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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

[X]      Annual  Report  Pursuant  to  Section  13 or  15(d)  of the  Securities
         Exchange Act of 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

[_]      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 Registrant as Specified in Its Charter)

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

                         21900 BURBANK BLVD., SUITE 270
                        WOODLAND HILLS, CALIFORNIA 91367
               (Address of Principal Executive Offices) (Zip Code)

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

           Securities registered pursuant to Section 12(b) of the Act:

     Title of Each Class               Name of Each Exchange On Which Registered
-----------------------------          -----------------------------------------
Common Stock, $.001 Par Value                    American Stock Exchange

           Securities registered pursuant to Section 12(g) of the Act:

                                      NONE

Indicate by check mark if the  registrant is a well-known  seasoned  issuer,  as
defined in Rule 405 of the Securities Act.

                                 Yes [_] No [X]

Indicate  by check mark if the  registration  is not  required  to file  reports
pursuant to Section 13 or Section 15(d) of the Act.

                                 Yes [_] No [X]

Indicate  by check  mark  whether  the  registrant:  (1) has filed  all  reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for past 90 days.

                                 Yes [X] No [_]

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

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated  filer or a  non-accelerated  filer (as defined in Rule 12b-2 of the
Exchange Act).

                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 June 30, 2006 the aggregate market value of the voting and non-voting  common
stock held by  non-affiliates  of the registrant was  $12,147,000.  At April 10,
2007 the issuer had 18,466,433 shares of Common Stock,  $.001 par value,  issued
and outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the issuer's proxy statement with respect to its 2007 annual meeting
of stockholders are incorporated by reference into Part III of this report.

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<PAGE>


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

<TABLE>
<CAPTION>

PART I                                                                                           PAGE
<S>           <C>                                                                                 <C>
Item 1.       Business......................................................................       2
Item 1A.      Risk Factors .................................................................       9
Item 1B.      Unresolved Staff Comments ....................................................      14
Item 2.       Properties....................................................................      15
Item 3.       Legal Proceedings.............................................................      15
Item 4.       Submission of Matters to a Vote of Security Holders...........................      16

PART II

Item 5.       Market for Registrant's Common Equity, Related Stockholder Matters
                 and Issuer Purchases of Equity Securities..................................      17
Item 6.       Selected Financial Data.......................................................      19
Item 7.       Management's Discussion and Analysis of Financial
                 Condition and Results of Operations........................................      20
Item 7A.      Quantitative and Qualitative Disclosures about Market Risk ...................      31
Item 8.         Financial Statements and Supplementary Data.................................      33
Item 9.       Changes in and Disagreements with Accountants on
                 Accounting and Financial Disclosure........................................      68
Item 9A.      Controls and Procedures.......................................................      68
Item 9B.      Other Information.............................................................      68

PART III

Item 10.      Directors, Executive Officers and Corporate Governance........................      69
Item 11.      Executive Compensation........................................................      69
Item 12.      Security Ownership of Certain Beneficial Owners and
                 Management and Related Stockholder Matters.................................      69
Item 13.      Certain Relationships and Related Transactions and Director Independence......      69
Item 14.      Principal Accounting Fees and Services........................................      69

PART IV

Item 15.      Exhibits and Financial Statement Schedules....................................      69
</TABLE>


                                       1
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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. In addition, we, or others
on our behalf,  may make forward looking statements in press releases or written
statements, or in our communications and discussions with investors and analysts
in the normal course of business through  meetings,  webcasts,  phone calls, and
conference  calls.  Words such as "expect,"  "anticipate,"  "outlook,"  "could,"
"target," "project," "intend," "plan," "believe," "seek," "estimate,"  "should,"
"may," "assume,"  "continue,"  variations of such words and similar  expressions
are intended to identify such forward looking  statements.  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  in "Item  1A.  Risk  Factors."  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.  Except  as  required  under  the  federal
securities  laws and the rules and  regulations  of the SEC,  we do not have any
intention or obligation to update publicly any forward looking  statements after
the distribution of this report, whether as a result of new information,  future
events, changes in assumptions, or otherwise.


                                     PART I

ITEM 1.  BUSINESS

GENERAL

         Tag-It  Pacific,  Inc. is an apparel  company that  specializes  in the
manufacturing and distribution of a full range of apparel accessories  including
zippers and trim items to manufacturers of fashion apparel,  specialty retailers
and mass merchandisers. We manufacture and distribute zippers under our TALON(R)
brand  name to  manufacturers  for  apparel  brands and  retailers  such as Levi
Strauss & Co.,  Abercrombie & Fitch,  Wal-Mart,  Kohl's,  The Gap and JC Penney,
among others. We also provide full service outsourced trim design,  sourcing and
management services and supply specified trim items for manufacturers of fashion
apparel  such  as  Abercrombie  &  Fitch,  Victoria's  Secret,  American  Eagle,
Motherhood, Express, Polo Ralph Lauren and others. Under our TEKFIT(R) brand, we
develop  and  sell  apparel  components  that  utilize  a  patented  technology,
including a stretch waistband.

         We were  incorporated  in the State of Delaware in 1997. We were formed
to  serve  as  the  parent  holding  company  of  Tag-It,   Inc.,  a  California
corporation, Tag-It Printing & Packaging Ltd., which changed its name in 1999 to
Tag-It  Pacific  (HK) LTD, a BVI  corporation,  Tagit de Mexico,  S.A.  de C.V.,
A.G.S.  Stationery,  Inc.,  a California  corporation,  and Pacific Trim & Belt,
Inc., a California corporation. All of these companies were consolidated under a
parent limited  liability  company in October 1997.  These companies  became our
wholly owned subsidiaries immediately prior to the effective date of our initial
public   offering  in  January  1998.  In  2000,  we  formed  two  wholly  owned
subsidiaries  of  Tag-It  Pacific,  Inc:  Tag-It  Pacific  Limited,  a Hong Kong
corporation, and Talon International,  Inc., a Delaware corporation. During 2006
we formed two wholly owned  subsidiaries of Tag-It Pacific,  Inc.;  Talon Zipper
(Shenzhen)  Company Ltd. in China, and Talon  International Pvt. Ltd., in India.
Our Web site is  WWW.TAGITPACIFIC.COM.  Our Web site  address  provided  in this
Annual  Report on Form 10-K is not  intended to function as a hyperlink  and the
information  on our  website is not and should  not be  considered  part of this
report and is not incorporated by reference in this document.


                                       2
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BUSINESS SUMMARY

         We operate our business within three product groups,  Talon,  Trim, and
Tekfit.  In our Talon group, we design,  engineer,  test and distribute  zippers
under our TALON  trademark and trade names to apparel brands and  manufacturers.
TALON enjoys brand  recognition in the apparel  industry  worldwide.  TALON is a
100-year-old brand, which is well known for quality and product innovation,  and
was the original  pioneer of the formed wire metal zipper for the jeans industry
and  is a  specified  zipper  brand  for  manufacturers  in the  sportswear  and
outerwear  markets  worldwide.  We  provide  a line  of  high  quality  zippers,
including a specialty  zipper for kids  clothing,  for  distribution  to apparel
manufacturers  in Asia,  Mexico and Central America and have sales and marketing
teams in all of these areas. We have also developed,  and are now  implementing,
joint  manufacturing  arrangements  in various  geographic  international  local
markets to finish and sell zippers under the TALON brand name.  Our  contractors
work  with,  purchase  or  install  equipment  locally  for dying and  producing
finished zippers.  We expect this program to significantly  improve the speed at
which we serve the market and to expand the  geographic  footprint  of our TALON
products. The TALON zipper is promoted both within our trim packages, as well as
a stand-alone product line.

         In our Trim products group, we act as a fully integrated  single-source
supplier,  designer  and  sourcing  agent  of a full  range  of trim  items  for
manufacturers of fashion  apparel.  Our business focuses on servicing all of the
trim  requirements of our customers at the  manufacturing and retail brand level
of the fashion apparel  industry.  Trim items include labels,  buttons,  rivets,
printed marketing material,  polybasic, packing cartons, and hangers. Trim items
comprise  a  relatively  small  part of the cost of most  apparel  products  but
comprise  the vast  majority  of  components  necessary  to  fabricate a typical
apparel product.  We offer customers a one-stop  outsourced service for all trim
related matters.  Our teams work with the apparel designers,  and function as an
extension of their staff.

         If our  customer  is  creating a new pair of cargo pants for their fall
collection,  our Trim products group will  collaborate with them on their design
vision,  then  present  examples of their vision in graphic form for all apparel
accessory  components.  We will design the buttons,  snaps,  hang tags,  labels,
zippers,  zipper pullers and other items.  Once our customer selects the designs
they like, our sourcing and production  teams  coordinate  with our  proprietary
database of manufacturers  worldwide to ensure the best  manufacturing  solution
for the items being produced.  The proper manufacturing and sourcing solution is
a critical part of our service.  Knowing the best facility or supplier to ensure
timely  production,  the proper paper  finishes,  distressing  or other types of
material needs or  manufacturing  techniques to be used is critical.  Because we
perform this function for many different global projects and apparel brands,  we
have a depth and breadth of knowledge in the manufacturing and sourcing that our
customers  cannot  achieve,  and  therefore  offer a  significant  value  to our
customers.  In  addition,  because  we are  consistently  innovating  new items,
manufacturing techniques and finishes, we bring many new, fresh and unique ideas
to our customers.  Once we identify the  appropriate  supply  source,  we create
production  samples of all of our designs and  products,  and review the samples
with our customers so they can make a final decision while looking at the actual
items  that  will  be  used on the  garments.  When  the  customer  selects  the
appropriate  items, we are identified as the  sole-source  trim supplier for the
project,  and our  customer's  factories  are then required to purchase the trim
products from us. Throughout the garment manufacturing  process, we consistently
monitor the timing and accuracy of the production items to ensure the production
items  exactly  match all  samples  when  delivered  to our  customer's  apparel
factories.

         We also serve as a specified  supplier in our zipper and trim  products
for a variety of major  retail brand and  private-label  oriented  companies.  A
specified  supplier  is a supplier  that has been  approved  for its quality and
service by a major retail brand or private-label  company.  Apparel  contractors
manufacturing for the retail brand or private-label  company must purchase their
zipper and trim requirements from a supplier that has been specified. We seek to
expand our services as a supplier of select items for such customers, to being a
preferred or single-source  provider of the entire brand  customer's  authorized
trim and  zipper  requirements.  Our  ability  to offer a full range of trim and
zipper products is attractive to brand name and private-label oriented customers
because it enables the  customer to address  their  quality and supply needs for
all of their  trim  requirements  from a single  source,  avoiding  the time and
expense  necessary  to monitor  quality  and supply  from  multiple  vendors and
manufacturer sources.  Becoming a specified supplier to brand


                                       3
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customers  gives us an advantage to become the  preferred or sole vendor of trim
and zipper items for all apparel  manufacturers  contracted  for  production for
that brand name.

         Our  teams  of  sales  employees,  representatives,  program  managers,
creative design personnel and global production and distribution coordinators at
our  facilities  located in the United  States,  China,  India and the Caribbean
enable  us to  take  advantage  of  and  address  the  increasingly  complicated
requirements of the large and expanding  demand for complete  apparel  accessory
solutions. We plan to continue to expand operations in Asia, Europe, Central and
South  America  and  the  Caribbean  to  take  advantage  of the  large  apparel
manufacturing markets in these regions.

PRODUCTS

         TALON  ZIPPERS - We offer a full line of metal  and  synthetic  zippers
bearing  the  TALON  brand  name.   TALON(R)   zippers  are  used  primarily  by
manufacturers  in  the  apparel   industry  and  are  distributed   through  our
distribution  facilities in the United  States,  India and China and through our
agents, distributors and affiliates in other international markets.

         We plan to  expand  our  distribution  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.  The  branded
apparel zipper market is dominated by one company and we are  positioning  TALON
to be a viable global  alternative  to this  competitor and capture an increased
market share position. We plan to leverage the brand awareness of the TALON name
by branding other products in our line with the TALON name.

         TRIM - We  consider  our high  level  of  customer  service  as a fully
integrated  single-source supplier essential to our success. We combine our high
level of customer service within our TRIM solutions with a history of design and
manufacturing expertise to offer our customers a complete trim solution product.
We believe this full-service  product gives us a competitive edge over companies
that only offer  selected  trim  components  because our full service  solutions
saves our  customers  substantial  time in  ordering,  designing,  sampling  and
managing trim orders from several different suppliers.  Our proprietary tracking
and order  management  systems allow us to seamlessly  supply trim solutions and
products to apparel brands, retailers and manufacturers around the world.

         We  produce  customized  woven,  leather,  synthetic,  embroidered  and
novelty labels and tapes,  which can be printed on or woven into a wide range of
fabrics and other materials using various types of high-speed  equipment.  As an
additional  service,  we may provide our customers the machinery  used to attach
the buttons, rivets and snaps we distribute.

         In  2005  we  marketed  and  supplied   complete  trim  packages  on  a
per-garment  basis  which we  assembled  on behalf of our  customers.  Each trim
package  included all items of trim that a customer needed in the manufacture of
a  particular  item of apparel,  including  thread,  zippers,  labels,  buttons,
rivets,  polybags,  packing  cartons  and  hangers.  We  also  included  printed
marketing  materials such as hang tags,  bar-coded hang tags,  pocket  flashers,
waistband  tickets and size  stickers that were attached to products to identify
and promote the  products,  permit  automated  data  collection,  provide  brand
identification and communicate  consumer  information such as a product's retail
price, size, fabric content and care instructions.  We continue to sell the trim
package components separately,  but phased-out the offering as a complete kit in
late 2005 as our cost of labor for the assembly was no longer  competitive,  and
the  market was not  willing to pay the  premium  for  pre-assembly  of the trim
material. In 2005 we also decided to discontinue offering thread as a portion of
our trim  products  and we  negotiated  an  agreement  with our supplier for the
return of substantially  all of the company's thread products.  We instead,  are
sharpening  our focus on the market  opportunity in which we add the most value,
our full-service Trim solutions.


                                       4
<PAGE>


         TEKFIT - We  distribute  a  proprietary  stretch  waistband  under  our
Exclusive  License and  Intellectual  Property  Rights  agreement  with  Pro-Fit
Holdings,  Limited.  The  agreement  gives us the  exclusive  rights  to sell or
sublicense  stretch  waistbands   manufactured  under  the  patented  technology
developed by Pro-Fit for garments manufactured anywhere in the world for sale in
the U.S.  market and for all U.S.  brands for the life of the  patent.  We offer
apparel manufacturers advanced, patented fabric technologies to utilize in their
garments  under the TEKFIT name.  This  technology  allows fabrics to be altered
through the addition of stretch  characteristics  resulting in greatly  improved
fit and comfort. This technology allows pant manufacturers to build-in a stretch
factor  into  standard  waistbands  that does not alter  the  appearance  of the
garment,  but will  allow  the waist to  stretch  out and back by as much as two
waist sizes.  Previously,  we supplied Levi Strauss & Co. with TEKFIT waistbands
for their Dockers(R) programs,  under an exclusive supply agreement.  In October
2006 our exclusive contract with this brand 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. Orders have already been placed by
a new brand and deliveries are scheduled early in 2007.  However,  sales of this
product to Levi are  expected to end during the first  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 at least the next two quarters,
if at all.  Consequently,  we expect sales and earnings  contributions from this
product line to decline significantly for at least the first half of 2007.

         Our efforts to expand this  product  offering to other  customers  have
also been  limited by a licensing  dispute.  As  described  more fully in Item 3
"Legal  Proceedings"  we are presently in litigation with Pro-Fit 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 the years ended  December  31, 2006 and 2005,  and 25% for the year
ended  December 31, 2004.  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 our  exclusive
sales of this product to Levi.

DESIGN AND DEVELOPMENT

         Our in-house creative team produces products with innovative technology
and  designs  that  we  believe  distinguish  our  products  from  those  of our
competitors.  We support our skills and  expertise in material  procurement  and
product-manufacturing  coordination with product technology and designs intended
to meet fashion demands, as well as functional and cost parameters.  We recently
introduced the Talon KidZip which is a specialty  zipper for children's  apparel
engineered to surpass  industry  established  strength and safety  tests,  while
maintaining the fashion image and requirements of today's apparel demands.

         Many  specialty  design  companies  with which we compete  have limited
engineering,  sourcing  or  manufacturing  experience.  These  companies  create
products or designs that often cannot be implemented  due to difficulties in the
manufacturing  process,  the  expenses  of  required  materials,  or a  lack  of
functionality  in the resulting  product.  We design products to function within
the limitations  imposed by the applicable  manufacturing  framework.  Using our
manufacturing  and sourcing  experience,  we ensure delivery of quality products
and we minimize the  time-consuming  delays that often arise in coordinating the
efforts of independent design houses and manufacturing facilities. By supporting
our  material  procurement  and  product  manufacturing   services  with  design
services, we believe that we reduce development and production costs and deliver
products to our customers sooner than many of our  competitors.  Our development
costs are low,  most of which are borne by our  customers.  Our design teams are
based out of our California and Hong Kong facilities.


                                       5
<PAGE>


CUSTOMERS

         We have more than 500  active  customers.  Our  customers  include  the
designated suppliers of well-known apparel manufacturers, such as Levi Strauss &
Co.,  Abercrombie & Fitch,  Juicy  Couture,  Victoria's  Secret,  and Polo Ralph
Lauren,  among others.  Our  customers  also include  contractors  for specialty
retailers  such as  Express  and the Gap and  mass  merchant  retailers  such as
Wal-Mart, Kohl's and Target.

         In 2002, we entered into an exclusive supply contract with Levi Strauss
& Co. which was extended  through  October  2006.  Under the terms of the supply
agreement,  Levi  Strauss & Co.  agreed to  purchase a minimum of $10 million of
TEKFIT stretch waistbands,  various other trim products,  garment components and
services over the term of the agreement. Levi Strauss & Co. also appointed TALON
as an approved zipper supplier. In October 2006 we mutually agreed to allow this
agreement  to expire and to allow us to market and sell this  waistband to other
customers.  We are currently discussing this product with, and preparing samples
for several large apparel brands and retailers.

         For the year ended  December 31, 2006, no single  customer  represented
more than 9% of our consolidated net sales;  however our three largest customers
represented  approximately 18% of our consolidated net sales. For the year ended
December  31,  2005,  no  single  customer  represented  more  than  10%  of our
consolidated  net  sales;  however,  our  three  largest  customers  represented
approximately  22% of our consolidated net sales. Two major customers  accounted
for approximately 22% of our net sales for the year ended December 31, 2004.

         Our  results  of our  operations  will  depend  to an  extent  upon the
commercial  success of these customers.  If these customers fail to purchase our
products at anticipated levels, or the relationship  terminates,  it may have an
adverse affect on our results of operations. If the financial condition of these
customers  were to  deteriorate,  resulting in an impairment of their ability to
purchase inventories or repay receivables, it may also have an adverse affect on
our results of  operations.  The  financial  position  and  operations  of these
customers are monitored on an ongoing basis.  United States export sales are not
a significant part of our business.  Backlogs are not considered material in the
industries in which we compete.

SALES AND MARKETING

         We sell our principal products through our own sales force based in Los
Angeles,  California,  various  other  cities in the United  States,  Hong Kong,
China, India, Taiwan and the Dominican Republic. We also employ customer service
representatives  who are assigned to key customers and provide in-house customer
service  support.  Our executives  have developed  relationships  with our major
customers at senior levels.  These executives actively  participate in marketing
and sales  functions  and the  development  of our overall  marketing  and sales
strategies.  When we become the outsourcing vendor for a customer's packaging or
trim requirements,  we position ourselves as if we are an in-house department of
the customer's trim procurement operation.

SOURCING AND ASSEMBLY

         We have  developed  expertise in  identifying  high quality  materials,
competitive  prices and approved vendors for particular  products and materials.
This  expertise  enables  us to  produce  a broad  range of  packaging  and trim
products at various price  points.  The majority of products that we procure and
distribute  are purchased on a finished  good basis.  Raw  materials,  including
paper products and metals used to manufacture  zippers,  used in the assembly of
our Trim  products  are  available  from  numerous  sources  and are in adequate
supply. We purchase products from several qualified material suppliers.

         We create most product artwork and any necessary dies and molds used to
design and manufacture our products.  All other products that we design and sell
are produced by third party vendors or under our direct  supervision  or through
joint manufacturing arrangements. We are confident in our ability to secure high
quality manufacturing  sources. We intend to continue to outsource production to
qualified  vendors,  particularly with respect to manufacturing  activities that
require substantial investment in capital equipment.


                                       6
<PAGE>


         Principally  through  our  Hong  Kong  facility,  we  distribute  TALON
zippers,  trim items and apparel  packaging and coordinate the  manufacture  and
distribution of the full range of our products.  Our Hong Kong facility supplies
several  significant trim programs,  services  customers located in Asia and the
Pacific Rim and sources products for our Los Angeles based operations.

INTELLECTUAL PROPERTY RIGHTS AND LICENSES

We have  trademarks as well as copyrights,  software  copyrights and trade names
for which we rely on  common  law  protection,  including  the TALON  trademark.
Several of our other  trademarks  are the  subject of  applications  for federal
trademark  protection  through  registration  with the United  States Patent and
Trademark  Office,  including  "Talon",  "Tag-It",  "Managed Trim  Solution" and
"TekFit". We also rely on our Exclusive License and Intellectual Property Rights
agreement  with Pro-Fit to sell our TEKFIT  Stretch  waistbands.  The  agreement
gives  us  the  exclusive  rights  to  sell  or  sublicense  stretch  waistbands
manufactured  under the  patented  technology  developed by Pro-Fit for garments
manufactured  anywhere in the world for the U.S. market and for all U.S. brands,
for an  indefinite  term that  extends for the  duration of the patent and trade
secrets  licensed  under the  agreement.  We are  presently in  litigation  with
Pro-Fit  relating to our rights under the  agreement,  as  described  more fully
elsewhere in this report.

