**Table
            of Contents**
 **Index
            to Financial
            Statements**




**U.S.
      SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**







**FORM
        10-KSB**
 
 ANNUAL
          REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 SECURITIES
        EXCHANGE ACT OF 1934
  For
          The
          Fiscal Year Ended **September 30, 2006**
 **000-28745**
 (Commission
        File No.)
 ______________
 
 **NATIONAL
        SCIENTIFIC CORPORATION**
 (Name
        of
        Small Business Issuer in its Charter)
 ______________
  **Texas**
                
                **86-0837077**(State
                    of Incorporation)
                
                (I.R.S.
                    Employer Identification No.)**8361
                    E. Evans Road, Suite 106**
                ****
                ******Scottsdale,
                    AZ**
                ****
                **85260**(Address
                    of Principal Executive Offices)
                
                (Zip
                    Code)
  **(480)
          948-8324**
 (Issuers
        Telephone Number, Including Area Code)
 
 Securities
        registered under Section 12(b) of the Exchange Act:
 **Preferred
        Stock, $0.10 par value**
  Securities
        registered under Section 12(g) of the Exchange Act:
 **Common
        Stock, $0.01 par value**
  Check
        whether the issuer (1) filed all reports required
        to be filed by Section 13 or 15 (d) of the Exchange Act during the past 12
        months (or for such shorter period that the registrant was required to file
        such
        reports) and (2) has been subject to such filing requirements for the past
        90
        days.  Yes x No o 
 Check
          if
          there is no disclosure of delinquent filers in response to Item 405 of
          Regulation S-B contained in this form and no disclosure will be contained,
          to
          the best of the registrant’s knowledge, in definitive proxy or information
          statements incorporated by reference in Part III of this Form 10-KSB or
          any
          amendment to this Form 10-KSB 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
  Revenues
          for the fiscal year ended September 30, 2006 were $227,251.
  The
          aggregate market value of voting stock held by non-affiliates of National
          Scientific Corporation’s (“NSC’s”) common stock, as of January 10, 2007 was
          approximately $2,926,889 (based on the last sale price of such stock as
          reported
          by OTC BB Stock Market). The number of shares outstanding of the registrant’s
          common stock, as of January 10,2007 was 99,108,039.
  Transitional
          Small Business Disclosure Format (Check One):  Yes o No x
 **Table
              of Contents**
 **Index
              to Financial
              Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 FORM
          10-KSB FOR THE FISCAL YEAR ENDED
          SEPTEMBER 30, 2006
 
 **TABLE
          OF CONTENTS**
  PagePart
                        IItem
                        1.
                    Description
                        of Business
                    3Item
                        2.
                    Properties
                    24Item
                        3.
                    Legal
                        Proceedings
                    24Item
                        4.
                    Submission
                        of Matters to a Vote of Security
                        Holders
                    25Part
                        IIItem
                        5.
                    Market
                        for Common Equity and Related Stockholder
                        Matters
                    25Item
                        6.
                    Management’s
                        Discussion
                        and Analysis of Financial Condition and Results of
                        Operations
                    30Item
                        7.
                    Financial
                        Statements
                    43Item
                        8.
                    Changes
                        in and Disagreements with Accountants on Accounting
                        and Financial Disclosure
                    43Item
                        8A.
                    Controls
                        and Procedures
                    43Item
                        8B.
                    Other
                        Information
                    44Part
                        IIIItem
                        9.
                    Directors,
                        Executive Officers, Promoters and Control
                        Persons; Compliance with Section 16(a) of the Exchange
                        Act
                    44Item
                        10.
                    Executive
                        Compensation
                    48Item
                        11.
                    Security
                        Ownership of Certain Beneficial Owners and
                        Management
                    53Item
                        12.
                    Certain
                        Relationships and Related
                        Transactions
                    54Item
                        13.
                    Exhibits
                        and Reports on Form 8-K
                    56Item
                        14.
                    Principal
                        Accountant Fees and Services
                    57Signatures
                    59
 
 2
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
 **PART
            I**
 
 **Forward
            Looking Information**
  This
              Form
              10-KSB contains certain forward-looking statements within the meaning
              of the
              Section 27A of the Securities Act of 1933 and Section 21E of the Securities
              Exchange Act of 1934. For this purpose, any statements contained in
              this Form
              10-KSB that are not statements of historical fact may be deemed to
              be forward
              looking statements. Without limiting the foregoing, words such as “may,” “will,”
“expect,” “believe,” “anticipate,” “estimate,” or “continue” or comparable
              terminology are intended to identify forward looking statements. These
              statements by their nature involve substantial risks and uncertainties
              and
              actual results may differ materially depending on a variety of factors,
              many of
              which are not within NSC’s control. These factors include, but are not limited
              to, economic conditions generally and in the industries in which NSC’s future
              customers participate; competition within NSC’s industry, including competition
              from much larger competitors; technological advances which could render
              NSC’s
              products less competitive or obsolete; failure by NSC to successfully
              develop
              new products or to anticipate current or prospective customers’ product needs;
              price increases or supply limitations for components purchased by NSC
              for use in
              its products; and delays, reductions, or cancellation of orders that
              may be
              placed with NSC. There can be no assurance that NSC will be able to
              develop its
              products or markets for its products in the future.
 
 
 **Item
                    1.**
                  **Description
                      of Business**
 
 **Overview**
 Our
              primary business involves the research, development, manufacture, and
              sale of
              hardware and software computer products and devices that span a range
              of
              industries. The majority of our products are electronic location-determining
              devices and digital video recording devices. These devices typically
              use small,
              portable radios, in conjunction with equally small but powerful mobile
              computers, to help establish and report the physical location of people
              and
              objects to which these devices are attached. Some of our location technologies
              use Global Positioning System (GPS) technology to determine position.
              Others use
              small computers in conjunction with video cameras and other sensors
              to record
              incidents on school buses. We also have other products that use non-GPS
              technology to establish and then report position. We refer to our
              location-determining devices as our location tracking products, or
              as location
              tools.
 
 Our
              primary customer focus for these location-tracking products is the
              safety
              market, related in many cases to the safety of children. Our products
              and
              services help our customers keep better track of their children. Our
              products
              are also used to keep track of adults, and as well to track and monitor
              physical
              assets, such as equipment or vehicles. Our location tracking products
              are often
              sold as an integrated system, by using them in conjunction with software
              that
              screen displays maps and other pertinent information.
 
 We
              have
              focused extensively on developing location tools since early 2002,
              and our
              primary business objective is to generate revenue and profit from the
              sale of
              our location tracking products and related services. The sale of these
              products
              and services resulted in small amounts of revenue late in the fiscal
              year ended
              September 30, 2006.
 3
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
 ·
                  Revenue
                        for the fiscal year ended September 30, 2005 was $73,226,
                        all derived from
                        the sale of location tracking products and
                        services;
 ·
                  Revenue
                        for the fiscal year ended September 30, 2006 was $227,251,
                        all derived
                        from the sale of location tracking products and
                        services;
 ·
                  Net
                        losses were $945,293 for the fiscal year ending September
                        30,
                        2006;
 ·
                  Net
                        losses were $1,140,782 for the fiscal year ending September
                        30,
                        2005.
  Prior
              to
              2002, we developed electronic component products, some of which are
              used in
              radio equipment, and some of which have other applications in the electronics
              field, such as in the memory systems of personal computers. All of
              these
              electronic component products have been issued U.S. patents. We focused
              extensively on developing these products and patenting them from 1996
              through
              early 2002, with the objective of licensing these products to other
              electronic
              companies for their use. This strategy has not generated any revenue
              to date. In
              early 2002, our focus shifted away from further development of our
              electronic
              component products, but we continue to explore licensing opportunities
              for our
              component products, keeping in mind that our primary objective today
              is to sell
              our location tools products.
 
 We
              originally incorporated as a Texas corporation in 1953. We changed
              our name to
              National Scientific Corporation in 1996 and we began the activities
              described in
              this annual report. Our principal executive offices are located at
              8361 E. Evans
              Road, Suite 106, Scottsdale, Arizona 85260. Our telephone number is
              (480)
              948-8324. Our Internet site is www.national-scientific.com .
 
 
 **Our
              Business**
 **Location
              Products**
 
 Most
              of
              our customers require tracking or monitoring of an object, asset, or
              person, and
              reporting this information back to a central location. Our location
              products use
              different technologies to determine position of the object and report
              it back to
              the user, usually determined by whether they are trying to track items
              outdoors
              or indoors. Our customers’ choice of the type of technology to use is primarily
              based on their environment. Our location tools products therefore fall
              into two
              different categories depending upon the type of application the customer
              requires. These are Outdoor Location Products and Indoor Location
              Products.
 
 Our
              current location technology has not been awarded any patents as of
              the date of
              this report and has been awarded trademark protection on one other.
              We use a
              combination of confidentiality agreements, copyright and other trade
              secret
              management techniques to protect our trade secrets.
 
 **Outdoor
              Location Products**
 
 ***Overview
              of This Technology***
 
 We
              have
              developed a group of products with the capability to determine location
              using a
              technology called Global Positioning System or GPS. These products
              report the
              location information as well as other desired information such as taking
              digital
              video pictures from a camera back to the user through a radio network.
              The
              products typically contain a small computer to provide the overall
              control and
              data processing capacity for the device. The product can be thought
              of as having
              three distinct pieces or systems. These are the data collection system,
              the data
              control & processing system, and the data transport system. This design
              concept is the basis for our outdoor location products. The diagram
              below shows
              in a general way that the GPS system works with our outdoor location
              products:
 4
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  
 ***Data
              Collection System***
 
 This
              system can be thought of as the “eyes and ears” of the product. It is comprised
              of two systems. One determines location of the product, while the other
              system
              records specific events that the customer may be interested in such
              as a door
              opening in a delivery truck. The location system determines the position
              of the
              product using a technology developed by the U.S. Government called
              the Global
              Positioning System, or GPS, as it is commonly known. The U.S. Government
              for
              limited commercial use first made GPS available in the 1980’s. The system
              consists of approximately 24 satellites that orbit the earth rapidly.
              It is a
              worldwide navigation support system that allows users of GPS receivers
              to
              determine their precise geographic locations to within a few meters
              in most
              cases. The network of satellites and their ground control and monitoring
              stations are maintained and operated by the United States Department
              of Defense,
              which maintains an ongoing satellite replenishment program to ensure
              continuous
              global system coverage. Access to the system for all users is currently
              provided
              free of charge by the U.S. Government.
 
 GPS
              works
              by ranging and triangulating the product’s position from a group of satellites.
              Of the 24 GPS satellites in orbit, a minimum of four is needed to reliably
              determine the product’s three-dimensional position. A GPS receiver measures
              distance by calculating the amount of time it takes a navigation and
              time
              reference radio signal from the satellite to make a one-way trip to
              the GPS
              receiver.
 
 One
              of
              the main drawbacks with GPS is that the GPS receiver requires a clear
              and
              unobstructed line of sight of the satellites to the GPS receiver. Thus,
              GPS
              receivers generally do not work indoors, where walls and roofs block
              reception.
              Even when the GPS receiver is outdoors, tall buildings, hills, and
              dense foliage
              such as trees may also block reception.
 5
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  Prior
                to
                May 2000, for reasons of national security, the U.S. Department of
                Defense
                intentionally degraded GPS signals to civilian users allowing civilian
                users to
                only obtain accurate information regarding their geographic locations
                accurate
                as to within a radius of about 100 meters. On May 2, 2000, the U.S.
                Department
                of Defense eased restrictions on civilian use of GPS technology,
                allowing
                civilian users to now calculate their geographical positions to accuracy
                of 10
                meters or better. Other government systems, such as the Federal Aviation
                Administration’s Wide Area Augmentation System (FAA WAAS) system, have further
                improved accuracy sine 2002 for civilian users in North America.
                These changes
                in policy significantly improve the utility of GPS for many
                applications.
  GPS
                receivers typically are very compact; and it is not necessary to
                have a large
                dish antenna to receive GPS signals. Typical information that can
                be obtained
                from these GPS signals are latitude, longitude, elevation, speed,
                direction,
                date, and time.
 
 The
              second part of this Data Collection System is customer specific. Many
              customers
              have additional types of data that they want to know or want collected
              relevant
              to a location. An example of this is, every time the delivery truck
              door is
              opened, it reports the position and time when the door was opened.
              This
              information can be used to detect and possibly deter theft from the
              vehicle.
              Another example is to report every incident of when the car traveled
              faster than
              an allowed speed. This information could be used to deter unsafe driving.
              Another is to record the location of every child entering or leaving
              a school
              bus, as well as taking a video of the event. This data input system
              can
              therefore be customized to meet the exact needs of a customer.
 
 Another
              kind of data collection technology we use in some of our products is
              called
              RFID, which stands for Radio Frequency Identification. RFID devices
              are small
              radios that could be used to track information about people or objects.
              RFID
              provides a low-cost solution for certain kinds of tracking activities,
              especially short-range activities, typically less than a hundred feet.
              RFID
              devices often are less costly to manufacture than GPS devices, although
              due to
              their short range, they may not be as versatile as GPS, which can work
              at
              distances of many miles or more.
 
 Another
              kind of data collection technology we use in some of our products is
              called DVR,
              which stands for digital video recorder. DVR devices use a small digital
              camera
              that takes up to 30 pictures per second and then stores these images
              electronically. When these individual pictures are ‘played back’, you see a
              movie of the recorded event. Schools are particularly interested in
              this type of
              technology in conjunction with GPS to monitor what is happening on
              their
              buses.
 
 ***Data
              Control & Processing System***
 
 This
              system can be thought of as the “brains” of the product. A technical term for
              this system is an embedded system, meaning one that lives deep inside
              the
              overall product. An embedded system is a small special-purpose computer
              system
              built into a larger device. The reason we use an embedded system in
              our products
              is to keep cost to us low, so our products stay more competitive in
              price.
              Simple embedded systems can cost us as little as a few dollars each
              and use very
              little power compared to the desktop computers that many people are
              familiar
              with, which typically cost much more. On our embedded systems there
              is typically
              no disk drive, operating system, keyboard, or screen. Our embedded
              systems
              instead communicate with other computers by radio. These other computers
              typically have a keyboard and screens, and they are used to display
              our
              information.
 
 The
              programs that we run on these systems are custom designed and built
              by our
              software engineers. These programs are called firmware. The firmware
              controls
              how the data is collected, what data should be collected and what events
              should
              be monitored and reported, what should be ignored, and how, when and
              what data
              should be sent back to the user. As we mentioned above, the system
              is relatively
              easy to customize, and the firmware is also easy to customize as it
              has been
              written in a modular fashion that allows changes to one section to
              be
              implemented without the need to completely re-write the program. This
              also helps
              us keep costs down.
 6
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
 ***Data
              Transport System***
 
 This
              system can be thought of as the “mouth” of the product. It communicates to the
              outside world where it is and what has happened. There are many different
              types
              of technology that can be used to transport this data back to the user,
              generally using some kind of wireless technology based on radios. We
              currently
              use cellular radios, satellite radios, Wi-Fi radios, and other special
              purpose
              radios.
 We
              use a
              cellular radio based on GSM cellular technology. GSM, or Global System
              for
              Mobile Communications, is a second-generation digital mobile telephone
              standard.
              GSM was initially developed as a pan-European collaboration, intended
              to enable
              mobile roaming between member countries. As of the date of this report,
              there
              are now more than 2 billion GSM customers in the world in 213 different
              countries, according to a report published in August 2006 by the GSM
              Association. We believe the use of GSM in our products makes them more
              attractive to customers internationally.
 
 The
              cellular radios typically operate in “real time.” When an event occurs, the data
              is immediately transported back to a user at a remote location.
 
 While
              cellular coverage and reception is good in urban areas, it is less
              effective in
              rural areas and is non-existent in most wilderness areas. Sometimes
              our products
              are used in areas where there is poor or no cellular coverage. To overcome
              this
              we sometimes use a special radio that communicates with satellites
              orbiting the
              earth. This form of communication has the advantage that our products
              can be
              used in very remote areas almost anywhere in the world. The major downside
              is
              that these radios are large and expensive and the airtime usage costs
              can be
              high. Another problem associated with this technology is that, like
              GPS, these
              satellite radios work best when there is a clear line of site to the
              satellites;
              as such they may not work well indoors, or under dense foliage or in
              deep
              valleys.
 
 The
              satellite radios typically operate in “real time.” When an event occurs, the
              data is immediately transported back to the user.
 
 Some
              of
              our customers do not want to have the expense of a real time cellular
              or
              satellite connection, nor are they interested in having the data in
              real time.
              For this we use either a special purpose radio or a Wi-Fi radio.
 
 The
              Wi-Fi
              radio operates in a very similar manner to cordless phones found in
              many
              households. These phones typically consist of a base station and handset.
              Our
              system is very similar; it consists of a base station unit that receives
              data
              from the mobile unit that would be on the asset or vehicle being tracked.
              The
              base station is typically attached to a personal computer that takes
              the raw
              data from the radio and re-formats it into information that can be
              displayed by
              other computers on the Internet. Wi-Fi stands for “Wireless Fidelity” and is a
              technology in very common use to wirelessly connect personal computers
              to other
              computer networks, including the Internet.
 
 Our
              special purpose radios work in a very similar manner to the Wi-Fi radio,
              except
              that they can sometimes transmit data over longer distances.
 
 Wi-Fi
              radios operate in an unlicensed part of the radio spectrum and as such
              do not
              have any special government licensing fees associated with them. Because
              they
              operate in a license-free spectrum, the Federal Communications Commission
              (FCC)
              imposes some restrictions on the use of these radios. One major restriction
              is
              that the radio signal range is limited to about 300 feet.
 
 Since
              most of the time our product operates well beyond 300 feet from the
              base
              station, all the collected data is stored within the device for later
              transmission when the product comes back into that range again. When
              the vehicle
              or asset comes back into base-station range, the mobile units automatically
              download their information. We call this mode of operation “near time.” These
“near time” products do not incur any special airtime usage charges. As such,
              they can be significantly cheaper to operate than the cellular or satellite
              equivalents.
 7
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  Once
              the
              data is transmitted back to the user they can either display the information
              on
              our software (see below) or on some other computer
              application.
  **Outdoor
              Location Tools Products**
  ***Travado
                IBUSTM*** System ****** The
                Travado ** IBUS***TM***  
                system comprises a small outdoor location and DVR module that is
                located on the
                bus and a software suite that is located on a base station back at
                the
                Transportation Department. The system is designed to monitor and
                track school or
                other buses as well as digitally record video. The data is automatically
                downloaded or transmitted via wireless technology such as Wi-Fi or
                high speed
                cellular back to the school base station without ever having to go
                to the bus to
                obtain the information. The unit can also log the children or passengers
                riding
                on the bus. We initially announced the Travado
                IBUS***TM*** product in April of 2003
                in
                conjunction with Verify Systems (see *Strategic
                Relationships* ).
                We
                announced the addition of digital video recording capability and
                changed the
                name to Travado IBUS***TM*** in December of 2004.
                In December 2005 we announced the completion of the first major installation
                and
                deployment. Travado IBUS***TM*** uses a GPS that
                allows it to determine its current location. The system also includes
                digital
                video cameras that record the bus ride. The system can also include
                an optional
                ID card reader. As the child enters the bus they simply swipe their
                ID card and
                a record is created of who got on the bus and where they got on the
                bus. As the
                bus travels along its route picking up passengers, there is a complete
                manifest
                and digital video recording of who is riding on the bus. At journey’s end the
                children simply swipe their ID cards as they disembark and another
                log is
                created. Should there be a difference in the logs, then the driver
                will be
                notified that there could be someone left on the bus. The Base Station
                provides
                a simple user interface to easily extract and view the data generated
                from the
                buses. This data can include the routes the buses have taken, the
                video recorded
                on the bus, and who is riding on the bus. We have developed
                Travado***TM*** tracking software, which
                is an
                internet-based mapping application that can be used to display the
                location on a
                computer screen of our Travado IBUS***TM*** and
                other locator products in the field.
                Travado***TM*** tracking software is not
                sold as a
                stand-alone product, but instead is a service we offer to purchasers
                of our
                Travado IBUS***TM*** and Travado
                Mini***TM*** customers.
 We
              have
              produced and installed about 250 units to date. We have presented informational
              samples to various school districts, which are evaluating and testing
              it. There
              are currently seven school districts that have our systems installed
              in their
              fleet and we continue to run pilot projects using Travado IBUS TM with school
              districts. We intend to market this product directly and through other
              sales
              channels. We have a few commercially significant sales of this product
              as of the
              date of this report, with total revenues from this area at approximately
              $272,000 since we introduced the product in December 2004. Sales of
              the product
              have steadily increased over the last four quarters. Our plan is to
              expand into
              markets beyond education, such as law enforcement and homeland
              security.
 
 ***Travado
              Mini*** TM ***or Mini-T*** TM. 
              Travado Mini TM or  Mini-T TM  is a small outdoor location product
              designed to provide real-time location and telemetry data of government
              and
              first responder vehicles. Much like our Travado IBUS TM product, the
              Travado  Mini-T TM  uses a GPS that allows it to determine its
              current location and sends this information in real-time over a Wi-Fi
              network.
              Testing was undertaken in Corpus Christi, Texas, on a citywide Wi-Fi
              mesh
              network developed by a team from Tropos with support from Intel (part
              of the
              Intel Digital Cities initiative). Our  Mini-T TM  unit
              successfully completed the evaluation stage and representatives from
              SAP and
              Intel made a presentation about the project at SAP’s Sapphire Boston event on
              May 17, 2005. The target market for this new product includes fire,
              police and
              ambulance, as well as the education market. We have made very few commercially
              significant sales of this product as of the date of this report, with
              total
              revenues from this area at approximately $19,000 since we introduced
              the product
              in mid 2005. However, we believe the sales cycle in government entities
              can be
              long and protracted, due to budget cycles, especially for new safety
              technology,
              so we are uncertain if these low sales are likely to stay low or to
              increase in
              the future. Our plan is to market this product to law enforcement and
              homeland
              security markets.
 8
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  ***StationMaster
                TM , Followit*** TM ***and
                Lobo Tracking Software*** TM.
                These
                were products that we developed or licensed in the past and while
                we still
                support some aspects of these products they have for all intent and
                purpose been
                discontinued as we continue to expand our efforts in the school bus
                market.
 **Indoor
              Location Products**
 
 ***Overview
              of This Technology***
 
 Indoor
              location presents many challenges that are not present in outdoor location.
              This
              is largely because GPS systems work poorly if at all when used indoors.
              While
              the GPS companies are working hard to overcome this limitation, there
              have not
              been any major breakthroughs as of yet. Most indoor location technology
              uses
              proprietary infrastructure and small radios called radio frequency
              identification tags, or RFID tags, which are typically small radio
              transmitters
              that run from battery power.
 
 Most
              of
              our indoor positioning technology is based on measuring the strength
              or loudness
              of a radio signal between the transmitter and the receiver. We do this
              because
              the further away a transmitter is from a receiver, the weaker or quieter
              the
              signal is that you will detect. Many types of radios can measure this
“loudness”
phenomenon and convert it into a useful numerical value. If you have
              three or
              four radio sources spread over an area and you can detect their value
              you can
              then triangulate your position based on that information. This is similar
              to the
              concept used by GPS, but since it does not depend on distant satellites,
              it can
              be applied indoors. However, for this approach to work economically,
              a large
              number of transmitters are required throughout the indoor area. This
              cost has
              greatly limited the deployment of indoor location technology as of
              the date of
              this report.
 Today
              many organizations are connecting their computers using Wi-Fi technology,
              rather
              than running expensive network cables. Wi-Fi® is a trademark of the Wi-Fi
              Alliance. We often use Wi-Fi without the hyphen in our product names
              to avoid
              confusion with this trademark. We have developed a means of using these
              new
              Wi-Fi networks to provide the transmitters needed for indoor positioning.
              We
              call this ‘piggy backing’ on to the Wi-Fi network, a network which is composed
              of many mounted receiving devices called Wi-Fi access points. The diagram
              below
              shows how our Wi-Fi-based indoor tracking technology works:
  9
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
   ***WiFi
                Tracker TM***
  WiFi
                Tracker TM is an indoor tracking product designed for tracking people and other
                assets. We announced this product in May of 2003. When used in conjunction
                with
                Wi-Fi enabled tracking software, the tags can be easily identified
                and located
                within the network. One of our software partners is a Finnish company,
                Ekahau,
                Inc. They have developed a software system that takes information
                determined by
                our tags and displays the tag’s position using Ekahau’s Positioning Engine TM
tracking software. The stage three version of the prototype, or “developer kit,”
of this product was completed in December of 2003. A newer version
                of the
                developer tag, version 1.2, was completed in August of 2004. We have
                presented
                samples to several customers, and have engaged in competitive field
                trials with
                prospective customers, including NASA, using early versions of this
                product.
                This product is targeted primarily at commercial users, and uses
                some RFID
                technology in its design. We have made a very small number of sales
                of this
                product as of the date of this report. The feedback from customer
                was that they
                require extended battery life (in excess of one year), and that the
                location
                signals generated from the Wi-Fi network can be dramatically influenced
                by
                changes in the environment and as such the overall accuracy of the
                technology
                can be degraded. In March 2005 we froze development of this product.
                We migrated
                the technology over to Mini-T TM where we are not reliant on extended battery
                operation (as the product operates in vehicles) and can still offer
                location
                telemetry in Digital Cities when GPS telemetry is denied. While we
                still receive
                requests for this product we have not found a worthwhile project
                to justify
                rejuvenating the development project or migrating this technology
                from Wi-Fi
                platforms to the newer Zigbee TM standard, in order to improve battery
                life.
 10
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
 
 
 ***Gotcha!®.*** Gotcha!®
is a small electronic product designed to alert parents or guardians
                when their
                small child wanders too far away from them. We announced this product
                in
                November of 2002, and began shipments of it during the summer of
                2003 to select
                distribution organizations. The product consists of two parts, one
                about the
                size of a small pager that attaches to a parent, and one the size
                of a key fob
                that attaches to a child. When the pre-set distance is exceeded,
                the child unit
                makes an audible sound to tell the parent that the child has wandered
                too far.
                It is then up to the parent to locate the wayward child by following
                the sound
                of the alert. The unit is designed to work well indoors or outdoors,
                although
                working through walls will tend to limit the unit’s range. We believe most of
                our customers will use this product indoors, in places like shopping
                malls. The
                tracker contains a small radio set used to transmit information between
                the
                parent and child, which are a form of RFID technology. The units
                are fully FCC
                certified and approved for operation in the U.S. The units are also
                certified
                for use in Canada. We plan to have these units certified for use
                in other
                countries as and when the business situation warrants. We have filed
                and
                received a successful trademark claim on Gotcha!®. We are currently marketing
                this product through various channels for an average price of approximately
                $35-$50 for a set that includes one parent unit and one child unit.
                This product
                was featured in December of 2003, and again in February 2004, on
                cable
                television’s Home Shopping Network TM, and on QVC in April 2004. We have
                manufactured this unit in quantity and have inventory available for
                delivery. We
                have made sales of this product of $103,000 in the two years ended
                September 30,
                2004. However, in the year ended September 30, 2005 sales of this
                product were
                $8,700. In the year ended September 30, 2006 sales of this product
                were
                $999.  Accordingly,
                we marked down our inventory of Gotcha!® products, by $17,827 and $46,775 during
                the years ended September 30, 2006 and September 30, 2005 respectively,
                for
                estimated obsolescence based on assumptions about age of the inventory
                and
                current demand.
 11
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **Location
            Tools Products Sales and Marketing**
 In
              February 2005 we adjusted our focus to concentrate on the sales and
              marketing of
              our Travado IBUS TM system to local Arizona school districts. These efforts
              culminated in appointing Auto Safety House as a local distributor covering
              Arizona and Nevada. Our first significant end-user was the Scottsdale
              Unified
              School District of Arizona, which has deployed our Travado IBUS TM system on
              roughly half their fleet during 2005. Since then we have established
              a reliable
              reputation in Arizona and this has culminated in obtaining several
              school
              districts in Arizona and other states. We expect this trend to continue
              throughout the coming year as more people become familiar with our
              technology
              and good references help promote the product.
  We
              believe the products we have developed will be more readily marketable
              by
              licensing and/or collaborating with companies that have complementary
              products
              and are already established in the market segments of interest. We
              have
              undertaken a search for candidates and are in the process of conducting
              due
              diligence and preliminary negotiations with potential distributors
              and partners.
              In the School Bus arena there are basically three avenues to the end
              customer:
              direct sales where we attend major trade shows and call on the customer
              directly; bus distributors who sell buses to the customer, and we can
‘piggy
              back’ on their sales activity; and communications companies who also call
              directly on school districts selling radio communication equipment
              and see our
              products as another revenue generating tool.
 
 In
              the
              Digital Cities arena we have an informal relationship with a large
              software
              developer called SAP. We have supplied them development Mini-T TM units and they
              are currently developing application software on our technology platform.
              End
              user pilots were started in 2006 with the product, and continue through
              the date
              of this report.
 
 We
              are
              also developing relationships with a number of security based companies
              that
              have openings in the mass transport market for either or Travado TM or Mini-T TM
systems.
 
 We
              believe that maintaining a close relationship with our customers and
              providing
              them with ongoing technical and marketing support is essential to end
              user
              customer satisfaction in the radio based wireless and semiconductor
              communications industry. Our staff interacts with customers during
              key stages of
              design and production, provides customers with current product application
              notes
              and engineering data, maintains regular contact with our customers’ sales and
              installation teams, and assists in the resolution of technical problems.
              We
              intend to assign a contract account manager to our largest customers,
              who will
              maintain regular contact with the customer to determine their product
              needs and
              concerns. Members of senior management are also involved with the sales
              process
              and intend to be involved in managing relationships with significant
              customers.
              As is typical of other new technologies, our location-based technologies
              can
              have a lengthy sales cycle that requires extensive application engineering
              support. We support potential customers’ activities and consider such support an
              important element of our sales and marketing efforts.
 
 We
              hired
              a part-time marketing brand manager for our Gotcha!® product in 2004. The
              marketing manager is responsible for finding and integrating distribution
              channels for Gotcha!® into marketplaces worldwide. Her role has since expanded
              to include the Travado TM product line. We are currently in discussion with a
              number of potential distribution partners in North America and elsewhere.
              We
              have also recently entered non-disclosure agreements and into negotiations
              with
              new distributors for our Gotcha!® products, one for schools in the United
              States, one for distribution services in Canada, and one for distribution
              services in Europe.
 
 We
              are
              marketing our location products worldwide through our internal sales
              resources
              including our website and other contract-based marketing resources
              located
              throughout the U.S., primarily in the school transportation sector.
              Additionally, senior management devotes substantial time and effort
              to
              developing customer relationships and contracts.
 12
 **Table
                  of Contents**
 **Index
                  to
                  Financial Statements**
  As
              of the
              date of this report, we have ongoing discussions with potential distributors
              of
              Travado IBUS TM in Arizona, Nevada, California, New York, Colorado, New Mexico,
              Washington, and Texas. Our primary focus as a Company this coming year
              is to
              develop and sell this product into the education, public safety, and
              related
              markets.
  **Location
              Tools and Location Services Industry**
 
 The
              market for Location Tools with GPS-enabled products is projected to
              grow during
              the next few years. According the Research & Consulting Outsource Services,
              the worldwide GPS market will reach $22B by 2008 ("World Global Positioning
              Systems Market Forecast (2006-2008)”, published March, 2006). We believe that
              the following are among the key factors underlying the projected industry
              growth
              in both business and consumer markets now and in the near
              future:
 ·
                  improved
                        accuracy of GPS will lead to an increase in the functions
                        of devices using
                        GPS;
 ·
                  additional
                      functions capable of being installed in devices addressing
                      GPS
                      applications;
 ·
                  increased
                      efficiencies in being able to track valuable
                      assets;
 ·
                  the
                      ability to provide relevant information (e.g. traffic reports,
                      weather
                      reports, location of stores and restaurants relative to the
                      location of
                      the vehicle) to occupants of passenger
                      vehicles;
 ·
                  the
                      ongoing miniaturization of technology products;
                      and
 ·
                  the
                      trend toward combining navigation, communications, and information
                      technologies in a single device for use in
                      vehicles.
  To
              date,
              many market leaders in the location services industry have concentrated
              primarily on vehicle or asset tracking segments of the markets associated
              with
              providing information to owners of fleet vehicles or assets. Real time
              tracking
              information of a vehicle or asset is often delivered by linking a GPS
              receiver
              to a device that is connected to a cellular network, allowing location
              of the
              vehicle or asset to be automatically transmitted to a base station
              via the
              Internet twenty-four hours a day. The user can, if needed, immediately
              contact
              an appropriate provider of emergency services. In addition, this allows
              those
              parties who are monitoring the location of the vehicle or asset to
              ensure that
              delivery and service fleet operations are using the most effective
              method of
              getting to a location, or to dispatch roadside assistance and emergency
              services, such as police or ambulances. The primary users include owners
              of
              expensive vehicles. This market is a segment of the overall GPS Telematics
              services market. The GPS Telematics market includes all vehicle mounted
              GPS
              systems that report their location remotely, typically using cellular
              phone
              related devices. In October 2002 market consulting firm Frost and Sullivan
              reported that revenue from this market segment exceeded $1B in 2003,
              and that
              the segment market may surpass $2.1B by 2008. Emergency assistance
              mandates,
              such as the U.S. Federal Communications Commission’s E911 Phase II initiative
              that require the manufacturers of cell phones and the providers of
              wireless
              communication to ensure that the location of a cell phone user can
              be determined
              with relative accuracy in emergency situations may also expand other
              wireless
              location product opportunities.
 
