UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended September 30, 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		27-6044172
(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 September 30, 2020 there were 5,000,000 shares of Common Stock of Korth Direct Mortgage Inc. outstanding.

 

 

 

TABLE OF CONTENTS

 

 

PART I – FINANCIAL INFORMATION

 

Item 1.	Consolidated Financial Statements
	Unaudited Consolidated Statements of Financial Condition	4
	Unaudited Consolidated Statements of Operations	5
	Unaudited Consolidated Statements of Cash Flows	6
	Unaudited Consolidated Statement of Changes in Stockholders’ Equity	7
	Notes to Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Consolidated Operations	18
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	20
Item 4.	Controls and Procedures	20
	PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3.	Defaults Upon Senior Securities	21
Item 4.	Mine Safety Disclosures	21
Item 5.	Other Information	21
Item 6.	Exhibits	22
SIGNATURES		22

 

 

PART I—FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements.

 

KORTH DIRECT MORTGAGE INC

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

		September 30, 2020				December 31, 2019
		(Unaudited)
ASSETS
Cash and Cash Equivalents		$	2,750,917			$	2,378,716
Restricted Cash			13,700,505				1,295,242
Deposits			149,028				-
Mortgages Owned			125,448,182				85,692,812
Mortgage Servicing Rights, at Fair Value			3,432,430				2,595,946
Portfolio Loans			1,410,265				2,152,835
Accounts Receivable			34,367				62,581
Securities			327,848				-
ROU Leased Asset			145,333				-
Goodwill			110,000				-
Property & Equipment, Net of Depreciation			142,458				-
Prepaid Expenses			136,874				10,584
TOTAL ASSETS		$	147,788,207			$	94,188,716
LIABILITIES AND  STOCKHOLDERS' EQUITY
LIABILITIES
Due to Parent		$	-			$	12,151
Escrows Payable			6,195,406				1,174,747
Due to Investors			259,288				120,496
Due to Clearinghouse Brokers			192,725				-
Lease liability			145,333				-
Preferred Dividend Payable			12,500				12,500
Deferred Revenue, net			375,658				289,569
Deferred Tax Liability			535,088				380,236
Accrued Expenses			133,703				66,945
Contingent liability, net			762,962				-
PPP loan payable			161,600				-
Mortgage Secured Notes Payable			132,693,992				85,692,812
Accounts Payable			155,608				14,234
Total Liabilities			141,623,863				87,763,690
STOCKHOLDERS' EQUITY
Accumulated Earnings			1,149,458				939,154
Additional Paid-in Capital			5,014,186				5,485,172
Common Stock, $0.0001 par value, 60,000,000 shares authorized
5,000,000 shares issued and outstanding at September 30, 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 September 30, 2020
and December 31, 2019			200				200
Total Stockholders' Equity			6,164,344				6,425,026
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	147,788,207			$	94,188,716

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

KORTH DIRECT MORTGAGE INC

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE PERIOD FROM JANUARY 1 THROUGH SEPTEMBER 30

 

		For the Nine Months Ended				For the Nine Months Ended
		September 30, 2020				September 30, 2019
REVENUES
Origination Revenue, Net		$	299,794			$	151,357
Servicing Revenue			784,955				119,791
Processing Revenue			38,919				9,420
Underwriting Income			85,685				-
Trading Profits			223,987				-
Interest Income			130,763				790
Commissions			2,849				-
Late Fees			8,434				18,999
Total Revenues			1,575,386				300,357
COST OF REVENUES
Broker Underwriting Expense			147,428				63,099
Mortgage Broker Expense			181,904				36,751
Co-Manager Engagement Fee			2,640				1,246
Bank Transaction Fees			10,127				7,410
Appraisal Costs			16,069				3,259
Marketing			42,155				18,520
License and Registration			31,943				7,351
Insurance Review			1,000				-
Ratings			31,759				13,097
Technology Fees			50,374				4,377
Total Cost of Revenues			515,399				155,110
GROSS PROFIT			1,059,987				145,247
OPERATING EXPENSES
Office Supplies			14,176				2,850
Accounting			56,203				26,000
Salaries			973,355				227,538
Payroll Taxes			54,640				13,462
Other Payroll Related Costs			27,591				-
Professional & Legal			95,996				52,344
Rent Expense			17,311				-
Utilities			4,106				-
Travel & Entertainment			8,342				25,603
Tradeshow Expense			9,199				-
Business Insurance			31,274				-
Business Development			-				2,768
Depreciation			600				-
Stock Compensation			19,359				-
Total Expenses			1,312,152				350,565
Net Loss From Operations			(252,165	)			(205,318	)
Other Income / (Loss)
Unrealized Gain on Mortgages			836,484				1,232,433
Unrealized Loss on Mortgage Security Note			(839	)			-
Interest Expense			(6,963	)			-
Interest Income			3,639				-
Gain from Forgiveness of EIDL Advance			10,000				-
Gain from Write-Off Due to Parent			-				548,802
Total Other Income			842,321				1,781,235
Net income before provision for income taxes			590,156				1,575,917
Provision for income taxes			154,852				169,052
Net Income			435,304				1,406,865
Series A Preferred Dividends			225,000				2,500
Net income attributable to common stockholder		$	210,304			$	1,404,365

