1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 9 REPORTER'S TRANSCRIPT 10 NOVEMBER 14, 2017 11 (Prepared from audio recording) 12 13 14 15 SPECIAL TAX APPEAL HEARING 16 APPEAL OF 17 LESLIE'S HOLDINGS, INC. & SUBS. 18 NO. 955278 19 AGAINST PROPOSED ASSESSMENT OF 20 SALES AND USE TAX 21 22 23 24 25 26 27 REPORTED BY: Jillian M. Sumner 28 CSR NO. 13619 1 1 P R E S E N T 2 For the Board of Equalization: Diane L. Harkey 3 Chair 4 Fiona Ma, CPA Member 5 Jerome E. Horton 6 Member 7 Sen. George Runner (Ret.) Member 8 Yvette Stowers 9 Appearing for Betty T. Yee, State Controller 10 (per Government Code Section 7.9) 11 Joann Richmond 12 Chief Board Proceedings 13 Division 14 For Franchise Tax Board: Laura Taing 15 Tax Counsel 16 Craig Swieso Tax Counsel 17 For Taxpayer: 18 Steve Weddell Taxpayer 19 Brook Hicks 20 Taxpayer 21 Kathy Freeman Representative 22 23 24 25 ---oOo--- 26 27 28 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 NOVEMBER 14, 2017 4 ---oOo--- 5 MS. HARKEY: So it is Mr. -- 6 MR. JOHNSON: Johnson. 7 MS. HARKEY: Mr. Johnson, would you please 8 introduce the items in this appeal? 9 MR. JOHNSON: Of course. 10 Good morning. John Johnson with the Appeals 11 Bureau. 12 The issue before the Board in this appeal is 13 whether interest -- 14 Oh, is that better? 15 Thank you. 16 The interest [sic] in this appeal is whether 17 interest expense incurred by the taxpayer during the 18 years at issue is properly classified as business or 19 nonbusiness income. 20 MS. HARKEY: Thank you. 21 Welcome to the State Board of Equalization. 22 You have 10 minutes to present your case. The FTB 23 will then have their 10 minutes. And you will have 24 five minutes on rebuttal. 25 And as you see, there's usually a lot of 26 questions. 27 So please introduce yourself for the record 28 and begin. Be sure you pull the microphone close to 3 1 you so you can speak in. 2 MS. FREEMAN: Good morning, Honorable -- 3 MS. HARKEY: Please pull the mic close to 4 your mouth. 5 Thank you. 6 MS. FREEMAN: Good morning, Honorable 7 Chairwoman and Honorable Members. 8 I have brought with me today the CFO for 9 Leslie's, as well as the Vice President and 10 Controller of Leslie's. 11 We're here today to discuss a matter 12 regarding the deductibility of the client's interest 13 expense. 14 There's been a great deal of confusion. 15 I've read through the hearing summary, and I don't 16 think it adequately reflects the question here. So 17 we're going to rephrase it into more appropriate 18 terms in that whether the interest paid by Leslie's 19 on debt incurred to fund a distribution to the 20 company's management team, integral to its trade or 21 business. Because when it's integral, it is 22 deductible and not allocable. 23 We found that the hearing summary is 24 somewhat confusing. But really what it boils down to 25 is Leslie's paid a distribution to its shareholders 26 who are, in fact, their management team. 27 Despite all of the redirect (phonetic) in 28 the briefs and in the hearing summary, that's what 4 1 we're here to discuss today is a distribution and 2 associated debt used to pay a portion of the 3 distribution part of it's ordinary and necessary 4 business deductions and not allocable. 5 Where we stand today in the dispute is that 6 we agree the interest expense is deductible as a 7 business expense. Despite qualifying as a deduction, 8 the FTB is arguing that it's only deductible in 9 Arizona and for federal purposes. 10 Basically, California has denied Leslie's 11 interest expense deduction. We have agreed that 12 Leslie's made a distribution that was funded in part 13 by debt and part by retained earnings, cash. And we 14 agree that the distribution by a corporation to its 15 shareholders is a normal corporate occurrence. This 16 is not an extraordinary event. And the FTB has 17 agreed to that in their briefs. 18 We have agreed that the barring to fund 19 day-to-day operations or grow is also a normal 20 corporate occurrence. And that we've also agreed 21 that Leslie's shareholders include 50 management 22 employees during this time period, its private equity 23 shareholder, LGP, and its lender, Goldman Sachs. 24 What are the points of Disagreement? What 25 is Leslie's trade or business? Who has met Leslie's 26 management team? The integral nature of these 27 borrowings to Leslie's trade or business, and whether 28 borrowing to fund a distribution is a normal 5 1 occurrence? 2 We also have a Disagreement on the 3 significance of Leslie's stock option plan and the 4 distribution to compensate and retain key management 5 employees. 6 Leslie's business is selling swimming pool 7 supplies and services. Leslie's has a pension plan. 8 It has a stock ownership plan. Both of these plans 9 are designed to keep and retain key employees. 10 The stock option plan is more specific and 11 designed to keep and retain key management employees. 12 Leslie's has a lower-pay structure, and they use 13 bonuses and the stock option plan to incentivize 14 their key players and their strategic growth to stay 15 with the company and to reward them for the success 16 of the business. 17 Leslie's has a unique business model. It's 18 ingenious. They have a set client base they can't 19 change. Once you build a swimming pool, you can't 20 stop maintaining it. 21 It's also recession-proof. When the 22 recession kicked in, like in 2007, you would think 23 businesses tank. Well, not Leslie's. Leslie's 24 business grew because people fired their pool service 25 people. And their business grew rapidly during that 26 time period. 27 Leslie's has a very rapid growth model, in 28 that they borrow to fund their growth model. They 6 1 borrow to fund their compensation. And it is an 2 integral part of their business. 3 They have been actively managing their debt 4 since LGP came into business in 1997. LGP was in 5 the -- substantively in the business for 20 years. 6 One of their longest investments ever, and one of 7 their more successful businesses. And it's this 8 extraordinary debt and growth model that has allowed 9 their business to expand exponentially. 10 FTB would have you believe that their 11 management team is just the key employees, and that 12 all they're doing is selling chemicals over the 13 counter to their customer base. 14 That is not true. 15 They have a very strategic growth model. 16 They've expanded rapidly over the last -- the first 17 10 years of their business. They more than doubled 18 their stores and their sales. And since the 19 distribution in 2007, they've nearly doubled their 20 sales again and their store openings. 21 This distribution, which actually 22 compensated their employees through their stock 23 option plan, was integral to rewarding these 24 employees and keeping them in place. 25 LGP is a critical piece of their business. 26 LGP is actively involved in their day-to-day 27 operations. FTB's own legal ruling 2003-3 discusses 28 the fact that you have companies that merely hold 7 1 their stock investments, and you have other companies 2 that are actively involved in managing their company. 3 FTB acknowledges that business model. That is our 4 business model. 5 I brought the client here today. We will 6 discuss shortly what all LGP actually did for their 7 day-to-day operations. 8 But LGP's team was integral to their 9 business, as well as their key management in growing 10 their business. 11 Again, Leslie's has a leverage business 12 model. They've restructured their debts to optimize 13 their cost of borrowing for purposes of optimizing 14 their profits. And this -- this debt model has 15 allowed them to expand their business footprint 16 dramatically and fund day-to-day operations, as well 17 as compensation to its employees. 18 FTB would argue that this distribution 19 somehow being funded by debt instead of cash -- which 20 it was partially paid by cash -- somehow changed the 21 nature of this distribution to some extraordinary 22 event. 23 Funding distributions through debt is a 24 common corporate occurrence, not just in the PE 25 world. The importance of funding a distribution 26 through debt is required in order to maintain stock 27 price. When your stock price is maintained, your 28 investors stay in the business. It keeps the lenders 8 1 interested in what -- lending you money at an optimal 2 rate. 3 Leslie's could just have easily taken the 4 cash and capital in their business and made this 5 distribution instead of debt. Money is fungible. 6 The fact that the FTB would have been fine 7 with this distribution had we used the cash and 8 capital instead of the debt just goes to prove that 9 the fact that how I chose to employee my resources is 10 at the discretion of a business and their investors 11 and their lenders to optimize the -- the business 12 performance. 13 FTB has spent the last 20 years dealing with 14 this transaction, it is so common. They spent 15 approximately 20 years dealing with the DISA regs, 16 the distributions in excess of capital. Because this 17 is such a common event. 18 They -- they track them because there are so 19 many. Because when they are triggered, they -- they 20 they come into income. That's how many there are. 21 In our case, it doesn't qualify it as a 22 deferred event, because our shareholder isn't filing 23 a combined report. But nevertheless, there's no 24 difference between that transaction and how you treat 25 a DISA. So it's so common. 26 Although the -- the briefs would tell you 27 otherwise, it -- it is in the normal course and is 28 ordinary for people to borrow and distribute to 9 1 maintain stock price and to keep their -- their 2 investors happy. 3 In this case, the distribution was used to 4 reward Leslie's employees for the success's of their 5 business. My client will discuss that shortly how 6 successful and growing the business has been. 7 Their stock option plan is an integral part 8 of their business as well as their pension plan. The 9 fact that we implemented the plan in 2000 and didn't 10 distribute until 2000 -- well, we thought it was an 11 optimal time to do so. 12 The fact that we're actually using the 13 incentive plan, and now the FTB has a problem with 14 the fact that we made a distribution, is contrary to 15 the point of the plan itself. Which is to attract, 16 retain, and maintain our key employees. 17 Our management team is not just the key 18 employees that are employed by Leslie's. LGP is 19 integral to that management team. Again, they're 20 involved day to day in those business operations. 21 So I was going to have the client, 22 Steve Weddell, who is the CFO, discuss how the 23 business operation's work. 24 And Brook's here in case you have any 25 additional questions regarding the operations. 26 MR. WEDDELL: Yeah. Thank you, Kathy. 27 And thank you for having us here for your 28 consideration. 10 1 So I am the CFO, Steve Weddell. I've been 2 with the company for about two-and-a-half years, 3 affiliated for the last seven working for the company 4 or in an advisory capacity. My history or background 5 is in public accounting as well as in investment 6 banking, raising capital through debt and equity 7 markets, as well as pursuing MMA (phonetic) 8 transactions for clients. 9 So, you know, as Kathy mentioned, the 10 structure we employ at Leslie's is absolutely 11 critical to the success of the business. 12 And so I have three take-aways for you 13 today: Yes, we do operate a leverage business 14 model. We've been leveraged for 20 years. And it's 15 been critically integral to the business to be able 16 to raise capital through the debt markets to pay 17 dividends to reward our shareholders and to grow our 18 business. 19 Number two, Leonard Green's involvement and 20 what they brought to the table. 21 They're not just equity. They're one of the 22 premier private equity firms in the world with 23 experience in consumer retail transactions. They 24 brought capabilities that we otherwise would not have 25 to be able to grow the business the way we have. 26 And No. 3, just the fact that the business 27 has thrived since re-capitalization transaction in 28 2007. This did not slow us down. It accelerated our 11 1 ability to -- to re -- to track and retain talent, 2 our ability to compensate employees for their 3 efforts. And as Kathy mentioned, we can be a little 4 lighter on cash from a compensation perspective, 5 because we have that equity. We have those options 6 to reward individuals. 7 So we'll walk through a couple other 8 additional facts here. So when you think about -- as 9 I think about capital structures, there's a lot of 10 different ways to deploy capital and to attract 11 capital. 12 We have revolvers to borrow through the 13 season, right? So we lose money for six months out 14 of the year. And then we make it all in the third 15 and fourth -- second and third calendar quarters 16 within the calendar year. 17 When you think about, you know, unsecured 18 debt, you can raise that through an operating company 19 or through a holding company. It's fungible. The 20 point is working to attract that capital from the 21 financial markets at the most attractive rates at the 22 right leverage levels to drive the value of the 23 business. 24 And so we chose in 2007 to go with a holding 25 structure to -- to ensure that we can get that lowest 26 cost of capital for our business to help the business 27 thrive. 28 And it's also important to note, again, 12 1 we're not publicly traded. And so when you think 2 about giving someone an equity incentive, then 3 telling them that they have no ability to monetize 4 that stock at any given point in time, they're 5 dependent on us as a leadership team and as partners 6 with our private equity firm to go out and find 7 opportunities to monetize the value within the 8 equity. 