UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





**FORM
      10-K**





ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934





For
      the
      Fiscal Year Ended


September
      30, 2006


Commission
      File No: 001-12629





**NATIONAL
      HOLDINGS CORPORATION**


(Exact
      Name of Registrant as specified in its charter)





**Delaware**
            **36-4128138**(State
                or other jurisdiction of
            (I.R.S.
                Employerincorporation
                or organization)
            Identification
                No.)





**875
      North Michigan Avenue, Suite 1560, Chicago, IL 60611**


(Address,
      including zip code, of principal executive offices)


Registrant's
      telephone number, including area code: (312) 751-8833





Securities
      registered pursuant to Section 12(b) of the Act: None


Securities
      registered pursuant to Section 12(g) of the Act: Common
      Stock, $.02 par value


(Title
      of
      class)





Indicate
      by check mark whether the registrant is a well-known seasoned issuer, as defined
      in Rule 405 of the Securities Act. YES
o NO
x





Indicate
      by check mark whether the registrant is not required to file reports pursuant
      to
      Section 13 or 15(d) of the Act. YES
o NO
x





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





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K of this chapter is not contained herein, and will not be
      contained, to the best of registrant's knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this Form
      10-K or any amendment to this Form 10-K. o





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





Indicate
      by check mark whether the registrant is a shell company (as defined in Exchange
      Act Rule 12b-2). YES
o NO
x





As
      of
      March 31, 2006, the aggregate market value of voting and non-voting common
      equity held by non-affiliates of the registrant, based on the closing sales
      price for the registrant's common stock, as quoted on the Over-the-Counter
      Bulletin Board was approximately $8,000,000 (calculated by excluding shares
      owned beneficially by directors and officers). As
      of
      December 5, 2006 there were 5,238,187 shares of the registrant's common stock
      outstanding.





DOCUMENTS
      INCORPORATED BY REFERENCE





Portions
      of the Company’s Proxy Statement filed with the Securities and Exchange
      Commission (the “SEC”) in connection with the Company’s Annual Meeting of
      Shareholders to be held on or about March 13, 2007 (the “Company’s 2007 Proxy Statement”)
      are incorporated by reference into Part III hereof.











**PART
      I**





**Item
      1. BUSINESS**





*Statements
      made in this report that relate to future plans, events, financial results
      or
      performance are forward-looking statements as defined under the Private
      Securities Litigation Reform Act of 1995. These statements are based upon
      current information and expectations. Actual results may differ materially
      from
      those anticipated as a result of certain risks and uncertainties. For details
      concerning these and other risks and uncertainties, see Part I,
      Item 1A, “Risk Factors” of this report, as well as the Company’s other
      reports on Forms 10-K, 10-Q and 8-K subsequently filed with the SEC from
      time to time. Readers are cautioned not to place undue reliance on these
      forward-looking statements, which speak only as of the date hereof. The Company
      undertakes no obligation to republish revised forward-looking statements to
      reflect events or circumstances after the date hereof or to reflect the
      occurrence of unanticipated events.*





**General**





National
      Holdings Corporation, a Delaware corporation organized in 1996 (“National
      Holdings” or **** the
      “Company”), **** is
      a
      financial services organization operating through its wholly owned subsidiary,
      National Securities Corporation, a Washington corporation organized in 1947
      (“National Securities”). National Securities conducts a national securities
      brokerage business through its main offices in Seattle, Washington and New
      York,
      New York, as well as 41 other branch offices located throughout the country,
      and
      one office outside the country. National Securities’ business includes
      securities brokerage for individual and institutional clients, market-making
      trading activities, asset management and corporate finance services. On
      March
      15, 2006, the Company changed its name from “Olympic Cascade Financial
      Corporation” to “National Holdings Corporation.”





National
      Securities provides a broad range of securities brokerage and investment
      services to a diverse retail and institutional clientele, as well as corporate
      finance and investment banking services to corporations and businesses. National
      Securities’ brokers operate as independent contractors. A registered
      representative who becomes an affiliate of National Securities establishes
      his
      own office and is responsible for the payment of expenses associated with the
      operation of such office, including rent, utilities, furniture, equipment,
      stock
      quotation machines and general office supplies. In return, the registered
      representative is entitled to retain a higher percentage of the commissions
      generated by his sales than a registered representative at a traditional
      employee-based brokerage firm. This arrangement allows National Securities
      to
      operate with a reduced amount of fixed costs and lowers the risk of operational
      losses for non-production.





The
      Company formed a new wholly owned subsidiary, National Insurance
      Corporation, a
      Washington corporation (“National Insurance”) in
      the
      third quarter of fiscal year 2006. National Insurance will provide fixed
      insurance products to its clients, including life insurance, disability
      insurance, long term care insurance and fixed annuities. National Insurance
      is
      in the process of completing the requisite state registrations, and has not
      yet
      commenced active business operations.





**Clearing
      Relationships**





In
      December 2003, the Company engaged in discussions with the NASD relating to
      the
      Security Agreement between National Securities and its then current clearing
      firm, First Clearing Corporation (“First Clearing”), a wholly owned subsidiary of Wachovia
      Corporation ,
      and its
      effect on the computation of National Securities’ net capital. As a result of
      these discussions, on December 15, 2003, the Company and First Clearing agreed
      in principle to the following: (1) National Securities’ clearing deposit was
      reduced from $1,000,000 to $500,000; (2) the excess $500,000 was paid to First
      Clearing to reduce the Company’s outstanding loan balance on its promissory
      note; and (3) the Security Agreement between National Securities and First
      Clearing was terminated. Furthermore, First Clearing forgave payment of an
      additional


-2-




$375,000
      loan that was due to be paid in January 2004, resulting in a $375,000 gain
      on
      extinguishments of debt in the first quarter of fiscal year 2004.





In
      February 2004, the Company paid First Clearing $250,000 to fully repay its
      promissory note that had a balance of approximately $1,006,000 at such time.
      As
      a result of the repayment of this note, the Company realized gains on
      extinguishments of debt of approximately $756,000 in the second quarter of
      fiscal year 2004. Additionally, National Securities and First Clearing mutually
      agreed to terminate their clearing relationship.





In
      June
      2004, National Securities entered into an agreement with Fiserv Securities,
      Inc.
      (“Fiserv”) to clear its brokerage business. The conversion from First Clearing
      to Fiserv was completed in the first week of October 2004. As part of this
      transaction, Fiserv provided National Securities with an $800,000 conversion
      assistance payment, $250,000 of which was paid upon execution of the clearing
      agreement, $250,000 of which was paid in mid-August 2004, and $300,000 of which
      was paid in October 2004.





In
      March
      2005, National Financial Services LLC (“NFS”) acquired the clearing business of
      Fiserv. In April 2005, National Securities entered into a clearing agreement
      with NFS that became effective in June 2005. As part of this transaction, NFS
      provided National Securities with a $1.0 million conversion fee credit to
      reimburse the Company for the transitional, incremental costs incurred by
      National Securities relating to the conversion of its clearing business to
      NFS.
      National Securities was paid $250,000 in May 2005, and the remaining $750,000
      was paid in July 2005. The clearing agreement includes a termination fee if
      National Securities terminates the agreement without cause. Additionally, in
      June 2005, National Securities entered into a clearing agreement with Penson
      Financial Services, Inc. (“Penson”) for the purpose of providing clearing
      services that are not provided by NFS. The Company believes that the overall
      effect of its clearing relationships has been beneficial to the Company’s cost
      structure, liquidity and capital resources. ****





**Recapitalization
      Transactions**





In
      fiscal
      year 2002, the Company completed a
      series
      of transactions under which certain new investors obtained a significant
      ownership in the Company through a $1,572,500 investment in the Company and
      by
      purchasing a majority of shares held by Steven A. Rothstein and family, a former
      Chairman, Chief Executive Officer and principal shareholder of the Company.
      The
      investors included Triage Partners LLC (“Triage”), an affiliate of Steven B.
      Sands, the former Chairman of the Company, and One Clark LLC (“One Clark”), an
      affiliate of Mark Goldwasser, the current Chairman, President and Chief
      Executive Officer of the Company. Triage
      purchased an aggregate of 7,863 shares of the Company’s Series A Convertible
      Preferred Stock, $.01 par value per share (the “Series A Preferred Stock”) from
      the Company and One Clark purchased an aggregate of 7,862 shares of the
      Company’s Series A Preferred Stock from the Company, which is convertible into
      shares of the Company’s common stock, $.02 par value per share (the “Common
      Stock”) at a price of $1.50 per share. The Company incurred $100,000 of legal
      costs related to these capital transactions. In connection with the Investment
      Transaction, Triage also purchased 285,000 shares of Common Stock from Mr.
      Rothstein and his affiliates at a price of $1.50 per share. In
      March
      2004 the Company’s Board of Directors declared an in-kind dividend of Series A
      Preferred Stock, resulting in the issuance to both Triage and One Clark of
      an
      additional 954 shares. In
      March
      2005 the Company’s Board of Directors declared an in-kind dividend of Series A
      Preferred Stock, resulting in the issuance to both Triage and One Clark of
      an
      additional 606 shares. In March 2006 the Company’s Board of Directors declared
      an in-kind dividend of Series A Preferred Stock, resulting in the issuance
      to
      both Triage and One Clark of an additional 565 shares. As
      of
      September 30 ,
      2006,
      Triage and One Clark own 9,988 and 9,987 shares, respectively, of the Company’s
      Series A Preferred Stock.





In
      connection with Steven Sands' resignation as Chairman and as a director of
      the
      Company, on April 1, 2005, the Company issued to his designee, Triage, a
      three-year warrant to purchase 50,000 shares of the Company’s common stock at
      $1.25 per share. As a result of Mr. Sands' resignation, the options to
      purchase  -3-


10,000
      shares of common stock of which he was the beneficial owner expired on April
      30,
      2005.





In
      August
      2005, upon the maturity of previously issued notes, the Company and the two
      note
      holders entered into new note agreements providing for $1.0
      million of notes
      with a maturity date of July 31, 2007, together with warrants having an
      expiration date of July 31, 2007 to purchase, in the aggregate, 200,000 shares
      of common stock at a price of $1.25 per share. These
      notes in the principal amount of $1.0 million were repaid in full in January
      2006.





In
      February 2006, upon
      the
      maturity of a previously issued secured demand note, National
      Securities and the holder entered into a new $1.0 million secured demand note collateral
      agreement with
      a
      maturity date of March 1, 2007. The holder also entered into a warrant agreement to
      purchase 150,000 shares of common stock at a price of $1.25 per share, with
      an  expiration
      date of July 31, 2007.





**Financial
      Information about Industry Segments**





The
      Company realized approximately 87% of its total revenues in fiscal year 2006
      from brokerage services, principal and agency transactions, and investment
      banking. During fiscal year 2006, brokerage services that consist of retail
      brokerage commissions represent 68% of total revenues, principal and agency
      transactions that consist of net dealer inventory gains represent 13% of total
      revenues, and investment banking, that consist of corporate finance commissions
      and fees, represent 19% of total revenues. For a more detailed analysis of
      our
      results by segment, see Item 7, “Management Discussion and Analysis of Financial
      Condition and Results of Operation.”





**Brokerage
      Services**





National
      Securities is registered as a broker-dealer with the SEC and is licensed in
      all
      50 states, the District of Columbia and Puerto Rico. National Securities is
      also
      a member of the NASD, the Municipal Securities Rulemaking Board ("MSRB") and
      the
      Securities Investor Protection Corporation ("SIPC"). Brokerage
      services to retail clients are provided through the Company's sales force of
      investment executives at National Securities.





National
      Securities’ goal is to meet the needs of its investment executives and their
      clients. To foster individual service, flexibility and efficiency and to reduce
      fixed costs, investment executives at National Securities act as independent
      contractors responsible for providing their own office facilities, sales
      assistants, telephone and quote service, supplies and other items of overhead.
      Investment executives are given broad discretion to structure their own
      practices and to specialize in different areas of the securities market subject
      to supervisory procedures. In addition, investment executives have direct access
      to research materials, management, traders, and all levels of support
      personnel.





The
      brokerage services provided by the investment executives at National Securities
      include execution of purchases and sales of stocks, bonds, mutual funds,
      annuities and various other securities for individual and institutional
      customers. In fiscal year 2006, stocks represent approximately 87% of the
      Company’s business, bonds represent approximately 3% of the Company’s business,
      and mutual funds and annuities make up the remaining 10% of the Company’s
      business. The percentage of each type of business varies over time as the
      investment preferences of the Company’s customers change based on market
      conditions.





Typically,
      National Securities does not recommend particular securities to customers.
      Recommendations to customers are determined by individual investment executives
      based upon their own research and analysis, subject to applicable NASD customer
      suitability standards. Most investment executives perform fundamental (as
      opposed to technical) analysis. Solicitations may be by telephone, seminars
      or
      newsletters. Investment executives may request trading to acquire an inventory
      position to facilitate sales to customers (subject to the investment executive's
      own risk). Supervisory personnel review trading activity from inventory
      positions to  -4-


ensure
      compliance with applicable standards of conduct.





The
      Company generally acts as an agent in executing customer orders to buy or sell
      listed and over-the-counter securities in which it does not make a market,
      and
      charges commissions based on the services the Company provides to its customers.
      In executing customer orders to buy or sell a security in which the Company
      makes a market, the Company may sell to, or purchase from, customers at a price
      that is substantially equal to the current inter-dealer market price plus or
      minus a mark-up or mark-down. The Company may also act as agent and execute
      a
      customer's purchase or sale order with another broker-dealer market-maker at
      the
      best inter-dealer market price available and charge a commission. The Company
      believes its mark-ups, mark-downs and commissions are competitive based on
      the
      services it provides to its customers. In each instance the commission charges,
      mark-ups or mark-downs, are in compliance with guidelines established by the
      NASD. In order to increase revenues generated from these activities, the Company
      continuously seeks to hire additional registered representatives, and works
      with
      its current registered representatives to increase their productivity.





The
      Company’s registered representatives are independent contractors, not salaried
      employees. As such, payments to these persons are based on commissions
      generated, and represent a variable cost rather than a fixed cost of operating
      our business. Commission expense represents a significant majority of the
      Company’s total expenses. The Company works to control its fixed costs in order
      to achieve profitability based upon its expectation of market conditions and
      the
      related level of revenues. Additionally, the Company requires
      most of its registered
      representatives to
      absorb
      their own overhead and expenses, thereby reducing the Company’s share of the
      fixed costs.





Investment
      executives in the brokerage industry are traditionally compensated on the basis
      of set percentages of total commissions and mark-ups generated. Most brokerage
      firms bear substantially all of the costs of maintaining their sales forces,
      including providing office space, sales assistants, telephone service and
      supplies. The average commission paid to investment executives in the brokerage
      industry generally ranges from 30% to 50% of total commissions
      generated.





Since
      National Securities requires most of its investment executives to absorb their
      own overhead and expenses, it pays a higher percentage of the net commissions
      and mark-ups generated by its investment executives, as compared to traditional
      investment executives in the brokerage industry. This arrangement also reduces
      fixed costs and lowers the risk of operational losses for non-production.
      National Securities’ operations include execution of orders, processing of
      transactions, internal financial controls and compliance with regulatory and
      legal requirements.





As
      of
      September 30, 2006, the Company had 89 employees and 278 independent
      contractors. Of these totals, 333 were registered representatives. Persons
      who
      have entered into independent contractor agreements are not considered employees
      for purposes of determining the Company’s obligations for federal and state
      withholding, unemployment and social security taxes. The Company’s independent
      contractor arrangements conform to accepted industry practice, and therefore,
      the Company does not believe there is a material risk of an adverse
      determination from the tax authorities that would have a significant effect
      on
      the Company's ability to recruit and retain investment executives or on the
      Company's current operations and financial results of operations. No employees
      are covered by collective bargaining agreements, and the Company believes its
      relations are good with both its employees and independent
      contractors.





The
      Company’s business plan includes the growth of its retail and institutional
      brokerage business, while recognizing the volatility of the financial markets.
      The markets improved in the second half of fiscal year 2003 and the first half
      of fiscal year 2004, but weakened again in the second half of fiscal year 2004,
      and continued to be weak in fiscal year 2005. The markets improved again in
      the
      first half of fiscal year 2006, but weakened in the second half of fiscal year
      2006. In response to these periodic slowdowns, the Company has periodically
      adjusted certain business activities, including, proprietary trading and
      market-making trading. The Company  -5-


believes
      that consolidation within the industry is inevitable. Concerns attributable
      to
      the volatile market, and increased competition, result in a number of
      acquisition opportunities being introduced to the Company. The Company is
      focused on maximizing the profitability of its existing operations, while it
      continues to seek selective strategic acquisitions.





Periodic
      reviews of controls are conducted and administrative and operations personnel
      meet frequently with management to review operating conditions. Compliance
      and
      operations personnel monitor compliance with applicable laws, rules and
      regulations.





**Principal
      and Agency Transactions**





The
      Company buys and maintains inventories in equity securities as a "market-maker"
      for sale of those securities to other dealers and to customers through National
      Securities. The Company may also maintain inventories in corporate, government
      and municipal debt securities for sale to customers. The level of National
      Securities’ market-making trading activities will increase or decrease depending
      on the relative strength or weakness of the broader markets. As of September
      30,
      2006, National Securities made markets in approximately 29 securities. National
      Securities anticipates that it will engage in some market-making trading
      activity in the future, which may include companies for which National
      Securities managed or co-managed a public offering.





The
      Company's trading departments require a commitment of capital. Most principal
      transactions place the Company's capital at risk. Profits and losses are
      dependent upon the skill of the traders, price movements, trading activity
      and
      the size of inventories. Since the Company's trading activities occasionally
      may
      involve speculative and thinly capitalized stocks, including stabilizing the
      market for securities which it has underwritten, the Company imposes position
      limits to reduce its potential for loss.





In
      executing customer orders to buy or sell a security in which the Company makes
      a
      market, the Company may sell to, or purchase from, customers at a price that
      is
      substantially equal to the current inter-dealer market price plus or minus
      a
      mark-up or mark-down. The Company may also act as agent and execute a customer's
      purchase or sale order with another broker-dealer market-maker at the best
      inter-dealer market price available and charge a commission. The Company
      believes its mark-ups, mark-downs and commissions are competitive based on
      the
      services it provides to its customers.





In
      executing customer orders to buy or sell listed and over-the-counter securities
      in which it does not make a market, the Company generally acts as an agent
      and
      charges commissions that the Company believes are competitive, based on the
      services the Company provides to its customers.





**Investment
      Banking**





National
      Securities provides corporate finance and investment banking services, including
      underwriting the sale of securities to the public and arranging for the private
      placement of securities with investors. National Securities’ corporate finance
      operations provide a broad range of financial and corporate advisory services,
      including mergers and acquisitions, project financing, capital structure and
      specific financing opportunities. National Securities also acts as an
      underwriter of equity securities in both initial and secondary public offerings. Corporate
      finance revenues will vary depending on the number of private and public
      offerings completed by National Securities during a particular fiscal
      year.





**Competition**





The
      Company is engaged in a highly competitive business. With respect to one or
      more
      aspects of its business, its competitors include member organizations of the
      New
      York Stock Exchange and other registered securities exchanges in the United
      States and Canada, and members of the NASD. Many of these organizations
      have  -6-


substantially
      greater personnel and financial resources and more sales offices than the
      Company. Discount brokerage firms affiliated with commercial banks provide
      additional competition, as well as companies that provide electronic on-line
      trading. In many instances, the Company is also competing directly for customer
      funds with investment opportunities offered by real estate, insurance, banking,
      and savings and loans industries. For a further discussion of risks facing
      the
      Company, please see “Risk Factors.”





**Government
      Regulation and Supervision**





The
      securities industry and National Securities’ business is subject to extensive
      regulation by the SEC, NASD, state securities regulators and other governmental
      regulatory authorities. The principal purpose of these regulations is the
      protection of customers and the securities markets. The SEC is the federal
      agency charged with the administration of the federal securities laws. Much
      of
      the regulation of broker-dealers, however, has been delegated to self-regulatory
      organizations, such as the NASD, that adopt rules, subject to approval by the
      SEC, which govern their members and conduct periodic examinations of member
      firms' operations. Securities firms are also subject to regulation by state
      securities commissions in the states in which they are registered. National
      Securities is a registered broker-dealer with the SEC and a member of the NASD.
      It is licensed to conduct activities as a broker-dealer in all 50 states, the
      District of Columbia and Puerto Rico.





In
      addition, as a registered broker-dealer and member of the NASD, National
      Securities is subject to the SEC's Uniform
      Net Capital Rule 15c3-1 ,
      which
      is designed to measure the general financial integrity and liquidity of a
      broker-dealer and requires
      the maintenance of minimum net capital .
      Net
      capital is defined as the net worth of a broker-dealer subject to certain
      adjustments. In computing net capital, various adjustments are made to net
      worth
      that exclude assets not readily convertible into cash. Additionally, the
      regulations require that certain assets, such as a broker-dealer's position
      in
      securities, be valued in a conservative manner so as to avoid over-inflation
      of
      the broker-dealer's net capital.  National
      Securities has elected to use the alternative standard method permitted by
      the
      rule. This requires that National Securities maintain minimum net capital equal
      to the greater of $250,000 or a specified amount per security based on the
      bid
      price of each security for which National Securities is a market maker. At
      September 30, 2006, National Securities’ net capital exceeded the requirement by
      $2,076,000.





The
      Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the NASD
      Conduct Rules require National Securities to supervise the activities of its
      investment executives. As part of providing such supervision, National
      Securities maintains Written Supervisory Procedures and a Compliance Manual.
      Compliance personnel and outside auditors conduct inspections of branch offices
      periodically to review compliance with the Company's procedures. A registered
      principal provides onsite supervision at each of the Company's larger offices.
      The other offices (averaging two investment executives per office) are not
      required by NASD rules to have a registered principal on site and are therefore
      supervised by registered principals of National Securities. Designated
      principals review customer trades to ensure compliance with the NASD Conduct
      Rules including mark-up guidelines.





**Venture
      Capital**





In
      March
      2001, the Company had its initial closing of Robotic Ventures Fund I, L.P.
      (the
“Fund”), a venture capital fund dedicated to investing in companies engaged in
      the business of robotics and artificial intelligence. The Fund raised a total
      of
      $5.2 million, $265,000 of which was capital directly invested by the Company
      into the Fund, representing a 5.1% limited partnership interest in the Fund.
      The
      Company serves as the managing member of Robotic Ventures Group LLC, the general
      partner of the Fund (the “Fund General Partner”). As the managing member of the
      Fund General Partner, the Company is entitled to a 2% management fee paid by
      the
      Fund. Additionally, the Company invested $1,000, and owns 24.5% of the limited
      liability company membership interests in the Fund
      General Partner, which is entitled to 20% of the profits generated by the Fund
      after investors in the Fund receive the return of their invested
      capital,  -7-


representing
      a 4.9% indirect interest in the profits of the Fund. The Company keeps the
      books
      and records of the Fund and oversees the Fund’s investments. From time to time,
      employees of National Securities will work with and advise the Fund’s investee
      companies on its business plan, capital structure and future goals. The Company
      has not been compensated or engaged to provide any management or advisory
      services to the investee companies. In February 2002, due to a dramatic slowdown
      in the technology venture markets, the Fund returned a majority of the
      uninvested capital to the investors, representing approximately 50% of the
      funds
      raised, and no further management fees are to be paid. In fiscal year 2006,
      the
      Fund made an in-kind distribution of common stock of iRobot Corporation, one
      of
      its investee companies.





The
      carrying amount of the Company’s investment in the Fund was $0 and $107,000 at
      September 30, 2006 and September 30, 2005, respectively. The Company’s
      investment in the Fund is accounted for in accordance with the equity method
      of
      accounting. The Company recognized income on this investment attributable to
      the
      in-kind stock distribution of $192,000 in fiscal year 2006, and no income or
      loss on this investment in fiscal years 2005 and 2004, respectively. During
      the
      formation of the Fund, the Company incurred various start-up expenses that
      were
      subsequently reimbursed by the Fund **.**





**Item
      1A. RISK FACTORS**





*The
      financial statements contained in this report and the related discussions
      describe and analyze the Company’s financial performance and condition for the
      periods indicated. For the most part, this information is historical. The
      Company’s prior results, however, are not necessarily indicative of the
      Company’s future performance or financial condition. The Company, therefore, has
      included the following discussion of certain factors that could affect the
      Company’s future performance or financial condition. These factors could cause
      the Company’s future performance or financial condition to differ materially
      from its prior performance or financial condition or from management’s
      expectations or estimates of the Company’s future performance or financial
      condition. These factors, among others, should be considered in assessing the
      Company’s future prospects and prior to making an investment decision with
      respect to the Company’s stock. The risks described below are not the only ones
      facing us. Additional risks not presently known to us or that we currently
      believe are immaterial may also impair our business
      operations.*





**The
      Company’s operations have generated reporting losses during certain fiscal
      years.**





Although
      the Company was profitable in fiscal years 2006 and 2004, it reported losses
      of
      approximately $1,183,000, $843,000, $3.4 million and $7.9 million in fiscal
      years 2005, 2003, 2002 and 2001, respectively. There is no assurance that the
      Company will be profitable in the future. The Company’s losses were primarily
      attributable to the market slowdowns and reduced trading activity and
      volatility, and the cessation of its market making activities. If
      we are
      unable to achieve or sustain profitability, we may need to curtail, suspend
      or
      terminate certain operations.





