**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

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** **

**FORM 10-Q**

 

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**(Mark One)**

** **

**x****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934**

** **

**For thequarterly period ended September 30, 2007**

** **

**OR**

** **

**o****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from     to       **

** **

**Commissionfile number:****0-18188**

 

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**PAULSONCAPITAL CORP.**

(Exact name ofregistrant as specified in its charter)

 

| **Oregon**                                                        | ** ** | **93-0589534**                        |
|-------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of   incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                              |       |                                  |
| **811 SW  Naito Parkway, Portland, Oregon**                       | ** ** | **97204**                             |
| (Address of  principal executive offices)                         |       | (Zip Code)                            |

 

Registrant’stelephone number, including area code: **503-243-6000**

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x   No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer o   Accelerated filer o   Non-accelerated filer x

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

| **Common stock, no par value** | ** ** | **6,077,150**                      |
|----------------------------------------------------|------------|------------------------------------|
| (Class)                                            |       | (Outstanding at  November 9, 2007) |

 

 

 

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**PAULSONCAPITAL CORP. AND SUBSIDIARY**

**FORM 10-Q**

**INDEX**

 

 
|                           |                                                                                                          | **Page** |
|--------------------------------|---------------------------------------------------------------------------------------------------------------|----------|
| PART I - FINANCIAL INFORMATION |                                                                                                          |
|                           |                                                                                                          |     |
| Item 1.                        | Financial Statements                                                                                          |     |
|                           |                                                                                                          |     |
|                           | Consolidated Balance Sheets -  September 30, 2007 and December 31, 2006 (unaudited)                           | 2        |
|                           |                                                                                                          |     |
|                           | Consolidated Statements of  Operations - Three and Nine Months Ended September 30, 2007 and 2006  (unaudited) | 3        |
|                           |                                                                                                          |     |
|                           | Consolidated Statements of  Cash Flows - Nine Months Ended September 30, 2007 and 2006 (unaudited)            | 4        |
|                           |                                                                                                          |     |
|                           | Notes to Consolidated  Financial Statements (unaudited)                                                       | 5        |
|                           |                                                                                                          |     |
| Item 2.                        | Management’s Discussion and Analysis  of Financial Condition and Results of Operations                   | 8        |
|                           |                                                                                                          |     |
| Item 3.                        | Quantitative  and Qualitative Disclosures About Market Risk                                                   | 14       |
|                           |                                                                                                          |     |
| Item 4.                        | Controls and Procedures                                                                                       | 14       |
|                           |                                                                                                          |     |
| PART  II - OTHER INFORMATION   |                                                                                                          |
|                           |                                                                                                          |     |
| Item 1.                        | Legal Proceedings                                                                                             | 14       |
|                           |                                                                                                          |     |
| Item 1A.                       | Risk Factors                                                                                                  | 14       |
|                           |                                                                                                          |     |
| Item 2.                        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                  | 15       |
|                           |                                                                                                          |     |
| Item 6.                        | Exhibits                                                                                                      | 15       |
|                           |                                                                                                          |     |
| Signatures                     | 16                                                                                                            |

 

1

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**PART I - FINANCIAL INFORMATION**

** **

**Item 1.  Financial Statements**

** **

**PaulsonCapital Corp. and Subsidiary**

**Consolidated Balance Sheets**

 
| ** **                                                                                                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                         | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| ** **                                                                                                         | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                         | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                                                                         |       | $                      | 12,959     |                  | $          | 219,341 |   |
| Receivable from  clearing organization                                                                             |       | 10,229,352             |       | 7,748,968             |       |
| Notes and other  receivables                                                                                       |       | 1,546,724              |       | 1,651,002             |       |
| Income taxes  receivable                                                                                           |       | —                 |       | 304,695               |       |
| Trading  securities, at market value                                                                               |       | 4,756,474              |       | 2,363,824             |       |
| Investment  securities, at market or estimated fair value                                                          |       | 14,385,274             |       | 19,542,643            |       |
| Underwriter  warrants, at estimated fair value                                                                     |       | 13,682,000             |       | 5,650,000             |       |
| Prepaid and  deferred expenses                                                                                     |       | 743,812                |       | 711,827               |       |
| Furniture and  equipment, at cost, net of accumulated depreciation and amortization of  $833,353 and $747,759      |       | 219,901                |       | 271,766               |       |
| Total Assets                                                                                                       |       | $                      | 45,576,496 |                  | $          | 38,464,066 |   |
|                                                                                                               |       |                   |       |                  |       |
| **Liabilities  and Shareholders’ Equity**                                                                     | ** ** | ** **             | ** ** | ** **            | ** ** |
| Accounts payable  and accrued liabilities                                                                          |       | $                      | 911,136    |                  | $          | 570,823 |   |
| Payable to  clearing organization                                                                                  |       | 326,611                |       | —                |       |
| Compensation,  employee benefits and payroll taxes                                                                 |       | 886,358                |       | 954,981               |       |
| Securities sold,  not yet purchased, at market value                                                               |       | 250,148                |       | 17,244                |       |
| Income taxes  payable - current                                                                                    |       | 1,107,299              |       | —                |       |
| Income taxes  payable - long-term                                                                                  |       | 218,000                |       | —                |       |
| Deferred revenue                                                                                                   |       | 400,000                |       | 475,000               |       |
| Deferred income  taxes                                                                                             |       | 2,929,950              |       | 1,670,000             |       |
| Total  Liabilities                                                                                                 |       | 7,029,502              |       | 3,688,048             |       |
|                                                                                                               |       |                   |       |                  |       |
| **Commitments  and Contingencies**                                                                                 |       | —                 |       | —                |       |
|                                                                                                               |       |                   |       |                  |       |
| **Shareholders’  Equity**                                                                                     |       |                   |       |                  |       |
| Preferred stock,  no par value; 500,000 shares authorized; none issued                                             |       | —                 |       | —                |       |
| Common stock, no  par value; 20,000,000 shares authorized; shares issued and outstanding: 6,077,150  and 6,179,011 |       | 1,969,919              |       | 1,920,293             |       |
| Retained  earnings                                                                                                 |       | 36,577,075             |       | 32,855,725            |       |
| Total  Shareholders’ Equity                                                                                   |       | 38,546,994             |       | 34,776,018            |       |
|                                                                                                               |       |                   |       |                  |       |
| Total  Liabilities and Shareholders’ Equity                                                                   |       | $                      | 45,576,496 |                  | $          | 38,464,066 |   |

