SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
----------
FORM 10-QSB
Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter ended March 31, 1999
Commission file number: 0-18188
PAULSON CAPITAL CORP.
Exact name of registrant as specified in its charter
Oregon 93-0589534
------ ----------
(State of incorporation) (I.R.S. Employer Identification)
811 S.W. Naito Parkway
Portland, OR 97204
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (503) 243-6000
Check whether the issuer (1) filed all reports required to be filed by
Sections 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 X No
--- ---
Number of shares outstanding of each of the issuer's classes of common
stock, as of May 10, 1999:
Common stock, no par value - 3,731,852 shares
Transitional Small Business Disclosure Format Yes No X
--- ---
1
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(unaudited)
<CAPTION>
3/31/99 12/31/98
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 54,326 $ 100,345
Receivable from broker-dealers
and clearing organizations 4,635,480 1,430,586
Notes and other receivables 789,698 439,967
Trading securities 1,547,122 2,119,737
Investment securities 7,195,370 9,697,387
Refundable income taxes 93,009 168,059
Prepaid and deferred expenses 164,063 578,556
Deferred income taxes 1,007,373 1,007,373
----------- -----------
Total current assets 15,486,441 15,542,010
----------- -----------
FURNITURE AND EQUIPMENT, net 559,427 359,329
----------- -----------
INVESTMENT IN REAL ESTATE 169,900 169,900
----------- -----------
$16,215,768 $16,071,239
=========== ===========
The accompanying notes are an integral part of these statements.
</TABLE>
2
<PAGE>
<TABLE>
PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS - CONTINUED
(unaudited)
<CAPTION>
3/31/99 12/31/98
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 758,508 $ 738,155
Payable to broker-dealers and clearing
organizations 1,507,066 753,413
Compensation, employee benefits and
payroll taxes 695,238 1,240,510
Securities sold, not yet purchased 49,061 61,479
----------- -----------
Total current liabilities 3,009,873 2,793,557
----------- -----------
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, 3,746,852 and
3,796,852, respectively 765,323 775,323
Retained earnings 12,440,572 12,502,359
----------- -----------
Total shareholders' equity 13,205,895 13,277,682
----------- -----------
$16,215,768 $16,071,239
=========== ===========
The accompanying notes are an integral part of these statements.
</TABLE>
3
<PAGE>
<TABLE>
PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
for the three month periods ended March 31, 1999
and March 31, 1998 (unaudited)
<CAPTION>
3/31/99 3/31/98
<S> <C> <C>
Revenues
Commissions $ 3,537,225 $ 2,717,473
Corporate finance 2,474 232,365
Investment income 392,130 332,974
Trading income (loss) 181,357 348,554
Interest and dividends 2,319 798
Other 831 4,977
----------- -----------
4,116,336 3,637,141
----------- -----------
Expenses
Commissions and salaries 3,179,050 2,422,031
Underwriting expenses -- 158,239
Rent, telephone and quotation services 239,189 214,774
Interest expense 1,244 1,515
Professional fees 132,846 95,068
Bad debt expense 30,000 30,000
Travel and entertainment 59,705 63,932
Settlements 15,000 3,693
Other 271,039 358,549
----------- -----------
3,928,073 3,347,801
----------- -----------
Earnings (loss) before income taxes 188,263 289,340
Provision for income taxes
Current 75,300 115,736
Deferred -- --
----------- -----------
Net Earnings (Loss) $ 112,963 $ 173,604
=========== ===========
Earnings (loss) per share $ .03 $ .04
=========== ===========
The accompanying notes are an integral part of these statements
</TABLE>
4
<PAGE>
<TABLE>
PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the three year period ended December 31, 1998
and the three months ended March 31, 1999 (unaudited)
<CAPTION>
Common Stock
---------------------------- Retained
Shares Amount Earnings
---------- ---------- ------------
<S> <C> <C> <C>
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
Exercise of stock options - - -
Issuance of common stock in lieu
of directors' cash compensation 4,283 16,500 -
Redemption of common stock (177,967) (35,593) (451,323)
Net loss for the year - - (35,640)
---------- ---------- ------------
Balance at December 31, 1998 3,796,852 $ 775,323 $ 12,502,359
Redemption of common stock (50,000) (10,000) (174,750)
Net earnings for the year to date - - 112,963
---------- ---------- ------------
