What To Make Of Polished’s (POL) Accounting Issues

Appliance online retailer Polished.com (NYSE:POL) announced that its June 30, 2022 quarterly filing will be delayed. This is due to potential accounting issues as identified by former employees. Three members of the managed team have resigned, though the former CEO remains on the board. As of September 30, the company’s cash balance remains broadly in line with past filings and it has not drawn its $40M revolver.

Late filings due to accounting issues for 10-Qs are relatively unusual, in part because the results are not audited, and delays often amount to a few days to work through new accounting rules. Even so the stock reaction is typically negative. With Polished, the filing, if it comes in by year-end, as the company plans, is likely to be almost 180 days late. It’s worth noting that around 13% of companies that file 10-Qs late due to accounting issues never file at all.

The company describes the issue as an investigation into “employment and inventory management practices” and concerns were raised by “former employees”. The investigation is expected to complete, by “the end of this calendar year” (i.e. December 31st 2022).

Prior Valuation

I previously indicated, in early April this year, that the shares may be worth around $4.69/share putting an 18x multiple on expected earnings. Now the earnings are in question and market multiple have declined in the bear market, especially for growth companies. If the adjustments to earnings were immaterial (which seems unlikely at this point) maybe the shares should trade at $3.38/share for a 13x multiple. Of course, it’s quite possible that assessment is based on inaccurate financial data.

Investors Are In The Dark

Investors don’t have much to go on. Perhaps the apparently stable cash balance and the undrawn revolver as well as the ‘resigning’ CEO remaining on the board are all potential positives. Though it’s also possible that the company is unable to remove the former CEO from the board in short order.

Delays In Filings

Still the delay in filing is material and unusually long compared to peer companies. At this point there’s a risk that the delay extends into 2023. Here’s the data on how long filings take once we’re at the 180 day mark as we appear to be with Polished.

Delay to file	Percentage of firms
180 days	39%
270 days	17%
365 days	7%
Longer than 365 days	10%
Never file	27%

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source: analysis of late 10Qs due to accounting in the 2011-2013 period

Prior Reporting

In this situation prior reporting does not inspire confidence (assuming the accounts are somewhat accurate, which may not be the case). The company generated net income of $8M in its last 10-K and $5M in its last 10-Q, though in both cases cashflow was negative due primarily to working capital swings. Given the recent acquisition, which closed in 2021 and basically transformed the business, we don’t have a long term track record to draw on and help us look past current accounting risk.

Outcomes

Using the base rates above we can consider the following scenarios, also giving weight to the fact that management are on record saying they expect to release results by year-end, though they could, of course, update that guidance.

The upside does appear large if the issues found are material to the company, but not to profitability. Still there’s high chance of dead money if there are further delays, or worse, bankruptcy.

Scenario	Probability	Stock valuation
Not impaired, but tainted by management change and accounting delay (20% discount)	30%	$2.70
Reduced profitability as accounting issues hit earnings (assume 50% hit to earnings)	30%	$1.35
Further delays (stock stays around current level)	22%	$0.48
Bankruptcy	18%	0
Weighted average outcome	$1.32/share
Upside	175%

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Market Implications

Another way to come at the analysis, is what the market currently implies. With the shares at $0.48 compared to $1.56 before the issued surfaced, the market is implying that crudely there is a 70% chance the company is worthless, compared to a 30% probability it returns to its former level before these issues arose.

In a similar way, the 2026 warrants, which did trade at $0.40 before these issues surfaced now trade at $0.06 implying around a 85% chance of bankruptcy, though of course the out of the money strike price of the warrants makes that analysis pretty simplistic.

Risks

The risks in this situation are extremely material.

• The historic financials likely cannot be relied on and the company may be worthless.
• The company may never become current with its filings and could ultimately be delisted.
• There may other unknown issues with company management, and the 2021 acquisition, which was a large part of the company’s value may have its earnings power overstated.

Conclusion

Polished is an interesting one to watch. Delays in filing of this magnitude are highly unusual, increasing the possibility that the company never files at all, since the bulk of late filing data is companies filing just a handful of days late. However, management do intend to file before year end per their most recent update.

The length of the filing delay and the inclusion of external consultants in the investigation process certainly implies there is potential merit to the allegations of former employees regarding employment and inventory practices. This also may imply cultural or control issues at the company.

Also Polished was a rather strange merger setup as it acquired a far larger non-public company (Appliance Connection), and if the financial reporting inaccurate since acquisition, then investors really don’t have much to go on. The investigation includes reporting back to 2021 when Appliance Connection was acquired.

Still, the cash position and undrawn revolver are somewhat positive. I suspect the market may be being too punitive to Polished currently, but the risks are high. Of course, it is a highly speculative situation and total loss is possible, but if the company can merely remain a going concern at its current scale, then there may be upside here. We should find out in the next two months.

I would also note that my long position in Polished is relatively small and more of a tracking position at this point given the risk of total loss.