SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
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Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended Commission file number: 0-18188
December 31, 1997
FORM 10-KSB/A
Amendment No. 1
PAULSON CAPITAL CORP.
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Name of small business issuer as specified in its charter
Oregon 93-0589534
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
811 S.W. Naito Parkway, Suite 200
Portland, OR 97204
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(Address of principal (Zip Code)
executive offices)
Issuer's telephone number, including area code: (503) 243-6000
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Securities registered pursuant to Section 12(b) of the Act:
None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
--------------------------
Title of class
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 X
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part II of this Form 10-KSB or any
amendment to this Form 10-KSB.
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State issuer's revenues for its most recent fiscal year:
$23,473,061
As of March 18, 1998, 3,956,169 shares of the registrant's common stock, no
par value, were outstanding and the aggregate market value of the shares of
common stock of the Registrant held by non-affiliates (based upon the average of
the closing bid and asked prices of Registrant's shares in the over-the-counter
market as of such date) was $12,114,219.375.
Transitional Small Business Disclosure Format:
Yes No X
--- ---
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Paulson Capital Corp. ("Paulson Capital" or the "Company"), established in
1970, is a holding company whose only operating subsidiary is Paulson Investment
Company, Inc. ("PIC"), a full service brokerage firm engaged in the purchase and
sale of securities from and to the public and for its own account and in
investment banking activities. The Company operates in one industry segment, the
financial services industry. At December 31, 1997 PIC employed 22 brokers and
had independent contractor arrangements with 79 brokers registered with the
National Association of Securities Dealers, Inc. ("NASD"). PIC also employed a
support staff of 47 persons in its headquarters in Portland, Oregon and in
certain of its branch offices. At December 31, 1997 PIC had 35 branch offices
throughout the United States.
The Company's headquarters are located at 811 S.W. Naito Parkway, Suite
200, Portland, Oregon 97204. Its telephone number is (503) 243-6000.
Principal Products, Services and Markets
Virtually all of Paulson Capital's business is carried on through PIC. PIC
is involved in the purchase and sale of most investment securities but is not
involved in commodities or futures. Three broad categories of securities
activities contribute to revenues of PIC: general securities (or retail),
trading and market making (or wholesale) and corporate finance/investment
banking. PIC also receives revenues from gains and losses in investment
accounts, from the exercise of underwriter warrants received in connection with
its corporate finance activities, and from other sources.
The following table indicates the approximate percentage of revenues that
were accounted for by each of these categories and from investment income
(including underwriter warrants) in the last five fiscal years:
1997 1996 1995 1994 1993
General Securities 54% 47% 54% 84% 65%
Trading 5 6 4 (1) 8
Corporate Finance 17 18 10 14 25
Investment Income 24 29 32 2 2
Other 0 0 0 1 0
In this table, "Trading" includes only the net profit or loss from PIC's trading
activities. See "Trading and Market Making."
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General Securities
As a securities broker, PIC acts as agent for its customers in the purchase
and sale of common and preferred stocks, options and debt securities traded on
securities exchanges or in the over-the-counter ("OTC") market. A major portion
of its revenues is derived from commissions from customers on these
transactions. In the OTC market, transactions with customers in securities not
listed on an exchange may be effected as principal, rather than agent, primarily
where PIC is a market maker in that security. Customer transactions in
securities are effected either on a cash or margin basis.
PIC enters into dealer agreements with mutual fund management companies and
publicly registered limited partnerships. Commissions on the sale of these
securities are derived from the standard dealers discounts, which range from
approximately 1 percent to 8.5 percent of the purchase price of the securities,
depending on the terms of the dealer agreement and the amount of the purchase.
PIC does not generally sell interests in limited partnerships which are not
publicly registered.
Pursuant to an agreement between PIC and Correspondent Services Corporation
("CSC"), a subsidiary of PaineWebber Group, Inc., CSC carries all of PIC's
customer securities accounts and performs the following services: (1)
preparation and mailing of monthly statements to PIC customers; (2) settlement
of contracts and transactions in securities between PIC and other broker-dealers
and between PIC and its customers; (3) custody and safe-keeping of securities
and cash, the handling of margin accounts, dividends, exchanges, rights
offerings and tender offers; and (4) the execution of customer orders placed on
an exchange. PIC determines the amount of commission to be charged to its
customers on agency transactions and the price of securities purchased or sold
in principal transactions. CSC receives compensation based on the size of the
transaction, subject to certain minimum and maximum amounts. The agreement
between PIC and CSC may be canceled by either party upon 60 days written notice,
which period may be reduced in certain events. In the event of a liability
arising from a bad debt from a customer, PIC is required to indemnify CSC
against any loss. This potential liability is uninsured.
In addition to providing clearing services for PIC, CSC loans money to PIC
in the ordinary course of PIC's business, pursuant to an arrangement under which
CSC agrees to finance PIC's trading accounts. At December 31, 1997, $1,544,210
was outstanding pursuant to this arrangement. See "Item 6 - Management's
Discussion and Analysis or Plan of Operation."
Trading and Market Making
In addition to executing trades as an agent, PIC regularly acts as a
principal in executing trades in equity securities, corporate debt securities
and municipal bonds. The amount of trading by PIC in the high yield bond market
has not been material. At December 31, 1997, PIC made a market in approximately
30 securities of 21 issuers. Of these, 18 were corporations for which PIC has
acted as managing or co-managing underwriter of public financings. In addition,
at December 31, 1997, PIC held securities of 10 companies in its investment
account. In 1997, the value of securities held in the trading accounts and
investment account ranged between $9,362,129 and $15,970,382. The level of
positions carried in PIC's trading and investment accounts fluctuates
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significantly. The size of the securities positions at any date may not be
representative of PIC's exposure on any other date, because the securities
positions vary substantially depending upon economic and market conditions, the
allocation of capital among types of inventories, underwriting commitments,
customer demands and trading volume. The aggregate value of inventories that PIC
may carry is limited by certain requirements under the SEC's net capital rules.
See "Net Capital Requirements."
PIC's market making activities are conducted both with other dealers in the
"wholesale market" and with PIC's customers. Transactions with customers are
effected as principal at a net price equal to the current interdealer price plus
or minus the approximate equivalent of a brokerage commission. Securities are
purchased primarily to provide an inventory for customers who wish to buy, and
short sales are likewise made primarily to serve customers. PIC's transactions
as principal expose PIC to risk because securities positions are subject to
fluctuations in market value and liquidity. Profits or losses on trading and
investment positions depend upon the skills of the employees in PIC's trading
department and employees responsible for taking investment positions. The
trading department is headquartered in PIC's Portland, Oregon office.
Corporate Finance
PIC raises capital through public offerings of securities for corporations
that are engaged in a variety of businesses. PIC participates in underwritings
of corporate securities as managing underwriter and as a syndicate member.
Management of an underwriting account is generally more profitable than
participation as a member of an underwriting syndicate. Revenues generated by
syndicate participations have not been material.
PIC generally underwrites public offerings of securities in the range of
$1.5 million to $20 million on a "firm commitment" basis, which means that it
agrees to purchase a specific amount of securities from the issuer at a discount
after the registration statement for the offering is declared effective by the
Securities and Exchange Commission (the "SEC") and resells the securities to the
public at a specified price. The underwriting involves risk of loss if PIC is
unable to resell at a profit the securities it is committed to purchase. This
risk is usually reduced by accepting other stock brokerage firms as a part of an
underwriting syndicate in which each member commits to purchase a specified
amount of the offering. PIC and other underwriters may also sell a portion of
their commitment through a "selling group" of other stock brokerage firms that
participate in selling the offering but are not subject to an underwriter's
commitment. As an underwriter, PIC is also subject to potential liability under
federal and state securities laws and other laws if the registration statement
or prospectus contains a material misstatement or omission. PIC's potential
liability as an underwriter is uninsured.
The commitment of capital by PIC between the time a firm commitment
underwriting agreement becomes effective and the time PIC resells the securities
constitutes a charge against its net capital. Accordingly, PIC's participation
in or initiation of underwritings may be limited by the financial requirements
of the SEC and NASD. See "Net Capital Requirements."
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Between June 1, 1978 and December 31, 1997 PIC acted as the managing
underwriter or co-managing underwriter for 127 securities offerings, raising
approximately $727 million for corporate finance clients. Of these, 79 were
initial public offerings. PIC typically receives 2 to 3 percent of the aggregate
amount of money raised in an offering to cover nonaccountable expenses and
between 7 and 9 percent as compensation to underwriters, selling group members
and registered representatives, although these percentages may be lower for
larger transactions. PIC also typically receives warrants to purchase
securities, equal to 10 percent of the securities sold in the offering, for a
period of five years at a price equal to 120 percent of the public offering
price, although a portion of these warrants are typically transferred as
compensation to persons associated with PIC and, in certain cases, to other
major underwriters in the public offering. See "Item 6 - Management's Discussion
and Analysis or Plan of Operation - Liquidity and Capital Resources."
Branch Offices
PIC branch offices are generally run by independent contractors that assume
liability for all the operating expenses of the branch. PIC typically receives
between 15 and 20 percent of the gross commission earned by the branch, with the
balance retained by the branch to pay its expenses and staff. Persons in these
branches are registered with PIC, and PIC assumes the same compliance and
regulatory obligations as would be the case if PIC were fully responsible for
the branch's expenses. As of December 31, 1997, PIC had 35 branch offices in
Arizona, California, Connecticut, Georgia, Hawaii, Idaho, Nevada, New York,
Oregon, Texas, Utah and Washington. All of these branches except one in Salem,
Oregon are operating as independent contractor offices. PIC continues to be
responsible for all expenses of the Salem office.
Research
PIC employs three persons that devote a majority of their time to gathering
and analyzing information which is intended to provide PIC with an adequate
basis for performing its investment banking activities and to provide customers
with a regular flow of information on the companies for which PIC has in the
past provided investment banking services.
Regulation
PIC is registered with the SEC as a broker-dealer under the Securities
Exchange Act of 1934. It is also registered as a broker-dealer under the laws of
43 states and Washington, D.C. PIC is a member of the NASD.