9 So how do you do that? You sell shares or 10 you raise capital and you pay dividends. You use 11 cash off the balance sheet that we generate over time 12 and earnings to distribute to shareholders. 13 So it's absolutely critical to be in a 14 position to do transactions exactly like this in 15 2007. Raise debt at the operating level. Raise debt 16 at the holding level. It's fungible; 17 interchangeable. Compensate the individuals who 18 really drove the growth of the business over the 19 last, as Kathy said, seven years. 20 Few factors from a Leonard Green perspective 21 and the value they bring. Again, they're -- they're 22 equity, right? But they're a unique partner. They 23 gave us insights from an operation's perspective; 24 contract negotiations related to product development; 25 direct sourcing; transportation; HR benefits; IT 26 security; indirect procurement. 27 They have biweekly, monthly, quarterly, 28 annual seminars and sessions where we actively 13 1 participate. They send their individuals into our 2 business to help us evaluate strategic alternatives 3 to deploy our capital, develop our new store growth 4 plan. 5 They facilitate our talent acquisition and 6 how we retain our employees; the development of 7 incentive plans and exactly what those motivating 8 factors are to kind of drive the results. 9 And then finally they are the ones who help 10 us with capital markets and make transactions, right? 11 So we're in the business of selling pool 12 supplies, and try to have a little fun while we're at 13 it. But they're out there in the markets every day. 14 They understand what debt investors need. They know 15 that we have to have a solid, stable equity base and 16 equity value underlying the business in order to 17 attract that capital to reward our employees. 18 So I can definitely say that it is a unique 19 experience within the industry working with folks 20 like Leonard Green who are so actively involved. 21 MS. RICHMOND: Time's expired. 22 MR. WEDDELL: The last point -- 23 Can I make one last point? 24 MS. HARKEY: Certainly. 25 MR. WEDDELL: From a growth perspective -- 26 so since 2007, we've grown our store base 66 percent, 27 our sales 88 percent, our profits 113 percent. This 28 did not detract in any way our ability to attract 14 1 people to grow our business and create successful 2 opportunities for our people. 3 Thank you. 4 MS. HARKEY: Thank you very much. 5 FTB, please introduce yourself for the 6 record. You have 10 minutes. 7 MS. TAING: Good morning, Chairwoman Harkey 8 and Members of the Board. My name is Laura Taing, 9 and to my right is Craig Swieso. We represent the 10 Franchise Tax Board in this matter. 11 During the years at issue, Leslie's 12 Poolmart, appellant, operated a swimming pool 13 supplies and services business in the United States. 14 In 2007, after a corporate restructure, 15 appellant borrowed $310 million to pay a $346 million 16 distribution to its shareholders, comprised of 17 77 percent Leonard Green & Partners, a private equity 18 firm, 16 percent of its own management, and 6 percent 19 Goldman Sachs and GSO. 20 Appellant paid approximately $103 million in 21 interest on the loan during the years at issue. 22 On its original California income tax 23 returns, appellant classified this interest expense 24 as a nonbusiness loss, fully allocable to Arizona, 25 its commercial domicile. 26 In 2011 appellant amended its returns to 27 reclassify the expense as a business loss, which 28 resulted in claims for refund that FTB audit denied. 15 1 At issue in this appeal is whether the 2 interest expense constitutes a business or 3 nonbusiness loss for California purposes. 4 California classifies income and loss items 5 as business or nonbusiness pursuant to Revenue and 6 Taxation Code Section 25120. Business income is 7 comprised of two tests; the transactional test and 8 the functional test. 9 The transactional test examines whether the 10 income-producing transaction arose in the regular 11 course of the taxpayer's business. 12 The functional task examines whether the 13 income-producing property was integral to the 14 taxpayer's regular trade or business operations. 15 Integral requires that the property 16 contribute materially to the taxpayer's production of 17 business income. Otherwise, all corporate 18 transaction would pass this test. 19 Satisfaction of either test results in 20 income -- business income that is apportioned. 21 Nonbusiness income is all income other than 22 business income that is allocated generally to the 23 taxpayer's commercial domicile. 24 In this case, interest expense fails both 25 business income tests. Because acquisition of the 26 loan was neither regular business activity nor 27 integral to appellant's operations, as it went 28 directly to the shareholders. 16 1 As relevant, appellant made a distribution 2 using loan proceeds and the companies retained 3 earnings to its investors. This transaction placed 4 the company in a $329 million ending deficit balance 5 in 2007. And yet none of the proceeds went towards 6 Leslie's actual business operations. 7 As such, the interest expense constitutes a 8 nonbusiness loss fully allocable to Arizona. 9 First, the interest expense failed the 10 transactional test. In short, appellant did not 11 regularly incur debt for the express purpose of 12 issuing a distribution to its shareholders. Such a 13 transaction was not and had never been a regular part 14 of Leslie's Swimming Pool Supplies and Services 15 business. 16 An appellant realized on ComCon, an 17 unpublished Court of Appeal decision. And in ComCon, 18 the Court found the taxpayer regularly acquired cable 19 companies in the expansion of its own cable business; 20 thus satisfying the regularity requirement of the 21 transactional test. 22 In contrast here, appellant has no such 23 history -- extensive history of issuing distribution 24 through debt financing. A transaction completely 25 unrelated to a swimming pool supplies and services 26 business. 27 Moreover, appellants own SEC 10-K annual 28 report dishevels any connection to the distribution 17 1 transaction. Which was described as a privately 2 placed financing transaction by Leslie's Holdings, 3 the parent, that the operating company did not 4 guarantee or pledge support for. And by which none 5 of the proceeds were made available to it. 6 Thus, the annual report admits that the loan 7 and distribution activity was not a regular business 8 transaction. 9 Also, contrary to appellant's assertion, 10 paying dividends to shareholders does not satisfy 11 the transactional test in this case. 12 While corporations do pay dividends to 13 reward shareholders, dividends are typically paid 14 from positive, retained earnings. And if this were 15 the case in this appeal, then there will be no need 16 for an interest accruing loan, and this appeal would 17 not be before your Board. So this transaction is 18 neither typical nor regular. 19 And more importantly, the transactions and 20 activities that courts and this Board have deemed to 21 satisfy the business income tax are always analyzed 22 in the context of the taxpayer's actual business 23 operations rather than relating to shareholder 24 ownership interest as it does here. 25 And even though appellant is majority owned 26 by a private equity firm, appellant is not a private 27 equity firm. 28 According to the 10-Ks, appellant is a 18 1 leading national retailer of swimming pool supplies 2 and related products. Therefore, as noted in the 3 hearing summary, the typical activities of private 4 equity firms are not relevant to the business income 5 analysis. 6 Second, the interest expense fails the 7 functional test. Appellant offers no evidence of how 8 the loan, the expense producing property was 9 integrated into the swimming pool supplies and 10 services business. This is because the loan in the 11 form of the distribution went immediately and 12 exclusively to the shareholders who are uninvolved in 13 appellant's business operations. 14 An appellant relies primarily on 15 Hoechst Celanese, a California Supreme Court case. 16 Appellant analogizes a pension plan in Celanese -- 17 Celanese case as both instruments of achieving 18 employee -- employee retention. 19 In Celanese, the Court found that the 20 surplus reversion income satisfied the functional 21 test. Because the pension plan was maintained and 22 used to retain and track employees who, in turn, 23 produced business income for the company. Thereby, 24 the pension plan was integral to the taxpayer's 25 business operations. 26 The loan in this appeal serves no such 27 operational function, as there's no evidence that it 28 was implemented for employee retention. Unlike the 19 1 Celanese taxpayer that had maintained and 2 administered the pension plan for years, appellant 3 has no similar records of long-term investment or 4 develop retention plan. 5 Also, whereas the pension plan broadly 6 improved the efficiency of the taxpayer's business 7 income producing work force, the distribution this 8 case benefited a small elite subset, two- to- three 9 percent of the work force. With such minimal impact, 10 the loan was not integral to appellant's business 11 operations. 12 Rather, Robert Hath, a Court of Appeal 13 case's analogies. Even though the Celanese Court 14 noted that the Robert Hath decision mistakenly 15 focused on the extraordinary nature of the 16 transaction, the correct result was still reached. 17 In Robert Hath, the Court held that losses 18 the tax incurred from the repurchase of a stock 19 warrant was a nonbusiness loss because taxpayer's 20 control and use of the warrants did not contribute 21 materially to the production of any business income 22 and were separate and distinct from the taxpayer's 23 business operations. 24 Similar to the warrant of Robert Hath, the 25 loan in this appeal was also separate and distinct 26 from appellant's regular business operations. The 27 business income tax aside, California Code of 28 Regulations Section 25120, subdivision D, regarding 20 1 the proration of deductions does not control. 2 As noted in the hearing summary, this 3 regulation does not support appellant's argument that 4 the interest expense must be applied to business 5 income, because there is no nonbusiness income to 6 which the expense could be associated. 7 However, by the same logic, the interest 8 expense cannot be a business expense either, because 9 there is no business income associated with it. As 10 the loan proceeds were directly transferred to 11 shareholders rather than into the business 12 operations. 13 Moreover, appellant's interpretation of this 14 regulation completely ignores the fact that the word 15 "income" refers to net income, which is revenue 16 generated minus expenses. 17 Here, appellant's nonbusiness expense 18 exceeded nonbusiness revenue to produce a nonbusiness 19 loss. 20 In Revenue and Taxation Code Section 24344 21 regarding the deductibility of interest expense is 22 not at issue in this appeal. 23 Put simply, the interest expense adoption 24 appeared on Schedule F, line 18, of the Form 100. 25 But the relevant inquiry is whether that deduction is 26 apportioned or allocated per the business/nonbusiness 27 rules. 28 Basically, the interest expense is still 21 1 subject to business or nonbusiness characterization. 2 And for California purposes, the interest expense 3 must be allocated, because it fails both income 4 tests. 5 For all these reasons, staff requests that 6 your Board deny appellant's claim for refund. 7 Thank you for your time. Mr. Swieso and I 8 will be happy to address any questions you have. 9 MS. HARKEY: Thank you. 10 You have five minutes to rebut. I'd suggest 11 you keep it to real specific issues. 12 MS. FREEMAN: Sure. 13 MS. HARKEY: Thank you. 14 MS. FREEMAN: So during the course of the 15 audit and the protest, the FTB has continued to 16 ignore our business model and the significance of it 17 instead of stock option plan and dividends to 18 compensating our employees. 19 Again, here, we have the same problem. The 20 client has no activities beyond its swimming pool 21 products. It does team with its management team, 22 which is LGP, and its key employees. 23 The FTB's assertion that this is not 24 qualitatively substantial is beyond comprehension 25 here. These employees are the key drivers of their 26 business. Their compensation is low, and they are 27 rewarded for the expansion and success of the 28 business through bonuses and their incentive stock 22 1 option plan. 2 You know, this is a common business practice 3 here. Stock option plans, pension plans, using these 4 and paying distributions through a leverage business 5 model are common, not just in a PE area. People do 6 this all the time. Okay. 7 This is -- there's -- if you read 25120, 8 25120 deals with the ability of the State to tax 9 income earned outside its borders. There is no 10 income earned outside its borders. We're dealing 11 with pure expense, which it does not fall within the 12 purview of 25120. 13 The FTB has suggested that there's no such 14 thing as a matching or necessity to match income and 15 expenses. That's -- that's beyond -- it's a core 16 fundamental concept in both accounting and tax that 17 you have to have a clear reflection of income here. 18 If you're going to deny an expense, you 19 should put that in the statute that the expenses 20 occurred to pay dividends are not deductible. And 21 you will impact virtually every corporation that 22 there is. Because this is not an extraordinary 23 event. 24 How Leslie's runs their business is atypical 25 of the entire business community. We hire key 26 employees. They're instrumental to our business. We 27 make sure they're happy and compensated. 