Edgar Filing: TAG IT PACIFIC INC

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

For the quarterly period ended March 31, 2007.

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

Commission file number 1-13669

TAG-IT PACIFIC, INC.
(Exact Name of Issuer as Specified in its Charter)

DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

21900 BURBANK BOULEVARD, SUITE 270
WOODLAND HILLS, CALIFORNIA 91367
(Address of Principal Executive Offices)

(818) 444-4100
(Registrant's Telephone Number, Including Area Code)

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 past 90 days.

Yes [X] No [_]

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 filer [_] Accelerated filer [_] Non-accelerated filer [X]

Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]

AT MAY 12, 2007 THE ISSUER HAD 18,541,433 SHARES OF COMMON STOCK, $.001
PAR VALUE, ISSUED AND OUTSTANDING.

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TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q

PART I FINANCIAL INFORMATION PAGE
----

Item 1. Financial Statements ............................................. 3

Consolidated Balance Sheets as of March 31, 2007 (unaudited)
and December 31, 2006 ............................................ 3

Consolidated Statements of Operations for the Three Months
Ended March 31, 2007 and 2006 (unaudited) ........................ 4

Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2007 and 2006 (unaudited) ........... 5

Notes to the Consolidated Financial Statements ................... 6

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...................................... 13

Item 3. Quantitative and Qualitative Disclosures about Market Risk ....... 26

Item 4. Controls and Procedures .......................................... 27

PART II OTHER INFORMATION

Item 1. Legal Proceedings ................................................ 27

Item 1A. Risk Factors ..................................................... 28

Item 6. Exhibits ......................................................... 29

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

TAG-IT PACIFIC, INC.
CONSOLIDATED BALANCE SHEETS

(Unaudited)
March 31, December 31,
2007 2006
------------ ------------
Assets
Current Assets:
Cash and cash equivalents ................... $ 3,272,097 $ 2,934,673
Accounts receivable, net .................... 4,865,809 4,664,766
Note receivable ............................. 1,413,817 1,378,491
Inventories, net ............................ 2,778,331 3,051,220
Recoverable legal costs ..................... 3,302,874 107,108
Prepaid expenses and other current assets ... 359,097 433,926
------------ ------------
Total current assets ........................... 15,922,024 12,570,184

Property and equipment, net .................... 5,710,843 5,623,040
Fixed assets held for sale ..................... 826,904 826,904
Note receivable, less current portion .......... 1,053,988 1,420,969
Due from related parties ....................... 709,822 675,137
Other intangible assets, net ................... 4,110,751 4,139,625
Other assets ................................... 355,496 437,569
------------ ------------
Total assets ................................... $ 28,759,829 $ 25,693,428
============ ============

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ............................. $ 5,222,665 $ 4,006,241
Accrued legal costs .......................... 3,518,359 427,917
Other accrued expenses ....................... 3,200,025 3,359,267
Demand notes payable to related parties ...... 664,970 664,970
Current portion of capital lease obligations . 426,879 432,728
Current portion of notes payable ............. 798,324 1,107,207
Secured convertible promissory notes ......... 12,480,512 12,472,622
------------ ------------
Total current liabilities ...................... 26,311,734 22,470,952

Unrecognized tax benefits ...................... 245,800 --
Capital lease obligations, less current portion 374,825 474,733
Notes payable, less current portion ............ 1,074,639 1,061,514
------------ ------------
Total liabilities .............................. 28,006,998 24,007,199
------------ ------------

Commitments and contingencies (Note 6)

Stockholders' Equity:
Preferred stock Series A, $0.001 par value;
250,000 shares authorized; no shares
issued or outstanding ..................... -- --

Common stock, $0.001 par value,
100,000,000 shares authorized;
18,541,433 shares issued and
outstanding at March 31, 2007;
18,466,433 at December 31, 2006 ........... 18,541 18,466
Additional paid-in capital ................... 51,900,173 51,792,502
Accumulated deficit .......................... (51,165,883) (50,124,739)
------------ ------------
Total stockholders' equity ..................... 752,831 1,686,229
------------ ------------
Total liabilities and stockholders' equity ..... $ 28,759,829 $ 25,693,428
============ ============

See accompanying notes to consolidated financial statements

TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

Three Months Ended March 31,
------------------------------
2007 2006
------------ ------------
Net sales .................................. $ 9,090,117 $ 10,638,216
Cost of goods sold ......................... 6,342,923 7,795,491
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Gross profit ............................... 2,747,194 2,842,725

Selling expenses ........................... 706,235 545,625
General and administrative expenses ........ 2,689,171 2,817,131
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Total operating expenses ................... 3,395,406 3,362,756
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Loss from operations ....................... (648,212) (520,031)

Interest expense, net ...................... 147,132 209,372
------------ ------------
Loss before income taxes ................... (795,344) (729,403)
Provision for income taxes ................. -- --
------------ ------------
Net loss ................................... $ (795,344) $ (729,403)
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Basic loss per share ....................... $ (0.04) $ (0.04)
============ ============
Diluted loss per share ..................... $ (0.04) $ (0.04)
============ ============

Weighted average number of common
shares outstanding:
Basic ................................. 18,533,100 18,241,045
============ ============
Diluted ............................... 18,533,100 18,241,045
============ ============

See accompanying notes to consolidated financial statements

TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Three Months Ended March 31,
--------------------------
2007 2006
----------- -----------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net loss ..................................... $ (795,344) $ (729,403)
Adjustments to reconcile net loss to net cash from
operating activities:
Depreciation and amortization ................. 377,215 305,304
Increase (decrease) in allowance for doubtful
accounts .................................... 7,500 (334,474)
Increase (decrease) in inventory valuation
reserves .................................... (159,796) (2,850,093)
Disposal of asset ............................. -- 8,502
Stock based compensation ...................... 65,000 189,124
Changes in operating assets and liabilities:
Receivables, including related party ........ (243,227) (242,669)
Inventories ................................. 432,685 3,734,521
Recoverable legal costs ..................... (3,195,767) --
Prepaid expenses and other current assets ... 74,829 343,196
Other assets a&oothero ...................... 10,016 (30,429)
Accounts payable and accrued expenses ....... 1,182,174 531,399
Accrued legal expenses ...................... 3,090,442 120,672
----------- -----------
Net cash from operating activities ............. 845,727 1,045,650
----------- -----------

Cash flows from investing activities:
Acquisition of property and equipment ....... (356,195) (25,148)
Proceeds from sale of equipment ............. -- 2,500
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Net cash used by investing activities .......... (356,195) (22,648)
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Cash flows from financing activities:
Collection of notes receivable .............. 331,656 20,332
Proceeds from exercise of stock options ..... 42,750 --
Repayment of capital leases ................. (105,756) (248,541)
Repayment of notes payable .................. (420,758) (45,567)
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Net cash used by financing activities ........ (152,108) (273,776)
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Net increase in cash ............................. 337,424 749,226
Cash at beginning of period ...................... 2,934,673 2,277,397
----------- -----------

Cash at end of period ............................ $ 3,272,097 $ 3,026,623
=========== ===========

Supplemental disclosures of cash flow
information: Cash received (paid) during
the period for:
Interest paid ............................... $ (262,144) $ (257,737)
Interest received ........................... $ 75,820 $ 36,696

See accompanying notes to consolidated financial statements.

TAG-IT PACIFIC, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1. PRESENTATION OF INTERIM INFORMATION

The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and in accordance with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. The accompanying unaudited consolidated financial statements reflect
all adjustments that, in the opinion of the management of Tag-It Pacific, Inc.
and its consolidated subsidiaries (collectively, the "Company"), are considered
necessary for a fair presentation of the financial position, results of
operations, and cash flows for the periods presented. The results of operations
for such periods are not necessarily indicative of the results expected for the
full fiscal year or for any future period. The accompanying financial statements
should be read in conjunction with the audited consolidated financial statements
of the Company included in the Company's Form 10-K for the year ended December
31, 2006. The balance sheet as of December 31, 2006 has been derived from the
audited financial statements as of that date but omits certain information and
footnotes required for complete financial statements.

NOTE 2. EARNINGS PER SHARE

The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:

PER SHARE
THREE MONTHS ENDED MARCH 31, 2007: LOSS SHARES AMOUNT
------------ ------------ ------------

Basic loss per share:
Loss available to common stockholders .................. $ (795,344) 18,533,100 $ (0.04)

Effect of Dilutive Securities:
Options ................................................ --
Warrants ............................................... --
------------ ------------ ------------
Loss available to common stockholders .................. $ (795,344) 18,533,100 $ (0.04)
============ ============ ============

THREE MONTHS ENDED MARCH 31, 2006: Basic loss per share:
Loss available to common stockholders .................. $ (729,403) 18,241,045 $ (0.04)

Effect of Dilutive Securities:
Options ................................................ --
Warrants ............................................... --
------------ ------------ ------------
Loss available to common stockholders .................. $ (729,403) 18,241,045 $ (0.04)
============ ============ ============

Warrants to purchase 1,093,813 shares of common stock at between $3.65
and $5.06, options to purchase 4,703,135 shares of common stock at between $0.37
and $5.23, convertible debt of $12,500,000 convertible at $3.65 per share and
other convertible debt of $500,000 convertible at $4.50 per share were

outstanding for the three months ended March 31, 2007, but were not included in
the computation of diluted loss per share because the effect of exercise or
conversion would have an antidilutive effect on loss per share.