The securities business is subject to extensive regulation under federal
and state laws. The principal purpose of regulation and discipline of
broker-dealers is the protection of customers and the securities markets rather
than protection of creditors and stockholders of broker-dealers. The SEC is the
federal agency charged with administration of the federal securities laws. Much
of the regulation of broker-dealers, however, has been delegated to
self-regulatory organizations, principally the NASD. These self-regulatory
organizations adopt rules (subject to approval by the SEC) which govern the
industry and conduct periodic examinations of member broker-dealers. Securities
firms are also subject to regulation and examination by state securities
commissions in the states in which they are registered.
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The regulations to which broker-dealers are subject cover all aspects of
the securities business, including sales methods, trading practices among
broker-dealers, capital structure of securities firms, record keeping and the
conduct of directors, officers and employees. Additional legislation, changes in
rules promulgated by the SEC and by self-regulatory bodies or changes in the
interpretation or enforcement of existing laws and rules often affect directly
the method of operation and profitability of broker-dealers. The SEC, NASD and
state regulatory authorities may conduct administrative proceedings which can
result in censure, fine, suspension or expulsion of a broker-dealer, its
officers or employees.
Net Capital Requirements
PIC is required to maintain minimum "net capital" under the SEC's net
capital rule of not less than 6.67 percent of its aggregate indebtedness. As of
December 31, 1997, PIC had net capital of $9,835,487, which exceeded its minimum
requirement of $145,080 by $9,690,407. The ratio of aggregate indebtedness of
$2,176,200 to net capital of $9,835,487 on December 31, 1997 was approximately
.22 to 1. In a public offering in which PIC acts as an underwriter, PIC must
have sufficient net capital to cover the amount of securities underwritten,
applying applicable formulae mandated by the SEC, during the period between
effectiveness and the closing of the transaction (usually about one week). This
results in a significant temporary increase in PIC's required net capital. In
many cases, the amount of securities underwritten by PIC has been limited by its
net capital. Any significant reduction in PIC's net capital, even if PIC were
still in compliance with the SEC's net capital rule for its retail and trading
activities, could have a material adverse impact on PIC's ability to continue
its investment banking activities.
Competition
All aspects of PIC's business are highly competitive. In its general
brokerage activities, PIC competes directly with numerous other broker-dealers,
many of which are large well known firms with substantially greater financial
and personnel resources than PIC. Many of PIC's competitors employ extensive
advertising and actively solicit potential clients in order to increase
business. In addition, brokerage firms compete by furnishing investment research
publications to existing clients, the quality and breadth of which are
considered important in the development of new business and the retention of
existing clients. PIC also competes with a number of smaller regional brokerage
firms.
Some commercial banks and thrift institutions offer securities brokerage
services. Many commercial banks offer a variety of investment banking services.
Competition among financial services firms also exists for investment
representatives and other personnel.
The securities industry has become considerably more concentrated and more
competitive since the Company was founded, as numerous securities firms have
either ceased operations or have been acquired by or merged into other firms.
This trend has been particularly pronounced among firms similar in size and
business mix to PIC. In addition, companies not engaged primarily in the
securities business, but with substantial financial resources, have acquired
leading securities firms. These developments have increased competition from
firms with greater capital resources
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than those of the Company. Various legislative and regulatory developments have
tended to increase competition within the industry or reduced profits for the
industry. In particular, various recent developments have tended to increase
competition from commercial banks.
The securities industry has experienced substantial commission discounting
by broker-dealers competing for brokerage business. In addition, an increasing
number of specialized firms now offer "discount" services to individual
customers. These firms generally effect transactions for their customers on an
"execution only" basis without offering other services such as portfolio
valuation, investment recommendations and research. The continuation of such
discounting and an increase in the number of new and existing firms offering
discounts could adversely affect the Company. In addition, rapid growth in the
mutual fund industry is presenting potential customers of PIC with an increasing
number of alternatives to traditional stock brokerage accounts.
In its investment banking activities, PIC competes with other brokerage
firms, venture capital firms, banks and all other sources of capital for small,
growing companies. Since PIC generally manages offerings smaller than $20
million, it does not typically compete with the investment banking departments
of large, well-known national brokerage firms. Nevertheless, PIC occasionally
manages larger offerings. In addition, large national and regional investment
banking firms occasionally manage offerings of a size that is competitive with
PIC, typically for fees and compensation less than that charged by PIC. When the
market for initial public offerings is active, many small regional firms that do
not typically engage in investment banking activities also begin to compete with
PIC.
Employees
At December 31, 1997, PIC had 69 employees, of whom 47 were executives and
support staff and 22 were involved in brokerage activities and compensated
primarily on a commission basis. PIC also had independent contractor
arrangements with 79 independent contractors, all of whom are compensated solely
on a commission basis. Paulson Capital had no employees separate from PIC.
ITEM 2. DESCRIPTION OF PROPERTY
PIC leases approximately 17,100 square feet of space for its office in
Portland, Oregon under a lease expiring May 31, 2002 at a monthly rent of
$22,848. PIC's Salem office rents space on a month to month basis. The Company
believes the existing leased space is suitable and adequate for its business for
the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
The Company and PIC are defendants in Holly Millar and Bertram Ostrau v.
Pearce Systems International, Inc., et al., filed in San Francisco Superior
Court, State of California, in March 1996. An asserted class action, plaintiffs
allege violations of the California securities law, deceit, negligent
misrepresentation and unfair business practices relating to alleged
misstatements
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in the prospectus used in connection with a February 1994, $5 million public
offering in which PIC acted as the managing underwriter. Plaintiffs seek
rescission of the offering as well as actual damages, interest, attorney fees
and punitive damages. No class has been certified, although a motion for class
certification is pending. The case is set for trial February 18, 1999. Discovery
in this matter is still in the early stages. Therefore, the Company and PIC have
not had an opportunity to investigate this matter fully but believe they have
meritorious defenses and intend to defend this matter vigorously. Pursuant to a
tolling agreement with the plaintiff, the Company (but not PIC) expects to be
dismissed without prejudice from the lawsuit.
Richard Toscano Claim Richard Toscano, a former PIC customer, has filed an
arbitration claim against PIC and Jeff Hudson, a former PIC broker, alleging
various securities law violations, including unsuitability and
misrepresentation, in connection with his account with PIC. He has also alleged
that PIC failed to supervise Mr. Hudson. Mr. Toscano seeks damages in excess of
$90,000 plus interest, attorney fees and punitive damages. PIC has not had an
opportunity to fully investigate this claim, but believes it has meritorious
defenses and intends to defend this matter vigorously.
Philip Cutler Claim In March 1996, Philip Cutler, a former PIC customer,
asserted various claims against Todd Bollman, a former PIC broker, and PIC
alleging unsuitability and churning in his account with PIC. Mr. Cutler has
indicated that his losses approach $90,000, not including commissions. PIC has
indicated to Mr. Cutler that it believes he is an experienced, sophisticated
investor who spoke regularly with Mr. Bollman and was well informed with respect
to the risks involved in the trading that he selected in his account. Although
Mr. Cutler indicated that he would seek arbitration, no arbitration has been
filed at this time. PIC has not had an opportunity to fully investigate this
matter, but believes it has meritorious defenses and intends to defend this
matter vigorously if an arbitration claim is filed.
Craig and Cherie Cline Claim In December 1997, Craig and Cherie Cline,
former PIC customers, asserted claims against PIC and Clint Holland, a PIC
broker, alleging misrepresentation, unsuitability and breach of fiduciary duty
in connection with the handling of their account by PIC and Mr. Holland. The
Clines have demanded $250,000 to settle this matter. PIC has not had an
opportunity to fully investigate this matter but believes it has meritorious
defenses and intends to defend this matter vigorously if an arbitration claim is
filed.
An adverse outcome in certain of the matters described above could have a
material adverse effect on PIC or the Company. PIC has been named in certain
other legal proceedings and has received notice that certain customers may
commence legal proceedings against PIC. The Company believes, based upon
information received to date and, where the Company believes it appropriate,
discussions with legal counsel, that resolution of this additional pending or
threatened litigation will have no material adverse effect on the consolidated
financial condition, results of operations, or business of the Company.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock trades in the over-the-counter market. The
Company's stock has not been actively traded. The Company's stock is quoted on
the Nasdaq SmallCap Market under the symbol "PLCC." The following are high and
low sales prices for the common stock for the periods shown, as obtained from
the Nasdaq Stock Market.
1997 Prices 1996 Prices 1995 Prices
High Low High Low High Low
1st Quarter $3.188 $2.500 $1.188 $.875 $.500 $.406
2nd Quarter 5.250 2.562 3.500 .906 .938 .438
3rd Quarter 6.875 3.500 3.188 1.750 1.000 .688
4th Quarter 6.562 4.625 3.125 2.562 1.750 .875
The high and low closing price for the first quarter of 1998 through March 18
were $5.50 and $4.625, respectively.
As of March 18, 1998, there were 3,970,536 shares of the Company's common
stock outstanding and held of record by 145 holders. The number of record
holders includes as single holders various institutions (such as brokerage
firms) that hold shares in "street name" for multiple shareholders. Based on the
number of requests for the Company's proxy materials for its 1997 annual
meeting, the Company believes there are approximately 450 beneficial holders of
its common stock. The Company repurchased 200,111 shares of common stock during
1997. Additional shares of common stock may be repurchased from time to time in
the future.
The Company has never paid a dividend on its common stock. Regulatory net
capital requirements may limit the ability of PIC to pay dividends to the
Company, which would affect the Company's ability to pay dividends to its
shareholders. The Company anticipates that, for the foreseeable future, earnings
will be retained for use in its business and does not anticipate the payment of
dividends.