**The
      Company may require additional financing.**





In
      order
      for the Company to have the opportunity for future success and profitability,
      it
      periodically may need to obtain additional financing, either through borrowings,
      public offerings, private offerings, or some type of business combination (e.g.,
      merger, buyout, etc.). The Company has actively pursued a variety of funding
      sources, and has consummated certain transactions in
      order
      to address its capital requirements. The
      Company may need to seek to raise additional capital through other available
      sources, including borrowing additional funds from third parties and
      there can be no assurance that it will be successful in such pursuits.
      Additionally, the issuance of new securities to raise capital will cause the
      dilution of shares held by current stockholders. Accordingly,
      if we are unable to generate adequate cash from operations, and if we are unable
      to find sources of funding, it would have an adverse impact on our liquidity
      and
      operations.  -8-





**If
      the Company is unable to pay its outstanding debt obligations when due, the
      Company’s operations may be materially adversely affected.**





At
      September 30, 2006, we had total indebtedness of $2,850,000, of which $1,850,000
      matures during fiscal year 2007. The Company cannot assure you that our
      operations will generate funds sufficient to repay our existing debt obligations
      as they come due. The Company’s failure to repay its indebtedness and make
      interest payments as required by our debt obligations, could have a material
      adverse affect on the Company’s operations.





**Because
      the common stock may be subject to "penny stock" rules, the market for the
      common stock may be limited.**





If
      the
      common stock becomes subject to the Securities and Exchange Commission’s (the
“SEC”) penny stock rules, broker-dealers may experience difficulty in completing
      customer transactions and trading activity in the Company’s securities may be
      adversely affected. If at any time the common stock has a market price per
      share
      of less than $5.00, and the Company does not have net tangible assets of at
      least $2,000,000 or average revenue of at least $6,000,000 for the preceding
      three years, transactions in the common stock may be subject to the “penny
      stock” rules promulgated under the Exchange Act. Under these rules,
      broker-dealers who recommend such securities to persons other than institutional
      accredited investors:





·
            must
                make a special written suitability determination for the
                purchaser;


·
            receive
                the purchaser’s written agreement to a transaction prior to
                sale;


·
            provide
                the purchaser with risk disclosure documents which identify certain
                risks
                associated with investing in “penny stocks” and which describe the market
                for these “penny stocks” as well as a purchaser’s legal remedies;
                and


·
            obtain
                a signed and dated acknowledgment from the purchaser demonstrating
                that
                the purchaser has actually received the required risk disclosure
                document
                before a transaction in a “penny stock” can be
                completed.





If
      the
      common stock becomes subject to these rules, broker-dealers may find it
      difficult to effectuate customer transactions and trading activity in the
      Company’s securities may be adversely affected. As a result, the market price of
      the Company’s securities may be depressed, and stockholders may find it more
      difficult to sell the Company’s securities.





**National
      Securities is subject to various risk associated with the securities
      industry.**





As
      a
      securities broker-dealer, National Securities is subject to uncertainties that
      are common in the securities industry. These uncertainties include:





·
            the
                volatility of domestic and international financial, bond and stock
                markets;


·
            extensive
                governmental regulation;


·
            litigation;


·
            intense
                competition;


·
            substantial
                fluctuations in the volume and price level of securities; and


·
            dependence
                on the solvency of various third parties.





As
      a
      result, revenues and earnings may vary significantly from quarter to quarter
      and
      from year to year. In periods of low volume, profitability is impaired because
      certain expenses remain relatively fixed. In the event of a market downturn,
      our
      business could be adversely affected in many ways. Our revenues are likely
      to
      decline in such circumstances and, if we were unable to reduce expenses at
      the
      same pace, our profit margins would erode.


-9-




**Failure
      to comply with net capital requirements could subject us to sanctions imposed
      by
      the SEC or the** **NASD.**





National
      Securities is subject to the SEC's net capital rule which requires the
      maintenance of minimum net capital. We compute net capital under the alternate
      method permitted by the net capital rule. National Securities is required to
      maintain net capital equal to the
      greater of $250,000 or a specified amount per security based on the bid price
      of
      each security for which National Securities is a market maker. The
      net
      capital rule is designed to measure the general financial integrity and
      liquidity of a broker-dealer. Compliance with the net capital rule limits those
      operations of broker-dealers that require the intensive use of their capital,
      such as underwriting commitments and principal trading activities. The rule
      also
      limits the ability of securities firms to pay dividends or make payments on
      certain indebtedness, such as subordinated debt, as it matures. The NASD may
      enter the offices of a broker-dealer at any time, without notice, and calculate
      the firm's net capital. If the calculation reveals a deficiency in net capital,
      the NASD may immediately restrict or suspend certain or all of the activities
      of
      a broker-dealer. National Securities may not be able to maintain adequate net
      capital, or its net capital may fall below requirements established by the
      SEC,
      and subject us to disciplinary action in the form of fines, censure, suspension,
      expulsion or the termination of business altogether.  In
      addition, if these net capital rules are changed or expanded, or if there is
      an
      unusually large charge against net capital, operations that require the
      intensive use of capital would be limited. A large operating loss or charge
      against net capital could adversely affect our ability to expand or even
      maintain our present levels of business ,
      which
      could have a material adverse effect on our business. In addition, we may become
      subject to net capital requirements in other foreign jurisdictions in which
      we
      currently operate or which we may enter. We cannot predict our future capital
      needs or our ability to obtain additional financing.





**The
      Company is exposed to risks associated with its underwriting
      activities.**





Participation
      in an underwriting syndicate or a selling group involves both economic and
      regulatory risks. An underwriter may incur losses if it is unable to resell
      the
      securities it is committed to purchase, or if it is forced to liquidate its
      commitment at less than the purchase price. In addition, under federal
      securities laws, other laws and court decisions with respect to underwriters'
      liabilities and limitations on the indemnification of underwriters by issuers,
      an underwriter is subject to substantial potential liability for misstatements
      or omissions of material facts in prospectuses and other communications with
      respect to such offerings. Acting as a managing underwriter increases these
      risks. Underwriting commitments constitute a charge against net capital and
      our
      ability to make underwriting commitments may be limited by the requirement
      that
      we must at all times be in compliance with the net capital rule.





**The
      Company’s business could be adversely affected by a breakdown in the financial
      markets.**





As
      a
      securities broker-dealer, National Securities’ business is materially affected
      by conditions in the financial markets and economic conditions generally, both
      in the United States and elsewhere around the world. Many factors or events
      could lead to a breakdown in the financial markets including war, terrorism,
      natural catastrophes and other types of disasters. These types of events could
      cause people to begin to lose confidence in the financial markets and their
      ability to function effectively. If the financial markets are unable to
      effectively prepare for these types of events and ease public concern over
      their
      ability to function, the Company’s revenues are likely to decline and adversely
      affect its operations.





**Market
      fluctuations may reduce the Company’s revenues and
      profitability.**





The
      Company’s revenue and profitability may be adversely affected by declines in the
      volume of securities transactions and in market liquidity. Additionally, the
      Company’s profitability may be adversely affected by losses from the trading or
      underwriting of securities or failure of third parties to meet commitments.  -10-


National
      Securities acts as a market maker in publicly traded common stocks. In market
      making transactions, the Company undertakes the risk of price changes or being
      unable to resell the common stock it holds or being unable to purchase the
      common stock it has sold. These risks are heightened by the illiquidity of
      many
      of the common stocks the Company trades and/or makes a market. Any losses from
      the Company trading activities, including as a result of unauthorized trading
      by
      the Company’s employees, could have a material adverse effect on the Company’s
      business, financial condition, results of operations or cash flows.





Lower
      securities price levels may also result in a reduced volume of transactions,
      as
      well as losses from declines in the market value of common stocks held for
      trading purposes. During periods of declining volume and revenue, the Company’s
      profitability would be adversely affected. Declines in market values of common
      stocks and the failure of issuers and third parties to perform their obligations
      can result in illiquid markets.





**Competition
      with other financial firms may have a negative effect on the Company’s
      business.**





The
      Company competes directly with national and regional full-service broker-dealers
      and a broad range of other financial service firms, including banks and
      insurance companies. Competition has increased as smaller securities firms
      have
      either ceased doing business or have been acquired by or merged into other
      firms. Mergers and acquisitions have increased competition from these firms,
      many of which have significantly greater financial, technical, marketing and
      other resources than the Company. Many of these firms offer their customers
      more
      products and research than currently offered by the Company. These competitors
      may be able to respond more quickly to new or changing opportunities,
      technologies and client requirements. The Company also faces competition from
      companies offering discount and/or electronic brokerage services, including
      brokerage services provided over the Internet, which the Company is currently
      not offering and does not intend to offer in the foreseeable future. These
      competitors may have lower costs or provide more services, and may offer their
      customers more favorable commissions, fees or other terms than those offered
      by
      the Company. To the extent that issuers and purchasers of securities transact
      business without the assistance of the Company, the Company’s operating results
      could be adversely affected.





**There
      are risks associated with our stock trading on the OTCBB rather than on a
      national exchange.**




There
      may
      be significant consequences associated with our stock trading on the OTCBB
      rather than a national exchange. The effects of not being able to list our
      securities on a national exchange include:




·
            limited
                release of the market price of our securities;


·
            limited
                news coverage;


·
            limited
                interest by investors in our securities;


·
            volatility
                of our stock price due to low trading volume;


·
            increased
                difficulty in selling our securities in certain states due to “blue sky”
                restrictions; and


·
            limited
                ability to issue additional securities or to secure additional
                financing.





**The
      Company is currently subject to extensive securities regulation and the failure
      to comply with these regulations could subject the Company to penalties or
      sanctions.**





The
      securities industry and the Company’s business are subject to extensive
      regulation by the SEC, state securities regulators and other governmental
      regulatory authorities. The Company is also regulated by industry
      self-regulatory organizations, including the NASD and the MSRB. National
      Securities is a registered broker-dealer with the SEC and a member firm of
      the
      NASD. Broker-dealers are subject to regulations which cover all aspects of
      the
      securities business, including sales methods and supervision, trading practices
      among broker-dealers, use and safekeeping of customers’ funds and securities,
      capital structure of securities firms, record keeping, and the conduct of
      directors, officers and employees. Changes  -11-


in
      laws
      or regulations or in governmental policies could cause us to change the way
      we
      conduct our business, which could adversely affect us.





Compliance
      with many of the regulations applicable to the Company involves a number of
      risks, particularly in areas where applicable regulations may be subject to
      varying interpretation. These regulations often serve to limit the Company’s
      activities, including through net capital, customer protection and market
      conduct requirements. If the Company is found to have violated an applicable
      regulation, administrative or judicial proceedings may be initiated against
      the
      Company that may result in a censure, fine, civil penalties, issuance of
      cease-and-desist orders, the deregistration or suspension of the Company’s
      broker-dealer activities, the suspension or disqualification of the Company’s
      officers or employees, or other adverse consequences. The imposition of any
      of
      these or other penalties could have a material adverse effect on the Company’s
      operating results and financial condition.





**The
      Company relies on clearing brokers and unilateral termination of the agreements
      with these clearing brokers could disrupt the Company’s
      business.**





The
      Company is an introducing brokerage firm, using third party clearing brokers
      to
      process its securities transactions and maintain customer accounts on a fee
      basis. The clearing brokers also provide billing services, extend credit and
      provide for control and receipt, custody and delivery of securities. The
      Company’s broker-dealer depends on the operational capacity and ability of the
      clearing brokers for the orderly processing of transactions. In addition, by
      engaging the processing services of a clearing firm, the Company is exempt
      from
      some capital reserve requirements and other regulatory requirements imposed
      by
      federal and state securities laws. If the clearing agreements are unilaterally
      terminated for any reason, the Company would be forced to find alternative
      clearing firms without adequate time to negotiate the terms of a new clearing
      agreement and without adequate time to plan for such change. There can be no
      assurance that if there were a unilateral termination of its clearing agreement
      that the Company would be able to find an alternative clearing firm on
      acceptable terms to them or at all.





In
      April
      2005, National Securities entered into a clearing agreement with NFS that became
      effective in June 2005. Additionally, in June 2005, National Securities entered
      into a clearing agreement with Penson for the purpose of providing clearing
      services that are not provided by NFS.





The
      Company permits its clients to purchase securities on a margin basis or sell
      securities short, which means that the clearing firm extends credit to the
      client secured by cash and securities in the client’s account. During periods of
      volatile markets, the value of the collateral held by the clearing brokers
      could
      fall below the amount borrowed by the client. If margin requirements are not
      sufficient to cover losses, the clearing brokers sell or buy securities at
      prevailing market prices, and may incur losses to satisfy client obligations.
      The Company’s has agreed to indemnify the clearing brokers for losses they incur
      while extending credit to its clients.





**Credit
      risk exposes the Company to losses caused by financial or other problems
      experienced by third parties** *.*





The
      Company is exposed to the risk that third parties that owe it money, securities
      or other assets will not perform their obligations. These parties include
      trading counterparts, customers, clearing agents, exchanges, clearing houses,
      and other financial intermediaries as well as issuers whose securities the
      Company holds. These parties may default on their obligations owed to the
      Company due to bankruptcy, lack of liquidity, operational failure or other
      reasons. This risk may arise, for example, from holding securities of third
      parties, executing securities trades that fail to settle at the required time
      due to non-delivery by the counterparty or systems failure by clearing agents,
      exchanges, clearing houses or other financial intermediaries, and extending
      credit to clients through bridge or margin loans or other arrangements.
      Significant failures by third parties to perform their obligations owed to
      the
      Company could adversely affect  -12-


the
      Company’s revenues and perhaps the Company’s ability to borrow in the credit
      markets.





**Our
      risk management policies and procedures may leave us exposed to unidentified
      risks or an unanticipated level of risk.**




The
      policies and procedures we employ to identify, monitor and manage risks may
      not
      be fully effective. Some methods of risk management are based on the use of
      observed historical market behavior. As a result, these methods may not
      accurately predict future risk exposures, which could be significantly greater
      than the historical measures indicate. Other risk management methods depend
      on
      evaluation of information regarding markets, clients or other matters that
      are
      publicly available or otherwise accessible by us. This information may not
      be
      accurate, complete, up-to-date or properly evaluated. Management of operational,
      legal and regulatory risks requires, among other things, policies and procedures
      to properly record and verify a large number of transactions and events. We
      cannot assure that our policies and procedures will effectively and accurately
      record and verify this information.




We
      seek
      to monitor and control our risk exposure through a variety of separate but
      complementary financial, credit, operational and legal reporting systems. We
      believe that we are able to evaluate and manage the market, credit and other
      risks to which we are exposed. Nonetheless, our ability to manage risk exposure
      can never be completely or accurately predicted or fully assured. For example,
      unexpectedly large or rapid movements or disruptions in one or more markets
      or
      other unforeseen developments could have a material adverse effect on our
      results of operations and financial condition. The consequences of these
      developments can include losses due to adverse changes in inventory values,
      decreases in the liquidity of trading positions, higher volatility in earnings,
      increases in our credit risk to customers as well as to third parties and
      increases in general systemic risk.





**Adverse
      results of current litigation and potential securities law liability would
      result in financial losses and divert management’s attention to
      business.**





Many
      aspects of National Securities’ business involve substantial risks of liability.
      There has been an increase in litigation and arbitration within the securities
      industry in recent years, including class action suits seeking substantial
      damages. National Securities is subject to potential claims by dissatisfied
      customers, including claims alleging they were damaged by improper sales
      practices such as unauthorized trading, sale of unsuitable securities, use
      of
      false or misleading statements in the sale of securities, mismanagement and
      breach of fiduciary duty. National Securities may be liable for the unauthorized
      acts of its retail brokers if it fails to adequately supervise their conduct.
      As
      an underwriter, National Securities may be subject to substantial potential
      liability under federal and state law and court decisions, including liability
      for material misstatements and omissions in securities offerings. National
      Securities may be required to contribute to a settlement, defense costs or
      a
      final judgment in legal proceedings or arbitrations involving a past
      underwriting and in actions that may arise in the future. National Securities
      carries “Errors and Omissions” insurance to protect against arbitrations;
      however, the policy is limited in items and amounts covered and there can be
      no
      assurance that it will cover a particular complaint. The adverse resolution
      of
      any legal proceedings involving the Company and/or National Securities could
      have a material adverse effect on the Company’s business, financial condition,
      results of operations or cash flows.





**The
      Company depends on** **senior
      employees and the loss of their services could harm our
      business** **.**





The
      Company depends on the continued services of its management team, particularly
      Mark Goldwasser, the Company’s Chairman, President and Chief Executive Officer,
      as well as its ability to hire additional members of management, and to retain
      and motivate its other officers and key employees. We may not be able to find
      an
      appropriate replacement for Mr. Goldwasser or any other executive officer if
      the
      need should arise. The Company maintains a $2.0 million life insurance policy
      on
      Mr. Goldwasser. Due to the regulated nature of some of our businesses, some
      of
      our executive officers, or other key personnel could become  -13-


subject
      to suspensions or other limitations on the scope of their services to us from
      time to time. If we lose the services of any executive officers or other key
      personnel, we may not be able to manage and grow our operations effectively,
      enter new brokerage markets or develop new products.





**The
      Company faces significant competition for registered representatives.**





We
      are
      dependent upon the independent contractor model for our retail brokerage
      business. We are exposed to the risk that a large group of independent
      contractors could leave the firm or decide to affiliate with another firm and
      that we are unable to recruit suitable replacements. A loss of a large group
      of
      our independent contractors could have a material adverse impact on our ability
      to generate revenue in the retail brokerage business.





**The
      price of our common stock is volatile.**





The
      price
      of our common stock has fluctuated substantially (See Part II, Item 5). The
      market price of our common stock may be highly volatile as a result of factors
      specific to the Company and the securities markets in general. Factors affecting
      volatility may include: variations in the Company’s annual or quarterly
      financial results or those of its competitors; economic conditions in general;
      and changes in applicable laws or regulations, or their judicial or
      administrative interpretations affecting the Company or its subsidiary or the
      securities industry. In addition, volatility of the market price of our common
      stock is further affected by its thinly traded nature.




**We
      have restricted shares outstanding that may depress the price of the common
      stock.**




As
      of
      September 30, 2006, of the 5,223,968 outstanding shares of our common stock,
      approximately 1,100,000 shares may be deemed restricted shares and, in the
      future, may be sold in compliance with Rule 144 under the Securities Act. Rule
      144 provides that a person holding restricted securities for one year may sell
      shares in brokerage transactions, subject to limitations based on the number
      of
      shares outstanding and trading volume. A person who is not affiliated with
      us
      and who has held restricted securities for two years is not subject to these
      limitations as long as the other conditions of Rule 144 are met. Such sales
      may
      have a depressive effect on the price of our common stock in the open
      market.




**The
      Company’s principal shareholders including our directors and officers control a
      large percentage of our shares of common stock and can significantly influence
      our corporate actions.**




At
      the
      present time, the Company’s executive officers, directors and/or entities that
      these individuals are affiliated with, and certain more than 5% shareholders,
      own approximately 38% of our common stock, including shares of common stock issuable
      upon conversion of our Series A and Series B preferred stock and conversion
      of
      our notes, and excluding stock options and warrants. Accordingly,
      these individuals and entities will be able to significantly influence most,
      if
      not all, of our corporate actions, including the election of directors, the
      appointment of officers, and potential merger or acquisition
      transactions .





**We
      will be subject to new requirements that we evaluate our internal controls
      over
      financial reporting under Section 404 of the Sarbanes-Oxley Act and other
      corporate governance initiatives that may expose us to certain
      risks.**




Currently,
      commencing September 30, 2007, we will be subject to the requirements of
      Section 404 of the Sarbanes-Oxley Act and the SEC rules and
      regulations that require an annual management report on our internal controls
      over financial reporting, including, among other matters, management’s
      assessment of the effectiveness of our internal control over financial
      reporting, and an attestation report by our independent registered public
      accounting firm addressing these assessments. The SEC is proposing to further
      extend the compliance dates for non-accelerated filers.  -14-




We
      cannot
      be certain as to the timing of the completion of our evaluation, testing and
      remediation actions or the impact of the same on our operations. If we are
      not
      able to implement the requirements of Section 404 in a timely manner or
      with adequate compliance, we may be subject to sanctions or investigation by
      regulatory authorities, including the SEC. Moreover, if we are unable to assert
      that our internal control over financial reporting is effective in any future
      period (or if our auditors are unable to express an opinion on the effectiveness
      of our internal controls), we could lose investor confidence in the accuracy
      and
      completeness of our financial reports, which may have an a material adverse
      effect on our Company.




Our
      compliance with the Sarbanes-Oxley Act may require significant expenses and
      management resources that would need to be diverted from our other operations
      and could require a restructuring of our internal controls over financial
      reporting. Any such expenses, time reallocations or restructuring could have
      a
      material adverse effect on our operations. The applicability of the
      Sarbanes-Oxley Act to us could make it more difficult and more expensive for
      us
      to obtain director and officer liability insurance, and also make it more
      difficult for us to attract and retain qualified individuals to serve on our
      boards of directors, or to serve as executive officers.





**We
      do not expect to pay any dividends on our common stock in the foreseeable
      future.**




We
      do not
      anticipate that we will pay any dividends to holders of our common stock in
      the
      foreseeable future. Other than dividends paid on our Series A and Series B
      preferred stock, we expect to retain all future earnings, if any, for investment
      in our business. In addition, our Certificates of Designation setting forth
      the
      relative rights and preferences of our Series A and Series B preferred stock
      limit our ability to pay dividends to the holders of our common
      stock.





**Item
      1B. UNRESOLVED STAFF COMMENTS**





None.





**Item
      2. PROPERTIES**





The
      Company owns no real property. Its corporate headquarters are shared with
      National Securities in leased space in Chicago, Illinois and New York, New
      York.
      The Company leases office space in Boca Raton, Florida, and through its
      subsidiary, the Company leases office space in Chicago, New York and Seattle,
      Washington. Independent contractors individually lease the branch offices that
      are operated by those independent contractors.





Leases
      expire at various times through June 2012. The Company believes the rent at
      each
      of its locations is at current market rates.





**Item
      3. LEGAL PROCEEDINGS**





The
      NASD
      was engaged in an industry-wide investigation of mutual fund trading activities.
      National Securities is one of the numerous broker-dealers contacted by the
      NASD
      with respect to this investigation. The NASD identified certain customer mutual
      fund transactions ordered through National Securities during the time period
      from October 2000 to February 2003 that it believed constituted mutual fund
      timing and/or excessive trading activity. National Securities engaged in
      discussions and negotiations with the NASD to informally resolve these matters.
      Such resolution resulted in a settlement, whereby National Securities, without
      admitting or denying any violations, agreed to make both restitution and pay
      a
      fine to the NASD, that in the aggregate approximate $600,000. Additionally,
      the
      Company is obligated to pay the fines imposed by the NASD on two executive
      officers totaling $50,000 pursuant to its indemnification obligations. The
      Company included the $650,000 in “Professional fees” in fiscal year 2004. The
      unpaid balance of $84,000 and $187,000 at
      September 30, 2006 and September 30, 2005, respectively, has
      been
      included in “Accounts Payable, Accrued Expenses and Other Liabilities” in the
      accompanying consolidated  -15-


statements
      of financial condition.





In
      September 2006, the former
      chairman and chief executive officer of the Company, Steven A. Rothstein,
      commenced an arbitration against the current chairman and chief executive
      officer of the Company, Mark Goldwasser, in the matter *Rothstein
      et al. vs. Goldwasser* ,
      NASD
      No. 06-04000.  Rothstein is alleging fraud and inequitable conduct relating
      to his attempts to sell his investment in the Company in calendar year
      2001, and is seeking approximately $5,750,000 in damages.  The
      Company is indemnifying Mr. Goldwasser in this action.  The Company
      and Mr. Goldwasser believe this action is without merit, and intends to
      vigorously defend this action.





