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, 2009




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




Commission
file number 1-13669




TALON
INTERNATIONAL, INC.


(Exact
Name of Registrant as Specified in Its Charter)




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





21900
      Burbank Blvd., Suite 270Woodland
      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:




None




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




Common
Stock, $.001 par value




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 whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).  Yes
[_]        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, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act).




Large
      accelerated filer [_]
            Accelerated
      filer [_]
            Non-accelerated
      filer [_]
            Smaller
      reporting company [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, 2009, the aggregate market value of the voting and non-voting common stock
held by non-affiliates of the registrant was $1,513,311.




At March
29, 2010 the issuer had 20,291,433 shares of Common Stock, $.001 par value,
issued and outstanding.




DOCUMENTS
INCORPORATED BY REFERENCE




None.













TALON
INTERNATIONAL, INC.




INDEX TO FORM 10-K






PART I
              
              
              PageItem 1.
              Business
              
              2Item 1A.
              Risk Factors
              
              8Item 1B.
              Unresolved Staff Comments
              
              16Item 2.
              Properties
              
              17Item 3.
              Legal Proceedings
              
              17







PART
      IIItem 5.
              Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities
              
              18Item 6.
              Selected Financial Data
              
              20Item 7.
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              
              21Item 7A.
              Quantitative and Qualitative Disclosures about Market
      Risk
              
              35Item 8.
              Financial Statements and Supplementary
      Data
              
              35Item 9.
              Changes in and Disagreements with Accountants
      on Accounting and Financial Disclosure
              
              70Item 9A(T) Controls and
      Procedures
              
              70Item 9B. Other Information
              
              71







PART
      IIIItem 10.
              Directors, Executive Officers and Corporate
      Governance
              
              71Item 11.
              Executive Compensation
              
              75Item 12.
              Security Ownership of Certain Beneficial Owners
      and Management and Related Stockholder Matters
              
              86Item 13.
              Certain Relationships and Related
      Transactions and Director Independence
              
              88Item 14.
              Principal Accounting Fees and
      Services
              
              89






PART
      IVItem 15.
              Exhibits and Financial Statement
    Schedule
              
              90










1








Back to Index to Form 10-K






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
      ability to refinance our debt facility or reach an agreement for an
      extension or restructuring of our debt with our existing
      lender;  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; and
      the global economic environment in general and consumer demand for
      apparel.  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




Talon
International, Inc. 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® brand name to
manufacturers for apparel brands and retailers such as Abercrombie & Fitch,
JC Penney, Wal-Mart, Kohl’s, Juicy Couture and Phillips-Van Heusen, 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 Victoria’s Secret, Tom Tailor, Abercrombie & Fitch, American
Eagle, Polo Ralph Lauren, New York and Company, Express,  and
others.  Under our Tekfit® brand, we develop and
sell a stretch waistband  that utilizes a patented technology that we
license from a third party.




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 Talon International, Inc.
(formerly Tag-It Pacific, Inc.): Talon Zipper (Shenzhen) Company Ltd. in China
and Talon International Pvt. Ltd., in India. On July 20, 2007 we changed our
corporate name from Tag-It Pacific, Inc. to Talon International,
Inc.  Our website is www.talonzippers.com.






2




Our
website 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.




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
worldwide, including principally Hong Kong, China, Taiwan, India, Indonesia,
Bangladesh, Mexico and Central America and we have sales and marketing teams in
most of these areas. We have developed joint manufacturing arrangements in
various geographical international local markets to manufacture, finish and
distribute zippers under the Talon brand name. Our
manufacturing partners operate to our specifications and under our quality
requirements, compliance controls and our direct manufacturing and quality
assurance supervision, producing finished zippers for our customers in their
local markets.  This operating model allows us 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 outsource 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 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
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.






3







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 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, Europe, and throughout Southeast Asia 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, and Central America to
take advantage of the large apparel manufacturing markets in these
regions.




Products




Talon Zippers - We offer a
full line of metal, coil and plastic zippers bearing the Talon brand name. Talonzippers are used
primarily by manufacturers in the apparel industry and are distributed through
our distribution facilities in the United States, Europe, Hong Kong, China,
Taiwan, India, Indonesia and Bangladesh and through these designated offices to
other international markets.




We expand
our distribution of Talon zippers through the
establishment of a combination of Talon owned sales,
distribution and manufacturing locations, strategic distribution relationships
and joint ventures.  These distributors and manufacturing joint
ventures, in combination with Talon owned and affiliated
facilities under the Talon brand, improve our
time-to-market by eliminating the typical setup and build-out phase for new
manufacturing capacity throughout the world by sourcing, finishing and
distributing to apparel manufacturers in their local
markets.   The branded apparel zipper market is dominated by one
company and we have positioned Talon to be a viable global
alternative to this competitor and capture an increased market share
position.  We 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 Trimsolutions 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 save our customers substantial
time in ordering, designing, sampling and managing trim orders from several
different suppliers.  Our proprietary tracking and order management
system allows 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.







4







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.  Pant
manufacturers use this technology 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.




Our
efforts to offer this product technology to customers have been limited by a
licensing dispute.  As described more fully in Item 3 “Legal
Proceedings” we are  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 sales of products incorporating the stretch waistband technology
represented only a small portion of our consolidated revenue for the years 2009,
2008 and 2007 as a consequence of this litigation.




The
percentages of total revenue contributed by each of our three primary product
groups for the last three fiscal years are as follows:




Year
      Ended December 31,2009
            
            2008
            
            2007Product
      Group Net Revenue:Talon zipper
            
            55.1
            %
            59.0
            %
            52.2
            %Trim
            
            44.7
            %
            40.6
            %
            46.1
            %Tekfit
            
            0.2
            %
            0.4
            %
            1.7
            %







Design
and Development




Our
in-house creative teams produce 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.  In 2006, we 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 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 in our California, Ohio
and China facilities.







5







Customers




We have
more than 800activecustomers.  Our
customers include the designated suppliers of well-known apparel retailers and
brands, such as Victoria’s Secret, Tom Tailor, Abercrombie & Fitch, Polo
Ralph Lauren, Phillips-Van Heusen, American Eagle and Juicy Couture, among
others.  Our customers also include contractors for specialty
retailers such as Express and mass merchant retailers such as Wal-Mart, Kohl’s,
Penney’s and Target.




For the
years ended December 31, 2009, 2008 and 2007, our three largest customers
represented approximately 9%, 8% and 9%, respectively, of consolidated net
sales.




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,
Indonesia, Taiwan, and Bangladesh.  We contract with outside sales
representatives in Europe, and we develop Central America opportunities through
our U.S. sales force and outside sales representatives. We also employ customer
service representatives who are assigned to key customersand 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.




Principally
through our China facilities, we distribute Talon zippers, trim items and
apparel packaging and coordinate the manufacture and distribution of the full
range of our products.  Our China facilities supply several
significant trim programs, services customers located in Asia and the Pacific
Rim and sources products for our U.S. and European 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 Talontrademark.  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”, “Kidzip”
and “Tekfit”.







6








We also
rely on our Exclusive License and Intellectual Property Rights agreement with
Pro-Fit to sell our Tekfit stretch waistbands,
which grants us the right to sell or sublicense stretch waistbands manufactured
under patented technology developed by Pro-Fit for garments manufactured
anywhere in the World for the U.S. market and for all U.S.
brands.  These license rights are for the duration of the patents and
trade secrets licensed under the agreement.  We are 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.
Backlogs of sales orders are not considered material in the industries in which
we compete, which reduces the predictability and reinforces the volatility of
these cyclical buying patterns on our sales volume.




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 commitments
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 YKK and Avery Dennison Corporation
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 unique stretch quality of our Tekfit waistbands will also
allow us to compete effectively in the market for waistband
components.




Segment
Information




We
operate 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.







7







Back to Index to Form 10-K


Financial
Information About Geographic Areas




We sell
the majority of our products for use by U.S. and European 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. or Europe, primarily in Hong Kong, China,
Taiwan, India, Indonesia, Bangladesh and Central America.




A summary
of our domestic and international net sales and long-lived assets is set forth
in Item 8 of this Annual Report on Form 10-K, Note 1 and Note 12 of the Notes to
Consolidated Financial Statements.




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, 2009, we had approximately 177 full-time employees including 24 in
the United States, 58 employees in Hong Kong, 91 employees in the Peoples
Republic of China, 1 in India, 1 in Indonesia, 1 in Taiwan and 1 in Sri
Lanka.  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 website,  www.talonzippers.com
(in the “Investor” section, as soon as reasonably practical after electronic
filing with or furnishing of such material to the SEC). We make available on our
website 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, Talon
International, Inc., 21900 Burbank Boulevard, Suite 270, Woodland Hills,
CA  91367.  Our website 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.




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.









8









We may not be able to refinance or
extend our debt facility due at June 30, 2010 and if we cannot we will default
on our credit agreement, which would have a material adverse effect on our
liquidity, business and operations and ability to continue as a going
concern.




Our cash
flows from operating activities will not be sufficient to repay our obligations
under the CVC debt facility which will become due and payable in full on June
30, 2010.  Accordingly an extension or modification of the CVC debt
will be required prior to the due date or it will be necessary for us to raise
additional debt or equity financing in order to repay the CVC debt. If we cannot
obtain an extension or modification of the CVC debt, or raise additional equity
or debt to satisfy this requirement we will default on our credit agreement and
the lender would have the right to exercise its remedies including enforcement
of its lien on substantially all of our assets.




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 operating plans, or meet
our debt obligations either of which could have a material adverse effect on our
financial condition and results of operations and affect our ability to operate
as a going concern.  See Note 2 of the Notes to Consolidated Financial
Statements.




We
will need to raise additional capital or refinance our existing debt structure
to meet our current and long term needs.




We have
historically satisfied our working capital requirements primarily through cash
flows generated from operations.  As we continue to expand globally in
response to the industry trend to outsource apparel manufacturing to offshore
locations, our foreign customers, some of which are backed by U.S. brands and
retailers, represent substantially all of our customers.  Our
revolving credit facility provides limited financing secured by our accounts
receivable, and our current borrowing capability may not provide the level of
financing we need to continue in or to expand into additional foreign
markets.  We are continuing to evaluate non-traditional financing
alternatives and equity transactions to provide capital needed to fund our
expansion and operations.




Even if
we are able to refinance or restructure our existing credit facility, if we
experience greater than anticipated reductions in sales, we may need to raise
additional capital, 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 reduce the scope of our business in response
to a substantial decline in sales, we may default on our credit
agreement.




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, our borrowing base availability limitations
related to eligible accounts receivable and inventories and our expansion into
foreign markets.  Our need for additional long-term financing includes
the integration and expansion of our operations to maximize the opportunities of
our Talon trade name, and the expansion of our operations in Asia, Europe and
Central America. 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 and we may need to implement additional cost savings
initiatives.







9







We
may not be able to satisfy the financial covenants in our debt agreements and if
we cannot, then our lender could declare the debt obligations in default, which
would have a material adverse effect on our liquidity, business and
operations.




Our
revolving credit and term loan agreement requires certain covenants, including a
minimum level of EBITDA as discussed in Note 6 of the Notes to Consolidated
Financial Statements.   If we fail to satisfy the EBITDA covenant
in three consecutive quarters, the credit agreement will be in default and can
be declared immediately due and payable by the lender.




In
anticipation of not being able to meet required covenants due to various
reasons, we either negotiate for changes in the relative covenants or negotiate
a waiver with the lender.   However, our expectations of future
operating results and continued compliance with all debt covenants cannot be
assured and our lender’s actions are not controllable by us.  If we
are in default under the loan agreement, all amounts due under the loan
agreement can be declared immediately due and payable and, unless we are able to
secure alternative financing to repay the lender in full, the lender would have
the right to exercise its remedies including enforcement of its lien on
substantially all of our assets.  Further, if the debt is placed in
default, we would be required to reduce our expenses, including curtailing
operations and to raise capital through the sale of assets, issuance of equity
or otherwise, any of which could have a material adverse effect on our financial
condition and results of operations and affect our ability to operate as a going
concern. See Note 2 of the Notes to Consolidated Financial Statements regarding
going concern.




The
ongoing U.S. and global financial and economic uncertainties could negatively
affect our business, results of operations and financial condition.




The
recent financial crisis affecting the global banking system and financial
markets and the going concern threats to financial institutions have resulted in
a tightening in the credit markets; a low level of liquidity in many financial
markets; and extreme volatility in credit, fixed income and equity
markets.  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 suppliers. There
can be no assurance that we will remain a preferred supplier 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 and financial
condition.




In
addition, our performance is subject to worldwide economic conditions and their
impact on levels of consumer spending that affect not only the ultimate
consumer, but also retailers, which are served by many of our largest customers.
Consumer spending has remained depressed in early 2010 after deteriorating
significantly in 2008 and 2009, and it may remain depressed or be subject to
further deterioration for the foreseeable future. The worldwide apparel industry
is heavily influenced by general economic cycles. Purchases of fashion apparel
and accessories tend to decline in periods of recession or uncertainty regarding
future economic prospects, as disposable income declines. Many factors affect
the level of consumer spending in the apparel industries, including, among
others: prevailing economic conditions, levels of employment, salaries and wage
rates, energy costs, interest rates, the availability of consumer credit,
taxation and consumer confidence in future economic conditions. During periods
of recession or economic uncertainty, we may not be able to maintain or increase
our sales to existing customers, make sales to new customers, or maintain our
earnings from operations as a percentage of net sales. As a result, our
operating results may be adversely and materially affected by sustained or
further downward trends in the United States or global economy.







10










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.  As described above, our
credit facility with CVC becomes due on June 30, 2010, and we will not have
sufficient cash to repay our obligations to CVC.  Unless and until we
are able to reach an agreement to refinance or restructure the debt, the
uncertainty created by this situation may make it more difficult to retain our
key management personnel.




The
current global credit crisis has increased our credit risks with vendors and
customers.




We extend
credit to some vendors by supplying them products. If any of these vendors are
unable to honor their commitments to us, due to bankruptcy, cessation of
operations or otherwise, we will likely experience losses on the products we
provided and lose profit margins on the unshipped orders. Most of our customers
are extended credit terms which are approved by us internally.  While
we have attempted to cover as much of our credit risks as possible, not all of
our risks can be fully hedged due to the current credit crisis. Such exposure
may translate into losses should there be any adverse changes to the financial
condition of certain customers.




Our operating results in our Tekfit
product group could be 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.
SeeItem
3, “Legal Proceedings” for discussion of this litigation. Our business in this
product group, and our future results of operations and financial condition
could be 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 could continue to incur additional legal fees
in increasing amounts to protect our license position.




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 or
the retailers they serve terminates, it may have an adverse effect on our
results because:




·
              We
      will lose a primary source of revenue if these customers choose not to
      purchase our products or services;
  ·
              We
      may lose the specific nomination of the retailer or
  brand;
  ·
              We
      may not be able to reduce fixed costs incurred in developing the
      relationship with these customers in a timely
  manner;
  ·
              We
      may not be able to recoup setup and inventory
  costs;
  ·
              We
      may be left holding inventory that cannot be sold to other customers;
      and
  ·
              We
      may not be able to collect our receivables from
  them.


11







If
customers default on inventory purchase commitments with us, we will be left
holding non-salable inventory.




We hold
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
non-salable inventory and this would have a negative impact on our operations
and cash flow.




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.




Our
products may not comply with various industry and governmental regulations and
our customers may incur losses in their products or operations as a consequence
of our non-compliance.




Our
products are produced under strict supervision and controls to ensure that all
materials and manufacturing processes comply with the industry and governmental
regulations governing the markets in which these products are
sold.  However, if these controls fail to detect or prevent
non-compliant materials from entering the manufacturing process, our products
could cause damages to our customer’s products or processes and could also
result in fines being incurred.  The possible damages and fines could
significantly exceed the value of our products and these risks may not be
covered by our insurance policies.




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:




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




·
            The
      timing and magnitude of customers’ marketing
  campaigns;




·
            The
      loss or addition of a major customer or of a major retailer
      nomination;




·
            The
      availability and pricing of materials for our
  products;




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




·
            Currency
      fluctuations;




·
            Delays
      caused by third parties; and




·
            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 which is now settled.






12








The outcome of any litigation in
which we have been named as a defendant is unpredictable and an adverse decision
in any such matter could have a material adverse effect on our financial
position and results of operations.





We are
defendants in various 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 we
intend to contest each lawsuit vigorously, no assurances can be given that the
results of these matters will be favorable to us.





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. Backlogs of sales orders are not considered
material in the industries in which we compete, which reduces the predictability
and reinforces the volatility of these cyclical buying patterns on our sales
volume.




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 have adverse effects on the
information reported.




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:




·
            Foreign
      trade disruptions;




·
            Import
      restrictions;




·
            Labor
      disruptions;




·
            Embargoes;




·
            Government
      intervention;




·
            Natural
      disasters; or




·
            Regional
      pandemics.







13







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 adversely impacting us by
these false claims.




Counterfeiting
of valuable trade names is commonplace in the apparel industry and while there
are industries 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 and to
pay for false claims.






14








During
the second quarter of 2009 it was discovered that certain Chinese factories had
counterfeited Talonzippers in conjunction with certain of our former employees, and sold
these products to existing and potential customers. We have initiated efforts to
eliminate and prosecute all offenders. Counterfeiting of known quality brand
products is commonplace within China and in particular where retailers limit
their sources to recognized brands such as Talon.  The full
extent of counterfeiting of Talon products, its effect on our business
operations and the costs to investigate and eliminate this activity are ongoing
and are generally undeterminable. However based upon evidence available we
believe the impact is not significant to our current overall
operations.  We continue to work closely with major retailers to
identify these activities within the marketplace and will aggressively combat
these efforts worldwide to protect the Talon brand.




We
have experienced and may continue to experience major fluctuations in the market
price for our common stock.




The
following factors could cause the market price of our common stock to decrease,
perhaps substantially:




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




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




·
            Interest
      rates;




·
            Changes
      in accounting principles;




·
            Intellectual
      property and legal matters;




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




·
            Announcements
      of key developments by our
competitors;




·
            Changed
      perceptions about our ability to renegotiate or replace our credit and
      revolving term loan agreement before maturity at June 30, 2010;
      and




·
            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.






15






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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
March 29, 2010, our officers and directors and their affiliates owned
approximately 19.6% of the outstanding shares of our common
stock.  The Dyne family, which includes Mark Dyne and Colin Dyne, who
are also our directors, and Larry Dyne who is our President; beneficially owned
approximately 13.4% of the outstanding shares of our common stock at March 29,
2010.  Additionally, at March 29, 2010, CVC California, LLC, our
lender, beneficially owned approximately 8.6% of the outstanding shares of our
common stock.  As a result, our lender, officers and directors and the
Dyne family are able to exert considerable influence over the outcome of any
matters submitted to a vote of the holders of our common stock, including the
election of our Board of Directors.  The voting power of these
stockholders could also discourage others from seeking to acquire control of us
through the purchase of our common stock, which might depress the price of our
common stock.




We
may face interruption of production and services due to increased security
measures in response to terrorism.




Our
business depends on the free flow of products and services through the channels
of commerce.  In response to terrorists’ activities and threats aimed
at the United States, transportation, mail, financial and other services may be
slowed or stopped altogether.  Extensive delays or stoppages in
transportation, mail, financial or other services could have a material adverse
effect on our business, results of operations and financial
condition.  Furthermore, we may experience an increase in operating
costs, such as costs for transportation, insurance and security as a result of
the activities and potential delays.  We may also experience delays in
receiving payments







from
payers that have been affected by the terrorist activities.  The
United States economy in general may be adversely affected by the terrorist
activities and any economic downturn could adversely impact our results of
operations, impair our ability to raise capital or otherwise adversely affect
our ability to grow our business.









ITEM
1B.           UNRESOLVED STAFF
COMMENTS




Not
applicable.







16







Back to Index to Form 10-K


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 120 square feet of office space in New York, New York; 1,400
square feet of office space in Columbus, Ohio; 7,000 square feet of warehouse in
Grover, North Carolina; 450 square feet of office in Mt. Holly, North Carolina;
3,400 square feet of warehouse space in Simi Valley, California; 23,809 square
feet of office and warehouse space in Kwun Tong, Hong Kong; 10,168 square feet
of office and showroom space in Shenzhen, China; office space square footage
totaling 4,800  in various other cities in China; 1,000 square feet of
office space in Bangalore, India; 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.  The building we owned
in Kings Mountain, North Carolina was sold on October 22, 2008. We believe our
existing facilities are adequate to meet our needs for the foreseeable
future.









ITEM
3.           
  LEGAL PROCEEDINGS




In
October 2005, a shareholder class action complaint was filed in the United
States District Court for the Central District of California ("District
Court") against us, Colin Dyne, Mark Dyne, Ronda Ferguson and August F.
Deluca (collectively, the "Individual Defendants" and, together with us, the
"Defendants").  The action was styled Huberman v. Tag-It Pacific, Inc., et
al., Case No. CV05-7352 R(Ex). On January 23, 2006, the District Court
appointed Seth Huberman as the lead plaintiff ("Plaintiff") and in March 2006,
Plaintiff filed an amended complaint alleging that defendants made false and
misleading statements about our financial situation and our relationship with
certain of our large customers. The action was brought on behalf of all
purchasers of our publicly-traded securities during the period from November 13,
2003, to August 12, 2005. In August 2006, Defendants filed denying any material
allegations of wrongdoing. On February 20, 2007, the District Court denied the
Plaintiff class certification and in April 2007, the District Court granted
Defendants’ motion for summary judgment and entered judgment in favor of all
Defendants. On or about April 30, 2007, Plaintiff filed a notice of appeal with
the United States Court of Appeals for the Ninth Circuit and on January 16,
2009, the Ninth Circuit issued instructions to the District Court to
certify a class, and reversed the District Court’s grant of summary
judgment.  The District Court thereafter certified a class
and adopted a schedule for the case. On July 31, 2009, the parties
entered into a stipulation of settlement and dismissal of the matter with
prejudice.




Thereafter,
total settlement proceeds of $5.75 million were paid in full by our
insurers without any contribution from us or individual defendants.  On
December 7, 2009, the Court gave final approval to the settlement and the
case was dismissed with prejudice per the terms of the
settlement.




On April
16, 2004, we filed suit against Pro-Fit Holdings, Limited 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
exclusive rights in certain geographic areas to Pro-Fit’s stretch and rigid
waistband technology.  We also filed a second civil action against Pro-Fit
and related companies in the California Superior Court which was removed to the
United States District Court, Central District of California.  In the
second quarter of 2008, Pro-Fit and certain related companies were placed into
administration in the United Kingdom and filed petitions under Chapter 15 of
Title 11 of the United States Code.  As a consequence of the chapter 15
filings, all litigation by us against Pro-Fit has been stayed.  We
have incurred significant legal fees in this litigation, and unless the case is
settled or resolved, may continue to incur additional legal fees in order to
assert its rights and claims against Pro-Fit and any successor to those assets
of Pro-Fit that are subject to our exclusive license and intellectual property
agreement with Pro-Fit and to defend against any counterclaims.






17





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We
currently have pending various 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.









PART
II




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




Common
Stock




Our
common stock has been quoted on the OTC Bulletin Board under the symbol “TALN”
since December 28, 2007.  The following table sets forth the high and
low sales prices for the Common Stock as reported by the OTC Bulletin Board
during the periods indicated. Over-the-counter market quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not necessarily represent actual transactions.




High
            
            LowYear
      ended December 31, 20091st
      Quarter.
            
            $  0.14
            
            $0.062nd
      Quarter
            
            0.20
            
            0.073rd
      Quarter
            
            0.11
            
            0.054th
      Quarter
            
            0.09
            
            0.05Year
      ended December 31, 20081st
      Quarter.
            
            $  0.50
            
            $0.222nd
      Quarter
            
            0.38
            
            0.193rd
      Quarter
            
            0.29
            
            0.104th
      Quarter
            
            0.25
            
            0.10




On March
26, 2010 the closing sales price of our common stock as reported on OTC Bulletin
Board was $0.13 per share.  As of March 26, 2010, there were 23 record
holders of our common stock and approximately 81.6% of our outstanding shares
are held by brokers and dealers.




Dividends




We have
never paid dividends on our common stock.  We are restricted from
paying dividends under our senior secured credit facility.  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, 2004 to December
31, 2009, compared with the cumulative returns of the American Stock Exchange
Market Value (U.S. & Foreign) Index and The Dow Jones U.S. Clothing &
Accessories Index.  The comparison assumes $100 was invested on
December 31, 2004 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.






18

















Cumulative Total
      Return12/04
            12/05
            12/06
            12/07
            12/08
            12/09Talon
      International, Inc.
            
            100.00
            8.00
            22.89
            9.00
            2.44
            2.00AMEX
      Composite
            
            100.00
            125.80
            150.40
            178.95
            108.56
            147.27Dow
      Jones US Clothing & Accessories
            
            100.00
            104.43
            129.44
            97.40
            58.68
            100.09







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.






19






Back to Index to Form 10-K





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 Annual Report on Form 10-K.