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

KORTH DIRECT MORTGAGE INC

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		For the Nine Months Ended				For the Nine Months Ended
		September 30, 2020				September 30, 2019
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income		$	435,304			$	1,406,865
Adjustments to Reconcile Net Income to
Net Cash Provided by/(Used in) Operating Activities:
Unrealized Gain on Mortgages Owned			(836,484	)			(1,232,433	)
Unrealized Loss on Mortgage Security Notes			839				-
Gain from Write-Off of Due to Parent			-				(548,802	)
Gain from forgiveness of EIDL advance			(10,000	)			-
Stock compensation expense			19,359				-
Depreciation			600				-
Deferred income taxes			154,852				169,052
Changes in Operating Assets and Liabilities:
Restricted Cash			(12,405,263	)			(4,494,631	)
Mortgage Secured Notes Issued			47,001,180				32,782,936
Mortgage Secured Notes Purchased			(101,717	)			-
Portfolio Loans			742,570				(460,000	)
Accounts Receivable			36,623				(130,000	)
Prepaid Expenses			(75,820	)			-
Deposits			(41,717	)			-
Due to Parent			(45,247	)			139,175
Deferred Revenue, net			86,089				159,829
Escrow Payable			5,020,659				266,735
Due to Investors			138,792				69,896
Due to clearinghouse brokers			92,805				-
Interest payable			6,963				-
Accrued Expenses			(40,965	)			30,409
Accounts Payable			76,618				-
Notes Payable			-				460,000
New Mortgage Lending			(39,755,370	)			(28,624,937	)
Total Adjustments			65,366				(1,412,771	)
NET CASH PROVIDED BY/(USED IN) OPERATING ACTIVITIES			500,670				(5,906	)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment			(132,610	)			-
Acquisition of related party affiliate, net of cash acquired			229,141				-
NET CASH PROVIDED BY INVESTING ACTIVITIES			96,531				-
CASH FLOWS FROM FINANCING ACTIVITIES
Net Proceeds from issuance of preferred stock			-				4,750,000
Payment of Series A preferred stock dividends			(225,000	)			-
NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES			(225,000	)			4,750,000
NET INCREASE IN CASH AND CASH EQUIVALENTS			372,201				4,744,094
CASH AND CASH EQUIVALENTS – Beginning of Period		$	2,378,716			$	15,323
CASH AND CASH EQUIVALENTS – End of Period		$	2,750,917			$	4,759,417

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

KORTH DIRECT MORTGAGE INC

UNAUDITED CONSOLIDATED 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			-				-				-				-				19,359				-				19,359
Acquisition of related party affiliate (see Note 4)			-				-				-				-				(490,345	)							(490,345	)
Series A preferred stock dividends declared			-				-				-				-				-				(225,000	)			(225,000	)
Net income			-				-				-				-				-				435,304				435,304
Balance at September 30, 2020			200,000			$	200				5,000,000			$	500			$	5,014,186			$	1,149,458			$	6,164,344

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

KORTH DIRECT MORTGAGE INC

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 - NATURE OF BUSINESS

 

Korth Direct Mortgage Inc. (the “Company”) is incorporated in the State of Florida. The Company was created to originate mortgages and fund those mortgages with notes secured by mortgage loans. On July 31, 2020, the Company acquired substantially all of the equity of J.W. Korth & Company Limited Partnership, a Michigan limited partnership (“J.W. Korth”), and its general partner, J.W. Korth, LLC, a Florida limited liability company. J.W. Korth is an SEC and FINRA registered securities broker dealer. The financials of J. W. Korth were integrated into the financials of the Company as of August 1, 2020.

