998 The following table sets forth the stock options granted to the Chief Executive Officer and the other executive officers of the Company as of October 3, 1998, during the twelve months ended October 3, 1998, pursuant to the Company's Incentive Stock Option Plan, NQ Option Plan, or otherwise.
Individual Grants -------------------------------------------------- % of Total Potential Realizable Value Options at Assumed Annual Rates of Stock Granted to Exercise Price Appreciation for Option Term(1) Employees or ------------------------------------- Options in Base Expiration Granted Fiscal Year Price Date 0%($) 5%($) $10%($) ---------- ----------- -------- ---------- ------- ------ ------- Michael J. Fourticq.. - - - - Brian P. McDermott... - - - - Robert D. Olsen...... - - - - Cynthia G. Watts..... - - - - John T. Ball......... 23,000(2) 82.1% $14.50 10/31/07 - 209,736 531,513
(1) Potential realizable value is based on an assumption that the stock price of the common stock appreciates at the annual rate shown (compounded annually) from the date of grant until the end of the ten-year option term. These numbers are calculated based on requirements promulgated by the Securities and Exchange Commission and do not reflect the Company's estimate of future stock price growth. (2) Granted pursuant to 1997 Stock Option Plan. Options vest over three years. Certain options vest only in the event the Company achieves certain performance targets. 40 AGGREGATED OPTION EXERCISES IN 1998 AND FISCAL YEAR-END OPTION VALUE The following table sets forth the stock option exercises by the named executive officers during 1998. In addition, the table indicates the total number and value of exercisable and non-exercisable options held by each such officer as of October 3, 1998.
Number of Unexercised Value of Unexercised Shares Acquired Value Options at In-the-Money Options at on Exercise(#) Realized($) October 3, 1998 October 3, 1998 --------------- ----------- ------------------------- ------------------------- Name Exercisable Unexercisable Exercisable Unexercisable ---- ----------- ------------- ----------- ------------- Michael J. Fourticq... - - 4,976 - 74,640 - Brian P. McDermott.... - - 25,661 51,334 141,163 282,337 Robert D. Olsen....... - - 69,427 33,334 883,078 150,003 Cynthia G. Watts...... - - 10,000 6,000 121,500 33,000 John T. Ball.......... - - 1,666 21,334 9,163 117,337
- --------------- (1) Potential unrealized value is (i) the fair market value at October 3, 1998 ($20.00 per share) less the option exercise price times (ii) the number of shares. DIRECTORS' COMPENSATION Directors do not receive any compensation directly for their service on the Company's Board of Directors. The Company has agreed, however, to pay LGP certain fees for various management, consulting and financial planning services, including assistance in strategic planning, providing market and financial analyses, negotiating and structuring financing and exploring expansion opportunities. 41 ITEM 12. PRINCIPAL SHAREHOLDERS AND STOCK OWNERSHIP OF MANAGEMENT The following table sets forth information as of October 3, 1998 with respect to (i) all persons known by the Company to be the beneficial owner of more than 5% of the Company's common stock; (ii) all executive officers of the Company; (iii) all directors; and (iv) all directors and executive officers as a group. The address for the directors and executive officers is in care of the Company.