Balance at March 31, 1999 3,746,852 $ 765,323 $ 12,440,572
========== ========== ============
The accompanying notes are an integral part of these statements
</TABLE>
5
<PAGE>
<TABLE>
PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
for the three month periods ended March 31, 1999 and March 31, 1998
<CAPTION>
3/31/99 3/31/98
------------ -------------
<S> <C> <C>
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities
Net earnings (loss) $ 112,963 $ 173,604
Adjustments to reconcile net earnings (loss)
to net cash used in operating activities
Unrealized (appreciation) depreciation
on investment securities 1,111,176 644,506
Realized gain on investment securities (1,503,306) (977,480)
Depreciation and amortization 26,117 18,040
Gain from sale of furniture and equipment -- --
Change in assets and liabilities
Receivables (3,554,625) 1,917,995
Trading securities 572,615 5,678,885
Refundable income taxes 75,050 40,736
Prepaid and deferred expenses 414,493 140,892
Accounts payable and accrued liabilities 228,734 (5,820,783)
Securities sold, not yet purchased (12,418) 23,622
Income taxes payable -- --
------------ -------------
Net cash provided by (used in) operating activities (2,529,201) 1,840,017
------------ -------------
Cash flows from investing activities
Purchases of investment securities (11,071,970) (10,666,360)
Proceeds from sale of investment securities 13,966,117 8,961,785
Additions to furniture and equipment (226,215) (45,017)
Proceeds from sale of furniture and equipment -- --
------------ -------------
Net cash provided by (used in) investing activities $ 2,667,932 $ (1,749,592)
------------ -------------
The accompanying notes are an integral part of these statements
</TABLE>
6
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) - CONTINUED
<CAPTION>
3/31/99 3/31/98
------------ -------------
<S> <C> <C>
Cash flows from financing activities
Proceeds from exercise of stock options -- --
Payments to retire common stock (184,750) (75,260)
Decrease in bank overdraft payable -- --
------------ -------------
Net cash provided by (used in) financing activities (184,750) (75,260)
------------ -------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (46,019) 15,165
Cash and cash equivalents at beginning of year 100,345 73,220
------------ -------------
Cash and cash equivalents at March 31 $ 54,326 $ 88,385
============ =============
Cash paid during the three months for
- -------------------------------------
Interest $ 1,244 $ 1,515
============ =============
Income taxes $ 250 $ 75,000
============ =============
</TABLE>
The accompanying notes are an integral part of these statements
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions for interim financial statements in
Article 10 of Regulation S-X and, therefore, do not include all information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the interim financial
statements include all adjustments (consisting only of normal recurring
accruals) necessary to state fairly the information shown therein. The nature of
the Company's business is such that the results of any interim period are not
necessarily indicative of results for a full fiscal year.
2. Securities Owned
Any losses from the disposition of securities are reflected in trading
revenues on the income statement for the period.
3. Commitments and Contingencies
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 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. No date for a
trial has been set. Pursuant to a tolling agreement with the plaintiff, the
Company (but not PIC) expects to be dismissed without prejudice from the
lawsuit. PIC and plaintiffs reached a settlement in principle in August 1998.
The settlement is subject to court approval. The total payment by PIC under the
settlement would depend upon the number of purchasers in the public offering who
file valid claims. PIC believes the maximum total payment by PIC under the
settlement would be approximately $920,000, but the actual payment could be
less, depending upon the number of valid claims filed. A disagreement among the
parties has arisen during the drafting of the settlement agreement about terms
that would not affect PIC's maximum potential settlement payment. At this time,
it is unclear what effect this disagreement will have on the settlement. If the
case does not settle, the Company and PIC believe they have meritorious defenses
and intend to defend this matter vigorously.