 

See accompanyingNotes to Consolidated Financial Statements

 

2

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**PaulsonCapital Corp. and Subsidiary**

**Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                              | ** ** | **For the Three Months Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                                                   | ** ** | **2006**                                                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                              | ** ** | ** **                                                                 | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues**                            |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Commissions                             |       | $                                                                          | 4,090,223  |                                                                      | $          | 3,156,476 |   | $ | 12,810,762 |   | $ | 11,335,870 |   |
| Corporate  finance                      |       | 21,230                                                                     |       | 1,414,620                                                                 |       | 4,467,037 |   | 4,646,808 |   |
| Investment  income (loss)               |       | 1,672,110                                                                  |       | (3,170,780                                                                | )          | 4,227,946 |   | (8,259,811 | ) |
| Trading income  (loss)                  |       | 58,344                                                                     |       | (1,595,605                                                                | )          | 1,769,107 |   | (1,814,315 | ) |
| Interest and  dividends                 |       | 48,988                                                                     |       | 15,203                                                                    |       | 119,987 |   | 41,367 |   |
| Other                                   |       | 60,121                                                                     |       | (680                                                                      | )          | 232,196 |   | 934 |   |
|                                    |       | 5,951,016                                                                  |       | (180,766                                                                  | )          | 23,627,035 |   | 5,950,853 |   |
|                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| **Expenses**                            |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Commissions and  salaries               |       | 3,669,120                                                                  |       | 3,314,795                                                                 |       | 12,452,211 |   | 11,759,338 |   |
| Underwriting  expenses                  |       | 14,529                                                                     |       | 188,579                                                                   |       | 323,993 |   | 356,025 |   |
| Rent, telephone  and quotation services |       | 313,066                                                                    |       | 307,326                                                                   |       | 930,246 |   | 893,592 |   |
| Professional  fees                      |       | 151,828                                                                    |       | 155,774                                                                   |       | 497,001 |   | 606,151 |   |
| Bad debt expense                        |       | 27,192                                                                     |       | 2,643                                                                     |       | 182,041 |   | 4,261 |   |
| Travel and  entertainment               |       | 107,505                                                                    |       | 45,722                                                                    |       | 184,689 |   | 299,061 |   |
| Advertising and  promotion              |       | 92,820                                                                     |       | 47,542                                                                    |       | 177,546 |   | 133,245 |   |
| Settlement  expense                     |       | 190,000                                                                    |       | 185,461                                                                   |       | 499,717 |   | 190,211 |   |
| Depreciation and  amortization          |       | 29,267                                                                     |       | 29,032                                                                    |       | 85,594 |   | 73,509 |   |
| Other                                   |       | 349,184                                                                    |       | 365,012                                                                   |       | 1,125,043 |   | 1,064,427 |   |
|                                    |       | 4,944,511                                                                  |       | 4,641,886                                                                 |       | 16,458,081 |   | 15,379,820 |   |
|                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Income (loss)  before income taxes      |       | 1,006,505                                                                  |       | (4,822,652                                                                | )          | 7,168,954 |   | (9,428,967 | ) |
|                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Income tax  expense (benefit):          |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Current                                 |       | 714,423                                                                    |       | (580,503                                                                  | )          | 1,461,025 |   | 1,534,136 |   |
| Deferred                                |       | (377,823                                                                   | )          | (1,025,833                                                                | )          | 1,259,950 |   | (4,941,458 | ) |
|                                    |       | 336,600                                                                    |       | (1,606,336                                                                | )          | 2,720,975 |   | (3,407,322 | ) |
|                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Net income  (loss)                      |       | $                                                                          | 669,905    |                                                                      | $          | (3,216,316 | ) | $ | 4,447,979 |   | $ | (6,021,645 | ) |
|                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Basic net income  (loss) per share      |       | $                                                                          | 0.11       |                                                                      | $          | (0.52 | ) | $ | 0.73 |   | $ | (0.97 | ) |
|                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Diluted net  income (loss) per share    |       | $                                                                          | 0.11       |                                                                      | $          | (0.52 | ) | $ | 0.72 |   | $ | (0.97 | ) |
|                                    |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Shares used in  per share calculations: |       |                                                                       |       |                                                                      |       |   |   |   |   |
| Basic                                   |       | 6,087,341                                                                  |       | 6,167,621                                                                 |       | 6,129,613 |   | 6,180,099 |   |
| Diluted                                 |       | 6,097,321                                                                  |       | 6,167,621                                                                 |       | 6,139,665 |   | 6,180,099 |   |

 

See accompanyingNotes to Consolidated Financial Statements

 

3

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**PaulsonCapital Corp. and Subsidiary**

**Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                                       | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2007**                                                                  | ** ** | **2006** | ** ** |
| ** **                                                                                       | ** ** | ** **                                                                | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities:**                                                       |       |                                                                      |       |   |   |
| Net income  (loss)                                                                               |       | $                                                                         | 4,447,979  |   | $ | (6,021,645 | ) |
| Adjustments to  reconcile net income (loss) to net cash flows provided by operating  activities: |       |                                                                      |       |   |   |
| Receipt of  underwriter warrants                                                                 |       | (3,052,009                                                                | )          | (2,771,247 | ) |
| Unrealized  (appreciation) depreciation/expiration of underwriter warrants                       |       | (5,668,719                                                                | )          | 3,609,357 |   |
| Non-cash  compensation associated with underwriter warrants                                      |       | 688,728                                                                   |       | 891,890 |   |
| Depreciation and  amortization                                                                   |       | 85,594                                                                    |       | 73,509 |   |
| Deferred income  taxes                                                                           |       | 1,259,950                                                                 |       | (4,941,458 | ) |
| Loss on asset  disposition                                                                       |       | —                                                                    |       | 7,613 |   |
| Recognition of  deferred revenue                                                                 |       | (75,000                                                                   | )          | 500,000 |   |
| Change in assets  and liabilities:                                                               |       |                                                                      |       |   |   |
| Receivables  from/payable to clearing organization                                               |       | (2,153,773                                                                | )          | 4,814,978 |   |
| Notes and other  receivables                                                                     |       | 104,278                                                                   |       | (876,868 | ) |
| Income taxes  receivable                                                                         |       | 304,695                                                                   |       | — |   |
| Trading and  investment securities                                                               |       | 2,764,719                                                                 |       | 10,177,197 |   |
| Prepaid and  deferred expenses                                                                   |       | (31,985                                                                   | )          | 181,213 |   |
| Accounts  payable, accrued liabilities and compensation payables                                 |       | 271,690                                                                   |       | (1,912,930 | ) |
| Dividends  payable                                                                               |       | —                                                                    |       | (929,317 | ) |
| Securities sold,  not yet purchased                                                              |       | 232,904                                                                   |       | (20,078 | ) |
| Income taxes  payable - current                                                                  |       | 1,107,299                                                                 |       | (2,481,415 | ) |
| Income taxes  payable - long-term                                                                |       | 128,000                                                                   |       | — |   |
| Net cash  provided by operating activities                                                       |       | 414,350                                                                   |       | 300,799 |   |
|                                                                                             |       |                                                                      |       |   |   |
| **Cash  flows from investing activities:**                                                       |       |                                                                      |       |   |   |
| Additions to  furniture and equipment                                                            |       | (33,729                                                                   | )          | (111,123 | ) |
|                                                                                             |       |                                                                      |       |   |   |
| **Cash  flows from financing activities:**                                                       |       |                                                                      |       |   |   |
| Proceeds from  stock option exercise                                                             |       | 77,110                                                                    |       | 21,030 |   |
| Payments to  retire common stock                                                                 |       | (664,113                                                                  | )          | (221,214 | ) |
| Net cash used in  financing activities                                                           |       | (587,003                                                                  | )          | (200,184 | ) |
|                                                                                             |       |                                                                      |       |   |   |
| Decrease in cash  and cash equivalents                                                           |       | (206,382                                                                  | )          | (10,508 | ) |
|                                                                                             |       |                                                                      |       |   |   |
| **Cash  and cash equivalents:**                                                                  |       |                                                                      |       |   |   |
| Beginning of  period                                                                             |       | 219,341                                                                   |       | 129,549 |   |
|                                                                                             |       |                                                                      |       |   |   |
| End of period                                                                                    |       | $                                                                         | 12,959     |   | $ | 119,041 |   |
|                                                                                             |       |                                                                      |       |   |   |
| **Supplemental  cash flow information:**                                                         |       |                                                                      |       |   |   |
| Cash paid during  the period for income taxes                                                    |       | $                                                                         | 415,236    |   | $ | 4,015,551 |   |

 

**Supplemental non-cash information:**

As of January 1, 2007, we adopted FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes.” As a result, we recorded anadjustment of $90,000 from retained earnings to income taxes payable -long-term. 

 

See accompanying Notes toConsolidated Financial Statements.

 

4

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**PAULSONCAPITAL CORP. AND SUBSIDIARY**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1.  Basis ofPresentation**

 

The financial informationfor Paulson Capital Corp. and its wholly-owned subsidiary, Paulson InvestmentCompany, included herein as of September 30, 2007 and December 31, 2006 and forthe three and nine-month periods ended September 30, 2007 and 2006 isunaudited; however, such information reflects all adjustments, consisting onlyof normal recurring adjustments, which, in the opinion of management, arenecessary for a fair presentation of the financial position, results ofoperations and cash flows for the interim periods. The financial information asof December 31, 2006 is derived from our Annual Report on Form 10-K for theyear ended December 31, 2006. The interim consolidated financial statementsshould be read in conjunction with the consolidated financial statements andthe notes thereto included in our Annual Report on Form 10-K for the year endedDecember 31, 2006. The results of operations for the interim periods presentedare not necessarily indicative of the results to be expected for the full year.

 

**Note 2.  Commitments andContingencies**

 

In December 2005, we received notice of possible claims being assertedagainst us by two individuals who invested in Wood River Partners LP (“WoodRiver”). The investors purchased their interests in Wood River directly fromWood River. One of the individuals was a customer of ours. Along with hisbrother, they have indicated that they paid $1,050,000 for their interests inWood River. The individuals have indicated that they believe they may haveclaims against us under the Oregon Securities Law for rescission, interest andattorney fees. On November 6, 2007, the case was settled and the individualsreleased all their claims.

# ** **

On March 30, 2007, Dow Jones & Company (“Dow Jones”)sent us a demand for payment of $122,640, allegedly due as a termination feepursuant to a Newswires Subscription Agreement, dated February 1, 2005. DowJones claims that we did not timely terminate prior to the date the NewswiresSubscription Agreement purports to automatically renew. We rejected Dow Jones’demand. We believe the automatic renewal provision is unenforceable and that,even if it is enforceable, Dow Jones’ increase of our 2007 subscription ratesprovided us with the right to terminate the Newswires Subscription Agreement.We believe we have meritorious defenses, and, if Dow Jones initiates legalaction, we are prepared immediately to file a motion for summary judgment.Thereafter, if necessary, we intend to defend the matter vigorously.

 

On August 3, 2007, the Robert G. and Lois A. MadsenFamily Trust retained legal counsel and requested to inspect account documentsrelating to the handling of the account. Although no demand has been made, thetrustee of the Trust previously indicated that he believed the Trust hadsuffered losses in excess of $210,000, allegedly due to unsuitable andunauthorized trading. We do not know whether any claim will be asserted. Webelieve we have meritorious defenses, and, if legal action is initiated, weintend to defend the matter vigorously.

 

An adverse outcome in certainof the matters described above could have a material adverse effect on ourconsolidated financial position or results of operations. We also have beennamed in or threatened with certain other legal proceedings. We believe, basedupon information received to date and, where we believe it appropriate,discussions with legal counsel, that resolution of additional pending orthreatened litigation will not have a material adverse effect on ourconsolidated financial condition, results of operations, or business.

 

5

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**Note 3.  Stock-BasedCompensation**

 

During the first ninemonths of 2007, 22,000 options were exercised at a weighted average exerciseprice of $3.51 per share. At September 30, 2007, we had 95,000 optionsoutstanding at a weighted average exercise price of $4.20 per share.