 

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 unaudited 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 consolidated financial statements include the accounts of the Company and J.W. Korth, its wholly-owned subsidiary. Intercompany balances and transactions have been eliminated upon consolidation.

 

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. The deals have been funded in multiple ways, including private placements, SEC registered deals, and 144A offerings. As of the date of these financial statements, the Company has funded loans totaling $125,448,182 and it issued MSNs secured by those loans, in the amount of $132,693,992. There were two loans that were part of a single MSN issuance, where the loans closed after the quarter end, leading to the excess value of MSNs compared to Mortgages Owned of approximately $7,300,000. The loans were completed and funded on October 1 and October 6, 2020.

 

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 September 30, 2020, the Company had issued Portfolio Loans in the amount of $1,410,265. These loans were funded by the Company, as well as affiliates.

 

 

GOODWILL

Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Section 350 requires an annual assessment of the recoverability of goodwill using a two-step process. The first step of the impairment test involves a comparison of the fair value of the reporting unit to its carrying value. If the carrying value is higher than the fair value or there is an indication that impairment may exist, a second step must be performed to compute the amount of the impairment. Management conducted its annual assessment of goodwill impairment and determined that there were no indicators of goodwill impairment and therefore did not record an impairment loss for the period ending September 30, 2020.

 

REVENUE RECOGNITION

The Company’s primary sources of revenue are generated from origination fees, servicing fees, processing fees, underwriting income, trading profits, 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.

 

Underwriting Income

Underwriting income represents revenue earned by J. W. Korth for underwriting and distribution of the Company’s securities. Revenues from underwriting income are recognized on settlement date of the trades.

 

Trading Profits

Trading profits represent revenue generated through the trading of securities either for its own account or on behalf of the J. W. Korth’s clients.. Revenue from trading profits are recognized upon settlement of the securities transactions.

 

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

Prior to the acquisition of J.W. Korth on July 31, 2020, items due to parent are operating expenses due to the parent company for salaries, credit cards, and other business expenses. Subsequent to the July 2020 acquisition, intercompany transactions have been eliminated upon consolidation.

 

DEPRECIATION

Depreciation is provided on a straight-line basis using estimated useful lives of three to seven years.

 

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 periods ended September 30, 2019, are summarized as follows:

 

STATEMENT OF OPERATIONS For the Nine Months ended September 30, 2019:		As Previously Reported				Prior Period Impact				Revised Amounts
Revenues:
Origination Revenues, net		$	969,275			$	(817,918	)		$	151,357
Total Revenues			1,118,275				(817,918	)			300,357
Cost of Revenues:
Broker Underwriting Expense			457,275				(394,176	)			63,099
Mortgage Broker Expense			231,720				(194,969	)			36,751
Co-Manager Engagement Fee			7,113				(5,867	)			1,246
Appraisal Costs			1,995				1,264				3,259
Ratings			40,000				(26,903	)			13,097
Total Cost of Revenues			775,761				(620,651	)			155,110
Gross Profit (Loss)			342,514				(197,267	)			145,247
Operating Expenses:
Professional and Legal			64,843				(12,499	)			52,344
Total Operating Expenses			363,064				(12,499	)			350,565
Net Loss from Operations			(20,550	)			(184,768	)			(205,318	)
Total Other Income			1,781,235				-				1,781,235
Net Income before Provision for Income Taxes			1,760,685				(184,768	)			1,575,917
Provision for Income Taxes			(3,785	)			(165,267	)			(169,052	)
Net Income		$	1,756,900			$	(350,035	)		$	1,406,865

 

 

NOTE 4 – ACQUISITION OF RELATED PARTY AFFILIATE

 

On July 31, 2020, the Company acquired substantially all of the equity of J.W. Korth, a Michigan limited partnership, and its general partner, J.W. Korth, LLC, a Florida limited liability company. The Company’s acquisitions of J.W. Korth and J.W. Korth, LLC are together referred to as the “Acquisitions.”

