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

                                    FORM 10-Q

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

               For the quarterly period ended September 30, 2006.

                                       OR

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

                         Commission file number 1-13669

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

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

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

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



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

                              Yes [X]       No [ ]

         Indicate by check mark whether the  registrant  is a large  accelerated
filer,  an  accelerated  filer or a  non-accelerated  filer . See  definition of
"accelerated  filer and large  accelerated  filer"in  Rule 12b-2 of the Exchange
Act. (Check one):

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

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

         AT NOVEMBER 13, 2006 THE ISSUER HAD 18,466,433  SHARES OF COMMON STOCK,
$.001 PAR VALUE, ISSUED AND OUTSTANDING.

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<PAGE>


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



PART I      FINANCIAL INFORMATION                                           PAGE
                                                                            ----

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

            Consolidated Balance Sheets as of September 30, 2006
            (unaudited) and December 31, 2005 .................................3

            Consolidated Statements of Operations for the Three Months and
            the Nine Months Ended September 30, 2006 and 2005 (unaudited)......4

            Consolidated Statements of Cash Flows for the
            Nine Months Ended September 30, 2006 and 2005 (unaudited)..........5

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

Item 2.     Management's Discussion and Analysis of Financial Condition
            and Results of Operations.........................................18

Item 3.     Quantitative and Qualitative Disclosures about Market Risk........35

Item 4.     Controls and Procedures...........................................35


PART II     OTHER INFORMATION

Item 1.     Legal Proceedings.................................................38

Item 1A.    Risk Factors .....................................................39

Item 4.     Submission of Matters to a Vote of Security Holders...............39

Item 6.     Exhibits .........................................................39


                                       2
<PAGE>


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

<CAPTION>
                                                       (unaudited)
                                                       September 30,   December 31,
                                                           2006            2005
                                                       ------------    ------------
<S>                                                    <C>             <C>
                        Assets
Current Assets:
   Cash and cash equivalents .......................   $  3,726,234    $  2,277,397
   Trade accounts receivable, net ..................      5,054,939       5,652,990
   Note receivable .................................      1,344,049         662,369
   Inventories .....................................      3,150,063       5,573,099
   Prepaid expenses and other current assets .......        681,513         618,577
                                                       ------------    ------------
      Total current assets .........................     13,956,798      14,784,432

Property and equipment, net ........................      5,846,119       6,438,096
Fixed assets held for sale .........................        826,904         826,904
Note receivable, less current portion ..............      1,778,781       2,777,631
Due from related parties ...........................        643,774         730,489
Other intangible assets, net .......................      4,172,001       4,255,125
Other assets .......................................        449,396         508,117
                                                       ------------    ------------
Total assets .......................................   $ 27,673,773    $ 30,320,794
                                                       ============    ============

          Liabilities and Stockholders' Equity
Current Liabilities:
   Accounts payable ................................   $  4,857,098    $  6,719,226
   Accrued legal costs .............................        722,550       2,520,111
   Other accrued expenses ..........................      3,814,618       4,168,552
   Demand notes payable to related parties .........        664,971         664,971
   Current portion of capital lease obligations ....        425,896         590,884
   Current portion of notes payable ................      1,495,196         186,837
                                                       ------------    ------------
      Total current liabilities ....................     11,980,329      14,850,581

Capital lease obligations, less current portion ....        586,807         856,495
Notes payable, less current portion ................      1,112,623       1,261,018
Secured convertible promissory notes ...............     12,464,557      12,440,623
                                                       ------------    ------------
      Total liabilities ............................     26,144,316      29,408,717
                                                       ------------    ------------

Commitments, Contingencies and guarantees - (Note 5)           --              --

Stockholders' equity:
   Preferred stock, Series A $0.001 par value;
      250,000 shares authorized, no shares
      issued or outstanding ........................           --              --
   Common stock, $0.001 par value, 100,000,000
      shares authorized; 18,466,433 shares issued
      and outstanding at September 30, 2006;
      18,241,045 at December 31, 2005 ..............         18,466          18,241
   Additional paid-in capital ......................     51,680,677      51,327,878
   Accumulated deficit .............................    (50,169,686)    (50,434,042)
                                                       ------------    ------------
Total stockholders' equity .........................      1,529,457         910,077
                                                       ------------    ------------
Total liabilities and stockholders' equity .........   $ 27,673,773    $ 30,320,794
                                                       ============    ============
</TABLE>

         See accompanying notes to consolidated financial statements.