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
SELECTED FINANCIAL DATA
(in thousands except per share amounts)
Income Statement Information
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
Revenues $23,473 $25,618 $18,031 $9,345 $18,884
Commissions and Salaries 12,552 12,092 9,688 7,782 12,572
Other Expenses 4,003 4,073 3,637 3,319 4,843
Total Expenses 16,555 16,165 13,325 11,101 17,415
Pretax Income (loss) 6,918 9,453 4,706 (1,755) 1,469
Net Income (loss) 4,354 5,727 2,925 (1,080) 836
Diluted Earnings (loss) $1.09 $1.33 $.67 ($.25) $.18
per share
Average number of
common shares outstanding 4,005 4,323 4,357 4,372 4,535
Balance Sheet Information
December 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
Total Assets $22,463 $16,291 $9,542 $4,653 $6,052
Working Capital 13,411 9,737 4,759 1,851 3,051
Short-Term Debt 100 100 100 100 100
Long-Term Debt 0 0 0 0 0
Shareholders' Equity $13,784 $9,899 $4,886 $2,001 $3,173
</TABLE>
Results of Operations
PIC's revenues and operating results are influenced by fluctuations in the
equity underwriting markets as well as general economic and market conditions,
particularly conditions in the over-the-counter market, where PIC's investment
account, trading inventory positions and underwriter warrants are heavily
concentrated. Significant fluctuations can occur in PIC's revenues and operating
results from one period to another. PIC's results of operations depend upon many
factors, such as the number of companies that are seeking public financing, the
quality and financial
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condition of those companies, market conditions in general, the performance of
previous PIC underwritings and interest in certain industries by investors. As a
result, revenues and income derived from these activities may vary significantly
from year to year. In the tables below, "Trading Income" is the net gain or loss
from trading positions before commissions paid to the representatives in the
trading department. "Investment Income" includes amounts received, if any, from
the exercise of PIC's underwriter warrants.
Summary of Changes in Major Categories
of Revenues and Expense
<TABLE>
<CAPTION>
1997 vs. 1996 1996 vs. 1995
----------------------- -----------------------
<S> <C> <C> <C> <C>
Revenues:
Sales Commissions $544,748 4.5% $2,519,052 26.1%
Corporate Finance (631,269) (13.8%) 2,674,864 142.1%
Investment Income (1,765,814) (24.0%) 1,595,558 27.7%
Trading Income (301,286) (20.1%) 796,232 113.6%
Other 8,396 24.9% 2,015 6.3%
Expenses:
Commissions and Salaries $459,550 3.8% $2,404,918 24.8%
Underwriting Expenses (183,533) (19.4%) 448,985 90.4%
Rent, Telephone & Quotes 36,114 4.5% (134,539) (14.4%)
Other 77,778 3.3% 121,245 5.5%
Pretax Income ($2,535,134) (26.8%) $4,747,112 100.9%
</TABLE>
1997 Compared to 1996
Total revenues for 1997 fell 8.4 percent from 1996, from $25,618,286 to
$23,473,061. As shown in the table above, sales commissions rose $544,748, or
4.5 percent, from $12,184,046 in 1996 to $12,728,794 in 1997. This small
increase resulted primarily from the more favorable price movements and trading
levels in smaller capitalization OTC issues in 1997, compared to more moderate
levels in 1996. The Nasdaq Industrial Average rose more in 1996 (15.03 percent)
compared to 1997 (14.57 percent), but PIC's focus is on very small
capitalization issues, especially tied to PIC's corporate finance clients, which
experienced a more favorable market in 1997. Corporate finance revenues fell
13.8 percent, or $631,269, in 1997 compared to 1996. Seven transactions were
completed in 1996, raising a total of $118 million for the issuers; 6
transactions were completed in 1997, raising an aggregate of $93 million for
corporate finance clients. Investment income decreased $1,765,814, from
$7,346,825 in 1996 to $5,581,011 in 1997. Two underwriter warrants were
exercised in 1996 while one warrant was exercised in 1997, and the profits from
investments sold in the investment account in 1996 were significantly greater
than in 1997. Trading income fell $301,286, or 20.1 percent, from $1,496,871 in
1996 to $1,195,585 in 1997. This decline was due to lower trading levels in 1997
and the generally more favorable markets in OTC issues in 1996 compared to 1997.
Total expenses rose $389,909 in 1997 from 1996, an increase of 2.4 percent
from $16,165,164 to $16,555,073. Commissions and salaries rose $459,550, or 3.8
percent, from
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$12,092,256 in 1996 to $12,551,806 in 1997. This increase was primarily due to
increased commission revenues resulting in a higher level of commissions paid.
Higher commission rates are generally paid to employee registered
representatives at higher production levels as an incentive. Underwriting
expenses decreased by $183,533, or 19.4 percent, due primarily to decreased
legal fees for the fewer corporate finance transactions completed in 1997
compared to 1996. Rent, telephone and quote expenses increased from $799,358 in
1996 to $835,472 in 1997, an increase of 4.5 percent. Other expenses increased
3.3 percent, from $2,327,700 in 1996 to $2,405,478 in 1997, primarily due to
increased professional and consulting fees, offset partially by declines in
settlements and bad debt expenses.
The Company had a pretax profit of $9,453,122 in 1996 compared to a pretax
profit of $6,917,988 in 1997. The primary reasons for this decrease were the
significant decreases in investment income, corporate finance revenues and
trading income. Independent of investment income, the Company would have had
pretax income of $1,336,977 in 1997 compared to pretax income of $2,106,297 in
1996. Investment income during both years was significantly higher than in any
previous year in the Company's history. This was due to gains in the value of
the underwriter warrants sold and greater profits on positions held in response
to significant increases in OTC prices, particularly the technology sector. This
source of income cannot be expected to regularly recur. Significant fluctuations
can occur in PIC's revenues and operating results from one period to another.
The Company also incurred an expense of $3,725,920 for income taxes in 1996,
compared to $2,563,593 in 1997.
1996 Compared to 1995
Total revenues for 1996 rose 42.1 percent from 1995, from $18,030,565 to
$25,618,286. As shown in the table above, sales commissions rose $2,519,052, or
26.1 percent, from $9,664,994 in 1995 to $12,184,046 in 1996. This increase
resulted primarily from the more favorable price movements and trading levels in
smaller capitalization OTC issues in 1996, compared to more moderate levels in
1995. The Nasdaq Industrial Average rose less in 1996 (15.03 percent) compared
to 1995 (29.97 percent), but PIC's focus is on very small capitalization issues
which experienced a more favorable market in 1996. Specifically, very active
trading levels in the securities of two issuers for which PIC recently completed
corporate finance transactions increased sales commissions. Corporate finance
revenues rose 142.1 percent or $2,674,864 in 1996 compared to 1995. Seven
transactions were completed in 1996, raising a total of $118 million for the
issuers; seven transactions were completed in 1995, raising an aggregate of
$39.70 million for corporate finance clients. Investment income increased
$1,595,558, to $7,346,825 in 1996 from $5,751,267 in 1995. Two underwriter
warrants were exercised in 1996 while seven warrants were exercised in 1995, but
the profits from investments sold in the investment account in 1996 were
significantly greater than in 1995. Trading income rose $796,232, to $1,496,871
in 1996 from $700,639 in 1995. This improvement was also due to greater trading
levels and generally higher prices in OTC issues in 1996 compared to 1995.
Total expenses rose $2,840,609 in 1996 from 1995, an increase of 21.3
percent from $13,324,555 to $16,165,164. Commissions and salaries rose
$2,404,918, or 24.8 percent, from $9,687,338 in 1995 to $12,092,256 in 1996.
This increase was primarily due to increased commission revenues resulting in a
higher level of commissions paid. Higher commission rates are
13
<PAGE>
generally paid to employee registered representatives at higher production
levels as an incentive. Underwriting expenses increased by $448,985 or 90.4
percent, due primarily to increased legal fees for the larger corporate finance
transactions completed in 1996 compared to 1995. Rent, telephone and quote
expenses decreased from $933,897 in 1995 to $799,358 in 1996, a decrease of 14.4
percent. This was primarily due to reduced office rent expenses as the result of
subleasing to independent contractors and lower quotation expenses due to
replacing leased quotation machines with purchased personal computers. Other
expenses increased 5.5 percent, from $2,206,455 in 1995 to $2,327,700 in 1996,
primarily due to increased accruals for PIC's profit sharing and 401(k) plan.
The Company had a pretax profit of $9,453,122 in 1996 compared to a pretax
profit of $4,706,010 in 1995. The primary reasons for this increase were the
significant increases in corporate finance revenues, investment income and
trading income. Independent of investment income, the Company would have had a
loss before income taxes of $1,045,257 in 1995 compared to pretax income of
$2,106,297 in 1996. Investment income during both years was significantly higher
than in any previous year in the Company's history. This was due to gains in the
value of the underwriter warrants sold and greater profits on positions held in
response to significant increases in OTC prices, particularly the technology
sector. This source of income cannot be expected to regularly recur. Significant
fluctuations can occur in PIC's revenues and operating results from one period
to another. The Company also incurred an expense of $3,725,920 for income taxes
in 1996, compared to $1,780,977 in 1995.
Liquidity and Capital Resources
Conducting business as a dealer in securities requires that a substantial
inventory of securities be maintained and that a large amount of liquid assets
be readily available. PIC is also required to maintain net capital as described
in "Item 1 - Description of Business -- Net Capital Requirements" above. The
Company's working capital at December 31, 1997 was $13,411,233. Of PIC's total
assets (net of intercompany accounts) at December 31, 1997 of $21,929,580,
approximately 73 percent consisted of securities in PIC's investment account and
trading inventory of securities, at market value, and approximately 21 percent
consisted of cash, certificates of deposit and receivables from its
correspondent broker and other dealers.
PIC's securities inventory is stated at market value. The liquidity of the
market for many of PIC's securities holdings, however, varies with trends in the
stock market. Since many of the securities held by PIC are thinly traded, and
PIC is in many cases a primary market maker in the issues held, any significant
sales of PIC's positions could adversely affect the liquidity and prices of the
issues held. In general, falling prices in OTC securities (which make up most of
PIC's trading positions) lead to decreased liquidity in the market for these
issues, while rising prices in OTC issues tends to increase the liquidity of the
market for these securities. The overall decline in prices for the OTC
securities traded by PIC in 1994 was combined with a general reduction in the
liquidity of the markets for these securities. This situation was the reverse of
1997, 1996, 1995 and 1993, when increases in prices of OTC securities increased
the liquidity of the markets for these securities. PIC's investment account and
trading inventory accounts are stated at fair market value, which is at or below
quoted market price. They include shares of restricted stock recorded by PIC
14
<PAGE>
at their original cost of $776,475 which the Company believes, based upon
available evidence, approximates market value.