The
      Company is also a defendant in various other arbitrations and administrative
      proceedings, lawsuits and claims seeking
      in the aggregate damages of approximately $1,800,000 to $2,000,000. The
      Company believes
      such claims are substantially without merit, and estimates that its liability,
      primarily for defense costs, will approximate $300,000 (exclusive of unspecified
      punitive damages related to certain claims and inclusive of expected insurance
      coverage). These matters arise in the normal course of business. The Company
      intends to vigorously defend itself in these actions, and believes that the
      eventual outcome of these matters will not have a material adverse effect on
      the
      Company. However,
      the ultimate outcome of these matters cannot be determined at this time. The
      amounts related to such matters that are reasonably estimable and which have
      been accrued at September 30, 2006 and 2005, is $241,000 and $206,000 (primarily
      legal fees), respectively, and have
      been included in “Accounts Payable, Accrued Expenses and Other Liabilities” in
      the accompanying consolidated statements of financial condition . The
      Company has included in “Professional fees” litigation and other NASD related
      expenses of $799,000, $790,000 and $1,424,000 for the fiscal years ended
      September 30, 2006, 2005 and 2004, respectively.





**Item
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**





There
      were no matters submitted to a vote of security holders in the fourth quarter
      of
      fiscal year ended September 30, 2006.





**PART
      II**





**Item
      5. MARKET FOR THE REGISTRANT'S COMMON STOCK, RELATED** **STOCKHOLDER
      MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**





**Market
      Information**





On
      March
      20, 2006, our common stock commenced trading under the symbol “NHLD” on the
      OTCBB reflecting the Company’s name change. Quotations
      on the OTCBB reflect inter-dealer prices, without retail mark-up, mark-down
      or
      commission and may not necessarily represent actual transactions. From
      November 1, 2004 to March 17, 2006, our common stock traded on the OTCBB under
      the symbol “OLYD”. Previously, the common stock traded on the AMEX under the
      symbol “OLY”.





The
      following table sets forth the high
      and low closing sales prices for the common stock as
      reported on the AMEX for the period from October 1, 2004 to October 31, 2004,
      and as reported on the OTCBB for the period from November 1, 2004 to
      September 30, 2006.




**Period**
              
              **High**
              
              **Low**October
                  1, 2004/December 31, 2004
              
              $1.10
              
              $0.41January
                  1, 2005/March 31, 2005
              
              $1.35
              
              $0.85April
                  1, 2005/June 30, 2005
              
              $1.40
              
              $0.95July
                  1, 2005/September 30, 2005
              
              $1.15
              
              $0.70October
                  1, 2005/December 31, 2005
              
              $1.20
              
              $0.53January
                  1, 2006/March 31, 2006
              
              $1.60
              
              $0.75April
                  1, 2006/June 30, 2006
              
              $1.55
              
              $1.05July
                  1, 2006/September 30, 2006
              
              $1.60
              
              $1.20




-16-




The
      closing price of the common stock on December 5, 2006, as quoted on the OTCBB,
      was $1.19 per share.





**Shareholders**





As
      of
      September 30, 2006, the Company had approximately 1,000 shareholders, including
      those shareholders holding stock in street name and trust accounts.





**Dividends**





Delaware
      law authorizes the Company’s Board of Directors to declare and pay dividends
      with respect to the common stock either out of its surplus (as defined in the
      Delaware Corporation Law) or, in case there is no such surplus, out of its
      net
      profits for the fiscal year in which the dividend is declared and/or the
      preceding fiscal
      year; provided, however, that no dividend may be paid out of net profits unless
      the Company’s capital exceeds the aggregate amount represented by the issued and
      outstanding stock of all classes having a preference in the distribution of
      assets. T he
      Company’s ability
      to pay dividends in the future also may be restricted by its operating
      subsidiary's obligation to comply with the net capital requirements imposed
      on
      broker-dealers by the SEC and the NASD.  Prior to
      the issuance of the Series A and Series B preferred stock, no shareholder held
      preferential rights in liquidation. The Company has declared and paid cash
      dividends on its Series B preferred stock in fiscal year 2006, and anticipates
      that we will continue to do so in the coming fiscal year. We do not anticipate
      that we will pay any dividends to holders of our common stock in the foreseeable
      future.





The
      holders of the Series A Convertible preferred stock are entitled to receive
      dividends on a quarterly basis at a rate of 9% per annum, per share. Such
      dividends are cumulative and accrue whether or not declared by the Company’s
      Board of Directors, but are payable only when, as and if declared by the
      Company’s Board of Directors. In March 2004, the Company’s Board of Directors
      declared an in-kind dividend in the aggregate of 3,352 shares of Series A
      preferred stock, in payment of approximately $503,000 of dividends accrued
      through January 31, 2004. In March 2005, the Company’s Board of Directors
      declared an in-kind dividend in the aggregate of 2,143 shares of Series A
      preferred stock, in payment of approximately $322,000 of dividends accrued
      through March 31, 2005. In March 2006, the Company’s Board of Directors declared
      an in-kind dividend in the aggregate of 1,996 shares of Series A preferred
      stock, in payment of approximately $300,000 of dividends accrued through March
      31, 2006. Such shares were issued on April 30, 2006. In March 2006, the
      Company’s shareholders approved an amendment to decrease the conversion price of
      the Series A preferred stock to $1.25 per share from $1.50 per share. At
      September 30, 2006, the amount of accumulated dividends on the Company’s 35,316
      issued and outstanding shares of Series A preferred stock was approximately
      $159,000.





The
      holders of the Company’s Series B Convertible preferred stock, convertible into
      the Company’s common stock at $.75 per share, are entitled to receive dividends
      on a quarterly basis at a rate of 10% per annum per share. Such dividends are
      cumulative and are payable only when declared by the Company’s Board of
      Directors. In August 2006, the Company’s Board of Directors declared a cash
      dividend of $25,000 payable to the holders of the Series B preferred stock
      that
      was paid in October 2006.





Both
      the
      holders of the Company’s Series A and Series B Convertible preferred stock have
      voting rights equal to the number of shares of common stock into which such
      shares of preferred stock could be converted at a particular record
      date.


-17-




**Securities
      Authorized for Issuance under Equity Compensation Plans**





Item
      12
      of Part III contains information concerning securities authorized for issuance
      under our equity compensation plans.





**Item
      6. SELECTED FINANCIAL DATA**





Set
      forth
      below is the historical financial data with respect to the Company for the
      fiscal years ended 2006, 2005, 2004, 2003 and 2002. This information has been
      derived from, and should be read in conjunction with, the audited financial
      statements, which appear elsewhere in this report. The financial data for the
      fiscal year ended 2002 has been restated to reflect the discontinued operations
      of the Company’s former subsidiary, WestAmerica Investment Group. The
      information for the fiscal year 2002 has been revised to reflect the cumulative
      dividends on the Series A Preferred Stock. All information is expressed in
      thousands of dollars except for per share information.




2006
              
              2005
              
              2004
              
              2003
              
              2002Net
                  revenues
              
              $
              58,727
              
              $
              45,730
              
              $
              62,460
              
              $
              50,158
              
              $
              42,002Net
                  income (loss) from continuingoperations
              
              
              595
              
              
              (1,183
              )
              
              566
              
              
              (843
              )
              
              (3,745
              )Preferred
                  stock dividends
              
              
              (381
              )
              
              (290
              )
              
              (266
              )
              
              (250
              )
              
              (168
              )Net
                  income (loss) per common sharefrom
                  continuing operationsBasic
              
              
              0.04
              
              
              (0.29
              )
              
              0.08
              
              
              (0.34
              )
              
              (1.73
              )Diluted
              
              
              0.04
              
              
              (0.29
              )
              
              0.07
              
              
              (0.34
              )
              
              (1.73
              )Weighted
                  average number of sharesused
                  in computing income (loss)per
                  shareBasic
              
              
              5,146,422
              
              
              5,024,643
              
              
              3,580,446
              
              
              3,175,315
              
              
              2,255,449Diluted
              
              
              5,278,299
              
              
              5,024,643
              
              
              4,106,742
              
              
              3,175,315
              
              
              2,255,449Total
                  assets
              
              
              9,707
              
              
              7,960
              
              
              9,722
              
              
              8,735
              
              
              7,948Total
                  liabilities
              
              
              6,864
              
              
              7,030
              
              
              7,793
              
              
              9,064
              
              
              8,039Stockholders’
                  equity (deficit)
              
              
              2,843
              
              
              930
              
              
              1,929
              
              
              (329
              )
              
              (91
              )Cash
                  dividends
              
              
              46
              
              
              —
              
              
              —
              
              
              —
              
              
              —


**Item
      7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF
      OPERATIONS**





*The
      Private Securities Litigation Reform Act of 1995 provides a safe harbor for
      forward-looking statements. This Report may contain certain statements of a
      forward-looking nature relating to future events or future business performance.
      Any such statements that refer to the Company’s estimated or anticipated future
      results or other non-historical facts are forward-looking and reflect the
      Company’s current perspective of existing trends and information. These
      statements involve risks and uncertainties that cannot be predicted or
      quantified and, consequently, actual results may differ materially from those
      expressed or implied by such forward-looking statements. Such risks and
      uncertainties include, among others, risks and uncertainties detailed in Item
      1
      above. Any forward-looking statements contained in or incorporated into this
      Report speak only as of the date of this Report. The Company undertakes no
      obligation to update publicly any forward-looking statement, whether as a result
      of new information, future events or otherwise.*


-18-




**Critical
      Accounting Policies and Estimates**




The
      SEC
      recently issued proposed guidance for disclosure of critical accounting policies
      and estimates. The Company’s most critical accounting policies relate to income
      recognition, income taxes, and stock-based compensation. The SEC defines
“critical accounting estimates” as those that require application of
      management’s most difficult, subjective or complex judgments, often as a result
      of the need to make estimates about the effects of matters that are inherently
      uncertain and may change in subsequent periods. In fiscal years 2006 and 2005,
      the Company estimated its ability to collect the receivables due from its
      registered representatives. These receivables are derived from debts owed to
      the
      Company and from money advanced to the registered representatives that may
      be
      forgiven over time based on the representatives’ affiliation with, and
      production at, National Securities. The Company also estimated the amount of
      reserves necessary to cover existing contingencies.





**Results
      of Operations**





**Fiscal
      Year 2006 Compared with Fiscal Year 2005**





The
      Company’s fiscal year 2006 resulted in an increase in revenues, and a
      comparatively lesser increase in expenses compared with fiscal year 2005. The
      increase in revenues is primarily due to the completion of investment banking
      transactions in fiscal
      year 2006 . As
      a
      result, the Company reported net income of $595,000 compared with a net loss
      of
      $1,183,000 for the fiscal years 2006 and 2005, respectively. This represents
      an
      improvement of $1,778,000 from the prior year.


Fiscal
                  Year
              
              Increase
                  (Decrease)2006
              
              2005
              
              Amount
              
              PercentCommissions
              
              $
              32,140,000
              
              $
              33,134,000
              
              $
              (994,000
              )
              
              (3
              %)Proprietary
                  trading
              
              
              7,391,000
              
              
              5,646,000
              
              
              1,745,000
              
              
              31
              %Market
                  making
              
              
              323,000
              
              
              —
              
              
              323,000
              
              
              n/aMark-ups
                  and mark-downs
              
              
              124,000
              
              
              64,000
              
              
              60,000
              
              
              94
              %Net
                  dealer inventory gains
              
              
              7,838,000
              
              
              5,710,000
              
              
              2,128,000
              
              
              37
              %Investment
                  banking
              
              
              11,323,000
              
              
              528,000
              
              
              10,795,000
              
              
              2045
              %Interest
                  and dividends
              
              
              2,891,000
              
              
              2,739,000
              
              
              152,000
              
              
              6
              %Transfer
                  fees and clearance services
              
              
              3,336,000
              
              
              3,097,000
              
              
              239,000
              
              
              8
              %Other
              
              
              1,199,000
              
              
              522,000
              
              
              677,000
              
              
              130
              %$
              58,727,000
              
              $
              45,730,000
              
              $
              12,997,000
              
              
              28
              %


Total
      revenues increased $12,997,000, or 28%, in fiscal year 2006 to $58,727,000
      from
      $45,753,000 in fiscal year 2005. This increase is mainly due to the completion
      of investment banking transactions. During fiscal year 2006, total trading
      volume increased 2%, compared to fiscal year 2005. The lesser increase in
      trading volume compared to revenues reflects an increase in the average revenue
      per trade, partially offset by the Company’s re-entry into market making
      activities. Commission revenue decreased $994,000, or 3%, to $32,140,000 from
      $33,134,000 during fiscal year 2006 compared with fiscal year 2005. Net dealer
      inventory gains, which includes profits on proprietary trading, market making
      activities and customer mark-ups and mark-downs, increased $2,128,000, or 37%,
      to $7,838,000 from $5,710,000 during fiscal year 2006 compared with fiscal
      year
      2005. The increase is primarily due to an increase in proprietary trading in
      the
      foreign bond market, and reflects the Company’s re-entry into market making
      activities. During fiscal year 2006, revenues from proprietary trading increased
      $1,745,000, or 31%, to $7,391,000 from $5,646,000 in fiscal year 2005, revenues
      from market making activities increased to $323,000 from $0 in fiscal year
      2005,
      and revenues from customer mark-ups and mark-downs increased $60,000, or 94%,
      to
      $124,000 from $64,000 in fiscal year 2005.


-19-




Investment
      banking revenue increased $10,795,000, or 2,045%, to $11,323,000 from $528,000
      in fiscal year 2006 compared with fiscal year 2005. The
      increase in investment banking revenues is attributable to the Company having
      completed significantly more investment banking transactions in
      fiscal year 2006 than in fiscal year 2005. Interest and dividend income
      increased $152,000, or 6%, to $2,891,000 from $2,739,000 in fiscal year 2006
      compared with fiscal year 2005. The
      increase in interest income is attributable to an increase in the interest
      rate
      charged for debit balances in National Securities’ customer accounts from the
      same period last year. Transfer fees increased $239,000, or 8%, to $3,336,000
      in
      fiscal year 2006 from $3,097,000 in fiscal year 2005. The increase is due to
      higher transfer fees for trades generated from the retail brokerage business
      of
      brokers recently associated with the Company.





Other
      revenue, consisting of asset management fees, miscellaneous transaction fees
      and
      trading fees, and other investment income, increased $677,000, or 130%, to
      $1,199,000 from $522,000 during fiscal year 2006 compared to fiscal year 2005.
      The increase is due to an increase in fee based assets under management and
      investment income realized in the Company’s venture capital fund in fiscal year
      2006.




Fiscal
                  Year
              
              Increase
                  (Decrease)2006
              
              2005
              
              Amount
              
              PercentCommission
                  expense related to:Commission
                  revenue
              
              $
              28,451,000
              
              $
              28,504,000
              
              $
              (53,000
              )
              
              0
              %Net
                  dealer inventory gains
              
              
              5,617,000
              
              
              3,919,000
              
              
              1,698,000
              
              
              43
              %Investment
                  banking
              
              
              8,208,000
              
              
              415,000
              
              
              7,793,000
              
              
              1878
              %Commissions
              
              
              42,276,000
              
              
              32,838,000
              
              
              9,438,000
              
              
              29
              %Employee
                  compensation
              
              
              5,835,000
              
              
              5,010,000
              
              
              825,000
              
              
              16
              %Clearing
                  fees
              
              
              1,538,000
              
              
              432,000
              
              
              1,106,000
              
              
              256
              %Communications
              
              
              1,748,000
              
              
              1,670,000
              
              
              78,000
              
              
              5
              %Occupancy
                  and equipment costs
              
              
              2,805,000
              
              
              2,886,000
              
              
              (81,000
              )
              
              (3
              %)Professional
                  fees
              
              
              1,213,000
              
              
              1,520,000
              
              
              (307,000
              )
              
              (20
              %)Interest
              
              
              494,000
              
              
              448,000
              
              
              46,000
              
              
              10
              %Taxes,
                  licenses and registration
              
              
              617,000
              
              
              344,000
              
              
              273,000
              
              
              79
              %Other
                  administrative expenses
              
              
              1,606,000
              
              
              1,765,000
              
              
              (159,000
              )
              
              (9
              %)$
              58,132,000
              
              $
              46,913,000
              
              $
              11,219,000
              
              
              24
              %


In
      comparison with the 28% increase in total revenues, total expenses increased
      24%, or $11,219,000, to $58,132,000 for fiscal year 2006 compared to $46,913,000
      in fiscal year 2005. The increase in total expenses is primarily the result
      of
      higher commission expenses directly associated with commission revenues,
      particularly investment banking revenues.





Commission
      expense, which includes expenses related to commission revenue, net dealer
      inventory gains and investment banking, increased $9,438,000, or 29%, to
      $42,276,000 in fiscal year 2006 from $32,838,000 in fiscal year 2005. Commission
      expense related to commission revenue decreased $53,000, or less than 1%, to
      $28,451,000 in fiscal year 2006 from $28,504,000 in fiscal year 2005; commission
      expense related to net dealer inventory gains increased $1,698,000, or 43%,
      to
      $5,617,000 in fiscal year 2006 from $3,919,000 in fiscal year 2005; and
      commission expense related to investment banking increased $7,793,000, or
      1,878%, to $8,208,000 in fiscal year 2006 from $415,000 in fiscal year 2005.
      Commission expense as a percentage of commission revenues increased to 89%
      in
      fiscal year 2006 from 86% in fiscal year 2005. This increase is attributable
      to
      changes in the production of particular brokers, not all of who are paid at
      the
      same commission rate and an increase in the amortization of advances to
      registered representatives. Commission expense as a percentage of net dealer
      inventory gains increased to 72% in fiscal year 2006 from 69% in fiscal year
      2005. This increase is attributable to changes in the production of particular
      brokers and traders, not all of who are paid at the same commission rate.
      Commission expense as a percentage of investment banking revenues decreased
      to
      72% in fiscal year 2006 from 79% in fiscal year 2005. This decrease is
      attributable to the type and size of the particular investment banking
      transactions completed in the current  -20-


fiscal
      year. Commission expense includes the amortization of advances to registered
      representatives of $1,281,000 and $1,206,000 for fiscal years 2006 and 2005,
      respectively. These amounts fluctuate based upon the amounts of advances
      outstanding and the time period for which the registered representatives have
      agreed to be affiliated with National Securities.





Employee
      compensation expense increased $825,000, or 16%, to $5,835,000 in fiscal year
      2006 from $5,010,000 in fiscal year 2005. The increase is attributable to new
      hires, bonuses based on current year’s profits and year-end bonuses that were
      paid to certain staff employees in the first quarter of fiscal year 2006.
      Overall, combined commission and employee compensation expense, as a percentage
      of revenue remained relatively constant at approximately 82% and 83% in fiscal
      years 2006 and 2005, respectively.


Clearing
      fees increased $1,106,000, or 256%, to $1,538,000 in fiscal year 2006 from
      $432,000 in fiscal year 2005. The increase in clearing fees is attributable
      to a
      different pricing structure for certain products with different clearing firms,
      and the receipt in fiscal year 2005 of a $1.0 million conversion fee credit
      from
      the Company’s clearing firm.





Communication
      expenses increased $78,000, or 5%, to $1,748,000 from $1,670,000 in fiscal
      year
      2006 compared to fiscal year 2005. The increase is primarily due to
      telecommunication incentives provided to certain brokers who recently became
      affiliated with the Company, and additional quotation machines for the Company’s
      market making activities, offset by the receipt of a refund of prior periods’
charges from a service provider. Occupancy costs decreased $81,000, or 3%,
      to
      $2,805,000 from $2,886,000 in fiscal year 2006 compared to fiscal year 2005.
      The
      decrease in occupancy expense is due to an overall reduction in leased office
      space. Professional fees decreased $307,000, or 20%, to $1,213,000 from
      $1,520,000 in fiscal year 2006 compared to fiscal year 2005. The decrease in
      professional fees is due to the Company having expensed approximately $320,000
      of professional fees relating to the proposed merger with First Montauk in
      fiscal year 2005.





Interest
      expense increased $46,000, or 10%, to $494,000 from $448,000 in fiscal year
      2006
      compared to fiscal year 2005. The increase is primarily attributable to the
      acceleration of amortization on notes that were paid prior to maturity and
      amortization related to new notes issued by the Company in the third quarter
      of
      fiscal year 2006. Included in interest expense is the amortization of $193,000
      and $163,000 for fiscal years 2006 and 2005, respectively. Taxes, licenses
      and
      registration increased $273,000, or 79%, to $617,000 from $344,000 in fiscal
      year 2006 compared fiscal year 2005. The increase is due to registration
      incentives provided to certain brokers who became affiliated with the Company
      in
      fiscal year 2006, and the receipt of a refund of prior years’ state business
      taxes in fiscal year 2005. Other administrative expenses decreased $159,000,
      or
      9%, to $1,606,000 from $1,765,000 in fiscal year 2006 compared to fiscal year
      2005. The decrease in other expenses is due to costs incurred in fiscal year
      2005 relating to the Company’s change of clearing firms.




The
      Company reported net income of $595,000 in fiscal year 2006 compared to a net
      loss of $1,183,000 in fiscal
      year 2005 .
      The net
      income attributable to common stockholders in fiscal year 2006 was $214,000,
      or
      diluted earnings of $.04 per common share, as compared to a net loss
      attributable to common stockholders of $1,473,000, or $.29 per common share
      in
      fiscal year 2005. The net income attributable to common stockholders for fiscal
      year 2006 and the net loss attributable to common stockholders for fiscal year
      2005 reflects $381,000 and $290,000 of cumulative Preferred Stock dividends
      on
      the Company’s Preferred Stock for
      fiscal years 2006 and 2005, respectively .





**Fiscal
      Year 2005 Compared with Fiscal Year 2004**





The
      Company’s fiscal year 2005 resulted in a decrease in revenues, and a
      comparatively lesser decrease in expenses compared with fiscal year 2004. The
      decrease in revenues is primarily due to the weaker securities markets
      experienced by the Company, and the Company’s cessation of its market making
      activities. As
      a
      result, the Company reported a net loss of $1,183,000 compared with net income
      of $566,000 for the fiscal


-21-




years
      2005 and 2004, respectively. This represents a reduction of $1,749,000 from
      the
      prior year.




Fiscal
                  Year
              
              Increase
                  (Decrease)2005
              
              2004
              
              Amount
              
              PercentCommissions
              
              $
              33,134,000
              
              $
              46,881,000
              
              $
              (13,747,000
              )
              
              (29
              %)Proprietary
                  trading
              
              
              5,646,000
              
              
              6,642,000
              
              
              (996,000
              )
              
              (15
              %)Market
                  making
              
              
              —
              
              
              645,000
              
              
              (645,000
              )
              
              n/aMark-ups
                  and mark-downs
              
              
              64,000
              
              
              117,000
              
              
              (53,000
              )
              
              (45
              %)Net
                  dealer inventory gains
              
              
              5,710,000
              
              
              7,404,000
              
              
              (1,694,000
              )
              
              (23
              %)Investment
                  banking
              
              
              528,000
              
              
              1,548,000
              
              
              (1,020,000
              )
              
              (66
              %)Interest
                  and dividends
              
              
              2,739,000
              
              
              3,420,000
              
              
              (681,000
              )
              
              (20
              %)Transfer
                  fees and clearance services
              
              
              3,097,000
              
              
              2,806,000
              
              
              291,000
              
              
              10
              %Other
              
              
              522,000
              
              
              401,000
              
              
              121,000
              
              
              30
              %$
              45,730,000
              
              $
              62,460,000
              
              $
              (16,730,000
              )
              
              (27
              %)


Total
      revenues decreased $16,730,000, or 27%, in fiscal year 2005 to $45,730,000
      from
      $62,460,000 in fiscal year 2004. This decrease is mainly due to the weaker
      securities markets that reduced commission revenues, the number of commission
      tickets generated, and the charge per ticket that affects commission revenue.
      During fiscal year 2005, total trading volume decreased 50%, compared to fiscal
      year 2004. This decrease is attributable in part to the current cessation of
      the
      Company’s market making activities. Trading volume in this fiscal year related
      to retail brokerage decreased 24%. Commission revenue decreased $13,747,000,
      or
      29%, to $33,134,000 from $46,881,000 during fiscal year 2005 compared with
      fiscal year 2004. Net dealer inventory gains, which includes profits on
      proprietary trading, market making activities and customer mark-ups and
      mark-downs, decreased $1,694,000, or 23%, to $5,710,000 from $7,404,000 during
      fiscal year 2005 compared with fiscal year 2004. The decrease is due to a
      reduction in proprietary trading in the bond market and the current cessation
      of
      the Company’s market making activities. During fiscal year 2005, revenues from
      proprietary trading decreased $996,000, or 15%, to $5,646,000 from $6,642,000
      in
      fiscal year 2004, revenues from market making activities decreased to $0 from
      $645,000 in fiscal year 2004, and revenues from customer mark-ups and mark-downs
      decreased $53,000, or 45%, to $64,000 from $117,000 in fiscal year
      2004.





