UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q/A

(Amendment No. 1)

 

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2020
or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from_______________________________________________to________________________________________________

 

Commission File Number: 000-1695962

 

KORTH DIRECT MORTGAGE INC

(Exact name of registrant as specified in its charter)

 

Florida		27-0644172
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

2937 SW 27th Avenue, Suite 307, Miami FL 33133

(Address of principal executive offices)

(305) 668-8485

(Registrant’s telephone number, including area code)

 

____________________________________________________________________

(Former name, former address and formal fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      ☒ Yes   ☐ No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).      ☒ Yes   ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

  

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	Smaller Reporting company	☒
		Emerging growth company	☒

  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes  ☐ No ☒

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Securities registered pursuant to Section 12(b) of the Act: None.

 

As of March 31, 2020 there were 5,000,000 shares of Common Stock of Korth Direct Mortgage Inc. outstanding.

 

 

 

EXPLANATORY NOTE

 

Korth Direct Mortgage Inc. (the “Company”) is filing this Amendment No. 1 (this “Amendment”) to its Quarterly Report on Form 10-Q, originally filed with the U.S. Securities and Exchange Commission (the “SEC”) on June 29, 2020 (the “Original Form 10-Q”), solely to disclose (i) that the Company had filed the Original Form 10-Q after the May 14, 2020 deadline otherwise applicable to such filing (the “Original Deadline”) in reliance on the 45-day extension provided by an order issued by the SEC under Section 36 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), dated March 4, 2020 (Release No. 34-88318), as modified and superseded by a new SEC order issued on March 25, 2020 (Release No. 34-88465) (collectively, the “Order”); and (ii) the reasons why the Company could not file the Original Form 10-Q on a timely basis before the Original Deadline, as described below.

 

On May 15, 2020, the Company filed a Current Report on Form 8-K with the SEC (the “Form 8-K”) to indicate its intention to rely on the Order for a filing extension in connection with the Company’s filing of the Original Form 10-Q. Consistent with the Company’s statements made in the Form 8-K, the Company was unable to file the Original Form 10-Q prior to the Original Deadline. In particular, the economic downturn and volatility in the financial markets has caused severe disruptions in the Company’s operating and financing activities, including travel restrictions and limited support from staff and professional advisors. The Company has been following the recommendations of local government and health authorities to minimize exposure risk for its employees for the past several months, including having employees work remotely, and, as a result, the Original Form 10-Q was not able to be completed by the filing deadline, due to insufficient time to facilitate the internal and external review process.

 

In accordance with Rules 12b-15 and 13a-14 under the Exchange Act, the Company has also amended Part II, Item 6 to include currently dated certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 from the Company’s principal executive officer and principal financial officer. Because no financial statements have been included in this Amendment, and this Amendment does not contain or amend any disclosure with respect to Items 307 and 308 of Regulation S-K, paragraphs 3, 4 and 5 of the certifications have been omitted. Similarly, because no financial statements have been included in this Amendment, certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 have been omitted.

 

Except as described above, this Amendment does not modify or update disclosures in, or exhibits to, the Original Form 10-Q. Furthermore, this Amendment does not change any previously reported financial results, nor does it reflect events occurring after the filing of the Original Form 10-Q. Accordingly, this Amendment should be read in conjunction with the Original Form 10-Q and the Company’s filings with the SEC subsequent to the filing of the Original Form 10-Q.

 

 

TABLE OF CONTENTS

 

 

PART I – FINANCIAL INFORMATION

 

Item 1.	Financial Statements	4
	Unaudited Statements of Financial Condition	4
	Unaudited Statements of Operations	5
	Unaudited Statements of Cash Flows	6
	Unaudited Statement of Changes in Stockholder’ Equity	7
	Notes to Unaudited Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	17
Item 4.	Controls and Procedures	17
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	18
Item 1A.	Risk Factors	18
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	18
Item 3.	Defaults Upon Senior Securities	18
Item 4.	Mine Safety Disclosures	18
Item 5.	Other Information	18
Item 6.	Exhibits	19
SIGNATURES		19

 

 

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF FINANCIAL CONDITION

 