 NSC
              has
              decided to concentrate in a specialized segment of this market, the
              School Bus
              market. By combining a number of technologies namely DVR, student tracking,
              and
              GPS we have developed a product that offers a number of compelling
              features and
              benefits.
 
 In
              the
              2002-03 school year, it was estimated by School Bus Fleet that there
              were 25.4
              million pupils transported daily by 470,395 school buses. The buses
              traveled a
              total of 4.3 billion miles annually, and in excess of $12B was spent
              in
              operating them during that time. We believe that this figure will be
              the same or
              high for schools in school year 2006-2007.
 
 In
              the
              United States, School Districts purchased a total of 41,699 new buses
              in 2004 an
              increase of 12.7% from 2003. It was further estimated by School Bus
              Fleet that
              in the school year 2004-05 only 19% of the respondents to their survey
              had video
              in more than 60% of their fleet. In fact over 40% of the respondents
              had less
              than 20% of their fleet equipped with video. Regarding child tracking
              there are
              less than 3% of buses equipped with this technology.
 13
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
  **Location
            Tools Customers**
  Our
              ideal
              customers for Travado IBUS TM are school districts that have fleet in excess of
              30 buses, where they can gain significant savings in time and effort
              in
              maintaining their video recording equipment and tape libraries. We
              reach these
              potential customers through a variety of avenues mentioned above. We
              also have
              had interest in this product from both the military and homeland security
              who
              are both interested in a more rugged version of our product.
 
 We
              will
              continue to market Mini-T TM through partners such as SAP and let our
              applications provider provide most of the initial sales effort.
 **Location
            Tools Products - Government Regulation**
 Since
              our
              location-based products are based on the use, in most cases, of radio
              technology, we are required to comply with a variety of Federal, State,
              and
              local regulations regarding the use of radio devices. The primary set
              of
              regulations that concerns our products are those promulgated by the
              Federal
              Communication Commission, or FCC, which is tasked with managing the
              use of the
              radio spectrum in the United States. We have two strategies for compliance
              with
              these regulations. First, we have certain products, such as our Gotcha!® child
              safety product, which we have independently tested and certified for
              compliance
              by the FCC or their approved third party laboratories. In the case
              of Gotcha!®,
              we achieved this certification, called a Grant of Equipment Authorization,
              on
              July 26, 2003, and we were issued FCC identifier number Q79-703 as
              a result.
              This process typically takes several months and creates testing costs
              of between
              $5,000 and $10,000 per device certification. In other cases, we elect
              to
              purchase complete and certified radio systems to incorporate into our
              products
              that have already achieved this certification. This is the case with
              our Travado
              IBUS TM product, which uses 2.4GHz Wi-Fi radios manufactured by a supplier
              of
              ours that has already achieved this certification. Using this second
              approach
              typically accelerates time to market over the first approach outlined,
              but may
              add to the cost of manufacturing the product over the long term.
 
 In
              November 2004, we received radio frequency use approval from the government
              of
              Canada for our Gotcha!® product, known as “CA” approval, IC: 5521A-P and IC:
              5522A-C for the parent unit and child unit, respectively. This is one
              of the
              steps required to sell products like Gotcha!® in Canada.
 
 For
              markets outside the United States, we may be required to comply with
              other
              government regulations regarding the use of radios. For example, the
“CE”
certification, formally called the “European Union EMC” program, has
              similarities in part to the FCC certification program in the United
              States.
              While we design our products to meet this and other important international
              regulations, we have not formally applied for the “European Union EMC”
certification on any of our products, but may choose to do so in the
              future,
              when we believe we have more time to devote to developing sales channels
              in
              those international markets. We may also be required to comply with
              government
              regulations regarding the export of certain kinds of technology. To
              date, we
              have no plans to export our technology to areas where such special
              U.S.
              government export restrictions might be in force, such as to Cuba.
 
 An
              important additional aspect of FCC government regulation that affects
              our
              location tools products is the management of the cellular airwaves.
              In
              particular, the FCC mandate entitled E911-Phase II puts a burden on
              cellular
              network operators to provide position information of cellular phone
              users to
              within approximately 100 feet of accuracy in the very near future.
              Some cellular
              network operators can provide this today. We believe that some of our
              products
              based on cellular devices and GPS can in the future be manufactured
              without the
              GPS unit, while still being able to accurately determine location.
              This may
              allow us to penetrate new markets by lowering the cost and size of
              some of our
              products.
 14
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
 **Location
              Tools Products - Environmental Regulation**
 
 There
              are
              few if any special environmental compliance concerns unique to us that
              would be
              different than those that apply to other design companies in the United
              States
              in general. This is principally because we use third parties to manufacture
              and
              distribute our location tools products, and in the opinion of management,
              the
              significant environmental risks associated with our electronic products
              relate
              to the manufacturing of these units, not the design function.
 **Location
              Tools Products - Research and Development**
 
 Over
              the
              last two full fiscal years, we have spent approximately $577,000 directly
              accounted for as pure research and development of our products overall,
              including semiconductor products and location tools products. In addition
              to
              these direct expenses, our small staff spends considerable time and
              indirect
              resources in this area, and we estimate that in excess of 50% of the
              available
              personnel resources are involved in research and development of our
              location
              tools products over the last three years. We have conducted several
              simulations
              and/or developed working prototypes of most of our products. We have
              successfully developed and sold several location products, most prominently
              our
              Travado IBUS TM products. We will continue to conduct research in several areas,
              especially for new location services products, however most of the
              ongoing
              effort will now be switched to sustaining development that will concentrate
              on
              extended product testing and refinement. Our limited research into
              new location
              tools products is expected to be in military tracking markets, and
              first
              responder safety markets.
 
 In
              late
              2004, we entered into a joint research and development program with
              TurboWorx of
              Connecticut. This firm specializes in developing computing software
              that can
              efficiently handle large amounts of information by spreading its load
              macros
              across many smaller computer systems. Given the large amount of information
              produced by our location devices, especially video information, our
              engineers
              believe that this TurboWorx technology may offer us great advantages
              as our
              product lines develop. This work remains long term on our product road
              map, but
              due to series financial difficulties at TurboWorx, they no longer play
              an active
              role for us in any immediate product plans (See *Strategic
              Relationships Including Marketing Firms, Material Suppliers, and
              Distributors* below).
 
 We
              have
              also worked closely with the research arm of SAP on the development
              of certain
              features in our Mini-T TM products (See *Strategic
              Relationships Including Marketing Firms, Material Suppliers, and
              Distributors* below).
 
 The
              following table summarizes the current development status of each of
              our current
              location tools products. The categories below have the following
              meanings:
 ·
                  “Product
                      Name” refers to the device we described in the section just
                      above;
 ·
                  “Proof
                      of Concept Prototype Built” means that we produced early samples in a
                      laboratory or test facility to demonstrate the concept of the
                      product’s
                      viability in a limited fashion. These early prototypes are
                      not useful for
                      commercial sale without additional research and development,
                      and will
                      likely not be available for testing by third
                      parties;
 ·
                  “Pre-Production
                      Prototype Tested and Available” means a form of the product was created
                      and tested that would be directly useful for commercial sale,
                      should we
                      decide to manufacture it on a large enough scale, and that
                      interested
                      third parties may receive samples from us that they can fully
                      test in
                      their own environment, should they so
                      desire;
 ·
                  “Design
                      Available for Licensing from Us” means that we either hold patent rights
                      or other trade secret rights to create this product, and that
                      we are able
                      and willing to enter into agreements with other parties for
                      them to
                      license from us these rights for their
                      use;
 ·
                  “Production
                      Device Available for Sale” means that either we or another third party
                      under license to use is manufacturing this product currently,
                      and is
                      offering it for general sale in the marketplace
                      today.
  15
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
 
 **Pre-Production**
                  
                  
                  **Design**
                  
                  
                  **Production****Proof
                      of**
                  
                  
                  **Prototype**
                  
                  
                  **Available**
                  
                  
                  **Device****Concept**
                  
                  
                  **Tested**
                  
                  
                  **For
                      Licensing**
                  
                  
                  **Available****Product
                      Name**
                  
                  
                  **Prototype
                      Built**
                  
                  
                  **&
                      Available**
                  
                  
                  **From
                      Us**
                  
                  
                  **For
                      Sale**Travado
                      IBUS TM System
                  
                  
                  Complete
                  
                  
                  Complete
                  
                  
                  Yes
                  
                  
                  YesTravado
                        TM Mini or Mini-T TM
                  
                  
                  Complete
                  
                  
                  Complete
                  
                  
                  Yes
                  
                  
                  YesGotcha!®
                  
                  
                  Complete
                  
                  
                  Complete
                  
                  
                  Yes
                  
                  
                  YesWiFi
                      Tracker TM
                  
                  
                  Complete
                  
                  
                  Complete
                  
                  
                  Yes
                  
                  
                  Yes
  **Location
              Tools** - **Patents
              and Trademarks**
 
 We
              were
              granted a United States trademark on our Gotcha!® location tool for child safety
              applications in May of 2004.
 
 **Location
              Tools Products and Services Competition**
 
 The
              market for communications and information products related to location-based
              services is highly competitive and we expect competition to increase
              in the
              general marketplace. We believe that the principal competitive factors
              that will
              differentiate the various competitors in this marketplace will be product
              features, quality, customer service, brand, advertising, price positioning,
              time-to-market, and availability. The market for GPS-based products
              is
              relatively recent as a direct result of the U.S. Government’s removal of the GPS
              based filters in May 2000 to allow for more accurate tracking. Many
              of the
              companies in the vehicle tracking market have expensive systems that
              are
              permanently installed into the vehicle and often involve a fee-based
              monthly
              subscription service. Most of our products are removable, and some
              can be used
              without incurring any monthly airtime charges. Many GPS device vendors
              have been
              offering products to the marine, aviation, and outdoors enthusiast
              markets for
              several years. We do not generally compete in those markets. For the
              personal
              safety locating products markets, we consider our principal competitors
              in the
              consumer market to be Wherify, Digital Angel, Angel Alert, and Child
              Guard. For
              our commercial vehicle and asset tracking markets, our principal competitors
              include @Road, Axiom Navigation, ALK, and Thales Navigation. There
              are
              approximately 100 other smaller companies offering similar products
              and services
              that we presently offer. There is significant other competition from
              large
              competitors in the GPS/Navigation market, including General Motors-OnStar®
system. We have no current plans to directly compete with major automotive
              suppliers for in-vehicle navigation solutions, due to the amount of
              resources
              required to successfully compete.
 
 Regarding
              the School Bus market there are three distinct segments in which we
              operate.
              These are Bus Tracking, Video Recording, and Student Tracking.
 
 In
              the
              Bus Tracking segment there are currently 13 companies offering GPS
              based school
              bus tracking and another 22 dabbling in the periphery of tracking systems,
              such
              as route and fleet optimization. The most notable competitors in this
              segment
              are @Roads, Every Day Wireless, and Honeywell Video Systems. Most of
              these
              systems currently require the user to go to the bus and plug in a computer
              drive
              of some kind in order to download the data, others only display the
              GPS
              co-ordinates and speed on a tape or DVR recording. Our system allows
              users to
              automatically download and map the route as well as displaying speed
              and
              location on a DVR recording.
  16
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  In
              the
              Video Recording segment there are at least 22 competitors all offering
              a
              conventional tape recorder style product. When you look at those offering
              DVR
              this number drops to 12. These product all require the ‘video technician’ to go
              out to the bus to collect the hard drive and then download the contents
              at a
              special workstation. With our product users do not need to go out to
              the bus to
              get video. A user can be at a different location and request and get
              the desired
              video. Notable competitors in this segment are Honeywell Video Systems,
              Gatekeeper, REI, and Seon.
 
 In
              Student Tracking we were only able to determine one competitor of note,
              Every
              Day Wireless.
 
 When
              you
              consider that each of these three components bought individually as
              stand alone
              products can cost well in excess of $6,000 per bus, the NSC Travado
TM product
              offers significant competitive advantage as our retail price is significantly
              less than this figure, often less than 1⁄2 of this amount, depending on the volume
              requirements and features requested by a given customer.
 
 **Semiconductor
              Products**
  **Overview**
 
 The
                semiconductor products market is of secondary focus for us because
                we believe
                that we have a better chance of generating revenue from the sale
                of our location
                tools. This is based on our assessment of the current state of the
                semiconductor
                market, the current level of maturity of our semiconductor products,
                the skills
                of our staff, and our current size and capital structure. However,
                we believe
                that over a long period of time we may be able to extract value from
                the
                semiconductor products we have, because none of our patents in this
                area will
                expire until at least 2017 if we continue to pay required patent
                maintenance
                fees, which we intend to do. As a result, we continue to operate
                in this market,
                although we commit very few current resources to it, relative to
                what we commit
                to the location tools market.  We
                intend
                to maintain key elements of our portfolio of semiconductor intellectual
                property
                because we believe there is potential for the products we might offer
                to
                prospective licensees in the future, as the technology required to
                manufacture
                some of these designs is developed by others. There is no assurance
                that the
                technology required to manufacture some of these designs will ever
                be developed,
                or that when it is developed, that our patents will still be
                enforceable.
 
 The
                largest target market for our products is the electronic memory market,
                which is
                the target for our TMOS® product. Electronic memory is used widely in many
                computer related products, such as personal computers. Our other
                patents tend to
                fall into the “discrete device market,” which the Semiconductor Industry
                Association (SIA) defines as discrete components including power
                transistors and
                radio frequency solutions that are found in wireless consumer products.
                These
                kinds of products are used widely in radios. These technologies form
                an
                important part of communications systems worldwide through voice
                and data
                communications networks, cordless and cellular wireless telephony
                systems and
                emerging cable and wireless broadband communications networks. Our
                sales and
                marketing efforts for semiconductor products are limited to our web
                presence on
                our own internet site, our presence in the United States Patent and
                Trademark
                office database and website.
 
 We
                filed
                patent applications on a number of product designs between 1997 and
                2002
                relating to semiconductor products. During this time we brought eight
                major
                research and development projects to the patent or patent application
                stage. The
                United States Patent and Trademark Office, the USPTO awarded our
                first U.S.
                patent June 15, 1999. All of our products in this area are based
                on paper
                designs, with limited laboratory work having been performed on some
                of them. Our
                primary semiconductor and electronic device products and related
                patent filings
                include the following areas:
 17
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **Product
                      Name**
                  
                  **Use
                      and Function of Product**Heterojunction
                      Bipolar Transistor
                  
                  Used
                      in the manufacture of digital circuits found in devices such
                      as cellular
                      phones, personal computers and automotive circuitry. Transistors
                      provide
                      electronic control over current flow, and are a part of many
                      electronic
                      circuits. Heterojunction bipolar transistors are used most
                      frequently in
                      power amplifiers, radio frequency integrated circuits and other
                      circuits.Monolithic
                      Inductor
                  
                  Used
                      in a wide range of electronic circuits for telecommunications
                      applications. The inductor’s most common application is as a component of
                      a radio frequency circuit used to manipulate radio waves into
                      certain
                      other electrical signals. The inductor does this, usually in
                      conjunction
                      with a capacitor, by producing an amplified current when stimulated
                      by a
                      specific frequency of radio signal.Distributed
                      Amplifier
                  
                  Used
                      in all electronic products that require some level of power
                      increase such
                      as telecommunications, microwave, internet communications,
                      automotive and
                      bio-medical products as well as automated manufacturing
                      products.TMOS®
                      Memory
                  
                  Used
                      in digital computing devices such as microcomputers and workstations
                      and
                      battery powered devices such as personal data appliances and
                      cellular
                      phones that require a memory function.Mode
                      Dielectric Resonator
                  
                  Used
                      in many applications including microwave oscillators, narrowband
                      microwave
                      filters, radar detectors, speed guns, automatic door openers,
                      cellular
                      portable phones, and global positioning satellites. The resonator’s most
                      common application is as a component of a radio frequency circuit
                      used to
                      manipulate radio waves into certain other electrical signals.
                      The
                      resonator does this by producing a current of predictable size
                      when
                      stimulated by a specific frequency of radio signal.High
                      Frequency Wireless Transceiver
                  
                  Allows
                      the transmission and reception of radio waves and is used in
                      a variety of
                      wireless devices.Communications
                      Receiver with Integrated IF Filter and Method Therefor
                  
                  This
                      device is intended to allow for the self-tuning of certain
                      radio elements,
                      such as the VCO. We believe this self-tuning function could
                      allow
                      manufactures of VCO and related devices to produce more accurate
                      ratios at
                      a lower price, since the post-manufacturing tuning process
                      many use today
                      could be skipped.
  **Semiconductor
              Products - Patents and Trademarks**
 
 We
              have
              applied for U.S. patents relating to these technologies, most of which
              have
              already been issued. These include the following, all of which have
              a 20-year
              life following date of filing.
 **Expected****Patent****Expiration****Product
                      Name**
                  
                  **Summary
                      of Patent Information**
                  
                  **Date**Heterojunction
                      Bipolar Transistor
                  
                  On
                      September 29, 1997, we filed a U.S. Patent application for
                      a
                      Heterojunction Bipolar Transistor (HBT). U.S. Patent 5,912,481
                      was issued
                      for this device on June 15, 1999. We were also successful in
                      our
                      Continuation in Process application on this device, as the
                      United States
                      Patent and Trademark Office issued us a patent on January 9,
                      2001 under
                      U.S. Patent 6,171,920, covering intellectual property required
                      to
                      manufacture this transistor. The assignment of this patent
                      to us is
                      recorded at USPTO at reel no: 0111356, frame 0934.
                  
                  Sep.
                      2017
 
 18
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **Expected****Patent****Expiration****Product
                        Name**
                    
                    **Summary
                        of Patent Information**
                    
                    **Date**Monolithic
                        Inductor
                    
                    On
                        October 31, 1997, we filed a U.S. Patent application for
                        a Monolithic
                        Inductor. The U.S. Patent Office issued a Notice of Allowance
                        for this
                        application on September 7, 1999. U.S. Patent 6,013,939 was
                        issued for
                        this device on January 11, 2000. We were also successful
                        in our
                        Continuation in Process application on this device, as the
                        United States
                        Patent and Trademark Office issued us a patent on August
                        28, 2001 under
                        U.S. Patent 6,281,778. The assignments for these patents
                        to us are
                        recorded directly on the issued patent from the USPTO.
                    
                    Oct.
                        2017Distributed
                        Amplifier
                    
                    On
                        July 10, 1998, we filed a U.S. Patent application for a Distributed
                        Amplifier. The U.S. Patent Office issued a Notice of Allowance
                        on this
                        application on September 29, 1999. U.S. Patent 6,008,694
                        was received for
                        this device on December 28, 1999. On May 23, 2001, we a filed
                        a U.S.
                        Patent application for a Monolithic Balanced RF Power Amplifier,
                        another
                        version of this product. U.S. Patent 6,424,227 was issued
                        for this device
                        on July 23, 2002.The assignments for these patents to us
                        have recorded
                        directly on the issued patents from the USPTO.
                    
                    Jul.
                        2018TMOS®
                        Memory
                    
                    On
                        December 17, 1997, we filed a U.S. Patent application for
                        a High
                        Performance N-Channel Metal-Oxide-Semiconductor (NMOS) Static
                        Random
                        Access Memory (SRAM). U.S. Patent 6,104,631 was received
                        for this device
                        on August 15, 2000. We were also successful in our Continuation
                        in Process
                        application on this device, as the United States Patent and
                        Trademark
                        Office issued us a patent on October 9, 2001 under U.S. Patent
                        6,301,147.
                        The assignment of these patents to us is recorded directly
                        on the issued
                        patents from the USPTO.
                    
                    Dec.
                        2017Mode
                        Dielectric Resonator
                    
                    On
                        June 18, 1998, we filed a U.S. Patent application for a Mode
                        Dielectric
                        Resonator. The U.S. Patent Office issued a Notice of Allowance
                        for this
                        application on August 1, 2000. The U.S. Patent and Trademark
                        Office issued
                        us U.S. Patent 6,169,467 for this device on January 2, 2001.
                        The
                        assignment of this patent to us is recorded at USPTO at reel
                        number:
                        011358, frame 0462.
                    
                    Jun.
                        2018Communications
                        Receiver with Integrated IF Filter and Method Therefor
                    
                    On
                        April 11, 2001, we filed a U.S. Patent application for a
                        Communications
                        Receiver with Integrated IF Filter and Method Therefor. The
                        U.S. Patent
                        and Trademark Office issued us U.S. Patent 6,885,853 for
                        this device on
                        April 26, 2005.
                    
                    Apr.
                        2021
  We
              have
              filed patent applications for other semiconductor-related patents since
              2000,
              including some improvements to the above existing products as well
              as on related
              devices. The commercial importance of these inventions and the final
              disposition
              of these applications are uncertain. At this time, we are not actively
              pursuing
              patent protection outside the United States for these semiconductor
              products. We
              also hold the U.S. trademark to the word TMOS®, awarded to us July 1, 2003, U.S.
              Trademark registration number 2732825. The commercial significance
              of this
              patent award and any new provisional patent filing are not known at
              this
              time.
 19
 **Table
                    of Contents**
 **Index
                    to Financial
                    Statements**
  **Semiconductor
              Products - Government Regulation**
 
 Since
              our
              semiconductor products are used, in most cases, as parts of radios,
              our
              customers are required to comply with a variety of Federal, State,
              and local
              regulations regarding the use of radio devices. The primary set of
              regulations
              that concern our customers’ products are those promulgated by the Federal
              Communication Commission, or FCC, which is tasked with managing the
              use of the
              radio spectrum in the United States. However, since this is our customers’
responsibility and not ours, we do not believe we are subject to any
              special
              level of government regulation in this line of business other than
              that which
              would be faced by other U.S. Companies in general.
 
 We
              may
              also be required to comply with government regulations regarding the
              export of
              certain kinds of technology. To date, we have no plans to export our
              technology
              to areas where such U.S. government export restrictions might be in
              force, such
              as to Cuba.
 
 **Semiconductor
              Products - Environmental Regulation**
 
 There
              are
              numerous environmental regulations that affect the manufacturing of
              semiconductor products in general. However, there are few if any special
              environmental compliance concerns unique to us that would be different
              from
              those that apply to other companies in the United States in general.
              This is
              principally because we use third parties to manufacture and distribute
              our
              semiconductor products, as our business model is based on licensing
              our designs
              to others, who then bear the main costs of complying with the environmental
              rules that directly relate to manufacturing these final goods. Should
              any single
              manufacturer be subject to special enforcement action in this area,
              we would
              retain the right to switch to another manufacturer, as we currently
              have no
              exclusive manufacturing relationships in this area.
 
 **Semiconductor
              Products - Research and Development**
 
 We
              have
              conducted little research and development of our semiconductor products
              since
              2002. Since fiscal year 2002, we have spent less than $25,000 on research
              and
              development of our semiconductor products and $13,800 for legal services
              required to protect patents for all of our products.
 
 The
              following table summarizes the current development status of each of
              our current
              semiconductor products.
 **Pre-Production**
                  
                  **Design**
                  
                  **Production****Proof
                      of**
                  
                  **Prototype**
                  
                  **Available**
                  
                  **Device****Concept**
                  
                  **Tested**
                  
                  **for
                      Licensing**
                  
                  **Available****Product
                      Name**
                  
                  **Prototype
                      Built**
                  
                  **&
                      Available**
                  
                  **From
                      Us**
                  
                  **For
                      Sale**TMOS®
                      Memory
                  
                  Complete
                  
                  No
                  
                  Yes
                  
                  NoMode
                      Dielectric Resonator
                  
                  Complete
                  
                  Complete
                  
                  Yes
                  
                  NoHigh
                      Frequency Wireless Transceiver
                  
                  Complete
                  
                  No
                  
                  Yes
                  
                  NoDistributed
                      Amplifier
                  
                  Complete
                  
                  No
                  
                  Yes
                  
                  NoMonolithic
                      Inductor
                  
                  Complete
                  
                  No
                  
                  Yes
                  
                  NoHeterojunction
                      Bipolar Transistor
                  
                  No
                  
                  No
                  
                  Yes
                  
                  NoCommunications
                      Receiver Filter
                  
                  No
                  
                  No
                  
                  No
                  
                  No
 20
 **Table
                    of Contents**
 **Index
                    to Financial
                    Statements**
 **Strategic
              Relationships Including Marketing Firms, Material Suppliers, and
              Distributors**
 
 This
              section covers relationships that may involve both location tools products
              and
              semiconductor products, as some of these suppliers and distributors
              may be
              active in both areas. However, since most of our business activity
              since 2002
              relates to the location tools products, you can assume unless otherwise
              stated
              below that the primary purpose of these relationships has to do with
              the
              location tools product line.
 
 In
              September 2006 we entered into an informal agreement with Zepco (a
              manufacturer
              and distributor of automotive data recorders) located in Richardson,
              Texas, to
              distribute our Travado Product in Texas. To date there have been several
              significant Requests for Quotation (RFQ) generated from this
              relationship.
  In
              April
              2006 we entered into an informal agreement with Applied Preventative
              Maintenance, LLC company, located in Seattle Washington as a Travado
              representative to represent our products in the Northwest USA. To date
              there
              have been several significant RFQ’s generated from this
              relationship.
 Throughout
              2006 we were successful in having our Travado product specified into
              several
‘new bus orders’, which had to subsequently be submitted for competitive bid to
              the bus distributors by the school districts, as such we have had an
              increasing
              presence in the bus distributor market. We expect to se a significant
              number of
              units being ordered by these distributors during the first calendar
              quarter of
              2007.
 
 In
              May of
              2005, we began to work with SAP on developing a specialized version
              of our
              Mini-T TM product targeted at large-footprint Wi-Fi networks. Our initial goal
              was to develop a version of our Mini-T TM product for a pilot in Corpus Christi,
              Texas, in August of 2005. SAP’s primary interest was in developing an
              application solution that could extract data from our Mini-T TM, and present
              powerful reports and mapping information to prospective SAP customers.
              In August
              of 2005, Michael Grollman and David Mandala of our staff participated,
              along
              with SAP, IBM, Intel, Verizon, and others, in a presentation of the
              capabilities
              of our systems to the City of Corpus Christi. The presentation included
              tracking
              police vehicles using a large Wi-Fi network (with redundant cellular
              capabilities). Our presenters believe the demonstration was exciting
              and
              successful, SAP, the City of Corpus Christi and the City of Palo Alto
              have both
              purchased from us small quantities of our Mini-T TM product for further testing,
              and we expect to work with these parties and new pilots, as well as
              more
              expansive systems, during calendar year 2007.
 
 In
              the
              early part of 2005 we began working with Auto Safety House (ASH), a
              recognized
              leading distributor of Thomas Built Buses in Arizona and Nevada, to
              develop
              channel sales for our Travado IBUS TM product in the local area. As of the date
              of this report, ASH submitted four purchase orders for IBUS TM systems to be
              installed on their clients’ buses. Our product is now listed on the Mohave
              Educational Services Co-operative through our Arizona and Nevada distribution
              partner, ASH. This Co-operative allows us to sell our products directly
              to the
              school districts in Arizona without going through a formal bid
              process.
 
 In
              December 2004 we signed an agreement with LDL Enterprises in Palm Springs,
              California. Under this agreement Dr. Marcile Wright, EDD, CEO of LDL
              Enterprises, is to provide marketing services in California for various
              NSC
              products, especially Travado IBUS TM technology. This is a commission-only
              agreement, with a one-year term, and is nonexclusive. This agreement
              was not
              extended in 2006.
 21
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
 In
              November 2004, we entered into a distributor agreement with Ingram
              Micro of
              Canada. The material terms of this agreement required us to pay regular
              fees to
              Ingram Micro based on the number of products we stock with them in
              Canada, in
              exchange for their promotion and distribution of our products with
              their
              Canadian resellers, which include firms such as Radio Shack and Wal-Mart
              of
              Canada. Either party with 30 days notice can cancel the agreement.
              We plan to
              distribute Gotcha!® as well as potentially other products, including some new
              video-related products we may acquire as part of a developing strategic
              relationship with Aethra of Italy, a leader in video technology, an
              UR Group of
              Italy. In November 2004, we shipped an initial quantity of Gotchas
              to Ingram
              Micro in Canada on consignment. We believe Ingram Micro and others
              have been
              unable to deliver on their end of the distribution agreement, in part
              perhaps
              due to turnover of some key managers there. The product is still located
              in
              Canada, and has been fully marked down in our inventory.
 
 In
              October 2004, we commenced a new strategic working relationship with
              TurboWorx,
              Inc. (“Turbo”) regarding joint technology development and cooperative marketing.
              The relationship was first memorialized in a Memorandum of Understanding
              (“MOU”)
              in early November 2004. The two companies see benefit in connecting
              NSC’s
              location sensor technology to the computing engines developed by TurboWorx.
              In
              November 2004, we entered into a Letter of Intent (“LOI”) with Turbo regarding a
              stock exchange transaction with Turbo, for an amount of stock equal
              to less than
              10% of the outstanding common stock of each company and the payment
              of cash by
              Turbo to NSC. The LOI contemplated a due diligence process prior to
              the share
              exchange, as well as a Securities Exchange Agreement (the “Share Exchange
              Agreement”) to memorialize the proposed exchange. A Share Exchange Agreement
              was
              entered into on January 28, 2005 and the transaction was closed on
              February 1,
              2005. We have exchanged 7,150,000 shares of our restricted common stock
              for
              360,000 shares of Turbo common stock plus $240,000. We have agreed
              to distribute
              at least 50% of the Turbo shares to our shareholders after Turbo registers
              such
              shares on Form SB-2. Both Turbo and NSC granted each other “piggyback”
registration rights with regard to the exchanged shares. In conjunction
              with the
              transaction, the Company agreed to pay the placement agent, Casimir
              Capital
              $25,000 and issued warrants to purchase 800,000 of the Company’s common stock on
              February 3, 2005 at an exercise price of $0.11 per share. The fair
              value of the
              warrants and the cash consideration of $240,000, was taken into consideration
              when recording the investment, however the consideration paid to Casimir
              did not
              increase the fair value of the investment and therefore, was impaired.
              The
              agreement provides the Company to receive reimbursement from Turbo
              for all our
              legal and accounting expenses associated with this transaction, up
              to a maximum
              of $150,000. Our claims to date for reimbursement of expenses totaling
              approximately $38,200 were paid in May 2005. On July 7, 2005, TurboWorx
              received
              a comment letter from the U.S. Securities and Exchange Commission in
              response to
              its first June 6, 2005 filing of Form SB-2. TurboWorx filed an amended
              registration statement or Form SB-2/A. TurboWorx addressed the SEC’s comments
              fully and filed an amended registration statement or Form SB-2/A on
              October 12,
              2005. This filing was subsequently withdrawn by TurboWorx, which we
              believe puts
              TurboWorx in breach of their Share Exchange Agreement with us. We are
              pursuing
              legal action as a result of this breach, and have stopped any distributions
              of
              their stock from us until this matter is settled. O n
              September 30, 2006, we took an impairment charge of $289,100 against
              our
              investment in TurboWorx, Inc. The
              Company’s investment in these equity securities was carried at $289,100 at
              September 30, 2005, which included an impairment charge of $91,344
              in fiscal
              2005. The Company regularly monitored this investment for impairment
              in the
              carrying value, and as a result of this monitoring, we determined in
              September
              2006 that is was appropriate to impair this investment up to its full
              value, due
              to serious financial distress we believe is happening at
              TurboWorx.
 On
              October 1, 2004, we changed our stock transfer agent from Corporate
              Stock
              Transfer (“CST”) of Colorado, to Computershare Investor Services of Illinois
              (“Computershare”). The new contact information for our stock transfer agent is
              Computershare Investor Services, 2 North LaSalle Street, Chicago, IL,
              60602, and
              their telephone number is 312-588-4753. The principle reason for the
              change was
              to improve shareholder services, particularly online services, which
              in our
              opinion are much more developed at Computershare than they were at
              CST.
 