In October 1998, Russell W. Cummings, a former PIC customer, filed a
lawsuit in California state court asserting claims against PIC and a former PIC
registered representative alleging violations of the California Consumers Legal
Remedies Act, fraud, negligent misrepresentation, breach of contract, tortious
breach of the implied covenant of good faith and fair dealing, breach of
fiduciary duty and negligence. Prior to filing the complaint, plaintiff
8
<PAGE>
demanded payment of $250,000. The complaint seeks damages in excess of $100,000
in connection with options and short sales transactions beginning in 1996.
Plaintiff has agreed to arbitrate the matter before the NASD. PIC has not had an
opportunity to fully investigate this claim, but believes it has meritorious
defenses and intends to defend this matter vigorously. Discovery has not yet
commenced.
In October 1998, Masood Asif, a former PIC customer, filed a lawsuit in
California state court against PIC, an officer and director of PIC, and a former
PIC registered representative alleging breach of fiduciary duty, negligent
misrepresentation, suppression of facts and churning. Plaintiff seeks damages of
$100,000 and punitive damages of $100,000. Subsequently, the former customer has
agreed to arbitrate his claims and to have his state court case stayed until the
arbitration is completed. PIC has not had an opportunity to fully investigate
this claim, but believes it has meritorious defenses and intends to defend this
matter vigorously.
In January 1999, Shahid and Lita Choudhry and Iqbal Waraich, former
customers of PIC, filed an NASD arbitration claim against PIC and a former PIC
registered representative alleging that the registered representative managed
their account improperly, failed to follow claimant's instructions on particular
transactions and failed to provide ongoing investment advice. Claimants allege
negligence, fraud, unsuitability, breach of fiduciary duty, violations of the
federal securities laws, failure to supervise and violation of NASD rules,
seeking damages of $115,000, plus punitive damages and interest. PIC has not had
an opportunity to fully investigate this claim, but believes it has meritorious
defenses and intends to defend this matter vigorously.
In June 1998, Natalie Tirrell, a former PIC customer, filed an NASD
arbitration claim asserting claims against PIC and a PIC registered
representative alleging misrepresentations and excessive commissions. Claimant
alleges damages in excess of $50,000. Based on PIC's investigation of the claim,
PIC has answered denying all liability. This matter is set for arbitration
before the NASD on June 7, 1999. PIC believes it has meritorious defenses and
intends to defend this matter vigorously.
In April 1999, Philip Cutler, a former PIC customer, filed an NASD
arbitration claim asserting claims against PIC for alleged misrepresentations,
excessive commissions and a failure to supervise. Claimant alleges damages in
excess of $100,000. PIC has not yet filed an answer to the statement of claim
and discovery has not commenced. PIC has not had an opportunity to investigate
this matter fully, but believes it has meritorious defenses and intends to
defend this matter vigorously.
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
9
<PAGE>
or threatened litigation will have no material adverse effect on the
consolidated financial condition, results of operations, or business of the
Company.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Three Months Ended March 31, 1999 vs. Three Months Ended March 31, 1998
Results of Operations
The revenues and operating results of the Company's operating subsidiary,
Paulson Investment Company, Inc. ("PIC"), 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 operations depend upon many factors,
such as the number of companies that are seeking public financing, the quality
and financial 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 period to period. In the table 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.
<TABLE>
Summary of Changes in Major Categories
of Revenues and Expenses
<CAPTION>
Quarters Ended
3/31/99 vs. 3/31/98
<S> <C> <C>
Revenues:
Sales Commissions $ 819,752 30.2%
Corporate Finance (229,891) (98.9%)
Investment Income 59,156 17.8%
Trading Income (167,197) (48.0%)
Other (2,625) (45.4%)
---------- -------
Total $ 479,195 13.2%
Expenses:
Commissions and Salaries $ 757,019 31.3%
Underwriting Expenses (158,239) (100.0%)
Rent, Telephone and Quotes 24,415 11.4%
Other (42,923) (7.8%)
---------- -------
Total $ 580,272 17.3%
Pretax Income $ (101,077) (34.9%)
</TABLE>
11
<PAGE>
Total revenues for the first quarter of 1999 rose 13.2 percent from the
first quarter of 1998, to $4,116,336 from $3,637,141. As shown in the table
above, sales commissions rose $819,752, or 30.2 percent, from $2,717,473 in the
first quarter of 1998 to $3,537,225 in the comparable 1999 period. This increase
resulted primarily from the more favorable price movements and trading levels in
the overall market (especially large company stocks and technology issues),
despite flat to down markets for the very small capitalization issues (the
primary focus of PIC's investment banking and trading businesses) in the 1999
quarter compared to 1998. The Nasdaq Industrial Average rose 11.53 percent in
the first quarter of 1998 but only 6.32 percent in the first quarter of 1999.