(In thousands except per share
      data)2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Consolidated
      Statement of Operations Data:Talon
      zippers net sales
            
            $
            21,341
            
            
            $
            28,429
            
            
            $
            21,160
            
            
            $
            17,005
            
            
            $
            13,594Trim
      net sales
            
            
            17,274
            
            
            
            19,537
            
            
            
            18,689
            
            
            
            22,503
            
            
            
            24,788Tekfit
      net sales
            
            
            61
            
            
            
            205
            
            
            
            681
            
            
            
            9,317
            
            
            
            8,949Total
      net sales
            
            $
            38,676
            
            
            $
            48,171
            
            
            $
            40,530
            
            
            $
            48,825
            
            
            $
            47,331Income
      (loss) from operations (1)
            
            $
            289
            
            
            $
            (5,962
            )
            
            $
            (3,171
            )
            
            $
            1,331
            
            
            $
            (27,098
            )Net
      income (loss)
            
            $
            (2,693
            )
            
            $
            (8,359
            )
            
            $
            (4,922
            )
            
            $
            309
            
            
            $
            (29,538
            )Net
      income (loss) per share – basic
            
            $
            (0.13
            )
            
            $
            (0.41
            )
            
            $
            (0.24
            )
            
            $
            0.02
            
            
            $
            (1.62
            )Net
      income (loss) per share – diluted
            
            $
            (0.13
            )
            
            $
            (0.41
            )
            
            $
            (0.24
            )
            
            $
            0.02
            
            
            $
            (1.62
            )Weighted
      average shares outstanding – basic
            
            
            20,291
            
            
            
            20,291
            
            
            
            20,156
            
            
            
            18,377
            
            
            
            18,226Weighted
      average shares outstanding – diluted
            
            
            20,291
            
            
            
            20,291
            
            
            
            20,156
            
            
            
            18,956
            
            
            
            18,226Consolidated
      Balance Sheet Data:Cash
      and cash equivalents
            
            $
            2,265
            
            
            $
            2,400
            
            
            $
            2,919
            
            
            $
            2,935
            
            
            $
            2,277Total
      assets
            
            $
            13,834
            
            
            $
            15,603
            
            
            $
            21,684
            
            
            $
            25,694
            
            
            $
            30,321Capital
      lease obligations, line of credit and notes payable
            
            $
            15,270
            
            
            $
            13,316
            
            
            $
            12,696
            
            
            $
            16,214
            
            
            $
            16,001Stockholders’
      equity (deficit)
            
            $
            (11,179
            )
            
            $
            (8,762
            )
            
            $
            (717
            )
            
            $
            1,686
            
            
            $
            912Total
      liabilities and stockholders’ equity
            
            $
            13,834
            
            
            $
            15,603
            
            
            $
            21,684
            
            
            $
            25,694
            
            
            $
            30,321Per
      Share Data:Net
      book value per common share
            
            $
            (0.55
            )
            
            $
            (0.43
            )
            
            $
            (0.04
            )
            
            $
            0.09
            
            
            $
            0.05Common
      shares outstanding
            
            
            20,291
            
            
            
            20,291
            
            
            
            20,291
            
            
            
            18,466
            
            
            
            18,241





(1)
Income (loss) from operations for each fiscal year includes the following items
(in thousands):




2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Restructuring
      Charges
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            (2,924
            )Inventory
      Impairment
            
            $
            -
            
            
            $
            (692
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            (3,447
            )Losses
      from a former customer and impairment of related marketable
      securities
            
            $
            -
            
            
            $
            (1,040
            )
            
            $
            (1,088
            )
            
            $
            -
            
            
            $
            -Executive
      severance
            
            $
            -
            
            
            $
            (724
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            -Related
      Party Note Impairment
            
            $
            (200
            )
            
            $
            (474
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            -Prior
      years consulting fees
            
            $
            (201
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Impairment
      charges Idle Equipment and Building
            
            $
            -
            
            
            $
            (2,430
            )
            
            $
            (127
            )
            
            $
            -
            
            
            $
            -Combined
            
            $
            (401
            )
            
            $
            (5,360
            )
            
            $
            (1,215
            )
            
            $
            -
            
            
            $
            (6,371
            )







20








Back to Index to Form 10-K


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.




Talon International, 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 pursue
the global expansion of Talon zippers through the
establishment of Talon owned sales, distribution and manufacturing locations,
strategic distribution relationships and joint ventures.   These
distributors and manufacturing joint ventures, in combination with Talon owned
and affiliated facilities under the Talon brand, improve our
time-to-market by eliminating the typical setup and build-out phase for new
manufacturing capacity throughout the world 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 are expanding 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 business provides
manufacturers with the patented technology, manufacturing know-how and materials
required to produce pants incorporating an expandable
waistband.    Our efforts to expand this product offering to
other customers have 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 less than
2% of our consolidated revenues for the years ended December 31, 2009, 2008 and
2007. Our business prospects for this group could be adversely affected if our
dispute with Pro-Fit is not resolved in a manner favorable to us.




Effects
of the Global Economic Recession




During
2009, we experienced a general decrease in sales which reflected the impact of
the global recession on the apparel industry and the corresponding lower demand
for all apparel products including our Talon zipper and trims
products.  The apparel industry and our customers are expected to
continue to be adversely impacted by this recession in early 2010 and perhaps
beyond, depending upon the global economic trends. During 2009 the year-to-year
comparative sales performance by quarter with 2008 reflected improvements
throughout the year after the sharp retail industry decline that began late in
2008.  The first quarter of 2009 reflected a sales decline from the
same quarter in 2008 by more than 34%.  The sales shortfall from the
second quarter
of 2009 as compared to 2008 reduced to 26% and the sales shortfall from the
third quarter of 2009 as compared to 2008 reduced again to
18%.






21







These
declines from our sales levels in 2008 reflect the severe impact of the global
decline in retail purchases and a sharp reduction in retail inventories by our
customers as a consequence of the falling consumer demand.  We believe
the modest improvements in our quarter to quarter sales performance during the
year evidence improved consumer and customer confidence in the overall economy
and our ability to retain preferred supplier positions with customers as the
industry sharply reduced its supplier base.  Our fourth quarter sales
in 2009 reflected an increase of 9.0% over the fourth quarter in
2008.  This was attributable to the improving trend in consumer and
customer confidence, the rebuilding of retail inventories across the industry,
and from sales with customers where we have secured preferred positions. Early
in 2010, consumer confidence remains weak, however retail inventories are still
near historic lows and as these rebuild to more normal levels, our expectation
is that sales of our products should exceed the overall retail
growth.




Results
of Operations




Net
Sales




For the
years ended December 31, 2009, 2008 and 2007, total sales by geographic region
based on customer delivery locations were as follows:




Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Sales:United States
            
            $
            3,396,705
            
            
            $
            3,332,257
            
            
            $
            3,692,468Hong Kong
            
            
            13,131,762
            
            
            
            15,181,280
            
            
            
            14,178,421China
            
            
            8,990,718
            
            
            
            13,614,709
            
            
            
            11,159,726India
            
            
            1,650,990
            
            
            
            2,536,929
            
            
            
            2,187,684Bangladesh
            
            
            2,008,869
            
            
            
            2,434,382
            
            
            
            1,924,943Other
            
            
            9,496,746
            
            
            
            11,071,423
            
            
            
            7,386,313Total
            
            $
            38,675,790
            
            
            $
            48,170,980
            
            
            $
            40,529,555







The
net revenues for the three primary product groups are as follows:




Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Product
      Group Net Revenue:Talon zipper
            
            $
            21,341,132
            
            
            $
            28,428,885
            
            
            $
            21,159,595Trim
            
            
            17,274,158
            
            
            
            19,537,302
            
            
            
            18,688,698Tekfit
            
            
            60,500
            
            
            
            204,793
            
            
            
            681,262Total
            
            $
            38,675,790
            
            
            $
            48,170,980
            
            
            $
            40,529,555







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.




The net
reduction in sales in 2009 versus 2008 ($9.5 million or 19.7%) was due mainly to
the impact of the global recession on the apparel industry and the related lower
demand for Talon products.






22







The net
increase of sales in 2008 versus 2007 was primarily due to an increase in Talon
zipper sales ($7.3 million or 34.4%) as a result of new brand nominations and
sales within Southeast Asia, together with new and increased program sales in
the Trim division ($0.8 million or 4.5% increase) partially offset by a decline
in sales of Tekfit products.




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, 2009, 2008 and 2007 (amounts in thousands) and
the percentage change in such operating expenses as compared to the previous
year:




2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007Sales
            
            $
            38,676
            
            
            
            (20
            )
      %
            
            $
            48,171
            
            
            
            19
            %
            
            $
            40,530Cost
      of goods sold
            
            
            27,363
            
            
            
            (23
            )
      %
            
            
            35,554
            
            
            
            25
            %
            
            
            28,423%
      of
      sales
            
            
            71
            %
            
            
            
            
            
            
            74
            %
            
            
            
            
            
            
            70
            %Sales
      and marketing expenses
            
            
            2,713
            
            
            
            (32
            )
      %
            
            
            3,982
            
            
            
            1
            %
            
            
            3,931%
      of sales
            
            
            7
            %
            
            
            
            
            
            
            8
            %
            
            
            
            
            
            
            10
            %General
      and administrative expense
            
            
            8,311
            
            
            
            (25
            )
      %
            
            
            11,127
            
            
            
            10
            %
            
            
            10,132%
      of sales
            
            
            22
            %
            
            
            
            
            
            
            23
            %
            
            
            
            
            
            
            25
            %Impairment
      of note receivable and related loss on marketable
    securities
            
            
            -
            
            
            
            -
            %
            
            
            1,040
            
            
            
            (4
            )
      %
            
            
            1,088%
      of sales
            
            
            -
            %
            
            
            
            
            
            
            2
            %
            
            
            
            
            
            
            3
            %Impairment
      loss on fixed assets
            
            
            -
            
            
            
            -
            %
            
            
            2,430
            
            
            
            1,813
            %
            
            
            127%
      of sales
            
            
            -
            %
            
            
            
            
            
            
            5
            %
            
            
            
            
            
            
            .3
            %







Cost
of goods sold




Cost of goods sold for
the year ended December 31, 2009 declined $8.2 million, to 71% of sales versus
74% of sales in the year ended December 31, 2008.  The reduction in the
cost of goods sold reflected lower overall sales volumes of $6.2 million due to
the impact of the global recession on the apparel industry and the related lower
demand for Talon products, lower direct costs associated with a greater mix of
Trim product sales of $0.8 million, lower product obsolescence in amount of $0.8
million, lower freight and duty costs of $0.3 million and lower contract service
of $0.1 million.




Cost of
goods sold for the year ended December 31, 2008 increased $7.1 million, to 74%
of sales versus 70% of sales in the year ended December 31, 2007.  Our
increased sales volumes and a product sales mix change to a higher proportion of
lower margin Talon zipper products versus Trim components primarily increased
costs of goods sold for 2008 by about $6.2 million. In addition, we also
recorded an additional $0.7 million charge for inventory
valuation reserves in 2008 versus $0.1 million in 2007 and also experienced $0.3
million in 2008 in increased freight and manufacturing costs.






23








Sales
and marketing expenses




Sales and
marketing expenses for the year ended December 31, 2009 decreased $1.3 million
as compared to 2008 and decreased as a percentage of sales by 1.3% to
7.0%.  The lower selling costs reflect lower salaries and benefits of $0.8
million and related travel and communications expense of $0.2 million, along
with lower production development supplies and samples of $0.3 million primarily
associated with reduced sales volumes.




Sales and
marketing expenses for the year ended December 31, 2008 remained relatively
unchanged in dollar terms as compared to 2007 but decreased as a percentage of
sales by 1.4% to 8.3%.  Our production samples increased as we
targeted new customers and programs within the industry for growth offset by
lower marketing costs.




General
and administrative expenses




General
and administrative expenses for the year ended December 31, 2009 of $8.3 million
were 21.5% of sales and were $2.8 million lower than 2008. General and
administrative expenses for the year ended December 31, 2008, were 23.1% of
sales. The general and administrative expenses in 2008 included $0.7 million in
compensation and related costs mainly associated with the severance of the
former chief executive officer and chief operating officer.  The
reduction in the general and administrative expenses, in addition to the
severance charges, reflects lower salaries and benefit costs of $0.5 million
principally associated with reduced staffing in Asia and the U.S. due to a
reduction in sales volume, reduced facility, maintenance and insurance costs of
$0.5 million due to a reduction in our leased facilities, lower professional and
other outside services of $0.4 million primarily resulting from the termination
of a related party consulting contract, lower depreciation charges of $0.4
million, lower bad debt expense in amount of $0.2 million mainly due to related
party note receivable allowance and lower stock-based compensation of $0.1
million.




General
and administrative expenses for the year ended December 31, 2008, was $11.1
million; $1.0 million higher than in 2007.  The general and
administrative expenses in 2008 include $0.7 million in compensation and related
costs mainly associated with the severance of our former chief executive officer
and chief operating officer while the 2007 expenses included $0.9 million of
professional costs related to consulting contracts with two former directors.
Other major factors affecting general and administrative expenses in 2008 were
higher salaries, benefits, travel and facility costs of $.3 million from
expanded operations in Asia which supported the higher sales; higher
depreciation of $0.2 million primarily from idle equipment; higher bad debt
expense of $0.4 million primarily due to the impairment of a related party note
receivable; higher stock based compensation of $0.2 million associated with new
incentive option grants and $0.1 million of higher sampling costs associated
with new programs.




Impairment
of note receivable and related loss on marketable securities





Loss on
marketable securities for the year ended December 31, 2008 includes $1.0 million
in a valuation reserve for the full value of our investment in marketable
securities that we received in exchange for the Azteca Production International,
Inc. note receivable. Operating expense in 2007 included $1.1 million in bad
debt reserve provisions associated with the note receivable due from Azteca
Production International, Inc.




As of
December 31, 2006 a note receivable from Azteca Productions International, Inc.
(“Azteca”) was outstanding in the amount of $2,799,460. The note provided for
payment in monthly installments over thirty-one months beginning March 1,
2006.







24







Azteca
failed to make the scheduled note payments due on July 1, 2007 and all
subsequent periods thereafter, triggering a default, and resulting in the entire
note balance becoming immediately due and payable.  In September 2007,
after meeting with and conducting extensive discussions with Azteca, Azteca
failed to provide to us certain security interests as required under the note or
to make the scheduled note payments and Azteca further expressed its belief that
it would be unable to make note payments in the foreseeable
future.  As a result, in the third quarter of 2007, we recorded a
charge of $2,127,653 to write-off the remaining outstanding note balance from
Azteca as a bad debt.  With continued discussions however, in December
2007, an agreement was reached whereby Azteca delivered to us 2,000,000 shares
of unrestricted common stock of a separate public corporation with a value of
$1,040,000, in exchange for cancellation of the Azteca note receivable.
Accordingly, in the fourth quarter of 2007, we reversed a portion of the
impairment recorded in September 2007, reflecting income of $1,040,000 as a
reversal of the previously recorded bad debt.




No sales of these securities occurred
in 2008 and on September 30, 2008, this public company issued its quarterly SEC
filing stating it had no customers, cash flow, or new orders and that it was in
violation of its financial covenants to its lender. Consequently, we concluded
that the marketable securities were permanently impaired and as a result,
recognized a loss on these securities for the full value of the investment of
$1,040,000 at September 30, 2008.




Impairment
loss on property and equipment




Operating
expenses for the years ended 2008 and 2007 include $2.4 million and $0.1
million, respectively, in impairment valuations for certain equipment and
building. See Note 1 of the Notes to Consolidated Financial Statements. During
2009 no impairment valuations were recorded for property and
equipment.




Interest expense andinterestincome




Interest
expense for the year ended December 31, 2009 increased approximately $0.2
million or 7.4% to $2.7 million, as compared to $2.5 million in 2008. In 2009,
our interest increased as a result of higher amortization of financing costs and
debt discount amortization related to our revolving credit and term notes offset
by the decrease in interest as a result of the sale of the North Carolina
property and subsequent payoff of the mortgage on this property. Interest income
for the year ended December 31, 2009 decreased about $57,000 to $8,000 as
compared to $64,000 in 2008 primarily due to the interest income on the related
party note receivable was recorded against the note receivable reserve in
2009.




Interest
expense for the year ended December 31, 2008 increased approximately $0.6
million or 30.1% to $2.5 million, as compared to $1.9 million in 2007. In 2008,
we recorded a full year of interest expense and amortization of deferred
financing costs for our revolving credit and term notes, which carry a higher
cost, as compared to 2007 which included only a partial year of interest related
to our revolving credit and term notes and a partial year of our previous
secured convertible notes payable. These secured convertible notes payable were
paid off early in the third quarter of 2007. Interest expense also included $1.2
million in amortized deferred financing charges, compared to $0.7 million in
2007, associated with the fair value of equity components issued in connection
with the debt facility. Interest income for the year ended December 31, 2008
decreased about $178,000 to $64,000 as compared to $242,000 in 2007 primarily
due to the write-off of the Azteca note receivable. See Note 1 of the Notes to
Consolidated Financial Statements.




Income
taxes




The
provision for income tax was approximately $254,000 in 2009, which includes a
charge for foreign withholding taxes arising from our domestic royalty charges
to our foreign operations, domestic state income taxes, tax provision for our
profitable operations in Hong Kong offset by adjustments to deferred tax assets
in Hong Kong and India. There is not sufficient evidence to determine that it is
more likely than not that we will be able to utilize its domestic and part of
our foreign net operating loss carry forwards to offset future taxable income
and as a result, these losses have a full valuation reserve against
them.






25







The net
tax benefit for income taxes was approximately $40,000 in 2008.  It
includes a charge for foreign withholding taxes arising from our domestic
royalty charges to our foreign operations and domestic state income taxes offset
by a tax benefit from our operating loss carry forwards in Hong Kong and
India.




The
provision for income taxes was $0.1 million for the year ended December 31,
2007.  It principally includes income tax provisions from operations
in China and India; offset by an income tax benefit from net operating loss
carry forward in Hong Kong.




Liquidity
and Capital Resources




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




December 31,
              2009
            
            
            December 31,
              2008Cash
      and cash equivalents
            
            $
            2,265
            
            
            $
            2,400Total
      assets
            
            $
            13,834
            
            
            $
            15,603Current
      liabilities
            
            $
            24,262
            
            
            $
            10,899Non-current
      liabilities
            
            $
            751
            
            
            $
            13,466Stockholders’
      deficit
            
            $
            (11,179
            )
            
            $
            (8,762
            )







We
believe that our existing cash and cash equivalents and our anticipated cash
flows from our operating activities will be sufficient to fund our minimum
working capital and capital expenditure needs for operating activities for at
least the next twelve months.




Our
existing cash and cash equivalents and our anticipated cash flows from operating
activities will not be sufficient to satisfy the CVC debt facility due at June
30, 2010.  Accordingly an extension or modification of the CVC debt
will be required prior to the due date or it will be necessary for us to raise
additional debt or equity financing in order to satisfy the CVC debt. If we
cannot obtain an extension or modification of the CVC debt, or raise additional
equity or debt to satisfy this requirement we will default on our credit
agreement. 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 or restructure our existing debt, CVC will have the
right to exercise its remedies including enforcement of its lien on
substantially all of our assets.  See Note 6 of the Notes to the
Consolidated Financial Statements.




Cash
      and cash equivalents




Our cash
is held with financial institutions.  Substantially all of the
balances at December 31, 2009 and 2008 are in excess of federally insured
limits, and there is no restricted cash. We have pledged cash of $252,324 as a
compensating balance in a legal dispute with a trade supplier in China. The
pledge will be eliminated upon settlement of the dispute or upon our payment of
the trade payable of the same amount.




Cash and
cash equivalents for the year ended December 31, 2009 decreased by $0.1 million
from December 31, 2008 due to a decrease in cash generated by operating
activities and increased cash used in investment activities, offset by increased
revolver note borrowing and term note borrowing in financing
activities.




Cash and
cash equivalents for the year ended December 31, 2008 decreased by $0.5 million
from December 31, 2007 due to a decrease in cash generated by operating
activities, net of proceeds from the disposition of the building in North
Carolina and lower overall net cash used in financing activities.






26








Cash
flows




The
following table summarizes our cash flow activity for the years ended December
31, 2009, 2008 and 2007 (amounts in thousands):




2009
            
            
            2008
            
            
            2007Net
      cash provided by operating activities
            
            $
            186
            
            
            $
            363
            
            
            $
            2,137Net
      cash used in investing activities
            
            
            (487
            )
            
            
            (133
            )
            
            
            (725
            )Net
      cash provided by (used in) financing activities
            
            
            193
            
            
            
            (779
            )
            
            
            (1,433
            )Net
      effect of foreign currency translation on cash
            
            
            (27
            )
            
            
            30
            
            
            
            5Net
      decrease in cash and cash equivalents
            
            $
            (135
            )
            
            $
            (519
            )
            
            $
            (16
            )





Operating
Activities





Cash
provided by operating activities is our primary recurring source of funds, and
reflects net income from operations excluding non cash charges, and changes in
operating capital. Cash provided by operating activities was $0.2 million for
the year ended December 31, 2009 resulted principally from:




Net
      income before non-cash expenses
            
            $
            183,000Increased
      Inventory
            
            
            (71,000
            )Accounts
      receivable reduction
            
            
            722,000Accounts
      payable and accrued expense reduction
            
            
            (1,014,000
            )Other
      increases in operating capital
            
            
            366,000Cash
      provided by operating activities
            
            $
            186,000





Cash
provided by operating activities was $0.4 million for the year ended December
31, 2008.  The cash generated by operating activities during 2008
resulted primarily from reductions in inventory net of reserves of $0.8 million,
prepaid expenses of $0.5 million and an increase in accounts payables and
accrued expenses of $1.3 million.




Cash
provided by operating activities was $2.1 million for the year ended December
31, 2007.  The cash generated by operating activities during 2007
resulted primarily from reductions in accounts receivable net of applied
reserves of $3.3 million, $0.6 million in reductions in inventory net of
reserves applied, $0.6 million in collections on the note receivable and
increases in accounts payable of $2.1 million offset by increases in prepaid
assets and other assets of approximately $0.5 million.  Included in
the net reserves was the write-off of the Azteca note and subsequent payment in
shares as discussed in Note 1 of the Notes to Consolidated Financial
Statements.




Investing
      Activities




Net cash
used in investing activities for the year ended December 31, 2009 was
approximately $487,000 resulting in expenditures in amount of approximately
$543,000 principally associated with the development of our new ERP system that
was implemented in March 2009 and leasehold improvements for our new facility in
China and proceeds from sale of equipment mainly associated with equipment held
for sale as of December 31, 2008.




Cash
flows from investing activities for the year ended December 31, 2008 include the
sale of the North Carolina property with proceeds of $0.7 million offset by
capital expenditures of $0.8 million primarily for new office space in Asia and
improvements in our technology systems.




Net cash
used in investing activities for the year ended December 31, 2007 consisted of
capital expenditures of $0.7 million for leasehold improvements, office
equipment for new employees, improvements in our technology systems and a
marketing website acquisition.






27







Financing
      Activities





Net cash
provided by financing activities for the year ended December 31, 2009 was
approximately $193,000 and primarily reflects additional borrowings under our
revolver line of credit, offset by the repayment of borrowings under capital
leases and notes payable.




Net cash
used in financing activities for the year ended December 31, 2008 was $0.8
million with $1.2 million in revolver note borrowings and $2.0 million used for
repayment of the revolver, term note and other notes payable and capital lease
obligations.




Net cash
used in financing activities for the year ended December 31, 2007 was $1.4
million.  During 2007, $13.8 million (net of issuance costs) was
provided by the issuance of common stock and warrants and by borrowings, under a
new debt facility (see below), designated to pay off our previously existing
convertible promissory notes and to provide funds for future growth. The
proceeds from this debt facility were used to pay the $12.5 million of secured
convertible promissory notes, and $1.0 million was used to pay a related party
note of $0.6 million and associated accrued interest.  Approximately
$1.2 million was used for the repayment of borrowings under capital leases and
notes payable and $0.5 million in initial borrowings under the revolving note
were repaid.





On June
27, 2007, we entered into a Revolving Credit and Term Loan Agreement with
Bluefin Capital, LLC that provides for a $5.0 million revolving credit loan and
a $9.5 million term loan with a three year term maturing June 30, 2010. Bluefin
Capital subsequently assigned its rights and obligations under the credit
facility agreements to an affiliate, CVC California, LLC (“CVC”).  The
revolving credit portion of the facility, as amended, permits borrowings based
upon a formula including 85% of eligible receivables and 55% of eligible
inventory and provides for monthly interest payments at the U.S.A. prime rate
(3.25% at December 31, 2009) plus 2.0%.  The term loan bears interest at
8.5% annually with quarterly interest payments and repayment in full at
maturity.




Borrowings
under both credit facilities are secured by all of our assets. As of December
31, 2009 our borrowing base ($4,546,996) was lower than our actual borrowing
($4,988,988) by $441,992, therefore we did not have available borrowing at that
date. There was $3,000 in available borrowings at December 31,
2008.




Our cash
flows from operating activities will not be sufficient to satisfy the CVC debt
facility when it becomes due on June 30, 2010.  Accordingly, we are
seeking an extension or modification of the CVC debt prior to the due date and
also exploring raising additional debt or equity financing in order to satisfy
the CVC debt. There can be no assurance that additional debt or equity financing
will be available on acceptable terms or at all. If we cannot obtain an
extension or modification of the CVC debt, or raise additional equity or debt to
satisfy this requirement we will default on our credit agreement. If we are
unable to secure additional financing or restructure our existing debt, CVC will
have the right to exercise its remedies including enforcement of its lien on
substantially all of our assets.  See Note 1 of the Notes to
Consolidated Financial Statements




In
connection with the Revolving Credit and Term Loan Agreement, we issued
1,500,000 shares of common stock to the lender for $0.001 per share, and issued
warrants to purchase 2,100,000 shares of common stock.  The warrants
were exercisable over a five-year period and initially 700,000 warrants were
exercisable at $0.95 per
share; 700,000 warrants were exercisable at $1.05 per share; and 700,000
warrants were exercisable at $1.14 per share.  The warrants did not
require cash settlements. The relative fair value of the equity ($2,374,169,
which includes a reduction for financing costs) issued with this debt facility
was allocated to paid-in-capital and reflected as a debt discount to the face
value of the term note.




This
discount is being amortized over the term of the note and recognized as
additional interest cost as amortized.  Costs associated with the debt
facility included debt fees, commitment fees, registration fees and legal and
professional fees of $486,000.  The costs allocable to the debt
instruments are reflected as a reduction to the face value of the note on the
balance sheet.






28







On
November 19, 2007, we entered into an amendment of the credit agreement with the
lender to modify the original financial covenants and to extend until June 30,
2008 the application of the original EBITDA covenants in exchange for additional
common stock and a price adjustment to the lenders outstanding warrants issued
to the lender in connection with the loan agreement.  In connection
with this amendment we issued an additional 250,000 shares of common stock to
the lender for $0.001 per share, and the exercise price for all of the
previously issued warrants for the purchase of 2,100,000 shares of common stock
was amended to an exercise price of $0.75 per share.   The new
relative fair value of the equity issued with this debt of $2,430,000, including
the modifications in this amendment and a reduction for financing costs, is
being amortized over the term of the note.