SEASONALITY

         We typically  experience seasonal  fluctuations in sales volume.  These
seasonal  fluctuations  result in sales volume decreases in the first and fourth
quarters  of each  year  due to the  seasonal  fluctuations  experienced  by the
majority of our customers.  The apparel industry  typically  experiences  higher
sales volume in the second quarter in preparation for back-to-school  purchases,
and the third quarter in preparation for year-end holiday purchases.

INVENTORIES

         In order to meet the rapid delivery  requirements of our customers,  we
may be required  to  purchase  inventories  based upon  projections  made by our
customers.  In these cases we may carry a  substantial  amount of  inventory  on
their behalf. We attempt to manage this risk by obtaining  customer  commitments
to purchase any excess inventories.  These buyback  arrangements provide that in
the event that  inventories  remain with us in excess of six to nine months from
our receipt of the goods from our vendors or the  termination of production of a
customer's product line related to the inventories,  the customer is required to
purchase the inventories  from us under normal invoice and selling terms.  While
these  agreements  provide us some  advantage in the  negotiated  disposition of
these  inventories,  we cannot be assured that our customers will complete these
agreements or that we can enforce these agreements  without adversely  affecting
our business operations.

COMPETITION

         We compete in highly competitive and fragmented industries that include
numerous  local and regional  companies that provide some or all of the products
we offer. We also compete with United States and international design companies,
distributors and  manufacturers of tags, trim,  packaging  products and zippers.
Some of our competitors,  including Paxar  Corporation,  YKK,  Universal Button,
Inc., Avery Denison  Corporation and Scovill  Fasteners,  Inc. have greater name
recognition,   longer  operating  histories  and  greater  financial  and  other
resources.

         Because  of  our   integrated   materials   procurement   and  assembly
capabilities and our full-service trim solutions, we believe that we are able to
effectively  compete  for  our  customers'  business,   particularly  where  our
customers require  coordination of separately sourced production  functions.  We
believe  that to  successfully  compete in our  industry we must offer  superior
product pricing, quality,  customer service, design capabilities,  delivery lead
times and complete supply-chain management. We also believe the TALON brand name
and the quality of our TALON brand zippers will allow us to gain market share in
the zipper industry. The


                                       7
<PAGE>


unique stretch  quality of our TEKFIT  waistbands  will also allow us to compete
effectively in the market for waistband components.

SEGMENT INFORMATION

         We operate  primarily in one industry  segment,  the  distribution of a
full  range of apparel  zipper and trim  products  to  manufacturers  of fashion
apparel, specialty retailers and mass merchandisers.

FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREA

         We sell the  majority of our  products  for use by U.S.  based  brands,
retailers  and  manufacturers.  The majority of these  customers  produce  their
products  or  outsource  the  production  of  their  products  in  manufacturing
facilities located outside of the U.S., primarily in Asia, Mexico, the Dominican
Republic and Central and South America.

         A summary of our domestic and  international  net sales and  long-lived
assets is set forth in Item 8,  "Notes to  consolidated  financial  statements",
Note 14.  Approximately  90% of our  overall  net sales  came from sales to U.S.
based or contract manufacturers' facilities located outside of the United States
during the year ended December 31, 2006.

         We are subject to certain risks  referred to in Item 1A, "Risk Factors"
and  Item  3,  "Legal   Proceedings",   including   those   normally   attending
international and domestic operations,  such as changes in economic or political
conditions, currency fluctuations,  foreign tax claims or assessments,  exchange
control  regulations  and the effect of  international  relations  and  domestic
affairs of foreign countries on the conduct of business, legal proceedings,  and
the availability and pricing of raw materials.

EMPLOYEES

         As of December 31, 2006, we had approximately  135 full-time  employees
including 35 in the United  States,  74 employees in Hong Kong,  24 employees in
China and 2 in Taiwan.  Our labor forces are non-union.  We believe that we have
satisfactory employee and labor relations.

CORPORATE GOVERNANCE AND INFORMATION RELATED TO SEC FILINGS

         Our  Annual  Reports  on Form  10-K,  Quarterly  Reports  on Form 10-Q,
Current  Reports on Form 8-K and  amendments  to those  reports  filed with,  or
furnished to, the Securities and Exchange Commission ("SEC") pursuant to Section
13(a) or 15(d) of the  Securities  Exchange  Act of 1934 are  available  free of
charge through our Web site,  WWW.TAGITPACIFIC.COM  (in the "Investor Relations"
section,  as  soon as  reasonably  practical  after  electronic  filing  with or
furnishing  of such  material to the SEC) We make  available at the Web site our
(i) shareholder communications policies, (ii) Code of Ethical Conduct, (iii) the
charters of the Audit and Nominating  Committees of our Board of Directors,  and
(iv) Employee  Complaint  Procedures for Accounting and Auditing Matters.  These
materials are also available free of charge in print to stockholders who request
them by writing to:  Investor  Relations,  Tag-It Pacific,  Inc.,  21900 Burbank
Boulevard, Suite 270, Woodland Hills, CA 91367. Our Web site address provided in
this Annual  Report on Form 10-K is not intended to function as a hyperlink  and
the  information on our website is not and should not be considered part of this
report and is not incorporated by reference in this document.


                                       8
<PAGE>


ITEM 1A. 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 Item 3, "Legal  Proceedings" for discussion of this litigation.  We derive 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 affect 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.  While some orders have already been placed by a new brand and
deliveries  are  scheduled  early in 2007,  sales  of this  product  to Levi are
expected to end during the first 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 at  least  the next two  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


                                       9
<PAGE>


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.

         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;


                                       10
<PAGE>


         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 Item 3,  "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  AFFECT 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 affect 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:


                                       11
<PAGE>


         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.

         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.


                                       12
<PAGE>


         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


                                       13
<PAGE>


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 1B. UNRESOLVED STAFF COMMENTS

         None.


                                       14
<PAGE>


ITEM 2.  PROPERTIES

         Our  headquarters  are  located in the greater  Los  Angeles  area,  in
Woodland Hills,  California,  where we lease  approximately 8,800 square feet of
administrative and product  development space. In addition to the Woodland Hills
facility,  we lease 675 square feet of office  space in Columbus,  Ohio;  21,000
square feet of office and warehouse space in Kwun Tong, Hong Kong;  6,000 square
feet of office and showroom space in Shenzhen,  China;  and 4,100 square feet of
warehouse space in Santiago, Dominican Republic. The lease agreements related to
these properties  expire at various dates through  September 2010. We also own a
building with 41,650 square feet of  manufacturing  and warehouse space in Kings
Mountain,  North Carolina, which is being held for sale. We believe our existing
facilities are adequate to meet our needs for the foreseeable future.

ITEM 3.  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 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 it is anticipated that the Court will enter a judgment in favor of
all  Defendants  shortly.  It is possible that Plaintiff will appeal the summary
judgment and class  certification  rulings.  We believe that this matter will be
resolved in trial or in settlement within the limits of our 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 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  adjudication  that we
did not breach our


                                       15
<PAGE>


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  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.

         We have  agreements  with our  foreign  subsidiaries  that  provide for
royalty  payments to the U.S. parent company for the sales of products  carrying
the TALON(R)  brand name,  and that also provide for a cost sharing  arrangement
associated with various corporate  administrative  and operations support costs.
These agreements may give rise to inquiries and possible disputes by the foreign
taxing authority,  resulting in the possible disallowance of some of these costs
and potentially resulting in higher foreign income taxes than has been provided.
We believe that our basis of charging  these  royalties  and its  allocation  of
costs to foreign  subsidiaries  is  appropriate  under the various taxing agency
laws, and that any  disagreement or  disallowance  regarding such costs will not
have a material affect on the financial statements of the Company. 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, we filed a procedural
opposition to the claim and submitted  documents to the Mexican Tax Authority in
opposition  to this claim,  supporting  our 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 we conducted our  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.  We  believe  that any such claim is  defective  on both  procedural  and
documentary grounds and does not believe there will be a material adverse affect
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.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matters were submitted to a vote of our security  holders during the
fourth quarter of 2006.


                                       16
<PAGE>


                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY,  RELATED STOCKHOLDER MATTERS AND
         ISSUER PURCHASES OF EQUITY SECURITIES

COMMON STOCK

         Tag-It  Pacific's Common Stock is traded on the American Stock Exchange
under the symbol  "TAG." The  following  table sets forth the high and low sales
prices for the Common Stock as reported by the American Stock Exchange.

                                                        HIGH            LOW
YEAR ENDED DECEMBER 31, 2006                          --------       --------
     1st  Quarter.................................    $   0.84       $   0.33
     2nd Quarter..................................        0.81           0.38
     3rd Quarter..................................        1.38           0.63
     4th Quarter..................................        1.35           0.72

YEAR ENDED DECEMBER 31, 2005
     1st  Quarter.................................    $   5.45       $   4.24
     2nd Quarter..................................        4.10           2.11
     3rd Quarter..................................        2.11           0.79
     4th Quarter..................................        0.89           0.29

         On March 22,  2007,  the  closing  sales  price of our Common  Stock as
reported on the American  Stock  Exchange  was $1.88 per share.  As of March 22,
2007, there were 1,964 record holders of our Common Stock.

DIVIDENDS

         We have never paid  dividends on our Common  Stock.  We are  restricted
from paying dividends under our Secured Convertible  Promissory Notes until such
notes are fully paid or converted to Common Stock. It is our intention to retain
future earnings for use in our business.

PERFORMANCE GRAPH

         The  following  graph sets forth the  percentage  change in  cumulative
total stockholder return of our common stock during the period from December 31,
2001 to December 31, 2006,  compared with the cumulative returns of the American
Stock Exchange Market Value (U.S. & Foreign) Index and The Dow Jones US Clothing
& Accessories  Index.  The comparison  assumes $100 was invested on December 31,
2001 in our common stock and in each of the foregoing  indices.  The stock price
performance on the following graph is not necessarily indicative of future stock
price performance.


                                       17
<PAGE>


                          [PERFORMANCE GRAPH OMITTED]



                                            Cumulative Total Return
                             ---------------------------------------------------
                             12/01    12/02    12/03    12/04    12/05    12/06
---------------------------  ------   ------   ------   ------   ------   ------
TAG-IT PACIFIC, INC .......  100.00    91.90   113.67   113.92     9.11    26.08
AMEX COMPOSITE ............  100.00   100.08   144.57   178.46   220.35   262.17
DOW JONES US CLOTHING
  & ACCESSORIES ...........  100.00   101.10   126.45   149.40   156.02   193.39


         The information under this "Performance  Graph" subheading shall not be
deemed to be "filed" for the purposes of Section 18 of the  Securities  Exchange
Act of 1934, or otherwise subject to the liabilities of such section,  nor shall
such  information or exhibit be deemed  incorporated  by reference in any filing
under  the  Securities  Act of 1933 or the  Exchange  Act,  except  as  shall be
expressly set forth by specific reference in such a filing.


                                       18
<PAGE>


ITEM 6.  SELECTED FINANCIAL DATA

         The following selected financial data is not necessarily  indicative of
our future  financial  position or results of future  operations,  and should be
read in  conjunction  with Item 7,  "Management's  Discussion  and  Analysis  of
Financial  Condition and Results of Operations" and the  Consolidated  Financial
Statements  and Notes  thereto  included in Item 8,  "Financial  Statements  and
Supplementary Data" of this Report on Form 10-K.

<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                                               (IN THOUSANDS EXCEPT PER SHARE DATA)
                                                      -------------------------------------------------------
                                                        2002      2003(1)    2004(1,2)    2005(1)      2006
                                                      --------   --------    --------    --------    --------
<S>                                                   <C>        <C>         <C>         <C>         <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenue .....................................   $ 60,073   $ 64,443    $ 55,109    $ 47,331    $ 48,825
Income (loss) from operations .....................   $  3,044   $ (5,881)   $(14,527)   $(27,409)   $  1,021
Net income (loss) .................................   $  1,496   $ (4,745)   $(17,609)   $(29,538)   $    309
Net income (loss) per share - basic ...............   $   0.14   $  (0.46)   $  (1.02)   $  (1.62)   $   0.02
Net income (loss) per share - diluted .............   $   0.14   $  (0.46)   $  (1.02)   $  (1.62)   $   0.02
Weighted average shares outstanding - basic .......      9,232     10,651      17,316      18,226      18,377
Weighted average shares outstanding - diluted .....      9,531     10,651      17,316      18,226      18,956

CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents .........................   $    285   $ 14,443    $  5,461    $  2,277    $  2,935
Total assets ......................................   $ 54,055   $ 67,770    $ 56,448    $ 30,321    $ 25,694
Capital lease obligations, line of credit and notes
  payable .........................................   $ 21,263   $ 11,759    $ 18,792    $ 16,001    $ 16,214
Convertible redeemable preferred stock ............   $  2,895   $  2,895    $   --      $   --      $   --
Stockholders' equity ..............................   $ 18,467   $ 43,564    $ 30,195    $    912    $  1,686
Total liabilities and stockholders' equity ........   $ 54,055   $ 67,770    $ 56,448    $ 30,321    $ 25,694

PER SHARE DATA:
Net book value per common share ...................   $   1.98   $   3.79    $   1.66    $   0.05    $   0.09
Common shares outstanding .........................      9,320     11,508      18,171      18,241      18,466
</TABLE>

----------

(1)      We incurred  restructuring costs of $6.4 million, $.4 million, and $7.7
         million  during  the years  ended  December  31,  2005,  2004 and 2003,
         respectively.

(2)      We  incurred  net  charges  of  $4.3  million  from  the  write-off  of
         obligations  due from a former major  customer and other fourth quarter
         adjustments  totaling $9.5 million  during the year ended  December 31,
         2004.


                                       19
<PAGE>


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

OVERVIEW

         The  following  management's  discussion  and  analysis  is intended to
assist the reader in understanding our consolidated  financial statements.  This
discussion  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 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 design,  development,  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  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 pants incorporating an
expandable  waistband.  These  products  were  previously  produced  by  several
manufacturers  for one  single  brand.  In  October  2006 our  exclusive  supply
contract with this 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.  Orders have already been placed by a new
brand  customer in October 2006 as a result of these  efforts.  However sales to
the previous brand are expected to decline significantly in 2007 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 decline  significantly for at least the first half of 2007; though we believe
our sales of this  product will grow  subsequently  as we market our products to
new customers throughout the year.

         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 Item 3. "Legal  Proceedings",  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 the years  ended  December  31,  2006 and  2005,  and 25% in 2004;
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.


                                       20
<PAGE>


         In an effort to better  align our  organizational  and cost  structures
with its future  growth  opportunities,  in August  2005 our Board of  Directors
adopted a restructuring  plan that was  substantially  completed by December 31,
2005.  The plan included  restructuring  our global  operations  by  eliminating
redundancies in our Hong Kong operation,  closing our facilities in Mexico,  and
closing our North Carolina  manufacturing  facility.  We have also refocused our
sales  efforts on higher  margin  products,  which may result in lower net sales
initially as we focus on  acquiring  high  quality  customers,  and decrease our
customer concentration.  As a result of this restructuring,  we now operate with
fewer  employees  and will have  lower  associated  operating  and  distribution
expenses.

         During 2005, we recorded charges in connection with this  restructuring
plan in  accordance  with  SFAS No.  146 (as  amended),  "Accounting  for  Costs
Associated  with Exit or Disposal  Activities." In addition,  the  restructuring
plan  resulted in the carrying  value of certain  long-lived  assets,  primarily
equipment,  being  impaired.  Accordingly,  in  2005 we  recorded  a  charge  to
recognize  the  impairment  of these  assets in  accordance  with SFAS No.  144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."

         Our North Carolina manufacturing facility has been classified as "Fixed
assets held for sale" in our consolidated  financial statements.  Management has
committed  to sell the  asset  and has  listed  the  property  for  sale  with a
commercial  real estate agent.  We believe the sale of the asset is probable and
that the sale is expected to be completed  within one year. The major components
of  manufacturing  equipment used in this plant to  manufacture  zippers are not
classified as assets held for sale since  management  intends to re-deploy  this
equipment in the manufacture of TALON zippers through investment or sale of this
equipment  to  distributors  of TALON  zippers.  This  equipment  is  separately
identified  as idle  equipment as a component of "Property and  Equipment".  See
"Notes to consolidated financial statements," Note 1.

         Restructuring  costs  recorded  in the third  quarter of 2005 were $6.2
million.  Additional  restructuring  costs of $0.2 million were  incurred in the
fourth  quarter of 2005.  Total  restructuring  costs in 2005 were $6.4 million.
These costs  include $3.4 million of  inventory  write-downs  charged to cost of
goods sold;  $2.2 million for the  impairment  of long-lived  assets  (primarily
machinery and equipment), $0.2 million of one-time employee termination benefits
and other costs of $0.2 million  which were charged to  operating  expenses.  In
addition,  an impairment  charge to goodwill of $0.4 million was recorded.  This
goodwill  was  associated  with an  acquisition  made to benefit our Central and
South American  operations.  Since these operations were closed during 2005, the
goodwill  was impaired and written  off.  During the first  quarter of 2004,  we
incurred  and  recorded  residual  restructuring  charges of $0.4 million from a
restructuring plan implemented in 2003.

         In 2004,  following  negotiations  with Tarrant Apparel Group, a former
customer,  we determined that a significant  portion of the obligations due from
this  customer  were  uncollectible.   Accordingly,   included  in  general  and
administrative  expenses for 2004 are charges of $4.3 million related  primarily
to the write-down of this receivable and leaving a remaining balance  receivable
from this customer of $4.5 million. An affiliate of the customer repaid the $4.5
million  receivable  balance over the period from May through  December 2005. In
addition to this $4.3 million  write-down  in 2004, we also recorded an accounts
receivable  reserve of $5.0 million (or 9.1% of net sales) in the fourth quarter
of 2004  based  on  management's  estimate  of the  collectibility  of  accounts
receivable primarily related to two other customers.

         Our bad debt  expense for the year ended  December  31,  2005  includes
reserves  of $3.6  million  recorded  in the  second  quarter  of 2005  based on
management's  estimate at the time of the collectibility of accounts  receivable
from one customer.  The fourth quarter of 2005 includes  charges of $0.6 million
representing the present value discount of a subsequent note received in 2006 in
exchange for that same customer's accounts receivable.

         In  connection  with  our  2005  restructuring  plan,  we  recorded  an
inventory  write-down of $3.4 million in the third  quarter of 2005.  During the
fourth quarter of 2004, we recorded inventory  write-downs totaling $2.7 million
based  on  management's   estimate  of  the  net  realizable  value  of  certain
inventories.


                                       21
<PAGE>


         In 2004, we incurred net  operating  losses and increased our valuation
allowance for deferred tax assets to reduce our net deferred tax asset from $2.8
million to $1.0 million.  The decrease in the net deferred tax asset resulted in
a charge of $1.8 million  against the  provision  for income taxes in the fourth
quarter of 2004.  In 2005,  we further  reduced  the net  carrying  value of the
deferred tax asset to zero, resulting in an addition to the provision for income
taxes of $1.0 million for the year ended December 31, 2005.

RESULTS OF OPERATIONS

         NET SALES

         For the years ended December 31, 2006,  2005, and 2004,  total sales by
geographic region based on customer delivery  locations were as follows (amounts
in thousands):

                          2006      CHANGE       2005      CHANGE        2004
                        --------   --------    --------   --------     --------
United States .......   $  5,287       (41)%   $  8,903         85 %   $  4,823
Asia ................     28,975        45       20,005         57       12,786
Mexico ..............      2,476       (71)       8,526        (60)      21,453
Dominican Republic ..      9,138        54        5,915        (39)       9,678
Other ...............      2,949       (26)       3,982        (38)       6,369
                        --------   --------    --------   --------     --------
    Total ...........   $ 48,825         3 %   $ 47,331        (14)%   $ 55,109
                        ========   ========    ========   ========     ========

         Sales are influenced by a number of factors,  including demand, pricing
strategies,  foreign  exchange  effects,  new product  launches and indications,
competitive  products,  product supply, and acquisitions.  See Item 1 "Business"
for a discussion of our principal products.

         Sales  in  2006  increased  modestly  from  2005 as a net  result  of a
substantial  decline within selected  markets offset by large increases in other
geographical  markets.  Sales,  principally  of Trim  products,  to customers in
Mexico  declined  sharply  in 2006 from 2005 as the  industry  shift of  apparel
production   from  Latin  America  to  Asia  continued   from  2005,   from  the
discontinuance of approximately $4.0 million in sales of products from 2005, and
as we completed the closure of our assembly and distribution  operations  within
Mexico.  Sales of Trim and TALON  products  to  customers  within the U.S.  also
declined  significantly as a result of the industry shift of apparel  production
and as a result of our closure of our  manufacturing  facility in North Carolina
during the third  quarter of 2005.  The  decline of apparel  production  and our
sales in the North and Central American regions was substantially  offset by the
shifting of this production to  manufacturers  within Asia, and our expansion of
operations with customers in this region.  Additionally,  expanded demand by our
exclusive  customer  for the TEKFIT  waistband  also  resulted in a  substantial
increase  in  our  sales  to  the  Dominican   Republic,   where  the  principal
manufacturers  of this  product are located.  Sales  within  Other  geographical
regions also reflect the worldwide shifting of apparel production to Asia.

         The net  decrease of sales in 2005 was  primarily  due to a decrease in
sales to our customers in Mexico of trim products and, to a lesser extent, TALON
zippers,  resulting  from the industry  shift of apparel  production  from Latin
America to Asia. Sales in Asia of our trim products and TALON zippers  increased
significantly during 2005. We responded to these market changes in 2005 with the
implementation of a restructuring  plan that included reducing our operations in
Mexico and  focusing  our  efforts  on the  market in Asia.  Sales of our TEKFIT
waistband  decreased in 2005 because of lower demand from our exclusive customer
for this product. During 2005, we continued our plan to decrease reliance on two
significant customers in Mexico. These two customers  contributed  approximately
$7.7 million or 16.3% of revenues for the year ended December 31, 2005.


