**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTOND.C. 20549**

 

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**FORM 10-Q**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2005**

 

**o****  TRANSITION REPORT UNDER SECTION 13 OR15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For thetransition period from              to**

 

**Commissionfile number: 0-18188**

 

**PAULSON CAPITAL CORP.**

(Exact name of small business issuer asspecified in its charter)

 

**Oregon**

(State or other jurisdiction of incorporationor organization)

 

**93-0589534**

(IRS employer identification number)

 

**811 S.W.Naito ParkwayPortland, OR 97204**

(Address of principal executive offices)

 

**(503) 243-6000**

(Issuer’s telephone number)

 

Indicate by check mark whether the issuer (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the issuer was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.Yes  ý    No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer

(as defined in Rule 12b-2of the Exchange Act):Yes  o    No  ý

 

Number of shares outstanding of each of theissuer’s classes of common stock, as of the latest practicable date:

 

Common stock, no par value 3,121,946 as of May 10,2005

 

Transitional Small Business Disclosure Format(check one): Yes  o    No  ý

 

 

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**PAULSONCAPITAL CORP.**

 

**INDEX TO FORM 10-Q**

 
| Part I  - | FINANCIAL INFORMATION                                                                                                                                                          |   |
|---------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                |                                                                                                                                                                           |   |
| Item 1  -      | Financial Statements:                                                                                                                                                          |   |
|                |                                                                                                                                                                           |   |
|                | Consolidated Balance  Sheets:  –    March 31, 2005 and December 31, 2004                                                                    |   |
|                |                                                                                                                                                                           |   |
|                | Consolidated  Statements of Income:   –**    **For the  Three Months Ended March 31, 2005 and 2004                                               |   |
|                | ** **                                                                                                                                                                     |   |
|                | Consolidated  Statement of Stockholders’ Equity   –    For the Year Ended December 31, 2004 and the Three  Months Ended March 31, 2005 |   |
|                |                                                                                                                                                                           |   |
|                | Consolidated  Statements of Cash Flows:   –    For the Three Months Ended March 31, 2005 and  2004                                               |   |
|                |                                                                                                                                                                           |   |
|                | Notes  to Condensed Consolidated Interim Financial Statements                                                                                                                  |   |
|                |                                                                                                                                                                           |   |
| Item 2 -            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                                    |   |
|                |                                                                                                                                                                           |   |
| Item  3 -           | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                    |   |
|                |                                                                                                                                                                           |   |
| Item 4 -            | Controls and  Procedures                                                                                                                                                       |   |
|                |                                                                                                                                                                           |   |
| Part II -      | OTHER INFORMATION                                                                                                                                                              |   |
|                |                                                                                                                                                                           |   |
| Item 2 -            | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                                                                   |   |
|                |                                                                                                                                                                           |   |
| Item 6 -            | Exhibits                                                                                                                                                                       |   |
|                |                                                                                                                                                                           |   |
| Signatures -        |                                                                                                                                                                           |   |
|                |                                                                                                                                                                           |   |
| Certifications      |                                                                                                                                                                           |   |

 

2

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**PART I****— FINANCIAL INFORMATION**

 

ITEM1.  FINANCIAL STATEMENTS

 

PAULSONCAPITAL CORP. AND SUBSIDIARYCONSOLIDATED BALANCE SHEETS

 

 
| ** **                                                                                                                           | ** ** | **03/31/05**    | ** ** | **12/31/04** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                                                                                                                           | ** ** | **(unaudited)** | ** ** | ** **   | ** ** |
| **ASSETS**                                                                                                                           |       |            |       |         |       |
|                                                                                                                                 |       |            |       |         |       |
| Cash and  cash equivalents                                                                                                           |       | $               | 137,265    |         | $          | 132,845 |   |
| Receivable  from clearing organization                                                                                               |       | 7,489,014       |       | 7,856,254    |       |
| Notes and  other receivables                                                                                                         |       | 698,651         |       | 442,934      |       |
| Income taxes  receivable                                                                                                             |       | 851,000         |       | 851,000      |       |
| Trading  securities, at market value                                                                                                 |       | 1,747,202       |       | 3,029,326    |       |
| Investment  securities, at market value                                                                                              |       | 21,444,935      |       | 20,774,645   |       |
| Underwriter  warrants, at estimated fair value                                                                                       |       | 11,000,000      |       | 9,416,000    |       |
| Prepaid and  deferred expenses                                                                                                       |       | 1,450,943       |       | 1,583,346    |       |
| Furniture  and equipment, net                                                                                                        |       | 233,959         |       | 239,028      |       |
|                                                                                                                                 |       |            |       |         |       |
| Total assets                                                                                                                         |       | $               | 45,052,969 |         | $          | 44,325,378 |   |
|                                                                                                                                 |       |            |       |         |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                       |       |            |       |         |       |
|                                                                                                                                 |       |            |       |         |       |
| **LIABILITIES**                                                                                                                      |       |            |       |         |       |
| Accounts  payable and accrued liabilities                                                                                            |       | $               | 446,382    |         | $          | 2,138,856 |   |
| Dividends  payable                                                                                                                   |       | 4,457           |       | —       |       |
| Payable to  clearing organization                                                                                                    |       | 64,664          |       | 1,021,860    |       |
| Compensation,  employee benefits and payroll taxes                                                                                   |       | 1,736,731       |       | 2,108,056    |       |
| Securities  sold, not yet purchased, at market value                                                                                 |       | 119,701         |       | 50,144       |       |
| Deferred  income taxes                                                                                                               |       | 7,147,930       |       | 5,436,000    |       |
|                                                                                                                                 |       |            |       |         |       |
| Total  liabilities                                                                                                                   |       | 9,519,865       |       | 10,754,916   |       |
|                                                                                                                                 |       |            |       |         |       |
| **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,  3,174,590 at 03/31/05 and 3,190,300 at 12/31/04 |       | 1,740,005       |       | 1,745,824    |       |
| Retained  earnings                                                                                                                   |       | 33,793,099      |       | 31,824,638   |       |
|                                                                                                                                 |       |            |       |         |       |
| Total  shareholders’ equity                                                                                                     |       | 35,533,104      |       | 33,570,462   |       |
|                                                                                                                                 |       |            |       |         |       |
| Total liabilities  and shareholders’ equity                                                                                     |       | $               | 45,052,969 |         | $          | 44,325,378 |   |

 

The accompanying notes are an integral part ofthese statements.