On April
3, 2008, we executed a further amendment to the credit agreement.  The
amendment included a redefining of the EBITDA covenants, and the cancellation of
the common stock warrants previously issued to the lender in exchange for our
issuance of an additional note payable to the lender for $1.0
million.  The note bears interest at 8.5% and both the note and
accrued interest are payable at maturity on June 30, 2010.  In
addition, our borrowing base was modified in this amendment
by  increasing the allowable portion of inventory held by third party
vendors to $1.0 million with no more than $500,000 held at any one vendor and
increasing the percentage of accounts receivable to be included in the borrowing
base to 85%. We incurred a one-time modification fee of $145,000 to secure the
amendment of the agreement.  The new relative fair value of the equity
issued with this debt of $2,542,000, including the modifications in this
amendment and a reduction for financing costs, is being amortized over the term
of the note.




Under the
terms of the credit agreement, as amended, we are required to meet certain
coverage ratios, among other restrictions including a restriction from declaring
or paying a dividend prior to repayment of all the obligations. The financial
covenants, as amended, require that we maintain at the end of each fiscal
quarter “EBITDA” (as defined in the agreement) in excess of the principal and
interest payments for the same period of not less than $1.00 and in excess of
ratios set out in the agreement for each quarter.




We failed
to satisfy the minimum EBITDA requirement for quarter ended December 31, 2008 as
well as the quarter ended March 31, 2009, and in connection with such failures,
on March 31, 2009 we entered into a further amendment to the credit agreement
with CVC. This amendment provided for the issuance of an additional term note to
CVC in the principal amount of $225,210 in lieu of paying a cash waiver fee in
connection with our failures to satisfy the EBITDA requirements for the quarters
ended December 31, 2008 and March 31, 2009; deferral of the term note quarterly
interest payment of $215,000 due April 1, 2009; a temporary increase to the
borrowing base formulas and calculations under the revolving credit facility;
the re-lending by CVC of $125,000 under the term loan portion of credit
facility; a consent to allow us to sell equipment that has been designated as
held for sale more fully described in Note 6 of the Notes to Consolidated
Financial Statements; and the granting to CVC of the right to designate a
non-voting observer to attend all meetings of our Board of
Directors.




We
financed building, land and equipment purchases through notes payable and
capital lease obligations expiring through June 2011.  The building
and land mortgage were fully paid when the property was sold in October 2008.
The remaining equipment obligations bear interest at rates of 6.6% and 12.1% per
annum, and under these obligations, we are required to make monthly payments of
principal and interest.




The
outstanding balance including accrued interest of our notes payable to related
parties at December 31, 2009 and December 31, 2008 was $266,000 and $222,000,
respectively.  Included in this balance are demand notes of $85,000
which bear interest at 10% (total balance as of December 31, 2009 of $230,000)
have no scheduled monthly payments and are due within fifteen days following
demand. The remainder of the notes payable to related parties includes our note
payable to an officer for $36,000. The note bears 6% interest annually and the
maturity date is the earlier of December 31, 2011 or ten days following
employment termination date. The note is fully presented as part of current
liabilities as of December 31, 2009.






29







We have
historically satisfied our working capital requirements primarily through cash
flows generated from operations and borrowings under our credit
facility.  As we continue to expand globally with our apparel
manufacturing in offshore locations, our customers (some of which are backed by
U.S. brands and retailers) are substantially all foreign based
entities.  Our revolving credit facility provides limited financing
secured by our accounts receivable, and our current borrowing capability may not
provide the level of financing we need to continue in or to expand into
additional foreign markets.  We are continuing to evaluate
non-traditional financing of our foreign assets and equity transactions to
provide capital needed to fund our expansion and on-going operations. If we
experience greater than anticipated reductions in sales, we may need to raise
additional capital, or further reduce the scope of our business in order to
fully satisfy our future short-term operating requirements.  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, our borrowing base availability limitations
related to eligible accounts receivable and inventories and our expansion into
foreign markets.  Our need for additional long-term financing includes
the integration and expansion of our operations to exploit our rights under our
Talon trade name, the expansion of our operations in the Asian and European
markets. 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.




Contractual
Obligations




The
following summarizes our contractual obligations at December 31, 2009 and the
effects such obligations are expected to have on liquidity and cash flow in
future periods:




Payments
      Due by PeriodLess
      than
            
            
            
            1-3
            
            
            
            4-5
            
            
            AfterContractual
      Obligations
            
            Total
            
            
            1
      Year
            
            
            Years
            
            
            Years
            
            
            5
      YearsDemand
      notes payable to related parties (1)
            
            $
            229,400
            
            
            $
            229,400
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Note
      Payable to Related Party
            
            
            36,500
            
            
            
            36,500
            
            
            
            -
            
            
            
            -
            
            
            
            -Capital
      lease obligations
            
            
            88,400
            
            
            
            58,400
            
            
            
            27,400
            
            
            
            2,600
            
            
            
            -Operating
      leases
            
            
            821,300
            
            
            
            551,700
            
            
            
            269,600
            
            
            
            -
            
            
            
            -Revolver
      & Term Note
            
            
            16,301,000
            
            
            
            16,301,000
            
            
            
            -
            
            
            
            -
            
            
            
            -Other
      notes payable
            
            
            61,100
            
            
            
            61,100
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      Obligations
            
            $
            17,537,700
            
            
            $
            17,238,100
            
            
            $
            297,000
            
            
            $
            2,600
            
            
            $
            -





(1)
            The
      majority of notes payable to related parties is due on demand with the
      remainder due and payable on the fifteenth day following the date of
      delivery of written demand for payment and includes accrued interest
      payable through December 31, 2009.








Off-Balance
Sheet Arrangements




At
December 31, 2009 and 2008, 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 certain transactions to which we were or will be a party,
andin which any
director, executive officer, or shareholder of more than 5% of our common stock
or any member of their immediate family had or will have a direct or indirect
material interest, see Item 13, “Certain Relationships and Related Transactions
and Director Independence,” of this Report.






30







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 of operations, 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:




·
            Accounts
      and note receivable balances are evaluated on a continual basis and
      allowances are provided for potentially uncollectible accounts based on
      management’s estimate of the collectability 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.




The bad
debt expenses, recoveries and allowances for the twelve months ended December
31, 2009, 2008 and 2007 are as follows:






Twelve
      Months EndedDecember
      31,2009
            
            
            2008
            
            
            2007Bad
      debt expenses for accounts receivable
            
            $
            120,701
            
            
            $
            77,558
            
            
            $
            206,253Bad
      debt expense for notes receivable, including related party
            
            $
            200,000
            
            
            $
            474,010
            
            
            $
            1,087,653Recoveries
            
            $
            (1,016
            )
            
            $
            (3,049
            )
            
            $
            (19,500
            )Allowance
      for doubtful accounts
            
            $
            232,329
            
            
            $
            217,323
            
            
            $
            140,420Allowance
      for doubtful accounts, related party
            
            $
            740,417
            
            
            $
            474,010
            
            
            $
            -







31








·
            Inventories
      are stated at the lower of cost, determined using the first-in, first-out
      basis or market value and are all substantially finished
      goods.  The costs of inventory include the purchase price,
      inbound freight and duties, conversion costs and certain allocated
      production overhead costs.  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, impaired 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.




The
inventory reserve expenses and allowances for the years ended December 31, 2009,
2008 and 2007 are as follows:




Twelve
      Months Ended
              December
      31,2009
            
            
            2008
            
            
            2007Inventory
      valuation expense
            
            $
            60,612
            
            
            $
            692,382
            
            
            $
            148,000Allowance
      for inventory valuation reserves
            
            $
            1,184,621
            
            
            $
            1,211,170
            
            
            $
            1,019,000









·
            We
      record deferred tax assets arising from temporary timing differences
      between recorded net income and taxable net income when and if we believe
      that future earnings will be sufficient to realize the tax
      benefit.  For those jurisdictions where the expiration date of
      tax benefit carry-forwards or the projected taxable earnings indicate that
      realization is not likely, a valuation allowance is
      provided.  If we determine that we may not realize all of our
      deferred tax assets in the future, we will make an adjustment to the
      carrying value of the deferred tax asset, which would be reflected as an
      income tax expense.  Conversely, if we determine that we will
      realize a deferred tax asset, which currently has a valuation allowance,
      we would be required to reverse the valuation allowance, which would be
      reflected as an income tax benefit.  We believe that our
      estimate of deferred tax assets and determination to record a valuation
      allowance against such assets are critical accounting estimates because
      they are subject to, among other things, an estimate of future taxable
      income, which is susceptible to change and dependent upon events that may
      or may not occur, and because the impact of recording a valuation
      allowance may be material to the assets reported on the balance sheet and
      results of operations.  See Note 10 of the Notes to Consolidated
      Financial Statements.






·
            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 were evaluated, and we determined
      that certain components of idle equipment would not either be effectively
      redeployed or would be sold or disposed.  Accordingly, we took
      $2,430,000 in impairment charges for the period ending December 31, 2008.
      See Note 1 of the Notes to Consolidated Financial
    Statements.






32






·
            Sales
      are recognized when persuasive evidence of an arrangement exists, product
      title has passed, 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, which returns have
      been insignificant.




·
            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
      Financial Accounting Standards Board (“FASB”) Accounting Standards
      Codification (“ASC”) No450, “Contingencies”, we
      accrue estimates of the probable and estimable losses for the resolution
      of these claims. The ultimate
      resolution of these claims could affect our future results of operations
      for any particular quarterly or annual period should our exposure be
      materially different from our earlier estimates or should liabilities be
      incurred that were not previously
accrued.




New
Accounting Pronouncements





In
June 2009, the Financial FASB issued ASC 105-10, “Generally Accepted Accounting
Principles”(“ASC 105-10”). Effective for our financial statements issued
for interim and annual periods commencing with the quarterly period ended
September 30, 2009, the FASB Accounting Standards Codification
(“Codification” or “ASC”) is the source of authoritative U.S. GAAP recognized by
the FASB to be applied by nongovernmental entities. Rules and interpretive
releases of the SEC under authority of federal securities laws are also sources
of authoritative GAAP for SEC registrants. The Codification supersedes all
then-existing, non-SEC accounting and reporting standards. In the FASB’s view,
the Codification does not change GAAP, and therefore the adoption of ASC 105-10,
Generally Accepted Accounting Principles, did not have an effect on our
consolidated financial position, results of operations or cash flows. However,
where we have referred to specific authoritative accounting literature, the
Codification literature is disclosed.





In
April 2009, the FASB issued ASC 820-10, “Fair Value Measurements and
Disclosures” (Topic 820). ASC 820-10 provides guidance on how to
determine the fair value of assets and liabilities when the volume and level of
activity for the asset/liability has significantly decreased. ASC 820-10 also
provides guidance on identifying circumstances that indicate a transaction is
not orderly. In addition, ASC 820-10 requires disclosure in interim and annual
periods of the inputs and valuation techniques used to measure fair value and a
discussion of changes in valuation techniques. ASC 820-10 was effective
beginning in the second quarter of fiscal year 2009. The adoption of ASC 820-10
did not have a material impact on the consolidated financial
statements.





In
April 2009, the FASB issued ASC 320-10, “Investments - Debt and Equity
Securities” (“ASC 320-10”). ASC 320-10 amends the requirements for the
recognition and measurement of other-than-temporary impairments for debt
securities by modifying the pre-existing “intent and ability” indicator. Under
ASC 320-10, other-than-temporary impairment is triggered when there is intent to
sell the security, it is more likely than not that the security will be required
to be sold before recovery, or the security is not expected to recover the
entire amortized cost basis of the security. Additionally, ASC 320-10 changes
the presentation of other-than-temporary impairment in the income statement for
those impairments involving credit losses. The credit loss component will be
recognized in earnings and the remainder of the impairment will be recorded in
other comprehensive income. ASC 320-10 was effective beginning in the second
quarter of fiscal year 2009. The implementation of ASC 320-10 did not have a
material impact on the consolidated financial statements.





In
April 2009, the FASB issued ASC 825-10, “Financial Instruments” (“ASC
825-10”). ASC 825-10 requires interim disclosures regarding the fair values of
financial instruments. Additionally, ASC 825-10 requires disclosure of the
methods and significant assumptions used to estimate the fair value of financial
instruments on an interim basis as well as changes of the methods and
significant assumptions from prior periods. ASC 825-10 does not change the
accounting treatment for these financial instruments and did not have a material
impact on the consolidated financial statements.






33
 
 
 
 In
April 2009, the FASB issued ASC 805, “Business Combinations”(“ASC
805”). ASC 805 amends the original guidance relating to the initial recognition
and measurement, subsequent measurement and accounting and disclosures of assets
and liabilities arising from contingencies in a business combination which were
adopted by us as of the beginning of fiscal 2009 and it did not have a material
impact on the consolidated financial statements. We will apply the requirements
of ASC 805 prospectively to any future acquisitions.




In May
2009, the FASB issued ASC 855-10, “Subsequent Events” (“ASC
855-10”). ASC 855-10 provides general standards of accounting for and disclosure
of events that occur after the balance sheet date but before financial
statements are issued or are available to be issued. ASC 855-10 was adopted by
us in the second quarter of 2009 and did not have a material impact on the
consolidated financial statements. The implementation of ASC 855-10 did not have
a material impact on the consolidated financial statements. See Note 16 of the
Notes to Consolidated Financial Statements for the disclosures regarding ASC
855-10.




In June
2009, the FASB issued ASC 860, “Transfers and Servicing”
(”ASC 860”). ASC 860 seeks to improve the relevance, representational
faithfulness, and comparability of the information that a reporting entity
provides in its financial statements about a transfer of financial assets; the
effects of a transfer on its financial position, financial performance, and cash
flows  and a transferor’s continuing involvement, if any, in
transferred financial assets. ASC 860 is applicable for annual periods beginning
after November 15, 2009. The implementation of ASC 860 is not expected to have a
material impact on the consolidated financial statements.




In
June 2009, the FASB issued accounting guidance contained within ASC 810,
“Consolidations”, which
pertains to the consolidation of variable interest entities, “Amendments to FASB
Interpretation No. 46R”, (“ASC 810”). This guidance within ASC 810 requires
an analysis to be performed to determine whether a variable interest gives the
entity a controlling financial interest in a variable interest entity. This
standard requires an ongoing reassessment and eliminates the quantitative
approach previously required for determining whether an entity is the primary
beneficiary. This standard is effective for fiscal years beginning after
November 15, 2009. The implementation of ASC 810 is not expected to have an
impact on the consolidated financial statements.




In
August 2009, the FASB issued ASC 820-10-35, “Fair Value Measurements and
Disclosures” (“ASC 820-10-35”), which provides amendments to Topic 820.
ASC 820-10-35 provides additional guidance clarifying the measurement of
liabilities at fair value. ASC 820-10-35 is effective in the fourth quarter 2009
for a calendar year entity. ASC 820-10-35 did not have a material impact on the
consolidated financial statements.




In
January 2010, the FASB issued Accounting Standards Update 2010-06, “Fair Value Measurements and
Disclosures” (Topic 820): Improving Disclosures about Fair Value
Measurements.  This guidance amends the disclosure requirements
related to recurring and nonrecurring fair value measurements and requires new
disclosures on the transfers of assets and liabilities between Level 1 (quoted
prices in active market for identical assets or liabilities) and Level 2
(significant other observable inputs) of the fair value measurement hierarchy,
including the reasons and the timing of the transfers. Additionally, the
guidance requires a roll forward of activities on purchases, sales, issuance and
settlements of the assets and liabilities measured using significant
unobservable inputs (Level 3 fair value measurements). The guidance will become
effective for the reporting period beginning January 1, 2010, except for the
disclosure on the roll forward activities for Level 3 fair value measurements,
which will become effective for the reporting period beginning January 1, 2011.
Other than requiring additional disclosures, adoption of this new guidance will
not have a material impact on the consolidated financial
statements.









34







Back to Index to Form 10-K


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 and Chinese
Yuan.   We do not intend to purchase contracts to hedge the
exchange exposure for future product purchases. There were no hedging contracts
outstanding as of December 31, 2009.  Currency fluctuations can
increase the price of our products to foreign customers which can adversely
impact the level of our export sales from time to time.  The majority
of our cash equivalents are held in United States dollars in various bank
accounts and we do not believe we have significant market risk exposure with
regard to our investments.  At December 31, 2009, the Revolving Credit
Note of $5.0 million was subject to interest rate fluctuations.  A one
percentage point increase in interest rates would result in an annualized
increase to interest expense of approximately $50,000 on our variable rate
borrowings.









ITEM
8.            
 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA






TABLE
OF CONTENTS




PageReport of Independent Registered Public
      Accounting
      Firm
            
            36Consolidated Balance
      Sheets
            
            37Consolidated Statements of
      Operations
            
            38Consolidated Statements of Stockholders’
      Deficit
            
            39Consolidated Statements of Cash
      Flows
            
            40Notes to Consolidated Financial
      Statements
            
            42











35











REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM




To the
Board of Directors and Stockholders


Talon
International, Inc.


Woodland
Hills, California





We have
audited the accompanying consolidated balance sheets of Talon International,
Inc. and subsidiaries as of December 31, 2009 and 2008, and the related
consolidated statements of operations, stockholders' deficit, and cash flows for
each of the three years in the period ended December 31, 2009. Our audits also
included the financial statement schedule of Talon International, Inc. and
subsidiaries, listed in Item 15(a). These financial statements and financial
statement schedule 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 provide 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 Talon International, Inc.
and subsidiaries as of December 31, 2009 and 2008, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2009, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.




We were
not engaged to examine management's assessment of the effectiveness of Talon
International, Inc. and subsidiaries’ internal control over financial reporting
as of December 31, 2009, included in the accompanying Management's Report on
Internal Control Over Financial Reporting and,  accordingly, we do not
express an opinion thereon.




The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, for the year ended December 31, 2009, the
Company incurred a net loss of $2,692,977. In addition, the Company had an
accumulated deficit of $66,344,009 and a working capital deficit of $17,056,232
at December 31, 2009. These factors, among others, as discussed in Note 2 to the
financial statements, raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The consolidated financial statements do not include
any adjustments that might result from the outcome of this
uncertainty.









/s/
      SingerLewak  LLP
              SINGERLEWAK  LLP
              
              Los
      Angeles, California
              March
      29, 2010







36








TALON
INTERNATIONAL, INC.




CONSOLIDATED BALANCE SHEETS




December
      31,
              2009
            
            
            December
      31,
              2008AssetsCurrent
      Assets:Cash and cash
      equivalents
            
            $
            2,264,606
            
            
            $
            2,399,717Accounts receivable,
      net
            
            
            3,021,642
            
            
            
            3,856,613Inventories, net
            
            
            1,679,302
            
            
            
            1,669,149Prepaid expenses and other current
      assets
            
            
            240,554
            
            
            
            473,955Total
      current
      assets
            
            
            7,206,104
            
            
            
            8,399,434Property
      and equipment, net
            
            
            2,280,586
            
            
            
            2,491,899Note
      receivable from related party, net
            
            
            -
            
            
            
            200,000Intangible
      assets, net
            
            
            4,110,751
            
            
            
            4,110,751Other
      assets
            
            
            236,386
            
            
            
            400,494Total
      assets
            
            $
            13,833,827
            
            
            $
            15,602,578Liabilities
      and Stockholders’ DeficitCurrent
      liabilities:Accounts payable
            
            $
            6,337,368
            
            
            $
            7,674,768Accrued expenses
            
            
            2,678,659
            
            
            
            2,617,166Revolver note
    payable
            
            
            4,988,988
            
            
            
            -Term notes payable, net of
      discounts
            
            
            9,876,114
            
            
            
            -Notes payable to related
      parties
            
            
            265,871
            
            
            
            222,264Current portion of long term
      obligations
            
            
            115,336
            
            
            
            385,098Total
      current liabilities
            
            
            24,262,336
            
            
            
            10,899,296Revolver
      note payable, net of current portion
            
            
            -
            
            
            
            4,638,988Term
      notes payable, net of discounts and current portion
            
            
            -
            
            
            
            8,067,428Capital
      lease obligations, net of current portion
            
            
            23,477
            
            
            
            1,910Other
      liabilities
            
            
            726,875
            
            
            
            756,888Total
      liabilities
            
            
            25,012,688
            
            
            
            24,364,510Commitments
      and contingencies (Note 11)Stockholders’
      Deficit: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;
              20,291,433 shares issued and
      outstanding at December 31, 2009
              and 2008
            
            
            20,291
            
            
            
            20,291Additional paid-in
      capital
            
            
            55,070,568
            
            
            
            54,769,072Accumulated
    deficit
            
            
            (66,344,009
            )
            
            
            (63,651,032
            )Accumulated other comprehensive
      income
            
            
            74,289
            
            
            
            99,737Total
      stockholders’
      deficit
            
            
            (11,178,861
            )
            
            
            (8,761,932
            )Total
      liabilities and stockholders’ deficit
            
            $
            13,833,827
            
            
            $
            15,602,578









See
accompanying notes to consolidated financial statements.







37








TALON
INTERNATIONAL, INC.




CONSOLIDATED STATEMENTS OF OPERATIONS









Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Net
      sales
            
            $
            38,675,790
            
            
            $
            48,170,980
            
            
            $
            40,529,555Cost
      of goods
      sold
            
            
            27,363,216
            
            
            
            35,553,857
            
            
            
            28,422,820Gross
      profit
            
            
            11,312,574
            
            
            
            12,617,123
            
            
            
            12,106,735Sales
      and marketing
      expenses
            
            
            2,712,814
            
            
            
            3,982,124
            
            
            
            3,930,815General
      and administrative expenses
            
            
            8,310,684
            
            
            
            11,127,376
            
            
            
            10,132,042Impairment
      loss of marketable securities and related note receivable
            
            
            -
            
            
            
            1,040,000
            
            
            
            1,087,653Impairment
      loss on property and equipment
            
            
            -
            
            
            
            2,429,506
            
            
            
            126,904Total operating
      expenses
            
            
            11,023,498
            
            
            
            18,579,006
            
            
            
            15,277,414Income
      (loss) from
      operations
            
            
            289,076
            
            
            
            (5,961,883
            )
            
            
            (3,170,679
            )Interest
      expense,
      net
            
            
            2,727,919
            
            
            
            2,436,675
            
            
            
            1,680,079Net
      loss before provision for (benefit from) income taxes
            
            
            (2,438,843
            )
            
            
            (8,398,558
            )
            
            
            (4,850,758
            )Provision
      for (benefit from) income taxes
            
            
            254,134
            
            
            
            (39,772
            )
            
            
            70,949Net
      loss
            
            $
            (2,692,977
            )
            
            $
            (8,358,786
            )
            
            $
            (4,921,707
            )







See
accompanying notes to consolidated financial statements.








38








TALON
INTERNATIONAL, INC.


CONSOLIDATED STATEMENTS OF STOCKHOLDERS’
DEFICIT


YEARS
ENDED DECEMBER 31, 2009, 2008 AND 2007








Preferred
      Stock
              
              
              Additional
              
              
              OtherCommon
      Stock
              
              
              Series
      A
              
              
              Paid-In
              
              
              ComprehensiveShares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Income (losses)
              
              
              (Deficit)
              
              
              TotalBalance,
      January 1, 2007
              
              
              18,466,433
              
              
              $
              18,466
              
              
              
              -
              
              
              $
              -
              
              
              $
              51,792,502
              
              
              $
              -
              
              
              $
              (50,124,739
              )
              
              $
              1,686,229Common
      stock issued upon exercise of options
              
              
              75,000
              
              
              
              75
              
              
              
              
              
              
              
              
              
              
              
              42,671
              
              
              
              
              
              
              
              
              
              
              
              42,746Common
      stock warrants issued in private placement transaction
              
              
              1,750,000
              
              
              
              1,750
              
              
              
              
              
              
              
              
              
              
              
              2,429,988
              
              
              
              
              
              
              
              
              
              
              
              2,431,738Stock
      based compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              245,000
              
              
              
              
              
              
              
              
              
              
              
              245,000Foreign
      currency translation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              44,444
              
              
              
              
              
              
              
              44,444Adoption
      of ASC 850
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (245,800
              )
              
              
              (245,800
              )Net  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (4,921,707
              )
              
              
              (4,921,707
              )Balance,
      December 31, 2007
              
              
              20,291,433
              
              
              
              20,291
              
              
              
              -
              
              
              
              -
              
              
              
              54,510,161
              
              
              
              44,444
              
              
              
              (55,292,246
              )
              
              
              (717,350
              )Warrant
      fair value adjustment
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (148,302
              )
              
              
              
              
              
              
              
              
              
              
              (148,302
              )Stock
      based compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              407,213
              
              
              
              
              
              
              
              
              
              
              
              407,213Foreign
      currency translation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              55,293
              
              
              
              
              
              
              
              55,293Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (8,358,786
              )
              
              
              (8,358,786
              )Balance,
      December 31, 2008
              
              
              20,291,433
              
              
              
              20,291
              
              
              
              -
              
              
              
              -
              
              
              
              54,769,072
              
              
              
              99,737
              
              
              
              (63,651,032
              )
              
              
              (8,761,932
              )Stock
      based compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              301,496
              
              
              
              
              
              
              
              
              
              
              
              301,496Foreign
      currency translation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (25,448
              )
              
              
              
              
              
              
              (25,448
              )Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (2,692,977
              )
              
              
              (2,692,977
              )Balance,
      December 31, 2009
              
              
              20,291,433
              
              
              $
              20,291
              
              
              
              -
              
              
              $
              -
              
              
              $
              55,070,568
              
              
              $
              74,289
              
              
              $
              (66,344,009
              )
              
              $
              (11,178,861
              )
   See
accompanying notes to consolidated financial statements.









39








TALON
INTERNATIONAL, INC.




