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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

 
(Mark One)

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to                         

Commission file number: 000-18188
PAULSON CAPITAL CORP.
(Exact name of registrant 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’s telephone number, including area code:  503-243-6000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  [X]   No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]    No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [   ]    Accelerated filer [   ]
Non-accelerated filer [   ] (Do not check if a smaller reporting company)      Smaller reporting company [ X]
                                                                                                                                                           
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes [  ]  No [X]

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

Common stock, no par value
 
5,766,985
(Class)
 
(Outstanding at November 8, 2012)
 


 
 

 
 
PAULSON CAPITAL CORP. AND SUBSIDIARIES
FORM 10-Q
INDEX



PART I - FINANCIAL INFORMATION
Page
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets – September 30, 2012 and December 31, 2011 (unaudited)
2
     
 
Consolidated Statements of Operations - Three and Nine Month Periods Ended September 30, 2012 and 2011 (unaudited)
3
     
 
Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2012 and 2011 (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
15
     
Item 4.
Controls and Procedures
15
     
PART II - OTHER INFORMATION
 
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
15
     
Item 6.
Exhibits
16
     
Signatures
17
 
 
1

 
 
Paulson Capital Corp. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)

   
September 30,
2012
   
December 31,
2011
 
Assets
           
Cash
  $ 456,130     $ 292,002  
Receivable from clearing organization
    3,423,754       5,511,538  
Notes and other receivables, net of allowances for doubtful accounts of $509,997 and $387,853
    1,188,806       607,454  
Income taxes receivable
    45,085       10,835  
Trading and investment securities owned, at fair value
    7,470,867       7,708,868  
Underwriter warrants, at fair value
    1,344,000       1,395,000  
Prepaid and deferred expenses
    486,889       543,987  
Furniture and equipment, at cost, net of accumulated depreciation and amortization of $155,113 and $930,199
    10,050       48,755  
Total Assets
  $ 14,425,581     $ 16,118,439  
Liabilities and Shareholders' Equity
               
Accounts payable and accrued liabilities
  $ 404,294     $ 136,839  
Payable to clearing organization
    52,700       366,588  
Compensation, employee benefits and payroll taxes
    78,831       658,940  
Trading securities sold, not yet purchased, at fair value
    -       356,705  
Deferred revenue
    156,666       229,590  
Total Liabilities
    692,491       1,748,662  
Commitments and Contingencies
    -       -  
Shareholders' Equity
               
Preferred stock, no par value; 500,000 shares authorized; none issued
    -       -  
Common stock, no par value; 10,000,000 shares authorized; shares issued and outstanding: 5,766,985 and 5,767,985
    2,163,711       2,163,941  
Retained earnings
    11,569,379       12,205,836  
Total Shareholders' Equity
    13,733,090       14,369,777  
Total Liabilities and Shareholders' Equity
  $ 14,425,581     $ 16,118,439  
 
See accompanying Notes to Consolidated Financial Statements
 
 
2

 

Paulson Capital Corp. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
 
   
For the Three Months Ended
September 30,
 
For the Nine Months ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Revenues
                       
Commissions
  $ 67,963     $ 3,486,974     $ 3,724,988     $ 11,796,990  
Corporate finance
    22,199       77,984       69,663       255,672  
Investment income (loss)
    141,205       58,621       (438,416 )     (153,889 )
Trading income (loss)
    (132,220 )     (392,830 )     810,625       (1,529,357 )
Interest and dividends
    399,941       124,640       560,656       391,912  
Loss on asset disposition
    -       -       (702 )     -  
Gain (loss) on sale of assets
    (23,471 )     -       1,596,185       -  
Other
    44,753       45,140       139,738       136,602  
      520,370       3,400,529       6,462,737       10,897,930  
                                 
Expenses
                               
Commissions and salaries
    278,687       3,514,332       4,367,736       11,892,962  
Underwriting expenses
    4,500       1,051       42,214       11,701  
Rent and utilities
    39,885       143,655       254,892       429,364  
Communication and quotation services
    48,713       136,460       265,953       401,136  
Professional fees
    160,577       76,014       590,507       463,123  
Travel and entertainment
    3,897       30,129       49,724       91,542  
Advertising and promotion
    185       4,044       9,308       20,183  
Settlement expense
    73,917       (25,000 )     73,917       -  
Clearing expenses
    10,329       79,965       174,525       297,561  
Bad debt expense
    -       4,167       232,129       4,167  
Depreciation and amortization
    406       4,698       4,963       14,340  
Licenses, taxes and insurance
    170,249       109,973       436,593       349,162  
Other
    57,556       130,470       307,364       472,349  
      848,901       4,209,958       6,809,825       14,447,590  
                                 