 

The Company was founded by J.W. Korth with James W. Korth, its Chairman and Chief Executive Officer, and his daughter, Holly MacDonald-Korth, the Company’s President and Chief Financial Officer. Mr. Korth is the Managing Partner of J.W. Korth and Ms. MacDonald-Korth is J.W. Korth’s Managing Director and Chief Financial Officer. J.W. Korth is registered with the Securities and Exchange Commission as a broker-dealer and investment advisor, and with the Financial Industry Regulatory Authority (“FINRA”) as a broker-dealer. Together, prior to closing of the Acquisitions Mr. Korth and Ms. MacDonald-Korth together owned approximately 80% of J.W. Korth’s partnership interests and controlled the business and operations of J.W. Korth. J.W. Korth funded the organization and operation of the Company pursuant to a support agreement with the Company from inception until April 2019, at which time the Company became self-sustaining and J.W. Korth forgave a receivable owed to it by the Company. Until the closing of the Acquisitions, the Company was controlled by J.W. Korth, which owned all of its voting common stock.

 

The Company originates, funds and services loans which it makes to commercial borrowers. The loans are held by the Company as lender. The Company funds its loans directly in the capital markets through issuance of Mortgage Secured Notes (“MSNs” or “Notes”), which are sold through J.W. Korth as underwriter through exemptions from registration available under Rule 144A, Regulation D, and other exemptions from registration. The Company and J.W. Korth determined that the Company could operate more efficiently if J.W. Korth became a wholly-owned subsidiary of the Company. J.W. Korth submitted its then-proposed sale to FINRA, as required by FINRA rules, and FINRA advised J.W. Korth that it could proceed with the closing.

 

Pursuant to the Purchase Agreement, as a condition of closing J.W. Korth agreed to distribute all of its 5,000,000 shares of common stock in the Company to its partners ratably in accordance with their partnership interests in J.W. Korth pursuant to exemptions from registration available under Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated under the Securities Act.

 

Prior to the closing, J. W. Korth LLC owned 73.6% of the Common Capital interest of J W Korth and at closing received 3,680,000 shares of the Company. Simultaneously J W Korth LLC distributed the Company shares it received from J.W. Korth to its members James Korth and Holly MacDonald-Korth according to their membership interests which were 80% and 20% respectively.

 

At closing, after the distribution to its members of the Company shares distributed to J W Korth LLC, the Company acquired all of the membership interests in JW Korth LLC from Mr. Korth and Ms. MacDonald-Korth for consideration of the payment to (i) the Preferred Capital Interest partners of J.W. Korth of accrued and unpaid 6% dividends through July 31, 2020, and (ii) James Korth of $150,000 in payment of the value of his JW Korth LLC’s Common Capital Interest account.

 

As post-closing commitments the Company agreed to (i) retain Mr. Korth as the managing partner of J.W. Korth, Ms. MacDonald-Korth as J.W. Korth’s chief financial officer, and all other employees of JW Korth who were employed at closing of the Transactions; (ii) operate J.W. Korth as an SEC registered broker-dealer and investment advisor; (iii) pay the JW Korth Preferred Capital Interest Partners quarterly dividends concurrently with its payment of the Company’s Series A Preferred Stock dividends at least annually; (iv) in such years as it pays Series A Preferred dividends, redeem 25% annually of the JW Korth Preferred Capital Interest partners through a capital contribution to JW Korth; and (v) make a discretionary redemption of all accounts of the limited partners of J.W. Korth under the J.W. Korth partnership agreement. Upon redemption of the limited partners’ accounts and the payment of the other consideration to described above to the JW Korth partners, KDM will own 100% of the voting interests in JW Korth.

 

 

The following table summarizes the consideration paid, or to be paid, for the Acquisitions:

 

		Consideration
Accrued & unpaid dividends to the Preferred Capital Interest partners		$	213,443
JW Korth LLC’s Common Capital Interest account			150,000
Contingent liability to redeem J.W. Korth Preferred Capital Interest Partners			696,253
Disposition of outstanding loan due from J.W. Korth Executive Officer			69,780
Total Consideration Paid		$	1,129,476

 

The following table summarizes the net book value of assets and liabilities acquired as of the closing date, July 31, 2020:

 

		Net Book Value
J.W. Korth Net Book Value		$	889,131
Less: Preferred Interest in J.W. Korth by Company prior to acquisition			(250,000	)
Adjusted Net Book Value acquired		$	639,131

 

Since the acquisition was between related parties, the transaction was recorded at net book value as of the closing date. The difference of $490,345 between the consideration paid and the net book value of the assets and liabilities acquired was recorded as an offset to equity, specifically to Additional Paid-in Capital. Disclosure of supplemental pro forma information for revenue and earnings related to the acquisition, assuming the acquisition was made at the beginning of the earliest period presented, has not been disclosed since the effects of the acquisition would not have been material to the results of operation for the periods presented.