                                       22
<PAGE>


         COST OF GOODS SOLD AND SELECTED OPERATING EXPENSES

         The  following  table  summarizes  cost  of  goods  sold  and  selected
operating  expenses  for the years  ended  December  31,  2006,  2005,  and 2004
(amounts in thousands):

<TABLE>
<CAPTION>
                                      2006      CHANGE       2005      CHANGE        2004
                                     -------    -------     -------    -------     -------
<S>                                  <C>           <C>      <C>            <C>     <C>
Sales ............................   $48,825          3%    $47,331        (14)%   $55,109
                                     -------    -------     -------    -------     -------
Cost of goods sold ...............    34,356        (27)%    47,070          5%     44,814
    % of sales ...................        70%        99%         81%
                                     -------    -------     -------    -------     -------
Selling expenses .................     2,778         (5)%     2,929          1%      2,899
    % of sales ...................         6%         6%          5%
                                     -------    -------     -------    -------     -------
General and administrative expense    10,670        (52)%    22,267          4%     21,509
    % of sales ...................        22%        47%         39%
                                     -------    -------     -------    -------     -------
Restructuring charges ............         0       (100)%     2,474        496%        415
    % of sales ...................         0%                     5%                     1%
                                     -------    -------     -------    -------     -------
</TABLE>

         COST OF GOODS SOLD

         Cost of goods sold for the year ended  December  31, 2006  declined 27%
from 2005 as the result of a number of the actions we  implemented in connection
with our 2005 restructuring  plan, and as a result of our focus on higher margin
product sales and  continued  efforts to reduce costs  worldwide.  Cost of goods
sold in 2006  declined by  approximately  $4.8  million  (10.3%)  from 2005 as a
result of higher direct margins on products sold; by approximately  $1.9 million
(4.0%)  from  lower  freight  &  duty  charges;  by  a  reduction  in  inventory
adjustments and obsolescence of $1.6 million (3.5%);  by the elimination of $3.4
million (7.3%) in  restructuring  charges incurred in 2005; and by approximately
$1.8 million  (3.8%) from  reductions  in  manufacturing  and overhead  charges;
offset by  increases  of  approximately  $0.8  million  (1.8%)  on higher  sales
volumes.

         Cost of goods sold  increased  5% for the year ended  December 31, 2005
primarily  due to a $3.4 million  (7.7%)  write-down  of inventory in connection
with the 2005 restructuring plan, and an increase in our inventory  obsolescence
reserve of $2.1 million (4.7%),  including $0.5 million in the fourth quarter of
2005.  Cost of sales also  increased as a percentage  of sales due to unabsorbed
overhead costs incurred in our North Carolina manufacturing facility and charges
of  approximately  $0.2 million (0.5%)  associated with unrealized  charge-backs
recorded in the second quarter of 2005 and $0.6 million (1.3%) in credits issued
to customers  during the first  quarter for defective  products  received from a
major supplier. Cost of goods sold declined by approximately $4.1 million (9.1%)
as a result of the decline in revenue from 2004 to 2005.

         Cost of goods  sold for the year  ended  December  31,  2004,  included
inventory  write-downs  totaling $2.7 million (5% of net sales)  recorded in the
fourth  quarter of 2004 based on  management's  estimate  of the net  realizable
value of certain inventory.

         SELLING EXPENSES

         Selling  expense for the year ended  December 31, 2006  decreased  $0.2
million (5.0%) from 2005 as a result of lower travel and entertainment  costs of
$0.3 million;  lower legal costs of $0.3 million; and other employee benefit and
administrative  cost  reductions  of  approximately  $0.1  million;   offset  by
increases in sales  commissions  of  approximately  $0.3  million and  increased
spending for sales and  marketing  programs of $0.2  million.  Selling  expenses
increased  1.0% for the year ended  December  31, 2005 because we were unable to
reduce expenses in direct proportion to the decrease in sales. In 2004,  selling
expenses  represented  5% of net sales,  and  included  $0.4  million in royalty
expense related to the intellectual property rights agreement with Pro-Fit.


                                       23
<PAGE>


         GENERAL AND ADMINISTRATIVE EXPENSES

         General and  administrative  expenses  for the year ended  December 31,
2006  decreased  $11.6  million or 52% from 2005.  $0.5 million of the reduction
from 2005 was the result of  restructuring  and impairment  charges  recorded in
2005,  and bad debt expense  recorded in 2005 of $5.9 million as compared to bad
debt recoveries in 2006 of $0.5 million.  Other general and administrative costs
in 2006 as compared to 2005 include  reductions  in legal costs by $1.9 million;
lower employee and benefit costs by $1.9 million; reduced facility costs of $0.6
million;  and  reductions  in  other  administrative  and  travel  costs of $1.4
million;  offset by  approximately  $0.7 million in increased  professional  and
audit fees; and stock based compensation expense of $0.4 million associated with
the implementation of FAS 123(R).

         General  and  administrative   expenses  increased  approximately  $0.7
million  (4%)  in  2005   compared  to  2004.   This  increase  in  general  and
administrative  expenses  resulted  from an net  increase of $2.6 million in the
reserve  for  doubtful  accounts  recorded  in 2005,  higher  legal  expenses of
approximately $3.5 million related primarily to the Pro-Fit  litigation,  and an
impairment  charge to goodwill of $0.5 million  incurred in connection  with the
2005  restructuring   plan;  offset  by  reductions  in  employment  levels  and
associated costs in connection with the restructuring plan.

         Included  in general  and  administrative  expenses  for the year ended
December  31,  2004  are  charges  of  $4.3  million  related  primarily  to the
write-down of  receivables  due from one customer.  We also recorded an accounts
receivable reserve of $5.0 million (or 9% of net sales) in the fourth quarter of
2004 based on management's estimate of the collectibility of accounts receivable
primarily  related to two other  customers.  In the first  quarter  of 2004,  we
incurred additional  restructuring  charges of $0.4 million related to the final
residual costs associated with our restructuring  plan implemented in the fourth
quarter of 2003.

         RESTRUCTURING CHARGES

         Restructuring costs in 2005 were the result of the adoption of our 2005
restructuring  plan.  Restructuring  costs recorded in the third quarter of 2005
were $6.2 million.  Additional costs of $0.2 million were incurred in the fourth
quarter of 2005. Total  restructuring costs of $6.4 million were recorded in the
Consolidated  Statement of  Operations  for the year ended  December 31, 2005 as
follows (in millions):

Cost of goods sold ................................................   $      3.4
Operating expenses:
   General & administrative expenses ..............................          0.5
   Restructuring charges ..........................................          2.5
                                                                      ----------
Total restructuring costs .........................................   $      6.4
                                                                      ==========

         During the first quarter of 2004, we incurred  restructuring charges of
$0.4 million for final residual  costs  associated  with our 2003  restructuring
plan.

     INTEREST EXPENSE, NET

         Net interest  expense for the year ended  December  31, 2006  decreased
from 2005 by  approximately  $0.4  million  principally  as a result of interest
earnings in 2006 from the note receivable.

         Interest expense increased  approximately $0.2 million (or 33%) to $1.1
million for 2005 from $0.8 million for 2004.  The  increase in interest  expense
was  primarily  due to higher debt levels  associated  with the $12.5 million 6%
secured  convertible  notes payable dated  November  2004, the $0.8 million 6.5%
mortgage  note  payable to First  National  Bank  dated June 2004,  and the $0.9
million 6.5%  equipment  note payable to First National Bank dated November 2004
which were outstanding for the entire year in 2005 compared to a partial year in
2004; partially offset by the repayment of a remaining $1.4 million due pursuant
to a note payable and a reduction in amounts due to factor in 2005.


                                       24
<PAGE>


         INCOME TAXES

         Income tax provisions for the year ended December 31, 2006  principally
include a royalty tax from the Inland Revenue Department in Hong Kong applicable
to 2005,  net of an estimated  tax benefit for 2006  foreign  losses and minimum
federal and state filing fees.

         The  provision  for income  taxes for the year ended  December 31, 2005
principally  reflects the  elimination  of the net deferred tax asset in 2005 of
$1.0 million,  and estimated foreign taxes. Based on the Company's net operating
losses,  there is not  sufficient  evidence to determine  that it is more likely
than not that the Company will be able to utilize its net  operating  loss carry
forwards to offset future taxable income.

         The  provision  for income  taxes was $2.3  million  for the year ended
December 31, 2004 .The income tax provision  primarily reflects a charge of $1.8
million as a result of a decrease in the value of net deferred  tax assets,  and
foreign income taxes of $0.5 million on foreign earnings.

LIQUIDITY AND CAPITAL RESOURCES

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

                                                     DECEMBER 31,   DECEMBER 31,
                                                         2006           2005
                                                     ------------   ------------
Cash and cash equivalents ........................   $      2,935   $      2,277
Total assets .....................................         25,694         30,321
Current debt .....................................         22,471         14,851
Non-current debt .................................          1,536         14,558
Stockholders' equity .............................          1,686            912

         CASH AND CASH EQUIVALENTS

         Our cash is held with financial institutions.  Substantially all of the
balances  at  December  31,  2006 and 2005 are in  excess of  federally  insured
limits.  As of December  31, 2006 and 2005 we had  restricted  cash  balances of
$50,000 related to cash collateral for a letter of credit with Wells Fargo Bank.

         FINANCING ARRANGEMENTS

         The Company currently does not have an active financing  arrangement to
provide  for  working  capital  requirements  and  cash  provided  by  operating
activities is our only recurring source of funds. We financed building, land and
equipment purchases through notes payable and capital lease obligations expiring
through June 2011. These obligations bear interest at rates of 6.5% and 6.6% per
annum, and under these obligations,  we are required to make monthly payments of
principal  and  interest.  In June 2006 we entered  into a note payable with our
legal counsel in exchange for legal fees outstanding to this firm related to our
Pro-Fit litigation. The note agreement provides for monthly payments against the
note in amounts equal to payments we receive from our note receivable until such
time as the  note is paid in full.  The note  receivable  is  fully  pledged  as
collateral against this note payable.

         A factoring agreement for the purchase of eligible receivables from our
Hong Kong subsidiary exists with East Asia Heller,  wherein the factor purchases
our eligible accounts  receivable and may assume the credit risk with respect to
those accounts for which the factor has given its prior approval.  If the factor
does not assume the credit risk for a receivable, the collection risk associated
with the  receivable  remains  with us. The  agreement  provides for us to pay a
fixed  commission  rate  and for us to  borrow  up to 80% of  eligible  accounts
receivable.  Interest is charged at 1.5% over the Hong Kong  Dollar  prime rate.
However,  during 2005 and 2006 the factor  declined to advance funds to us under
this agreement. Accordingly, no outstanding advances as of December 31, 2006 and
2005 existed.


                                       25
<PAGE>


         In 2005, we entered into a letter of credit with Wells Fargo Bank. This
letter of credit provides for a maximum of $50,000,  expires in June 2007 and is
secured by cash on hand  managed by Wells Fargo  Bank.  At  December  31,  2006,
outstanding letters of credit under the Wells Fargo facility were $50,000.  This
letter  is  pledged  as  collateral  for a bond  posted in  connection  with our
litigation with Todo Textile, S. A. in which a settlement  agreement was reached
in 2006.  Upon release of the bond held by the court in this matter,  the letter
of credit will be released  and the  settlement  amount of $40,000 paid from the
proceeds.

         The outstanding  balance of our demand notes payable to related parties
at December 31, 2006 and 2005 was $665,000.  Included is a $500,000  convertible
secured promissory note payable with interest at 11% payable quarterly. The note
is due on demand and is  convertible  into common  stock at the  election of the
holder  at a rate of $4.50  per  share.  The  remaining  demand  notes  totaling
$165,000 bear interest at 0%-10%,  have no scheduled monthly  payments,  and are
due within fifteen days from demand.

         CASH FLOWS

         The  following  table  summarizes  our cash flow activity for the years
ended December 31, 2006, 2005, and 2004 (amounts in thousands):

                                             2006          2005          2004
                                           --------      --------      --------
Net cash provided by (used in)
  operating activities ...............     $  2,020      $  1,112      $(11,382)
Net cash used in investing
  activities .........................         (345)       (1,454)       (3,616)
Net cash provided by (used in)
  financing activities ...............       (1,018)       (2,841)        6,016
Net increase (decrease) in cash
  and cash equivalents ...............          657        (3,183)       (8,982)

         OPERATING ACTIVITIES

         Cash  and  cash  equivalents  for the  year  ended  December  31,  2006
increased by $0.7 million from December 31, 2005  principally  arising from cash
generated by operating activities,  net of payments on notes payable and capital
leases.

         Cash provided by operating  activities is our only recurring  source of
funds and was $2.0  million  for the year  ended  December  31,  2006.  The cash
generated  by  operating  activities  during 2006  resulted  primarily  from net
earnings (before non-cash expenses) of approximately $2.3 million; reductions in
inventory  net of  applied  reserves  of  $2.5  million;  and  $1.0  million  in
reductions in accounts receivable net of reserves applied;  net of reductions in
accounts  payable of $2.6 million and  reductions in other  liabilities,  net of
approximately $1.2 million.

         The net decrease in inventory  of $2.5 million  reflects the  Company's
efforts to dispose of and lower slower-moving and obsolete inventory components.
The cost of net  inventories  eliminated  during the year was $8.6 million,  and
reserves  applicable  to this  inventory  of $6.1  million were applied to these
dispositions.  Accounts receivable for the year ended December 31, 2006 declined
by $2.1 million  primarily as a result of improved  collections and faster turns
of  accounts   receivable,   and  by  approximately  $0.7  million  in  accounts
written-off.  Accounts  receivable  reserves  declined by $1.1  million from the
write-off of uncollectible  accounts and by approximately  $0.4 million from the
collection  of accounts  reserved for in prior years.  In addition,  during 2006
collections of accounts written-off in prior years was $0.5 million.

         The increase in cash provided by operating  activities  during the year
ended  December 31, 2005 resulted  from,  among other  changes,  a $10.6 million
decrease in accounts  receivable,  including  the  collection  of a $4.5 million
receivable from one customer;  a $3 million increase in accounts payable; a $2.8
million decrease in inventories; a $2.1 million increase in accrued legal costs;
substantially offset by a net loss of $29.5 million.


                                       26
<PAGE>


         At December  31,  2005,  accounts  receivable  from Azteca  Productions
International  ("Azteca"), a significant customer, was approximately $10,968,000
less a reserve of $7,528,000,  totaling  $3,440,000,  net. In February 2006, the
Company  accepted a note agreement from Azteca which provides for total payments
including  principal  and  interest  of $4.0  million  in  exchange  for the net
outstanding  accounts receivable balance.  The balance of the note receivable at
December 31, 2005 of $3,440,000 reflects a $560,000 charge to discount the note,
using a 10.5%  discount  rate,  to its net present  value.  The Azteca  accounts
receivable,  net at  December  31,  2005 was  reclassified  on the  accompanying
consolidated  balance  sheets to note  receivable  to  reflect  this  subsequent
settlement.

         The decrease in cash provided by operations for 2004 resulted primarily
from a net loss of $17.6 million together with a net increase of $7.6 million in
accounts receivable due primarily to slower customer  collections of receivables
during the year. This decrease was partially offset by a $4 million net increase
in  the  allowance  for  doubtful  accounts  and  a  $7.8  million  decrease  in
inventories.

         INVESTING ACTIVITIES

         Net cash used in investing  activities  for the year ended December 31,
2006 and  2005  consisted  of  capital  expenditures  of $0.3  million  and $1.5
million, respectively for leasehold improvements and equipment purchases.

         Net cash used in investing  activities  for the year ended December 31,
2004 consisted of capital  expenditures of $3.6 million for computer  equipment,
the  purchase of  additional  TALON  zipper  equipment  and  building,  land and
leasehold  improvements  related to the TALON  manufacturing  facility  in North
Carolina. The building and land purchase of the TALON manufacturing facility was
reported as a non-cash financing transaction.

         FINANCING ACTIVITIES

         Net cash used in financing  activities for the years ended December 31,
2006 and 2005  primarily  reflects the  repayment  of notes  payable and capital
lease obligations.  In 2006 net cash used in financing  activities also included
$0.6 in  collections  from the note  receivable.  In 2005 cash used in financing
activities  also  included,  the  repayment of  borrowings  under a bank line of
credit  partially  offset by proceeds  from the  exercise  of stock  options and
warrants.

         Net cash provided by financing  activities  for the year ended December
31, 2004  primarily  reflects funds raised from secured  convertible  promissory
notes of $12.5  million,  the exercise of stock options and  warrants,  proceeds
from notes  payable and a capital lease  obligation,  offset by the repayment of
borrowings under our credit facility and notes payable.

         We currently satisfy our working capital requirements primarily through
cash flows  generated  from  operations.  As the major apparel  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 and
expectation 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 that
we will be successful in completing a modification or replacement of these notes
prior to their maturity.


                                       27
<PAGE>


         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 for 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 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 December 31,
2006 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:

<TABLE>
<CAPTION>
                                                   Payments Due by Period
                            -------------------------------------------------------------------
                                           Less than        1-3           4-5          After
Contractual Obligations        Total        1 Year         Years         Years        5 Years
-------------------------   -----------   -----------   -----------   -----------   -----------
<S>                         <C>           <C>           <C>           <C>           <C>
Demand notes payable
   to related parties (1)   $ 1,181,000   $ 1,181,000   $      --     $      --     $      --
Capital lease obligations   $ 1,027,000   $   506,000   $   521,000   $      --     $      --
Operating leases ........   $ 1,421,000   $   437,000   $   754,000   $   229,000   $     1,000
Notes payable ...........   $ 2,426,000   $ 1,193,000   $   604,000   $   629,000   $      --
Convertible notes payable   $13,143,000   $13,143,000   $      --     $      --     $      --
                            -----------   -----------   -----------   -----------   -----------
     Total Obligations ..   $19,198,000   $16,460,000   $ 1,879,000   $   858,000   $     1,000
                            ===========   ===========   ===========   ===========   ===========
</TABLE>

(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 December 31, 2006.

         At December 31, 2006 and 2005, 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

         For a description of  transactions to which we were or will be a party,
and in which any director,  executive officer, or shareholder of more than 5% of
our  common  stock or any  member of their  immediate


                                       28
<PAGE>


family had or will have a direct or indirect material  interest,  see Note 16 of
the Notes to the consolidated  financial  statements  included in Item 8 of this
Report.

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


                                       29
<PAGE>


                  and results of operations. See Notes to consolidated financial
                  statements, Note 12, "Income Taxes".

         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.  As part of our  2005  restructuring
                  plan,  certain  long-lived  assets,  primarily  machinery  and
                  equipment,   were   impaired   and   their   values   adjusted
                  accordingly.

         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.  See  Note  11,  "2005
                  Restructuring Costs".

         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.


                                       30
<PAGE>


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
(GAAP), 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.

         In September  2006, the SEC issued Staff  Accounting  Bulletin No. 108,
CONSIDERING   THE  EFFECTS  OF  PRIOR  YEAR   MISSTATEMENTS   WHEN   QUANTIFYING
MISSTATEMENTS  IN CURRENT YEAR  FINANCIAL  STATEMENTS  ("SAB  108"),  to address
diversity in practice in quantifying financial statement misstatements.  SAB 108
requires the  quantification of misstatements  based on their impact on both the
balance sheet and the income  statement to determine  materiality.  The guidance
provides  for  a  one-time   cumulative   effect   adjustment   to  correct  for
misstatements that were not deemed material under a company's prior approach but
are material  under the SAB 108 approach.  SAB 108 is effective for fiscal years
ending after  November 15, 2006.  The  implementation  of SAB 108 did not have a
material impact on our financial position, results of operations or cash flows.

         In June 2006, the Financial  Accounting Standards Board ("FASB") issued
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 in accordance with FASB Statement No. 109,  ACCOUNTING FOR
INCOME TAXES.  FIN 48 also  prescribes a recognition  threshold and  measurement
attribute for the  financial  statement  recognition  and  measurement  of a tax
position  taken or expected  to be taken in a tax return  that  results in a tax
benefit.  Additionally,  FIN 48  provides  guidance  on  de-recognition,  income
statement  classification  of  interest  and  penalties,  accounting  in interim
periods, disclosure, and transition. This interpretation is effective for fiscal
years beginning after December 15, 2006. We are currently  evaluating the effect
that the  application  of FIN 48 will  have on its  results  of  operations  and
financial condition.

         In February  2006,  the FASB issued  Statement of Financial  Accounting
Standards No. 155, "Accounting for Certain Hybrid Financial  Instruments" ("SFAS
155"),  which amends SFAS No. 133,  "Accounting for Derivatives  Instruments and
Hedging Activities" ("SFAS 133") and SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and  Extinguishment  of Liabilities"  ("SFAS 140).
SFAS 155 amends SFAS 133 to narrow the scope  exception  for  interest-only  and
principal-only   strips  on  debt   instruments  to  include  only  such  strips
representing  rights to receive a specified portion of the contractual  interest
or  principle  cash flows.  SFAS 155 also  amends  SFAS 140 to allow  qualifying
special-purpose  entities  to hold a  passive  derivative  financial  instrument
pertaining to beneficial interests that itself is a derivative instrument.  SFAS
No. 155 is effective for all financial  instruments acquired or issued after the
beginning of an entity's first fiscal year that begins after September 15, 2006.
We do not believe that SFAS No. 155 will have a material impact on the Company's
financial position, results of operations or cash flows.

ITEM 7A. 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 Yuan's and British
Pounds.  During 2004, we purchased forward exchange contracts for British Pounds
to hedge the  payments  of  product  purchases.  We do not  intend  to  purchase
additional   contracts  to  hedge  the  exchange  exposure  for  future  product
purchases.  There were no hedging contracts outstanding as of December 31, 2006.
Currency


                                       31
<PAGE>


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 December 31, 2006, none of our indebtedness
was subject to interest rate fluctuations.