		March 31, 2020				December 31, 2019
		(Unaudited)
ASSETS
Cash and Cash Equivalents		$	2,683,058			$	2,378,716
Restricted Cash			9,722,418				1,295,242
Mortgages Owned			90,583,473				85,692,812
Mortgage Servicing Rights, at Fair Value			2,880,391				2,595,946
Portfolio Loans			1,608,969				2,152,835
Accounts Receivable			-				62,581
Securities			99,710				-
Prepaid Expenses			40,956				10,584
TOTAL ASSETS		$	107,618,975			$	94,188,716
LIABILITIES AND  STOCKHOLDER'S EQUITY
LIABILITIES
Due to Parent		$	59,176			$	12,151
Escrows Payable			1,195,534				1,174,747
Due to Investors			126,884				120,496
Preferred Dividend Payable			12,500				12,500
Deferred Revenue, net			286,986				289,569
Deferred Tax Liability			430,085				380,236
Accrued Expenses			21,356				66,945
Mortgage Secured Notes Payable			98,983,473				85,692,812
Accounts Payable			6,962				14,234
Total Liabilities			101,122,956				87,763,690
STOCKHOLDERS' EQUITY
Accumulated Earnings			1,003,694				939,154
Additonal Paid-in Capital			5,491,625				5,485,172
Common Stock, $0.0001 par value, 60,000,000 shares authorized
5,000,000 shares issued and outstanding at March 31, 2020
and December 31, 2019			500				500
Series A Preferred Stock, $0.001 par value, 40,000,000 shares authorized,
200,000 shares issued and outstanding at March 31, 2020
and December 31, 2019			200				200
Total Stockholders' Equity			6,496,019				6,425,026
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY		$	107,618,975			$	94,188,716

 

See accompanying notes to the unaudited financial statements.

 

 

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF OPERATIONS

FOR THE PERIOD FROM JANUARY 1 THROUGH MARCH 31

 

		For the Three Months Ended				For the Three Months Ended
		March 31, 2020				March 31, 2019
REVENUES
Origination Revenue, Net		$	86,787			$	18,094
Servicing Revenue			209,505				4,116
Processing Revenue			-				1,500
Interest Income			52,345				270
Late Fees			8,119				5,119
Total Revenues			356,756				29,099
COST OF REVENUES
Broker Underwriting Expense			41,272				11,682
Mortgage Broker Expense			47,647				1,667
Co-Manager Engagement Fee			877				58
Bank Fees			1,041				2,702
Appraisal Costs			421				1,612
Marketing			14,971				3,360
License and Registration			6,781				595
Insurance Review			1,000				-
Ratings			320				5,398
Technology Fees			9,968				2,055
Total Cost of Revenues			124,298				29,129
GROSS PROFIT (LOSS)			232,458				(30	)
OPERATING EXPENSES
Office Supplies			3,994				642
Accounting			15,620				5,500
Salaries			236,225				86,295
Payroll Taxes			15,285				4,372
Heath Insurance			(338	)			-
Professional & Legal			29,293				92
Travel & Entertainment			5,605				7,919
Tradeshow Expense			8,454				-
Business Insurance			6,112				-
Business Development			-				1,171
Stock Compensation			6,453				-
Total Expenses			326,703				105,991
Net Loss From Operations			(94,245	)			(106,021	)
Other Income / (Loss)
Unrealized Gain on Mortgages			284,445				399,525
Unrealized Loss on Mortgage Security Note			(811	)			-
Gain from Write-Off Due to Parent			-				548,802
Total Other Income			283,634				948,327
Net income before provision for income taxes			189,389				842,306
Provision for income taxes			49,849				-
Net Income			139,540				842,306
Series A Preferred Dividends			75,000				-
Net income attributable to common stockholders		$	64,540			$	842,306

 

See accompanying notes to the unaudited financial statements.

 

 

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF CASH FLOWS

 

		For the Three Months Ended				For the Three Months Ended
		March 31, 2020				March 31, 2019
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income		$	139,540			$	842,306
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Unrealized Gain on Mortgages Owned			(284,445	)			(399,525	)
Unrealized Loss on Mortgage Security Notes			811
Gain from Write-Off of Due to Parent			-				(548,802	)
Stock compensation expense			6,453				-
Deferred income taxes			49,849				-
Changes in Operating Assets and Liabilities:
Restricted Cash			(8,427,176	)			(67,444	)
Mortgage Secured Notes Issued			13,290,661				14,535,047
Mortgage Secured Notes Purchased			(100,521	)			-
Portfolio Loans			543,866				-
Accounts Receivable			62,581				-
Prepaid Expenses			(30,372	)			-
Due to Parent			47,025				54,680
Deferred Revenue, net			(2,583	)			79,454
Escrow Payable			20,787				68,566
Due to Investors			6,388				(1,121	)
Accrued Expenses			(45,589	)			5,500
Accounts Payable			(7,272	)			-
New Mortgage Lending			(4,890,661	)			(14,535,047	)
Total Adjustments			239,802				(808,692	)
NET CASH PROVIDED BY OPERATING ACTIVITIES			379,342				33,614
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of Series A preferred stock dividends			(75,000	)			-
NET CASH USED IN FINANCING ACTIVITIES			(75,000	)			-
NET INCREASE IN CASH AND CASH EQUIVALENTS			304,342				33,614
CASH AND CASH EQUIVALENTS – Beginning of Period			2,378,716				15,323
CASH AND CASH EQUIVALENTS – End of Period		$	2,683,058			$	48,937

 

See accompanying notes to the unaudited financial statements.