 

3

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PAULSONCAPITAL CORP. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF INCOME(unaudited)

 
| ** **                                      | ** ** | **Three months ended** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **03/31/05**           | ** ** | **03/31/04** | ** ** |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Revenues**                                    | ** ** | ** **             | ** ** | ** ** | ** ** |
| Commissions                                     |       | $                      | 4,141,057  |   | $ | 5,237,631 |   |
| Corporate  finance                              |       | 119,985                |       | 4,009,488 |   |
| Investment  income (loss)                       |       | 5,152,499              |       | (2,001,275 | ) |
| Trading  income                                 |       | 702,004                |       | 444,195 |   |
| Interest and  dividends                         |       | 7,691                  |       | 4,798 |   |
| Other                                           |       | 11,169                 |       | 915 |   |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
|                                            |       | 10,134,405             |       | 7,695,752 | ** ** |
| **Expenses**                                    | ** ** | ** **             | ** ** | ** ** | ** ** |
| Commissions  and salaries                       |       | 4,254,004              |       | 5,662,749 |   |
| Underwriting  expenses                          |       | —                 |       | 252,458 |   |
| Rent,  telephone and quotation services         |       | 306,498                |       | 303,543 |   |
| Interest  expense                               |       | —                 |       | 73 |   |
| Professional  fees                              |       | 442,766                |       | 264,139 |   |
| Bad debt  expense                               |       | —                 |       | 40,000 |   |
| Travel and  entertainment                       |       | 60,146                 |       | 55,066 |   |
| Settlement  expense                             |       | 262,168                |       | 9,590 |   |
| Depreciation  and amortization                  |       | 23,057                 |       | 30,865 |   |
| Other                                           |       | 505,977                |       | 501,404 |   |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
|                                            |       | 5,854,616              |       | 7,119,887 | ** ** |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
| Income  before income taxes                     |       | 4,279,789              |       | 575,865 |   |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
| Income tax  expense (benefit)                   | ** ** | ** **             | ** ** | ** ** | ** ** |
| Current                                         |       | —                 |       | 274,548 |   |
| Deferred                                        |       | 1,711,930              |       | (56,295 | ) |
|                                            |       | 1,711,930              |       | 218,253 | ** ** |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Net  Income**                                 |       | $                      | 2,567,859  |   | $ | 357,612 |   |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
| Basic and  diluted earnings per share           |       | $                      | 0.81       |   | $ | 0.11 |   |
| ** **                                      | ** ** | ** **             | ** ** | ** ** | ** ** |
| Weighted  average number of shares outstanding: | ** ** | ** **             | ** ** | ** ** | ** ** |
| Basic                                           |       | 3,178,847              |       | 3,161,322 |   |
| Diluted                                         |       | 3,182,953              |       | 3,187,743 |   |

 

The accompanying notes are an integral part ofthese statements.

 

4

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PAULSONCAPITAL CORP. AND SUBSIDIARYCONSOLIDATED STATEMENT OFSHAREHOLDERS’ EQUITYFor the year ended December 31, 2004and the three month period ended March 31, 2005

 
| ** **                                                                 | ** ** | **Common Stock** | ** ** | **Retained  Earnings** | ** ** |
|----------------------------------------------------------------------------|------------|------------------|------------|------------------------|------------|
| ** **                                                                 | ** ** | **Shares**       | ** ** | **Amount**             | ** ** | ** ** |
|                                                                       |       |             |       |                   |       |   |   |
| Balance at December 31,  2003                                         |       | 3,124,811        |       | $                      | 1,173,045  |   | $ | 28,421,863 |   |
|                                                                       |       |             |       |                   |       |   |   |
| Stock  options exercised and income tax benefit from stock option exercise |       | 78,500           |       | 577,518                |       | — |   |
|                                                                       |       |             |       |                   |       |   |   |
| Redemption  of common stock                                                |       | (13,011          | )          | (4,739                 | )          | (86,825 | ) |
|                                                                       |       |             |       |                   |       |   |   |
| Net income  for the year                                                   |       | —           |       | —                 |       | 3,489,600 |   |
|                                                                       |       |             |       |                   |       |   |   |
| Balance at December 31,  2004                                         |       | 3,190,300        |       | 1,745,824              |       | 31,824,638 |   |
|                                                                       |       |             |       |                   |       |   |   |
| Redemption  of common stock (unaudited)                                    |       | (15,710          | )          | (5,819                 | )          | (122,834 | ) |
|                                                                       |       |             |       |                   |       |   |   |
| Dividends to  common shareholders (unaudited)                              |       | —           |       | —                 |       | (476,564 | ) |
|                                                                       |       |             |       |                   |       |   |   |
| Net earnings  for the year to date (unaudited)                             |       | —           |       | —                 |       | 2,567,859 |   |
|                                                                       |       |             |       |                   |       |   |   |
| Balance at March 31,  2005 (unaudited)                                |       | 3,174,590        |       | $                      | 1,740,005  |   | $ | 33,793,099 |   |

 

The accompanying notes are an integral part ofthis statement.

 

5

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PAULSON CAPITAL CORP. ANDSUBSIDIARYCONSOLIDATED STATEMENTS OFCASH FLOWS(unaudited)