Investment
      banking revenue decreased $1,020,000, or 66%, to $528,000 from $1,548,000 in
      fiscal year 2005 compared with fiscal year 2004. The decrease in investment
      banking revenues is attributable to the
      Company having
      completed fewer corporate finance transactions in fiscal year 2005 than in
      fiscal year 2004. Interest and dividend income decreased $681,000, or 20%,
      to
      $2,739,000 from $3,420,000 in fiscal year 2005 compared with fiscal year 2004.
      The decrease in interest income is primarily attributable to an overall decrease
      in the interest rate charged for debit balances in National Securities’ customer
      accounts from the same period last year. Transfer fees increased $291,000,
      or
      10%, to $3,097,000 in fiscal year 2005 from $2,806,000 in fiscal year 2004.
      The
      increase is due to higher transfer fees for trades generated from the retail
      brokerage business of brokers recently associated with the Company.





Other
      revenue, consisting of asset management fees, increased $121,000, or 30%, to
      $522,000 from $401,000 during fiscal year 2005 compared to fiscal year 2004.
      The
      increase is due to an increased level of assets under management.  -22-


Fiscal
                  Year
              
              Increase
                  (Decrease)2005
              
              2004
              
              Amount
              
              PercentCommission
                  expense related to:Commission
                  revenue
              
              $
              28,504,000
              
              $
              38,980,000
              
              $
              (10,476,000
              )
              
              (27
              %)Net
                  dealer inventory gains
              
              
              3,919,000
              
              
              3,714,000
              
              
              205,000
              
              
              6
              %Investment
                  banking
              
              
              415,000
              
              
              1,238,000
              
              
              (823,000
              )
              
              (66
              %)Commissions
              
              
              32,838,000
              
              
              43,932,000
              
              
              (11,094,000
              )
              
              (25
              %)Employee
                  compensation
              
              
              5,010,000
              
              
              5,449,000
              
              
              (439,000
              )
              
              (8
              %)Clearing
                  fees
              
              
              432,000
              
              
              2,391,000
              
              
              (1,959,000
              )
              
              (82
              %)Communications
              
              
              1,670,000
              
              
              2,589,000
              
              
              (919,000
              )
              
              (35
              %)Occupancy
                  and equipment costs
              
              
              2,886,000
              
              
              2,983,000
              
              
              (97,000
              )
              
              (3
              %)Professional
                  fees
              
              
              1,520,000
              
              
              2,559,000
              
              
              (1,039,000
              )
              
              (41
              %)Litigation
                  settlement
              
              
              —
              
              
              400,000
              
              
              (400,000
              )
              
              n/aInterest
              
              
              448,000
              
              
              397,000
              
              
              51,000
              
              
              13
              %Taxes,
                  licenses and registration
              
              
              344,000
              
              
              560,000
              
              
              (216,000
              )
              
              (39
              %)Other
                  administrative expenses
              
              
              1,765,000
              
              
              1,765,000
              
              
              —
              
              
              0
              %$
              46,913,000
              
              $
              63,025,000
              
              $
              (16,112,000
              )
              
              (26
              %)
 In
      comparison with the 28% decrease in total revenues, total expenses decreased
      26%, or $16,112,000, to $46,913,000 for fiscal year 2005 compared to $63,025,000
      in fiscal year 2004. The decrease in total expenses is a result of lower
      commission expenses directly associated with commission revenues, lower clearing
      fees and lower professional fees.





Commission
      expense, which includes expenses related to commission revenue, net dealer
      inventory gains and investment banking, decreased $11,094,000, or 25%, to
      $32,838,000 in fiscal year 2005 from $43,932,000 in fiscal year 2004. Commission
      expense related to commission revenue decreased $10,476,000, or 27%, to
      $28,504,000 in fiscal year 2005 from $38,980,000 in fiscal year 2004; commission
      expense related to net dealer inventory gains increased $205,000, or 6%, to
      $3,919,000 in fiscal year 2005 from $3,714,000 in fiscal year 2004; and
      commission expense related to investment banking decreased $823,000, or 66%,
      to
      $415,000 in fiscal year 2005 from $1,238,000 in fiscal year 2004. Commission
      expense as a percentage of commission revenues increased to 86% in fiscal year
      2005 from 83% in fiscal year 2004. This increase is attributable to changes
      in
      the production of particular brokers, not all of who are paid at the same
      commission rate and an increase in the amortization of advances to registered
      representatives. Commission expense as a percentage of net dealer inventory
      gains increased to 69% in fiscal year 2005 from 50% in fiscal year 2004. This
      increase is attributable to changes in the production of particular brokers
      and
      traders, not all of who are paid at the same commission rate. Commission expense
      as a percentage of investment banking was relatively unchanged between fiscal
      year 2005 and fiscal year 2004. Commission expense includes the amortization
      of
      advances to registered representatives of $1,206,000 and $763,000 for fiscal
      years 2005 and 2004, respectively. These amounts fluctuate based upon the
      amounts of advances outstanding and the time period for which the registered
      representatives have agreed to be affiliated with National
      Securities.





Employee
      compensation expense decreased $439,000, or 8%, to $5,010,000 in fiscal year
      2005 from $5,449,000 in fiscal year 2004. The decrease is attributable to
      personnel reductions and bonuses based on operating income that were paid to
      senior management in fiscal year 2004. Overall, combined commission and employee
      compensation expense, as a percentage of revenue increased to 83% from 78%
      in
      fiscal years 2005 and 2004, respectively. The increase is attributable to an
      overall higher payout percentage to National Securities’ retail brokers, and the
      relatively fixed employee compensation component.





Clearing
      fees decreased $1,959,000, or 82%, to $432,000 in fiscal year 2005 from
      $2,391,000 in fiscal year 2004. The reduction in clearing fees is attributable
      to the lower trading volume in fiscal year 2005


-23-




compared
      to fiscal year 2004, and lower clearing costs associated with the Company’s new
      clearing agreement. Clearing fees in fiscal year 2005 were reduced by the $1.0
      million conversion fee credit the Company received from its clearing firm,
      NFS,
      to offset the transitional, incremental conversion costs incurred by the
      Company. Clearing fees in fiscal year 2004 were reduced by the $800,000
      conversion assistance payment the Company received from its clearing firm,
      Fiserv, to offset conversion costs incurred by the Company. In fiscal year
      2004,
      clearing fees were reduced based on ticket volume in the amount of $250,000,
      from forgiveness of debt that was fully repaid in February 2004, from the
      Company’s prior clearing firm.





Communication
      expenses decreased $919,000, or 35%, to $1,670,000 from $2,589,000 in fiscal
      year 2005 compared to fiscal year 2004. The decrease is due to a reduction
      in
      the number of quotation machines resulting from the current cessation of the
      Company’s market making activities, and cost savings realized from a new
      telephone vendor. Occupancy costs decreased $97,000, or 3%, to $2,886,000 from
      $2,983,000 in fiscal year 2005 compared to fiscal year 2004. The decrease
      resulted from an overall reduction in leased office space. Professional fees
      decreased $1,039,000, or 41%, to $1,520,000 from $2,559,000 in fiscal year
      2005
      compared to fiscal year 2004. The decrease in professional fees is due to a
      decrease in legal fees relating to various lawsuits and arbitrations in fiscal
      year 2005. In fiscal year 2005 the Company expensed approximately $320,000
      of
      professional fees relating to the proposed merger with First Montauk. In fiscal
      year 2004 professional fees included legal fees, fines and restitution payments
      related to the NASD investigation of mutual fund trading activities, and legal
      fees regarding an arbitration panel award of damages against the Company of
      approximately $400,000 related to an employment contract with a former employee
      of the Company.





Interest
      expense increased $51,000, or 13%, to $448,000 from $397,000 in fiscal year
      2005
      compared to fiscal year 2004. The increase is due to interest on the notes
      issued by the Company in the second quarter of fiscal year 2004. Included in
      interest expense is the amortization of $163,000 and $113,000 for fiscal years
      2005 and 2004, respectively, attributable to those notes, and other notes that
      were modified in fiscal years 2005 and 2004. Taxes, licenses and registration
      decreased $216,000, or 39%, to $344,000 from $560,000 in fiscal year 2005
      compared to fiscal year 2004. The decrease resulted from a refund of prior
      years
      state business taxes, a reduction in registration fees paid as an incentive
      for
      new brokers and lower taxes attributable to our reduced level of revenues.
      Other
      administrative expenses were $1,765,000 in both fiscal years 2005 and 2004.




The
      Company realized gains on extinguishments of debt of $1,131,000 from its prior
      clearing firm, First Clearing, in fiscal year 2004.





The
      Company reported a net loss before income taxes of $1,183,000 in fiscal year
      2005 compared to net income before income taxes of $566,000 in
      fiscal
      year 2004 .
      The net
      loss attributable to common stockholders in fiscal year 2005 was $1,473,000
      or
      $.29 per common share, as compared to diluted earnings attributable to common
      stockholders of $300,000, or $.07 per common share in fiscal year 2004. The
      net
      loss attributable to common stockholders for fiscal year 2005 and the net income
      attributable to common stockholders for fiscal year 2004 reflects $290,000
      and
      $266,000 of cumulative Preferred Stock dividends on the Company’s Preferred
      Stock for
      fiscal years 2005 and 2004, respectively .





**Liquidity
      and Capital Resources**





National
      Securities, as a registered broker-dealer, is subject to the SEC’s Uniform Net
      Capital Rule 15c3-1 that requires the maintenance of minimum net capital.
      National Securities has elected to use the alternative standard method permitted
      by the rule. This requires that National Securities maintain minimum net capital
      equal to the greater of $250,000 or a specified amount per security based on
      the
      bid price of each security for which National Securities is a market maker. At
      September 30, 2006, National Securities’ net capital exceeded the requirement by
      $2,076,000.  -24-


Advances,
      dividend payments and other equity withdrawals from the Company’s subsidiary are
      restricted by the regulations of the SEC and other regulatory agencies. These
      regulatory restrictions may limit the amounts that a subsidiary may dividend
      or
      advance to the Company.





The
      Company extends unsecured credit in the normal course of business to its
      brokers. The determination of the appropriate amount of the reserve for
      uncollectible accounts is based upon a review of the amount of credit extended,
      the length of time each receivable has been outstanding, and the specific
      individual brokers from whom the receivables are due. The allowance for doubtful
      accounts increased by $99,000 in fiscal year 2006, reflecting the amount of
      loss
      that can be reasonably estimated by management.





The
      objective of liquidity management is to ensure that the Company has ready access
      to sufficient funds to meet commitments, fund deposit withdrawals and
      efficiently provide for the credit needs of customers.





In
      the
      first quarter of fiscal year 2003, the Company consummated a private placement
      of its securities, and issued 1,016,186 shares of Common Stock and 1,016,186
      warrants. In December 2005, the Company extended the expiration date of the
      warrants issued in this private placement, including the placement agent
      warrants, to December 23, 2006 from December 23, 2005.





In
      January 2004, the Company consummated a private offering of its securities
      to a
      limited number of accredited investors pursuant to Rule 506 of Regulation D
      under the Securities Act wherein the Company issued an aggregate of $200,000
      of
      three-year, 10% senior subordinated promissory notes to five unaffiliated
      parties. The note holders received three-year warrants to purchase an aggregate
      of 50,000 shares of Common Stock at an exercise price of $1.40 per share, with
      an allocated fair value of approximately $40,000. In December 2004, the Company
      rescinded a note in the principal amount of $25,000 **** and
      a
      warrant to purchase 6,250 shares of Common Stock. The remaining notes in the
      principal amount of $175,000 were repaid in full in March 2006.





In
      February 2004, the Company consummated a private offering of its securities
      to a
      limited number of accredited investors pursuant to Rule 506 of Regulation D
      under the Securities Act wherein the Company issued an aggregate of $850,000
      of
      three-year, 10% senior subordinated promissory notes to four unaffiliated
      parties. The note holders received three-year warrants to purchase an aggregate
      of 170,000 shares of Common Stock at an exercise price of $1.50 per share,
      with
      an allocated fair value of approximately $143,000.





In
      the
      fourth quarter of fiscal year 2004, the Company consummated a private placement
      of its securities to a limited number of accredited investors pursuant to Rule
      506 of Regulation D under the Securities Act. Each unit in the offering sold
      for
      $1.60 and consisted of two shares of Common Stock and one three-year warrant
      to
      purchase one share of Common Stock at a per share price of $1.50. Net proceeds
      of approximately $930,000 closed in the fourth quarter of fiscal year 2004,
      and
      the Company correspondingly issued 1,250,000 shares of Common Stock and 625,000
      warrants.





In
      January 2006, the Company consummated
      a private placement of its securities to a limited number of accredited
      investors in a transaction exempt from registration under Section 4(2) of the
      Securities Act. The investors made a $2.0 million investment in the Company
      by
      purchasing an aggregate of the following: (i) $1 .0
      million for
      10,000 shares of the Company’s newly created Series B Preferred Stock, which has
      a 10% dividend rate and is convertible into Common Stock at a price of $.75
      per
      share, and (ii) 11 %
      convertible promissory notes in the principal amount of $1 .0
      million , which
      are
      convertible into Common Stock at a price of $1.00 per share with warrants
      to purchase an aggregate of 300,000 shares of Common Stock at an exercise price
      of $1.00 per share.





The
      convertible promissory notes mature in January 2011. The Company granted
      warrants to acquire 300,000 shares of common stock to the note holders, and
      the
      fair value of the warrants was calculated using  -25-


the
      Black-Scholes Option Valuation Model. The Company recorded a debt discount
      of
      approximately $187,000 that will be charged to interest expense over the life
      of
      the debt.





The
      investment included $1.7 million by St. Cloud Capital Partners, L.P. (“St.
      Cloud”), and an aggregate of $300,000 by two unrelated investors. Marshall S.
      Geller, the Senior Managing Member of
      SCGP,
      LLC, the General Partner of St. Cloud, became a
      member of the Board of Directors of the Company
      simultaneous with the closing of the transaction. The
      Company incurred legal fees and other costs related to this capital transaction,
      in the amount of $56,000. The Company capitalized one-half of the fees to
      deferred financing costs that will be amortized to interest expense over the
      life of the convertible promissory notes and one-half of the fees were charged
      to paid-in capital.





In
      January 2006, t he
      Company used $1.0 million of the proceeds from the above private placement
      to
      pay in full $1.0 million of promissory notes held by two unrelated note holders
      that had a maturity date of July 31, 2007.





In
      March
      2006, the Company issued 159,090 shares of the Company’s common stock to an
      unaffiliated party for $175,000 in a
      private placement exempt from registration under Section 4(2) of the Securities
      Act .
      The
      proceeds from the private placement were used to retire $175,000 of the
      Company’s promissory notes that were due to mature in January 2007.





In
      May
      2006, the Company filed a Registration Statement on Form S-1 under the
      Securities Act of 1933 for the resale of certain shares of Common Stock, shares
      of Common Stock issuable upon the conversion of preferred stock and notes,
      and
      exercise of certain warrants previously issued in connection with private
      placement transactions. The Registration Statement became effective on November
      6, 2006. The Company will receive proceeds from the exercise of warrants that
      were included in the registration statement.





In
      December 2003, the Company engaged in discussions with the NASD relating to
      the
      Security Agreement between National Securities and First Clearing, and its
      effect on the computation of National Securities’ net capital. As a result of
      these discussions, on December 15, 2003, the Company and First Clearing agreed
      in principle to the following: (1) National Securities’ clearing deposit was
      reduced from $1,000,000 to $500,000; (2) the excess $500,000 was paid to First
      Clearing to reduce the Company’s outstanding loan balance on its promissory
      note; and (3) the Security Agreement between National Securities and First
      Clearing was terminated. Furthermore, First Clearing forgave payment of a
      $375,000 loan that was due to be paid in January 2004, resulting in a $375,000
      gain on extinguishment of debt in the first quarter of fiscal year 2004.





In
      February 2004, the Company paid First Clearing $250,000 to fully repay its
      promissory note that had a balance of approximately $1,006,000 at such time.
      As
      a result of the repayment of this note, the Company realized a gain on
      extinguishment of debt of approximately $756,000 in the second quarter of fiscal
      year 2004. Additionally, National Securities and First Clearing mutually agreed
      to terminate their clearing relationship.





In
      June
      2004, National Securities entered into an agreement with Fiserv to clear its
      brokerage business. The conversion from First Clearing to Fiserv was completed
      in the first week of October 2004. As part of this transaction, Fiserv provided
      National Securities with an $800,000 conversion assistance payment, $250,000
      of
      which was paid upon execution of the clearing agreement, $250,000 of which
      was
      paid in mid-August 2004, and $300,000 of which was paid in October
      2004.





In
      March
      2005, NFS acquired the clearing business of Fiserv. In April 2005, National
      Securities entered into a clearing agreement with NFS that became effective
      in
      June 2005. As part of this transaction, NFS provided National Securities with
      a
      $1.0 million conversion fee credit to reimburse the Company for the
      transitional, incremental costs incurred by National Securities relating to
      the
      conversion of its clearing  -26-


business
      to NFS. National Securities was paid $250,000 in May 2005, and the remaining
      $750,000 was paid in July 2005. The clearing agreement includes a termination
      fee if National Securities terminates the agreement without cause that is
      initially $2.0 million and reduces to $125,000 over the eight-year term of
      the
      agreement. Additionally, in June 2005 National Securities entered into a
      clearing agreement with Penson for the purpose of providing clearing services
      that are not provided by NFS. The Company believes that the overall effect
      of
      its clearing relationships has been beneficial to the Company’s cost structure,
      liquidity and capital resources. ****





In
      January 2004, $1.0 million of notes with an interest rate of 9% held by two
      note
      holders matured. At that time warrants held by the note holders to purchase,
      in
      the aggregate, 100,000 shares of common stock at a price of $5.00 per share
      and
      100,000 shares of common stock at a price of $1.25 per share expired. In January
      2004, the Company and the two note holders entered into new note agreements
      providing for $1.0
      million of notes
      with an interest rate of 12% and a maturity date of July 31, 2005, together
      with
      warrants having an expiration date of July 31, 2005 to purchase, in the
      aggregate, 100,000 shares of common stock at a price of $1.75 per share and
      100,000 shares of common stock at a price of $1.25 per share. In July 2005
      these
      notes matured and warrants expired. In August 2005, the Company and the two
      note
      holders entered into new note agreements providing for $1.0
      million of notes
      with a maturity date of July 31, 2007, together with warrants having an
      expiration date of July 31, 2007 to purchase, in the aggregate, 200,000 shares
      of common stock at a price of $1.25 per share. These
      notes in the principal amount of $1.0 million were repaid in full in January
      2006.





In
      February 2004, National Securities and the holder of a $1.0 million secured
      demand note that matured on February 1, 2004, entered into a new secured demand
      note collateral
      agreement with
      a
      maturity date of March 1, 2005, together
      with warrants having an expiration date of July 31, 2005 to purchase 75,000
      shares of common stock at a price of $1.75 per share and 75,000 shares of common
      stock at a price of $1.25 per share .
      In
      February 2005, National Securities and the holder entered into a new $1.0
      million secured demand collateral
      agreement note
      with
      a maturity date of March 1, 2006. In August 2005, National Securities and the
      holder entered into a new warrant agreement that provided for an expiration
      date of July 31, 2007 to purchase 150,000 shares of common stock at a price
      of
      $1.25 per share .
      In
      February 2006, National Securities and the holder entered into a new $1.0
      million secured demand note collateral
      agreement with
      a
      maturity date of March 1, 2007.





As
      of
      September 30, 2006, advances to registered representatives decreased $97,000
      to
      $1,556,000 from $1,653,000 as of September 30, 2005. This decrease is
      attributable to the amortization of advances in fiscal year 2006 in excess
      of
      advances made to registered representatives who became affiliated with National
      Securities during this period, and advances to registered representatives
      already affiliated with National Securities who agreed to renew their
      affiliation.





In
      fiscal
      year 2006 and 2005, the Company received proceeds of approximately $0 and
      $20,000, respectively, from the exercise of outstanding employee stock options
      and warrants.





The
      Company has historically satisfied its capital needs with cash generated from
      operations or from financing activities. The Company believes that it will
      have
      sufficient funds to maintain its current level of business activities during
      fiscal year 2006. If market conditions should weaken, the Company would need
      to
      consider curtailing certain of its business activities, reducing its fixed
      overhead costs and/or seek additional sources of financing.  -27-


The
      following table shows the contractual obligations of the Company as of September
      30, 2006:




Notes
              
              SecuredFiscal
                  Year Ending
              
              Payable
              
              Demand
                  Note
              
              Leases
              
              Total2007
              
              $
              850,000
              
              $
              1,000,000
              
              $
              1,602,000
              
              $
              3,452,0002008
              
              
              —
              
              
              —
              
              
              1,556,000
              
              
              1,556,0002009
              
              
              —
              
              
              —
              
              
              584,000
              
              
              584,0002010
              
              
              —
              
              
              —
              
              
              562,000
              
              
              562,0002011
              
              
              1,000,000
              
              
              —
              
              
              579,000
              
              
              1,579,000Thereafter
              
              
              —
              
              
              —
              
              
              443,000
              
              
              443,000Less:
                  Deferred debt discount
              
              
              (204,000
              )
              
              —
              
              
              —
              
              
              (204,000
              )$
              1,646,000
              
              $
              1,000,000
              
              $
              5,326,000
              
              $
              7,972,000


**Inflation**





The
      Company believes that the effect of inflation on its assets, consisting of
      cash,
      securities, office equipment, leasehold improvements and computers has not
      been
      significant.





**Recently
      Issued Accounting Standards**





In
      February 2006, the FASB issued Statement of Financial Accounting Standard 155
      “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”), which
      eliminates the exemption from applying SFAS 133 “Accounting for Derivative
      Instruments and Hedging Activities” (“SFAS 133”) to interests in securitized
      financial assets so that similar instruments are accounted for similarly
      regardless of the form of the instruments. SFAS 155 also allows the election
      of
      fair value measurement at acquisition, at issuance, or when a previously
      recognized financial instrument is subject to a remeasurement event. Adoption
      is
      effective for all financial instruments acquired or issued after the beginning
      of the first fiscal year that begins after September 15, 2006. Early
      adoption is permitted. The adoption of SFAS 155 is not expected to have a
      material effect on the Company’s consolidated financial position, results of
      operations or cash flows.





In
      March
      2006, the FASB issued Statement of Financial Accounting Standard 156 “Accounting
      for Servicing of Financial Assets” (“SFAS 156”), which requires all separately
      recognized servicing assets and servicing liabilities be initially measured
      at
      fair value. SFAS 156 permits, but does not require, the subsequent measurement
      of servicing assets and servicing liabilities at fair value. Adoption is
      required as of the beginning of the first fiscal year that begins after
      September 15, 2006. Early adoption is permitted. The adoption of SFAS 156
      is not expected to have a material effect on the Company’s consolidated
      financial position, results of operations or cash flows.





In
      September 2006, the FASB issued SFAS No. 157, “Accounting for Fair Value
      Measurements” (“SFAS 157”). SFAS 157 defines fair value, and establishes a
      framework for measuring fair value in generally accepted accounting principles
      and expands disclosure about fair value measurements. SFAS 157 is effective
      for
      the Company for financial statements issued subsequent to November 15,
      2007. The Company does not expect the new standard to have a material impact
      on
      the Company’s financial position, results of operations or cash flows.





In
      September 2006, the staff of the SEC issued Staff Accounting Bulletin No. 108
      (“SAB 108”) which provides interpretive guidance on how the effects of the
      carryover or reversal of prior year misstatements should be considered in
      quantifying a current year misstatement. SAB 108 becomes effective in fiscal
      year 2007. Adoption of SAB 108 is not expected to have a material impact on
      the
      Company’s consolidated financial position, results of operations or cash
      flows.  -28-


**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**





The
      Company's primary market risk arises from the fact that it engages in
      proprietary trading and makes dealer markets in equity securities. Accordingly,
      the Company may be required to maintain certain amounts of inventories in order
      to facilitate customer order flow. The Company may incur losses as a result
      of
      price movements in these inventories due to changes in interest rates, foreign
      exchange rates, equity prices and other political factors. The Company is not
      subject to direct market risk due to changes in foreign exchange rates. However,
      the Company is subject to market risk as a result of changes in interest rates
      and equity prices, which are affected by global economic conditions. The Company
      manages its exposure to market risk by limiting its net long or short positions.
      Trading and inventory accounts are monitored daily by management and the Company
      has instituted position limits.





Credit
      risk represents the amount of accounting loss the Company could incur if
      counterparties to its proprietary transactions fail to perform and the value
      of
      any collateral proves inadequate. Although credit risk relating to various
      financing activities is reduced by the industry practice of obtaining and
      maintaining collateral, the Company maintains more stringent requirements to
      further reduce its exposure. The Company monitors its exposure to counterparty
      risk on a daily basis by using credit exposure information and monitoring
      collateral values. The Company maintains a credit committee, which reviews
      margin requirements for large or concentrated accounts and sets higher
      requirements or requires a reduction of either the level of margin debt or
      investment in high-risk securities or, in some cases, requiring the transfer
      of
      the account to another broker-dealer.





