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 June 30, 2020
2021

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 INCINC.

(Exact name of registrant as specified in its charter)

(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.

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 June 30, 20202021 there were 5,000,000 shares of Common Stock of Korth Direct Mortgage Inc. outstanding.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

PART I—FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements.

KORTH DIRECT MORTGAGE INCINC.

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

See accompanying notes to the unaudited consolidated financial statements.

KORTH DIRECT MORTGAGE INCINC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE PERIOD FROM JANUARY 1 THROUGH JUNE 30

See accompanying notes to the unaudited consolidated financial statements.

KORTH DIRECT MORTGAGE INCINC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to the unaudited consolidated financial statements.

KORTH DIRECT MORTGAGE INCINC.

UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

See accompanying notes to the unaudited consolidated financial statements.

KORTH DIRECT MORTGAGE INCINC.

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 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.

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 Company andfinancials of J. W. Korth & Company executed a support agreement that provides financial, managerial, and office support towere integrated into the financials of 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 worthas of at least $1,000,000 for a minimum period of 90 days.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 auditedunaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 20192020 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 are solely forinclude the Company. The financial statementsaccounts of the parent company, J. W.Company and J.W. Korth, its wholly-owned subsidiary. Intercompany balances and transactions have these accounts consolidated within them.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 (”CM Loans”) that it makes by issuing Mortgage Secured Notes (“MSNs”), in series, each of which areMSN series is secured by those same mortgages.the mortgage or mortgages funded from proceeds of the MSN series. Our MSNs have been funded in multiple ways, including private placements, SEC registered offerings, and Rule 144A offerings. As of the date of these financial statements, the Company has funded loansCM Loans totaling $102,972,421$254,310,056 and it issued MSNs secured by those loans in the amount of $102,972,421.$263,715,056. There is one CM Loan that was part of a single MSN series issuance closed after the quarter end, resulting in an excess value of MSNs compared to Mortgages Owned of approximately $9,405,000. The deals have beenCM Loan was completed and funded in multiple ways, including private placements, SEC registered deals, and 144A offerings.on July 27, 2021.

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 June 30, 2020,2021, the Company had issued Portfolio Loans in the amount of $1,561,476.$2,056,266. 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 June 30, 2021.

REVENUE RECOGNITION

The Company has fourCompany’s primary sources of revenue:revenue are 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 from our CM Loans 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 the 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 J.W. Korth’s clients. Revenue from trading profits is recognized upon settlement of the securities transactions.

Interest Income

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

LEASES

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The standard requires organizations to recognize right-of-use (“ROU”) assets and lease liabilities on the balance sheet and disclose key information about leases that were historically classified as operating leases under previous generally accepted accounting principles. Leases will be classified as financing or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The Company adopted the new lease standard on January 1, 2019, and has chosen to use that date as the effective date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. The new lease guidance provides a number of optional practical expedients in transition. The Company has elected the “package of practical expedient,” which permits it to not reassess under the new standard its prior conclusions about lease identification, lease classification, and initial direct costs. As part of the adoption of this standard, the Company recognized lease liabilities with a corresponding ROU leased asset of approximately the same amount based on the present value of the remaining lease payments pursuant to current leasing standards for existing operating leases. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

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.

ESTIMATESDUE TO CLEARINGHOUSE BROKERS

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 dateJ.W. Korth, a wholly owned subsidiary of the financial statementsCompany, operates as an SEC and FINRA registered securities broker dealer. Securities transactions are traded through broker clearinghouses and, upon settlement, funds are transferred in and out of the reported amountsCompany’s bank accounts. Unsettled transactions create short-term payables and receivables due to and from the broker clearinghouses. As of revenues and expenses duringJune 30, 2021, the reporting period. Actual results could differ from those estimates.Company had a net amount due to clearinghouse brokers of $1,681.

DUE TO PARENT AND PAYABLESDEPRECIATION

Items dueDepreciation is provided on a straight-line basis using estimated useful lives of three 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.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.expense

NOTE 3 - CORRECTION– ACQUISITION OF PRIOR PERIOD ACCOUNTING ERRORRELATED PARTY AFFILIATE

DuringOn July 31, 2020, the preparationCompany 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 2019 financial statements,acquisitions of J.W. Korth and J.W. Korth, LLC are together referred to as 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.“Acquisitions.”