28 In this case, we're not allowed to 23 1 necessarily have a readily available market for our 2 stock. So dividends are the key component of that 3 instead of stock option plan. 4 The -- the occurrences where we bought back 5 stock is for the employees who have left the 6 business, not from the people that are still employed 7 there. This is a key component of our business 8 model. And it's -- and it's atypical. 9 What you would be suggesting here is that 10 the interest expense, if I'm wholly California, is 11 100 percent deductible. Because this is not an 12 extraordinary transaction. The FTB has spent 20 13 years dealing with this exact problem through their 14 DISA regulation that just passed. There's nothing 15 extraordinary here. You're creating an opportunity 16 for people to plan around distributions, because 17 everybody pays dividends either through cash or di -- 18 or funding them through loans. 19 So if I borrow my money, I would focus on 20 borrowing money to pay my distribution. So I get 100 21 percent deduction if I'm in California. That does, 22 of course, find in question, The FTB never addressed 23 the fact that if I'm issuing a dividend distribution 24 at DISA that exceeds capital and retained earnings, 25 is that nonbusiness as well? That's going to provide 26 further planning opportunities for an event that 27 happens all the time. 28 So there's nothing extraordinary here. LGP 24 1 is critical and crucial to the operations of this 2 business, and it's integral to its operation. It is 3 its management team. The FTB would have you think 4 otherwise. They've played an integral role in their 5 operations. 6 MR. WEDDELL: Yeah. 7 The only thing I would add is when you talk 8 about, kind of, regular occurrence, right? We've 9 done five capital transactions in the last five 10 years. It's a private company. The concept of 11 raising money on a monthly or quarterly basis to 12 compensate individuals doesn't make any sense, right? 13 This -- five transactions for me doing three dividend 14 re-capitalizations in the last 10 years is pretty 15 ordinary, pretty common. It's not a one-time event. 16 And so one of the things I also looked at, 17 as well as mentioned, 75 percent was owned by LGP. 18 Twenty percent of that -- so 20 percent total. So 19 LGP owned 55 percent; 20 percent was owned by GCP 20 California Fund. Invested in 2005, monetized in 21 2010. One of the most successful CalPERS' 22 investments ever made in the private equity space. 23 So when you talk about benefit to 24 individuals and to the management team at 16 percent, 25 it's relevant and it makes a difference. 26 Thank you. 27 MS. HARKEY: Thank you. 28 Okay. Members. 25 1 Welcome -- 2 MR. RUNNER: Well, thank you. 3 MS. HARKEY: -- Member Runner. Thank you 4 for rushing in here. 5 Anyway, does anybody have questions? Who 6 would like to start? 7 MS. STOWERS: I guess I'll start. 8 MS. HARKEY: Okay. Thank you. 9 MS. STOWERS: Franchise Tax Board, in the 10 briefings you indicated -- I believe in your 11 arguments today you indicated that LGP was 12 contractually limited to consulting on investment and 13 financing. 14 What's the basis for that statement? 15 Because they're saying that LGP was involved in their 16 day-to-day operations. 17 MS. TAING: In the record, there is a 18 management services agreement between LGP and 19 Leslie's. And so LGP provides investment banking 20 services consulting in financial planning services 21 and major transaction services in exchange for over a 22 million dollars per year. 23 That is what that statement refers to. 24 MS. STOWERS: Their -- their management. 25 To the appellant, you testified that they 26 were involved in day-to-day activities. 27 MR. WEDDELL: Right. 28 MS. STOWERS: What's in the record to 26 1 support that statement? 2 MR. WEDDELL: Day-to-day activity. If 3 you're looking at consulting services, that's -- 4 consulting services is about as broad as you can get. 5 They bring their expertise. They see a lot of 6 business models. They have a lot of interactions 7 with professional experts around the country in 8 consumer retail operations. 9 And so in that capacity, it is a broad 10 capability. It's a consulting -- it, to me, is about 11 as broad as you can get. When you think about the 12 decisions we've made in our business, the directions 13 we've gone investing in our internet business, 14 investing in store growth, investing in commercial, 15 where we build our stores, they're involved in those 16 conversations. 17 My typical experience has been that you have 18 a Board meeting four times a year every quarter. You 19 have an annual budget review. You get an approval, 20 and then they go away. And they kind of wish you 21 well and come back every quarter to talk about 22 operations. 23 That's not this case. They have a team of 24 portfolio services experts around for their portfolio 25 companies to benefit from, to improve the operations. 26 And I can't tell you the number of times I've been 27 personally involved or seen individuals within our 28 organization involved with those services and see the 27 1 value they bring as late as last week. 2 MS. FREEMAN: I would also add that we did 3 have examples of things they had done operationally 4 within the record, including, you know, supply chain 5 management, and obtaining better pricing on products, 6 and involvement in store location decisions. And 7 that is in the record. 8 MS. STOWERS: Okay. 9 Going back, kind of focusing on the 10 transactional test. I believe your -- to the 11 appellants, I believe your testimony is that you guys 12 have done this on a regular basis. You have done a 13 re-capitalization. Those have been after the years 14 at issue. 15 MR. WEDDELL: So taking private back in 16 1997, I did a transaction in 2005, 2007, 2010, 2012, 17 2016, 2017. So those are all the transactions 18 since -- in the last 10 years. And since 2007, we've 19 done five. So we're two transactions prior to that. 20 And, again, outside of Leslie's, this is 21 absolutely common ordinary course activity for 22 privately owned companies. 23 MS. STOWERS: But -- but -- but for 24 Leslie's. That's -- 25 MR. WEDDELL: Yes. 26 MS. STOWERS: -- who I want to focus on. 27 MR. WEDDELL: Yes, it has -- 28 MS. STOWERS: But for -- for Leslie -- 28 1 MR. WEDDELL: Right. 2 MS. STOWERS: -- for -- prior to 2007, had 3 Leslie obtained a loan to make a distribution? 4 MR. WEDDELL: In 2005, yes. So two years 5 prior. 6 MS. FREEMAN: And I would also comment that, 7 you know, dividend distributions depend on where you 8 are in the growth model. Leslie's was in a rapidly 9 growth stage. And it's very common for businesses 10 including, like, Apple and Microsoft, to initially 11 pay distributions when you're growing. 12 So they did have the incentive stock option 13 plan in place in 2000. And they chose to 14 strategically not utilize it until later on when 15 it -- when it was appropriate to do so based on the 16 availability of funds and their continuing growth 17 model. 18 MS. STOWERS: To the Franchise Tax Board, do 19 you agree with them that they actually had obtained a 20 loan in 2005 to make a distribution to their 21 shareholders? 22 MS. TAING: I do have in the record that 23 there was a 2005 re-capitalization and a 2009 24 re-capitalization. So during the years at issue, 25 there would be -- there would be three. 26 MS. STOWERS: Do you consider that to be 27 regular? 28 MR. SWIESO: If I may, what we need to keep 29 1 in mind is who is the taxpayer here. The taxpayer 2 we're about is Leslie's, the pool supply business. 3 We're not here about Lee Roy [sic] Green. 4 MS. STOWERS: Mm-hm. 5 MR. SWIESO: Lee Roy Green was the recipient 6 of the distribution. Lee Roy Green may drive the 7 re-capitalizations; but functionally, what we need -- 8 fundamentally, what we need to focus on is the debt 9 was incurred, distributed -- a very small portion of 10 it was a dividend. 11 A distribution -- a dividend is only if 12 there's retained earnings or earnings and profits. 13 When this distribution was made, Leslie's only had 14 less than a $20 million retained earnings. They 15 borrowed $300 million. 16 So the bulk of that debt that was held by 17 Leslie's went to -- as a distribution, not a 18 dividend, to the existing shareholder, Leonard Green. 19 A small portion went to, as we've pointed 20 out, only two- to- three percent of the existing 21 employee base. 22 The interest off of that debt, which is 23 being held by Leslie's, is what's at issue here. Not 24 what Leonard Green is doing. What is Leslie's doing? 25 So the focus needs to be on; was this debt -- was 26 this debt -- did it have anything to do with the 27 operations of Leslie's Pool Supplies? 28 Did this have anything to do with having an 30 1 ability to sell more stuff? What we see is this is, 2 instead, a distribution to existing shareholders. As 3 the witness has stated, they monetized all of the 4 assets of Leslie's Pool Supplies. They leveraged it. 5 They basically collateralized, took all of the value 6 out of it, gave it to the existing shareholder. 7 There's no evidence that any of these funds 8 went to the pool supply business. If it did, we 9 wouldn't be here. 10 This is about whether or not funds that go 11 to existing -- this is about whether or not interest 12 on debt that are paid to existing shareholders should 13 be allowed to -- to -- to reduce other types of 14 income that California can fairly tax. 15 MS. STOWERS: Thank you. 16 I -- I want to ask more questions in a 17 little while. But I will see if other Members have 18 questions, if that's okay with you. 19 MS. HARKEY: Thank you. 20 Any more questions? 21 MR. WEDDELL: I would like to rebut one 22 point. 23 Taking out all the equity in the business, 24 you cannot raise that in the capital markets if there 25 is not underlying equity value in the business. This 26 is an opportunity to prudently manage our capital 27 structure, take a portion of the equity out, 28 absolutely, to reward those individuals who have 31 1 really contributed. Which includes management 2 shareholders, but also includes some of the investors 3 who are actively involved in the business. So I 4 think that's very important to keep in mind. 5 And, again, like I said before, we grew 6 113 percent of our profits since we did this 7 transaction. If we put this business in such harms 8 way by doing this transaction, I don't see it. 9 Because it's been an incredible run over the last 10 10 years as we've grown our business. 11 MS. FREEMAN: I have one more comment on 12 the -- what you have an issue here is an issue of 13 qualitative substantiality. The FTB keeps harping on 14 the fact that this is three percent of our employees. 15 These people -- these three percent are the 16 employees driving the growth of this business, making 17 the core strategic decisions on where to open stores, 18 what product mix to handle, you know, debt financing, 19 and which employees to hire to help further grow the 20 business. 21 The business has grown substantively. I 22 think you have some information on California growth 23 as well as the growth of the business as far as 24 stores and employees and sales. 25 MR. WEDDELL: Yeah. 26 So we had, in California, we've got about 27 180 stores today. I think back at the time of the 28 transaction it was closer to about 90 locations. So 32 1 almost doubled the number of locations in the state 2 of California since that 2007 transaction. 3 MS. FREEMAN: And it has substantially 4 improved the growth of the employees in the state as 5 well. 6 I would reiterate, this is a common business 7 model, a common business practice. Leveraging to pay 8 distributions is not uncommon. This is not an 9 extraordinary event. 10 MS. HARKEY: Do you have some questions? 11 MS. MA: Yeah. 12 MS. HARKEY: Member Ma. 13 MS. MA: Yeah. So I do have a statement. I 14 don't know how they could borrow $310 million if they 15 didn't have the ability to pay back or the assets. 16 So when you say they only had, what, $20 17 million capitalization? 18 MR. SWIESO: They -- they had retained 19 earnings. Basically you take assets minus existing 20 liabilities. What's the remaining leftover is what's 21 known as retained earnings. 22 When it's determined if it's a dividend is 23 when you disgorge those retained earnings back to 24 the -- back to the taxpayer -- back to the 25 shareholder. Pardon me. 26 So what they were able to do based on 27 their -- their -- their structure as a going concern, 28 they were able to monetize their assets, plus what 33 1 would be perceived as profits in the future. Borrow 2 $300 million -- more than $300 million. That, to the 3 extent there was retainer and that was a dividend, it 4 would have -- that would have been a dividend to the 5 shareholders. Which would have included management 6 employees. 7 The rest of that merely would have been a 8 distribution. Which is not necessarily rewarding you 9 for prior profits, it's just basically taking out 10 cash from the business. 11 So they've been -- obviously, they've 12 been -- since Leslie's continues to be a growing 13 concern, they're able to pay -- they are able to 14 service the debt. Because if they weren't servicing 15 the debt, we wouldn't be here. Because there would 16 be no interest expense paid. 17 The whole issue is, though, with respect to 18 that interest expense on the money that went to the 19 shareholders, is that interest expense, is that 20 allowed as a deduction against Leslie's business 21 income? Which is basically the selling the pool 22 supplies and whatnot. 