VBI Vaccines 10-Q 2007 Q3 Quarterly report

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, 2007

OR

o 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: 0-18188

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 o

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  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	6,077,150
(Class)	(Outstanding at November 9, 2007)

PAULSON CAPITAL 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

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

Paulson Capital 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 accompanying Notes to Consolidated Financial Statements

2

Paulson Capital 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 accompanying Notes to Consolidated Financial Statements

3

Paulson Capital 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 an adjustment of $90,000 from retained earnings to income taxes payable - long-term.

See accompanying Notes to Consolidated Financial Statements.

4

PAULSON CAPITAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.  Basis of Presentation

The financial information for Paulson Capital Corp. and its wholly-owned subsidiary, Paulson Investment Company, included herein as of September 30, 2007 and December 31, 2006 and for the three and nine-month periods ended September 30, 2007 and 2006 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, 2006 is derived from our Annual Report on Form 10-K for the year ended December 31, 2006. 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, 2006. 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.  Commitments and Contingencies

In December 2005, we received notice of possible claims being asserted against us by two individuals who invested in Wood River Partners LP (“Wood River”). The investors purchased their interests in Wood River directly from Wood River. One of the individuals was a customer of ours. Along with his brother, they have indicated that they paid $1,050,000 for their interests in Wood River. The individuals have indicated that they believe they may have claims against us under the Oregon Securities Law for rescission, interest and attorney fees. On November 6, 2007, the case was settled and the individuals released 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 fee pursuant to a Newswires Subscription Agreement, dated February 1, 2005. Dow Jones claims that we did not timely terminate prior to the date the Newswires Subscription 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 rates provided us with the right to terminate the Newswires Subscription Agreement. We believe we have meritorious defenses, and, if Dow Jones initiates legal action, 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. Madsen Family Trust retained legal counsel and requested to inspect account documents relating to the handling of the account. Although no demand has been made, the trustee of the Trust previously indicated that he believed the Trust had suffered losses in excess of $210,000, allegedly due to unsuitable and unauthorized trading. We do not know whether any claim will be asserted. We believe we have meritorious defenses, and, if legal action is initiated, we intend to defend the matter vigorously.

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

5

Note 3.  Stock-Based Compensation

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

Note 4.  Earnings Per Share

Following is a reconciliation of our shares used for our basic net income (loss) per share and our 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 123,861 shares 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 issue price, which totaled $637,000, was offset against retained earnings. The 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. 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”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” which defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. FIN 48 applies to all tax positions accounted for under SFAS No. 109, “Accounting for Income Taxes.” FIN 48 is effective as of the beginning of the first fiscal year beginning after December 15, 2006.

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

On initial adoption of FIN 48, we had unrecognized tax benefits of $174,000, all of which would have an impact on the effective tax rate if recognized. Interest and penalties accrued on unrecognized tax benefits were $16,000. We do not believe it is reasonably possible that the total amount of unrecognized benefits will significantly increase or decrease within the next 12 months.

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

The tax years which remain 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 was completed during the second quarter of 2007 resulting in a benefit of $154,000 that was received in July 2007. There were no decreases in prior

6

unrecognized tax benefits resulting from settlements with taxing authorities or the lapse of applicable 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 liabilities on our balance sheet as of December 31, 2006, and the full amount was accrued as 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 received an 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 accrued as a component of accounts payable and accrued liabilities on our balance sheet as 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 an outstanding legal claim in July 2007. We paid $220,000 in connection with this settlement in the fourth quarter of 2007. The full amount was accrued as a component of accounts payable and accrued liabilities on our balance sheet as of 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 been reclassified to conform to the current period presentation.

Note 9. Subsequent Events

Underwriter Warrants

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

Settlement of Legal Matter

In November 2007, we settled a 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 third quarter of 2007.

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 an increased risk of legal proceedings, which may result in significant losses to us that we cannot recover. Claimants in these proceedings may be customers, employees, 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 control approximately 60 percent of our common stock and may have interests differing from those of other stockholders.

Overview

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

•securities brokerage activities for which we earn commission revenues;

•corporate finance revenues consisting principally of underwriting discounts and underwriter warrants;

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

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

Because we operate in the financial services industry, our revenues and earnings are substantially affected by general conditions in financial markets. 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. 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 brokerage

8

and corporate finance revenues tend to result in sharper fluctuations, on a percentage basis, in net income or loss.

Our investment income or loss and, to a lesser extent, our 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. The result of this volatility on the value of our investment portfolio and securities held in connection with our trading and investment activities include large quarterly fluctuations in income or loss from these operations and substantial increases or decreases in our net worth 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 vest immediately. The warrants are generally 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

With the exception of the adoption of FIN 48 as described in Note 6 of Notes to Consolidated Financial Statements, we reaffirm the critical accounting policies and estimates as reported 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.

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 over-the-counter market, 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 year to year. Our revenues include the following:

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

•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 exercise of underwriter warrants and the sale of securities with quoted market prices and securities that are not readily marketable, and (iv) the unrealized appreciation and depreciation of underwriter warrants held; and

•Trading income (loss), which is the gain or loss from trading positions before commissions paid to the representatives in the trading department.

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The following tables set forth the changes in our operating results in the three and nine-month periods ended September 30, 2007 compared to the three and nine-month periods ended September 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-month periods ended September 30, 2007 compared to the same periods of 2006. The total number of trades, including mutual fund trades, executed by our brokers were 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 the comparable periods of 2006. We had 83 brokers at September 30, 2007 compared to 91 brokers at September 30, 2006.