CONSOLIDATED STATEMENTS OF CASH FLOWS







Year
      ended December 31, 2009
            
            
            Year
      ended December 31, 2008
            
            
            Year
      ended December 31, 2007Cash
      flows from operating activities:Net loss
            
            $
            (2,692,977
            )
            
            $
            (8,358,786
            )
            
            $
            (4,921,707
            )Adjustments to reconcile net loss
      to net cash
              provided
      by operating activities:Depreciation
      and amortization
            
            
            725,979
            
            
            
            1,079,441
            
            
            
            1,168,434Amortization
      of deferred financing cost and debt discounts
            
            
            1,462,563
            
            
            
            1,186,837
            
            
            
            736,042Stock
      based compensation
            
            
            301,496
            
            
            
            407,213
            
            
            
            245,000Bad
      debt expense
            
            
            119,685
            
            
            
            74,509
            
            
            
            186,753Related
      party note impairment
            
            
            200,000
            
            
            
            474,010
            
            
            
            -Additions
      to inventory valuation reserve
            
            
            60,612
            
            
            
            692,382
            
            
            
            148,000Impairment
      of marketable securities and related note
              receivable
            
            
            -
            
            
            
            1,040,000
            
            
            
            1,087,653Impairment
      loss on property and equipment
            
            
            -
            
            
            
            2,429,506
            
            
            
            126,904Loss
      from disposal of assets
            
            
            5,462
            
            
            
            49,000
            
            
            
            58,076Changes
      in operating assets and liabilities:Accounts
      and notes receivable, including related parties
            
            
            721,841
            
            
            
            (419,891
            )
            
            
            1,048,662Note
      receivable collections
            
            
            -
            
            
            
            -
            
            
            
            596,491Inventories
            
            
            (70,768
            )
            
            
            125,896
            
            
            
            415,793Prepaid
      expenses and other current assets
            
            
            234,340
            
            
            
            474,317
            
            
            
            (404,532
            )Other
      assets
            
            
            165,613
            
            
            
            (302,735
            )
            
            
            (202,150
            )Accounts
      payable and accrued expenses
            
            
            (1,013,856
            )
            
            
            1,358,483
            
            
            
            1,764,148Other
      liabilities
            
            
            (34,100
            )
            
            
            53,026
            
            
            
            83,651Net
      cash provided by operating activities
            
            
            185,890
            
            
            
            363,208
            
            
            
            2,137,218Cash
      flows from investing activities:Proceeds
      from sale of
      equipment
            
            
            56,058
            
            
            
            686,510
            
            
            
            -Acquisition
      of property and equipment
            
            
            (543,117
            )
            
            
            (819,876
            )
            
            
            (725,498
            )Net
      cash used in investing
      activities
            
            
            (487,059
            )
            
            
            (133,366
            )
            
            
            (725,498
            )Cash
      flows from financing activities:Proceeds
      from exercise of stock options and warrants
            
            
            -
            
            
            
            -
            
            
            
            42,746Proceeds
      from issuance of stock options and warrants, net of issuance
      costs
            
            
            -
            
            
            
            -
            
            
            
            2,463,017Revolver
      note borrowings
            
            
            350,000
            
            
            
            1,200,000
            
            
            
            4,307,806Repayment
      of revolver note borrowings
            
            
            -
            
            
            
            (521,722
            )
            
            
            (500,000
            )Term
      note borrowings, net of issuance costs
            
            
            125,000
            
            
            
            -
            
            
            
            7,131,720Payments
      on term note
            
            
            -
            
            
            
            (125,000
            )
            
            
            (449,840
            )Proceeds
      from other notes including related party
            
            
            -
            
            
            
            -
            
            
            
            291,753Payments
      of demand note payable to related party
            
            
            -
            
            
            
            -
            
            
            
            (579,794
            )Payments
      of notes payable
            
            
            (144,064
            )
            
            
            (1,003,528
            )
            
            
            (13,687,882
            )Payments
      of capital lease obligations
            
            
            (138,101
            )
            
            
            (328,668
            )
            
            
            (452,232
            )Net
      cash (used in) provided by financing activities
            
            
            192,835
            
            
            
            (778,918
            )
            
            
            (1,432,706
            )Net
      effect of foreign currency exchange translation on cash
            
            
            (26,777
            )
            
            
            29,935
            
            
            
            5,171Net
      decrease in cash and cash equivalents
            
            
            (135,111
            )
            
            
            (519,141
            )
            
            
            (15,815
            )Cash
      and cash equivalents, beginning of year
            
            
            2,399,717
            
            
            
            2,918,858
            
            
            
            2,934,673Cash
      and cash equivalents, end of
      year
            
            $
            2,264,606
            
            
            $
            2,399,717
            
            
            $
            2,918,858




See
accompanying notes to consolidated financial statements.









40








TALON
INTERNATIONAL, INC.




CONSOLIDATED
STATEMENTS OF CASH FLOWS







Supplemental
      disclosures of cash flow information:
            
            Year
      ended December 31, 2009
            
            
            Year
      ended December 31, 2008
            
            
            Year
      ended December 31, 2007Cash received (paid) during the
      year for:Interest paid
            
            $
            (1,037,683
            )
            
            $
            (1,301,790
            )
            
            $
            (1,166,333
            )Interest received
            
            $
            1,675
            
            
            $
            15,509
            
            
            $
            182,263Income taxes paid (principally
      foreign)
            
            $
            (91,136
            )
            
            $
            (183,970
            )
            
            $
            (90,530
            )Non-cash financing
      activity:Notes
      payable issued in modification of loan agreement
            
            $
            -
            
            
            $
            1,000,000
            
            
            $
            -Note
      payable issued for executive bonus earned
            
            $
            35,000
            
            
            $
            -
            
            
            $
            -Debt
      waiver, modification fee and interest
            
            $
            236,337
            
            
            $
            145,000
            
            
            $
            -Notes
      receivable, converted to marketable securities
            
            $
            -
            
            
            $
            1,040,000
            
            
            $
            -Deferred
      financing cost
            
            $
            -
            
            
            $
            -
            
            
            $
            217,302Capital lease obligation
            
            $
            31,450
            
            
            $
            -
            
            
            $
            57,793Effect
      of foreign currency translation on net assets
            
            $
            (25,448
            )
            
            $
            55,293
            
            
            $
            44,444








See
accompanying notes to consolidated financial statements.






41








TALON
INTERNATIONAL, INC.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS






NOTE
1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




Nature
of Business




Talon
International, Inc. (together with its subsidiaries, 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




Talon
International, Inc. is the parent holding company of Tag-It, Inc., a California
corporation, Tag-It Pacific (HK) Ltd., a BVI corporation, TagIt 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 the Company 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 Talon International, Inc.




On July
20, 2007, the Company changed its corporate name from Tag-It Pacific, Inc. to
Talon International, Inc.




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’ deficit, if material, and transaction gains and losses, if any,
are recorded in the consolidated statement of operations in the period
incurred.  During 2009, 2008 and 2007, 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.  The accounting estimates that require the Company’s most
significant, difficult and subjective judgments include the valuation of
marketable equity securities; the valuation allowance for accounts receivable,
notes receivable and inventory and the assessment of recoverability of
long-lived assets and intangible assets, stock-based compensation and the
recognition and measurement of current and deferred income taxes (including the
measurement of uncertain tax positions). Actual results could differ materially
from the Company’s estimates.






42









TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS






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 $1.0 million and $0.9 million at financial institutions in excess
of governmentally insured limits at December 31, 2009 and 2008. The Company has
pledged cash of $252,324 as a compensating balance collateral in a legal dispute
with a trade supplier in China. The pledge will be eliminated upon settlement of
the dispute or upon the Company’s payment of the trade payable of the same
amount.




Marketable
Securities




The portfolio of marketable securities
is stated at the lower of cost or market at the balance sheet date and consists
of common stocks.  The Company accounts for its investments, which are
all available for sales securities, under the provisions of Financial Accounting
Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No.320,“Investments - Debt and Equity
Securities” (“ASC 320”). Realized gains or losses are determined on the
specific identification method and are reflected in
income.  Unrealized losses are recorded directly in other
comprehensive income except those unrealized losses that are deemed to be other
than temporary, which losses are reflected in income.




Allowance
for Accounts and Notes Receivable Doubtful Accounts




The
Company is required to make judgments as to the collectability of accounts and
notes receivable based on established aging policy, historical experience and
future expectations. The allowances for doubtful accounts represent allowances
for customer trade accounts and notes receivable that are estimated to be
partially or entirely uncollectible. These allowances are used to reduce gross
trade receivables or note receivable to their net realizable value. The Company
records 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 the Company’s historical experience, for
issues not yet identified.  The total allowance for accounts
receivable doubtful accounts at December 31, 2009 and 2008 was $232,329 and
$217,323, respectively, and for notes receivable at December 2009 and 2008 was
$720,417 and $474,010, respectively. See Note 3.




Inventories




Inventories
are stated at the lower of cost, determined using the first-in, first-out basis,
or market value and are all substantially finished goods. The costs of inventory
include the purchase price, inbound freight and duties, conversion costs and
certain allocated production overhead costs.  Inventory reserves are
recorded for damaged, obsolete, excess and slow-moving inventory. The Company
uses 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.










43





TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Inventories
consist of the following:


December
      31,2009
            
            
            2008Finished
      goods
            
            $
            2,863,923
            
            
            $
            2,880,319Less
      inventory valuation
      reserves
            
            
            1,184,621
            
            
            
            1,211,170Total
      inventories
            
            $
            1,679,302
            
            
            $
            1,669,149





Impairment
of Long-Lived Assets





The
Company records 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 the Company’s long-lived assets. See Property
and Equipment section.





Property
and Equipment




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.




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
            1
      year







Property
and equipment consist of the following:


December
      31,2009
            
            
            2008Furniture
      and fixtures
            
            $
            270,927
            
            
            $
            613,924Machinery
      and equipment
            
            
            838,636
            
            
            
            365,951Computer
      equipment
            
            
            3,774,748
            
            
            
            3,654,765Leasehold
      improvements
            
            
            358,063
            
            
            
            332,270Dies
      and molds
            
            
            34,336
            
            
            
            106,273Equipment
      held for sale
            
            
            65,000
            
            
            
            407,6555,341,710
            
            
            
            5,480,838Accumulated
      depreciation and amortization
            
            
            3,061,124
            
            
            
            2,988,939Net
      property and equipment
            
            $
            2,280,586
            
            
            $
            2,491,899







44





TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Depreciation
expense for the years ended December 31, 2009, 2008 and 2007 was $725,979,
$1,079,441 and $1,136,000 respectively.




Equipment
held for sale at December 31, 2008 of $407,655 consisted of idle equipment which
was principally machinery and equipment formerly used for the production of
zipper chain and the assembly of finished zippers in the production and assembly
facilities in North Carolina and in Mexico and was temporarily rendered idle
with the closing of those operations in 2005. The Company relocated this
equipment to Asia in 2008 to more effectively redeploy or sell the
equipment.  The Company analyzed the potential sales value of the
equipment and determined that it was likely that a sale of this equipment would
not recover its original carrying value. As a result, at December 31, 2008 the
Company recorded an impairment charge of $2,026,000 for the difference between
the estimated sales value of the equipment and the previous carrying
value.  The adjusted carrying value of the equipment at December 31,
2008 was approximately $350,000. The Company also determined that certain
components of its Tekfit equipment, which is used in the manufacture of the
Tekfit proprietary stretch waistband, would not be redeployed as a consequence
of lower demand for this product and the effect of the current economic crisis
on the apparel industry.  As a result at December 31, 2008 the Company
recorded an impairment charge of $403,500 for the Tekfit equipment which will
not be utilized in foreseeable operations. The adjusted carrying value of this
equipment at December 31, 2008 was approximately $58,000.




Equipment
held for sale net book value at December 31, 2009 was $65,000. During 2009
various impaired assets were redeployed back into operations at their former
carrying values or at fair values, or sold for amounts consistent with the
adjusted values




Intangible
Assets, net




Intangible
assets consist of tradename and exclusive license and intellectual property
rights.  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 ASC 350, “Intangibles
– Goodwill and
Other”. 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
ASC 360, “Property, Plant, and
Equipment”.




At
December 31, 2009, the Company evaluated its 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, 2009 and
2008.  Amortization expense related to exclusive license and
intellectual property rights of $29,000 were recorded for the year ended
December 31, 2007. During the first quarter of 2007, the exclusive license and
intellectual property became fully amortized, thus no amortization expense for
intangible assets was recorded for the years ended December 31, 2009 and
2008.




Intangible
assets as of December 31, 2009 and 2008 are as follows:




December
      31,2009
            
            
            2008Tradename
            
            $
            4,110,751
            
            
            $
            4,110,751Accumulated
      amortization
            
            
            -
            
            
            
            -Tradename,
      net
            
            
            4,110,751
            
            
            
            4,110,751Exclusive
      license and intellectual property rights
            
            
            612,500
            
            
            
            612,500Accumulated
      amortization
            
            
            (612,500
            )
            
            
            (612,500
            )Exclusive
      license and intellectual property rights, net
            
            
            -
            
            
            
            -Intangible
      assets, net
            
            $
            4,110,751
            
            
            $
            4,110,751







45








TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




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 the Company 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 FASB ASC 740, "Income Taxes," (“ASC 740”)
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.  ASC 740
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.





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.





On
January 1, 2007 the Company adopted the provisions of accounting guidance
regarding uncertain income tax positions under ASC 740. ASC 740 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements and prescribes a recognition threshold and measurement
process for financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return.  ASC 740 also provides
guidance on the recognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition associated with income tax
liabilities. As a result of the implementation of ASC 740, the Company
recognized an increase in liabilities for unrecognized tax benefits of
approximately $245,800, which was accounted for as an increase in the January 1,
2007 accumulated deficit. See Note 10.





Stock-Based
Compensation





The Company has employee equity
incentive plans, which are described more fully in Note 8. Effective
January 1, 2006, the Company adopted FASB ASC 718, “Compensation - Stock
Compensation” (“ASC 718”), 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.  Accordingly, the Company
measure share-based compensation at the grant date based on the fair value of
the award.




The
Company adopted ASC 718 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 years ended December 31,
2007, 2008 and 2009 reflect the impact of ASC 718.




Options issued to consultants, which
are more fully described in Note 8, are accounted for in accordance with the
provisions of FASB ASC 505-50, “Equity-Based Payments to
Non-Employees”.







46






TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




ASC 718
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 years ended December 31,
2009, 2008 and 2007 included compensation expense for share-based payment awards
granted prior to, but not yet vested as of January 1 of the applicable year
based on the grant date fair value estimated in accordance with the pro-forma
provisions of ASC 718 and compensation expense for the share-based payment
awards granted subsequent to January 1 based on the grant date fair value
estimated in accordance with the provisions of ASC 718.  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
2009, 2008  and 2007 is based on awards expected to vest, ASC 718
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 years ended December 31, 2009, 2008 and 2007,
expected forfeitures are immaterial and as such the Company is recognizing
forfeitures as they occur.




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 volatility using historical
data.  The expected option term is estimated using the “safe harbor”
provisions under ASC 718.




Foreign
Currency Translation




The
Company has operations and holds assets in various foreign
countries.  The local currency is the functional currency for the
Company’s subsidiaries in China and India.  Assets and liabilities are
translated at end-of-period exchange rates while revenues and expenses are
translated at the average exchange rates in effect during the
period.  Equity is translated at historical rates and the resulting
cumulative translation adjustments are included as a component of accumulated
other comprehensive income (loss) until the translation adjustments are
realized. Gains and losses resulting from foreign currency transactions and
remeasurement adjustments of monetary assets and liabilities not held in an
entity’s functional currency (affects primarily the Company’s subsidiary in Hong
Kong where the local currency Hong Kong Dollar is not the functional currency)
are included in earnings.




Comprehensive
Income




The
Company has adopted FASB ASC 220,
"Comprehensive
Income”” (“ASC 220”), issued by the FASB and effective for financial
statements with fiscal years beginning after December 15, 1997. ASC 220
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements.




Included
in comprehensive income for the years ended December 31, 2009, 2008 and 2007 are
unrealized gains (losses) in foreign currency translation of $(25,448) and
$55,293 and $44,444, respectively. The foreign currency translation adjustment
represents the net currency translation adjustment gains and losses related to
the Company’s China and India subsidiaries.









47







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




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 2009 presentation including Fixed Assets Held for Sale, which is now
part of Property and Equipment.




Classification
of Expenses




Cost of Goods Sold - 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.




Sales and Marketing Expense –
Sales and marketing 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.




Interest Expense and Interest
Income – Interest expense reflects the cost of borrowing and amortization
of deferred financing costs and discounts.  Interest expense for the
years ended December 31, 2009, 2008 and 2007 was $2,735,438, $2,500,740 and
$1,922,062, respectively.  Interest income of $7,518, $64,065 and
$241,983 for the years ended December 31, 2009, 2008 and 2007, respectively,
consists of earnings from outstanding amounts due to the Company under notes and
other interest bearing receivables.




Shipping
and Handling 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 goods sold.









48










TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Litigation




The Company is  currently
involved in various lawsuits, claims and inquiries, most of which are routine to
the nature of the business and in accordance with FASB ASC450, “Contingencies”, the Company accrue estimates of the
probable and estimable losses for the resolution of these claims. The ultimate
resolution of these claims could affect the Company’s future results of
operations for any particular quarterly or annual period should the Company’s
exposure be materially different from the Company’s earlier estimates or should
liabilities be incurred that were not previously accrued. See Note
11.




Fair
Value of Financial Information






Effective
January 1, 2008, the Company adopted Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC”) No 820, “Fair Value Measurements and
Disclosures” (“ASC 820”). Fair value is defined as an exit price,
representing the amount that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants. As
such, fair value is a market-based measurement that should be determined based
on assumptions that market participants would use in pricing an asset or a
liability. As a basis for considering such assumptions, the guidance establishes
a three-tier value hierarchy, which prioritizes the inputs used in the valuation
methodologies in measuring fair value:






Level 1—Observable
inputs that reflect quoted prices (unadjusted) for identical assets or
liabilities in active markets.






Level 2—Include
other inputs that are directly or indirectly observable in the
marketplace.






Level 3—Unobservable
inputs which are supported by little or no market activity.






The fair
value hierarchy also requires an entity to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair
value.




In
accordance with this guidance, the Company measures its cash equivalents at fair
value. The Company’s cash equivalents are classified within Level 1. Cash
equivalents are valued primarily using quoted market prices utilizing market
observable inputs. At December 31, 2009, cash equivalents consisted of
money market funds measured at fair value on a recurring basis. Fair value of
the Company’s money market funds was approximately $495,000 at December 31,
2009.




Effective
January 1, 2009, the Company adopted the FASB staff position that delayed
the guidance on fair value measurements for non financial assets and non
financial liabilities. The adoption of this guidance did not have a material
impact on the Company's consolidated financial statements.




New
Accounting Pronouncements





In
June 2009, the Financial FASB issued ASC 105-10, “Generally Accepted Accounting
Principles”(“ASC 105-10”). Effective for the Company’s financial
statements issued for interim and annual periods commencing with the quarterly
period ended September 30, 2009, the FASB Accounting Standards Codification
(“Codification” or “ASC”) is the source of authoritative U.S. GAAP recognized by
the FASB to be applied by nongovernmental entities. Rules and interpretive
releases of the SEC under authority of federal securities laws are also sources
of authoritative GAAP for SEC registrants.






49








TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The
Codification supersedes all then-existing, non-SEC accounting and reporting
standards. In the FASB’s view, the Codification does not change GAAP, and
therefore the adoption of ASC 105-10, Generally Accepted Accounting Principles,
did not have an effect on the Company’s consolidated financial position, results
of operations or cash flows. However, where the Company has referred to specific
authoritative accounting literature, the Codification is disclosed.





In
April 2009, the FASB issued ASC 820-10, “Fair Value Measurements and
Disclosures” (Topic 820). ASC 820-10 provides guidance on how to
determine the fair value of assets and liabilities when the volume and level of
activity for the asset/liability has significantly decreased. ASC 820-10 also
provides guidance on identifying circumstances that indicate a transaction is
not orderly. In addition, ASC 820-10 requires disclosure in interim and annual
periods of the inputs and valuation techniques used to measure fair value and a
discussion of changes in valuation techniques. ASC 820-10 was effective
beginning in the second quarter of fiscal year 2009. The adoption of ASC 820-10
did not have a material impact on the consolidated financial
statements.





In
April 2009, the FASB issued ASC 320-10, “Investments - Debt and Equity
Securities” (“ASC 320-10”). ASC 320-10 amends the requirements for the
recognition and measurement of other-than-temporary impairments for debt
securities by modifying the pre-existing “intent and ability” indicator. Under
ASC 320-10, other-than-temporary impairment is triggered when there is an intent
to sell the security, it is more likely than not that the security will be
required to be sold before recovery, or the security is not expected to recover
the entire amortized cost basis of the security. Additionally, ASC 320-10
changes the presentation of other-than-temporary impairment in the income
statement for those impairments involving credit losses. The credit loss
component will be recognized in earnings and the remainder of the impairment
will be recorded in other comprehensive income. ASC 320-10 was effective
beginning in the second quarter of fiscal year 2009. The implementation of ASC
320-10 did not have a material impact on the consolidated financial
statements.





In
April 2009, the FASB issued ASC 825-10, “Financial Instruments” (“ASC
825-10”). ASC 825-10 requires interim disclosures regarding the fair values of
financial instruments. Additionally, ASC 825-10 requires disclosure of the
methods and significant assumptions used to estimate the fair value of financial
instruments on an interim basis as well as changes of the methods and
significant assumptions from prior periods. ASC 825-10 does not change the
accounting treatment for these financial instruments and did not have a material
impact on the consolidated financial statements.





In
April 2009, the FASB issued ASC 805, “Business Combinations”(“ASC
805”). ASC 805 amends the original guidance relating to the initial recognition
and measurement, subsequent measurement and accounting and disclosures of assets
and liabilities arising from contingencies in a business combination which were
adopted by the Company as of the beginning of fiscal 2009 and it did not have a
material impact on the consolidated financial statements. The Company will apply
the requirements of ASC 805 prospectively to any future
acquisitions.




In May
2009, the FASB issued ASC 855-10, “Subsequent Events” (“ASC
855-10”). ASC 855-10 provides general standards of accounting for and disclosure
of events that occur after the balance sheet date but before financial
statements are issued or are available to be issued. ASC 855-10 was adopted by
the Company in the second quarter of 2009 and did not have a material impact on
the consolidated financial statements. The implementation of ASC 855-10 did not
have a material impact on the consolidated financial statements. See Note 16 for
the disclosures regarding ASC 855-10.




In June
2009, the FASB issued ASC 860, “Transfers and Servicing”
(”ASC 860”). ASC 860 seeks to improve the relevance, representational
faithfulness, and comparability of the information that a reporting entity
provides in its financial statements about a transfer of financial assets; the
effects of a transfer on its financial position, financial performance, and cash
flows  and a transferor’s continuing involvement, if any, in
transferred financial assets. ASC 860 is applicable for annual periods beginning
after November 15, 2009. The implementation of ASC 860 is not expected to have a
material impact on the consolidated financial statements.






50





TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





In
June 2009, the FASB issued accounting guidance contained within ASC 810,
“Consolidations”, which
pertains to the consolidation of variable interest entities “Amendments to FASB
Interpretation No. 46R”, (“ASC 810”). This guidance within ASC 810 requires
an analysis to be performed to determine whether a variable interest gives the
entity a controlling financial interest in a variable interest entity. This
standard requires an ongoing reassessment and eliminates the quantitative
approach previously required for determining whether an entity is the primary
beneficiary. This standard is effective for fiscal years beginning after
November 15, 2009. The implementation of ASC 810 is not expected to have an
impact on the consolidated financial statements.




In
August 2009, the FASB issued ASC 820-10-35, “Fair Value Measurements and
Disclosures” (“ASC 820-10-35”), which provides amendments to Topic 820.
ASC 820-10-35 provides additional guidance clarifying the measurement of
liabilities at fair value. ASC 820-10-35 is effective in the fourth quarter 2009
for a calendar year entity. ASC 820-10-35 did not have a material impact on the
consolidated financial statements.




In
January 2010, the FASB issued Accounting Standards Update 2010-06, “Fair Value Measurements and
Disclosures” (Topic 820): Improving Disclosures about Fair Value
Measurements.  This guidance amends the disclosure requirements
related to recurring and nonrecurring fair value measurements and requires new
disclosures on the transfers of assets and liabilities between Level 1 (quoted
prices in active market for identical assets or liabilities) and Level 2
(significant other observable inputs) of the fair value measurement hierarchy,
including the reasons and the timing of the transfers. Additionally, the
guidance requires a roll forward of activities on purchases, sales, issuance and
settlements of the assets and liabilities measured using significant
unobservable inputs (Level 3 fair value measurements). The guidance will become
effective for the reporting period beginning January 1, 2010, except for the
disclosure on the roll forward activities for Level 3 fair value measurements,
which will become effective for the reporting period beginning January 1, 2011.
Other than requiring additional disclosures, adoption of this new guidance will
not have a material impact on the Company’s consolidated financial
statements.









NOTE
2 — SIGNIFICANT RISKS AND UNCERTAINTIES




The
Company’s consolidated financial statements have been prepared on a going
concern basis of accounting which contemplates the continuity of operations and
the realization of assets, liabilities and commitments in the normal course of
business. During the years 2009 and 2008, the Company experienced net losses,
and has a working capital deficit and an accumulated deficit as of December 31,
2009 of $17,056,232 and $66,344,009, respectively.




The
Company’s cash flows from operating activities in 2010 will not be sufficient to
make the debt payments of $14,865,102 due at June 30, 2010 as required by the
Revolving Credit and Term Loan Agreement with CVC California, LLC (“CVC”).
Accordingly an extension or modification of the CVC debt will be required prior
to the due date or it will be necessary for the Company to raise additional debt
or equity financing in order to satisfy the CVC debt. If the Company cannot
obtain an extension or modification of the CVC debt, or raise additional equity
or debt to satisfy this requirement it will default on the CVC credit agreement.
There can be no assurance that additional debt or equity financing will be
available to the Company on acceptable terms or at all.   If the
Company is unable to secure additional financing and satisfy its debt obligation
to CVC the Company’s financial condition and results of operations could be
materially adversely affected and the Company may not be able to continue to
operate as a going concern.  See Note 6.




At
December 31, 2009 the Company was in compliance with the minimum EBITDA
requirements of the CVC credit agreement; however it is uncertain whether the
Company will be in compliance with the financial covenants in future
quarters.  As of March 31, 2009 and at December 31, 2008, the Company
failed to meet the minimum EBITDA requirements in the CVC credit agreement and
was required to pay a fee to waive these requirements.