 
| ** **                                                                                      | ** ** | **Three months ended** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                      | ** ** | **03/31/05**           | ** ** | **03/31/04** | ** ** |
|                                                                                            |       |                   |       |   |   |
| Cash flows  from operating activities                                                           |       |                   |       |   |   |
| Net earnings                                                                                    |       | $                      | 2,567,859  |   | $ | 357,612 |   |
| Adjustments  to reconcile net earnings to net cash provided by (used in) operating  activities: |       |                   |       |   |   |
| Receipt of  underwriter warrants                                                                |       | —                 |       | (2,858,966 | ) |
| Unrealized  (appreciation) depreciation/expiration of underwriter warrants                      |       | (1,584,000             | )          | 1,670,636 |   |
| Noncash  compensation associated with underwriter warrants                                      |       | —                 |       | 659,930 |   |
| Depreciation  and amortization                                                                  |       | 23,057                 |       | 30,865 |   |
| Deferred  income taxes                                                                          |       | 1,711,930              |       | (56,295 | ) |
| Change in  assets and liabilities                                                               |       |                   |       |   |   |
| Receivables                                                                                     |       | (255,717               | )          | 154,934 |   |
| Receivables  from/payable to clearing organization                                              |       | (589,956               | )          | (1,698,145 | ) |
| Trading and  investment securities                                                              |       | 611,834                |       | 2,043,999 |   |
| Prepaid and  deferred expenses                                                                  |       | 132,403                |       | 131,816 |   |
| Accounts  payable and accrued liabilities                                                       |       | (2,059,342             | )          | (765,504 | ) |
| Securities  sold, not yet purchased                                                             |       | 69,557                 |       | 139,730 |   |
| Income taxes  payable/receivable                                                                |       | —                 |       | 108,494 |   |
|                                                                                            |       |                   |       |   |   |
| Net cash  provided by (used in) operating activities                                            |       | 627,625                |       | (80,894 | ) |
|                                                                                            |       |                   |       |   |   |
| Cash flows  from investing activities                                                           |       |                   |       |   |   |
| Additions to  furniture and equipment                                                           |       | (17,988                | )          | (35,783 | ) |
|                                                                                            |       |                   |       |   |   |
| Cash flows  from financing activities                                                           |       |                   |       |   |   |
| Proceeds  from exercise of stock options and tax benefit from stock option exercise             |       | —                 |       | 446,843 |   |
| Dividends  paid to common shareholders                                                          |       | (476,564               | )          | (312,481 | ) |
| Payments to  retire common stock                                                                |       | (128,653               | )          | — |   |
|                                                                                            |       |                   |       |   |   |
| Net cash  provided by (used in) financing activities                                            |       | (605,217               | )          | 134,362 |   |
|                                                                                            |       |                   |       |   |   |
| NET INCREASE  IN CASH AND CASH EQUIVALENTS                                                      |       | 4,420                  |       | 17,685 |   |
|                                                                                            |       |                   |       |   |   |
| Cash and  cash equivalents at beginning of period                                               |       | 132,845                |       | 155,314 |   |
|                                                                                            |       |                   |       |   |   |
| Cash and  cash equivalents at end of period                                                     |       | $                      | 137,265    |   | $ | 172,999 |   |
|                                                                                            |       |                   |       |   |   |
| Cash paid  during the period for:                                                               |       |                   |       |   |   |
|                                                                                            |       |                   |       |   |   |
| Interest                                                                                        |       | $                      | —     |   | $ | — |   |
| Income taxes                                                                                    |       | $                      | 19,527     |   | $ | 5,162 |   |

 

The accompanying notes are an integral part ofthese statements.

 

6

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**PAULSONCAPITAL CORP. AND SUBSIDIARY**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS******(unaudited)

 

1.               Basisof Presentation

 

These financial statements are those of the Companyand its wholly owned subsidiary. In the opinion of management, the accompanyingunaudited consolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission and include alladjustments (consisting only of normal recurring adjustments) necessary topresent fairly the Company’s financial position as of March 31, 2005 andits results of operations and cash flows for the three months ended March 31,2005 and 2004. The nature of the Company’s business is such that the results ofany interim period are not necessarily indicative of results for a full fiscalyear. The accompanying unaudited financial statements and related notes shouldbe read in conjunction with the audited financial statements and Form 10-KSBof the Company for the fiscal year ended December 31, 2004.

 

2.               Dividend

 

On January 27, 2005, the Company announced theauthorization by the Board of Directors of a $0.15 special cash dividend toshareholders of record on February 10, 2005. The dividend was paid on March 3,2005.

 

3.               SecuritiesOwned

 

Gains and losses from the disposition of tradingsecurities are reflected as trading revenues in the income statement for theperiod. Gains and losses from the disposition of investment securities arereflected as investment revenues in the income statement for the period.

 

4.               Commitmentsand Contingencies

 

In March 2002, the Company’s wholly ownedsubsidiary, Paulson Investment Company (“PIC”), and one of its registeredrepresentatives, Marvin Cox, were named as defendants in a lawsuit filed byLouis Barinaga, a former PIC customer. Barinaga’s claims related to purchases of convertible notes of E.com,which were purchased directly from E.com. Claimant abated his lawsuit and refiled his claims before the NASD.  Subsequently, Barinaga amended hisarbitration statement of claim to include claims for breach of fiduciary duty,violations of federal and state securities laws, fraud and negligence relatingto transactions in stock of e.Digital. Barinaga’s amended statement of claim also named UBS PaineWebber, Inc.as a respondent.  Barinaga claimed thatCox, PIC and UBS PaineWebber, Inc.’s actions prevented him from realizingin excess of $12 million on sales of e.Digital stock.  Barinaga sought over $18 million plusinterest and fees on the e.Digital claims. The e.Digital stock in question was subject to an agreement entered intobetween Barinaga and UBS PaineWebber, Inc. An arbitration hearing was set to begin on January 24, 2005.  The claim of Barinaga relating to E.com noteswas settled prior to the start of the arbitration.  The remaining claim of Barinaga relating toe.Digital stock also was settled between PIC and Barinaga prior to the start ofthe arbitration.  The settlement has beenconsummated with Barinaga.  However, PIC’sinsurance carrier, after previously providing settlement authorization to PIC,has now withdrawn that authorization because of a dispute between Cox andBarinaga.  PIC believes that theinsurance carrier is obligated to provide the settlement authorization to whichit previously agreed.  PIC has filed suitagainst the insurance carrier and intends to pursue the insurance proceedsvigorously. As of December 31, 2004, the Company has recorded the totalamount of the settlement expense in its financial statements.

 

In October 2002, PIC was named as a defendant ina lawsuit filed by Special Situations Fund III, LP and Special SituationsCayman Fund, LP.  The lawsuit was filedin U.S. District Court for the District of New Jersey.  It asserts various federal securities lawclaims and common law fraud and negligence against numerous defendants,including PIC, arising out of two follow-on offerings of Suprema Specialties, Inc.  PIC participated in one of the two offerings,the August 25, 2000 follow-on offering of Suprema Specialties, Inc.,as a member of the underwriting syndicate, underwriting 75,000 shares intotal.  The stock was sold in the August 25,2000 offering at a price of $8.00 per share. Plaintiffs seek damages for the purchase of 399,151 shares of SupremaSpecialties, Inc. stock between August 25, 2000 and November 14,2001.  The federal district court has dismissedthe claims against PIC.  Plaintiffs haveappealed and the case currently is pending before the United States ThirdCircuit Court of Appeals.  PIC believesit has meritorious defenses and intends to defend this matter vigorously.