Loss before income taxes
    (328,531 )     (809,429 )     (347,088 )     (3,549,660 )
                                 
Income tax expense (benefit):
                               
Current
    -       (147,075 )     -       (144,075 )
Deferred
    -       -       -       -  
      -       (147,075 )     -       (144,075 )
                                 
Net loss
  $ (328,531 )   $ (662,354 )   $ (347,088 )   $ (3,405,585 )
                                 
Basic and diluted net loss per share
    (0.06 )     (0.11 )     (0.06 )     (0.59 )
                                 
Shares used in basic and diluted per share calculations:
    5,766,985       5,767,985       5,767,288       5,768,271  
 
See accompanying Notes to Consolidated Financial Statements
 
 
3

 

Paulson Capital Corp. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
 
   
For the Nine Months Ended
September 30,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net loss
  $ (347,088 )   $ (3,405,585 )
Adjustments to reconcile net loss to net cash flows provided by operating activities:
               
Receipt of underwriter warrants
    -       (122,000 )
Unrealized depreciation/expiration of underwriter warrants
    51,000       176,000  
Receipt of securities from investing activities     (439,000 )     -  
Depreciation and amortization
    4,963       14,340  
Bad debt expense
    232,129       4,167  
Loss on asset disposition
    702       -  
Gain on sale of assets
    (1,596,185 )     -  
Change in assets and liabilities:
               
Receivables from/payable to clearing organization, net
    1,773,896       1,917,527  
Notes and other receivables
    (429,081 )     (204,518 )
Income taxes receivable
    (34,250 )     119,727  
Trading and investment securities owned
    677,001       2,153,494  
Prepaid and deferred expenses
    57,098       147,178  
Deferred revenue
    (72,924 )     (114,795 )
Accounts payable, accrued liabilities and compensation payables
    (312,654 )     (524,959 )
Trading securities sold, not yet purchased
    (356,705 )     (3,690 )
Income taxes payable - uncertain tax positions
    -       (144,075 )
Net cash provided by (used in) operating activities
    (791,098 )     12,811  
                 
Cash flows from investing activities:
               
Additions to furniture and equipment
    (800 )     (41,145 )
Proceeds from sale of fixed assets
    250       -  
Proceeds from sale of assets
    1,245,375       -  
Net cash  provided by (used in) investing activities
    1,244,825       (41,145 )
                 
Cash flows from financing activities:
               
Dividends paid to common shareholders
    (288,349 )     -  
Payments to retire common stock
    (1,250 )     (2,400 )
Net cash used in financing activities
    (289,599 )     (2,400 )
                 
Increase (decrease) in cash
    164,128       (30,734 )
                 
Cash:
               
Beginning of period
    292,002       375,649  
                 
End of period
  $ 456,130     $ 344,915  
                 
Supplemental cash flow information:
               
Cash (paid) received during the period for income taxes, net
  $ (26,000 )   $ 119,727  
Receivable from sale of assets
  $ 384,400     $ -  
 
See accompanying Notes to Consolidated Financial Statements
 
 
4

 

PAULSON CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1.  Basis of Presentation

The financial information for Paulson Capital Corp. and its wholly-owned subsidiaries, Paulson Investment Company and Paulson Capital Properties, LLC, included herein as of September 30, 2012 and December 31, 2011 and for the three- and nine-month periods ended September 30, 2012 and 2011 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2011 is derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2011. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

Note 2.  Earnings Per Share

The number of shares used for our basic net income (loss) per share and diluted net income (loss) per share was the same for both periods presented. For the three- and nine-month periods ended September 30, 2012, we had 218,500 anti-dilutive stock options outstanding. For the three- and nine-month periods ended September 30, 2011, we had 406,000 anti-dilutive stock options outstanding.

Note 3. Fair Value Measurements

Various inputs are used in determining the fair value of our assets and liabilities carried at fair value and are summarized into three broad categories:

 
·
Level 1 – unadjusted quoted prices in active markets for identical securities;
 
·
Level 2 – other significant observable inputs, including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.; and
 
·
Level 3 – significant unobservable inputs, including our own assumptions in determining fair value.

The inputs or methodology used for valuing securities is not necessarily an indication of the risk associated with investing in those securities.