The Company assessedwas founded by J.W. Korth with James W. Korth, its Chairman and Chief Executive Officer, and his daughter, Holly MacDonald-Korth, the materialityCompany’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 accounting errorAcquisitions Mr. Korth and determined thatMs. MacDonald-Korth together owned approximately 80% of J.W. Korth’s partnership interests and controlled the prior period financial statements were not materially misstated as a resultbusiness and operations of J.W. Korth. J.W. Korth funded the organization and operation of the accounting error. Accordingly,Company pursuant to a support agreement with the Company has electedfrom inception until April 2019, at which time the Company became self-sustaining and J.W. Korth forgave a receivable owed to correctit by the error inCompany. Until 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 footnotesclosing of the current period financial statements.Acquisitions, the Company was controlled by J.W. Korth, which owned all of its voting common stock.

The financial statement impacts of the accounting error on the interim period ended June 30, 2019, are summarized as follows:

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 or placement agent 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:

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

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 4 – CONTINGENT LIABILITY

As part of the acquisition of related party affiliate discussed above in Note 3, the Company agreed to pay (i) the Preferred Capital Interest partners of J.W. Korth accrued and unpaid dividends of 6% per annum 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 June 30, 2021:

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 June 30, 2020,2021, this account has a balance of $1,493,409.$9,642,629.

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 June 30, 2020,2021, this account has a balance of $182,631 (commitment fees/accrued interest).$8,992,316, which consists of borrower early payments and commitments and also a balance of $9,405,000 pending closing of one loan. This account corresponds to the Due to Investors liability.

WeThe Company also maintainmaintains 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 June 30, 2020,2021 were $116,101. There is an additional account that consists of reserves for one borrower in the accounts have a balanceamount of $151,956.$2,029,492.

NOTE 56 - COMMITMENTS

ThePrior to the acquisition of J.W. Korth in July 2020, the Company reliesrelied entirely on its parent, J. W.J.W. Korth to provide office space, internet connectivity, phone service, and incidentals through mid-2019. Theincidentals. In November 2020, the Company is currently negotiatingsigned a lease for new office space in Miami, Florida, for a term of sixty-two months with the right to extend the term of the lease for two additional, successive periods of two years upon the same terms and conditions as the initial term. In December 2020, the Company entered into a Sublease Agreement to sublet a portion of the office space described above. The subtenant has agreed to cover the proportionate amount of the lease costs associated with the office space based on essentially the same terms as the lease described above, including the rights to extend for two successive two-year periods.

On January 13, 2021, J.W. Korth negotiated a five-month early termination of its lease for its Miami office and will rely entirely on its parent for office space at the Coral Gables location. The J. W. Korth Michigan office has renegotiated a new lease which it expectsbegan in May 2021.

The net present value of future lease payments pursuant to move intothe operating lease agreements are included in the thirdROU Leased Asset and the Lease Liability accounts on the Consolidated Statement of Financial Condition. The ROU Leased Asset represents the right to use an underlying asset for the remaining lease term. The Lease Liability represents the obligation to make lease payments pursuant to the terms of the lease agreements.

Rental expense for the quarter ended June 30, 2021 was $148,977, which includes additional expenses for common area, direct operating expense, utilities, parking, and taxes.

As of 2020.June 30, 2021, the net present value of the future lease liabilities, using the weighted-average discount rate of 4.24%, which is commensurate with the Company’s secured borrowing rate, over the weighted-average remaining life of 4.6 years was $1,081,288.

The following is a schedule of the maturities of future lease payments over the remaining life of the operating leases, reconciled to the net present value of as of June 30, 2021:

PPP Loan

In April 2020, J. W. Korth, at that time the parent company of KDM, availed itself of a Paycheck Protection Program loan (“PPP Loan”) in the amount of $161,600, which was forgiven in April 2021.

NOTE 67 - 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 78 - CUSTOMERS

As of June 30, 2020,2021, the Company had fourteenNaN 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, weWe do not have any over concentration with a concentration of customers where onesingle borrower accounts for 45% of our totalor location other than three large loans outstanding with two loans adding up to $46.45 million. Currently, 51% of the loans, by unpaid balance, are geographically concentrated in the statestates of Ohio.Ohio, Virginia, and California for a total of approximately 109,000,000.

NOTE 89 – RELATED PARTY TRANSACTIONS

The Due to Parent account is used to account for billsAs of December 31, 2020, the intercompany transactions and expenses paid by J. W.balances between the Company and J.W. Korth on behalfhave been eliminated upon consolidation as a result 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 six months ended June 30, 2019. The Company owed J.W. Korth $6,050 and $12,151 as of June 30, 2020, and December 31, 2019, respectively.acquisition.