 

7

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On April 12, 2005, the NASD sent a letter to PIC’soutside counsel indicating that the NASD Department of Enforcement had made apreliminary determination to recommend that disciplinary action be broughtagainst PIC, and certain other PIC employees and former employees, forviolations of NASD Rules of Conduct 2110, for mutual fund market-timing,and 3010, for failure to supervise the firm’s mutual fund market-timingbusiness.  The NASD also has made asimilar preliminary determination with respect to PIC’s president, apparentlyfor failure to supervise as he did not participate in any of the tradesidentified by the NASD as rule violations. The NASD has proposed to resolve the action with PIC in return for apayment by PIC of $341,000 in restitution and $525,000 in fines.  The conduct at question relates to activitiesundertaken in August and September of 2003 by employees in PIC’s NewYork City office.  Paulson believes thatnone of the activities violated any state or federal laws or regulations.Accordingly, PIC believes it has meritorious defenses and intends to defendthis matter vigorously.  PIC is to file aresponse to the NASD’s preliminary determination on May 17, 2005.  If this matter is not settled, it willproceed to a hearing before the NASD, either in 2005 or 2006.

 

An adverse outcome in certain of the mattersdescribed above could have a material adverse effect on PIC or the Company. PICalso has been named in certain other legal proceedings and has received noticethat certain customers may commence legal proceedings against PIC. The Companyhas no additional legal proceedings other than through PIC. The Companybelieves, based upon information received to date and, where the Companybelieves it appropriate, discussions with legal counsel, that resolution ofthis additional pending or threatened litigation will have no material adverseeffect on the consolidated financial condition, results of operations, orbusiness of the Company.

 

5.               StockOptions

 

The Company has a stock-based employee compensationplan. As allowed under SFAS No. 123 “Accounting for Stock-BasedCompensation,” the Company continues to account for stock options for employeesunder APB No. 25, “Accounting for Stock Issued to Employees,” and has adoptedthe disclosure only requirements of SFAS No. 123. There were no stockoption grants in the three month periods ended March 31, 2005 or 2004. Accordingly,no pro forma income effect is shown.

 

6.               Earnings Per Share

 

The following table is a reconciliation ofthe numerators and denominators of the basic and diluted per share computationsfor each of the three months ended March 31, 2005 and March 31, 2004.

                

 
| ** **                                                                      | ** ** | **Income**      | ** ** | **Weighted  Average Shares** | ** ** | **Per Share  Amount** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------|------------|------------------------------|------------|-----------------------|------------|
| ** **                                                                      | ** ** | **(Numerator)** | ** ** | **(Denominator)**            | ** ** | ** **            | ** ** |
|                                                                            |       |            |       |                         |       |                  |       |
| Three Months  Ended March 31, 2005 Income available to common stockholders |       | $               | 2,567,859  |                         | 3,178,847  |                  | $          | 0.81 |   |
|                                                                            |       |            |       |                         |       |                  |       |
| Effect of  dilutive securities – options                                   |       | —          |       | 4,106                        |       |                  |       |
|                                                                            |       |            |       |                         |       |                  |       |
| Diluted  earnings per share                                                     |       | $               | 2,567,859  |                         | 3,182,953  |                  | $          | 0.81 |   |
|                                                                            |       |            |       |                         |       |                  |       |
| Three Months  Ended March 31, 2004 Income available to common stockholders |       | $               | 357,612    |                         | 3,161,322  |                  | $          | 0.11 |   |
|                                                                            |       |            |       |                         |       |                  |       |
| Effect of  dilutive securities – options                                   |       | —          |       | 26,421                       |       |                  |       |
|                                                                            |       |            |       |                         |       |                  |       |
| Diluted  earnings per share                                                     |       | $               | 357,612    |                         | 3,187,743  |                  | $          | 0.11 |   |

 

8

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS

 

**General**

 

FORWARD-LOOKINGSTATEMENTS

 

This report, including, without limitation, “Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” contains or incorporates both historical and “forward-looking”statements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. Words such as “anticipates”, “believes”, “expects”, “intends”, “future”and similar expressions identify forward-looking statements.  Any such forward-looking statements in thisreport reflect our current views with respect to future events and financialperformance and are subject to a variety of factors that could cause our actualresults to differ materially from historical results or from anticipatedresults expressed or implied by such forward-looking statements.  Because of such factors, we cannot assure youthat the results anticipated in this report will be realized.  As noted elsewhere in this report, variousaspects of our business are subject to extreme volatility often as a result offactors beyond our ability to anticipate or control.  In particular, factors, such as the conditionof the securities markets, which are in turn based on popular perceptions ofthe health of the economy generally, can be expected to affect the volume ofour business as well as the value of the securities maintained in our tradingand investment accounts.  Other factorsthat may affect our future financial condition or results of operations includethe following:

 

•                  Theperformance of companies whose securities we have underwritten or otherwisesold to our customers may affect our reputation with other potential syndicateand selling group members and institutional and other retail accounts and mayalso affect the amount of money in our customers’ portfolios available for thekinds of investments that we offer.

 

•                  Thevalue of our investment portfolio, including the value of securities without areadily ascertainable market value, that we have estimated for the purpose ofreporting on our financial condition and results of operations, may besignificantly and adversely affected by changes in the value of the companiesthemselves or of comparable companies whose stock values we use in estimatingthe value of our portfolio securities.

 

•                  Weare subject to a very high degree of regulation and are responsible forcompliance with applicable regulations by all of our personnel.  A significant regulatory infraction by us orany of our registered representatives could result in significant penalties,including the loss of our license to conduct securities business in one or morejurisdictions.

 

•                  Alternativesavailable to our customers to transact securities trades could affect ourability to continue to execute our brokerage customers’ transactions.

 

•                  Theloss of our Chairman, Chester Paulson, could have a material adverse impact onour business.