The
      Company monitors its market and credit risks daily through internal control
      procedures designed to identify and evaluate the various risks to which the
      Company is exposed. There can be no assurance, however, that the Company's
      risk
      management procedures and internal controls will prevent losses from occurring
      as a result of such risks.





The
      following table shows the market values of the Company's securities owned
      and
      securities sold, but not yet purchased as of
      September 30, 2006:




Securities
                  sold, butSecurities
                  owned
              
              not
                  yet purchasedCorporate
                  stocks
              
              $
              459,000
              
              $
              162,000Corporate
                  bonds
              
              
              —
              
              
              —Government
                  obligations
              
              
              16,000
              
              
              —$
              475,000
              
              $
              162,000





-29-




**Item
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**





See
      Part
      IV, Item 15(a)(1) for a list of financial statements filed as part of this
      Report.





**Item
      9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**





There
      were no disagreements with accountants on accounting and financial disclosure
      for the fiscal year ended September 30, 2006.





**Item
      9A. CONTROLS AND PROCEDURES**





Evaluation
      of disclosure controls and procedures. Based on
      the evaluation of the Company’s disclosure controls and procedures (as defined
      in the Exchange Act Rules 13a-15(e) and 15d-15(e)) required by the Exchange
      Act Rules 13a-15(b) or 15d-15(b), the Company’s Chief Executive Officer and
      Acting Chief Financial Officer have concluded that, as of the end of the period
      covered by this report, the Company’s disclosure controls and procedures were
      adequate and effective to ensure that material information relating to the
      Company and its consolidated subsidiaries would be made known to them by others
      within those entities, particularly during the period in which this yearly
      report on Form 10-K was being prepared.





Changes
      in internal controls. There
      were no significant changes in the Company’s internal controls or in other
      factors that could significantly affect those controls and procedures subsequent
      to the date of our evaluation nor any significant deficiencies or material
      weaknesses in such disclosure controls and procedures requiring corrective
      actions.





**Item
      9B. OTHER INFORMATION**





There
      is
      no other information to be disclosed by the Company during the fourth quarter
      of
      fiscal year 2006 that has not been reported on a current report on Form
      8-K.






**PART
      III**





**Item
      10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**





The
      other
      information required by this Item will be included in the Company’s 2007 Proxy
      Statement and  is
      incorporated herein by reference.





**Item
      11. EXECUTIVE COMPENSATION**





The
      information required by this Item will be included in the Company’s 2007 Proxy
      Statement and is incorporated herein by reference.





**Item
      12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND** **MANAGEMENT**





The
      information required by this Item will be included in the Company’s 2007 Proxy
      Statement and is incorporated herein by reference.


-30-




**Item
      13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**





The
      information required by this Item will be included in the Company’s 2007 Proxy
      Statement and is incorporated herein by reference.





**Item
      14.**  **PRINCIPAL
      ACCOUNTING FEES AND SERVICES**





The
      information required by this Item will be included in the Company’s 2007 Proxy
      Statement and is incorporated herein by reference.





**Item
      15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES**





(a)
            The
                following financial statements are included in Part II, Item
                8:





1.
            Financial
                Statements


Independent
      Auditors' Reports


Consolidated
      Financial Statements


Statements
      of Financial Condition, September 30, 2006 and September 30, 2005


Statements
      of Operations for the Years ended September 30, 2006, September 30, 2005 and
      September 30, 2004


Statement
      of Changes in Stockholders' Equity (Deficit) for the Years ended September
      30,
      2006, September 30, 2005 and September 30, 2004


Statements
      of Cash Flows for the Years ended September 30, 2006, September 30, 2005 and
      September 30, 2004


Notes
      to
      Consolidated Financial Statements





2.
            Financial
                Statement Schedules





Schedules
                not listed above have been omitted because they are not applicable
                or have
                been included in footnotes to the consolidated financial
                statements.





(b)
            See
                Exhibit Index.




-31-




**SIGNATURES**








Pursuant
      to the requirements of Section 13 or 15(d) of the Securities and Exchange Act
      of
      1934, the Registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.





NATIONAL
      HOLDINGS CORPORATION


(Registrant)




Date:
      December 7, 2006


By: /s/
      Mark
      Goldwasser


Mark
      Goldwasser


Chairman,
      President and Chief Executive Officer




Date:
      December 7, 2006


By: /s/
      Robert H. Daskal


Robert
      H.
      Daskal


Chief
      Financial Officer








Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the dates indicated.








Date:
      December 7, 2006


By: /s/
      Mark
      Goldwasser


Mark
      Goldwasser,


Chairman,
      President and Chief Executive Officer




Date:
      December 7, 2006


By: /s/
      Gary
      A. Rosenberg


Gary
      A.
      Rosenberg, Director




Date:
      December 7, 2006


By: /s/
      Robert J. Rosan


Robert
      J.
      Rosan, Director




Date:
      December 7, 2006


By: /s/
      Peter
      Rettman


Peter
      Rettman, Director




Date:
      December 7, 2006


By: /s/
      Norman J. Kurlan





Norman
      J.
      Kurlan, Director




Date:
      December 7, 2006


By: /s/
      Marshall S. Geller


Marshall
      S. Geller, Director


-32-




**EXHIBIT
      INDEX**




3.1
              Certificate
                  of Incorporation, as amended, previously filed as Exhibit 3.5.
                  to Form
                  10-Q in May 2004 and hereby incorporated by reference.3.2
              The
                  Company's Bylaws, as amended, previously filed as Exhibit 3.3 to
                  Form 10-Q
                  in February 2002, and hereby incorporated by reference.3.3
              The
                  Company’s By-Laws, as amended and restated on December 12,
                  2001.3.4
              Certificate
                  of Designations, Preferences, and Relative Optional or Other Special
                  Rights of Preferred Stock and Qualifications, Limitations and Restrictions
                  Thereof of Series A Convertible Preferred Stock, as amended,previously
                  filed as Exhibit 3.6 to Form 10-Q in May 2004 and hereby incorporated
                  by
                  reference.3.5
              Certificate
                  of Designation of Series B Preferred Stock, filed with the Secretary
                  of
                  State of the State of Delaware on January 11, 2006.3.6
              Certificate
                  of Amendment to the Certificate of Incorporation, filed with the
                  Secretary
                  of State of the State of Delaware on March 15, 2006filed
                  as Exhibit 3.6 to Form 10-Q in May 2006 and hereby incorporated
                  by
                  reference.3.7
              Certificate
                  of Amendment to the Certificate of Designation of Series A Preferred
                  Stock, filed with the Secretary of State of the State of Delaware
                  on March
                  15, 2006filed
                  as Exhibit 3.7 to Form 10-Q in May 2006 and hereby incorporated
                  by
                  reference.4.1
              Form
                  of Warrant filed as Exhibit 4.1 to Form 8-K in January 2006 and
                  hereby
                  incorporated by reference.4.2
              Form
                  of Promissory Note filed as Exhibit 4.2 to Form 8-K in January
                  2006 and
                  hereby incorporated by reference.10.1
              Office
                  lease, Chicago, Illinois, previously filed as Exhibit 10.27 to
                  Form 10-K
                  in December 1996 and hereby incorporated by reference.10.2
              Office
                  lease, Spokane, Washington, previously filed as Exhibit 10.28 to
                  Form 10-K
                  in December 1996 and hereby incorporated by reference.10.3
              Amended
                  office lease, Chicago, Illinois, previously filed as Exhibit 10.29
                  to Form
                  10-K in December 1996 and hereby incorporated by
                  reference.10.4
              Purchase
                  agreement between shareholders of Friend and the Company, previously
                  filed
                  as Exhibit 10.30 to Form 10-K in December 1997 and hereby incorporated
                  by
                  reference.10.5
              Purchase
                  agreement between shareholders of WestAmerica and the Company,
                  previously
                  filed as Exhibit 10.31 to Form 10-K in December 1997 and hereby
                  incorporated by reference.10.6
              Purchase
                  agreement between shareholders of Travis and the Company, previously
                  filed
                  as Exhibit 10.32 to Form 10-K in December 1997 and hereby incorporated
                  by
                  reference.10.7
              Borrowing
                  agreement between Seattle-First National Bank and the Company previously
                  filed as Exhibit 10.33 to Form 10-K in December 1998 and hereby
                  incorporated by reference.10.8
              Note
                  payable agreement, previously filed as Exhibit 10.34 to Form 10-K
                  in
                  December 1998 and hereby incorporated by reference.10.9
              Note
                  payable agreement, previously filed as Exhibit 10.35 to Form 10-K
                  in
                  December 1998 and hereby incorporated by reference.10.10
              Note
                  payable agreement, previously filed as Exhibit 10.36 to Form 10-K
                  in
                  December 1998 and hereby incorporated by reference.10.11
              Sales
                  agreement between Friend and the Company previously filed as Exhibit
                  10.37
                  to Form 10-K in December 1998 and hereby incorporated by
                  reference.10.12
              1996
                  Stock Option Plan, previously filed as Exhibit 4.1 to Form S-8
                  in February
                  1999 and hereby incorporated by reference.10.13
              1997
                  Stock Option Plan, previously filed as Exhibit 4.2 to Form S-8
                  in February
                  1999 and hereby incorporated by reference.10.14
              1999
                  Stock Option Plan, previously filed as Exhibit 4.3 to Form S-8
                  in February
                  1999 and hereby incorporated by
                  reference.
  -33-
  10.15*
              Employment
                  contract dated July 1999, previously filed as Exhibit 10.15 to
                  Form 10-K
                  in December 1999 and hereby incorporated by reference.10.16*
              Employment
                  contract dated July 1999 previously filed as Exhibit 10.16 to Form
                  10-K in
                  December 1999 and hereby incorporated by reference.10.17*
              Employment
                  contract dated July 1999 previously filed as Exhibit 10.17 to Form
                  10-K in
                  December 1999 and hereby incorporated by reference.10.18*
              Employment
                  contract dated July 1999 previously filed as Exhibit 10.18 to Form
                  10-K in
                  December 1999 and hereby incorporated by reference.10.19*
              Employment
                  contract dated July 1999 previously filed as Exhibit 10.19 to Form
                  10-K in
                  December 1999 and hereby incorporated by reference.10.20
              Office
                  lease, Seattle, Washington previously filed as Exhibit 10.20 to
                  Form 10-K
                  in December 1999 and hereby incorporated by reference.10.21
              2000
                  Stock Option Plan previously filed as Exhibit 4.1 to Form S-8 in
                  June 2000
                  and hereby incorporated by reference.10.22*
              Employment
                  contract dated June 2000, previously filed as Exhibit 10.21 to
                  Form 10-Q
                  in August 2000 and hereby incorporated by reference.10.23
              Form
                  of Note payable agreement dated January 2001, previously filed
                  as Exhibit
                  10.23 to Form 10-Q in May 2001 and hereby incorporated by
                  reference.10.24
              Secured
                  Demand Note dated February 2001, previously filed as Exhibit 10.24
                  to Form
                  10-Q in May 2001 and hereby incorporated by reference.10.25
              Loan
                  and security agreement dated January 2001, previously filed as
                  Exhibit
                  10.25 to Form 10-Q in February 2001 and hereby incorporated by
                  reference.10.26
              2001
                  Stock Option Plan, previously included in the Proxy Statement-Schedule
                  14A
                  filed in January 2001 and hereby incorporated by
                  reference.10.27
              Audit
                  committee charter, previously filed as Exhibit 10.22 to Form 10-Q
                  in
                  August 2000 and hereby incorporated by reference.10.28
              Clearing
                  Agreement previously filed as Exhibit 10.28 to Form 10-K in December
                  2001
                  and hereby incorporated by reference.10.29
              First
                  Amendment to Clearing Agreement previously filed as Exhibit 10.29
                  to Form
                  10-K in December 2001 and hereby incorporated by
                  reference.10.30
              Purchase
                  Agreement by and among Olympic Cascade Financial Corporation, Mark
                  Goldwasser and Triage Partners, LLC dated as of December 14, 2001,
                  previously filed as Exhibit 10.30 to Form 8-K in January 2002 and
                  hereby
                  incorporated by reference.10.31
              Stock
                  Purchase Agreement between Steven A. Rothstein, certain other persons
                  or
                  entities and Triage Partners, LLC dated as of December 14, 2001,
                  previously filed as Exhibit 10.31 to Form 8-K in January 2002 and
                  hereby
                  incorporated by reference.10.32
              Securities
                  Exchange Agreement by and among Olympic Cascade Financial Corporation,
                  Gregory P. Kusnick, Karen Jo Gustafson, Gregory C. Lowney and Maryanne
                  K.
                  Snyder dated as of December 14, 2001, previously filed as Exhibit
                  10.32 to
                  Form 8-K in January 2002 and hereby incorporated by
                  reference.10.33
              Escrow
                  Agreement by and made among Olympic Cascade Financial Corporation,
                  Mark
                  Goldwasser, Triage Partners, LLC and National Securities Corporation
                  dated
                  as of December 28, 2001, previously filed as Exhibit 10.33 to Form
                  8-K in
                  January 2002 and hereby incorporated by reference.10.34
              Second
                  Amendment to Clearing Agreement, previously filed as Exhibit 10.34
                  to Form
                  10-Q in February 2002 and hereby incorporated by
                  reference.10.35
              Form
                  of Warrant issued in December 2002.10.36
              Form
                  of Securities Purchase Agreement,previously filed as Exhibit 10.36 to Form 8-K in February 2004
                  and hereby
                  incorporated by reference.10.37
              Form
                  of Note,previously
                  filed as Exhibit 10.37 to Form 8-K in February 2004 and hereby
                  incorporated by reference.
  -34-
  10.38
              Form
                  of Warrant,previously filed as Exhibit 10.38 to Form 8-K in February 2004
                  and hereby
                  incorporated by reference.10.39
              Form
                  of Registration Rights Agreement,
                  previously filed as Exhibit 10.39 to Form 8-K in February 2004
                  and hereby
                  incorporated by reference.10.40
              Clearing
                  Agreement previously filed as Exhibit 10.36 to Form 10-K in June
                  2004 and
                  hereby incorporated by reference.10.41
              Form
                  of Warrant issued in August 2004 filed as Exhibit 10.40 to Form
                  8-K in
                  August 2004 and hereby incorporated by reference.10.42
              Form
                  of Registration Rights Agreement dated in August 2004 filed as
                  Exhibit
                  10.41 to Form 8-K in August 2004 and hereby incorporated by
                  reference.10.43*
              Severance
                  Agreement dated February 4, 2005 between Michael A. Bresner and
                  National
                  Securities Corporationfiled as Exhibit 10.43 to Form 8-K in February 2005 and hereby
                  incorporated by reference.10.44
              Agreement
                  and Plan of Merger dated February 10, 2005, by and among Olympic
                  Cascade
                  Financial Corporation, FMFC Acquisition Corporation and First Montauk
                  Financial Corp.filed as Exhibit 10.44 to Form 8-K in February 2005 and hereby
                  incorporated by reference.10.45
              Warrant
                  issued by the Company to Triage Partners LLC dated April 1,
                  2005filed as Exhibit 10.45 to Form 8-K in April 2005 and hereby incorporated
                  by reference.10.46
              Amended
                  and Restated Agreement and Plan of Merger dated June 27, 2005,
                  by and
                  among Olympic Cascade Financial Corporation, OLY Acquisition Corporation
                  and First Montauk Financial Corp.filed as Exhibit 10.46 to Form 8-K in June 2005 and hereby incorporated
                  by
                  reference.10.47
              Letter
                  Agreement dated as of October 24, 2005 terminating the Amended
                  and
                  Restated Agreement and Plan of Merger, dated June 27, 2005, by
                  and among
                  Olympic Cascade Financial Corporation, OLY Acquisition Corporation
                  and
                  First Montauk Financial Corp.filed as Exhibit 10.47 to Form 8-K in October 2005 and hereby incorporated
                  by reference.10.48
              Securities
                  Purchase Agreement dated as of January 11, 2006 by and among Olympic
                  Cascade Financial Corporation and the investors set forth therein
                  filed as
                  Exhibit 10.48 to Form 8-K in January 2006 and hereby incorporated
                  by
                  reference.10.49
              Registration
                  Rights Agreement dated as of January 11, 2006 by and among Olympic
                  Cascade
                  Financial Corporation and the investors set forth therein filed
                  as Exhibit
                  10.49 to Form 8-K in January 2006 and hereby incorporated by
                  reference.10.50*
              Employment
                  Agreement dated as of March 15, 2006 between the Company and Mark
                  Goldwasserfiled
                  as Exhibit 10.50 to Form 10-Q in May 2006 and hereby incorporated
                  by
                  reference.10.51
              Securities
                  Purchase Agreement dated as of March 17, 2006filed
                  as Exhibit 10.51 to Form 10-Q in May 2006 and hereby incorporated
                  by
                  reference.14.
              The
                  Code of Ethicsfiled as Exhibit 14 to Form 10-K in December 2003 and hereby incorporated
                  by reference.16.1
              Change
                  in Certifying Accountant, previously filed in Form 8-K in August 1998 and
                  hereby incorporated by reference.16.2
              Investment
                  Transaction previously filed in Form 8-K in January 2002 and hereby
                  incorporated by reference.16.3
              Resignation
                  of Director previously filed in Form 8-K in April 2002 and hereby
                  incorporated by reference.16.4
              Change
                  in its Independent Public Accountants, previously filed in Form
                  8-K in May
                  2003 and hereby incorporated by reference.16.5
              Change
                  in its Independent Public Accountants, previously filed in Form
                  8-K in
                  October 2003 and hereby incorporated by reference.21.
              Subsidiaries
                  of Registrant.23.1
              Consent
                  of Feldman Sherb Erhlich & Co., P.C., previously filed to Forms S-8 in
                  February 1999 and June 2000 and Forms S-3 in May 1999 and June
                  1999 and
                  hereby incorporated by
                  reference.
  -35-
  23.2
              Consent
                  of Moss Adams LLP, previously filed to Forms S-8 in February 1999
                  and June
                  2000 and Forms S-3 in May 1999 and June 1999 and hereby incorporated
                  by
                  reference.23.3
              Consent
                  of Camhy Karlinsky & Stein LLP, previously filed to Form S-8 in
                  February 1999 and Forms S-3 in May 1999 and June 1999 and hereby
                  incorporated by reference.23.4
              Consent
                  of D’Ancona & Pflaum LLC, previously filed to Forms S-8 in June 2000
                  and June 2001 and hereby incorporated by reference.23.5
              Consent
                  of Marcum & Kliegman LLP24.
              Power
                  of Attorney, previously filed to Forms S-3 in May 1999 and June
                  1999.31.1
              Chief
                  Executive Officer’s Certificate pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002.31.2
              Acting
                  Chief Financial Officer’s Certificate pursuant to Section 302 of the
                  Sarbanes-Oxley Act of 2002.32.1
              Chief
                  Executive Officer’s Certificate pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.32.2
              Acting
                  Chief Financial Officer’s Certificate pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.
 
 *
              Compensatory
                  agreements
  -36-
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  To
        the
        Board of Directors and Stockholders
 National
        Holdings Corporation
  We
        have
        audited the accompanying consolidated statements of financial condition of
        National Holdings Corporation (the "Company") as of September 30, 2006 and
        2005,
        and the related consolidated statements of operations, changes in stockholders'
        equity and cash flows for each of the three years in the period ended September
        30, 2006. These consolidated financial statements are the responsibility
        of the
        Company's management. Our responsibility is to express an opinion on these
        financial statements based on our audits.
  We
        conducted our audits in accordance with the 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. The Company is not required
        to
        have, nor were we engaged to perform, an audit of its internal control over
        financial reporting. Our audits include consideration of internal control
        over
        financial reporting as a basis for designing audit procedures that are
        appropriate in the circumstances, but not for the purpose of expressing an
        opinion on the effectiveness of the Company’s internal control over financial
        reporting. Accordingly, we express no such opinion. An audit also includes
        examining, on a test basis, evidence supporting the amounts and disclosures
        in
        the financial statements, 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 consolidated financial statements referred to above present
        fairly,
        in all material respects, the consolidated financial position of National
        Holdings Corporation as of September 30, 2006 and 2005, and the consolidated
        results of its operations and its cash flows for each of the three years
        in the
        period ended September 30, 2006, in conformity with accounting principles
        generally accepted in the United States of America.
   /s/
        Marcum & Kliegman LLP
  New
        York,
        New York
 November
        28, 2006
 F-1
  **NATIONAL
                    HOLDINGS CORPORATION AND SUBSIDIARIES****CONSOLIDATED
                    STATEMENTS OF FINANCIAL
                    CONDITION**
  **ASSETS**September
                    30,
                
                September
                    30,2006
                
                2005CASH
                
                $
                1,441,000
                
                $
                398,000DEPOSITS
                    WITH CLEARING ORGANIZATIONS
                
                
                300,000
                
                
                300,000RECEIVABLES
                    FROM BROKER-DEALERS AND CLEARING ORGANIZATIONS
                
                
                3,548,000
                
                
                3,329,000OTHER
                    RECEIVABLES, net of allowance for uncollectible accounts of
                    $467,000and
                    $368,000 at September 30, 2006 and 2005, respectively
                
                
                380,000
                
                
                485,000ADVANCES
                    TO REGISTERED REPRESENTATIVES
                
                
                1,556,000
                
                
                1,653,000SECURITIES
                    OWNEDMarketable,
                    at market value
                
                
                475,000
                
                
                166,000Non-marketable,
                    at fair value
                
                
                402,000
                
                
                —FIXED
                    ASSETS, net
                
                
                305,000
                
                
                250,000SECURED
                    DEMAND NOTE
                
                
                1,000,000
                
                
                1,000,000OTHER
                    ASSETS
                
                
                300,000
                
                
                379,000TOTAL
                    ASSETS
                
                $
                9,707,000
                
                $
                7,960,000**LIABILITIES
                    AND STOCKHOLDERS' EQUITY**PAYABLE
                    TO BROKER-DEALERS AND CLEARING ORGANIZATIONS
                
                $
                113,000
                
                $
                122,000SECURITIES
                    SOLD, BUT NOT YET PURCHASED, at market
                
                
                162,000
                
                
                44,000ACCOUNTS
                    PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
                
                
                3,943,000
                
                
                4,045,000CONVERTIBLE
                    NOTES PAYABLE, net of debt discounts of $159,000 and $0at
                    September 30, 2006 and 2005, respectively
                
                
                841,000
                
                
                —NOTES
                    PAYABLE, net of debt discounts of $45,000 and $206,000at
                    September 30, 2006 and 2005, respectively
                
                
                805,000
                
                
                1,819,000TOTAL
                    LIABILITIES
                
                
                5,864,000
                
                
                6,030,000SUBORDINATED
                    BORROWINGS
                
                
                1,000,000
                
                
                1,000,000COMMITMENTS
                    AND CONTINGENCIES (NOTES 14 and 15)
                
                
                —
                
                
                —STOCKHOLDERS'
                    EQUITYPreferred
                    stock, $.01 par value, 200,000 shares authorized; 50,000
                    sharesdesignated
                    as Series A and 20,000 shares designated as Series B
                
                
                —
                
                
                —Series
                    A 9% cumulative convertible preferred stock, $.01 par value,
                    50,000shares
                    authorized; 35,316 shares issued and outstanding
                    (liquidationpreference:
                    $3,531,600) at September 30, 2006 and 33,320 shares issued andoutstanding
                    (liquidation preference: $3,332,000) at September 30, 2005
                
                
                —
                
                
                —Series
                    B 10% cumulative convertible preferred stock, $.01 par value,
                    20,000shares
                    authorized; 10,000 shares issued and outstanding
                    (liquidationpreference:
                    $1,000,000) at September 30, 2006 and 0 shares issued andoutstanding
                    at September 30, 2005
                
                
                —
                
                
                —Common
                    stock, $.02 par value, 30,000,000 shares authorized;5,223,968
                    and 5,045,878 shares issued and outstanding,at
                    September 30, 2006 and 2005, respectively
                
                
                104,000
                
                
                101,000Additional
                    paid-in capital
                
                
                16,956,000
                
                
                15,295,000Accumulated
                    deficit
                
                
                (14,217,000
                )
                
                (14,466,000
                )TOTAL
                    STOCKHOLDERS' EQUITY
                
                
                2,843,000
                
                
                930,000TOTAL
                    LIABILITIES AND STOCKHOLDERS' EQUITY
                
                $
                9,707,000
                
                $
                7,960,000
 See
          notes
          to consolidated financials statements.
 F-2




**NATIONAL
                  HOLDINGS CORPORATION AND SUBSIDIARIES****CONSOLIDATED
                  STATEMENTS OF OPERATIONS**
  Years
                  EndedSeptember
                  30,
                2006
              
              September
                  30,
                2005
              
              September
                  30,
                2004REVENUESCommissions
              
              $
              32,140,000
              
              $
              33,134,000
              
              $
              46,881,000Net
                  dealer inventory gains
              
              
              7,838,000
              
              
              5,710,000
              
              
              7,404,000Investment
                  banking
              
              
              11,323,000
              
              
              528,000
              
              
              1,548,000Total
                  commission and fee revenues
              
              
              51,301,000
              
              
              39,372,000
              
              
              55,833,000Interest
                  and dividends
              
              
              2,891,000
              
              
              2,739,000
              
              
              3,420,000Transfer
                  fees and clearing services
              
              
              3,336,000
              
              
              3,097,000
              
              
              2,806,000Other
              
              
              1,199,000
              
              
              522,000
              
              
              401,00058,727,000
              
              
              45,730,000
              
              
              62,460,000EXPENSESCommissions
                  and fees
              
              
              42,276,000
              
              
              32,838,000
              
              
              43,932,000Employee
                  compensation and related expenses
              
              
              5,835,000
              
              
              5,010,000
              
              
              5,449,000Clearing
                  fees
              
              
              1,538,000
              
              
              432,000
              
              
              2,391,000Communications
              
              
              1,748,000
              
              
              1,670,000
              
              
              2,589,000Occupancy
                  and equipment costs
              
              
              2,805,000
              
              
              2,886,000
              
              
              2,983,000Professional
                  fees
              
              
              1,213,000
              
              
              1,520,000
              
              
              2,559,000Litigation
                  settlement
              
              
              —
              
              
              —
              
              
              400,000Interest
              
              
              494,000
              
              
              448,000
              
              
              397,000Taxes,
                  licenses, registration
              
              
              617,000
              
              
              344,000
              
              
              560,000Other
                  administrative expenses
              
              
              1,606,000
              
              
              1,765,000
              
              
              1,765,00058,132,000
              
              
              46,913,000
              
              
              63,025,000Net
                  income (loss) from operations
              
              
              595,000
              
              
              (1,183,000
              )
              
              (565,000
              )Gains
                  on extinguishments of debt
              
              
              —
              
              
              —
              
              
              1,131,000Net
                  income (loss)
              
              
              595,000
              
              
              (1,183,000
              )
              
              566,000Preferred
                  stock dividends
              
              
              (381,000
              )
              
              (290,000
              )
              
              (266,000
              )Net
                  income (loss) attributable to common stockholders
              
              $
              214,000
              
              $
              (1,473,000
              )
              $
              300,000INCOME
                  (LOSS) PER COMMON SHAREBasic:Net
                  income (loss) attributable to common stockholders
              
              $
              0.04
              
              $
              (0.29
              )
              $
              0.08Diluted:Net
                  income (loss) attributable to common stockholders
              
              $
              0.04
              
              $
              (0.29
              )
              $
              0.07Weighted
                  average number of shares outstanding:Basic
              
              
              5,146,422
              
              
              5,024,643
              
              
              3,580,446Diluted
              
              
              5,278,299
              
              
              5,024,643
              
              
              4,106,742


See
      notes to consolidated financials
      statements.