 In
              late
              summer of 2004 we began working with BearCom Wireless Worldwide in
              regards to
              the sale and distribution of our Travado IBUS TM product. Currently the only
              formal agreement between NSC and BearCom is a Non-Disclosure Agreement
              (NDA).
              BearCom is focused on marketing our Travado TM products in Florida.
 22
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
 In
              May of
              2003, we commenced an informal strategic co-development and co-marketing
              program
              with Ekahau, Inc. of Finland (“Ekahau”). The purpose of the program is to
              develop and co-market tracking products based on Wi-Fi technology,
              where we
              would make tracking hardware that would work cooperatively with tracking
              software made by Ekahau. Ekahau has developed a software application
              called the
              Ekahau Positioning Engine TM that can be used to determine location of Wi-Fi
              devices in a standard Wi-Fi network. We are developing a hardware product
              to
              interface with Ekahau’s software that can be attached to people or objects that
              are moving within Wi-Fi networks, to establish the real-time location
              of those
              people or objects. In December of 2003, we completed our first prototype
              of this
              Wi-Fi product, and displayed it with Ekahau at the Wi-Fi Planet Conference
              and
              Exposition in San Jose, California. Additional development of this
              product
              occurred during the spring of 2004, resulting in a new generation of
              products
              being introduced in August 2004. Customer feedback highlighted the
              need for
              extended battery life and Wi-Fi is not the ideal platform to maximize
              battery
              life. Therefore we redefined our product offering and amalgamated it
              into the
              Mini-T TM. For this aspect of technology, our relationship with Ekahau is
              documented by a source code licensing and non-disclosure agreement.
              Ekahau is a
              small privately held technology development company with a limited
              customer
              base.
 
 In
              May
              2003, we entered into a six-month agreement with New York-based Stanton,
              Walker
& Company (“Stanton Walker”) for business advisory and consulting services.
              Stanton Walker agreed to assist us in expanding our existing strategies
              for
              business growth as well as developing new strategies, such as merger
              and
              acquisition planning. We paid for the services of Stanton Walker using
              our
              common stock, valued at approximately $100,000 at the time of issue.
              We did not
              procure any services from Stanton Walker in calendar year 2005 and
              have not yet
              determined what additional services, if any, we may procure in the
              future.
 
 In
              March
              of 2003, we received a blanket purchase order for $250,000 of IBUS
TM technology
              from Verify Systems of Connecticut, originally planned for delivery
              before June
              of 2004. Shipments began against this order in May of 2003, for pilot
              testing
              during the summer of 2003. Testing was continued through two pilot
              programs. A
              third pilot program was conducted in Arizona starting in November of
              2003.
              Verify Systems was a small privately held technology development company
              with a
              limited customer base, very small operations, and limited assets. In
              May 2004,
              partially in response to Verify System’s failure to timely market our products,
              we agreed to license the marketing materials and software tools of
              Verify
              Systems and assume the primary sales effort for these products ourselves.
              The
              material terms of this agreement require that Verify Systems give us
              an
              unlimited and indefinite license to use their software products, in
              exchange for
              a cash payment of $6,000 and a royalty of 5% of sales of their software
              products
              over the next two years. In the fall of 2004 Verify Systems ceased
              operations.
              Subsequently we have developed our own proprietary software for use
              in our
              Travado TM systems and now no longer rely upon Verify Systems for this
              component.
 In
              December 2002, we entered into a development and co-marketing agreement
              with
              Geotechnolgies, Inc., a privately held small firm headquartered in
              Castle Rock,
              CO. Geotechnologies is a software development firm that specializes
              in making
              mapping software that we believe complements our location tools products.
              To
              date our activities with Geotechnolgies have been jointly developing
              and
              presenting solutions that involve our location tools products and their
              mapping
              products to various private sector and government prospective clients.
              March
              6-9, 2005, together with strategic partner Geotechnologies, Inc., we
              exhibited
              our Travado TM technology platform at the Geospatial Information and Technology
              Association (GITA) Annual Conference and Exhibition held in Denver,
              CO. This is
              a highly regarded educational event for geospatial professionals. No
              sales have
              resulted from these efforts to date, although we completed a demonstration
              project with them at the Army Proving Grounds, Yuma, Arizona, in the
              summer of
              2006.
  In
              June
              of 2002, we entered into an agreement with Followit AB, a Swedish technology
              firm, for international distribution of GPS products. The international
              distribution agreement, dated June 1, 2002, grants us non-exclusive
              distribution
              rights for the Followit TM locator product in the United States, Canada, and
              Mexico. The Followit TM locator product uses the Global Positioning System (GPS)
              and cellular technology, with a sophisticated mapping interface to
              provide
              tracking capabilities for a wide variety of assets or individuals.
              Distributor
              prices were defined in the agreement and payment terms are letter of
              credit and
              net thirty (30) days from the receipt by us of a correct invoice. The
              contract
              automatically renewed after one year unless either party provides written
              notice
              to end the agreement thirty (30) days prior to the automatic renewal
              period. At
              the current time, we do not anticipate that we will continue using
              their
              products other than on a rare special order basis, as we have developed
              our own
              tracking and location products, and our focus is not on markets that
              the
              Followit product is targeted at servicing. We continue to service existing
              Followit TM customers who purchased units from National Scientific Corporation
              and plan to continue to do so for the foreseeable future.
 23
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 Other
              key
              suppliers over the last three years also include Digi-Key Corporation
              of
              Minnesota for electronic components, Solar PC of Las Vegas, Nevada
              for circuit
              boards, Wireless To U for WiFi antennas and Hyperlink Technologies
              for Wi-Fi
              connectors. We purchase most of our GPS chipsets and GPS modules from
              distributors of US Global Sat. Our primary video camera supplier is
              Security
              Labs, Inc. We are not dependant on these particular suppliers, as there
              are
              alternative sources in the market for the kinds of component materials
              we use in
              our products. However, in the event we needed to change over suppliers,
              we may
              experience some small delays in time to market for certain products,
              or small
              increases in supply costs due to small design changes that may be required
              in
              our products because of such a change *.*
 **Personnel**
 
 As
              of the
              date of this report, we have two full time employees, five part time
              employees,
              as well as a number of part time relationships with contractors for
              certain
              services. Most employees work in the Scottsdale, Arizona corporate
              office.
              Management believes employee relations are good. None of our personnel
              are
              covered by collective bargaining agreements.
 
 **Subsequent
              Events**
 
 On
              October 20, 2006 NSC executed a lease for 1,601 square feet of office/warehouse
              space at 8361 E. Evans Road, Suite 106 Scottsdale, Arizona 85260. The
              lease for
              this Scottsdale facility commences on November 1, 2006 and expires
              October 31,
              2008 and is at a base rental rate of $1,963 per month before taxes.
 
 In
              December 2006 NSC completed Travado IBUS TM installations for schools district in
              Arizona including Amphitheater, Sunnyside, Gilbert, Mayer, and a small
              charter
              school, NOAH. We have completed our work in Oregon for Jefferson County
              schools
              on another Travado IBUS TM project.
 
 In
              December, 2006 NSC received a purchase order from Clover Park School
              District
              for approximately $400,000 of Travado IBUS TM systems. This work is expected to
              be initiated and largely completed in the first calendar quarter of
              2007.
 **Item
                    2.**
                  **Properties**
  NSC
            leases 1,601 square feet of office space at 8361 E Evans Rd, Suite 106,
            Scottsdale, Arizona 85260-6951. The lease for the Scottsdale facility
            expires
            October 31, 2008 and is at a rental rate of $1,963 per month before taxes
            for
            the remainder of the lease (See Subsequent Events above).
 
 Currently,
            the Company does not have a policy regarding investments in real estate,
            interests in real estate, real estate mortgages, or securities of or
            interests
            in persons primarily engaged in real estate activities.
 **Item
                    3.**
                  **Legal
                      Proceedin****gs**
  We
              are
              currently a plaintiff in one lawsuit, and a defendant in none.
  24
 **Table
                    of Contents**
 **Index
                    to Financial
                    Statements**
 In
              January 2002, we initiated legal proceedings in Maricopa County Superior
              Court
              against Phoenix Semiconductor, Inc. (“PSI”) for breach of contract. We engaged
              PSI, and advanced approximately $400,000 to PSI, to build thyristors
              (an
              electronic component) for us to sell. When we engaged PSI, we obtained
              a
              security interest in a portion of PSI’s equipment assets. Before we initiated
              legal action, both PSI and its principal shareholder Chongkook John
              Rhee filed
              for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.
              In
              December 2002, PSI and the NSC agreed to a settlement of the secured
              claim
              against PSI in the form of a cash payment of approximately $100,000
              to NSC
              together with certain other unsecured claims remaining. The cash payment
              is
              subject to a contracted sale of substantially all fixed assets of PSI
              and formal
              approval of the bankruptcy court. In late 2005, we received word that
              the
              bankruptcy court was likely to dismiss the PSI bankruptcy claim, due
              to a
              failure by the debtor in possession to timely file a reorganization
              plan.
              Although this may improve slightly our chances of collection in this
              suit, we
              are unsure of the current value of any PSI assets; therefore we are
              unable to
              determine the final outcome of the lawsuit. Since our collection of
              this
              judgment is uncertain, it is not reflected in our current financial
              statements.
 
 We
              filed
              a complaint in Maricopa County Superior Court in August 2002, seeking
              $155,550
              plus interest from E4World Corporation for breach of contract. We were
              awarded a
              judgment of $179,000 in May 2003 against E4World Corporation. We are
              now in the
              collection phase of this judgment, and, there is no assurance that
              we will
              collect any of this judgment. Since our collection of this judgment
              is
              uncertain, it is not reflected in our current financial statements.
              We continue
              to assert our claim to secure assets held by E4World in a separate
              legal
              matter.
 
 From
              time
              to time in the normal course of business operations, we are involved
              in other
              legal proceedings, none of which are expected to have a material adverse
              affect
              on business operations.
 
 **Item
                    4.**
                  **Submission
                      of Matters to Vote of Security
                      Holders**
 
 None.
 
   **PART
            II**
  
 **Item
                    5.**
                  **Market
                      for Common Equity and Related Stockholder
                      Matters**
 
 Our
              common stock is quoted and traded on a limited and sporadic basis on
              the OTC
              Bulletin Board operated by The NASDAQ Stock Market, Inc. under the
              trading
              symbol “NSCT.” The limited and sporadic trading does not constitute, nor should
              it be considered, an established public trading market for our common
              stock. We
              have 867 shareholders of record, also known as “registered shareholders,” of our
              common stock as January 10, 2007. The company also has more than 8,000
              unregistered shareholders, also known as “beneficial shareholders,” of our
              common stock. The following table sets forth the high and low sale
              prices for
              our common stock for the periods indicated, as reported by the OTC
              Bulletin
              Board, NASDAQ Trading and Market Services.
 25
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
  National
              Scientific Corporation - Market for Common Equity:
  **High**
                        
                        **Low****Fiscal
                            2006**Fourth
                            Quarter (through September 30, 2006)
                        
                        $
                        0.055
                        
                        $
                        0.026Third
                            Quarter (through June 30, 2006)
                        
                        $
                        0.060
                        
                        $
                        0.030Second
                            Quarter (through March 31, 2006)
                        
                        $
                        0.060
                        
                        $
                        0.030First
                            Quarter (through December 31, 2005)
                        
                        $
                        0.060
                        
                        $
                        0.032**Fiscal
                            2005**Fourth
                            Quarter (through September 30, 2005)
                        
                        $
                        0.070
                        
                        $
                        0.034Third
                            Quarter (through June 30, 2005)
                        
                        $
                        0.090
                        
                        $
                        0.060Second
                            Quarter (through March 31, 2005)
                        
                        $
                        0.135
                        
                        $
                        0.055First
                            Quarter (through December 31, 2004)
                        
                        $
                        0.011
                        
                        $
                        0.050**Fiscal
                            2004**Fourth
                            Quarter (through September 30, 2004)
                        
                        $
                        0.170
                        
                        $
                        0.072Third
                            Quarter (through June 30, 2004)
                        
                        $
                        0.190
                        
                        $
                        0.115Second
                            Quarter (through March 31, 2004)
                        
                        $
                        0.210
                        
                        $
                        0.135First
                            Quarter (through December 31, 2003)
                        
                        $
                        0.230
                        
                        $
                        0.130
  **Dividends**
  As
              of
              September 30, 2006, we have never declared or paid any cash dividends
              on our
              common stock. Our board of directors has sole discretion to pay cash
              dividends
              or other dividends or other distributions with respect to our common
              stock based
              on our financial condition, results of operations, capital requirements,
              contractual obligations and other relevant factors.
  **Impact
              of the “Penny Stock” Rules on Buying or Selling our Common
              Stock**
  Trading
              in our common stock is subject to the “penny stock” rules. The SEC has adopted
              regulations that generally define a penny stock to be any equity security
              that
              has a market price of less than $5.00 per share. These rules require
              that any
              broker-dealer who recommends our securities to persons other than prior
              customers and accredited investors, must, before the sale, make a special
              written suitability determination for the purchaser and receive the
              purchaser’s
              written agreement to execute the transaction. In addition, unless an
              exception
              is available, the broker-dealer must deliver a disclosure schedule
              explaining
              the penny stock market and the risks associated with trading in the
              penny stock
              market prior to any transaction. Further, broker-dealers must disclose
              commissions payable to both the broker-dealer and the registered representative
              and current quotations for the securities they offer. The additional
              burdens
              imposed upon broker-dealers by such requirements may discourage them
              from
              transactions in our common stock, which could severely limit the market
              price
              and liquidity of our securities.
 26
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
  **Description
              of Securities**
  **Common
              Stock**
  As
              of
              September 30, 2006 we are authorized to issue up to 187,000,000 shares
              of common
              stock, par value $0.01 per share. As of September 30, 2006, there were
              99,108,039 shares of common stock outstanding. We had 867 shareholders
              of record
              of common stock on September 30, 2006. Each holder of common stock
              is entitled
              to one vote for each share held on all matters. Our articles of incorporation
              and bylaws do not provide for cumulative voting in elections of directors
              or any
              other matters brought before shareholder meetings.
  The
              holders of our common stock are entitled to receive such dividends,
              if any, as
              may be declared by our board of directors from time to time out of
              legally
              available funds. The dividend rights of our common stock are junior
              to any
              preferential dividend rights of any outstanding shares of preferred
              stock. The
              holders of our common stock also are entitled to receive distributions
              upon our
              liquidation, dissolution or winding up of our assets that are legally
              available
              for distribution, after payment of all debt and other liabilities and
              distribution in full of preferential amounts, if any, to be distributed
              to
              holders of our preferred stock.
  The
              holders of our common stock are not entitled to preemptive, subscription,
              redemption or conversion rights. The rights, preferences and privileges
              of
              holders of our common stock are subject to, and may be adversely affected
              by,
              the rights of any series of preferred stock that we may designate and
              issue in
              the future.
  **Preferred
              Stock**
  Our
              board
              of directors is authorized by our articles of incorporation to issue
              up to
              4,000,000 shares of one or more series of preferred stock, par value
              $0.10 per
              share. No shares of such preferred stock have been authorized for issuance
              by
              our board of directors, and we have no present plans to issue any such
              shares.
              In the event that the board of directors issues shares of serial preferred
              stock, it may exercise its discretion in establishing the terms of
              such
              preferred stock.
  Our
              board
              of directors may determine the voting rights, if any, of the series
              of preferred
              stock being issued, including the right to:
 ·
                  vote
                      separately or as a single class with the common stock and/or
                      other series
                      of preferred stock;
 ·
                  have
                      more or less voting power per share than that possessed by
                      the common
                      stock or other series of preferred stock;
                      and
 ·
                  vote
                      on specified matters presented to the shareholders or on all
                      of such
                      matters or upon the occurrence of any specified event or
                      condition.
 
 If
              our
              company liquidates, dissolves or winds up, the holders of our preferred
              stock
              may be entitled to receive preferential cash distributions fixed by
              our board of
              directors when creating the particular preferred stock series before
              the holders
              of our common stock are entitled to receive anything. Preferred stock
              authorized
              by our board of directors could be redeemable or convertible into shares
              of any
              other class or series of our stock.
 27
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
  The
              issuance of preferred stock by our board of directors could adversely
              affect the
              rights of holders of the common stock by, among other things, establishing
              preferential dividends, liquidation rights or voting powers. See “Risk Factors”
above.
  **Stock
            Option Plan**
 Our
              board
              of directors adopted the 2000 Stock Option Plan effective January 1,
              2001. Our
              stockholders formally approved the 2000 Stock Option Plan on February
              14,
              2001.
  **Summary
              of 2000 Plan**
  The
              following is a summary of certain provisions of the 2000 Stock Option
              Plan:
  Administration
  Either
              our board of directors or a committee appointed by our board of directors
              may
              administer the 2000 Stock Option Plan.
  Eligibility
  Nonqualified
              Options. Nonqualified options may be granted only to our officers,
              directors, including our non-employee directors, employees and advisors
              who, in
              the judgment of the committee, are responsible for our management or
              our success
              and who, at the time of the granting of the nonqualified options, are
              our
              officers, directors, employees or advisors.
  Incentive
              Options. Incentive stock options may be granted only to our employees
              who,
              in the judgment of the committee or our board of directors, are responsible
              for
              our management or our success and who, at the time of the granting
              of the
              incentive stock option, are also our employees. No incentive stock
              option may be
              granted under the 2000 Stock Option Plan to any individual who would,
              immediately before the grant of such incentive stock option, directly
              or
              indirectly, own more than 10% of the total combined voting power of
              all classes
              of our capital stock unless: such incentive stock option is granted
              at an option
              price not less than 110% of the fair market value of the shares on
              the date the
              incentive stock option is granted; and such incentive stock option
              expires on a
              date not later than five years from the date the incentive stock option
              is
              granted.
  Option
              Price
  The
              purchase price as represented by our common stock offered under the
              2000 Stock
              Option Plan must be at least 100% of the fair market value of our common
              stock
              (if the option is an incentive stock option), or at least 25% of the
              fair market
              value of our common stock at the time the option is granted (if the
              option is a
              nonqualified option), or such higher purchase price as may be determined
              by the
              committee or our board of directors at the time of grant. If, however,
              we grant
              an incentive stock option to an individual who would, immediately before
              the
              grant, directly or indirectly own more than 10% of the total combined
              voting
              power of all of our classes of stock, the purchase price of the shares
              of our
              common stock covered by such incentive stock option may not be less
              than 110% of
              the fair market value of such shares on the day the incentive stock
              option is
              granted. As the price of our common stock is currently quoted on the
              OTC
              Bulletin Board, the fair market value of our common stock underlying
              options
              granted under the 2000 Stock Option Plan would be the last closing
              sale price of
              our common stock on the day the options are granted. If there is no
              market price
              for our common stock, then our board of directors and the committee
              may, after
              taking all relevant facts into consideration, determine the fair market
              value of
              our common stock.
 28
 **Table
                    of Contents**
 **Index
                    to Financial
                    Statements**
  Exercise
            of Options
  An
            option
            holder under the 2000 Stock Option Plan may exercise his or her option
            in whole
            or in part as provided under the terms of the grant, but in no event
            shall an
            option be exercisable after the expiration of ten years from the grant
            date. An
            option holder may not exercise any option after the option holder ceases
            to be
            one of our employees except in the case of disability or death. Our committee
            may, however, extend the right of exercise up to three months after the
            date of
            termination of the option holder’s employment with us. If we terminate an option
            holder’s employment by reason of disability, the committee or our board of
            directors may extend the exercise period for a specified period, generally
            one
            year, following the date of termination of the option holder’s employment. If an
            option holder dies while in our employ and the option holder has not
            fully
            exercised his or her options, the options may be exercised in whole or
            in part
            at any time within one year after the option holder’s death by the executors or
            administrators of the option holder’s estate or by any person or persons who
            acquired the option directly from the option holder by bequest or
            inheritance.
  In
            the
            event of the death of an employee or consultant while in our employ,
            the
            committee or our board of directors is authorized to accelerate the
            exercisability of all outstanding options under the 2000 Stock Option
            Plan.
  Under
            the
            2000 Stock Option Plan, we may grant one or more options to an individual,
            as
            long as the aggregate fair market value of the shares covered by incentive
            options exercisable for the first time during any calendar year shall
            not exceed
            $100,000.
  Acceleration
            and Exercise upon Change of Control
  All
            option holders’ unvested options automatically will become exercisable in the
            event of a change of control of our company as defined in the 2000 Stock
            Option
            Plan.
  Payment
            for Option Shares
  An
            option
            holder may exercise his or her options by delivering written notice to
            us at our
            principal office setting forth the number of shares with respect to which
            the
            option is to be exercised, together with cash or certified check payable
            to us
            for an amount equal to the option price of such shares. We may not issue
            any
            shares underlying an option grant until full payment has been made of
            all
            amounts due. We will deliver a certificate or certificates representing
            the
            number of shares purchased as soon as practicable after payment is received.
            Our
            board of directors or the committee may, in its discretion, permit the
            holder of
            an option to pay all or a portion of the exercise price by a simultaneous
            sale
            of our common stock to be issued upon exercise of an option pursuant
            to a
            brokerage or similar arrangement.
  Termination
            of the 2000 Stock Option Plan
  The
            2000
            Stock Option Plan will terminate on December 1, 2010, unless our board
            of
            directors terminates the 2000 Stock Option Plan prior to its expiration
            date.
            Any option outstanding under the 2000 Stock Option Plan at the time of
            termination shall remain in effect until the option is exercised or
            expires.
  Amendment
            of the 2000 Stock Option Plan
  Our
            board
            of directors may at any time modify or amend the 2000 Stock Option Plan
            without
            obtaining the approval of our shareholders as it shall deem advisable
            to comply
            with Section 422 of the Internal Revenue Code or Rule 16b-3 of the Securities
            and Exchange Act of 1934, as amended, or in any other respect.
 29
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
  Transferability
            of Options
  An
            option
            holder may not assign any option under the 2000 Stock Option Plan other
            than by
            will or the laws of descent and distribution or if our board of directors
            or the
            committee agrees otherwise.
  Issuance
            and Reservation of Shares
  As
            of
            September 30, 2006, we have issued options to purchase an aggregate of
            4,159,938
            shares of our common stock. We have reserved the right to issue a total
            of
            7,000,000 shares of our common stock for issuance under the 2000 Stock
            Option
            Plan.
  **Item
                    6.**
                  **Management’s
                      Discussion and Analysis of Financial Condition and Results
                      of
                      Operation**
 