Following are the disclosures related to our financial assets and liabilities (in thousands):

   
September 30, 2012
 
December 31, 2011
   
Fair Value
 
Input Level
 
Fair Value
 
Input Level
Trading and investment securities owned:
               
Corporate equities, marketable
  $ 3,338  
Level 1
  $ 3,763  
Level 1
Corporate equities, not readily marketable
    3,916  
Level 3
    3,857  
Level 3
Corporate options/warrants, marketable
    217  
Level 1
    89  
Level 1
Underwriter warrants
    1,344  
Level 3
    1,395  
Level 3
Trading securities sold, not yet purchased:
                   
Corporate equities, marketable
    -  
Level 1
    357  
Level 1
 
 
5

 
 
Following is a summary of activity related to our Level 3 financial assets and liabilities (in thousands):

   
 
 
Underwriter
Warrants
   
Not Readily
Marketable
 Investment
Securities
 
Balance, December 31, 2011
  $ 1,395     $ 3,857  
Fair value of underwriter warrants received included as a component of corporate finance income
    -       -  
Investment in privately-held company
    -       439  
Net unrealized gain (loss), included as a component of investment loss related to securities held
    (51 )     (380 )
Balance, September 30, 2012
  $ 1,344     $ 3,916  

   
 
 
Underwriter
Warrants
   
Not Readily
Marketable
 Investment
Securities
 
Balance, December 31, 2010
  $ 1,122     $ 2,945  
Fair value of underwriter warrants received included as a component of corporate finance income
    122       -  
Investment in privately-held company
    -       210  
Net unrealized gain (loss), included as a component of investment income (loss) related to securities held
    (176 )     42  
Balance, September 30, 2011
  $ 1,068     $ 3,197  

Valuation of Marketable Trading and Investment Securities Owned
The fair value of marketable trading and investment securities owned is determined based on quoted market prices. Securities traded on a national exchange are stated at the last reported sales price on the day of valuation; other securities traded in the over-the-counter market and listed securities for which no sale was reported on that date are stated at the last quoted bid price.

Valuation of Not Readily Marketable Investment Securities
Securities not readily marketable include investment securities (a) for which there is no market on a securities exchange or no independent publicly quoted market, (b) that cannot be publicly offered or sold unless registration has been effected under the Securities Act of 1933, or (c) that cannot be offered or sold because of other arrangements, restrictions or conditions applicable to the securities or to us. The fair value of not readily marketable securities is estimated by management using available information including the following: quoted market prices of similar securities (i.e., unrestricted shares of the same company); price of recent known trades of the same or similar securities; the cost of the security, if recently purchased, adjusted for changes in the financial condition of the issuer; all other information available from review of available documents related to the issuer or discussions with management of the issuer.

Valuation of Underwriter Warrants
We estimate the fair value of our underwriter warrants using the Black-Scholes Option Pricing Model. The warrants generally have a five-year expiration date and vest immediately. The warrants are generally subject to a restriction period of six months to one-year in which we cannot exercise the warrants. The Black-Scholes model requires us to use five inputs including: stock price, risk free rate, exercise price, time remaining on the warrant and price volatility. After stock price, the most influential factor in this model is price volatility, which we calculate for each company’s warrants based on each company’s own historical closing stock prices as well as an index of historical prices for comparable companies. When we initially receive a new underwriter warrant from an initial public offering, its calculated volatility factor is entirely based on the volatility of an index of comparable companies, since there is no price history for a new publicly traded company. As each underwriter warrant approaches its expiration date, its volatility factor is derived primarily from the historical prices of its underlying common stock. There is no assurance that we will ultimately be able to exercise any of our warrants in a way that will realize the value that we attribute to them in our financial statements based on this model.
 
 
6

 

Valuation of Trading Securities Sold, Not Yet Purchased
As a securities broker-dealer, we are engaged in various securities trading and brokerage activities as principal. In the normal course of business, we sometimes sell securities that we do not currently own and will therefore be obligated to purchase such securities at a future date. This obligation is recorded on our balance sheet at the fair value based on quoted market prices of the related securities and will result in a trading loss on the securities if the fair value increases and a trading gain if the fair value decreases between the balance sheet date and the purchase date.

There were no changes to our valuation methods or techniques during the nine-month periods of 2012 or 2011.

Note 4. Divestiture of Brokerage Operations

In the first quarter of 2012, the Company announced that it had reached an agreement with JHS Capital Advisors, LLC (JHS) to sell substantially all of its retail brokerage operations, including many of its branch and non-branch offices as well as registered personnel (employees and independent contractors), to JHS. The sale closed on April 16, 2012. In consideration of the sale, the Company is to be paid approximately $1,653,247 net of certain deductions for compensation expenses. $1,107,741 was received at closing on April 16, 2012, with the balance to be paid over three installments on July 16, 2012, October 15, 2012 and January 11, 2013. These installment payments to the Company are supported by a standby letter of credit issued in favor of the Company, and the total installment amounts of $568,306 were included within notes and other receivables. During the three- and nine-month periods ended September 30, 2012, the Company received $165,183 as the first installment payment. Subsequent to the end of the current nine-month period, the Company received the second installment payment of $153,666. The final purchase price is subject to recalculation after six months based upon the aggregate gross dealer commissions for the twelve month period ended at that time.