51









TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The
Company’s consolidated financial statements do not reflect any adjustments
relating to the recoverability and classification of recorded asset amounts or
classification of liabilities that would be required if a default under the
Company’s credit agreement occurred and the Company was unable to obtain a
waiver, modify the covenants, or satisfy the payment obligations under the
agreement.




The
Company’s performance is subject to worldwide economic conditions and their
impact on levels of consumer spending that affect not only the ultimate
consumer, but also retailers, which constitute many of its largest customers.
Consumer spending has deteriorated significantly over the last eighteen months
and may remain depressed, or be subject to further deterioration for the
foreseeable future. The worldwide apparel industry is heavily influenced by
general economic cycles. Purchases of fashion apparel and accessories tend to
decline in periods of recession or uncertainty regarding future economic
prospects, as disposable income declines. Many factors affect the level of
consumer spending in the apparel industries, including, among others: prevailing
economic conditions, levels of employment, salaries and wage rates, energy
costs, interest rates, the availability of consumer credit, taxation and
consumer confidence in future economic conditions.




During
periods of recession or economic uncertainty, the Company may not be able to
maintain or increase the sales to existing customers, make sales to new
customers or maintain the Company’s earnings from operations as a percentage of
net sales. As a result, the operating results may be adversely and materially
affected by sustained or further downward trends in the United States or global
economy. The Company’s ability to continue as a going concern is dependent on
its ability to generate sufficient cash flow to meet its obligations on a timely
basis, to obtain additional financing as may be required and ultimately to
attain profitable operations.




In
response to these conditions, the Company has taken steps to significantly
reduce its operating costs, eliminate employees in response to lower volumes,
and curtail capital and discretionary spending to better align the Company’s
organizational and cost structures with future Company and industry expectations
and uncertainties and insure the Company will have sufficient cash flow to cover
its operating needs.   The Company has also implemented programs
to increase sales incentives, to secure preferred supplier status with customers
and to accelerate cash collections from customers.




There can
be no assurance, however, that the Company will be successful in any of these
matters or that the Company’s efforts will be sufficient to ensure the Company
can continue as a going concern.









NOTE
3 — NOTE RECEIVABLE FROM RELATED PARTY, NET




Note
Receivable from Related Party, Net at December 31, 2009 and 2008 include the
unsecured note and accrued interest receivable net of valuation reserves, of $0
and $200,000, respectively due from Colin Dyne, a director and stockholder of
the Company. The note bears interest at 7.5% and is due on
demand.  The amount of principal and accrued interest due from Colin
Dyne under this note at December 31, 2009 and 2008 was $720,417 and $674,010,
respectively.  The Company has recorded a valuation reserve against
this note of $720,417 and $474,010 at December 31, 2009 and 2008,
respectively.






52






TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





In
determining the fair value of the Note Receivable, the Company analyzed the
expected recovery of the note amount and the collection period for the
anticipated note payments, the risk of receiving these payments, and commissions
expected to be earned under the agreement to pay commissions on collected
revenues of the business opportunities presented to the Company. Anticipated
payments on this note in 2008 and 2009 were not received. Accordingly, full
collection of this note is considered at risk, and the Company is reviewing
collection remedies. In November 2009, the Company entered into an agreement to
pay a commission to an affiliate of Colin Dyne of 7% of collected revenues
associated with the sales of selected business opportunities, with 2% of the 7%
earned applied to the note receivable balance.  Commissions of $16,524
were paid in cash and $5,483 were applied to the note receivable balance for the
year ended December 31, 2009. During the years ended December 31, 2009 and 2008
the Company recorded impairment charges of $200,000 and $474,010, respectively
against this note.









NOTE
4 — NOTES PAYABLE TO RELATED PARTIES




Demand
notes payable to related parties consist of two notes payable issued from
1995-1998 to parties related to or affiliated with a director of the Company
with interest rates of 10% per annum, due and payable on the fifteenth day
following delivery of written demand for payment.




On August
6, 2009 a note was issued to Lonnie D. Schnell, the Chief Executive Officer and
Chief Financial Officer of the Company in partial satisfaction of 2008 annual
incentive awards to which Mr. Schnell was entitled.  The note bears 6%
interest annually and the maturity date is the earlier of December 31, 2011 or
ten days following Mr. Schnell’s employment termination date.  The
note is fully presented in current liabilities. Interest on the note began
accruing as of April 16, 2009 the date the award was originally required to be
paid.




The
outstanding amounts of notes payable to related parties in current liabilities
as of December 31, 2009 and 2008 were $265,871 and $222,264,
respectively.




Interest
expense, interest accrual and interest amount paid related to the notes payable
to related parties for the years ended December 31, 2009, 2008 and 2007 are as
follows:




Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Interest
      expense
            
            $
            8,608
            
            
            $
            9,173
            
            
            $
            30,568Accrued
      interest balance
            
            $
            145,696
            
            
            $
            137,088
            
            
            $
            127,915Interest
      paid
            
            $
            -
            
            
            $
            -
            
            
            $
            518,546









53







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
5 — LONG TERM OBLIGATIONS




Capital
Leases




The
Company financed equipment purchases through various capital lease obligations
expiring through June 2014.  These obligations bear interest at
various rates ranging from 8.0% to 15.4% per annum.  Future minimum
annual payments under these capital lease obligations are as
follows:




Years ending December 31,
            
            Amount2010
            
            $
            58,3612011
            
            
            9,2472012
            
            
            9,2472013
            
            
            8,9062014
            
            
            2,578Total
      payments
            
            
            88,339Less
      amount representing
      interest
            
            
            (10,636
            )Balance
      at December 31,
      2009
            
            
            77,703Less
      current
      portion
            
            
            54,226Long-term
      portion
            
            $
            23,477








At
December 31, 2009, total property and equipment under capital lease obligations
and related accumulated depreciation was $1,025,034 and $405,445
respectively.  At December 31, 2008, total property and equipment
under capital lease obligations and related accumulated depreciation was
$840,914 and $479,742, respectively.





Notes
Payable





Notes
payable consist of the following:


December
      31,2009
            
            
            2008$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; note payments were accelerated in October
      2008 changing the monthly payments to $25,000 and the unpaid principal and
      interest due from November 22, 2009 to June 30, 2009; secured by
      manufacturing equipment
            
            $
            -
            
            
            $
            144,064$25,200
      demand note payable to E.C.D. International dated September 30, 1995;
      interest at 10.0%; payable on the fifteenth day following delivery of
      written demand for payment; balance includes accrued interest of
      $35,910
            
            
            61,110
            
            
            
            58,590Notes
      Payable
            
            
            61,110
            
            
            
            202,654Less
      Current portion
            
            
            61,110
            
            
            
            202,654Notes
      payable, net of current portion
            
            $
            -
            
            
            $
            -











54








TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





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





Years ending December 31,
            
            Amount2010
            
            $
            63,630Total
            
            $
            63,630







NOTE
6 — DEBT FACILITY




On June
27, 2007, the Company entered into a Revolving Credit and Term Loan Agreement
with Bluefin Capital, LLC that provides for a $5.0 million revolving credit loan
and a $9.5 million term loan for a three year period ending June 30,
2010.  Bluefin Capital subsequently assigned its rights and
obligations under the credit facility agreements to an affiliate, CVC
California, LLC.  The revolving credit portion of the facility permitted
borrowings based upon a formula including 75% of the Company’s eligible
receivables and 55% of eligible inventory, and provided for monthly interest
payments at the prime rate (3.25% at December 31, 2009) plus
2.0%.  The term loan bears interest at 8.5% annually with quarterly
interest payments and repayment in full at maturity.  Borrowings under
both credit facilities are secured by substantially all of the assets of the
Company.




In
connection with the Revolving Credit and Term Loan Agreement, the Company issued
1,500,000 shares of common stock to the lender for $0.001 per share, and issued
warrants to purchase 2,100,000 shares of common stock.  The warrants
were exercisable over a five-year period and initially 700,000 warrants were
exercisable at $0.95 per share; 700,000 warrants were exercisable at $1.05 per
share; and 700,000 warrants were exercisable at $1.14 per share.  The
warrants did not require cash settlements. The relative fair value of the equity
($2,374,169, which includes a reduction for financing costs) issued with this
debt facility was allocated to paid-in-capital and reflected as a debt discount
to the face value of the term note.




This
discount is being amortized over the term of the note and recognized as
additional interest cost as amortized.  Costs associated with the debt
facility included debt fees, commitment fees, registration fees and legal and
professional fees of $486,000.  The costs allocable to the debt
instruments are reflected as a reduction to the face value of the note on the
balance sheet.




On
November 19, 2007, the Company entered into an amendment to the credit agreement
to modify the original financial covenants and to extend until June 30, 2008 the
application of the original EBITDA covenant in exchange for additional common
stock of the Company and a price adjustment to the outstanding warrants issued
to the lender in connection with the loan agreement.  In connection
with this amendment the Company issued an additional 250,000 shares of common
stock to the lender for $0.001 per share, and the exercise price for all of the
previously issued warrants for the purchase of 2,100,000 shares of common stock
was amended to an exercise price of $0.75 per share.   The new
relative fair value of the equity issued with this debt of $2,430,000, including
the modifications in this amendment and a reduction for financing costs, is
being amortized over the term of the note.






55







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




On April
3, 2008, the Company executed a further amendment to the credit
agreement.  The amendment included a redefining of the EBITDA
covenants, and the cancellation of the common stock warrants previously issued
to the lender in exchange for the issuance by the Company of an additional note
payable to CVC for $1.0 million.  The note bears interest at 8.5% and
both the note and accrued interest are payable at maturity on June 30,
2010.  In addition, the Company’s borrowing base was modified in this
amendment by  increasing the allowable portion of inventory held by
third party vendors to $1.0 million with no more than $500,000 held at any one
vendor and increasing the percentage of accounts receivable to be included in
the borrowing base to 85%. The Company incurred a one-time modification fee of
$145,000 to secure the amendment.  The new relative fair value of the
equity issued with this debt of $2,542,000, including the modifications in this
amendment and a reduction for financing costs, is being amortized over the term
of the note.




In
connection with the April 2008 amendment the Company evaluated the debt
amendment under ASC 470-50, “Debt - Modifications and
Extinguishments”.  It was determined that the debt modification
did not constitute a material change as defined by ASC 470-50 and did not
qualify for treatment as a troubled debt restructuring.  Accordingly,
the Company recorded a reduction to equity and an increase to notes payable for
the fair value of the warrants of $260,205 and the difference ($739,795) between
the fair value of the warrants at the time of repurchase and the face value of
the note has been recorded as an additional deferred cost and is reflected as a
reduction to the face value of the note on the balance sheet.  This
cost is being amortized using the interest-method over the life of the modified
notes and is to be reflected as interest expense.




Under the
terms of the credit agreement, as amended, the Company is required to meet
certain coverage ratios, among other restrictions, including a restriction from
declaring or paying a dividend prior to repayment of all the obligations. The
financial covenants, as amended, require that the Company maintain at the end of
each fiscal quarter “EBITDA” (as defined in the agreement) in excess of the
principal and interest payments for the same period of not less than $1.00 and
in excess of ratios set out in the agreement for each quarter.




The
Company failed to satisfy the minimum EBITDA requirement for quarter ended
December 31, 2008 as well as the quarter ended March 31, 2009, and in connection
with such failures, on March 31, 2009 the Company entered into a further
amendment to the agreement with CVC.




This
amendment provided for the issuance of an additional term note to CVC in the
principal amount of $225,210 in lieu of paying a cash waiver fee in connection
with the Company’s failures to satisfy the EBITDA requirements for the quarters
ended December 31, 2008 and March 31, 2009; deferral of the term note quarterly
interest payment of $215,000 due April 1, 2009; a temporary increase to the
borrowing base formulas and calculations under the revolving credit facility;
the re-lending by CVC of $125,000 under the term loan portion of credit
facility; a consent to allow the Company to sell equipment that has been
designated as held for sale more fully described in Note 1; and the granting to
CVC of the right to designate a non-voting observer to attend all meetings of
the Company’s Board of Directors.




As of
December 31, 2009, the Company had outstanding borrowings of $10,725,210 under
the term notes (discounted carrying value of $9,876,114), and $4,988,988 under
the revolving credit note.




Interest
expense related to the Revolving Credit and Term Loan Agreement for the year
ended December 31, 2009 was $2,638,927, which includes $1,462,563 in
amortization of discounts and deferred financing costs.  Interest
expense related to the Revolving Credit and Term Loan Agreement for the year
ended December 31, 2008 was $2,370,570, which includes $1,186,837 in
amortization of discounts and deferred financing costs. Interest expense related
to the Revolving Credit and Term Loan Agreement for the year ended December 31,
2007 was $1,008,520, which includes $461,102 in amortization of discounts and
deferred financing.







56








TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
7 — STOCKHOLDERS’ DEFICIT AND 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.





Common
Stock





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
$612,500, which was fully amortized by the year ended December 31,
2007.   The Company is currently in litigation with this licensor
(See Notes 1 and 11).







NOTE
8 — STOCK OPTION INCENTIVE PLAN AND WARRANTS




Stock
Option Incentive Plan





The
Company accounts for stock-based awards to employees and directors in accordance
with FASB ASC 718, “Compensation - Stock
Compensation” (“ASC 718”), which requires the measurement and recognition
of compensation expense for all share-based payment awards made to employees and
directors based on estimated fair values. Options issued to consultants are
accounted for in accordance with the provisions of FASB ASC 505-50, “Equity-Based Payments to
Non-Employees”.






57







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





On July
14, 2008, at the Company’s annual meeting of stockholders, a new 2008 Stock Plan
was approved by the stockholders.  The 2008 Stock Plan authorizes up
to 2,500,000 shares of common stock for issuance pursuant to awards granted to
individuals under the plan. On July 31, 2007, at the Company’s annual meeting of
stockholders, the 2007 Stock Plan was approved which replaced the 1997 Stock
Plan. The 2007 Stock Plan authorizes up to 2,600,000 shares of common stock for
issuance pursuant to awards granted to individuals under the
plan.  Options granted to certain employees in 2008 include certain
vesting acceleration features based on Company performance as determined by the
Board of Directors each year. Consistent with ASC 718-10, the stock based
compensation expense for the employee options are recognized on a time-phased
vesting schedule through the vesting date of December 31, 2010.  In
calculating the outcome of meeting performance conditions for 2009 and 2008, the
Company did not meet performance criteria and accordingly, there was no
accelerated vesting for these options.  Options granted for the year
ended December 31, 2009 and 2008 totaled 1,955,000 and 2,960,000,
respectively.




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 years ending after 2006, the average market
price of the Company’s stock for the five trading days following 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.




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





Employees
      and Directors
            
            Number
      of
              Shares
            
            
            Weighted
      Average Exercise PriceOptions
      outstanding - January 1, 2007
            
            
            5,002,635
            
            
            $
            1.42Granted
            
            
            46,600
            
            
            $
            1.02Canceled
            
            
            (376,000
            )
            
            $
            0.76Options
      outstanding - December 31, 2007
            
            
            4,673,235
            
            
            $
            1.46Granted
            
            
            2,960,000
            
            
            $
            0.21Canceled
            
            
            (532,699
            )
            
            $
            0.69Options
      outstanding – December 31, 2008
            
            
            7,100,536
            
            
            $
            0.98Granted
            
            
            1,955,000
            
            
            $
            0.09Canceled
            
            
            (2,417,686
            )
            
            $
            0.96Options
      outstanding – December 31, 2009
            
            
            6,637,850
            
            
            $
            0.73








The
aggregate intrinsic value of stock options exercised during 2007 was $72,000,
which is the difference between the exercise prices of the stock versus the
quoted price of the Company’s common stock on the date the options were
exercised. There were no stock options exercised in 2009 and 2008.






58







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





The
Company has also issued certain warrants and options to
non-employees.  The following table summarizes all options issued to
Non-Employees:





Non-Employees
            
            Number
      of
              Shares
            
            
            Weighted
      Average Exercise PriceOptions
      & warants outstanding - January 1, 2007
            
            
            1,318,813
            
            
            $
            3.93Granted
            
            
            2,100,000
            
            
            $
            0.75Canceled
            
            
            (255,000
            )
            
            $
            2.73Options
      and warrants outstanding - December 31, 2007
            
            
            3,163,813
            
            
            $
            1.97Canceled
            
            
            (2,845,318
            )
            
            $
            0.55Options
      and warrants outstanding – December 31, 2008
            
            
            318,495
            
            
            $
            3.65Canceled
            
            
            (318,495
            )
            
            $
            3.65Options
      and warrants outstanding – December 31, 2009
            
            
            -
            
            
            
            -







The
Company’s determination of fair value of share-based payment awards on the date
of grant uses the Black-Scholes model and the assumptions noted in the following
table for the years ended December 31. 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 employee stock
option exercise behaviors.  The expected option term is estimated
using the “safe harbor” provisions under ASC 718. 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.






2009
            2008
            2007Expected
      volatility
            115-122%
            95%
            64%Expected
      term in years
            5.0-6.1
      yrs
            6.1
      yrs
            6.1
      yrsExpected
      dividends
            -
            -
            -Risk-free
      rate
            2.7-3.3%
            3.5%
            4.8%







A summary of the Company’s stock
option information under all Stock Plans as of December 31, 2009 is as
follows:




Employee
      and Director
            
            Number
      of Shares
            
            
            Weighted
      Average Exercise Price
            
            
            Weighted
      Average Remaining Contractual Life (Years)
            
            
            Intrinsic
      ValueOutstanding
      at December 31, 2009
            
            
            6,637,850
            
            
            $
            0.73
            
            
            
            7.6
            
            
            $
            0.00Outstanding
      at December 31, 2009
            
            
            6,637,850
            
            
            $
            0.73
            
            
            
            7.6
            
            
            $
            0.00Vested
      and Expected to Vest
            
            
            6,494,413
            
            
            $
            0.74
            
            
            
            7.6
            
            
            $
            0.00Exercisable
            
            
            3,886,713
            
            
            $
            1.11
            
            
            
            6.8
            
            
            $
            0.00








The
aggregate intrinsic value of the stock options is calculated as the difference
between the exercise price of a stock option and the quoted price of the
Company’s common stock at December 31, 2009. It excludes stock options that have
exercise prices in excess of the quoted price of the Company’s common stock at
December 31, 2009.






59






TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





There was
approximately $211,000 of total unrecognized compensation costs related to
non-vested stock options as of December 31, 2009. This cost is expected to be
recognized over the weighted-average period of 1.5 years.




When
options are exercised, the Company’s policy is to issue previously registered,
unissued shares of common stock.  In July of 2008 and 2007, at the
Company’s annual meetings of stockholders, the 2008 and 2007 Stock Plans were
approved, which authorize up to 2,500,000 and 2,600,000 shares of common stock,
respectively, for issuance pursuant to awards granted to individuals under the
plan.








NOTE
9 — NET LOSS PER SHARE




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




December
      31, 2009
            
            
            December
      31, 2008
            
            
            December
      31, 2007Years
      ended:
            
            Net
      loss
              (Numerator)
            
            
            Shares
      (Denominator)
            
            
            Per
      Share Amount
            
            
            Net
      loss (Numerator)
            
            
            Shares
      (Denominator)
            
            
            Per
      Share Amount
            
            
            Net
      loss (Numerator)
            
            
            Shares
      (Denominator)
            
            
            Per
      Share AmountBasic
      and diluted loss available to common stockholders
            
            $
            (2,692,977
            )
            
            
            20,291,433
            
            
            $
            (0.13
            )
            
            $
            (8,358,786
            )
            
            
            20,291,433
            
            
            $
            (0.41
            )
            
            $
            (4,921,707
            )
            
            
            20,155,563
            
            
            $
            (0.24
            )







Options
to purchase 6,637,850 shares of common stock for between $0.06 and $5.23, per
share were outstanding for the year ended December 31, 2009, but were not
included in the computation of diluted loss per share because the effect of
exercise or conversion would have an antidilutive effect on loss per
share.




Warrants
to purchase 318,495 shares for common stock for $3.65 and options to purchase
7,100,536 shares of common stock at between $0.18 and $5.23, per share were
outstanding for the year ended December 31, 2008, but were not included in the
computation of diluted loss per share because the effect of exercise or
conversion would have an antidilutive effect on loss per share.




Warrants
to purchase 3,163,813 shares for common stock for between $0.75 and $5.06 and
options to purchase 4,653,235 shares of common stock at between $0.37 and $5.23
were outstanding for the year ended December 31, 2007, but were not included in
the computation of diluted loss per share because the effect of exercise or
conversion would have an antidilutive effect on the net loss per
share.






60







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
10 — INCOME TAXES




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





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Current:Federal
            
            $
            -
            
            
            $
            3,754
            
            
            $
            40,030State
            
            
            (1,109
            )
            
            
            15,306
            
            
            
            4,559Foreign
            
            
            126,517
            
            
            
            51,539
            
            
            
            134,442125,408
            
            
            
            70,599
            
            
            
            179,031Deferred:Federal
            
            
            -
            
            
            
            40,030
            
            
            
            (40,030
            )State
            
            
            -
            
            
            
            1,059
            
            
            
            (1,059
            )Foreign
            
            
            128,726
            
            
            
            (151,460
            )
            
            
            (66,993
            )128,726
            
            
            
            (110,371
            )
            
            
            (108,082
            )$
            254,134
            
            
            $
            (39,772
            )
            
            $
            70,949





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





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Current:Federal
      statutory rate
            
            
            34.0
            %
            
            
            34.0
            %
            
            
            34.0
            %State
      taxes net of federal benefit
            
            
            0.0
            
            
            
            (0.1
            )
            
            
            (1.6
            )Income
      earned from foreign subsidiaries
            
            
            (0.6
            )
            
            
            (2.6
            )
            
            
            (54.9
            )Net
      operating loss valuation allowance adjustments
            
            
            (23.2
            )
            
            
            (33.4
            )
            
            
            (18.4
            )Change
      in effective state tax rate
            
            
            -
            
            
            
            -
            
            
            
            0.1Other
            
            
            (20.6
            )
            
            
            2.6
            
            
            
            39.3(10.4
            )%
            
            
            0.5
            %
            
            
            (1.5
            )%







Net loss
before income taxes is as follows:





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Domestic
            
            $
            (2,180,959
            )
            
            $
            (6,844,883
            )
            
            $
            (11,827,832
            )Foreign
            
            
            (257,884
            )
            
            
            (1,553,675
            )
            
            
            6,977,074$
            (2,438,843
            )
            
            $
            (8,398,558
            )
            
            $
            (4,850,758
            )









61







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





The
primary components of temporary differences which give rise to the Company’s
deferred tax presented as part of other assets in the Company’s balance sheet
are as follows:




December
      31,2009
            
            
            2008Net
      deferred tax asset:Net
      operating loss carry-forward
            
            $
            23,330,598
            
            
            $
            22,122,386Depreciation
      and amoritzation (liability)
            
            
            (480,643
            )
            
            
            82,623Bad
      debt and note receivable allowance
            
            
            286,226
            
            
            
            195,933Marketable
      security impairment
            
            
            -
            
            
            
            399,038Related
      party interest
            
            
            57,073
            
            
            
            155,210Inventory
      allowance
            
            
            32,009
            
            
            
            171,496Credit
      carryforwards
            
            
            116,271
            
            
            
            95,221Stock
      options expense
            
            
            515,439
            
            
            
            389,186Payroll
      and director's fee
            
            
            295,145
            
            
            
            50,862Other
            
            
            82,806
            
            
            
            25,00024,234,924
            
            
            
            23,686,955Less:
      Valuation allowance
            
            
            (24,145,360
            )
            
            
            (23,468,657
            )$
            89,564
            
            
            $
            218,298







On
January 1, 2007 the Company adopted the provisions of new accounting guidance
regarding uncertain income tax positions. This guidance is found under FASB ASC
Topic 740 “Income
Taxes” (“ASC 740”). ASC 740 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements and prescribes a
recognition threshold and measurement process for financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return.  ASC 740 also provides guidance on the recognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition associated with income tax liabilities.





As a
result of the implementation of ASC 740, the Company recognized an increase in
liabilities for unrecognized tax benefits of $245,800, which was accounted for
as an increase in the January 1, 2007 accumulated deficit. Interest recorded per
ASC 740 is recorded as part of interest expense, net in the Company’s statements
of operations.





A
reconciliation of the ASC 740 adjustments is as follows:





Year
      Ended December 31,2009
            
            
            2008Beginning
      Balance
            
            $
            274,000
            
            
            $
            258,000Interest
      and penalties
            
            
            15,525
            
            
            
            16,000Ending Balance
            
            $
            289,525
            
            
            $
            274,000










62







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





At
December 31, 2009 and 2008, Talon International, Inc. had Federal net operating
loss carry-forwards (or “NOLs”) of approximately $62.3 million and $60.2
million, respectively and state NOLs of $29.5 million and $24.0 million
respectively.  The Federal NOL is available to offset future taxable
income through 2026, and the state NOL expires in 2029.  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.  The Company had a
limitation due to Section 382 during 2004 to 2006; however, as of December 31,
2009 the Company has no limitation. Thus, the limitation has had no impact on
the Company’s NOL carry-forwards.




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 ASC 740 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. ASC
740 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 2009,
2008 and 2007, 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 domestic and foreign deferred tax assets in future year
with the exception of the alternative minimum tax credit carry-forward of
$41,089 in 2007.  Accordingly, at December 31, 2009, and 2008 the
Company has recorded a valuation allowance of $24.1 million and $23.5 million,
respectively; which reduces the carrying value of its net deferred tax
assets.




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, 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.




In 2009
and 2008 there were no undistributed earnings from its foreign subsidiaries. In
2007, the Company included in its consolidated U.S. federal tax return as a
deemed dividend, $4.6 million which was all of the undistributed earnings of its
foreign subsidiaries as a result of the loan agreement with CVC. See Note
6.









63







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




NOTE
11 — 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
2013.  The Company accounts for its leases in accordance with FASB ASC
840 “Leases”, 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 statement of operations
on a straight-line basis over the related lease term.




The
future minimum lease commitments at December 31, 2009 are as
follows:




Years
      Ending December 31,
            
            Amount2010
            
            $
            551,7002011
            
            
            189,3002012
            
            
            76,6002013
            
            
            3,700Total minimum
      payments
            
            $
            821,300




Total
rental expense for the years ended December 31, 2009, 2008 and 2007 aggregated
$843,390, $813,373 and $591,312, 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, 2009,
2008 and 2007 amounted to $14,898, $24,061, $25,494, respectively.




