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, 1998
FORM 10-KSB
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
- --------------------------------- -----
(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 X No
----- -----
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not 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:
$14,560,532
As of March 22, 1999, 3,796,852 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 $7,539,598.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement for the 1999 annual
meeting of shareholders to be filed with the Securities and Exchange Commission
are incorporated by reference into Part III.
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, 1998 PIC employed 20 brokers and
had independent contractor arrangements with 78 brokers registered with the
National Association of Securities Dealers, Inc. ("NASD"). PIC also employed a
support staff of 37 persons in its headquarters in Portland, Oregon and in
certain of its branch offices. At December 31, 1998 PIC had 36 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:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
General Securities 78% 54% 47% 54% 84%
Trading 4 5 6 4 (1)
Corporate Finance 12 17 18 10 14
Investment Income 6 24 29 32 2
Other 0 0 0 0 1
</TABLE>
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, 1998, no loans
were 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, 1998, PIC made a market in approximately
34 securities of 22 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, 1998, PIC held securities of 24 companies in its investment
account. In 1998, the value of securities held in the trading accounts and
investment account ranged between $8,694,148 and $13,818,133. The level of
positions carried in PIC's trading and investment
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accounts fluctuates 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, 1998 PIC acted as the managing
underwriter or co-managing underwriter for 131 securities offerings, raising
approximately $764 million for corporate finance clients. Of these, 81 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, 1998, PIC had 36 branch offices in
Arizona, California, Connecticut, Georgia, Hawaii, Idaho, Nevada, New Jersey,
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
45 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, 1998, PIC had net capital of $8,064,062, which exceeded its minimum
requirement of $129,784 by $7,934,278. The ratio of aggregate indebtedness of
$1,946,765 to net capital of $8,064,062 on December 31, 1998 was approximately
0.24 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
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leading securities firms. These developments have increased competition from
firms with greater capital resources 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. A growing number of discount
brokerage firms offer their services over the Internet, further decreasing
offered commission rates and increasing ease of use for customers. 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, 1998, PIC had 57 employees, of whom 37 were executives and
support staff and 20 were involved in brokerage activities and compensated
primarily on a commission basis. PIC also had independent contractor
arrangements with 78 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.
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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 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. The case is set
for trial April 6, 1999. 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
which 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
broker 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 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. PIC believes the
lawsuit was filed in breach of plaintiff's agreement to arbitrate all disputes
with PIC, and PIC intends to seek to compel plaintiff to arbitrate the matter.
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 filed a lawsuit in California state court
against PIC, an officer and director of PIC, and a former PIC broker alleging
breach of fiduciary duty, negligent misrepresentation, suppression of facts and
churning. Plaintiff seeks damages of $100,000 and punitive damages of $100,000.
Mr. Asif subsequently 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 July 1998, Rose Wasserman, a former PIC customer, asserted claims
against PIC and a PIC broker alleging churning, penny-stock violations, breach
of fiduciary duty, fraud, violations of the federal securities laws, negligent
misrepresentation and negligent supervision. Claimant has demanded approximately
$35,000 to settle her claims and has indicated that she will file an NASD
arbitration claim if the case is not settled. PIC has not had an opportunity to
fully
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investigate this claim, but believes it has meritorious defenses and intends to
defend this matter vigorously if an arbitration claim is filed.
In January 1999, Shahid T. Choudhry, Lita A. Choudhry and Iqbal Waraich,
former PIC customers, filed an arbitration against PIC and a former PIC broker
alleging that the former PIC
broker 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 if an arbitration claim or lawsuit is filed.
In June 1998, Natalie P. Tirrell, a former PIC customer, filed an NASD
arbitration claim asserting claims against PIC and Robert Castaneda, a PIC
broker, alleging misrepresentations and excessive commissions. Claimant alleges
damages in excess of $50,000. Based on PIC's early investigation of the claim,
PIC has answered denying all liability. Discovery has not yet 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 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.