 

**Note 4.  Earnings Per Share**

 

Following is areconciliation of our shares used for our basic net income (loss) per share andour diluted net income (loss) per share: 

 
| ** **                                                                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Shares used for  basic income (loss) per share                                                                        |       | 6,087,341                                            |       | 6,167,621                                           |       | 6,129,613 |   | 6,180,099 |   |
| Effect of  dilutive stock options                                                                                     |       | 9,980                                                |       | —                                              |       | 10,052 |   | — |   |
| Shares used for  diluted net income (loss) per share                                                                  |       | 6,097,321                                            |       | 6,167,621                                           |       | 6,139,665 |   | 6,180,099 |   |
|                                                                                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Stock options  not included in diluted net income (loss) per share because their effect  would have been antidilutive |       | —                                               |       | 187,000                                             |       | — |   | 187,000 |   |

 

**Note 5.Repurchases of Common Stock**

 

In the first nine months of 2007, we repurchased a total of 123,861shares of our common stock for a weighted average price of $5.36 per share,which totaled approximately $664,000. The amount paid above the original issueprice, which totaled $637,000, was offset against retained earnings. The plan to repurchase up to a total of600,000 shares of our common stock was approved by our Board of Directors inSeptember 2001 and does not have an expiration date. As of September 30, 2007,191,876 shares remained available for purchase.

 

**Note 6.Adoption of Interpretation No. 48**

 

In July 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,”which defines the threshold for recognizing the benefits of tax returnpositions in the financial statements as “more-likely-than-not” to be sustainedby the taxing authority. FIN 48 applies to all tax positions accounted forunder SFAS No. 109, “Accounting for Income Taxes.” FIN 48 is effective as ofthe beginning of the first fiscal year beginning after December 15, 2006.

 

We adopted theprovisions of FIN 48 on January 1, 2007. In accordance with paragraph 19, weelected to treat interest and penalties accrued on unrecognized tax benefits astax expense within our financial statements. Upon adoption, we adjusted our financial statements to reflect those taxpositions that are more-likely-than-not to be sustained as of the adoptiondate. The adjustment totaled $90,000 and was recorded directly as a reductionto our retained earnings balance on January 1, 2007.

 

On initial adoption ofFIN 48, we had unrecognized tax benefits of $174,000, all of which would havean impact on the effective tax rate if recognized. Interest and penaltiesaccrued on unrecognized tax benefits were $16,000. We do not believe it isreasonably possible that the total amount of unrecognized benefits willsignificantly increase or decrease within the next 12 months.

 

During the three and nine-monthperiods ended September 30, 2007, unrecognized tax benefits increased $3,000and $2,000, respectively, as a result of tax positions taken in prior periodsand $4,000 and $26,000, respectively, as a result of tax positions taken duringthe current periods.

 

The tax years whichremain open to examination in the U.S., our only major taxing jurisdiction,were 2003 and 2006. An IRS examination for the 2004 and 2005 tax years wascompleted during the second quarter of 2007 resulting in a benefit of $154,000that was received in July 2007. There were no decreases in prior 

 

6

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unrecognized taxbenefits resulting from settlements with taxing authorities or the lapse ofapplicable statutes of limitation.

 

**Note 7.Settlement of Legal Claims**

 

In May 2007, we paid$210,000 in connection with a previously settled legal claim. Of this amount,$190,000 was accrued as a component of accounts payable and accrued liabilitieson our balance sheet as of December 31, 2006, and the full amount was accruedas of March 31, 2007. We received $120,000 in insurance recovery on this claim,which was recorded as other income in the second quarter of 2007. We receivedan additional $22,000 in insurance recovery in the third quarter of 2007.

 

In June 2007, we paid$60,000 in connection with a legal claim. Of this amount, $50,000 was accruedas a component of accounts payable and accrued liabilities on our balance sheetas of March 31, 2007. In the third quarter of 2007, we received a total of$55,000 in insurance recovery, of which $17,000 offset settlement expense and$38,000 offset legal expense.

 

We settled anoutstanding legal claim in July 2007. We paid $220,000 in connection with thissettlement in the fourth quarter of 2007. The full amount was accrued as acomponent of accounts payable and accrued liabilities on our balance sheet asof June 30, 2007. We do not expect insurance recovery on this claim.

 

See also Note 9.Subsequent Events.

 

**Note 8.Reclassifications**

 

Certain amounts in the prior period financial statements have beenreclassified to conform to the current period presentation.

 

**Note 9.Subsequent Events**

 

***UnderwriterWarrants***

 

As a result of a changein regulations regarding deferred compensation under Section 409A of theInternal Revenue Code, underwriter warrants received after January 1, 2005 andheld by employees and independent contractors are considered non-qualifieddeferred compensation. On October 17, 2007, in order to avoid adverse taxconsequences, all affected employees and contractors waived their rights totheir underwriter warrants in return for payment of their pro rata share of thegain when we exercise the warrants and sell the corresponding stock.

 

***Settlementof Legal Matter***

 

In November 2007, we settleda legal matter for $187,500, which will be paid in the fourth quarter of 2007.The $187,500 was reflected as a component of settlement expense in the thirdquarter of 2007.

 

7

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**Item 2  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Forward Looking Statements andRisk Factors**

 

This report, including,without limitation, Item 2. “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” containsor incorporates both historical and “forward-looking” statements within themeaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended. Words suchas “anticipates,” “believes,” “expects,” “intends,” “future” and similarexpressions identify forward-looking statements. Any such forward-lookingstatements in this report reflect our current views with respect to futureevents and financial performance and are subject to a variety of factors thatcould cause our actual results to differ materially from historical results orfrom anticipated results expressed or implied by such forward-lookingstatements. Because of such factors, we cannot assure you that the resultsanticipated in this report will be realized. As noted elsewhere in this report,various aspects of our business are subject to extreme volatility often as aresult of factors beyond our ability to anticipate or control. In particular,factors, such as the condition of the securities markets, which are in turnbased on popular perceptions of the health of the economy generally, can beexpected to affect the volume of our business as well as the value of thesecurities maintained in our trading and investment accounts. Otherfactors that may affect our future financial condition or results of operationsinclude the following:

 

•                 Aspects of our business arevolatile and affected by factors beyond our control.

•                 Our ability to attract andretain customers may be affected by our reputation.

•                 We are subject to extensiveregulation that could result in investigations, fines or other penalties.

•                 We face intense competitionin our industry.

•                 Our future success dependson retaining existing management and hiring and assimilating new key employees,and our inability to attract or retain key personnel would materially harm ourbusiness and results of operations.