Contingencies




On April
16, 2004, the Company filed suit against Pro-Fit Holdings, Limited 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 the Company’s 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 the Company exclusive rights in certain geographic areas to Pro-Fit’s
stretch and rigid waistband technology.  The Company also filed a second
civil action against Pro-Fit and related companies in the California Superior
Court which was removed to the United States District Court, Central District of
California.  In the second quarter of 2008, Pro-Fit and certain related
companies were placed into administration in the United Kingdom and filed
petitions under Chapter 15 of Title 11 of the United States Code.  As a
consequence of the chapter 15 filings, all litigation by the Company against
Pro-Fit has been stayed. The Company has incurred significant legal fees in this
litigation, and unless the case is settled or resolved, may continue to incur
additional legal fees in order to assert its rights and claims against Pro-Fit
and any successor to those assets of Pro-Fit that are subject to its exclusive
license and intellectual property agreement with Pro-Fit and to defend against
any counterclaims.






64







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





The
Company currently has pending a number of other claims, suits and complaints
that arise in the ordinary course of the Company’s business.  The
Company believes that it has meritorious defenses to these claims and that the
claims are either covered by insurance or, after taking into account the
insurance in place, would not have a material effect on the Company’s
consolidated financial position or results of operations if adversely determined
against the Company.




In
November 2002, the FASB issued Topics of the FASB ASC 460-10, “Guarantees” (“ASC 460-10”)
and FASB ASC 850-10, “Related
Party Disclosures” (”ASC 850-10”). The following is a summary of the
Company’s agreements that it has determined are within the scope of ASC 460-10
and ASC 850-10:




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




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







65







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
12 — SEGMENT REPORTING AND GEOGRAPHIC INFORMATION




The
Company manufactures and distributes a full range of zipper, trim and waistband
items to manufacturers of fashion apparel, specialty retailers and mass
merchandisers. The Company’s organization is based on divisions representing the
major product lines, and the Company’s operating decisions use these divisions
to assess performance, allocate resources and make other operating
decisions.  Within these product lines there is not enough difference
between the types of products to justify segmented reporting by product type or
to account for these products separately.  The net revenues and
operating margins for the three primary product groups are as
follows:








Twelve
      months endedDecember
      31, 2009Talon
            
            
            Trim
            
            
            Tekfit
            
            
            ConsolidatedNet
      sales
            
            $
            21,341,132
            
            
            $
            17,274,158
            
            
            $
            60,500
            
            
            $
            38,675,790Cost
      of goods sold
            
            
            16,590,224
            
            
            
            10,741,595
            
            
            
            31,397
            
            
            
            27,363,216Gross
      profit
            
            
            4,750,908
            
            
            
            6,532,563
            
            
            
            29,103
            
            
            
            11,312,574Operating
      expenses *
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            11,023,498Income
      from operations
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            289,076Twelve
      months endedDecember
      31, 2008Talon
            
            
            Trim
            
            
            Tekfit
            
            
            ConsolidatedNet
      sales
            
            $
            28,428,885
            
            
            $
            19,537,302
            
            
            $
            204,793
            
            
            $
            48,170,980Cost
      of goods sold
            
            
            22,783,957
            
            
            
            12,666,844
            
            
            
            103,056
            
            
            
            35,553,857Gross
      profit
            
            
            5,644,928
            
            
            
            6,870,458
            
            
            
            101,737
            
            
            
            12,617,123Operating
      expenses *
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            18,579,006Loss
      from operations
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            (5,961,883
            )Twelve
      months endedDecember
      31, 2007Talon
            
            
            Trim
            
            
            Tekfit
            
            
            ConsolidatedNet
      sales
            
            $
            21,159,595
            
            
            $
            18,688,698
            
            
            $
            681,262
            
            
            $
            40,529,555Cost
      of goods sold
            
            
            15,711,171
            
            
            
            12,190,803
            
            
            
            520,846
            
            
            
            28,422,820Gross
      profit
            
            
            5,448,424
            
            
            
            6,497,895
            
            
            
            160,416
            
            
            
            12,106,735Operating
      expenses *
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            15,277,414Loss
      from operations
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            (3,170,679
            )*
      Operating expenses are not segregated by division and includes impairment
      reserve losses.











66








TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





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 31,2009
            
            
            2008
            
            
            2007Sales:United
      States
            
            $
            3,396,705
            
            
            $
            3,332,257
            
            
            $
            3,692,468Hong
      Kong
            
            
            13,131,762
            
            
            
            15,181,280
            
            
            
            14,178,421China
            
            
            8,990,718
            
            
            
            13,614,709
            
            
            
            11,159,726India
            
            
            1,650,990
            
            
            
            2,536,929
            
            
            
            2,187,684Bangladesh
            
            
            2,008,869
            
            
            
            2,434,382
            
            
            
            1,924,943Other
            
            
            9,496,746
            
            
            
            11,071,423
            
            
            
            7,386,313Total
            
            $
            38,675,790
            
            
            $
            48,170,980
            
            
            $
            40,529,555Long-lived
      Assets:United
      States
            
            $
            4,661,855
            
            
            $
            4,955,725
            
            
            $
            8,778,381Hong
      Kong
            
            
            1,193,617
            
            
            
            989,761
            
            
            
            556,864China
            
            
            236,768
            
            
            
            243,905
            
            
            
            109,770Other
            
            
            4,097
            
            
            
            5,604
            
            
            
            576,182Total
            
            $
            6,096,337
            
            
            $
            6,194,995
            
            
            $
            10,021,197









NOTE
13 — MAJOR CUSTOMERS AND VENDORS




For the
years ended December 31, 2009, 2008 and 2007, the Company’s three largest
customers represented approximately 9%, 8% and 9%, respectively, of consolidated
net sales.




Three
vendors, each representing more than 9% of the Company’s purchases, accounted
for approximately 38% of the Company’s purchases for the year ended December 31,
2009. Five vendors, each representing more than 6% of the Company’s purchases,
accounted for approximately 46% of the Company’s purchases for the year ended
December 31, 2008.  Three vendors, each representing more than 10% of
the Company’s purchases, accounted for approximately 50% of the Company’s
purchases for the year ended December 31, 2007. One vendor accounted for
substantially all of the Company’s purchases associated with its Tekfitproduct for the years
ended December 31, 2008 and 2007.




Included
in accounts payable and accrued expenses at December 31, 2009 and 2008 is
$2,624,494 and $3,593,552 due to these vendors.









NOTE
14 — RELATED PARTY TRANSACTIONS




Colin
Dyne, a director and stockholder of the Company is also a director, officer and
significant stockholder in People’s Liberation, Inc., the parent company of
Versatile Entertainment, Inc. and William Rast Sourcing. During the years ended
December 31, 2009 and 2008 the Company had sales of approximately $1,000 and
$88,000, respectively, to Versatile Entertainment.  Accounts
receivable of $200 and $18,000 were outstanding from Versatile Entertainment at
December 31, 2009 and 2008, respectively.






67







TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





During
the years ended December 31, 2009 and 2008 the Company had sales of $206,400 and
$457,000, respectively, to William Rast Sourcing.  Accounts receivable
of $41,200 and $51,000 were outstanding from William Rast Sourcing at December
31, 2009 and 2008, respectively.




Note
Receivable from Related Party, Net at December 31, 2009 and 2008 include the
unsecured note and accrued interest receivable net of valuation reserves, of $0
and $200,000, respectively due from Colin Dyne. The note bears interest at 7.5%
and is due on demand.  The amount of principal and accrued interest
due from Colin Dyne under this note at December 31, 2009 and 2008 was $720,417
and 674,010, respectively.  The Company has recorded a valuation
reserve against this note of $720,417 and $474,010 at December 31, 2009 and
2008, respectively.  See note 3.




In
November 2009, the Company entered into an agreement to pay a commission to an
affiliate of Colin Dyne of 7% of collected revenues associated with the sales of
selected business opportunities, with 2% of the 7% earned applied to the note
receivable balance. Commissions of $16,524 were paid in cash and $5,483 were
applied to the note receivable balance for the year ended December 31, 2009.
During the years ended December 31, 2009 and 2008 the Company recorded
impairment charges of $200,000 and $474,010, respectively against this
note.




For the
year ended December 31, 2008 consulting fees of $250,000 were paid to Colin
Dyne, whose consulting agreement terminated November 30, 2008.




Notes
payable to related parties includes demand notes and advances to parties related
to or affiliated with Mark Dyne, the Chairman of the Board of Directors of the
Company and a significant stockholder.  The balance of demand notes
payable and interest expense due to Mark Dyne and affiliated parties at December
31, 2009 and 2008 was $229,356 and 222,264, respectively.




Accrued
expenses includes consulting fees and associated interest in the amount of
$251,568 due to Diversified Consulting, LLC, a company owned by Mark Dyne, in
consideration for the final payment under the Diversified consulting agreement
dated March 20, 2000.




Notes
payable to related parties also includes a note and associated interest due to
Lonnie D. Schnell, the Chief Executive Officer and Chief Financial Officer of
the Company. This note issued on August 6, 2009 in partial satisfaction of 2008
annual incentive amounts to which Mr. Schnell was entitled, bears 6% interest
annually and the maturity date is the earlier of December 31, 2011 or ten days
following Mr. Schnell’s employment termination date. The balance of the note
payable and accrued interest expense due to Mr. Schnell at December 31, 2009 was
$36,516.




Consulting
fees and related interest paid or accrued to Diversified Consulting, LLC, a
company owned by Mark Dyne, amounted to $401,568, $150,000 and $150,000
for  the years ended December 31, 2009, 2008, and 2007,
respectively.  This consulting arrangement terminated on March 20,
2010.




Freedom
Apparel, an entity owned by the spouse and a relative of Larry Dyne, the
President of the Company, has from time to time purchased products from the
Company.  For the years ended December 31, 2009 and 2008 the company
had sales of $0 and $70,500, respectively to Freedom Apparel. At December 31,
2009 and 2008, accounts receivable included $0 and $35,000, respectively, due
from this entity.







68








TALON
INTERNATIONAL, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
15 — QUARTERLY RESULTS (UNAUDITED)




Quarterly
results for the years ended December 31, 2009 and 2008 are reflected
below:




1st
            
            
            2nd
            
            
            3rd
            
            
            4th2009Net
      sales
            
            $
            6,515,754
            
            
            $
            12,583,765
            
            
            $
            10,426,764
            
            
            $
            9,149,507Gross
      profit
            
            $
            1,984,167
            
            
            $
            3,561,447
            
            
            $
            2,950,703
            
            
            $
            2,816,257Income
      (loss) from operations
            
            
            (535,170
            )
            
            
            832,045
            
            
            
            200,908
            
            
            
            (208,707
            )Net
      Income (loss)
            
            $
            (1,178,528
            )
            
            $
            74,855
            
            
            $
            (647,156
            )
            
            $
            (942,148
            )Basic
      and diluted net income (loss) per share
            
            $
            (0.06
            )
            
            $
            0.01
            
            
            $
            (0.03
            )
            
            $
            (0.05
            )2008Net
      sales
            
            $
            9,985,489
            
            
            $
            17,020,629
            
            
            $
            12,772,021
            
            
            $
            8,392,841Gross
      profit
            
            $
            2,757,965
            
            
            $
            4,900,904
            
            
            $
            3,219,352
            
            
            $
            1,738,902Income
      (loss) from operations
            
            $
            (1,310,234
            )
            
            $
            1,050,875
            
            
            $
            (1,716,289
            )
            
            $
            (3,986,235
            )Net
      Income (loss)
            
            $
            (1,838,744
            )
            
            $
            598,157
            
            
            $
            (2,440,155
            )
            
            $
            (4,678,044
            )Basic
      and diluted net income (loss) per share
            
            $
            (0.09
            )
            
            $
            0.03
            
            
            $
            (0.12
            )
            
            $
            (0.23
            )







During
2009 the Company fully reserve note receivable from related party in amount of
$0.2 million. During 2008, the Company had material charges of $5.4 million for
impairments of fixed assets, marketable securities, inventory, and severance and
related party notes receivable.





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
16 — SUBSEQUENT EVENTS




The
Company evaluated subsequent events after the balance sheet date of December 31,
2009 through the date these audited financial statements were
issued.




Effective
as of March 15, 2010 William  Sweedler, a member of Board of Directors
of the Company since 2006, resigned as a Class II Director of the Company. Mr.
Sweedler was also a member of the Audit and Compensation Committees of the Board
of Directors. The Company has not yet identified a replacement director for Mr.
Sweedler.






69




Back to Index to Form 10-K


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




None.








ITEM 9A(T).     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.




As of the
end of the period covered by this report, management, with the
participation of Lonnie D. Schnell, our principal executive and principal
financial officer, carried out an evaluation of the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in Rule
13a-15(e) under the Exchange Act).  Based upon that evaluation,
Mr. Schnell concluded that these disclosure controls and procedures were
effective as of the end of the period covered by this Annual Report on Form
10-K.






Management’s
Report on Internal Control over Financial Reporting




Management
is responsible for establishing and maintaining adequate internal control over
financial reporting for the Company.  In order to evaluate the
effectiveness of internal control over financial reporting, as required by
Section 404 of the Sarbanes-Oxley Act, the Company’s management has conducted an
assessment, including testing, using the criteria in Internal Control – Integrated
Framework, issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  Our system of internal control over
financial reporting is designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States.  Because of its inherent limitations,
internal control over financial reporting may not prevent or detect
misstatements.  Further, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.  Based on its
assessment, our management has concluded that control over financial reporting
was effective as of December 31, 2009.




This
annual report does not include an attestation report of our independent
registered public accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation by our independent
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit the company to provide only management’s
report in this annual report.






Changes
in Internal Control over Financial Reporting




No change
in our internal control over financial reporting (as defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934) occurred during the fourth quarter of
our fiscal year ended December 31, 2009 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.






70







Back to Index to Form 10-K


ITEM
9B.          OTHER
INFORMATION





None.




PART
III




ITEM
10.            DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE






The
following table sets forth the name, age and position of each of our executive
officers and directors as of March 29, 2010.




Name
            Age
            PositionMark  Dyne
      (1)
            49
            Chairman
      of the Board of DirectorsColin
      Dyne (1)
            47
            Vice
      Chairman of the Board of DirectorsBrent
      Cohen
            51
            DirectorJoseph
      Miller
            46
            DirectorRaymond
      Musci
            49
            DirectorLonnie
      D. Schnell
            61
            Chief
      Executive Officer & Chief Financial Officer,
  DirectorLarry
      Dyne (1)
            38
            PresidentJames
      E. Reeder
            52
            Vice
      President, Corporate Controller





(1)      Mark
Dyne, Colin Dyne and Larry Dyne are brothers.






71





Class
      I Directors: Terms Expiring In 2010Joseph
      Miller
            Mr.
      Miller has served on the Board of Directors since June 2005. Since 2003,
      he has been a Managing Director of Europlay Capital Advisors, LLC, a
      merchant banking and advisory firm. From 1998 to 2003, Mr. Miller was a
      Senior Vice President at Houlihan Lokey Howard & Zukin, a leading
      middle-market investment bank.  From 1994 to 1998, Mr. Miller
      served as the Vice President, Corporate Development for Alliance
      Communications Corporation, Canada’s leading independent producer and
      distributor of filmed entertainment.  Mr. Miller has bachelor’s
      degree in Economics and Business from the University of California, Los
      Angeles. Mr. Miller was nominated to our board of directors for his
      extensive domestic and international management experience, and knowledge
      of associated industry practices and trends, and for his financial
      management expertise.
              
              Member:    Audit and Nominating
      CommitteesBrent
      Cohen
            Mr.
      Cohen has served on the Board of Directors since 1998.  Mr.
      Cohen served as Chief Executive Officer and a director of Dovebid Inc.
      from August 2005 to February 2008.  Mr. Cohen served as
      President and was a member of the Board of Directors of First Advantage
      Corporation (formed by the merger of US Search and First American
      Financial screening companies) from June 2003 to 2005.  Mr.
      Cohen served as Chairman of the Board, President and Chief Executive
      Officer of US Search from February 2000 until June 2003.
      Mr. Cohen previously held various management positions in both the
      management consulting and auditing practice of Arthur Young &
      Company (now Ernst & Young). Mr. Cohen holds a Bachelor of
      Commerce degree, a Graduate Diploma in Accounting and an MBA from the
      University of Cape Town in South Africa. He is also a chartered
      accountant. Mr. Cohen was nominated to our board of directors for his
      extensive domestic and international management experience, and knowledge
      of associated industry practices and trends.
              
              Member:Compensation,
      Nominating and Governance CommitteesClass
      II Directors: Terms Expiring In 2011Lonnie
      D. Schnell
            Mr.
      Schnell joined us in January 2006 as our Chief Financial Officer, was
      appointed as Chief Executive Officer in February 2008 and has served on
      our Board of Directors since May 2008. Mr. Schnell served as Vice
      President of Finance for Capstone Turbine Corporation, a manufacturer of
      micro-turbine electric generators from 2004 until 2005. From 2002 to 2004
      Mr. Schnell served as Chief Financial Officer of EMSource, LLC, an
      electronic manufacturing service company. Prior to EMSource, in 2002, Mr.
      Schnell served as Chief Financial Officer of Vintage Capital Group, a
      private equity investment firm. From 1999 through 2002, Mr. Schnell served
      as Chief Financial Officer of Need2Buy, Inc. a business-to-business
      internet marketplace for electronic components. Mr. Schnell has completed
      an executive MBA program with the Stanford University Executive Institute,
      and earned his Bachelor of Science in Accounting at Christian Brothers
      University. Mr. Schnell is a Certified Public Accountant with experience
      in the international accounting firm of Ernst & Young LLP. Mr. Schnell
      was nominated to our board of directors for his extensive domestic and
      international management experience, and knowledge of associated industry
      practices and trends, and for his financial management
      expertise.    72
   Raymond
      Musci
            Ray
      Musci has served as our Director  since June 2005. Mr. Musci
      serves as a Director and Chief Operating Officer of New Motion, Inc.
      (NasdaqGM: NWMO), a publicly traded company that develops, publishes and
      distributes mobile entertainment services and products. From October 1999
      to June 2005, Mr. Musci served as the President and Chief Executive
      Officer and a director of BAM! Entertainment, Inc., a publicly traded
      company that develops, publishes and distributes entertainment software
      products and video games. Mr. Musci currently serves as a director of
      Brilliant Digital Entertainment, Inc.  From May 1990 to July
      1999, Mr. Musci served as the President, Chief Executive Officer and as a
      director of Infogrames Entertainment, Inc. (formerly Ocean of America,
      Inc.), a company that develops, publishes and distributes software
      products. Mr. Musci also previously served as a director of Ocean
      International, Ltd., the holding company of Ocean of America, Inc. and
      Ocean Software, Ltd., and as Executive Vice President/General Manager of
      Data East USA, Inc., a subsidiary of Data East Corp., a Japanese company.
      Mr. Musci was nominated to our board of directors for his extensive
      domestic and international management experience, and knowledge of
      associated industry practices and trends, and for his financial management
      expertise.
              
              Member:    Audit, Compensation and
      Nominating CommitteesClass
      III Directors: Terms Expiring In 2012Mark
      Dyne
            Mr.
      Dyne has served as Chairman of the Board of Directors since
      1997.  Mr. Dyne currently serves as the Chief Executive Officer
      and the Managing Partner of Europlay Capital Advisors, LLC, a merchant
      banking and advisory firm.  Mr. Dyne previously served as
      Chairman and Chief Executive Officer of Sega Gaming Technology Inc. (USA),
      a gaming company, and Chairman and Chief Executive Officer of Virgin
      Interactive Entertainment Ltd., a distributor of computer software
      programs and video games based in London, England. Mr. Dyne was a founder
      and director of Packard Bell NEC Australia Pty. Ltd., a manufacturer and
      distributor of personal computers through the Australian mass merchant
      channel, and he was a founder and former director of Sega Ozisoft Pty
      Ltd., a leading distributor of entertainment software in both Australia
      and New Zealand. Mr. Dyne was nominated to our board of directors for his
      extensive domestic and international management experience, and knowledge
      of associated industry practices and trends.
              
              Member:    Governance
      CommitteeColin
      Dyne
            Currently,
      Mr. Dyne serves as Vice Chairman of the Board of Directors. Mr. Dyne
      founded Tag-It, Inc., one of our subsidiaries, in 1991 with his father,
      Harold Dyne. Mr. Dyne served as our President from inception and as our
      Chief Executive Officer from 1997 to 2005.  Since May 2007,
      Colin Dyne has served as Chief Executive Officer and a director of
      People’s Liberation, Inc. (OTCBB: PPLB), which designs, markets and sells
      high-end casual apparel under the brand names “People’s Liberation” and
      “William Rast.”  Before founding Tag-It, Inc. in 1991, Mr. Dyne
      worked in numerous positions within the stationery products industry,
      including owning and operating retail stationery businesses and servicing
      the larger commercial products industry through contract stationery and
      printing operations. Mr. Dyne was nominated to our board of directors for
      his extensive domestic and international management experience, and
      knowledge of associated industry practices and trends.   73
    Other
      Executive OfficersLarry
      Dyne
            Larry
      Dyne was appointed as our President in May 2009. He has been our employee
      since 1992, and was formerly Executive Vice President of Sales as well as
      vice president of product development and global sourcing, and vice
      president of trim sales. Through these positions, Mr. Dyne has established
      extensive and long-term relationships with the world’s top brands and
      clothing retailers. He was also formerly responsible for domestic
      production for all printing.James
      E. Reeder
            James
      E. Reeder joined us in May 2009 and was appointed Vice President,
      Corporate Controller. From January 2007 to September 2008 Mr. Reeder
      served as Chief Financial Officer at Sheffield Manufacturing, an aerospace
      parts manufacturer and at Data Exchange Corporation, an international
      provider of supply chain solutions. From January 2002 to October 2006 Mr.
      Reeder was Vice President Finance for Special Devices, Inc., a
      manufacturer of automotive safety devices and was previously Chief
      Financial Officer for Power Lift Corporation, a distributor of Caterpillar
      materials and equipment. Mr. Reeder also served in various senior
      financial roles at Avery Dennison Corporation for approximately 14 years.
      Mr. Reeder has an MBA in Finance and Strategic Planning from the
      University of California at Berkeley and a B.S., Economics Summa Cum Laude
      from California State Polytechnic University, Pomona.







Audit
Committee; Audit Committee Financial Expert




We
currently have a separately designated standing Audit Committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act.  The Audit
Committee currently consists of Raymond Musci and Joseph
Miller.   The Board of Directors has further determined that Mr.
Musci is an “audit committee financial expert” as such term is defined in Item
401(h) of Regulation S-K promulgated by the SEC.




Section
16(a) Beneficial Ownership Reporting Compliance




Section
16(a) of the Securities Exchange Act of 1934 requires our executive
officers, directors and persons who own more than ten percent of a registered
class of our equity securities to file reports of ownership and changes in
ownership with the Securities and Exchange Commission.  Executive officers,
directors and greater-than-ten percent stockholders are required by Securities
and Exchange Commission regulations to furnish us with all Section 16(a) forms
they file.  Based solely on our review of the copies of the forms received
by us and written representations from certain reporting persons that they have
complied with the relevant filing requirements, we believe that, during the year
ended December 31, 2009, all of our executive officers, directors and
greater-than-ten percent shareholders complied with all Section 16(a) filing
requirements, except that one Form 4, reporting one transaction, was filed late
by James E. Reeder.




Code
of Ethics




We
have adopted a Code of Ethical Conduct that applies to our principal
executive officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions, as well as to our other
employees and directors generally.  A copy of our Code of Ethical Conduct
is filed as an exhibit to our Annual Report on Form 10-K.








74




Back to Index to Form 10-K


ITEM
11.            EXECUTIVE
COMPENSATION






COMPENSATION
DISCUSSION AND ANALYSIS





Talon
International Inc.’s executive compensation program is administered by the
Compensation Committee of our Board of Directors, or referred to in this section
as the “Committee.”  The Committee is responsible for, among other
functions: (1) reviewing and approving corporate goals and objectives relevant
to the Chief Executive Officer’s compensation and evaluating the performance of
the Chief Executive Officer in light of these corporate goals and objectives;
(2) reviewing and making recommendations to the Board of Directors with respect
to the compensation of other executive officers; (3) administering our
incentive-compensation and equity based plans, which may be subject to the
approval of the Board of Directors; and (4)  negotiating, reviewing
and recommending the annual salary, bonus, stock options and other benefits,
direct and indirect, of the Chief Executive Officer,  and other
current and former executive officers.  The Committee also has the
authority to select and/or retain outside counsel, compensation and benefits
consultants, or any other consultants to provide independent advice and
assistance in connection with the execution of its
responsibilities.




Our named
executive officers for 2009 were as follows:




·
            Lonnie
      D. Schnell, Chief Executive Officer & Chief Financial
      Officer;




·
            Larry
      Dyne, President (promoted to President in May 2009);
  and




·
            James
      E. Reeder, Vice President, Corporate Controller (appointed May
      2009).







Compensation
Philosophy




Our
executive compensation program is designed to drive company performance to
maximize shareholder value while meeting our needs and the needs of our
employees.  The specific objectives of our executive compensation
program include the following:




·
            Alignment– to align
      the interests of executives and shareholders through equity-based
      compensation awards;




·
            Retention– to attract,
      retain and motivate highly qualified, high performing executives to lead
      our continued growth and success;
and




·
            Performance– to
      provide rewards commensurate with performance by emphasizing variable
      compensation that is dependent upon the executive’s achievements and
      company performance.




In order
to achieve these specific objectives, our executive compensation program is
guided by the following core principles:




·
            Rewards
      under incentive plans are based upon our short-term and longer-term
      financial results and increasing shareholder
  value;




·
            Senior
      executive pay is set at sufficiently competitive levels to attract, retain
      and motivate highly talented individuals who are necessary for us to
      achieve our goals, objectives and overall financial
    success;






75








·
            Compensation
      of an executive is based on such individual’s role, responsibilities,
      performance and experience, taking into account the desired pay
      relationships within the executive team;
and




·
            Our
      executive compensation program places a strong emphasis on
      performance-based variable pay to ensure a high pay-for-performance
      culture.  Annual performance of our company and the executive
      are taken into account in determining annual bonuses that ensures a high
      pay-for-performance culture.