<TABLE>
<CAPTION>
1998 Prices 1997 Prices 1996 Prices
High Low High Low High Low
<S> <C> <C> <C> <C> <C> <C>
1st Quarter $6.750 $4.625 $3.188 $2.500 $1.188 $ .875
2nd Quarter 5.625 4.125 5.250 2.562 3.500 .906
3rd Quarter 4.125 2.312 6.875 3.500 3.188 1.750
4th Quarter 3.875 2.000 6.562 4.625 3.125 2.562
</TABLE>
The high and low closing price for the first quarter of 1999 through March 11
were $5.500 and $2.625, respectively.
As of March 11, 1999, there were 3,796,852 shares of the Company's common
stock outstanding and held of record by 139 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 1998 annual
meeting, the Company believes there are approximately 450 beneficial holders of
its common stock. The Company repurchased 177,967 shares of common stock during
1998. 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.
In 1998 the Company issued an aggregate of 4,283 unregistered Shares of the
Company's stock as compensation to persons attending meetings of its board of
directors. Such persons include directors, executive officers of the Company,
and a director of PIC who is neither an officer of the Company or PIC. These
issuances are exempt from registration under Section 4(2) of the Securities Act
of 1933, as amended.
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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,
1998 1997 1996 1995 1994
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues $14,560 $23,473 $25,618 $18,031 $ 9,345
Commissions and Salaries 10,371 12,552 12,092 9,688 7,782
Other Expenses 4,108 4,003 4,073 3,637 3,319
Total Expenses 14,479 16,555 16,165 13,325 11,101
Pretax Income (loss) 81 6,918 9,453 4,706 (1,755)
Net Income (loss) (36) 4,354 5,727 2,925 (1,080)
Diluted Earnings (loss) ($.01) $1.09 $1.33 $.67 ($.25)
per share
Average number of common shares 3,918 4,005 4,323 4,357 4,372
outstanding
</TABLE>
Balance Sheet Information
<TABLE>
<CAPTION>
December 31,
1998 1997 1996 1995 1994
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total Assets $16,071 $22,463 $16,291 $9,542 $ 4,653
Working Capital 12,748 13,411 9,737 4,759 1,851
Short-Term Debt 0 100 100 100 100
Long-Term Debt 0 0 0 0 0
Shareholders' Equity $13,278 $13,784 $ 9,899 $4,886 $ 2,001
</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 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,
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"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>
<CAPTION>
Summary of Changes in Major Categories
of Revenues and Expense
1998 vs. 1997 1997 vs. 1996
<S> <C> <C> <C> <C>
Revenues:
Sales Commissions ($1,404,382) (11.0%) $544,748 4.5%
Corporate Finance (2,208,823) (56.3%) (631,269) (13.8%)
Investment Income (4,719,273) (84.6%) (1,765,814) (24.0%)
Trading Income (605,763) (50.7%) (301,286) (20.1%)
Other 25,712 61.0% 8,396 24.9%
Expenses:
Commissions and Salaries ($2,180,827) (17.4%) $459,550 3.8%
Underwriting Expenses 235,911 31.0% (183,533) (19.4%)
Rent, Telephone & Quotes 6,965 0.8% 36,114 4.5%
Other (137,933) (5.7%) 77,778 3.3%
Pretax Income ($6,836,645) (98.8%) ($2,535,134) (26.8%)
</TABLE>
1998 Compared to 1997
Total revenues for 1998 fell 38.0 percent from 1997, to $14,560,532 from
$23,473,061. As shown in the table above, sales commissions fell $1,404,382, or
11.0 percent, to $11,324,412 in 1998 from $12,728,794 in 1997. This decrease
resulted primarily from the less favorable price movements and trading levels in
smaller capitalization OTC issues in 1998 compared to 1997. The Nasdaq
Industrial Average rose more in 1997 (11.17 percent) than in 1998 (6.55
percent), and PIC's focus is on very small capitalization issues, especially
those tied to PIC's corporate finance clients, which experienced a less
favorable market in 1998. Corporate finance revenues fell 56.3 percent, or
$2,208,823, in 1998 compared to 1997. Four transactions were completed in 1998,
raising a total of $37 million for the issuers; 6 transactions were completed in
1997, raising an aggregate of $93 million for corporate finance clients.