                                       32
<PAGE>


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                                TABLE OF CONTENTS
                                                                            PAGE
                                                                            ----
Report of Independent Registered Public Accounting Firm.................     34
Report of Independent Registered Public Accounting Firm.................     35
Consolidated Balance Sheets.............................................     36
Consolidated Statements of Operations...................................     37
Consolidated Statements of Stockholders' Equity and
  Convertible Redeemable Preferred Stock................................     38
Consolidated Statements of Cash Flows...................................     39
Notes to Consolidated Financial Statements..............................     40


                                       33
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Tag It Pacific Inc.
Woodland Hills, California

We have  audited the  consolidated  balance  sheets of Tag It Pacific  Inc.  and
subsidiaries  as of  December  31, 2006 and 2005,  and the related  consolidated
statements  of  operations,  stockholders'  equity  and  convertible  redeemable
preferred  stock,  and cash flows for each of the two years in the period  ended
December 31, 2006. Our audits also included the financial statement schedules of
Tag It Pacific  Inc.,  listed in Item  15(a).  These  financial  statements  and
financial   statement   schedules  are  the   responsibility  of  the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audits.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.  We  believe  that  our  audits  provided  a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects,  the financial position of Tag It Pacific Inc.
and  subsidiaries  as of December  31,  2006 and 2005,  and the results of their
operations  and their cash  flows for each of the two years in the period  ended
December  31,  2006,  in  conformity  with U.S.  generally  accepted  accounting
principles.  Also, in our opinion,  the related financial  statement  schedules,
when  considered  in relation to the basic  consolidated  financial  statements,
taken as a whole,  present fairly in all material  respects the  information set
forth therein.

/S/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP

Los Angeles, California
April 9, 2007


                                       34
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Tag-It Pacific, Inc.
Los Angeles, California

         We have audited the accompanying consolidated statements of operations,
stockholders'  equity and convertible  redeemable preferred stock and cash flows
of Tag-It Pacific,  Inc. and  subsidiaries for the year ended December 31, 2004.
The financial statements are the responsibility of the Company's management. Our
responsibility  is to express an opinion on these financial  statements based on
our audit.

         We conducted our audit in  accordance  with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain  reasonable  assurance about whether the
financial  statements  are free of  material  misstatement.  The  Company is not
required  to have,  nor were we engaged  to  perform,  an audit of its  internal
control over financial reporting.  Our audit included  consideration of internal
control over financial  reporting as a basis for designing audit procedures that
are appropriate in the  circumstances,  but not for the purpose of expressing an
opinion on the  effectiveness  of the Company's  internal control over financial
reporting.  Accordingly,  we express  no such  opinion.  An audit also  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial  statements  and  assessing the  accounting  principles  used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audit  provided  a
reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly,  in all material  respects,  the results of operations of Tag-It
Pacific,  Inc. and subsidiaries and their cash flows for the year ended December
31, 2004, in conformity with  accounting  principles  generally  accepted in the
United States of America.

                                                   /s/ BDO Seidman, LLP

Los Angeles, California
March 31, 2005


                                       35
<PAGE>


<TABLE>
                              TAG-IT PACIFIC, INC.
                           CONSOLIDATED BALANCE SHEETS
<CAPTION>

                                                             December 31,     December 31,
                                                                2006              2005
                                                            -------------    -------------
<S>                                                         <C>              <C>
Assets
Current Assets:
   Cash and cash equivalents ............................   $   2,934,673    $   2,277,397
   Accounts receivable, net .............................       4,664,766        5,652,990
   Note receivable ......................................       1,378,491          662,369
   Inventories, net .....................................       3,051,220        5,573,099
   Prepaid expenses and other current assets ............         541,034          618,577
                                                            -------------    -------------
Total current assets ....................................      12,570,184       14,784,432

Property and equipment, net .............................       5,623,040        6,438,096
Fixed assets held for sale ..............................         826,904          826,904
Note receivable, less current portion ...................       1,420,969        2,777,631
Due from related parties ................................         675,137          655,489
Other intangible assets, net ............................       4,139,625        4,255,125
Other assets ............................................         437,569          583,117
                                                            -------------    -------------
Total assets ............................................   $  25,693,428    $  30,320,794
                                                            =============    =============

Liabilities and Stockholders' Equity
Current liabilities:
  Accounts payable ......................................   $   4,006,241    $   6,719,226
  Accrued legal costs ...................................         427,917        2,520,111
  Other accrued expenses ................................       3,359,267        4,168,552
  Demand notes payable to related parties ...............         664,970          664,971
  Current portion of capital lease obligations ..........         432,728          590,884
  Current portion of notes payable ......................       1,107,207          186,837
  Current portion of secured convertible
    promissory notes ....................................     12,472,622             --
                                                            -------------    -------------
Total current liabilities ...............................      22,470,952       14,850,581

Capital lease obligations, less current portion .........         474,733          856,495
Notes payable, less current portion .....................       1,061,514        1,261,018
Secured convertible promissory notes ....................            --         12,440,623
                                                            -------------    -------------
Total liabilities .......................................      24,007,199       29,408,717
                                                            -------------    -------------

Commitments and contingencies (Note 13)

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; 18,466,433
     shares issued and outstanding at
     December 31, 2006; 18,241,045 at
     December 31, 2005 ..................................          18,466           18,241
  Additional paid-in capital ............................      51,792,502       51,327,878
  Accumulated deficit ...................................     (50,124,739      (50,434,042
                                                            -------------    -------------
Total stockholders' equity ..............................       1,686,229          912,077
                                                            -------------    -------------
Total liabilities and stockholders' equity ..............   $  25,693,428    $  30,320,794
                                                            =============    =============
</TABLE>

                             See accompanying notes.


                                       36
<PAGE>


<TABLE>
                              TAG-IT PACIFIC, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<CAPTION>
                                               Year Ended     Year Ended       Year Ended
                                              December 31,   December 31,     December 31,
                                                  2006           2005            2004
                                              ------------   ------------    ------------
<S>                                           <C>            <C>             <C>
Net sales .................................   $ 48,825,002   $ 47,331,176    $ 55,109,481
Cost of goods sold ........................     34,356,034     47,070,381      44,813,736
                                              ------------   ------------    ------------
Gross profit ..............................     14,468,968        260,795      10,295,745

Selling expenses ..........................      2,777,772      2,928,659       2,899,329
General and administrative expenses .......     10,670,311     22,267,070      21,508,607
Restructuring charges .....................           --        2,474,281         414,675
                                              ------------   ------------    ------------
Total operating expenses ..................     13,448,083     27,670,010      24,822,611

Income (loss) from operations .............      1,020,885    (27,409,215)    (14,526,866)
Interest expense, net .....................        677,682      1,069,015         804,888
                                              ------------   ------------    ------------

Income (loss) before income taxes .........        343,203    (28,478,230)    (15,331,754)
Provision for income taxes ................         33,900      1,059,479       2,277,214
                                              ------------   ------------    ------------

Net income (loss) .........................        309,303    (29,537,709)    (17,608,968)
Less: Preferred stock dividends ...........           --             --           (30,505)
                                              ------------   ------------    ------------

Net income(loss)  to common shareholders ..   $    309,303   $(29,537,709)   $(17,639,473)
                                              ============   ============    ============

Basic income(loss) per share ..............   $       0.02   $      (1.62)   $      (1.02)
                                              ============   ============    ============
Diluted income( loss) per share ...........   $       0.02   $      (1.62)   $      (1.02)
                                              ============   ============    ============

Basic weighted average shares outstanding .     18,377,484     18,225,851      17,316,202
                                              ============   ============    ============
Diluted weighted average shares outstanding     18,955,796     18,225,851      17,316,202
                                              ============   ============    ============
</TABLE>


                             See accompanying notes.


                                       37
<PAGE>


<TABLE>
                              TAG-IT PACIFIC, INC.
         CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND CONVERTIBLE
     REDEEMABLE PREFERRED STOCK YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
<CAPTION>

                                                                         Preferred Stock                Preferred Stock
                                             Common Stock                    Series A                       Series D
                                     ---------------------------   ---------------------------   ----------------------------
                                        Shares         Amount         Shares         Amount         Shares          Amount
                                     ------------   ------------   ------------   ------------   ------------    ------------
<S>                                    <C>          <C>                    <C>            <C>        <C>         <C>
BALANCE, JANUARY 1, 2004 .........     11,508,201   $     11,510           --             --          572,818    $ 22,918,693
   Conversion of preferred
     stock Series C and
     accrued dividends ...........        700,144            700                          --             --              --
   Conversion of preferred
     stock Series D ..............      5,728,180          5,728                          --         (572,818)    (22,918,693)
   Warrants issued in
     private placement
     transaction .................           --             --             --             --             --              --
   Common stock issued upon
     exercise of options and
     warrants ....................        214,276            214           --             --             --              --
   Common stock and warrants
     issued for services .........         20,500             21           --             --             --              --
   Tax benefit from exercise
     of stock options ............           --             --             --             --             --              --
   Preferred stock dividends .....           --             --             --             --             --              --
   Net loss ......................           --             --             --             --             --              --
                                     ------------   ------------   ------------   ------------   ------------    ------------
BALANCE, DECEMBER 31, 2004 .......     18,171,301         18,173                          --             --              --
   Common stock issued upon
     exercise of options and
     warrants ....................         69,744             68                          --             --              --
   Net loss ......................           --             --             --             --             --              --
                                     ------------   ------------   ------------   ------------   ------------    ------------
BALANCE, DECEMBER 31, 2005 .......     18,241,045         18,241           --             --             --              --
   Common stock issued for
     services ....................        225,388            225           --             --             --              --
   Stock based compensation ......           --             --             --             --             --              --
   Net income ....................           --             --             --             --             --              --
                                     ------------   ------------   ------------   ------------   ------------    ------------
BALANCE, DECEMBER 31, 2006 .......     18,466,433   $     18,466           --             --             --              --
                                     ============   ============   ============   ============   ============    ============


<CAPTION>
                                                                                    Convertible Redeemable
                                                                                       Preferred Stock
                                   Additional     Retained                                 Series C
                                    Paid-In       Earnings                       ----------------------------
                                    Capital       (Deficit)         Total           Shares          Amount
                                  ------------   ------------    ------------    ------------    ------------
<S>                               <C>            <C>             <C>                 <C>         <C>
BALANCE, JANUARY 1, 2004 .........$ 23,890,356   $ (3,256,860)   $ 43,563,699         759,494    $  2,895,001
   Conversion of preferred
     stock Series C and
     accrued dividends ...........   3,353,008           --         3,353,708        (759,494)     (2,895,001)
   Conversion of preferred
     stock Series D ..............  22,912,965           --              --              --              --
   Warrants issued in
     private placement
     transaction .................     189,815           --           189,815            --              --
   Common stock issued upon
     exercise of options and
     warrants ....................     557,514           --           557,728            --              --
   Common stock and warrants
     issued for services .........      85,710           --            85,731            --              --
   Tax benefit from exercise
     of stock options ............      84,034           --            84,034            --              --
   Preferred stock dividends .....        --          (30,505)        (30,505)           --              --
   Net loss ......................        --      (17,608,968)     (17,608,96)           --              --
                                  ------------   ------------    ------------    ------------    ------------
BALANCE, DECEMBER 31, 2004 .......  51,073,402    (20,896,333)     30,195,242            --              --
   Common stock issued upon
     exercise of options and
     warrants ....................        --          254,476         254,544            --              --
   Net loss ......................        --       (29,537,70)     (29,537,70)           --              --
                                  ------------   ------------    ------------    ------------    ------------
BALANCE, DECEMBER 31, 2005 .......  51,327,878     (50,434,04)        912,077            --              --
   Common stock issued for
     services ....................     102,504           --           102,729            --              --
   Stock based compensation ......     362,120           --           362,120            --              --
   Net income ....................        --          309,303         309,303            --              --
                                  ------------   ------------    ------------    ------------    ------------
BALANCE, DECEMBER 31, 2006 .......$ 51,792,502   $(50,124,739)      1,686,229            --              --
                                  ============   ============    ============    ============    ============
</TABLE>


                             See accompanying notes.


                                       38
<PAGE>


<TABLE>
                              TAG-IT PACIFIC, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
                                                               Year Ended      Year Ended      Year Ended
                                                              December 31,    December 31,    December 31,
                                                                  2006           2005            2004
                                                              ------------    ------------    ------------
<S>                                                           <C>             <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income (loss) ......................................   $    309,303    $(29,537,709)    (17,608,968)
   Adjustments to reconcile net income (loss) to net cash
       provided by (used in) operating activities:
     Depreciation and amortization ........................      1,523,225       1,931,990       1,547,223
     Decrease in deferred income taxes ....................           --         1,000,000       1,800,000
     Common stock and warrants issued for services ........         32,729            --            85,731
       Stock based compensation ...........................        362,120
     Increase(decrease) in allowance for doubtful accounts      (1,117,500)      2,630,759       4,042,428
     Increase(decrease) in inventory valuation reserve ....     (6,064,000)        940,973            --
     Asset impairment due to restructuring ................           --         2,343,531            --
     Impairment of goodwill ...............................           --           450,000            --
       Disposal of assets .................................        129,179            --              --
   Changes in operating assets and liabilities:
     Accounts receivable ..................................      2,086,076      10,666,295      (7,640,984)
     Inventories ..........................................      8,585,879       2,791,747       7,791,060
     Prepaid expenses and other current assets ............         77,543       1,880,443          13,121
     Other assets .........................................       (140,217)        314,998         147,046
     Accounts payable .....................................     (2,587,985)      2,986,302      (2,647,692)
                                                                                 2,113,197         245,796
     Accrued legal costs ..................................       (442,194)
     Other accrued expenses ...............................       (733,767)        671,348         831,346
     Income taxes payable .................................           (480)        (71,589)         12,032
                                                              ------------    ------------    ------------
   Net cash provided by (used in) operating activities ....      2,019,911       1,112,285     (11,381,861)
                                                              ------------    ------------    ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from sale of equipment ........................          2,500            --              --
   Acquisition of property and equipment ..................       (347,188)     (1,453,848)     (3,615,899
                                                              ------------    ------------    ------------
   Net cash used in investing activities ..................       (344,688)     (1,453,848)     (3,615,899)
                                                              ------------    ------------    ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Note receivable collections ............................        640,539            --              --
   Proceeds from secured convertible promissory notes .....           --              --        11,663,685
   Proceeds from exercise of stock options and warrants ...           --           254,544         557,728
   (Repayment) of line of credit and due to factor, net ...           --          (614,506)     (6,481,007)
   Proceeds from capital lease obligation .................           --              --           950,000
   Payment of capital lease obligations ...................       (604,351)       (906,765)       (332,583)
   Proceeds from notes payable ............................           --              --           880,000
   Repayment of notes payable .............................     (1,054,135)     (1,574,975)     (1,222,170)
                                                              ------------    ------------    ------------
   Net cash (used in) provided by financing activities ....     (1,017,947)     (2,841,702)      6,015,653
                                                              ------------    ------------    ------------
Net increase (decrease) in cash and cash equivalents ......        657,276      (3,183,265)     (8,982,107)
Cash and cash equivalents, beginning of year ..............      2,277,397       5,460,662      14,442,769
                                                              ------------    ------------    ------------
Cash and cash equivalents, end of year ....................   $  2,934,673    $  2,277,397    $  5,460,662
                                                              ============    ============    ============

SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:
   Cash received (paid) during the year for:
    Interest paid .........................................   $ (1,045,881)   $ (1,135,460)   $   (693,045)
     Interest received ....................................   $    368,090          33,931          32,340
     Income taxes paid ....................................   $    (33,900)        (64,064)       (495,345)
     Income taxes received ................................   $       --      $     39,571          17,903
   Non-cash financing activity:
     Capital lease obligation .............................   $     64,432    $    273,376    $    249,418
     Accounts receivable, net converted to notes receivable   $  1,775,000    $  3,440,000    $    470,799
     Preferred Series D stock converted to common stock ...   $       --      $       --      $ 22,918,693
     Preferred Series C stock converted to common stock ...   $       --      $       --      $  2,895,001
     Accrued dividends converted to common stock ..........   $       --      $       --      $    458,707
     Mortgage note payable ................................   $       --      $       --      $    765,000
     Warrants issued to placement agent ...................   $       --      $       --      $     93,815
</TABLE>


                             See accompanying notes.


                                       39
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS

         Tag-It  Pacific,  Inc.  (the  "Company")  is an  apparel  company  that
specializes  in the  distribution  of trim  items to  manufacturers  of  fashion
apparel, specialty retailers and mass merchandisers.  The Company acts as a full
service  outsourced trim management  department for  manufacturers,  a specified
supplier  of trim  items to owners  of  specific  brands,  brand  licensees  and
retailers,  a manufacturer and distributor of zippers under the TALON brand name
and  a  distributor  of  stretch   waistbands  that  utilize  licensed  patented
technology under the TEKFIT brand name.

ORGANIZATION AND BASIS OF PRESENTATION

         Tag-It Pacific,  Inc. is the parent holding company of Tag-It,  Inc., a
California corporation,  Tag-It Pacific (HK) Ltd., a BVI corporation,  Tag-It de
Mexico,  S.A.  de  C.V.,  A.G.S.  Stationery,  Inc.,  a  California  corporation
(collectively,  the  "Subsidiaries"),  all of which  were  consolidated  under a
parent  limited  liability  company on October 17, 1997 and became  wholly-owned
subsidiaries  of the  Company  immediately  prior to the  effective  date of the
Company's  initial  public  offering in January 1998.  Immediately  prior to the
initial public offering,  the outstanding membership units of Tag-It Pacific LLC
were  converted to 2,470,001  shares of Common Stock of the Company.  In January
2000, the Company formed Tag-It Pacific Limited, a Hong Kong corporation, and in
April  2000,   the  Company  formed  Talon   International,   Inc.,  a  Delaware
corporation.  During  2006 we formed two  wholly  owned  subsidiaries  of Tag-It
Pacific,  Inc.;  Talon  Zipper  (Shenzhen)  Company  Ltd.  in  China,  and Talon
International  Pvt.  Ltd.,  in India.  All newly  formed  corporations  are 100%
wholly-owned  Subsidiaries of Tag-It Pacific,  Inc.  Logistica en Avios, S.A. de
C.V. was an affiliated entity over which the Company exercised  control,  and as
such, is accounted for in the same manner as a wholly-owned subsidiary.

         All  significant  intercompany  accounts  and  transactions  have  been
eliminated in consolidation.  Assets and liabilities of foreign subsidiaries are
translated  at rates of exchange in effect at the close of the period.  Revenues
and expenses are translated at the weighted  average of exchange rates in effect
during the year. The resulting translation gains and losses are deferred and are
shown  as a  separate  component  of  stockholders'  equity,  if  material,  and
transaction gains and losses, if any, are recorded in the consolidated statement
of income in the period incurred.  During 2006, 2005 and 2004,  foreign currency
translation and transaction gains and losses were not material. The Company does
not engage in hedging activities with respect to exchange rate risk.

USE OF ESTIMATES

         The preparation of consolidated financial statements in conformity with
generally accepted  accounting  principles requires management to make estimates
and assumptions  that affect the reported  amounts of assets and liabilities and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the reported  amounts of revenues and expenses  during the year.
Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

         The Company considers all highly liquid  investments  purchased with an
initial maturity of three months or less to be cash equivalents. The Company had
approximately $2.9 million and $2.2 million at financial  institutions in excess
of federally insured limits at December 31, 2006 and 2005.


                                       40
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR DOUBTFUL ACCOUNTS

         We are required to make judgments as to the  collectibility of accounts
receivable based on established aging policy,  historical  experience and future
expectations.  The allowances  for doubtful  accounts  represent  allowances for
customer  trade  accounts  receivable  that are  estimated  to be  partially  or
entirely  uncollectible.  These  allowances  are  used  to  reduce  gross  trade
receivables to their net realizable  value. We record these  allowances based on
estimates related to the following  factors:  (i) customer specific  allowances;
(ii) amounts based upon an aging schedule;  and (iii) an estimated amount, based
on our historical experience, for issues not yet identified.

INVENTORIES

         Inventories are stated at the lower of cost or market value and are all
substantially  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:

                                                     Year Ended December 31,
                                                --------------------------------
                                                    2006                 2005
                                                -----------          -----------
Finished goods .......................          $ 4,293,220          $12,879,099
Less reserves ........................            1,242,000            7,306,000
                                                -----------          -----------
Total inventories ....................          $ 3,051,220          $ 5,573,099
                                                ===========          ===========

PROPERTY AND EQUIPMENT AND FIXED ASSETS HELD FOR SALE

         Property and equipment are recorded at historical cost. Maintenance and
repairs are  expensed as  incurred.  Upon  retirement  or other  disposition  of
property  and  equipment,  the  related  cost and  accumulated  depreciation  or
amortization  are removed from the accounts and any gains or losses are included
in results of  operations.  During the year ended  December 31, 2005 the Company
wrote-off fully depreciated equipment,  films, dies and art designs no longer in
service,  and changed its estimates of the expected useful lives of the dies and
molds to 3 months or 1 year, depending upon the nature of the tool.

         Depreciation   of  property  and   equipment  is  computed   using  the
straight-line method based on estimated useful lives as follows:

         Furniture and fixtures     5 years

         Machinery and equipment    5 to 10 years

         Computer equipment         5 years

         Leasehold improvements     Term  of  the  lease  or  the estimated life
                                    of  the related  improvements,  whichever is
                                    shorter.