 

NOTE 5 - RESTRICTED CASH

 

The Company maintains multiple 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 September 30, 2020, this account has a balance of $5,932,065.

 

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 September 30, 2020, this account has a balance of $7,505,098 (commitment fees/accrued interest), which includes a balance of $7,505,098 pending closing of two loans.

 

We also maintain multiple lockbox accounts that collect rental payments directly from tenants on the borrowers’ behalf. These accounts typically net out funds monthly. The lockbox account balances as of September 30, 2020, the accounts have a balance of $263,341.

 

 

NOTE 6 - COMMITMENTS

 

Prior to the acquisition, the Company relied entirely on its parent, J.W. Korth, to provide office space, internet connectivity, phone service, and incidentals through mid-2019. The acquired Partnership leases office space in Miami, Florida and Lansing, Michigan under operating leases that expire at various times in 2021.

 

The following is a schedule of future minimum rental payments required under the terms of the leases as September 30, 2020:

 

2020			24,883
2021			27,561
		$	52,444

 

Rental expense for the period ended September 30, 2020 is $17,311, which includes additional expenses for common area, direct operating expenses, utilities, parking and taxes. As of September 30, 2020, the present value using the discount rate of 4.24% of our lease is:

 

2020			12,013
2021			48,052
		$	60,065

 

The Company is currently negotiating a lease for new office space, which it expects to move into in the fourth quarter of 2020.

 

NOTE 7 - 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 8 - CUSTOMERS

 

As of September 30, 2020, the Company had twenty five 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 37% of our total loans outstanding with two loans adding up to $46.34 million. Currently, approximately 41% of the loans, by unpaid balance, are geographically concentrated in the state of Ohio.

 

NOTE 9 – RELATED PARTY TRANSACTIONS

 

Prior to the acquisition of J.W. Korth in July 2020, the Due to Parent account was 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 nine months ended September 30, 2019. As of September 30, 2020, the intercompany transactions and balances between the Company and J.W. Korth have been eliminated upon consolidation as a result of the acquisition.

 

On May 13, 2020, the Company executed a preferred partner subscription agreement with J. W. Korth in the amount of $250,000, which was eliminated upon consolidation as a result of the acquisition of J.W. Korth in July 2020 (see Note 4 above).

 

Prior to the acquisition of J.W. Korth in July 2020, the Company paid underwriting fees of $158,138 in 2020. J. W. Korth has been the initial purchaser of all the mortgage secured notes for the nine months ended September 30, 2020.

 

In March 2020, the Company purchased an MSN in the amount of $100,000 included on the statement of financial condition as Securities.

 

On April 1, 2020, the Company closed a first lien and corresponding MSN, along with a second lien loan of $500,000 on the same property. The funding for the second lien was provided by 110 Capital LLC, an entity controlled by a KDM director and employee. KDM services both notes.

 

NOTE 10 – 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 nine months ended September 30, 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			643,072				(503,194	)			139,878
Amortization of deferrals			(299,794	)			246,005				(53,789	)
Deferred Revenue at September 30, 2020			2,192,378				(1,816,720	)			375,658

 

NOTE 11 – 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
Risk-free interest rate:		1.76%
Expected term:		5.75 years
Expected dividend yield:		0%
Expected volatility:		35.01%

 

For the nine months ended September 30, 2020, the Company recorded $19,359 of stock-based compensation expense. As of September 30, 2020, there was $45,178 in total unrecognized compensation expense related to non-vested employee stock options granted under the Incentive Plan, which is expected to be recognized over 1.75 years.

 

Stock option activity for the nine months ended September 30, 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 September 30, 2020			835,000			$	1.00				9.0
Options exercisable at September 30, 2020			417,500			$	1.00				9.0
Options expected to vest at September 30, 2020			417,500			$	1.00				9.0

 

NOTE 12 – 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 13 – 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.