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

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

Corporate finance income in the nine-month period ended September 30, 2007 included underwriting discounts earned from the following:

•an initial public offering in the first quarter of 2007 in which we raised $9.8 million for Converted Organics Inc., as well as the Black-Scholes value of the underwriter warrants received in connection with that offering;

•an initial public offering in the second quarter of 2007 in which we raised $14.0 million for Vaughan Foods Inc., as well as the Black-Scholes value of the underwriter warrants received in connection with that offering;

•one private offering during the second quarter of 2007 in which we raised $2.8 million for our client; and

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

Corporate finance income of $1.4 million in the three-month period ended September 30, 2006 primarily represented underwriting discounts earned from one initial public offering in which we raised $16.5 million for Ascent Solar Technologies, Inc., as well as the Black-Scholes value of the underwriter warrants received in connection with that offering.

Corporate finance income of $4.6 million in the nine-month period ended September 30, 2006 also included underwriting discounts earned from a public offering in which we raised $19.5 million for American Mold Guard, Inc., as well as the Black-Scholes value of the underwriter warrants received in connection with that offering. In addition we completed several private transactions, including PIPEs, during the three and nine-month periods ended September 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 the market value or 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 income increased $1.7 million and $3.6 million, respectively, in the three and nine-month periods ended September 30, 2007 compared to the same periods of 2006. The income in nine-month period ended September 30, 2007 was due to highly favorable results for certain securities that we were holding in our trading inventories in the first two quarters of 2007. The 2006 results reflected lower volume and lower prices for several of the securities we held in our trading inventories. Our focus is on very small

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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 value of 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-month periods ended September 30, 2007 compared to the same periods of 2006. The increases were primarily due to increases in commissions and salaries, bad debt expense and settlement expense.

Commissions and salaries increased $0.4 million and $0.7 million, respectively, in the three and nine-month periods ended September 30, 2007 compared to the same periods of 2006, primarily due to higher commissions earned on higher commission revenue. Retail commissions as a percentage of retail sales was comparable between the current year and prior year periods.

Bad debt expense is recorded for specific amounts when they are determined by management to be uncollectible. 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 finance client.

Settlement expense of $0.2 million in the three-month period ended September 30, 2007 is related to the settlement of a legal claim in November 2007 that was expensed during the third quarter of 2007. The $0.5 million of settlement expense in the nine-month period ended September 30, 2007 also included an accrual for $220,000 in connection 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 expect insurance recovery on the claim that settled in November 2007 or on the one that settled in July 2007. See also Notes 7 and 9 of Notes to Consolidated Financial Statements.

Settlement expense in the 2006 periods is primarily related to the settlement of one matter in the third quarter of 2006.

Liquidity and Capital Resources

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

In addition, our sources of liquidity include our trading positions, investment 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 securities (which make up most of our trading positions) lead to decreased liquidity in the market for these issues, while rising prices in NASDAQ issues tend to increase the liquidity of the market for these securities.

We believe our liquidity is sufficient to meet our needs for both the short and long-term horizon. However, 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, 2007.

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

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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, 2007, we owned 16 underwriter warrants from 15 issuers, all but three of which were exercisable. Five of the warrants had an exercise price below the September 30, 2007 market price of the securities receivable upon exercise. The intrinsic value of these warrants was $6.8 million at September 30, 2007. 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 our estimate of their value can be expected in the future.

Cash provided by operating 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-cash income items of $6.8 million and changes in our operating assets and liabilities as discussed in more detail below.

Our net receivable from our clearing organization increased $2.2 million to $9.9 million at September 30, 2007 from $7.7 million at December 31, 2006, primarily due to the results of the activity in our trading and investment accounts, as well as the timing of general corporate expenditures.

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

Underwriter warrants increased $8.0 million to $13.7 million at September 30, 2007 compared to $5.7 million at December 31, 2006. A roll-forward of the value of the warrants was as 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 receivable decreased $1.6 million to a payable of $1.3 million at September 30, 2007 from a receivable of $0.3 million at December 31, 2006, primarily due to receipt of refunds, adjustments made for the adoption of Interpretation No. 48 during the first quarter of 2007 and taxable income in the first nine months of 2007. See also Note 6 of Notes to Consolidated Financial Statements.

Accounts payable and accrued 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 million accrual for a legal settlement that occurred in November 2007, but was expensed in the third quarter of 2007.

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

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

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. During the first 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 for repurchase. This repurchase program does not have an expiration date.

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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 Pronouncements

There has been no change in new accounting pronouncements since the filing of our Form 10-K for the year ended December 31, 2006, which was filed with the Securities and Exchange Commission on April 2, 2007.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in our reported market risks or risk management policies since the filing of our Form 10-K for the year ended December 31, 2006, which was filed with the Securities and Exchange Commission on April 2, 2007.

Item 4.    Controls and Procedures

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our President 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 President 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 President 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 1.    Legal Proceedings

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

Item 1A. Risk Factors

Our Annual Report on Form 10-K for the year ended December 31, 2006 includes a detailed discussion of our risk factors. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K. Accordingly, the information in this Form 10-Q should be read in conjunction with the risk factors and information disclosed 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. See also Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report under the heading “Forward Looking Statements and Risk Factors.”

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

We repurchased the following 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 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.

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.

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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 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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