On May 13,In March 2020, the Company executed a preferred partner subscription agreement with J. W. Korth & Company, which is reflected under the caption “Preferred Interest in Affiliate” of the Unaudited Statement of Financial Condition.

The Company paid underwriting fees of $90,838 and $34,233 to J. W. Korth & Company for the six months ended June 30, 2020 and 2019, respectively. J. W. Korth has been the initial purchaser of all the mortgage security notes for the six months ended June 30, 2020.

The Company also purchased an MSN in the amount of $100,000 shown$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.

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).

As of June 30, 2021, the Company paid underwriting fees of $152,267 to J.W. Korth in 2021.

On February 12, 2021, the Company closed a first lien and corresponding MSN, along with a second lien loan of $200,000 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 910 – 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 sixthree months ended June 30, 2020:2021:

NOTE 1011 – 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$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$1.00 per share. The weighted-average grant date fair values of options granted was $0.1855$0.1855 per share. The fair values of the stock-based awards granted were calculated with the following weighted-average assumptions:

For the six months ended June 30, 2020,2021, the Company recorded $12,906$12,906 of stock-based compensation expense. As of June 30, 2020,2021, there was $51,632$25,816 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 years.1.0 year.

Stock option activity for the six months ended June 30, 2020,2021, is summarized as follows:

NOTE 1112 – 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.$4,750,000. The Company paid $250,000$250,000 in expenses related to the preferred stock issuance to J. W. Korth as underwriter and distributor. Each share was sold for $25,$25, and is convertible into common stock at a ratio of 5 shares of common stock for each share of Series A Preferred Stock.

On June 29, 2021, the Company issued 19,000 shares of its Series B 6.50% Cumulative Non-Voting Redeemable Secured Preferred Stock, with a liquidation preference of $1,000 per share, for net proceeds of $18,302,500. The Company paid $697,500 in expenses related to the preferred stock issuance to its financial advisor and placement agent.

The Series B preferred stock is non-convertible and will pay cumulative dividends, if and when declared by the Company’s board of directors, at a rate of 6.50% per annum. Dividends declared will be payable quarterly in arrears on the 15th day of January, April, July and October of each year. The Series B preferred stock ranks senior to KDM’s outstanding Series A 6% Cumulative Perpetual Convertible Preferred Stock, par value $0.001 per share, or Series A preferred stock, and all of KDM’s common stock, and will rank pari passu with, or senior to, all future issuances of preferred stock of KDM.

The Company is required to use commercially reasonable efforts to maintain a nationally-recognized statistical ratings organization, or NRSRO, rating for so long as any shares of Series B preferred stock remain outstanding. If the Company fails to maintain an NRSRO rating for the Series B preferred stock of at least BBB (or the equivalent thereof), the dividend rate applicable to the Series B preferred stock will be increased by 25 basis points, and in the event the Company fails to maintain an NRSRO rating of at least BBB- (or the equivalent thereof), the dividend rate applicable to the Series B preferred stock will be increased by an additional 25 basis points.

The Series B preferred stock is redeemable at the Company’s option, in whole or in part, on or after June 29, 2026, at a redemption price per share equal to $1,000.00 per share, plus accrued and unpaid dividends, if any. Subject to applicable law, the Company is required to redeem the Series B preferred stock, in each case at a redemption price equal to $1,000.00 per share, plus accrued and unpaid dividends, as follows:

The Company’s obligations to redeem the Series B preferred stock will be secured by a security interest on servicing fees, as specified in each mortgage secured note issued by the Company, which is the difference between the interest payable pursuant to the mortgage secured note and the interest receivable pursuant to the related commercial real estate mortgage loan. The requisite holders of Series B preferred stock will be entitled to exercise rights and remedies pursuant to such security interest in the event that the Company does not pay the relevant mandatory redemption price (inclusive of any accrued and unpaid dividends) within thirty (30) days of the applicable redemption date, except with respect to the final redemption date, which is not be subject to a thirty (30)-day grace period.

NOTE 1213 – 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,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.

Securities

J. W. Korth holds $225,000 of defaulted Banco Cruzeiro del Sur bonds which it reasonably believes it will receive par value for from the receiver handling the liquidation in Brazil. Local counsel has informed us that the bank has sufficient cash to pay off our bonds. We therefore carry them at par value.