 

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:

 

		September 30, 2020
		Total				Level I				Level II				Level III
Financial Assets
Mortgages Owned		$	125,448,182			$	-			$	125,448,182			$	-
Mortgage Servicing		$	3,432,430			$	-			$	-			$	3,432,430
Securities			327,848				-				-				327,848
Total Financial Assets		$	129,208,460			$	-			$	125,448,182			$	3,760,278
Financial Liabilities
Mortgage Secured Notes Payable		$	132,693,992			$	-			$	132,693,992			$	-
		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 nine months ended September30, 2020

 

The following table presents a reconciliation of changes in Level 3 assets and liabilities reported in the Statements of Financial Condition for the nine months ended September 30, 2020:

 

Changes in assets:
Period ended September 30, 2020		Mortgage Servicing Value				Securities				Total Value
Beginning balance at January 1, 2020		$	2,595,946			$	-			$	2,595,946
Purchases			-				100,000				100,000
Trades			-				225,041				225,041
Sales			-				-				-
Issues			-				-				-
Settlements			-				-				-
Net realized gain/loss or Interest income			-				3,646				3,646
Unrealized Gain from newly issued mortgages			1,168,632				-				1,168,632
Fair Value adjustment			(332,148	)			(839	)			(332,987	)
Transfers into Level 3			-				-				-
Transfers out of Level 3			-				-				-
Ending balance at September 30, 2020		$	3,432,430			$	327,848			$	3,760,278

 

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 nine months ended September 30, 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 September 30, 2020:

 

Investment type		Fair Value				Valuation technique		Unobservable inputs		Values
Mortgage servicing		$	3,432,430			Net Present Value		Prepayment Discount			15.55	%
								Discount rate			15.00	%
Securities		$	327,848			Net Present Value

 

 

NOTE 14 – INCOME TAXES

 

The provision for income taxes was $154,852 for the nine months ended September 30, 2020. The effective tax rate was 26.2% of the income before income taxes of $590,156, 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.

 

The provision for income taxes was $169,052 for the nine months ended September 30, 2019. The effective tax rate was 10.7% of the income before income taxes of $1,575,917, which differs from the federal statutory rate of 21% due to the effect of income attributed to the LLC partnership prior to June 2019, state income taxes and certain of the Company’s expenses that are not deductible for tax purposes.

 

NOTE 15 – PROPERTY AND EQUIPMENT

 

Property and Equipment are summarized as follows:

 

Equipment		$	52,741
Furniture and fixures		$	158,017
		$	210,758
Accumulated depreciation		$	(68,300	)
Net Property Equipment		$	142,458

 

Depreciation expense for the period ending September 30, 2020 was $600. For the new furniture and equipment bought for the Company post acquisition, in August and September 2020, no depreciation has been charged.

 

NOTE 16 – DUE TO CLEARINGHOUSE BROKERS

 

J.W. Korth, the Company’s wholly-owned subsidiary, operates as an SEC and FINRA registered securities broker dealer. The securities transactions are traded through broker clearinghouses and, upon settlement, funds are transferred in and out of the Company’s bank accounts. Unsettled transactions create short-term payables and receivables due to and from the broker clearinghouses. As of September 30, 2020, the Company had a net amount due to the clearinghouse brokers of $192,725.

 

NOTE 17 – CONTINGENT LIABILITY

 

As part of the acquisition of related party affiliate discussed above in Note 4, the Company agreed to pay (i) the Preferred Capital Interest partners of J.W. Korth accrued and unpaid 6% dividends through July 31, 2020; (ii) the JW Korth Preferred Capital Interest Partners quarterly dividends concurrently with its payment of the Company’s Series A Preferred Stock dividends at least annually; and (iii) in such years as it pays Series A Preferred dividends, redeem 25% annually of the JW Korth Preferred Capital Interest partners through a capital contribution to JW Korth.

 

The following table summarizes the unpaid Contingent Liability outstanding as of September 30, 2020:

 

Accrued & unpaid dividends through July 31, 2020		$	59,746
Contingent liability to redeem J.W. Korth Preferred Capital Interest Partners			696,253
Accrued quarterly dividends recorded as interest expense through September 30, 2020			6,963
Contingent Liability, net		$	762,962

 

 

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. We also operate under the trade name KDM Financial, and our subsidiary is J W Korth & Company, L.P.

 

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.

 

Prior to July 31, 2020, we were wholly owned by J. W. Korth & Company, L.P. (“J.W. Korth”), a FINRA and SEC registered broker-dealer founded in 1982. On July 31, 2020, we acquired substantially all of the equity of J.W. Korth.