 

 

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

 

		Series A Preferred Stock								Common Stock								Additional Paid				Accumulated
		Shares				Amount				Shares				Amount				in Capital				Earnings				Totals
Balance at January 1, 2020			200,000			$	200				5,000,000			$	500			$	5,485,172			$	939,154			$	6,425,026
Options issued to employees and directors			-				-				-				-				6,453				-				6,453
Series A preferred stock dividends declared			-				-				-				-				-				(75,000	)			(75,000	)
Net income			-				-				-				-				-				139,540				139,540
Balance at March 31, 2020			200,000			$	200				5,000,000			$	500			$	5,491,625			$	1,003,694			$	6,496,019

 

See accompanying notes to the unaudited financial statements.

 

KORTH DIRECT MORTGAGE INC

NOTES TO UNAUDITED FINANCIAL STATEMENTS

 

NOTE 1 - NATURE OF BUSINESS

 

Korth Direct Mortgage Inc. (the “Company”) is incorporated in the State of Florida. The Company is a wholly owned subsidiary of J. W. Korth & Company Limited Partnership (“J. W. Korth”), an SEC and FINRA registered broker dealer. The Company was created to originate mortgages and fund those mortgages with notes secured by mortgage loans. 

 

The Company and J. W. Korth & Company executed a support agreement that provides financial, managerial, and office support to the Company until it is fully operational. Pursuant to this agreement, for any moneys owed by the Company to J. W Korth, J. W. Korth may not seek reimbursement from the Company until the Company shall maintain a liquid net worth of at least $1,000,000 for a minimum period of 90 days.

 

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with US generally accepted accounting principles (“GAAP”) have been condensed or omitted. These audited financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 2019 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

PRINCIPLES OF CONSOLIDATION

The accompanying financial statements are solely for the Company. The financial statements of the parent company, J. W. Korth, have these accounts consolidated within them.

 

BASIS OF ACCOUNTING

The accompanying financial statements have been prepared on the accrual basis of accounting, in accordance with GAAP.

 

USE OF ESTIMATES

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

CASH AND CASH EQUIVALENTS

For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.

 

MORTGAGE VALUATION

Mortgages that are current are carried at the principal value owed by the borrower, as of the date of the financial statements, according to the amortization schedule for the loan. All mortgages owned as of the date of these financial statements are current. The net present value of the servicing revenue is recorded as mortgage servicing rights, at fair value on the Statements of Financial Condition, and is recognized on the Statement of Operations as an unrealized gain on mortgages.

 

MORTGAGE SECURED NOTES

The Company funds the mortgage loans that it makes by issuing Mortgage Secured Notes (“MSNs”), which are secured by those same mortgages. As of the date of these financial statements, the Company has funded loans totaling $90,583,473 and it issued MSNs secured by those loans, in the amount of $98,983,473. There was a single loan that closed after the quarter end, leading to the excess value of MSNs compared to Mortgages Owned of approximately $8,500,000. The loan was completed and funded on April 3, 2020. The deals have been funded in multiple ways, including private placements, SEC registered deals, and 144A offerings.

 

PORTFOLIO LOANS

The Company recognizes loans made with its own capital, or those not securitized, under the caption “Portfolio Loans” on the balance sheet. As of March 31, 2020, the Company had issued Portfolio Loans in the amount of $1,608,969. These loans were funded by the Company, as well as affiliates.

 

 

REVENUE RECOGNITION

The Company has four primary sources of revenue: origination fees, servicing fees , processing fees, and interest income.

 

Origination Fees

Loan origination fees represent revenue earned from originating mortgage loans; net of any credits given to the borrower. Loan origination fees generally represent flat, per-loan fee amounts and are deferred and recognized as revenue over the life of the loan. The associated loan origination costs are also deferred and recognized as expense over the life of the loan. The deferred portion of the loan origination fees is netted against the deferred portion of the loan origination costs, which include mortgage broker expenses, and reported as a net deferred revenue liability on the Company’s Statement of Financial Condition.