23 MS. MA: Okay. 24 So to Leslie's, like, why would someone lend 25 you that much money -- 26 MR. WEDDELL: Sure. 27 MS. MA: -- if they think you don't have the 28 ability to pay it back? 34 1 MR. WEDDELL: They -- they do know that we 2 can pay it back. And, in fact, the debt in question 3 here is paid back in 2010 in full. So never missed 4 an interest payment, never had a problem with 5 servicing our debt. 6 My experience going back to 1997 when this 7 business was acquired -- again, highly leveraged 8 business model. You can't continue to go to the 9 markets unless the markets have the confidence you've 10 got the right team, the right assets, the right 11 strategy, and a certain level of profitability to 12 generate returns to pay off that debt. 13 The equity holders are always the ones 14 sitting at the end of the line, right? So if we 15 can't service our debt -- I mean, think about all the 16 other business models out there in the country. The 17 number of companies that have debt. If you can 18 service that debt, pay it back, people will pay you 19 on the expectations for both past earnings. That's 20 the track record on the multiple they might pay you. 21 And the future expectations for profit growth and the 22 ability to provide for a reasonable return. 23 So it's a -- it's a market clearing device. 24 You go to the market, and if you don't have a story, 25 if you don't have the people, you don't have the 26 strategy, you can't raise the debt, you can't raise 27 the equity. There are no dividends. There's no 28 conversation. 35 1 MS. FREEMAN: And remember that Leslie's has 2 an ingenuous business model. They don't lose 3 customers. When you build a pool, you're stuck with 4 it. You have to maintain it. You have to fix it. 5 Your pool turns green and it's a detriment to your 6 house if you want to sell it. 7 In the recession, their -- their business 8 model exploded. Because people fired their pool 9 service people, and now they're coming to Leslie's to 10 do it themselves. 11 So it's an ingenious model. Who wouldn't 12 lend them the money to help compensate the people to 13 help further -- further business growth? 14 MS. HARKEY: Okay. 15 MS. MA: Okay. Hold on. I'm not done 16 yet. 17 MS. HARKEY: Oh, I'm sorry. Go ahead. 18 MS. MA: Okay. So can you talk about this 19 Arizona audit? 20 MS. FREEMAN: Sure. 21 MS. MA: What happened in Arizona? 22 MS. FREEMAN: Yeah. So in Arizona the 23 client was consistent in his filing positions and 24 that it had received advice from their prior preparer 25 to treat this as nonbusiness. 26 There is no position to treat an expense as 27 a pure expense that's nonbusiness. There's no -- the 28 code in 25120 discusses income, not expenses. We're 36 1 not dealing with a loss here. It's absolutely just 2 an expense item. 3 Arizona came in, said, "No, this is 4 treatable against your normal business income. It's 5 not allocable income." And then allowed the 6 deduction against business income, because it did 7 meet the criteria to be nonbusiness. Because there 8 is no such thing. 9 The FTB has declined it. We're now being 10 whipsawed. And despite the fact that we're being 11 consistent in every state and have -- currently 12 leaving it as nonbusiness. And we will file refund 13 claims. Because our goal is to be consistent here. 14 But we believe deductibility against 15 business income is appropriate here because it helped 16 generate the profitability of the business. It was 17 qualitatively substantial, this distribution in 18 compensating its employees in driving the business. 19 MS. MA: Okay. So Arizona audited you? 20 MS. FREEMAN: Yes. 21 MS. MA: And they reclassified this interest 22 as business expense -- 23 MS. FREEMAN: Yes. 24 MS. MA: -- against business income. 25 MS. FREEMAN: Yes. 26 MS. MA: Which means against your 27 operations. 28 MS. FREEMAN: Yes. 37 1 MS. MA: Your daily operations. 2 MS. FREEMAN: Absolutely. They determined 3 that. 4 MS. MA: And the justification, did they 5 write anything about, you know, like -- 6 MS. FREEMAN: They just basically concluded 7 this is not nonbusiness. 8 MS. MA: It's just not nonbusiness, so 9 therefore -- 10 MS. FREEMAN: It's not. There's -- yeah. 11 MS. MA: So there's -- so they determined 12 this is part of your -- 13 MS. FREEMAN: It's integral to our business 14 operations. 15 MS. MA: Okay. 16 MS. TAING: May I respond to that? 17 MS. MA: Sure. 18 MS. TAING: So my understanding is that 19 appellant originally filed -- originally classified 20 the interest expense as nonbusiness. 21 And, yes, they were audited by Arizona. And 22 they received a determination letter at audit denying 23 the nonbusiness characterization of the expense. 24 There actually is no whipsaw effect in this 25 case. And that's because appellant has -- appellant 26 is protesting this exact same issue in Arizona. And 27 that case is in an even earlier stage than it is here 28 in California. 38 1 And then also in Arizona appellant is a 2 consolidated return filer. They're subject to 3 slightly different rules. 4 I mean, in the record determination letter 5 doesn't state too much about this. But that's -- 6 that's also part of the determination. 7 And also per appellant's request, the case 8 in Arizona is held in abeyance until the decision 9 today. So when tax -- when, you know, appellant 10 makes the whipsaw argument, there is no actual 11 whipsaw occurring. 12 MS. MA: Okay. 13 Taxpayers, what's your response to that? 14 Are you guys just -- 15 MS. FREEMAN: We've asked them to hold it in 16 abeyance so we don't end up being ultimately 17 whipsawed. Currently we are whipsawed because their 18 determination is it's business. We've asked them to 19 hold the case so we -- in case we continue to get 20 whipsawed to pursue it further. 21 But at this moment, the current 22 determination is it's a business expense against 23 business income. And it's being held. 24 MS. MA: Okay. So what does that mean to be 25 held in abeyance? I don't understand that. 26 MS. FREEMAN: They've agreed to not move 27 further in the proceedings -- 28 MS. MA: Until after today. 39 1 MS. FREEMAN: -- until after we're done, 2 yes. 3 MS. MA: Okay. 4 MS. HARKEY: I -- I have an issue here. 5 I've got the 10-K from -- we were looking for one -- 6 this is actually, I think, from 2010, maybe. 7 Anyway, on page 20 of 72 it goes into the 8 working capital and what you did here. It says, 9 during February of 2007 the company's parent, 10 Holdings, consummated a privately placed financing 11 transaction. The company did not guarantee or pledge 12 support for this financing, nor were any of the 13 proceeds made available to the company. 14 Holdings issued 310 million in senior notes 15 due in 2017, and 100 million preferred equity. The 16 interest rate and senior notes -- blah, blah, blah. 17 The notes are non-callable for two years and 18 have other covenants for, you know -- that are 19 customary for high-yield issues. The preferred 20 shares had dividend rate, and the company does not 21 expect that holding servicing of its debt will effect 22 the company's liquidity. And that you believe you 23 have other funds. 24 So this 10-K -- if you could explain this. 25 It says that Holdings consummated the privately 26 placed transaction, and the company did not guarantee 27 or pledge support for the financing. Nor were any of 28 the proceeds made available to the company. Which I 40 1 think is the FTB's point. 2 MR. WEDDELL: Maybe. But let me explain to 3 you how -- so operating company, right? Holds all 4 the asset and does have the operations. We can 5 choose to finance more debt at the operating company 6 level at a much higher rate, or we can choose 7 alternative structures. 8 One of the alternative structures is you 9 create a holding company. That holding company can 10 raise debt in -- in the public markets, at our point 11 of view, at more attractive levels. 12 You can do two things with that cash. You 13 can push that cash down to the operating company, and 14 use cash off the balance sheet to pay a dividend up 15 to -- up to shareholders. Or you take that cash, 16 erase that holdings, and give it to the shareholders. 17 The shareholders are at Leslie's Holding Inc., right? 18 So at that holding company level, that was part of 19 the reorganization. 20 And when we created Holdings, all the 21 shareholders of Poolmart, the operating company, 22 exchanged their shares one for one into the holding 23 company. So very common transaction. 24 The reason there's language in there that 25 says the company doesn't guarantee the debt, that is 26 the holding structure, right? The holding structure 27 is such that you get more favorable rates at the 28 operating level from a debt financing perspective 41 1 when you don't have to guarantee that piece of debt. 2 So I do think it's fungible. We could have 3 chosen to take cash off the balance sheet and 4 upstreamed it to shareholders. We could have raised 5 more debt in the ordinary course of our operations at 6 the operating company level. Use some of that to 7 invest in the business. Use some of that to -- to 8 distribute to shareholders. 9 The choice was here, a more attractive 10 capital structure for the business. A more 11 attractive capital structure for the business enables 12 shareholders to benefit, right? Management and 13 investor partners, as well as, you know, the ability 14 to continue to grow the business. 15 So it is factually accurate in the 10-K. 16 And there's absolute rational for the actions that 17 were taken. 18 MS. HARKEY: Okay. The 10-K also says the 19 company believes its internally generated funds as 20 well as its borrowing capacity are adequate to meet 21 its working capital needs, maturing obligations, 22 capital expenditure requirements, including those 23 related to opening of new stores. 24 So I think the point here I'm trying to 25 understand is that, you know -- well, this -- this 26 appeal is Leslie's Holdings appeal. 27 Okay. I'm gonna stop. I have to think 28 about this a minute. 42 1 MR. WEDDELL: And I think it's important to 2 note that that dividend is compensation, right? 3 So, again, if you think about the operations 4 of the business, if we under-compensate from a cash 5 perspective, individuals and what they can get on the 6 market, compensate them through equity -- equity 7 grants including options, that's a pretty integral 8 part of the operation of the business. We spent all 9 day yesterday -- 10 MS. HARKEY: Well, you've gone into that 11 several times. 12 MR. WEDDELL: Sure. 13 MS. HARKEY: What I'm trying to do is break 14 this apart really simply. 15 MR. WEDDELL: Okay. 16 MS. HARKEY: Like, you've got 310 -- 17 Holdings got $310 million. Okay. 18 MR. WEDDELL: Right. 19 MS. HARKEY: Okay. What did they do with 20 that? Where did -- 310 and subtract out. 21 MR. WEDDELL: Right. 22 MS. HARKEY: So what happened to it? 23 MR. WEDDELL: So fees and expenses and 24 dividend out to shareholders, right? So that is the 25 upstream. Raise the debt at the top company, 26 dividend out that amount. 27 Again, back to my point, you -- you have to 28 look at the whole picture. You can't just look at 43 1 the Holdings piece. The Holdings structure and what 2 it offers is integral to the part of the business 3 that we operate. 4 We can choose to put that debt at the 5 operating company or the holding company. To me, 6 they're the same. I have an obligation as a company, 7 maybe not legally in the eyes of debt holders, but as 8 an operator, to deliver on cash flows to pay off that 9 debt in the future, right? 10 So, to me, it's fungible. Holdco or opco, 11 it's about whether or not you can get a more 12 attractive capital structure by employing a holding 13 company structure. And that's what we did. 14 MS. FREEMAN: Well -- and I would also point 15 out that they could just have easily taken the 16 capital and the cash -- which they took some of the 17 cash to pay these and reward their management team as 18 opposed to using the debt. 19 So the fact that we chose the order that we 20 did, and we could just have easily done otherwise, it 21 shouldn't matter how we chose to fund the 22 compensation to our management team. 23 MS. HARKEY: Well, it -- it does, I think, 24 for writing off -- for expensing the interest. I 25 think that's -- 26 MS. FREEMAN: Well, money's fungible. 27 MS. HARKEY: Yeah, money may be fungible, 28 but interest expensing is -- is the debate here. 44 1 Okay. 2 So I'm trying to figure out if, you know -- 3 I can see that you did expand. And I apologize that 4 I did not review this 10-K before I got here. 5 My staff wrote me up a nice little memo on 6 everything, but I like to see the numbers and where 7 it went. 8 And I think the 10-K is your statement of 9 exactly what you did. This is a couple years after 10 the transaction. 11 Anyway, I'll defer to other Members. 12 MS. MA: I -- I do have a question. Because 13 this 10-K is Leslie's Poolmart, Inc. -- 14 MS. HARKEY: Right. 15 MS. MA: -- versus Leslie's Holdings. Now, 16 does Leslie's Holdings also have a 10-K? 17 MR. WEDDELL: No 10-K. No. The only 18 difference is the debt, some interest, as well as 19 some tax offsets. So beyond -- Leslie's Holdings 20 owns 100 percent of Leslie's Poolmart. 21 So, again, it's effectively, in my mind, the 22 same company. Legally, not the same company. But 23 from an operation's perspective, there is a 24 difference. 25 So just -- so it says this is a 2009 10-K 26 that you have 622 company-owned retail stores in 27 35 states, mail order catalogs, approximate mailing 28 list of 7.8 million addresses. 45 1 Now, the way you capitalize your company is 2 this -- is this true that it gives you the ability to 3 open up more stores quicker versus a traditional 4 company, like a mom-and-pop company who has to, like, 5 basically save to open up another store? 6 MR. WEDDELL: It does. 7 MS. MA: Or they can borrow on their assets, 8 right, to open up another store versus the way your 9 business model is. You borrow so that you can expand 10 quicker. 