 

We originate, fund and service loans which are made to commercial borrowers. The loans are held by KDM as the lender. We fund our loans directly in the capital markets through issuance of Mortgage Secured Notes (“MSNs” or “Notes”), which are sold through J.W. Korth as underwriter through exemptions from registration available under Rule 144A, Regulation D, and other exemptions from registration. The Company and J.W. Korth determined that the we could operate more efficiently if J.W. Korth became a wholly-owned subsidiary of the Company. J.W. Korth submitted its then-proposed sale to FINRA, as required by FINRA rules, and FINRA advised J.W. Korth that it could proceed with the closing.

 

Pursuant to the Purchase Agreement, as a condition of closing J.W. Korth agreed to distribute all of its 5,000,000 shares of common stock in the Company to its partners ratably in accordance with their partnership interests in J.W. Korth pursuant to exemptions from registration available under Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated under the Securities Act.

 

As post-closing commitments the Company agreed to (i) retain Mr. Korth as the managing partner of J.W. Korth, Ms. MacDonald-Korth as J.W. Korth’s chief financial officer, and all other employees of JW Korth who were employed at closing of the Transactions; (ii) operate J.W. Korth as an SEC registered broker-dealer and investment advisor; (iii) pay the JW Korth Preferred Capital Interest Partners quarterly dividends concurrently with its payment of the Company’s Series A Preferred Stock dividends at least annually; (iv) in such years as it pays Series A Preferred dividends, redeem 25% annually of the JW Korth Preferred Capital Interest partners through a capital contribution to JW Korth; and (v) make a discretionary redemption of all accounts of the limited partners of J.W. Korth under the J.W. Korth partnership agreement. Upon redemption of the limited partners’ accounts and the payment of the other consideration to described above to the JW Korth partners, KDM will own 100% of the voting interests in JW Korth.

 

The following table summarizes the consideration paid, or to be paid, for the Acquisitions:

 

		Consideration
Accrued & unpaid dividends to the Preferred Capital Interest partners		$	213,443
JW Korth LLC’s Common Capital Interest account			150,000
Contingent liability to redeem J.W. Korth Preferred Capital Interest Partners			696,253
Disposition of outstanding loan due from J.W. Korth Executive Officer			69,780
Total Consideration Paid		$	1,129,476

 

 

The following table summarizes the net book value of assets and liabilities acquired as of the closing date, July 31, 2020:

 

		Net Book Value
J.W. Korth Net Book Value		$	889,131
Less: Preferred Interest in J.W. Korth by Company prior to acquisition			(250,000	)
Adjusted Net Book Value acquired		$	639,131

 

Since the acquisition was between related parties, the transaction was recorded at net book value as of the closing date. The difference of $490,345 between the consideration paid and the net book value of the assets and liabilities acquired was recorded as an offset to equity, specifically to Additional Paid-in Capital. Disclosure of supplemental pro forma information for revenue and earnings related to the acquisition, assuming the acquisition was made at the beginning of the earliest period presented, has not been disclosed since the effects of the acquisition would not have been material to the results of operation for the periods presented.

 

Results of Operations for the Nine Months ended September 30, 2020

 

The Company generated revenues of $1,575,386 for the nine months ended September 30, 2020, an increase of $1,275,029 compared with revenues of $300,357 for the nine months ended September 30, 2019. The increase in revenues generated from originating fees, servicing revenue, and interest income was due to an increase of $83.6 million in mortgages owned and serviced from September 30, 2019, to September 30, 2020. As of September 30, 2020, the Company owned mortgages of $125,448,182 compared with mortgages of $41,798,402 as of September 30, 2019. Revenues increased by $312,787 during the nine months ended September 30, 2020, as a result of the acquisition of J.W. Korth, primarily generated from trading profits and broker underwriting income.

 

Gross profits increased by $914,740 to $1,059,987 during the nine months ended September 30, 2020, compared with gross profits of $145,247 during the nine months ended September 30, 2019. The increase in gross profits was primarily attributed to the increase in the amount of mortgages serviced during the nine months ended September 30, 2020 with lower levels of mortgage related costs as a percentage of revenues, which generated higher gross margins.