Note 5. Stockholders' Equity

Repurchase of Common Stock
In the first quarter of 2012, we repurchased 1,000 shares of our common stock for $1,250, or $1.25 per share, pursuant to our stock repurchase program previously approved by our Board of Directors. Following this repurchase, 68,011 shares remain available for repurchase. This repurchase plan does not have an expiration date.

In the first quarter of 2011, we repurchased 2,000 shares of our common stock for $2,400, or $1.20 per share.

Common Share Dividends
In March 2012, the Board of Directors approved a special cash dividend of $0.05 per common share payable April 16, 2012 to shareholders of record April 4, 2012. Dividends in the amount of $288,349 were paid to common shareholders in the second quarter.

Note 6. New Accounting Guidance

Management has reviewed the new accounting guidance and determined that there is not a material impact on our financial statements.

Note 7. Reclassifications

Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation.
 
 
7

 
 
Item 2.                      Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

This report, including, without limitation, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains or incorporates both historical and “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, 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 this report reflect our current views with respect to future events and financial performance and are subject to a variety of factors that could cause our actual results to differ materially from historical results or from anticipated results expressed or implied by such forward-looking statements. Because of such factors, we cannot assure you that the results anticipated in this report will be realized. As noted elsewhere in this report, various aspects of our business are subject to extreme volatility, often as a result of factors beyond our ability to anticipate or control. In particular, factors, such as the condition of the securities markets, which are in turn based on popular perceptions of the health of the economy generally, can be expected to affect the volume of our business as well as the value of the securities maintained in our trading and investment accounts. Other factors that may affect our future financial condition or results of operations include the following:

 
·
Aspects of our business are volatile and affected by factors beyond our control.
 
·
Our ability to attract and retain customers may be affected by our reputation. 
 
·
We are subject to extensive regulation that could result in investigations, fines or other penalties.
 
·
We face intense competition in our industry. 
 
·
Our future success depends on retaining existing management and hiring and assimilating new key employees, and our inability to attract or retain key personnel would materially harm our business and results of operations.
 
·
We are subject to the risk of legal proceedings, which may result in significant losses to us that we cannot recover. Claimants in these proceedings may be customers, employees, investors or regulatory agencies, among others, seeking damages for mistakes, errors, negligence or acts of fraud by our employees.
 
·
As a public company, we are subject to complex legal and accounting requirements that require us to incur substantial expense and expose us to risk of non-compliance.
 
·
Our directors and executive officers control approximately 47% of our common stock and may have interests differing from those of other stockholders.

OVERVIEW

Substantially all of our business has historically consisted of the securities brokerage and corporate finance activities of our wholly-owned subsidiary, Paulson Investment Company, Inc. ("PIC"), which has operations in four principal categories, all of them in the financial services industry. These categories are: 

 
·
corporate finance revenues consisting principally of underwriting discounts and underwriter warrants;
 
·
securities trading from which we record profit or loss, depending on trading results;
 
·
investment income resulting from earnings on, and increases or decreases in the value of, our investment portfolio; and
 
·
securities brokerage activities for which we earn commission revenues.

During the second quarter of fiscal 2012 ended June 30, 2012, the Company sold substantially all PIC's retail brokerage business to JHS Capital Advisors, LLC and is focusing its operations on boutique investment banking.

In addition, Paulson Capital Properties, LLC, a 100% owned subsidiary, was established for the purpose of purchasing, improving and remarketing underappreciated real estate. Through September 30, 2012, we had not purchased any real estate.
 