 **Overview**
  Our
              business focuses on the research, development, and sale of location
              tools used
              to track or monitor people or objects such as vehicles or other mobile
              equipment. We also own devices and designs that are used in the semiconductor
              and electronics industries.
  From
              1996
              to 2002, we engaged primarily in developing devices and designs that
              are used in
              the semiconductor and electronics industries. This resulted in a number
              of U.S.
              patents, but did not produce any significant amount of revenue. Additionally,
              during the period from 2000 to 2001 we engaged in the business of distributing
              electronic and other semiconductor-related products to customers in
              Asia and the
              United States in order to generate revenue. In 2001, we discontinued
              those
              activities because they did not produce the profit margins we had originally
              expected.
  In
              2002,
              we began to focus on applications of electronic devices in the location
              tools
              market. We also began to decrease our focus on semiconductor designs
              and
              devices, due primarily to difficult market conditions in the semiconductor
              industry. We plan to continue our focus on location tools for the foreseeable
              future.
  Our
              first
              shipment and sale of our consumer-oriented location tools began with
              the sale
              and shipment of our Followit TM product in August 2002.
  In
              December of 2002, we entered into an agreement with Electroconnect
              of Scotland
              to produce a prototype and then manufacture our Gotcha!® product. This agreement
              is based on us paying for units as ordered, and does not require minimum
              purchase amounts.
  In
              December 2002, we entered into an agreement with FutureCom Global,
              Inc. (FCG) of
              Arizona (now doing business as 21st Century Technology) to assist us
              in the
              marketing and distribution of our location tools. The term of the agreement
              is
              two years and it is renewable for up to one additional year. The agreement
              allows FCG to market our Followit TM, StarPilot TM, and Gotcha!® products through
              media and trade shows, as well as through networks of sales representatives
              in a
              variety of consumer marketplaces, including general retail. The agreement
              may be
              extended to the new company, but given the lack of current activity
              from this
              group in selling our products, we do not believe this is likely.
  Our
              sales
              during the fiscal year ended September 30, 2004, consisted largely
              of sales of
              our Gotcha!® child safety product through FutureCom Global, and to a lesser
              extent of our GPS related products, including IBUS TM to Verify Systems, and
              early prototype versions of the TrakJack TM product to Positus Corp.
 30
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
  During
              fiscal year 2005, the Company increased its focus on its newer business-oriented
              products, such as Travado IBUS TM, which entered the market in March 2005, and
              decreased its focus on consumer products, such as Gotcha!® and Followit TM.
              Starting from the last two quarters of fiscal year 2005 and during
              fiscal year
              2006, we have generally seen a gradual increase in the sales of our
              business-oriented products, although we can make no assurance that
              this trend
              will continue into any future periods.
 **Patents
              and Proprietary Rights**
  We
              currently hold U.S. patents on nine devices and designs and have several
              domestic patent applications pending. Most of our patent work is focused
              on
              protection in the United States today, due to the high cost of acquiring
              and
              maintaining patents in other markets. We plan to continue to develop
              our
              existing patented technologies as well as develop new performance-enhancing
              devices and designs for use in the semiconductor, electronics and location
              industries. Our business plan contemplates that we will generate revenue
              by
              entering into strategic joint venture licensing agreements, manufacturing
              agreements, development agreements, distribution and marketing agreements
              and
              other arrangements with firms and/or entities that will either incorporate
              our
              technologies into their product offerings or sell them directly to
              their
              customers.
  **Results
              of Operations**
  **Years
              Ended September 30, 2006 and 2005**
  We
              generated $227,251 and $73,226 of revenue for the fiscal years ending
              September
              30, 2006 and 2005, respectively. During the year ended September 30,
              2006, the
              Company’s increased focus on business-oriented products, such as Travado IBUS
TM
and Travado Mini TM, generated revenues of approximately $226,000, while revenues
              from its consumer-oriented Gotcha!® products declined to less than $1,000. The
              initial deliveries of its business-oriented products, such as Travado
              IBUS TM,
              which entered the market in March 2005 generated sales of approximately
              $64,000
              in the fiscal year ended September 30, 2005 while the consumer-oriented
              products
              such as Gotcha!® and Followit TM generated sales of approximately $9,000 for
              entire fiscal year 2005.
  Gross
              profit increased to $103,562 in fiscal 2006 from $24,446 in fiscal
              2005.
  Costs
              and
              expenses decreased to $661,114 in fiscal 2006 from $1,047,937 in fiscal
              2005.
  Salaries
              and benefits, of administration and marketing personnel decreased to
              $258,977 in
              fiscal 2006, from $337,708 in fiscal 2005. This decrease is mainly
              attributable
              to staff reductions and the reduction of hours worked by part-time
              employees.
  Research
              and development expenditures decreased to $185,638 for the fiscal year
              ended
              September 30, 2006, from $391,591 for the previous fiscal year mainly
              because
              two engineers took a leave of absence in January 2006 and were not
              replaced, and
              a liability of $36,540 for research and development work carried out
              for us by a
              foreign consultant during fiscal years 2001 and 2002 was reversed in
              accordance
              with our policy to void unclaimed invoices for between 24 and 36 months. 
The Company has focused an increasingly significant amount of its time
              and
              energy on development of new sources of revenue through the building
              of new
              customer relationships. The Company has also spent and plans to spend
              resources
              on the development of strategic partnerships with other technology
              firms to
              assist us in taking products to market faster. The Company will continue
              to
              explore innovative ways to take its technology expertise and products
              to market,
              across its entire portfolio of semiconductor and location electronics
              related
              devices.
 31
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
  Stock
              compensation decreased to $14,946 in fiscal 2006 from $16,173 in fiscal
              2005. In
              fiscal 2005, warrants were recorded at the Black-Scholes value on the
              issue
              date.
  Other
              expenses decreased to $183,726 in fiscal 2006 from  $255,690 in fiscal 2005
              as a result of reductions in depreciation, insurance costs, bad debt
              expense,
              marketing, selling, telephone, insurance, statutory filing fees, travel
              and
              office costs. The expense reductions were somewhat offset by increases
              in
              expenses such as financing origination fees, rent, factor’s fees and
              accountant’s fees.
  We
              marked
              down our inventory of Gotcha!® products, during fiscal 2006 and 2005 by $17,827
              and $46,775  respectively, for estimated obsolescence based on assumptions
              about age of the inventory and current demand. As a result, our inventory
              of
              Gotcha!® products has been reserved one hundred per cent.
  Interest expenses increased
              to
              $94,241 during fiscal 2006 from $25,947 in fiscal 2005 due to the provision
              in
              the fiscal 2006 of interest for the interest bearing Notes Payable
              and the
              amortization of debt discount and the beneficial conversion feature
              to interest
              expense (See Notes Payable and Long Term Debt above). These costs were
              not
              incurred in fiscal 2005.
  During
              fiscal 2006, amortization of deferred offering costs, amounting to
              $4,400 have
              been charged to operations as compared to no amortization of deferred
              offering
              costs in fiscal 2005.
  On
              September 30, 2006, we took an impairment charge of $289,100 against
              our
              investment in TurboWorx, Inc. The Company’s investment in these equity
              securities was carried at $289,100 at September 30, 2005, which included
              an
              impairment charge of $91,344 in fiscal 2005. The Company regularly
              monitored
              this investment for impairment in the carrying value, and as a result
              of this
              monitoring, we determined in September 2006 that it was appropriate
              to impair
              this investment up to its full value, due to serious financial distress
              we
              believe is happening at TurboWorx.
  We
              have
              focused an increasingly significant amount of our time and energy on
              development
              of new sources of revenue through the building of new distributor and
              customer
              relationships. This has included increased attendance at trade shows,
              increased
              expenditures on promotional literature, Internet advertising and promotion
              through website listings, on-site customer product demonstrations,
              and other
              marketing related activities intended to foster customer acquisition.
              We have
              also developed plan to continue to develop strategic partnerships with
              other
              technology firms to assist our marketing efforts. We will continue
              to research
              and implement innovative ways to take our technology expertise and
              products to
              market, across our entire portfolio of semiconductor and electronics-related
              devices.
  In
              January 2003 we initiated a restricted stock retainage program or plan
              (“Stock
              Retainage Program”) to retain key staff during a period of financial difficulty
              in calendar year 2002. Our board allocated approximately $150,000 in
              restricted
              common stock from this Stock Retainage Program as a pool of shares
              of our
              restricted common stock, to be granted to key employees at the direction
              of the
              board for the year and the next, subject to NSC exceeding sales growth
              objectives and expense control objectives in 2003. Failure to meet
              these
              objectives under the plan would result in serious risk of forfeiture
              by staff of
              some or all of these stock grants by all participants. All goals set
              were team
              goals. The plan has been used as a tool to achieve salary deferral
              and other
              salary concessions from the staff in order to retain key employees
              during this
              period of fiscal hardship. The plan’s sales goals were not met in calendar year
              2003, although the plan was nonetheless largely successful in assisting
              to
              retain key staff, even during this period of deferred or reduced salary.
              In
              January of 2004 and again in February of 2005, our board extended this
              program
              into 2006, and set new sales growth objectives for the year at a level
              50%
              higher than the previous year’s program for 2005, and unchanged for 2006, giving
              plan participants an additional two years to fully earn these previously
              outstanding restricted stock grants. No new shares were added to the
              plan,
              although plan participants were able to convert some long-term back
              pay into
              restricted stock at that time, if desired. All of the stock under this
              program
              is restricted under SEC Section 144. As of September 30, 2006, none
              of these
              grants have been fully earned, and they remain subject to substantial
              risk of
              forfeiture.
 32
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
  We
              expect
              to continue to increase our focus on sales and marketing of our Location
              Tools TM
products for the foreseeable future. This includes significantly increased
              attendance at trade shows and other product marketing events as well
              as recent
              additional investment in product promotion through outreach programs
              with the
              trade press, using public relations resources. Partly as a result of
              these
              efforts and others, revenues have begun to be generated from operations,
              and
              thus we have emerged now from development stage operations.
  **Liquidity
              and Capital Resources**
  NSC
              has
              not been profitable and has experienced a cash flow deficit from operations
              due
              to its development stage and substantial on-going investment in research
              and
              development efforts. We have financed our operations primarily through
              the sale
              of common stock, through personal loans from officers and directors,
              some debt
              financing, and to a very limited extent and only just recently, through
              the sale
              of our products.
  As
              of
              September 30, 2006, NSC’s cash and cash equivalents totaled $43,899 and total
              current assets were $196,987. NSC has recently initiated product-marketing
              efforts after several years of research and development and has not
              yet reached
              break even in terms of both cash flow and profitability. As of September
              30,
              2006, NSC has total liabilities of $1,619,146 including notes payable
              of
              $417,123, accounts payable of $249,177, accrued expenses of $848,446
              and amounts
              due to factors of $104,400. The accounts payables total of $249,177
              includes
              invoices of approximately $75,000 that are aged over three years. The
              accrued
              expenses total of $848,446 includes approximately $496,000 of unpaid
              wages.
  We
              have
              an accumulated deficit of approximately $24.8 million as of September
              30, 2006
              which includes approximately $10 million of non-cash transactions,
              in fiscal
              years 2000 and 2001, for restricted common stock issued as payment
              for research,
              consulting and capital formation expenses. A substantial portion of
              the
              consulting expenses related to the issuance of one million shares of
              common
              stock to Dr. Hashemi, our former Group President, as a signing bonus
              on
              September 1, 2000. These shares were later returned to us. We expect
              operating
              losses in the foreseeable future as we continue our efforts to commercially
              exploit our portfolio of patents and develop commercial products. Accumulated
              cash used in operating services from the Company’s inception to September 30,
              2006 totaled approximately $8.7 million.
  Cash
              used
              in operations was approximately $306,342 for the year ended September
              30, 2006
              compared with approximately $599,498 for the year ended September 30,
              2005. The
              decrease in cash used in operations is attributable to the increased
              level of
              deferrals during fiscal 2006 of salaries and reimbursement of expenses
              to
              officers and employees for production supplies acquired on behalf of
              the
              Company.
  We
              have
              financed our operations primarily through the sale of common stock,
              granting of
              options and warrants, and through some debt financing. Those activities
              since
              2001 are summarized below.
  In
              March
              2001, we established a line of credit with Wells Fargo HSBC Trade Bank
              totaling
              $500,000. The line of credit was collateralized with deposits at Wells
              Fargo
              Bank. Borrowings under the line of credit bear interest at the prime
              rate of
              Wells Fargo Bank, National Association. At September 30, 2001, there
              was
              $430,000 outstanding under this line of credit. At September 30, 2002
              the entire
              line of credit had been repaid, and the line of credit had been
              terminated.
  In
              May
              2001, we entered into a common stock purchase agreement with Coriander
              Enterprises Limited, a British Virgin Islands corporation, for the
              future
              issuance and sale of shares of our common stock. A registration statement
              filed
              with the Securities and Exchange Commission was declared effective
              on October
              11, 2001. This stock purchase agreement established an equity line
              of credit.
              Under this arrangement, we at our sole discretion, were to make up
              to 24 draw
              down requests over a two year period, pursuant to which Coriander Enterprises
              was obligated to purchase up to $24 million of our common stock, at
              prices that
              will vary based upon the market price of the common stock. As of August
              2002,
              changes in the market price and/or trading volume of our common stock
              have
              terminated our ability to draw down funds under the equity line of
              credit.
 33
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
  On
              April 29, 2002 Lou Ross, then-Chairman of the Board, sold 240,000 shares
              of
              common stock in the Company. The proceeds (net of sales commissions)
              of $41,125
              were loaned to the Company. The loan, which bears 6% interest per annum,
              is
              payable in twelve monthly installments of $3,649 beginning October
              29, 2002. In
              July 2002, Lou Ross, then-Chairman of the Board, sold 260,000 shares
              of common
              stock in the Company. The proceeds (net of sales commissions and approximately
              $4,000 withheld by Mr. Ross for taxes) of approximately $34,000 were
              loaned to
              the Company. The loan, which bears 6% interest per annum, is to be
              repaid in
              twelve installments of $3,022 beginning February 28, 2003. This loan
              was
              restructured in June of 2003 to a three-year non-interest bearing loan,
              with no
              payments due until the end of the loan period.  On June 11, 2003, the
              Company issued a three-year interest free convertible note of $43,250,
              with no
              payments required of the Company until the end of the three-year period,
              to its
              then-Director Lou Ross for past services rendered (See 10-KSB report
              for the
              year ended September 30, 2003). The Company can pay this note at any
              time before
              the three-year period elapses with either cash or its common restricted
              stock or
              a combination of cash and stock, at its sole discretion. Mr. Ross retired
              from
              the Company’s board on September 30, 2003.  The Company intends to convert
              this Note to common shares when requested to by Mr. Ross.
  During
              the fiscal years ending September 30, 2004 and 2003, NSC issued 160,084
              and
              946,270 shares, respectively, of NSC common stock to consultants in
              lieu of cash
              compensation. During fiscal 2004, the Company granted 790,000 options
              to NSC
              consultants and employees to purchase shares of NSC’s common stock. The options
              granted had exercise prices ranging from $0.09 per share to $0.16 per
              share. The
              exercise prices were generally below market on the date of grant, and
              vested. We
              granted these options as a means of compensation to consultants to
              conserve
              operating cash. During fiscal 2003, substantially all option grants
              were issued
              to employees. During fiscal 2006, 310,681 options granted were issued
              to a
              consultant and 60,000 options granted were issued to an outside director
              for
              board fees. During fiscal 2006, no options were granted to
              employees.
  In
              November 2002, the Company commenced a private offering of restricted
              common
              stock and common stock purchase warrants and raised approximately $470,000
              in
              cash and $30,000 in debt forgiveness from this effort. The Company
              issued
              11,625,000 shares of restricted common stock for the cash collected
              and 500,000
              shares of restricted common stock for the forgiven debt, and granted
              4,800,000
              warrants to purchase common stock at a strike price of $0.30 and 200,000
              warrants at a strike price of $0.50 per share. No underwriters were
              involved in
              connection with this private placement. The sales and issuances of
              the
              securities issued pursuant to the foregoing private placement are exempt
              from
              registration under the Securities Act of 1933, as amended, pursuant
              to Section
              4(2) thereof, and Rule 506 of Regulation D. All of the 5,000,000 warrants
              issued
              in connection with this offering expired on December 31, 2004 without
              being
              exercised.
  In
              June
              2003, the Company commenced a private offering of restricted common
              stock and
              common stock purchase warrants. The Company raised from this offering
              in the
              fiscal year ending September 30, 2003, approximately $200,000 in cash,
              and
              issued 2,500,000 shares of restricted common stock and granted 2,000,000
              warrants to purchase common stock at exercise prices ranging from $0.35
              and
              $0.50 per share. The Company has continued to raise funds under this
              private
              offering after September 30, 2003. From June 2003 through December
              31, 2003, the
              Company had raised a total of approximately $280,000 in cash from this
              effort,
              and issued a total of 3,300,000 shares of restricted common stock and
              granted a
              total of 2,400,000 warrants to purchase common stock at exercise prices
              ranging
              from $0.35 to $0.75 per share. The warrants expire on June 30, 2006.
              No
              underwriters were involved in connection with this private placement.
              The sales
              and issuances of the securities issued pursuant to the foregoing private
              placement are exempt from registration under the Securities Act of
              1933, as
              amended, pursuant to Section 4(2) thereof, and Rule 506 of Regulation
              D. On June
              30, 2006, the share purchase warrants which should have expired on
              June 30, 2006
              had their expiry dates extended for one year.
  In
              January of 2004, we entered into a financing program with a U.S. investment
              fund. The terms of this program include a six-month Note payable at
              maturity in
              July 2004 for $160,000, at an effective annual interest rate of 13%.
              The
              transaction also included 640,000 warrants good for three years to
              purchase the
              Company’s restricted stock, at $0.13 during the first and second year of the
              warrant’s lifetime, and $0.15 during the third and final year of the warrant’s
              lifetime. These warrants include anti-dilution provisions, as well
              as
              registration rights in the event that we file an appropriate registration
              statement with the SEC during the next three years. This $160,000 Note
              was
              repaid in full in May of 2004.
 34
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 During
              March 2004 we secured short-term loans in the aggregate principal amount
              of
              $36,000. The interest rate on the loan was less than 10% plus minor
              processing
              fees. The notes were repaid in full in April 2004.
  On
              March
              15, 2004, NSC commenced a private offering of restricted common stock
              units
              through a placement agent. The offer consisted of one share of common
              stock and
              a warrant to purchase three quarters of a share of common stock. On
              June 14,
              2004, we completed this private placement with aggregate gross proceeds
              of
              approximately $1.1 million and issued 10,334,266 shares of restricted
              common
              stock and warrants to purchase 7,750,700 shares of our common stock
              at an
              exercise price of $0.11 per share. The warrants have a term of five
              years, and
              include certain registration rights. After deducting commissions and
              other
              expenses relating to the private placement, we received aggregate net
              proceeds
              of approximately $972,864. Additional disbursements by the Company
              related to
              the private placement further reduced the net proceeds to $935,044,
              the majority
              of which was spent by September 30, 2004. We invested part of the proceeds
              of
              the private placement to finance the continued development and marketing
              of
              Wi-Fi and RFID related Location Tools TM products. We used part of the proceeds
              for expanded marketing and sales efforts, for further commercialization
              of our
              other Location Tools TM product line, and for other corporate purposes. The Units
              were sold to accredited investors pursuant to an exemption from the
              registration
              requirements of the Securities Act of 1933 (the “Act”) and applicable state
              exemptions from registration. On June 24, 2004, we filed a Registration
              Statement on Form SB-2 with the Securities and Exchange Commission
              in connection
              to register the shares. The Securities and Exchange Commission declared
              the
              Registration Statement effective on July 7, 2004.
  In
              November 2004, we entered into a Letter of Intent (“LOI”) with Turbo regarding a
              stock exchange transaction with Turbo, for an amount of stock equal
              to less than
              10% of the outstanding common stock of each company and the payment
              of cash by
              Turbo to NSC. The LOI contemplated a due diligence process prior to
              the share
              exchange, as well as a Securities Exchange Agreement (the “Share Exchange
              Agreement”) to memorialize the proposed exchange. A Share Exchange Agreement
              was
              entered into on January 28, 2005 and the transaction was closed on
              February 1,
              2005. We have exchanged 7,150,000 shares of our restricted common stock
              for
              360,000 shares of the common stock of Turbo plus $240,000. In conjunction
              with
              the transaction, the Company agreed to pay, the placement agent, Casimir
              Capital
              $25,000 and issued warrants to purchase 800,000 of the Company’s common stock on
              February 3, 2005 at an exercise price of $0.11 per share.  The Company’s
              investment in these equity securities was carried at $289,100 at September
              30,
              2005, which included an impairment charge of $91,344 in fiscal 2005.  The
              Company also recorded an additional impairment in its investment in
              TurboWorx
              Inc. of $289,100 at September 30, 20006, due to financial distress
              at
              TurboWorx.
  In
              December 2004, our Chairman Michael Grollman made personal loans to
              the Company
              in the amount of $65,000 to assist us with short-term cash requirements.
              The
              loan is evidenced by an unsecured promissory note that provides for
              repayment
              within 90 days or less, at no interest. The promissory note also provides
              that
              if repayment takes longer than 90 days, then interest accrues at a
              rate of 6
              percent per year until paid in full. We paid this Note in full in February
              of
              2005.
  On
              February 24, 2005, March 28, 2005, May 2, 2005, and May 27, 2005 our
              Chairman
              Michael Grollman made new personal loans to the Company totaling $159,000
              to
              assist us with working capital needs. The loans are evidenced by a
              demand note
              that provides for repayment within five business days of a demand notice
              from
              Mr. Grollman, with interest of 6% compounded annually from June 1,
              2005. As of
              September 30, 2006, these loans were outstanding.
  In
              June
              and August 2005 we secured short-term loans in the aggregate principal
              amount of
              $18,000. The interest rate on the loans was less than 10%. These loans
              were
              repaid in full in September and November 2005.
 35
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 In
              June
              2005 the Company entered into a financing program with an unrelated
              party to
              assist us with working capital needs. The program, evidenced by a promissory
              note, allows the Company to borrow in two tranches, each of $22,500
              payable in
              seventy-five days. The transaction provides the note holder with a
              security
              interest prior to delivery in any assets purchased for the fulfillment
              of Auto
              Safety House (ASH) and ScottsdaleUnifiedSchool District orders and
              a security
              interest in any receivable from the fulfillment of such orders. The
              program also
              required support from Mr. Grollman. Interest at 13% APR is payable
              if payment is
              extended past maturity. The agreement also required the Company to
              grant the
              note holder a warrant to purchase 135,000 shares of the Company’s common stock
              at an exercise price of $0.062. The Company received the first traunch
              on June
              24, 2005. This loan was paid in full on September 20, 2005.
  On
              September 7, 2005, we entered into a one-year factoring agreement with
              United
              Capital Funding of Florida. The agreement provides for a maximum amount
              of
              funding of $100,000, although this amount may be increased or decreased
              on a
              case-by-case basis. The initial and periodic factoring fee is .45%.
              The
              factoring period is five days and the purchase price is 80% of the
              face amount.
              United Capital Funding is a specialized financial services firm offering
              Accounts Receivable Management and working capital funding via factoring.
              We
              expect to increase our cash flow with this arrangement.
  On
              November 1, 2005, as an important phase in the current years financing
              plan, we
              entered into a financing program with a U.S. investment fund. The terms
              of this
              program include a five-year Note payable at maturity in November 2010
              for
              $175,000, at a stated annual interest rate of 8%. Interest is due and
              payable
              semi-annually on May 1st and November 1st for each year in which the
              note is
              outstanding The transaction also included 1,200,000 restricted common
              shares and
              a conversion/exchange option to convert the principal amount and any
              unpaid
              interest of the Note into common shares at a per share conversion price
              of
              $0.0525. These shares include weighted average anti-dilution provisions,
              as well
              as piggyback registration rights. Additionally, the Note has various
              put and
              call rights. The 1,200,000 restricted common shares were recorded at
              $0.043,
              which was the five-day average market closing price of our stock. The
              note and
              common stock were issued with a debt discount of $51,600 and a beneficial
              conversion feature of $9,933. The discount and beneficial conversion
              feature are
              being amortized to interest expense over the term of the note, which
              is
              approximately 60 months. The issuance of the shares resulted in deferred
              financing costs of $24,000. The deferred financing costs are being
              amortized
              over term of the note, which is approximately 60 months, and are included
              in the
              statement of operations as offering costs.
  On
              November 23, 2005, we issued 500,000 of the Company’s restricted common shares,
              to Mr. Michael Grollman, at the closing price of $0.036 in lieu of
              his partial
              forgiveness of $18,000 of the Company’s accounts payable and accrued expense
              indebtedness to him.
  In
              November 2005 we entered into an agreement with an investment bank
              to provide
              additional equity or debt funding, They did bring one offer to the
              table that
              was subsequently rejected by management, due to a failure by the offering
              party
              to effectively negotiate.
  In
              2006
              we entered into an agreement with Aleron to provide additional equity
              funding
              and M&A direction.  Due to the increasing sales activity during the
              second half of calendar year 2006, management has temporarily withdrawn
              from
              this activity.
  On
              March
              15, 2006, we issued 430,000 of the Company’s restricted common shares, to Mr.
              Graham Clark, at the closing market price of $0.035 in lieu of his
              partial
              forgiveness of $15,050 of the Company’s back pay indebtedness to
              him.
  On
              April
              7, 2006, we issued 500,000 of the Company’s restricted common shares, to Mr.
              Michael Grollman, at the closing market price of $0.032 in lieu of
              his partial
              forgiveness of $16,000 of the Company’s back pay indebtedness to
              him.
  On
              May
              25, 2006, we issued 1,150,000 of the Company’s restricted common shares, to Mr.
              Graham Clark, at the closing market price of $0.035 in lieu of his
              partial
              forgiveness of $40,250 of the Company’s back pay indebtedness to
              him.
 36
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 On
              June
              17, 2006, we raised $10,000 from a private placement and issued 571,429
              shares
              of common stock at an average market price per share of $0.0175. In
              connection
              with this private placement, we issued a warrant to purchase 200,000
              shares of
              our common stock exercisable at $0.050 per share through June 30, 2009.
              No
              underwriters were involved in connection with this private placement.
              The sales
              and issuances of the securities issued pursuant to the foregoing private
              placement are exempt from registration under the Securities Act of
              1933, as
              amended, pursuant to Section 4(2) thereof, and Rule 506 of Regulation
              D.3.
  On
              August
              8, 2006, we raised $10,000 from a private placement and issued 571,429
              shares of
              common stock at an average market price per share of $0.0175. In connection
              with
              this private placement, we issued a warrant to purchase 250,000 shares
              of our
              common stock exercisable at $0.050 per share through August 30, 2009.
              No
              underwriters were involved in connection with this private placement.
              The sales
              and issuances of the securities issued pursuant to the foregoing private
              placement are exempt from registration under the Securities Act of
              1933, as
              amended, pursuant to Section 4(2) thereof, and Rule 506 of Regulation
              D.3.
  At September 30, 2006
              there were
              15,384,197 outstanding warrants to purchase 15,434,197 shares of common
              stock,
              at prices ranging from $0.035 to $0.75, with expiration dates from
              June 2007 to
              August 2011. There were 15,434,197 outstanding warrants at September
              30, 2005.
              During fiscal 2006, a share purchase warrant to purchase 1,200,000
              shares, with
              an exercise price of $.090, was cancelled.
   **ADDITIONAL
            FACTORS THAT MAY AFFECT OUR FUTURE OPERATING RESULTS**
  **In
              addition to the other information contained in this Annual Report on
              Form
              10-KSB, the following important factors should be carefully considered
              in
              evaluating NSC and its business because such factors currently have
              a
              significant impact on NSC’s business, prospects, financial condition and results
              of operation.**
 
 **An
              investment in our common stock is very risky. You may lose the entire
              amount of
              your investment.**
 
 Before
              you invest in shares of our common stock, you should be aware of various
              risks,
              including those described below. You should carefully consider these
              risk
              factors, together with all of the other information included in this
              annual
              report, before you decide whether to purchase the shares of our common
              stock.
              The risks set out below are not the only risks we face.
 
 If
              any of
              the following risks occur, our business, financial condition and results
              of
              operation could be materially and adversely affected. In such a case,
              the
              trading price of our common stock could decline, and you may lose all
              or part of
              your investment.
 37
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 Keep
              these risk factors in mind when you read “forward-looking” statements elsewhere
              in this annual report. These are statements that relate to our expectations
              for
              future events and time periods. Generally, the words, “anticipate,” “expect,”
“intend,” and similar expressions identify forward-looking statements.
              Forward-looking statements involve risks and uncertainties, and future
              events
              and circumstances could differ significantly from those anticipated
              in the
              forward-looking statements.
 
 **Risks
              Relating to our Business**
 
 **We
              have experienced significant losses and we may never be
              profitable.**
 
 We
              have
              generated nominal revenue and significant losses and negative cash
              flows from
              our research and development endeavors since we began these activities
              in 1996.
              As of September 30, 2006, we had an accumulated deficit of $24,795,755.
              We had
              revenue for the fiscal year ended September 30, 2006 of $227,251 and
              a net loss
              for the same fiscal year of $945,293. The future profitability of our
              business
              will depend primarily on our ability to generate revenues from the
              sale of our
              products and the licensing of our technology. If our revenue grows
              at a slower
              rate than we anticipate or if our expenditures exceed our expectations
              or cannot
              be adjusted to reflect slower revenue growth, we may not achieve or
              sustain
              profitability. Our auditors have issued going concern opinions on our
              financial
              statements for the fiscal years ending September 30, 2006 and 2005.
 
 **Our
              future success is highly dependent on the continued availability of
              key
              employees and consultants including Michael Grollman and Graham
              Clark.**
 
 Our
              success depends substantially on the continued services of our two
              executive
              officers, Michael Grollman and Graham Clark. The loss of the services
              of any of
              our executive officers or key employees could harm our business. Mr.
              Grollman
              and Mr. Clark have entered into employment and non-compete agreements
              with us,
              but the loss of their services would have a material adverse effect
              on our
              business. In addition to Mr. Grollman and Mr. Clark, we employ or contract
              with
              other engineers and scientists who may be also critical to our success,
              especially Dr. El-Badawy El-Sharawy, who developed the majority of
              our
              semiconductor patented products. Both Mr. Clark and Dr. El-Sharawy
              are foreign
              nationals, and there is a risk that the Immigration and Naturalization
              Service
              (INS) may at any time withdraw their permission to work in the United
              States for
              us. Although our scientists and engineers have entered into confidentiality
              agreements with us, most have not entered into non-compete agreements
              with us.
              The loss of one or more of our research personnel could prevent or
              delay the
              ongoing development of our products and services, which would materially
              and
              adversely affect our business.
 
 **We
              have a limited operating history on which to evaluate our business
              or
              prospects.**
 
 We
              are
              company with limited revenue that just recently emerged from a development
              stage. Our business focus changed in 2002 from semiconductor product
              licensing
              to development of location tools and we have only a limited operating
              history on
              which you can base an evaluation of our business and prospects, with
              only
              approximately $300,477 in net revenue generated from this line of business
              for
              the two-years ending September 30, 2006. Accordingly, our business
              prospects
              must be considered in light of the risks, uncertainties, expenses and
              difficulties frequently encountered by companies in their early stages
              of
              development, particularly companies in new and rapidly evolving markets,
              such as
              the electronics and wireless location tools services markets.
 
 **We
              will require additional financing in order to complete the development
              of our
              products and services and otherwise develop our business operations.
              Such
              financing may not be available on acceptable terms, if at
              all.**
 
 We
              changed our business emphasis in 2002 and we do not know if our products
              will
              achieve significant levels of market acceptance. We may encounter unforeseen
              difficulties that may deplete our limited capital resources more rapidly
              than
              anticipated.
 38
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 We
              will
              likely be required to make significant product development expenditures
              and
              spend additional money to maintain and expand our marketing efforts.
              Although we
              completed a private offering in June 2004 and a Stock Exchange Agreement
              in
              February 2005 that provided us with capital, we have used much of it
              through
              September 30, 2005. We will need to seek additional equity financing
              in the
              future if our products do not generate revenue or if our expenses are
              greater
              than expected. The timing and amount of any capital requirements cannot
              be
              predicted at this time. We cannot be sure that any financing will be
              available
              on acceptable terms, if at all. If such financing is not available
              on
              satisfactory terms, we may be unable to continue, develop or expand
              our
              business, develop new products or penetrate existing markets at the
              rate desired
              and our ability to continue in business may be jeopardized. If adequate
              financing is not available, we may be required to terminate or significantly
              curtail our operations, or enter into arrangements with collaborative
              partners
              or others that may require us to relinquish rights to certain of our
              technologies, or potential markets that we would not otherwise relinquish.
              This
              would have a negative impact on the value of your shares.
 
 **We
              rely heavily on international third parties to manufacture our
              products.**
 
 We
              currently lack the facilities to manufacture our products on a commercial
              scale **.** If
              any of
              our customers require our location tools in commercial quantities in
              the near
              term, we will have to rely on one or more third-party contractors,
              some of which
              are outside the United States such as Electroconnect, Ltd., to manufacture
              the
              products to satisfy the needs of such customers. Reliance on one or
              more
              international third-party manufacturers exposes us to the risk that
              delivery
              schedules cannot be met, and that we cannot fulfill orders for some
              of our
              products in a timely way at the right price in U.S. dollars. This risk
              includes
              the concern that:
 ·
                  Third-party
                      manufacturers might be unable to manufacture our products in
                      the volume
                      and of the quality required to meet customers’
                      needs;
 ·
                  Our
                      existing and future contract manufacturers may not perform
                      as agreed or
                      may not remain in the contract manufacturing business for the
                      time
                      required to supply our customers;
 ·
                  If
                      any third-party manufacturer makes improvements in the manufacturing
                      process for our products, we may not own, or may have to share,
                      the
                      intellectual property rights to the
                      innovation.
  Each
              of
              these conditions could delay the shipments to our customers, approvals
              required
              by regulatory authorities, and the commercialization of some of our
              customers’
products. These risks could also result in higher costs to the customer
              or could
              deprive us of potential product revenues.
 
 **We
              have a small number of customers, and the loss of these customers would
              have a
              material adverse effect on our business.**
 
 During
              the year ended September 30, 2006, we derived approximately 92% of
              our total
              revenue from two customers. The loss of any of these customers would
              have a
              material adverse effect on our business, financial condition and results
              of
              operations. We are working to diversify our customer base in order
              to reduce our
              dependence on a small number of customers. We may not be able to succeed
              in
              these efforts.
 39
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 **We
              will need to significantly increase our sales and support
              operations.**
 
 We
              will
              need to create and substantially grow our direct and indirect sales
              operations,
              both domestically and internationally, in order to create and increase
              market
              awareness and sales of our products and services. For example, our
              Travado IBUS
TM products will require us to gain significant new sales skills in the
              education
              market. The sale of our products and services will require the engagement
              of
              sophisticated and highly knowledgeable sales personnel. Similarly,
              the
              anticipated complexity of our products and services and the difficulty
              of
              customizing them will require us to hire research and development personnel
              and
              customer service and support personnel, highly trained in hardware
              and software
              engineering. Competition between us and others to retain qualified
              sales
              personnel, engineers, and scientists is intense due to the limited
              number of
              available qualified candidates for such positions. Because of our limited
              resources, many of our competitors are in a financial position to offer
              potential employees greater compensation and benefits than those that
              we may be
              able offer them.
 
 **Risks
              Relating To Our Industry**
 
 **We
              may be held liable for harm caused by products that our customers
              use.**
 
 Often
              times, our products are used to enhance the safety and security of
              individuals
              and organizations because they provide real time information on location.
              For
              example, our Gotcha!® is used to help keep track of children and keep them safe
              in public places. Should these products fail to perform as intended,
              or should
              these products directly or indirectly cause injuries or illness to
              people, we
              may be required to incur substantial costs in defending against claims
              and may
              be required to pay damages arising from these actions. Although we
              have
              liability insurance and will try to limit our liability for improper
              use of our
              products, such protections may not be sufficient to protect us from
              the cost of
              such claims. Damages awarded in a product liability action could be
              substantial
              and if damages exceed our insurance coverage, our financial condition
              would be
              negatively affected.
  **Since
              many of our prospective business partners and suppliers are small electronics
              and software companies, we are and will be subject to risks, uncertainties
              and
              trends that affect these small companies in these
              industries.**
 
 For
              the
              foreseeable future, we will derive a substantial portion of our revenue
              from
              selling our products in combination with software and hardware products
              developed by other companies in areas complementary to our line of
              business.
              These are sometimes other small technology companies. As a result,
              we will be
              subject to risks and uncertainties that affect the electronic and software
              industries and possible reduction and delays in research and development
              expenditures by companies in these industries. For example, our GPS
              products
              produce coordinates that are usually displayed on a map to be meaningful.
              As a
              result, we have developed partnerships with mapping software companies
              to help
              us display this data in ways useful to our customers. For special mapping
              services such as this, we often deal with small privately-held technology
              firms,
              such as Geotechnologies, Inc. for military and related applications.
              Although we
              take certain steps to locate secondary suppliers and partners in each
              market
              where we depend on such small suppliers, we are often dependant on
              these firms
              to supply us and our customers with key products in a timely way. High
              costs and
              delays in product delivery by us to our customers could be experienced
              as a
              result of supplier changeover if these suppliers do not perform as
              we expect
              them to perform. These factors could negatively affect our delivery
              schedules
              and potentially our financial results.
 40
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 **The
              semiconductor and electronics markets experience wider demand and pricing
              fluctuations than most other industries.**
 
 We
              may
              experience extreme cyclical fluctuations in the demand and supply for
              our
              products, which may cause a decline in our sales or the prices of our
              products
              and a corresponding decline in our revenues and profitability. For
              example, our
              TMOS® memory products fall into a class of computer memory products that
              often
              see annual price swings of over 50% or more in particular lines of
              products,
              according to the reports issued by the Semiconductor Industry Association
              over
              the last 10 years. We believe, based on reports from the Semiconductor
              Industry
              Association and on the rate at which technologies in these markets
              become
              popular, and then rapidly obsolete, that year-to-year price swings
              in the
              semiconductor industry can be more extreme than in many other industries.
              Should
              we be successful in licensing our patented semiconductor designs at
              all, these
              kinds of extreme price swings could delay by several years the development
              of
              revenue from these patented semiconductor products.
 
 **Risks
              Relating to Our Technology**
 
 **Some
              of our wireless technology is subject to substantial government
              regulation.**
 
 The
              wireless electronics industry faces significant regulation by governmental
              entities in the United States and other countries. The nature and the
              extent to
              which these regulations apply to our customers will vary depending
              on the nature
              of any of our customer’s products. Most of the wireless products developed by us
              will require regulatory approval by governmental agencies prior to
              sale. In
              particular, radios we include in our products will require testing
              and other
              approval procedures by the Federal Communications Commission (“FCC”) and by
              foreign regulatory authorities. Some of this work has been completed,
              such as
              FCC approval of our Gotcha!® child safety product. In some cases, we purchase
              pre-approved assemblies for use in our products that have existing
              FCC approval
              for their radios, such as with our Travado IBUS TM products. Other work remains
              to be done for other products with the FCC before the products can
              be sold to
              consumers, such as with the next version of our WiFi Tracker TM product. The
              process of obtaining these approvals and the subsequent compliance
              with
              appropriate federal and foreign statutes and regulations can be costly
              and time
              consuming, and can cause significant delays in the sale of some of
              our
              products.
 
 **We
              may not be able to license or maintain access to the technologies that
              we need
              to conduct our business, such as GPS.**
 
 In
              addition to the technologies that we develop, we will rely heavily
              on
              technologies that we license from other companies or institutions.
              We may not be
              able to license technologies that we need in the future or we may be
              unable to
              license such technologies on a commercially reasonable basis. In particular,
              we
              depend on wireless technologies such as GPS that have been developed
              and are
              owned by others. If we are unable to license the technologies we need
              in the
              future, or to license or otherwise acquire such technologies on commercially
              reasonable terms, we may experience increased costs (and, therefore,
              reduced
              profits) or be unable to engage in certain activities that require
              those
              technologies. In the case of GPS, we are dependant on the U.S. Department
              of
              Defense to operate a large network of GPS satellites safely and at
              a low cost to
              consumers into the future, without degrading the signal accuracy. Prior
              to the
              year 2000, the Department of Defense degraded GPS accuracy for civilian
              uses on
              a regular basis, and has reserved the right to do so again in the future,
              without warning. Such an action by the Department of Defense could
              make our GPS
              based products less accurate, and thus potentially less desirable to
              our
              customers, and have a negative effect on our sales.
 41
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 **Our
              success will depend on our ability to protect our proprietary technology,
              especially our location tools product designs.**
 
 Our
              rights to a substantial portion of our components products technology
              are as the
              assignee of several United States patents and patent applications.
              We also
              protect our intellectual property, especially for our location tools,
              through
              the use of confidentiality agreements and other trade secret management
              practices. We also hold U.S. trademarks, such as TMOS® and Gotcha!®. In the case
              of most of our patented electronic component products, we have a contractual
              obligation to pay royalties to Dr. El-Badawy El-Sharawy in the event
              that these
              products generate any royalties to us, in order to maintain these rights
              of
              assignment. Our success will depend largely on our ability to protect
              and
              exploit our intellectual property, to obtain additional patents for
              other
              technologies and products, to defend patents once obtained, and maintain
              trade
              secrets over time. Failure to do so may introduce domestic or foreign
              competition that could significantly reduce our ability to generate
              sales at
              acceptable margins.
 