•                 We are subject to an increased risk of legalproceedings, which may result in significant losses to us that we cannot recover.Claimants in these proceedings may be customers, employees, or regulatoryagencies, among others, seeking damages for mistakes, errors, negligence oracts of fraud by our employees.

•                 As a public company, we aresubject to complex legal and accounting requirements that require us to incursubstantial expense and expose us to risk of non-compliance.

•                 Our directors control approximately 60percent of our common stock and may have interests differing from those ofother stockholders.

 

**Overview**

 

Substantially all of ourbusiness consists of the securities brokerage and corporate finance activitiesof our wholly-owned subsidiary, Paulson Investment Company, Inc., whichhas operations in four principal categories, all of them in the financialservices industry. These categories are:

 

•                 securitiesbrokerage activities for which we earn commission revenues;

•                 corporatefinance revenues consisting principally of underwriting discounts andunderwriter warrants;

•                 securitiestrading from which we record profit or loss, depending on trading results; and

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

 

Because we operate in thefinancial services industry, our revenues and earnings are substantiallyaffected by general conditions in financial markets. In our securitiesbrokerage business, the amount of our revenues depends on levels of marketactivity requiring the services we provide. Our corporate finance activity,which consists of acting as the managing underwriter of initial and follow-onpublic offerings, private investments in public equity (“PIPEs”) and privateplacements for smaller companies, is similarly affected by the strength of themarket for new equity offerings, which has historically experienced substantialcyclical fluctuation. Although we attempt to match operating costs withactivity levels, many of our expenses are either fixed or difficult to changeon short notice. Accordingly, fluctuations in brokerage 

 

8

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and corporate financerevenues tend to result in sharper fluctuations, on a percentage basis, in netincome or loss.

 

Our investment income orloss and, to a lesser extent, our trading income or loss is affected by changesin market valuation of securities generally and, in particular, by changes invaluation of the equity securities of microcap companies in which ourinvestments and trading activities tend to be concentrated. Equity markets ingeneral, and microcap equity markets in particular, have always experiencedsignificant volatility and this volatility has, in recent years, been extreme.The result of this volatility on the value of our investment portfolio andsecurities held in connection with our trading and investment activitiesinclude large quarterly fluctuations in income or loss from these operationsand substantial increases or decreases in our net worth as our securitiesholdings are marked to market.

 

A substantial portion ofour corporate finance business consists of acting as managing underwriter ofinitial and follow-on public offerings for microcap and smallcap companies. Asa part of our compensation for these activities, we typically receivewarrants exercisable to purchase securities similar to those that we offer andsell to the public. The warrants generally have a five-year expiration date andvest immediately. The warrants are generally subject to a restricted period ofsix months to one-year during which we cannot exercise. The exercise price istypically 120% of the price at which the securities were initially sold to thepublic. Accordingly, unless there is at least a 20% increase in the price ofthese securities at some time more than six months and less than five yearsafter the offering, the warrants will remain “under water” and will ultimatelyexpire unexercised. We also receive warrants in connection with PIPEs, whichhave varying terms and conditions.

 

**Critical Accounting Policies andUse of Estimates**

 

With the exception of theadoption of FIN 48 as described in Note 6 of Notes to Consolidated FinancialStatements, we reaffirm the critical accounting policies and estimates asreported in our Annual Report on Form 10-K for the year ended December 31,2006, which was filed with the Securities and Exchange Commission on April 2,2007.

 

**Resultsof Operations**

 

Our revenues andoperating results are influenced by fluctuations in the equity markets as wellas general economic and market conditions, particularly conditions in theover-the-counter market, where our investment and trading positions and theunderlying stock for the underwriter warrants are heavily concentrated.Significant fluctuations can occur in our revenues and operating results fromone period to another. Our results of operations depend upon many factors, suchas the number of companies that are seeking financing, the quality andfinancial condition of those companies, market conditions in general, theperformance of our previous underwritings and interest in certain industries byinvestors. As a result, revenues and income derived from these activities mayvary significantly from year to year. Our revenues include the following:

 

•                 Commissions,which represent amounts earned from our retail securities brokerage activities;

•                 Corporatefinance revenues, which are a function of total proceeds from offerings doneduring the period, compensation per offering and the fair value of underwriterwarrants received;

•                 Investmentincome (loss), which includes (i) the unrealized appreciation and depreciationof securities held based on quoted market prices, (ii) the unrealizedappreciation and depreciation of securities held that are not readilymarketable, based upon our estimate of their fair value, (iii) realizedgains and losses on the exercise of underwriter warrants and the sale ofsecurities with quoted market prices and securities that are not readilymarketable, and (iv) the unrealized appreciation and depreciation ofunderwriter warrants held; and

•                 Tradingincome (loss), which is the gain or loss from trading positions beforecommissions paid to the representatives in the trading department.

 

9

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The following tables setforth the changes in our operating results in the three and nine-month periodsended September 30, 2007 compared to the three and nine-month periods endedSeptember 30, 2006 (dollars in thousands):

 
| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | **%   Increase** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------|------------|--------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2007**                                             | ** ** | **2006**     | ** ** | **(Decrease)**        | ** ** | **(Decrease)** | ** ** |
| Revenues:                               | ** ** | ** **                                           | ** ** | ** **   | ** ** | ** **            | ** ** | ** ** | ** ** |
| Commissions                             |       | $                                                    | 4,090      |         | $          | 3,157                 |       | $ | 933 |   | 29.6 | % |
| Corporate  finance                      |       | 21                                                   |       | 1,415        |       | (1,394                | )          | (98.5 | ) |
| Investment  income (loss)               |       | 1,672                                                |       | (3,171       | )          | 4,843                 |       |   | * |
| Trading income  (loss)                  |       | 59                                                   |       | (1,596       | )          | 1,655                 |       |   | * |
| Interest and  dividends                 |       | 49                                                   |       | 15           |       | 34                    |       | 226.7 |   |
| Other                                   |       | 60                                                   |       | (1           | )          | 61                    |       |   | * |
| Total revenues  (loss)                  |       | 5,951                                                |       | (181         | )          | 6,132                 |       |   | * |
| Expenses:                               |       |                                                 |       |         |       |                  |       |   |   |
| Commissions and  salaries               |       | 3,669                                                |       | 3,315        |       | 354                   |       | 10.7 |   |
| Underwriting expenses                   |       | 15                                                   |       | 189          |       | (174                  | )          | (92.1 | ) |
| Rent, telephone  and quotation services |       | 313                                                  |       | 307          |       | 6                     |       | 2.0 |   |
| Professional  fees                      |       | 152                                                  |       | 156          |       | (4                    | )          | (2.6 | ) |
| Bad debt expense                        |       | 27                                                   |       | 3            |       | 24                    |       |   | * |
| Travel and  entertainment               |       | 107                                                  |       | 46           |       | 61                    |       | 132.6 |   |
| Advertising and  promotion              |       | 93                                                   |       | 47           |       | 46                    |       | 97.9 |   |
| Settlement  expense                     |       | 190                                                  |       | 185          |       | 5                     |       | 2.7 |   |
| Depreciation and  amortization          |       | 29                                                   |       | 29           |       | —                |       | — |   |
| Other                                   |       | 349                                                  |       | 365          |       | (16                   | )          | (4.4 | ) |
| Total expenses                          |       | 4,944                                                |       | 4,642        |       | 302                   |       | 6.5 |   |
| Income (loss)  before income taxes      |       | $                                                    | 1,007      |         | $          | (4,823                | )          | $ | 5,830 |   |   | * |