F-3




**NATIONAL
                  HOLDINGS CORPORATION AND SUBSIDIARIES****CONSOLIDATED
                  STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
                  (DEFICIT)****YEARS
                  ENDED SEPTEMBER 30, 2006, SEPTEMBER 30, 2005 AND SEPTEMBER 30,
                  2004**
  AdditionalPreferred
                  Stock
              
              Common
                  Stock
              
              Paid-InShares
              
              Amount
              
              Shares
              
              Amount
              
              Capital
              
              Deficit
              
              TotalBALANCE,
                  September 30, 2003
              
              
              27,825
              
              $
              —
              
              
              3,367,558
              
              $
              67,000
              
              $
              12,628,000
              
              $
              (13,024,000
              )
              $
              (329,000
              )Issuance
                  of series A preferred stock dividends
              
              
              3,352
              
              
              —
              
              
              —
              
              
              —
              
              
              503,000
              
              
              (503,000
              )
              
              —Exercise
                  of stock options
              
              
              —
              
              
              —
              
              
              26,003
              
              
              1,000
              
              
              25,000
              
              
              —
              
              
              26,000Exercise
                  of warrants
              
              
              —
              
              
              —
              
              
              240,771
              
              
              5,000
              
              
              290,000
              
              
              —
              
              
              295,000Issuance
                  of restricted common stock:From
                  private placement
              
              
              —
              
              
              —
              
              
              1,250,000
              
              
              25,000
              
              
              905,000
              
              
              —
              
              
              930,000Settlement
                  of arbitration
              
              
              —
              
              
              —
              
              
              100,000
              
              
              2,000
              
              
              98,000
              
              
              —
              
              
              100,000Warrants
                  issued in connection with debt
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              341,000
              
              
              —
              
              
              341,000Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              566,000
              
              
              566,000BALANCE,
                  September 30, 2004
              
              
              31,177
              
              
              —
              
              
              4,984,332
              
              
              100,000
              
              
              14,790,000
              
              
              (12,961,000
              )
              
              1,929,000Issuance
                  of series A preferred stock dividends
              
              
              2,143
              
              
              —
              
              
              —
              
              
              —
              
              
              322,000
              
              
              (322,000
              )
              
              —Exercise
                  of warrants
              
              
              —
              
              
              —
              
              
              21,546
              
              
              —
              
              
              19,000
              
              
              —
              
              
              19,000Issuance
                  of restricted common stock:Settlement
                  of arbitration
              
              
              —
              
              
              —
              
              
              40,000
              
              
              1,000
              
              
              39,000
              
              
              —
              
              
              40,000Warrants
                  issued in connection with debt
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              125,000
              
              
              —
              
              
              125,000Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (1,183,000
              )
              
              (1,183,000
              )BALANCE,
                  September 30, 2005
              
              
              33,320
              
              
              —
              
              
              5,045,878
              
              
              101,000
              
              
              15,295,000
              
              
              (14,466,000
              )
              
              930,000Issuance
                  of series A preferred stock dividends
              
              
              1,996
              
              
              —
              
              
              —
              
              
              —
              
              
              300,000
              
              
              (300,000
              )
              
              —Payment
                  of series B preferred stock dividends
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (46,000
              )
              
              (46,000
              )Issuance
                  of restricted common stock:From
                  private placement
              
              
              —
              
              
              —
              
              
              159,090
              
              
              3,000
              
              
              170,000
              
              
              —
              
              
              173,000Employee
                  bonuses
              
              
              —
              
              
              —
              
              
              19,000
              
              
              —
              
              
              12,000
              
              
              —
              
              
              12,000Issuance
                  of series B preferred stock
              
              
              10,000
              
              
              —
              
              
              —
              
              
              —
              
              
              972,000
              
              
              —
              
              
              972,000Warrants
                  issued in connection with debt
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              187,000
              
              
              —
              
              
              187,000Amortization
                  of deferred compensation
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              20,000
              
              
              —
              
              
              20,000Net
                  income
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              595,000
              
              
              595,000BALANCE,
                  September 30, 2006
              
              
              45,316
              
              $
              —
              
              
              5,223,968
              
              $
              104,000
              
              $
              16,956,000
              
              $
              (14,217,000
              )
              $
              2,843,000


See
        notes to consolidated financials
        statements.
 F-4


**NATIONAL
                  HOLDINGS CORPORATION AND SUBSIDIARIES****CONSOLIDATED
                  STATEMENTS OF CASH FLOWS**
  Years
                  endedSeptember
                  30,
                2006
              
              September
                  30,
                2005
              
              September
                  30,
                2004CASH
                  FLOWS FROM OPERATING ACTIVITIESNet
                  income (loss)
              
              $
              595,000
              
              $
              (1,183,000
              )
              $
              566,000Adjustments
                  to reconcile net income (loss) to netcash
                  provided by (used in) operating activitiesDepreciation and amortization
              
              
              162,000
              
              
              145,000
              
              
              165,000Gains on extinguishments of debt
              
              
              —
              
              
              —
              
              
              (1,131,000
              )Amortization of deferred financing costs
              
              
              4,000
              
              
              —
              
              
              —Amortization of note discount
              
              
              189,000
              
              
              163,000
              
              
              122,000Compensatory element of common stock issuance
              
              
              12,000
              
              
              —
              
              
              —Compensatory element of common stock option issuances
              
              
              19,000
              
              
              —
              
              
              —Provision for doubtful accounts
              
              
              25,000
              
              
              150,000
              
              
              200,000Forgiveness of loan
              
              
              —
              
              
              —
              
              
              (251,000
              )Issuance of common stock in settlement of arbitration
              
              
              —
              
              
              40,000
              
              
              100,000Changes
                  in assets and liabilitiesDeposits
                  with clearing organizations
              
              
              —
              
              
              695,000
              
              
              46,000Receivables
                  from broker-dealers, clearing organizations and others
              
              
              (42,000
              )
              
              829,000
              
              
              (1,569,000
              )Securities
                  owned: marketable, at market value
              
              
              (309,000
              )
              
              (17,000
              )
              
              225,000Securities
                  owned: non-marketable, at fair value
              
              
              (402,000
              )
              
              —
              
              
              —Other
                  assets
              
              
              104,000
              
              
              101,000
              
              
              65,000Payables
              
              
              (111,000
              )
              
              (737,000
              )
              
              127,000Securities
                  sold, but not yet purchased, at market
              
              
              118,000
              
              
              11,000
              
              
              (83,000
              )Net
                  cash provided by (used in) operating activities
              
              
              364,000
              
              
              197,000
              
              
              (1,418,000
              )CASH
                  FLOWS FROM INVESTING ACTIVITIESPurchase
                  of fixed assets
              
              
              (217,000
              )
              
              (94,000
              )
              
              (219,000
              )Net
                  cash used in investing activities
              
              
              (217,000
              )
              
              (94,000
              )
              
              (219,000
              )CASH
                  FLOWS FROM FINANCING ACTIVITIESNet
                  proceeds from issuance of common stock and warrants
              
              
              173,000
              
              
              —
              
              
              930,000Net
                  proceeds from issuance of preferred stock
              
              
              972,000
              
              
              —
              
              
              —Net
                  proceeds from issuance of convertible notes payable
              
              
              1,000,000
              
              
              —
              
              
              —Net
                  proceeds from issuance of notes payable and warrants
              
              
              —
              
              
              —
              
              
              1,036,000Cash
                  payment of deferred financing costs
              
              
              (28,000
              )
              
              —
              
              
              —Payment
                  of notes payable
              
              
              (1,175,000
              )
              
              (75,000
              )
              
              (750,000
              )Dividends
                  paid
              
              
              (46,000
              )
              
              —
              
              
              —Exercise
                  of stock options and warrants
              
              
              —
              
              
              19,000
              
              
              321,000Net
                  cash provided by (used in) financing activities
              
              
              896,000
              
              
              (56,000
              )
              
              1,537,000NET
                  INCREASE (DECREASE) IN CASH
              
              
              1,043,000
              
              
              47,000
              
              
              (100,000
              )CASH
                  BALANCEBeginning
                  of the year
              
              
              398,000
              
              
              351,000
              
              
              451,000End
                  of the year
              
              $
              1,441,000
              
              $
              398,000
              
              $
              351,000SUPPLEMENTAL
                  DISCLOSURES OF CASH FLOW INFORMATIONCash
                  paid during the year for:Interest
              
              $
              501,000
              
              $
              450,000
              
              $
              363,000Series
                  B preferred stock dividends
              
              $
              46,000
              
              $
              —
              
              $
              —SUPPLEMENTAL
                  DISCLOSURES OF NONCASH INVESTING ANDFINANCING
                  ACTIVITIESWarrants
                  issued in connection with debt
              
              $
              187,000
              
              $
              125,000
              
              $
              341,000Series
                  A preferred stock dividends
              
              $
              300,000
              
              $
              322,000
              
              $
              503,000


See
      notes to consolidated financials
      statements.


F-5




NATIONAL
      HOLDINGS CORPORATION


AND
      SUBSIDIARIES





NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS





SEPTEMBER
      30, 2006, SEPTEMBER 30, 2005 AND SEPTEMBER 30, 2004





1.
            ORGANIZATION





National
      Holdings Corporation (“National Holdings” or **** the
      “Company”), a
      Delaware corporation organized in 1996, **** is
      a
      financial services organization, operating through its wholly owned subsidiary,
      National Securities Corporation (“National Securities”) a
      Washington corporation organized in 1947 . National
      Securities conducts a national securities brokerage business through its main
      offices in Seattle, Washington and New York, New York. The
      Company’s business includes securities brokerage for individual and
      institutional clients, market-making trading activities, asset management and
      corporate finance services. National Securities is an introducing broker and
      clears all transactions through clearing organizations on a fully disclosed
      basis. On March 15, 2006, the Company changed its name from “Olympic Cascade
      Financial Corporation” to “National Holdings Corporation.”




National
      Holdings formed a new wholly owned subsidiary, National Insurance
      Corporation, a
      Washington corporation (“National Insurance”) in
      the
      third quarter of fiscal year 2006. National Insurance will provide fixed
      insurance products to its clients, including life insurance, disability
      insurance, long term care insurance and fixed annuities. National Insurance
      is
      in the process of completing the requisite state registrations, and has not
      yet
      commenced active business operations.





2.
              SUMMARY
                  OF SIGNIFICANT ACCOUNTING
                  POLICIES





a.
                Principles
                    of Consolidation-
                    The consolidated financial statements include the accounts of
                    National
                    Holdings, National Securities and National Insurance, its wholly
                    owned
                    subsidiaries. All significant inter-company accounts and transactions
                    have
                    been eliminated in
                    consolidation.





b.
            Estimates****-****The
                preparation of financial statements in conformity with accounting
                principles generally accepted in the United States of America requires
                management to make estimates and assumptions that affect the reported
                amounts of assets and liabilities, 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.





c.
            Revenue
                Recognition-
                Customer security transactions and the related commission income
                and
                expense are recorded as of the trade date. Investment banking revenues
                include gains, losses, and fees, net of syndicate expenses, arising
                from
                securities offerings in which the Company acts as an underwriter
                or agent.
                Investment banking revenues also include fees earned from providing
                financial advisory services. Investment banking management fees are
                recorded on the offering date, sales concessions on the settlement
                date,
                and underwriting fees at the time the underwriting is completed and
                the
                income is reasonably determinable. Customers who are financing their
                transaction on margin are charged interest. The Company’s margin
                requirements are in accordance with the terms and conditions mandated
                by
                its clearing firms, National Financial Services
                LLC




F-6




(“NFS”)
      and Penson Financial Services, Inc. (“Penson”). The interest is billed on the
      average daily balance of the margin account.




Net
      dealer inventory gains result from securities transactions entered into for
      the
      account and risk of the Company. Net dealer inventory gains are recorded on
      a
      trade date basis. Transfer fees are charged for each customer’s security
      transaction, and are recognized as of the trade date. Investment advisory fees
      are account management fees for high net worth clients. These fees are billed
      quarterly and recognized at such time that collection is probable.




The
      Company generally acts as an agent in executing customer orders to buy or sell
      listed and over-the-counter securities in which it does not make a market,
      and
      charges commissions based on the services the Company provides to its customers.
      In executing customer orders to buy or sell a security in which the Company
      makes a market, the Company may sell to, or purchase from, customers at a price
      that is substantially equal to the current inter-dealer market price plus or
      minus a mark-up or mark-down. The Company may also act as agent and execute
      a
      customer's purchase or sale order with another broker-dealer market-maker at
      the
      best inter-dealer market price available and charge a commission. Mark-ups,
      mark-downs and commissions are generally priced competitive based on the
      services it provides to its customers. In each instance the commission charges,
      mark-ups or mark-downs, are in compliance with guidelines established by the
      NASD.





d.
            Fixed
                Assets-
                Fixed assets are recorded at cost. Depreciation is calculated using
                the
                straight-line method based on the estimated useful lives of the related
                assets, which range from three to five years. Leasehold improvements
                are
                amortized using the straight-line method over the shorter of the
                estimated
                useful lives of the assets or the terms of the leases. Expenditures
                for
                maintenance and repairs, which do not extend the economic useful
                life of
                the related assets, are charged to operations as incurred. When assets
                are
                retired or otherwise disposed of, the costs and related accumulated
                depreciation or amortization are removed from the accounts and any
                gain or
                loss on disposal is recognized.





e.
              Income
                  Taxes-
                  The Company recognizes deferred tax assets and liabilities based
                  on the
                  difference between the financial statements carrying amounts and
                  the tax
                  basis of assets and liabilities, using the effective tax rates
                  in the
                  years in which the differences are expected to reverse. A valuation
                  allowance related to deferred tax assets is also recorded when
                  it is more
                  likely than not that some or all of the deferred tax asset will
                  not be
                  realized.





f.
            Investment
                in Limited Partnership****-
                The Company accounts for its investment in the limited partnership
                in
                accordance with the equity method of accounting. Such asset has been
                included in other assets in the accompanying consolidated statements
                of
                financial condition. The Company has an investment in the limited
                partnership for which the carrying value is $0 at September 30,
                2006.





g.
            Fair
                Value of Financial Instruments****-
                The carrying amounts reported in the balance sheet for cash, receivables,
                accounts payable, accrued expenses and other liabilities approximates
                fair
                value based on the short-term maturity of these
                instruments.





F-7





h.
            Impairment
                of Long-Lived Assets****-****The
                Company reviews long-lived assets for impairment whenever circumstances
                and situations change such that there is an indication that the carrying
                amounts may not be recovered. At September 30, 2006, the Company
                has
                determined that there has been no impairment of its long-lived
                assets.





i.
            Income
                (Loss) per Common Share-
                Basic income (loss) per share is computed on the basis of the weighted
                average number of common shares outstanding. Diluted income (loss)
                per
                share is computed on the basis of the weighted average number of
                common
                shares outstanding plus the potential dilution that could occur if
                securities or other contracts to issue common shares were exercised
                or
                converted.




Fiscal
                  Years EndedSeptember
                  30,
              
              September
                  30,
              
              September
                  30,2006
              
              2005
              
              2004Numerator:Net
                  income (loss)
              
              $
              595,000
              
              $
              (1,183,000
              )
              $
              566,000Preferred
                  stock dividends
              
              
              (381,000
              )
              
              (290,000
              )
              
              (266,000
              )Numerator
                  for basic and diluted earnings per share--netincome
                  (loss) attributable to common stockholders
              
              $
              214,000
              
              $
              (1,473,000
              )
              $
              300,000Denominator:Denominator
                  for basic earnings per share--weightedaverage
                  shares
              
              
              5,146,422
              
              
              5,024,643
              
              
              3,580,446Effective
                  of dilutive securities:Stock
                  options
              
              
              36,520
              
              
              —
              
              
              36,182Warrants
              
              
              95,357
              
              
              —
              
              
              490,114Dilutive
                  potential common shares
              
              
              131,877
              
              
              —
              
              
              526,296Denominator
                  for diluted earnings per share--adjustedweighted-average
                  shares and assumed conversions
              
              
              5,278,299
              
              
              5,024,643
              
              
              4,106,742Net
                  income (loss) available to common stockholdersBasic:
              
              $
              0.04
              
              $
              (0.29
              )
              $
              0.08Diluted:
              
              $
              0.04
              
              $
              (0.29
              )
              $
              0.07




For
        the
        fiscal year ended September 30, 2006, 5,158,613 shares attributable to
        outstanding Series A and B Preferred Stock and convertible notes were excluded
        from the calculation of diluted net income per share because if included
        the
        effect would be anitdilutive. For the fiscal year ended September 30, 2005,
        5,357,278 shares attributable to outstanding Series A Preferred Stock, stock
        options and warrants were excluded from the calculation of diluted net income
        per share because if included the effect would be anitdilutive. For the fiscal
        year ended September 30, 2004, 2,078,465 shares attributable to outstanding
        Series A Preferred Stock were excluded from the calculation of diluted net
        income per share because if included the effect would be
        anitdilutive.




j.
              Stock-Based
                  Compensation-
                  Prior to October 1, 2005, the Company accounted for employee stock
                  transactions in accordance with Accounting Principle Board, APB
                  Opinion
                  No. 25, “Accounting for Stock Issued to Employees.”
                  The
 F-8


Company
      had adopted the pro forma disclosure requirements of Statement of Financial
      Accounting Standards No. 123, “Accounting For Stock-Based Compensation.”




Effective
      October 1, 2005, the Company adopted FASB Statement of Financial Accounting
      Standard (“SFAS”) No. 123R “Share Based Payment.”  This statement is a
      revision of SFAS Statement No. 123, and supersedes APB Opinion No. 25,
      and its related implementation guidance. SFAS 123R addresses all forms of share
      based payment (“SBP”) awards including shares issued under employee stock
      purchase plans, stock options, restricted stock and stock appreciation rights.
      Under SFAS 123R, SBP awards will result in a charge to operations that will
      be
      measured at fair value on the awards grant date, based on the estimated number
      of awards expected to vest over the service period.  During fiscal year
      2006, the Company granted 170,000 stock options with a fair value of
      approximately $88,000. A charge of approximately $20,000 was recorded in fiscal
      year 2006, relating to the amortization of the fair value associated with these
      grants.




For
      fiscal years 2005 and 2004, the Company applied APB Opinion No. 25,
“Accounting for Stock Issued to Employees.”  As required under SFAS
      No. 148, “Accounting for Stock-based Compensation - Transition and
      Disclosure,” the following table presents pro forma net income and basic and
      diluted earnings per share as if the fair value-based method had been applied
      to
      all awards during those years.




Fiscal
                  Years EndedSeptember
                  30,
              
              September
                  30,2005
              
              2004Net
                  income (loss) attributable to common stockholders - as
                  reported
              
              $
              (1,473,000
              )
              $
              300,000Stock-based
                  employee compensation cost determined underfair
                  value method, net of tax effects
              
              
              (869,000
              )
              
              (286,000
              )Net
                  income (loss) attributable to common stockholders - pro
                  forma
              
              $
              (2,342,000
              )
              $
              14,000Earnings
                  (loss) per shareBasic
                  earnings (loss) loss per share:Net
                  income (loss) attributable to common stockholders - as
                  reported
              
              $
              (0.29
              )
              $
              0.08Per
                  share stock-based employee compensation costdetermined
                  under fair value method, net of tax effects
              
              
              (0.17
              )
              
              (0.08
              )Net
                  income (loss) attributable to common stockholders - pro
                  forma
              
              $
              (0.46
              )
              $
              —Diluted
                  earnings (loss) loss per share:Net
                  income (loss) attributable to common stockholders - as
                  reported
              
              $
              (0.29
              )
              $
              0.07Per
                  share stock-based employee compensation costdetermined
                  under fair value method, net of tax effects
              
              
              (0.17
              )
              
              (0.07
              )Net
                  income (loss) attributable to common stockholders - pro
                  forma
              
              $
              (0.46
              )
              $
              —




The
      Black-Scholes option valuation model was used to estimate the fair value of
      the
      options granted during the fiscal years ended September 30, 2005, 2004
      and





F-9





2003.
      The
      model includes subjective input assumptions that can materially affect the
      fair
      value estimates. The model was developed for use in estimating the fair value
      of
      traded options that have no vesting restrictions and that are fully
      transferable. For example, the expected volatility is estimated based on the
      most recent historical period of time equal to the weighted average life of
      the
      options granted. Options issued under the Company's option plans have
      characteristics that differ from traded options. In the Company's opinion,
      this
      valuation model does not necessarily provide a reliable single measure of the
      fair value of its employee stock options. Principal assumptions used in applying
      the Black-Scholes model along with the results from the model were as
      follows:


Fiscal
                    Years EndedSeptember
                    30,
                
                September
                    30,
                
                September
                    30,2006
                
                2005
                
                2004Assumptions:Risk-free
                    interest rate
                
                
                4.40
                %
                
                3.15
                %
                
                2.48
                %Expected
                    life, in years
                
                
                3.0
                
                
                5.0
                
                
                3.0Expected
                    volatility
                
                
                88
                %
                
                135
                %
                
                123
                %


As
      of
      September 30, 2006, there was $68,000 of total deferred compensation costs
      related to share-based compensation arrangements.