         Dies, and molds            3 months to 1 years

         Idle equipment             5 to 10 years


                                       41
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Property and equipment consist of the following:

                                                       Year Ended December 31,
                                                     ---------------------------
                                                        2006            2005
                                                     -----------     -----------
Furniture and fixtures .........................     $   582,832     $   551,623
Machinery and equipment ........................       1,682,296       3,319,786
Computer equipment .............................       3,422,058       3,325,997
Leasehold improvements .........................         214,807         139,803
Dies, and molds ................................         106,273         106,273
Idle equipment .................................       4,434,980       2,806,475
                                                     -----------     -----------
                                                      10,443,246      10,249,958
Accumulated depreciation and amortization ......       4,820,206       3,811,862
                                                     -----------     -----------
Net property and equipment .....................     $ 5,623,040     $ 6,438,096
                                                     ===========     ===========

         Depreciation  expense for the years ended  December 31, 2006,  2005 and
2004 was $1,090,000, $1,499,000, and $1,277,000, respectively.

         During the year ended  December 31, 2005, the Company  wrote-off  fixed
assets  with a net  book  value  of  $2,036,000  in  connection  with  the  2005
restructuring plan.

         Idle  equipment is  principally  machinery and  equipment  used for the
production of zipper chain and the assembly of finished zippers.  This equipment
was originally  associated with the production and assembly  facilities in North
Carolina and in Mexico,  and was  temporarily  rendered idle with the closing of
these  operations in connection  with the 2005  Restructuring  Plan. The Company
intends  to  redeploy  this  equipment  during the next year  within  production
operations being  established in Asia and India.  The equipment  continues to be
depreciated based upon its estimated useful lives.

         Fixed  assets  held for sale  consists of the North  Carolina  land and
manufacturing  facility.  Management has the authority and has committed to sell
the asset;  the asset is listed for sale with a commercial real estate agent who
is actively  marketing the  property;  the sale of the asset is probable and the
sale  is  expected  to  be  completed  within  one  year.  See  Note  11,  "2005
Restructuring Plan".

GOODWILL AND OTHER INTANGIBLE ASSETS

         Intangible assets consist of goodwill, tradename, and exclusive license
and intellectual  property rights.  Goodwill represents the excess of costs over
fair value of assets of  businesses  acquired.  Goodwill and  intangible  assets
acquired in a purchase business combination and determined to have an indefinite
useful  life are not  amortized,  but  instead  tested for  impairment  at least
annually in accordance  with the provisions of FASB Statement No. 142,  Goodwill
and Other Intangible  Assets.  Intangible assets with estimable useful lives are
amortized over their respective  estimated useful lives,  which average 5 years,
to their estimated  residual  values,  and reviewed for impairment in accordance
with FASB Statement No. 144, Accounting for Impairment or Disposal of Long-Lived
Assets.

         At December 31, 2006, the Company evaluated its Other Intangible Assets
and determined  that there was no impairment of these assets and made no changes
to the net carrying  amount of Tradename  for the years ended  December 31, 2006
and 2005.  At  December  31,  2005,  the  Company  evaluated  its  Goodwill  and
determined  that an impairment  adjustment in the amount of $450,000  related to
goodwill  was  necessary  to reduce  the  carrying  value of  goodwill  to zero.
Amortization expense related to exclusive license and


                                       42
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

intellectual  property  rights of $115,500  were  recorded for each of the years
ended December 31, 2006, 2005 and 2004.

         Goodwill and other  intangible  assets as of December 31, 2006 and 2005
are as follows:

                                                        Year Ended December31,
                                                     --------------------------
                                                        2006            2005
                                                     -----------    -----------
Goodwill ..........................................  $      --      $   500,000
  Accumulated amortization ........................         --          (50,000)
  Impairment write-off ............................         --         (450,000)
                                                     -----------    -----------
  Goodwill, net ...................................  $      --      $      --
                                                     ===========    ===========
Other Intangible Assets:
  Tradename .......................................  $ 4,110,750    $ 4,110,750
  Accumulated amortization ........................         --             --
                                                     -----------    -----------
      Tradename, net ..............................    4,110,750      4,110,750

  Exclusive license and intellectual
    property rights ...............................      577,500        577,500
  Accumulated amortization ........................     (548,625)      (433,125)
                                                     -----------    -----------
      Exclusive license and intellectual
        property rights, net ......................       28,875        144,375
                                                     -----------    -----------
  Other intangible assets, net ....................  $ 4,139,625     $ 4,255,125
                                                     ===========    ===========

          The  estimated  amortization  expense for these assets for  succeeding
years is $28,875 for 2007.

IMPAIRMENT OF LONG-LIVED ASSETS

         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.  During the year ended
December 31, 2005, the Company recorded asset  impairment  charges in connection
with its 2005 Restructuring Plan (See Note 11).

INCOME TAXES

         Income taxes are accounted  for under the asset and  liability  method.
Deferred  tax  assets  and   liabilities  are  recognized  for  the  future  tax
consequences   attributable  to  differences  between  the  financial  statement
carrying  amounts of existing assets and  liabilities  and their  respective tax
bases and tax benefit carry-forwards. Deferred tax liabilities and assets at the
end of each period are determined  using enacted tax rates.  The Company records
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.

         The provisions of SFAS No. 109,  "Accounting for Income Taxes," require
the  establishment of a valuation  allowance when, based on currently  available
information and other factors,  it is more likely than not that all or a portion
of a deferred  tax asset will not be  realized.  SFAS No. 109  provides  that an
important factor in determining whether a deferred tax asset will be realized is
whether there has been sufficient income


                                       43
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

in recent  years and whether  sufficient  income is expected in future  years in
order to utilize the deferred tax asset.

         The Company  believes  that its  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.

STOCK-BASED COMPENSATION

         On  January  1,  2006,  the  Company  adopted  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.  SFAS 123(R) supersedes the Company's previous accounting
under Accounting  Principles Board Opinion No. 25,  "Accounting for Stock Issued
to  Employees"  ("APB 25") for periods  beginning in fiscal 2006. In March 2005,
the Securities and Exchange  Commission issued Staff Accounting Bulletin No. 107
("SAB 107")  relating to SFAS 123(R).  The Company has applied the provisions of
SAB 107 in its adoption of SFAS 123(R).

         The  Company  adopted  SFAS  123(R)  using  the  modified   prospective
transition method,  which requires the application of the accounting standard as
of January 1, 2006.  The Company's  financial  statements as of and for the year
ended  December 31, 2006 reflect the impact of SFAS 123(R).  In accordance  with
the modified  prospective  transition method, the Company's financial statements
for prior  periods have not been  restated to reflect,  and do not include,  the
impact of SFAS 123(R). There was no stock-based  compensation expense related to
employee or director  stock options  recognized  during the years ended December
31, 2005 or 2004.  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."

         As a result of adopting  SFAS 123(R) on January 1, 2006,  the Company's
income before  income taxes and net income for the year ended  December 31, 2006
are  $395,000  lower  than  if it  had  continued  to  account  for  share-based
compensation under APB Opinion 25.

         The following  table  illustrates the effect on net income and loss per
share if the Company had applied the fair value  recognition  provisions of SFAS
123(R) to stock-based  awards granted under the Company's  stock option plans in
all periods presented. For purposes of this pro-forma disclosure, the fair value
of the  options  is  estimated  using  the  Black-Scholes-Merton  option-pricing
formula  ("Black-Scholes  model") and  amortized to expense  generally  over the
options' vesting periods.


                                       44
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                                       2005            2004
                                                   ------------    ------------
Net loss as reported ...........................   $(29,537,709)   $(17,608,968)
Add:  Stock-based employee compensation expense
     included in reported net income, net of
     related tax effects .......................           --              --

Deduct:  Total stock-based employee
     compensation expense determined under fair
     value method for all awards, net of
     related tax effects .......................       (221,167)        (55,228)
                                                   ------------    ------------
Pro forma net loss .............................   $(29,758,876)   $(17,664,196)
                                                   ============    ============
 Loss per share:
     Basic - as reported .......................   $      (1.62)   $      (1.02)
     Basic - pro forma .........................   $      (1.63)   $      (1.02)

         SFAS  123(R)   requires   companies  to  estimate  the  fair  value  of
share-based payment awards to employees and directors on the date of grant using
an  option-pricing  model.  The  value  of the  portion  of the  award  that  is
ultimately  expected to vest is recognized as expense over the requisite service
periods in the Company's  Statements  of  Operations.  Stock-based  compensation
expense  recognized in the  Statements of Operations for the year ended December
31, 2006 included  compensation  expense for share-based  payment awards granted
prior to,  but not yet vested as of January 1, 2006 based on the grant date fair
value  estimated in  accordance  with the  pro-forma  provisions of SFAS 123 and
compensation  expense for the share-based  payment awards granted  subsequent to
January 1, 2006 based on the grant date fair value  estimated in accordance with
the provisions of SFAS 123(R).  For  stock-based  awards issued to employees and
directors,   stock-based   compensation  is  attributed  to  expense  using  the
straight-line   single  option  method,   which  is  consistent   with  how  the
prior-period  pro formas were  provided.  As  stock-based  compensation  expense
recognized in the Statements of Operations for 2006 is based on awards  expected
to vest, SFAS 123(R)  requires  forfeitures to be estimated at the time of grant
and revised,  if necessary,  in subsequent  periods if actual forfeitures differ
from those estimates. For the year ended December 31, 2006, expected forfeitures
are immaterial and as such the Company is recognizing forfeitures as they occur.
In the pro-forma  information  provided  under SFAS 123 for the periods prior to
2006, the Company accounted for forfeitures as they occurred.

         Prior  to the  adoption  of SFAS  123(R),  the  Company  accounted  for
stock-based  awards to employees and directors  using the intrinsic value method
in accordance with APB Opinion 25. Under the intrinsic value method, the Company
recognized share-based  compensation equal to the award's intrinsic value at the
time of grant over the requisite service periods using the straight-line method.
Forfeitures  were recognized as incurred.  During the years ended December,  31,
2005 and 2004, there was no stock-based  compensation  expense recognized in the
Statements  of  Operations  for awards  issued to employees and directors as the
awards had no intrinsic value at the time of grant because their exercise prices
equaled the fair values of the common stock at the time of grant.

         The Company's determination of fair value of share-based payment awards
to employees  and directors on the date of grant uses the  Black-Scholes  model,
which is affected by the Company's stock price as well as assumptions  regarding
a number of complex and subjective  variables.  These variables include, but are
not limited to, the expected  stock price  volatility  over the expected term of
the awards, and actual and projected  employee stock option exercise  behaviors.
The Company estimates expected


                                       45
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

volatility  using  historical  data. The expected option term is estimated using
the "safe harbor" provisions under SAB 107.

         The Company has elected to adopt the detailed  method  provided in SFAS
123(R) for calculating the beginning  balance of the additional  paid-in capital
pool  ("APIC  pool")  related  to  the  tax  effects  of  employee   stock-based
compensation,  and to  determine  the  subsequent  impact  on the APIC  pool and
Statements of Cash Flows of the tax effects of employee stock-based compensation
awards that are outstanding upon adoption of SFAS 123(R).

COMPREHENSIVE INCOME

         The  Company has  adopted  Statement  of  Financial  Standard  No. 130,
"Reporting  Comprehensive Income" ("SFAS 130"), issued by the FASB and effective
for financial  statements  with fiscal years  beginning after December 15, 1997.
SFAS 130 establishes standards for reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements.  There
were no material other  comprehensive  income items for the years ended December
31, 2006, 2005 and 2004.

REVENUE RECOGNITION

         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.

         Sales rebates and discounts  are common  practice in the  industries in
which the Company operates. Volume, promotional, price, cash and other discounts
and customer incentives are accounted for as a reduction to gross sales. Rebates
and discounts are recorded  based upon  estimates at the time products are sold.
These  estimates are based upon historical  experience for similar  programs and
products. The Company reviews such rebates and discounts on an ongoing basis and
accruals for rebates and  discounts are  adjusted,  if necessary,  as additional
information becomes available.

RECLASSIFICATION

         Certain  reclassifications  have been made to the prior year  financial
statements to conform to 2006 presentation.

CLASSIFICATION OF EXPENSES

         COST OF SALES - Cost of goods sold primarily  includes expenses related
to inventory purchases,  customs, duty, freight,  overhead expenses and reserves
for obsolete  inventory.  Overhead  expenses  primarily consist of warehouse and
operations salaries, and other warehouse expenses.

         SELLING EXPENSE - Selling expenses  primarily  include royalty expense,
sales salaries and commissions,  travel and  entertainment,  marketing and other
sales-related costs.

         GENERAL  AND  ADMINISTRATIVE  EXPENSES  -  General  and  administrative
expenses   primarily  include   administrative   salaries,   employee  benefits,
professional  service fees,  facility  expenses,  information  technology costs,
investor relations, travel and entertainment, depreciation and amortization, bad
debts, restructuring costs and other general corporate expenses.


                                       46
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SHIPPING AND HANDLING COSTS

         In accordance with Emerging Issues Task Force (EITF) 00-10,  Accounting
for Shipping  and  Handling  Fees and Costs,  the Company  records  shipping and
handling  costs billed to customers as a component of revenue,  and shipping and
handling  costs  incurred by the Company for outbound  freight are recorded as a
component  of cost of sales.  Total  shipping  and  handling  costs  included as
component  of revenue  for the years  ended  December  31,  2006,  2005 and 2004
amounted to $146,000,  $98,000 and $194,000.  Total  shipping and handling costs
included  as a component  of cost of sales for each of these  years  amounted to
$691,000, $925,000 and $1,002,000.

RESTRUCTURING CHARGES

         The Company records 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  as they  are  incurred  and on the  accrual  basis  for
one-time benefit  arrangements.  The Company records 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 the Company 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.
The Company reviews the status of restructuring  activities on a quarterly basis
and, if appropriate,  records changes based on updated  estimates.  See Note 11,
"2005 Restructuring Plan".

LITIGATION

         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.

FAIR VALUE OF FINANCIAL INFORMATION

         The following  methods and  assumptions  were used to estimate the fair
value of each class of  financial  instruments  for which it is  practicable  to
estimate that value.  ACCOUNTS  RECEIVABLE:  Due to the short-term nature of the
receivables,  the fair value  approximates  the carrying value. DUE FROM RELATED
PARTIES AND NOTES PAYABLE TO RELATED PARTIES:  Due to the short-term  nature and
current  market  borrowing  rates  of  the  loans  and  notes,  the  fair  value
approximates the carrying value. NOTES PAYABLE: Fair value approximates carrying
value based upon current market borrowing rates for loans with similar terms and
maturities.

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
(GAAP), 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


                                       47
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

November 15, 2007,  with earlier  application  encouraged.  The Company does not
believe that SFAS No. 157 will have a material impact on the Company's financial
position, results of operations or cash flows.

         In September  2006, the SEC issued Staff  Accounting  Bulletin No. 108,
CONSIDERING   THE  EFFECTS  OF  PRIOR  YEAR   MISSTATEMENTS   WHEN   QUANTIFYING
MISSTATEMENTS  IN CURRENT YEAR  FINANCIAL  STATEMENTS  ("SAB  108"),  to address
diversity in practice in quantifying financial statement misstatements.  SAB 108
requires the  quantification of misstatements  based on their impact on both the
balance sheet and the income  statement to determine  materiality.  The guidance
provides  for  a  one-time   cumulative   effect   adjustment   to  correct  for
misstatements that were not deemed material under a company's prior approach but
are material  under the SAB 108 approach.  SAB 108 is effective for fiscal years
ending after  November 15, 2006.  The  implementation  of SAB 108 did not have a
material impact on the financial  position,  results of operations or cash flows
of the Company.

         In June 2006, the Financial  Accounting Standards Board ("FASB") issued
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 in accordance with FASB Statement No. 109,  ACCOUNTING FOR
INCOME TAXES.  FIN 48 also  prescribes a recognition  threshold and  measurement
attribute for the  financial  statement  recognition  and  measurement  of a tax
position  taken or expected  to be taken in a tax return  that  results in a tax
benefit.  Additionally,  FIN 48  provides  guidance  on  de-recognition,  income
statement  classification  of  interest  and  penalties,  accounting  in interim
periods, disclosure, and transition. This interpretation is effective for fiscal
years beginning after December 15, 2006. The Company is currently evaluating the
effect that the application of FIN 48 will have on its results of operations and
financial condition.

         In February  2006,  the FASB issued  Statement of Financial  Accounting
Standards No. 155, "Accounting for Certain Hybrid Financial  Instruments" ("SFAS
155"),  which amends SFAS No. 133,  "Accounting for Derivatives  Instruments and
Hedging Activities" ("SFAS 133") and SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and  Extinguishment  of Liabilities"  ("SFAS 140).
SFAS 155 amends SFAS 133 to narrow the scope  exception  for  interest-only  and
principal-only   strips  on  debt   instruments  to  include  only  such  strips
representing  rights to receive a specified portion of the contractual  interest
or  principle  cash flows.  SFAS 155 also  amends  SFAS 140 to allow  qualifying
special-purpose  entities  to hold a  passive  derivative  financial  instrument
pertaining to beneficial interests that itself is a derivative instrument.  SFAS
No. 155 is effective for all financial  instruments acquired or issued after the
beginning of an entity's first fiscal year that begins after September 15, 2006.
The Company  does not believe  that SFAS No. 155 will have a material  impact on
the Company's financial position, results of operations or cash flows.

NOTE 2 - ACCOUNTS AND NOTE RECEIVABLE

         At  December  31,  2006  a  note  receivable  from  Azteca  Productions
International  ("Azteca") was outstanding in the amount of $2,799,460.  The note
is receivable in monthly  installments over thirty-one months beginning March 1,
2006. The payments are $50,000 per month for the first 5 months, then range from
$133,000-$267,000  per month until paid in full. At December 31, 2005,  accounts
receivable  from  Azteca,  a  significant  customer in 2005,  was  approximately
$10,968,000 less a reserve of $7,528,000. In February 2006, the Company accepted
a note  agreement  from  Azteca  which  provided  for total  payments  including
principal  and  interest  of $4.0  million in exchange  for the net  outstanding
accounts receivable balance. The value of the note receivable recorded effective
at December 31, 2005  reflected a $560,000  charge to the face value to discount
the note,  using a 10.5%  discount  rate, to its net present  value.  The Azteca
accounts  receivable,   net  at  December  31,  2005  was  reclassified  on  the
accompanying  consolidated  balance  sheets to note  receivable  to reflect this
subsequent  settlement.  The following summarizes the future minimum payments of
the note receivable:


                                       48
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDING DECEMBER 31,                                             Amount
---------------------------------------------------------           -----------
2007 ....................................................           $ 1,599,996
2008 ....................................................             1,483,339
                                                                    -----------
Total payments ..........................................             3,083,335
Less amount representing interest .......................              (283,875)
                                                                    -----------
Balance at December 31, 2006 ............................             2,799,460
Less current portion ....................................             1,378,491
                                                                    -----------
Long-term portion .......................................           $ 1,420,969
                                                                    ===========

         Accounts  receivable  are  included  on the  accompanying  consolidated
balance sheet net of an allowance for doubtful accounts. The total allowance for
doubtful  accounts at December 31, 2006 was  $71,500.  The total  allowance  for
doubtful accounts at December 31, 2005 was $1,188,758, after reclassification of
the net Azteca receivable to note receivable.

         In 2004,  following  negotiations  with Tarrant Apparel Group, a former
customer,  we determined that a significant  portion of the obligations due from
this  customer  were  uncollectible.   Accordingly,   included  in  general  and
administrative  expenses for 2004 are charges of $4.3 million related  primarily
to the write-down of this receivable and leaving a remaining balance  receivable
from this customer of $4.5 million. An affiliate of the customer repaid the $4.5
million receivable balance over the period from May through December 2005.

NOTE 3 - FACTORING AGREEMENT

         The Company entered into a factoring agreement with East Asia Heller in
2004 for the  purchase of eligible  receivables  from its Hong Kong  subsidiary,
Tag-It  Pacific  (HK)  Limited.   The  factor  may  purchase  eligible  accounts
receivable  and assume the credit risk with respect to those  accounts for which
they have given their prior  approval.  If the factor does not assume the credit
risk for a  receivable,  the  collection  risk  associated  with the  receivable
remains  with the  Company.  The Company  pays a fixed  commission  rate and may
borrow up to 80% of its  eligible  accounts  receivable.  Interest is charged at
1.5% over the Hong Kong Dollar  prime rate (7.75% and 7.75% at December 31, 2006
and 2005). However, during 2005 and 2006 the factor declined to advance funds to
the Company under this agreement. Accordingly, as of December 31, 2006, and 2005
there were no outstanding advances from the factor.

NOTE 4 - DEMAND NOTES PAYABLE TO RELATED PARTIES

         Demand notes payable to related parties consist of the following:

                                                  Year Ended December 31,
                                                --------------------------------
                                                    2006                2005
                                                ------------        ------------

Two notes payable  issued from  1995-1998 to
parties   related  to  or  affiliated   with
directors of the Company with interest rates
ranging  from 0% to 10% per  annum,  due and
payable  on  the   fifteenth  day  following
delivery of written demand for payment ......   $     85,176        $     85,176

Convertible  secured note payable  issued in
October  2000 to a director  of the  Company
bears interest at 11%, payable quarterly, is
due on demand and  convertible  into  common
stock at the  election  of the  holder  at a
rate of $4.50 per share, the market


                                       49
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

value of the  Company's  common stock on the
date of approval by the  Company's  Board of
Directors.    The   note   is   secured   by
substantially all of the Company's assets ...        500,000             500,000

Unsecured notes payable to a director of the
Company  accrue  interest at 7% and 8.5% per
annum,  principal and interest due on demand
and fifteen days from demand ................         79,795              79,795
                                                ------------        ------------
                                                $    664,971        $    664,971
                                                ============        ============

         Interest expense related to the demand notes payable to related parties
for the years  ended  December  31,  2006,  2005 and 2004  amounted  to $67,753,
$67,753, and $81,628. Included in accrued expenses at December 31, 2006 and 2005
was  $515,738 and $447,986 of related  accrued  interest.  There was no interest
paid on the demand notes during the years ended December 31, 2006 and 2005.