 

Servicing Fees

Loan servicing fees represent revenue earned for servicing loans for various investors. Loan servicing fees are a percentage of the outstanding unpaid principal balance and represent the difference between the CM Loan interest received and the MSN interest payable. Servicing fees are recognized as revenue as the related mortgage payments are received; similarly, loan servicing expenses are charged to operations as incurred.

 

Processing Fees

Processing fees are collected from the borrower at the time the commitment letter is signed and cover a variety of expenses during the underwriting process. If the Company cancels the transaction, then unused fees are refunded. If the transaction is unable to proceed for any reason not the fault of the Company, then the Company keeps the full processing fee. Revenues from processing fees are recognized at closing or at the time a transaction is canceled.

 

Interest Income

Revenue that falls under this caption is primarily derived from interest earned on Portfolio Loans. Interest earned on cash and securities also falls under this caption.

 

STOCK-BASED COMPENSATION

The Company estimates the fair values of share-based payments on the date of grant using a Black-Scholes option pricing model. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The Company’s accounting policy is to recognize forfeitures as they occur.

 

The Black-Scholes option pricing model requires assumptions for the expected volatility of the share price of our common stock, the expected dividend yield, and a risk-free interest rate over the expected term of the stock-based award. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

 

Unrealized Gain on Mortgages Owned

The net present value of the servicing income is recognized at the time the mortgage is initiated. This value uses several inputs that are highly subjective including: discount rate, prepayment rate, the current interest rate environment, and default rate assumptions. Since the Company has a short operating history and a small number of loans outstanding, we have a limited basis to predict prepayment rates and default rates.

 

ESTIMATES

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

DUE TO PARENT AND PAYABLES

Items due to parent are operating expenses due to the parent company for salaries, credit cards, and other business expenses . Amounts are reconciled and paid off monthly and balances in this account are due to timing.

 

 

INCOME TAXES 

On June 6, 2019, the Company converted from a Florida limited liability company into a Florida corporation. Effective with the conversion into a Florida corporation, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance on deferred tax assets is established when management considers it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

Tax benefits from an uncertain tax position are only recognized if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Interest and penalties related to unrecognized tax benefits are recorded as incurred as a component of income tax expense.

 

NOTE 3 - CORRECTION OF PRIOR PERIOD ACCOUNTING ERROR

 

During the preparation of the Company’s 2019 financial statements, the Company identified an accounting error related to the recognition of revenue and expenses associated with loan origination fees and the corresponding loan origination costs. In prior periods, the loan origination fees and the corresponding loan origination costs were recognized as revenue and expense at the time the loans were funded. However, the proper accounting, according to generally accepted accounting principles, is to defer these revenues and expenses at the time of funding and recognize the revenue and expenses over the life of the respective loans.

 

The Company assessed the materiality of the accounting error and determined that the prior period financial statements were not materially misstated as a result of the accounting error. Accordingly, the Company has elected to correct the error in the current year comparative financial statements by adjusting the prior period information presented and disclosing the impact on the prior period’s financial statements within the footnotes of the current period financial statements.

 

The financial statement impacts of the accounting error on the interim period ended March 31, 2019, are summarized as follows:

 

STATEMENT OF OPERATIONS For the Three Months ended March 31, 2019:		As Previously Reported				Prior Period Impact				Revised Amounts
Revenues:
Origination Revenues, net		$	493,825			$	(475,731	)		$	18,094
Total Revenues			504,830				(475,731	)			29,099
Cost of Revenues:
Broker Underwriting Expense			181,775				(170,093	)			11,682
Mortgage Broker Expense			203,025				(201,358	)			1,667
Co-Manager Engagement Fee			-				58				58
Appraisal Costs			1,195				417				1,612
Ratings			26,000				(20,602	)			5,398
Total Cost of Revenues			420,707				(391,578	)			29,129
Gross Profit (Loss)			84,123				(84,153	)			(30	)
Operating Expenses:
Professional and Legal			4,791				(4,699	)			92
Total Operating Expenses			110,690				(4,699	)			105,991
Net Loss from Operations			(26,567	)			(79,454	)			(106,021	)
Total Other Income			948,327				-				948,327
Net Income		$	921,760			$	(79,454	)		$	842,306

 

 

NOTE 4 - RESTRICTED CASH

 

The Company maintains two segregated accounts in trust for borrowers and investors. The value of these accounts is carried under the asset “Restricted Cash.”

 

The “In Trust for 1” account holds the monthly tax and insurance payments collected from borrowers and distributes payments annually, on behalf of borrowers, to the appropriate tax authority and insurance companies. This account corresponds to the Escrow Payable liability. As of March 31, 2020, this account has a balance of $1,148,219.