                                       3
<PAGE>


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

<CAPTION>
                                            Three Months Ended             Nine Months Ended
                                               September 30,                 September 30,
                                       ---------------------------    ---------------------------
                                           2006           2005            2006           2005
                                       ------------   ------------    ------------   ------------
<S>                                    <C>            <C>             <C>            <C>
Net sales ..........................   $ 13,366,945   $  9,472,898    $ 38,251,248   $ 38,167,821
Cost of goods sold .................      9,218,539     11,567,128      27,132,880     36,254,108
                                       ------------   ------------    ------------   ------------
   Gross profit ....................      4,148,406     (2,094,230)     11,118,368      1,913,713

Selling expenses ...................        910,996        549,434       2,131,515      1,940,283
General and administrative expenses       2,684,695      4,908,555       8,136,448     19,649,868
Impairment of goodwill .............           --          450,000            --          450,000
Restructuring Costs ................           --        2,278,835            --        2,278,835
                                       ------------   ------------    ------------   ------------
   Total operating expenses ........      3,595,691      8,186,824      10,267,963     24,318,986

Income (loss) from operations ......        552,715    (10,281,054)        850,405    (22,405,273)
Interest expense, net ..............        158,741        264,551         519,692        802.400
                                       ------------   ------------    ------------   ------------
Income (loss) before income taxes ..        393,974    (10,545,605)        330,713    (23,207,673)
Provision (benefit) for income taxes         54,857       (260,731)         66,357      1,202,282
                                       ------------   ------------    ------------   ------------
   Net Income (loss) ...............   $    339,117   $(10,284,874)   $    264,356   $(24,409,955)
                                       ============   ============    ============   ============

Basic income (loss) per share ......   $       0.02   $      (0.56)   $       0.01   $      (1.34)
                                       ============   ============    ============   ============
Diluted income (loss) per share ....   $       0.02   $      (0.56)   $       0.01   $      (1.34)
                                       ============   ============    ============   ============

Weighted average number of common
 shares outstanding:
   Basic ...........................     18,440,927     18,241,045      18,347,509     18,220,731
                                       ============   ============    ============   ============
   Diluted .........................     19,279,648     18,241,045      18,719,531     18,220,731
                                       ============   ============    ============   ============
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       4
<PAGE>


<TABLE>
                              TAG-IT PACIFIC, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

<CAPTION>
                                                                          Nine Months Ended
                                                                            September 30,
                                                                    ----------------------------
                                                                        2006            2005
                                                                    ------------    ------------
<S>                                                                 <C>             <C>
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
    Net income (loss) ...........................................   $    264,356    $(24,409,952)
Adjustments to reconcile net income (loss) to net
  cash used by operating activities:
   Depreciation and amortization ................................        766,917       1,441,087
   (Decrease) increase in allowance for doubtful accounts .......     (1,046,500)      6,195,691
   Increase in deferred tax asset valuation allowance ...........           --         1,000,000
   (Decrease) increase in inventory valuation reserves ..........     (5,844,532)      3,918,189
   Asset impairment due to restructuring ........................           --         2,036,091
   Impairment of goodwill .......................................           --           450,000
   Disposal of assets ...........................................        255,320            --
   Stock based compensation .....................................        283,024            --
   Changes in operating assets and liabilities:
      Receivables, including related party ......................      1,731,266       6,589,814
      Inventories ...............................................      8,267,568      (4,450,771)
      Prepaid expenses and other current assets .................        (63,273)      1,013,803
      Note Receivable ...........................................        317,170            --
      Other Assets ..............................................         58,721         337,541
      Accounts payable and accrued expenses .....................     (2,087,081)      6,435,797
      Accrued legal costs .......................................       (147,561)        141,003
      Income taxes payable ......................................         66,357        (116,319)
                                                                    ------------    ------------
Net cash provided by operating activities .......................      2,821,752         581,974
                                                                    ------------    ------------