11 MR. WEDDELL: Mm-hm. 12 MS. MA: But these companies are not going 13 to lend to you unless you have the ability to 14 actually pay them back. 15 MR. WEDDELL: That's right. And part of -- 16 MS. MA: And you've done three different 17 rounds of offerings, right? 18 MR. WEDDELL: Mm-hm. 19 MS. MA: To expand quicker. And you're 20 still a private company or -- 21 MR. WEDDELL: That's correct. Still 22 private. 23 MS. MA: Still private company. So -- 24 MR. WEDDELL: The other comment I was going 25 to make is when you think of the revolver, right, 26 asset-based revolved. That's -- that's an integral 27 part of our operation. Because of the way our season 28 plays out. We make money when the sun's out, right? 46 1 So in the summertime. 2 So during those leaning periods, that's when 3 we're developing our stores. We still have all that 4 infrastructure cost. We use capital structure 5 broadly speaking, right, to enable us to invest 6 through that seasonality, generate the profits in the 7 summertime, and be able to return the capital back 8 to -- to -- 9 MS. MA: We do that at the State, too. 10 Like, we wait until -- 11 MR. WEDDELL: There you go. 12 MS. MA: -- income taxes are filed, and we 13 borrow money. And then we pay it back after 14 everybody files their income tax. 15 MR. WEDDELL: Right. 16 MS. MA: So we get that, too. So, yeah. 17 MS. STOWERS: Madam Chair. 18 MS. HARKEY: Thank you. 19 Yes. 20 MS. STOWERS: Just, kind of, clarification. 21 So you borrowed the money, Leslie's 22 Holdings. The majority of that money went to make a 23 distribution to your shareholders? 24 MS. FREEMAN: Yes. 25 MS. STOWERS: Subsequently, Leslie's 26 Holdings, or through the operating company, was able 27 to expand, open new retail stores. But not from -- 28 directly from the money that you borrowed from the 47 1 310 that you borrowed -- the 310 million. 2 MS. FREEMAN: The point of the distribution 3 was to compensate the management that had already 4 grown -- more than doubled the business in the prior 5 10 years. 6 MS. STOWERS: I'm not -- I'm not asking that 7 question. I just want to make sure I'm following the 8 money. The money that you borrowed went to the 9 shareholders. The money that you borrowed was not 10 put down to the operating company to expand the 11 operating company. 12 MS. FREEMAN: Not directly, but it is 13 compensation. 14 MS. STOWERS: Okay. That's what -- I wanted 15 to make sure that I -- that's -- that's what your -- 16 that's what -- that's how I'm -- 17 MS. FREEMAN: And we don't think it's -- 18 MS. STOWERS: -- following the money. So -- 19 MS. FREEMAN: -- required to go directly 20 back -- 21 MS. STOWERS: I'm still talking. 22 MS. FREEMAN: Sorry. 23 MS. STOWERS: And so as you continue to 24 service the debt, and you paid off the debt, you were 25 able to use the profits from the operating company to 26 pay it off. 27 MR. WEDDELL: That's correct. 28 MS. STOWERS: Okay. I just wanted to make 48 1 sure I have a clear understanding of what happened. 2 MR. WEDDELL: Right. 3 And, again, we ended that year with 4 60 million in cash on hand, right? 5 And so could I have pushed some of that 6 capital down? It's the way I finance my company. 7 It's the way I finance my -- 8 MS. STOWERS: It's a business choice that 9 you make. 10 MR. WEDDELL: Mm-hm. That's right. 11 MS. STOWERS: And we always have to -- in 12 the tax world, there's a lot of times some negative 13 results when you make business choices, you know. 14 Your tax calls may not agree with -- or your tax 15 consequences may not agree favorably with your 16 business choices. 17 That's my only comment. 18 MS. HARKEY: Member Runner. 19 MR. RUNNER: Just -- just a -- let me -- let 20 me start with the issue of the transactional test. 21 Let me go to the taxpayer. 22 The frequency of the activities, you 23 believe, then, meets that test? 24 MR. WEDDELL: That's -- 25 MS. FREEMAN: Yes, we do. 26 MR. WEDDELL: I do, definitely. 27 MR. RUNNER: And to summarize the frequency 28 of those transactions. 49 1 MR. WEDDELL: So in capital -- so basic 2 capital structure management. The frequency of those 3 interactions in the -- in the Leslie's experience has 4 been, you know, every few years we'll evaluate the 5 marketplace and determine whether or not we can get a 6 more favorable capital structure in the debt markets, 7 in the capital markets. 8 And so from my perspective, when you think 9 about this transaction having happened three other 10 times in the course of the last five years doing five 11 transactions as a private company to manage the 12 capital structure more frequently would be more of a 13 distraction. It's not feasible to manage a capital 14 structure on a monthly or quarterly basis when you 15 think about going out to the capital markets. 16 Now, that being said, we actively manage it 17 every day. Every week we're focused on cash, making 18 sure we're generating the returns so we can service 19 our debt, so we can service all of our obligations. 20 And so I want to say that the capital 21 structure event may not occur more than every couple 22 years. But actively managing the capital structure 23 happens on a weekly, monthly, quarterly basis. 24 MR. RUNNER: Okay. Let me go to the FTB in 25 that regards to the frequency question. 26 Why does that not meet, in your opinion, 27 that test? 28 MS. TAING: It doesn't meet because Leslie's 50 1 is not in the business of dividend 2 re-capitalizations. I mean, that's -- that's the 3 simplest way to put it. 4 And then, you know, we have the ComCon case 5 where the taxpayer had scores of cable acquisitions. 6 Leslie's has three during the tax years at issue. 7 And, you know, quite frankly, if the 8 transaction was -- if -- the dividend 9 re-capitalizations are not regular, because they're 10 not part of the business operations. They don't 11 relate to selling pool supplies, you know, pool 12 services. It really relates to financial strategies 13 and what their management -- 14 MR. RUNNER: How do you separate the 15 financial strategies in terms of their business model 16 in regards to what is their core activity? 17 How do you -- I mean, those business 18 transactions and activities are what allows them to 19 go ahead and do their core activity. 20 MS. TAING: Well, if you look at the 21 language of the transactional test, you know, uses 22 regular trade or business. Whether the income 23 producing transaction arose in the regular course of 24 the taxpayer's business. 25 Sorry. 26 MR. RUNNER: Mm-hm. 27 MS. TAING: And then we have the Hoechst 28 Celanese Supreme Court case, which actually defines a 51 1 taxpayer's regular trade or business -- regular trade 2 activities. And I can -- I can quote it for you. 3 The Celanese case, which was cited by the 4 California Supreme Court, you know, basically said 5 that the income from the pension reversion did not 6 satisfy the transactional test. Because reversion 7 and activities necessary to execute the reversion 8 were extraordinary, rather than normal trade or 9 business activities pertaining to the manufacture of 10 sale and sale of chemicals, fibers, and specialty 11 products of the taxpayer. 12 So when we're talking -- when we're looking 13 at the transactional test, we're looking at the 14 taxpayer's actual business. And here, you know, 15 Leslie's Poolmart is a retailer of Swimming Pool 16 Supplies. They're not in the business of dividend 17 re-capitalizations. 18 MR. SWIESO: And if I might add, there's 19 nothing in the existing case law authorities or 20 opinions by your Board which indicates frequency of 21 transactions satisfies strictly speaking what's known 22 as the transactional test for determining business 23 income. 24 MR. RUNNER: The -- the -- let me -- go 25 ahead and have you respond to that. 26 MR. WEDDELL: I was going to say if the 27 form of financing -- if any form of financing -- I'm 28 not in the business of raising capital on a daily 52 1 basis, quarterly basis, monthly basis, at the 2 operating company. And I have a lot more debt at the 3 operating company. 4 It's a means to fund the business. Whether 5 it comes from the holding structure or it comes from 6 the operating structure, financings are integral to 7 the capital markets in United States. It finances 8 business. It grows business. It gives people 9 confidence in your ability to grow the business. 10 We get leases because of who we are. We're 11 a national credit. We can point to Moody's and S&P, 12 and we can talk about, you know, the -- our standing 13 within the capital markets community. 14 So it does have impact. When we have 15 financing at an operating company or at a holding 16 company, it is integral to what we do on a day-to-day 17 basis. 18 Our alternative is go to the public markets 19 and go public. And have a public currency. And pay 20 down our debt, right? That is an option. 21 But the option we've chosen is -- is down 22 the route of raising debt to fund our capital 23 structure. And it's absolutely common within the 24 U.S. economy. 25 MR. RUNNER: Let me -- 26 MS. FREEMAN: I have -- 27 MR. RUNNER: Oh -- 28 MS. FREEMAN: I have one more comment. 53 1 MR. RUNNER: Real quick here. Go ahead. 2 MS. FREEMAN: The FTB has conceded the 3 dividends are a normal occurrence for any business, 4 any corporation. In this case, because they were in 5 the growth mode, similar to Apple and Microsoft, they 6 didn't initially pay dividends. Okay. 7 They did put in place this incentive stock 8 option plan. But they waited until it was 9 appropriate financially to start using dividends as a 10 means of compensation for their employees. 11 So not only did their employees have to wait 12 seven years to receive any dividend distributions, 13 additional compensation -- and, again, their 14 employees are not on the high end of their 15 compensation scale. They had to wait seven years 16 until 2007 to actually receive a benefit under that 17 component piece of their compensation plan. 18 This is -- this compensation plan is 19 integral to Leslie's business to maintain their 20 employees. So even though the money doesn't go 21 directly back into the business, it is directly 22 benefiting the business by paying their employees the 23 compensation they expected through the dividends. 24 Because, again, you can't sell the stock 25 publicly. It is integral to keeping and retaining 26 those employees that were essential to this growth 27 model. 28 MR. RUNNER: Let me ask you in regards to 54 1 the discussion or the issue with the audit of the 2 state of Arizona. Is that what prompted the refund 3 here? 4 MS. FREEMAN: Yes. We did not want to get 5 whipsawed. 6 MR. RUNNER: Well, hold on. I've got one 7 going yes, and one going no. 8 MR. HICKS: No, the original -- the original 9 refund -- the original amended return was filed in 10 2011. The audit related to Arizona occurred after 11 that and has developed since that point. 12 MR. RUNNER: What -- what -- what prompted 13 you to ask for the -- what changed -- in terms of 14 your filing differences, what -- if it was not the 15 Arizona issue, what prompted you to all the sudden 16 say, "I think we did it wrong. We'd like to go ahead 17 and get a refund now"? 18 MR. WEDDELL: Right. So in 2007 when we 19 originally did the transaction, we accounted for it a 20 certain way from a tax filing perspective. 21 MR. RUNNER: Uh-huh. 22 MR. WEDDELL: In 2010 we did have an equity 23 transaction where you had new financial partners come 24 in. Through their diligence, when they reviewed the 25 tax filings, they looked at the position we took. 26 And were, I guess, dumbfounded by the way we had 27 treated it. They had never seen it treated that way. 28 And they prompted us to do more work. 55 1 And so with a new set of advisors, we went 2 through and reviewed the regs and what our position 3 was, and determined at that point that we did have a 4 position to go back to the State of California and -- 5 and revise our filings. So that was the prompt. 6 MR. RUNNER: So -- so see if I get the 7 timeline right. 8 So you chose to go ahead and -- and -- and 9 file for refund upon examination of the -- of that 10 previous filing. 11 MR. WEDDELL: Correct. 12 MR. RUNNER: Then after that there was a 13 determination by the state of Arizona -- 14 MR. WEDDELL: Right. 15 MR. RUNNER: -- that reinforced that; is 16 that what -- 17 MR. HICKS: There was an -- there was an 18 audit -- conducted an audit. And during that audit 19 they found this position that we had taken to be 20 incorrect per their -- per their -- 21 MR. RUNNER: This position being -- 22 MR. HICKS: The business interest. 23 MR. RUNNER: Mm-hm. 24 MR. HICKS: The interest that we're talking 25 about. 26 MR. RUNNER: All right. 27 MS. FREEMAN: Treating it as nonbusiness. 28 MR. RUNNER: Treating it as nonbusiness. 56 1 Which then reinforced your reason for the -- 2 MS. FREEMAN: Yes. 3 MR. RUNNER: -- for the -- for the -- 4 MR. WEDDELL: Amended returns. 5 MR. RUNNER: -- for the amended returns here 6 in California. 7 MS. FREEMAN: Yeah. 8 MR. HICKS: The logical sequence for us was, 9 since we felt like that we were at a -- we were 10 advised originally to be -- to file the way we filed, 11 we were then put with a new advisory team that put us 12 in the position that we felt like was correct. We 13 made the filing in California to amend it so that we 14 could, in sequence, get that correct. And then upon 15 that being correct, we would fix Arizona. 16 MR. WEDDELL: Mm-hm. 17 MR. HICKS: But in the time period, Arizona 18 audited us, and we are now in an unfavorable position 19 in both places. 20 MR. WEDDELL: Is that clear? 21 MR. RUNNER: Is it -- yeah, I think so. 22 MR. WEDDELL: Okay. 23 MR. RUNNER: Let me -- let me ask FTB. 24 I'm trying to -- in my head, I'm trying to 25 get to the decision or issue is -- is basically FTB's 26 position inconsistent with, then, the Arizona audit? 