 

The “In Trust for 2” account receives payments from borrowers, distributes payments to investors, and pays the servicing fee to the Company. This account corresponds to the Due to Investors liability. As of March 31, 2020, this account has a balance of $8,526,884 (commitment fees/accrued interest), which includes a balance of $8,500,000 pending closing of a loan. 

 

NOTE 5 - COMMITMENTS

 

The Company relies entirely on its parent, J. W. Korth, to provide office space, internet connectivity, phone service, and incidentals through mid-2019. The Company is currently negotiating a lease for new office space, which it expects to move into in the third quarter of 2020.

 

NOTE 6 - INDEMNIFICATIONS

 

The Company provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. These indemnifications generally are standard contractual terms and are entered into in the normal course of business. The maximum potential amount of future payments that the Company could be required to make under these indemnifications cannot be estimated. However, the Company believes that it is unlikely it will have to make material payments under these arrangements and has not recorded any contingent liability in the financial statements for these indemnifications.

 

NOTE 7 - CUSTOMERS

 

As of March 31, 2020, the Company had thirteen customers. The Company defines customers as borrowers that have an active loan with the Company, or are in the midst of the underwriting process and have a commitment fee on deposit with the Company. Further, we have a concentration of customers where one borrower accounts for 51% of our total loans outstanding with two loans adding up to $47 million. Currently, 48% of the loans, by unpaid balance, are geographically concentrated in the state of Ohio.

 

NOTE 8 – RELATED PARTY TRANSACTIONS

 

The Due to Parent account is used to account for bills and expenses paid by J. W. Korth on behalf of the Company. The Company was largely supported by its parent company, J. W. Korth, from inception through late 2019. The Company owed J. W. Korth $548,802 on March 30, 2019; however, this debt was forgiven as of March 31, 2019, pursuant to an agreement dated May 1, 2019, between J. W. Korth and the Company. The cancellation of this liability resulted in a one-time gain, which is included on the Unaudited Statements of Operations for the three months ended March 31, 2019. The Company owed J.W. Korth $59,176 and $12,151 as of March 31, 2020, and December 31, 2019, respectively.

 

The Company paid underwriting fees of $41,272 and $181,775 to J. W. Korth & Company for the three months ended March 31, 2020 and 2019, respectively. J. W. Korth has been the initial purchaser of all the mortgage security notes for the three months ended March 31, 2020.

 

The Company also purchased an MSN in the amount of $100,000 shown on the statement of financial condition as Securities.

 

NOTE 9 – DEFERRED REVENUE, NET

 

Loan origination fees are deferred and recognized as revenue over the life of the respective loan. The associated loan origination costs are also deferred and recognized as expense over the life of the loan. The deferred portion of the loan origination fees is netted against the deferred portion of the loan origination costs and reported as a net deferred revenue liability on the Company’s Statement of Financial Condition.

 

 

The following is a summary of the loan originating fees and costs deferred and amortized for the three months ended March 31, 2020:

 

			Deferred Origination Fees				Deferred Origination Costs				Deferred Revenue, net
Deferred Revenue at December 31, 2019		$	1,849,100			$	(1,559,531	)		$	289,569
New loan deferrals			100,000				(87,375	)			12,625
Amortization of deferrals			(86,787	)			71,579				(15,208	)
Deferred Revenue at March 31, 2020			1,862,313				(1,575,327	)			286,986

 

NOTE 10 – EMPLOYEE AND DIRECTOR STOCK OPTIONS

 

On June 28, 2019, the Company’s Board of Directors adopted the 2019 Stock Option Plan (the “Incentive Plan”). The Incentive Plan provides for the grant of both incentive and non-statutory stock options to key employees, directors or other persons having a service relationship with the Company for the purchase of up to an aggregate of 1,000,000 shares of the Company’s unissued, or reacquired, common stock, $0.001 par value. The Plan will be administered by the Board of Directors or a committee appointed by the Board.

 

In June 2019, the Company issued options to purchase 835,000 shares of the Company’s common stock at an exercise price of $1.00 per share. The weighted-average grant date fair values of options granted was $0.1855 per share. The fair values of the stock-based awards granted were calculated with the following weighted-average assumptions:

 

		2019 and Q1 2020
Risk-free interest rate:		1.76%
Expected term:		5.75 years
Expected dividend yield:		0%
Expected volatility:		35.01%

 

For the three months ended March 31, 2020, the Company recorded $6,453 of stock-based compensation expense. As of March 31, 2020, there was $58,087 in total unrecognized compensation expense related to non-vested employee stock options granted under the Incentive Plan, which is expected to be recognized over 2.25 years.