Cash flows from investing activities:
   Acquisition of property and equipment ........................       (325,702)     (1,634,024)
   Proceeds from sale of equipment ..............................          2,500            --
                                                                    ------------    ------------
Net cash used by investing activities ...........................       (323,202)     (1,634,024)
                                                                    ------------    ------------

Cash flows from financing activities:
    Repayment of bank line of credit, net .......................           --          (555,013)
    Proceeds from exercise of stock options and warrants ........           --           254,541
    Payment of capital leases ...................................       (434,676)       (683,876)
    Repayment of notes payable ..................................       (615,037)     (1,531,887)
                                                                    ------------    ------------
Net cash (used) by financing activities .........................     (1,049,713)     (2,516,235)
                                                                    ------------    ------------

Net increase (decrease) in cash .................................      1,448,837      (3,568,285)
Cash at beginning of period .....................................      2,277,397       5,460,662
                                                                    ------------    ------------
Cash at end of period ...........................................   $  3,726,234    $  1,892,377
                                                                    ============    ============

Supplemental disclosures of cash flow information:
   Cash received (paid) during the period for:
      Interest paid .............................................   $   (780,460)   $   (923,839)
      Income taxes refunded (paid) ..............................   $       --      $    (47,720)
      Interest received .........................................   $    264,339    $     29,734
   Non-cash financing activities:
      Capital lease obligation ..................................   $     64,433    $    270,597
      Accounts payable & accrued legal converted to notes payable   $  1,775,000    $       --
</TABLE>

         See accompanying notes to consolidated financial statements


                                       5
<PAGE>


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

NOTE  1           PRESENTATION OF INTERIM INFORMATION

        The accompanying  unaudited  consolidated financial statements have been
prepared in accordance  with  accounting  principles  generally  accepted in the
United  States for interim  financial  information  and in  accordance  with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not  include  all  of the  information  and  footnotes  required  by  accounting
principles  generally  accepted  in the  United  States for  complete  financial
statements. The accompanying unaudited consolidated financial statements reflect
all adjustments  that, in the opinion of the management of Tag-It Pacific,  Inc.
and its subsidiaries (collectively, the "Company"), are considered necessary for
a fair presentation of the financial position,  results of operations,  and cash
flows for the periods presented.  The results of operations for such periods are
not necessarily  indicative of the results  expected for the full fiscal year or
for any future period. The accompanying  financial  statements should be read in
conjunction with the audited  consolidated  financial  statements of the Company
included in the Company's  Form 10-K for the year ended  December 31, 2005.  The
balance  sheet  as of  December  31,  2005  has been  derived  from the  audited
financial statements as of that date but omits certain information and footnotes
required for complete financial statements.

         The accompanying  consolidated  financial statements have been prepared
assuming that the Company will continue as a going concern,  which  contemplates
the  realization  of assets and the  satisfaction  of  liabilities in the normal
course of business.  The Company has experienced  substantial  recurring  losses
from  operations on declining  revenues and has an accumulated  deficit of $50.2
million as of September 30, 2006. These matters, among others, raise substantial
doubt about the Company's ability to continue as a going concern.  The Company's
continuation  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 maintain profitable
operations.  In response  to these  matters,  during 2005 the Company  adopted a
restructuring  plan  designed to better align the Company's  organizational  and
cost  structures with its future growth  opportunities.  In connection with this
restructuring,  management's  operating plan for 2006 includes  increased sales,
higher margins on certain products, reduced expenses as a percentage of revenues
and improved cash flows sufficient to cover the Company's operating needs. There
can be no assurance  that the Company will be successful in these  matters.  The
financial  statements do not include any adjustments  that might result from the
outcome of this uncertainty.