Corporate finance revenues fell 98.9 percent, or $229,891, in the first quarter
of 1999 compared to the first quarter of 1998. One corporate finance transaction
was completed in the 1998 quarter, raising a total of $3.8 million for the
issuer; no transactions were completed in the 1999 quarter. Corporate finance
revenue is directly related to the amount of money raised in completed
transactions. Investment income rose $59,156, or 17.8 percent, from $332,974 in
the first quarter of 1998 to $392,130 in the first quarter of 1999, primarily
due to increased trading profits in the investment account. There were no
underwriter warrant exercises in either the 1998 or 1999 quarters. Trading
income fell $167,197, or 48.0 percent, to $181,357 in the first quarter of 1999
from $348,554 in the comparable 1998 period. This decrease was also due to
losses on inventory positions in the 1999 quarter in the subdued market for very
small capitalization companies described above.
Total expenses rose $580,272 in the first quarter of 1999 from the
comparable 1998 period, an increase of 17.3 percent, from $3,347,801 to
$3,928,073. Commissions and salaries rose $757,019, or 31.3 percent, from
$2,422,031 in the 1998 period to $3,179,050 in 1999. This increase was primarily
due to increased commission revenues resulting in a higher level of commissions
paid. (Higher percentage commission levels are generally paid to employee
registered representatives at higher production levels.) Underwriting expenses
fell by $158,239, due primarily to the lack of corporate finance transactions in
1999; one transaction was completed in 1998. Rent, telephone and quote expenses
increased from $214,774 in the 1998 period to $239,189 in 1999, an increase of
11.4 percent, primarily due to expenses related to improvements in quotations
and phone systems. Other expenses decreased 7.8 percent, from $552,757 in the
first quarter of 1998 to $509,834 in the first quarter of 1999. This decrease
was primarily due to decreased advertising, profit sharing and other
miscellaneous expenses more than offsetting an increase in professional fees
relating to litigation.
The Company had a pretax profit of $188,263 in the first quarter of 1999
compared to a pretax profit of $289,340 in the comparable 1998 period, primarily
due to lower trading income and corporate finance in the 1999 quarter more than
offsetting higher sales commissions. Significant fluctuations can occur in PIC's
revenues and operating results from one period to another.
The Company also accrued $115,736 in income taxes for the first quarter of
1998, compared to an accrual for income taxes in the first quarter of 1999 of
$75,300. Independent of
12
<PAGE>
investment income, the Company would have had a loss before income taxes of
$43,634 in the first quarter of 1998 compared to a loss before income taxes of
$203,867 in the first quarter of 1999.
Liquidity and Capital Resources
The majority of PIC's assets are cash and assets readily convertible to
cash. 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 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 tend to increase the liquidity of the market
for these securities. The overall increase in prices for the OTC securities
traded by PIC in both 1996 and 1998 was combined with a general increase in the
liquidity of the markets for these securities. The decline in prices for the OTC
securities traded by PIC in early 1999 was combined with a general decrease in
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.
PIC borrows money from its clearing firm in the ordinary course of its
business, pursuant to an understanding under which the clearing firm agrees to
finance PIC's trading accounts. As of March 31, 1999, no net loans were
outstanding 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 the Company. 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 March 31, 1999, PIC owned 30 underwriter warrants
(from 28 issuers), of which 27 were currently exercisable and seven 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.