PIC owed $100,000 at December 31, 1997 pursuant to a subordinated loan from
an investor. PIC also borrows money from CSC in the ordinary course of its
business, pursuant to an arrangement under which CSC agrees to finance PIC's
trading accounts in an amount determined by the size of those accounts and the
type of securities held, with interest charged at prevailing margin rates. As of
December 31, 1997, $1,544,210 was owed by PIC to CSC pursuant to this
arrangement. PIC and the Company are generally able to meet their compensation
and other obligations out of current liquid assets.
Another source of capital to PIC and the Company has been the exercise of
underwriter warrants issued to PIC in connection with its corporate finance
activities and the sale of the underlying securities. These warrants are not
reflected on the balance sheet of PIC or Paulson Capital. While the warrants and
the securities issuable upon exercise of the warrants are not immediately
saleable, PIC receives the right to require the issuer to register the
underlying securities for resale to the public. Profits, if any, from the
warrants are realized based upon the difference between the market price and the
exercise price on the date of exercise. Further profits or losses are
subsequently realized when the underlying securities are sold. Profits and
losses realized from the warrants are recorded as "Investment Income." There is
no public market for the underwriter warrants. The securities receivable upon
exercise of the underwriter warrants cannot be resold unless the issuer has
registered these securities with the SEC and the states in which the securities
will be sold or exemptions are available. Any delay or other problem in the
registration of these securities would have an adverse impact upon PIC's ability
to obtain funds from the exercise of the underwriter warrants and the resale of
the underlying securities. At December 31, 1997, PIC owned 34 underwriter
warrants (from 33 issuers), of which 28 were currently exercisable and 10 had an
exercise price below the current market price of the securities receivable upon
exercise. The value of the firm's underwriter warrants depends on the prices of
the underlying securities. These prices are influenced by general movements in
the prices of OTC securities as well as the success of the issuers of the
underwriter warrants.
In 1997, $2,161,948 of net cash was used in operating activities. The major
adjustments to reconcile this result to the Company's net income included a
realized gain on investment securities of $5,988,817, an increase of $3,749,019
in trading securities and an increase of $240,724 in prepaid and deferred
expenses, partially offset by an increase of $2,236,523 in accounts payable and
accrued liabilities, a $562,999 decrease in receivables, $407,806 unrealized
depreciation on investment securities and a $310,354 decrease in refundable
income taxes. In 1997, $2,526,927 of net cash was provided by investing
activities, primarily sales of investment securities exceeding purchases of
investment securities. Net cash used in financing activities in 1997 totalled
$477,204, resulting primarily from payments to repurchase common stock,
partially offset by proceeds from the exercise of stock options. See "Financial
Statements -- Consolidated Statements of Cash Flows."
As a securities broker-dealer, the Company's wholly owned subsidiary, PIC,
is required by SEC regulations to meet certain liquidity and capital standards.
In the unlikely event that PIC was unable to meet these regulatory standards, it
would be unable to pay dividends to the Company.
15
<PAGE>
Since PIC is the Company's only operating business, such a failure could have a
material adverse affect on the Company.
At December 31, 1997, the Company had no material commitments for capital
expenditures.
In general, the primary sources of PIC's, and therefore the Company's,
liquidity, including PIC's trading positions, borrowings on those positions and
profits realized upon the exercise of underwriter warrants, all depend in large
part on the trend in the general markets for OTC securities. Rising OTC price
levels will tend to increase the value and liquidity of PIC's trading positions,
the amount that can be borrowed from CSC based upon those positions, and the
value of PIC's underwriter warrants. The Company believes its liquidity is
sufficient to meet its needs for the foreseeable future.
Inflation
Because PIC's assets are primarily liquid, they are not significantly
affected by inflation. The rate of inflation affects PIC's expenses, such as
employee compensation, office leasing and communications costs. These costs may
not readily be recoverable in the price of services offered by the Company. To
the extent inflation results in rising interest rates and has other adverse
effects in the securities markets and the value of securities held in inventory
or PIC's investment account, it may adversely affect the Company's financial
position and results of operations.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
(a) Financial Statements Page
Report of Independent Certified Public Accountants F-1
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-2
Consolidated Statements of Earnings for the years ended December 31,
1997, 1996 and 1995 F-3
Consolidated Statement of Shareholders' Equity for the years ended
December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 F-5
Notes to Consolidated Financial Statements F-7
Supplementary Schedule of Warrants Owned F-17
16
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There has been no Form 8-K filed within 24 months prior to the date of the
most recent consolidated financial statements reporting a change of accountants
and/or reporting disagreements on any matter of accounting principle or
financial statement disclosure.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY; COMPLIANCE WITH SECTION
16(a) OF THE EXCHANGE ACT
Directors of the Company are elected for a term of one year and until their
successors are elected and qualify. Executive officers are appointed by the
board of directors and do not have fixed terms of office. The board of directors
and executive officers as of December 31, 1997 are set forth below. The year
each person became a director follows his or her name.
<TABLE>
<CAPTION>
Principal Occupation(s)
Positions(s) with During Past
Name Age Company Five Years
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Chester L.F. Paulson 61 President and Director Director of Corporate
(1970) Finance of PIC (President
of PIC until 7/92)
Jacqueline M. Paulson 58 Secretary-Treasurer Secretary-Treasurer of
(1976) and Director PIC (Chief Executive
Officer of PIC from 7/92
to 8/93)
Kenneth T. LaMear 63 Director Chief Executive Officer
(1985) of PIC (Senior Vice
President of PIC prior to
8/93)
</TABLE>
Chester L.F. Paulson and Jacqueline M. Paulson are husband and wife.
Mr. LaMear failed to file on a timely basis two reports required by Section
16(a) of the Securities Exchange Act of 1934 with respect to the exercise of
options for 14,285 shares of the Company's common stock in August 1996 and the
gifting of 1,600 shares of the Company's common stock to his grandson in
September 1997.
17
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning the
compensation for services in all capacities to the Company and its subsidiary
for the fiscal years ended December 31, 1997, 1996 and 1995 of those persons who
were, at December 31, 1997, the Chief Executive Officer of the Company and the
only other executive officers of the Company whose total annual compensation
exceeded $100,000 in 1997 (the "Named Executive Officers").
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Long Term
Compensation
Annual Compensation ---------------------
Name and ------------------------------------------ Securities Underlying All Other
Principal Position Year Salary $ (1) Bonus $ (2) Options (# Shares) Compensation $ (3)
- --------------------- ---- ----------- ----------- --------------------- ------------------
<S> <C> <C> <C> <C> <C>
Chester L.F. Paulson, 1997 569,234 200,000 -- 24,956
President 1996 551,672 200,000 -- 1,118,095
1995 269,430 75,000 14,285 903,968
Kenneth T. LaMear, 1997 107,657 115,000 -- 24,956
CEO of PIC 1996 71 004 120,000 -- 25,121
1995 128,061 75,000 14,285 8,644
Jacqueline M. Paulson, 1997 131,849 75,000 -- 24,956
Secretary-Treasurer 1996 120,497 75,000 -- 7,270
1995 21,599 75,000 14,285 1,652
(1) Mr. Paulson is not paid any salary. The amounts included in the
"Salary" column above for Mr. Paulson consist of amounts paid contingent upon
the completion of PIC's corporate finance transactions. The amounts included in
"Salary" for Mr. LaMear include retail commissions from Mr. LaMear's service as
a registered representative of PIC as well as a salary of $20,400, $20,400 and
$20,400 in 1997, 1996 and 1995, respectively. No Named Executive Officer
received any perquisites or other personal benefits the aggregate amount of
which exceeded the lesser of either $50,000 or 10 percent of the total annual
salary and bonus reported for 1997 in the Summary Compensation Table.
(2) Bonus amounts are based upon a percentage (fixed by the Board of
Directors) of a bonus pool based upon profits, if any. The Board has authorized
15 percent of PIC's pretax income up to $1 million and 10 percent of pretax
income thereafter to be placed into the bonus pool. For 1995, the bonus pool
calculation was $587,296, but the Board of Directors reduced actual bonus
payments to officers and directors to $525,000. For 1996, the bonus pool
calculation was $1,116,466, but the Board of Directors reduced actual bonus
payments to officers and directors to $760,000. For 1997, the bonus pool
calculation was $869,738, but the Board of Directors reduced actual bonus
payments to officers and directors to $820,000.
(3) Amounts shown for 1997, 1996 and 1995 include contributions of $1,500
for each of Messrs. Paulson and LaMear and Ms. Paulson relating to PIC's match
of employee contributions pursuant to PIC's 401(k) retirement plan. Amounts
shown for 1997 include contributions of $23,456 for each of Mr. Paulson, Mr.
LaMear and Ms. Paulson to PIC's tax qualified profit sharing plan. Amounts shown
for 1996 include contributions of $18,497, $23,621 and $5,770, respectively, for
Mr. Paulson, Mr. LaMear and Ms. Paulson to the profit sharing plan. Amounts
shown for 1995 include contributions of $8,215, $7,144 and $152, respectively,
for Mr. Paulson, Mr. LaMear and Ms. Paulson to the profit sharing plan. The
profit sharing plan provides for annual contributions at the discretion of PIC's
board of directors which are allocated to participants' accounts in proportion
to their compensation. Of the amount allocated to an individual, 20 percent, 40
percent, 60 percent, 80 percent and 100 percent is vested after two, three,
four, five and six years of service, respectively. In the event of death,
retirement at or after age 59, or termination of employment because of
disability, the participant immediately becomes entitled to 100 percent of his
or her account. No portion of the Company's contributions to the plan became
vested during fiscal 1997 with respect to any executive officer or director.
Retirement benefits are based on the investment performance of each
participant's account under the plan. There was no other annual compensation,
restricted stock awards, or long term incentive plan payouts during the periods
shown. The amounts shown for Mr. Paulson in 1997, 1996 and 1995 also include $0,
$1,161,098 and $894,253, respectively, representing the net gain received from
the exercise of underwriter warrants allocated to him, based upon the difference
in the price of the security on the date of the exercise of the warrant and the
exercise price of the warrant. Underwriter warrants are received by PIC upon the
completion of corporate finance transactions for its clients.