                                       6
<PAGE>


NOTE 2            EARNINGS (LOSS) PER SHARE

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


<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, 2006:    INCOME (LOSS)      SHARES        PER SHARE
                                          ------------    ------------    ------------
<S>                                       <C>               <C>           <C>
Basic Income per share:
Income available to common stockholders   $    339,117      18,440,927    $       0.02

Effect of Dilutive Securities:
Options ...............................           --           838,721            --
Warrants ..............................           --              --              --
                                          ------------    ------------    ------------
Income available to common stockholders   $    339,117      19,279,648    $       0.02
                                          ============    ============    ============

THREE MONTHS ENDED SEPTEMBER 30, 2005:
Basic loss per share:
Loss available to common stockholders .   $(10,284,874)     18,241,045    $      (0.56)

Effect of Dilutive Securities:
Options ...............................           --              --              --
Warrants ..............................           --              --              --
                                          ------------    ------------    ------------
Loss available to common stockholders .   $(10,284,874)     18,241,045    $      (0.56)
                                          ============    ============    ============

NINE MONTHS ENDED SEPTEMBER 30, 2006:
Basic income per share:
Income available to common stockholders   $    264,356      18,347,509    $       0.01

Effect of Dilutive Securities:
Options ...............................           --           372,022            --
Warrants ..............................           --              --              --
                                          ------------    ------------    ------------
Income available to common stockholders   $    264,356      18,719,531    $       0.01
                                          ============    ============    ============

NINE MONTHS ENDED SEPTEMBER 30, 2005:
Basic loss per share:
Loss available to common stockholders .   $(24,409,955)     18,220,731    $      (1.34)

Effect of Dilutive Securities:
Options ...............................           --              --              --
Warrants ..............................           --              --              --
                                          ------------    ------------    ------------
Loss available to common stockholders
                                          $(24,409,955)     18,220,731    $      (1.34)
                                          ============    ============    ============
</TABLE>


        Warrants to purchase  1,243,813  shares of common stock  exercisable  at
between  $3.50 and $5.06 per share,  options  to  purchase  4,897,635  shares of
common stock  exercisable at between $0.37 and $5.23 per share,  and convertible
debt of $12,500,000  convertible at $3.65 per share,  were  outstanding  for the
three months ended  September  30, 2006.  In  connection  with the  "Share-Based
Payment,"  ("SFAS  123(R)")  calculation  (see  note 3),  3,435,135  shares  and
2,775,135  shares were included in the  computation  of diluted income per share
for the three months and nine months ended September 30, 2006 respectively.


                                       7
<PAGE>


         Warrants to purchase  1,510,479  shares of common stock  exercisable at
between  $3.50 and $5.06 per share,  options  to  purchase  1,942,000  shares of
common stock exercisable at between $1.30 and $5.23 per share,  convertible debt
of $500,000 convertible at $4.50 per share and convertible debt of $12.5 million
convertible  at $3.65 per share were  outstanding  for the three and nine months
ended  September 30, 2005,  but were not included in the  computation of diluted
earnings per share  because  exercise or conversion  would have an  antidilutive
effect on earnings per share.