27 MS. TAING: FTB's position is not 28 inconsistent with the Arizona audit. Arizona has a 57 1 slightly different law. 2 As I mentioned earlier, appellant is a 3 consolidated return rather than a combined return 4 filer in Arizona. And the determination in Arizona 5 is not final. 6 MR. RUNNER: Well -- okay. Let's not go 7 there. But let's go with the audit itself that came 8 out. 9 Is the law difference in -- between 10 California and Arizona, is the -- is the -- is the 11 substance of the law that's different between Arizona 12 and California, then, relevant to the idea of the 13 interest expense? 14 I mean, is it -- I mean, are they -- let me 15 see how to say this. 16 Is the fact that they viewed -- they viewed 17 this differently in terms of an interest expense 18 consistent -- 19 MR. SWIESO: If I may -- 20 MR. RUNNER: -- with the law that's 21 different? 22 MR. SWIESO: In California we do not have a 23 consolidated filing for -- other than railroads. 24 MR. RUNNER: Okay. Right. 25 MR. SWIESO: Arizona, they allow 26 consolidated irrespective of whether or not you're 27 unitary or not. 28 MR. RUNNER: Mm-hm. 58 1 MR. SWIESO: You own A, B, C and D. They 2 may not be unitary; you treat them all as one 3 taxpayer. 4 MR. RUNNER: Mm-hm. 5 MR. SWIESO: Now, neither of us are -- are 6 that deep into the vagaries of Arizona law. But we 7 do understand that with respect to business and 8 nonbusiness issues, there's a different treatment 9 when you come in under this consolidated methodology. 10 It is our understanding that Arizona, its 11 decision to treat this the way they did is due to the 12 Arizona consolidated methodology. And not 13 necessarily to determining it under the rules that, 14 for instance, California or other combined reporting 15 states would do with respect to the 16 nonbusiness/business methodology. 17 MS. TAING: And if I might -- 18 MR. RUNNER: Okay. Go ahead. 19 MS. TAING: If I may add, too, that the 20 Arizona audit determination letter also mentions a 21 lack of documentation as a basis for their 22 determination. And for California purposes, we don't 23 know what that means. 24 MR. RUNNER: Okay. 25 Let me ask the taxpayer, in regards to the 26 difference in filing and the consolidated versus 27 non-consolidated issues between the two states -- 28 MS. FREEMAN: So what I would say is while 59 1 there's a requirement to file a consolidated return 2 versus the combined report, the concept of whether 3 income is business or nonbusiness or an expense in 4 this case should fall within that purview. Which we 5 don't think the application of 25120 is appropriate 6 here because it's a pure expense. 7 The taxpayer filed an error on their 8 original return, which their advisors noted. The 9 determination of whether something is business or 10 nonbusiness is the same. 11 So the -- the -- Arizona has concluded they 12 didn't meet the burden that -- because, again, all 13 income is business unless clearly nonbusiness. 14 They -- they concluded that we did not meet the 15 criteria that it's clearly nonbusiness. In addition 16 to the fact that there really is no provision -- 17 MR. RUNNER: And you don't believe whether 18 it's consolidated or not consolidated it is relevant 19 to that discussion? 20 MS. FREEMAN: Absolutely not. 21 MR. RUNNER: Okay. Thank you. 22 MS. HARKEY: Members. 23 MR. HORTON: I guess so. 24 Madam Chair. 25 MS. HARKEY: Member Horton. 26 MR. HORTON: Question of the Department. 27 The Department's made a quantitative 28 argument relative to the number of employees -- 60 1 MR. SWIESO: I'm sorry, I'm hearing 2 impaired. I -- 3 MR. HORTON: My apologies. 4 Department's made a quantitative argument 5 relative to the number of employees arguing to the 6 three percent. 7 What do you say to the quantitative argument 8 that that two- to- three percent of employees, 9 pursuant to the argument put forth by the taxpayer, 10 were the primary employees that drove the company, 11 drove the operation, drove the success of the 12 business? 13 MR. SWIESO: That may well be, but they only 14 received 16 percent of the distribution. 15 So -- and you could -- the argument may well 16 be made that they were being compensated for prior 17 profitable activity. The fact remains, they only got 18 16 percent. We're talking about $100 million worth 19 of interest expense that relates to the entire debt 20 proceeds. 21 MR. HORTON: This distribution -- to the 22 argument that this distribution somehow incentivizes 23 the subsequent investors to participate in the 24 operation so that the business could grow, your 25 thoughts on that. 26 MR. SWIESO: Actually, to be quite honest, I 27 haven't seen any evidence that there were subsequent 28 investors that caused the business to grow. 61 1 My understanding -- correct me if I'm 2 wrong -- it's, you had the cash go to existing 3 shareholders. 4 Now, it's conceivable. It's conceivable 5 that other people could say, "Look, you involve 6 yourself with LGP, you're going to get a pay out like 7 this." 8 LGP, with all due respect, is a winner. We 9 wouldn't be here if they weren't. So you get 10 involved with LGP, you may get a payout like this. 11 So -- but that's LGP. That's not Leslie's Pool 12 Supplies. 13 The question still -- and I keep harping at 14 it as counsel has said -- is whether or not this 15 interest expense relates to Leslie's Pool Supplies, 16 and whether or not it should offset their other 17 business income. 18 MR. HORTON: Okay. 19 To that question, help us connect the dots. 20 How did the loan and the distribution to the 21 shareholders lead to the growth and the expansion of 22 the operation, that that activity was so -- such an 23 integral part of the operation of the business, that 24 the shareholders invest anything back into the -- 25 into the company? 26 I -- I believe in earlier testimony the 27 retained earnings was 20 -- 28 MR. SWIESO: Less than 20. 62 1 MR. HORTON: Less than 20. 2 To the extent that it was less than 20, or 3 that there was a thought process in your business 4 model to somehow capitalize the operation that you 5 supplant that by doing this -- 6 MR. WEDDELL: Yeah, it's a couple things. 7 And, again, kind of getting back to familiar frames, 8 I look at the Leonard Green folks as partners in the 9 business. Not your typical private equity firm. In 10 the details, in the weeds, providing value when asked 11 and when not asked. 12 MR. HORTON: Partners in the business in 13 what capacity? 14 MR. WEDDELL: In the capacity of 15 consultants, effectively. So being there for 16 critical business decisions, where to invest, how to 17 deploy capital structure, what companies potentially 18 to buy, and how many number of stores to open up, 19 where to open up those stores. Things of those 20 nature. The ability to retract and retain employees. 21 I'm at Leslie's Pool port today, because I 22 knew Leonard Green. I had worked with the management 23 team before. And they offered an incentive package 24 including equity. Like many of our other leaders 25 within the business, they have over 80 people of 26 equity in the business who really drive the results 27 of the operation in the business. 28 And so connecting the dots, it's time and 63 1 energy. It's efforts. It's resources. It's access 2 to debt markets, access to experts. It's access to 3 the intangibles and the tangibles that make 4 businesses grow, right? 5 The fact that we have the reputation we have 6 in the capital markets enables us to get better lease 7 terms within our -- our stores, over 900 today. 8 And so it's not dollar for dollar, I think. 9 Because we're trying to connect the dots explicitly 10 dollar-for-dollar. To me, again, it's a fungible 11 capital structure. 12 MR. HORTON: I don't think it's necessary to 13 connect it dollar for dollar. I mean, I agree with 14 your argument in that respect. But connecting the 15 Leonard Green's activities to the operation of the 16 business as a consultant and somehow the 17 distribution -- I'm presuming the distribution, the 18 argument is the distribution somehow enhances the 19 retention of Leonard Green. 20 MS. FREEMAN: I would agree with that. 21 In addition, it's important to not -- 22 MR. HORTON: Tell me how that occurs. 23 MS. FREEMAN: So I would argue that the FTB 24 is artificially bifurcating the business. These 25 people worked together to grow the business. It's 26 not just the key management shareholders and Leonard 27 Green shareholders. These are the people that grew 28 the business and operated the business. You can't 64 1 bifurcate them. 2 And the dividend distribution was 3 compensation for past and future -- past successes of 4 the business. Which they had successfully more than 5 doubled the business in the first 10 years. But it 6 is also an incentive to keep them around so they 7 could continue their business model and grow the 8 business. 9 MR. HORTON: During the seven years prior to 10 the distribution, what occurred to retained employees 11 during that period of time? Or -- or was there 12 some -- some implied or actual agreement between the 13 employees that at some point they would benefit? 14 MR. WEDDELL: Sure. So I think if you look 15 at the kind of core group of managers who were at the 16 business, they had been in private equity for a 17 number of years. So they understood the model. The 18 carrot that they had was that equity payout. If they 19 come to work every day, if they grow this business, 20 if they create equity value, they will share in the 21 upside. 22 MR. HORTON: Is that an implied or -- 23 MR. WEDDELL: It's implied. It's not 24 guaranteed, right? So they've got their cash 25 compensation, they've got their base plus bonuses, 26 and then they got option grants. And those option 27 grants are the -- is the equity. That equity was 28 kind of the -- was the carrot, right? 65 1 So it's the -- the cash is the dividend, and 2 the -- sorry, bad reference. But it's kind of the 3 annual pay. And then the upside really comes from 4 the ownership of an equity stake. And that was in 5 the form of options. 6 So in advance of 2007, that was really the 7 means of compensation for employees was more that 8 cash and bonus compensation. 9 MR. HORTON: Seven years prior was there a 10 communication to the employees that this would occur? 11 MR. WEDDELL: There would have been an 12 option plan that was in place at the time. And 13 that's in the filings out there. 14 The specific timing or the type of event 15 wouldn't have been formalized. But it is my 16 understanding, and my experience has been, the 17 expectation is that the monetizations through share 18 sales is worse, as well as through dividend and 19 re-capitalizations. 20 MS. FREEMAN: And that -- and that is what 21 helped keep the employees around. And the fact that 22 it would happen again in the future also helped make 23 sure the employees -- the key employees stuck around. 24 And I think Larry Hayward just retired. 25 MR. WEDDELL: Just retired after 20 years. 26 MS. FREEMAN: Yeah. 27 MR. WEDDELL: But, again, very common. It's 28 a -- it's -- it's the way private equity works. The 66 1 people understand. 2 And I think with Leslie's, pretty unique 3 experience. I don't think many companies can -- can 4 demonstrate the success that this business has had. 5 And so I think for our employees and our 6 management team members, it's been very good. But I 7 think it's -- it's common understanding that the 8 equity opportunity is powerful. And it drives people 9 to perform and behave in a like-minded way towards a 10 common goal. And that's growing a business. 11 MR. HORTON: Thank you, Madam Chair. 12 MS. MA: Okay. I'm going to take the 13 reverse. So let's say you did not borrow, right? So 14 you did not borrow. So where do you think the 15 company would be? 16 MR. WEDDELL: Hard to have an alternate 17 universe. I think you'd have less incentivization 18 from an employee perspective. 19 Again, I think the key to transactions is to 20 reinforce the -- the power of the franchise. It's -- 21 it's -- the -- you have one less interaction into the 22 capital markets, right? One less set of 23 relationships you've developed over -- 24 MS. MA: So you'd have less stores? 25 MR. WEDDELL: So it could. 26 And, again, it could lead to less growth. 27 It could lead to loss of individuals. You can 28 imagine. If a person doesn't get a payout, maybe 67 1 their life situation changes such that they need to 2 move on and move to other opportunities. 3 So it's very difficult for me here to say 4 today that without the transaction, I know what the 5 future would have been. 6 But it certainly -- there were a lot of 7 benefits to that transaction that helped reinforce 8 who Leslie's is and what we can deliver to -- to 9 individuals -- or stakeholders, I should say. 10 MS. MA: Okay. So, you know, companies -- 11 someone mentioned companies like Google or Microsoft. 12 I mean, how do they finance their business? Do they 13 do the same sort of borrowing and -- 14 MS. FREEMAN: Actually, there's a -- 15 MS. MA: -- shareholder dividends or -- or 16 incentives? 17 MS. FREEMAN: Yeah, there's actually an 18 article on Apple on the fact that they had to stop 19 paying dividends for quite a while. And that they 20 had continued on to borrow. Because the rates of 21 borrowings were so cheap, that it was better to 22 borrow the money to fund the distribution than to 23 repay the taxes on the dividends. 24 It was a problem. But there were companies 25 all over the country and the world borrowing to pay 26 distributions because the cost of capital is so low, 27 and the need to maintain stock price so that their -- 28 their invested capital doesn't leave. 