Investment income decreased $4,719,273, to $861,738 in 1998 from $5,581,011 in
1997. No underwriter warrants were exercised in 1998 while one warrant was
exercised in 1997, and the profits from investments sold in the investment
account in 1997 were significantly greater than in 1998. Trading income fell
$605,763, or 50.7 percent, to $589,822 in 1998 from $1,195,585 in 1997. This
decline was due to lower trading levels in 1998 and the generally more favorable
markets in smaller capitalization OTC issues in 1997 compared to 1998.
Total expenses fell $2,075,884 in 1998 from 1997, a decrease of 12.5
percent to $14,479,189 from $16,555,073. Commissions and salaries fell
$2,180,827, or 17.4 percent, to $10,370,979 in 1998 from $12,551,806 in 1997.
This decrease was primarily due to decreased commission revenues resulting in a
lower level of commissions paid. Higher commission rates are generally paid to
employee registered representatives at higher production levels as an incentive.
13
<PAGE>
Underwriting expenses increased by $235,911, or 31.0 percent. While fewer
transactions were completed in 1998, PIC was the sole manager for all
transactions and bore all the expenses. In addition, expenses were incurred on
transactions that were not completed. Rent, telephone and quote expenses
increased to $842,437 in 1998 from $835,472 in 1997, an increase of 0.8 percent.
Other expenses decreased 5.7 percent, to $2,267,545 in 1998 from $2,405,478 in
1997, with increased settlements and travel and entertainment expenses more than
offset by declines in professional fees and other expenses.
The Company had a pretax profit of $81,343 in 1998 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 a pretax loss of $780,395 in
1998. Investment income in 1995 through 1997 was significantly higher than in
any previous year in the Company's history, 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, and 1998's investment
income, while lower than in 1995, 1996 and 1997, was higher than most years
prior to 1995. Significant fluctuations can occur in PIC's revenues and
operating results from one period to another. The Company also incurred an
expense of $116,983 for income taxes in 1998, compared to $2,563,593 in 1997.
Income taxes exceeded pretax income in 1998 due to an underestimation by the
Company of taxes due in 1997.
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)
than in 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 $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.
14
<PAGE>
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.
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, 1998 was $12,748,453. Of PIC's total
assets (net of intercompany accounts) at December 31, 1998 of $15,316,031,
approximately 77 percent consisted of securities in PIC's investment account and
trading inventory of securities, at market value, and approximately 10 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. While OTC indices increased
in price in 1998, prices and liquidity generally declined for very small
capitalization issues, which are PIC's focus. 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,
with an original cost of $946,475, currently valued at $326,475, which the
Company believes, based upon available evidence, approximates market value.
15
<PAGE>
PIC 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, 1998, no
loans were 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, 1998, PIC owned 31 underwriter
warrants (from 29 issuers), of which 27 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 1998, $2,839,764 of net cash was provided by operating activities. The
major adjustments to reconcile this result to the Company's net income included
a decrease of $6,782,065 in trading securities, a $3,051,643 decrease in
receivables, a realized gain on investment securities of $404,441 and a
write-down of notes receivable of $267,193, partially offset by a decrease of
$5,516,418 in accounts payable and accrued liabilities, $994,262 unrealized
appreciation on investment securities and $718,273 in deferred income taxes. In
1998, $2,325,723 of net cash was used in investing activities, primarily
purchases of investment securities exceeding sales of investment securities. Net
cash used in financing activities in 1998 totalled $486,916, resulting from
payments to repurchase common stock. 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. Since PIC is the Company's only
operating business, such a failure could have a material adverse affect on the
Company.
16
<PAGE>
At December 31, 1998, 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.
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.
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. 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
17
<PAGE>
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 is approximately 20
percent complete and expects these upgrades and conversions to be completed by
June 30, 1999. The Company believes these efforts were on schedule as of
December 31, 1998. 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 December 31, 1998. 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.
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 December 31, 1998 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.