 

9

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**Overview**

 

Substantially all of our business consists ofthe securities brokerage and investment banking activities of our wholly ownedsubsidiary, Paulson Investment Company, Inc., or PIC.  PIC has operations in four principalcategories, all of them in the financial services industry.  These categories are:

 

•                  securitiesbrokerage activities for which PIC earns commission revenues;

•                  corporatefinance revenues consisting principally of underwriting discounts andunderwriter warrants;

•                  securitiestrading from which PIC records profit or loss, depending on trading results;and

•                  investmentincome resulting from earnings on, and increases or decreases in the value of,PIC’s investment portfolio.

 

Because we operate in the financial servicesindustry, our revenues and earnings are substantially affected by generalconditions in financial markets. In our securities brokerage and corporatefinance business, the amount of our revenues depends on levels of marketactivity requiring the services we provide. Our investment banking activity, which consists primarily of acting asthe managing underwriter of initial and follow-on public offerings for smallercompanies, is similarly affected by the strength of the market for new equityofferings, which has historically experienced substantial cyclicalfluctuation.  Although we attempt tomatch operating costs with activity levels, many of our expenses are eitherfixed or difficult to change on short notice. Accordingly, fluctuations in brokerage and investment banking revenuestend to result in sharper fluctuations, on a percentage basis, in net income orloss.

 

Our investment income or loss and, to alesser extent, our trading income or loss are affected by changes in marketvaluation of securities generally and, in particular, by changes in valuationof the equity securities of microcap companies in which our investments andtrading activities tend to be concentrated. Equity markets in general, and microcap equity markets in particular,have always experienced significant volatility and this volatility has, inrecent years, been extreme.  The resultsof this volatility on the value of our investment portfolio and securities heldin connection with our trading and investment activities include largequarterly fluctuations in income or loss and substantial increases or decreasesin our net worth as our securities holdings are marked to market. Thesecurities in the investment account are held for investment, not activelytraded, and not deemed part of operations in accordance with managementintentions.

 

A substantial portion of our investmentbanking business consists of acting as managing underwriter of initial andfollow-on public offerings for microcap companies.  As a part of our compensation for thisactivity, we typically receive warrants exercisable to purchase securitiesidentical to those that we offer and sell to the public.  Generally, the warrants are not exercisablefor the first year after the offering in which they are earned and arethereafter exercisable for four years, after which they expire.  The exercise price is typically 120% of theprice at which the securities are initially sold to the public. Accordingly,unless there is at least a 20% increase in the price of these securities atsome time more than one and less than five years after the offering, thewarrants will remain “under water” and will ultimately expire unexercised.

 

### **Critical Accounting Policies**

###  

The following discussion and analysis of ourfinancial condition and results of operations is based upon our consolidatedfinancial statements, which have been prepared in accordance with US GAAP.  In preparing our consolidated financial statements,we must make estimates and judgments that affect the reported amounts of assetsand liabilities, revenues and expenses, and related disclosure of contingentassets and liabilities at the date of our financial statements.  Actual results are likely to differ fromthese estimates under different assumptions and conditions.

 

The critical accounting policies describedbelow include those that reflect significant judgments and uncertainties, whichpotentially could produce materially different results under differentassumptions and conditions.  We believeour critical accounting policies are limited to those described below.

 

10

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*Use of Estimates.*We are required to estimate the value of securities that we hold at the date ofany financial statements and to include that value, and changes in such value,in those financial statements. Accordingly, the aggregate estimated value of securities, includingwarrants, as of the date of any balance sheet is recorded as an asset on thatbalance sheet.  When a new warrant isreceived as a result of our investment banking activity, its estimated value isincluded in corporate finance revenue on the date on which it is earned.  Subsequently, any change in estimated valueis recorded as investment income or loss. When a warrant is exercised, the book value is adjusted to reflect thevalue of the securities purchased, net of the exercise price, and theadjustment amount is recorded as income or loss for the relevant period. If thewarrant expires unexercised, the book value is adjusted to zero and thedecrease is recorded as a loss in the relevant period.

 

We estimate the value of our underwriterwarrants using the Black-Scholes Option Pricing Model. The Black-Scholes modelrequires us to use historical price data combined with certain assumptions andjudgments as inputs for the model.  Themost influential factor in this model is price volatility, which we calculatefor each issuing company’s warrants based on the respective company’s ownhistorical stock price movements as well as an index of historical prices forcomparable companies.  When we initiallyreceive a new underwriter warrant from an initial public offering, itscalculated volatility factor is entirely based on the volatility of an index ofcomparable companies, since there is no price history for a new publicly tradedcompany.  As each underwriter warrantapproaches its expiration date, its volatility factor is derived primarily fromthe historical prices of its underlying common stock.  We cannot assure you that we will ultimatelybe able to exercise any of our warrants in a way that will realize the valuethat we attribute to them in our financial statements based on this model. Asof March 31, 2005, our underwriter warrants, based on the Black-ScholesOption Pricing Model, were valued at approximately $11.0 million, up from theestimated value of $9.4 million as of December 31, 2004.

 

In addition to our underwriter warrants, wehold other securities, some of which have very limited liquidity and some ofwhich do not have a readily ascertainable market value.  We are required to carry these securities atestimated fair value.

 

As a result of the factors described above,our revenues and earnings are subject to substantial fluctuation from period toperiod based on circumstances, many of which are beyond our control.  An increase in financial market activitygenerally, and/or an increase in equity valuations generally, will normallyresult in increases in our revenues, earnings and net worth as our activitylevels and the value of our investment portfolio increase.  Conversely, a general market retrenchmentwill typically lead to decreased revenues, earnings and net worth as a resultboth of decreased activity and the need to adjust high investment portfoliovalues to lower levels.  Accordingly,results for any historical period are not necessarily indicative of similarresults for any future period.

 

**Results of Operations**

 

PIC’s revenues and operating results areinfluenced by fluctuations in the equity underwriting markets as well asgeneral economic and market conditions, particularly conditions in theover-the-counter market, where PIC’s investment account, trading inventorypositions and underwriter warrants are heavily concentrated.  Significant fluctuations can occur in PIC’srevenues and operating results from one period to another.  PIC’s results of operations depend upon manyfactors, such as the number of companies that are seeking public financing, thequality and financial condition of those companies, market conditions ingeneral, the performance of previous PIC underwritings and interest in certainindustries by investors.  As a result,revenues and income derived from these activities may vary significantly fromyear to year.  In the tables below, “CorporateFinance” revenues are a function of total proceeds from offerings done duringthe period, compensation per offering, and the fair value of underwriterwarrants received.  “Investment Income”includes realized gains from the exercise of underwriter warrants, gains andlosses from the sales of investment securities, and unrealized gains and lossesfrom underwriter warrants and other investment securities.  “Trading Income” is the net gain or loss fromtrading positions before commissions paid to the representatives in the tradingdepartment.

