GENERAL

Capital Financial Holdings, Inc. derives the majority of its revenues and net income from sales of mutual funds, insurance products, and various other securities through Capital Financial Services, Inc. ("CFS"), the Company's broker-dealer subsidiary.

The Company has been engaged in the financial services business since 1987. The Company was incorporated September 22, 1987, as a North Dakota corporation. The Company's principal offices are located at 1 Main Street North, Minot, North Dakota 58703. As of June 30, 2012, the Company had 16 full-time employees consisting of officers, securities distribution, data processing, compliance, accounting, and clerical support staff.

CFS is a full-service brokerage firm. CFS is registered with the SEC as an investment advisor and broker-dealer and also with FINRA as a broker-dealer. CFS specializes in providing investment products and services to independent investment representatives, financial planners, and investment advisors and currently supports over 220 investment representatives and investment advisors.

RESULTS OF OPERATIONS

                      Three Months Ended            Six Months Ended
                           June 30,                     June 30,
                      2012          2011           2012          2011
Net income (loss)      90,316       170,073       (307,477 )     244,342
Income per share:
Basic                    0.00          0.01          (0.02 )        0.01
Diluted                  0.00          0.01          (0.02 )        0.01

The Company reported net income for the quarter ended June 30, 2012, of $90,316, compared to net income of $170,073 for the same quarter in 2011. The Company reported net loss for the six months ended June 30, 2012 of $307,477, compared to a net income of $244,342 for the same period in 2011.

Operating Revenues

Total operating revenues for the quarter ended June 30, 2012 were $4,866,975, an increase of 3% from $4,698,677 for the quarter ended June 30,2011. The increases for the three month period resulted primarily from increases in commission income received by CFS.Total operating revenues for the six months ended June 30, 2012, were $9,027,753 a decrease of 8.5% from $9,868,767 for the six months ended June 30, 2011. The decrease for the six month period resulted from a decrease in commission and fee income relating to CFS, the Company's broker-dealer division.

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Fee Income

Fee income for the quarter ended June 30, 2012 was $234,730, a decrease of 7% from $252,179 for the quarter ended June 30, 2011. Fee income for the six months ended June 30, 2012 was $494,036, a decrease of 3% from $509,913 fro the six months ended June 30, 2011. The decreases were due to decline in fee income received by CFS, as a result of lower values of client assets under management.

The Company earns investment advisory fees in connection with CFS' registered investment advisor. The Company pays the registered representatives a portion of this fee income as commission expense and retains the balance. These fees constituted 5.5% of the Company's consolidated revenues for 2012.

Commission Income

Commission income includes CFS commissions. The Company pays the registered representatives a percentage of this income as commission expense and retains the balance. Commission income for the quarter ended June 30, 2012 was $4,580,968, an increase of 6% from $4,320,866 for the quarter ended June 30, 2011. The increases were due primarily to the increase in commissions received by CFS due to market conditions. Commission income for the six months ended June 30, 2012 was $8,455,856, a decrease of 7% from $9,096,445 for the six months ended June 30, 2011.The decreases were due primarily to the reduction in commissions received by CFS due to market conditions. Future market conditions will continue to impact commission levels. Commission revenues constituted 94% of the Company's consolidated revenues for 2012.

Other income

Interest and other income for the quarter ended June 30, 2012 was $51,277, a decrease of 59% from $125,632 for the quarter ended June 30, 2011. Interest and other income for the six months ended June 30, 2012 was $87,861, a decrease of 67% from $262,409 for the six months ended June 30, 2011. The decreases were due to a reduction in settlement checks and income received, regarding the subsidiaries that closed including the mutual fund division and the energy division. Interest and other income constituted 1% of the Company's consolidated revenues for the three months ended June 30, 2012.

Operating Expenses

Total operating expenses for the quarter ended June 30, 2012 were $4,730,519, an increase of 1% from $4,698,677 for the quarter ended June 30, 2011. The increases resulted from the net increase in the expense categories described below. Total operating expenses for the six months ended June 30, 2012 were $9,343,089, a decrease of 4% from $9,736,950 for the six months ended June 30, 2011. The decreases resulted from the net decreases in the expense categories described in the paragraphs below.

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Compensation and benefits

Compensation and benefits expense for the quarter ended June 30, 2012 was $312,404, a decrease of 4% from $324,212 for the quarter ended June 30, 2011. The decrease resulted from a decrease in the number of employees. Compensation and benefits expense for the six months ended June 30, 2012 was $575,665, an increase of 3% from $559,087 for the six months ended June 30, 2011. The increases resulted from an increase in wages to employees, increases in 401K matching, payroll taxes, and paid bonuses.

Commission expense

Commission expense for the quarter ended June 30, 2012 was $4,129,532, an increase of 3% from $3,991,226 for the quarter ended June 30, 2011. The increase in commission expense corresponds with the increase in commission income for the quarter. Commission expense for the six months ended June 30, 2012 was $7,699,448, a decrease of 9% from $8,454,727 for the six months ended June 30, 2011. The decreases in commission expense correspond with the decreases in commission income for the six months ended June 30, 2012.