18
<PAGE>
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.
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.
19
<PAGE>
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, 1998 and 1997 F-2
Consolidated Statements of Earnings for the years ended
December 31, 1998, 1997 and 1996 F-3
Consolidated Statement of Shareholders' Equity for the years
ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 F-5
Notes to Consolidated Financial Statements F-7
Supplementary Schedule of Warrants Owned F-17
Schedule II - Valuation and Qualifying Account F-18
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
All information required by Items 9, 10, 11 and 12 of Part III of this
Report will be included in the Company's definitive proxy statement for its 1999
annual meeting of shareholders filed or to be filed not later than 120 days
after the end of the fiscal year covered by this Report and is incorporated
herein by reference, other than the information with respect to executive
officers of the Company included below.
20
<PAGE>
FINANCIAL STATEMENTS AND REPORT
OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
PAULSON CAPITAL CORP. AND SUBSIDIARY
DECEMBER 31, 1998, 1997 AND 1996
<PAGE>
[LOGO]
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, 1998 and 1997,
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1998.
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, 1998 and 1997, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 1998, 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, 1998 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, 1998. In our opinion, this schedule presents fairly, in all
material respects, the information required to be set forth therein.
GRANT THORNTON LLP
Portland, Oregon
January 28, 1999
F-1
<PAGE>
<TABLE>
<CAPTION>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 1998 1997
------------- -------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 100,345 $ 73,220
Receivable from broker-dealers and clearing organizations 1,430,586 4,497,086
Notes and other receivables 439,967 657,918
Trading securities 2,119,737 8,901,802
Investment securities 9,697,387 7,068,580
Refundable income taxes 168,059 101,907
Prepaid and deferred expenses 578,556 400,845
Secured demand note - 100,000
Deferred income taxes 1,007,373 289,100
------------- -------------
Total current assets 15,542,010 22,090,458
------------- -------------
FURNITURE AND EQUIPMENT, net 359,329 202,605
------------- -------------
INVESTMENT IN REAL ESTATE 169,900 169,900
------------- -------------
$ 16,071,239 $ 22,462,963
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 738,155 $ 264,294
Payable to broker-dealers and clearing organizations 753,413 6,041,296
Compensation, employee benefits and payroll taxes 1,240,510 1,942,906
Securities sold, not yet purchased 61,479 330,729
Subordinated note payable - 100,000
------------- -------------
Total current liabilities 2,793,557 8,679,225
------------- -------------
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, 3,796,852 and
3,970,536, respectively 775,323 794,416
Retained earnings 12,502,359 12,989,322
------------- -------------
13,277,682 13,783,738
------------- -------------
$ 16,071,239 $ 22,462,963
============= =============
The accompanying notes are an integral part of these statements.
</TABLE>
F-2
<PAGE>
<TABLE>
<CAPTION>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Revenues
Commissions $ 11,324,412 $ 12,728,794 $ 12,184,046
Corporate finance 1,716,691 3,925,514 4,556,783
Investment income 861,738 5,581,011 7,346,825
Trading income 589,822 1,195,585 1,496,871
Interest and dividends 48,668 7,010 18,035
Other 19,201 35,147 15,726
-------------- -------------- --------------
14,560,532 23,473,061 25,618,286
-------------- -------------- --------------
Expenses
Commissions and salaries 10,370,979 12,551,806 12,092,256
Underwriting expenses 998,228 762,317 945,850
Rent, telephone and quotation services 842,437 835,472 799,358
Interest expense 60,889 5,996 7,010
Professional fees 389,478 639,386 492,773
Bad debt expense 84,670 55,011 180,352
Travel and entertainment 283,234 158,649 153,261
Settlements 518,362 67,299 297,465
Other 930,912 1,479,137 1,196,839
-------------- -------------- --------------
14,479,189 16,555,073 16,165,164
-------------- -------------- --------------
Earnings before income taxes 81,343 6,917,988 9,453,122
Income tax expense 116,983 2,563,593 3,725,920
-------------- -------------- --------------
NET EARNINGS (LOSS) $ (35,640) $ 4,354,395 $ 5,727,202
============== ============== ==============
Earnings (loss) per common share $ (.01) $ 1.10 $ 1.34
============== ============== ==============
Earnings (loss) per common share - assuming dilution $ (.01) $ 1.09 $ 1.33
============== ============== ==============
The accompanying notes are an integral part of these statements.