Warrants to purchase 1,243,813 shares of common stock at between $3.50
and $5.06, options to purchase 4,474,635 shares of common stock at between $0.37
and $5.23, convertible debt of $12,500,000 convertible at $3.65 per share, and
other convertible debt of $500,000 convertible at $4.50 per share were
outstanding for the three months ended March 31, 2006, but were not included in
the computation of diluted loss per share because the effect of exercise or
conversion would have an antidilutive effect on loss per share.

NOTE 3. STOCK BASED COMPENSATION

The Company accounts for stock-based awards to employees and directors
in accordance with Statement of Financial Accounting Standards No. 123 (revised
2004), "Share-Based Payment," ("SFAS 123(R)") which requires the measurement and
recognition of compensation expense for all share-based payment awards made to
employees and directors based on estimated fair values. Options issued to
consultants are accounted for in accordance with the provisions of Emerging
Issues Task Force (EITF) No. 96-18, "Accounting for Equity Instruments That Are
Issued to Others Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services".

There were no options granted during the three months ended March 31,
2007. During the three months ended March 31, 2007, a consultant exercised
options to acquire 75,000 shares of common stock. Cash received upon exercise
was $42,750 or $0.57 per share. At the time of exercise, the total intrinsic
value of the options exercised was approximately $72,000 (or $0.96 per share).
Because the option exercised was a non-qualified stock option, the Company will
receive a tax deduction for the intrinsic value amount.

During the three months ended March 31, 2006, the Company granted
10-year options to employees and directors to acquire 2,610,135 shares of common
stock at a weighted-average exercise price of $0.42. Options granted were valued
using the Black-Scholes option-pricing model at values ranging from $0.20 to
$0.34 per share. Assumptions used to value the options were: expected term of
5.3 - 6.1 years, expected volatility of 140%, expected annual dividends of zero
and a risk-free interest rate of 4.29% - 4.60%.

During the three months ended March 31, 2006, the Company granted two
10 year options to a consultant to acquire a total of 75,000 shares of common
stock at $0.57 per share. An option of 50,000 shares was vested when granted,
and an option for 25,000 shares vested on December 31, 2006. The option for
50,000 shares was valued at $0.56 per share using the following assumptions:
expected term of 10 years, expected volatility of 160%, expected dividend rate
of zero, and risk-free interest rate of 4.53%. The option for 25,000 shares
vesting at December 31, 2006 was also initially valued at $0.56 per share using
the same assumptions, but was revalued each reporting period until vested in
accordance with EITF 96-18. During the three months ended March 31, 2006, no
options or warrants were exercised.

The following table summarizes the activity in the Company's share
based plans during the three months ended March 31, 2007. At March 31, 2007 the
Company may issue additional awards to acquire up to a total of 2,621,477 shares
of common stock under the 1997 Plan.

Weighted
Average
Number of Shares Exercise Price
---------------- ----------------

EMPLOYEES AND DIRECTORS
Options and warrants outstanding - January 1, 2007 .... 5,002,635 $ 1.41
Granted .......................................... -- --
Exercised ........................................ -- --
Cancelled ........................................ (299,500) $ 1.03
---------------- ----------------
Options and warrants outstanding - March 31, 2007 ...... 4,703,135 $ 1.44
================ ================

NON-EMPLOYEES
Options and warrants outstanding - January 1, 2007 .... 1,318,813 $ 4.13
Granted .......................................... -- --
Exercised ........................................ (75,000) $ .57
Cancelled ........................................ (150,000) $ 3.50
---------------- ----------------
Options and warrants outstanding - March 31, 2007 ..... 1,093,813 $ 4.46
================ ================

NOTE 4. INVENTORIES

Inventories are stated at the lower of cost or market value and are all
categorized as finished goods. Inventory reserves are recorded for damaged,
obsolete, excess and slow-moving inventory. We use estimates to record these
reserves. Slow-moving inventory is reviewed by category and may be partially or
fully reserved for depending on the type of product and the length of time the
product has been included in inventory. Reserve adjustments are made for the
difference between the cost of the inventory and the estimated market value, if
lower, and charged to operations in the period in which the facts that give rise
to these adjustments become known. Market value of inventory is estimated based
on the impact of market trends, an evaluation of economic conditions and the
value of current orders relating to the future sales of this type of inventory.

Inventories consist of the following:

March 31, December 31,
2007 2006
------------ ------------
Finished goods ............................... $ 3,860,500 $ 4,293,220
Less reserves ................................ 1,082,200 1,242,000
------------ ------------
Total inventories ............................ $ 2,778,300 $ 3,051,220
============ ============

NOTE 5. INCOME TAXES

On January 1, 2007 the Company adopted the provisions of Financial
Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes-an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements and prescribes a recognition threshold and
measurement process for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN

48 also provides guidance on the recognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition associated
with income tax liabilities.

As a result of the implementation of FIN 48, the Company recognized an
increase in liabilities for unrecognized tax benefits of approximately $245,800,
which was accounted for as an increase in the January 1, 2007 accumulated
deficit.

The Company recognizes interest accrued related to unrecognized tax
benefits in interest expense and penalties in income tax expense. There was no
interest or penalties recognized during the three months ended March 31, 2007
and 2006 for unrecognized tax benefits. At March 31, 2007 the Company had
approximately $33,800 accrued in interest and penalties associated with the
unrecognized tax liabilities.

NOTE 6. CONTINGENCIES AND GUARANTEES

In May, 2006, the Company received notice from the American Stock
Exchange ("AMEX") that it was not in compliance with certain of the continued
listing standards as set forth in the AMEX Company Guide due to the failure to
comply with Section 1003(a)(i) and Section 1003(a)(ii) of the Company Guide,
which effectively required that the Company maintain shareholders' equity of at
least $4,000,000. Following the notice from AMEX the Company was afforded the
opportunity to submit a "plan of compliance" to AMEX outlining in detail how the
Company expected to achieve the minimum equity requirements and to regain
compliance. On August 3, 2006 the Company received notification from AMEX that
the Company's plan to regain compliance with the minimum shareholders' equity
requirements of the AMEX Company Guide had been accepted and the Company has
been granted an extension until November 16, 2007 to achieve the AMEX continued
listing requirements. During this period the Company will be subject to periodic
review by the AMEX Staff and failure to make progress consistent with the plan
or to regain compliance with continued listing standards by the end of the
extension period could result in being delisted from the American Stock
Exchange.

On October 12, 2005, a shareholder class action complaint-- HUBERMAN V.
TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex)--was filed against us and
certain of our current and former officers and directors in the United States
District Court for the Central District of California alleging claims under
Section 10(b) and Section 20 of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5 promulgated thereunder. The action is brought on behalf of all
purchasers of our publicly-traded securities during the period from November 14,
2003 to August 12, 2005. On January 23, 2006 the court heard competing motions
for appointment of lead plaintiff/counsel and appointed Seth Huberman as lead
plaintiff. The lead plaintiff thereafter filed an amended complaint on March 13,
2006. The amended complaint alleges that defendants made false and misleading
statements about the Company's financial situation and its relationship with
certain of its large customers during a purported class period between November
13, 2003 and August 12, 2005. It purports to state claims under Section
10(b)/Rule 10b-5 and Section 20(a) of the Securities Exchange Act of 1934. The
Company filed a motion to dismiss the amended complaint, which motion was denied
by the Court on July 17, 2006. On December 21, 2006 the Court established a
trial date of May 1, 2007 and ordered completion of discovery by March 19, 2007.
On February 20, 2007, the Court denied class certification. Plaintiff has moved
the court to reconsider the ruling, and also to intervene a new plaintiff to
pursue class certification. Both of those motions were denied on April 2, 2007.
In addition, the same day the Court granted defendants' motion for summary
judgment, and on or about April 5, 2007 the Court entered judgment in favor of
all defendants. On or about April 30, 2007, plaintiff filed a notice of appeal.
We believe that this matter will be resolved in trial or in settlement within
the limits of its insurance coverage, however the outcomes of this action or an
estimate of the potential losses, if any, related to the lawsuit cannot be

reasonably predicted, and an adverse resolution of any of the lawsuit could
potentially have a material adverse effect on our financial position and results
of operations.