 
8

 

Because we operate in the financial services industry, our revenues and earnings are substantially affected by general conditions in financial markets. Further, past performance is not necessarily indicative of results to be expected in future periods. In our securities brokerage business, the amount of our revenues depends on levels of market activity requiring the services we provide. Our corporate finance activity, which consists of acting as the managing underwriter of initial and follow-on public offerings, private investments in public equity (“PIPEs”) and private placements for smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced substantial cyclical fluctuation. During the first nine months of 2012, the number of global IPO's fell by approximately 47% to 142, which raised proceeds of $70.7 billion, compared to the first nine months of 2011 when 269 IPO's were completed for total proceeds of $113 billion. Fewer initial public offerings from China and continued economic weakness in Europe contributed to the declines.  In the United States, the number of IPO's was up slightly to 99 during the current nine-month period, compared to 96 in the first nine months of 2011. Total proceeds for the US IPO's increased to $35.0 billion from $29.2 billion raised in the first nine months of 2011. The outlook for the remainder of 2012 is encouraging globally. Although many companies delayed their initial public offerings due to continued concerns about weak economic growth rates internationally, the number of companies in the global IPO pipeline continues to increase to near historic high levels. Although we attempt to match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in corporate finance revenues tend to result in sharper fluctuations, on a percentage basis, in net income or loss.

Our investment and trading income or loss is affected by changes in market valuation of securities generally and, in particular, by changes in valuation of the equity securities of microcap companies in which our investments and trading activities tend to be concentrated. Equity markets in general, and microcap equity markets in particular, have always experienced significant volatility and this volatility has, in recent years, been extreme. As a result, the value of our investment portfolio and securities held in connection with our trading and investment activities has experienced large quarterly fluctuations in income or loss, and our net worth has substantially increased or decreased as our securities holdings are marked to market.
 
A substantial portion of our corporate finance business consists of acting as managing underwriter of initial and follow-on public offerings for microcap and smallcap companies. As a part of our compensation for these activities, we typically receive warrants exercisable to purchase securities similar to those that we offer and sell to the public. The warrants generally have a five-year expiration date and are subject to a restricted period of six months to one-year during which we cannot exercise. The exercise price is typically 120% of the price at which the securities were initially sold to the public. Accordingly, unless there is at least a 20% increase in the price of these securities at some time more than six months and less than five years after the offering, the warrants will remain “under water” and will ultimately expire unexercised. We also receive warrants in connection with PIPEs, which have varying terms and conditions.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

We reaffirm the critical accounting policies and estimates as reported in our Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission on March 8, 2012.

SALE OF RETAIL BROKERAGE OPERATIONS

In February 2012, the Company announced it had reached an agreement with JHS Capital Advisors, LLC (JHS) of Tampa, Florida to sell substantially all of its retail brokerage operations, including many of its branch and non-branch offices as well as registered personnel (employees and independent contractors), to JHS. Under the transaction, Paulson advisors became registered representatives of JHS and, through JHS, will continue to use RBC Correspondent Services, a division of RBC Capital Markets, LLC, for custody of client assets and securities, trade execution and portfolio reporting.
 
 
9

 
 
The sale closed on April 16, 2012. Under the agreement, the Company is to be paid approximately $1,653,247 net of certain deductions for compensation expenses. $1,107,741 was received on closing on April 16, 2012, and the balance is to be paid over three installments on July 16, 2012, October 15, 2012 and January 11, 2013. During the three- and nine-month periods ended September 30, 2012, the Company received $165,183 as the first installment payment. Subsequent to September 30, 2012, the Company received the second installment payment of $153,666. The final purchase price is subject to recalculation after six months based upon the aggregate gross dealer commissions for the twelve month period ended at that time. The agreement also requires twelve directors, officers and employees of the Company to enter into non-solicitation and non-competition agreements pursuant to which they are prohibited from soliciting employees and registered representatives of JHS for two years from the closing date and, subject to a limited exception, engaging in the retail brokerage business for one year from the closing date.

The Company continues to operate independently as a broker/dealer focused on its core competencies in boutique investment banking activities, and continues as a public company under the symbol "PLCC" on the NASDAQ Exchange.

RESULTS OF OPERATIONS

Our revenues and operating results are influenced by fluctuations in the equity markets as well as general economic and market conditions, particularly conditions in the NASDAQ and over-the-counter markets, where our investment and trading positions and the underlying stock for the underwriter warrants are heavily concentrated. Significant fluctuations can occur in our revenues and operating results from one period to another. Our results of operations depend upon many factors, such as the number of companies that are seeking financing, the quality and financial condition of those companies, market conditions in general, the performance of our previous underwritings and interest in certain industries by investors. As a result, revenues and income derived from these activities may vary significantly from period to period. Our revenues include the following:

 
·
Corporate finance revenues, which are a function of total proceeds from offerings done during the period, compensation per offering and the fair value of underwriter warrants received;
 
·
Investment income (loss), which includes (i) the unrealized appreciation and depreciation of securities held based on quoted market prices, (ii) the unrealized appreciation and depreciation of securities held that are not readily marketable, based upon our estimate of their fair value, (iii) realized gains and losses on the sale of securities with quoted market prices and securities that are not readily marketable, (iv) income on the exercise of underwriter warrants, and (v) the unrealized appreciation and depreciation of underwriter warrants held;
 
·
Trading income (loss), which is the gain or loss from trading positions before commissions paid to the representatives in the trading department; and
 
·
Commissions, which represent amounts earned from our retail securities brokerage activities.
 
