See accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF OPERATIONS

FOR THE PERIOD FROM JANUARY 1 THROUGH MARCH 31

See accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF CASH FLOWS

See accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF OPERATIONS

FOR THE PERIOD FROM JANUARY 1 THROUGH SEPTEMBER 30

See Accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTSSTATEMENT OF CASH FLOWSCHANGES IN STOCKHOLDERS’ EQUITY

See accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 1 - NATURE OF BUSINESS

Korth Direct Mortgage Inc. (the “Company” or “KDM”) is a Florida corporation. In June 2019,incorporated in the Company converted to a corporation from a limited liability company formerly known as Korth Direct Mortgage, LLC.State of Florida. The Company is a wholly-ownedwholly owned subsidiary of J. W. Korth & Company L.P.Limited Partnership (“J. W. Korth”), an SEC and FINRA registered broker dealer. The Company originateswas created to originate mortgages and funds loans made to commercial real estate borrowers. fund those mortgages with notes secured by mortgage loans. 

The loans are held by KDM as lender. KDM also services its loans, though it may useCompany and J. W. Korth & Company executed a sub-servicer for some loans. KDM funds its loans directly in the capital markets through issuance of Mortgage Secured Notes (“MSNs” or “Notes”). The MSNs are special obligations of KDM, payablesupport agreement that provides financial, managerial, and office support to the extent that the underlying mortgageCompany until it is paidfully operational. Pursuant to this agreement, for any moneys owed by the borrower. MSNs are secured by KDM’s interest inCompany to J. W Korth, J. W. Korth may not seek reimbursement from the underlying corresponding mortgage loan (“CM Loan”). CM Loans are secured obligationsCompany until the Company shall maintain a liquid net worth of the borrowers that are generallyat least $1,000,000 for a single-purpose entity that owns the underlying property that KDM finances.minimum period of 90 days.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with US generally accepted accounting principles (“GAAP”) have been condensed or omitted. These unauditedaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 20182019 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

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

BASIS OF ACCOUNTING

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

USE OF ESTIMATES

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

CASH AND CASH EQUIVALENTS

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

MORTGAGE VALUATION

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

MORTGAGE SECURED NOTES

The Company funds the mortgage loans that it makes by issuing Mortgage Secured Notes (“MSNs”), which are secured by those same mortgages. As of the date of these financial statements, the Company has funded loans totaling $45,956,402$90,583,473 and it issued MSNs secured by those loans, in the amount of $41,798,402.$98,983,473. There was a single loan that closed after the quarter end, leading to the excess value of MSNs compared to Mortgages Owned of approximately $8,500,000. The loan was completed and funded on April 3, 2020. The deals have been funded in multiple ways, including private placements, SEC registered deals, and 144A offerings.

PORTFOLIO LOANS

The Company recognizes loans made with its own capital, or those not securitized, under the caption “Portfolio Loans” on the balance sheet. In August 2019,As of March 31, 2020, the Company made a bridge loan to a customer to assisthad issued Portfolio Loans in getting the loan closed which it planned to be repaid upon that customer’s next loan funding. This $460,000 loan wasamount of $1,608,969. These loans were funded by the Company, as well as affiliates, and was paid off in October 2019.affiliates.

REVENUE RECOGNITION

The Company has three primary sources of revenue: origination fees, servicing fees, and processing fees.

REVENUE RECOGNITION

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

Origination Fees

Loan origination fees represent revenue earned from originating mortgage loans,loans; net of any credits given to the borrower. Origination fees may be on loans where KDM or another party is lender and KDM has acted as a broker in the transaction. Loan origination fees generally represent flat, per-loan fee amounts and are deferred and recognized as revenue atover the timelife of the loansloan. The associated loan origination costs are funded.also deferred and recognized as expense over the life of the loan. The deferred portion of the loan origination fees is netted against the deferred portion of the loan origination costs, which include mortgage broker expenses, and reported as a net deferred revenue liability on the Company’s Statement of Financial Condition.

Servicing Fees

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

Processing Fees

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

Interest Income

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

STOCK-BASED COMPENSATION

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

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

Unrealized Gain on Mortgages Owned

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

ESTIMATES

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

DUE TO PARENT AND PAYABLES

Items due to parent are operating expenses due to the parent company J. W. Korth, pursuantfor salaries, credit cards, and other business expenses . Amounts are reconciled and paid off monthly and balances in this account are due to the support agreement. timing.

INCOME TAXES 

On At September 30,June 6, 2019, the Company owed J.W Korth $84,495. On May 2,converted from a Florida limited liability company into a Florida corporation. Effective with the conversion into a Florida corporation, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance on deferred tax assets is established when management considers it is more likely than not that some portion or all of the deferred tax assets will not be realized.