</TABLE>
18
<PAGE>
STOCK OPTION GRANTS IN LAST FISCAL YEAR
There were no stock options granted to the Named Executive Officers in
1997.
OPTION EXERCISES AND YEAR-END OPTION VALUES
The following table indicates for each Named Executive Officer (1) stock
options exercised during the year ended December 31, 1997, including the value
realized on the date of exercise, (ii) the number of shares subject to
exercisable (vested) and unexercisable (unvested) stock options as of December
31, 1997 and (iii) the value of "in-the-money" options, which represents the
positive spread between the exercise price of existing stock options and the
year-end price of the Common Stock.
<TABLE>
<CAPTION>
Number of Shares Subject to $ Value of Unexercised
Unexercised Options at Fiscal In-the-Money Options at
Year-End Fiscal Year-End
Number of Shares $ Value ---------------------------- ----------------------------
Name Acquired on Exercise Realized (1) Exercisable Unexercisable Exercisable Unexercisable
---- -------------------- ------------ ----------- ------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Chester L.F. Paulson 14,285 $ 44,194.22 0 0 0 0
Kenneth T. LaMear 0 0 0 0 0 0
Jacqueline M. Paulson 34,285 $101,694.22 0 0 0 0
(1) The amount set forth representing the value realized represents the
difference between the last sale price of $4.00 per share of Common Stock on
July 2, 1997, the date of exercise, and the exercise price of the options
exercised ($.90625 for all options except $1.125 for options for 20,000 shares
exercised by Ms. Paulson). Options to purchase 38,570 shares of the Company's
common stock were exercised by employees of PIC other than the Named Executive
Officers during 1997.
</TABLE>
19
<PAGE>
The Company has no employment agreements with any of its executive
officers.
Compensation of Directors. Under the 1991 Directors' Meeting Stock
Incentive Plan (the "1991 Plan"), the Company pays its directors and certain
officers invited to the meetings of the Board of Directors $500 per meeting, up
to a maximum of six meetings per year, payable in Common Stock of the Company
based upon the stock price on the day prior to the meeting. The 1991 Plan was
adopted by the Company's stockholders at the 1991 annual meeting of stockholders
in June 1991. The 1991 Plan was amended to also cover participants at meetings
of the board of directors of any subsidiary of the Company at the 1993 annual
meeting of stockholders in June 1993. Similar payments were made to directors
prior to the adoption of the 1991 Plan. The three non-officer directors of the
Company, three officers of PIC and one non-officer director of PIC were issued a
total of 2,266 shares in 1997 (1,566 shares at $2.875 and 700 shares at $5.00).
Messrs. Paulson and LaMear and Ms. Paulson each received 448 shares and
directors and executive officers as a group received 1,344 shares.
ITEM 11. STOCK OWNERSHIP OF PRINCIPAL OWNERS AND MANAGEMENT
The following table provides information concerning persons known to the
Company to be the beneficial owners of more than 5 percent of the Company's
outstanding Common Stock as of March 31, 1998, and sets forth the number of
shares of Common Stock beneficially owned by each director of the Company and by
all directors of the Company and executive officers of the Company or PIC as a
group:
<TABLE>
<CAPTION>
Name and Address of Relationship to Shares Beneficially Percent of
Beneficial Owner Company Owned Class
<S> <C> <C> <C>
Chester L.F. and President of Chairman of 1,579,431 39.9 %
Jacqueline M. Paulson, the Board of Directors of
as joint tenants (1) the Company, officer and
director of PIC (Mr. Paulson);
Secretary-Treasurer and
Director of the Company and
officer and director of PIC
(Ms. Paulson)
Kenneth T. LaMear (1) Director, officer and 56,406 1.4 %
director of PIC
Shannon P. Pratt Director 0 _
4475 SW Scholls Ferry
Portland, OR 97225
Paul Shoen Director 8,400 0.2%
PO Box 524
Glenbrook, NV 89413
John Westergaard Director 0 _
460 West 43rd Street
New York, NY 10036
Steve Kleemann 283,200 7.2%
526 Via Sinuosa
Santa Barbara, CA 93110
All Directors and 1,644,237 41.6 %
Executive Officers as
a group (6 persons)
(1) Address is 811 SW Naito Parkway, Suite 200, Portland, OR 97204
</TABLE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
20
<PAGE>
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) The following financial statements are included in Part II, Item 7:
Report of Independent Certified Public Accountants
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Earnings for the years ended December 31, 1997,
1996 and 1995
Consolidated Statement of Shareholders' Equity for the years ended December
31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
Supplementary Schedule of Warrants Owned
(2) The following financial schedule for the years 1997, 1996 and 1995 are
submitted herewith:
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
Exhibits
Number Description
- --------------------------------------------------------------------------------
3.1 Articles of Incorporation (incorporated by reference to Exhibit 3.1 to
the Company's Registration Statement on Form 10 filed with the
Commission on December 18, 1989 (the "Form 10"))
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the Form 10)
10.1 Office lease dated June 28, 1988 (incorporated by reference to Exhibit
10.2 to the Form 10)
21
<PAGE>
10.3 Contract with Correspondent Services Corporation, dated July 24, 1992
(Incorporated by reference to Exhibit 10.3 to the Form 10-Q for the
quarter ended September 30, 1992 filed with the Commission on November
13, 1992)
10.4 Office Lease renewal for the period from 6/1/93 to 5/31/98, dated as
of March 12, 1992 (Incorporated by reference to Exhibit 10.4 to the
Form 10-K for the year ended December 31, 1992 filed with the
Commission on March 31, 1993)
10.5 Office Lease renewal for the period from 6/1/97 to 5/31/02, dated as
of May 6, 1997 (Incorporated by reference to Exhibit 10.4 to the Form
10-QSB for the quarter ended June 30, 1997 filed with the Commission
on August 13, 1997.
21.1 Subsidiaries The Company's only subsidiary is Paulson Investment
Company, Inc., an Oregon corporation.
27 Financial Data Schedule
27.1 Restated Financial Data Schedule for fiscal year ended December 31,
1996.
(b) There were no reports on Form 8-K filed during the last quarter of the
period covered by this report.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 of the Securities Exchange
Act of 1934, the Registrant has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized.
PAULSON CAPITAL CORP.
Date: May 4, 1998 By: CHESTER L.F. PAULSON
-------------------------------------
Chester L.F. Paulson
President
23
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Signature Title Date
- --------------------------------------------------------------------------------
(1) Principal Executive and Financial Officer
CHESTER L.F. PAULSON March 30, 1998
- ------------------------- Chairman of the Board --------------------
Chester L.F. Paulson and President
(2) Principal Accounting Officer
CAROL RICE March 17, 1998
- ------------------------- Principal Accounting --------------------
Carol Rice Officer
(3) Directors
JACQUELINE M. PAULSON March 30, 1998
- ------------------------- Secretary, Treasurer --------------------
Jacqueline M. Paulson and Director
KENNETH T. LAMEAR March 30, 1998
- ------------------------- Director --------------------
Kenneth T. LaMear
- ------------------------- Director --------------------
Shannon Pratt
PAUL SHOEN March 20, 1998
- ------------------------- Director --------------------
Paul Shoen
JOHN WESTERGAARD March 20, 1998
- ------------------------- Director --------------------
John Westergaard
24
<PAGE>
FINANCIAL STATEMENTS AND REPORT
OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
PAULSON CAPITAL CORP. AND SUBSIDIARY
DECEMBER 31, 1997, 1996 AND 1995
<PAGE>
Report of Independent Certified Public Accountants
Board of Directors and Shareholders
Paulson Capital Corp.
We have audited the accompanying consolidated balance sheets of Paulson Capital
Corp. (an Oregon corporation) and Subsidiary as of December 31, 1997 and 1996,
and the related consolidated statements of earnings, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Paulson Capital
Corp. and Subsidiary as of December 31, 1997 and 1996, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The accompanying
supplementary schedule of warrants owned as of December 31, 1997 is presented
for purposes of additional analysis and is not a required part of the basic
consolidated financial statements. Such information has been subjected to the
auditing procedures applied in the audits of the basic consolidated financial
statements and, in our opinion, is fairly stated, in all material respects, in
relation to the basic consolidated financial statements taken as a whole.
We have also audited Schedule II for each of the three years in the period ended
December 31, 1997. In our opinion, this schedule presents fairly, in all
material respects, the information required to be set forth therein.
Portland, Oregon GRANT THORNTON LLP
February 11, 1998
F-1
<PAGE>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED BALANCE SHEETS
December 31,
<TABLE>
<CAPTION>
ASSETS 1997 1996
-------------- --------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 73,220 $ 185,445
Receivable from broker-dealers and clearing organizations 4,497,086 5,035,144
Notes and other receivables 657,918 182,859
Trading securities 8,901,802 5,152,783
Investment securities 7,068,580 4,789,270
Refundable income taxes 101,907 412,261
Prepaid and deferred expenses 400,845 160,121
Secured demand note 100,000 100,000
Deferred income taxes 289,100 112,000
-------------- --------------
Total current assets 22,090,458 16,129,883
-------------- --------------
FURNITURE AND EQUIPMENT, net 202,605 150,925
-------------- --------------
INVESTMENT IN REAL ESTATE 169,900 -
-------------- --------------
DEFERRED INCOME TAXES - 10,400
-------------- --------------
$ 22,462,963 $ 16,291,208
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 264,294 $ 380,707
Payable to broker-dealers and clearing organizations 6,041,296 3,690,844
Compensation, employee benefits and payroll taxes 1,942,906 1,940,422
Securities sold, not yet purchased 330,729 280,688
Subordinated note payable 100,000 100,000
-------------- --------------
Total current liabilities 8,679,225 6,392,661
-------------- --------------
SHAREHOLDERS' EQUITY
Preferred stock, no par value; authorized, 500,000
shares; issued and outstanding, no shares - -
Common stock, no par value; authorized, 10,000,000
shares; issued and outstanding, 3,970,536 and
4,081,241, respectively 794,416 733,701
Retained earnings 12,989,322 9,164,846
-------------- --------------
13,783,738 9,898,547
-------------- --------------
$ 22,462,963 $ 16,291,208
============== ==============
The accompanying notes are an integral part of these statements.