Amount and Nature of Percentage of Name and Address Beneficial Ownership of Shares of Beneficial Owner Common Stock(1)(2) Outstanding(2) ------------------- ----------------------- -------------- GEI(3)..................................... 1,055,172 73.6% Gregory J. Annick(4)....................... 1,055,172 73.6 John G. Danhakl(4) ........................ 1,055,172 73.6 Brian P. McDermott(5)...................... 192,218 13.2 Michael J. Fourticq(6)..................... 144,827 10.1 Robert D. Olsen(7)......................... 86,393 5.7 Cynthia G. Watts(8)........................ 12,000 0.8 John T. Ball(9)............................ 7,666 0.5 Dr. Dale R. Laurance....................... - - Occidental(10)............................. 252,996 15.0 All executive officers and directors as a group (8 persons)....................... 1,498,276 97.0%
- --------------- (1) The address of Messrs. Fourticq, McDermott, Olsen, Ball and Ms. Watts is 20630 Plummer Street, Chatsworth, California 91311. The address of Occidental and Dr. Laurance is 10889 Wilshire Boulevard, Los Angeles, California 90029. The address of GEI and Messrs. Annick and Danhakl is 11111 Santa Monica Boulevard, Suite 2000, Los Angeles, California 90025. (2) Computed based upon the total number of shares of Leslie's common stock outstanding and the number of shares of Leslie's common stock underlying warrants and options of that person exercisable within 60 days. In accordance with Rule 13(d)-3 of the Exchange Act, any Leslie's common stock which is subject to warrants or options exercisable within 60 days is deemed to be outstanding for the purpose of computing the percentage of outstanding shares of Leslie's common stock owned by the person holding such warrants or options, but is not deemed to be outstanding for the purpose of computing the percentage of outstanding shares of Leslie's common stock owned by any other person. (3) GEI is a Delaware limited partnership managed by LGP, which is an affiliate of the general partner of GEI. Each of Leonard I. Green, Jonathan D. Sokoloff, Peter J. Nolan, Mr. Annick, Mr. Danhakl and Jennifer Holden Dunbar, either directly (whether through ownership interest or position) or through one of more intermediaries, may be deemed to control LGP and such general partner. LGP and such general may be deemed to control the voting and disposition of the shares of Leslie's common stock owned by GEI. Accordingly, for certain purposes, Messrs. Green, Sokoloff, Nolan, Annick and Danhakl and Ms. Holden Dunbar may be deemed to be beneficial owners of the shares of Leslie's common stock held by GEI. (4) Includes the shares beneficially owned by GEI, of which Messrs. Annick and Danhakl and associates. (5) Includes 25,666 shares subject to options exercisable within 60 days and 166,552 shares of Leslie's common stock. (6) Includes 4,976 shares subject to options exercisable within 60 days and 139,851 shares of Leslie's common stock. (7) Includes 69,427 shares subject to options exercisable within 60 days and 16,966 shares of Leslie's common stock. (8) Includes 10,000 shares subject to options exercisable within 60 days and 2,000 shares of Leslie's common stock. (9) All such shares are subject to options exercisable within 60 days. (10) All such shares are obtainable upon the exercise of warrants. 42 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS MANAGEMENT AGREEMENT Pursuant to the terms of a Management Agreement among LGP, HPA and Leslie's, (i) upon consummation of the Transactions, Leslie's paid LGP a transaction fee in the amount of $1.4 million, one-half of which was be paid to HPA for distribution among the HPA Group, including to Michael Fourticq. Brian McDermott and Robert Olsen, and (ii) Leslie's has agreed to pay LGP an annual management fee equal to 1.6% of the total sum invested by GEI in Leslie's. OCCIDENTAL CONTRACT A wholly-owned subsidiary of Occidental has a long-standing relationship with the Company as a supplier of certain of chemical chlorine compounds. A multi-year supply agreement terminated during 1997, and a new multi-year agreement was entered into between the parties on mutually satisfactory terms and conditions. STOCKHOLDERS AGREEMENT In connection with the Transactions, Leslie's, GEI, the members of the HPA Group, Brian P. McDermott and Manette J. McDermott, as Co-Trustees of the McDermott Family Trust, Occidental, the holders of the Subscription Stock and members of management who received NQ Options or ISO Options entered into a Stockholders Agreement (the "Stockholders Agreement"). The Stockholders Agreement provides the Company and certain Stockholders certain rights to repurchase a portion of the NQ Options, NQ Shares and the Subscription Stock of certain other Stockholders upon their ceasing to provide services to the Company. The Stockholders Agreement generally restricts the transferability of securities of the Company ("Securities") held by certain of the Stockholders and establishes a right of first refusal, in the event certain Stockholders seek to transfer any of their Securities to a third party, in favor of some other Stockholders. In addition, GEI has certain "drag-along" rights and if GEI desires to sell any Securities, other Stockholders have certain "tag-along" rights to participate in such sale. The Stockholders Agreement also grants demand registration rights to certain Stockholders and piggyback registration rights for all Stockholders. In the Stockholders Agreement, Mr. Fourticq and Mr. McDermott are given certain rights to be elected as directors of the Company. 