LESL

Business Context and Reporting Period

Company: Leslie's, Inc. (LESL)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended September 28, 2024 (52 weeks)
Business Overview: Leslie's is the largest direct-to-consumer brand in the U.S. pool and spa care industry, operating over 1,000 physical locations and a robust digital platform. The company sells chemicals, equipment, parts, and services to residential and professional consumers. The business is highly seasonal, with peak sales occurring in the third and fourth fiscal quarters.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Sales decreased by $121.1 million (8.3%) primarily due to an 8.8% decline in comparable sales driven by lower traffic and average order value. Non-comparable sales from new locations contributed $7.9 million.
• Margin Compression: Gross margin decreased 200 basis points to 35.8%. Drivers included negative product rate impacts (121 bps), occupancy cost deleverage (94 bps), and the expensing of previously capitalized distribution center costs (50 bps) due to inventory reductions. A one-time $5.0 million item related to rebates and warranties also impacted margins.
• Profitability Shift: The company reported a net loss of $23.4 million in 2024 compared to net income of $27.2 million in 2023. This was driven by lower operating income and increased interest expense ($70.4 million vs. $65.4 million) due to higher interest rates.
• Working Capital: Net cash provided by operating activities improved significantly to $107.5 million from $6.5 million, largely due to an $85.9 million reduction in inventory levels.
• Legal Proceedings: The company is defending against a securities class action lawsuit filed in September 2023 and two derivative actions filed in March 2024 alleging false statements regarding financial guidance and operations. No material loss has been estimated.

Guidance, Outlook, and Risks

• Internal Control Weaknesses: Management and the independent auditor (Ernst & Young) identified material weaknesses in internal control over financial reporting as of September 28, 2024. These relate to (1) physical inventory performance and costing validation, and (2) the accounting for vendor rebates. The auditor issued an adverse opinion on internal controls. Remediation is expected to be completed in fiscal 2025.
• Seasonality: The business remains highly seasonal. Sales and earnings are concentrated in the third and fourth quarters (April–September). The first and second quarters typically generate net losses and negative operating cash flows due to inventory build-up and pre-season investments.
• Debt and Liquidity: The company carries substantial indebtedness ($783.7 million Term Loan). All debt bears variable interest rates, exposing the company to interest rate risk. As of September 28, 2024, the company had $239.6 million available under its Revolving Credit Facility and was in compliance with all covenants.
• Strategic Focus: Management plans to drive growth by acquiring new consumers, increasing share of wallet among existing customers via loyalty programs, expanding the professional market, and utilizing strategic M&A. No acquisitions were completed in fiscal 2024.
• Risks: Key risks include weather sensitivity, supply chain disruptions (specifically granular chlorine compounds), competition from mass merchants, and the potential impact of high interest rates on consumer credit and debt servicing costs.

Investor Verification Checklist

• Internal Control Remediation: Verify the progress of remediation efforts for the material weaknesses in inventory and vendor rebate accounting, as these led to an adverse audit opinion on internal controls.
• Comparable Sales Trend: Monitor the trajectory of comparable sales, which have declined for two consecutive years (-11.0% in 2023, -8.8% in 2024), to assess if the decline is stabilizing.
• Inventory Management: Review future inventory levels and turnover ratios to ensure the company is not over-stocking or under-stocking relative to demand, given the recent significant drawdown.
• Interest Rate Exposure: Assess the impact of variable interest rates on the $783.7 million Term Loan and the company's ability to service debt if rates rise further.
• Legal Exposure: Track the status of the securities class action and derivative lawsuits to determine potential financial impact or management distraction.
• Vendor Rebate Accounting: Scrutinize the recognition of vendor rebates, a specific area of identified control weakness, to ensure accurate margin reporting.