</TABLE>
F-2
<PAGE>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF EARNINGS
Year ended December 31,
<TABLE>
<CAPTION>
1997 1996 1995
--------------- -------------- -------------
<S> <C> <C> <C>
Revenues
Commissions $ 12,728,794 $ 12,184,046 $ 9,664,994
Corporate finance 3,925,514 4,556,783 1,881,919
Investment income 5,581,011 7,346,825 5,751,267
Trading income 1,195,585 1,496,871 700,639
Interest and dividends 7,010 18,035 21,237
Other 35,147 15,726 10,509
--------------- -------------- -------------
23,473,061 25,618,286 18,030,565
--------------- -------------- -------------
Expenses
Commissions and salaries 12,551,806 12,092,256 9,687,338
Underwriting expenses 762,317 945,850 496,865
Rent, telephone and quotation services 835,472 799,358 933,897
Interest expense 5,996 7,010 6,442
Professional fees 639,386 492,773 432,350
Bad debt expense 55,011 180,352 366,920
Travel and entertainment 158,649 153,261 149,500
Settlements 67,299 297,465 614,446
Branch office expenses - - 6,322
Other 1,479,137 1,196,839 630,475
--------------- -------------- -------------
16,555,073 16,165,164 13,324,555
--------------- -------------- -------------
Earnings before income taxes 6,917,988 9,453,122 4,706,010
Income tax expense 2,563,593 3,725,920 1,780,977
--------------- -------------- -------------
NET EARNINGS $ 4,354,395 $ 5,727,202 $ 2,925,033
=============== ============== =============
Earnings per common share $ 1.10 $ 1.34 $ .67
=============== ============== =============
Earnings per common share - assuming dilution $ 1.09 $ 1.33 $ .67
=============== ============== =============
The accompanying notes are an integral part of these statements.
</TABLE>
F-3
<PAGE>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Three year period ended December 31, 1997
<TABLE>
<CAPTION>
Common Stock
------------------------------------ Retained
Shares Amount Earnings
------------- ------------ ---------------
<S> <C> <C> <C>
Balance at December 31, 1994 4,363,501 $ 775,730 $ 1,225,043
Issuance of common stock in lieu
of directors' cash compensation 10,338 10,500 -
Redemption of common stock (49,300) (50,341) -
Net earnings for the year - - 2,925,033
------------ ------------ ---------------
Balance at December 31, 1995 4,324,539 735,889 4,150,076
Exercise of stock options 38,570 40,892 -
Issuance of common stock in lieu
of directors' cash compensation 3,432 7,500 -
Redemption of common stock (285,300) (50,580) (712,432)
Net earnings for the year - - 5,727,202
------------ ------------ ---------------
Balance at December 31, 1996 4,081,241 733,701 9,164,846
Exercise of stock options 87,140 89,283 -
Issuance of common stock in lieu
of directors' cash compensation 2,266 8,000 -
Redemption of common stock (200,111) (36,568) (529,919)
Net earnings for the year - - 4,354,395
------------ ------------ ---------------
Balance at December 31, 1997 3,970,536 $ 794,416 $ 12,989,322
============ ============ ===============
The accompanying notes are an integral part of this statement.
</TABLE>
F-4
<PAGE>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
<TABLE>
<CAPTION>
1997 1996 1995
---------------- -------------- --------------
<S> <C> <C> <C>
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities
Net earnings $ 4,354,395 $ 5,727,202 $ 2,925,033
Adjustments to reconcile net earnings to
net cash used in operating activities
Unrealized depreciation
on investment securities 407,806 36,304 182,108
Realized gain on investment securities (5,988,817) (7,383,129) (5,933,375)
Deferred income taxes (166,700) (29,500) 89,800
Common stock issued for compensation
of directors 8,000 7,500 10,500
Depreciation and amortization 59,994 53,028 49,830
(Gain)/loss from sale of furniture and equipment (6,800) - 7,884
Changes in assets and liabilities
Receivables 562,999 (833,711) (2,559,286)
Trading securities (3,749,019) (1,892,386) (1,696,723)
Refundable income taxes 310,354 (255,123) 357,862
Prepaid and deferred expenses (240,724) 177,917 (168,770)
Accounts payable and accrued liabilities 2,236,523 1,801,823 1,907,249
Securities sold, not yet purchased 50,041 (64,862) 147,730
----------------- ---------------- -------------
Net cash used in operating activities (2,161,948) (2,654,937) (4,680,158)
------------------ ---------------- -------------
Cash flows from investing activities
Purchases of investment securities (28,103,962) (19,493,160) (5,166,256)
Proceeds from sale of investment securities 31,405,663 22,969,705 10,013,596
Issuance of note receivable (500,000) - -
Additions to furniture and equipment (114,474) (88,072) (41,416)
Purchase of real estate (169,900) - -
Proceeds from sale of furniture and equipment 9,600 - 5,075
----------------- --------------- -------------
Net cash provided by investing activities 2,526,927 3,388,473 4,810,999
----------------- --------------- -------------
</TABLE>
F-5
<PAGE>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
<TABLE>
<CAPTION>
1997 1996 1995
-------------- ------------- ------------
<S> <C> <C> <C>
Cash flows from financing activities
Proceeds from exercise of stock options $ 89,283 $ 40,892 $ -
Payments to retire common stock (566,487) (763,012) (50,341)
Decrease in bank overdraft payable - - (51,888)
--------------- -------------- -------------
Net cash used in financing activities (477,204) (722,120) (102,229)
--------------- -------------- -------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALANTS (112,225) 11,416 28,612
Cash and cash equivalents at beginning of year 185,445 174,029 145,417
--------------- -------------- ------------
Cash and cash equivalents at end of year $ 73,220 $ 185,445 $ 174,029
=============== ============== =============
Cash paid during the year for
Interest $ 6,000 $ 6,000 $ 6,000
=============== ============== =============
Income taxes $ 2,405,275 $ 4,026,942 $ 1,846,600
=============== ============== =============
The accompanying notes are an integral part of these statements.
</TABLE>
F-6
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company's wholly-owned subsidiary, Paulson Investment Company, Inc.
(Subsidiary) is a registered broker-dealer in securities under the
Securities and Exchange Act of 1934, as amended. The Subsidiary renders
broker-dealer services in securities on both an agency and principal basis
to its customers who are fully introduced to Correspondent Services
Corporation (CSC), a subsidiary of Paine Webber Group, Inc. The Subsidiary
also acts as lead or participating underwriter for over-the-counter
securities offerings. The subsidiary conducts business throughout the
United States. The Subsidiary is exempt from the reserve requirements under
SEC Rule 15c3-3(k)(2)(ii), since it does not handle or carry customer
securities and cash.
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying financial statements follows.
1. Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Paulson Capital Corp. and its wholly-owned subsidiary, Paulson Investment
Company, Inc. All significant intercompany balances and transactions have
been eliminated in the consolidation.
2. Revenue Recognition
Securities transactions and related revenue are recorded on a trade date
basis. Managers' fees, underwriters' fees, and other underwriting revenues
are recognized at the time the underwriting is completed. Tax shelter
revenue is recognized at the time individual tax shelter units are sold.
3. Fair Value of Financial Instruments
The carrying amounts reflected in the balance sheet for cash, cash
equivalents, notes and other receivables and payables approximate their
respective fair values due to the short maturities of these instruments.
The fair values of trading and investing securities owned and securities
sold, not yet purchased are recorded primarily at quoted prices for those
or similar instruments. Changes in the market value of these securities are
reflected currently in the results of operations for the year.
4. Furniture and Equipment
Depreciation of furniture and equipment is computed generally by the
straight-line method over their estimated useful lives. Leasehold
improvements are amortized over the lesser of their estimated useful life
or the lives of their respective leases. For tax purposes, depreciation is
computed using accelerated methods.
5. Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, cash due from banks and brokerage accounts, certificates of
deposit and highly liquid debt instruments purchased with a maturity of
three months or less.
F-7
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
6. Use of Estimates
In preparing the Company's financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets
and liabilities, the disclosure 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.
7. Earnings Per Share
The Company has adopted Financial Accounting Standard No. 128, "Earnings
Per Share". The 1996 and 1995 calculations have been adjusted to conform
with the requirements of this standard. Earnings per share are computed
based on the weighted average number of common and dilutive common
equivalent shares outstanding during the year (Note I).
8. Income taxes
The Company provides for income taxes based on income reported for
financial reporting purposes. Deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases
of assets and liabilities as measured by the enacted tax rates which are
expected to be in effect when these differences reverse. Deferred tax
expense is the result of changes in deferred tax assets and liabilities.
NOTE B - RECEIVABLE FROM AND PAYABLE TO BROKER-DEALERS AND CLEARING
ORGANIZATIONS
The Company's subsidiary introduces all customer transactions in securities
traded on U.S. securities markets to CSC on a fully-disclosed basis. The
agreement between the Company's subsidiary and its clearing broker provides
that the Company's subsidiary is obligated to assume any exposure related
to nonperformance by customers or counterparties. The Company's subsidiary
monitors clearance and settlement of all customer transactions on a daily
basis.
The exposure to credit risk associated with the nonperformance of customers
and counterparties in fulfilling their contractual obligations pursuant to
these securities transactions can be directly impacted by volatile trading
markets which may impair the customer's or counterparty's ability to
satisfy their obligations to the Company's subsidiary. In the event of
nonperformance, the Company's subsidiary may be required to purchase or
sell financial instruments at unfavorable market prices resulting in a
loss. Management does not anticipate nonperformance by customers and
counterparties in the above situations.
In addition to the clearing services provided, CSC also loans money to the
Company's subsidiary to finance trading accounts.