KDM also holds a small amount of its own MSNs in an account which it may buy from time to time to provide liquidity to clients of J. W. Korth. These bonds are carried at the published statement values. 

Fair Value Disclosure

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

Fair Value Measurements

Changes in Fair Value Measurements for the threesix months ended June 30, 20202021

The following table presents a reconciliation of changes in Level 3 assets and liabilities reported in the Statements of Financial Condition for the six months ended June 30, 2020:2021: 

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 six months ended June 30, 2020,2021, 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 June 30, 2020:2021:

NOTE 1314 – INCOME TAXES

The provision for income taxes was $12,868$807,762 for the six months ended June 30, 2020.2021. The effective tax rate was approximately 35%25.7% of the income before income taxes of $36,781,$3,141,235, which differs from the federal statutory rate of 21%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 $12,868 for the six months ended June 30, 2020. The effective tax rate was 35.0% of the income before income taxes of $36,781, which differs from the federal statutory rate of 21% due to 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:

Depreciation expense for the period ending June 30, 2021 was $16,193.

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, 2019,2020, filed with the Securities and Exchange Commission (the “SEC”) on May 14, 2020;March 30, 2021; and (iii) our management’s discussion and analysis of financial condition and results of operations included in our 20192020 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, 2019.2020.

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^th135 San Lorenzo Avenue, Suite 307, Miami,600, Coral Gables, Florida 33133,33146, 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 principal subsidiary is J W Korth & Company, Limited Partnership (“J. W. Korth”).

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

Prior to July 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 believeOn July 31, 2020, we will become independent from our parent company byacquired substantially all of the endequity 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.J.W. Korth.

ForWe originate, fund and service loans which are made to commercial borrowers. The loans are held by KDM as the quarter ended June 30, 2020, KDM owed J Wlender. 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 & Company $6,050, as part of inter-company receivables. The Support Agreement remains in place.underwriter or placement agent through exemptions from registration available under Rule 144A, Regulation D, and other exemptions from registration.

Results of Operations for the Sixsix Months ended June 30, 20202021

The Company generated revenues of $3,305,696 for the six months ended June 30, 2021, an increase of $2,549,115 compared with revenues of $756,581 for the six months ended June 30, 2020, an increasea 337% increase. As of $611,123June 30, 2021, the Company owned mortgages of $254,310,056 compared with revenuesmortgages of $145,458 for$175,370,580 as of December 31, 2020 and $102,972,421 as of June 30, 2020, a 45% and 147% increase, respectively.

Gross profits increased by $2,100,283 to $2,560,470 during the six months ended June 30, 2019. The increase in revenues (originating fees, servicing revenue, and interest income) was due to an increase of $71.4 million in mortgages owned and serviced from June 30, 2019, to June 30, 2020. As of June 30, 2020, the Company owned mortgages of $102,972,4212021, compared with mortgagesgross profits of $32,103,492 as of June 30, 2019.

Gross profits increased by $420,781 to $460,187 during the six months ended June 30, 2020, compared with gross profits of $39,406 during the six months ended June 30, 2019.2020. The increase in gross profits was primarily attributed to the increase in the amount of mortgages serviced during the first quarter of 2020six months ended June 30, 2021 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, these numbers were driven largely by loans closed prior to the current quarter. The COVID-19 pandemic has slowed down the lending cycle, most notably due to the pull-back in the credit markets. This pull-back has resulted in a drag on the securitization timelines, making time to close deals up to 6 weeks vs the prior 2-3. Nevertheless, we have made great strides in filling up the lending pipeline with over $200M of loans in the works. This robust lending pipeline should lead to closings of 25-30% of that amount. To the extent that credit markets recover their prior vigor, and KDM fulfills its efforts to find additional and alternative capital sources and relationships, we expect total deal volume to be reduced by approximately 50% of our 2020 target lending volume, with parallel reduction in revenues. That is, I was hoping to complete $150-$200M in new lending, and I expect to end the year with $75-$100M in new lending. The marketing time period for securitizations has extended significantly leading to delays in the origination to closing timeline.

Operating expenses were $2,654,484 during the six months ended June 30, 2021, which was an increase of $1,973,568 compared with operating expenses of $680,916 during the six months ended June 30, 2020,01, 2020. The increase in operating expenses was driven primarily by the increase of $1,184,402 in payroll related costs and $338,257 in professional and legal, $881,777 of the year over year increase in payroll expense was due to acquisition of J. W. Korth which was an increase of $476,290 compared with operating expenses of $204,626acquired July 31, 2020.