General and administrative expense

Total general and administrative expenses for the quarter ended June 30, 2012 were $281,543, a decrease of 19% from $345,753 for the quarter ended June 30, 2011. The decreases were due primarily to a decrease in the legal expenses incurred through litigation costs for CFH. The total general and administrative expenses for the six months ended June 30, 2012 were $731,513, an increase of 6% from $688,617 for the six months ended June 30, 2011. The increases were due primarily to an increase in legal expenses incurred through litigation costs and settlements for CFS paid by the Company.

Depreciation and amortization

Depreciation and amortization expense for the quarter ended June 30, 2012 was $7,039, a decrease of 59% from $17,242 for the quarter ended June 30, 2011. Depreciation and amortization expense for the six month ended June 30, 2012 were $21,931, a decrease of 36% from $34,519 for the six months ended June 30, 2011.

Liquidity and Capital Resources

Net cash provided by operating activities was $290,327 for the six months ended June 30, 2012, as compared to net cash provided by operating activities of $400,545 during the six months ended June 30, 2011.

Net cash provided by investing activities was $927,337 for the six months ended June 30, 2012, compared to net cash used in investing activities of $5,666 for the six months ended June 30, 2011. The primary difference corresponds with the sale of the building and the disposal of assets that occurred during 2012.

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Net cash used in financing activities was $1,109,825 for the six months ended June 30, 2012, compared to net cash used by financing activities of $978,348 for the six months ended June 30, 2011. During the six months ended June 30, 2012 the Company paid down the promissory note with PawnMart with payments totaling $1,048,235.

At June 30, 2012, the Company held $1,266,437 in cash and cash equivalents, as compared to $1,158,598 at December 31, 2011. The Company is required to maintain certain levels of cash and liquid securities in CFS to meet regulatory net capital requirements.

The Company currently has no lines of credit available.

The Company has historically relied upon sales of its equity securities and debt instruments, as well as bank loans, for liquidity and growth. Management believes that the Company's existing liquid assets, along with cash flow from operations, will provide the Company with sufficient resources to meet its ordinary operating expenses during the next twelve months. Significant, unforeseen or extraordinary expenses may require the Company to seek alternative financing sources, including common or preferred share issuance or additional debt financing.

In addition to the liabilities coming due in the next twelve months, management expects that the principal needs for cash may be broker recruitment, repurchase shares of the Company's common stock, and debt service. Management also expects to realize increases in consultant expenses as well as increased compliance and legal costs with respect to its broker dealer subsidiary related to regulatory and litigation matters.

FORWARD-LOOKING STATEMENTS

When used herein, in future filings by the Company with the Securities and Exchange Commission ("SEC"), in the Company's press releases, and in other Company-authorized written or oral statements, the words and phrases "can be," "expects," "anticipates," "may affect," "may depend," "believes," "estimate," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. Such statements are subject to certain risks and uncertainties, including those set forth in this "Forward-Looking Statements" section, which could cause actual results for future periods to differ materially from those presently anticipated or projected. The Company does not undertake and specifically disclaims any obligation to update any forward-looking statement to reflect events or circumstances after the date of such statements.

Forward-looking statements include, but are not limited to, statements about the Company's:

?  Business strategies and investment policies,


?  Possible or assumed future results of operations and operating cash flows,


?  Financing plans and the availability of short-term borrowing,


?  Competitive position,


?  Potential growth opportunities,


?  Recruitment and retention of the Company's key employees,


?  Potential operating performance, achievements, productivity improvements,
   efficiency and cost reduction efforts,


?  Likelihood of success and impact of litigation,


?  Expected tax rates,


?  Expectations with respect to the economy, securities markets, the market for
   merger and acquisition activity, the market for asset management activity, and
   other industry trends,


?  Competition, and


?  Effect from the impact of future legislation and regulation on the Company.




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The following factors, among others, could cause actual results to differ materially from forward-looking statements, and future results could differ materially from historical performance:

?  General political and economic conditions which may be less favorable than
   expected;


?  The effect of changes in interest rates, inflation rates, the stock markets,
   or other financial markets;


?  Unfavorable legislative, regulatory, or judicial developments;


?  Adverse findings or rulings in arbitrations, litigation or regulatory
   proceedings;


?  Incidence and severity of catastrophes, both natural and man-made;


?  Changes in accounting rules, policies, practices, and procedures which may
   adversely affect the business;


?  Terrorist activities or other hostilities which may adversely affect the
   general economy.

The Company is a financial services holding company that, through its broker dealer subsidiary, provides brokerage, investment advisory, insurance and related services. The Company operates in a highly regulated and competitive industry that is influenced by numerous external factors such as economic conditions, marketplace liquidity and volatility, monetary policy, global and national political events, regulatory developments, competition, and investor preferences. The Company's revenues and net earnings may be either enhanced or diminished from period to period by such external factors. The Company remains focused on continuing to reduce redundant operating costs, upgrade operating efficiency, recruit quality representatives and grow our revenue base. The Company provides broker-dealer services in support of trading and investment by its representatives' customers in corporate equity and debt securities, U.S. Government securities, municipal securities, mutual funds, private placement alternative investments, variable annuities and variable life insurance. The Company also provides investment advisory services for its representative's customers

A key component of the broker-dealer subsidiary's business strategy is to recruit well-established, productive representatives who generate substantial revenues from an array of investment products and services. Additionally, the broker-dealer subsidiary assists its representatives in developing and expanding their business by providing a variety of support services and a diversified range of investment products for their clients.