 
10

 
 
The following tables set forth the changes in our operating results in the three- and nine month periods ended September 30, 2012 compared to the three- and nine-month periods ended September 30, 2011 (dollars in thousands):

   
Three Months Ended
September 30,
   
Favorable
(Unfavorable)
   
Percentage
 
   
2012
   
2011
   
Change
   
Change
 
Revenues:
                       
Commissions
  $ 68     $ 3,487     $ (3,419 )     (98.0 )%
Corporate finance
    22       78       (56 )     (71.8 )
Investment income
    141       59       82       139.0  
Trading loss
    (132 )     (393 )     261       66.4  
Interest and dividends
    400       125       275       220.0  
Gain (loss) on sale of assets
    (24 )     -       (24 )     (100.0 )
Other
    45       45       -       *  
Total revenues
    520       3,401       (2,881 )     (84.7 )
Expenses:
                               
Commissions and salaries
    279       3,514       3,235       92.1  
Underwriting expenses
    4       1       (3 )     (300.0 )
Rent and utilities
    40       144       104       72.2  
Communication and quotation services
    49       136       87       64.0  
Professional fees
    161       76       (85 )     (111.8 )
Travel and entertainment
    4       30       26       86.7  
Advertising and promotion
    -       4       4       100.0  
Settlement expense
    74       (25 )     (99 )     (396.0 )
Clearing expenses
    10       80       70       87.5  
Bad debt expense
    -       4       4       100.0  
Depreciation and amortization
    -       5       5       100.0  
Licenses, taxes and insurance
    170       110       (60 )     (54.5 )
Other
    58       131       73       55.7  
Total expenses
    849       4,210       3,361       79.8  
Loss before income taxes
  $ (329 )   $ (809 )   $ 480       59.3 %


*Not meaningful.


   
Nine Months Ended
September 30,
   
Favorable
(Unfavorable)
   
Percentage
 
   
2012
   
2011
   
Change
   
Change
 
Revenues:
                       
Commissions
  $ 3,725     $ 11,797     $ (8,072 )     (68.4 )%
Corporate finance
    70       256       (186 )     (72.7 )
Investment loss
    (438 )     (154 )     (284 )     (184.4 )
Trading income (loss)
    810       (1,529 )     2,339       153.0  
Interest and dividends
    561       392       169       43.1  
Loss on asset disposition
    (1 )     -       (1 )     (100.0 )
Gain on sale of assets
    1,596       -       1,596       100.0  
Other
    140       136       4       2.9  
Total revenues
    6,463       10,898       (4.435 )     (40.7 )
Expenses:
                               
Commissions and salaries
    4,368       11,893       7,525       63.3  
Underwriting expenses
    42       12       (30 )     (250.0 )
Rent and utilities
    255       429       174       40.6  
Communication and quotation services
    266       401       135       33.7  
Professional fees
    590       463       (127 )     (27.4 )
Travel and entertainment
    50       92       42       45.7  
Advertising and promotion
    9       20       11       55.0  
Settlement expense
    74       -       (74 )     (100.0 )
Clearing expenses
    175       298       123       41.3  
Bad debt expense
    232       4       (228 )     (5700.0 )
Depreciation and amortization
    5       14       9       64.3  
Licenses, taxes and insurance
    437       349       (88 )     (25.2 )
Other
    307       473       166       35.1  
Total expenses
    6,810       14,448       7,638       52.9  
Loss before income taxes
  $ (347 )   $ (3,550 )   $ 3,203       90.2 %
 
 
11

 
 
Revenues
The United States markets had a strong third quarter of 2012, with the NASDAQ Composite rising 6.2%. For the first nine months of 2012, the NASDAQ increased by 19.6%, The Dow Jones Industrial Average was up 4.3% in the third quarter and increased 10% for the nine month period. Third quarter performance was driven by international government stimulus programs and moderate economic growth in the United States, particularly in manufacturing and housing.

Commissions declined 98% during the third quarter ended September 30, 2012 compared to the third quarter of 2011 and declined 68.4% for the first nine months of 2012 compared to the first nine months of 2011. The declines were largely due to the sale of substantially all the Company's retail brokerage business to JHS effective April 16, 2012. As of September 30, 2012, the Company had 5 registered representatives, which were included in the Company's 17 employees, compared to 98 registered representatives as of September 30, 2011.