 

Stock option activity for the three months ended March 31, 2020, is summarized as follows:

 

2019 Stock Option Plan:		Shares				Weighted Average Exercise Price				Weighted Remaining Contractual Life (Years)
Options outstanding at January 1, 2020			835,000			$	1.00				9.5
Granted			-
Exercised			-
Expired or forfeited			-
Options outstanding at March 31, 2020			835,000			$	1.00				9.25
Options exercisable at March 31, 2020			417,500			$	1.00				9.25
Options expected to vest at March 31, 2020			417,500			$	1.00				9.25

 

NOTE 11 – PREFERRED EQUITY

 

On September 27, 2019, the Company issued 200,000 shares of its Series A 6% Cumulative Perpetual Convertible Preferred Stock for net proceeds of $4,750,000. The Company paid $250,000 in expenses related to the preferred stock issuance to J. W. Korth as underwriter and distributor. Each share was sold for $25, and is convertible into common stock at a ratio of 5 shares of common stock for each share of Series A Preferred Stock. 

 

 

NOTE 12 – FAIR VALUE

 

FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not assumptions specific to the entity.

 

ASC 820 establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

 

Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

 

Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

 

ASC 820 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurements. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

 

Valuation Process

 

Cash and cash equivalents: 

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

 

Mortgages Owned and Mortgage Secured Notes Payable:

Mortgage loans for which the Company has the intention and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding principal balances, net of any unearned income, premiums or discounts. If a decline in fair value below the carrying balance is other-than-temporary, an unrealized impairment loss is recorded and the loan is recorded at the lower fair value at each reporting period. To-date, the Company has not recorded any impairment losses related to the mortgage loans.

 

Due to the fact that the Company issues notes secured directly by underlying loans, our assets and liabilities in this category have identical values and assets have offsetting balances. The MSN for $8.4 million is recorded in the restricted cash due to timing difference because the Note was issued before the investment was made.

 

Mortgage Servicing: 

The net present value of the servicing income is recognized at the time the mortgage is initiated as an unrealized gain. This value uses several inputs that are highly subjective including: discount rate, constant prepayment rate, the current interest rate environment, and default rate assumptions. Since the Company has limited operating history and a small amount of loans outstanding, we have a limited basis to predict prepayment rates and default rates, but have engaged a third party, MIAC Analytics, to assist us in our valuation of this asset. The amount is included on the Unaudited Statement of Financial Condition as “Mortgage Servicing Rights, at Fair Value.” 

 

Mortgage Secured Notes Receivable:

From time to time the Company may buy-back mortgage secured notes previously issued to investors. These securities are available for sale, but may be held until maturity. These securities are recorded at fair value each quarter with the change in fair value recognized as an unrealized gain or loss each reporting period. The fair value estimate uses several inputs that are highly subjective including: discount rate, constant prepayment rate, the current interest rate environment, and default rate assumptions. Since the Company has limited operating history and a small amount of loans outstanding, we have a limited basis to predict prepayment rates and default rates, but have engaged a third party, MIAC Analytics, to assist us in our valuation of this asset.

 

 

Fair Value Disclosure

 

The following tables display the Company’s assets and liabilities measured at fair value on a recurring basis:

 

		March 31, 2020
		Total				Level I				Level II				Level III
Financial Assets
Mortgages Owned		$	90,583,473			$	-			$	90,583,473			$	-
Mortgage Servicing		$	2,880,391			$	-			$	-			$	2,880,391
Securities			99,710				-				-				99,710
Total Financial Assets		$	93,563,574			$	-			$	90,583,473			$	2,980,101
Financial Liabilities
Mortgage Secured Notes Payable		$	98,983,473			$	-			$	98,983,473			$	-

 

		December 31, 2019
Financial Assets
Mortgages Owned		$	85,692,812			$	-			$	85,692,812			$	-
Mortgage Servicing			2,595,946				-				-				2,595,946
Total Financial Assets		$	88,288,758			$	-			$	85,692,812			$	2,595,946
Financial Liabilities
Mortgage Secured Notes Payable		$	85,692,812			$	-			$	85,692,812			$	-

 

Fair Value Measurements

 

Changes in Fair Value Measurements for the three months ended March 31, 2020

 

The following table presents a reconciliation of changes in Level 3 assets and liabilities reported in the Statements of Financial Condition for the three months ended March 31, 2020:

 

Changes in assets:
Period ended March 31, 2020		Mortgage Servicing Value				Securities				Total Value
Beginning balance at January 1, 2020		$	2,595,946			$	-			$	2,595,946
Purchases			-				100,000				100,000
Sales			-				-				-
Issues			-				-				-
Settlements			-				-				-
Net realized gain/loss or Interest income			-				521				521
Unrealized Gain from newly issued mortgages			459,647				-				459,647
Fair Value adjustment			(175,202	)			(811	)			(176,013	)
Transfers into Level 3			-				-				-
Transfers out of Level 3			-				-				-
Ending balance at March 31, 2020		$	2,880,391			$	99,710			$	2,980,101

 

 

The Company’s policy for recording transfers between levels of the fair value hierarchy is to recognize as of the financial statement date. For the three months ended March 31, 2020, there were no transfers between levels.