Compensation
Elements




We
compensate senior executives through a variety of components, including base
salary, annual incentives, equity incentives and benefits and perquisites, in
order to provide our employees with a competitive overall compensation
package.  The mix and value of these components are impacted by a
variety of factors, such as responsibility level, individual negotiations and
performance and market practice.  The purpose and key characteristics
for each component are described below.




Base
Salary




Base
salary provides executives with a steady income stream and is based upon the
executive’s level of responsibility, experience, individual performance and
contributions to our overall success. Competitive base salaries, in conjunction
with other pay components, enable us to attract and retain highly talented
executives.  The Committee typically sets base salaries for our senior
executives at market levels. However, base salaries will vary in practice based
upon an individual’s performance, individual experience and negotiations and for
changes in job responsibilities.




Management
Incentive Bonuses




Management
incentive bonuses are a variable performance-based component of
compensation.  The primary objective of an annual incentive bonus is
to reward executives for achieving corporate and individual goals and to align a
meaningful portion of total pay opportunities for executives and other key
employees to the attainment of our company’s performance goals. These awards are
also used as a means to recognize the contribution of our executive officers to
overall financial, operational and strategic success.




Equity
Incentives




Equity
incentives are intended to align senior executive and shareholder interests by
linking a meaningful portion of executive pay to long-term shareholder value
creation and financial success over a multi-year period.  Equity
incentives are also provided to our executives to attract and enhance the
retention of executives and other key employees and to facilitate stock
ownership by our senior executives. The Committee also considers individual and
company performance when determining long-term incentive
opportunities.




Health
& Welfare and 401-K Benefits




The named
executive officers participate in a variety of retirement, health and welfare
and paid time-off benefits designed to enable us to attract and retain our
workforce in a competitive marketplace.  Health and welfare and paid
time-off benefits help ensure that we have a productive and focused
workforce.




Severance
and Change of Control Arrangements




We do not
have a formal plan for severance or separation pay for our employees, but we
typically include a severance provision in the employment agreements of our
executive officers that is triggered in the event of involuntary termination
without cause or in the event of a change in control.






76







In order
to preserve the morale and productivity and encourage retention of our key
executives in the face of the disruptive impact of an actual or rumored change
in control, we provide a bridge to future employment in the event that an
executive’s job is eliminated as a consequence of a change in
control.  This provision is intended to align executive and
shareholder interests by enabling executives to consider corporate transactions
that are in the best interests of the shareholders and other constituents
without undue concern over whether the transactions may jeopardize the
executive’s own employment.  Our employment agreements with our
current named executive officers provide a lump sum payment and benefits
continuation as a result of an involuntary termination without cause or for good
reason following a change in control, plus accelerated vesting of stock or
option awards.




Other
Benefits




In order
to attract and retain highly qualified executives, we provide some of our named
executive officers, with automobile allowances that we believe are consistent
with current market practices. Our executives also may participate in a 401(k)
plan under which we match contributions for all employees up to 100% of an
employee’s contributions to a maximum of $1,000 and subject to any limitations
imposed by ERISA.






Other
Factors Affecting Compensation




Accounting and Tax
Considerations




We
consider the accounting implications of all aspects of our executive
compensation program.  Our executive compensation program is designed
to achieve the most favorable accounting (and tax) treatment possible as long as
doing so does not conflict with the intended plan design or program
objectives.




Process
for Setting Executive Compensation




When
making pay determinations for named executive officers, the Committee considers
a variety of factors including, among others: (1) actual company performance as
compared to pre-established goals, (2) overall company performance and size
relative to industry peers, (3) individual executive performance and expected
contribution to our future success, (4) changes in economic conditions and the
external marketplace and (5) in the case of named executive officers, other than
Chief Executive Officer, the recommendation of our Chief Executive
Officer.  Ultimately, the Committee uses its judgment when determining
how much to pay our executive officers.  The Committee evaluates each
named executive officer’s performance during the year against established goals,
leadership qualities, business responsibilities, current compensation
arrangements and long-term potential to enhance shareholder
value.  The opinions of outside consultants are also taken into
consideration in deciding what salary, bonus, long-term incentives and other
benefits and severance to give each executive in order to meet our objectives
stated above. The Committee considers compensation information from data
gathered from annual reports and proxy statements from companies that the
Committee generally considers comparable to us; compensation of other company
employees for internal pay equity purposes; and levels of other executive
compensation plans from compensation surveys.  The Committee sets the
pay for the named executive officers and other executives, by element and in the
aggregate, at levels that it believes are competitive and necessary to attract
and retain talented executives capable of achieving our long-term
objectives.







77









Factors
Considered




In
administering the compensation program for senior executives, including named
executive officers, the Committee considers the following:




·
            Cash versus non-cash
      compensation.  The pay elements are cash-based except for
      the long-term incentive program, which may be cash-based, equity-based, or
      a combination.  In 2009, the long-term incentive program pay
      elements were cash-based.  In 2008, the long-term incentive
      program for the named executive officers consisted entirely of stock
      option awards that vest in installments over a one to four year period
      from the date of grant;




·
            Prior year’s
      compensation.  The committee considers the prior year’s
      bonuses and long-term incentive awards when approving bonus payouts or
      equity grants;




·
            Adjustments to Compensation.On an annual basis, and in connection with setting executive
      compensation packages, the Committee reviews our operating income growth, earnings before
      interest and taxes growth, earnings per share growth, cash flow
      growth, operating margin, revenue growth and total shareholder return
      performance.  In addition, the Committee considers peer group
      pay practices, emerging market trends and other factors.  No
      specific weighing is assigned to these factors nor are particular targets
      set for any particular factor.  Total compensation from year to
      year can vary significantly based on our and the individual executive’s
      performance;


·
            Application of discretion.It is our policy and practice to use discretion in determining the
      appropriate compensation levels considering
  performance.





REPORT
OF COMPENSATION COMMITTEE





The
Compensation Committee of our Board of Directors consists of Brent Cohen and
Raymond Musci.  The Compensation Committee is responsible for
considering and making recommendations to the Board of Directors regarding
executive compensation and is responsible for administering our stock option and
executive incentive compensation plans.




The
Compensation Committee has reviewed and discussed with management the
Compensation Discussion and Analysis included in this report. Based on the
review and discussion with management, the Compensation Committee recommended to
the Board of Directors that the Compensation Discussion and Analysis be included
in the Company’s Annual Report on Form 10-K.




Compensation
Committee


Brent
Cohen


Raymond
Musci





March 29,
2010







78






EXECUTIVE
COMPENSATION




Summary
Compensation Table




The
following table sets forth, as to each person serving as Chief Executive Officer
and Chief Financial Officer during 2009 and the two highly compensated executive
officers other than the Chief Executive Officer and Chief Financial Officer at
the end of the 2009 whose compensation exceeded $100,000 (referred to as “named
executive officers”), information concerning all compensation earned for
services to us in all capacities for 2009.







Name
      and
              Principal
      Position
            Year
            
            Salary
            
            
            Bonus
            
            
            Option
      Awards
              (3)
            
            
            Non-Equity
      Incentive Plan Compensation (4)
            
            
            All
      Other Compensation
              (5)
            
            
            TotalLonnie
      D. Schnell (1)
            2009
            
            $
            310,573
            
            
            $
            -
            
            
            $
            51,418
            
            
            $
            94,000
            
            
            $
            25,643
            
            
            $
            481,634Chief
      Executive
              Officer
      and
              Chief
      Financial
            2008
            
            
            275,000
            
            
            
            -
            
            
            
            140,806
            
            
            
            35,000
            
            
            
            25,116
            
            
            
            475,922Officer
            2007
            
            
            225,000
            
            
            
            45,000
            
            
            
            -
            
            
            
            -
            
            
            
            11,343
            
            
            
            281,343Larry
      Dyne (2)President
            2009
            
            
            284,612
            
            
            
            -
            
            
            
            37,462
            
            
            
            71,000
            
            
            
            16,345
            
            
            
            409,419Executive
      Vice
              President,Sales
            2008
            
            
            250,000
            
            
            
            40,000
            
            
            
            109,516
            
            
            
            -
            
            
            
            19,682
            
            
            
            419,198James
      E. ReederVice
      President,
              Corporate
              Controller
            2009
            
            
            100,439
            
            
            
            -
            
            
            
            18,920
            
            
            
            12,100
            
            
            
            6,512
            
            
            
            137,971








(1)
            Mr.
      Schnell was appointed Chief Executive Officer effective February 4, 2008
      and previously served as Chief Financial
  Officer.





(2)
            Mr.
      Dyne was appointed President effective May 1, 2009 and previously served
      as Executive Vice President, Sales.





(3)
            The
      amounts in this column represent the aggregate grant date fair value
      computed in accordance with ASC 718 with respect to options granted in the
      applicable year.  Pursuant to SEC rules, the amounts shown
      exclude the impact of estimated forfeitures related to service-based
      vesting conditions.  For additional information on the valuation
      assumptions with respect to these grants, refer to Note 8 of our Notes to
      Consolidated Financial Statements in this Annual Report on Form 10-K.
      These amounts do not reflect the actual value that may be realized by the
      named executive officers which depends on the value of our shares in the
      future.





(4)
            Non-equity
      incentive plan compensation consists of awards under the Management
      Incentive Plan, a cash incentive plan, which is established pursuant to
      our employment agreements with Mr. Schnell and Mr. Dyne for the year in
      which the award is earned. As described further below, options granted in
      2009 to Mr. Schnell and Mr. Dyne and a promissory note issued to Mr.
      Schnell were awarded in satisfaction of bonus amounts to which such
      executives were entitled for fiscal 2008 in accordance with Management
      Incentive Plan, including $53,230 and $40,000 in bonus payments for Mr.
      Schnell and Mr. Dyne, respectively, previously reported as 2008 non-equity
      incentive plan compensation to these executives in our 2008 Annual Report
      on Form 10-K.









79










(5)
            All
      other compensation consists of the following (amounts in
      dollars):







Mr.
      Lonnie D. Schnell
            
            
            Mr.
      Larry Dyne
            
            
            Mr.
      James E. Reeder2009
            
            
            2008
            
            
            2007
            
            
            2009
            
            
            2008
            
            
            2009Health
      & medical insurance (a)
            
            $
            17,802
            
            
            $
            13,793
            
            
            $
            11,019
            
            
            $
            9,938
            
            
            $
            9,429
            
            
            $
            5,362Life
      & disability insurance (b)
            
            
            301
            
            
            
            323
            
            
            
            324
            
            
            
            4,000
            
            
            
            4,078
            
            
            
            150401k
      contribution (c)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,000Automobile
      allowances
            
            
            7,540
            
            
            
            11,000
            
            
            
            -
            
            
            
            2,407
            
            
            
            6,175
            
            
            
            -Total
            
            $
            25,643
            
            
            $
            25,116
            
            
            $
            11,343
            
            
            $
            16,345
            
            
            $
            19,682
            
            
            $
            6,512




(a)
            Includes
      payments of medical premiums.


(b)
            Includes
      executive and group term life and disability
  insurance.


(c)
            Represents
      our contribution to 401k programs.







Executive
Compensation





The 2009
compensation for Lonnie Schnell, our Chief Executive Officer was in accordance
with our employment agreement with him. The terms and conditions established in
this agreement were the result of our consideration of our current operating
performance levels, 2007 and 2006 operating performance, our 2005 Restructuring
and Strategic Plan, compensation levels for our previous CEO, comparative
industry compensation levels and negotiations with Mr.
Schnell.   The base compensation was evaluated in conjunction
with the long-term equity awards and annual bonus incentives to establish a
compensation arrangement providing a substantial incentive for the achievement
of our long-term objectives and for adding shareholder
value.  Accordingly, the base compensation was established near
minimum industry levels for the same role in comparable companies, and a
long-term equity option of 900,000 shares of common stock, representing
approximately 4.4% of our outstanding shares at the time, was granted as an
inducement to maximum performance achievements and increased shareholder values.
The option grant was established to vest monthly over a three-year term, after a
minimum initial term of twelve months, to coincide with the objectives of our
strategic plan.





In
addition to the long-term equity incentive, a cash incentive, referred to as the
Management Incentive Program (“MIP”), was established as provided in Mr.
Schnell’s employment agreement setting aside 12% of our earnings before
interest, taxes, depreciation and amortization (“EBITDA”), and selected expenses
associated with non-operating charges, in 2008 and 2009 for annual bonus awards
to him and the other senior executives.  The MIP fund awards are shown
in the table above as non-equity incentive plan compensation. MIP awards were
not distributed in 2007 due to our operating performance; however, a
discretionary bonus was granted to Mr. Schnell as approved by the Board of
Directors. In 2009, Mr. Schnell was awarded (a) a 10-year non-qualified stock
option to purchase 700,000 shares of common stock, which option was immediately
vested and has an exercise price of $0.09 per share, and (b) a promissory note
in the principal sum of $35,000, which note bears interest at the rate of 6.0%
per annum accruing from April 16, 2009 and matures on the earlier of December
31, 2011 and a date that is ten business days following the date Mr. Schnell’s
employment with us terminates for any reason.  The 2008 annual
incentive bonuses awarded to Mr. Schnell in the form of options and a promissory
note were paid in satisfaction of all bonus amounts to which he was entitled for
fiscal 2008 in accordance with his employment agreement, including $53,230 in
bonus payments for Mr. Schnell previously reported as 2008 non-equity incentive
plan compensation our 2008 Annual Report on Form 10-K.






80







The 2009
compensation for Larry Dyne, our President was in accordance with our employment
agreement with him. The terms and conditions established in this agreement were
the result of our consideration of our current operating performance levels,
2007 and 2006 operating performance, our 2005 restructuring and Strategic Plan,
compensation levels for our previous CEO, comparative industry compensation
levels and negotiations with Mr. Dyne.   The base compensation
was evaluated in conjunction with the long-term equity awards and annual bonus
incentives to establish a compensation arrangement providing a substantial
incentive for the achievement of our long-term objectives and for adding
shareholder value.  Accordingly, the base compensation was established
near minimum industry levels for the same role in comparable companies, and a
long-term equity option of 700,000 shares of common stock, representing
approximately 3.4% of our outstanding shares at the time, was granted as an
inducement to maximum performance achievements and increased shareholder values.
The option grant was established to vest monthly over a three-year term, after a
minimum initial term of twelve months, to coincide with the objectives of our
strategic plan. In addition Mr. Dyne’s employment agreement provided that he
would be eligible to participate in the MIP annual cash incentive plan. In 2009,
Mr. Dyne was awarded a 10-year non-qualified stock option to purchase 510,000
shares of our common stock, which option was immediately vested and has an
exercise price of $0.09 per share.  The 2008 annual incentive bonuses
awarded to Mr. Dyne in the form of this option grant were paid in satisfaction
of all bonus amounts to which he was entitled for fiscal 2008 in accordance with
his employment agreement, including $40,000 in bonus payments for Mr. Dyne
previously reported as 2008 non-equity incentive plan compensation in our 2008
Annual Report on Form 10-K.





The 2009
compensation for James E. Reeder, our Vice President, Corporate Controller was
in accordance with our at-will employment agreement with him.  The
terms and conditions established in this agreement were the result of our
consideration of our current operating performance levels, compensation levels
for our previous corporate controller, comparative industry compensation levels
and negotiations with Mr. Reeder.   The base compensation was
evaluated in conjunction with the long-term equity awards and annual bonus
incentives to establish a compensation arrangement providing a substantial
incentive for the achievement of our long-term objectives and for adding
shareholder value.  Accordingly, the base compensation was established
near minimum industry levels for the same role in comparable companies, and a
long-term equity option of 200,000 shares of common stock, representing
approximately 1.0% of our outstanding shares, was established as an inducement
to maximum performance achievements and increased shareholder values. The option
grant was established to vest monthly over a four-year term, after a minimum
initial term of twelve months, to coincide with the objectives of our strategic
plan.  In addition to the long-term equity incentive, Mr. Reeder was a
participant in the Management  Incentive Plan for 2009 and was awarded
a bonus of $12,100 under this plan.  During the first year of
employment  a bonus of not less than $20,000 was guaranteed in the
employment agreement.







Grants
      of Plan-Based Awards in Fiscal 2009




The
following table provides information about equity-awards granted to each named
executive officer in 2009 under our 2008 and 2007 Stock Plans.





Name
            Grant
              Date(1)
            Approval
              Date(1)
            All
      Other Option Awards: Number of Securities Underlying Options
      (#)
            Exercise
      or Base Price of Option Awards
              ($/SH)(2)
            Market
      Price on Grant Date
              ($/SH)(2)
            Grant
      Date Fair Value of Option Awards
              ($)(3)Lonnie
      D. Schnell
            8/6/09
            8/6/09
            700,000
            $0.09
            $0.09
            $51,418Larry
      Dyne
            8/6/09
            8/6/09
            510,000
            $0.09
            $0.09
            $37,462James
      E. Reeder
            6/1/09
            6/1/09
            200,000
            $0.11
            $0.13
            $18,920







81






(1)
            The
      grant date of an option award is the date that the compensation committee
      fixes as the date the recipient is entitled to receive the
      award.  The approval date is the date that the compensation
      committee approves the award.




(2)
            The
      exercise price of option awards may differ from the market price on the
      date of grant.  The exercise price of options granted in 2009 is
      equal to the average closing sales prices of our common stock for the five
      trading days prior to and including the grant date, as reported on the
      OTCBB, while the market price on the date of grant is the closing price of
      our common stock on that date.




(3)
            The
      grant date fair value is generally the amount we would expense in our
      financial statements over the award’s service period, but does not include
      a reduction for forfeitures.




Option
awards granted to our executive officers in 2009 have a 10 year term. The
options granted to Mr. Schnell and Mr. Dyne are fully vested as of the date of
grant, and were awarded in satisfaction of incentive bonuses that such
executives were entitled to receive for fiscal year 2008.  The option
granted to Mr. Reeder in 2009 vests over a four-year period.




Outstanding
Equity Awards at Fiscal Year 2009





The
following table provides information with respect to outstanding stock options
held by each of the named executive officers as of December 31,
2009:




Number
      of Securities
              Underlying
      Unexercised OptionsName
            Grant
      Date
            
            (#)
      Exercisable
            
            
            (#)
      Unexercisable
            
            
            Option
      Exercise Price ($)
            
            Option
      Expiration DateLonnie
      D. Schnell
            1/26/06
            
            
            391,667
            (1)
            
            
            8,333
            (1)
            
            $
            0.59
            
            1/26/166/25/08
            
            
            -
            
            
            
            900,000
            (2)
            
            $
            0.20
            
            06/24/188/6/09
            
            
            700,000
            
            
            
            -
            
            
            $
            0.09
            
            8/6/19Larry
      Dyne
            2/28/00
            
            
            15,000
            
            
            
            -
            
            
            $
            4.62
            
            02/27/104/10/00
            
            
            15,000
            
            
            
            -
            
            
            $
            4.25
            
            04/09/1012/12/00
            
            
            20,000
            
            
            
            -
            
            
            $
            3.75
            
            12/11/1011/18/01
            
            
            15,000
            
            
            
            -
            
            
            $
            3.64
            
            11/17/1112/31/02
            
            
            25,000
            
            
            
            -
            
            
            $
            3.63
            
            12/30/124/01/03
            
            
            25,000
            
            
            
            -
            
            
            $
            3.50
            
            03/31/134/08/03
            
            
            45,500
            
            
            
            -
            
            
            $
            3.70
            
            04/07/134/18/05
            
            
            50,000
            
            
            
            -
            
            
            $
            3.14
            
            04/17/151/16/06
            
            
            425,000
            
            
            
            -
            
            
            $
            0.37
            
            01/15/166/25/08
            
            
            -
            
            
            
            700,000
            (3)
            
            $
            0.20
            
            06/24/188/6/09
            
            
            510,000
            
            
            
            -
            
            
            $
            0.09
            
            8/6/19James
      E. Reeder
            6/1/09
            
            
            -
            
            
            
            200,000
            (4)
            
            $
            0.11
            
            6/1/19




(1)
            These
      options become exercisable with respect to 8,333 shares each month until
      fully vested.




(2)
            These options vest in full on
      December 31, 2010.  The options provide for early vesting with
      respect to up to 600,000 shares each based on our performance as compared
      to the Board of Directors approved budget for each of 2008 and
      2009.  There was no early vesting for 2009 based on upon
      performance.




(3)
            These
      options vest in full on December 31, 2010.  The options provide
      for early vesting with respect to up to 466,666 shares each based on our
      performance as compared to the Board of Directors approved budget for each
      of 2008 and 2009.  There was no early vesting for 2009 based on
      upon performance.




(4)
            These
      options shall become exercisable with respect to 25% of the total options
      shares at the end of one year from the date of the grant and the remaining
      shares shall become exercisable in 36 monthly installments equal to
      1/48th
      of the Option shares on the last day of each calendar month thereafter
      until fully exercisable.









82







Employment
Agreements, Termination of Employment and Change of Control
Arrangements




Employment
Agreements




We have
entered into the following employment agreements with our named executive
officers.




Lonnie D. Schnell, Chief Executive
Officer and Chief Financial Officer.On June 18, 2008, we
entered into an Executive Employment Agreement with Lonnie D. Schnell, pursuant
to which Mr. Schnell serves as our Chief Executive Officer. This employment
agreement has a term continuing though December 31, 2010, which may be extended
to December 31, 2011.  Pursuant to this agreement, Mr. Schnell will
receive an annual base salary of $275,000 for 2008, $300,000 for 2009 and
$325,000 for each subsequent year of the term and will be entitled to receive an
annual incentive bonus, which for 2008 and 2009 was based upon our earnings
before interest, taxes, depreciation and amortization. Mr. Schnell is entitled
to an auto allowance of $1,000 per month.  In the event that prior to
the end of the term, Mr. Schnell’s employment is terminated by us “without
cause” (as defined in the agreement), by Mr. Schnell for “good reason” (as
defined in the agreement) or due to Mr. Schnell’s death or disability, then
conditional upon his execution of a release of claims, Mr. Schnell or his estate
will be entitled to receive, in addition to all accrued salary, (i) severance
payments equal to Mr. Schnell’s base salary for the  remaining term of
the agreement or, in the case of death or disability, through December 31, 2010,
(ii) a prorated portion of the annual incentive bonus for the year in which the
termination occurred, (iii)full acceleration of vesting of the options issued to
Mr. Schnell pursuant to the agreement and all other options held by him and (iv)
continued medical coverage for Mr. Schnell and his  dependents for the
remaining term of the agreement.  In connection with the employment
agreement, Mr. Schnell was granted an option to purchase 900,000 shares of our
common stock, which vests in full on December 31, 2010, subject to earlier
vesting if Mr. Schnell meets performance criteria established by the Board for
fiscal 2008 and 2009.  Mr. Schnell’s options will vest in full upon a
change of control of our company or upon termination of Mr. Schnell’s employment
without cause, for good reason or due to his death or disability.




Larry Dyne, President.On
June 18, 2008, we entered into an Executive Employment Agreement with Larry
Dyne, pursuant to which Mr.  Dyne will serve as our Executive Vice
President of Global Sales.  In May 2009 Mr. Dyne was promoted to
President of Talon International, Inc. This employment agreement has a term
continuing though December 31, 2010, which may be extended to December 31,
2011.  Pursuant to this agreement, Mr. Dyne will receive an annual
base salary of $250,000 for 2008, $275,000 for 2009 and $300,000 for each
subsequent year of the term and will be entitled to receive an annual incentive
bonus, which for 2008 and 2009 was based upon our earnings before interest,
taxes, depreciation and amortization. Mr. Dyne is entitled to an auto allowance
of $950 per month.  In the event that prior to the end of the term,
Mr. Dyne’s employment is terminated by us “without cause” (as defined in the
agreement), by Mr. Dyne for “good reason” (as defined in the agreement) or due
to Mr.  Dyne’s death or disability, then conditional upon his
execution of a release of claims, Mr. Dyne or his estate will be entitled to
receive, in addition to all accrued salary, (i) severance payments equal to Mr.
Dyne’s base salary for the remaining term of the agreement  or, in the
case of death or disability, through December 31, 2010, (ii) a prorated portion
of the annual incentive  bonus for the year in which the
termination  occurred, (iii) full acceleration of vesting of the
options issued to Mr.  Dyne pursuant to the agreement and all other
options held by him and (iv) continued medical coverage for Mr. Dyne and his
dependents for the remaining term of the agreement.  In connection
with the employment agreement, Mr. Dyne was granted an option to purchase
700,000 shares of our common stock, which vests in full on December 31, 2010,
subject to earlier vesting if Mr. Dyne meets performance criteria established by
the Board for fiscal 2008 and 2009. Mr. Dyne’s options will vest in full upon a
change of control of our company or upon termination of Mr. Dyne’s employment
without cause, for good reason or due to his death or disability.






83








Potential
Severance Payments




As
described above, our employment agreements with Lonnie Schnell and Larry Dyne
provided for severance benefits in the event that the executive’s employment is
terminated due to executive’s death or disability, by us without “cause” or by
the executive for “good reason.”  The following table sets forth
severance payments and benefits that we would have been obligated to pay to
Messrs. Schnell and Dyne assuming a triggering event had occurred under each of
their respective agreements as of December 31, 2009:




Name
            
            Cash
      Severance Payment ($)(1)
            
            
            Non-Equity
      Incentive ($)
            
            
            Continuation
      of Health Benefits ($)
            
            
            Value
      of Acceleration of Vesting of Equity Awards ($)(2)
            
            
            Total
      Severance Benefits ($)Lonnie
      D. Schnell
            
            
            355,713
            
            
            
            94,000
            
            
            
            18,524
            
            
            
            -
            
            
            
            468,237Larry
      Dyne
            
            
            327,453
            
            
            
            71,000
            
            
            
            10,369
            
            
            
            -
            
            
            
            408,822




(1)
            Includes
      (i) earned and unpaid base salary through the date of termination, (ii)
      accrued but unpaid vacation and (iii) cash severance payments based on the
      executive’s salary payable in a lump sum or periodic payments as provided
      in the executive’s employment
agreement.




(2)
            Based
      on the closing price of our common stock on December 31, 2009 of $0.09, as
      reported by the OTC Bulletin Board.





