This information was all included at the end of a long post earlier today, but, in retrospect, I buried the lede. So here it is again, on it’s own. Sitestar(SYTE) borrowed money from CEO Frank Erhartic’s mother at an interest rate that was 8% in one filing and 10% in one much later. At both times, prevailing interest rates were far lower, and the company had more than enough cash on hand to pay off the loan. The company never disclosed the loan was to the CEO’s mother- a fact I only learned about in an email from the CEO.
I had seen the following note in the company’s 10-Q for the third quarter of 2013:
NOTE 11 – NOTES PAYABLE – STOCKHOLDERS
Notes payable – stockholders at September 30, 2013 and December 31, 2012 consist of the following:
2013 2012 Note payable to officer and stockholder on a line of credit of $750,000 at an annual interest rate of 10%. The accrued interest and principal are due on January 1, 2020. $ 280 $ 280 Note payable to stockholder for $50,000 at an annual interest rate of 8% interest. The accrued interest and principal are due on January 1, 2020. 50,000 50,000 Totals 50,280 50,280 Less current portion — — Long-term portion $ 50,280 $ 50,280
Based on this I asked CEO Frank Erhartic for more information about the loan
Neal Shanske: I am also confused about the need for the company to borrow money, and pay above-market interest to, a director, presumably Mr. Ehrartic. Given the company’s surplus capital and below-market returns, why is the company paying interest on this loan rather than repaying it in full? If the company requires capital, I would think that non-recourse debt secured against real estate would be a preferable alternative.
Frank Erhartic: Actually, the loan outstanding is not my loan. It is my mother’s loan to the company when we needed it for acquisitions of real estate. All debt in the past was collateralized by me personally and personally guaranteed. This was to do acquisitions of Internet customers. Since Sitestar didn’t have any real amount of tangible assets a bank could loan on, I had to put up my properties. I shouldn’t have to do that now since we now have real estate to back up any loans. We have had the cash mostly to do what we have been doing and at some point, we can use the equity of the rental properties to purchase more and bigger deals. We are working on building that up so we can do just that.
As you can see, the CEO disclosed that the loan was from his mother. His explanation of it makes no sense, however, as the company had $120,852 in cash and $3,268,675 in real estate on its balance sheet.
By the time the 10K was filed several months later, Mr. Erhartic’s loan had been paid off, but was reported to have had a due date of January 1, 2014, and his mother’s loan had ballooned to $59,826 from $50,000.
At the end of the first quarter, the note had increased again to $60,990, but was omitted, somehow, from NOTE 5 on Notes Payable. By the end of Q2, it increased again, to $63,547, still with no mention in the footnote on Notes Payable. Q3 had the note rise only slightly, to $63,867, and again lacked mention in the footnote.
Finally, in the 10K for 2014, the note is shown as having been paid off during the 4th quarter, and the footnote has returned, but the interest rate somehow became 10%.
The fact that the shareholder who held the loan was a related party was never disclosed in any filing that I could find. The magically changing balance and magically changing interest rate are not documented anywhere, and there is no indication that the arrangement was approved by independent directors.
The Board should immediately begin an investigation into this loan and its reporting. In particular, it needs to determine
a) How did the due date on Mr. Erhartic’s loan change?
b) Was Mr. Erhartic’s loan properly documented?
c) How did the interest rate on Mr. Erhartic’s mother’s loan change?
d) What caused the balance of the the loan from Mr. Erhartic’s mother to rise through 2014?
e) Was the loan from Mr. Erhartic’s mother properly documented?
f) Was the reporting regarding the loan in the company’s filings in 2013 and 2014 proper? In particular, was the company remiss in not disclosing that the lender was a related party?
g) Are there now controls in place to prevent this from happening again?
h) If the Board determines there was improper behavior on the part of Mr. Erhartic and/or any other employee, what the appropriate sanction should be.
This investigation should be begun immediately and completed before the end of 2015.
The Board must demonstrate that it takes its responsibilities to shareholders seriously.
Disclosure: The author owns a significant stake in Sitestar
I wish I would have seen these post earlier to give Sitestar investors insight into company practices. As I am not an investor in the company, I have the unique advantage of living near one of Sitestar’s larger properties. When Mr. Erhartic initially bought this property, he immediately moved into the property while “renovations” were underway. Basically minial efforts were made to flip the property and in fact the property has deteriorated while Mr. Erhartic inhabited the property. The home owner’s association (HOA) of this neighborhood had to repeative enforce basic rules such has mowing the lawn and removing trash bins from curb. The fence on this property literally fell into disarray and the pool has gone from functional to eyesore. Mr. Erhartic moved out the property and left it sit unoccupied for the next couple years. He would have the lawn mowed once a month. This summer, Mr. Erhartic hired a couple to complete some renovations on the house. The fence was fixed and some cosmetic work was performed. According to this husband and wife team, Mr. Erhartic routinely employs them to work on various properties only to pull them off the jobsite when repairs are nearing completion. The also stated Mr and Mrs Erhartic (who was previously on the board of directors) were in the process of a divorce and he was waiting for the divorce to finalize before selling off the property. The work was started in the spring of 2015, then abruptly stopped. I am not sure what kind of scheme Mr. Erhartic was running, but I feel sorry for people who invested in this company when it seems like he had a personal agenda ahead of business.
Being pulled off of unfinished properties was a common situation working for frank. Rental property was the worse. He would rent the property out and have the tenants moving in before completion. He would hire anyone off the streets and let them work on these houses with no supervision or direction allowing for many mistakes. There were very few permits pulled for the work on these houses which means there were no inspections on the work performed. I told frank many times the quality of the work was below par. Frank’s answer was for me to mind my f*cking business. That was it for me. I realized Frank is not capable of any kind of renovation of property. If I was an investor of Sitestar I would look at Frank’s personal properties to see if they were obtained using funds of Sitestar but putting properties in his name.
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