NOTE 3            STOCK BASED COMPENSATION

        On  January  1,  2006,  the  Company  adopted   Statement  of  Financial
Accounting  Standards  No. 123 (revised  2004),  "Share-Based  Payment,"  ("SFAS
123(R)") which requires the measurement and recognition of compensation  expense
for all  share-based  payment  awards made to employees and  directors  based on
estimated fair values.  SFAS 123(R) supersedes the Company's previous accounting
under Accounting  Principles Board Opinion No. 25,  "Accounting for Stock Issued
to  Employees"  ("APB 25") for periods  beginning in fiscal 2006. In March 2005,
the Securities and Exchange  Commission issued Staff Accounting Bulletin No. 107
("SAB 107")  relating to SFAS 123(R).  The Company has applied the provisions of
SAB 107 in its adoption of SFAS 123(R).

        The  Company   adopted  SFAS  123(R)  using  the  modified   prospective
transition method,  which requires the application of the accounting standard as
of January 1, 2006. The Company's  financial  statements as of and for the three
and nine months ended  September 30, 2006 reflect the impact of SFAS 123(R).  In
accordance  with the  modified  prospective  transition  method,  the  Company's
financial statements for prior periods have not been restated to reflect, and do
not include,  the impact of SFAS 123(R).  There was no stock-based  compensation
expense  related to employee or director  stock  options  recognized  during the
three and nine months ended September 30, 2005. Stock-based compensation expense
recognized  under SFAS 123(R) for employee and  directors for the three and nine
months ended September 30, 2006 was $117,647 and $283,024,  respectively.  Basic
and diluted income per share for the quarter ended September 30, 2006 would have
been $0.02 per share,  if the Company had not adopted SFAS  123(R),  compared to
reported basic and diluted  income of $0.02 per share.  Basic and diluted income
per share for the nine months ended September 30, 2006 would have been $0.01 per
share,  if the Company had not adopted SFAS 123(R),  compared to reported  basic
and diluted loss of $0.01 per share.

        During the quarter ended September 30, 2006, the Company granted options
to acquire  660,000  shares at an exercise  price of $.69 per share.  During the
nine months ended  September 30, 2006,  the Company  granted awards of stock for
225,388  shares at an  average  market  price of $0.45 per share and  options to
acquire 3,570,523 shares at an average exercise price of $0.47 per share. Awards
to acquire  1,625,000 shares were granted to employees  outside of the 1997 Plan
(see Note 6), and awards of stock and  options to acquire  165,253  shares  were
granted to a consultant.  The estimated  fair value of all awards granted during
the quarter was  $43,756,  and the  estimated  fair value of all awards  granted
during the nine months ended  September  30, 2006 was $353,024 of which  $70,000
was accrued for as of  December  31,  2005.  Assumptions  used to value  options
granted to  employees  during the nine  months  ended  September  30,  2006 were
expected  volatility  of 57% to 64%,  expected  term of 5.0 years to 6.1  years,
risk-free interest rate of approximately 4.8%, and an expected dividend yield of
zero.  Assumptions  used to value options  granted to consultants  were expected
volatility  of 65%,  expected  term of 10 years  (contractual  life),  risk-free
interest rate of 4.5%, and expected divided yield of zero.

        Options issued to consultants are being accounted for in accordance with
the provisions of Emerging  Issues Task Force (EITF) No. 96-18,  "Accounting for
Equity Instruments That Are Issued to Others Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services."


                                       8
<PAGE>


        The  following  table  illustrates  the  effect on net loss and loss per
share if the Company had applied the fair value  recognition  provisions of SFAS
123(R) to stock-based  awards granted under the Company's stock option plans for
the three months and nine months ended  September 30, 2005. For purposes of this
pro-forma  disclosure,  the fair  value of the  options is  estimated  using the
Black-Scholes-Merton   option-pricing   formula   ("Black-Scholes   model")  and
amortized to expense  generally  over the  options'  requisite  service  periods
(vesting periods).