</TABLE>
F-3
<PAGE>
<TABLE>
<CAPTION>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Three year period ended December 31, 1998
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
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
============ =========== ============
The accompanying notes are an integral part of this statement.
</TABLE>
F-4
<PAGE>
<TABLE>
<CAPTION>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities
Net earnings (loss) $ (35,640) $ 4,354,395 $ 5,727,202
Adjustments to reconcile net earnings (loss) to
net cash provided by (used in) operating activities
Unrealized (appreciation) depreciation
on investment securities (994,262) 407,806 36,304
Realized gain on investment securities 404,441 (5,988,817) (7,383,129)
Deferred income taxes (718,273) (166,700) (29,500)
Common stock issued for compensation
of directors 16,500 8,000 7,500
Depreciation and amortization 89,448 59,994 53,028
(Gain)/loss from sale of furniture and equipment 6,180 (6,800) -
Write-down of notes receivable 267,193 - -
Changes in assets and liabilities
Receivables 3,051,643 562,999 (833,711)
Trading securities 6,782,065 (3,749,019) (1,892,386)
Refundable income taxes (66,152) 310,354 (255,123)
Prepaid and deferred expenses (177,711) (240,724) 177,917
Accounts payable and accrued liabilities (5,516,418) 2,236,523 1,801,823
Securities sold, not yet purchased (269,250) 50,041 (64,862)
------------- ------------- -------------
Net cash provided by (used in)
operating activities 2,839,764 (2,161,948) (2,654,937)
------------- ------------- -------------
Cash flows from investing activities
Purchases of investment securities (27,439,553) (28,103,962) (19,493,160)
Proceeds from sale of investment securities 25,400,567 31,405,663 22,969,705
Proceeds from repayment of notes receivable 500,000 - -
Issuance of note receivable (534,385) (500,000) -
Additions to furniture and equipment (254,652) (114,474) (88,072)
Purchase of real estate - (169,900) -
Proceeds from sale of furniture and equipment 2,300 9,600 -
------------- ------------- -------------
Net cash provided by (used in)
investing activities (2,325,723) 2,526,927 3,388,473
------------- ------------- -------------
The accompanying notes are an integral part of these statements.
</TABLE>
F-5
<PAGE>
<TABLE>
<CAPTION>
Paulson Capital Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from financing activities
Proceeds from exercise of stock options $ - $ 89,283 $ 40,892
Payments to retire common stock (486,916) (566,487) (763,012)
------------ ------------ ------------
Net cash used in financing activities (486,916) (477,204) (722,120)
------------ ------------ ------------
Net Increase (Decrease) in Cash and
Cash Equivalents 27,125 (112,225) 11,416
Cash and cash equivalents at beginning of year 73,220 185,445 174,029
------------ ------------ ------------
Cash and cash equivalents at end of year $ 100,345 $ 73,220 $ 185,445
============ ============ ============
Cash paid during the year for
Interest $ 61,389 $ 6,000 $ 6,000
============ ============ ============
Income taxes $ 901,408 $ 2,405,275 $ 4,026,942
============ ============ ============
Noncash investing and financing activity
Repayment of secured demand note collateral agreement $ 100,000 $ - $ -
============ ============ ============
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
Paulson Capital Corp. (the Company) is a holding company whose 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. Manager's fees, underwriter's 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.
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.
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 adopted Financial Accounting Standard No. 128, "Earnings Per
Share" in 1997. The 1996 calculation has been adjusted to conform with the
requirements of this standard. Earnings (loss) 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 under the liability method. 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. Income tax expense is the tax payable for the period
and the change during the period in net deferred tax assets and
liabilities.