 

11

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**Summary ofChanges in Major Categoriesof Revenues and Expense**

 

**ThreeMonths Ended March 31, 2005 v. March 31, 2004**

 
| ** **                        | ** ** | ** **              | ** ** | ** **         | ** ** | **Three Months Ended**  | ** ** |
|-----------------------------------|------------|-------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **Increase/(Decrease)** | ** ** | **Percent Change** | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
| Revenues:                         |       |                    |       |               |       |                    |       |   |   |
| Sales Commissions                 |       | $                       | (1,096,574 | )                  | (20.9      | )                       | $          | 4,141,057 |   | $ | 5,237,631 |   |
| Corporate Finance                 |       | (3,889,503              | )          | (97.0              | )          | 119,985                 |       | 4,009,488 |   |
| Investment Income                 |       | 7,153,774               |       | N/A                |       | 5,152,499               |       | (2,001,275 | ) |
| Trading Income                    |       | 257,809                 |       | 58.0               |       | 702,004                 |       | 444,195 |   |
| Other                             |       | 13,147                  |       | 230.1              |       | 18,860                  |       | 5,713 |   |
|                              |       |                    |       |               |       |                    |       |   |   |
| Total                             |       | 2,438,653               |       | 31.7               |       | 10,134,405              |       | 7,695,752 |   |
|                              |       |                    |       |               |       |                    |       |   |   |
| Expenses:                         |       |                    |       |               |       |                    |       |   |   |
| Commissions and Salaries          |       | (1,408,745              | )          | (24.9              | )          | 4,254,004               |       | 5,662,749 |   |
| Underwriting Expenses             |       | (252,458                | )          | N/A                |       | —                  |       | 252,458 |   |
| Rent, Telephone & Quotes |       | 2,955                   |       | 1.0                |       | 306,498                 |       | 303,543 |   |
| Other                             |       | 392,977                 |       | 43.6               |       | 1,294,114               |       | 901,137 |   |
|                              |       |                    |       |               |       |                    |       |   |   |
| Total                             |       | (1,265,271              | )          | (17.8              | )          | 5,854,616               |       | 7,119,887 |   |
|                              |       |                    |       |               |       |                    |       |   |   |
| Pretax Income                     |       | $                       | 3,703,924  |               | 643.2      |                    | $          | 4,279,789 |   | $ | 575,865 |   |

 

**Three Months Ended March 31, 2005 vs.Three Months Ended March 31, 2004**

 

**Revenues**

 

Total revenues for the first quarter of 2005increased $2.4 million. As shown in the table above, sales commissions—whichare commissions generated from the retail stock brokerage business—decreased$1.1 million as a result of lackluster market performance and the lack of commissionsassociated with corporate finance transactions. Sales commissions are alsodirectly related to the number of brokers engaged by the Company. The Companyhad 92 stock brokers as of March 31, 2005, as compared to 110 as of March 31,2004, a decrease of 16 percent.

 

Corporate finance revenue decreased $3.9million, from the first quarter of 2004 to the first quarter of 2005. TheCompany completed two corporate finance transactions in the first quarter of2004, with no comparable transactions in the first quarter of 2005. During thefirst quarter of 2005, the Company had a small private placement andparticipated in a few small transactions in which another investment bankingfirm was the lead underwriter resulting in approximately $120,000 in corporatefinance revenues.

 

Investment income increased $7.2 million inthe first quarter of 2005 as compared to the first quarter of 2004. Investmentincome can be volatile period-over-period based on the fact it is driven by themarket value or fair value of the securities and underwriter warrants held bythe Company. Investment income consists of (1) the unrealized and realizedappreciation and depreciation of securities held based on quoted market prices,(2) the unrealized appreciation and depreciation of securities held thatare not readily marketable, based upon the Company’s estimate of their fairvalue, (3) the realized gain and loss on the sale of securities that arenot readily marketable, and (4) the unrealized appreciation anddepreciation of underwriter warrants held by the Company.  The appreciation of underwriter warrantstotaled $1.6 million during the first quarter of 2005, as compared to thedepreciation and expiration of underwriter warrants of $1.7 million for thefirst quarter of 2004. In addition, the Company’s holdings of Charles &Colvard, Ltd., in its investment account increased in value over $1.5 millionduring the first quarter of 2005. The remainder of the total investment incomeis the result of the unrealized and realized depreciation of securities withquoted market prices. There was no change in the estimated fair value ofsecurities not readily marketable during the first quarter of 2005.

 

12

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Trading income increased $257,809 in thefirst quarter or 2005 as compared to the first quarter of 2004, as a result ofexceptional performance from a couple of the Company’s market makingsecurities. PIC’s focus is on very small capitalization issues, especiallythose tied to PIC’s corporate finance clients.

 

**Expenses**

 

Total expenses decreased by $1.3 million inthe first quarter of 2005 from the first quarter of 2004, a decrease of 17.8percent. The largest dollar decrease was in commissions and salaries with adecrease of $1.4 million in the first quarter of 2005 as compared to the firstquarter of 2004. Commission expense decreased approximately $626,000 as aresult of lower sales commissions paid on lower commission revenue.Administrative salary expense decreased approximately $783,000 primarily as aresult of first quarter 2004 compensation expense associated with underwriterwarrants and no corresponding expense in the first quarter of 2005.Underwriting expenses decreased by approximately $252,000 from the firstquarter of 2004 as a result of no corporate finance transactions in firstquarter 2005 compared to two corporate finance transactions in the firstquarter of 2004. Other expenses increased approximately $392,977, or 43.6percent. The increase in other expenses is primarily attributable to anapproximate $179,000 increase in professional fees associated with legalactivity related to settlements and fees associated with Sarbanes-Oxleycompliance and an estimated $250,000 in settlement expense. The remainder ofthe net increase in other expenses consists of increases and decreases invarious expense categories.