                                                   Three Months     Nine Months
                                                       Ended           Ended
                                                   September 30,   September 30,
                                                       2005            2005
                                                   ------------    ------------
Net loss as reported ...........................   $(10,284,874)   $(24,409,955)
Plus: Stock-based expense recognized in the
   Statement of Operations, net of tax .........           --              --
Less: Stock-based expense determined under
   fair-value based method, net of tax .........        (65,332)       (142,393)
                                                   ------------    ------------
Pro forma net loss .............................   $(10,350,206)   $(24,552,348)
                                                   ============    ============
------------------------------------------------
Net loss per share:
As reported -- basic and diluted ...............   $      (0.56)   $      (1.34)
Pro forma -- basic and diluted .................   $      (0.56)   $      (1.34)
                                                   ============    ============


        SFAS 123(R) requires companies to estimate the fair value of share-based
payment  awards  to  employees  and  directors  on the  date of  grant  using an
option-pricing  model.  The value of the portion of the award that is ultimately
expected to vest is recognized as expense over the requisite  service periods in
the  Company's  Statements  of  Operations.   Stock-based  compensation  expense
recognized in the  Statements of Operations  for the three and nine months ended
September 30, 2006 included  compensation expense for share-based payment awards
granted  prior to,  but not yet  vested as of January 1, 2006 based on the grant
date fair value  estimated in accordance  with the pro-forma  provisions of SFAS
123  and  compensation  expense  for  the  share-based  payment  awards  granted
subsequent  to January 1, 2006 based on the grant date fair value  estimated  in
accordance with the provisions of SFAS 123(R).  For stock-based awards issued to
employees and directors, stock-based compensation is attributed to expense using
the  straight-line  single  option  method,  which  is  consistent  with how the
prior-period  pro formas were  provided.  As  stock-based  compensation  expense
recognized in the Statements of Operations for 2006 is based on awards  expected
to vest, SFAS 123(R)  requires  forfeitures to be estimated at the time of grant
and revised,  if necessary,  in subsequent  periods if actual forfeitures differ
from those  estimates.  For the three and nine months ended  September 30, 2006,
expected  forfeitures  are  immaterial  and as such the  Company is  recognizing
forfeitures as they occur. In the pro-forma  information provided under SFAS 123
for the periods prior to fiscal 2006, the Company  accounted for  forfeitures as
they occurred.

        Prior  to the  adoption  of  SFAS  123(R),  the  Company  accounted  for
stock-based  awards to employees and directors  using the intrinsic value method
in  accordance  with APB 25.  Under the  intrinsic  value  method,  the  Company
recognized share-based  compensation equal to the award's intrinsic value at the
time of grant over the requisite service periods using the straight-line method.
Forfeitures were recognized as incurred.  During the three and nine months ended
September, 30, 2005, there was no stock-based compensation expense recognized in
the Statements of Operations for awards issued to employees and directors as the
awards had no intrinsic value at the time of grant because their exercise prices
equaled the fair values of the common stock at the time of grant.


                                       9
<PAGE>


        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
term is estimated using the "safe harbor" provisions under SAB 107.

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

NOTE 4            INVENTORIES

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

Inventories consist of the following:          September 30,        December 31,
                                                    2006                 2005
                                                -----------          -----------

Finished goods .......................          $ 4,611,500          $12,879,100
Less reserves ........................            1,461,500            7,306,000
                                                -----------          -----------
Total inventories ....................          $ 3,150,000          $ 5,573,100
                                                ===========          ===========


