New language in the latest annual report filed by Leslie’s Inc. (LESL) a direct-to-consumer (DTC) pool and spa brand, indicates the company’s auditor spent additional time scrutinizing vendor rebates. Leslie’s auditor, EY, did not flag vendor rebates as a critical audit matter in the previous year’s annual report.

Leslie’s promises rebates to vendors in return for vendors achieving certain sales volumes. Until a vendor sells a Leslie product, rebates are accounted for as a reduction of inventory. When a sale is made, Leslie’s recognizes a reduction in COS.

We suspect Leslie’s auditor scrutinized vendor rebates due to the impact they can initially have on the company’s inventory position. In the year ended October 1, 2022, sales increased 16.3% but inventory jumped 81.9% in 2022.

Leslie’s vendor rebate receivables fell 3.46% and now account for 43.14% of receivables, down from 52.06% the previous year.

Separately, Leslie’s and its auditor identified a material weakness associated with ineffective information technology general controls (ITGCs) in the area of user access, over certain information technology (IT) systems that support the Company’s financial reporting processes. Automated and manual business process controls that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted to the extent that they rely upon information and configurations from the affected IT systems.

Though Leslie’s says it has not identified any financial misstatements, the deficiencies in ITGCs created a more than remote possibility that a material misstatement to the consolidated financial statements would not be prevented or detected on a timely basis.