On April 16, 2004 the Company filed suit against Pro-Fit Holdings,
Limited ("Pro-Fit") in the U.S. District Court for the Central District of
California -- TAG-IT PACIFIC, INC. V. PRO-FIT HOLDINGS, LIMITED, CV 04-2694 LGB
(RCx) -- asserting various contractual and tort claims relating to our exclusive
license and intellectual property agreement with Pro-Fit, seeking declaratory
relief, injunctive relief and damages. It is the Company's position that the
agreement with Pro-Fit gives us the exclusive rights in certain geographic areas
to Pro-Fit's stretch and rigid waistband technology. On September 17, 2004,
Pro-Fit filed an answer denying the material allegations of the complaint and
filed counterclaims alleging various contractual and tort claims seeking
injunctive relief and damages. We filed a reply denying the material allegations
of Pro-Fit's pleading. Pro-Fit has since purported to terminate the exclusive
license and intellectual property agreement based on the same alleged breaches
of the agreement that are the subject of the parties' existing litigation, as
well as on an additional basis. On February 9, 2005, and again on June 16, 2005,
we amended our pleadings in the litigation to assert additional breaches by
Pro-Fit of its obligations under the agreement and under certain additional
letter agreements, and for a declaratory judgment that Pro-Fit's patent No.
5,987,721 is invalid and not infringed by us. Thereafter, Pro-Fit filed an
amended answer and counterclaims denying the material allegations of the amended
complaint and alleging various contractual and tort claims seeking injunctive
relief and damages. Pro-Fit further asserted that we infringed its United States
Patent Nos. 5,987,721 and 6,566,285. We filed a reply denying the substantive
allegations of the amended counterclaims. On June 5, 2006 the Court denied the
Company's motion for partial summary judgment holding that summary
adjudification that we did not breach our agreement with Pro-Fit by engaging in
certain activities in Columbia was not appropriate. The Court also held that
Pro-Fit was not "unwilling or unable" to fulfill orders by refusing to fill
orders with goods produced in the United States. The Court did not find that we
breached our agreement with Pro-Fit and a trial is required to determine issues
concerning our activities in Columbia and whether other actions by Pro-Fit
constituted an unwillingness or inability to fill orders. As a result of a
change in the law, we dismissed our antitrust claims against Pro-Fit. The Court
has not yet set a date for trial of this matter. We have historically derived a
significant amount of revenue from the sale of products incorporating the
stretch waistband technology and our business, results of operations and
financial condition could be materially adversely affected if the dispute with
Pro-Fit is not resolved in a manner favorable to us. Additionally, we have
incurred significant legal fees in this litigation, and unless the case is
settled, we will continue to incur additional legal fees in increasing amounts
as the case accelerates to trial.

A subsidiary, Tag-It de Mexico, S.A. de C.V., has operated under the
Mexican government's Maquiladora Program, which entitles Tag-It de Mexico to
certain favorable treatment as respects taxes and duties regarding certain
imports. In July of 2005, the Mexican Federal Tax Authority asserted a claim
against Tag-It de Mexico alleging that certain taxes had not been paid on
imported products during the years 2000, 2001, 2002 and 2003. In October of
2005, the Company filed a procedural opposition to the claim and submitted
documents to the Mexican Tax Authority in opposition to this claim, supporting
the Company's position that the claim was without merit. The Mexican Federal Tax
Authority failed to respond to the opposition filed, and the required response
period by the Tax Authority has lapsed. In addition, a controlled entity
incorporated in Mexico (Logistica en Avios, S.A. de C.V.) through which the
Company conducted its operations in 2005, may be subjected to a claim or claims
from the Mexican Tax Authority, as identified directly above, and additionally
to other tax issues, including those arising from employment taxes. The Company
believes that any such claim is defective on both procedural and documentary
grounds and does not believe there will be a material adverse effect on us.

We currently have pending a number of other claims, suits and
complaints that arise in the ordinary course of our business. We believe that we
have meritorious defenses to these claims and that the claims are either covered
by insurance or, after taking into account the insurance in place, would not
have a material effect on our consolidated financial condition if adversely
determined against us.

In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of the Company's
agreements that it has determined are within the scope of FIN 45:

In accordance with the bylaws of the Company, officers and directors
are indemnified for certain events or occurrences arising as a result of the
officer or director's serving in such capacity. The term of the indemnification
period is for the lifetime of the officer or director. The maximum potential
amount of future payments the Company could be required to make under the
indemnification provisions of its bylaws is unlimited. However, the Company has
a director and officer liability insurance policy that reduces its exposure and
enables it to recover a portion of any future amounts paid. As a result of its
insurance policy coverage, the Company believes the estimated fair value of the
indemnification provisions of its bylaws is minimal and therefore, the Company
has not recorded any related liabilities.

The Company enters into indemnification provisions under its agreements
with investors and its agreements with other parties in the normal course of
business, typically with suppliers, customers and landlords. Under these
provisions, the Company generally indemnifies and holds harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
the Company's activities or, in some cases, as a result of the indemnified
party's activities under the agreement. These indemnification provisions often
include indemnifications relating to representations made by the Company with
regard to intellectual property rights. These indemnification provisions
generally survive termination of the underlying agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is unlimited. The Company has not incurred material
costs to defend lawsuits or settle claims related to these indemnification
agreements. As a result, the Company believes the estimated fair value of these
agreements is minimal. Accordingly, the Company has not recorded any related
liabilities.

NOTE 7. NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements", ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. SFAS No. 157 applies
under other accounting pronouncements that require or permit fair value
measurements, and does not require any new fair value measurements. The
application of SFAS No. 157 however may change current practice within an
organization. SFAS No. 157 is effective for all fiscal years beginning after
November 15, 2007, with earlier application encouraged. We do not believe that
SFAS No. 157 will have a material impact on our financial position, results of
operations or cash flows.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115," ("SFAS No. 159") which expands the use of fair value. Under
SFAS No. 159 a company may elect to use fair value to measure accounts and loans
receivable, available-for-sale and held-to-maturity securities, equity method
investments, accounts payable, guarantees, issued debt and other eligible
financial instruments. SFAS No. 159 is effective for years beginning after
November 15, 2007. We do not believe that SFAS No. 159 will have a material
impact on our financial position, results of operations or cash flows.

NOTE 8. GEOGRAPHIC INFORMATION

The Company specializes in the distribution of a full range of trim
items to manufacturers of fashion apparel, specialty retailers and mass
merchandisers. There is not enough difference between the types of

products developed and distributed by the Company to account for these products
separately or to justify segmented reporting by product type.

The Company distributes its products internationally and has reporting
requirements based on geographic regions. Long-lived assets are attributed to
countries based on the location of the assets and revenues are attributed to
countries based on customer delivery locations, as follows:

Three Months Ended March 31,
Country / Region -------------------------------
SALES 2007 2006
----------- -----------
United States ........................ $ 842,500 $ 913,300
Asia ................................. 7,023,300 6,320,400
Mexico ............................... 280,000 1,135,500
Dominican Republic ................... 385,100 1,640,800
Other ................................ 559,200 628,200
----------- -----------
$ 9,090,100 $10,638,200
=========== ===========

March 31, December 31,
2007 2006
----------- -----------
LONG-LIVED ASSETS:
United States ..................... $ 9,595,700 $ 9,531,659
Asia .............................. 408,100 386,516
Mexico ............................ 3,700 5,078
Dominican Republic ................ 641,000 668,067
----------- -----------
$10,648,500 $10,591,320
=========== ===========

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD LOOKING STATEMENTS

This report and other documents we file with the SEC contain forward
looking statements that are based on current expectations, estimates, forecasts
and projections about us, our future performance, our business or others on our
behalf, our beliefs and our management's assumptions. These statements are not
guarantees of future performance and involve certain risks, uncertainties, and
assumptions that are difficult to predict. We describe our respective risks,
uncertainties, and assumptions that could affect the outcome or results of
operations below. We have based our forward looking statements on our
management's beliefs and assumptions based on information available to our
management at the time the statements are made. We caution you that actual
outcomes and results may differ materially from what is expressed, implied, or
forecast by our forward looking statements. Reference is made in particular to
forward looking statements regarding projections or estimates concerning our
business, including demand for our products and services, mix of revenue
streams, ability to control and/or reduce operating expenses, anticipated gross
margins and operating results, cost savings, product development efforts,
general outlook of our business and industry, international businesses,
competitive position, adequate liquidity to fund our operations and meet our
other cash requirements.

OVERVIEW

The following management's discussion and analysis is intended to
assist the reader in understanding our consolidated financial statements. This
management's discussion and analysis is provided as a supplement to, and should
be read in conjunction with, our consolidated financial statements and
accompanying notes.

Tag-It Pacific, Inc. designs, sells, manufactures and distributes
apparel zippers, specialty waistbands and various apparel trim products to
manufacturers of fashion apparel, specialty retailers and mass merchandisers. We
sell and market these products under various branded names including Talon, and
Tekfit. We operate the business globally under three product groups.

We plan to increase our global expansion of Talon zippers through the
establishment of a network of Talon owned sales, distribution and manufacturing
locations, distribution relationships, and joint ventures. The network of these
distributors and manufacturing joint ventures in combination with Talon owned
and affiliated facilities under the Talon brand is expected to improve our
time-to-market by eliminating the typical setup and build-out phase for new
manufacturing capacity throughout the world, and by sourcing, finishing and
distributing to apparel manufacturers in their local markets.

We have strategically structured our trim business to focus as an
outsourced product development, sourcing and sampling department for the most
demanding brands and retailers. We believe that trim design differentiation
among brands and retailers has become a critical marketing tool for our
customers. By assisting our customers in the development, design, sampling and
sourcing of trim, we expect to achieve higher margins for our trim products,
create long-term relationships with our customers, grow our sales to a
particular customer by supplying trim for a larger proportion of their brands,
and better differentiate our trim sales and services from those of our
competitors. We plan to aggressively expand our trim business footprint
globally, so we may better serve our apparel factory customers in the field, in
addition to our brand and retail customer. We believe we can lead the industry
in trim sourcing by having both an intimate relationship with our brand and
retail customers, and having a distributed service organization to serve our
factory customers (those that manufacture for the apparel brand and retailers)
globally.