NOTE B - RECEIVABLE FROM AND PAYABLE TO BROKER-DEALERS AND CLEARING
ORGANIZATIONS
The Subsidiary introduces all customer transactions in securities traded on
U.S. securities markets to CSC on a fully-disclosed basis. The agreement
between the Subsidiary and its clearing broker provides that the Subsidiary
is obligated to assume any exposure related to nonperformance by customers
or counterparties. The 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 Subsidiary. In the event of
nonperformance, the 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
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, the above clearing services and trading account financing
resulted in the following:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Receivable from CSC $ 1,430,586 $ 4,497,086
Payable to CSC (753,413) (6,041,296)
------------ ------------
Net receivable (payable) $ 677,173 $ (1,544,210)
============ ============
</TABLE>
NOTE C - NOTES AND OTHER RECEIVABLES
Notes and other receivables consist of the following:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Underwriting $ 267,191 $ 500,000
Employees 49,493 57,477
Independent brokers 69,909 82,529
Other 53,374 17,912
------------ ------------
$ 439,967 $ 657,918
============ ============
</TABLE>
In connection with an underwriting, the Subsidiary accepted a note
receivable on December 18, 1997 in the amount of $500,000. On February 6,
1998 the note was paid. Three additional notes totaling $534,385 were
accepted during 1998. These notes are uncollateralized and the Subsidiary
has recorded an allowance of $267,193 against them.
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 Subsidiary. For the years ended
December 31, 1998, 1997, and 1996, notes and receivables of $85,448,
$17,206, and $81,627, respectfully, were determined by management to be
uncollectible and written off.
F-9
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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.
The categories of trading securities and their related market values
follow:
<TABLE>
<CAPTION>
1998 1997
------------------------------ ------------------------------
Long Short Long Short
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Common stock $ 1,686,731 $ 50,672 $ 1,313,920 $ 16,662
Preferred stock 39,008 5,511 31,756 32,582
State and municipal bonds 243,055 5,296 91,395 76,044
Corporate bonds 150,943 - 53,596 5,441
US Government Agency - - 7,411,135 -
------------ ------------- ------------ -------------
$ 2,119,737 $ 61,479 $ 8,901,802 $ 130,729
============ ============= ============ =============
</TABLE>
As a securities broker-dealer, the Subsidiary is engaged in various
securities trading and brokerage activities as principal. In the normal
course of business, the 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 Subsidiary which are readily marketable
are stated at market value. Included in investment securities are certain
securities which are not readily marketable. Securities not readily
marketable include investment securities (a) for which there is no market
on a securities exchange or no independent publicly quoted market, (b) that
cannot be publicly offered or sold unless registration has been effected
under the Securities Act of 1933, or (c) that cannot be offered or sold
because of other arrangements, restrictions, or conditions applicable to
the securities or to the Company. At December 31, 1998 and 1997 these
securities consist of corporate stocks at estimated fair value of $326,475
and $776,475. A summary of the investment security portfolio follows:
<TABLE>
<CAPTION>
Market Unrealized Carrying
Cost Value Loss Value
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
1998
Common stock $ 11,993,688 $ 9,697,387 $ (2,296,301) $ 9,697,387
============ ============ ============ ===========
1997
Common stock $ 7,712,550 $ 7,068,580 $ (643,970) $ 7,068,580
============ ============ ============ ===========
</TABLE>
The Company also had recorded $200,000 of common stock sold, not yet
purchased in its investment account at December 31, 1997.
Realized gains included in the determination of net earnings were $404,441,
$5,988,817, and $7,383,129 for the years ended December 31, 1998, 1997 and
1996, 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>
1998 1997
------------ ------------
<S> <C> <C>
Office equipment $ 905,710 $ 707,039
Leasehold improvements 120,354 120,354
Vehicles 65,619 28,035
------------ ------------
1,091,683 855,428
Less accumulated depreciation
and amortization 732,354 652,823
------------ ------------
$ 359,329 $ 202,605
============ ============
</TABLE>
NOTE F - SUBORDINATED NOTE PAYABLE
The Subsidiary had borrowings subordinated to claims of general creditors
pursuant to a secured demand note collateral agreement. This agreement was
in accordance with the National Association of Security Dealers and the
Securities and Exchange Commission requirements and the related borrowings
were subordinated to the claims of general creditors and were renewable
annually on their maturity dates.