NOTE 5 - CAPITAL LEASE OBLIGATIONS

         The Company financed equipment  purchases through various capital lease
obligations  expiring  through August 2010.  These  obligations bear interest at
various rates ranging from 4.6% to 15% per annum. Future minimum annual payments
under these capital lease obligations are as follows:

YEARS ENDING DECEMBER 31,                                             Amount
---------------------------------------------------------           -----------
2007 ....................................................           $   505,029
2008 ....................................................               336,970
2009 ....................................................               184,606
2010 ....................................................                   430
                                                                    -----------
Total payments ..........................................             1,027,035
Less amount representing interest .......................              (119,574)
                                                                    -----------
Balance at December 31, 2006 ............................               907,461
Less current portion ....................................               432,728
                                                                    -----------
Long-term portion .......................................           $   474,733
                                                                    ===========

         At December 31, 2006,  total property and equipment under capital lease
obligations and related accumulated  depreciation was $3,533,154 and $1,178,469,
respectively.  At December 31, 2005,  total property and equipment under capital
lease  obligations  and related  accumulated  depreciation  was  $3,468,721  and
$661,533, respectively.


                                       50
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6 - NOTES PAYABLE

         Notes payable consist of the following:

                                                    Year Ended December 31,
                                                --------------------------------
                                                   2006                2005
                                                ------------        ------------
$765,000 note payable to First National Bank
dated  June  3,  2004;   interest  at  6.5%;
payable in eighty-four  monthly  payments of
principal  and interest of $5,746  beginning
July  2004;  twenty-year  amortization,  all
unpaid  principal  and  interest due June 3,
2011 (seven  years);  secured by building in
North Carolina ..............................   $    712,950        $    734,787

$880,000 note payable to First National Bank
dated  November 22, 2004;  interest at 6.5%;
payable  in  sixty   monthly   payments   of
principal and interest of $17,254  beginning
December  2004;  all  unpaid  principal  and
interest due  November 22, 2009;  secured by
manufacturing equipment .....................        548,068             713,068

$1,650,000 note payable to Hennigan, Bennett
& Dorman,  LLP dated May 31, 2006;  interest
at  3.0%;   payable  in   fourteen   monthly
payments of principal and interest beginning
June  2006,  of  $50,000  for the  first two
payments,  and  $133,333 for the next twelve
months   thereafter   until  July  1,  2007;
secured by the note receivable ..............        907,703                --
                                                ------------        ------------
      Notes Payable..........................      2,168,721           1,447,855
      Less Current portion...................      1,107,207             186,837
                                                ------------        ------------
Notes payable, net of current portion .......   $  1,061,514        $  1,261,018
                                                ============        ============

         Future  minimum annual  payments under these notes payable  obligations
are as follows:

YEARS ENDING DECEMBER 31,                                               Amount
-------------------------------------------------------               ----------
2007 ..................................................               $1,107,207
2008 ..................................................                  213,030
2009 ..................................................                  210,218
2010 ..................................................                   28,301
2011 and thereafter ...................................                  609,965
                                                                      ----------
Total .................................................               $2,168,721
                                                                      ==========

NOTE 7 - SECURED CONVERTIBLE PROMISSORY NOTES

         On November 10, 2004, the Company raised $12.5 million from the sale of
Secured Convertible Promissory Notes (the "Notes") to existing shareholders. The
Notes are  convertible  into  common  stock at a price of $3.65 per share,  bear
interest at 6% payable  quarterly,  are due  November 9, 2007 and are secured by
the TALON  trademarks.  The Notes are convertible at the option of the holder at
any time after  closing.  The  Company may repay the Notes at any time after one
year from the closing  date with a 15%  prepayment  penalty.  At  maturity,  the
Company may repay the Notes in cash or require  conversion if certain conditions
are met. In connection with the issuance of the Notes, the Company issued to the
Note holders,  warrants to purchase up to 171,235  shares of common  stock.  The
warrants  have a term of five years,  an  exercise  price of $3.65 per share and
vested 30 days after  closing.  The fair value of the warrants was  estimated at


                                       51
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

approximately  $96,000  utilizing  the  Black-Scholes  model and  recorded  as a
discount against the face value of the Notes. The discount is amortized over the
three-year  term  of  the  Notes  on a  straight-line  basis.  The  Company  has
registered the resale by the holders of the shares  issuable upon  conversion of
the Notes and exercise of the warrants.  In connection with this financing,  the
Company paid the  placement  agent  $704,000 in cash,  and issued the  placement
agent a warrant to purchase  215,754 common shares at an exercise price of $3.65
per share.  The warrant is exercisable  beginning May 10, 2005 through  November
10, 2009.  The fair value of the warrant was estimated at $93,815  utilizing the
Black-Scholes model and recorded as deferred financing costs which are amortized
over the three- year term of the Notes. The full amount of principal under these
secured  convertible  promissory  notes is due  November  7, 2007.  (See Item 7.
Management's Discussion and Analysis).

NOTE 8 - STOCKHOLDERS' EQUITY AND CONVERTIBLE REDEEMABLE PREFERRED STOCK

PREFERRED STOCK

STOCKHOLDER'S RIGHTS PLAN

         In October 1998, the Company adopted a stockholder's rights plan. Under
the rights plan the Company  distributed  one preferred share purchase right for
each outstanding share of Common Stock outstanding on November 6, 1998. Upon the
occurrence  of certain  triggering  events  related to an  unsolicited  takeover
attempt of the Company,  each  purchase  right not owned by the party or parties
making the  unsolicited  takeover  attempt  will  entitle its holder to purchase
shares  of the  Company's  Series A  Preferred  Stock at a value  below the then
market  value of the  Series A  Preferred  Stock.  The  rights of holders of the
Common Stock will be subject to, and may be adversely affected by, the rights of
holders of the share purchase rights, the Series A Preferred Stock and any other
preferred  stock that may be issued in the future.  The  issuance  of  preferred
stock,  while  providing  desirable  flexibility  in  connection  with  possible
acquisitions  and other corporate  purposes,  could make it more difficult for a
third party to acquire a majority of the Company's outstanding voting stock.

SERIES D PREFERRED STOCK PRIVATE PLACEMENT TRANSACTION

         On December 18, 2003,  the Company sold an aggregate of 572,818  shares
of non-voting  Series D Convertible  Preferred  Stock,  at a price of $44.00 per
share,  to  institutional  investors and  individual  accredited  investors in a
private placement transaction.  The Company received net proceeds of $23,083,693
after  commissions  and  other  offering  expenses.  The  Series  D  Convertible
Preferred  Stock  was  convertible  after  approval  at  a  special  meeting  of
stockholders  at a  rate  of 10  common  shares  for  each  share  of  Series  D
Convertible  Preferred Stock.  Except as required by law, the Series D Preferred
shares had no voting rights.  The Series D Preferred  shares accrued  dividends,
commencing on June 1, 2004, at an annual rate of 5% of the initial  stated value
of  $44.00  per  share,  payable  quarterly.  In  the  event  of a  liquidation,
dissolution  or winding-up of the Company,  the Series D Preferred  shares would
have been entitled to receive,  prior to any distribution on the common stock, a
distribution  equal to the initial  stated  value of the shares plus all accrued
and unpaid dividends.

         At a special  meeting of  stockholders  held on February 11, 2004,  the
stockholders of the Company  approved the issuance of 5,728,180 shares of common
stock upon conversion of the Series D Preferred  Stock. At the conclusion of the
meeting,  all  of the  shares  of  the  Series  D  Convertible  Preferred  Stock
automatically  converted  into  common  shares  and  the  Series  D  Convertible
Preferred Stock was eliminated.


                                       52
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         The Company has registered the common shares issued upon  conversion of
the  Series D  Convertible  Preferred  Stock  for  resale by the  investors.  In
conjunction with the private placement  transaction the Company issued a warrant
to  purchase  572,818  common  shares to the  placement  agent.  The  warrant is
exercisable beginning June 18, 2004 through December 18, 2008. The fair value of
the warrant was estimated at approximately  $165,000 utilizing the Black-Scholes
model and was recorded as a reduction of the proceeds  from the placement of the
Series D  Convertible  Preferred  Stock.  The Company has  determined  that this
transaction did not result in a beneficial conversion feature.

SERIES  C  PREFERRED  STOCK  PURCHASE  AGREEMENT  AND  CO-MARKETING  AND  SUPPLY
AGREEMENT

         In  accordance  with the Series C Preferred  Stock  Purchase  Agreement
entered into with Coats North America Consolidated,  Inc. ("Coats") on September
20, 2001, the Company  issued 759,494 shares of Series C Convertible  Redeemable
Preferred  Stock to Coats North  America  Consolidated,  Inc. in exchange for an
equity  investment from Coats of $3,000,001  cash. The Series C Preferred shares
were  convertible  at the option of the holder after one year at the rate of the
closing price  multiplied by 125% of the ten-day  average closing price prior to
closing.  The Series C  Preferred  shares were  redeemable  at the option of the
holder after four years. If the holders elected to redeem the Series C Preferred
shares,  the  Company  had the option to redeem for cash at the stated  value of
$3,000,001  or in the form of the  Company's  common  stock at 85% of the market
price of the  Company's  common stock on the date of  redemption.  If the market
price of the  Company's  common  stock on the date of  redemption  was less than
$2.75 per share, the Company was required to redeem for cash at the stated value
of the Series C Preferred shares. The Company could elect to redeem the Series C
Preferred  shares  at any time for cash at the  stated  value.  The terms of the
Series C Preferred  shares provided for cumulative  dividends at a rate of 6% of
the stated value per annum,  payable in cash or the Company's  common stock. The
dividends  were  payable  at the  earlier  of  the  declaration  of  the  Board,
conversion or  redemption.  Each Series C Preferred  share had the right to vote
for each of the Company's common shares that the Series C Preferred shares could
then be  converted  into  on the  record  date.  Total  legal  and  other  costs
associated with this  transaction of $105,000 were netted against the $3,000,001
proceeds received from Coats.

         In connection with the Series C Preferred Stock Purchase Agreement, the
Company also  entered  into a 10-year  Co-Marketing  and Supply  Agreement  with
Coats. The Co-Marketing and Supply Agreement provides for selected introductions
into Coats' customer base and the Company's trim packages will exclusively offer
thread manufactured by Coats.

         On February  25,  2004,  the  holders of the Series C  Preferred  Stock
converted  all 759,494  shares of Series C  Preferred  Stock,  plus  $458,707 of
accrued  dividends,  into 700,144 shares of common stock. The Series C Preferred
Stock was eliminated in March 2004.

SERIES  B  PREFERRED  STOCK  PURCHASE  AGREEMENT,   DISTRIBUTION  AGREEMENT  AND
TRADENAME PURCHASE AGREEMENT

         On April 3, 2000, the Company entered into a ten-year exclusive license
and  distribution  agreement  with Talon,  Inc.  and its parent  company,  Grupo
Industrial Cierres Ideal, S.A. de C.V. ("GICISA").  Under this agreement, Tag-It
Pacific,  Inc. was the exclusive sales,  marketing,  distribution and e-commerce
arm for "TALON"  products for all customers in the United  States,  Mexico-based
maquiladores, Canada and the Pacific Rim and had the exclusive license to market
trim  products  under the "TALON"  brand name.  In exchange for these  exclusive
distribution  rights,  the Company issued 850,000 shares of Series B Convertible
Preferred  stock to  GICISA.  After a  period  of 30  months,  the  shares  were
convertible  into the Company's common stock once the average price per share of
the Company's  common stock reached or exceeded  $8.00 for a 30-day  consecutive
period.  The preferred stock was  automatically  convertible  into shares of the
Company's  common  stock based on a rate of one minus the fraction of $2.50 over
the average per share closing price of the Company's common stock for the 30-day
period preceding the conversion.


                                       53
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         The Series B Convertible  Preferred stock had a liquidation  preference
of $.001 per share, and was entitled to receive  non-cumulative  dividends on an
as converted  basis,  if and when, such dividends were declared on the Company's
common stock and was  redeemable  by the Company  under  certain  conditions  as
outlined in the agreement.

         The estimated fair value of the Series B Convertible Preferred stock on
April 3, 2000 was $1,400,000.  The Company recorded the value of the license and
distribution  rights as a long-term  asset,  which was being  amortized over the
ten-year period of the agreement. The unamortized balance of the long-term asset
at December 21, 2001 was $1,166,667.

         On September 30, 2000, the Company  purchased  inventory from GICISA in
exchange for an unsecured  note  payable in the amount of  $2,830,024.  The note
payable was non-interest  bearing and was due April 1, 2002. The Company imputed
interest for the holding period of the note amounting to $272,000.  The note was
subordinate to the obligations due under a credit facility with UPS Capital. The
note  payable  balance  at  December  21,  2001 was  $2,767,182,  net of imputed
interest of $62,842.

         On December  21,  2001,  the  Company  entered  into an Asset  Purchase
Agreement with Talon, Inc. and GICISA. Pursuant to the Asset Purchase Agreement,
the Company  acquired  from Talon,  Inc. and GICISA:  (1) certain  inventory and
equipment,  (2) all patent  rights  held by Talon,  Inc.  and (3) all of Talon's
rights to its trade names and  trademarks  bearing the TALON name.  In addition,
the Asset  Purchase  Agreement  terminated  the  exclusive  10-year  license and
distribution  agreement,  dated as of April 3, 2000 by and  among  the  Company,
GICISA and Talon, Inc.

         Under the Asset Purchase  Agreement,  the Company issued to Talon, Inc.
500,000 shares of common stock, par value $0.001 per share, a promissory note in
the amount of $4,900,000 and $100,000 in cash held in escrow. The Asset Purchase
Agreement  required Talon,  Inc. to place 50,000 shares of the Company's  common
stock  and  $100,000  in  escrow  for a  period  of 12  months  to  satisfy  any
indemnification  claims the Company may have under the Asset Purchase Agreement.
The common  stock was valued at the market value of the  Company's  stock on the
date of closing.  The  promissory  note was unsecured,  and accrued  interest at
prime plus 2%. In connection with the Asset Purchase Agreement, the Company also
entered  into a mutual  release with Talon,  Inc.  and GICISA  pursuant to which
Talon,  Inc.  and GICISA  released the Company  from its  obligations  under the
unsecured note payable of $2,830,024  dated September 30, 2000 and other current
liabilities  under the Exclusive  License and Distribution  Agreement.  Further,
850,000  shares of the Company's  series B convertible  preferred  stock held by
GICISA were canceled at the closing of the Asset Purchase Agreement. The balance
of the  unsecured  promissory  note was $1.4 million at December  31, 2004.  The
unsecured  promissory  note and all  outstanding  obligations due under the note
payable were paid in full as of June 1, 2005.

         The Series B  Convertible  Preferred  Stock was  eliminated in February
2004.

COMMON STOCK

2003 PRIVATE PLACEMENT

         On May 30,  2003,  the Company  raised  approximately  $6,037,500  in a
private placement transaction with five institutional  investors.  Pursuant to a
securities  purchase agreement with these institutional  investors,  the Company
sold 1,725,000  shares of its common stock at a price per share of $3.50.  After
commissions  and expenses,  the Company  received net proceeds of  approximately
$5.5  million.  The  Company  has  registered  the shares  issued in the private
placement  with  the  Securities  and  Exchange  Commission  for  resale  by the
investors.  In conjunction with the private placement  transaction,  the Company


                                       54
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

issued  warrants to purchase  172,500  shares of common  stock to the  placement
agent.  The warrants are exercisable  beginning  August 30, 2003 through May 30,
2008 and have a per share exercise price of $5.06.

STOCK GRANT AGREEMENT

         Pursuant to Stock Grant Agreements between the Company and Herman Roup,
dated December 1, 2001, January 1, 2002 and July 17, 2002, the Company issued to
Mr.  Roup an  aggregate  20,500  shares  of  common  stock in 2004 for  services
provided to the Company valued at $74,825.

EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY RIGHTS AGREEMENT

         On April 2, 2002,  the Company  entered into an  Exclusive  License and
Intellectual  Property Rights Agreement (the  "Agreement") with Pro-Fit Holdings
Limited  ("Pro-Fit").  The Agreement  gives the Company the exclusive  rights to
sell or sublicense  waistbands  manufactured under patented technology developed
by Pro-Fit for garments manufactured anywhere in the world for the United States
market and all United States  brands.  In  accordance  with the  Agreement,  the
Company  issued  150,000  shares of its common stock which were  recorded at the
market  value of the  stock on the date of the  Agreement.  The  shares  contain
restrictions  related to the transfer of the shares and registration rights. The
Agreement  has an  indefinite  term that  extends for the  duration of the trade
secrets  licensed  under the  Agreement.  The Company has recorded an intangible
asset  amounting to $577,500  and is  amortizing  this asset on a  straight-line
basis over its estimated  useful life of five years. The Company is currently in
litigation with this supplier (See Notes 1 and 13).

NOTE 9 - STOCK OPTION INCENTIVE PLAN AND WARRANTS

STOCK OPTION INCENTIVE PLAN

          On October 1, 1997, the Company  adopted the 1997 Stock Incentive Plan
(the "1997 Plan"),  which  authorized  the granting of a variety of  stock-based
incentive  awards.  The Board of Directors,  who  determines  the recipients and
terms of the awards granted,  administers the 1997 Plan. On July 31, 2006 at the
Company's annual meeting of stockholder's  two amendments to the 1997 Stock Plan
were approved  which (1) increased the maximum  number of shares of common stock
that may be issued pursuant to awards granted under the 1997 Plan from 3,077,500
shares to 6,000,000  shares,  and (2)  increased  the number of shares of common
stock that may be issued pursuant to awards granted to any individual  under the
plan in a single year to 50% of the total number of shares  available  under the
plan.

          The Company  believes  that such awards  better align the interests of
its  employees  with those of its  shareholders.  Option  awards  are  generally
granted with an exercise price equal to the market price of the Company's  stock
on the  date of the  grant  for  years  prior to  2006,  and for the year  ended
December 31, 2006, the average market price of the Company's  stock for the five
trading days prior to the date of the grant;  those option awards generally vest
over periods  determined  by the Board from  immediate to 4 years of  continuous
service, and have 10 year contractual terms.

         As of December 31, 2006,  the Company may issue awards to acquire up to
a total of 2,321,977  shares of common stock under the 1997 Plan, and there were
awards  issued and  outstanding  under the Plan to acquire a total of  3,452,635
shares of common  stock,  including  options  issued to a consultant  to acquire
75,000 shares of common stock at $0.57 per share. During 2006 the Company issued
options outside the Plan to employees to acquire 1,625,000 shares of stock at an
average  exercise price of $0.46 per share,  and granted 135,135 shares of stock
to an employee with a fair market value of $50,000.

      The  following  table  summarizes  all  options  issued to  employees  and
directors including those issued outside the plan.


                                       55
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         The following table summarizes the activity for the periods:

                                                                       Weighted
                                                                        Average
                                                           Number      Exercise
Employee and Director                                    of Shares      Price
-----------------------------------------------------   ----------    ----------
Options outstanding - January 1, 2004 ...............    1,978,000    $     3.55
     Granted ........................................         --      $     --
     Exercised ......................................     (115,375)   $     3.36
     Canceled .......................................     (120,625)   $     4.00
                                                        ----------    ----------
Options outstanding - December 31, 2004 .............    1,742,000    $     3.53
     Granted ........................................      425,000    $     3.22
     Exercised ......................................       (1,250)   $     3.63
     Canceled .......................................     (332,750)   $     3.50
                                                        ----------    ----------
Options outstanding - December 31, 2005 .............    1,833,000    $     3.46
     Granted ........................................    3,471,135    $     0.31
     Canceled .......................................     (301,500)   $     3.56
                                                        ----------    ----------
Options outstanding - December 31, 2006 .............    5,002,635    $     1.41
                                                        ==========    ==========

         The  Company  has  also  issued   certain   warrants   and  options  to
non-employees.  As of December 31, 2006, there were warrants issued to acquire a
total of 1,243,813  shares of common stock, and options to acquire 75,000 shares
of common stock  outstanding  to  non-employees.  During 2006 the Company issued
90,253  shares of stock to a consultant  in exchange  for  services  with a fair
market value of $51,000.

         The following table summarizes the activity for the periods:

                                                                       Weighted
                                                                        Average
                                                           Number      Exercise
NON-EMPLOYEES                                            of Shares      Price
------------------------------------------------------  ----------    ----------
Options & warrants outstanding - January 1, 2004 .....   1,277,885    $     4.58
     Granted .........................................     416,989    $     3.65
     Exercised .......................................     (80,901)   $     2.68
     Canceled ........................................     (35,000)   $     4.55
                                                        ----------    ----------
Options & warrants outstanding - December 31, 2004 ...   1,578,973    $     4.35
     Granted .........................................        --      $     --
     Exercised .......................................     (68,494)   $     3.65
     Canceled ........................................    (133,332)   $     4.54
                                                        ----------    ----------
Options & warrants outstanding - December 31, 2005 ...   1,377,147    $     4.36
     Granted .........................................      75,000    $     0.57
     Exercised .......................................        --      $     --
     Canceled ........................................    (133,334)   $     4.54
                                                        ----------    ----------
Options & warrants outstanding - December 31, 2006 ...   1,318,813    $     4.13
                                                        ==========    ==========

         The Company's determination of fair value of share-based payment awards
to employees and directors on the date of grant uses the Black-Scholes model and
the assumptions noted in the following table for the years ended December 31, as
indicated.  Expected  volatilities are based on the historical volatility of the
Company's stock price and other factors.  These variables  include,  but are not
limited to, the expected  stock price  volatility  over the expected term of the
awards, and actual and projected


                                       56
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

employee stock option exercise behaviors.  The expected option term is estimated
using the "safe harbor" provisions under SAB 107. The risk free rate for periods
within the contractual life of the option is based on the U.S. Treasury yield in
effect at the time of the grant.