 
| ** **                              | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | **%  Increase** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|-----------------|------------|
| ** **                              | ** ** | **2007**                                            | ** ** | **2006**     | ** ** | **(Decrease)**  | ** ** | **(Decrease)** | ** ** |
| Revenues:                               | ** ** | ** **                                          | ** ** | ** **   | ** ** | ** **      | ** ** | ** ** | ** ** |
| Commissions                             |       | $                                                   | 12,811     |         | $          | 11,336          |       | $ | 1,475 |   | 13.0 | % |
| Corporate  finance                      |       | 4,467                                               |       | 4,647        |       | (180            | )          | (3.9 | ) |
| Investment  income (loss)               |       | 4,228                                               |       | (8,260       | )          | 12,488          |       |   | * |
| Trading income  (loss)                  |       | 1,769                                               |       | (1,814       | )          | 3,583           |       |   | * |
| Interest and  dividends                 |       | 120                                                 |       | 41           |       | 79              |       | 192.7 |   |
| Other                                   |       | 232                                                 |       | 1            |       | 231             |       |   | * |
| Total revenues                          |       | 23,627                                              |       | 5,951        |       | 17,676          |       | 297.0 |   |
| Expenses:                               |       |                                                |       |         |       |            |       |   |   |
| Commissions and  salaries               |       | 12,452                                              |       | 11,759       |       | 693             |       | 5.9 |   |
| Underwriting  expenses                  |       | 324                                                 |       | 356          |       | (32             | )          | (9.0 | ) |
| Rent, telephone  and quotation services |       | 930                                                 |       | 894          |       | 36              |       | 4.0 |   |
| Professional  fees                      |       | 497                                                 |       | 606          |       | (109            | )          | (18.0 | ) |
| Bad debt expense                        |       | 182                                                 |       | 4            |       | 178             |       |   | * |
| Travel and  entertainment               |       | 185                                                 |       | 299          |       | (114            | )          | (38.1 | ) |
| Advertising and  promotion              |       | 177                                                 |       | 133          |       | 44              |       | 33.1 |   |
| Settlement  expense                     |       | 500                                                 |       | 190          |       | 310             |       | 163.2 |   |
| Depreciation and  amortization          |       | 86                                                  |       | 74           |       | 12              |       | 16.2 |   |
| Other                                   |       | 1,125                                               |       | 1,065        |       | 60              |       | 5.6 |   |
| Total expenses                          |       | 16,458                                              |       | 15,380       |       | 1,078           |       | 7.0 |   |
| Income (loss)  before income taxes      |       | $                                                   | 7,169      |         | $          | (9,429          | )          | $ | 16,598 |   |   | * |

 

----

*Not meaningful.

 

***Revenues***

 

Commissions increased$0.9 million and $1.5 million, respectively, in the three and nine-monthperiods ended September 30, 2007 compared to the same periods of 2006. Thetotal number of trades, including mutual fund trades, executed by our brokerswere 26,523 and 78,518 in the three and nine-month periods ended September 30,2007, respectively, compared to 22,918 and 76,601, respectively, in thecomparable periods of 2006. We had 83 brokers at September 30, 2007 compared to91 brokers at September 30, 2006.

 

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The decrease in thenumber of brokers at September 30, 2007 compared to September 30, 2006,reflected our strategy of having fewer, but higher producing brokers. Inaccordance with our plan to hire additional experienced brokers, we hired 15independent brokers in October and November 2007.

 

We did not complete anycorporate finance transactions during the third quarter of 2007.

 

Corporate finance incomein the nine-month period ended September 30, 2007 included underwritingdiscounts earned from the following:

 

•                  an initialpublic offering in the first quarter of 2007 in which we raised $9.8 millionfor Converted Organics Inc., aswell as the Black-Scholes value of the underwriter warrants received inconnection with that offering;

•                  an initialpublic offering in the second quarter of 2007 in which we raised $14.0 millionfor Vaughan Foods Inc., as well as the Black-Scholes value of the underwriterwarrants received in connection with that offering;

•                  one privateoffering during the second quarter of 2007 in which we raised $2.8 million forour client; and

•                  one privatetransaction completed during the first quarter of 2007 in which we raised $2.2million for our client.

 

Corporate finance incomeof $1.4 million in the three-month period ended September 30, 2006 primarilyrepresented underwriting discounts earned from one initial public offering inwhich we raised $16.5 million for AscentSolar Technologies, Inc., as well as the Black-Scholes value of theunderwriter warrants received in connection with that offering.

 

Corporate finance income of $4.6 million in the nine-month period endedSeptember 30, 2006 also included underwriting discounts earned from a publicoffering in which we raised $19.5 million for American Mold Guard, Inc.,as well as the Black-Scholes value of the underwriter warrants received inconnection with that offering. In addition we completed several privatetransactions, including PIPEs, during the three and nine-month periods endedSeptember 30, 2006.