Other income increased by $2,977,738 to $3,235,248 during the six months ended June 30, 2019. The increase in operating expenses was the result2021, compared with other income of increases of $376,243 in payroll related costs, $71,025 in accounting, professional and legal fees, $16,116 in other operating expenses, and $12,906 in non-cash stock compensation expense to support the growth of the overall business.

Other income decreased by $889,653 to $257,510 during the six months ended June 30, 2020,2020. The increase in other income was due to the unrealized gain of $3,093,810 on mortgage servicing rights.

During the six months ended June 30, 2021, the Company recorded $1,425,121 in deferred income tax expense compared with other$393,104 of deferred income tax expense from June 30, 2020.

Net income increased $3,104,453 to $3,141,234 for the six months ended June 30, 2021, compared with net income of $1,147,163$36,781 during the six months ended June 30, 2019.2020. The majority ofincrease in 2021 was primarily attributed to the decreaseincrease in other income was due to the forgiveness of $548,802$2,977,738, and a decrease in net loss from operations of debt due to J. W. Korth & Company, our parent company, during$126,715, compared with the six months ended June 30, 2019. In addition, unrealized gain on mortgages decreased by $339,560 during the first half of 2020 compared with the first half 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 six months ended June 30, 2020, the Company recorded $12,868 in income tax expense.

Net income decreased $958,030 to $23,913 for the six months ended June 30, 2020, compared with net income of $981,943 during the six months ended June 30, 2019. The decrease in 2020 was primarily attributed to the decrease in other income of $889,653, born largely by a one-time gain from debt forgiveness from J W Korth & Company in March 2019, an increase in net loss from operations of $55,509, and an increase of $12,868 in income taxes generated during the six months ended June 30, 2020, compared the six months ended June 30, 2019.2020.

Financial Condition for the six Months Ended June 30, 20202021

As of June 30, 2020,2021, we had $2,210,656$19,889,664 in cash, fourteenforty-three loans totaling $107,888,644,$256,366,322, consisting of $103,472,421$254,310,056 in mortgages and $1,561,476$2,056,266 in portfolio loans, and Mortgage Servicing Rights with a fair value of $2,854,747$6,958,266 on our balance sheet. We have had four loans partially or completely pay off in the amount of $8,722,136 for the six months ended June 30, 2021.

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,Liquidity and capital needed for accelerating growth of the Company.

Capital and Liquidity NeedsResources

The Company completed a $5,000,000 (less issue costsissued 19,000 shares of $250,000) Series A 6% Cumulative Perpetual ConvertibleB Secured Preferred Stock in September 2019.for a net capital infusion of $18,302,481 on June 29, 2021. The Series B Preferred is secured by the Company’s servicing revenue. (See Note 12 to the Financial Statements for more detailed information.) We expect to raise additional preferredbelieve that this capital as necessary, in 2020 and succeeding years.will provide us with sufficient liquidity for growth for near term.

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 theour business.

Status of KDM Loans

We post the annual reviews of each of our mortgage loans (“CM LoansLoans”) 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.performing. We have not seen any negative impact of COVID-19 so far on our borrower’sborrowers’ ability to pay their mortgages.

Item 3. Quantitative and Qualitative Disclosures About Market RiskRisk..

We have no instruments subject to market risk.

Item 4. Controls and ProceduresProcedures..

We are responsible for establishing and maintaining adequate internal control over financial reporting as such termitem is defined by Securities Exchange Act Rule 13a-15(f)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 June 30, 2020,2021, as required by Securities Exchange Act Rule 13a-15(c)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 June 30, 2020.2021.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is not subject to any material legal proceeding.proceedings. The Company iswas a defendant in a suit regarding a mortgage brokerage fee dispute. The suit was dismissed with prejudice via summary judgement in favor of the Company on March 23, 2021.

The Company’s broker-dealer subsidiary and its principals are 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 indemnified forcooperating with the suit bySEC and believes at this time the borrower in the transaction which is the subjectoutcome of the suit. We doinvestigation is not believe that the proceeding isexpected to have a material under Item 103 of SEC Regulation S-K.adverse financial effect on KDM.

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, 2019.2020. 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.See Current Report on Form 8-K with respect to the Company’s issuance of Series B Preferred Stock on June 29, 2021..

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not Applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

*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.