Potential
Change in Control Payments





As
described above, our employment agreements with Lonnie Schnell and Larry Dyne
provide for accelerated vesting of all or a portion of the options held by such
executives upon a change in control.  However, as of December 31,
2009, there were no unvested stock options held by the named executive officers
that had an exercise price lower than the closing price of our common stock on
December 31, 2009 of $0.09 per share, as reported by the OTC Bulletin
Board.  As a result, there would have been no value of the accelerated
vesting had a change in control occurred on December 31,
2009.  Currently, there are no other benefits payable to our named
executive officers upon a change in control.





Director
Compensation





The
general policy of the Board of Directors is that compensation for independent
directors should be a mix of cash and equity-based compensation.  We
do not pay management directors for Board service in addition to their regular
employee compensation.  The full Board of Directors has the primary
responsibility for reviewing and considering any revisions to director
compensation.






84










The
following table details the total compensation earned by our non-employee
directors in 2009.




Name
            
            Fees
      Earned or Paid in Cash
            
            
            Option
      Awards (7)
            
            
            TotalMark
      Dyne (1)
            
            $
            28,500
            
            
            $
            -
            
            
            $
            28,500Colin
      Dyne (2)
            
            
            -
            
            
            
            -
            
            
            
            -Brent
      Cohen (3)
            
            
            30,500
            
            
            
            -
            
            
            
            30,500Joseph
      Miller (4)
            
            
            30,000
            
            
            
            -
            
            
            
            30,000Raymond
      Musci (5)
            
            
            35,000
            
            
            
            -
            
            
            
            35,000William
      Sweedler (6)
            
            
            30,500
            
            
            
            
            
            
            
            30,500Total
            
            $
            154,500
            
            
            $
            -
            
            
            $
            154,500







(1)
            As
      of December 31, 2009, Mr. Mark Dyne held options to purchase a total of
      265,000 shares.




(2)
            As
      of December 31, 2009, Mr. Colin Dyne held options to purchase a total of
      480,000 shares.




(3)
            As
      of December 31, 2009, Mr. Cohen held options to purchase a total of
      150,000 shares.  The other compensation consists of consulting
      fees for services rendered.




(4)
            As
      of December 31, 2009, Mr. Miller held options to purchase a total of
      120,000 shares.




(5)
            As
      of December 31, 2009, Mr. Musci held options to purchase a total of
      120,000 shares.




(6)
            As
      of December 31, 2009, Mr. Sweedler held options to purchase a total of
      90,000 shares. Mr. Sweedler resigned from his position as board member on
      March 15, 2010.




(7)
            The
      amounts in this column represent the aggregate grant date fair value
      computed in accordance with ASC 718 with respect to stock options granted
      in 2009. For additional information on the valuation assumptions with
      respect to option grants, including the options granted in 2009, see Note
      8 of the Notes to Consolidated Financial Statements in this Annual Report
      on Form 10-K. These amounts do not reflect the actual value that may be
      realized by the named executive officers which depends on the value of our
      shares in the future.




Our
policy is to pay non-employee directors $1,500 for their personal attendance at
any meeting of the Board of Directors, $1,000 for their personal attendance at
any committee meeting, and $500 for attendance at any telephonic meeting of the
Board of Directors or of a committee of the Board of Directors.  We
also pay non-employee directors an annual retainer of $20,000 for Board service
and an additional retainer of $5,000 for service on each committee. The Chairman
of the Board receives an annual retainer of $25,000 for Board
service.  We also reimburse directors for their reasonable travel
expenses incurred in attending board or committee meetings and pay non-employee
directors a per diem for board services.




We do not
have a formal policy with regard to option grants to our Board of Directors, but
we generally follow a practice of granting an option for 30,000 shares of stock
upon initial appointment or election to the Board of Directors, and thereafter
issuing annual option grants to all non-employee members of 30,000
shares.




In
November 2009, we entered into an agreement to pay a commission to an affiliate
of Colin Dyne of 7% of collected revenues associated with the sales of selected
business opportunities, with 2% of the 7% earned applied to the note receivable
balance with Colin Dyne.  Commissions of $16,524 were paid in cash and
$5,483 were applied to the note receivable balance for the year ended December
31, 2009.







85







Back to Index to Form 10-K


Compensation
Committee Interlocks and Insider Participation





The
Compensation Committee of our Board of Directors currently consists of Brent
Cohen and Raymond Musci.  None of our current executive officers has
served as a member of the board of directors or compensation committee of any
entity for which a member of our Board of Directors or Compensation Committee
has served as an executive officer.








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






Equity
Compensation Plan Information




The
following table sets forth certain information as of December 31, 2009 regarding
equity compensation plans (including individual compensation arrangements) under
which our equity securities are authorized for issuance:












Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
            
            
            Weighted-average
      exercise price of outstanding options, warrants and rights
            
            
            Number
      of securities remaining available for future issuance under equity
      compensation plansEquity
      compensation plans approved by security holders
            
            
            6,237,850
            
            
            $
            0.74
            
            
            
            555,000Equity
      compensation plans not approved by security holders
            
            
            400,000
            
            
            $
            0.59
            
            
            
            -Total
            
            
            6,637,850
            
            
            $
            0.73
            
            
            
            555,000







Options
issued pursuant to equity compensation plans not approved by security holders
consist of inducements options to purchase 400,000 shares of common stock
granted to an employee in 2006 which are exercisable at a price of $0.59 per
share and expire in January 2016.




Each of
the above plans provides that the number of shares with respect to which options
and warrants may be granted, and the number of shares of common stock subject to
an outstanding option or warrant, shall be proportionately adjusted in the event
of a subdivision or consolidation of shares or the payment of a stock dividend
on common stock.




Security
Ownership of Certain Beneficial Owners and Management




The
following table presents information regarding the beneficial ownership of our
common stock as of March 29, 2010:




·
            each
      person who is known to us to be the beneficial owner of more than 5% of
      our outstanding common stock;


·
            each
      of our current directors;


·
            each
      of our named executive officers;
and


·
            all
      of our directors and executive officers as a
  group






86








Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission that deem shares to be beneficially owned by any person who
has or shares voting or investment power with respect to such
shares.  Shares of common stock under warrants or options currently
exercisable or exercisable within 60 days of the date of this information are
deemed outstanding for purposes of computing the percentage ownership of the
person holding such warrants or options but are not deemed outstanding for
computing the percentage ownership of any other person.  As a result,
the percentage of outstanding shares of any person as shown in this table does
not necessarily reflect the person’s actual ownership or voting power with
respect to the number of shares of common stock actually outstanding at March
29, 2010. Unless otherwise indicated, the persons named in this table have sole
voting and sole investment power with respect to all shares shown as
beneficially owned, subject to community property laws where
applicable.  As of March 29, 2010, we had 20,291,433 shares of common
stock issued and outstanding.




The
address of each person listed is in our care, at 21900 Burbank Boulevard, Suite
270, Woodland Hills, California 91367, unless otherwise set forth below such
person’s name.




Name
      of Beneficial Owner
            
            Number
      of Shares
            
            Percent
      of ClassExecutive
      Officers:Lonnie
      D. Schnell, Chief Executive Officer & Chief Financial Officer &
      Director (1)
            
            1,225,000
            
            5.7%Larry
      Dyne, President, Officer (2)
            
            1,245,100
            
            5.8%James
      E. Reeder, V.P. Corporate Controller,  Officer
            
            34,000
            
            *Directors:Mark
      Dyne, Chairman of the Board of Directors (3)
            
            1,100,667
            
            5.4%Colin
      Dyne, Director (4)
            
            572,780
            
            2.8%Brent
      Cohen, Director (5)
            
            150,000
            
            *Raymond
      Musci, Director (5)
            
            120,000
            
            *Joseph
      M. Miller, Director (5)
            
            120,000
            
            *Directors
      and executive officers as a group (8 persons) (6)
            
            4,567,547
            
            19.4%Other
      5% Holders:Bluefin
      Capital, LLC
              105 S. Narcissus Ave., Suite 712
              West Palm Beach, FL  33401
            
            1,750,000
            
            8.6%





*
            Less
      than 1%.


(1)
            Includes
      1,100,000 shares of common stock reserved for issuance upon exercise of
      stock options that are currently exercisable or will become exercisable
      within 60 days.


(2)
            Includes
      1,115,500 shares of common stock reserved for issuance upon exercise of
      stock options that are currently exercisable.  Also includes
      129,600 shares of common stock held by a family trust which Mr. Larry Dyne
      may be deemed to beneficially own.


(3)
            Includes
      265,000 shares of common stock reserved for issuance upon exercise of
      stock options which are currently exercisable and 176,600 shares held by a
      limited liability company of which Mr. Dyne is the manager and a
      member.


(4)
            Includes
      390,000 shares of common stock reserved for issuance upon exercise of
      stock options that are currently
exercisable.


(5)
            Consists
      of shares of common stock reserved for issuance upon the exercise of the
      stock options that are currently
exercisable.


(6)
            Includes
      3,260,500shares
      of common stock reserved for issuance upon exercise of stock options which
      currently are exercisable or will become exercisable within 60
      days.








87








Back to Index to Form 10-K


The
information as to shares beneficially owned has been individually furnished by
our respective directors, named executive officers, and our other stockholders,
or taken from documents filed with the Securities and Exchange
Commission.






ITEM 13.      
     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE




Review
and Approval of Related Party Transactions




We have
adopted a policy that requires Board of Directors approval of transactions with
related persons as defined by SEC regulations, including any sales or purchase
transaction, asset exchange transaction, operating agreement, or advance or
receivable transaction that could put our assets or operating performance at
risk.  All of our directors and executive officers are required at all
times, but not less than annually, to disclose all relationships they have with
companies or individuals that have conducted business with, or had an interest
in, us.  Our executive officers monitor our operations giving
consideration to the disclosed relationships and refer potential transactions to
the Board of Directors for approval.  The Board of Directors considers
a related party transaction for its potential economic benefit to us, to ensure
the transaction is “arms length” and in accordance with our policies and that it
is properly disclosed in our reports to shareholders.




Reportable
Related Party Transactions




Other
than the employment arrangements described elsewhere in this report and the
transactions described below, since January 1, 2009, there has not been, nor is
there currently proposed, any transaction or series of similar transactions to
which we were or will be a party:




·
            in
      which the amount involved exceeds $120,000;
and




·
            in
      which any director, executive officer, shareholder who beneficially owns
      5% or more of our common stock or any member of their immediate family had
      or will have a direct or indirect material
  interest.




Colin
Dyne, Vice Chairman of our Board of Directors and a stockholder, is also an
executive officer, director and significant shareholder of People’s Liberation,
Inc., the parent company of Versatile Entertainment, Inc.  During
2009, we had sales of $1,000 to Versatile Entertainment.  At December
31, 2009 accounts receivable of $200 were outstanding from Versatile
Entertainment.  Colin Dyne also holds an interest in William Rast
Sourcing.  During 2009 we had sales of $206,400 to William Rast
Sourcing.  At December 31, 2009 accounts receivable of $41,200 were
outstanding from William Rast Sourcing.




At
December 31, 2009, we had $720,517 of unsecured notes, advances and accrued
interest receivable due from Colin Dyne.  The notes and advances bear
interest at 7.5% and are due on demand.  We have recorded a valuation
reserve against this note of $720,517 at December 31, 2009. In November 2009, we
entered into an agreement to pay a commission to an affiliate of Colin Dyne of
7% of collected revenues associated with the sales of selected business
opportunities, with 2% of the 7% earned applied to the note receivable
balance.  Commissions of $16,524 were paid in cash and $5,483 were
applied to the note receivable balance for the year ended December 31,
2009.




As of
December 31, 2009, we had an aggregate of $229,356 in notes and advances due to
Mark Dyne, the Chairman of our Board of Directors and a significant stockholder,
or to parties related to or affiliated with Mark Dyne.  The notes are
payable on demand and accrue interest at 10% per annum.







88







Back to Index to Form 10-K


As of
December 31, 2009 accrued expenses includes $251,568 in consideration for the
final payment under a consulting agreement dated March 20, 2000 to Diversified
Consulting LLC, a company owned by Mark Dyne, Chairman of our Board of
Directors, that ended on March 20, 2010. We paid or accrued total consulting
fees and related interest to Diversified Consulting, LLC, in the amount of
$401,568 during the year ended December 31, 2009.




Director
Independence




Because
our common stock is quoted on the OTC Bulletin Board, we are not subject to the
listing requirements of any securities exchange or Nasdaq regarding the
independence of our directors.  However, our Board of Directors has
determined that as of December 31, 2009, a majority of our Board of Directors is
comprised of “independent” directors within the meaning of the applicable rules
for companies listed on The Nasdaq Stock Market.  The Board determined
that each of Brent Cohen, Joseph Miller, Raymond Musci and William Sweedler were
independent.  The Board has also determined that each of Joseph
Miller, Raymond Musci and William Sweedler meet the independence requirements
for services on the Audit Committee pursuant to the rules for companies traded
on The Nasdaq Stock Market.




In March
2010, William Sweedler resigned from his position as board member. As a result,
as of the date of filing of this Annual Report we no longer have a majority of
Board of Directors that qualifies as independent under The Nasdaq Stock Market
listing standards. We are in the process of identifying potential candidates to
replace to Mr. Sweedler on the Board.  It is anticipated that any
candidate for this vacant Board seat would be an independent
director.







ITEM 14.       
    PRINCIPAL ACCOUNTING FEES AND SERVICES




Services
Provided by the Independent Auditors




The audit
committee of our Board of Directors is responsible for the appointment,
compensation, retention and oversight of the work of the independent
auditors.




SingerLewak
LLP served as our independent registered public accounting firm for each of the
fiscal years ended December 31, 2009, 2008 and 2007.




Audit Fees -The aggregate
fees billed by our independent registered public accounting firm for
professional services rendered for the audit of our annual financial statements
and review of our financial statements included in our Forms 10-Q or services
that are normally provided in connection with statutory and regulatory filings
were $370,000 for fiscal year 2009 and $439,000 for fiscal year
2008.




Audit-Related Fees -The
aggregate fees billed by our independent registered public accounting firm for
professional services rendered for assurance and related services reasonably
related to the performance of the audit or review of our financial statements
(other than those reported above)were $0 for fiscal year 2009 and 28,000 for
fiscal year 2008.




Tax Fees -The aggregate fees
billed by our independent registered public accounting firm for professional
services rendered for tax compliance, tax advice and tax planning were $37,000
for fiscal year 2009 and $54,000 for fiscal year 2008.






89







Back to Index to Form 10-K


All Other Fees –The
aggregate fees billed by our independent public registered accounting firm for
services rendered to us other than the services described above under “Audit
Fees,” “Audit-Related Fees” and “Tax Fees” were $5,000 for fiscal year 2009 and
$24,000 for fiscal year 2008 which was primarily related governmental
regulations not related to our annual or quarterly financial
statements.




The audit
committee approved all of the foregoing services provided by SingerLewak
LLP.




Policy
Regarding Pre-Approval of Services Provided by the Independent
Auditors





The audit
committee has established a general policy requiring it’s pre-approval of all
audit services and permissible non-audit services provided by the independent
auditors, along with the associated fees for those services. For both types of
pre-approval, the audit committee considers whether the provision of a non-audit
service is consistent with the SEC’s rules on auditor independence, including
whether provision of the service (1) would create a mutual or conflicting
interest between the independent auditors and the Company, (2) would place the
independent auditors in the position of auditing its own work, (3) would result
in the independent auditors acting in the role of management or as our employee,
or (4) would place the independent auditors in a position of acting as an
advocate for us.  Additionally, the audit committee considers whether
the independent auditors are best positioned and qualified to provide the most
effective and efficient service, based on factors such as the independent
auditors’ familiarity with our business, personnel, systems or risk profile and
whether provision of the service by the independent auditors would enhance our
ability to manage or control risk or improve audit quality or would otherwise be
beneficial to us.









PART
IV




ITEM 15.         
  EXHIBITS, FINANCIAL STATEMENT SCHEDULE




(a) List
the following documents filed as a part of this report:




(1)  Financial
Statements




See Index
to Financial Statements in Item 8 of this Annual Report on Form 10-K, which
is incorporated herein by reference.




(2)  Financial Statement
Schedule




Schedule
II – Valuation and Qualifying Accounts Reserves is included beginning on the
following page.




(3)  Exhibits




See
Exhibit Index attached to this Annual Report on Form 10-K, which is incorporated
herein by reference.






90










Schedule
II – Valuation and Qualifying Accounts and Reserves (amounts in
thousands)









Description
            
            Balance
      at Beginning of Year
            
            
            Additions
            
            
            Deductions
            
            
            Balance
      at End of Year2009Allowance
      for doubtful accounts deducted from accounts receivable in the balance
      sheet
            
            $
            217
            
            
            $
            122
            
            
            $
            107
            
            
            $
            232Allowance
      for doubtful accounts deducted from related party in the balance
      sheet
            
            
            474
            
            
            
            200
            
            
            
            -
            
            
            
            674Reserve
      for inventory valuation deducted from inventories on the balance
      sheet
            
            
            1,211
            
            
            
            61
            
            
            
            87
            
            
            
            1,185Valuation
      reserve deducted from Deferred tax assets
            
            
            23,469
            
            
            
            676
            
            
            
            -
            
            
            
            24,145$
            25,371
            
            
            $
            1,059
            
            
            $
            194
            
            
            $
            26,2362008Allowance
      for doubtful accounts deducted from accounts receivable in the balance
      sheet
            
            $
            141
            
            
            $
            74
            
            
            $
            (2
            )
            
            $
            217Allowance
      for doubtful accounts deducted from related party in the balance
      sheet
            
            
            -
            
            
            
            474
            
            
            
            -
            
            
            
            474Reserve
      for inventory valuation deducted from inventories on the balance
      sheet
            
            
            1,019
            
            
            
            692
            
            
            
            500
            
            
            
            1,211Valuation
      reserve deducted from Deferred tax assets
            
            
            20,163
            
            
            
            4,400
            
            
            
            1,094
            
            
            
            23,469$
            21,323
            
            
            $
            5,640
            
            
            $
            1,592
            
            
            $
            25,3712007Allowance
      for doubtful accounts deducted from accounts receivable in the balance
      sheet
            
            $
            72
            
            
            $
            135
            
            
            $
            66
            
            
            $
            141Allowance
      for doubtful accounts deducted from notes receivable in the balance
      sheet
            
            
            -
            
            
            
            1,088
            
            
            
            1,088
            
            
            
            -Reserve
      for inventory valuation deducted from inventories on the balance
      sheet
            
            
            1,242
            
            
            
            148
            
            
            
            371
            
            
            
            1,019Valuation
      reserve deducted from Deferred tax assets
            
            
            19,225
            
            
            
            938
            
            
            
            -
            
            
            
            20,163Total
            
            $
            20,539
            
            
            $
            2,309
            
            
            $
            1,525
            
            
            $
            21,323







(1)
            Additions
      to the allowance for doubtful accounts include provisions for
      uncollectible accounts.  Bad debt expense includes (and
      additions above exclude) net direct write-offs of approximately $(2,000),
      $0.0 and $114,000 for the years ended December 31, 2009, 2008 and 2007,
      respectively.  Additions to the inventory valuation reserve
      include current year provisions.  Additionally, in 2009, 2008
      and 2007 there were direct write-offs of $223,000, $500,000 and 371,000,
      respectively.




(2)
            Deductions
      from the allowance for doubtful accounts include amounts applied to
      write-offs and reversals of prior period provisions.  Deductions
      from the inventory valuation reserve include application of the reserve
      against obsolete, excess, slow-moving or disposed
    inventory.








91














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.










TALON INTERNATIONAL, INC./s/
      Lonnie D.
      Schnell
              By:  Lonnie
      D. Schnell
              Its:  Chief
      Executive Officer & Chief Financial Officer
              (Principal
      Executive Officer & Principal Financial Officer)/s/ James E.
      Reeder
              By:  James
      E. Reeder
              Its:
      Vice President, Corporate Controller
              (Principal
      Accounting Officer)












92










POWER
OF ATTORNEY




Each
person whose signature appears below constitutes and appoints Lonnie D. Schnell
and Mark Dyne, 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/
      Lonnie D.
      Schnell
              Lonnie
      D. Schnell
            Chief
      Executive Officer and Chief Financial Officer, Director (Principal
      Executive and Financial Officer)
            March
      29, 2010/s/
      James E. Reeder
              James
      E. Reeder
            Vice
      President, Corporate Controller (Principal Accounting
    Officer)
            March
      29, 2010/s/ Mark
      Dyne
              Mark
      Dyne
            Chairman
      of the Board of Directors
            March
      29, 2010/s/
      Colin
      Dyne
              Colin
      Dyne
            Vice
      Chairman of the Board of Directors
            March
      29, 2010/s/
      Brent
      Cohen
              Brent
      Cohen
            Director
            March
      29, 2010/s/
      Raymond
      Musci
              Raymond
      Musci
            Director
            March
      29, 2010/s/ Joseph
      Miller
              Joseph
      Miller
            Director
            March
      29, 2010






93













EXHIBIT INDEX




Exhibit
      Number
            Exhibit Description3.1
            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, 2006.3.1.5
            Certificate
      of Ownership and Merger.  Incorporated by reference to Exhibit
      3.1 to Form 8-K filed on July 20, 2007.3.2
            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.10.5
            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.   94
   Exhibit
      Number
            Exhibit Description10.6
            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.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
            Form
      of Investor Rights Agreements dated December 28,
      2001.  Incorporated by reference to Exhibit 99.4 to Form 8-K
      filed on January 23, 2002.10.14
      (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, 2003.10.15
      (2)
            2007
      Stock Plan.  Incorporated by reference to Exhibit 10.20 to the
      Form 10-K filed on April 25, 2008.10.16
            Revolving
      Credit and Term Loan Agreement dated June 27, 2007, by and between Tag-It
      Pacific, Inc. and Bluefin Capital, LLC.  Incorporated by
      reference to Exhibit 10.35 to Form 10-Q filed on August 14,
      2007.10.16.1
            Amendment
      No. 1 to Loan Agreement dated July 30, 2007, by and between the Registrant
      and Bluefin Capital, LLC. Incorporated by reference to Exhibit 10.20 to
      the Form 10-K filed on April 25, 2008.10.16.2
            Amendment
      No. 2 to Loan Agreement dated November 19, 2007, by and between the
      Registrant and Bluefin Capital, LLC.  Incorporated by reference
      to Exhibit 10.35.2 to Form 8-K filed on November 26, 2007.10.16.3
            Amendment
      No. 3 to Loan Agreement dated as of March 31, 2008, by and between the
      Registrant and Bluefin Capital, LLC.  Incorporated by reference
      to Exhibit 10.21.3 to Form 10-Q filed on May 15, 2008.10.16.4
            Amendment
      No. 4 to Loan Agreement dated as of March 31, 2009, by and between the
      Registrant and CVC California, LLC.  Incorporated by reference
      to Exhibit 10.19.4 to Form 10-Q filed on May 15, 2009.    95
   Exhibit Number
              Exhibit
      Description
 10.17
            Guaranty
      Agreement, dated June 27, 2007, by Talon International, Inc., Tag-It,
      Inc., A.G.S. Stationary, Inc., Tag-It Pacific Limited, Tag-It Pacific (HK)
      Ltd., Tagit de Mexico, S.A. de C. V., Talon Zipper (Shenzhen) Company,
      Ltd., and Talon International, Pvt. Ltd. in favor of Bluefin Capital,
      LLC.  Incorporated by reference to Exhibit 10.36 to Form 10-Q
      filed on August 14, 2007.10.18
            Collateral
      Agreement, dated June 27, 2007, by and among Tag-It Pacific, Inc., Talon
      International, Inc., Tag-It, Inc., A.G.S. Stationary, Inc., Tag-It Pacific
      Limited, Tag-It Pacific (HK) Ltd., Tagit de Mexico, S.A. de C. V., Talon
      Zipper (Shenzhen) Company, Ltd., and Talon International, Pvt. Ltd. in
      favor of Bluefin Capital, LLC.  Incorporated by reference to
      Exhibit 10.37 to Form 10-Q filed on August 14, 2007.10.19
            Registration
      Rights Agreement, dated June 27, 2007, by Talon International, Inc., for
      the benefit of holders.  Incorporated by reference to Exhibit
      4.10 to Registration Statement on Form S-3 filed on August 10,
      2007.10.20
            Promissory
      Note, dated June 27, 2007, executed by Colin Dyne in favor of Tag-It
      Pacific, Inc.  Incorporated by reference to Exhibit 10.40 to
      Form 10-Q filed on August 14, 2007.10.21
      (2)
            Executive
      Employment Agreement, dated June 18, 2008, between Talon International,
      Inc. and Lonnie Schnell.  Incorporated by reference to Exhibit
      10.1 to Form 8-K filed on June 24, 2008.10.21.1
      (2)
            Amendment
      No. 1 to Executive Employment Agreement, dated August 6, 2009, between
      Talon International, Inc. and Lonnie Schnell.  Incorporated by
      reference to Exhibit 10.1 to Form 8-K filed on August 10,
      2009.10.22
      (2)
            Executive
      Employment Agreement, dated June 18, 2008, between Talon International,
      Inc. and Larry Dyne.  Incorporated by reference to Exhibit 10.1
      to Form 8-K filed on June 24, 2008.10.22.1
      (2)
            Amendment
      No. 1 to Executive Employment Agreement, dated August 6, 2009, between
      Talon International, Inc. and Larry Dyne.  Incorporated by
      reference to Exhibit 10.2 to Form 8-K filed on August 10,
      2009.10.23
      (2)
            Talon
      International, Inc. 2008 Stock Incentive Plan. Incorporated by reference
      to Exhibit 4.10 to Registration Statement on Form S-8 filed on July 18,
      2008.10.24
      (2)
            Sales
      and Service Representative Agreement, dated November 13, 2009, between
      Talon International, Inc. and The Link Trading
      LLC.  Incorporated by reference to Exhibit 10.28 to Form 10-Q
      filed on November 13, 2009.14.1
            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 SingerLewak LLP.    96
  Exhibit Number
              Exhibit
      Description
 24.1
            Power
      of Attorney (included on signature page).31.1
            Certificate
      of Chief Executive Officer and 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.









97