Our Tekfit services provide manufacturers with the patented technology,
manufacturing know-how and materials required to produce garments incorporating
an expandable waistband. These products are currently produced by several
manufacturers for one single brand. In October 2006 our exclusive supply

contract with this single brand expired. With the expiration of this exclusive
contract we now have broader access to other customers and we intend to actively
expand this product offering to other brands. However, sales to the previous
single brand are expected to decline significantly through the next several
quarters, and orders from new brands are not expected to fully offset these
declines in the near term. Consequently we expect sales and earnings
contributions from this product line to be significantly lower for at least the
first half of 2007; though we believe our sales of the product will grow
significantly from current levels as we market our products to new customers in
the coming months.

Our efforts to expand this product offering to other customers have
also been limited by a licensing dispute. As described more fully in this report
under Contingencies and Guarantees (see Note 6 to our unaudited consolidated
financial statements), we are presently in litigation with Pro-Fit Holdings
Limited related to our exclusively licensed rights to sell or sublicense stretch
waistbands manufactured under Pro-Fit's patented technology.

The revenues we derive from the sale of products incorporating the
stretch waistband technology, represented approximately 19% of our consolidated
revenues for 2006 and accordingly the results of operations and financial
condition could be materially adversely affected if our dispute with Pro-Fit is
not resolved in a manner favorable to us, or if we are unsuccessful in securing
new customers to replace the revenues previously generated by the single brand.

RESULTS OF OPERATIONS

The following table sets forth selected statements of operations data
shown as a percentage of net sales for the periods indicated:

THREE MONTHS ENDED MARCH 31,
-----------------------------
2007 2006
------------ ------------
Net Sales .................................... 100.0% 100.0%
Cost of goods sold ........................... 69.8 73.3
------------ ------------
Gross margin ................................. 30.2 26.7
Selling expenses ............................. 7.8 5.1
General and administrative expenses .......... 29.5 26.5
------------ ------------
Operating loss ............................... (7.1)% (4.9)%
============ ============

SALES

For the three months ended March 31, 2007 and 2006, sales by geographic
region based on the location of the customer as a percentage of sales:

THREE MONTHS ENDED MARCH 31,
----------------------------
2007 2006
------------ ------------
United States .................................. 9.3% 8.6%
Asia ........................................... 77.3 59.4
Mexico ......................................... 3.0 10.7
Dominican Republic ............................. 4.2 15.4
Other .......................................... 6.2 5.9
------------ ------------
Total ..................................... 100.0% 100.0%
============ ============

Sales for the three months ended March 31, 2007 were $9.1 million, or
$1.5 million (14.5%) less than sales for the same period in 2006. The net
decrease reflects the decline in sales of Tekfit products resulting from the
termination in October 2006 of our exclusive contract for this product. Sales in
Asia increased for the three months ended March 31, 2007 by approximately $0.7
million or 11% over the same period in 2006; offset by a decline in sales from
Mexico in 2006 that were discontinued or were shifted to Asia in response to the
shift of apparel production from Latin America to Asia and other worldwide
markets that began in 2004. We responded to these market changes with a
restructuring plan implemented in the third quarter of 2005 that included
reducing our operations in Mexico and focusing our efforts on the markets in
Asia.

COST OF SALES

Cost of sales for the three months ended March 31, 2007 were $6.3
million, or 69.8% of sales, as compared to $7.8 million, or 73.3% of sales, for
the same period in 2006. The total reduction in cost of sales for the period of
$1.4 million is primarily the result of improved manufacturing, distribution,
and inventory costs of approximately $0.4 million, and lower costs of
approximately $1.0 million associated with the net volume decline. The cost
reductions for the three months ended March 31, 2007 principally reflect the
elimination of inventory write-offs recorded in the first quarter of 2006.

SELLING EXPENSES

Selling expense for the three months ended March 31, 2007 were $0.7
million, or 7.8% of sales, as compared to $0.5 million, or 5.1% of sales, for
the same period in 2006. The increase in selling costs reflects the costs
associated with additional sales employees (approximately $120,000) and
additional marketing and advertising expenses (approximately $130,000), offset
by lower royalty costs and administrative costs (approximately $90,000)
associated with the decline in Tekfit sales.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expense for the three months ended March 31,
2007 were $2.6 million, or 29.5 percent of sales, as compared with $2.8 million,
or 26.5% of sales, for the same period in 2006. The increase in the general and
administrative expense as a percentage of sales is principally the result of the
lower sales volume in the period. The net reduction in general and
administrative costs of $125,000 results from lower legal costs ($232,000),
lower professional and audit costs ($63,000), lower share-based compensation
costs ($54,000), and lower administrative costs ($78,000); partially offset by
increases in costs associated with the expansion of the business in Asia,
including increased employee and facility costs ($80,000); and fewer bad debts
recoveries ($222,000).

For the three months ended March 31, 2007 we incurred $0.9 million in
professional, audit and legal fees associated mainly with the completion of our
year-end audit, and in litigation expenses associated with our Pro-Fit license.
These costs represent a decrease of $0.3 million over the comparable costs in
the same period of 2006. During the three months ended March 31, 2007 the
share-based compensation costs associated with the implementation of FAS 123R
was $65,000 as compared with $119,000 for the same period in 2006. For the three
months ended March 31, 2007 general and administrative expenses were net of
$10,000 in net recoveries of bad debts, and for the three months ended March 31,
2006 general and administrative expenses were net of $233,000 in net bad debt
recoveries.

INTEREST EXPENSE

Interest expense decreased by approximately $60,000 to $147,000 for the
three months ended March 31, 2007, as compared to the same period in 2006 due to
lower borrowings under certain notes, net of increased interest earnings on our
note receivable.

INCOME TAXES

There was no provision for income taxes for the three months ended
March 31, 2007 or 2006 due to the operating losses incurred and no benefit for
income taxes has been recorded since there is not sufficient evidence to
determine that we will be able to utilize our net operating loss carry-forwards
to offset future taxable income.

LIQUIDITY AND CAPITAL RESOURCES

The following table summarizes selected financial data at (amounts in
thousands):

March 31, December 31,
2007 2006
------------ ------------
Cash and cash equivalents ........................ $ 3,272 $ 2,935
Total assets ..................................... 28,760 25,694
Current debt ..................................... 26,312 22,471
Non-current debt ................................. 1,449 1,536
Stockholders' equity ............................. 753 1,686

CASH AND CASH EQUIVALENTS

Cash and cash equivalents increased by $337,000 at March 31, 2007 as
compared to December 31, 2006, principally due to cash generated by operating
activities and lower cash used in financing activities, net of increases in
capital expenditures.

Cash provided by operating activities is our only recurring source of
funds, and was approximately $0.8 million for the three months ended March 31,
2007. The cash provided by (used by) operating activities during the three
months resulted principally from:

Net loss before non-cash expenses ........................... $ (353,000)
Inventory reductions, net of reserves ....................... 273,000
Receivable increases, net of reserves ....................... (236,000)
Increase in accounts payable and accrued expense ............ 1,182,000
Other ....................................................... (20,000)
-----------
$ 846,000

Net cash used in investing activities for the three months ended March
31, 2007 was $356,000 as compared to $23,000 for the three months ended March
31, 2006. These expenditures were principally associated with leasehold
improvements in new facilities, office equipment for new employees, improvements
in our technology systems and a marketing website acquisition. The cash used in
the first quarter of 2006 represents capital expenditures for replacement
computer equipment.

Net cash used in financing activities for the three months ended March
31, 2007 was approximately $152,000 and primarily reflects the repayment of
borrowings under capital leases and notes payable, net of collections under our
note receivable and funds raised from the exercise of stock options. For the
three months ended March 31, 2006 the cash used by financing activities was
$274,000 and represented the repayment of notes payable and capital leases,
partially offset by our note receivable payments.

Accrued legal costs at March 31, 2007 of $3.5 million principally
reflects amounts due in from our defense of the Class Action compliant filed
against us in October 2005, (See Note 6 for more discussion of this litigation).
The recoverable legal costs of $3.3 million at March 31, 2007 reflects
contractual and anticipated reimbursements from our insurance carriers
associated with this litigation.

We currently satisfy our working capital requirements primarily through
cash flows generated from operations. As the major industry brands continue to
outsource apparel manufacturing to offshore locations, our foreign customers,
though backed by U.S. brands and retailers, will continue to increase. This
makes traditional financing arrangements with U.S. banks and financial
institutions difficult and accordingly we continue to evaluate non-traditional
financing of our foreign assets.

We believe that our existing cash and cash equivalents and anticipated
cash flows from our operating activities and available financing will be
sufficient to fund our minimum working capital and capital expenditure needs for
at least the next twelve months. This conclusion is based on the belief that we
have successfully completed the restructuring plan adopted in 2005, and that our
strategic plan and the company's current structure will allow for continued
profitability; that we will collect our note and accounts receivable in
accordance to existing terms; and that we will complete a refinancing of the
convertible notes payable by their maturity date in November 2007. We have
discussed the refinancing of these notes with the current note holders and with
various financial and investment institutions. We believe we will be successful
in completing a modification or replacement of these notes prior to their
maturity.