 **Risks
              Related to Our Securities**
 
 **Our
              stock price has been volatile and we expect it to remain volatile,
              which could
              limit investors’ ability to sell stock at a profit at the time of the investors’
choosing.**
 
 We
              have a
              limited trading market for our common stock, and our common stock has
              experienced price volatility in that market. In fiscal 2005 our stock
              price
              ranged from a high of $0.135 to a low of $0.034 per share, and in fiscal
              2006
              our stock price ranged from a high of $0.060 to a low of $0.026. This
              price
              volatility may substantially increase your risk of loss.
 
 The
              volatile price of our stock makes it difficult for investors to predict
              the
              value of their investment, to sell shares at a profit at any given
              time, or to
              plan purchases and sales in advance. A variety of factors may affect
              the market
              price of our common stock. These include, but are not limited to:
 ·
                  announcements
                      of technological innovations or new commercial products by
                      our competitors
                      or us;
 ·
                  developments
                      concerning proprietary rights, including
                      patents;
 ·
                  regulatory
                      developments in the United States and foreign
                      countries;
 ·
                  economic
                      or other crises and other external
                      factors;
 ·
                  period-to-period
                      fluctuations in our revenues and other results of
                      operations;
 ·
                  changes
                      in financial estimates by securities analysts;
                      and
 ·
                  sales
                      of our common stock.
 We
              will
              not be able to control many of these factors, and we believe that
              period-to-period comparisons of our financial results will not necessarily
              be
              indicative of our future performance.
 
 In
              addition, the stock market in general, and the market for electronics
              companies
              in particular, has experienced extreme price and volume fluctuations
              that may
              have been unrelated or disproportionate to the operating performance
              of
              individual companies. These broad market and industry factors may seriously
              harm
              the market price of our common stock, regardless of our operating performance,
              and may have a negative impact on your ability to sell shares of our
              stock.
 42
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 **Our
              Articles of Incorporation allow us to sell preferred stock without
              shareholder
              approval.**
 
 Our
              Board
              of Directors has the authority to issue up to 4,000,000 shares of preferred
              stock and to determine the price, rights, preferences, privileges and
              restrictions, including voting rights, of those shares without any
              additional
              vote or action by our shareholders. The rights of the holders of the
              common
              stock will be subject to, and could be materially adversely affected
              by, the
              rights of the holders of any preferred stock that may be issued in
              the future.
              For example we could issue preferred stock that has superior rights
              to dividends
              or is convertible into shares of common stock. This might adversely
              affect the
              market price of the common stock.
 
 **Trading
              of our common stock is limited.**
 
 Trading
              of our common stock is conducted on the National Association of Securities
              Dealers’ Over-the-Counter Bulletin Board, or “OTC Bulletin Board.” This
              adversely affects the liquidity of our common stock, not only in terms
              of the
              number of shares that can be bought and sold at a given price, but
              also through
              delays in the timing of transactions and reduction in security analysts’ and the
              media’s coverage of us. This may result in lower prices for our common stock
              than might otherwise be obtained and could also result in a larger
              spread
              between the bid and ask prices for our common
              stock.
 **Item
                    7.**
                  **Financial
                      Statements**
 
 The
              financial statements of NSC are included (with an index listing all
              such
              statements) in a separate financial section at the end of the Annual
              Report on
              Form 10-KSB.
 **Item
                    8.**
                  **Changes
                      In and Disagreements with Accountants on Accounting and Financial
                      Disclosure**
 
 None.
 
 **Item
                    8a.**
                  **Controls
                      and Procedures**
  Our
                management has responsibility for establishing and maintaining adequate
                internal
                control over financial reporting for us. Our management uses a framework
                for
                establishing these internals controls. This framework includes review
                of
                accounting detailed records on at least a quarterly basis by multiple
                senior
                officers of National Scientific, at least one of whom operates outside
                of the
                corporate finance and accounting area, and one of whom operates within
                the area
                of corporate finance and accounting. This review process includes
                review of
                significant accounting records and source documents, such as general
                journal
                entry records, accounts payable records, and monthly bank statement
                reconciliations. Documentary records are kept of this review
                process.
 43
 **Table
                          of Contents**
 **Index
                          to Financial
                          Statements**
 The
                Company carried out an evaluation, under the supervision and with
                the
                participation of the Company’s management, including its Chief Executive Officer
                and Acting Chief Financial Officer and its President, of the effectiveness,
                as
                of September 30, 2005, of the design and operation of the Company’s disclosure
                controls and procedures pursuant to Exchange Act Rule 13a-15. Based
                upon that
                evaluation, the Chief Executive Officer and Acting Chief Financial
                Officer and
                its President concluded that the Company’s disclosure controls and procedures
                are effective.
 
 There
                have been no significant negative changes in the our internal control
                over
                financial reporting during the year ended September 30, 2006 that
                have
                materially affected, or are reasonably likely to materially affect,
                the
                Company’s internal control over financial reporting.
 
 These
                controls and procedures for our disclosure as well as our internal
                controls over
                financial reporting are processes designed by, or under the supervision
                of, the
                principal executive and principal financial officers, and effected
                by the board
                of directors, management and other personnel, to provide reasonable
                assurance
                regarding the reliability of financial reporting and the preparation
                of
                financial statements for external purposes in accordance with generally
                accepted
                accounting principles. We believe that a control system, no matter
                how well
                designed and operated, cannot provide absolute assurance that the
                objectives of
                the control system are met, and no evaluation of controls can provide
                absolute
                assurance that all control issues and instances of fraud, if any,
                within a
                company have been detected. However, our Chief Executive Officer
                and Acting
                Chief Financial Officer and our President have concluded that the
                Company’s
                disclosure controls and procedures and its internal controls and
                procedures are
                effective at providing that reasonable level of assurance.
 
 Our
                management believes that upon significant future growth in the number
                of
                accounting transactions we process, perhaps within the next year,
                additional
                review and enhancement of internal controls will be required. Our
                management is
                planning to assign additional staff resources to assist with support
                for growth
                in the internal controls area when the increase in transaction velocity
                dictates
                this as a prudent step in order to maintain our effective level of
                internal
                controls.
 
 Our
                external auditors, Epstein Weber & Conover, PLC have not issued an
                attestation report on management’s assessment of the Company’s internal control
                over financial reporting, as it is not yet required since the Company
                has less
                than $75 million in “public float.”
 **Item
                    **8b.****
                  **Other
                      Information**
 
 Not
            Applicable.
  **PART
            III**
  **Item
                    9.**
                  **Directors,
                      Executive Officers, Promoters and Control Persons; Compliance
                      with Section
                      16(a) of the Exchange
                      Act**
 
 Directors
              hold office until the next succeeding annual meeting of shareholders,
              and until
              their successors have been elected and qualified.
  The
              directors, executive officers, significant employees and consultants
              of National
              Scientific, their respective ages and positions with us are as
              follows:
  44
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
 **Name**
                  
                  **Age**
                  
                  **Position**Michael
                      A. Grollman
                  
                  45
                  
                  CEO,
                      Chairman of the Board of DirectorsGraham
                      L. Clark
                  
                  51
                  
                  President,
                      Director, SecretaryGregory
                      Szabo
                  
                  53
                  
                  Director
                      (Outside)
 
 **Directors
              and Executive Officers**
 
 *Michael
              A. Grollman* .
              Michael
              Grollman first became Chief Operation Officer in October 2000. Mr.
              Grollman was
              named President in April 2001, Chief Executive Officer in January of
              2002,
              Chairman of the Board in December 2002, and Acting Chief Financial
              Officer in
              June of 2003. From 1998 to September 2000, Mr. Grollman served as Regional
              Service Director of MicroAge, Inc., a company that provides customer-configured
              technology solutions to businesses. He served as General Manager, Executive
              Vice
              President and Chief Technology Officer for Advanced Information Systems
              from
              1987 to 1998. Mr. Grollman received his Bachelor of Science degree
              in chemistry
              from the State University of New York. He received his MBA from Arizona
              State
              University.
 
 *Graham
              L. Clark.* Graham
              Clark joined National Scientific in early 2001 as general manager of
              the sales
              organization. He became Vice President of Technology Applications & Sales
              for National Scientific in the spring of 2002, a Director in August
              of 2002, and
              became Corporate Secretary in January of 2003. Mr. Clark was named
              President of
              National Scientific in September of 2003. For the two years immediately
              before
              joining National Scientific, Mr. Clark was the General Manager of the
              Billet
              Precision Engineering Group, a privately held manufacturing company
              providing
              custom engineering and manufacturing solutions to the semiconductor
              industry and
              other related industries. Prior to his tenure with Billet, he worked
              as
              Corporate General Manager for Amtech Systems, Inc. a semiconductor
              equipment
              manufacturer. Six years prior, he was a founder and senior partner
              of GC
              Technology, a private representative organization for semiconductor
              capital
              equipment. Mr. Clark has a Bachelor of Science degree in mechanical
              engineering
              from Paisley University in Scotland.
 
 *Gregory
              Szabo* joined
              National Scientific’s board on October 1, 2003 as an outside Director. Mr. Szabo
              serves on the Board’s Audit and Compensation Committees. Mr. Szabo served in
              various executive positions at Exten Corporation, including President
              of Exten
              Corp. and CEO of MultiCell Technologies, Inc. from approximately May
              2000 to
              April 2004, where he was responsible for public reporting, fund-raising
              for the
              corporation and overall accountability for its subsidiaries, including
              revenue
              generation, intellectual property protection and organizational development.
              Mr.
              Szabo was also a director at Exten, a publicly traded company (OTC:
              MUCL.OB).
              Immediately before joining Exten, Mr. Szabo was for a number of years
              President
              and CEO of Titan Scan Corporation, a division of Titan Corporation,
              with
              subsidiaries in sterilization, defense, software and communications.
              Mr. Szabo
              has held several executive positions with Sunrise Medical Inc., a manufacturer
              and distributor of numerous institutional and retail products. Mr.
              Szabo earned
              a BA in Psychology from the University of Toledo and a MA in Management
              from the
              Drucker Graduate School at Claremont University.
 
 **Significant
              Advisors and Key Employees**
 
 *El-Badawy
              El-Sharawy, Ph.D.* Dr.
              El-Sharawy is a Senior Scientific Consultant to us, starting with us
              in 1996.
              Dr. El-Sharawy is currently Assistant Professor of Electrical Engineering
              at
              Arizona State University’s Telecommunications Research Center, Department of
              Electrical Engineering, and has been there for over ten years. His
              expertise
              includes, but is not limited to, microwave circuits, anistropic devices
              and
              applied electromagnetics. He is a senior member of IEEE and is a recipient
              of
              the 1980 Egyptian Engineering Syndicate Medal of Honor.
 45
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 *David
              Mandala.* Mr.
              Mandala is our Chief Systems Architect. Mr. Mandala serves as lead
              developer for
              several GPS tracking product lines and is responsible for research
&
development, architecture, prototype creation and client product presentations.
              Most recently prior to joining NSC Mr. Mandala led a group of OLAP
              developers at
              Texas Instruments. Mr. Mandala previously worked for NSC during 2002
              and 2003.
              Prior to working for NSC he developed an on-line lab infrastructure
              for embedded
              computer hardware and server systems for DevelopOnline Corporation;
              he developed
              a number of database and courseware packages for Linuxcare, Inc., and
              has also
              made significant technological contributions to Ciba-Geigy, Dragon
              Medical
              Interactive Communications, and Sony Corporation. Mr. Mandala received
              his
              formal electronics education while serving in the United States
              Navy.
 
 *Oscar
              Quadros, Chartered Accountant* .
              Mr.
              Quadros is our controller, and works for us on a part-time basis. He
              joined us
              in late 2002. He is a Fellow of the Institute of Chartered Accountants
              in
              Ireland, and is a graduate of University College Dublin, Ireland, with
              a
              Bachelor of Commerce, major in Accounting and Economics. From August
              1998 to
              June 2002, he was CFO/Controller at A3T Incorporated & Axxis 3T Inc. of
              Scottsdale, Arizona. His 40 years of experience in international accounting
              and
              finance include senior auditor roles at Alexander MacLennan Trundell
& Co.,
              Public Accountants; Atkinson & Boyd, Public Accountants; and as an audit
              manager at Coopers & Lybrand, Public Accountants. He has also worked as a
              Director of Accounting at Canadelle Inc. (Subsidiary of Sara Lee Corporation),
              Canada, and as Vice President Finance/Controller at Jeno Neuman & Sons of
              Montreal, Canada.
 
 *Rhonda
              Jobe* .
              Rhonda
              Jobe has been part-time marketing manager for us since 2003. Ms. Jobe
              has
              extensive experience in the wireless communications and computing fields.
              Prior
              to working for NSC Ms. Jobe was Vice President of Marketing for Geoworks
              Corporation, a public company specializing in wireless data applications
              within
              the field service and field force industries. Ms. Jobe headed the wireless
              data
              division for US West Cellular, introducing wireless data products and
              services
              to large and medium-sized businesses. Ms. Jobe also worked for Motorola
              for over
              20 years in managerial, product management and marketing positions.
              She was
              responsible for product development and marketing of wireless data
              products and
              applications within the public safety and utilities industries. Mr.
              Jobe
              attended Arizona State University, Motorola University and the University
              of
              Michigan, focusing on marketing and technical product management.
 
 *Susan
              L. Regan, Esq.* Ms.
              Regan
              has been part-time legal counsel for us since 2002. Ms. Regan holds
              a Bachelor
              of Science degree from Heidelberg College in Ohio, a Master’s Degree in Planning
              and Resource Management from the University of Alaska, and a Juris
              Doctorate
              from the Thomas M. Cooley School of Law in Michigan. She is admitted
              to practice
              law in both Washington State and the State of Arizona. She was in part-time
              private practice for the three years prior to joining us. Previously
              she was
              employed with Standard Insurance Company group legal department as
              in house
              counsel.
  **Board
                of Directors**
 
 Our
                business is managed under the direction of the Board of Directors.
                The Board
                meets on a regularly scheduled basis to review significant developments
                affecting us and to act on matters requiring Board approval. It also
                holds
                special meetings when an important matter requires Board action between
                scheduled meetings. The Board met four (4) times during fiscal 2006.
                Each
                serving director attended 100% of the meetings held in 2006 by the
                Board and the
                committees of the Board on which such director served. The Board
                of Directors
                was made up of three members during fiscal 2006. Michael A. Grollman
                has been a
                director since November of 2000. Graham L. Clark has been a director
                since
                August of 2002. Former director Mr. Lou Ross retired from the board
                on September
                30, 2003 for personal reasons, citing no conflicts with management
                or board
                policy. Mr. Szabo joined the board on October 1, 2003. Currently,
                our Board of
                Directors consists of three members, Michael A. Grollman, Chairman,
                Graham L.
                Clark, Secretary, and Gregory Szabo. These Board members were re-elected
                by
                shareholder vote in April 2006.
 46
 **Table
                          of Contents**
 **Index
                          to Financial
                          Statements**
 **Audit
                Committee**
 
 Our
                Board’s audit committee was established in December 2000. The audit committee
                met two (2) times during calendar year 2006. Mr. Greg Szabo is chairman
                of our
                audit committee as an outside director and financial expert, and
                is currently
                its sole member. The audit committee has reviewed our financial statements
                for
                the fiscal year ended September 30, 2006, as audited by Epstein Weber
&
Conover, PLC, National Scientific’s independent auditors. Epstein Weber &
Conover, PLC has discussed these financial statements with management
                and the
                audit committee.
 
 **Compensation
                Committee and Board Compensation**
 
 Our
                board’s Compensation Committee was established in March 2003. The Compensation
                Committee met once during calendar year 2005, and has met once in
                calendar year
                2006. Mr. Greg Szabo currently heads our Compensation Committee as
                an outside
                director, and is currently its sole member. The Compensation Committee
                approved
                the executive compensation plan for the fiscal years ending September
                30, 2005
                and 2006, respectively.
 
 Our
                board
                as a whole approves board member compensation. This plan was approved
                by the
                Board originally in 2000, and was amended in the summer of 2003.
                Currently,
                employees of National Scientific who also serve on the board receive
                no
                additional compensation for board service. All newly appointed non-employee
                directors appointed after the end of fiscal year 2002 will be provided
                with a
                one-time grant of 20,000 shares of National Scientific restricted
                common stock
                upon original appointment to the board. This stock will be subject
                to forfeiture
                back to us should the Director for any reason not serve a full term
                on the board
                at least up to the next annual meeting of shareholders.
 
 Additionally,
                non-employee directors will also be paid $1,250 per board meeting,
                which
                includes telephonic board meetings as well as face-to-face board
                meetings. The
                $1,250 fee will be in the form of $250 cash and $1,000 of National
                Scientific
                restricted common stock. The restricted common stock will be at risk
                of
                forfeiture if the director does not serve his complete term. The
                fee will not be
                paid for telephone conversations involving Board members or others
                where no
                formal board meeting has been declared, or for normal committee meetings.
                Non-employee directors will also be paid retrospectively a quarterly
                retainer of
                10,000 options (as defined in the 2000 NSC Stock Option Plan) to
                purchase
                free-trading National Scientific common stock at the end of each
                fiscal quarter
                they have served. The options will be immediately vested at point
                of grant, and
                will be issued at an exercise price equal to the average closing
                price for our
                common stock for that quarter. Non-employee directors who serve on
                a board
                committee, such as the audit or compensation committees, will also
                be paid
                retrospectively a quarterly additional retainer of 10,000 options,
                as defined in
                the 2000 National Scientific Stock Option Plan, to purchase free
                trading common
                stock. The options will be immediately vested at point of grant,
                and will be
                issued at an exercise price equal to the average closing price for
                National
                Scientific’s common stock for that quarter. Non-employee directors who serve
                on
                multiple committees will be paid this bonus only once for general
                committee
                service, however, as it is not paid for each committee of service.
                All directors
                are paid any reasonable out of pocket expenses required to attend
                board
                meetings, such as travel, if any.
 
 **Compliance
                with Section 16(a) of the Securities Exchange Act of 1934**
 
 Section
                16(a) of the Securities Exchange Act of 1934, as amended, requires
                our directors
                and executive officers, as well as persons beneficially owning more
                than 10% of
                the our outstanding Common Stock, to file certain reports of ownership
                with the
                Commission within specified time periods. Such officers, directors,
                and
                shareholders are also required by Commission’s rules to furnish the Company with
                copies of all Section 16(a) forms they file.
 47
 **Table
                          of Contents**
 **Index
                          to Financial
                          Statements**
 Based
                solely on our review of such forms, all requirements received by
                it, or written
                representations from certain reporting persons, we believe that between
                October
                1, 2002 and September 30, 2006, all Section 16(a) filing requirements
                applicable
                to its officers, directors and 10% shareholders were met.
 
 **Code
                of Ethics**
 
 Our
                board
                adopted on July 28, 2004, a code of ethical conduct that applies
                to our
                principal executive officers and principal financial officer. Its
                purpose is to
                promote honest and ethical conduct, including the ethical handling
                of actual or
                apparent conflicts of interest between personal and professional
                relationships,
                full, fair, accurate, timely, and understandable disclosure in reports
                and
                documents that a small business issuer files with, or submits to,
                the Commission
                and in other public communications made by the small business issuer,
                compliance
                with applicable governmental laws, rules and regulations; the prompt
                internal
                reporting of violations of the code to an appropriate person or persons
                identified in the code; and accountability for adherence to the code.
                A copy of
                this code has been filed with the Securities and Exchange Commission.
                An
                additional copy can be found on our website at www. nsct.info  or
                by
                writing to the Company and requesting one.
 **Item
                      10.**
                  **Executive
                      Compensation**
 
 The
            following table sets forth certain information
            regarding annual and long-term compensation for services rendered to
            us during
            the fiscal years ended September 30, 2006, 2005, and 2004 to the Chief
            Executive
            Officer of National Scientific, and other named executive officers who
            served us
            in fiscal year 2006 and whose total salary and non-cash compensation
            exceeded
            $100,000 for the applicable fiscal periods. The table below includes
            salary
            earned and paid in the fiscal year ended September 30, 2006.
  **Summary
            Compensation Table**
 **Long-Term
                      Compensation****Annual
                      Compensation**
                  
                  **Awards**
                  
                  **Payouts****Other**
                  
                  **Restricted**
                  
                  **Securities****Annual**
                  
                  **Stock**
                  
                  **Underlying**
                  
                  **LTIP**
                  
                  **All
                      other****Name
                      and Principal**
                  
                  **Fiscal**
                  
                  **Salary**
                  
                  **Bonus**
                  
                  **Compensation**
                  
                  **Award(s)**
                  
                  **Options/**
                  
                  **Payout**
                  
                  **Compensation****Position**
                  
                  **Year**
                  
                  **($)****(1)**
                  
                  **($)**
                  
                  **($)**
                  
                  **($)****(2)**
                  
                  **SARs
                      (#)**
                  
                  **($)**
                  
                  **($)****(3)**Michael
                      A. Grollman
                  
                  
                  2006
                  
                  
                  100
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  179,900CEO,
                      Chairman(4)
                  
                  
                  2005
                  
                  
                  69,200
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  110,8002004
                  
                  
                  94,200
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  70,800Graham
                      L. Clark
                  
                  
                  2006
                  
                  
                  25,750
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  124,250President,
                      Director(5)
                  
                  
                  2005
                  
                  
                  87,000
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  63,0002004
                  
                  
                  101,100
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  41,400Gregory
                      Szabo
                  
                  
                  2006
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  3,599
                  
                  
                  –
                  
                  
                  –
                  
                  
                  1,000Director(6)
                  
                  
                  2005
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  1,0002004
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  2,250
  (1)
                    Unpaid
                        wages in this table are subject to Agreements with listed
                        persons that
                        allow for interest of approximately prime rate plus 2% accruing
                        on those
                        unpaid wages until paid. These accruals for interest are
                        shown as
                        approximate through fiscal year-end September 2006, and are
                        detailed on
                        notes (4) and (5) by person(2)
                    Stock
                        grants, if any, included in this column are for common stock
                        valued at 90%
                        of the closing sales price for such shares on the date of
                        grant. Closing
                        sales price at fiscal year end September 2006 was approximately
                        $0.026 per
                        share, and closing sales price at fiscal year end September
                        2005 was
                        approximately $0.045 per share.
 48
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 (3)
                            Includes
                                unpaid salary forgone at the election of executive
                                officers Grollman and
                                Clark pursuant to a registrant program under which
                                stock, stock-based or
                                other forms of non-cash compensation may be received
                                by a named executive
                                in lieu of a portion of annual compensation earned
                                in a covered fiscal
                                year.(4)
                            Salaries
                                of $179,900, $110,800, and $70,800 were not paid
                                in cash, but deferred to
                                a future period for fiscal years 2006, 2005, and
                                2004 respectively. In
                                December 2003 Mr. Grollman agreed to convert approximately
                                $150,000 of his
                                back pay and accrued vacation pay to our restricted
                                common stock, at a
                                rate equal to the then currently available private
                                placement share price
                                of $0.10 per share. Mr. Grollman received this stock
                                in January of 2004.
                                On August 17, 2005, Mr. Grollman agreed to convert
                                approximately $34,500
                                of his back pay to our restricted common stock, the
                                rate of the average
                                market price per share of $0.046. On August 31, 2005,
                                Mr. Grollman agreed
                                to convert approximately $15,190 of his back pay
                                to our restricted common
                                stock, the rate of the average market price per share
                                of $0.035. On April
                                7, 2006, Mr. Grollman agreed to convert approximately
                                $16,000 of his back
                                pay to our restricted common stock, the rate of the
                                average market price
                                per share of $0.032. Also subsequent to fiscal 2006
                                year-end, Mr. Grollman
                                deferred all of his October and November monthly
                                salary of $15,000 to a
                                future period. During fiscal 2006 and up to December
                                2006, Mr. Grollman’s
                                share of contributions to the Company’s health insurance program of $7,365
                                were deducted from the balance of wages owing, leaving
                                as of the end of
                                December 2006, unpaid wages of approximately $299,000,
                                accrued vacation
                                pay of approximately $44,502 and accrued interest
                                on deferred salary of
                                approximately $54,752, for a combined total of approximately
                                $380,854.(5)
                            Salaries
                                  of $124,250, $63,000, and $41,400 were not paid
                                  in cash, but deferred to a
                                  future period for fiscal years 2006, 2005, and
                                  2004 respectively. On
                                  August 17, 2005, Mr. Clark agreed to convert approximately
                                  $23,000 of his
                                  back pay to our restricted common stock, the rate
                                  of the average market
                                  price per share of $0.046. On August 31, 2005,
                                  Mr. Clark agreed to convert
                                  approximately $9,500 of his back pay to our restricted
                                  common stock, the
                                  rate of the average market price per share of $0.035.
                                  On March 15, 2006,
                                  Mr. Clark agreed to convert approximately $15,050
                                  of his back pay to our
                                  restricted common stock, the rate of the average
                                  market price per share of
                                  $0.035. On May 25, 2006, Mr. Clark agreed to convert
                                  approximately $40,250
                                  of his back pay to our restricted common stock,
                                  the rate of the average
                                  market price per share of $0.035. Also subsequent
                                  to September 30, 2006
                                  year-end, Mr. Clark deferred all of his October
                                  and November monthly
                                  salary of $12,500 to a future period. During fiscal
                                  2006 and up to
                                  December 2006, Mr. Clark’s share of contributions to the Company’s health
                                  insurance program of $8,433 were deducted from
                                  the balance of wages owing,
                                  leaving as of the end of December 2006, unpaid
                                  wages of approximately
                                  $157,173, accrued vacation pay of approximately
                                  $40,570 and accrued
                                  interest on deferred salary of approximately $32,233
                                  for a combined total
                                  of approximately $237,776.(6)
                            Other
                                  Compensation for 2006, 2005 and 2004 of $1,000,
                                  $1,000 and $2,250 is for
                                  board fees, as is the $3,599 in restricted stock,
                                  which is subject to
                                  forfeiture if board term is not
                                  completed.
 **Long
            Term Incentive Plans - Awards in the Last Two Fiscal Years**
 
 **Performance
                        or**
                  
                  **Estimated
                        Future Payouts Under Non-****Other
                        Period**
                  
                  **Stock
                      Priced-Based Plans****Number
                      of**
                  
                  **Until****Shares**
                  
                  **Maturation
                        or**
                  
                  **Threshold**
                  
                  **Target**
                  
                  **Maximum****Name**
                  
                  **(#)****(1)**
                  
                  **Payout**
                  
                  **($
                        or #)**
                  
                  **($
                        or #)**
                  
                  **($
                        or #)**Michael
                      A. Grollman(2)
                  
                  
                  1,250,000
                  
                  
                  Dec
                      2006Graham
                      L. Clark(3)
                  
                  
                  1,000,000
                  
                  
                  Dec
                      2006
 ____________
 (1)
                  All
                      grants in this table are based on our fiscal year 2002 Stock
                      Retainage
                      Program. This program was implemented by our board in September
                      2002, and
                      shares were granted at that time. Actual issuance of shares
                      for the named
                      executive participants took place in January of 2003. Our board
                      allocated
                      approximately $150,000 in common stock from this Stock Retainage
                      Program
                      pool of shares, to be granted to key employees during the year,
                      subject to
                      National Scientific exceeding sales growth objectives and expense
                      reduction objectives, and subject to the employees remaining
                      with us
                      through the next 15 months, or longer, if the awards were not
                      earned after
                      15 months. Failure to meet these objectives under the plan
                      can result in
                      the forfeiture by staff of some or all of the stock grants
                      by all
                      participants. These goals were the same for all plan participants,
                      which
                      included other non-executives, as well the named executives.
                      These goals
                      were not met in calendar year 2003. In January of 2004, our
                      board extended
                      this program into 2004, and set new sales growth objectives
                      for the year
                      at a level 50% higher than the previous year’s program, giving plan
                      participants an additional year to fully earn this stock grant.
                      The plan
                      was extended by the Company board to run through at least December
                      2007.
 49
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
  (2)
                    Mr.
                        Grollman was granted 750,000 shares of stock from this Stock
                        Retainage
                        Program pool of shares, subject to National Scientific achieving
                        in excess
                        of $400,000 in sales in calendar year 2004. Mr. Grollman
                        was granted an
                        additional 500,000 shares of stock under this program, subject
                        to sales
                        exceeding $1,500,000 for calendar year 2004. In July of 2005,
                        the board
                        indicated that it mat waive Mr. Grollman’s risk of forfeiture on these
                        shares in 2006, based on his forbearance on collecting of
                        the various
                        Notes due to him at the end of fiscal 2005 – however, no final board
                        action has been taken on this matter.(3)
                    Mr.
                        Clark was granted 500,000 shares of stock from our Stock
                        Retainage Program
                        pool of shares discussed above, subject to National Scientific
                        achieving
                        in excess of $400,000 in sales in calendar year 2004. Mr.
                        Clark was
                        granted an additional 500,000 shares of stock under this
                        program, subject
                        to sales exceeding $1,500,000 for calendar year
                        2004.
  **Option/SAR
                Grants and Exercises of Options/SAR Grants during Last Fiscal
                Year**
 No
                    individual grants of stock options (whether or not in tandem
                    with SARs), or
                    freestanding SARs (including options and SARs that subsequently
                    have been
                    transferred) were made during the fiscal year ending September
                    30, 2006, to any
                    of the named executive officers, nor did any of the named executive
                    officers
                    exercise any options or SAR grants during that period.
 
 **Employee
                    Stock Retainage Plan**
 
 In
                    September 2002, by unanimous vote, our board initiated a restricted
                    stock
                    retainage program or plan (“Stock Retainage Program”) to retain key staff during
                    a period of financial difficulty in calendar year 2002. The board
                    allocated
                    approximately $150,000 in restricted common stock from this Stock
                    Retainage
                    Program as a pool of shares of our restricted common stock, to
                    be granted to key
                    employees at the direction of the board for the year and the
                    next, subject to
                    National Scientific exceeding sales growth objectives and expense
                    control
                    objectives in 2003. Failure to meet these objectives under the
                    plan would result
                    in serious risk of forfeiture by staff of some or all of these
                    stock grants by
                    all participants. All goals set were team goals. The plan has
                    been used as a
                    tool to achieve salary deferral and other salary concessions
                    from the staff
                    during this period of fiscal hardship, in order to retain key
                    employees during
                    this period The plan’s sales goals were not met in calendar year 2003, although
                    the plan was nonetheless largely successful in assisting to retain
                    key staff,
                    even during this period of deferred or reduced salary. In January
                    of 2004, our
                    board extended this program into 2005, and set new sales growth
                    objectives for
                    the year at a level 50% higher than the previous year’s program, giving plan
                    participants an additional year to fully earn these previously
                    outstanding
                    restricted stock grants. No new shares were added to the plan,
                    although plan
                    participants were able to convert some long-term back pay into
                    restricted stock
                    at that time, if desired. In February of 2005, the plan was extended
                    by the
                    board into 2006, with goals set at the same level as 2005. As
                    of the date of
                    this report, the plan currently covers officers Michael Grollman
                    and Graham
                    Clark, and employees who are not officers including Oscar Quadros,
                    and David
                    Mandala. The plan has not been submitted to our shareholders
                    for approval. All
                    of the stock under this program is restricted under SEC Section
                    144. As of the
                    date of this report none of these grants have been fully earned,
                    and they remain
                    subject to substantial risk of forfeiture.
 50
 **Table
                              of Contents**
 **Index
                              to Financial
                              Statements**
 **Employment
                    Agreements**
 
 We
                    engaged Mr. Grollman as an independent contractor from October
                    7, 2000 until
                    November 30, 2000. He was paid $15,000 monthly for his services
                    as an
                    independent contractor. Effective December 1, 2000, Mr. Grollman
                    became an
                    employee of National Scientific under a one-year contract to
                    serve as our Chief
                    Operating Officer. Mr. Grollman was named President in April
                    2001. The contract
                    automatically renews for additional one-year terms unless either
                    party chooses
                    to terminate, and it remains in force through at least calendar
                    year 2005. Mr.
                    Grollman’s contract calls for an annual gross salary of $180,000, payable
                    semi-monthly. Also in accordance with the contract, on December
                    1, 2000, we
                    granted Mr. Grollman 100,000 shares of common stock, subject
                    to risk of
                    forfeiture should Mr. Grollman not fulfill the terms of his employment
                    agreement. Also on December 1, 2000, we granted Mr. Grollman
                    500,000 vested
                    options to purchase common stock at the closing sales price of
                    the common stock
                    on December 1, 2000. Additional option grants are included in
                    Mr. Grollman’s
                    employment contract for each whole dollar amount increase in
                    the market value of
                    our Common Stock. The whole dollar amount increase is measured
                    over a moving
                    two-week average. For each whole dollar amount attained between
                    $1 and $15
                    inclusive, Mr. Grollman will receive 75,000 options at the whole
                    dollar amount
                    option price. Mr. Grollman is also entitled to additional options
                    at various but
                    declining levels for increases in stock value up to $50 per Common
                    Share. In the
                    event of a change in control or sale of substantially all the
                    assets of National
                    Scientific, the employment agreement between Mr. Grollman and
                    us automatically
                    terminates, and Mr. Grollman is to receive one hundred fifty
                    percent (150%) of
                    the then current year’s annual salary.
 