<TABLE>
<CAPTION>
Maturity Date Interest Rate 1998 1997
------------------- ------------- ------------ ------------
<S> <C> <C> <C>
Secured demand note
May 31, 1998 6% $ - $ 100,000
</TABLE>
This borrowing was included in the Subsidiary's computation of net capital
at December 31, 1997. Additionally, it was not cancelable by either party
and, to the extent it is required to maintain compliance with minimum net
capital requirements, could not be repaid. This borrowing expired in 1998
and was not renewed.
NOTE G - INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Current tax expense
Federal $ 724,613 $ 2,364,177 $ 3,008,653
State 110,643 366,116 746,767
------------ ------------ ------------
835,256 2,730,293 3,755,420
------------ ------------ ------------
Deferred tax expense (benefit)
Federal (623,461) (142,543) (11,740)
State (94,812) (24,157) (17,760)
------------ ------------ ------------
(718,273) (166,700) (29,500)
------------ ------------ ------------
$ 116,983 $ 2,563,593 $ 3,725,920
============ ============ ============
</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>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Income tax expense at
statutory federal tax rate $ 27,700 $ 2,352,000 $ 3,214,000
State taxes net of federal benefit 4,200 237,000 510,000
Permanent and other differences 85,083 (25,407) 1,920
------------ ------------ ------------
$ 116,983 $ 2,563,593 $ 3,725,920
============ ============ ============
</TABLE>
The deferred income tax asset at December 31, 1998 consists primarily of
basis differences in short-term investments of approximately $899,000, an
allowance for notes receivable of approximately $105,000 and other items of
$3,373. The deferred income tax asset at December 31, 1997 and 1996 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 approximately $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 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 1998, 1997 or 1996.
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 the disclosure only 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 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.
There was not activity under the Plans during 1998. The following table
summarizes activity under the Plans for the two years ended December 31,
1997:
<TABLE>
<CAPTION>
Weighted
Shares Average
Under Exercise
Option Price
------------ ------------
<S> <C> <C>
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>
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
in the period ended December 31, 1998:
<TABLE>
<CAPTION>
Weighted
Average Per-
Income Shares Share
1996 (Numerator) (Denominator) Amount
---- ----------- ------------- ------
<S> <C> <C> <C>
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
=========== ============= ======
1998
----
Basic earnings (loss) per share
Income (loss) available to
common stockholders $ (35,640) 3,917,788 $ (.01)
=========== ============= ======
</TABLE>
During the year ended December 31, 1998 there were no potentially dilutive
securities outstanding. 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, certain options
were not included in 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:
<TABLE>
<CAPTION>
Year ended
December 31,
------------
<S> <C>
1999 $ 274,176
2000 274,176
2001 274,176
2002 114,240
-----------
$ 936,768
===========
</TABLE>
The lease provides for payment of taxes and other expenses by the Company.
Rental expense for the years ended December 31, 1998, 1997 and 1996
approximated $270,000, $240,000 and $250,000, respectively.
NOTE K - WARRANTS OWNED
As provided for in certain underwriting agreements, the Company was granted
warrants to purchase shares of common stock of certain 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, 1998,
1997 and 1996 were $0, $500,000, and $500,000, respectively.
NOTE M - CONTINGENCIES
The Company 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.
The Company is a defendant in a class action alleging violations of
California securities law and other laws relating to a public offering in
which the Company acted as the managing underwriter. The Company and the
plaintiffs reached a settlement in principle during 1998. The settlement is
subject to court approval. The total payment by the Company under the
settlement would depend upon the number of purchasers in the public
offering who file valid claims. The Company believes the range of payment
possible under the settlement would be between approximately $400,000 and
$920,000. An accrual of $500,000 has been recorded based upon management's
estimate of the most likely amount.