If we are unable to successfully complete the refinancing of the
convertible notes or to collect our note and accounts receivable, or experience
greater than anticipated reductions in sales, we may need to raise additional
capital, or obtain alternate financing to repay the convertible notes, or
further reduce the scope of our business in order to fully satisfy our future
short-term liquidity requirements. If we cannot raise additional capital or
arrange alternate financing or reduce the scope of our business in response to a
substantial decline in sales, we may default on the payment of the convertible
notes payable. The event of a default on the payment of these notes will
materially affect the business operations in the long-term, however the on-going
operations for 2007 are nevertheless anticipated to substantially continue
throughout the 2007 year-end as operations from assets not pledged to these
notes continues.

The extent of our future long-term capital requirements will depend on
many factors, including our results of operations, future demand for our
products, the size and timing of future acquisitions, and our expansion into
foreign markets. Our need for additional long-term financing includes the
integration and expansion of our operations to exploit our rights under our
Talon trade name, the expansion of our operations in the Asia and other markets
and the further development of our waistband technology. If our cash from
operations is less than anticipated or our working capital requirements and
capital expenditures are greater than we expect, we may need to raise additional
debt or equity financing in order to provide for our operations. We are
continually evaluating various financing strategies to be used to expand our
business and fund future growth or acquisitions. There can be no assurance that
additional debt or equity financing will be available on acceptable terms or at
all. If we are unable to secure additional financing, we may not be able to
execute our plans for expansion, including expansion into foreign markets to
promote our Talon brand trade name and we may need to implement additional cost
savings initiatives.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

The following summarizes our contractual obligations at March 31, 2007
and the effects such obligations are expected to have on liquidity and cash flow
in future periods:

Payments Due by Period
-------------------------------------------------------------------
Less than 1-3 4-5 After
Contractual Obligations Total 1 Year Years Years 5 Years
------------------------- ----------- ----------- ----------- ----------- -----------

Demand notes payable
to related parties(1) $ 1,197,600 $ 1,197,600 $ -- $ -- $ --
Capital lease obligations $ 902,600 $ 493,000 $ 409,600 -- $ --
Operating leases ........ $ 1,342,800 $ 448,000 $ 878,000 $ 16,800 $ --
Notes payable ........... $ 2,114,600 $ 882,700 $ 619,500 $ 612,400 $ --
Convertible notes payable $12,958,200 $12,958,200 $ -- $ -- $ --
----------- ----------- ----------- ----------- -----------
Total Obligations .. $18,515,800 $15,979,500 $ 1,907,100 $ 629,200 $ --
=========== =========== =========== =========== ===========

(1) The majority of notes payable to related parties are due on demand with
the remainder due and payable on the fifteenth day following the date
of delivery of written demand for payment, and include accrued interest
payable through March 31, 2007.

At March 31, 2007 and 2006, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.

RELATED PARTY TRANSACTIONS

A director and significant shareholder of Tarrant Apparel Group is also
a significant shareholder of the Company. Sales to Tarrant for the three months
ended March 31, 2007 were $100, and sales to Tarrant for the three months ended
March 31, 2006 were $25,300. As of March 31, 2007 and December 31, 2006 there
were no amounts due from Tarrant.

Colin Dyne, a director and significant stockholder of the Company is
also a significant shareholder in People's Liberation, Inc. During the three
months ended March 31, 2007 and 2006, we had sales of $141,800 and $15,500,
respectively, to subsidiaries of People's Liberation, Inc. At March 31, 2007,
accounts receivable included $104,400 outstanding from People's Liberation
subsidiaries. At December 31, 2006, accounts receivable of $83,400 were
outstanding from subsidiaries of People's Liberation, Inc.

Due from related parties at March 31, 2007 includes $709,800 and at
December 31, 2006, $675,100 of unsecured notes, advances and accrued interest
receivable from Colin Dyne. The notes and advances bear interest at 7.5% and are
due on demand.

Demand notes payable to related parties includes notes and advances to
Mark Dyne, the Chairman of the Board of Directors of the Company or to parties
related to or affiliated with Mark Dyne. The balance of Demand notes payable to
related parties at March 31, 2007 and at December 31, 2006 was $665,000.

Consulting fees paid to Diversified Investments, a company owned by
Mark Dyne, amounted to $37,500 for the three months ended March 31, 2007 and
2006.

Consulting fees of $68,750 were paid for services provided by Colin
Dyne for the three months ended March 31, 2007 and 2006. Consulting fees of
$73,400 were paid for services provided by Jonathan Burstein, a Director for the
three months ended March 31, 2007.

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND 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 for the reporting period and as of
the financial statement date. We base our estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. These estimates and assumptions affect the reported amounts of
assets and liabilities, the disclosure of contingent liabilities and the
reported amounts of revenue and expense. Actual results could differ from those
estimates.

Critical accounting policies are those that are important to the
portrayal of our financial condition and results, and which require us to make
difficult, subjective and/or complex judgments. Critical accounting policies
cover accounting matters that are inherently uncertain because the future
resolution of such matters is unknown. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
the preparation of our consolidated financial statements:

o Accounts receivable balances are evaluated on a continual
basis and allowances are provided for potentially
uncollectible accounts based on management's estimate of the
collectibility of customer accounts. If the financial
condition of a customer were to deteriorate, resulting in an
impairment of its ability to make payments, an additional
allowance may be required.

Allowance adjustments are charged to operations in the period
in which the facts that give rise to the adjustments become
known.

o Inventories are stated at the lower of cost or market value.
Inventory is evaluated on a continual basis and reserve
adjustments are made based on management's estimate of future
sales value, if any, of specific inventory items. Inventory
reserves are recorded for damaged, obsolete, excess and
slow-moving inventory. We use estimates to record these
reserves. Slow-moving inventory is reviewed by category and
may be partially or fully reserved for depending on the type
of product and the length of time the product has been
included in inventory. Reserve adjustments are made for the
difference between the cost of the inventory and the estimated
market value, if lower, and charged to operations in the
period in which the facts that give rise to these adjustments
become known. Market value of inventory is estimated based on
the impact of market trends, an evaluation of economic
conditions and the value of current orders relating to the
future sales of this type of inventory.

o We record deferred tax assets arising from temporary timing
differences between recorded net income and taxable net income
when and if we believe that future earnings will be sufficient
to realize the tax benefit. For those jurisdictions where the
expiration date of tax benefit carry-forwards or the projected
taxable earnings indicate that realization is not likely, a
valuation allowance is provided. If we determine that we may
not realize all of our deferred tax assets in the future, we
will make an adjustment to the carrying value of the deferred
tax asset, which would be reflected as an income tax expense.
Conversely, if we determine that we will realize a deferred
tax asset, which currently has a valuation allowance, we would
be required to reverse the valuation allowance, which would be
reflected as an income tax benefit. We believe that our
estimate of deferred tax assets and determination to record a
valuation allowance against such assets are critical
accounting estimates because they are subject to, among other
things, an estimate of future taxable income, which is
susceptible to change and dependent upon events that may or
may not occur, and because the impact of recording a valuation
allowance may be material to the assets reported on the
balance sheet and results of operations.

o We record impairment charges when the carrying amounts of
long-lived assets are determined not to be recoverable.
Impairment is measured by assessing the usefulness of an asset
or by comparing the carrying value of an asset to its fair
value. Fair value is typically determined using quoted market
prices, if available, or an estimate of undiscounted future
cash flows expected to result from the use of the asset and
its eventual disposition. The amount of impairment loss is
calculated as the excess of the carrying value over the fair
value. Changes in market conditions and management strategy
have historically caused us to reassess the carrying amount of
our long-lived assets. Long-lived assets are evaluated on a
continual basis and impairment adjustments are made based upon
management's valuations.

o Sales are recognized when persuasive evidence of an
arrangement exists, product delivery has occurred, pricing is
fixed or determinable, and collection is reasonably assured.
Sales resulting from customer buy-back agreements, or
associated inventory storage arrangements are recognized upon
delivery of the products to the customer, the customer's
designated manufacturer, or upon notice from the customer to
destroy or dispose of the goods. Sales, provisions for
estimated sales returns, and the cost of products sold are
recorded at the time title transfers to customers. Actual
product returns are charged against estimated sales return
allowances.

o Upon approval of a restructuring plan by management, we record
restructuring reserves for certain costs associated with
facility closures and business reorganization activities as
they are incurred or when they become probable and estimable.
Such costs are recorded as a current liability. We record
restructuring reserves in compliance with SFAS 146 "Accounting
for Costs Associated with Exit or Disposal Activities",
resulting in the recognition of employee severance and related
termination benefits for recurring arrangements when they
became probable and estimable and on the accrual basis for
one-time benefit arrangements. We record other costs
associated with exit activities as they are incurred. Employee
severance and termination benefits are estimates based on
agreements with the relevant union representatives or plans
adopted by us that are applicable to employees not affiliated
with unions. These costs are not associated with nor do they
benefit continuing activities. Inherent in the estimation of
these costs are assessments related to the most likely
expected outcome of the significant actions to accomplish the
restructuring. Changing business conditions may affect the
assumptions related to the timing and extent of facility
closure activities. We review the status of restructuring
activities on a quarterly basis and, if appropriate, records
changes based on updated estimates.

o We are currently involved in various lawsuits, claims and
inquiries, most of which are routine to the nature of the
business, and in accordance with SFAS No. 5, "Accounting for
Contingencies." We accrue estimates of the probable and
estimable losses for the resolution of these claims. The
ultimate resolution of these claims could affect our future
results of operations for any particular quarterly or annual
period should our exposure be materially different from our
earlier estimates or should liabilities be incurred that were
not previously accrued.

NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements", ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value
measurements, and does not require any new fair value measurements. The
application of SFAS No. 157 however may change current practice within an
organization. SFAS No. 157 is effective for all fiscal years beginning after
November 15, 2007, with earlier application encouraged. We do not believe that
SFAS No. 157 will have a material impact on our financial position, results of
operations or cash flows.

CAUTIONARY STATEMENTS AND RISK FACTORS

Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In addition to other

information contained in this report, readers should carefully consider the
following cautionary statements and risk factors.

OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY
AFFECTED IF WE ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING
OUR RIGHTS UNDER OUR EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY AGREEMENT WITH
PRO-FIT. Pursuant to our agreement with Pro-Fit Holdings, Limited, we have
exclusive rights in certain geographic areas to Pro-Fit's stretch and rigid
waistband technology. We are in litigation with Pro-Fit regarding our rights.
See Part II, Item 1, "Legal Proceedings" for discussion of this litigation. We
have derived a significant amount of revenues from the sale of products
incorporating the stretch waistband technology. Our business, results of
operations and financial condition could be materially adversely affected if we
are unable to reach a settlement in a manner acceptable to us and ensuing
litigation is not resolved in a manner favorable to us. Additionally, we have
incurred significant legal fees in this litigation, and unless the case is
settled, we will continue to incur additional legal fees in increasing amounts
as the case accelerates to trial.

IF WE LOSE OUR LARGER CUSTOMERS OR THEY FAIL TO PURCHASE AT ANTICIPATED
LEVELS, OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED. Our results
of operations will depend to a significant extent upon the commercial success of
our larger customers. If these customers fail to purchase our products at
anticipated levels, or our relationship with these customers terminates, it may
have an adverse effect on our results because:

o We will lose a primary source of revenue if these customers
choose not to purchase our products or services;

o We may not be able to reduce fixed costs incurred in
developing the relationship with these customers in a timely
manner;

o We may not be able to recoup setup and inventory costs;

o We may be left holding inventory that cannot be sold to other
customers; and

o We may not be able to collect our receivables from them.

In October 2006, our exclusive supply agreement with Levi Strauss &
Co., pursuant to which we supplied Levi with TEKFIT waistbands for their Dockers
programs, expired. With the expiration of this contract we now have broader
access to other customers and we intend to actively expand this product offering
to other brands. Sales of this product to Levi are expected to end during the
second quarter of 2007 and to be significantly lower than in the previous year,
and orders from new brands are not expected to fully offset these declines for
several quarters, if at all. The revenues we derived from the sale of products
incorporating the stretch waistband technology represented approximately 19% of
our consolidated revenues for the years ended December 31, 2005 and 2006. A
failure to attract new customers for our TEKFIT waistbands could have a material
adverse effect on our sales and results of operations.

IF WE ARE NOT ABLE TO REGAIN COMPLIANCE WITH LISTING REQUIREMENTS, OUR
SHARES MAY BE REMOVED FROM LISTING ON AMEX. In May 2006 we were advised by AMEX
that we were non-compliant with the minimum net equity listing requirements and
we were afforded an opportunity to submit a plan to AMEX that provided for
increases in our equity beyond the minimum $4.0 million equity requirement
within an eighteen-month timeframe from the date of the notice from AMEX. On
August 3, 2006 AMEX accepted our plan to regain compliance and has given us an
extension until November 16, 2007 to become compliant with the AMEX continued
listing standards. During this period, we will be subject to periodic review by
the AMEX staff and failure to make progress consistent with the plan or to
regain compliance with continued listing standards by the end of the extension
period could result in being delisted from the American Stock Exchange. In
addition we have suffered substantial recurring losses and may fail to comply
with other listing requirements of AMEX. We may not be able to regain compliance
with these matters within the time allowed by the exchange, and our shares of
common stock may be removed from the listing on AMEX.

IF WE ARE NOT ABLE TO RESTRUCTURE THE $12.5 MILLION SECURED CONVERTIBLE
PROMISSORY NOTES PAYABLE TO EXTEND THE MATURITY OF THIS DEBT, OR TO SECURE
ALTERNATE FINANCING TO REPLACE THESE NOTES, WE MAY DEFAULT ON THEIR PAYMENT. The
$12.5 million in convertible notes payable mature in November 2007 and it is
more likely than not that we will not be able to generate sufficient cash flow
from operations in time to pay these notes. The debt holders have a conversion
option at $3.65 per share and we can require conversion only if the market price
of our stock exceeds 120% of the conversion price for a minimum of fifteen
trading days just prior to their maturity and certain trading volume
requirements are met. In the event that the shares are not converted, in order
to obtain an extension of the note term we may have to lower the conversion
price of the debt resulting in additional dilution of the current shareholder
value, or we may default on their payment and the note holders, in addition to
pursuing other remedies, may take action to secure the collateral for these
notes, the TALON brand name, resulting in substantial disruption to our business
operations and adversely affecting the financial operating results and financial
position of the company going forward.

WE MAY NOT BE ABLE TO COLLECT OUR NOTE RECEIVABLE. On April 11, 2007 a
favorable verdict was awarded to the plaintiff in a trademark infringement
lawsuit in which Azteca Production International, Inc. is a defendant. We have
an outstanding note from Azteca at March 31, 2007 of $2.5 million and this
adverse ruling against them may impact their ability to repay our note
receivable. The outcome of this event or an estimate of the potential impact if
any, on the collectibility of our note receivable cannot be predicted at this
time. The failure to collect payments under this note as scheduled could have a
material adverse effect on our financial position, results of operations and
cash flow. At March 31, 2007 Azteca had met all payment requirements under the
note as scheduled.

IF CUSTOMERS DEFAULT ON INVENTORY PURCHASE COMMITMENTS WITH US, WE WILL
BE LEFT HOLDING NON-SALABLE INVENTORY. We hold significant inventories for
specific customer programs, which the customers have committed to purchase. If
any customer defaults on these commitments, or insists on markdowns, we may
incur a charge in connection with our holding significant amounts of non-salable
inventory and this would have a negative impact on our operations and cash flow.

OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS WORSEN. Our
revenues depend on the health of the economy and the growth of our customers and
potential future customers. When economic conditions weaken, certain apparel
manufacturers and retailers, including some of our customers may experience
financial difficulties that increase the risk of extending credit to such
customers. Customers adversely affected by economic conditions have also
attempted to improve their own operating efficiencies by concentrating their
purchasing power among a narrowing group of vendors. There can be no assurance
that we will remain a preferred vendor to our existing customers. A decrease in
business from or loss of a major customer could have a material adverse effect
on our results of operations. Further, if the economic conditions in the United
States worsen or if a wider or global economic slowdown occurs, we may
experience a material adverse impact on our business, operating results, and
financial condition.

BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, WE MAY NOT BE ABLE
TO ALWAYS OBTAIN MATERIALS WHEN WE NEED THEM AND WE MAY LOSE SALES AND
CUSTOMERS. Lead times for materials we order can vary significantly and depend
on many factors, including the specific supplier, the contract terms and the
demand for particular materials at a given time. From time to time, we may
experience fluctuations in the prices, and disruptions in the supply, of
materials. Shortages or disruptions in the supply of materials, or our inability
to procure materials from alternate sources at acceptable prices in a timely
manner, could lead us to miss deadlines for orders and lose sales and customers.

WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS
IN OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND
STOCK PRICE VOLATILITY. We operate in an industry that is subject to significant
fluctuations in operating results from quarter to quarter, which may lead to
unexpected reductions in revenues and stock price volatility. Factors that may
influence our quarterly operating results include:

o The volume and timing of customer orders received during the
quarter;

o The timing and magnitude of customers' marketing campaigns;

o The loss or addition of a major customer;

o The availability and pricing of materials for our products;

o The increased expenses incurred in connection with the
introduction of new products;

o Currency fluctuations;

o Delays caused by third parties; and

o Changes in our product mix or in the relative contribution to
sales of our subsidiaries.

Due to these factors, it is possible that in some quarters our
operating results may be below our stockholders' expectations and those of
public market analysts. If this occurs, the price of our common stock could be
adversely affected. In the past, following periods of volatility in the market
price of a company's securities, securities class action litigation has often
been instituted against such a company. In October 2005, a securities class
action lawsuit was filed against us. See Part II, Item 1, "Legal Proceedings"
for a detailed description of this lawsuit.