A
      summary
      of the status of the Company’s nonvested shares as of September 30, 2006, and
      changes during the fiscal year then ended is presented below:




WeightedAverageGrant
                  DateNonvested
                  Shares
              
              Shares
              
              Fair
                  ValueNonvested
                  at September 30, 2005
              
              
              10,000
              
              $
              —Granted
              
              
              170,000
              
              $
              0.52Vested
              
              
              (101,250
              )
              $
              0.62Expired
              
              
              (3,750
              )
              $
              —Nonvested
                  at September 30, 2006
              
              
              75,000
              
              $
              0.33




k.
            Concentrations
                of Credit Risk-
                The Company is engaged in trading and providing a broad range of
                securities brokerage and investment services to a diverse group of
                retail
                and institutional clientele, as well as corporate finance and investment
                banking services to corporations and businesses. Counterparties to
                the
                Company’s business activities include broker-dealers and clearing
                organizations, banks and other financial institutions. The Company
                uses
                clearing brokers to process transactions and maintain customer accounts
                on
                a fee basis for the Company. The Company uses two clearing brokers
                for
                substantially all of its business. The Company permits the clearing
                firms
                to extend credit to its clientele secured by cash and securities
                in the
                client’s account. The Company’s exposure to credit
                risk





F-10





associated
      with the non-performance by its customers and counterparties in fulfilling
      their
      contractual obligations can be directly impacted by volatile or illiquid trading
      markets, which may impair the ability of customers and counterparties to satisfy
      their obligations to the Company. The Company has agreed to indemnify the
      clearing brokers for losses they incur while extending credit to the Company’s
      clients. It is the Company’s policy to review, as necessary, the credit standing
      of its customers and each counterparty. Amounts due from customers that are
      considered uncollectible by the clearing broker are charged back to the Company
      by the clearing broker when such amounts become determinable. Upon notification
      of a charge back, such amounts, in total or in part, are then either (i)
      collected from the customers, (ii) charged to the broker initiating the
      transaction and included in other receivables in the accompanying consolidated
      statements of financial condition, and/or (iii) charged as an expense in the
      accompanying consolidated statements of financial condition, based on the
      particular facts and circumstances.




The
      Company maintains cash with major financial institutions. The Federal Deposit
      Insurance Corporation (“FDIC”) insures up to $100,000 at each institution. At
      times such amounts may exceed the FDIC limits. At September 30, 2006 the
      uninsured cash bank balance was $1,051,000. The Company believes it is not
      exposed to any significant credit risks for cash.




l.
            Other
                Receivables-
                The Company extends unsecured credit in the normal course of business
                to
                its brokers. The determination of the amount of uncollectible accounts
                is
                based on the amount of credit extended and the length of time each
                receivable has been outstanding, as it relates to each individual
                broker.
                The allowance for doubtful accounts reflects the amount of loss that
                can
                be reasonably estimated by management, and is included in other expenses
                in the accompanying consolidated statements of
                operations.





m.
            Advances
                to Registered Representatives-
                Advances are given to certain registered representatives as an incentive
                for their affiliation with National Securities. The representative
                signs
                an independent contractor agreement with National Securities for
                a
                specified term, typically a three-year period. The advance is then
                amortized on a straight-line basis over the amount of time the
                representative is obligated to be affiliated with National Securities,
                and
                is included in commissions expense in the accompanying consolidated
                statements of operations. In the event the representative’s affiliation
                with National Securities terminates prior to the fulfillment of their
                contract, the representative is required to repay the unamortized
                balance.





n.
            Securities
                Owned-
                Marketable securities which consist of publicly traded unrestricted
                common
                stock and bonds are valued at the closing price on the valuation
                date.
                Non-marketable securities which consist of non-tradable warrants
                exercisable into freely trading common stock of public companies
                are
                carried at fair value as determined in good faith by
                management.




o.
            Other
                Assets-
                Other assets consist of investment in a venture capital fund, pre-paid
                expenses and lease deposits.





p.
            Recently
                Issued Accounting Standards****-
                In February 2006, the FASB issued Statement of Financial Accounting
                Standard 155 “Accounting for Certain
                Hybrid





F-11





Financial
      Instruments” (“SFAS 155”), which eliminates the exemption from applying SFAS 133
“Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) to
      interests in securitized financial assets so that similar instruments are
      accounted for similarly regardless of the form of the instruments. SFAS 155
      also
      allows the election of fair value measurement at acquisition, at issuance,
      or
      when a previously recognized financial instrument is subject to a remeasurement
      event. Adoption is effective for all financial instruments acquired or issued
      after the beginning of the first fiscal year that begins after
      September 15, 2006. Early adoption is permitted. The adoption of SFAS 155
      is not expected to have a material effect on the Company’s consolidated
      financial position, results of operations or cash flows.




In
      March
      2006, the FASB issued Statement of Financial Accounting Standard 156 “Accounting
      for Servicing of Financial Assets” (“SFAS 156”), which requires all separately
      recognized servicing assets and servicing liabilities be initially measured
      at
      fair value. SFAS 156 permits, but does not require, the subsequent measurement
      of servicing assets and servicing liabilities at fair value. Adoption is
      required as of the beginning of the first fiscal year that begins after
      September 15, 2006. Early adoption is permitted. The adoption of SFAS 156
      is not expected to have a material effect on the Company’s consolidated
      financial position, results of operations or cash flows.




In
      September 2006, the FASB issued SFAS No. 157, “Accounting for Fair Value
      Measurements” (“SFAS 157”). SFAS 157 defines fair value, and establishes a
      framework for measuring fair value in generally accepted accounting principles
      and expands disclosure about fair value measurements. SFAS 157 is effective
      for
      the Company for financial statements issued subsequent to November 15,
      2007. The Company does not expect the new standard to have a material impact
      on
      the Company’s financial position, results of operations or cash
      flows.




In
      September 2006, the staff of the SEC issued Staff Accounting Bulletin No. 108
      (“SAB 108”) which provides interpretive guidance on how the effects of the
      carryover or reversal of prior year misstatements should be considered in
      quantifying a current year misstatement. SAB 108 becomes effective in fiscal
      year 2007. Adoption of SAB 108 is not expected to have a material impact on
      the
      Company’s consolidated financial position, results of operations or cash
      flows.




3.
            SIGNIFICANT
                AGREEMENTS AND TRANSACTIONS





a.
            CLEARING
                AGREEMENTS





In
      December 2003, the Company engaged in discussions with the NASD relating to
      the
      Security Agreement between National Securities and its then current clearing
      firm, First Clearing Corporation (“First Clearing”), a wholly owned subsidiary of Wachovia
      Corporation ,
      and its
      effect on the computation of National Securities’ net capital. As a result of
      these discussions, on December 15, 2003, the Company and First Clearing agreed
      in principle to the following: (1) National Securities’ clearing deposit was
      reduced from $1,000,000 to $500,000; (2) the excess $500,000 was paid to First
      Clearing to reduce the Company’s outstanding loan balance on its promissory
      note; and (3) the Security Agreement between National Securities and First
      Clearing was terminated. Furthermore, First





F-12





Clearing
      forgave payment of an additional $375,000 loan that was due to be paid in
      January 2004, resulting in a $375,000 gain on extinguishments of debt in the
      first quarter of fiscal year 2004.




In
      February 2004, the Company paid First Clearing $250,000 to fully repay its
      promissory note that had a balance of approximately $1,006,000 at such time.
      As
      a result of the repayment of this note, the Company realized gains on
      extinguishments of debt of approximately $756,000 in the second quarter of
      fiscal year 2004. Additionally, National Securities and First Clearing mutually
      agreed to terminate their clearing relationship.




In
      June
      2004, National Securities entered into an agreement with Fiserv Securities,
      Inc.
      (“Fiserv”) to clear its brokerage business. The conversion from First Clearing
      to Fiserv was completed in the first week of October 2004. As part of this
      transaction, Fiserv provided National Securities with an $800,000 conversion
      assistance payment, $250,000 of which was paid upon execution of the clearing
      agreement, $250,000 of which was paid in mid-August 2004, and $300,000 of which
      was paid in October 2004.




In
      March
      2005, NFS acquired the clearing business of Fiserv. In April 2005, National
      Securities entered into a clearing agreement with NFS that became effective
      in
      June 2005. As part of this transaction, NFS provided National Securities with
      a
      $1.0 million conversion fee credit to reimburse the Company for the
      transitional, incremental costs incurred by National Securities relating to
      the
      conversion of its clearing business to NFS. National Securities was paid
      $250,000 in May 2005, and the remaining $750,000 was paid in July 2005. The
      clearing agreement includes a termination fee if National Securities terminates
      the agreement without cause. Additionally, in June 2005, National Securities
      entered into a clearing agreement with Penson for the purpose of providing
      clearing services that are not provided by NFS. The Company believes that the
      overall effect of its clearing relationships has been beneficial to the
      Company’s cost structure, liquidity and capital resources.





b.
            CAPITAL
                TRANSACTIONS





(i)
            In
                August 2005, upon the maturity of previously issued notes, the Company
                and
                two note holders entered into new note agreements providing for$1.0
                million ofnotes
                with a maturity date of July 31, 2007, together with warrants having
                an
                expiration date of July 31, 2007 to purchase, in the aggregate, 200,000
                shares of common stock at a price of $1.25 per share.These
                notes in the principal amount of $1.0 million were repaid in full
                in
                January 2006.  In
                February 2006,upon
                the maturity of a previously issued secured demand note,National
                Securities and the holder entered into a new $1.0 million secured
                demand
                notecollateral
                agreementwith
                a maturity date of March 1, 2007. The holder also entered into a
                warrant
                agreementto
                purchase 150,000 shares of common stock at a price of $1.25 per share,
                with anexpiration
                date of July 31, 2007.




F-13




The
      Company recorded total allocated fair value of $130,000 to the warrants. The
      fair value of the warrants was recorded as a debt discount and is being
      amortized to interest expense.





(ii)
            In
                the first quarter of fiscal year 2003, the Company consummated a
                private
                placement of its securities, and issued 1,016,186 shares of restricted
                common stock and 1,016,186 warrants. In December 2005, the Company
                extended the expiration date of the warrants issued in this private
                placement, including the placement agent warrants, to December 23,
                2006
                from December 23, 2005.





(iii)
            In
                January 2004, the Company consummated a private offering of its securities
                to a limited number of accredited investors pursuant to Rule 506
                of
                Regulation D under the Securities Act wherein the Company issued
                an
                aggregate of $200,000 of three-year, 10% senior subordinated promissory
                notes to five unaffiliated parties. The note holders received three-year
                warrants to purchase an aggregate of 50,000 shares of the Company’s common
                stock at an exercise price of $1.40 per share, with an allocated
                fair
                value of approximately $40,000. In December 2004, the Company rescinded
                a
                note in the principal amount of $25,000****and
                a warrant to purchase 6,250 shares of Common Stock. The remaining
                notes in
                the principal amount of $175,000 were repaid in full in March
                2006.




In
      February 2004, the Company consummated a private offering of its securities
      to a
      limited number of accredited investors pursuant to Rule 506 of Regulation D
      under the Securities Act wherein the Company issued an aggregate of $850,000
      of
      three-year, 10% senior subordinated promissory notes to four unaffiliated
      parties. The note holders received three-year warrants to purchase an aggregate
      of 170,000 shares of the Company’s common stock at an exercise price of $1.50
      per share, with an allocated fair value of approximately $143,000.




The
      Company is accreting the total allocated fair value of $183,000 over the
      three-year term of these promissory notes, and the balance from the January
      2004
      notes was accreted in March 2006. Such accretion has been included in “Interest”
in the accompanying consolidated financial statements.





(iv)
            In
                the fourth quarter of fiscal year 2004, the Company consummated a
                private
                placement of its securities to a limited number of accredited investors
                pursuant to Rule 506 of Regulation D under the Securities Act. Each
                unit
                in this offering sold for $1.60 and consisted of two shares of the
                Company’s common stock and one three-year warrant to purchase one share of
                the Company’s common stock at a per share price of $1.50. Net proceeds of
                $930,000 closed in the fourth quarter of fiscal year 2004, and the
                Company
                correspondingly issued 1,250,000 shares of the Company’s common stock and
                625,000 warrants.




(v)
            In
                the fourth quarter of fiscal year 2004, the Company issued 100,000
                shares
                of common stock as part of the settlement of an arbitration, as payment
                of
                approximately $100,000. In the second quarter of fiscal year 2005,
                the
                Company issued 40,000 shares of common stock as part of the settlement
                of
                two arbitrations as payment of approximately $40,000. Such payments
                have




F-14




been
      included in “Professional fees”, and the issuance of the shares of common stock
      has been included in “Common stock” and “Additional paid-in capital”, in the
      accompanying consolidated financial statements.





(vi)
            In
                January 2006, the Company completeda
                financing transaction exempt from registration under Section 4(2)
                of the
                Securities Act, under which certain new investors made a $2.0 million
                investment in the Company by purchasing an aggregate of the following:
                (i)$1.0
                millionfor 10,000 shares of the Company’s newly created Series B Preferred Stock,
                which has a 10% dividend rate and is convertible into Common Stock
                at a
                price of $.75 per share, and (ii)11%
                convertible promissory notes in the principal amount of $1.0
                million,which
                are convertible into Common Stock at a price of $1.00 per
                sharewithwarrants
                to purchase an aggregate of 300,000 shares of Common Stock at an
                exercise
                price of $1.00 per share.





The
      convertible promissory notes mature in January 2011. The Company granted 300,000
      warrants to acquire shares of common stock to the note holders, and the fair
      value of the warrants was calculated using the Black-Scholes Option Valuation
      Model. The Company recorded a debt discount of approximately $187,000 that
      will
      be charged to interest expense over the life of the debt.




The
      investment included $1.7 million by St. Cloud Capital Partners, L.P. (“St.
      Cloud”), and an aggregate of $300,000 by two unrelated investors. Marshall S.
      Geller, the Senior Managing Member of
      SCGP,
      LLC, the General Partner of St. Cloud, became a
      member of the Board of Directors of the Company
      simultaneous with the closing of the transaction. The
      Company incurred legal fees and other costs related to this capital transaction,
      in the amount of $56,000.




In
      January 2006, t he
      Company used $1.0 million of the proceeds from the above private placement
      to
      pay in full $1.0 million of promissory notes held by two unrelated note holders
      that had a maturity date of July 31, 2007.





(vii)
            In
                March 2006, the Company issued 159,090 shares of the Company’s common
                stock to an unaffiliated party for $175,000in
                a private placement exempt from registration under Section 4(2) of
                the
                Securities Act.
                The proceeds from the private placement were used to retire $175,000
                of
                the Company’s promissory notes that were due to mature in January
                2007.





(viii)
            In
                May 2006, the Company filed a Registration Statement on Form S-1
                under the
                Securities Act of 1933 for the resale of certain shares of Common
                Stock,
                shares of Common Stock issuable upon the conversion of preferred
                stock and
                notes, and exercise of certain warrants previously issued in connection
                with private placement transactions. The Registration Statement became
                effective on November 6, 2006.





4.
            BROKER-DEALERS
                AND CLEARING ORGANIZATIONS RECEIVABLES AND
                PAYABLES





At
      September 30, 2006 and 2005 the receivables of $3,548,000 and $3,329,000,
      respectively, from brokers and dealers represent net amounts due for fees and
      commissions. At September


F-15





30,
      2006
      and 2005, the amounts payable to broker dealers and clearing organizations
      of
      $113,000 and $122,000, respectively, represent amounts payable for inventory
      purchases on behalf of the Company and its customers.





5.
            OTHER
                RECEIVABLES





An
      analysis of other receivables, and the allowance for uncollectible accounts
      on
      such receivables for the fiscal years ended September 30, 2004, 2005 and 2006
      is
      as follows:




Other
              
              
              
              NetReceivables
              
              Allowance
              
              ReceivablesBalance,
                  September 30, 2003
              
              $
              1,359,000
              
              $
              (650,000
              )
              $
              709,000Additions
              
              
              435,000
              
              
              —
              
              
              435,000Collections
              
              
              (55,000
              )
              
              —
              
              
              (55,000
              )Provision
              
              
              —
              
              
              (200,000
              )
              
              (200,000
              )Balance,
                  September 30, 2004
              
              
              1,739,000
              
              
              (850,000
              )
              
              889,000Additions
              
              
              110,000
              
              
              —
              
              
              110,000Collections
              
              
              (364,000
              )
              
              —
              
              
              (364,000
              )Provision
              
              
              —
              
              
              (150,000
              )
              
              (150,000
              )Write-offs
              
              
              (632,000
              )
              
              632,000
              
              
              —Balance,
                  September 30, 2005
              
              
              853,000
              
              
              (368,000
              )
              
              485,000Additions
              
              
              343,000
              
              
              —
              
              
              343,000Collections
              
              
              (349,000
              )
              
              —
              
              
              (349,000
              )Provision
              
              
              —
              
              
              (99,000
              )
              
              (99,000
              )Balance,
                  September 30, 2006
              
              $
              847,000
              
              $
              (467,000
              )
              $
              380,000


The
      $632,000 write off in fiscal year 2005 represents a reduction in the allowance
      for uncollectible amounts that had been reserved for in previous periods. Since
      this was a write off of an already existing allowance for uncollectible
      accounts, there was only a balance sheet effect and there was no income
      statement effect.





6.
            ADVANCES
                TO REGISTERED REPRESENTATIVES





An
      analysis of advances to registered representatives for the fiscal years ended
      September 30, 2005 and 2006 is as follows:


Balance,
                    September 30, 2004
                
                $
                1,736,000Advances
                
                
                1,123,000Amortization
                    of advances
                
                
                (1,206,000
                )Balance,
                    September 30, 2005
                
                
                1,653,000Advances
                
                
                1,184,000Amortization
                    of advances
                
                
                (1,281,000
                )Balance,
                    September 30, 2006
                
                $
                1,556,000


The
      unamortized advances outstanding at September 30, 2006, 2005 and 2004
      attributable to registered representatives who ended their affiliation with
      National Securities prior to the fulfillment of their obligation was $32,000,
      $44,000 and $40,000, respectively.


F-16




7.
            SECURITIES
                OWNED AND SECURITIES SOLD, BUT NOT YET PURCHASED, AT
                MARKET





The
      following table shows the market values of the Company's
      securities owned
      and
      securities sold, but not yet purchased as of
      September 30, 2006 and 2005, respectively:


September
                  30, 2006
              
              September
                  30, 2005Securities
              
              
              
              SecuritiesSecurities
              
              sold,
                  but not
              
              Securities
              
              sold,
                  but notowned
              
              yet
                  purchased
              
              owned
              
              yet
                  purchasedCorporate
                  stocks
              
              $
              459,000
              
              $
              162,000
              
              $
              150,000
              
              $
              25,000Corporate
                  bonds
              
              
              —
              
              
              —
              
              
              —
              
              
              19,000Government
                  obligations
              
              
              16,000
              
              
              —
              
              
              16,000
              
              
              —$
              475,000
              
              $
              162,000
              
              $
              166,000
              
              $
              44,000


Securities
      sold, but not yet purchased commit the Company to deliver specified securities
      at predetermined prices. The transactions may result in market risk since,
      to
      satisfy the obligation, the Company must acquire the securities at market
      prices, which may exceed the values reflected in the consolidated statements
      of
      financial condition.





Non-marketable
      securities owned at September 30, 2006 consist of non-tradable warrants
      exercisable into freely trading common stock of public companies totaling
      $402,000.





8.
            FIXED
                ASSETS





Fixed
      assets as of September 30, 2006 and 2005, respectively, consist of the
      following:




September
                  30,
                2006
              
              September
                  30,
                2005
              
              Estimated
                  Useful LivesOffice
                  machines
              
              $
              138,000
              
              $
              138,000
              
              
              5
                  yearsFurniture
                  and fixtures
              
              
              160,000
              
              
              157,000
              
              
              5
                  yearsTelephone
                  system
              
              
              34,000
              
              
              34,000
              
              
              5
                  yearsElectronic
                  equipment
              
              
              596,000
              
              
              399,000
              
              
              3
                  yearsLeasehold
                  improvements
              
              
              262,000
              
              
              246,000
              
              
              Lesser
                  of terms of leases or useful lives1,190,000
              
              
              974,000Less
                  accumulated depreciation and amortization
              
              
              (885,000
              )
              
              (724,000
              )Fixed
                  assets - net
              
              $
              305,000
              
              $
              250,000


Depreciation
      and amortization expense for the years ended September
      30, 2006, 200 5
      and
      2004 was $162,000, $145,000 and $165,000, respectively.


F-17




9.
            OTHER
                ASSETS





Other
      assets as of September 30, 2006 and 2005, respectively, consist of the
      following:




September
                  30,
                2006
              
              September
                  30,
                2005Pre-paid
                  expenses
              
              $
              203,000
              
              $
              234,000Deposits
              
              
              38,000
              
              
              38,000Deferred
                  financing costs
              
              
              24,000
              
              
              —Other
              
              
              235,000
              
              
              107,000Total
              
              $
              500,000
              
              $
              379,000


10.
            ACCOUNTS
                PAYABLE, ACCRUED EXPENSES AND OTHER
                LIABILITIES





Accounts
      payable, accrued expenses and other liabilities as of September 30, 2006 and
      2005, respectively, consist of the following:




September
                  30,
                2006
              
              September
                  30,
                2005Commissions
                  payable
              
              $
              1,993,000
              
              $
              2,204,000Legal
                  payable
              
              
              325,000
              
              
              555,000Other
              
              
              1,625,000
              
              
              1,286,000Total
              
              $
              3,943,000
              
              $
              4,045,000


11.
            CONVERTIBLE
                NOTES PAYABLE





In
      January 2006, the Company completed a
      financing transaction that included  11 %
      convertible promissory notes in the principal amount of $1,000,000
      that are
      convertible into common stock at a price of $1.00 per share .
      The
      convertible promissory notes mature in January 2011. The Company granted 300,000
      warrants to acquire shares of common stock to the note holders, and the fair
      value of the warrants was calculated using the Black-Scholes Option Valuation
      Model. The Company recorded a debt discount of approximately $187,000 that
      will
      be charged to interest expense over the life of the debt. Such amortization
      has
      been included in “Interest” in the accompanying consolidated financial
      statements.





The
      following table summarizes convertible notes payable at September 30,
      2006.




September
                  30,
                2006Notes
                  payable to noteholders
              
              $
              1,000,000Less:
                  Deferred debt discount
              
              
              (159,000
              )$
              841,000


F-18




12.
            NOTES
                PAYABLE





In
      August
      2005, upon the maturity of previously issued notes, the Company and two note
      holders entered into new note agreements providing for $1.0
      million of notes
      with a maturity date of July 31, 2007, together with warrants having an
      expiration date of July 31, 2007 to purchase, in the aggregate, 200,000 shares
      of common stock at a price of $1.25 per share. These
      notes in the principal amount of $1.0 million were repaid in full in January
      2006.





As
      discussed in Note 3b(iii) in January 2004, the Company consummated a private
      offering of its securities to a limited number of accredited investors wherein
      the Company issued an aggregate of $200,000 of three-year, 10% senior
      subordinated promissory notes to five unaffiliated parties. The note holders
      received three-year warrants to purchase an aggregate of 50,000 shares of the
      Company’s common stock at an exercise price of $1.40 per share, with an
      allocated fair value of approximately $40,000. In December 2004, the Company
      rescinded a note in the principal amount of $25,000 **** and
      a
      warrant to purchase 6,250 shares of Common Stock. The remaining notes in the
      principal amount of $175,000 were repaid in full in March 2006.





In
      February 2004, the Company consummated a private offering of its securities
      to a
      limited number of accredited investors wherein the Company issued an aggregate
      of $850,000 of three-year, 10% senior subordinated promissory notes to four
      unaffiliated parties. The note holders received three-year warrants to purchase
      an aggregate of 170,000 shares of the Company’s common stock at an exercise
      price of $1.50 per share, with an allocated fair value of approximately
      $143,000.





The
      Company is amortizing the total allocated fair value of $183,000 over the
      three-year term of these promissory notes, and the balance from the January
      2004
      notes was amortized in March 2006. Such amortization has been included in
“Interest” in the accompanying consolidated financial statements.





The
      following table summarizes notes payable at September 30, 2006 and 2005,
      respectively:




September
                  30,
                2006
              
              September
                  30,
                2005Notes
                  payable to noteholders
              
              $
              —
              
              $
              1,000,0002004
                  private placements
              
              
              850,000
              
              
              1,025,000850,000
              
              
              2,025,000Less:
                  Deferred debt discount
              
              
              (45,000
              )
              
              (206,000
              )$
              805,000
              
              $
              1,819,000


The
      notes
      outstanding on September 30, 2006 mature in fiscal year 2007.





13.
            SECURED
                DEMAND NOTE / SUBORDINATED
                BORROWINGS





Subordinated
      borrowings represent a secured demand note that was entered into between
      National Securities and a related party. National Securities is a registered
      broker-dealer. The secured demand note was entered into in accordance with
      the
      form prescribed by the NASD, and it is accounted for in accordance with
      broker-dealer accounting SEC rule 15c3-1d. Accordingly, our balance sheet
      includes both an asset (“Secured demand note”) and the





F-19





corresponding
      liability (“Subordinated borrowings”) in an identical amount. The secured demand
      note is available to compute net capital under SEC rule 15c3-1. The borrowings
      are subordinated to the claims of present and future creditors of the Company
      and cannot be repaid where such repayment will cause the Company to fail to
      meet
      its minimum net capital requirements in accordance with SEC rule
      15c3-1.