 

In spite of positive year over year revenues, KDM growth slowed significantly in the second and third quarters of 2020 due to the global pandemic and the pull-back in credit markets. Our sector of the market began to recover in Q3 and we were able to complete nearly $30M of lending in August and September. We hope to close and additional $50-60M by year end.

 

Operating expenses were $1,312,152 during the nine months ended September 30, 2020, which was an increase of $961,587 compared with operating expenses of $350,565 during the nine months ended September 30, 2019. The increase in operating expenses was the result of increases of $814,586 in payroll related costs, $73,855 in accounting, professional and legal fees, $53,787 in other operating expenses, and $19,359 in non-cash stock compensation expense to support the growth of the overall business. $288,609, primarily payroll related costs, of the $961,587 increase in operating expenses for the nine months ended September 30, 2020 were generated by J.W. Korth, which was acquired July 31, 2020.

 

Other income decreased by $938,914 to $842,321 during the nine months ended September 30, 2020, compared with other income of $1,781,235 during the nine months ended September 30, 2019. The decrease in other income was due to the forgiveness of $548,802 of debt due to J. W. Korth, our parent company at the time, during the nine months ended September 30, 2019. In addition, unrealized gain on mortgages decreased by $395,949 during the nine months ended September 30, 2020, due to reduced levels of new loans generated during the first three quarters of 2020 compared with the first three quarters 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 nine months ended September 30, 2020, the Company recorded $154,852 in deferred income tax expense compared with $169,052 of deferred income tax expense from June 2019 through September 30, 2019.

 

Net income decreased $971,561 to $435,304 for the nine months ended September 30, 2020, compared with net income of $1,406,865 during the nine months ended September 30, 2019. The decrease in 2020 was primarily attributed to the decrease in other income of $938,914, an increase in net loss from operations of $46,847, partially offset by a decrease of $14,200 in income taxes generated during the nine months ended September 30, 2020, compared with the nine months ended September 30, 2019.

 

Financial Condition for the nine Months Ended September 30, 2020

 

As of September 30, 2020, we had $2,750,917 in cash, twenty-one loans totaling $126,858,447, consisting of $125,448,182 in mortgages and $1,410,265 in portfolio loans, and Mortgage Servicing Rights with a fair value of $3,432,430 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 2021 and succeeding years.

 

The Company is also looking to secure lines of credit and lender financing in forms that will comply with 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. We have not seen impact of COVID-19 so far on our borrower’s ability to pay their mortgages.

 

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 item 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 September 30, 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 September 30, 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.

 

The Company’s broker-dealer subsidiary is subject to an investigation of technical aspects of its financial advisory activities by the SEC regarding the reporting and treatment of certain trades and the disclosures made in the subsidiary’s financial advisory brochure. The inquiry involves rule interpretations by the subsidiary of the technical aspects of recording and reporting for purchases and sales of bonds and the relevance of certain disclosures in the brochure. The transactions in question do not involve KDM issued securities. The firm is fully cooperating with the SEC and believes at this time the outcome of the investigation is not expected to have a material effect on KDM or its subsidiary.

 

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	Description
1.1	Underwriting Agreement
3.1	Articles of Conversion from Korth Direct Mortgage LLC to Korth Direct Mortgage Inc. dated May 31, 2019
3.2	Articles of Incorporation of Korth Direct Mortgage Inc. dated May 31, 2019
3.3	Bylaws of Korth Direct Mortgage Inc. dated May 31, 2019
4.1	Trust Indenture and Security Agreement between Korth Direct Mortgage LLC, and Delaware Trust Company dated November 17, 2017
4.2	Trust Indenture and Security Agreement (Rule 144A Offerings) between Korth Direct Mortgage LLC, and Delaware Trust Company dated September 20, 2018
4.3	Trust Indenture and Security Agreement (Private Placements) between Korth Direct Mortgage Inc. and Delaware Trust Company dated September 30, 2020
10.0	Support Agreement
25.	Statement of Eligibility of Trustee
31.1	Section 302 Certificate of Chief Executive Officer*
31.2	Section 302 Certificate of Chief Financial Officer *
32.1	Section 906 Certificate of Chief Executive Officer*
32.2	Section 906 Certificate of Chief Financial Officer*
101.	Interactive Data File

 

*Filed herewith.

 

 

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: November 20, 2020	By:	/s/ James W. Korth
		James W. Korth, Chief Executive Officer

 

 

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