F-8
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE B - RECEIVABLE FROM AND PAYABLE TO BROKER-DEALERS AND CLEARING
ORGANIZATIONS - Continued
At December 31, 1997 and 1996, the above clearing services and trading
account financing resulted in the following:
<TABLE>
<CAPTION>
1997 1996
--------------- --------------
<S> <C> <C>
Receivable from CSC $ 4,497,086 $ 5,035,144
Payable to CSC (6,041,296) (3,690,844)
---------------- ---------------
Net receivable (payable) $ (1,544,210) $ 1,344,300
================ ===============
</TABLE>
NOTE C - NOTES AND OTHER RECEIVABLES
Notes and other receivables consist of the following:
<TABLE>
<CAPTION>
1997 1996
---------------- ---------------
<S> <C> <C>
Underwriting $ 500,000 $ -
Employees 57,477 38,570
Independent brokers 82,529 77,671
Other 17,912 66,618
---------------- ---------------
$ 657,918 $ 182,859
================ ================
</TABLE>
In connection with an underwriting, the Company's subsidiary accepted a
note receivable on December 18, 1997 in the amount of $500,000. On February
6, 1998 the note was paid.
Employee and independent broker receivables relate principally to advances
and expenses in excess of commission earnings and inventory losses charged
to the registered representatives of the Company's subsidiary. For the
years ended December 31, 1997, 1996, and 1995, notes and receivables of
$17,206, $81,627, and $369,964, respectfully, were determined by management
to be uncollectible and written off.
NOTE D - TRADING AND INVESTMENT SECURITIES
Trading securities and securities sold, not yet purchased, represent the
market value of securities held long and short by the Company's subsidiary.
F-9
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE D - TRADING AND INVESTMENT SECURITIES - Continued
The categories of trading securities and their related market values
follow:
<TABLE>
<CAPTION>
1997 1996
---------------------------- -------------------------------
Long Short Long Short
------------ ---------- -------------- ------------
<S> <C> <C> <C> <C>
Common stock $ 1,313,920 $ 16,662 $ 448,722 $ 134,355
Preferred stock 31,756 32,582 29,029 9,088
State and municipal bonds 91,395 76,044 144,324 80,814
Corporate bonds 53,596 5,441 53,423 56,431
US Government Agency 7,411,135 - 4,477,285 -
------------ ---------- -------------- ------------
$ 8,901,802 $ 130,729 $ 5,152,783 $ 280,688
============ ========== ============== ============
</TABLE>
As a securities broker-dealer, the Company's subsidiary is engaged in
various securities trading and brokerage activities as principal. In the
normal course of business, the Company's subsidiary has sold securities
that it does not currently own and will therefore be obligated to purchase
such securities at a future date. This obligation is recorded in the
financial statements at the market value of the related securities. A
trading loss will occur on the securities if the market price increases and
a trading gain will occur if the market price decreases.
Investment securities held by the Company's subsidiary are stated at market
value. A summary of the investment security portfolio follows:
<TABLE>
<CAPTION>
Market Unrealized Carrying
Cost Value Loss Value
------------ ------------ -------------- ------------
<S> <C> <C> <C> <C>
1997
Common stock $ 7,712,550 $ 7,068,580 $ (643,970) $ 7,068,580
============ ============ ============== ============
1996
Common stock $ 5,025,434 $ 4,789,270 $ (236,164) $ 4,789,270
============ ============ ============== ============
</TABLE>
The Company also had recorded $200,000 of common stock sold, not yet
purchased in its investment account at December 31, 1997.
Investment securities owned include shares of restricted stock which are
recorded by the Company's subsidiary at their original cost of $776,475.
Management believes, based on the available evidence, that this carrying
value approximates market.
Realized gains included in the determination of net earnings were
$5,988,817, $7,383,129, and $5,933,375 for the years ended December 31,
1997, 1996 and 1995, respectively.
F-10
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE E - FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost and consist of the following:
<TABLE>
<CAPTION>
1997 1996
----------- ----------
<S> <C> <C>
Office equipment $ 707,039 $ 623,600
Leasehold improvements 120,354 120,354
Vehicles 28,035 25,245
----------- ----------
855,428 769,199
Less accumulated depreciation
and amortization 652,823 618,274
----------- ----------
$ 202,605 $ 150,925
=========== ==========
</TABLE>
NOTE F - SUBORDINATED NOTE PAYABLE
The Company's subsidiary has borrowings subordinated to claims of general
creditors pursuant to a secured demand note collateral agreement. This
agreement is in accordance with the National Association of Securities
Dealers, Inc. and the Securities and Exchange Commission requirements and
the related borrowings are subordinated to the claims of general creditors
and are renewable annually on their maturity dates.
Maturity Date Interest Rate 1997 1996
------------------------ -------------- ---------- -----------
Secured demand note
May 31, 1998 6% $ 100,000 $ 100,000
This borrowing is included in the Subsidiary's computation of net capital.
Additionally, it is not cancelable by either party and, to the extent it is
required to maintain compliance with minimum net capital requirements, may
not be repaid.
NOTE G - INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- -------------- -------------
<S> <C> <C> <C>
Current tax expense
Federal $ 2,364,177 $ 3,008,653 $ 1,478,713
State 366,116 746,767 212,464
---------------- --------------- ------------
2,730,293 3,755,420 1,691,177
---------------- --------------- ------------
Deferred tax expense (benefit)
Federal (142,543) (11,740) 38,700
State (24,157) (17,760) 51,100
---------------- --------------- ------------
(166,700) (29,500) 89,800
---------------- --------------- ------------
$ 2,563,593 $ 3,725,920 $ 1,780,977
================ =============== ============
</TABLE>
F-11
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE G - INCOME TAXES - Continued
Income tax expense for each year varies from the amount computed by
applying the statutory federal income tax rate to earnings before taxes as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------------- -------------- -------------
<S> <C> <C> <C>
Income tax expense (benefit)
at statutory federal tax rate $ 2,352,000 $ 3,214,000 $ 1,600,000
State taxes net of federal benefit 237,000 510,000 205,000
Permanent and other (25,407) 1,920 (24,023)
--------------- -------------- --------------
$ 2,563,593 $ 3,725,920 $ 1,780,977
=============== ============== ==============
</TABLE>
The deferred income tax asset consists primarily of basis differences in
short-term investment securities.
NOTE H - COMMON STOCK
Directors are compensated for their attendance at a maximum of six
scheduled meetings per year. Compensation is $500 of the Company's stock
for each meeting. The value of the stock is determined at the close of
business the day prior to a scheduled meeting.
The Company's subsidiary has a key employee stock purchase plan. Under the
plan, the Subsidiary will match funds (up to $25,000), committed by key
employees, for the purchase of shares of the Company's common stock. The
committed and matching funds will be used by the Subsidiary to purchase
stock of the Company in the open market or by negotiated transactions. One
half of the shares will be resold to the participating employee and one
half of the shares will be transferred to the employee for no cash
consideration. The named participants, the number of shares purchased in
the open market and the amount of matching funds will be at the discretion
of the Board of Directors of the Subsidiary. No participants were named and
no purchases of common stock under this plan were made during 1997, 1996 or
1995.
The Company's Nonemployee Stock Option Plan had 100,000 registered shares
of common stock reserved for issuance.
F-12
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE H - COMMON STOCK - Continued
The Company has adopted only the disclosure provisions of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation" (FAS
123). It applies APB Opinion No.25, "Accounting for Stock Issued to
Employees," in accounting for its Plans and therefore does not recognize
compensation expense. Had the Company elected to recognize compensation
expense based upon the fair value at the grant date for awards under these
Plans consistent with the methodology prescribed by FAS 123, the effect on
the Company's pro forma net income and earnings per share would have been
immaterial.
The following table summarizes activity under the Plans for the three years
ended December 31, 1997:
<TABLE>
<CAPTION>
Weighted
Shares Average
Under Exercise
Option Price
----------- ------------
<S> <C> <C>
Balance at December 31, 1994 192,700 $1.20
Granted 99,995 .91
Exercised - -
Canceled (101,250) 1.17
-----------
Balance at December 31, 1995 191,445 1.07
Granted - -
Exercised (38,570) 1.06
Canceled (51,450) 1.19
-----------
Balance at December 31, 1996 101,425 1.01
Granted - -
Exercised (87,140) 1.02
Canceled (14,285) .91
-----------
Balance at December 31, 1997 - -
===========
</TABLE>
The weighted-average fair value of options granted during the year ended
December 31, 1995 was $0.36. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes options-pricing
model with the following weighted-average assumptions: no dividends;
expected volatility of 62%; risk-free interest rate of 5.9% and expected
life of 2.5 years.
F-13
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE I - EARNINGS PER SHARE
The following table is a reconciliation of the numerators and denominators
of the basic and diluted per share computations for each of the three years
ended December 31, 1997:
<TABLE>
<CAPTION>
Weighted
Average
Income Shares Per-Share
1995 (Numerator) (Denominator) Amount
---- -------------- ---------------- ----------
<S> <C> <C> <C>
Basic earnings per share
Income available to
common stockholders $ 2,925,033 4,350,826 $.67
Effect of dilutive securities
Stock options - 6,219
-------------- --------------
Diluted earnings per share
Income available to
common stockholders
$ 2,925,033 4,357,045 $.67
============== ============== =========
1996
Basic earnings per share
Income available to
common stockholders $ 5,727,202 4,269,694 $1.34
Effect of dilutive securities
Stock options - 52,941
-------------- --------------
Diluted earnings per share
Income available to
common stockholders
$ 5,727,202 4,322,635 $1.33
============== ============== ==========
1997
Basic earnings per share
Income available to
common stockholders $ 4,354,395 3,973,034 $1.10
Effect of dilutive securities
Stock options - 32,344
-------------- --------------
Diluted earnings per share
Income available to
common stockholders
$ 4,354,395 4,005,378 $1.09
============== ================ =======
</TABLE>
During the year ended December 31, 1997 all outstanding stock options were
included in the computation of diluted earnings per share since the
options' exercise price was less than the average market price of the
common shares. During 1996 and 1995 various options were not included in
the same calculation because they were antidilutive.
F-14
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE J - LEASES
Future minimum payments, by year and in the aggregate, required under
non-cancelable operating leases with initial or remaining terms of one year
or more consist of the following:
Year ended
December 31,
---------------
1998 $ 274,176
1999 274,176
2000 274,176
2001 274,176
2002 114,240
------------
$ 1,210,944
============
The lease provides for payment of taxes and other expenses by the Company.
