10-Q: Leslie's Q3 Earnings Plunge Amid Sales Decline, Control Issues

Leslie's Inc. reported a significant drop in Q3 net income and comparable sales, alongside ongoing material weaknesses in internal financial controls and recent credit rating downgrades.

Summary

• Sales for the three months ended June 28, 2025, decreased by 12.2% to $500.3 million, down from $569.6 million in the prior year period.
• Net income for the three months ended June 28, 2025, was $21.7 million, a significant decrease from $60.7 million in the prior year period.
• Diluted earnings per share for the three months ended June 28, 2025, fell to $0.12 from $0.33 in the prior year period.
• Comparable sales growth for the three months ended June 28, 2025, was a negative 12.4%, worsening from a negative 4.0% in the prior year period.
• For the nine months ended June 28, 2025, sales decreased by 8.5% to $852.7 million, down from $932.3 million.
• The net loss for the nine months ended June 28, 2025, widened to $74.2 million, compared to a net loss of $13.5 million in the prior year period.
• Diluted loss per share for the nine months ended June 28, 2025, was $0.40, compared to a loss of $0.07 in the prior year period.
• Net cash used in operating activities for the nine months ended June 28, 2025, was $39.4 million, a substantial decrease from $60.4 million provided by operating activities in the prior year period.
• Disclosure controls and procedures were deemed ineffective as of June 28, 2025, due to un-remediated material weaknesses in internal control over financial reporting related to inventory controls and vendor rebates.
• Credit ratings were downgraded by Standard & Poor's (B from B+) and Moody's (Caa1 from B2) during the quarter ended March 29, 2025.

Sentiment

Score: 2

Explanation: The company reported significant declines across key financial metrics including sales, net income, and comparable sales. The shift to negative operating cash flow for the nine-month period, coupled with ongoing material weaknesses in internal controls and recent credit rating downgrades, indicates a very negative financial performance and outlook.

Positives

• Interest expense decreased by $2.4 million for the three months and $6.0 million for the nine months ended June 28, 2025, due to lower interest rates and reduced term loan balances.
• Net cash used in investing activities decreased by $15.3 million for the nine months ended June 28, 2025, primarily due to lower investments in property and equipment.
• The company completed hiring for all open accounting roles during the quarter ended June 28, 2025, with experienced personnel to assist with remediation efforts for internal control weaknesses.
• Subsequent to quarter end, the company paid off the remaining $20.0 million outstanding on its Revolving Credit Facility.

Negatives

• Sales declined significantly by 12.2% for the three months and 8.5% for the nine months ended June 28, 2025, driven by lower transaction volume and product mix.
• Gross profit decreased by 13.5% for the three months and 13.2% for the nine months ended June 28, 2025.
• Gross margin declined to 39.6% from 40.2% for the three months and to 34.0% from 35.8% for the nine months.
• Net income for the three months decreased by $38.9 million, and the net loss for the nine months increased by $60.7 million.
• Operating income decreased by $29.4 million for the three months, and the company reported an operating loss of $19.8 million for the nine months, compared to an operating income of $30.7 million in the prior year.
• Net cash flow from operating activities shifted from a positive $60.4 million to a negative $39.4 million for the nine months, primarily due to increased product inventories and reduced accrued expenses.
• Credit ratings were downgraded by both S&P and Moody's during the quarter ended March 29, 2025, indicating increased credit risk.
• The company's disclosure controls and procedures were deemed ineffective due to un-remediated material weaknesses in internal control over financial reporting.

Risks

• Ability to execute on growth strategies.
• Supply disruptions or increased costs, including from trade policies.
• Ability to maintain favorable relationships with suppliers and manufacturers.
• Competition from mass merchants and specialty retailers.
• Impacts from weather conditions, changes in the economy (high interest rates, recession fears, inflationary pressures), geopolitical events, and the housing market.
• Disruptions in the operations of distribution centers.
• Ability to implement technology initiatives without disrupting operations.
• Ability to execute on management transition plans and attract/retain senior management and qualified personnel.
• Regulatory changes and developments affecting products, including evolving ESG standards.
• Ability to obtain additional capital to finance operations.
• Commodity price inflation and deflation.
• Impacts from epidemics, pandemics, or natural disasters.
• Impacts from cyber incidents and other security threats or disruptions.
• Ability to regain and maintain compliance with Nasdaq listing standards.
• Ability to implement a proposed reverse stock split in a timely manner, if at all, and its anticipated effects.
• Ability to remediate material weaknesses or other deficiencies in internal control over financial reporting or maintain effective disclosure controls and procedures.
• Unpredictable changes in consumer purchasing patterns due to factors like stockpiling of chemicals.