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

NOTE 3 - CORRECTION OF PRIOR PERIOD ACCOUNTING ERROR

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

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

The financial statement impacts of the accounting error on the interim period ended March 31, 2019, J. W. Korth forgave its receivable of $548,802 that was on the Company’s balance sheetare summarized as Due to Parent in order to assist the Company in strengthening its balance sheet and Stockholder’s Equity.follows:

INCOME TAXES

The Company converted to a corporation from a limited liability company in June of this year. The Company was previously a limited liability company and disregarded entity. As of June 4, 2019, the company has estimated income taxes at 21%.

In accordance with Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 740 –Income Taxes, management has evaluated uncertain tax positions taken or expected to be taken in the Company’s tax returns. In order for a benefit to be recognized, a tax position must be more-likely-than-not to be sustained when challenged or examined by the applicable taxing authority. For the nine months ended September 30, 2019, the Company has no material uncertain tax positions to be accounted for in the financial statements.

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

The “In Trust for 1” account holds the monthly tax and insurance payments collected from borrowers and distributes payments annually, on behalf of borrowers, to the appropriate tax authority and insurance companies. This account corresponds to the Escrow Payable liability. As of September 30, 2019,March 31, 2020, this account has a balance of $391,780.$1,148,219.

The “In Trust for 2” account receives payments from borrowers, distributes payments to investors, and pays the servicing fee to the Company. This account corresponds to the Due to Investors liability. As of September 30, 2019,March 31, 2020, this account has a balance of $4,264,305$8,526,884 (commitment fees/accrued interest), which includes a balance of $4,158,000$8,500,000 pending closing of a loan.

The Company relies partiallyentirely on its parent, J. W. Korth, to provide office space, internet connectivity, phone service, and incidentals through mid-2019. The Company is currently negotiating a lease for new office space, which it expects to move into in the endthird quarter of 2019.2020.

NOTE 6 - INDEMNIFICATIONS

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

As of September 30, 2019,March 31, 2020, the Company has ten customers excluding the $460K portfolio loan.had thirteen customers. The Company defines customers as borrowers that have an active loan with the Company, or are in the midst of the underwriting process and have a commitment fee on deposit with the Company. Further, we have a concentration of customers where one borrower accounts for 51% of our total loans outstanding with two loans adding up to $47 million. Currently, 22%48% of the loans, by unpaid balance, are geographically concentrated in the state of Ohio and 23% are concentrated in the state of New Jersey.Ohio.

The Due to Parent account is used to account for bills and expenses paid by J. W. Korth on behalf of the Company. The Company was previously largely supported by its parent company, J. W. Korth.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 ninethree months ended September 30,March 31, 2019. The Company owed J.W. Korth $84,495$59,176 and $494,122$12,151 as of September 30, 2019March 31, 2020, and December 31, 2018,2019, respectively.

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

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

NOTE 9 – DEFERRED REVENUE, NET

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

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

NOTE 10 – EMPLOYEE AND DIRECTOR STOCK OPTIONS

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

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

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

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

NOTE 11 – PREFERRED EQUITY

On September 27, 2019, the Company issued 200,000 shares of its Series A 6% Cumulative Perpetual Convertible Preferred Stock.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.

GAAPNOTE 12 – FAIR VALUE

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

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

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

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

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

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

Valuation Process

Cash and cash equivalents: 

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

Mortgages Owned and Mortgage Secured Notes Payable:

All ofMortgage loans for which the loans on the balance sheet as of September 30, 2019 are carried at principal value, as are the corresponding Mortgage Secured Notes Payable. The Company has determined that 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 values were determined byvalue below the marketcarrying balance is other-than-temporary, an unrealized impairment loss is recorded and the loan is recorded at the time of sale and should be classified as Level II of thelower fair value hierarchy. The carrying amounts for these items approximate the fair value. For amortizing loans,at each reporting period. To-date, the Company discounts thosehas not recorded any impairment losses related to remaining principal value.the mortgage loans.

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

Mortgage ServicingServicing:

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:

Fair Value Measurements

Changes in Fair Value Measurements for the ninethree months ended September 30, 2019March 31, 2020

The following table presents a reconciliation of changes in Level 3 assets and liabilities reported in the Statements of Financial Condition for the ninethree months ended September 30, 2019:March 31, 2020:

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 ninethree months ended September 30, 2019,March 31, 2020, there were no transfers between levels.

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

The following table presents quantitative information regarding the significant unobservable inputs the Company uses to determine the fair value of Level 3 investments held as of September 30, 2019:March 31, 2020:

NOTE 13 – INCOME TAXES

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

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

The following is a discussion of our historical consolidated financial condition and results of operations, and should be read in conjunction with (i) our historical consolidated financial statements and accompanying notes thereto included elsewhere in this Quarterly Report on Form 10-Q; (ii) our Annual Report on Form 10-K for the year ended December 31, 2018,2019, filed with the Securities and Exchange Commission (the “SEC”) on March 28, 2019;May 14, 2020; and (iii) our management’s discussion and analysis of financial condition and results of operations included in our 20182019 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, 2018.

2019.

Overview

Korth Direct Mortgage Inc. (“KDM,” the “Company”“Company,”, “we,“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 iswww.korthdirect.com.