13
<PAGE>
In the three months ended March 31, 1999, $2,529,201 of net cash was used
in operating activities of the Company. The major adjustments to reconcile this
result to the Company's net profit of $112,963 include an increase in
receivables of $3,554,625 and a realized gain on investment securities of
$1,503,306 more than offsetting unrealized depreciation on investment securities
of $1,111,176, a decrease in trading securities of $572,615, a decrease in
prepaid and deferred expenses of $414, 493 and an increase in accounts payable
and accrued liabilities of $228,734. In the quarter, $2,667,932 of net cash was
provided to the Company by investing activities, the result of $13,966,117 in
proceeds from the sale of investment securities more than offsetting the
purchase of $11,071,970 of investment securities and $226,215 of additions to
furniture and equipment. $184,750 of net cash was used in financing activities
in the quarter, consisting of payments to retire common stock. The net decrease
in cash and cash equivalents for the quarter totaled $46,019. 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.
At March 31, 1999, the Company had no material commitments for capital
expenditures.
In general, the primary ongoing 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 its clearing firm 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.
Year 2000 Efforts
The Company has begun to address the issue of computer programs and
embedded computer chips being unable to distinguish between the year 1900 and
the year 2000 (the "Y2K" issue). The Company has no proprietary operating system
or applications software, nor do any of its operations use mainframe or
mini-computer systems. Therefore, the Company's focus with respect to the Y2K
issue is: (1) its PC hardware and software purchased from third parties; and
(2) external suppliers and service providers.
14
<PAGE>
The general phases of the Company's Y2K efforts are: (1) inventorying
computer hardware and software and other items which may be affected by the Y2K
issue; (2) assigning priorities to identified items; (3) assessing the Y2K
compliance of items determined to be material to the to the Company;
(4) repairing or replacing material items that are determined not to be Y2K
compliant; (5) testing material items; and (6) designing and implementing
contingency and business continuation plans for the Company.
The Company has been conducting a comprehensive review and analysis of its
information systems since early 1998 and completed an inventory of its computer
technology and a determination of material items in the third quarter of 1998.
Material items are those believed by the Company to have a risk involving
property damage or affecting revenues. During the first half of 1999, the
Company is upgrading and replacing certain components of its computer
technology. The Company is replacing a large number of its desktop personal
computers with newer Y2K compliant models, and it is also upgrading server
hardware and/or software for certain of its network systems. The Company is also
conducting further hardware and software testing through the end of 1999. All
testing of hardware and software will be performed by the Company in conjunction
with certain of its external suppliers. The Company also expects to upgrade or
convert operating system and applications software that is not Y2K compliant.
The Company believes the upgrade or conversion of its desktop hardware and
applications and operating system software was approximately 20 percent complete
on March 31, 1999 and expects these upgrades and conversions to be completed by
June 30, 1999. The Company believes these efforts were on schedule as of March
31, 1999. The testing phase is conducted as hardware or software is replaced and
is also scheduled to be completed by mid-1999. Contingency planning for the
desktop computers and related software began in the third quarter of 1998 and is
expected to be completed by the third quarter of 1999.
The Company's efforts with respect to external suppliers and service
providers involves identifying and prioritizing critical suppliers and
communicating with them about their plans and progress in addressing the Y2K
issue. Detailed evaluations of the most critical third parties have been
initiated. These evaluations will be followed by the development of contingency
plans, which are scheduled for the second quarter of 1999. The Company believes
these efforts were on schedule as of March 31, 1999. The most critical service
provider to PIC, the Company's operating subsidiary, is its clearing firm,
Correspondent Services Corporation ("CSC") and CSC's parent company,
PaineWebber, which serves as the custodian for PIC's brokerage customers. CSC
has established a plan to thoroughly address the Y2K issue, which the Company
has reviewed. PIC is working with CSC to upgrade certain of PIC's computer
systems. CSC will be providing PIC with newer, Y2K compliant networking hardware
and software for its home office in Portland, Oregon and its branch office in
Salem, Oregon. CSC will also be providing PIC with newer, faster circuits for
Paulson's computer systems. The Company believes PIC will incur only a nominal
net monthly increase in its ongoing fee to CSC for these and related services.
15
<PAGE>
The total cost associated with required modifications to become Y2K
compliant is not expected to be material to the Company's financial position.