Future Outlook

The business is highly seasonal, with sales and earnings highest during the third and fourth fiscal quarters (April through September). Sales are substantially lower during the first and second fiscal quarters, typically resulting in net losses and negative operating cash flow. The company anticipates completing remediation activities for material weaknesses in internal control over financial reporting during fiscal year 2025. Macroeconomic trends, including inflation and varying interest rates, are expected to continue impacting consumer sensitivity to price and purchasing patterns, potentially leading to declines in sales and/or gross profit. The company is assessing the potential impacts of the recently signed One Big Beautiful Bill Act (OBBBA) but does not currently expect a material impact on its 2025 financial results.

Management Comments

• Management believes the use of the discrete effective tax rate method is more appropriate due to the sensitivity of tax adjustments to marginal pre-tax book profitability anticipated for the year.
• Management disputes the allegations of wrongdoing in the class action and derivative lawsuits and intends to defend vigorously in these matters.
• Management does not expect the resolutions of any legal matters to have a material effect on the consolidated financial position or results of operations.
• Management is committed to continuing to improve internal control processes and anticipates remediation activities for material weaknesses will be completed during fiscal year 2025.

Industry Context

The company operates in the $15 billion U.S. pool and spa care industry, primarily in the aftermarket segment, which is characterized by non-discretionary products essential for maintenance. The business is highly sensitive to weather conditions, with hot weather increasing demand and unseasonably cool or rainy weather reducing it. The industry has also experienced unpredictable changes in demand due to customer stockpiling of granular chlorine compounds over the past three years. The company holds a market-leading share of approximately 15% of residential aftermarket product spend as of 2023, with a physical network larger than its 20 largest competitors combined and digital sales significantly larger than its largest digital competitor.

Management Changes

Corporate Governance

Legal Proceedings

• A class action complaint for violation of federal securities laws was filed on September 8, 2023, alleging materially false and misleading statements regarding financial guidance, business operations, and prospects. A motion to dismiss was granted on July 14, 2025, but the plaintiff can file a second amended complaint by August 13, 2025.
• Three derivative actions were filed on March 13, 2024, March 14, 2024, and December 17, 2024, against officers and directors, alleging harm to the company through false or misleading statements. These actions are stayed pending the outcome of the securities class action.
• The company disputes all allegations of wrongdoing and intends to defend itself vigorously, not expecting a material effect on its financial position or results of operations from these matters.

Stakeholder Impact

• Shareholders: Negative impact due to significant declines in sales, net income, and diluted EPS, as well as ongoing internal control issues and credit rating downgrades, likely leading to downward pressure on share price.
• Creditors: Increased risk perception due to credit rating downgrades (S&P B from B+, Moody's Caa1 from B2) and a shift to negative operating cash flow, potentially affecting future borrowing costs or access to capital.
• Employees: Potential impact from corporate restructuring activities, as severance costs are included in Adjusted EBITDA adjustments.
• Customers: Potential impact from changes in product mix, pricing, and availability, as well as the company's ability to maintain service levels amidst operational challenges.

Next Steps

• Continue remediation efforts for material weaknesses in internal control over financial reporting, with anticipated completion during fiscal year 2025.
• Defend vigorously against the class action and derivative lawsuits, with the plaintiff allowed to file a second amended complaint by August 13, 2025.
• Monitor and assess the potential impacts of the One Big Beautiful Bill Act (OBBBA) on financial results.

Key Dates

Recommendation

The company's Q3 and nine-month results show a severe deterioration in financial performance, with significant declines in sales, gross profit, net income, and a shift to negative operating cash flow. The negative comparable sales growth of 12.4% is particularly alarming. Compounding these issues are un-remediated material weaknesses in internal financial controls, which raise serious concerns about financial reporting reliability, and recent credit rating downgrades. While the company is addressing these issues, the current trajectory, coupled with macroeconomic headwinds and legal proceedings, presents a highly unfavorable investment profile. A seasoned investor would likely view these results as a strong indicator to divest or avoid the stock due to heightened risk and poor operational execution.

Keywords

Leslie's, LESL, Quarterly Report, Financial Results, Pool and Spa, Retail, Chemicals, Equipment, E-commerce, Internal Controls, Credit Rating, Sales Decline, Net Loss, Operating Income, Cash Flow, Debt, Litigation, Seasonality