NOTE 5            COMMITMENTS, CONTINGENCIES AND GUARANTEES

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


                                       10
<PAGE>


        On October 12, 2005, a shareholder class action complaint--  Huberman vs
Tag-It Pacific,  Inc., et al., Case No.  CV05-7352  R(Ex)--was filed against the
Company and certain of the Company's  current and former  officers and directors
in the United  States  District  Court for the Central  District  of  California
alleging  claims under Section 10(b) and Section 20 of the  Securities  Exchange
Act of 1934, as amended,  and Rule 10b-5 promulgated  thereunder.  The action is
brought on behalf of all purchasers of the Company's publicly-traded  securities
during the period from November 14, 2003 to August 12, 2005. On January 23, 2006
the court heard competing motions for appointment of lead  plaintiff/counsel and
appointed Seth Huberman as lead plaintiff.  The lead plaintiff  thereafter filed
an amended  complaint on March 13, 2006. The amended  complaint alleges that the
defendants made false and misleading  statements  about the Company's  financial
situation  and its  relationship  with certain of its large  customers  during a
purported  class  period  between  November  13,  2003 and August 12,  2005.  It
purports to state claims under Section 10(b)/Rule 10b-5 and Section 20(a) of the
Securities  Exchange  Act of 1934.  The  Company  filed a motion to dismiss  the
amended  complaint,  which  motion  was  denied by the  Court on July 17,  2006.
Although the Company  believes that it and the other defendants have meritorious
defenses  to the class  action  complaint  and  intend to  contest  the  lawsuit
vigorously,  if there is an adverse  resolution to the lawsuit the results could
have a material adverse effect on the Company's  financial  position and results
of operations. At this early stage of the litigation, the Company is not able to
reasonably  predict the outcome of this action or estimate  potential losses, if
any, related to the lawsuit.

         On April 16,  2004,  the Company  filed suit against  Pro-Fit  Holdings
Limited  ("Pro-Fit")  in the U.S.  District  Court for the  Central  District of
California - Tag-It Pacific,  Inc. v. Pro-Fit Holdings  Limited,  CV 04-2694 LGB
(RCx) - asserting various  contractual and tort claims relating to 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 the  exclusive  rights in
certain geographic areas to Pro-Fit's stretch and rigid waistband technology. On
September 17, 2004, Pro-Fit filed an answer denying the material  allegations of
the complaint and filed  counterclaims  alleging  various  contractual  and tort
claims seeking injunctive relief and damages.  The Company filed a reply denying
the material  allegations of Pro-Fit's pleading.  Pro-Fit has since purported to
terminate the exclusive license and intellectual property agreement based on the
same  alleged  breaches of the  agreement  that are the subject of the  parties'
existing litigation, as well as on an additional basis. On February 9, 2005, and
again on June 16, 2005,  the Company  amended its pleadings in the litigation to
assert additional breaches by Pro-Fit of its obligations under the agreement and
under certain additional letter agreements,  and for a declaratory judgment that
Pro-Fit's  patent No.  5,987,721  is invalid and not  infringed  by the Company.
Thereafter,  Pro-Fit  filed an amended  answer  and  counterclaims  denying  the
material  allegations of the amended complaint and alleging various  contractual
and tort claims seeking injunctive relief and damages.  Pro-Fit further asserted
that  the  Company  infringed  its  United  States  Patent  Nos.  5,987,721  and
6,566,285.  The Company filed a reply denying the substantive allegations of the
amended counterclaims. At the Company's request, the Court bifurcated the breach
of contract issues for trial.  The parties have filed summary  judgment  motions
which may dispose of some of the issues in this case prior to trial.  On June 5,
2006 the Court denied one of the Company's motions for summary judgment, holding
that  the  issue of  whether  U.S.  Patent  No.  6,566,285  relating  to  curved
waistbands,  was  licensed  to the  Company  presented  a disputed  question  of
material  fact which could not be resolved  without a trial.  On August 17, 2006
the Court denied the Company's  motion for partial summary judgment holding that
summary  adjudication that the Company did not breach its agreement with Pro-Fit
by engaging in certain  activities  in Columbia was not  appropriate.  The Court
also held that  Pro-Fit  was not  "unwilling  or unable"  to  fulfill  orders by
refusing to fill orders with goods produced in the United States.  The Court did
not find that the Company  breached its  agreement  with Pro-Fit and,  again,  a
trial is required to determine  issues  concerning  the Company's  activities in
Columbia and whether other actions by Pro-Fit  constituted an  unwillingness  or
inability to fill orders. Mediation to attempt to resolve this case is scheduled
to occur on December 11, 2006.  No trial date is currently  set for trial of any
issues. As the Company derives a significant  amount of revenue from the sale of


                                       11
<PAGE>


products incorporating the stretch waistband technology, the Company's business,
results of operations  and  financial  condition  could be materially  adversely
affected if the dispute with  Pro-Fit is not  resolved in a manner  favorable to
the Company.  Additionally,  the Company has incurred  significant legal fees in
this  litigation,  and  unless  the  case is  settled  will  continue  to  incur
additional legal fees in increasing amounts as the case accelerates to trial.