F-15
<PAGE>
Paulson Capital Corp. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE N - NET CAPITAL REQUIREMENT
The 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, 1998, the Subsidiary's net capital and
required net capital were $8,064,062 and $129,784, respectively, and its
ratio of aggregate indebtedness to net capital was .24 to 1. The
Subsidiary's absolute minimum net capital is $100,000.
F-16
<PAGE>
Paulson Capital Corp. and Subsidiary
SUPPLEMENTARY SCHEDULE OF WARRANTS OWNED
December 31, 1998
<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
Audiohighway (units) ERC 12-17-99 163,900 $ 7.80 2003, 12/17
AVI Biopharma, Inc. (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
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
Cell Robotics International, Inc. (units) ERC 2-2-99 29,800 $ 9.90 2003, 02/01
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
Global Payment Technology ERC 2-6-96 103,500 $ 6.60 2000, 02/06
Hometown Auto Retailers NC ERC 7-28-99 120,690 $ 10.80 2003, 07/28
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
Pacific Aerospace & Electronics (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
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
WSG Systems, Inc. ERC 4-8-99 11.0260 $ 6,000.00 2003, 03/31
</TABLE>
F-17
<PAGE>
<TABLE>
<CAPTION>
Paulson Capital Corp. and Subsidiary Schedule II
Valuation and Qualifying Accounts
Years ended December 31, 1998, 1997 and 1996
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, 1998 $ - $ 352,641 $ 85,448 $ 267,193
Year ended Dec. 31, 1997 - 17,206 17,206 -
Year ended Dec. 31, 1996 - 81,627 81,627 -
</TABLE>
F-18
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
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, 1998 are set forth below. The year
each person became a director follows his or her name.
<TABLE>
<CAPTION>
Position(s) with Principal Occupation(s)
Name Age Company During Past Five Years
<S> <C> <C> <C>
Chester L.F. Paulson 62 President and Director Director of Corporate Finance of PIC
(1970)
Jacqueline M. Paulson 59 Secretary-Treasurer Secretary-Treasurer of PIC
(1976) and Director
Kenneth T. LaMear 64 Director Senior Vice President of PIC since February 1998,
(1985) Chief Executive Officer of PIC until February 1998
Shannon P. Pratt 65 Director Managing Director, Founder - Willamette
(1998) Management Associates, a business valuation firm
Paul Shoen 42 Director Chairman of the Board of Directors and Chief
(1998) Executive Officer of Panetechnicon Aviation,
an operator and lessor of aircraft; private
investor; Director -- AMERCO, the parent company
of U-Haul Trucking Rental and Telepartner A/S, a
long distance telephone provider
John Westergaard 67 Director Publisher/Editor of Westergaard Online
(1998) Systems, Inc., an Internet publisher of
financial "webzines"
</TABLE>
Chester L.F. Paulson and Jacqueline M. Paulson are husband and wife.
21
<PAGE>
(a) 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)
10.2 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)
10.3 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.
27.1 Financial Data Schedule
(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: March 19, 1999 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 Chairman of the Board March 19, 1999
- ----------------------------- and President
Chester L.F. Paulson
(2) Principal Accounting Officer
CAROL RICE Principal Accounting March 17, 1999
- ----------------------------- Officer
Carol Rice
(3) Directors
JACQUELINE M. PAULSON Secretary, Treasurer March 19, 1999
- ----------------------------- and Director
Jacqueline M. Paulson
KENNETH T. LAMEAR Director March 23, 1999
- -----------------------------
Kenneth T. LaMear
Director
- ----------------------------- --------------
Shannon Pratt
PAUL SHOEN Director March 23, 1999
- -----------------------------
Paul Shoen
JOHN WESTERGAARD Director March 22, 1999
- -----------------------------
John Westergaard
24
<PAGE>
Exhibit Page
Number Description 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)
10.2 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)
10.3 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.
27.1 Financial Data Schedule
<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, 1998 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS,
SHAREHOLDERS' EQUITY AND CASH FLOWS FOR THE TWELVE MONTHS IN THE PERIOD
ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
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