 In
                    January of 2002 Mr. Grollman agreed to defer 20% of his salary
                    until such a time
                    as cash was more available, reducing his immediately payable
                    cash salary to
                    $12,000 per month. For September, October, and November of 2002,
                    Mr. Grollman
                    deferred 100% of his payable salary, reducing his immediately
                    payable cash
                    salary to $0 per month. Mr. Grollman agreed from January 2003
                    through December
                    2003 to reduce his total payable salary for the 2003 year to
                    $120,000 per year.
                    In addition to this reduction, during the year ended September
                    30, 2003 Mr.
                    Grollman deferred $70,360 of his salary and was paid $64,640
                    in cash. During the
                    year ended September 30, 2004 Mr. Grollman deferred $70,800 of
                    his salary and
                    was paid $94,200 in cash. For calendar year 2004, Mr. Grollman
                    agreed to defer
                    up to $30,000 of his contracted pay as needed. During the year
                    ended September
                    30, 2005 Mr. Grollman deferred $110,800 of his salary and was
                    paid $69,200 in
                    cash. During the year ended September 30, 2006 Mr. Grollman deferred
                    $179,900 of
                    his salary and was paid $100 in cash. Also subsequent to fiscal
                    2006 year-end,
                    Mr. Grollman deferred all of his October and November salary
                    of $15,000 to a
                    future period. During fiscal 2006 and up to November 2006, Mr.
                    Grollman’s share
                    of contributions to the Company’s health insurance program of $7,365 were
                    deducted from the balance of wages owing, leaving as of the end
                    of November
                    2006, unpaid wages of $284,100 accrued vacation pay of $43,502
                    and accrued
                    interest on deferred salary of approximately $53,252 for a combined
                    total of
                    approximately $380,854.
 
 In
                    September 2002, our board initiated a restricted stock retainage
                    program (“Stock
                    Retainage Program”) to retain key staff during a period of financial difficulty
                    in calendar year 2002. The board allocated approximately $150,000
                    in common
                    stock from this Stock Retainage Program pool of shares, to be
                    granted to key
                    employees during the year, subject to National Scientific exceeding
                    sales growth
                    objectives and expense reduction objectives in 2003. Failure
                    to meet these
                    objectives under the plan would result in the forfeiture by staff
                    of this entire
                    stock grant by all participants. These goals were not met in
                    calendar year 2003.
                    In January of 2004, our Board extended this program into 2004,
                    and set new sales
                    growth objectives for the year at a level 50% higher than the
                    previous year’s
                    program, giving plan participants an additional year to fully
                    earn this stock
                    grant. On August 19, 2003, a participant of the plan left us
                    and his grant of
                    800,000 shares were forfeited at the average market price per
                    share of $0.15. On
                    September 30, 2003 the 800,000 shares of common stock resulting
                    from the
                    forfeiture was allocated to the plan. We issued this stock under
                    the terms of
                    the plan to several employees in 2004 who are not officers or
                    directors of
                    National Scientific. As of the date of this report none of these
                    grants have
                    been fully earned, and they remain subject to substantial risk
                    of
                    forfeiture.
 
 Mr.
                    Grollman was granted 750,000 shares of stock from this Stock
                    Retainage Program
                    pool of shares, subject to National Scientific achieving in excess
                    of $400,000
                    in sales in calendar year 2004. Mr. Grollman was granted an additional
                    500,000
                    shares of stock under this program, subject to sales exceeding
                    $1,500,000 for
                    calendar year 2004.
 51
 **Table
                              of Contents**
 **Index
                              to Financial
                              Statements**
 In
                    December 2003 Mr. Grollman agreed to convert approximately $150,000
                    of his back
                    pay and accrued vacation pay to our restricted common stock,
                    at a rate equal to
                    the then currently available private placement share price of
                    $0.10 per share.
                    Mr. Grollman received this stock in January of 2004.
 
 On
                    August
                    31, 2005, Mr. Grollman agreed to convert approximately $15,190
                    of his back pay
                    to our restricted common stock, the rate of the average market
                    price per share
                    of $0.035. Mr. Grollman received this stock in September of 2005.
 
 On
                    November 23, 2005, Mr. Grollman agreed to convert approximately
                    $18,000 of our
                    accounts payable and accrued expense indebtedness to him to our
                    restricted
                    common stock, the rate of the average market price per share
                    of
                    $0.036.
 
 On
                    April
                    7, 2006, Mr. Grollman agreed to convert approximately $16,000
                    of his back pay to
                    our restricted common stock, the rate of the average market price
                    per share of
                    $0.032.
 
 Mr.
                    Clark
                    was hired in December 2000 as manager of the sales organization.
                    His salary was
                    $120,000 per year base salary, plus commission on sales. He became
                    Vice
                    President of Technology Applications & Sales for us in September 2001, and a
                    director and a corporate officer in August of 2002. In January
                    of 2003, Mr.
                    Clark entered into a one-year employment agreement with National
                    Scientific to
                    serve as Vice President of Technology Applications & Sales. In June of 2003
                    Mr. Clark was named President of National Scientific. The contract
                    automatically
                    renews for additional one-year terms unless either party chooses
                    to terminate.
                    Mr. Clark’s contract provides for an annual gross salary of $150,000, payable
                    monthly. In the event of a change in control or sale of substantially
                    all our
                    assets, the employment agreement between Mr. Clark and National
                    Scientific
                    automatically terminates, and Mr. Clark is to receive fifty percent
                    (50%) of the
                    then current year’s annual salary.
 
 For
                    September, October, and November of 2002, Mr. Clark deferred
                    100% of his payable
                    salary, reducing his immediately payable cash salary to $0 per
                    month. During the
                    year ended September 30, 2003 Mr. Clark deferred $50,360 of his
                    salary and was
                    paid $69,640 in cash. During the year ended September 30, 2004
                    Mr. Clark
                    deferred $41,400 of his salary and was paid $101,100 in cash.
                    During the year
                    ended September 30, 2005 Mr. Clark deferred $63,000 of his salary
                    and was paid
                    $87,000 in cash. During the year ended September 30, 2006 Mr.
                    Clark deferred
                    $124,250 of his salary and was paid $24,750 in cash. Also subsequent
                    to
                    September 30, 2006 year-end, Mr. Clark deferred all of his October
                    and November
                    monthly salary of $12,500 to a future period. During fiscal 2006
                    and up to
                    November 2006, Mr. Clark’s share of contributions to the Company’s health
                    insurance program of $8,433 were deducted from the balance of
                    wages owing,
                    leaving as of the end of November 2006, unpaid wages of $167,173,
                    accrued
                    vacation pay of $39,570 and accrued interest on deferred salary
                    of $31,033 for a
                    combined total of approximately $237,776.
 
 Mr.
                    Clark
                    was granted 500,000 shares of stock from our Stock Retainage
                    Program pool of
                    shares discussed above, subject to National Scientific achieving
                    in excess of
                    $400,000 in sales in calendar year 2004. Mr. Clark was granted
                    an additional
                    500,000 shares of stock under this program, subject to sales
                    exceeding
                    $1,500,000 for calendar year 2004.
 
 On
                    August
                    31, 2005, Mr. Clark agreed to convert approximately $9,500 of
                    his back pay to
                    our restricted common stock, the rate of the average market price
                    per share of
                    $0.035. Mr. Clark received this stock in September of 2005.
 
 On
                    March
                    15, 2006, Mr. Clark agreed to convert approximately $15,050 of
                    his back pay to
                    our restricted common stock, the rate of the average market price
                    per share of
                    $0.035.
 52
 **Table
                              of Contents**
 **Index
                              to Financial
                              Statements**
 On
                    May
                    25, 2006, Mr. Clark agreed to convert approximately $40,250 of
                    his back pay to
                    our restricted common stock, the rate of the average market price
                    per share of
                    $0.035.
  In
                    January 2003, we, under our Restricted Stock Retainage Plan initiated
                    in
                    September 2002, issued 2,550,000 shares of common stock at an
                    average price of
                    $0.06 or 90% of the price on the grant date of September 30,
                    2002. These grants
                    were provided originally to Michael Grollman, Graham Clark, David
                    Mandala, and
                    Karen Fuhre. Mr. Mandala left the firm in mid-2003, and his shares
                    under the
                    plan were reallocated to Oscar Quadros and Paul Davidson. These
                    stock grants
                    were contingent upon National Scientific achieving sales targets
                    for calendar
                    year 2003. Should these targets not be met, these shares would
                    be forfeited, or
                    we and the employees involved in the program would elect to establish
                    new goals
                    for calendar year 2004, in order to motivate the staff to perform
                    and
                    simultaneously conserve cash resources during the next calendar
                    year, using the
                    same stock grants, as yet unearned, as long term incentive.
 
 During
                    the fiscal year ended September 30, 2004, we issued 160,084 shares,
                    of our
                    common stock to our consultants in lieu of cash compensation.
                    During the fiscal
                    year ended September 30, 2005 we generally did not use the services
                    of
                    consultants, therefore, we did not issue shares of our common
                    stock to our
                    consultants in lieu of cash compensation to them. During fiscal
                    2004, we granted
                    790,000 options to our consultants and employees to purchase
                    shares of our
                    common stock. The options granted had exercise prices ranging
                    from $0.09 per
                    share to $0.16 per share. The exercise prices were generally
                    below market on the
                    date of grant, and vested. We granted these options as a means
                    of compensation
                    to consultants to conserve operating cash. During fiscal 2005,
                    no options were
                    granted to consultants or employees. The only options granted
                    were issued to an
                    outside director for board fees.
 
 During
                    fiscal 2006, in order to conserve cash, 310,681 stock options
                    were granted to
                    William Sklar, a consultant, for investor relations services.
                    152,358 stock
                    options were granted to Mr. Sklar on June 26, 2006. The weighted
                    average grant
                    date fair value of these options was $0.0376. 158,323 stock options
                    were granted
                    to Mr. Sklar on September 20, 2006. The weighted average grant
                    date fair value
                    of these options was $0.0259. Stock based compensation of $9,816
                    was recognized
                    in the financial statements for the year ended September 30,
                    2006 using the
                    Black-Scholes option pricing model value on the grant date. The
                    options have a
                    life of ten years. Also, during fiscal 2006, 60,000 options granted
                    were issued
                    to an outside director for board fees. During fiscal 2006, no
                    options were
                    granted to employees.
  **Item
                    11.**
                  **Security
                      Ownership of Certain Beneficial Owners and
                      Management**
  The
              table
              below sets forth certain information, as of November 30, 2006, concerning
              the
              beneficial ownership by (i) all current directors, (ii) each of our
              named
              executive officers, (iii) each person known to us to be the beneficial
              owner of
              more than five percent (5%) of our outstanding common stock, and (iv)
              all of our
              directors and executive officers as a group. To our knowledge, all
              persons
              listed in the table have sole voting and investment power with respect
              to their
              shares, except to the extent that their respective spouses share authority
              under
              applicable law.
 53
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
 **Number
                      of****Common
                      Shares**
                  
                  
                  **Percent
                      of****Beneficially**
                  
                  
                  **Outstanding****Name
                      and Address of Beneficial Owner****(1)**
                  
                  
                  **Owned****(2)**
                  
                  
                  **Shares**Michael
                      A. Grollman
                  
                  
                  6,250,000
                  (3)
                  
                  6.3%Graham
                      L. Clark
                  
                  
                  3,781,667
                  (4)
                  
                  3.8%Gregory
                      Szabo
                  
                  
                  382,764
                  (5)
                  
                  0.4%All
                      executive officers and directors as a group
                    (3
                      persons)
                  
                  
                  10,414,431
                  
                  
                  10.5%
  (1)
                  The
                      business address for all directors and officers is c/o National
                      Scientific
                      Corporation, 8361 E. Evans Road, Suite 106, Scottsdale, Arizona
                      85260.(2)
                  A
                      person is deemed to be the beneficial owner of securities that
                      can be
                      acquired within 60 days from the date set forth above through
                      the exercise
                      of any option, warrant or right. Shares of Common Stock subject
                      to
                      options, warrants or rights that are currently exercisable
                      or exercisable
                      within 60 days are deemed outstanding for computing the percentage
                      of the
                      person holding such options, warrants or rights, but are not
                      deemed
                      outstanding for computing the percentage of any other person.
                      The amounts
                      and percentages are based upon the approximately 95,795,459
                      shares of
                      Common Stock outstanding as December 28, 2006.(3)
                  Includes
                      1,050,000 shares underlying currently exercisable stock options
                      and
                      warrants, and 5,200,000 shares of restricted Common Stock including
                      2,000,000 shares subject to substantial risk of
                      forfeiture.(4)
                  Includes
                      326,667 shares underlying currently exercisable stock options
                      and warrants
                      and 3,455,000 shares of restricted Common Stock including 1,500,000
                      shares
                      subject to substantial risk of forfeiture.(5)
                  Includes
                      180,000 shares underlying currently exercisable stock options
                      and warrants
                      and 202,764 shares of restricted Common Stock subject to substantial
                      risk
                      of forfeiture.
  **Item
                    12.**
                  **Certain
                      Relationships and Related
                      Transactions**
  In
                October 2002, Mr. Lou Ross, the former Chairman of the Board, and
                a Director
                until September 30, 2003, was paid for his services as an active
                member of the
                board in shares of restricted common stock, in lieu of cash. The
                former Chairman
                received 66,806 restricted common shares at an average price on the
                date of
                grant of $0.11 per share.
 
 In
                June
                2003, we entered into an agreement to restructure and repay an outstanding
                debt
                to Mr. Lou Ross, a Director of National Scientific. Together with
                Mr. Ross, we
                aggregated the value of all sums we currently owed to Mr. Ross. This
                included
                notes executed of approximately $75,000, all salary deferred by Mr.
                Ross in 2002
                of approximately $8,300, and all cash board fees deferred in 2002
                by Mr. Ross of
                approximately $3,000, for a total amount payable to Mr. Ross as of
                June 11, 2003
                of approximately $86,500. Mr. Ross agreed to accept one-half of this
                sum, or
                $43,250, in restricted common stock issued at the then-current market
                price of
                $0.15 cents per share, for a total share grant to Mr. Ross of 288,334
                shares.
                Mr. Ross also agreed to convert the remaining one-half of the total
                debt
                outstanding from us to him, or $43,250, into a three-year interest
                free note,
                with no payments required by us until the end of the three-year period,
                and
                which could be paid by us at any time before the three-year period
                elapses with
                either cash or its restricted common stock or a combination of cash
                and stock.
                With this agreement, we no longer have any outstanding delinquent
                notes to Mr.
                Ross, and our liabilities have been reduced by $43,250, though he
                remains a
                significant stockholder of ours.
 54
 **Table
                          of Contents**
 **Index
                          to Financial
                          Statements**
 Mr.
                Ross
                also agreed to take a reduction in his Director’s fees for the period from
                February 2003 to the end of the fiscal year ending in September 2003,
                and to
                accept 50,000 shares of our restricted common stock in lieu of cash
                for these
                board services, which was paid to him in stock on June 11, 2003.
                On September
                30, 2003, at the point of his resignation from the Board, Mr. Ross
                surrendered
                all stock options he had received from us.
 
 On
                September 30, 2002 we started a restricted Stock Retainage Program
                to retain key
                staff during a period of financial difficulty with significant periods
                of cash
                wage deferrals. We allocated approximately 3,350,000 shares with
                a current
                market value of $150,000 from this Stock Retainage Program pool of
                shares in
                fiscal 2002, to be granted to key personnel. Grants from this pool
                of shares
                were made to Michael Grollman, Graham Clark, Karen Fuhre, Oscar Quadros,
                and
                Paul Davidson. As of the date of this report, none of these grants
                have been
                fully earned, and they remain subject to substantial risk of
                forfeiture.
 
 In
                December 2004, our Chairman Michael Grollman made personal loans
                to the Company
                in the amount of $65,000 to assist us with short-term cash requirements.
                The
                loan is evidenced by an unsecured promissory note that provides for
                repayment
                within 90 days or less, at no interest. The promissory note also
                provides that
                if repayment takes longer than 90 days, then interest accrues at
                a rate of 6
                percent per year until paid in full. We paid this Note in full in
                February of
                2005.
 
 On
                February 24, 2005, March 28, 2005, May 2, 2005, and May 27, 2005
                our Chairman
                Michael Grollman made new personal loans to the Company totaling
                $159,000 to
                assist us with working capital needs. The loans are evidenced by
                a demand note
                that provides for repayment within five business days of a demand
                notice from
                Mr. Grollman, with interest of 6% compounded annually from June 1,
                2005. As of
                September 30, 2006, these loans were outstanding.
 
 **Where
                You Can Find More Information**
 
 We
                file
                reports and other information with the U.S. Securities and Exchange
                Commission.
                You may read and copy any document that we file at the SEC’s public reference
                facilities at 450 Fifth Street N.W., Room 1024, Washington, D.C.
                20549. Please
                call the SEC at 1-800-732-0330 for more information about its public
                reference
                facilities. Our SEC filings are also available to you free of charge
                at the
                SEC’s website at www.sec.gov.
 
 Copies
                of
                publicly available documents that we have filed with the SEC can
                also be
                inspected and copied at the offices of the National Association of
                Securities
                Dealers, Inc., 1735 K. Street, N.W., Washington, D.C. 20006.
  You
                should only rely upon the information included in or incorporated
                by reference
                into this annual report and the exhibits to the annual report. We
                have not
                authorized anyone to provide you with additional or different information.
                You
                should not assume that the information included in or incorporated
                by reference
                into this annual report is accurate as of any date later than the
                date on the
                front of the annual report.
 55
 **Table
                    of Contents**
 **Index
                    to Financial
                    Statements**
   **Item
                    13.**
                  **Exhibits
                      and Reports on Form
                      8-K**
 
 **(a)**
                  **Exhibits**
 
 **Exhibit
                      Number**
                  
                  **Description**3.1
                  
                  Articles
                      of Incorporation(1)3.2
                  
                  Bylaws(2)10.1
                  
                  Employment
                      Agreement between National Scientific Corporation and Michael
                      A. Grollman
                      dated January 2001(4)10.2
                  
                  Employment
                      Agreement between National Scientific Corporation and Graham
                      L. Clark
                      dated January 2003(6)10.3
                  
                  NSC
                      Consulting Agreement dated August 2001, and Amendments dated
                      August 2002
                      and July 2003, with Dr. El-Badawy El-Sharawy(6)10.4
                  
                  Amended
                      and Restated 2000 Stock Option Plan(3)10.5
                  
                  Form
                      of 2004 Stock Retainage Plan Agreement(6)10.6
                  
                  Agreement
                      Regarding Management Consulting Services with Stanton Walker
                      of New York
                      dated May 2003(6)10.7
                  
                  Agreement
                      Regarding Distribution and Marketing of Gotcha!® Child Safety Product and
                      other products dated December 2002 with FutureCom Global, Inc.(6)10.8
                  
                  Purchase
                      Order from Verify Systems, Inc, dated March 2003 for IBUS TM School Child
                      Tracking Systems(5)10.9
                  
                  Letter
                      of Understanding and Agreement dated April 2004 Regarding Sales
                      and
                      Distribution of Verify School safety products, and an Unlimited
                      Software
                      License with Anthony Grosso and CIS Services, LLC(6)10.10
                  
                  Letter
                      of Intent from Positus, Inc. dba Bike & Cycle Trak, dated February
                      2003 for Design of Power Sports Tracking System(6)10.11
                  
                  Purchase
                      Order from Positus, Inc. dba Bike & Cycle Trak, for Design of Power
                      Sports Tracking System dated March 2003(6)14
                  
                  Code
                      of Ethics(7)31
                  
                  Certification
                      Pursuant to Section 302 of the Sarbanes-Oxley Act32
                  
                  Certification
                      Pursuant to Section 906 of the Sarbanes-Oxley
                      Act
 ____________
 (1)
                  Incorporated
                      by reference to the Registrant’s Form 10-SB filed on or about January 3,
                      2000.
 (2)
                  Incorporated
                      by reference to the Registrant’s Form 10-QSB for the quarter ended March
                      31, 2001 and filed on or about May 15,
                      2001.
 (3)
                  Incorporated
                      by reference to the Registrant’s Form 10-QSB for the quarter ended
                      December 31, 2000 and filed on or about February 14,
                      2001.
 (4)
                  Incorporated
                      by reference to the Registrant’s Form 10-KSB for the year ended September
                      30, 2000 and filed on or about December 19,
                      2000.
 (5)
                  Incorporated
                      by reference to the Registrant’s Form S-8 filed on or around June 3,
                      2003.
 (6)
                  Incorporated
                      by reference to the Registrant’s Form SB2 filed on or around June 24,
                      2004.
 (7)
                  Incorporated
                      by reference to the Registrant’s Form 10-QSB for the quarter ended June
                      30, 2004 and filed on or about August 16,
                      2004.
 56
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
 
 **(b)**
                  **Reports
                      on Form 8-K**
  The
              Company filed one Report on Form 8-K on November 17, 2005, relating
              to a financing
              program with a U.S. investment fund.
 
 The
              Company filed one Report on Form 8-K on November 30, 2005, relating
              to a change
              in its Certifying Accountant.
 
 The
              Company filed one Report on Form 8-K on December 8, 2005, relating
              to a change
              in its Certifying Accountant with a letter from the outgoing Certifying
              Accountant indicating no accounting disagreements with management.
 **Item
                    14.**
                  **Principal
                      Accountant Fees And
                      Services**
 
 Fees
              paid
              or accrued due, for services performed by our principal accountants,
              during the
              years ended September 30, 2006 and 2005 were as follows:
 **2006**
                      
                      **2005**Audit
                          fees - audit of annual financial statements and review
                          of financial
                          statements included in our 10-QSB, services normally provided
                          by the
                          accountant in connection with statutory and regulatory
                          filings.
                      
                      $
                      27,850
                      
                      $
                      23,350Audit-related
                          fees - related to the performance of audit or review of
                          financial
                          statements not reported under “audit fees” above
                      
                      
                      –
                      
                      
                      –Tax
                          fees - tax compliance, tax advice and tax planning
                      
                      
                      –
                      
                      
                      –All
                          other fees - services provided by our principal accountants
                          other than
                          those identified above
                      
                      
                      –
                      
                      
                      –Total
                          fees paid or accrued to our principal accountants Epstein
                          Weber &
                          Conover, PLC in 2006 and Hurley & Company in 2005
                      
                      $
                      27,850
                      
                      $
                      23,350
  Fees
              paid
              to the principal accountants were approved by the Audit
              Committee.
 **All
              other Fees**
  None.
 
 Hurley
              & Company, Certified Public Accountants, based in California, were our
              principal auditors for part of fiscal year 2005. This firm is licensed
              to
              practice public accounting by the state of California, and is also
              registered
              with the Public Company Accounting Oversight Board. The senior audit
              partner Mr.
              Michael Hurley is also licensed to practice public accounting in Arizona.
              Our
              shareholders in each of the previous three fiscal years have ratified
              the use of
              this firm. During fiscal year 2005, Hurley & Company reviewed our unaudited
              financial statements as filed in our form 10-QSB for the quarters ended
              December
              31, 2004, March 31, 2005 and June 30, 2005.
 57
 **Table
                        of Contents**
 **Index
                        to Financial
                        Statements**
 The
              Board
              of Directors considered that under newly adopted regulations and guidelines
              arising from the Sarbanes-Oxley Act, it could be required to rotate
              its
              independent auditors during fiscal year 2005. Accordingly, on November
              23, 2005,
              the Company engaged Epstein Weber & Conover, PLC, Certified Public
              Accountants, of Scottsdale, Arizona, as the independent public accountants
              for
              the Company for fiscal 2005 to replace Hurley & Company. The shareholders
              voted to ratify such engagement at the Company’s Annual Meeting of Shareholders
              on April 27, 2005. This change did not reflect on the quality of service
              provided in the past by Hurley & Company.
 
 During
              the Company’s two most recent fiscal years and any subsequent interim period
              preceding the departure of Hurley & Company, there were no unresolved
              disagreements with Hurley & Company on any matter concerning accounting
              principles or practices, financial statement disclosure, or auditing
              scope or
              procedure; which disagreements, if not resolved to the satisfaction
              of Hurley
& Company would have caused Hurley & Company to make reference to the
              subject matter of the disagreements in connection with its reports.
              Hurley &
Company as the Company’s principal independent accountant, did not provide an
              adverse opinion or disclaimer of opinion to the Company’s financial statements,
              nor modify its opinion as to uncertainty, audit scope or accounting
              principles.
 
 **Review
              of Audited Financial Statements & Report of the Audit
              Committee**
 
 The
              audit
              committee has reviewed and discussed the audited financial statements
              with
              management. The audit committee has discussed with the independent
              auditors the
              matters required to be discussed by SAS 61. The audit committee has
              received the
              written disclosures and the letter from the independent accountants
              required by
              Independence Standards Board Standard No. 1 (Independence Standards
              Board
              Standard No. 1, Independence Discussions with Audit Committees) and
              has
              discussed with the independent accountant the independent accountant’s
              independence. Based on the review and these discussions, the audit
              committee
              recommended to the Board of Directors that the audited financial statements
              be
              included in the company’s Annual Report on Form 10-KSB for the last fiscal year
              for filing with the Commission.
 
 **Financial
              Information Systems Design and Implementation Fees and Other
              Services**
 
 We
              did
              not engage Epstein Weber & Conover, PLC, to provide services to us regarding
              financial information systems design and implementation during the
              fiscal year
              ended September 30, 2006. The Board of Directors has considered whether
              the
              provision of non-audit services is compatible with maintaining Epstein
              Weber
& Conover, PLC’s, independence, and has decided not to secure such services
              from Epstein Weber & Conover, PLC, at this time in that
              area.
 58
 **Table
                    of Contents**
 **Index
                    to Financial
                    Statements**
 
 **SIGNATURES**
 
 Pursuant
            to the requirements of Section 13 or 15(d) of the Securities Exchange
            Act of
            1934, the Registrant caused this report to be signed on its behalf by
            the
            undersigned, thereunto duly authorized.
  **NATIONAL
                        SCIENTIFIC CORPORATION**Date: 
January
                        16, 2007
                      By:
                      /s/ 
Michael
                        A.
                        GrollmanMichael
                          A. Grollman
                        Director,
                          Chief Executive Officer,Acting
                          Chief
                        Financial
                          Officer and Chairman
 By:
                        /s/ 
Graham
                          L.
                          ClarkGraham
                              L. Clark
                            Director,
                              President, and
                              Secretary
 By:
                        /s/ 
Gregory
                          SzaboGregory
                              Szabo
                            Director
  59
 **Table
                            of Contents**
 **Index
                            to Financial
                            Statements**
  **NATIONAL
                    SCIENTIFIC CORPORATION**
 
 **AUDITED
                    FINANCIAL STATEMENTS**
 **For
                    the Years Ended September 30, 2006 and 2005**
 
 **INDEX**
 
 **Page**Report
                              of Epstein Weber & Conover, PLC, Independent
                              Registered Public Accounting Firm
                          F-2Balance
                              Sheets (September 30, 2006 and 2005)
                          F-3Statements
                              of Operations (Years Ended September 30, 2006 and 2005)
                          F-4Statements
                              of Shareholders’ (Deficit) (Years Ended September 30, 2006 and
                              2005)
                          F-5Statements
                              of Cash Flows (Years Ended September 30, 2006
                              and 2005)
                          F-7Notes
                              to Financial Statements (Years Ended September 30,
                              2006 and 2005)
                          F-9
 F-1
 **Table
                                of Contents**
 **Index
                                to Financial Statements**
   **REPORT
                    OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  
 Board
                    of
                    Directors,
 National
                    Scientific Corporation
 
 We
                    have
                    audited the accompanying balance sheets of National Scientific
                    Corporation as of
                    September 30, 2006 and 2005 and the related statements of operations,
                    changes in
                    shareholders’ deficit and cash flows for the years then ended. These financial
                    statements are the responsibility of National Scientific Corporation’s
                    management. Our responsibility is to express an opinion on these
                    financial
                    statements based on our audit.
 
 We
                    conducted our audits in accordance with auditing standards of
                    the Public Company
                    Accounting Oversight Board (United States). Those standards require
                    that we plan
                    and perform the audit to obtain reasonable assurance about whether
                    the financial
                    statements are free of material misstatement. An audit includes
                    examining, on a
                    test basis, evidence supporting the amounts and disclosures in
                    the financial
                    statements. An audit also includes assessing the accounting principles
                    used and
                    significant estimates made by management, as well as evaluating
                    the overall
                    financial statement presentation. We believe that our audits
                    provide a
                    reasonable basis for our opinion.
 
 In
                    our
                    opinion, the financial statements referred to above present fairly,
                    in all
                    material respects, the financial position of National Scientific
                    Corporation as
                    of September 30, 2006 and 2005 and the results of its operations
                    and its cash
                    flows for the years then ended, in conformity with accounting
                    principles
                    generally accepted in the United States of America.
 
 The
                    accompanying financial statements have been prepared assuming
                    that National
                    Scientific Corporation will continue as a going concern. As discussed
                    in Note 2
                    to the financial statements, National Scientific Corporation
                    has not yet
                    generated significant revenues, and is dependent upon raising
                    capital from
                    investors. Additionally, National Scientific Corporation has
                    incurred aggregate
                    losses during the past two years of over $2,086,000 and has a
                    total
                    shareholders’ deficit of approximately $1,400,000 at September 30, 2006. These
                    matters raise substantial doubt about the Company’s ability to continue as a
                    going concern. Management’s plans concerning these matters are also described in
                    Note 2. The financial statements do not include any adjustments
                    that might
                    result from the outcome of this uncertainty.
 