 

The Company has established valuation processes and policies for its Level 3 investments to ensure that the methods used are fair and consistent in accordance with ASC 820 – Fair Value Measurements and Disclosures. The Company’s valuation committee performs reviews of the Level 3 investments’ valuations, which include reviewing any significant price changes reported from the prior period. When a Level 3 investment has a significant price change, the valuation committee reviews relevant market data to substantiate the price change.

 

The following table presents quantitative information regarding the significant unobservable inputs the Company uses to determine the fair value of Level 3 investments held as of March 31, 2020:

 

Investment type		Fair Value				Valuation technique		Unobservable inputs		Values
Mortgage servicing		$	2,880,391			Net Present Value		Prepayment Discount			13.06	%
								Discount rate			15.00	%

 

NOTE 13 – INCOME TAXES

 

The provision for income taxes was $49,849 for the three months ended March 31, 2020. The effective tax rate was approximately 26% of the income before income taxes of $189,389, which differs from the federal statutory rate of 21% due to the effect of state income taxes and certain of the Company’s expenses that are not deductible for tax purposes.

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following is a discussion of our historical consolidated financial condition and results of operations, and should be read in conjunction with (i) our historical consolidated financial statements and accompanying notes thereto included elsewhere in this Quarterly Report on Form 10-Q; (ii) our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission (the “SEC”) on May 14, 2020; and (iii) our management’s discussion and analysis of financial condition and results of operations included in our 2019 Form 10-K. This discussion includes forward-looking statements that are subject to risk and uncertainties. Actual results may differ substantially from the statements we make in this section due to a number of factors that are discussed in “Forward-Looking Statements” herein and “Part I – Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2019.

 

Overview

 

Korth Direct Mortgage Inc. (“KDM,” the “Company,”,“we,” or “us”) was organized in Florida on July 24, 2009, under the name HCMK Consulting LLC. We changed our name to Korth Direct Mortgage, LLC, on August 24, 2016.  On June 3, 2019, we converted from a limited liability company to a corporation, Korth Direct Mortgage Inc. Concurrently with our conversion into a corporation, James W. Korth was named Chief Executive Officer, Holly MacDonald-Korth was named President and Chief Financial Officer, and we appointed a board of directors.

 

Our principal executive offices are located at 2937 SW 27^th Avenue Suite 307, Miami, Florida 33133, and our telephone number is (305) 668-8485. Our website address is www.korthdirect.com.

 

KDM began its formal operations in October of 2016 when we engaged our Chief Lending Officer. We are a licensed in Florida as a Mortgage Lender Servicer. Our NMLS License Number is 1579547. Our operating history is limited. As of March 31, 2020, we were wholly owned by J. W. Korth & Company, L.P. (“J.W. Korth & Company”), a FINRA and SEC registered broker-dealer founded in 1982. We believe we will become independent from our parent company by the end of 2020. We do not anticipate incurring any research and development expenses nor expenses for plant and equipment, and that office space will continue to be shared with our parent company during calendar year 2020. We anticipate renting office space in 2020 and adding support staff by the end of that year as our lending and servicing activities require. 

 

For the quarter ended March 31, 2020, KDM owed J W Korth & Company $59,176, as part of inter-company receivables. The Support Agreement remains in place.

 

Results of Operations for the Three Months ended March 31, 2020

 

The Company generated revenues of $356,756 for the three months ended March 31, 2020, an increase of $327,657 compared with revenues of $29,099 for the three months ended March 31, 2019. The increase in revenues (originating fees, servicing revenue, and interest income) was due to an increase of $62.9 million in mortgages owned and serviced from March 31, 2019, to March 31, 2020. As of March 31, 2020, the Company owned mortgages of $90,583,473 compared with mortgages of $27,708,513 as of March 31, 2019.

 

Gross profits increased by $232,488 to $232,458 during the three months ended March 1, 2020, compared with a gross loss of $30 during the three months ended March 31, 2019. The increase in gross profits was primarily attributed to the increase in the amount of mortgages serviced during the first quarter of 2020 with lower levels of mortgage related costs as a percentage of revenues, which generated higher gross margins.