 

Investment income (loss)included the following (in thousands):

 
| ** **                                                                                                                                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net unrealized  gain (loss) related to underwriter warrants                                                                                                                 |       | $                                                    | 1,037      |                                                | $          | (1,670 | ) | $ | 5,669 |   | $ | (3,609 | ) |
| Net unrealized  depreciation of securities held based on quoted market prices or, for  securities that are not readily marketable, our estimate of their fair market  value |       | (2,024                                               | )          | (1,743                                              | )          | (4,742 | ) | (11,343 | ) |
| Net realized  gains on the exercise of underwriter warrants and the sale of securities with  quoted market prices and securities that are not readily marketable            |       | 2,659                                                |       | 242                                                 |       | 3,301 |   | 6,692 |   |
|                                                                                                                                                                        |       | $                                                    | 1,672      |                                                | $          | (3,171 | ) | $ | 4,228 |   | $ | (8,260 | ) |

 

Investment income (loss)is volatile from period to period due to the fact that it is driven by themarket value or fair value of the securities and underwriter warrants held. Inaddition, the performance of the securities in which we have a concentrationcan significantly affect our investment income from period to period.

 

Trading income increased$1.7 million and $3.6 million, respectively, in the three and nine-month periodsended September 30, 2007 compared to the same periods of 2006. The income innine-month period ended September 30, 2007 was due to highly favorable resultsfor certain securities that we were holding in our trading inventories in thefirst two quarters of 2007. The 2006 results reflected lower volume and lowerprices for several of the securities we held in our trading inventories. Ourfocus is on very small 

 

11

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capitalization issues,especially those tied to our corporate finance clients. Trading income (loss)can be volatile from period to period because it is driven by the market valueof the securities in which we make a market.

 

***Expenses***

 

Total expenses increased$0.3 million and $1.1 million, respectively, in the three and nine-monthperiods ended September 30, 2007 compared to the same periods of 2006. Theincreases were primarily due to increases in commissions and salaries, bad debtexpense and settlement expense.

 

Commissions and salariesincreased $0.4 million and $0.7 million, respectively, in the three andnine-month periods ended September 30, 2007 compared to the same periods of2006, primarily due to higher commissions earned on higher commission revenue.Retail commissions as a percentage of retail sales was comparable between thecurrent year and prior year periods.

 

Bad debt expense isrecorded for specific amounts when they are determined by management to beuncollectible. Bad debt expense in the nine-month period ended September 30,2007 included a $104,000 write-off of a loan to a potential corporate financeclient.

 

Settlement expense of$0.2 million in the three-month period ended September 30, 2007 is related tothe settlement of a legal claim in November 2007 that was expensed during thethird quarter of 2007. The $0.5 million of settlement expense in the nine-monthperiod ended September 30, 2007 also included an accrual for $220,000 inconnection with a legal claim that settled in July 2007, as well as a net$63,000 adjustment for open claims and insurance recovery. We do not expectinsurance recovery on the claim that settled in November 2007 or on the onethat settled in July 2007. See also Notes 7 and 9 of Notes to ConsolidatedFinancial Statements.

 

Settlement expense in the2006 periods is primarily related to the settlement of one matter in the thirdquarter of 2006.

 

***Liquidity and Capital Resources***

* *

Our primary sources ofliquidity include our cash and cash equivalents and receivables from ourclearing organization, offset by payables to our clearing organization.

 

In addition, our sourcesof liquidity include our trading positions, investment positions, borrowings onthose positions and profits realized upon the sale of the securities underlyingunderwriter warrants exercised. The liquidity of the market for many of oursecurities holdings, however, varies with trends in the stock market. Sincemany of the securities we hold are thinly traded, and we are, in many cases, aprimary market maker in the issues held, any significant sales of our positionscould adversely affect the liquidity of the issues held. In general, fallingprices in NASDAQ securities (which make up most of our trading positions) leadto decreased liquidity in the market for these issues, while rising prices inNASDAQ issues tend to increase the liquidity of the market for thesesecurities.

 

We believe our liquidityis sufficient to meet our needs for both the short and long-term horizon.However, our liquidity could be negatively affected by protracted unfavorablemarket conditions.

 

As a securitiesbroker-dealer, we are required by SEC regulations to meet certain liquidity andcapital standards. We believe we were in compliance with these standards atSeptember 30, 2007.

 

Following the lapse ofrestrictions upon issuance, capital available from the sale of the underlyingsecurities of underwriter warrants exercised can fluctuate significantly fromperiod to period as the value of the underlying securities fluctuates withoverall market and individual company financial condition or performance. Thereis no public market for the underwriter warrants. The securities receivableupon exercise of the underwriter warrants cannot be resold unless the issuerhas registered these securities with the SEC and with the states in which thesecurities will be sold unless exemptions are available. Any 

 

12

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delay or other problem inthe registration of these securities would have an adverse impact upon ourability to obtain funds from the exercise of the underwriter warrants and theresale of the underlying securities.

 

At September 30, 2007, weowned 16 underwriter warrants from 15 issuers, all but three of which wereexercisable. Five of the warrants had an exercise price below the September 30,2007 market price of the securities receivable upon exercise. The intrinsicvalue of these warrants was $6.8 million at September 30, 2007. There is littleor no direct relationship between the intrinsic value of our underwriterwarrants at the end of any given period and the fair value calculated using theBlack-Scholes option pricing model. The prices of the securities underlying theunderwriter warrants are very volatile, and substantial fluctuations in ourestimate of their value can be expected in the future.

 

Cash provided byoperating activities in the first nine months of 2007 totaled $0.4 million,primarily due to our net income of $4.4 million being offset by net non-cashincome items of $6.8 million and changes in our operating assets andliabilities as discussed in more detail below.

 

Our net receivable fromour clearing organization increased $2.2 million to $9.9 million at September30, 2007 from $7.7 million at December 31, 2006, primarily due to the resultsof the activity in our trading and investment accounts, as well as the timingof general corporate expenditures.

 

Changes in our tradingand investment securities are dependent on the purchase and sale of securitiesduring the period, as well as changes in their fair market values during theperiod.

 

Underwriter warrantsincreased $8.0 million to $13.7 million at September 30, 2007 compared to $5.7million at December 31, 2006. A roll-forward of the value of the warrants wasas follows (in thousands):

 
| **Balance,  December 31, 2006**                                |   | $     | 5,650  |   |
|----------------------------------------------------------------|--------|-------|--------|--------|
| Fair value of  warrants received, net of employee compensation |   | 3,052 |   |
| Net unrealized  gain on value of warrants                      |   | 5,669 |   |
| Value of  warrants exercised                                   |   | (689  | )      |
| **Balance,  September 30, 2007**                               |   | $     | 13,682 |   |

 

Income taxes receivabledecreased $1.6 million to a payable of $1.3 million at September 30, 2007 froma receivable of $0.3 million at December 31, 2006, primarily due to receipt ofrefunds, adjustments made for the adoption of Interpretation No. 48 during thefirst quarter of 2007 and taxable income in the first nine months of 2007. Seealso Note 6 of Notes to Consolidated Financial Statements.