43 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1),(2) The following financial statements and financial statement schedules are included herewith and are filed as part of this annual report. Consolidated Balance Sheets at September 27, 1997 and December 28, 1996 Consolidated Statements of Income for the nine months ended September 27, 1997 and September 28, 1996 (unaudited) and the years ended December 28, 1996 and December 30, 1995 Consolidated Statements of Shareholders' Equity (Deficit) for the nine months ended September 27, 1997 and the years ended December 28, 1996 and December 30, 1995. Consolidated Statements of Cash Flows for the nine months ended September 27, 1997 and September 28, 1996 (unaudited) and the years ended December 28, 1996 and December 30, 1995 Notes to Consolidated Financial Statements Report of Independent Public Accountants (a)(3) The following exhibits set forth below are filed as part of this annual report or are incorporated herein by reference. EXHIBIT NUMBER DESCRIPTION - ------- 3.1 Amended and Restated Certificate of Incorporation of the Company* 3.2 Certificate of Merger of Leslie's Poolmart into the Company* 3.3 Certificate of Merger of Poolmart USA Inc. into the Company* 3.4 Certificate of Designation, Preferences and Rights of Exchangeable Cumulative Redeemable Preferred Stock, Series A* 3.5 Bylaws of the Company* 3.6 Certificate of Amendment to Certificate of Designation, Preferences and Rights of Exchangeable Cumulative Redeemable Preferred Stock, Series A 4.1 Indenture dated as of June 11, 1997 between the Company and U.S. Trust Company of California, N.A.* 10.1 Credit Agreement dated June 11, 1997 among the Company, Wells Fargo Bank, N.A. and the financial institutions signatory thereto, including Security Agreement, Stock Pledge Agreement and Guarantees of subsidiaries* 10.2 Preferred Stock and Warrant Purchase Agreement dated as of June 11, 1997 between the Company and Occidental Petroleum Corporation* 10.3 Warrant dated June 11, 1997 for the purchase of shares of common stock of the Company issued to Occidental Petroleum Corporation* 10.4 Stockholders Agreement and Subscription Agreement dated as of June 11, 1997 among the Company and Green Equity Investors II, LP, Richard H. Hillman, Michael J. Fourticq, Greg Fourticq, Brian P. McDermott, the Trustees of the McDermott Family Trust, Occidental Petroleum Corporation and the Stockholders identified on the signature pages thereto* 10.5 NQ Option Plan and form of Agreement* 10.6 ISO Option Plan and form of Agreements* 10.7 Lease for Dallas Distribution Center* 10.8 Lease for Ontario Distribution Center* 10.9 Lease for Bridgeport Distribution Center* 10.10 Form of Director's and Officer's Indemnification Agreement dated as of June 11, 1997 between the Company and certain members of management* 10.11 Management Agreement dated as of June 11, 1997 between the Company and Leonard Green & Partners, LP* 44 Exhibit Number Description - ------- ----------- 10.12 Noncompetition Agreement, dated August 31, 1992, among Sandy's Pool Supply, Inc., Leslie's Poolmart, and Philip Leslie* 10.13 Noncompetition Agreement, dated August 31, 1992, among Sandy's Pool Supply, Inc., Leslie's Poolmart, and Sander Bass* 10.14 Purchase Agreement dated June 6, 1997 between the Company and BT Securities Corporation* 10.15 Registration Rights Agreement dated as of June 11, 1997 by and between the Company and BT Securities Corporation* 21.1 Subsidiaries 24.1 Power of Attorney (included on signature page) 27.1 Financial Data Schedule - -------- *Previously filed (b) Reports on Form 8-K None. 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on December 22, 1998. LESLIE'S POOLMART, INC. (Registrant) By: /s/ ROBERT D. OLSEN ------------------------------- Robert D. Olsen Chief Financial Officer KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Brian P. McDermott, Robert D. Olsen, and each of them, his true and lawful attorney-or attorneys-in-fact and agent or agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including pre-or post-effective amendments) to this Report on Form l0-k, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agent, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the date indicated.