68 1 When you buy into a company, you expect 2 to -- either to stop price that go up, to get 3 dividends, or some combination thereof. If you -- if 4 you don't get your expected returns if you're 5 expecting dividends, you'll take your money 6 elsewhere. And your capital and the value of your 7 stock goes down. The ability to borrow money and 8 attract capital goes down. And it inhibits your 9 ability to grow your business. 10 That is absolutely why companies all across 11 the country do borrow regularly to fund distributions 12 if they don't have the cash readily available. 13 Because investors expect it. 14 MS. MA: So I guess to the Franchise Tax 15 Board, do you audit all these companies that have 16 that same business model? 17 MR. SWIESO: This is the -- I've been with 18 the state 25 years tomorrow. This is the first time 19 I've encountered this. 20 What usually happens is -- first off, Apple 21 or Google or Microsoft, what's pretty common is they 22 would do the stock options things. And so, you know, 23 we'll give you stock. We'll let -- we'll get it so 24 you can buy our stock at "x" and you can sell it at 25 "2.5x." 26 What is happening here, again, is 27 Leonard Green is the private equity firm. They 28 basically monetized, collateralized, leveraged all of 69 1 the assets of the operating company, the company that 2 sells pool supplies. Took that money out, gave 3 77 percent of that money to the existing 4 shareholders. 5 Sixteen percent went to their existing 6 employees. So there could be an argument with 7 respect to that, that we're not making that 8 concession necessarily. 9 But 77 percent of this went to the existing 10 shareholders. They're saying that the shareholders 11 were octave managers. But they -- it -- it -- there 12 hasn't really been any evidence on a day-to-day 13 oper -- that what they're doing is changing it. 14 It seems to me -- it seems to me that how 15 the business grew -- I will concede all of the states 16 that -- the arguments that they're making that their 17 business is recession-proof. And it grew when other 18 businesses were down. 19 It appears as though how they were able to 20 expand is they had profits from existing businesses. 21 From the existing footprint, they were able to take a 22 portion of those profits, pay off the interest for 23 the debt, and then use other profits to expand. 24 There's been no evidence that any of this 25 cash that was taken out of the existing assets went 26 back into the business to grow the business. 27 They're very successful. They should be 28 lotted for that. We're not trying to punish them for 70 1 being successful. It just comes down to with respect 2 to that discreet borrowing of $300 million. Is the 3 interest on that -- the interest expense on that, 4 should that go against the portion of the business 5 that sells pool supplies, or it should be treated 6 otherwise? 7 We continue to assert it should be treated 8 otherwise as a nonbusiness item. 9 MS. TAING: I would also like to add that, 10 you know, appellant's argument that issuing 11 distributions through debt financing is a common 12 business model is, in fact, not common. Because we 13 have -- California Corporate Code Section 508, which 14 actually explicitly says that corporations should 15 ensure in good faith that before issuing 16 distribution, that the corporation's retained 17 earnings immediately prior to the distribution equals 18 or exceed the amount of the distribution. 19 That is not what we have in this case. 20 MS. MA: Okay. 21 So to the taxpayers -- yeah -- 22 MS. FREEMAN: Okay. So the comment that the 23 FTB has never seen this -- they just spent 20 years 24 dealing with the DISA reg. The DISA reg is exactly 25 this model. 26 The fact that they're dealing with the 27 income component, which is the distribution in excess 28 of basis, how do you think that's achieved? That's 71 1 achieved through borrowings. If you've exhausted 2 your retained earnings and your capital, you're 3 borrowing money to make those distributions. 4 They've just spent 20 years addressing this 5 problem, because it's so common. The fact that they 6 isolated it for this taxpayer and somehow want to 7 treat it differently, this -- this has monumental 8 repercussions because it's such a common practice. I 9 deal with this every day in practice. This is a 10 common event. 11 MR. SWIESO: May I respond to that? 12 MS. MA: Okay. So -- hold -- hold on. I 13 have a question. 14 So they mention the shareholders that got 15 the distribution. So who are these shareholders? 16 MR. WEDDELL: So, again -- so I think we had 17 stated in there is about 55 percent call it Leonard 18 Green Investors. So it's not just Leonard Green, 19 it's the investors of Leonard Green. So some of the 20 biggest pension funds in the country. 21 Twenty percent was a GCP fund, California 22 fund, right? So the CalPERS fund, unique investment 23 vehicle. 24 Another 15 percent or so was kind of the 25 management team. And the last five percent was 26 Golden Sachs and GSO, who were debt investors. Part 27 of -- again, comes back to capital structure. Part 28 of their requirement for investing in the business 72 1 was to get a small equity stake. So they did get a 2 small equity stake. 3 So those were the investors at the time of 4 the transaction. 5 MS. MA: So let's say -- did you -- was it 6 mandatory for you to take that money out, that 7 390 million? Was it necessary? 8 MR. WEDDELL: Mandatory in the sense, like, 9 if you were a shareholder did you have to accept it, 10 or -- 11 MS. MA: No, I'm just saying, like, what 12 was -- 13 MR. WEDDELL: -- or as a business? 14 MS. MA: What was your thinking about -- 15 MR. WEDDELL: Sure. 16 MS. MA: -- taking it? I mean, was it part 17 of an agreement? Or did you feel like, you know, it 18 was the right timing? People were demanding it? 19 I -- I'm -- 20 MR. WEDDELL: Right. So I think it's -- 21 and, again, not having been here at that time, but 22 I'll talk about in general. It was just -- when the 23 capital markets provide you with opportunity to 24 extend out your structure, right? Potentially raise 25 debt. You take advantage of it, right? 26 2007 was a pretty good time to be in the 27 markets raising capital at very favorable or 28 attractive rates. It's -- one of the benefits of 73 1 doing that transaction at that time is we were able 2 to reward our shareholders. All shareholders, right? 3 Leonard Green Investors, Plus Partners, the 4 management shareholders and other stakeholders 5 involved in the business. 6 So was it required? No. 7 If we didn't distribute the funds, then it 8 probably wouldn't have raised the capital. So -- and 9 certainly not a necessity, but, again, it reinforces 10 the story. It reinforces your opportunity to attract 11 people, reward people for all their efforts over the 12 leaner years. 13 MS. MA: All right. But you didn't have to 14 take the 390 million to put back into the business 15 because you had debts or -- 16 MR. WEDDELL: No. 17 MS. MA: -- you were trying to open more 18 stores? 19 MR. WEDDELL: No. 20 MS. STOWERS: Quick question. 21 MS. HARKEY: Yes, please. 22 MS. STOWERS: Would the Franchise Tax Board 23 please clarify this 20-year project that the 24 appellant has indicated you guys have been doing, the 25 DISA reg? 26 MR. SWIESO: Thank you. I wrote the DISA 27 regs. The DISA regs is an acronym, Deferred 28 Intercompany Stock Account. And it only relates to 74 1 dividends through distribution between members of a 2 combined reporting group. 3 Leonard Green is not a part of Leslie's 4 combined reporting group. If Leonard Green was part 5 of the combined reporting group, there would have 6 been a DISA. We wouldn't be here. We wouldn't be 7 here. 8 That is not what this case is about. That 9 is a -- that -- that just doesn't relate. It has no 10 bearing. 11 MS. STOWERS: You're saying you wouldn't be 12 here if they were part of the group, because you 13 would be saying that Leonard Green was part of the 14 operations? 15 MR. SWIESO: Well, you'd have the DISA, 16 you'd have -- okay. The point would be this, is that 17 the distribution would have gone up to Leonard Green 18 and it would have created this deferred intercompany 19 stock account. Which would have been basically 20 deferred income. And so whenever Leonard Green sells 21 off its stock, it has to pick that up. 22 Let me say, I did misspeak. Because we'd 23 still be dealing -- we'd be dealing with two issues. 24 We'd be dealing with the DISA, and we'd be dealing 25 with the interest expense. So that would still 26 arise. 27 But DISA, the Deferred Intercompany Stock 28 Account methodology principles do not apply in this 75 1 case. She's correct that they came out back in the 2 mid '90s when the feds issued their intercompany 3 treasuries. And we did a -- we did a conformity reg 4 after that. I was on the team that wrote that, 5 specifically the DISA board (phonetic). 6 MS. STOWERS: Okay. Thank you. 7 MS. FREEMAN: I do have a rebuttal on that. 8 MS. STOWERS: I have no more questions. 9 MS. HARKEY: I -- I will hear your 10 rebuttal. 11 MS. FREEMAN: Okay. So a deferred -- a DISA 12 is really a distribution in excess of basis. The 13 question of whether you currently recognize it or 14 defer it is a function of who is in your group. 15 Leonard Green wasn't in our group. The -- 16 the recipients of the distribution would have 17 recognized it as income. Okay. 18 The FTB has contemplated borrowings for 19 distributions. Because there's an example in the reg 20 to this exact point. It's an acknowledged point in 21 the regulation that people borrow to create these 22 distributions in excess of basis. Which is exactly 23 what we're dealing with here. 24 MR. SWIESO: This is the first time that 25 we've had a private equity firm monetize leverage. 26 And it's come up with this issue. 27 MS. HARKEY: I -- I would just like to say 28 that how you chose to finance your operation, either 76 1 going public or keep it private -- which is what you 2 chose to do -- 3 MR. WEDDELL: Mm-hm. 4 MS. HARKEY: -- is not really the subject of 5 this. I know you're trying to make it. But what 6 we're looking at is the 310, what it was used for, 7 was it con -- was it part of the operations, etc? 8 Now, it may be that this type of equity 9 structure has a continuing need, and that's what this 10 Board -- or has a continuing use. And it does for a 11 private company. Usually going in and out of these 12 types of things. 13 But this company, LGP, is permanent. At 14 least permanent for now. 15 MR. WEDDELL: They raise funds -- in the 16 context of what? Permanent -- 17 MS. HARKEY: Well, you -- it looks like -- 18 I'm looking at 2007 and whatnot. And from 2005 19 you've been -- they've been paid a million, a million 20 point eight. 21 MR. WEDDELL: Mm-hm. 22 MS. HARKEY: So they've been -- 23 MR. WEDDELL: Management fee. Sure. 24 MS. HARKEY: -- a management fee for your 25 capital. I'm sure -- I'm still not sure that it -- 26 that your choice of how to finance is -- is at issue. 27 MR. WEDDELL: To a degree, from my 28 perspective, it is. 77 1 If I had borrowed at the operating company, 2 I could have borrowed more money. I could have 3 incurred more interest in the -- in the form of rate. 4 It would have cost me more, because I'd have more 5 leverage on the operating business. 6 The capital markets availed to us another 7 structure which included borrowing at a holdco, which 8 creates a little more risk for those shareholders. 9 But on the overall debt, it's a better rate. 10 That's why we would've done it. If we didn't get a 11 better rate on the overall structure, we wouldn't 12 have done it. 13 And the mere fact that it's at the holding 14 company instead of at the operating company, it's 15 unassociated with our business. It's the capital 16 structure we use to operate our company. It's the -- 17 it's the entity that owns the equity that rewards all 18 of our shareholders, including our management team. 19 So -- 20 MS. FREEMAN: And -- and I would argue -- 21 MS. HARKEY: And keeps -- and keeps you 22 afloat. 23 MR. WEDDELL: And in -- yes, because it's 24 part of the whole structure. And so I have an 25 asset-back-to-loan or revolver that I use on an 26 annual basis to fund my operations during the lean 27 times, right, as we talked about earlier. And 28 without that, I can't grow stores. I can't pay 78 1 salaries. 2 MS. HARKEY: That was -- that was another -- 3 another question I had. Did you have ratios and cash 4 flow requirements in your agreement? 5 MR. WEDDELL: In 2010 -- I'm sorry -- 2007, 6 at the operating level, I actually don't know. 7 MR. HICKS: On the -- are we talking about 8 on the debt? 9 MS. HARKEY: On the -- on the company. 10 Because you used -- you used the structure to get 11 yourselves -- and you had -- you just mentioned you 12 had an agreement. What was that agreement? 13 MR. WEDDELL: Which one? 14 MS. HARKEY: The -- the agreement -- 15 MR. WEDDELL: The management agreement with 16 Leonard Green? 17 MS. HARKEY: The management agreement. But 18 there was some kind of debt agreement that you just 19 acknowledged. 20 MR. WEDDELL: Oh, the asset-based revolver. 21 MR. HICKS: Asset-based revolver. 22 MS. HARKEY: What's the asset-based 23 revolver? Let's get into that a little bit. 24 MR. WEDDELL: Yeah. So it's a cash flow 25 loan, right? 26 MS. HARKEY: Right. 27 MR. WEDDELL: So it's a -- a hypothetical 28 $20 million dollars, I can borrow on it to the extent 79 1 I have assets to cover it. I use that cash from 2 operations, but it's meant to be kind of a short-term 3 borrowing vehicle. 4 So a lot of times people call it the cash 5 flow revolver loans. 6 MS. HARKEY: Okay. Is that with a bank or 7 is that with -- 8 MR. WEDDELL: It's with the bank. Exactly. 9 MS. HARKEY: It's with the bank. 10 MR. WEDDELL: Correct. 11 MS. HARKEY: And the money that you borrowed 12 from that, isn't that more expensive? 