Rental expense for the years ended December 31, 1997, 1996 and 1995
amounted to $241,396, $251,587, and $298,421, respectively.
NOTE K - WARRANTS OWNED
As provided for in certain underwriting agreements, the Company has
acquired warrants to purchase shares of common stock of the underlying
corporations. These warrants are not readily marketable without
registration or reliance upon an exemption therefrom, and no attempt has
been made to assign a value to them.
NOTE L - EMPLOYEE BENEFIT PLANS
Retirement benefits for employees of the Company, who have completed
certain service requirements, are provided by a defined contribution
profit-sharing plan. Plan contributions are determined by the Board of
Directors. Contributions to the plan for the years ended December 31, 1997,
1996 and 1995 were $500,000, $500,000, and $150,000, respectively.
NOTE M - CONTINGENCIES
The Company's subsidiary has been named by individuals in certain legal
actions, some of which claim state and federal securities law violations
and claim principal and punitive damages. As preliminary hearings and
discovery in these cases is not complete, it is not possible to assess the
degree of liability, the probability of an unfavorable outcome or the
impact on the Company's financial statements, if any. The Company's
management denies the charges in these legal actions and is vigorously
defending against them. No provision for any liability that may result from
the above contingencies has been made in the financial statements.
F-15
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE N - NET CAPITAL REQUIREMENT
The Company's subsidiary is subject to the net capital rule (Rule 15c3-1)
of the Securities and Exchange Commission. This rule prohibits the
Subsidiary from engaging in any securities transaction at a time when its
"aggregate indebtedness" exceeds fifteen times its "net capital" as those
terms are defined by the rule. At December 31, 1997, the Subsidiary's net
capital and required net capital were $9,835,487 and $145,080,
respectively, and its ratio of aggregate indebtedness to net capital was
.22 to 1. The Subsidiary's absolute minimum net capital is $100,000.
NOTE O - RELATED PARTY TRANSACTION
During the year, the Company purchased real estate from a relative of an
officer and director of the Company. The real estate is carried at cost
which management believes approximates market value based on a third party
appraisal.
F-16
<PAGE>
Paulson Capital Corp. and Subsidiary
SUPPLEMENTARY SCHEDULE OF WARRANTS OWNED
December 31, 1997
<TABLE>
<CAPTION>
Shares Exercise
Entitled to Price Expiration
Description Purchase Per-Share Date
- -------------------------------------------------------------------- ----------- ------------ --------------
<S> <C> <C> <C>
Advantage Marketing Systems (units) ERC 11-12-98 65,520 $ 5.40 2002, 11/12
AntiVirals (units) ERC 6-3-98 112,700 $ 10.80 2002, 06/03
C3, Inc. ERC 11-14-98 214,592 $ 18.00 2002, 11/14
California Culinary Academy, Inc. ERC 06-30-94 71,000 $ 7.80 1998, 06/30
Cal-Maine Foods, Inc. ERC 12-11-97 177,100 $ 8.40 2001, 12/10
Caring Products International, Inc. (units) ERC 12-9-98 83,075 $ 6.00 2002, 12/09
Cell Robotics International, Inc. (units) ERC 9-19-96 9.3725 $ 25,000.00 2000, 09/18
Cellegy Pharmaceuticals, Inc. (units) ERC 8-11-96 18,745 $ 20.63 2000, 08/11
Complete Management, Inc. ERC 12-27-96 107,720 $ 10.80 2000, 12/27
Complete Management, Inc. ERC 6-11-97 31,377 $ 21.04 2001, 06/11
Cusac Industries, Ltd. (units) ERC 1-11-96 11,901 $ 12.00 2000, 01/11
E.Com International, Inc., ERC 12-5-97 75,587 $ 3.50 2002, 12/31
Evergreen Resources, Inc. ERC 10-22-97 134,375 $ 6.90 2001, 10/22
Fortune Petroleum Corp. ERC 5-19-97 50,000 $ 4.00 1999, 05/19
Frontier Natural Gas Corp. (units) ERC 11-19-94 26,005 $ 28.92 1998, 11/12
Global Payment Technology ERC 2-6-96 103,500 $ 6.60 2000, 02/06
International Nursing Services, Inc. (units) ERC 9-12-95 15,301 $ 28.20 1999, 09/12
Kyzen Corporation (units) ERC 8-3-96 15,498 $ 14.95 2000, 08/03
Microfield Graphics, Inc. ERC 6-22-96 79,750 $ 7.20 2000, 06/22
Microvision Inc. (units) ERC 8-27-97 123,760 $ 9.60 2001, 08/27
Neotherapeutics Inc. (units) ERC 9-25-97 161,000 $ 9.12 2001, 09/25
Northern Bank of Commerce ERC 8-4-94 2,000 $ 6.60 1999, 08/04
PCT Holdings, Inc. (units) ERC 7-15-97 146,700 $ 3.75 2001, 07/15
Pearce Systems International, Inc. (units) ERC 2-10-95 47,722 $ 8.70 1999, 02/11
Penultimate, Inc. (units) ERC 12-22-94 38,298 $ 8.10 1998, 12/22
Premium Cigars International, Ltd. ERC 8-21-98 2,000 $ 8.40 2002, 08/21
R-B Rubber Products, Inc. ERC 5-10-96 55,100 $ 5.10 2000, 05/10
Sparta Surgical Corp. (units) ERC 7-12-95 11,221 $ 12.00 1999, 07/12
Supergen, Inc. (units) ERC 3-12-97 268,950 $ 7.20 2001, 03/12
Telepartners A/S (units) 8-22-98 102,437 $ 6.00 2002, 06/30
TJ Systems Corp. Ser. A Convertible Prfd. ERC 8-4-94 21,535 $ 12.00 1998, 08/04
TSS LTD (units) ERC 5-5-94 95,310 $ 1.20 1998, 05/05
Willard Pease Oil & Gas Co. Ser. A Cum. Cnv. Pfd. ERC 8-13-94 64,197 $ 12.00 1998, 08/13
WRT Energy Corp. 9% Convertible Preferred ERC 10-20-94 48,147 $ 30.00 1998, 10/20
</TABLE>
F-17
<PAGE>
Schedule II
Paulson Capital Corp. and Subsidiary
Valuation and Qualifying Accounts
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Balance Additions-Charges Balance
Beginning to Cost and Deductions at End
Description of Year Expenses Write-offs of Year
- ----------------------------- ---------- ----------------- ---------- --------
<S> <C> <C> <C> <C>
Allowance for doubtful
accounts:
Year ended Dec. 31, 1997 $ - $ 17,206 $ 17,206 $ -
Year ended Dec. 31, 1996 - 81,627 81,627 -
Year ended Dec. 31, 1995 - 369,964 369,964 -
</TABLE>
F-18
<PAGE>
EXHIBIT INDEX
Exhibit Description
Number Page Number
- ------ -----------
3.1 Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the
Company's Registration Statement on Form 10 filed with the Commission on
December 18, 1989 (the "Form 10"))
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the Form 10)
10.1 Office lease dated June 28, 1988 (incorporated by reference to Exhibit 10.2
to the Form 10)
10.3 Contract with Correspondent Services Corporation, dated July 24, 1992
(Incorporated by reference to Exhibit 10.3 to the Form 10-Q for the quarter
ended September 30, 1992 filed with the Commission on November 13, 1992)
10.4 Office Lease renewal for the period from 6/1/93 to 5/31/98, dated as of
March 12, 1992 (Incorporated by reference to Exhibit 10.4 to the Form 10-K
for the year ended December 31, 1992 filed with the Commission on March 31,
1993)
10.5 Office Lease renewal for the period from 6/1/97 to 5/31/02, dated as of May
6, 1997 (Incorporated by reference to Exhibit 10.4 to the Form 10-QSB for
the quarter ended June 30, 1997 filed with the Commission on August 13,
1997.
21.1 Subsidiaries The Company's only subsidiary is Paulson Investment Company,
Inc., an Oregon corporation.
27 Financial Data Schedule
27.1 Restated Financial Data Schedule for fiscal year ended December 31, 1996.
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET OF PAULSON CAPITAL CORP. AND SUBSIDIARY AS OF
DECEMBER 31, 1997 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS,
SHAREHOLDERS' EQUITY AND CASH FLOWS FOR THE TWELVE MONTHS IN THE PERIOD ENDED
DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 73
<RECEIVABLES> 5,155
<SECURITIES-RESALE> 0
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 15,970
<PP&E> 203
<TOTAL-ASSETS> 22,463
<SHORT-TERM> 100
<PAYABLES> 8,348
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 331
<LONG-TERM> 0
0
0
<COMMON> 794
<OTHER-SE> 12,989
<TOTAL-LIABILITY-AND-EQUITY> 22,463
<TRADING-REVENUE> 1,196
<INTEREST-DIVIDENDS> 7
<COMMISSIONS> 12,729
<INVESTMENT-BANKING-REVENUES> 3,926
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 6
<COMPENSATION> 12,552
<INCOME-PRETAX> 6,918
<INCOME-PRE-EXTRAORDINARY> 6,918
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,354
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 1.09
</TABLE>
<TABLE> <S> <C>
<ARTICLE> BD
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 185
<RECEIVABLES> 5,218
<SECURITIES-RESALE> 0
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 9,942
<PP&E> 151
<TOTAL-ASSETS> 16,291
<SHORT-TERM> 100
<PAYABLES> 4,072
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 281
<LONG-TERM> 0
0
0
<COMMON> 734
<OTHER-SE> 9,165
<TOTAL-LIABILITY-AND-EQUITY> 16,291
<TRADING-REVENUE> 1,497
<INTEREST-DIVIDENDS> 18
<COMMISSIONS> 12,184
<INVESTMENT-BANKING-REVENUES> 4,557
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 7
<COMPENSATION> 12,092
<INCOME-PRETAX> 9,453
<INCOME-PRE-EXTRAORDINARY> 9,453
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,727
<EPS-PRIMARY> 1.34
<EPS-DILUTED> 1.33
</TABLE>