Signature Capacity Date --------- -------- ---- /s/ MICHAEL J. FOURTICQ Chairman of the Board of December 22, l998 - ---------------------------------- Directors Michael J. Fourticq /s/ BRIAN P. McDERMOTT Chief Executive Officer, December 22, l998 - ---------------------------------- President, and Director Brian P. McDermott /s/ GREGORY J. ANNICK Director December 22, 1998 - ---------------------------------- Gregory J. Annick /s/ JOHN G. DANHAKL Director December 22, 1998 - ---------------------------------- John G. Danhakl /s/ DR. DALE R. LAURANCE Director December 22, 1998 - ---------------------------------- Dr. Dale R. Laurance /s/ ROBERT D. OLSEN Chief Financial Officer and December 22, 1998 - ---------------------------------- Principal Accounting Officer Robert D. Olsen
46 EX-3.6 2 CERT OF AMENDMENT TO CERT OF DESIGNATION EXHIBIT 3.6 LESLIE'S POOLMART, INC. CERTIFICATE OF AMENDMENT OF THE CERTIFICATE OF DESIGNATION Leslie's Poolmart, Inc., a corporation duly organized and existing under the laws of the State of Delaware (hereinafter the "Company"), does hereby certify that: I. The amendment to the Company's Certificate of Designation set forth below was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware and has been consented to in writing by the stockholders, and written notice has been given, in accordance with Section 228 of the General Corporation Law of the State of Delaware. II. The Certificate of Designation, Preferences, and Rights of Exchangeable Cumulative Redeemable Preferred Stock, Series A (the "Certificate") was adopted as of June 11, 1997 as an amendment to the Company's Certificate of Incorporation, and the Certificate is hereby amended as follows: A. On page 2 of the Certificate, the first two sentences of Section (c) Dividends, subsection (i), are amended to read in their entirety as follows: - --------- Beginning on the Issue Date, each Holder shall be entitled to receive, when, as and if declared by the Board of Directors, out of funds legally available therefor, distributions in the form of dividends on each whole or fractional share of Series A Preferred Stock, at a rate per annum equal to ten and seven-eighths percent (10 7/8%) of the Liquidation Preference per share of the Series A Preferred Stock. Such dividends shall be payable in cash, quarterly in arrears, on each Dividend Payment Date, commencing on the first Dividend Payment Date after the Issue Date; provided, however, if any dividend payable on any Dividend Payment Date on or before the fifth anniversary of the Initial Preferred Stock Issue Date is not declared and paid in full in cash on such Dividend Payment Date, the amount payable as dividends on such Dividend Payment Date that is not paid in cash on such Dividend Payment Date shall be paid by the Company by the issuance of additional fully paid and non-assessable shares (including fractional shares, if applicable, or, at the Company's option, cash in lieu of such fractional shares) of Series A Preferred Stock having an aggregate Liquidation Preference equal to the amount of such dividends (rounded to the nearest whole cent). The Issue Date of such stock dividend shall be the Stock Dividend Payment Date of even date with (if applicable), or next following, the Dividend Payment Date. All dividends with respect to each whole or fractional share of Series A Preferred Stock shall be cumulative, whether or not earned or declared, on a daily basis from the Issue Date with respect to such whole or fractional share. B. Section (k) Definitions shall be amended as follows: ----------- The following definitions is hereby inserted on page 20 between the definition of "Special Voting Rights Date" and "Stockholders Agreement." "Stock Dividend Payment Date" means August 1, and February 1. IN WITNESS WHEREOF, Leslie's Poolmart, Inc. has caused this Certificate to be executed by its Chief Financial Officer this 15th day of September, 1998. LESLIE'S POOLMART, INC. By: /s/ Robert D. Olson ---------------------------- Robert D. Olson, Chief Financial Officer EX-21.1 3 SUBSIDIARIES EXHIBIT 21.1 SUBSIDIARIES The Company has three wholly-owned subsidiaries: Leslie's Pool Brite, Inc., a California corporation; Sandy's Pool Supply, Inc., a California corporation; and Blackwood & Simmons, Inc., a Georgia corporation. EX-27.1 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ACCOMPANYING FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS OCT-03-1998 SEP-28-1997 OCT-03-1998 9,564 0 5,270 0 47,440 68,128 39,842 0 121,286 32,026 0 29,361 0 (45,701) 0 121,286 0 252,923 0 153,565 0 0 10,513 5,023 2,233 2,790 0 0 0 2,790 0 0
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