13 MR. WEDDELL: It's the cheapest -- it's the 14 highest on the capital structure, it's the lowest 15 cost. 16 MS. HARKEY: Lowest cost. And -- 17 MR. WEDDELL: But it's meant to cover 18 operations unexpected. And so the intent is to keep 19 that as low -- the borrowings on that as low as 20 possible, but have it available for borrowings if 21 needed. 22 MS. HARKEY: Right. It's -- and I'm sure 23 you have leverage requirements, cash flow 24 requirements, and everything on that agreement with 25 the bank? 26 MR. WEDDELL: That's right. 27 MS. HARKEY: Okay. If you had not accessed 28 the other form of liquidity, how does that work with 80 1 your bank? Like, how did it work? 2 MR. WEDDELL: Sure. It's a package, right? 3 So I think when you do a financing, you look at the 4 entire capital structure. To the extent that we 5 didn't get that loan at that holding company, and we 6 got it done at the operating level, we would have 7 different terms on our operating debt. Both the term 8 loan, the asset-based revolver, any unsecured or 9 secured debt, rates go up, right? 10 And so the -- the terms of the agreement 11 would have to change potentially. And if they 12 change, that costs money, right? And so when you 13 think about capital markets and debt agreements, they 14 are dependant on overall leverage and expectations 15 for cash repayment. And -- and the cost of that is 16 the rate. 17 MS. HARKEY: Okay. And so by accessing this 18 other source of -- of financing, or -- or ability to 19 draw in the market, shall we way -- 20 MR. WEDDELL: Right. 21 MS. HARKEY: -- that kind of boosted your -- 22 MR. WEDDELL: More attractive. 23 MS. HARKEY: -- your potential for cash flow 24 and -- 25 MR. WEDDELL: Mm-hm. Correct. 26 MS. HARKEY: -- and ability to continue. 27 MR. WEDDELL: And, again, we didn't pursue 28 that alternative structure. I don't have it in 81 1 place. I can't compare and contrast. But that's 2 capital markets in essence. 3 MS. HARKEY: Right. 4 Okay. Members? 5 Member Ma. 6 MS. MA: I have another question. 7 So in 2007, you went through your reorg. 8 Why -- why did you decide to do that? 9 MR. HICKS: Yeah. Like I -- at the -- from 10 my perspective, it's -- the markets were attractive. 11 We sell pool supplies, right? We do rely on 12 Leonard Green and some of our partners to help advise 13 us from a capital markets perspective. 14 And they have daily conversations with 15 folks, investment bankers and other investors, 16 familiar with other companies who are in the markets. 17 So at the time it was an attractive time to be out in 18 the financing markets raising capital. 19 And so why -- why that -- why 2007 and not 20 2006? It was the life cycle of the business. It was 21 the profits that we had generated. It was our 22 ability to go out and tell the story to investors. 23 It was a right time for the markets when they were 24 open. And so we found receptive shareholders. 25 It's not the type of thing where I can tell 26 you in two years I will be in the market. You take 27 everything in consideration. The strength of the 28 business, the strength of the team, the assets, 82 1 whether or not capital markets, you think you'd get a 2 better outcome than you have today. Then you 3 capitalize when those opportunities are available. 4 And, again, right, it's noncommittal. So 5 you go out, and to the extent you don't get 6 attractive commitments from investors, you don't do 7 the financing. 8 So we were able -- in that time, in 2007, to 9 go out to the market and -- and found the 10 financing. 11 MS. MA: Okay. But when you reorganized, 12 you issued stock, right? 13 MR. WEDDELL: Exchanged stock. 14 MS. MA: Exchanged stock. 15 MR. WEDDELL: Correct. 16 MS. MA: To who? Everybody? 17 MR. WEDDELL: So all the Poolmart holders 18 had an option to -- well, not an option. They 19 converted over into holdings, right?. 20 MS. MA: Okay. And so you borrowed money 21 for that. Was that -- this is different than -- I 22 have in my notes that to perform the distribution for 23 the reorg you borrowed 310 million from lenders. 24 Is that different from -- 25 MR. WEDDELL: I think they were all 26 completed together, right? 27 The holding company was established because 28 of the debt that we were going to put in place, 83 1 right? So part of that financing process created the 2 holding structure. 3 When you do that, from an equity holder 4 perspective, you're going to convert all of your opco 5 shareholders to holdco shareholders, right? 6 Otherwise the -- some shareholders were 7 disproportionately benefit. 8 So the idea was to take all shareholders of 9 Poolmart, push them up to Holdings, layer on the 10 debt, and pay a dividend, right? And kind of keep 11 people on the same basis. 12 So it wasn't an option. It wasn't a choice 13 for folks to determine whether or not they wanted to 14 become holding shareholders. If you were a 15 shareholder in opco, you became a shareholder in 16 holdco. 17 Does that make sense? 18 MS. MA: Yeah. But I'm trying to figure 19 out -- because the money that was borrowed -- 20 MR. WEDDELL: Mm-hm. 21 MS. MA: -- was any of it used to, you know, 22 complete this reorganization, or to -- to do the 23 reorganization? 24 Because I'm having -- I'm -- I'm having a 25 little issue with -- 26 MR. WEDDELL: Okay. 27 MS. MA: -- whether the money borrowed went 28 as an incentive to shareholders and investors versus 84 1 the money went to operations which would include the 2 reorganization. 3 And that you needed to borrow the money also 4 to accomplish the reorganization to make the 5 company -- I don't know -- more efficient, more 6 effective. 7 I'm not sure why you reorganized. That's 8 what I'm trying to figure out. Besides just the, you 9 know -- the favorable financial markets, right? I 10 hear that. 11 MR. WEDDELL: Yup. 12 MS. MA: We all hear that. 13 MR. WEDDELL: Right. 14 MS. MA: But we're trying to figure out, 15 like, what was your thinking in doing that? Like, 16 why did you reorganize? And was any of this money 17 used for the reorganization, or was it just to reward 18 the shareholders and your investors? 19 MR. WEDDELL: Right. So the reorganization 20 could have occurred without the financing, right? So 21 it's kind of step one. Creation of that holding 22 company structure, transferring shareholders from the 23 opco level up to the holding level. That could have 24 been done without any financing. It was done because 25 we were going to do a financing. 26 So the capital, the new debt was raised and 27 put into that holding company at -- at the time of 28 the reorganization. Or you can think of shortly 85 1 thereafter the reorganization. 2 And then it comes back to the conversation 3 around whether or not you think that the equity in 4 holdings incentivizes employees in whether or not 5 that capital, that cash that came in, is fungible 6 with the operating company, right? 7 So I can take cash off my balance sheet, and 8 I can pay it out to shareholders. Or I can raise 9 money in this holding vehicle and distribute it to 10 shareholders, right? 11 So that's -- as I look at it, those are kind 12 of the choices. 13 MS. MA: Right. 14 MR. WEDDELL: But the reorg piece of it, 15 that could have been done independently. Wouldn't 16 have had a reason really to do the reorganization. 17 It's really a reorganization in name only. It's 18 creation of a opco or a holdco structure that owns 19 100 percent of the operating entity. So that was 20 the -- that was the purpose. 21 MS. MA: Right. So it seems like -- well, 22 if it could have been done independent, the 23 reorganization, of the money, then the money -- or 24 the borrowing wasn't, like, an integral part of the 25 reorganization. 26 MR. WEDDELL: I'd say that is fair. I would 27 say the borrowing was an integral part of the capital 28 structure, which goes back to all the conversations 86 1 that we've been having. 2 Whether or not it enables us to attract 3 people to borrow through the structure more 4 attractive rates, generate more cash flow, invest 5 more in the business. 6 MS. FREEMAN: And I would make one more 7 comment that you can't do a disproportionate 8 distribution. If you're going to incentivize your 9 management shareholders, you have to incentivize -- 10 you have to pay everybody. 11 MS. MA: So part of this money went to 12 incentivize everybody? 13 MS. FREEMAN: Well, Leonard Green was part 14 of their management team. Even though they weren't 15 internally within the company, they were the owners. 16 Similarly in ruling 2003-3, you have the opportunity 17 to have your management team be an income-producing 18 activity of the subsidiary shareholders. And that's 19 what you had here. Leonard Green was increasing 20 activity of Leslie's. 21 MS. MA: So is Leonard Green employees, 22 like, sit in your office with you? Or how are 23 they -- 24 MR. WEDDELL: Yeah. So we're based here out 25 in West LA. 26 They -- again, they have a team of portfolio 27 services professionals, as well as investment 28 professionals. Those individuals were highly 87 1 involved in our business as we look at over time, 2 right, since the initial investment that they had. 3 So it's everything from what you would 4 expect being Board Members, being fiduciaries to all 5 of the ancillary services they provide under the 6 agreement, right, to effectively better our company, 7 drive growth, enable us to make better decisions with 8 respect to acquisitions and -- and capital markets 9 transactions, right? 10 So they're not a Leslie's Pools Supplies' 11 employee. They are pretty integrally tied to our 12 business given the value that they contributed to the 13 business. 14 MS. MA: And when did Leonard Green get 15 involved in your business? 16 MR. WEDDELL: In nineteen -- they acquired 17 in 1997. And then they recently -- February of this 18 year, they sold their stake. So 20 years for a 19 private equity firm is pretty incredible. 20 MS. MA: And -- and -- and what would happen 21 if, you know, within that 20 years something 22 happened -- I don't know -- people wanted -- it was 23 okay to have their pools turn green, and nobody 24 needed your service anymore? 25 MR. WEDDELL: Right. 26 MS. MA: What would have happened? 27 MR. WEDDELL: I think any business would 28 fail. Or you revolve and you find other avenues of 88 1 revenue and profitability to ensure that you can 2 service your obligations for all stakeholders, as 3 debt holders, equity holders, employees, all the 4 constituents in this room. 5 MS. MA: And what would Leonard Green do, 6 like, as a private equity shareholder? 7 MR. WEDDELL: They would likely find 8 other -- as a shareholder, it would have made it a 9 lot more uncomfortable. So -- but practically, I 10 mean, they would have found other investments to the 11 extent this investment went away. And whether or not 12 they've chosen to sell or not. 13 I think their perspective was that over time 14 there were so many opportunities in this business and 15 in this industry to continue to grow it, that they 16 had the confidence in the strategies, and helped form 17 those strategies that -- that we pursued. 18 MS. MA: So you win some; you lose some, 19 right? With private equity, right? That's their -- 20 their model is to -- right? So that's their model. 21 But they invested with you -- 22 MR. WEDDELL: Pretty successful. 23 MS. MA: -- since 1997. So they were an 24 integral partner, or what -- what do you call them? 25 MR. WEDDELL: I -- they are -- I call them 26 partners because of the level of support they 27 provided to us. They're our private equity owner, 28 right? And so when you think about typical private 89 1 equity, it's three- to- five- year ownership cycles, 2 right? Their fund lives are 10 years. They were in 3 this business for 20 years, right? 4 So that's a pretty long horizon. That's a 5 horizon where you're not making decisions for next 6 quarter, you're making decisions for the next three, 7 five, ten years. And so that's how I differentiate 8 them from -- from other folks that I've been involved 9 with in the private equity realm. 10 MS. HARKEY: Members, do you have any more 11 questions? Is there a motion? 12 We have no opinions here. 13 Would you like to take this under submission 14 and think about it for a while? 15 MR. HORTON: We could -- 16 MS. HARKEY: Then I need a motion. 17 MR. HORTON: We'll take the matter under 18 submission. 19 MS. HARKEY: Is there a second for under 20 submission? 21 MS. MA: Yeah. Second. 22 MS. HARKEY: Second, Member Ma. 23 Any objection? 24 Thank you. 25 MS. FREEMAN: Thank you for your time, 26 Honorable Members. 27 MS. HARKEY: We will -- we will make our 28 decision and come back tomorrow and have a vote. 90 1 Each Member, I think, wants to go through a little 2 more thoroughly all of the issues on this case. 3 And I thank you very much. Thank both of 4 you. 5 And thank you, FTB. You've delved into the 6 weeds here quite a bit, which is really important, I 7 think, for the issue. Thank you. 8 MR. WEDDELL: Thank you for your 9 consideration. 10 MS. HARKEY: Thank you. 11 (Whereupon the matter concluded.) 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 91 1 2 REPORTER'S CERTIFICATE 3 4 State of California ) 5 ) ss 6 County of Sacramento ) 7 8 I, Jillian Sumner, Hearing Reporter for 9 the California State Board of Equalization certify 10 that from November 14, 2017 audio, I recorded 11 verbatim, in shorthand, to the best of my ability, 12 the proceedings in the above-entitled hearing; that I 13 transcribed the shorthand writing into typewriting; 14 and that the preceding pages 1 through 92 15 constitute a complete and accurate transcription of 16 the shorthand writing. 17 18 Dated: September 14, 2018 19 20 21 ____________________________ 22 JILLIAN SUMNER, CSR #13619 23 Hearing Reporter 24 25 26 27 28 92