                                             2006          2005         2004(1)
                                            -------       -------       -------
Expected volatility ....................         65%           64%          n/a
Expected term in years .................    6.1 yrs       1.2 yrs           n/a
Expected dividends .....................       --            --             n/a
Risk-free rate .........................        4.5%          2.0%          n/a

(1)      No share-based grants were made in 2004.

A summary of the option  activity  under the 1997 Plan as of December  31, 2006,
and changes during the year then ended is as follows:

<TABLE>
<CAPTION>
                                                                     Weighted
                                                        Weighted      Average
                                                         Average     Remaining
                                          Number of     Exercise    Contractual   Intrinsic
Employee and Director                       Shares       Price      Life (Years)    Value
---------------------------------------   ----------   ----------   -----------   ----------
<S>                                        <C>         <C>                 <C>    <C>
Outstanding at December 31, 2006 ......    5,002,635   $     1.41          7.90   $1,875,639
Vested and Expected to Vest ...........    4,927,355   $     1.43          7.88   $1,837,150
Exercisable ...........................    2,223,968   $     2.51          6.25   $  447,389
</TABLE>

         The  weighted  average  grant-date  fair  value of  options  granted to
employee's and director's during the years ended December 31, 2006 and 2005 were
$0.31 and $0.76, respectively. There were no grants in 2004. The total intrinsic
value of options exercised during the years ended December 31, 2005 and 2004 was
$1,700, and $130,000, respectively. There were no options exercised in 2006.

<TABLE>
<CAPTION>
                                                                       Weighted
                                                          Weighted      Average
                                                           Average     Remaining
                                             Number of    Exercise    Contractual  Intrinsic
NON-EMPLOYEE OPTIONS & WARRANTS:              Shares       Price      Life (Years)   Value
-----------------------------------------   ----------   ----------   -----------  ----------
<S>                     <C> <C>              <C>         <C>                <C>    <C>
Outstanding at December 31, 2006 ........    1,318,813   $     4.13         2.28   $   34,500
Vested and Expected to Vest .............    1,318,813   $     4.13         2.28   $   34,500
Exercisable .............................    1,318,813   $     4.13         2.28   $   34,500
</TABLE>


                                       57
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         The  weighted  average  grant-date  fair value of options and  warrants
granted to non-employees  during the years ended December 31, 2006, and 2004 was
$0.57 and $3.70, respectively. There were no grants in 2005. The total intrinsic
value of options and warrants exercised during the years ended December 31, 2005
and 2004 was $91,000 and $135,000, respectively. There were no options exercised
in 2006.  The fair value of the awards  approximates  the  values  expensed  for
pro-forma purposes for these periods.

         As of December  31,  2006,  there was  $645,248  of total  unrecognized
compensation costs related to non-vested share-based  compensation  arrangements
granted,  including  warrants.  This cost is expected to be recognized  over the
weighted-average  period of 2.0 years.  The total  fair  value of shares  vested
during the years ended December 31, 2006,  2005 and 2004 was $236,000,  $217,000
and $1,597,000, respectively.

         When options are exercised, the Company's policy is to issue previously
registered,  unissued  shares of common  stock.  As of December  31,  2006,  the
Company had  2,321,977  unissued  shares of common  stock  available in its 1997
Plan. On July 31, 2006, at the annual  shareholders  meeting an amendment to the
1997 Stock  Incentive  Plan was  adopted to  increase  the number of  authorized
shares under the 1997 Plan to a total of 6,000,000  shares.  The additional plan
shares  authorized  on July  31,  2006 of  2,922,500  shares  have  not yet been
registered.

NOTE 10 - INCOME (LOSS) PER SHARE

         The following is a reconciliation of the numerators and denominators of
the basic and diluted income (loss) per share computations:

<TABLE>
<CAPTION>
                                    December 31, 2006                              December 31, 2005
                       ------------------------------------------   -------------------------------------------
                          Income         Shares       Per Share         Loss            Shares      Per Share
Years ended:            (Numerator)   (Denominator)     Amount       (Numerator)    (Denominator)     Amount
--------------------   ------------   ------------   ------------   ------------    ------------   ------------
<S>                    <C>              <C>          <C>            <C>               <C>          <C>
Basic income (loss):
pershare:
    Income (loss)
    available
    to common
    stockholders ...   $    309,303     18,377,484   $       0.02   $(29,537,709)     18,225,851   $      (1.62)

Effect of dilutive
securities:
    Options ........           --          578,312           0.00           --              --             --
    Warrants .......           --             --             --             --              --             --
                       ------------   ------------   ------------   ------------    ------------   ------------
Income (loss)
available to common
stockholders .......   $    309,303     18,955,796   $       0.02   $(29,537,709)     18,225,851   $      (1.62)
                       ============   ============   ============   ============    ============   ============


<CAPTION>
                                    December 31, 2004
                       ------------------------------------------
                           Loss          Shares       Per Share
Years ended:            (Numerator)   (Denominator)     Amount
--------------------   ------------   ------------   ------------
<S>                    <C>              <C>          <C>
Basic income (loss):
pershare:
    Income (loss)
    available
    to common
    stockholders ...   $(17,639,47)     17,316,202   $      (1.02)

Effect of dilutive
securities:
    Options ........           --             --            --
    Warrants .......           --             --            --
                       ------------   ------------   ------------
Income (loss)
available to common
stockholders .......   $(17,639,47)     17,316,202   $      (1.02)
                       ============   ============   ============
</TABLE>

         Warrants to purchase  1,243,813 shares of common stock at between $3.50
and $5.06; options to purchase 1,642,500 shares of common stock at between $1.27
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 year ended  December 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 the income per share.

         Warrants to purchase  1,377,147 shares of common stock at between $3.50
and $5.06, options to purchase 1,833,000 shares of common stock at between $0.41
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 year ended  December 31, 2005, 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.


                                       58
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         Warrants to purchase  1,578,973 shares of common stock at between $3.50
and $5.06, options to purchase 1,742,000 shares of common stock at between $1.30
and $4.63,  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 year ended  December 31, 2004, 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 11 - 2005 RESTRUCTURING PLAN

         In an effort to better  align  the  Company's  organizational  and cost
structures  with its future growth  opportunities,  in August 2005 the Company's
Board  of  Directors  adopted  a  restructuring  plan for the  Company  that was
substantially  completed by December 2005. The plan included  restructuring  the
Company's  global  operations  by  eliminating  redundancies  in its  Hong  Kong
operation,  closing its Mexican  facilities,  converting its Guatemala  facility
from a  manufacturing  site to a  distributor,  and closing  its North  Carolina
manufacturing  facility.  The Company also refocused its sales efforts on higher
margin  products,  which  may have  resulted  in lower net  sales  with  certain
customers.  As a result,  the  Company now  operates  with fewer  employees  and
reduced associated  operating and manufacturing  expenses.  The Company recorded
charges in connection  with its  restructuring  plan in accordance with SFAS No.
146 (As  Amended),  "Accounting  for  Costs  Associated  with  Exit or  Disposal
Activities."  In addition,  the  Company's  restructuring  plan  resulted in the
carrying  value  of  certain  long-lived  assets,  primarily  equipment,   being
impaired.  Accordingly,  in 2005 the Company  recorded a charge to recognize the
impairment of these assets in accordance with SFAS No. 144,  "Accounting for the
Impairment or Disposal of Long-Lived Assets.

         The North Carolina manufacturing facility is a long-lived asset that is
classified as "held for sale" because it meets the criteria  listed in Paragraph
30 of SFAS 144.  Management has committed to sell the asset,  and is listing the
property for sale with a commercial real estate agent.  The Company believes the
sale of the asset is probable  and the sale is expected to be  completed  within
one year. The major components of manufacturing  equipment used in this plant to
manufacture  zippers  are not  classified  as held for sale  since  the  Company
intends to re-deploy this equipment in the  manufacture of TALON zippers through
investment or sale of this equipment to its distributors of TALON zippers.  This
equipment is separately identified as idle equipment as a component of "Property
and  equipment"  which are  included in the  accompanying  consolidated  balance
sheets (See Note 1).

         Restructuring  costs  recorded in 2005 were  $6,371,000.  Restructuring
costs include  $3,447,000  of inventory  write-downs,  restructuring  charges of
$2,474,000  consisting of $2,036,000  for the  impairment of long-lived  assets,
primarily  machinery and equipment,  $170,000 of one-time  employee  termination
benefits and other costs of $268,000,  which were fully paid by the end of 2005.
In  addition,  an  impairment  charge to goodwill in the amount of $450,000  was
recorded.  This goodwill was associated with an acquisition  made to benefit the
Central and South American operations.  Since these operations are being exited,
management  concluded that this goodwill was impaired and should be written off.
These  restructuring  costs  were  recorded  in the  Consolidated  Statement  of
Operations  for the year ended December 31, 2005 in the following line items and
amounts:

Cost of goods sold .........................................          $3,447,000
Operating expenses:
   General & administrative expenses .......................             450,000
   Restructuring charges ...................................           2,474,000
                                                                      ----------
Total restructuring costs ..................................          $6,371,000
                                                                      ==========


                                       59
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 - INCOME TAXES

         The components of the provision  (benefit) for income taxes included in
the consolidated statements of operations are as follows:

                                              Year Ended December 31,
                                  ----------------------------------------------
                                     2006              2005              2004
                                  ----------        ----------        ----------
Current:
     Federal .............        $   29,900        $   55,479        $  405,632
     State ...............             4,000             4,000            71,582
                                  ----------        ----------        ----------
                                      33,900            59,479           477,214
Deferred:
     Federal .............              --             850,000         1,530,000
     State ...............              --             150,000           270,000
                                  ----------        ----------        ----------
                                        --           1,000,000         1,800,000
                                  ----------        ----------        ----------
                                  $   33,900        $1,059,479        $2,277,214
                                  ==========        ==========        ==========

         A  reconciliation  of the  statutory  Federal  income tax rate with the
Company's effective income tax rate is as follows:

<TABLE>
<CAPTION>
                                                                Year Ended December 31,
                                                        ---------------------------------------
                                                           2006          2005           2004
                                                        ----------    ----------     ----------
<S>                                                           <C>          <C>            <C>
Current:
  Federal statutory rate ...............................      34.0%        (34.0)%        (34.0)%
  State taxes net of federal benefit ...................       2.3          (5.8)          (6.0)
  Income earned from foreign subsidiaries ..............      18.7           0.2            3.1
  Net operating loss valuation allowance adjustments ...     (71.7)         43.5           51.3
   Change in effective state tax rate ..................      22.4          --             --
  Other ................................................       4.2          (0.2)           0.5
                                                        ----------    ----------     ----------
                                                               9.9%          3.7 %         14.9 %
                                                        ==========    ==========     ==========
</TABLE>

         Income (loss) before income taxes is as follows:

                                          Year Ended December 31,
                           ----------------------------------------------------
                               2006                2005                2004
                           ------------        ------------        ------------
omestic ...........        $ (1,341,475)       $(28,724,518)       $(17,574,926)
Foreign ............          1,684,678             246,288           2,243,172
                           ------------        ------------        ------------
                           $    343,203        $(28,478,230)       $(15,331,754)
                           ============        ============        ============


                                       60
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         The primary components of temporary  differences which give rise to the
Company's deferred tax assets and deferred tax liabilities are as follows:

                                                     Year Ended December 31,
                                                 ------------------------------
                                                     2006              2005
                                                 ------------      ------------
Net deferred tax asset:
     Net operating loss carry-forwards .....     $ 19,053,346      $ 20,820,849
     Depreciation and amortization .........         (551,643)         (442,909)
     Bad debt reserve ......................           17,961           403,494
     Related party interest ................          189,605           160,996
     Inventory reserve .....................          289,813           448,674
     Other .................................          225,656            56,343
                                                 ------------      ------------
                                                   19,224,738        21,447,447
     Less:  Valuation Allowance ............      (19,224,738)      (21,447,447)
                                                 ------------      ------------
                                                 $       --        $      --
                                                 ============      ============

         At December 31, 2006,  Tag-It  Pacific,  Inc. had Federal and state net
operating loss  carry-forwards  (or "NOLs") of  approximately  $53.6 million and
$13.9  million,  respectively.  The Federal NOL is  available  to offset  future
taxable income  through 2024, and the state NOL expires in 2014.  Section 382 of
the  Internal  Revenue  Code places a  limitation  on the  realizability  of net
operating  losses in future  periods if the ownership of the Company has changed
more than 50% within a three-year  period.  As of December 31, 2006, some of our
net operating losses may be limited by the Section 382 rules. The amount of such
limitations, if any, has not yet been determined.

         Income taxes are accounted  for under the asset and  liability  method.
Deferred  tax  assets  and   liabilities  are  recognized  for  the  future  tax
consequences   attributable  to  differences  between  the  financial  statement
carrying  amounts of existing assets and  liabilities  and their  respective tax
bases and tax benefit carry-forwards. Deferred tax liabilities and assets at the
end of each period are determined  using enacted tax rates.  The Company records
deferred tax assets arising from temporary timing  differences  between recorded
net income and taxable net income when and if it believes  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.

         The provisions of SFAS No. 109,  "Accounting for Income Taxes," require
the  establishment of a valuation  allowance when, based on currently  available
information and other factors,  it is more likely than not that all or a portion
of a deferred  tax asset will not be  realized.  SFAS No. 109  provides  that an
important factor in determining whether a deferred tax asset will be realized is
whether there has been sufficient income in recent years and whether  sufficient
income is expected in future years in order to utilize the deferred tax asset.

         In 2006 and in prior  years,  the  Company  determined,  based upon its
cumulative  operating losses, that it was more likely than not that it would not
be in a  position  to fully  realize  all of its  deferred  tax assets in future
years.  Accordingly,  at December  31, 2006 the Company has recorded a valuation
allowance of $19.2 million, which reduces the carrying value of its net deferred
tax assets to $0. For the year ended  December  31,  2006 the  Company  recorded
operating  income and various rate and tax timing  differences  and the value of
its  net  deferred  tax  assets  declined  by  $2.2  million.   Accordingly,   a
corresponding  reduction in the valuation allowance was made, which retained the
carrying  value of the  Company's net deferred tax assets at $0. During 2005 the
Company  incurred  additional  operating losses which resulted in an increase in
the  Company's  net deferred tax assets by $11.5  million.  Accordingly,  it was
determined that the valuation  allowance from 2004 be increased by $12.5 million
to $21.4  million,  which  reduced the  carrying  value of its net  deferred tax
assets to $0 at December  31,  2005.  In 2004 the  Company  recorded a valuation
allowance of


                                       61
<PAGE>


                             TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

$8.9  million  based upon its  cumulative  operating  losses,  and  reduced  the
carrying  value of its net  deferred  tax asset to $1.0  million at December 31,
2004.

         The Company intends to maintain a valuation  allowance for its deferred
tax assets until sufficient evidence exists to support the reversal or reduction
of the allowance.  At the end of each period, the Company will review supporting
evidence,  including the performance  against sales and income  projections,  to
determine if a release of the  valuation  allowance is  warranted.  If in future
periods it is  determined  that it is more likely than not that the Company will
be able to recognize  all or a greater  portion of its deferred tax assets,  the
Company will at that time reverse or reduce the valuation allowance.

         The Company  believes  that its  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 its balance sheet
and results of operations.

         The Company has not provided  withholding of U.S.  federal income taxes
on  undistributed  earnings  of its  foreign  subsidiaries  because  the Company
intends to reinvest those earnings  indefinitely  or any taxes on these earnings
will be offset by the  approximate  credits  for foreign  taxes paid.  It is not
practical to determine the U.S.  federal tax  liability,  if any, which would be
payable if such earnings were not invested indefinitely.

NOTE 13 - COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

         The Company is a party to a number of  non-cancelable  operating  lease
agreements  involving  buildings  and  equipment,  which expire at various dates
through 2010.  The Company  accounts for its leases in accordance  with SFAS No.
13, whereby step provisions,  escalation clauses, tenant improvement allowances,
increases  based on an existing index or rate, and other lease  concessions  are
accounted  for in the  minimum  lease  payments  and are  charged  to the income
statement on a straight-line basis over the related lease term.

         The future  minimum  lease  commitments  at  December  31,  2006 are as
follows:

Years Ending December 31,                                               Amount
---------------------------------------------------------             ----------
2007 ....................................................             $  437,226
2008 ....................................................                407,224
2009 ....................................................                346,184
2010 ....................................................                213,364
2011 and thereafter .....................................                 16,757
                                                                      ----------
   Total minimum payments ...............................             $1,420,755
                                                                      ==========

         Total rental  expense for the years ended  December 31, 2006,  2005 and
2004 aggregated $640,864, $750,536, and $696,590, respectively.

PROFIT SHARING PLAN

         In October 1999, the Company  established a 401(k)  profit-sharing plan
for the benefit of eligible employees. The Company may make annual contributions
to the plan as determined by the Board of Directors. Total contributions for the
years  ended  December  31,  2006 and 2005  amounted  to  $22,276  and  $16,807,
respectively.  There were no  contributions  made during the year ended December
31, 2004.


                                       62
<PAGE>


                            TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CONTINGENCIES

         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 it is anticipated that the Court will enter a judgment in favor of
all  Defendants  shortly.  It is possible that Plaintiff will appeal the summary
judgment and class certification  rulings. The Company believes 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


                                       63
<PAGE>


                            TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 derive 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.

         Tag-It Pacific,  Inc. has agreements with its foreign subsidiaries that
provide  for  royalty  payments  to the U.S.  parent  company  for the  sales of
products  carrying  the  TALON(R)  brand name,  and that also provide for a cost
sharing  arrangement  associated  with  various  corporate   administrative  and
operations  support  costs.  These  agreements  may give rise to  inquiries  and
possible  disputes by the foreign  taxing  authority,  resulting in the possible
disallowance of some of these costs and potentially  resulting in higher foreign
income  taxes than has been  provided.  The Company  believes  that its basis of
charging these royalties and its allocation of costs to foreign  subsidiaries is
appropriate  under the various taxing agency laws, and that any  disagreement or
disallowance  regarding  such  costs  will not  have a  material  affect  on the
financial  statements of the Company.  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
affect 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


                                       64
<PAGE>


                            TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 14 - 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:

                                               Year Ended December 31,
                                     -------------------------------------------
                                         2006           2005            2004
                                     -----------     -----------     -----------
Sales:
     United States .............     $ 5,287,236     $ 8,902,734     $ 4,822,935
     Asia ......................      28,974,546      20,005,036      12,785,977
     Mexico ....................       2,476,313       8,526,367      21,452,805
     Dominican Republic ........       9,138,404       5,914,792       9,678,078
     Other .....................       2,948,503       3,982,247       6,369,686
                                     -----------     -----------     -----------
                                     $48,825,002     $47,331,176     $55,109,481
                                     ===========     ===========     ===========
Long-lived Assets:
     United States .............     $ 9,531,659     $ 9,797,110     $12,911,377
     Asia ......................         386,516         226,221         234,746
     Mexico ....................           5,078          23,754         187,721
     Dominican Republic ........         668,067         776,279         866,807
                                     -----------     -----------     -----------
                                     $10,591,320     $10,823,364     $14,200,651
                                     ===========     ===========     ===========

NOTE 15 - MAJOR CUSTOMERS AND VENDORS

         For the year ended  December 31, 2006, no single  customer  represented
more than 9% of the  Company's  consolidated  net sales;  however the  Company's
three largest customers represented approximately 18% of consolidated net sales.
For the year ended December 31, 2005, no single customer  represented  more than
10% of consolidated net sales;  however,  the Company's three largest  customers


                                       65
<PAGE>


                            TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

represented  approximately  22% of consolidated  net sales.  Two major customers
accounted  for  approximately  22% of the Company's net sales for the year ended
December 31, 2004.

         One major  vendor  accounted  for  substantially  all of the  Company's
purchases  associated  with its TekFit  product for the year ended  December 31,
2006 and represented 24% of the Company's overall purchases;  and three vendors,
each  representing  more  than 10% of the  Company's  purchases,  accounted  for
approximately  45% of the Company's  purchases  for the year ended  December 31,
2006. Three vendors accounted for  approximately 39% of the Company's  purchases
for  the  year  ended  December  31,  2005,  and  four  vendors   accounted  for
approximately  70% of the Company's  purchases  for the year ended  December 31,
2004. Included in accounts payable and accrued expenses at December 31, 2006 and
2005 is $2,682,000 and  $2,206,000  due to these vendors.  Terms are sight to 60
days.

NOTE 16 - RELATED PARTY TRANSACTIONS

         Prior to 2004 the  Company  operated an apparel  trim supply  agreement
with  Tarrant  Apparel  Group.  Two  of  Tarrant's   directors  and  significant
shareholders  are  also  significant  shareholders  of  the  Company.  In  2004,
following negotiations with Tarrant Apparel Group, the Company determined that a
significant   portion  of  the   obligations   due  from  this   customer   were
uncollectible.  Accordingly, included in general and administrative expenses for
2004 are charges of $4.3 million  related  primarily to the  write-down  of this
receivable and leaving a remaining balance receivable from this customer of $4.5
million at December  31, 2004.  An  affiliate  of the  customer  repaid the $4.5
million  receivable  balance over the period from May through December 2005. The
Company  terminated its supply  relationship  with Tarrant in 2004;  however the
Company  continues to conduct  business with Tarrant on a limited  basis.  Total
sales to Tarrant  for the years  ended  December  31,  2006,  2005 and 2004 were
$3,000, $574,000 and $758,000,  respectively.  As of December 31, 2005, accounts
receivable,  related party included  $0.05 million due from Tarrant.  No amounts
were due from Tarrant at December 31, 2006.

         Colin Dyne, a director of the Company is a significant  shareholder  in
People's Liberation,  Inc., the parent company of Versatile Entertainment,  Inc.
During  2006  and  2005  the  Company  had  sales  of  $147,000   and  $  76,000
respectively,  to  Versatile  Entertainment.   At  December  31,  2006  accounts
receivable of $83,400 were outstanding from Versatile Entertainment.