 

Accounts payable andaccrued liabilities increased $0.3 million to $0.9 million at September 30,2007 from $0.6 million at December 31, 2006, primarily due to a $0.2 millionaccrual for a legal settlement that occurred in November 2007, but was expensedin the third quarter of 2007.

 

Deferred revenue of $0.4million at September 30, 2007 related to amounts received from our clearingfirm based on the execution of a five-year agreement, and is being amortized atthe rate of $8,333 per month through September 2011.

 

Deferred income taxespayable increased $1.2 million to $2.9 million at September 30, 2007 from $1.7million at December 31, 2006, primarily due to a $3.3 million net unrealizedgain on securities and underwriter warrants during the first nine months of2007.

 

In September 2001, ourBoard of Directors approved a stock repurchase program pursuant to which we areauthorized to repurchase up to 600,000 shares of our common stock. During thefirst nine months of 2007, we repurchased a total of 123,861 shares for$664,000 and, at September 30, 2007, 191,876 shares remained available forrepurchase. This repurchase program does not have an expiration date.

 

13

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**Off-Balance Sheet Arrangements**

 

We do not have anyoff-balance sheet arrangements that have or are reasonably likely to have amaterial current or future effect on our financial condition, changes in financialcondition, revenues or expenses, results of operations, liquidity, capitalexpenditures or capital resources.

 

**New Accounting Pronouncements**

 

There has been no changein new accounting pronouncements since the filing of our Form 10-K for the yearended December 31, 2006, which was filed with the Securities and ExchangeCommission on April 2, 2007.

 

**Item 3.    Quantitative and Qualitative DisclosuresAbout Market Risk**

 

There have been nomaterial changes in our reported market risks or risk management policies sincethe filing of our Form 10-K for the year ended December 31, 2006, which wasfiled with the Securities and Exchange Commission on April 2, 2007.

 

**Item 4.    Controls and Procedures**

 

***DisclosureControls and Procedures***

 

Our management hasevaluated, under the supervision and with the participation of our Presidentand our Chief Financial Officer, the effectiveness of our disclosure controlsand procedures as of the end of the period covered by this report as defined inRule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934 (the“Exchange Act”). Based on that evaluation, our President and our ChiefFinancial Officer have concluded that, as of the end of the period covered bythis report, our disclosure controls and procedures are effective in ensuringthat information required to be disclosed in our Exchange Act reports is (1)recorded, processed, summarized and reported in a timely manner, and (2)accumulated and communicated to our management, including our President and ourChief Financial Officer, as appropriate, to allow timely decisions regardingrequired disclosure.

 

***Changesin Internal Control Over Financial Reporting***

 

There has been no changein our internal control over financial reporting that occurred during our lastfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1.**    **Legal Proceedings**

 

See Note 2 of Notes toConsolidated Financial Statements in Part I, Item 1.

 

**Item 1A.Risk Factors**

 

Our Annual Report on Form10-K for the year ended December 31, 2006 includes a detailed discussion of ourrisk factors. There have been no material changes from the risk factorspreviously disclosed in our Annual Report on Form 10-K. Accordingly, theinformation in this Form 10-Q should be read in conjunction with the riskfactors and information disclosed in our Annual Report on Form 10-K for theyear ended December 31, 2006, which was filed with the Securities and ExchangeCommission on April 2, 2007. See also Part I, Item 2 “Management’s Discussionand Analysis of Financial Condition and Results of Operations” in this reportunder the heading “Forward LookingStatements and Risk Factors.”

 

14

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**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

We repurchased thefollowing shares of our common stock during the third quarter of 2007:

 
| ** **                   | ** ** | **Total number  of shares  purchased** | ** ** | **Average  price paid  per share** | ** ** | **Total number of  shares purchased  as part of publicly  announced plan** | ** ** | **Maximum number  of shares that may  yet be purchased  under the plan** | ** ** |
|------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|
| July 1 to July  31           |       | —                                           |       | —                                  |       | 395,828                                                                                                       |       | 204,172                                                                                                          |       |
| August 1 to  August 31       |       | 296                                              |       | $                                       | 4.57       |                                                                                                          | 396,124    |                                                                                                             | 203,876    |   |
| September 1 to September  30 |       | 12,000                                           |       | 5.95                                    |       | 408,124                                                                                                       |       | 191,876                                                                                                          |       |
| Total                        |       | 12,296                                           |       | 5.92                                    |       | 408,124                                                                                                       |       | 191,876                                                                                                          |       |
|                              |            |                                                  |            |                                         |            |                                                                                                               |            |                                                                                                                  |            |  |

 

The plan to repurchase upto a total of 600,000 shares of our common stock was approved by our Board ofDirectors in September 2001 and does not have an expiration date.

 

**Item 6. Exhibits**

 

The following exhibitsare filed herewith and this list is intended to constitute the exhibit index:

 
| 31.1 |   | Certification  of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)  of the Securities Exchange Act of 1934.                            |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification  of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of  the Securities Exchange Act of 1934.                                |
| 32.1 |   | Certification  of Principal Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b)  of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350. |
| 32.2 |   | Certification  of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of  the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.     |

 

15

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| Date:  November  9, 2007 |   | PAULSON CAPITAL CORP.                  |
|------------------------------------|--------|----------------------------------------|
|                               |   |                                   |
|                               |   |                                   |
|                               |   | By                                     | /s/ CHESTER L. F.  PAULSON |   |
|                               |   | Chester L. F. Paulson                  |
|                               |   | President and Chief  Executive Officer |
|                               |   | Principal Executive Officer            |
|                               |   |                                   |
|                               |   |                                   |   |
|                               |   | By                                     |  /s/ KAREN L. JOHANNES |   |   |
|                               |   | Karen L. Johannes                      |
|                               |   | Chief Financial Officer                |
|                               |   | Principal Financial  Officer           |
|                                    |        |                                        |  |  |  |  |  |

 

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