 

**Income**

 

The Company had pretax income of $4.3 million(42.2 percent of revenues) in the first quarter of 2005 compared to pretaxincome of approximately $576,000 (7.5 percent of revenues) in the first quarterof 2004. Profitability, as a percentage of revenues, generally increases when asignificant portion of the Company’s revenues is derived from investment incomebecause fewer expenses are associated with investment income relative to theother revenue sources. Independent of the change in the Black-Scholes value ofthe underwriter warrants and the income and expense associated with the receiptof the underwriter warrants, the Company would have had pretax income totaling$2.7 million for the first quarter of 2005, compared to pretax income ofapproximately $48,000 for the first quarter of 2004. Because of theBlack-Scholes value of underwriter warrants and other factors, significantfluctuations often occur in PIC’s revenues and operating results from oneperiod to another.

 

**Liquidity and Capital Resources**

 

The majority of PIC’sassets are cash and assets readily convertible to cash.  PIC’s securities inventory is stated atmarket value for the securities that are readily marketable and estimated fairvalue for the securities that are not readily marketable. The liquidity of themarket for many of PIC’s securities holdings, however, varies with trends inthe stock market.  Since many of thesecurities held by PIC are thinly traded, and PIC is in many cases a primarymarket maker in the issues held, any significant sales of PIC’s positions couldadversely affect the liquidity of the issues held.  In general, falling prices in OTC securities(which make up most of PIC’s trading positions) lead to decreased liquidity inthe market for these issues, while rising prices in OTC issues tend to increasethe liquidity of the market for these securities.

 

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PIC borrows money from National Financial Services,its clearing firm, in the ordinary course of its business, pursuant to anunderstanding under which the clearing firm agrees to finance PIC’s tradingaccounts.  As of March 31, 2005, nonet loans were outstanding pursuant to this arrangement.  PIC and the Company are generally able tomeet their compensation and other obligations out of current liquid assets.

 

Another source of capital to PIC and the Company hasbeen the underwriter warrants issued to PIC in connection with its corporatefinance activities and the sale of the underlying securities. There is nopublic market for the underwriter warrants. The securities receivable uponexercise of the underwriter warrants cannot be resold unless the issuer hasregistered these securities with the SEC and with the states in which thesecurities will be sold unless exemptions are available.  Any delay or other problem in theregistration of these securities would have an adverse impact upon PIC’sability to obtain funds from the exercise of the underwriter warrants and theresale of the underlying securities.  At March 31,2005, PIC owned 14 underwriter warrants, all but three of which were thenexercisable; five had an exercise price below the March 31, 2005 marketprice of the securities receivable upon exercise.  The intrinsic value of these five warrants is$2.4 million. There is little or no direct relationship between the intrinsicvalue of PIC’s underwriter warrants at the end of any given period and the fairvalue calculated using the Black-Scholes pricing model, as described more fullyin Critical Accounting Policies above. The prices of these securities areinfluenced by general movements in the prices of OTC securities as well as thesuccess of the issuers of the underwriter warrants.  The prices of the securities underlying theunderwriter warrants are very volatile, and substantial fluctuations in theCompany’s estimate of their value can be expected in the future.

 

In the three months ended March 31,2005, approximately $628,000 of net cash was provided by operatingactivities.  The major adjustments toreconcile this result to the Company’s net income include the following itemsthat are positive adjustments to or provided cash to operating activities: anincrease in deferred income taxes of $1.7 million and a decrease in trading andinvestment securities of approximately $612,000. The following items arenegative adjustments to or a use of cash for operating activities: appreciationof underwriter warrants totaling $1.6 million and a decrease in accountspayable and accrued liabilities of $2.1 million. Net cash used in investingactivities in the first three months of 2005 was for additions to furniture andequipment of approximately $18,000. Net cash used in financing activities inthe first three months of 2005 approximated $605,000, resulting fromapproximately $477,000 in dividends paid to common shareholders andapproximately $129,000 in payments to retire common stock.

 

As a securities broker-dealer, PIC is required by SECregulations to meet certain liquidity and capital standards.  We believe we are in compliance with thesestandards.

 

At March 31, 2005, the Company had no materialcommitments for capital expenditures.

 

In general, the primary sources of PIC’s, andtherefore the Company’s, liquidity include PIC’s trading positions, borrowingson those positions and profits realized upon the exercise of underwriterwarrants. All of these sources depend in large part on the trend in the generalmarkets for OTC securities.  Rising OTCprice levels will tend to increase the value and liquidity of PIC’s tradingpositions, the amount that can be borrowed from National Financial Servicesbased upon those positions, and the value of PIC’s underwriter warrants.  The Company believes its liquidity is sufficientto meet its needs for both the short and long term horizon. The Company’sliquidity could be affected by protracted unfavorable market conditions.

 

**Inflation**

 

Because PIC’s assets are primarily liquid, they arenot significantly affected by inflation. The rate of inflation affects PIC’s expenses, such as employeecompensation, office leasing and communications costs.  These costs may not readily be recoverable inthe price of services offered by the Company. To the extent inflation results in rising interest rates and has otheradverse effects in the securities markets and the value of securities held ininventory or PIC’s investment account, it may adversely affect the Company’sfinancial position and results of operations.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK

 

Market risk is the risk of loss to the Company resulting primarily fromchanges in equity prices and to a significantly lesser extent, interest ratesand foreign currency rates.  The Companyhas exposure to market risk through the market-making and trading operations ofPIC, its broker-dealer subsidiary.  Inconnection with these activities, PIC maintains inventories in order to ensureavailability of securities and to facilitate client transactions as well astrading for its own proprietary equity investment account.  PIC was a market-maker for 46 equitysecurities from 40 different issuers and no tax exempt and taxable debtobligations at March 31, 2005.

 
| ** **                                                        | ** ** | **March 31, 2005**                 | ** ** | **December 31, 2004**                 | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                        | ** ** | **Trading and  investment  securities** | ** ** | **Securities sold but  not yet purchased** | ** ** | **Trading and  investment  securities** | ** ** | **Securities sold but  not yet purchased** | ** ** |
| Marketable equity and other securities at  fair value             |       | $                                       | 23,114,013 |                                       | $          | 119,701 |   | $ | 23,583,728 |   | $ | 50,144 |   |
|                                                              |       |                                    |       |                                       |       |   |   |   |   |
| Marketable debt securities                                        |       | 78,124                                  |       | —                                     |       | 220,243 |   | — |   |
|                                                              |       |                                    |       |                                       |       |   |   |   |   |
| Total marketable equity, debt and other  securities at fair value |       | $                                       | 23,192,137 |                                       | $          | 119,701 |   | $ | 23,803,971 |   | $ | 50,144 |   |