Corporate finance income in the third quarter of 2012 was down 71.8% from the third quarter of 2011, and declined 72.7% for the nine month period ended September 30, 2012 compared to the nine month period ended September 30, 2011.  The Company participated in a smaller private placement for The Patron Company in the first nine months of 2012, while we completed a larger private placement for The Patron Company in the third quarter of 2011.

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

   
Three months Ended
September 30,
   
Nine months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Net unrealized appreciation (depreciation) related to underwriter warrants
  $ 141     $ 44     $ (51 )   $ (176 )
Net unrealized appreciation (depreciation) of securities held based on quoted market prices or, for securities that are not readily marketable, our estimate of their fair value
         -           15       (253 )         22  
Net realized loss on the sale of securities with quoted market prices and securities that are not readily marketable
      -         -       (134 )       -  
    $ 141     $ 59     $ (438 )   $ (154 )

We did not exercise any underwriter warrants in the first three quarters of 2012 or 2011. Generally, when we exercise a warrant to obtain the underlying common stock, the common stock is subsequently sold in the near term and the related gain is reflected as a component of investment income.

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

Trading loss decreased by 66.4% to $132 thousand in the third quarter of 2012 compared to $393 thousand in the third quarter of 2011. For the first nine months of 2012, trading income was $810 thousand compared to a trading loss of $1.529 million for the first nine months of 2011. The trading income was positively affected by the market value of certain securities in which we make a market. Our focus is on very small capitalization issues, especially those tied to our corporate finance clients.
 
 
12

 
 
Expenses
Total expenses decreased by $3.361 million in the third quarter of 2012 compared to the third quarter of 2011, and decreased by $7.638 million for first nine months of 2012 compared to the first nine months of 2011. The decline in both periods was primarily due to the sale of the Company's retail brokerage operations in April 2012, which resulted in lower commissions and salaries, as well as related expenses including rent and utilities, and communications and quotation services. Bad debt expense decreased by $4,000 in the third quarter and increased by $228,000 in the nine-month period as the Company reserved the full amount of two notes receivable. Professional fees increased by $85,000 in the third quarter and increased $127,000 in the nine month period of 2012 compared to the same periods in 2011 primarily due to the sale of the Company's retail brokerage operations on April 16, 2012. Underwriting expenses increased by $3,000 in the third quarter of 2012 compared to the third quarter of 2011 and increased by $30,000 in the first nine months of 2012 compared to the first nine months of 2011. Expenses vary due to the timing and level of investment banking activity. Licenses, taxes and insurance increased by $60,000 in the third quarter and increased $88,000 in the nine month period of 2012 compared to the same periods in 2011 primarily due to higher insurance costs.


LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity include our cash and receivables from our clearing organization, offset by payables to our clearing organization.

In addition, our sources of liquidity include, to a certain extent, our trading positions, borrowings on those positions and profits realized upon the sale of the securities underlying underwriter warrants exercised. The liquidity of the market for many of our securities holdings, however, varies with trends in the stock market. Since many of the securities we hold are thinly traded, and we are, in many cases, a primary market maker in the issues held, any significant sales of our positions could adversely affect the liquidity of the issues held. In general, falling prices in NASDAQ and over-the-counter securities (which make up most of our trading positions) lead to decreased liquidity in the market for these issues, while rising prices in NASDAQ and over-the-counter issues tend to increase the liquidity of the market for these securities.

We believe our cash and receivables from our clearing organization at September 30, 2012 are sufficient to meet our cash and regulatory net capital needs for at least the next twelve-month period from September 30, 2012. Our liquidity could be negatively affected by protracted unfavorable market conditions.

As a securities broker-dealer, we are required by SEC regulations to meet certain liquidity and capital standards. We believe we were in compliance with these standards at September 30, 2012.

Following the lapse of restrictions upon issuance, capital available from the sale of the underlying securities of underwriter warrants exercised can fluctuate significantly from period to period as the value of the underlying securities fluctuates with overall market and individual company financial condition or performance. There is no public market for the underwriter warrants. The securities receivable upon exercise of the underwriter warrants cannot be resold unless the issuer has registered these securities with the SEC and with the states in which the securities will be sold unless exemptions are available. Any delay or other problem in the registration of these securities would have an adverse impact upon our ability to obtain funds from the exercise of the underwriter warrants and the resale of the underlying securities.