         Due from  related  parties  at  December  31,  2006  and 2005  includes
$675,137 and $655,489  respectively,  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  December  31,  2006 and 2005 was  $664,971.  See Note 4 for
further  discussion of these notes,  and related  accrued  interest and interest
expense.

         Transportation fees in the amount of $211,000 were paid to or on behalf
of a company  that Mark Dyne has an  ownership  interest  in for the year  ended
December 31, 2004.  Consulting fees paid to Diversified  Investments,  a company
owned by Mark Dyne,  amounted to $150,000  for each of the years ended  December
31, 2006, 2005 and 2004.

         Consulting  fees of $335,000  were paid for services  provided by Colin
Dyne, for the year ended December 31, 2006. Brent Cohen and Raymond Musci,  both
members of the Board of  Directors  were paid for services  provided  during the
year  ended   December  31,  2005  in  the  amount  of  $24,000,   and  $21,000,
respectively.  Mr. Cohen and Kevin Bermiester, a former director of the Company,
were paid for services  provided  during the year ended December 31, 2004 in the
amounts of $57,000 and $41,000, respectively.


                                       66
<PAGE>


                            TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 - QUARTERLY RESULTS (UNAUDITED)

         Quarterly  results for the years ended  December  31, 2006 and 2005 are
reflected below:

<TABLE>
<CAPTION>
                                                         4TH             3RD             2ND             1ST
--------------------------------------------------   ------------    ------------    ------------    ------------
<S>                                                  <C>             <C>             <C>             <C>
2006
Revenue ..........................................   $ 10,573,755    $ 13,366,944    $ 14,246,087    $ 10,638,216
Operating income (loss) ..........................   $    170,483    $    552,713    $    817,722    $   (520,032)
Net Income(loss) .................................   $     44,950    $    339,115    $    654,643    $   (729,404)
Basic and diluted income (loss) per share ........   $       0.00    $       0.02    $       0.04    $      (0.04)

2005
Revenue ..........................................   $  9,163,355    $  9,472,898    $ 15,639,646    $ 13,055,277
Operating (loss) income (1,2) ....................   $ (5,002,769)   $(10,281,054)   $(10,907,621)   $ (1,217,771)
Net (loss) income (2) ............................   $ (5,127,754)   $(10,284,874)   $(12,476,638)   $ (1,648,443)
Basic and diluted (loss) per share ...............   $      (0.28)   $      (0.56)   $      (0.68)   $      (0.09)
--------------------------------------------------   ------------    ------------    ------------    ------------
</TABLE>

(1)      The Company recorded restructuring charges of $6.2 million in the third
         quarter of 2005 (Note 11).

(2)      During  2005,  the Company  recorded  net  increases of $3.7 million to
         reserves for accounts receivable and inventories, and a decrease in net
         deferred tax asset  resulting in a charge to the  provision  for income
         taxes of $1 million during 2005.

         Quarterly and  year-to-date  computations of per share amounts are made
independently.  Therefore, the sum of per share amounts for the quarters may not
agree with the per share amounts for the year.

NOTE 18 - SUBSEQUENT EVENT (UNAUDITED)

         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  receivable from Azteca (see Note 2),
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 reasonably predicted
at this time. The failure to collect payments under this note as scheduled could
have a  material  adverse  effect  on our  financial  position  and  results  of
operations.


                                       67
<PAGE>


                            TAG-IT PACIFIC, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

         None

ITEM 9A. 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  December  31,  2006,  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 December 31, 2006, our disclosure
controls and procedures were effective at a reasonable assurance level.

         During  the last  fiscal  quarter,  there  have been no  changes in our
internal control over financial reporting that have materially affected,  or are
reasonably  likely to materially  affect,  our internal  control over  financial
reporting.

ITEM 9B. OTHER INFORMATION

         None.


                                       68
<PAGE>


                                    PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

         Information required by this Item 10 will appear in the proxy statement
for the 2007  Annual  Meeting of  Stockholders,  and is  incorporated  herein by
reference.

ITEM 11. EXECUTIVE COMPENSATION

         Information  regarding executive  compensation will appear in the proxy
statement  for the 2007  Annual  Meeting of  Stockholders,  and is  incorporated
herein by reference.

ITEM 12. SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT  AND
         RELATED STOCKHOLDER MATTERS

         Information  regarding  security ownership of certain beneficial owners
and  management  and  related  stockholder  matters  will  appear  in the  proxy
statement  for the 2007  Annual  Meeting of  Stockholders,  and is  incorporated
herein by reference.

ITEM 13. CERTAIN   RELATIONSHIPS   AND   RELATED   TRANSACTIONS   AND   DIRECTOR
         INDEPENDENCE

         Information  regarding certain  relationships and related  transactions
will appear in the proxy statement for the 2007 Annual Meeting of  Stockholders,
and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

         Information  regarding  principal  accountant  fees and  services  will
appear in the proxy statement for the 2007 Annual Meeting of  Stockholders,  and
is incorporated herein by reference.


                                     PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

         (a)      FINANCIAL STATEMENTS AND SCHEDULES.


                                       69
<PAGE>


     INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT ON SCHEDULE II



To the Board of Directors
Tag it Pacific, Inc.
Woodland Hills, California


The audits  referred  to in our  report,  dated  April 9, 2007  included  in the
related  financial  statement  schedule as of December  31, 2006 and for the two
years ended  December  31, 2006,  included in the annual  report on Form 10-K of
Tag-It Pacific, Inc. This financial statement scheduled is the responsibility of
the Company's  management.  Our  responsibility is to express an opinion on this
financial statement schedule based on our audit. In our opinion,  such financial
statement  schedule presents fairly, in all material  respects,  the information
set forth therein.



/S/ SINGER LEWAK GREENBAUM & GOLDSTEIN

Los Angeles, California
April 9, 2007


                                       70
<PAGE>


      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT ON SCHEDULE II


To the Board of Directors
Tag-It Pacific, Inc.
Los Angeles, California


The audit referred to in our report,  dated March 31, 2005, included the related
financial  statement  schedule  as of and for the year ended  December  31, 2004
included  in the  annual  report  on Form  10-K of  Tag-It  Pacific,  Inc.  This
financial statement schedule is the responsibility of the Company's  management.
Our responsibility is to express an opinion on this financial statement schedule
based on our audit. In our opinion,  such financial  statement schedule presents
fairly, in all material respects, the information set forth therein.


                                            /s/ BDO Seidman, LLP
                                            ------------------------------------

Los Angeles, California
March 31, 2005


                                       71
<PAGE>


SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES


<TABLE>
<CAPTION>
                COLUMN A                     COLUMN B      COLUMN C      COLUMN D      COLUMN E
-----------------------------------------   -----------   -----------   -----------   -----------
                                             Balance at                               Balance at
                                             Beginning                                  End of
DESCRIPTION                                   of year      Additions    Deductions       Year
                                            ===========   ===========   ===========   ===========
<S>                                         <C>           <C>           <C>           <C>
2006
Allowance for doubtful accounts deducted
  from accounts receivable in the balance
  sheet .................................   $ 1,189,000   $   198,000   $ 1,315,500   $    71,500
Reserve for obsolescence deducted from
  inventories on the balance sheet ......     7,306,000       557,000     6,621,000     1,242,000
Valuation reserve deducted from Deferred
  tax Assets ............................    21,447,000          --       2,222,000    19,225,000
                                            -----------   -----------   -----------   -----------
                                            $29,942,000   $   755,000   $10,158,500   $20,538,500
                                            ===========   ===========   ===========   ===========

2005
Allowance for doubtful accounts deducted
  from accounts receivable in the balance
  sheet .................................   $ 6,086,000   $ 2,631,000   $ 7,528,000   $ 1,189,000
Reserve for obsolescence deducted from
  inventories on the balance sheet ......     6,365,000     2,538,000     1,597,000     7,306,000
Valuation reserve deducted from Deferred
  tax Assets ............................     8,900,000    12,547,000          --      21,447,000
                                            -----------   -----------   -----------   -----------
                                            $21,351,000   $17,716,000   $ 9,125,000   $29,942,000
                                            ===========   ===========   ===========   ===========
2004
Allowance for doubtful accounts deducted
  from accounts receivable in the balance
  sheet .................................   $ 2,044,000   $ 5,500,000   $ 1,458,000   $ 6,086,000
Reserve for obsolescence deducted from
  inventories on the balance sheet ......     6,125,000     2,240,000     2,000,000     6,365,000
Valuation reserve deducted from Deferred
  tax Assets ............................     1,119,000     7,781,000          --       8,900,000
                                            -----------   -----------   -----------   -----------
                                            $ 9,288,000   $15,521,000   $ 3,458,000   $21,351,000
                                            ===========   ===========   ===========   ===========
</TABLE>

         (b)      Exhibits:

                  See Exhibit Index attached to this Annual Report on Form 10-K.


                                       72
<PAGE>


                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) 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.

                                       TAG-IT PACIFIC, INC.

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


                                POWER OF ATTORNEY

         Each person whose  signature  appears  below  constitutes  and appoints
Stephen  Forte and Lonnie D.  Schnell,  and each of them, as his true and lawful
attorneys-in-fact and agents with full power of substitution and resubstitution,
for him and his name, place and stead, in any and all capacities, to sign any or
all amendments to this Annual Report on Form 10-K and to file the same, with all
exhibits  thereto,  and  other  documents  in  connection  therewith,  with  the
Securities and Exchange  Commission,  granting unto said  attorneys-in-fact  and
agents,  and each of them,  full power and  authority to do and perform each and
every  act and  thing  requisite  and  necessary  to be done  in and  about  the
foregoing,  as  fully to all  intents  and  purposes  as he might or could do in
person,  hereby  ratifying and  confirming all that said  attorneys-in-fact  and
agents, or either of them, or their substitutes,  may lawfully do or cause to be
done by virtue hereof.

                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the dates indicated.

        SIGNATURE                        TITLE                         DATE
---------------------------   -----------------------------       --------------
/S/ MARK DYNE                    Chairman of the Board            April 12, 2007
---------------------------          of Directors
Mark Dyne

/S/ STEPHEN FORTE                Chief Executive Officer          April 12, 2007
---------------------------   (Principal Executive Officer)
Stephen Forte                         and Director

/S/ LONNIE D. SCHNELL            Chief Financial Officer          April 12, 2007
---------------------------    (Principal Accounting and
Lonnie D. Schnell                  Financial Officer)

/S/ COLIN DYNE                          Director                  April 12, 2007
---------------------------
Colin Dyne

/S/ JONATHAN BURSTEIN                   Director                  April 12, 2007
---------------------------
Jonathan Burstein

                                        Director                  April 12, 2007
---------------------------
Brent Cohen

/S/ SUSAN WHITE                         Director                  April 12, 2007
---------------------------
Susan White

/S/ RAYMOND MUSCI                       Director                  April 12, 2007
---------------------------
Raymond Musci

/S/ JOSEPH MILLER                       Director                  April 12, 2007
---------------------------
Joseph Miller

/S/ WILLIAM SWEEDLER                    Director                  April 12, 2007
---------------------------
William Sweedler


                                       73
<PAGE>


                                  EXHIBIT INDEX

EXHIBIT
NUMBER   EXHIBIT DESCRIPTION
-------  -----------------------------------------------------------------------
3.1      Certificate of Incorporation  of Registrant.  Incorporated by reference
         to  Exhibit  3.1 to Form  SB-2  filed  on  October  21,  1997,  and the
         amendments thereto.

3.1.2    Certificate  of Designation  of Rights,  Preferences  and Privileges of
         Series A Preferred Stock. Incorporated by reference to Exhibit A to the
         Rights  Agreement  filed as Exhibit  4.1 to Current  Report on Form 8-K
         filed as of November 4, 1998.

3.1.3    Certificate of Amendment of Certificate of Incorporation of Registrant.
         Incorporated  by  reference  to  Exhibit  3.4 to Annual  Report on Form
         10-KSB, filed March 28, 2000.

3.1.4    Certificate of Amendment of Certificate of Incorporation of Registrant.
         Incorporated  by reference to Exhibit 3.1.3 to Form 8-K filed on August
         4, 2006.

3.2      Bylaws of Registrant.  Incorporated by reference to Exhibit 3.2 to Form
         SB-2 filed on October 21, 1997, and the amendments thereto.

4.1      Specimen Stock Certificate of Common Stock of Registrant.  Incorporated
         by reference to Exhibit 4.1to Form SB-2 filed on October 21, 1997,  and
         the amendments thereto.

4.2      Rights Agreement,  dated as of November 4, 1998, between Registrant and
         American Stock Transfer and Trust Company as Rights Agent. Incorporated
         by reference  to Exhibit 4.1 to Current  Report on Form 8-K filed as of
         November 4, 1998.

4.3      Form of Rights  Certificate.  Incorporated by reference to Exhibit B to
         the Rights Agreement filed as Exhibit 4.1 to Current Report on Form 8-K
         filed as of November 4, 1998.

10.1     Form of Indemnification Agreement. Incorporated by reference to Exhibit
         10.1to Form SB-2 filed on October 21, 1997, and the amendments thereto.

10.2     Promissory Note, dated September 30, 1996,  provided by Tag-It, Inc. to
         Harold Dyne.  Incorporated  by reference to Exhibit  10.21 to Form SB-2
         filed on October 21, 1997, and the amendments thereto.

10.3     Promissory  Note,  dated June 30,  1991,  provided  by Tag-It,  Inc. to
         Harold Dyne.  Incorporated  by reference to Exhibit  10.23 to Form SB-2
         filed on October 21, 1997, and the amendments thereto.

10.4     Promissory  Note,  dated  January 31, 1997,  provided by Tag-It Inc. to
         Mark Dyne.  Incorporated  by  reference  to Exhibit  10.24 to Form SB-2
         filed on October 21, 1997, and the amendments thereto.

10.5     Promissory   Note,   dated  February  29,  1996,   provided  by  A.G.S.
         Stationary,  Inc. to Monto Holdings Pty. Ltd. Incorporated by reference
         to  Exhibit  10.25 of Form SB-2  filed on  October  21,  1997,  and the
         amendments thereto.

10.6     Promissory  Note,  dated  January 19, 1995,  provided by Pacific Trim &
         Belt,  Inc. to Monto  Holdings Pty. Ltd.  Incorporated  by reference to
         Exhibit  10.26  to  Form  SB-2  filed  on  October  21,  1997,  and the
         amendments thereto.


                                       74
<PAGE>


EXHIBIT
NUMBER   EXHIBIT DESCRIPTION
-------  -----------------------------------------------------------------------
10.7(2)  Amended  and  Restated  1997  Stock  Incentive  Plan.  Incorporated  by
         reference to Exhibit 10.7 to Form 10-Q filed on November 13, 2006.

10.8(2)  Form of Non-statutory Stock Option Agreement. Incorporated by reference
         to  Exhibit  10.30 to Form SB-2  filed on  October  21,  1997,  and the
         amendments thereto.

10.9     Promissory  Note,  dated  August 31,  1997,  provided by Harold Dyne to
         Pacific Trim & Belt, Inc. Incorporated by reference to Exhibit 10.32 to
         Form SB-2 filed on October 21, 1997, and the amendments thereto.

10.10    Promissory  Note,  dated  October 15, 1997,  provided by Harold Dyne to
         Pacific Trim & Belt, Inc. Incorporated by reference to Exhibit 10.34 to
         Form SB-2 filed on October 21, 1997, and the amendments thereto.

10.11    Promissory Note, dated October 15, 1997, provided by A.G.S.  Stationary
         Inc. to Monto Holdings Pty. Ltd.  Incorporated  by reference to Exhibit
         10.48 to Form  SB-2  filed on  October  21,  1997,  and the  amendments
         thereto.

10.12    Promissory  Note,  dated  November 4, 1997,  provided by Pacific Trim &
         Belt,  Inc. to Monto  Holdings Pty. Ltd.  Incorporated  by reference to
         Exhibit  10.49  to  Form  SB-2  filed  on  October  21,  1997,  and the
         amendments thereto.

10.13    Guaranty,  dated as of October 4, 2000, by A.G.S.  Stationery,  Inc. in
         favor or Mark I. Dyne.  Incorporated  by reference to Exhibit  10.40 to
         Form 10-K filed on April 4, 2001.

10.14    Guaranty, dated as of October 4, 2000, by Tag-It, Inc. in favor of Mark
         I. Dyne.  Incorporated by reference to Exhibit 10.41 to Form 10-K filed
         on April 4, 2001.

10.15    Guaranty, dated as of October 4, 2000, by Talon International,  Inc. in
         favor of Mark I. Dyne.  Incorporated  by reference to Exhibit  10.42 to
         Form 10-K filed on April 4, 2001.

10.16    Security  Agreement,  dated  as of  October  4,  2000,  between  A.G.S.
         Stationery, Inc. and Mark I. Dyne. Incorporated by reference to Exhibit
         10.44 to Form 10-K filed on April 4, 2001. Incorporated by reference to
         Exhibit 10.44 to Form 10-K filed on April 4, 2001.

10.17    Security  Agreement,  dated as of October 4, 2000, between Tag-It, Inc.
         and Mark I. Dyne.  Incorporated  by reference to Exhibit  10.45 to Form
         10-K filed on April 4, 2001.

10.18    Security  Agreement,  dated  as  of  October  4,  2000,  between  Talon
         International  Inc.  and Mark I. Dyne.  Incorporated  by  reference  to
         Exhibit 10.46 to Form 10-K filed on April 4, 2001.

10.19    Security  Agreement,  dated  as of  October  4,  2000,  between  Tag-It
         Pacific,  Inc. and Mark I. Dyne.  Incorporated  by reference to Exhibit
         10.47 to Form 10-K filed on April 4, 2001.

10.20    Convertible  Secured  Subordinated  Promissory  Note,  dated October 4,
         2000,  provided  by Mark I.  Dyne to the  Registrant.  Incorporated  by
         reference to Exhibit 10.48 to Form 10-K filed on April 4, 2001.


                                       75
<PAGE>


EXHIBIT
NUMBER   EXHIBIT DESCRIPTION
-------  -----------------------------------------------------------------------
10.21    Form  of  Investor   Rights   Agreements   dated   December  28,  2001.
         Incorporated  by reference to Exhibit 99.4 to Form 8-K filed on January
         23, 2002.

10.22    (1)  Intellectual  Property  Rights  Agreement,  dated  April 2,  2002,
         between  the  Company  and  Pro-Fit  Holdings,   Ltd.  Incorporated  by
         reference to Exhibit 10.69 to Form 10-K/A filed on October 1, 2003.

10.23    Common  Stock  Purchase  Warrant  dated  December  18, 2003 between the
         Company and Sanders  Morris  Harris Inc.  Incorporated  by reference to
         Exhibit 99.4 to Form 8-K filed on December 22, 2003.

10.24    Form of Secured  Convertible  Promissory  Note, dated as of November 9,
         2004.  Incorporated  by  reference to Exhibit 10.2 to Form S-3 filed on
         December 9, 2004.

10.25    Form of Common Stock  Purchase  Warrant,  dated as of November 9, 2004.
         Incorporated by reference to Exhibit 10.3 to Form S-3 filed on December
         9, 2004.

10.26    Trademark Security  Agreement,  dated as of November 9, 2004, among the
         Registrant  and the Secured  Parties  identified on the signature  page
         thereto. Incorporated by reference to Exhibit 10.4 to Form S-3 filed on
         December 9, 2004.

10.27    Registration Rights Agreement,  dated as of November 9, 2004, among the
         Registrant,  Sanders Morris Harris Inc. and the  Purchasers  identified
         therein. Incorporated by reference to Exhibit 10.5 to Form S-3 filed on
         December 9, 2004.

10.28    Common Stock Purchase  Warrant dated as of November 9, 2004,  issued by
         the Registrant in favor of Sanders Morris Harris Inc.  Incorporated  by
         reference to Exhibit 10.7 to Form S-3 filed on December 9, 2004.

10.29(2) Executive  Employment  Agreement  dated  March  16,  2006  between  the
         Registrant and Stephen P. Forte.  Incorporated  by reference to Exhibit
         10.1 to Form 10-Q filed on May 22, 2006.

10.30(2) Employment offer letter dated March 16, 2006 between the Registrant and
         Wouter van Biene.  Incorporated  by  reference  to Exhibit 10.2 to Form
         10-Q filed on May 22, 2006.

10.31(2) Employment offer letter dated March 16, 2006 between the Registrant and
         Lonnie D.  Schnell.  Incorporated  by reference to Exhibit 10.3 to Form
         10-Q filed on May 22, 2006.

10.32(2) Employment offer letter dated March 16, 2006 between the Registrant and
         Jonathan  Burstein.  Incorporated  by reference to Exhibit 10.4 to Form
         10-Q filed on May 22, 2006.

10.33(2) Consulting  Agreement  dated January 1, 2007 between the Registrant and
         Jonathan  Burstein.  Incorporated  by reference to Exhibit 10.1 to Form
         8-K filed on January 3, 2007.


                                       76
<PAGE>


EXHIBIT
NUMBER   EXHIBIT DESCRIPTION
-------  -----------------------------------------------------------------------
14.1     Code of Ethics.  Incorporated by reference to Exhibit 14.1 to Form 10-K
         filed on March 30, 2004.

21.1     Subsidiaries.

23.1     Consent of Singer Lewak Greenbaum & Goldstein LLP.

23.2     Consent of BDO Seidman, LLP.

24.1     Power of Attorney (included on signature page).

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)      Certain  portions  of  this  agreement  have  been  omitted  and  filed
         separately  with the Securities and Exchange  Commission  pursuant to a
         request for an order granting  confidential  treatment pursuant to Rule
         406 of the General Rules and  Regulations  under the  Securities Act of
         1933, as amended.

(2)      Indicates a management contract or compensatory plan.


                                       77