KDM began its formal operations in October of 2016 when we engaged our Chief Lending Officer. We are a licensed in Florida as a Mortgage Lender Servicer. Our NMLS License Number is 1579547. Our operating history is limited. As of September 30, 2019,March 31, 2020, we were wholly owned by J. W. Korth & Company, L.P. (“J.W. Korth & Company”), a FINRA and SEC registered broker-dealer founded in 1982. We believe we will become independent from our parent company by the end of 2019.2020. 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 2019.2020. We anticipate renting office space in 2020 and adding support staff by the end of that year as our lending and servicing activities require.

The total support we have received from J. W. Korth & Company through March 31, 2019, was $752,302. In November 2018, $203,500 was repaid to J.W. Korth & Company, and subsequently, as of March 31, 2019, J.W. Korth & Company forgave the remaining receivable from KDM of $548,802. For the quarter ended September 30, 2019,March 31, 2020, KDM owed J W Korth & Company $84,495,$59,176, as part of inter-company receivables. The Support Agreement remains in place.

Results of Operations for the NineThree Months ended September 30, 2019March 31, 2020

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

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

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

Other income decreased by $664,693 to $283,634 during the three months ended March 31, 2020, compared with other income of $1,754,400 for$948,327 during the ninethree months ended September 30, 2019, substantially attributableMarch 31, 2019. The majority of the decrease in other income was due to a one-time gain from the cancelationforgiveness of a payable$548,802 of debt due to J.W.J. W. Korth & Company, of $548,802. The Company had revenues of $1,118,275our parent company, during the nine-month period, 87% of which was attributable to origination revenue, and for the period we had servicing and processing revenue of $119,791 and $9,420, respectively. Servicing revenue was reduced by the sale of approximately $200,000 of servicing rights for 18three months which began in Januaryended March 31, 2019. Costs were dominated by mortgage broker and brokerage underwriting expenses of $231,720 and $457,275, respectively, which together accounted for approximately 60% of direct costs. Gross profits grew to $342,514, an 866% increase over the same period in 2018, when the Company had gross profits of $35,458. Operating expenses rose as well, but at a slower pace of 52% ($363,064 for the current period compared to $238,619 for the same period in 2018) as we shift more salaries and expenses to KDM that were previously being paid by J. W. Korth.

Higher expenses and costs were offset by theIn addition, unrealized gain on mortgages owned, which was $1,232,433 at September 30, 2019, an increasedecreased by $115,080 during the first quarter of $634,072 over2020 compared with the priorfirst quarter due to new lending. A discussion of the assumptions underlying the valuation can be found in Note 8 of the Notes to our Unaudited Financial Statements.2019.

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

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

Financial Condition for the ninethree Months Ended September 30, 2019March 31, 2020

As of September 30, 2019,March 31, 2020, we had eleven$2,683,058 in cash, thirteen loans including the 460Ktotaling $92,192,442, consisting of $90,583,473 in mortgages and $1,608,969 in portfolio loanloans, and Mortgage Servicing Rights with a fair value of $2,880,391 on our balance sheet for a total of $42,258,402 ($41,798,402 without $460K) at fair value. The original loan amounts totaled $42,300,250 ($41,840,250, without $460K); however, two loans are amortizing and are carried at their remaining principal balances. We have recognized an unrealized gain of $1,232,433, which is the change in net present value of the future servicing income we receive from the loans made to date. This value is highly subjective and includes such variables as constant prepayment rate (CPR), discount rate, and market pricing data; this value will be recalculated quarterly. The current value was provided by a third-party consulting firm and uses 15.0% for the discount rate and includes a 10.76% constant prepayment rate (“CPR”), along with other assumptions customary to the industry.sheet. 

When J. W. Korth & Company forgave its receivable from the Company, we realized a large one-time gain as well as a decline in our Due to Parent liability, resulting in a corresponding substantial increase in Stockholder’s Equity of $548,802.

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.

We have grown our origination team to 4 members and have a goal to close an additional $50M of loans in 2019.

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 20192020 and succeeding years.

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

Status of KDM Loans

We include ourpost the annual reviews of each of our CM Loans as exhibits to our quarterly reports on SEC Form 10-Q.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 are held by outside investors or securitized and reachloan is performing under the anniversary of their inception in a current reporting quarter are included as an exhibit to each report.lockbox.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We have no instruments subject to market risk.

Item 4. Controls and Procedures.

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

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

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

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our internal control over financial reporting as of June 30, 2019,March 31, 2020, as required by Securities Exchange Act Rule 13a-15(c). In making our assessment, we have utilized the criteria set forth by the 2013 Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We concluded that based on our evaluation our internal control over financial reporting was effective as of September 30, 2019.March 31, 2020.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, as amended.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.

See Item 3.01 of our Current Report on Form 8-K filed on June 12, 2019, for a description of the issuance of equity securities to our parent company pursuant to our conversion from a limited liability company to a corporation.Not applicable.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not Applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

*Filed herewith.herewith

** Previously Filed

SIGNATURES

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

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