 /s/
                    Epstein Weber & Conover, PLC
 
 Scottsdale,
                    Arizona
 January
                    11, 2007
  F-2
 **Table
                                of Contents**
 **Index
                                to Financial
                                Statements**
 **NATIONAL
                    SCIENTIFIC
                    CORPORATION**


**BALANCE
        SHEETS**
 **September
        30, 2006 and 2005**
  **2006**
              
              **2005****ASSETS**Current
                  Assets:Cash
                  and cash equivalents
              
              $
              43,899
              
              $
              1,616Trade
                  receivables, net
              
              
              141,498
              
              
              9,968Inventory,
                  net
              
              
              6,020
              
              
              23,735Other
                  assets
              
              
              5,570
              
              
              68Total
                  current assets
              
              
              196,987
              
              
              35,387Property
                  and equipment, net
              
              
              1,037
              
              
              7,680Deposits
              
              
              2,000
              
              
              2,000Deferred
                  offering costs, net
              
              
              19,600
              
              
              –Investment
              
              
              –
              
              
              289,100$
              219,624
              
              $
              334,167**LIABILITIES
                  AND SHAREHOLDERS’ (DEFICIT)**Current
                  Liabilities:Accounts
                  payable - related party
              
              $
              83,584
              
              $
              72,914Accounts
                  payable - other
              
              
              165,593
              
              
              183,664Accrued
                  expenses
              
              
              848,446
              
              
              519,132Due
                  to factors
              
              
              104,400
              
              
              –Notes
                  payable - related party
              
              
              159,000
              
              
              159,000Notes
                  payable - other
              
              
              133,375
              
              
              60,150Total
                  current liabilities
              
              
              1,494,398
              
              
              994,860Notes
                  payable, less current portion, net of discount and beneficial conversion
                  featureof
                  $50,252 and $0, as of September 30, 2006 and 2005,
                  respectively
              
              
              124,748
              
              
              –Total
                  liabilities
              
              
              1,619,146
              
              
              994,860Commitments
                  and contingencies
              
              
              –
              
              
              –Shareholders’
                  (deficit):Preferred
                  stock, par value $0.10; 4,000,000 shares authorized, and no shares
                  issued
                  and outstanding
              
              
              –
              
              
              –Common
                  stock, par value $0.01; 187,000,000 shares authorized, and shares
                  issued
                  and outstanding 99,108,039 and 94,095,459 at September 30, 2006
                  and 2005,
                  respectively
              
              
              991,081
              
              
              940,955Additional
                  paid-in capital
              
              
              22,405,152
              
              
              22,248,814Accumulated
                  deficit
              
              
              (24,795,755
              )
              
              (23,850,462
              )Total
                  shareholders’ (deficit)
              
              
              (1,399,522
              )
              
              (660,693
              )$
              219,624
              
              $
              334,167
 *See
        accompanying notes to*
 *financial
        statements, which are an integral part of the financial
        statements*
 F-3
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **STATEMENTS
        OF OPERATIONS**
 **For
        the Years Ended September 30, 2006 and 2005**
  **2006**
              
              **2005**Revenues
              
              $
              227,251
              
              $
              73,226Cost
                  of Sales
              
              
              123,689
              
              
              48,780Gross
                  profit
              
              
              103,562
              
              
              24,446Costs
                  and expensesSalaries
                  and benefits
              
              
              258,977
              
              
              337,708Research
                  and development
              
              
              185,638
              
              
              391,591Stock
                  compensation
              
              
              14,946
              
              
              16,173Other
              
              
              183,726
              
              
              255,690Inventory
                  obsolescence charge
              
              
              17,827
              
              
              46,775Total
                  costs and expenses
              
              
              661,114
              
              
              1,047,937Loss
                  from operations
              
              
              (557,552
              )
              
              (1,023,491
              )Other
                  income (expense)Interest
                  expense
              
              
              (94,241
              )
              
              (25,947
              )Amortization
                  of deferred offering costs
              
              
              (4,400
              )
              
              –Impairment
                  of investment
              
              
              (289,100
              )
              
              (91,344
              )(387,741
              )
              
              (117,291
              )Loss
                  before income taxes
              
              
              (945,293
              )
              
              (1,140,782
              )Income
                  tax expense
              
              
              –
              
              
              –Net
                  loss
              
              $
              (945,293
              )
              $
              (1,140,782
              )Net
                  loss per common share, basic and diluted
              
              $
              (0.01
              )
              $
              (0.01
              )Weighted
                  average number of shares outstanding
              
              
              96,754,136
              
              
              89,338,638
 *See
        accompanying notes to*
 *financial
        statements, which are an integral part of the financial
        statements*
 F-4
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **STATEMENTS
        OF CHANGES IN SHAREHOLDERS’ (DEFICIT)**
 **For
        the Years Ended September 30, 2006 and 2005**
  **Common
                    Stock**
                
                **Preferred
                    Stock****Number
                    of Shares**
                
                **Par
                    Value**
                
                **Number
                    of Shares**
                
                **Par
                    Value**
                
                **Additional**
                  **Paid-In**
                  **Capital**
                
                **Accumulated
                    Deficit**
                
                **Total**Balance,
                    September 30, 2005
                
                
                94,095,459
                
                $
                940,955
                
                
                –
                
                $
                –
                
                $
                22,248,814
                
                $
                (23,850,462
                )
                $
                (660,693
                )Stock
                    issued for servicesPrice
                    per share ranged:$0.0480
                
                
                18,744
                
                
                187
                
                
                –
                
                
                –
                
                
                712
                
                
                –
                
                
                899$0.0382
                
                
                23,585
                
                
                236
                
                
                –
                
                
                –
                
                
                664
                
                
                –
                
                
                900$0.0380
                
                
                47,393
                
                
                474
                
                
                –
                
                
                –
                
                
                1,326
                
                
                –
                
                
                1,800Issuance
                    of common stock accounted for as debt discount and beneficial
                    conversion
                    feature
                
                
                1,200,000
                
                
                12,000
                
                
                –
                
                
                –
                
                
                49,533
                
                
                –
                
                
                61,533Issuance
                    of common stock in exchange for accounts payable and accrued
                    expenses.
                    Shares issued for:$0.036
                
                
                500,000
                
                
                5,000
                
                
                –
                
                
                –
                
                
                13,000
                
                
                –
                
                
                18,000$0.035
                
                
                430,000
                
                
                4,300
                
                
                –
                
                
                –
                
                
                10,750
                
                
                –
                
                
                15,050$0.032
                
                
                500,000
                
                
                5,000
                
                
                –
                
                
                –
                
                
                11,000
                
                
                –
                
                
                16,000$0.035
                
                
                1,150,000
                
                
                11,500
                
                
                –
                
                
                –
                
                
                28,750
                
                
                –
                
                
                40,250Private
                    placement of common stock Shares issued for:
                  $0.0175
                
                
                1,142,858
                
                
                11,429
                
                
                –
                
                
                –
                
                
                8,571
                
                
                –
                
                
                20,0000Common
                    stock options issued, net
                
                
                –
                
                
                –
                
                
                –
                
                
                –
                
                
                11,346
                
                
                –
                
                
                11,346Warrants
                    issued with debt
                
                
                –
                
                
                –
                
                
                –
                
                
                –
                
                
                20,686
                
                
                –
                
                
                20,686Net
                    loss
                
                
                –
                
                
                –
                
                
                –
                
                
                –
                
                
                –
                
                
                (945,293
                )
                
                (945,293
                )Balance,
                  September 30, 2006
                
                
                99,108,039
                
                
                991,081
                
                $
                –
                
                $
                –
                
                $
                22,405,152
                
                $
                (24,795,755
                )
                $
                (1,399,522
                )
 *See
          accompanying notes to*
 *financial
        statements, which are an integral part of the financial
        statements*
 F-5
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **STATEMENTS
        OF CHANGES IN SHAREHOLDERS’ (DEFICIT)**
 **For
        the Years Ended September 30, 2006 and 2005**
  **Common
                  Stock**
              ****
              **Preferred
                  Stock**
              ****
              ****
              ****
              ****
              ****
              ****
              ********
              ****
              **Number
                  of**
                **Shares**
              
              **Par
                  Value**
              ****
              **Number
                  of**
                **Shares**
              ****
              **Par
                  Value**
              ****
              **Additional**
                **Paid-In**
                **Capital**
              ****
              **Accumulated**
                **Deficit**
              ****
              **Total**Balance,
                  September 30, 2004
              
              
              84,330,669
              
              $
              843,307
              
              
              –
              
              $
              –
              
              $
              21,627,654
              
              
              (22,709,680
              )
              $
              (238,719
              )Stock
                  Issued for servicesPrice
                  per share ranged:$0.1447
              
              
              6,218
              
              
              62
              
              
              –
              
              
              –
              
              
              838
              
              
              –
              
              
              900$0.1305
              
              
              13,770
              
              
              138
              
              
              –
              
              
              –
              
              
              1,659
              
              
              –
              
              
              1,797$0.0640
              
              
              10,373
              
              
              104
              
              
              –
              
              
              –
              
              
              560
              
              
              –
              
              
              664$0.0792
              
              
              25,429
              
              
              254
              
              
              –
              
              
              –
              
              
              1,760
              
              
              –
              
              
              2,014Common
                  stock options granted, net
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              6,108
              
              
              –
              
              
              6,108Shares
                  issued in exchange for accrued expenses
              
              
              1,934,000
              
              
              19,340
              
              
              –
              
              
              –
              
              
              62,850
              
              
              –
              
              
              82,190Private
                  placement of common stockShares
                  issued for:$0.04
              
              
              625,000
              
              
              6,250
              
              
              –
              
              
              –
              
              
              18,750
              
              
              –
              
              
              25,000Securities
                  Exchange Agreement of common
                  stock Shares issued for:$0.074
              
              
              7,150,000
              
              
              71,500
              
              
              –
              
              
              –
              
              
              457,600
              
              
              –
              
              
              529,100Warrants
                  issued as placement agent’s fee
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              66,344
              
              
              –
              
              
              66,344Warrants
                  issued with debt
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              4,691
              
              
              –
              
              
              4,691Net
                loss
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              –
              
              
              (1,140,782
              )
              
              (1,140,782
              )Balance,
                September 30, 2005
              
              
              94,095,459
              
              $
              940,955
              
              
              –
              
              $
              –
              
              $
              22,248,814
              
              $
              (23,850,462
              )
              $
              (660,693
              )
 *See
        accompanying notes to*
 *financial
        statements, which are an integral part of the financial
        statements*
 F-6
 **Table
                    of Contents**
 **Index
                    to Financial
                    Statements**
 **NATIONAL
        SCIENTIFIC CORPORATION**
 **STATEMENTS
        OF CASH FLOWS**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 **2006**
              
              **2005**Cash
                  flows from operating activities:Net
                  loss
              
              $
              (945,293
              )
              $
              (1,140,782
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Non
                  cash transactionsDepreciation
              
              
              6,643
              
              
              13,341Stock
                  and options issued for services, net
              
              
              14,945
              
              
              11,483Impairment
                  of inventory
              
              
              17,827
              
              
              46,775Impairment
                  of investment
              
              
              289,100
              
              
              91,344Warrant
                  expense
              
              
              20,686
              
              
              4,691Amortization
                  of deferred offering costs
              
              
              4,400
              
              
              –Amortization
                  of debt discount
              
              
              9,460
              
              
              –Amortization
                  of beneficial conversion feature
              
              
              1,821
              
              
              –Increase
                  in inventory
              
              
              (112
              )
              
              (4,360
              )(Increase)
                  decrease in receivables
              
              
              (131,530
              )
              
              15,829(Increase)
                  decrease in other assets and deposits
              
              
              (5,502
              )
              
              18,452Increase
                  in accounts payable and accrued expenses
              
              
              411,213
              
              
              343,729Net
                  cash used in operating activities
              
              
              (306,342
              )
              
              (599,498
              )Cash
                  flows from financing activities:Increase
                  in notes payable
              
              
              265,125
              
              
              264,500Repayment
                  of notes payable
              
              
              (16,900
              )
              
              (88,600
              )Net
                  proceeds from factors
              
              
              104,400
              
              
              –Payment
                  of financing activities
              
              
              (24,000
              )
              
              –Proceeds
                  from securities exchange agreement
              
              
              –
              
              
              240,000Proceeds
                  from issuance of common stock
              
              
              20,000
              
              
              25,000Net
                  cash provided by financing activities
              
              
              348,625
              
              
              440,900
 Net
                  increase (decrease) in cash and cash equivalents
              
              
              42,283
              
              
              (158,598
              )Cash
                  and cash equivalents, beginning of period
              
              
              1,616
              
              
              160,214Cash
                  and cash equivalents, end of period
              
              $
              43,899
              
              $
              1,616Supplementary
                  Disclosure of Cash Flow InformationCash
                  paid for interest
              
              $
              8,609
              
              $
              746Non-cash
                  investing and financing activities:Conversion
                  of accounts payable and accrued payroll to equity
              
              $
              89,300
              
              $
              82,190Common
                  stock exchanged for investment
              
              $
              –
              
              $
              289,100Debt
                  discount and beneficial conversion feature
              
              $
              61,533
              
              $
              –
 *See
        accompanying notes to*
 *financial
        statements, which are an integral part of the financial
        statements*
 F-7
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
 **NATIONAL
        SCIENTIFIC CORPORATION**
 **STATEMENTS
        OF CASH FLOWS (Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 
 **Summary
        of Non-Cash Investing and Financing Activities**
 
 On
        August
        17, 2005, Mr. Grollman agreed to convert approximately $34,500 of his back
        pay
        to our restricted common stock, at the rate of the average market price per
        share of $0.046.
 
 On
        August
        17, 2005, Mr. Clark agreed to convert approximately $23,000 of his back pay
        to
        our restricted common stock, at the rate of the average market price per
        share
        of $0.046.
 
 On
        August
        31, 2005, Mr. Grollman agreed to convert approximately $15,190 of his back
        pay
        to our restricted common stock, at the rate of the average market price per
        share of $0.035.
 
 On
        August
        31, 2005, Mr. Clark agreed to convert approximately $9,500 of his back pay
        to
        our restricted common stock, the rate of the average market price per share
        of
        $0.035.
 
 On
        January 27, 2005, in connection with the Company’s investment in TurboWorx, the
        Company issued common stock for $240,000 and 360,000 shares of
        TurboWorx.
 
 On
        November 23, 2005, Mr. Grollman agreed to convert approximately $18,000 of
        our
        accounts payable and accrued expense indebtedness to him to our restricted
        common stock, the rate of the average market price per share of
        $0.036.
 
 On
        April
        7, 2006, Mr. Grollman agreed to convert approximately $16,000 of his back
        pay to
        our restricted common stock, the rate of the average market price per share
        of
        $0.032.
 
 On
        March
        15, 2006, Mr. Clark agreed to convert approximately $15,050 of his back pay
        to
        our restricted common stock, the rate of the average market price per share
        of
        $0.035.
 
 On
        May
        25, 2006, Mr. Clark agreed to convert approximately $40,250 of his back pay
        to
        our restricted common stock, the rate of the average market price per share
        of
        $0.035.
 
 *See
        accompanying independent auditors’ report and notes to*
 *financial
        statements, which are an integral part of the financial
        statements*
  F-8
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS**
 **For
        the Years Ended September 30, 2006 and 2005**
  **1.**
              **Summary
                  of Significant Accounting
                  Policies**
 
 The
        following is a summary of the significant accounting policies followed by
        National Scientific Corporation (the “Company” or “us”). The policies conform to
        accounting principles generally accepted in the United States of America,
        which
        require management to make estimates and assumptions that affect the reported
        amounts of assets and liabilities and disclosure of contingent assets and
        liabilities at the date of the financial statements and the reported amounts
        of
        revenues and expenses during the reporting period. Actual results could differ
        from those estimates.
  *a.*
              *Operations*
  The
        Company was incorporated in Texas on June 22, 1953 as American Mortgage Company.
        On May 16, 1996, the Company changed its name to National Scientific
        Corporation. During 1996, the Company acquired the operations of Eden Systems,
        Inc. (Eden) as a wholly owned subsidiary. Eden was engaged in water treatment
        and the retailing of cleaning products. Eden’s operations were sold on October
        1, 1997. From September 30, 1997 through the year ended September 30, 2001,
        we
        aimed our efforts in the research and development of semiconductor proprietary
        technology and processes and in raising capital to fund its operations and
        research. Beginning in calendar 2002, we focused our efforts on the development,
        acquisition, enhancement and marketing of location device technologies. Our
        revenue is derived from sales of electronic devices, recognized as the product
        is delivered.
 
 *b.*
              *Cash
                  Equivalents*
 
 Cash
        equivalents include money market accounts and other short-term investments
        with
        an original maturity of three months or less.
 
 *c.*
              *Inventory*
 
 Inventories,
        primarily finished goods, are stated at the lower of cost or market values.
        Cost
        is primarily determined on a FIFO (first-in, first-out) basis.
 
 *d.*
              *Property
                  and Equipment*
 
 Property
        and equipment are recorded at cost and are being depreciated over estimated
        useful lives of five years using the straight-line method.
 
 *e.*
              *Advertising
                  and Promotion Costs*
 
 Advertising
        and promotion costs, which totaled $2,290 in 2006 and $13,233 in 2005, are
        expensed as incurred.
  F-9
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
 **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 
 *f.*
              *Stock
                  Based Compensation*
 
 The
        Company has elected to follow Accounting Principles Board Opinion No. 25,
        “ *Accounting
        for Stock Issued to Employees* ”
and
        related interpretations as permitted by SFAS 123 “Accounting for Stock-Based
        Compensation” as amended in accounting for its employee stock options. Under APB
        25, compensation expense is measured as the excess, if any, of the quoted
        market
        price of the Company’s stock at the date of grant over the exercise
        price.
 
 The
        following table illustrates the effect on net loss and loss per share if
        the
        Company applied the fair value recognition provisions of SFAS 123 to stock-based
        compensation:
  **2006**
              
              **2005**Net
                  loss as reported
              
              $
              (945,293
              )
              $
              (1,140,782
              )Add:
                  stock based compensation recorded in the statement of
                  operations
              
              
              14,946
              
              
              16,173Deduct:
                  total stock based compensation expense as determined under the
                  fair value
                  method
              
              
              (14,946
              )
              
              (21,773
              )Pro
                  forma net loss
              
              $
              (945,293
              )
              $
              (1,146,382
              )Loss
                  per share as reported
              
              
              (.01
              )
              
              (.01
              )Loss
                  per share, pro forma
              
              
              (.01
              )
              
              (.01
              )
 
 As
        required by SFAS 123, as amended, the fair value of each grant is estimated
        on
        the date of grant using the Black-Scholes option pricing method for pro forma
        footnote disclosure with the following assumptions for the year ended September
        30, 2006; dividend yield of 0% and expected option life of 10 years. Expected
        volatility ranged from 80.7% to 88.7% as of the date of issue. Risk free
        interest rates ranged from 4.55% to 5.04% as of the date of issue. For the
        year
        ended September 30, 2005; dividend yield of 0% and expected option life of
        10
        years, expected volatility ranged from 88.2% to 94.6% as of the date of issue,
        risk free interest rates ranged from 4.010% to 4.12% as of the date of
        issue.
  F-10
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 
 *g.*
              *Income
                  Taxes*
 
 Deferred
        tax assets and liabilities are recognized for the future tax consequences
        attributable to differences between the financial statement carrying amount
        of
        existing assets and liabilities and their respective tax bases, including
        operating loss and tax credit carry-forwards. Deferred tax assets and
        liabilities are measured using enacted tax rates expected to apply to taxable
        income in the years in which those temporary differences are expected to
        be
        recovered or settled. The effect in deferred tax assets and liabilities of
        a
        change in tax rates is recognized in income in the period that includes the
        enactment date. Valuation allowances are established when necessary to reduce
        deferred tax assets to the amount expected to be realized.
 
 *h.*
              *Research
                  and Development / Patents*
 
 Both
        research and development and the costs associated with obtaining patents
        and
        product development have been expensed as incurred. Patent costs are expensed,
        since the Company has not yet developed products, which have gained market
        acceptance.
 
 *i.*
              *Net
                  Loss Per Share*
 
 Net
        loss
        per share is computed by dividing the loss attributable to common shareholders
        by the weighted average number of shares outstanding during the period, which
        was 96,754,136 and 89,338,638 for the years ended September 30, 2006 and
        2005,
        respectively. Stock options outstanding of 4,159,938 and warrants outstanding
        of
        15,384,197 are considered anti-dilutive and were not considered in the
        calculation in the year ended September 30, 2006. Stock options outstanding
        of
        3,789,257 and warrants outstanding of 15,434,197 are considered anti-dilutive
        and were not considered in the calculation in the year ended September 30,
        2005.
 
 *j.*
              *Recently
                  Issued Accounting
                  Pronouncements*
 
 The
        Financial Accounting Standards Board (FASB) has established new pronouncements.
        The Company does not expect the adoption of these pronouncements to have
        a
        material impact on its financial positions, results of operations or cash
        flows.
 F-11
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 
 In
        December 2004, the FASB issued SFAS 123(R), *“Share-Based
        Payment,”* which
        addresses the accounting for employee stock options. SFAS 123(R) revises
        the
        disclosure provisions of SFAS 123 and supersedes APB 25. SFAS 123(R) requires
        that the cost of all employee stock options, as well as other equity-based
        compensation arrangements, be reflected in the financial statements based
        on the
        estimated fair value of the awards. In March 2005, the Securities & Exchange
        Commission (the “SEC”) issued Staff Accounting Bulletin No. 107, *“Share-Based
        Payment,”* which
        summarizes the views of the SEC staff regarding the interaction between SFAS
        123(R) and certain SEC rules and regulations, and is intended to assist in
        the
        initial implementation. SFAS 123(R) is effective for all public companies
        that
        file as small business issuers as of the beginning of the first interim or
        annual reporting period that begins after December 15, 2005. The Company
        is
        currently evaluating the provisions of SFAS 123(R) and its effect on its
        financial statements.
 
 In
        December 2004, the FASB issued SFAS 153, *“Exchanges
        of Nonmonetary Assets, an amendment of APB 29, Accounting for Nonmonetary
        Transactions.”* This
        Statement’s amendments are based on the principle that exchanges of nonmonetary
        assets should be measured based on the fair value of the assets exchanged.
        Further, SFAS 153 eliminates the narrow exception for nonmonetary exchanges
        of
        similar productive assets and replaces it with a broader exception for exchanges
        of nonmonetary assets that do not have commercial substance. Provisions of
        this
        statement are effective for fiscal periods beginning after June 15, 2005.
        The
        Company does not expect the adoption of this statement to have a material
        impact
        on its financial statements.
 
 In
        November 2004, the FASB issued SFAS No. 151, *Inventory
        Costs, an amendment of ARB No.43, Chapter 4* .
        SFAS
        No. 151 clarifies the accounting for abnormal amounts of idle facility expense,
        freight, handling costs and wasted materials. SFAS No. 151 is effective for
        inventory costs incurred during fiscal years beginning after June 15, 2005.
        The
        initial application of SFAS No. 151 will have no impact on the Company’s
        financial position or results of operations.
 
 In
        March
        2005, the FASB issued FASB Interpretation No. 47, *“Accounting
        for Conditional Asset Retirement Obligations”* (“FIN
        47”), which is an interpretation of SFAS 143, *“Accounting
        for Asset Retirement Obligations.”* FIN47
        clarifies terminology within SFAS 143 and requires an entity to recognize
        a
        liability for the fair value of a conditional asset retirement obligation
        when
        incurred if the liability’s fair value can be reasonably estimated. FIN 47 is
        effective for fiscal years ending after December 15, 2005. The Company does
        not
        expect the adoption of this statement to have a material impact on its financial
        statements.
 F-12
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 
 In
        May
        2005, the FASB issued SFAS 154, *“Accounting
        Changes and Error Corrections.”* SFAS 154
        replaces APB 20, *“Accounting
        Changes”* and SFAS
        3, *“Reporting
        Accounting Changes in Interim Financial Statements”* and
        establishes retrospective application as the required method for reporting
        a
        change in accounting principle. SFAS 154 provides guidance for determining
        whether retrospective application of a change in accounting principle is
        impracticable and for reporting a change when retrospective application is
        impracticable. The reporting of a correction of an error by restating previously
        issued financial statements is also addressed. SFAS 154 is effective for accounting
        changes and corrections of errors made in fiscal years beginning after December
        15, 2005. The Company does not expect the adoption of this statement to have
        a
        material impact on its financial statements.
  **2.**
              **Development
                  Stage Operations**
 
 Although
        the Company has been in operation since 1996, management considered NSC to
        be in
        the development stage until September 30, 2006. As of September 30, 2006,
        the
        Company is no longer in the development stage. From September 30, 1997 through
        the year ended September 30, 2001, the Company engaged its efforts in the
        research and development of semiconductor proprietary technology and processes
        and in raising capital to fund its operations and research. Beginning calendar
        2002, the Company focused its efforts toward the development, acquisition,
        enhancement and marketing of location device technologies. Since its initiation
        of operations in 1996, the Company has not realized significant revenue,
        except
        for approximately $882,000 generated through
        the export of electronic equipment, an isolated event, which occurred in
        fiscal
        2001.
 
 The
        Company experienced significant operating losses during 2006 and 2005, of
        $945,293 and $1,140,782 respectively, which raise substantial doubt about
        the
        Company’s ability to continue as a going concern. Of the total net operating
        losses, approximately $14,946 and $16,173 are related to stock issued for
        services and compensation in 2006 and 2005, respectively. The Company also
        recorded an impairment in its investment in TurboWorx Inc. of $289,100 and
        $91,344 in fiscal years 2006 and 2005 respectively. In fiscal 2006 and 2005
        the
        Company wrote down its inventory by $17,827 and $46,775 respectively. Management
        believes that its current cash position including cash funds arising from
        the
        exercise of outstanding options, and secured plant assets from legal
        settlements, equity private placement, product sales, and continued aggressive
        expense management to be sufficient to continue operations for the next twelve
        months. We also believe that we may be able to reduce outstanding liabilities
        through negotiations with our creditors, or possibly negotiate to extend
        the
        payment schedule for these debts. In the event these approaches do not provide
        us with adequate working capital, we may be required to further curtail or
        reduce our development activities, seek alternative funding sources, or seek
        protection under reorganization laws.
 
 The
        accompanying financial statements do not include any adjustments relating
        to the
        recoverability and classification of the recorded asset amounts or the amounts
        and classification of liabilities that might be necessary should the Company
        be
        unable to continue in existence.
  F-13
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
 **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 
 **3.**
              **Trade
                  Receivables**
 
 Trade
        receivables are net of reserves:
  **2006**
              
              **2005**Trade
                  receivables
              
              $
              141,498
              
              $
              35,168Less:
                  reserves
              
              
              –
              
              
              (25,200
              )$
              141,498
              
              $
              9,968
 
 On
        September 7, 2005, we entered into a factoring agreement with United Capital
        Funding (UCF) of Florida. UCF is a specialized financial services firm offering
        Accounts Receivable Management and working capital funding via factoring.
        We
        expect to improve our cash flow with this arrangement.
 
 Under
        the
        arrangement, we sell to UCF as absolute owner, invoices that we submit to
        UCF to
        be factored. Upon purchase, UCF assumes the risk of non-payment on purchased
        invoices, so long as the cause of non-payment is solely due to the occurrence
        of
        an insolvency event. As collateral securing the obligations, we grant UCF
        a
        continuing first priority security interest in all accounts and related
        inventory. Notwithstanding the creation of the above security interest, our
        relationship with UCF is one of Seller and Purchaser of accounts, and not
        that
        of lender and borrower. However, as there is certain recourse for non-payment,
        the accounts receivable are recorded at the estimated realizable value, net
        of
        allowances and the net advanced amount from UCF is recorded as an obligation
        at
        September 30, 2006. The initial and periodic factoring fee is .45% of the
        face
        amount of factored invoices. The factoring period is five days and the purchase
        price is 80% of the face amount, excluding sales tax.
 
 UCF
        typically advances to us 80% of the total amount of invoices factored, excluding
        sales tax. UCF retains 20% of the outstanding factored invoices as a reserve,
        which it holds until the customer pays the factored invoice to UCF.
 
 As
        of
        September 30, 2006, Trade Receivables of $141,498 included factored invoices
        totaling $140,875. As of September 30, 2005, Trade Receivables, net of $9,968
        included one factored invoice with a 20% reserve balance of $1,638.The remaining
        $8,830 included non-factored invoices.
 
 An
        outstanding note payable at September 30, 2005 of $8,900 was secured by an
        invoice for $8,330 included in the trade receivables total of $35,168 at
        September 30, 2005. The note was paid in full on November 3, 2005.
 F-14
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
 **4.**
              **Property
                  and Equipment**
 
 Property
        and equipment consists of the following at September 30, 2006 and
        2005:
 
 **2006**
              
              **2005**Computer
                  equipment
              
              $
              2,074
              
              $
              60,880Office
                  furniture
              
              
              –
              
              
              12,507Total
                  property and equipment
              
              
              2,074
              
              
              73,387Less:
                  accumulated depreciation
              
              
              (1,037
              
              
              (65,707
              )Net
                  property and equipment
              
              $
              1,037
              
              $
              7,680
 
 Fully
        depreciated Computer equipment and Office furniture of $58,806 and $12,507
        respectively, no longer in service were deleted in fiscal 2006.
 
 Depreciation
        expense for the years ended September 30, 2006 and 2005 was $6,643 and $13,341
        respectively.
 
 **5.**
              **Inventory,
                  net**
 
 Inventory,
        net consists of the following at September 30, 2006 and 2005:
 
 **2006**
              
              **2005**Inventory,
                  gross
              
              $
              70,622
              
              $
              70,510Less:
                  reserve for obsolescence
              
              
              (64,602
              )
              
              (46,775
              )Inventory,
                  net
              
              $
              6,020
              
              $
              23,735
 
 We
        marked
        down our inventory of Gotcha!® products, during the years ended September 30,
        2006 and 2005 by $17,827 and $46,775 respectively, for estimated obsolescence
        based on assumptions about age of the inventory and current demand.
 F-15
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
 **6.**
              **Investment**
 
 On
        January 28, 2005, the Company entered into a securities exchange agreement
        with
        TurboWorx, Inc., a Delaware corporation (“Turbo”) that provided for the exchange
        of 360,000 shares of the common stock of Turbo plus $240,000 in cash in exchange
        for 7,150,000 shares of NSC
        Common Stock (the “Exchange”). NSC and Turbo consummated the Exchange on
        February 1, 2005. The total value of the transaction of $620,444 was determined
        by the $240,000 cash paid to the Company, plus the then current market price
        of
        the Company’s common stock of $.074, plus the total fee of $91,344 charged by
        Casimir Capital, L.P. (“Casimir”) the placement agent. Casimir’s fee consisted
        of cash consideration of $25,000 and $66,344 that was determined to be the
        value
        of the 800,000 warrants, issued to the placement agent, with an exercise
        price
        of $0.11 at date of issue. Since Turbo’s common stock was not listed on any
        stock exchange or the Over the Counter Bulletin Board, the Company recorded
        the
        Investment of 360,000 Turbo shares at its net cost, the average market price
        of
        the 7,150,000 shares issued to Turbo less the cash received from Turbo. The
        consideration paid to Casimir did not increase the fair value of the investment
        and therefore, resulted in an impairment write-down of $91,344 in fiscal
        year
        2005. The Company’s investment in these equity securities was carried at
        $289,100 at September 30, 2005, which included an impairment charge of $91,344
        in fiscal 2005. The Company regularly monitored this investment for impairment
        in the carrying value, and as a result of this monitoring, we determined
        in
        September 2006 that it was appropriate to impair this investment up to its
        full
        value, $289,100, due to serious financial distress we believe is happening
        at
        TurboWorx.
 
 The
        Company intended to distribute at least 180,000 of the shares of Turbo stock
        it
        received in the Exchange to NSC shareholders of record on a pro rata basis
        as
        soon as practicable after the effective date of a registration statement
        on Form
        SB-2 registering the Turbo shares to be distributed to NSC shareholders.
        Turbo
        agreed to file such registration statement, and agreed to use its best efforts
        to have such filed registration statement declared effective no later than
        90
        days following the filing date. Turbo filed the SB-2 registration statement
        with
        the Securities and Exchange Commission on June 6, 2005. Turbo filed an amendment
        to the SB-2 registration statement with the Securities and Exchange Commission
        on October 12, 2005. When the registration becomes effective, NSC planned
        to
        announce the distribution. The parties also granted each other certain
“piggyback” registration rights regarding the exchanged shares. The registration
        rights terminate on December 31, 2007. The exchange is a further development
        resulting from the Memorandum of Understanding entered into between NSC and
        Turbo on October 29, 2004 regarding the joint development of technology and
        joint marketing. However, TurboWorx withdrew its SB-2 registration statement
        in
        June 2006, and has not re-filed it since that time. We determined that as
        of
        September 30, 2006, TurboWorx is not likely to complete this registration
        statement, and is thus in breach of its Exchange agreement. As a result,
        we do
        not consider at distribution of Turbo shares at this point to be a likely
        result.
 
 During
        the year ended September 30, 2006, NSC continued discussions with Turbo
        concerning their delinquency in obtaining an effective registration.  Turbo
        withdrew their then-current SB-2 filing in May 2006.  NSC
        is
        uncertain as to the direction Turbo will take, but now believes that Turbo
        may
        be in breach of the Share Exchange Agreement, and we have therefore started
        legal proceedings to recover our shares from them, and return to Turbo its
        common stock.
 