 

Changes in the value of PIC’s trading inventories and its proprietaryinvestment accounts result primarily from fluctuations in equity prices as wellas changes in interest rates and general market and economic conditions.  PIC’s primary method of controlling risk inits trading inventories and investment accounts is through daily monitoring anduse of position limits.  PIC’s tradinginventories consist primarily of Nasdaq equity securities: as of March 31,2005, the equity trading inventory limit was $2 million and the fixed incomelimit was $500,000.  PIC’s tradingactivities were within these limits at March 31, 2005.  Position limits in trading inventory accountsare monitored on a daily basis as are limit exceptions.  Debt obligation trading inventories arerelatively small, since, for the most part, these securities are purchased onlyupon orders from customers.  Consolidated positions and exposure reports are prepared and reviewedmonthly by the Senior Vice President of Trading.  Trading also monitors inventory levels andtrading results on a monthly basis, with particular focus on positionconcentration, liquidity and volatility. Trading prepares summary results every month to record each position atfair market value, which can require adjustments for lack of liquidity, highconcentration or other reasons.

 

Equity Price Risk

 

PIC is exposed to significant equity price risk as a result of itscustomer transactions and market-making activity in equity securities and itsconcentrations in a limited number of equities, many of which are related toits investment banking projects.  PIC’sbroker-dealer activities are client-driven, with the objective of meeting itsclients’ needs while earning a trading profit to compensate for the riskassociated with carrying inventories in equities, many of which are volatile,and some of which are illiquid, micro and small cap securities.  PIC attempts to reduce the risk of lossinherent in this activity by monitoring these securities positions continuouslythroughout each day. The average aggregate inventory held in PIC’s proprietaryinvestment account during the quarter ended March 31, 2005 wasapproximately $18.6 million. Prices of the marketable equities held in theseaccounts are readily available and monitored on a continuous basis.

 

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Interest Rate Risk

 

 PIC has very little directexposure to interest rate risk.  Arelatively minor amount of PIC’s trading inventory consists of debtobligations, and any of these positions PIC might have occasionally are in itstrading inventory for only a very short time. However, to the extent that interest rate fluctuations affect generalmarket conditions and cause investors to shift away from or more heavily intoequity investing, interest rates can have an effect on the value of PIC’sequity positions.

 

Foreign Currency Risk

 

PIC does not deal in securities denominated in foreign currencies andonly trades foreign equities upon receipt of an order from customers, so itdoes not have any significant exposure to foreign currency risk in its tradinginventory or investment accounts.

 

ITEM4.  CONTROLS AND PROCEDURES

 

(a)           Our management, with the participation of ourPresident and Chief Financial Officer, conducted an evaluation of ourdisclosure controls and procedures, as such terms are defined under Rules 13a-15(e) and15d-15(e) promulgated under the Securities Exchange Act of 1934, asamended, as of the end of the period covered by this report. Based on theirevaluation, our President and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective.

 

(b)           For the quarter ended March 31, 2005,there have been no changes in our internal control over financial reportingthat have materially affected or are reasonably likely to materially affect ourinternal control over financial reporting.

 

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**PART II****OTHER INFORMATION**

 

Item1. Legal Proceedings.

 

See Note 4 to Condensed Consolidated FinancialStatements in Part I.

 

Item 2. Unregistered Sales of Equity Securities andUse of Proceeds.

 

**Small Business Issuer Purchasesof Equity Securities**

 
| **Period**           | ** ** | **Paulson Capital  Corp. Total  Number of Shares  Purchased** | ** ** | **Paulson Capital Corp.  Average Price Paid  per Share** | ** ** | **Total Number of  Shares  Purchased as Part of  Publicly Announced  Plans  or Programs** | ** ** | **Maximum Number of  Shares that May Yet  Be Purchased Under  The Plans or  Programs** | ** ** |
|----------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| 01/01/05 to 01/31/05 |       | 13,210                                                        |       | $                                                        | 8.22       |                                                                                           | 13,210     |                                                                                        | 209,024    |   |
| 02/01/05 to 02/28/05 |       | None                                                          |       | N/A                                                      |       | N/A                                                                                            |       | 209,024                                                                                     |       |
| 03/01/05 to 03/31/05 |       | 2,500                                                         |       | $                                                        | 8.05       |                                                                                           | 2,500      |                                                                                        | 206,524    |   |
| Total                |       | 15,710                                                        |       | $                                                        | 8.19       |                                                                                           | 15,710     |                                                                                        | 206,524    |   |

 

All of the shares purchased were open-markettransactions as part of a corporate plan for stock repurchase. The stockrepurchase plan, approved by the board of directors on September 17, 2001,authorizes the repurchase of up to 300,000 shares. There is no expiration dateon the stock repurchase plan.

 

Item3. Defaults upon Senior Securities.

 

None

 

Item4. Submission of Matters to a Vote of Security Holders.

 

None

 

Item5. Other Information.

 

None

 

Item 6. Exhibits

 
| 31.1   |   | Certification of Principal Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith  electronically.                                                     |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                              |
| 31.2   |   | Certification of Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. Filed herewith electronically.                                                          |
|   |   |                                                                                                                                                                                              |
| 32.1   |   | Certification of Principal  Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith  electronically. |
|   |   |                                                                                                                                                                                              |
| 32.2   |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith  electronically.     |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                    | PAULSON CAPITAL CORP. |
|-------------------------|-----------------------|
|                    |                  |   |
|                    |                  |   |
| Date: May 17, 2005 | By:                   | /s/ CHESTER L.F. PAULSON |
|                    |                  | Chester L.F. Paulson |
|                    |                  | President  Principal Executive Officer |
|                    |                  |   |
| Date: May 17, 2005 | By:                   | /s/ CAROL RICE |
|                    |                  | Carol Rice |
|                    |                  | Chief Financial Officer  Principal Financial Officer |

 

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