 

Operating expenses were $326,703 during the three months ended March 31, 2020, which was an increase of $220,712 compared with operating expenses of $105,991 during the three months ended March 31, 2019. The increase in operating expenses was the result of increases of $160,505 in payroll related costs, $39,321 in accounting, professional and legal fees, $14,433 in other operating expenses, and $6,453 in non-cash stock compensation expense to support the growth of the overall business.

 

Other income decreased by $664,693 to $283,634 during the three months ended March 31, 2020, compared with other income of $948,327 during the three months ended March 31, 2019. The majority of the decrease in other income was due to the forgiveness of $548,802 of debt due to J. W. Korth & Company, our parent company, during the three months ended March 31, 2019. In addition, unrealized gain on mortgages decreased by $115,080 during the first quarter of 2020 compared with the first quarter of 2019.

 

 

In June 2019, the Company transitioned from a limited liability company to a C-corporation. Beginning in June 2019, the Company began recording a provision for income taxes. During the three months ended March 31, 2020, the Company recorded $49,849 in income tax expense. 

 

Net income decreased $702,766 to $139,540 for the three months ended March 31, 2020, compared with net income of $842,306 during the three months ended March 31, 2019. The decrease in 2020 was primarily attributed to the decrease in other income of $664,693, born largely by a one time gain from debt forgiveness from J W Korth & Company in March 2019. There was also an increase of $49,849 in income taxes, which were partially offset by an increase of $11,776 in income from operations generated during the first quarter of 2020 compared with the first quarter of 2019.

 

Financial Condition for the three Months Ended March 31, 2020

 

As of March 31, 2020, we had $2,683,058 in cash, thirteen loans totaling $92,192,442, consisting of $90,583,473 in mortgages and $1,608,969 in portfolio loans, and Mortgage Servicing Rights with a fair value of $2,880,391 on our balance sheet. 

 

On September 27, 2019, we completed our first round of equity funding by an issuance of $5,000,000 Series A 6% Cumulative Perpetual Convertible Preferred Stock. The proceeds of sale of this preferred equity allow us to have a reserve for advancing payments to noteholders, providing additional funding to our borrowers, and capital needed for accelerating growth of the Company.

 

Capital and Liquidity Needs

 

The Company completed a $5,000,000 (less issue costs of $250,000) Series A 6% Cumulative Perpetual Convertible Preferred Stock in September 2019. We expect to raise additional preferred capital, as necessary, in 2020 and succeeding years.

 

The Company is also looking to secure lines of credit and lender financing in forms that will comply with our no-debt covenants of our trust indentures, but allow us the flexibility to continue to grow the business. 

 

Status of KDM Loans

 

We post the annual reviews of each of our CM Loans on the korthdirect.com website along with any pertinent updates. All CM Loans are currently performing although one loan triggered its lockbox and entered a forbearance agreement, that loan is performing under the lockbox.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We have no instruments subject to market risk.

 

Item 4. Controls and Procedures.

We are responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined by Securities Exchange Act Rule 13a-15(f). Our internal controls are designed to provide reasonable assurance as to the reliability of our financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

 

Internal control over financial reporting has inherent limitations and may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable, not absolute, assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

 

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our internal control over financial reporting as of March 31, 2020, as required by Securities Exchange Act Rule 13a-15(c). In making our assessment, we have utilized the criteria set forth by the 2013 Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We concluded that based on our evaluation our internal control over financial reporting was effective as of March 31, 2020.

 

  

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings.

The Company is not subject to any material legal proceeding. The Company is a defendant in a suit regarding a mortgage brokerage fee dispute. The Company is fully indemnified for the suit by the borrower in the transaction which is the subject of the suit. We do not believe that the proceeding is material under Item 103 of SEC Regulation S-K.

 

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. Please refer to the “Risks Factors” section in our Annual Report for a discussion of risks to which our business, financial condition, results of operations and cash flows are subject.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

Not applicable.

 

Item 3. Defaults Upon Senior Securities.

None.

 

Item 4. Mine Safety Disclosures.

Not Applicable.

 

Item 5. Other Information.

None.

 

 

Item 6. Exhibits

 

Exhibit
Number
31.1	Section 302 Certification of Chief Executive Officer*
31.2	Section 302 Certification of Chief Financial Officer*
101.	Interactive Data File**

 

* Filed herewith

** Previously Filed

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	KORTH DIRECT MORTGAGE INC.
Dated: July 9, 2020	By:	/s/ James W. Korth
		James W. Korth, Chief Executive Officer

 

 

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