 **7.**
              **Accrued
                  Expenses**
 
 Accrued
        Expenses consisted of the following at September 30, 2006 and 2005:
 F-16
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
 **2006**
              
              ******2005**Salaries
                  & vacation pay - current management and staff
              
              $
              585,678
              
              $
              332,391Salaries
                  & vacation pay - former employee
              
              
              29,375
              
              
              29,375Payroll
                  taxes for back pay
              
              
              37,342
              
              
              27,952Interest
              
              
              101,698
              
              
              48,189Employee
                  stock retainage pool
              
              
              50,250
              
              
              50,250Other
                  liabilities
              
              
              44,103
              
              
              30,975$
              848,446
              
              $
              519,132
  **8.**
              **Accounts
                  Payable - Other**
  Accounts
        payable other decreased by $18,071 from $183,664 on September 30, 2005 to
        $165,593 at September 30, 2006. As part of this decrease, the Company reversed
        a
        liability of $36,540 to research and development expense, which was originally
        created for work carried out for the Company by a foreign consultant during
        fiscal years 2001 and 2002. The reversal was in accordance with our policy
        to
        void unclaimed invoices for between 24 and 36 months.
  **9.**
              **Earnings
                  Per Share**
 
 The
        following table reconciles weighted average shares outstanding to amounts
        used
        to calculate basic and diluted earnings per share for fiscal years 2006 and
        2005.
 
 **2006**
              ****
              ****
              **2005**Net
                  (loss)
              
              $
              (945,293
              )
              $
              (1,140,782
              )Weighted
                  average shares:Average
                  shares outstanding
              
              
              96,754,136
              
              
              89,338,638Effect
                  of diluted shares
              
              
              –
              
              
              –Average
                  Shares outstanding, adjusted for dilutive effect
              
              
              96,754,136
              
              
              89,338,638(Loss)
                  per share - basic
              
              $
              (0.01
              )
              $
              (0.01
              )(Loss)
                  per share - diluted
              
              $
              (0.01
              )
              $
              (0.01
              )
  F-17
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 Incremental
        common shares (not included in denominator of diluted earnings per share
        because
        of their anti-dilutive nature):
 
 **2006**
              ****
              ****
              **2005**Options
              
              
              4,159,938
              
              
              3,789,257Warrants
              
              
              15,384,197
              
              
              15,434,197Potential
                  common equivalents
              
              
              19,544,135
              
              
              19,223,454
 
 **10.**
              **Lease
                  Commitments**
 
 On
        August
        27, 2004 the Company signed a twenty-six month non-cancelable operating lease
        agreement for an office in Scottsdale, Arizona The lease for the Scottsdale
        facility expired October 31, 2006 at a rental rate of $3,051 per month before
        taxes for the remainder of the lease. On October 20, 2006 NSC executed a
        lease
        for 1,601 square feet of office/warehouse space at 8361 E. Evans Road, Suite
        106
        Scottsdale, Arizona 85260. The lease for this Scottsdale facility commenced
        on
        November 1, 2006 and expires October 31, 2008 and is at a base rental rate
        of
        $1,963 per month before taxes.
  Future
        minimum lease obligations at September 30, 2006 are as follows:
 **Year
                    ending September 30,**
                
                **Amount**2007
                
                $
                24,1842008
                
                
                23,7592009
                
                
                1,985$
                49,928
  Rent
        expense for the years ended September 30, 2006 and 2005 was approximately
        $39,000 and $33,000, respectively.
 
 **11.**
              **Income
                  Taxes**
 
 Deferred
        income taxes consist of the following at September 30, 2006 and
        2005:
 F-18
 **Table
                      of Contents**
 **Index
                      to Financial
                      Statements**
  **NATIONAL
              SCIENTIFIC CORPORATION**
 **NOTES
              TO FINANCIAL STATEMENTS** **(Continued)**
 **For
              the Years Ended September 30, 2006 and 2005**
 **2006**
                  ****
                  ****
                  **2005**Tax
                      Benefit of net operating loss carry-forwards and start up
                      costs
                  
                  $
                  6,600,000
                  
                  $
                  6,343,000Impairment
                      reserves
                  
                  
                  159,000
                  
                  
                  36,000Compensation
                      payable
                  
                  
                  36,000
                  
                  
                  26,000Allowance
                      for doubtful accounts
                  
                  
                  –
                  
                  
                  9,000Total
                  
                  
                  6,795,000
                  
                  
                  6,414,000Valuation
                      allowance
                  
                  
                  (6,795,000
                  )
                  
                  (6,414,000
                  )$
                  –
                  
                  $
                  –
 
 A
        reconciliation of expected to actual taxes follows
 **2006**
                ****
                ****
                **2005**Expected
                    federal and state tax recovery at 40%
                
                $
                (378,000
                )
                $
                (456,000
                )Non-deductible
                    stock compensation
                
                
                –
                
                
                –Other
                
                
                9,000
                
                
                (17,000(369,000
                )
                
                (473,000
                )Tax
                    benefits not realized - valuation allowance
                
                
                369,000
                
                
                473,000Realized
                    tax benefit
                
                $
                –
                
                $
                –
  The
          Company has recorded valuation allowances to offset the value of deferred
          tax
          assets, since it has recorded losses from operations since 1996 and the
          utilization of those assets is uncertain. During fiscal 2006 and 2005,
          the
          valuation allowance increased by $369,000 and $473,000,
          respectively.
 
 The
        Company has net operating loss carry-forwards of approximately $16,500,000
        at
        September 30, 2006, which may be used to offset future federal taxable income
        through 2025 and state taxable income through 2011.
 F-19
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
 **12.**
              **Related
                  Party Transactions**
 
 As
        described in the Company’s 10-KSB filing for the year ending September 30, 2003,
        and also in the Company’s Proxy Statement for 2004 filed January 30, 2004, the
        Company’s Board initiated on September 30, 2002 a restricted stock retainage
        program (“Stock Retainage Program”) to retain key staff during a period of
        financial difficulty. The Company allocated approximately $150,000 in restricted
        Common Stock from this Stock Retainage Program pool of shares in fiscal 2002,
        to
        be granted to key employees during the year, subject to the Company exceeding
        sales growth objectives and expense reduction objectives in 2003. Failure
        to
        meet these objectives under the plan would result in the forfeiture by staff
        of
        this entire stock grant by all participants, unless new objectives are approved
        by the board for calendar year 2004, in which case the stock grant would
        remain
        with the participants but be subject to forfeiture by participants until
        new
        objectives have been achieved in 2004. All stock grants under this program
        were
        granted in September 2002 but shares were not finally issued until January
        of
        2003. All of the stock under this program is restricted under SEC Section
        144,
        and cannot be traded by the Stock Retainage Program participants for at least
        one year from date of issue. The board extended the program in February of
        2005
        through to the end of 2006, with targets remaining at the 2005
        levels.
 
 The
        Company CEO, Michael Grollman was granted 750,000 shares of stock from this
        Stock Retainage Program pool of shares, subject to the Company achieving
        in
        excess of $200,000 in sales in calendar year 2003, and subject to him accepting
        a $60,000 per year pay reduction for the calendar year 2003, reducing his
        annual
        payable salary to $120,000 per year for 2003. Mr. Grollman was granted an
        additional 500,000 shares of stock under this program, subject to sales
        exceeding $1,000,000 for calendar year 2003. The Company’s President and
        Director Graham Clark was granted 500,000 shares of stock from the Company’s
        Stock Retainage Program pool of shares discussed above, subject to the Company
        achieving in excess of $200,000 in sales in calendar year 2003. Mr. Clark
        was
        granted an additional 500,000 shares of stock under this program, subject
        to
        sales exceeding $1,000,000 for calendar year 2003. The plan’s sales goals were
        not met in calendar year 2003, although the plan was nonetheless largely
        successful in assisting to retain key staff, even during this period of deferred
        or reduced salary. In January 2004, our board extended this program into
        2004,
        and set new sales growth objectives for the year at a level 50% higher than
        the
        previous year’s program, giving plan participants an additional year to fully
        earn these previously outstanding restricted stock grants. No new shares
        were
        added to the plan, although plan participants were able to convert some
        long-term back pay into restricted stock at that time. The board extended
        the
        program in February of 2005 through to the end of 2006, with targets remaining
        at the 2005 levels. The majority of the remaining restricted stock allocated
        under this program was granted to other Company staff, and is subject to
        substantially the same risk of forfeiture as the stock granted to Grollman
        and
        Clark under the Program.
 
 On
        January 27, 2004, we issued 250,000 shares, from the Stock Retainage Plan,
        to
        our employees Oscar Quadros, our controller, and 250,000 shares to Paul
        Davidson, our embedded systems development engineer. Neither of these
        individuals are nor have been officers or directors of the Company. The 500,000
        shares were issued from the plan following the forfeiture and return to the
        plan
        on August 19, 2003 of 800,000 shares from a participant of the plan who left
        the
        Company. The shares were issued at 90% of the average market price per share,
        on
        the date of issue, of $0.155.
 
 In
        December 2003 Mr. Grollman agreed to convert approximately $150,000 of his
        back
        pay and accrued vacation pay to our restricted common stock, at a rate equal
        to
        the then currently available private placement share price of $0.10 per share.
        Mr. Grollman received this stock in January of 2004.
 F-20
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
  In
        December 2004, our Chairman Michael Grollman made personal loans to the Company
        in the amount of $65,000 to assist us with short-term cash requirements.
        The
        loan is evidenced by an unsecured promissory note that provides for repayment
        within 90 days or less, at no interest. The promissory note also provides
        that
        if repayment takes longer than 90 days, then interest accrues at a rate of
        6
        percent per year until paid in full. We paid this Note in full in February
        of
        2005.
 
 On
        February 24, 2005, March 28, 2005, May 2, 2005, and May 27, 2005 our Chairman
        Michael Grollman made new personal loans to the Company totaling $159,000
        to
        assist us with working capital needs. The loans are evidenced by a demand
        note
        that provides for repayment within five business days of a demand notice
        from
        Mr. Grollman, with interest of 6% compounded annually from June 1, 2005.
        As of
        September 30, 2005, these loans were outstanding.
 
 On
        August
        17, 2005, Mr. Grollman agreed to convert approximately $34,500 of his back
        pay
        to our restricted common stock, at the rate of the average market price per
        share of $0.046.
 
 On
        August
        17, 2005, Mr. Clark agreed to convert approximately $23,000 of his back pay
        to
        our restricted common stock, at the rate of the average market price per
        share
        of $0.046.
 
 On
        August
        31, 2005, Mr. Grollman agreed to convert approximately $15,190 of his back
        pay
        to our restricted common stock, the rate of the average market price per
        share
        of $0.035.
 
 On
        August
        31, 2005, Mr. Clark agreed to convert approximately $9,500 of his back pay
        to
        our restricted common stock, the rate of the average market price per share
        of
        $0.035.
 
 On
        November 23, 2005, Mr. Grollman agreed to convert approximately $18,000 of
        our
        accounts payable and accrued expense indebtedness to him to 500,00 shares
        of our
        restricted common stock, the rate of the average market price per share of
        $0.036.
 
 On
        April
        7, 2006, Mr. Grollman agreed to convert approximately $16,000 of his back
        pay to
        500,000 shares of our restricted common stock, the rate of the average market
        price per share of $0.032.
 
 On
        March
        15, 2006, Mr. Clark agreed to convert approximately $15,050 of his back pay
        to
        430,000 shares of our restricted common stock, the rate of the average market
        price per share of $0.035.
 
 On
        May
        25, 2006, Mr. Clark agreed to convert approximately $40,250 of his back pay
        to
        1,150,000 shares of our restricted common stock, the rate of the average
        market
        price per share of $0.035.
  F-21
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
 
 **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**


The
        CEO
        and the President have employment contracts previously filed with the SEC
        that
        include termination clauses that fully vest their ownership of
        shares.
 
 **13.**
              **Disclosures
                  About Fair Value of Financial
                  Instruments**
 
 Fair
        value estimates are made at a specific point in time and are based on relevant
        market information and information about the financial instrument; they are
        subjective in nature and involve uncertainties, matters of judgment and,
        therefore, cannot be determined with precision.
 
 These
        estimates do not reflect any premium or discount that could result from offering
        for sale at one time the Company’s entire holdings of a particular instrument.
        Changes in assumptions could significantly affect the estimates.
 
 Since
        the
        fair value is estimated as of September 30, 2006, the amounts that will actually
        be realized or paid at settlement of the instruments could be significantly
        different.
 
 The
        carrying amount of cash and cash equivalents is assumed to be their fair
        value
        because of the liquidity of these instruments. Accounts payable and accrued
        expenses approximate fair value because of the short maturity of these
        instruments. O n
        September 30, 2006, we took an impairment charge of $289,100 against our
        investment in TurboWorx, Inc. The
        Company’s investment in these equity securities was carried at $289,100 at
        September 30, 2005, which included an impairment charge of $91,344 in fiscal
        2005. The Company regularly monitored this investment for impairment in the
        carrying value, and as a result of this monitoring, we determined in September
        2006 that is was appropriate to impair this investment up to its full value,
        due
        to serious financial distress we believe is happening at TurboWorx.
  **14.**
              **Stock
                  Options and Warrants**
 
 **Stock
        Options**
 
 As
        of
        September 30, 2006, the Company has a stock-based compensation plan wherein
        officers and employees were granted stock options. The Company applies APB
        25
        and related interpretations in accounting for the plan. Accordingly,
        compensation expense is equal to the difference between the exercise price
        of
        the options granted and the fair value of the common stock at the date of
        the
        grant.
 
 Under
        the
        above-mentioned 2000 Stock Option Plan, the purchase price must be at least
        100%
        of the fair market value of our common stock (if the option is an incentive
        stock option), or at least 25% of the fair market value of our common stock
        at
        the time the option is granted (if the option is a nonqualified grant), or
        such
        higher price as may be determined by the Board of Directors at the time of
        grant. If however, an incentive stock option is granted to an individual
        who
        would, immediately before the grant, directly or indirectly own more than
        10% of
        the total combined voting power of all our classes of stock, the purchase
        price
        of the shares of common stock covered by such incentive stock option may
        not be
        less than 110% of the fair market value of such shares on the day the incentive
        stock option is granted. As the price of the Company’s common stock is currently
        quoted on the OTC Bulletin Board, the fair market value of the common stock
        underlying options granted under the 2000 Stock Option Plan shall be the
        last
        closing sale price of the common stock on the day the options are granted.
        If
        there is no market price for the common stock, then our Board of Directors
        may,
        after taking all relevant facts into consideration, determine the fair market
        value of the Company’s common stock.
 F-22
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
  **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
 **Weighted**
                
                
                **Weighted****Number**
                
                
                **Average**
                
                
                **Average****of**
                
                
                **Exercise**
                
                
                **Fair****Shares**
                
                
                **Price**
                
                
                **Value**Options
                    Outstanding, September 30, 2004
                
                
                3,709,257
                
                $
                0.82
                
                $
                0.02Granted
                
                
                80,000
                
                
                0.10
                
                
                0.07Exercised
                
                
                –
                
                
                –
                
                
                –Expired
                
                
                –
                
                
                –
                
                
                –Options
                    Outstanding, September 30, 2005
                
                
                3,789,257
                
                $
                0.81
                
                $
                0.02Granted
                
                
                370,681
                
                
                0.04
                
                
                0.03Exercised
                
                
                –
                
                
                –
                
                
                –Expired
                
                
                –
                
                
                –
                
                
                –Options
                    Outstanding, September 30, 2006
                
                
                4,159,938
                
                $
                0.74
                
                $
                0.01
 As
        of
        September 30, 2006, we have issued options to purchase an aggregate of 4,159,938
        shares of our common stock leaving a balance of 2,840,062 available for grant.
        Also as of September 30, 2006, 4,159,938 options are exercisable and 4,159,938
        are vested. We have reserved the right to issue a total of 7,000,000 shares
        of
        our common stock for issuance under the 2000 Stock Option Plan. No options
        have
        been exercised or have expired during the year ended September 30,
        2006.
  The
        following table summarizes the status of stock options outstanding at September
        30, 2006:
 **Stock
                    Options Outstanding**
                
                **Stock
                    Options Exercisable****Weighted****Average****Remaining**
                
                **Weighted**
                
                
                
                **Weighted****Contractual**
                
                **Average**
                
                
                
                **Average****Number**
                
                **Life**
                
                **Exercise**
                
                **Number**
                
                **Exercise****Range
                    of Exercise Prices**
                
                **Outstanding**
                
                **(In
                    Years)**
                
                **Price**
                
                **Outstanding**
                
                **Price**$0.03
                    to $0.04
                
                
                370,681
                
                
                9.9
                
                $
                0.04
                
                
                370,681
                
                $
                0.04$0.05
                    to $0.46
                
                
                2,479,257
                
                
                6.8
                
                $
                0.18
                
                
                2,479,257
                
                $
                0.18$0.47
                    to $1.84
                
                
                1,000,000
                
                
                4.4
                
                $
                1.84
                
                
                1,000,000
                
                $
                1.84$1.85
                    to $3.00
                
                
                310,000
                
                
                4.6
                
                $
                2.49
                
                
                310,000
                
                $
                2.49Total
                
                
                4,159,938
                
                
                5.8
                
                $
                0.74
                
                
                4,159,938
                
                $
                0.74
 F-23
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
  **Warrants**
 **Weighted**
                
                **Weighted****Number**
                
                **Average**
                
                **Average****of**
                
                **Exercise**
                
                **Fair****Shares**
                
                **Price**
                
                **Value**Warrants
                    Outstanding, September 30, 2004
                
                
                18,249,197
                
                $
                0.21
                
                $
                0.15Granted
                
                
                2,185,000
                
                
                0.09
                
                
                0.05Exercised
                
                
                –
                
                
                –
                
                
                –Cancelled
                
                
                –
                
                
                –
                
                
                –Expired
                
                
                (5,000,000
                )
                
                0.03
                
                
                0.03Warrants
                    Outstanding, September 30, 2005
                
                
                15,434,197
                
                $
                0.17
                
                $
                0.09Granted
                
                
                1,150,000
                
                
                0.04
                
                
                0.03Exercised
                
                
                –
                
                
                –
                
                
                –Cancelled
                
                
                (1,200,000
                )
                
                0.09
                
                
                0.03Expired
                
                
                –
                
                
                –
                
                
                –Warrants
                    Outstanding, September 30, 2006
                
                
                15,384,197
                
                $
                0.15
                
                $
                0.01
 The
        warrants outstanding as of September 30, 2006 are as follows:
 **Warrants
                    Outstanding**
                
                
                **Warrants
                    Exercisable****Range
                    of Exercise Prices**
                
                
                **Number
                    of Shares**
                
                
                **Weighted
                    Average Exercise Price**
                
                
                **Weighted
                    Average Remaining Contractual Life (Years)**
                
                
                **Number
                    of Shares**
                
                
                **Weighted
                    Average Exercise Price**$0.035
                    to $0.035
                
                
                500,000
                
                $
                0.035
                
                
                4.92
                
                
                500,000
                
                $
                0.035$0.036
                    to $0.036
                
                
                200,000
                
                $
                0.036
                
                
                2.63
                
                
                200,000
                
                $
                0.036$0.050
                    to $0.050
                
                
                450,000
                
                $
                0.050
                
                
                2.84
                
                
                450,000
                
                $
                0.050$0.062
                    to $0.062
                
                
                135,000
                
                $
                0.062
                
                
                1.73
                
                
                135,000
                
                $
                0.062$0.090
                    to $0.090
                
                
                50,000
                
                $
                0.090
                
                
                1.97
                
                
                50,000
                
                $
                0.090$0.100
                    to $0.100
                
                
                3,108,497
                
                $
                0.100
                
                
                4.10
                
                
                3,108,497
                
                $
                0.100$0.110
                    to $0.110
                
                
                7,750,700
                
                $
                0.110
                
                
                2.52
                
                
                7,750,700
                
                $
                0.110$0.130
                    to $0.130
                
                
                640,000
                
                $
                0.130
                
                
                0.27
                
                
                640,000
                
                $
                0.130$0.350
                    to $0.350
                
                
                1,000,000
                
                $
                0.350
                
                
                0.75
                
                
                1,000,000
                
                $
                0.350$0.500
                    to $0.500
                
                
                1,275,000
                
                $
                0.500
                
                
                0.75
                
                
                1,275,000
                
                $
                0.500$0.750
                    to $0.750
                
                
                275,000
                
                $
                0.075
                
                
                0.75
                
                
                275,000
                
                $
                0.07515,384,197
                
                
                
                
                
                
                
                
                15,384,197
 F-24
 **Table
                of Contents**
 **Index
                to Financial
                Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
 
 
 During
        the year ended September 30, 2006, the Company has issued 1,150,000 warrants
        for
        financing activities. Each warrant entitles its owner to purchase one common
        share of the Company at purchase prices ranging from of $0.035 to $0.500
        with
        expiry dates ranging from April 2009 to August 2011.
 
 On
        April
        27, 2006, in connection with a short term financing note for $16,625, the
        Company issued to a shareholder a warrant to purchase 100,000 shares of common
        stock exercisable at $0.036 per share through April 27, 2009, which was
        determined to have a debt discount of $2,272. The debt discount of $2,272
        was
        expensed to interest expense during the current quarter.
 
 On
        May
        31, 2006, in connection with a short term financing note for $20,000, the
        Company issued to a shareholder a warrant to purchase 100,000 shares of common
        stock exercisable at $0.036 per share through May 31, 2009, which was determined
        to have a debt discount of $2,984. The debt discount of $ 2,984 was expensed
        to
        interest expense during the current quarter.
 
 On
        June
        17, 2006, we raised $10,000 from a private placement and issued 571,429 shares
        of common stock at an average market price per share of $0.0175. In connection
        with this private placement, we issued a warrant to purchase 200,000 shares
        of
        our common stock exercisable at $0.050 per share through June 30, 2009. No
        underwriters were involved in connection with this private placement. The
        sales
        and issuances of the securities issued pursuant to the foregoing private
        placement are exempt from registration under the Securities Act of 1933,
        as
        amended, pursuant to Section 4(2) thereof, and Rule 506 of Regulation
        D. 3.
  During
        the quarter ended June 30, 2006, a share purchase warrant to purchase 1,200,000
        shares, with an exercise price of $.090, was cancelled
 
 On
        June
        30, 2006, 250,000 share purchase warrants, with exercise prices ranging from
        $0.350 to $0.075, which would have expired on June 30, 2006, had their expiry
        date extended for one year. It was
        determined that there was no expense involved with the extension of the expiry
        dates.
 
 On
        August
        8, 2006, in connection with a short term financing note for $50,000, the
        Company
        issued to a shareholder a warrant to purchase 500,000 shares of common stock
        exercisable at $0.035 per share through August 8, 2011, which was determined
        to
        have a debt discount of $15,431. The debt discount of $15,431 was expensed
        to
        interest expense.
 
 On
        August
        8, 2006, we raised $10,000 from a private placement and issued 571,429 shares
        of
        common stock at an average market price per share of $0.0175. In connection
        with
        this private placement, we issued a warrant to purchase 250,000 shares of
        our
        common stock exercisable at $0.050 per share through August 30, 2009. No
        underwriters were involved in connection with this private placement. The
        sales
        and issuances of the securities issued pursuant to the foregoing private
        placement are exempt from registration under the Securities Act of 1933,
        as
        amended, pursuant to Section 4(2) thereof, and Rule 506 of Regulation
        D. 3.
  No
        share
        purchase warrants have been exercised during the fiscal year 2006.
 F-25
 **Table
                  of Contents**
 **Index
                  to Financial
                  Statements**
 
 **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
 
 **15.**
              **Commitments
                  and Contingencies**
 
 In
        January 2002, the Company initiated legal proceedings against Phoenix
        Semiconductor, Inc. (PSI) for breach of contract. The Company was awarded
        a
        judgment of approximately $179,000 in May 2003 against E4World Corporation.
        However, there is no assurance that NSC will collect any of this amount.
        Since
        collection of this judgment by NSC is uncertain, this positive judgment is
        not
        reflected in NSC’s current financial statements. The Company continues to press
        its claim to secure assets held by E4World in a separate legal matter, although
        there is no assurance that NSC will collect this claim, and thus this claim
        is
        not shown in the NSC financial statements. The Company is from time to time
        subject to claims and suits arising in the ordinary course of operations.
        In the
        opinion of management, the ultimate resolution of such pending legal proceedings
        will not have a material adverse effect on the Company’s financial position,
        results of operation or liquidity.
 
 **16.**
              **Notes
                  Payable and Long Term Debt**
 
 As
        of
        September 30, 2006 and 2005, all long-term debt consisted of the following
        notes
        payable:
 
 **2006**
              
              **2005**Note
                    payable to shareholder; unsecured; non-interest bearing; matures
                    in June
                    2006; repayment may be made by the Company with either cash or
                    its
                    restricted common stock or a combination of cash and
                    stock.
              
              $
              43,250
              
              $
              43,250Note
                    payable to an Officer of the Company; interest at 6%; principal
                    and
                    interest payable on demand; unsecured.
              
              
              159,000
              
              
              159,000Note
                  payable to shareholder; unsecured; non-interest bearing
              
              
              
              
              
              3,000Note
                  payable to shareholder; unsecured; interest at 6%
              
              
              
              
              
              5,000Note
                    payable to an employee; interest at 6%; principal and interest
                    payable on
                    demand; unsecured.
              
              
              
              
              
              8,900Note
                  payable to shareholder; unsecured; non-interest bearing
              
              
              1,000
              
              
              –Note
                  payable to shareholder; unsecured; non-interest bearing
              
              
              1,500
              
              
              –Note
                  payable to shareholder; unsecured; non-interest bearing
              
              
              1,000
              
              
              –Note
                  payable to shareholder; secured; interest at 12%
              
              
              16,625
              
              
              –Note
                  payable to shareholders; secured; interest at 12%
              
              
              20,000
              
              
              –Note
                      payable to an investment fund; payable in full in November
                      2010; interest
                      at 8% payable semi-annually in May and November;
                      unsecured.
              
              
              175,000
              
              
              –Note
                  payable to shareholders; secured; interest at 12%
              
              
              50,000
              
              
              –467,375
              
              
              219,150Less:Current
                  portion of long term debt
              
              
              (292,375
              )
              
              (219,150
              )Discount
              
              
              (42,140
              )
              
              –Beneficial
                  conversion feature
              
              
              (8,112
              )
              
              –Long-term
                  debt, net of current portion
              
              $
              124,748
              
              $
              –
  F-26
 **Table
              of Contents**
 **Index to Financial
              Statements**
  **NATIONAL
        SCIENTIFIC CORPORATION**
 **NOTES
        TO FINANCIAL STATEMENTS** **(Continued)**
 **For
        the Years Ended September 30, 2006 and 2005**
   On
        June
        11, 2003, the Company issued a three-year interest free convertible unsecured
        note of $43,250, with no payments required of the Company until the end of
        the
        three-year period, to its then-Director Mr. Lou Ross for past services rendered
        (See 10-KSB report for the year ended September 30, 2003). The Company can
        pay
        this note at any time before the three-year period elapses with either cash
        or
        its common restricted stock or a combination of cash and stock, at its sole
        discretion. The Company intends to convert this to its restricted common
        stock
        upon request from Mr. Ross. Mr. Ross retired from the Company’s board on
        September 30, 2003.
 
 On
        February 24, 2005, March 28, 2005, May 2, 2005, and May 27, 2005 our Chairman,
        Michael Grollman, made personal loans to the Company totaling $159,000 to
        assist
        us with working capital needs. The loans are evidenced by a demand note that
        provides for repayment within five business days of a demand notice from
        Mr.
        Grollman, with interest of 6% compounded annually from June 1, 2005. As of
        June
        30, 2006, these loans were outstanding.
 
 On
        November 1, 2005, as an important phase in the current years financing plan,
        we
        entered into a financing program with a U.S. investment fund. The terms of
        this
        program include a five-year Note payable at maturity in November 2010 for
        $175,000, at an effective annual interest rate of 8%. Interest is due and
        payable semi-annually on May 1 st and
        November 1 st for each
        year in which the note is outstanding The transaction also included 1,200,000
        restricted common shares and a conversion/exchange option to convert the
        principal amount and any unpaid interest of the Note into common shares at
        a per
        share conversion price of $0.0525. These shares include weighted average
        anti-dilution provisions, as well as piggyback registration rights. The
        1,200,000 restricted common shares were recorded at $0.043, which was the
        five-day average market closing price of our stock. The note and common stock
        were issued with a debt discount of $51,600 and a beneficial conversion feature
        of $9,933. The discount and beneficial conversion feature are being amortized
        to
        interest expense over the term of the note, which is approximately 60 months.
        The issuance of the shares resulted in deferred financing costs of $24,000.
        The
        deferred financing costs are being amortized over term of the note, which
        is
        approximately 60 months, and are included in the statement of operations
        as
        offering costs.
 
 In
        March
        2006 we secured short-term loans in the aggregate principal amount of $2,500.
        The loans are unsecured and non-interest bearing.
 
 On
        April
        27, 2006, we secured a short-term loan of $16,625 from a shareholder. The
        loan
        carries an origination/placement fee of $500 and has a perfectible security
        interest a) prior to delivery in any assets purchased for the fulfillment
        of
        SAP’s order dated March 16, 2006, and b) in any receivable resulting from the
        fulfillment of the SAP purchase order. The interest rate on the loan is 12%.
        The
        transaction also included 100,000 warrants to purchase our common stock at
        $0.036 at any time before April 27, 2009. The note had an approximate maturity
        date of June 15, 2006. At September 30, 2006 we were in default of the payment
        terms of this note, however, a partial payment towards principal and interest
        of
        $5,258 was made on October 6, 2006.
 
 On
        May
        31, 2006, we secured a short-term loan of $20,000 from a shareholder. The
        loan
        carries an origination/placement fee of $500 and has a perfectible security
        interest a) prior to delivery in any assets purchased for the fulfillment
        of
        Clover Park, WA’s order and b) in any receivable resulting from the fulfillment
        of the Clover Park purchase order. The interest rate on the loan is 12%.
        The
        transaction also included 100,000 warrants to purchase our common stock at
        $0.036 at any time before May 31, 2009. The note had a maturity date of July
        10,
        2006. At September 30, 2006 we were in default of the payment terms of this
        note.
 F-27
 **Table
                of Contents**
 **Index to Financial
                Statements**
  **NATIONAL
          SCIENTIFIC CORPORATION**
 **NOTES
          TO FINANCIAL STATEMENTS** **(Continued)**
 **For
          the Years Ended September 30, 2006 and 2005**
 On
        August
        8, 2006, we secured a short-term loan of $50,000 from a shareholder. The
        loan
        carries an origination/placement fee of $2,000 and has a perfectible security
        interest a) in the purchase orders of Gilbert School District and Jefferson
        County School District and b) a lien in property owned by Graham Clark at
        15449
        N. Cabrillo Drive, Fountain Hills, AZ 85268. The interest rate on the loan
        is
        12%. The transaction also included 500,000 warrants to purchase our common
        stock
        at $0.035 at any time before August 8, 2011. The note had a maturity date
        of
        November 6, 2006.
  The
        aggregate maturities of long-term debt for the fiscal periods ended September
        30, were as follows:
 
 2007
              
              $
              292,3752008
              
              
              –2009
              
              
              –2010
              
              
              –2011
              
              
              175,000$
              467,375




An
        outstanding note payable at September 30, 2005 of $8,900 was secured by an
        invoice for $8,330 included in the trade receivables total of $35,168 at
        September 30, 2005. The note was paid in full on November 3, 2005.
 
 **17.**
              **Subsequent
                  Events**
  On
        December 20, 2006 we extended the maturity date of the short-term
        loan of $50,000 secured on August 8, 2006 from November 6, 2006 to March
        31,
        2007. The extension term carried a two percent loan extension fee and included
        500,000 warrants to purchase our common stock at $0.035 at any time before
        August 8, 2011.
  On
        October 20, 2006 NSC executed a lease for 1,601 square feet of office/warehouse
        space at 8361 E. Evans Road, Suite 106 Scottsdale, Arizona 85260. The lease
        for
        this Scottsdale facility commenced on November 1, 2006 and expires October
        31,
        2008 and is at a base rental rate of $1,963 per month before taxes.
  F-28
 **Table
              of Contents**
 **Index to Financial
              Statements**