At September 30, 2012, we owned 11 underwriter warrants from 8 issuers, all but 1 of which were exercisable. None of the warrants had an exercise price below the September 30, 2012 market price of the securities receivable upon exercise. There is little or no direct relationship between the intrinsic value of our underwriter warrants at the end of any given period and the fair value calculated using the Black-Scholes option pricing model. The prices of the securities underlying the underwriter warrants are very volatile, and substantial fluctuations in their fair value can be expected in the future.
 
Cash used by operating activities totaled $791,000 in the first nine months ended September 30, 2012, which included our net loss of $347,000 as well as changes in our operating assets and liabilities as discussed in more detail below.
 
 
13

 

Our net receivable from our clearing organization totaled $3.4 million at September 30, 2012 and $5.1 million at December 31, 2011. Our net receivable from our clearing organization is affected by the results of the activity in our trading and investment accounts, as well as the timing of general corporate expenditures and cash flow requirements.

During the second quarter of 2012, we sold substantially all our retail brokerage business to JHS Capital Advisors, LLC and recorded a gain on sale of assets, after adjustments, of $1.596 million. Notes and other receivables net of allowances for doubtful accounts increased $581,000 to $1.188 million at September 30, 2012 from $607,000 at December 31, 2011, primarily due to the remainder of the note receivable from JHS for the remaining installment payments due under the sale of the Company's retail brokerage operations.

Changes in our trading and investment securities owned are dependent on the purchase and sale of securities during the period, as well as changes in their fair values during the period.

A summary of activity related to the fair value of our underwriter warrants was as follows (in thousands):

Balance, December 31, 2011
  $ 1,395  
Receipt of underwriter warrants
    -  
Net unrealized loss on value of warrants
    51  
Warrants exercised or expired
    -  
Balance, September 30, 2012
  $ 1,344  

Deferred revenue of $157,000 at September 30, 2012 was primarily related to amounts received from our clearing firm pursuant to a five-year agreement with three, one-year extensions, and is being amortized at the rate of $14,881 per month through April 2013.

In September 2001, our Board of Directors approved a stock repurchase program pursuant to which we are authorized to repurchase up to 600,000 shares of our common stock. In June 2008, our Board of Directors approved the repurchase of up to a total of an additional 200,000 shares of our common stock. We repurchased a total of 1,000 shares of our common stock during the first quarter of 2012 at an average price of $1.25 per share for a total of $1,250. Through September 30, 2012, a total of 731,989 shares had been repurchased and 68,011 shares remained available for repurchase under the program. This repurchase program does not have an expiration date.

In March 2012, the Board of Directors approved a special cash dividend of $0.05 per common share payable April 16, 2012 to shareholders of record April 4, 2012. The ex-dividend date was April 2, 2012. Dividends paid to common shareholders totaled $288,349.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

NEW ACCOUNTING GUIDANCE

See Note 5 of Notes to Consolidated Financial Statements.
 
 
14

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Not required for Smaller Reporting Companies.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures
Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that 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 Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


PART II - OTHER INFORMATION

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

We repurchased the following shares of our common stock during the first nine months of 2012:

   
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
 
January 1 to January 31
    -       -       -       69,011  
February 1 to February 29
    -       -       -       69,011  
March 1 to March 31
    1,000     $ 1.25       1,000       68,011  
April 1 to June 30
    -       -       -       68,011  
July 1 to September 30
    -       -       -       68,011  
   Total
    1,000     $ 1.25       1,000       68,011  

A plan to repurchase up to a total of 600,000 shares of our common stock was approved by our Board of Directors in September 2001 and does not have an expiration date. In June 2008, our Board of Directors approved the repurchase of up to a total of an additional 200,000 shares of our common stock. This authorization does not have an expiration date.
 
 
15

 
 
Item 6.  Exhibits

The following exhibits are 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.
 
101.INS***
XBRL Instance
 
101.SCH***
XBRL Taxonomy Extension Schema
 
101.CAL***
XBRL Taxonomy Extension Calculation
 
101.DEF***
XBRL Taxonomy Extension Definition
 
101.LAB***
XBRL Taxonomy Extension Labels
 
101.PRE***
XBRL Taxonomy Extension Presentation
 

*  
Filed herewith
**  
Furnished herewith
***  
XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
 
 
16

 
 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
Date: November 8, 2012 PAULSON CAPITAL CORP.  
     
       
 
By
/s/ “Chester L. F. Paulson”  
  Chester L. F. Paulson  
 
President and Chief Executive Officer
 
 
Principal Executive Officer
 
     
     
 
By
/s/ “Murray G. Smith”  
  Murray G. Smith  
 
Chief Financial Officer
 
 
Principal Financial Officer
 
 

                                                                      
17