In
      February 2001, National Securities entered into a three-year secured demand
      note
      collateral agreement with an employee of National Securities and a Director
      of
      the Company, to borrow securities that can be used by the Company for collateral
      agreements. These securities have been pledged through an unrelated
      broker-dealer, and have a borrowing value totaling $1,000,000. This note bears
      interest at 5% per annum with interest paid monthly. National Securities and
      the
      holder have entered into a new secured demand note collateral agreement with
      a
      maturity date of March 1,
      2007 .
      Certain
      of the securities totaling $412,000 have been pledged as collateral for a
      security deposit in the amount of $249,000 for an office lease, and two letters
      of credit in the amounts of $125,000 and $38,000, executed by the Company on
      behalf of National Securities. No amounts have been drawn on these letters
      of
      credit.





14.
            INCOME
                TAXES





The
      income tax (provision) benefit consists of:




Fiscal
                  Years EndedSeptember
                  30,
                2006
              
              September
                  30,
                2005
              
              September
                  30,
                2004Current
                  federal income tax benefit
              
              $
              —
              
              $
              —
              
              $
              —Current
                  state income tax provision
              
              
              —
              
              
              —
              
              
              —$
              —
              
              $
              —
              
              $
              —


The
      income tax (provision) benefit related to income (loss) from continuing
      operations before income taxes and extraordinary items varies from the federal
      statutory rate as follows:




Years
                  EndedSeptember
                  30,
                2006
              
              September
                  30,
                2005
              
              September
                  30,
                2004Statutory
                  federal rate
              
              $
              (168,000
              )
              $
              402,000
              
              $
              (192,000
              )State
                  income taxes net of federal income tax benefit
              
              
              (30,000
              )
              
              35,000
              
              
              (19,000
              )Losses
                  for which no benefit is provided
              
              
              —
              
              
              (437,000
              )
              
              —Utilization
                  of net operating loss carryforwards
              
              
              198,000
              
              
              —
              
              
              211,000$
              —
              
              $
              —
              
              $
              —


F-20


Significant
        components of the Company’s deferred tax assets that are included in other
        assets in the accompanying financial statements are as
        follows:


September
                  30,
                2006
              
              September
                  30,
                2005Deferred
                  tax assets:Net
                  operating loss carryforwards
              
              $
              3,874,000
              
              $
              4,187,000Reserves
                  for uncollectible receivables
              
              
              159,000
              
              
              128,000Other
                  temporary differences
              
              
              52,000
              
              
              44,000Total
                  deferred tax assets
              
              
              4,085,000
              
              
              4,359,000Deferred
                  tax liability:Other
                  temporary differences
              
              
              (137,000
              )
              
              —Deferred
                  tax asset
              
              
              3,948,000
              
              
              4,359,000Valuation
                  allowance
              
              
              (3,948,000
              )
              
              (4,359,000
              )Net
                  deferred tax asset
              
              $
              —
              
              $
              —


At
      September 30, 2006, the Company had available net operating loss carryovers
      of
      approximately $9.7 million that may be applied against future taxable income
      and
      expires at various dates through 2025, subject to certain limitations. The
      Company has a deferred tax asset arising substantially from the benefits of
      such
      net operating loss deduction and has recorded a valuation allowance for the
      full
      amount of this deferred tax asset since it is more likely than not, that these
      tax benefits will not be realized. The valuation allowance for the deferred
      tax
      asset decreased by $411,000 during the fiscal year ended September 30, 2006
      and
      increased by $547,000 during the fiscal year ended September 30,
      2005.





15.
            COMMITMENTS




Leases - As of
      September 30, 2006, the Company leases office space and equipment in various
      states expiring at various dates through 2012 and is committed under operating
      leases for future minimum lease payments as follows:




Fiscal
                  Year Ending2007
              
              $
              1,602,0002008
              
              
              1,556,0002009
              
              
              584,0002010
              
              
              562,0002011
              
              
              579,000Thereafter
              
              
              443,000$
              5,326,000


Rental
      expense under all operating leases for the years ended September 30, 2006,
      September 30, 2005 and September 30, 2004 was $1,901,000, $1,976,000 and
      $2,006,000, respectively.





Guarantees - The
      Company has secondarily guaranteed a lease of one of its branch offices, in
      the
      amount of $125,000 at September 30, 2006.


F-21





16.
            CONTINGENCIES





The
      NASD
      was engaged in an industry-wide investigation of mutual fund trading activities.
      National Securities is one of the numerous broker-dealers contacted by the
      NASD
      with respect to this investigation. The NASD identified certain customer mutual
      fund transactions ordered through National Securities during the time period
      from October 2000 to February 2003 that it believed constituted mutual fund
      timing and/or excessive trading activity. National Securities engaged in
      discussions and negotiations with the NASD to informally resolve these matters.
      Such resolution resulted in a settlement, whereby National Securities, without
      admitting or denying any violations, agreed to make both restitution and pay
      a
      fine to the NASD, that in the aggregate approximate $600,000. Additionally,
      the
      Company is obligated to pay the fines imposed by the NASD on two executive
      officers totaling $50,000 pursuant to its indemnification obligations. The
      Company included the $650,000 in “Professional fees” in fiscal year 2004. The
      unpaid balance of $84,000 and $187,000 at
      September 30, 2006 and September 30, 2005, respectively, has
      been
      included in “Accounts Payable, Accrued Expenses and Other Liabilities” in the
      accompanying consolidated statements of financial condition..




In
      September 2006, the former
      chairman and chief executive officer of the Company, Steven A. Rothstein,
      commenced an arbitration against the current chairman and chief executive
      officer of the Company, Mark Goldwasser, in the matter Rothstein
      et al. vs. Goldwasser ,
      NASD
      No. 06-04000.  Rothstein is alleging fraud and inequitable conduct relating
      to his attempts to sell his investment in the Company in calendar year
      2001, and is seeking approximately $5,750,000 in damages.  The
      Company is indemnifying Mr. Goldwasser in this action.  The Company
      and Mr. Goldwasser believe this action is without merit, and intends to
      vigorously defend this action.





The
      Company is also a defendant in various other arbitrations and administrative
      proceedings, lawsuits and claims seeking
      in the aggregate damages of approximately $1,800,000 to $2,000,000. The
      Company believes
      such claims are substantially without merit, and estimates that its liability,
      primarily for defense costs, will approximate $300,000 (exclusive of unspecified
      punitive damages related to certain claims and inclusive of expected insurance
      coverage). These matters arise in the normal course of business. The Company
      intends to vigorously defend itself in these actions, and believes that the
      eventual outcome of these matters will not have a material adverse effect on
      the
      Company. However,
      the ultimate outcome of these matters cannot be determined at this time. The
      amounts related to such matters that are reasonably estimable and which have
      been accrued at September 30, 2006 and 2005, is $241,000 and $206,000 (primarily
      legal fees), respectively, and have
      been included in “Accounts Payable, Accrued Expenses and Other Liabilities” in
      the accompanying consolidated statements of financial condition . The
      Company has included in “Professional fees” litigation and other NASD related
      expenses of $799,000, $790,000 and $1,424,000 for the fiscal years ended
      September 30, 2006, 2005 and 2004, respectively.





17.
            STOCKHOLDERS'
                EQUITY





Shares
      Authorized - During
      the fiscal year ended September 30, 2004, the Company decreased its authorized
      number of shares of common stock from 60,000,000 to 30,000,000, increased its
      authorized number of shares of preferred stock from 100,000 to 200,000 and
      increased the number of authorized shares designated as Series A preferred
      stock
      from 30,000 to 50,000. During the fiscal year ended September 30, 2006, of
      the
      200,000 authorized number of shares of preferred stock, the Company designated
      20,000 of such shares as Series B preferred stock.


F-22





Cumulative
      Dividends on Convertible Preferred Stock - The
      holders of the Series A convertible preferred stock are entitled to receive
      dividends on a quarterly basis at a rate of 9% per annum, per share. Such
      dividends are cumulative and accrue whether or not declared by the Company’s
      Board of Directors, but are payable only when, as and if declared by the
      Company’s Board of Directors. In March 2004, the Company’s Board of Directors
      declared an in-kind dividend in the aggregate of 3,352 shares of Series A
      preferred stock, in payment of approximately $503,000 of dividends accrued
      through January 31, 2004. In March 2005, the Company’s Board of Directors
      declared an in-kind dividend in the aggregate of 2,143 shares of Series A
      preferred stock, in payment of approximately $322,000 of dividends accrued
      through March 31, 2005. In March 2006, the Company’s Board of Directors declared
      an in-kind dividend in the aggregate of 1,996 shares of Series A preferred
      stock, in payment of approximately $300,000 of dividends accrued through March
      31, 2006. Such shares were issued on April 30, 2006. In March 2006, the
      Company’s shareholders approved an amendment to decrease the conversion price of
      the Series A preferred stock to $1.25 per share from $1.50 per share. At
      September 30, 2006, the amount of accumulated dividends on the Company’s 35,316
      issued and outstanding shares of Series A preferred stock was approximately
      $159,000.





The
      holders of the Company’s Series B Convertible preferred stock, convertible into
      the Company’s common stock at $.75 per share, are entitled to receive dividends
      on a quarterly basis at a rate of 10% per annum per share. Such dividends are
      cumulative and are payable only when declared by the Company’s Board of
      Directors. In August 2006, the Company’s Board of Directors declared a cash
      dividend of $25,000 payable to the holders of the Series B preferred stock
      that
      was paid in October 2006.





Stock
      Options - The
      Company’s stock option plans provide for the granting of stock options to
      certain key employees, directors and investment executives. Generally, options
      outstanding under the Company’s stock option plan are granted at prices equal to
      or above the market value of the stock on the date of grant, vest either
      immediately or ratably over up to five years, and expire five years subsequent
      to award.




In
        March
        2006, the Company’s shareholders approved the 2006 stock option plan that
        reserved 1,500,000 shares of common stock for issuance of options granted
        under
        such plan. A summary of the status of the Company’s stock options and warrants
        outstanding is presented below.


F-23





The
      following tables summarize information about stock options outstanding at
      September 30, 2006.


Stock
                  Options Under PlanWeightedAverage
                  PriceAuthorized
              
              Outstanding
              
              Per
                  ShareBalance,
                  September 30, 2003
              
              
              1,991,500
              
              
              404,150
              
              $
              5.08Granted
              
              
              —
              
              
              694,000
              
              $
              2.47Exercised
              
              
              (26,003
              )
              
              (26,003
              )
              $
              1.00Forfeitures
              
              
              —
              
              
              (46,997
              )
              $
              3.00Balance,
                  September 30, 2004
              
              
              1,965,497
              
              
              1,025,150
              
              $
              3.47Granted
              
              
              —
              
              
              672,000
              
              $
              1.32Exercised
              
              
              —
              
              
              —Forfeitures
              
              
              —
              
              
              (903,483
              )
              $
              3.73Balance,
                  September 30, 2005
              
              
              1,965,497
              
              
              793,667
              
              $
              1.352006
                  stock option plan
              
              
              1,500,000
              
              
              —Granted
              
              
              —
              
              
              170,000
              
              $
              1.14Exercised
              
              
              —
              
              
              —Forfeitures
              
              
              (1,033,497
              )
              
              (31,667
              )
              $
              1.58Balance,
                  September 30, 2006
              
              
              2,432,000
              
              
              932,000
              
              $
              1.30
   Options
                    Outstanding
                
                Options
                    ExercisableRange
                    of Exercise Prices
                
                Number
                    Outstanding
                
                Weighted
                    Average Remaining Contractual Life
                
                Weighted
                    Average Exercise Prices
                
                Number
                    Exercisable
                
                Weighted
                    Average Exercise Prices$0.40-$1.00
                
                
                150,000
                
                
                3.15
                
                $
                0.88
                
                
                75,000
                
                $
                0.75$1.25
                
                
                290,000
                
                
                3.38
                
                $
                1.25
                
                
                290,000
                
                $
                1.25$1.35-$1.375
                
                
                437,000
                
                
                3.55
                
                $
                1.37
                
                
                437,000
                
                $
                1.37$2.00-$3.80
                
                
                55,000
                
                
                1.51
                
                $
                2.22
                
                
                55,000
                
                $
                2.22932,000
                
                
                
                
                
                
                
                
                857,000


As
      of
      September 30, 2006, the aggregate intrinsic value of the Company’s outstanding
      and exercisable options was $56,000 and $37,000, respectively.





In
      February 2005, the Company issued 150,000 options to employees to purchase
      common stock. The options vested immediately at the date of the grant, have
      a
      5-year life and are exercisable at prices ranging from $1.25 to $1.375 per
      share. The weighted average fair value of these options is approximately $1.30
      per share. Also in February 2005, the Company modified the terms of 522,000
      existing options by restating the exercise price to a range from $1.25 to $1.375
      and fully accelerated the vesting period for these options.


F-24





In
      November 2005, the Company issued 100,000 options to an employee to purchase
      common stock. The options vest over two years, have a 5-year life and are
      exercisable at a price $1.00 per share. In March 2006, the Company issued 70,000
      options to non-employee directors to purchase common stock. The options fully
      vest in six months after the date of grant, have a 5-year life and are
      exercisable at a price $1.35 per share.





The
      following tables summarize information about warrants outstanding at September
      30, 2006.


WarrantsShares
              
              Weighted
                  Average Exercise Price
              
              ExercisableOutstanding
                  at September 30, 2003
              
              
              1,683,947
              
              $
              1.71
              
              
              1,683,947Granted
              
              
              909,500
              
              $
              1.09Exercised
              
              
              (240,771
              )
              $
              1.23Expired
              
              
              (27,600
              )
              $
              3.09Outstanding
                  at September 30, 2004
              
              
              2,325,076
              
              $
              1.36
              
              
              2,325,076Granted
              
              
              50,000
              
              $
              1.25Exercised
              
              
              (21,546
              )
              $
              0.93Expired
              
              
              (11,250
              )
              $
              3.61Outstanding
                  at September 30, 2005
              
              
              2,342,280
              
              $
              1.36
              
              
              2,342,280Granted
              
              
              300,000
              
              $
              1.00Expired
              
              
              (76,923
              )
              $
              1.25Outstanding
                  at September 30, 2006
              
              
              2,565,357
              
              $
              1.28
              
              
              2,565,357
   Warrants
                    Outstanding and ExercisableExercise
                    Prices
                
                Number
                  Outstanding
                
                Weighted
                    Average Remaining
                  Contractual
                    Life
                
                Weighted
                    Average
                  Exercise
                    Prices$0.65
                
                
                80,073
                
                
                0.23
                
                $
                0.65$0.80
                
                
                62,500
                
                
                0.94
                
                $
                0.80$1.00
                
                
                300,000
                
                
                4.28
                
                $
                1.00$1.25
                
                
                1,277,034
                
                
                0.45
                
                $
                1.25$1.40
                
                
                43,750
                
                
                0.29
                
                $
                1.40$1.50
                
                
                797,000
                
                
                0.78
                
                $
                1.50$5.00
                
                
                5,000
                
                
                0.16
                
                $
                5.002,565,357


As
      of
      September 30, 2006, the aggregate intrinsic value of the Company’s outstanding
      and exercisable warrants was $151,000.





In
      April
      2005, in connection with the resignation of the former chairmen of the Company,
      the Company issued to his designee, a three-year warrant to purchase 50,000
      shares of the Company’s common stock at $1.25 per share.


F-25





In
      January 2006, as discussed in Note 3b(vi), the Company completed a financing
      transaction that included five-year warrants to purchase 300,000 shares of
      the
      Company’s common stock at $1.00 per share.





18.
            NET
                CAPITAL REQUIREMENTS





National
      Securities, as a registered broker-dealer, is subject to the SEC’s Uniform Net
      Capital Rule 15c3-1 that requires the maintenance of minimum net capital.
      National Securities has elected to use the alternative standard method permitted
      by the rule. This requires that National Securities maintain minimum net capital
      equal to the greater of $250,000 or a specified amount per security based on
      the
      bid price of each security for which National Securities is a market maker. At
      September 30, 2006, National Securities’ net capital exceeded the requirement by
      $2,076,000.




Advances,
      dividend payments and other equity withdrawals from its subsidiaries are
      restricted by the regulations of the SEC, and other regulatory agencies. These
      regulatory restrictions may limit the amounts that a subsidiary may dividend
      or
      advance to the Company.





19.
            EMPLOYEE
                BENEFITS





The **** Company’s
      subsidiary has a defined 401(k) profit sharing plan (the “Plan”) that covers
      substantially all of its employees. Under the terms of the Plan, employees
      can
      elect to defer up to 25% of eligible compensation, subject to certain
      limitations, by making voluntary contributions to the Plan. The Company’s annual
      contributions are made at the discretion of the Board of Directors. During
      the
      fiscal years ended September 30, 2006, 2005 and 2004, the Company made no
      contributions to the Plan.





20.
            SUBSEQUENT
                EVENT





In
      the
      first quarter of fiscal year 2007, the Company received proceeds of
      approximately $11,000 from the exercise of outstanding warrants to purchase
      14,219 shares of the Company’s common stock.


F-26




21.
            UNAUDITED
                QUARTERLY DATA





Selected
      Quarterly Financial Data (Dollars in thousands, except per share
      data)




December
                  31,
              
              March
                  31,
              
              June
                  30,
              
              September
                  30,2004
              
              2005
              
              2005
              
              2005Revenues
              
              $
              13,108
              
              $
              12,206
              
              $
              9,996
              
              $
              10,420Net
                  income (loss)
              
              $
              (184
              )
              $
              (139
              )
              $
              111
              
              $
              (971
              )Preferred
                  stock dividends
              
              
              (71
              )
              
              (69
              )
              
              (75
              )
              
              (75
              )Net
                  income (loss) attributable to common stockholders
              
              $
              (255
              )
              $
              (208
              )
              $
              36
              
              $
              (1,046
              )Income
                  (loss) per common share - Basic
              
              $
              (0.05
              )
              $
              (0.04
              )
              $
              0.01
              
              $
              (0.21
              )Income
                  (loss) per common share - Diluted
              
              $
              (0.05
              )
              $
              (0.04
              )
              $
              0.01
              
              $
              (0.21
              )
  December
                  31,
              
              March
                  31,
              
              June
                  30,
              
              September
                  30,2005
              
              2006
              
              2006
              
              2006Revenues
              
              $
              13,691
              
              $
              18,787
              
              $
              13,984
              
              $
              12,265Net
                  income (loss)
              
              $
              259
              
              $
              424
              
              $
              152
              
              $
              (240
              )Preferred
                  stock dividends
              
              
              (76
              )
              
              (95
              )
              
              (104
              )
              
              (106
              )Net
                  income (loss) attributable to common stockholders
              
              $
              183
              
              $
              329
              
              $
              48
              
              $
              (346
              )Income
                  (loss) per common share - Basic
              
              $
              0.04
              
              $
              0.06
              
              $
              0.01
              
              $
              (0.07
              )Income
                  (loss) per common share - Diluted
              
              $
              0.04
              
              $
              0.04
              
              $
              0.01
              
              $
              (0.07
              )




Income
      (loss) per share for each quarter was computed independently using the
      weighted-average number of shares outstanding during the quarter. However,
      income (loss) per share for the year was computed using the weighted-average
      number of shares outstanding during the year. As a result, the sum of the income
      (loss) per share for the four quarters may not equal the full year income (loss)
      per share.


F-27




22.
            FINANCIAL
                INFORMATION - NATIONAL HOLDINGS CORPORATION





National
      Holdings was organized in 1996 and began operations on February 6, 1997. The
      following National Holdings (parent company only) financial information should
      be read in conjunction with the other notes to the consolidated financial
      statements.


**STATEMENTS
                  OF FINANCIAL CONDITION****ASSETS**September
                  30,
              
              September
                  30,2006
              
              2005Cash
              
              $
              134,000
              
              $
              2,000Investment
                  in subsidiaries
              
              
              4,309,000
              
              
              2,884,000Other
                  assets
              
              
              252,000
              
              
              153,000$
              4,695,000
              
              $
              3,039,000
  **LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Accounts
                  payable, accrued expensesand
                  other liabilities
              
              $
              206,000
              
              $
              290,000Convertible
                  notes payable
              
              
              841,000
              
              
              —Notes
                  payable
              
              
              805,000
              
              
              1,819,0001,852,000
              
              
              2,109,000Stockholders'
                  equity
              
              
              2,843,000
              
              
              930,000$
              4,695,000
              
              $
              3,039,000




**STATEMENTS
                  OF OPERATIONS**Years
                  endedSeptember
                  30,
              
              September
                  30,
              
              September
                  30,2006
              
              2005
              
              2004Operating
                  expenses
              
              $
              (1,017,000
              )
              $
              (1,247,000
              )
              $
              (1,215,000
              )Other
                  income (expense)Gains
                  on extinguishments of debt
              
              
              —
              
              
              —
              
              
              1,131,000Gain
                  on investment
              
              
              192,000
              
              
              —
              
              
              —Gain
                  on investment in subsidiaries
              
              
              1,420,000
              
              
              64,000
              
              
              650,000Net
                  income (loss) before income tax
              
              $
              595,000
              
              $
              (1,183,000
              )
              $
              566,000




F-28


**STATEMENTS
                  OF CASH FLOWS**Years
                  endedSeptember
                  30,
                2006
              
              September
                  30,
                2005
              
              September
                  30,
                2004CASH
                  FLOWS FROM OPERATING ACTIVITIESNet
                  income (loss)
              
              $
              595,000
              
              $
              (1,183,000
              )
              $
              566,000Adjustments
                  to reconcile net income (loss) to netcash
                  provided by (used in) operating activities(Gain)
                  loss on investment in subsidiaries
              
              
              (1,424,000
              )
              
              (157,000
              )
              
              (650,000
              )Gains
                  on extinguishments of debt
              
              
              —
              
              
              —
              
              
              (1,131,000
              )Amortization
                  of deferred financing costs
              
              
              4,000
              
              
              —
              
              
              —Amortization
                  of note discount
              
              
              189,000
              
              
              163,000
              
              
              122,000Compensatory
                  element of common stock issuance
              
              
              12,000
              
              
              —
              
              
              —Compensatory
                  element of common stock option issuances
              
              
              19,000
              
              
              —
              
              
              —Forgiveness
                  of loan
              
              
              —
              
              
              —
              
              
              (251,000
              )Issuance
                  of common stock in settlement of arbitration
              
              
              —
              
              
              40,000
              
              
              100,000Changes
                  in assets and liabilities
              
              
              (154,000
              )
              
              1,021,000
              
              
              (366,000
              )Net
                  cash provided by (used in) operating activities
              
              
              (759,000
              )
              
              (116,000
              )
              
              (1,610,000
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES(Capital
                  contributions to) advances from subsidiary - net
              
              
              (5,000
              )
              
              17,000
              
              
              207,000Net
                  cash provided by (used in) investing activities
              
              
              (5,000
              )
              
              17,000
              
              
              207,000CASH
                  FLOWS FROM FINANCING ACTIVITIESNet
                  proceeds from issuance of common stock and warrants
              
              
              173,000
              
              
              —
              
              
              930,000Net
                  proceeds from issuance of preferred stock
              
              
              972,000
              
              
              —
              
              
              —Net
                  proceeds from issuance of convertible notes payable
              
              
              1,000,000
              
              
              —
              
              
              —Net
                  proceeds from issuance of notes payable and warrants
              
              
              —
              
              
              —
              
              
              1,036,000Cash
                  payment of deferred financing costs
              
              
              (28,000
              )
              
              —
              
              
              —Payments
                  of notes payable
              
              
              (1,175,000
              )
              
              (75,000
              )
              
              (750,000
              )Dividends
                  paid
              
              
              (46,000
              )
              
              —
              
              
              —Exercise
                  of stock options and warrants
              
              
              —
              
              
              19,000
              
              
              321,000Net
                  cash provided by financing activities
              
              
              896,000
              
              
              (56,000
              )
              
              1,537,000NET
                  (DECREASE) INCREASE IN CASH
              
              
              132,000
              
              
              (155,000
              )
              
              134,000CASH
                  BALANCEBeginning
                  of year
              
              
              2,000
              
              
              157,000
              
              
              23,000End
                  of year
              
              $
              134,000
              
              $
              2,000
              
              $
              157,000SUPPLEMENTAL
                  DISCLOSURES OF CASH FLOW INFORMATIONCash
                  paid during the year for:Interest
              
              $
              406,000
              
              $
              389,000
              
              $
              272,000Series
                  B preferred stock dividends
              
              $
              46,000
              
              $
              —
              
              $
              —SUPPLEMENTAL
                  DISCLOSURES OF NONCASH INVESTING ANDFINANCING
                  ACTIVITIESWarrants
                  issued in connection with debt
              
              $
              187,000
              
              $
              125,000
              
              $
              341,000Series
                  A preferred stock dividends
              
              $
              300,000
              
              $
              322,000
              
              $
              503,000




F-29