THE OUTCOME OF LITIGATION IN WHICH WE HAVE BEEN NAMED AS A DEFENDANT IS
UNPREDICTABLE AND AN ADVERSE DECISION IN ANY SUCH MATTER COULD HAVE A MATERIAL
ADVERSE EFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS. We are
defendants in a number of litigation matters. These claims may divert financial
and management resources that would otherwise be used to benefit our operations.
Although we believe that we have meritorious defenses to the claims made in each
and all of the litigation matters to which we have been named a party, and
intend to contest each lawsuit vigorously, no assurances can be given that the
results of these matters will be favorable to us. An adverse resolution of any
of these lawsuits could have a material adverse effect on our financial position
and results of operations.

We maintain product liability and director and officer insurance that
we regard as reasonably adequate to protect us from potential claims; however we
cannot assure you that it will be adequate to cover any losses. Further, the
costs of insurance have increased dramatically in recent years, and the
availability of coverage has decreased. As a result, we cannot assure you that
we will be able to maintain our current levels of insurance at a reasonable
cost, or at all.

OUR CUSTOMERS HAVE CYCLICAL BUYING PATTERNS WHICH MAY CAUSE US TO HAVE
PERIODS OF LOW SALES VOLUME. Most of our customers are in the apparel industry.
The apparel industry historically has been subject to substantial cyclical
variations. Our business has experienced, and we expect our business to continue
to experience, significant cyclical fluctuations due, in part, to customer
buying patterns, which may result in periods of low sales usually in the first
and fourth quarters of our financial year.

OUR BUSINESS MODEL IS DEPENDENT ON INTEGRATION OF INFORMATION SYSTEMS
ON A GLOBAL BASIS AND, TO THE EXTENT THAT WE FAIL TO MAINTAIN AND SUPPORT OUR
INFORMATION SYSTEMS, IT CAN RESULT IN LOST REVENUES. We must consolidate and
centralize the management of our subsidiaries and significantly expand and
improve our financial and operating controls. Additionally, we must effectively
integrate the information systems of our worldwide operations with the
information systems of our principal offices in California. Our failure to do so
could result in lost revenues, delay financial reporting or adverse effects on
the information reported.

THE LOSS OF KEY MANAGEMENT AND SALES PERSONNEL COULD ADVERSELY AFFECT
OUR BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE
SALES. Our success has and will continue to depend to a significant extent upon
key management and sales personnel, many of whom would be difficult to replace.
The loss of the services of key employees could have a material adverse effect
on our business, including our ability to establish and maintain client
relationships. Our future success will depend in large part upon our ability to
attract and retain personnel with a variety of sales, operating and managerial
skills.

IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL
NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently,
we do not operate duplicate facilities in different geographic areas. Therefore,
in the

event of a regional disruption where we maintain one or more of our facilities,
it is unlikely that we could shift our operations to a different geographic
region and we may have to cease or curtail our operations. This may cause us to
lose sales and customers. The types of disruptions that may occur include:

o Foreign trade disruptions;

o Import restrictions;

o Labor disruptions;

o Embargoes;

o Government intervention;

o Natural disasters; or

o Regional pandemics.

INTERNET-BASED SYSTEMS THAT WE RELY UPON FOR OUR ORDER TRACKING AND
MANAGEMENT SYSTEMS MAY EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE
REVENUES AND CUSTOMERS. To the extent that we fail to adequately update and
maintain the hardware and software implementing our integrated systems, our
customers may be delayed or interrupted due to defects in our hardware or our
source code. In addition, since our software is Internet-based, interruptions in
Internet service generally can negatively impact our ability to use our systems
to monitor and manage various aspects of our customer's trim needs. Such defects
or interruptions could result in lost revenues and lost customers.

THE REQUIREMENTS OF THE SARBANES-OXLEY ACT, INCLUDING SECTION 404, ARE
BURDENSOME, AND OUR FAILURE TO COMPLY WITH THEM COULD HAVE A MATERIAL ADVERSE
AFFECT ON OUR BUSINESS AND STOCK PRICE. Effective internal control over
financial reporting is necessary for us to provide reliable financial reports
and effectively prevent fraud. Section 404 of the Sarbanes-Oxley Act of 2002
requires us to evaluate and report on our internal control over financial
reporting beginning with our annual report on Form 10-K for the fiscal year
ending December 31, 2007. Our independent registered public accounting firm will
need to annually attest to our evaluation, and issue their own opinion on our
internal control over financial reporting beginning with our annual report on
Form 10-K for the fiscal year ending December 31, 2008. We are preparing for
compliance with Section 404 by strengthening, assessing and testing our system
of internal control over financial reporting to provide the basis for our
report. The process of strengthening our internal control over financial
reporting and complying with Section 404 is expensive and time consuming, and
requires significant management attention. Failure to implement required
controls, or difficulties encountered in their implementation, could cause us to
fail to meet our reporting obligations. If we or our auditors discover a
material weakness in our internal control over financial reporting, the
disclosure of that fact, even if the weakness is quickly remedied, could
diminish investors' confidence in our financial statements and harm our stock
price. In addition, non-compliance with Section 404 could subject us to a
variety of administrative sanctions, including the suspension of trading,
ineligibility for listing on one of the national securities exchanges, and the
inability of registered broker-dealers to make a market in our common stock,
which would further reduce our stock price.

THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors have
greater name recognition, longer operating histories and greater financial and
other resources than we do.

UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR
LITIGATION COSTS AND ADVERSELY AFFECT OUR SALES. We rely on trademark, trade
secret and copyright laws to protect our designs and other proprietary property
worldwide. We cannot be certain that these laws will be sufficient to protect
our property. In particular, the laws of some countries in which our products
are distributed or may be distributed in the future may not protect our products
and intellectual rights to the same extent as the laws of the United States. If
litigation is

necessary in the future to enforce our intellectual property rights, to protect
our trade secrets or to determine the validity and scope of the proprietary
rights of others, such litigation could result in substantial costs and
diversion of resources. This could have a material adverse effect on our
operating results and financial condition. Ultimately, we may be unable, for
financial or other reasons, to enforce our rights under intellectual property
laws, which could result in lost sales.

IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY
BE SUED AND HAVE TO PAY LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR DISCONTINUE
SELLING OUR PRODUCTS. From time to time in our industry, third parties allege
infringement of their proprietary rights. Any infringement claims, whether or
not meritorious, could result in costly litigation or require us to enter into
royalty or licensing agreements as a means of settlement. If we are found to
have infringed the proprietary rights of others, we could be required to pay
damages, cease sales of the infringing products and redesign the products or
discontinue their sale. Any of these outcomes, individually or collectively,
could have a material adverse effect on our operating results and financial
condition.

COUNTERFEIT PRODUCTS ARE NOT UNCOMMON IN THE APPAREL INDUSTRY AND OUR
CUSTOMERS MAY MAKE CLAIMS AGAINST US FOR PRODUCTS WE HAVE NOT PRODUCED AND WE
MAY BE ADVERSELY IMPACTED BY THESE FALSE CLAIMS. Counterfeiting of valuable
trade names is commonplace in the apparel industry and while there are industry
organizations and federal laws designed to protect the brand owner, these
counterfeit products are not always detected and it can be difficult to prove
the manufacturing source of these products. Accordingly, we may be adversely
affected if counterfeit products damage our relationships with customers, and we
incur costs to prove these products are counterfeit, to defend ourselves against
false claims, or we may have to pay for false claims.

OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS
AND CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES. The following factors
could cause the market price of our common stock to decrease, perhaps
substantially:

o The failure of our quarterly operating results to meet
expectations of investors or securities analysts;

o Adverse developments in the financial markets, the apparel
industry and the worldwide or regional economies;

o Interest rates;

o Changes in accounting principles;

o Intellectual property and legal matters;

o Sales of common stock by existing shareholders or holders of
options;

o Announcements of key developments by our competitors; and

o The reaction of markets and securities analysts to
announcements and developments involving our company.

IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may
include expansion through internal growth, by acquiring complementary businesses
or by establishing strategic relationships with targeted customers and
suppliers. In order to do so or to fund our other activities, we may issue
additional equity securities that could dilute our stockholders' value. We may
also assume additional debt and incur impairment losses to our intangible assets
if we acquire another company.

WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS.
We may consider strategic acquisitions as opportunities arise, subject to the
obtaining of any necessary financing. Acquisitions involve numerous risks,
including diversion of our management's attention away from our operating
activities. We cannot assure you that we will not encounter unanticipated
problems or liabilities relating to the integration of an acquired

company's operations, nor can we assure you that we will realize the anticipated
benefits of any future acquisitions.

OUR ACTUAL TAX LIABILITIES MAY DIFFER FROM ESTIMATED TAX RESULTING IN
UNFAVORABLE ADJUSTMENTS TO OUR FUTURE RESULTS. The amount of income taxes we pay
is subject to ongoing audits by federal, state and foreign tax authorities. Our
estimate of the potential outcome of uncertain tax issues is subject to our
assessment of relevant risks, facts, and circumstances existing at that time.
Our future results may include favorable or unfavorable adjustments to our
estimated tax liabilities in the period the assessments are made or resolved,
which may impact our effective tax rate and our financial results.

WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue
additional shares of preferred stock and some provisions of our certificate of
incorporation and bylaws and of Delaware law could make it more difficult for a
third party to make an unsolicited takeover attempt of us. These anti-takeover
measures may depress the price of our common stock by making it more difficult
for third parties to acquire us by offering to purchase shares of our stock at a
premium to its market price.

INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD
LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As
of April 10, 2007, our officers and directors and their affiliates beneficially
owned approximately 20% of the outstanding shares of our common stock. The Dyne
family, which includes Mark Dyne, Colin Dyne, and Jonathan Burstein, who are
also our directors; Larry Dyne and the estate of Harold Dyne; beneficially owned
approximately 15% of the outstanding shares of our common stock at March 31,
2007. As a result, our officers and directors and the Dyne family are able to
exert considerable influence over the outcome of any matters submitted to a vote
of the holders of our common stock, including the election of our Board of
Directors. The voting power of these stockholders could also discourage others
from seeking to acquire control of us through the purchase of our common stock,
which might depress the price of our common stock.

WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED
SECURITY MEASURES IN RESPONSE TO TERRORISM. Our business depends on the free
flow of products and services through the channels of commerce. In response to
terrorists' activities and threats aimed at the United States, transportation,
mail, financial and other services may be slowed or stopped altogether.
Extensive delays or stoppages in transportation, mail, financial or other
services could have a material adverse effect on our business, results of
operations and financial condition. Furthermore, we may experience an increase
in operating costs, such as costs for transportation, insurance and security as
a result of the activities and potential delays. We may also experience delays
in receiving payments from payers that have been affected by the terrorist
activities. The United States economy in general may be adversely affected by
the terrorist activities and any economic downturn could adversely impact our
results of operations, impair our ability to raise capital or otherwise
adversely affect our ability to grow our business.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

All of our sales are denominated in United States dollars or the
currency of the country in which our products originate. We are exposed to
market risk for fluctuations in the foreign currency exchange rates for certain
product purchases that are denominated in Hong Kong dollars, Chinese yuans and
British pounds. There were no hedging contracts outstanding as of March 31, 2007
or December 31, 2006. Currency fluctuations can increase the price of our
products to foreign customers which can adversely impact the level of our export
sales from time to time. The majority of our cash equivalents are held in United
States dollars in various bank accounts and we do not believe we have
significant market risk exposure with regard to our investments. At March 31,
2007 none of our indebtedness was subject to interest rate fluctuations.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under the
Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities Exchange Commission's rules and forms, including to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is accumulated and communicated to our management,
including our principal executive and principal financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange
Act. Disclosure controls and procedures, no matter how well designed and
operated, can provide only reasonable, rather than absolute, assurance of
achieving the desired control objectives.

As of March 31, 2007, we conducted an evaluation, with the
participation of our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that as of March 31, 2007, our disclosure
controls and procedures were effective at a reasonable assurance level.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There were no significant changes in our internal controls over
financial reporting that occurred during the first quarter that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.

PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On October 12, 2005, a shareholder class action complaint-- HUBERMAN V.
TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex)--was filed against us and
certain of our current and former officers and directors in the United States
District Court for the Central District of California alleging claims under
Section 10(b) and Section 20 of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5 promulgated thereunder. The action is brought on behalf of all
purchasers of our publicly-traded securities during the period from November 14,
2003 to August 12, 2005. On January 23, 2006 the Court heard competing motions
for appointment of lead plaintiff/counsel and appointed Seth Huberman as lead
plaintiff. The lead plaintiff thereafter filed an amended complaint on March 13,
2006. The amended complaint alleges that defendants made false and misleading
statements about our company's financial situation and our relationship with
certain of our large customers during a purported class period between November
13, 2003 and August 12, 2005. It purports to state claims under Section
10(b)/Rule 10b-5 and Section 20(a) of the Securities Exchange Act of 1934. We
filed a motion to dismiss the amended complaint, which motion was denied by the
Court on July 17, 2006. On December 21, 2006, the Court established a trial date
of May 1, 2007 and ordered completion of discovery by March 19, 2007. On
February 20, 2007, the Court denied class certification. Plaintiff has moved the
court to reconsider the ruling, and also to intervene a new plaintiff to pursue
class certification. Both of those motions were denied on April 2, 2007. In
addition, the same day the Court granted our and the other defendants' motion
for summary judgment, and on or about April 5, 2007 the Court entered judgment
in favor of all defendants. On or about April 30, 2007, plaintiff filed a notice
of

appeal. We believe that this matter will be resolved in trial or in settlement
within the limits of its insurance coverage, however the outcomes of this action
or an estimate of the potential losses, if any, related to the lawsuit cannot be
reasonably predicted, and an adverse resolution of any of the lawsuit could
potentially have a material adverse effect on our financial position and results
of operations.

On April 16, 2004, we filed suit against Pro-Fit Holdings, Limited
("Pro-Fit") in the U.S. District Court for the Central District of California --
TAG-IT PACIFIC, INC. V. PRO-FIT HOLDINGS, LIMITED, CV 04-2694 LGB (RCx) --
asserting various contractual and tort claims relating to our exclusive license
and intellectual property agreement with Pro-Fit, seeking declaratory relief,
injunctive relief and damages. It is our position that the agreement with
Pro-Fit gives us the exclusive rights in certain geographic areas to Pro-Fit's
stretch and rigid waistband technology. On September 17, 2004, Pro-Fit filed an
answer denying the material allegations of the complaint and filed counterclaims
alleging various contractual and tort claims seeking injunctive relief and
damages. We filed a reply denying the material allegations of Pro-Fit's
pleading. Pro-Fit has since purported to terminate the exclusive license and
intellectual property agreement based on the same alleged breaches of the
agreement that are the subject of the parties' existing litigation, as well as
on an additional basis. On February 9, 2005, and again on June 16, 2005, we
amended our pleadings in the litigation to assert additional breaches by Pro-Fit
of its obligations under the agreement and under certain additional letter
agreements, and for a declaratory judgment that Pro-Fit's patent No. 5,987,721
is invalid and not infringed by us. Thereafter, Pro-Fit filed an amended answer
and counterclaims denying the material allegations of the amended complaint and
alleging various contractual and tort claims seeking injunctive relief and
damages. Pro-Fit further asserted that we infringed its United States Patent
Nos. 5,987,721 and 6,566,285. We filed a reply denying the substantive
allegations of the amended counterclaims. On June 5, 2006, the Court denied our
motion for partial summary judgment holding that summary adjudification that we
did not breach our agreement with Pro-Fit by engaging in certain activities in
Columbia was not appropriate. The Court also held that Pro-Fit was not
"unwilling or unable" to fulfill orders by refusing to fill orders with goods
produced in the United States. The Court did not find that we breached our
agreement with Pro-Fit and a trial is required to determine issues concerning
our activities in Columbia and whether other actions by Pro-Fit constituted an
unwillingness or inability to fill orders. As a result of a change in the law,
we dismissed our antitrust claims against Pro-Fit. The Court has not yet set a
date for trial of this matter. We have historically derived a significant amount
of revenue from the sale of products incorporating the stretch waistband
technology our business, results of operations and financial condition could be
materially adversely affected if the dispute with Pro-Fit is not resolved in a
manner favorable to us. Additionally, we have incurred significant legal fees in
this litigation, and unless the case is settled, we will continue to incur
additional legal fees in increasing amounts as the case accelerates to trial.

We currently have pending a number of other claims, suits and
complaints that arise in the ordinary course of its business. We believe that we
has meritorious defenses to these claims and that the claims are either covered
by insurance or, after taking into account the insurance in place, would not
have a material effect on our consolidated financial condition if adversely
determined against us.

ITEM 1A. RISK FACTORS

A restated description of the risk factors associated with the Company
is included under "Cautionary Statements and Risk Factors" in Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
contained in Item 2 of Part I of this report. This description includes any
material changes to and supersedes the description of the risk factors
associated with an investment in the Company previously disclosed in our Annual
Report on Form 10-K for 2006 and is incorporated herein by reference.

ITEM 6. EXHIBITS

10.33(1) Consulting Agreement dated January 1, 2007 by and between
Tag-It Pacific, Inc. and Jonathan Burstein. Incorporated by
reference to Exhibit 10.1 to Form 8-K filed on January 4,
2007.

10.34(1) Consulting Agreement effective April 1, 2007 by and between
Tag-It Pacific, Inc. and Colin Dyne.

31.1 Certificate of Chief Executive Officer pursuant to Rule
13a-14(a) under the Securities and Exchange Act of 1934, as
amended.

31.2 Certificate of Chief Financial Officer pursuant to Rule
13a-14(a) under the Securities and Exchange Act of 1934, as
amended.

32.1 Certificate of Chief Executive Officer and Chief Financial
Officer pursuant to Rule 13a-14(b) under the Securities and
Exchange Act of 1934, as amended.

(1) Indicates a management contract or compensatory plan.

SIGNATURES

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

Dated: May 15, 2007 TAG-IT PACIFIC, INC.

` /S/ LONNIE D. SCHNELL
--------------------------------
By: Lonnie D. Schnell
Its: Chief Financial Officer