The estimated total cost of the Company's Y2K efforts is estimated to be between
$180,000 and $280,000. The total amount expended on the Y2K issue by the Company
through March 31, 1999 was approximately $30,000. Of these expenditures,
approximately $27,000 related to the cost to repair or replace software and
related hardware problems and approximately $3,000 related to the cost of
identifying and communicating with external suppliers and working with them on
the Y2K issue. The estimated future cost of completing the Company's Y2K efforts
is estimated to be between $150,000 and $250,000 - between $125,000 and $200,000
to repair or replace software and related hardware and between $25,000 and
$50,000 to identify and communicate with external suppliers. Funds for these
costs are provided from PIC's operating budget.
The failure to correct a material Y2K problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. These failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Y2K problem, resulting in part from the uncertainty
of the Y2K readiness of third-party suppliers, the Company is unable to
determine at this time whether the consequences of Y2K failures will have a
material impact on the Company's results of operations, liquidity or financial
condition. The Company's Y2K efforts are expected to significantly reduce the
Company's level of uncertainty about the Y2K problem and, in particular, about
the Y2K compliance and readiness of its material external suppliers. The Company
believes that, with the implementation of new business systems and completion of
the project as scheduled, the possibility of significant interruptions of normal
operations should be reduced.
CAUTIONARY STATEMENT FOR THE PURPOSES OF THE "SAFE HARBOR" PROVISIONS
---------------------------------------------------------------------
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
-------------------------------------------------------
The Company is including the following cautionary statement to take
advantage of the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995 for any forward-looking statement made by, or on behalf of,
the Company. The factors identified in this cautionary statement are important
factors (but not necessarily all important factors) that could cause actual
results to differ materially from those expressed in any forward-looking
statement made by, or on behalf of, the Company. Where any forward-looking
statement includes a statement of the assumptions or bases underlying the
forward-looking statement, the Company cautions that, while it believes the
assumptions or bases to be reasonable and makes them in good faith, assumed
facts or bases almost always vary from actual results, and the differences
between assumed facts or bases and actual results can be material, depending on
the circumstances. Where, in any forward-looking statement, the Company
expresses an expectation or belief as to future results, that expectation or
belief is expressed in good faith and believed to have a reasonable basis, but
there is no assurance that the statement of expectation or belief will result or
be achieved or accomplished. Taking into account the foregoing, the following
are identified as important risk factors that could cause actual results to
differ materially from those expressed in any forward-looking statement made by,
or on behalf of, the Company.
16
<PAGE>
The dates on which the Company believes the Company's Y2K efforts will be
completed are based on its best estimates, which were derived using numerous
assumptions of future events, including the continued availability of certain
resources, third-party modification plans and other factors. However, there is
no guarantee that these estimates will be achieved or that there will not be a
delay in, or increased costs associated with, the implementation of the Y2K
efforts described above. A delay in the Y2K corrections by CSC could also impact
the Company's readiness. Specific factors that might cause differences between
the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability to locate
and correct all relevant computer code, timely responses to and corrections by
third-parties and suppliers, the ability to implement interfaces between the new
systems and the systems not being replaced, and similar uncertainties. Due to
the general uncertainty inherent in the Y2K problem, resulting in part from the
uncertainty of the Y2K readiness of third-parties, the Company cannot ensure its
ability to timely and cost-effectively resolve problems associated with the Y2K
issue that may affect its operations and business, or expose it to third-party
liability.
17
<PAGE>
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
See Note 3 of Notes to Condensed Consolidated Financial Statements in
Item 1.
Item 2. Changes in Securities.
None
Item 3. Defaults upon Senior Securities.
None
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K
Exhibit
No. Description
------- -----------
27 Financial Data Schedule
No Reports on Form 8-K were filed during the quarter ended March 31, 1999.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PAULSON CAPITAL CORP.
Date: May 11, 1999 By: CHESTER L.F. PAULSON
---------------------------- -------------------------------
Chester L.F. Paulson
President
Date: May 11, 1999 By: CAROL RICE
---------------------------- -------------------------------
Carol Rice
Principal Accounting Officer
19
<PAGE>
EXHIBIT INDEX
Exhibit Sequential
No. Description Page No.
------- ----------- ----------
27 Financial Data Schedule
20
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
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MARCH 31, 1999 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS,
SHAREHOLDERS' EQUITY AND CASH FLOWS FOR THE THREE MONTHS IN THE PERIOD ENDED
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