         The Company  currently has pending a number of other claims,  suits and
complaints  that  arise in the  ordinary  course of its  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
condition if adversely determined against the Company.

         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.

         Effective June 1, 2006 accrued legal fees for services  provided by the
Company's  counsel  in the  amount  of  $1,650,000  were  converted  into a note
payable. The note is payable over a fourteen-month  period,  bearing interest at
3% per annum,  and is secured with an assignment of a note receivable due from a
customer in substantially identical monthly payments.  Additionally,  during the
quarter  ended June 30, 2006 a trade  payable in the amount of $125,000 due to a
former supplier was converted into a non-interest  bearing note payable due over
three months.

NOTE 6            STOCK OPTIONS AND WARRANTS

         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.


                                       12
<PAGE>


         As of September 30, 2006, the Company may issue awards to acquire up to
a total of 2,501,977 shares of common stock under the 1997 Plan. As of September
30,  2006,  there  were  awards  issued and  outstanding  under the 1997 Plan to
acquire a total of 3,272,635 shares of common stock, including options issued to
a  consultant  to acquire  75,000  shares of common stock at $0.57 per share and
stock grants of 225,388 shares. During the nine months ended September 30, 2006,
the  Company  issued  options  outside the plan to acquire  1,625,000  shares of
common stock at an average exercise price of $0.46 per share.

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

         The following table summarizes the activity for the periods:

                                                                       Weighted
                                                                        Average
EMPLOYEE AND DIRECTOR                                   Number of      Exercise
                                                          Shares        Price
                                                        ----------    ----------
Options outstanding - January 1, 2005 ...............    1,742,000    $     3.53
     Granted ........................................      425,000    $     3.22
     Exercised ......................................       (1,250)   $     3.63
     Canceled .......................................     (332,750)   $     3.50
                                                        ----------    ----------
Options outstanding - December 31, 2005 .............    1,833,000    $     3.46
     Granted ........................................    3,405,270    $     0.47
     Issued .........................................     (135,135)   $     0.37
     Canceled .......................................     (280,500)   $     3.26
                                                        ----------    ----------
Options outstanding - September 30, 2006 ............    4,822,635    $     1.43
                                                        ==========    ==========


         The  Company  has also issued  certain  warrants,  stock and options to
non-employees. As of September 30, 2006, there were warrants issued to acquire a
total of 1,243,813  shares of common  stock,  a stock grant of 90,253 shares and
options to acquire 75,000 shares of common stock outstanding.

         The following table summarizes all stock-based awards (warrants, grants
and options) to non- employees:

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

Outstanding - January 1, 2005 .......................    1,377,147    $     4.36
  Granted ...........................................         --            --
                                                        ----------    ----------
Outstanding - December 31, 2005 .....................    1,377,147    $     4.36
  Granted ...........................................      165,253    $     0.57
  Issued ............................................      (90,253)   $     0.57
  Cancelled .........................................     (133,334)   $     4.54
                                                        ----------    ----------

Outstanding - September 30, 2006 ....................    1,318,813    $     4.13


                                       13
<PAGE>


         The weighted average exercise prices,  remaining  contractual lives and
aggregate intrinsic values for employee and director shares and options granted,
expected to vest, and exercisable as of December 31, 2005 and September 30, 2006
were as follows:

<TABLE>
<CAPTION>
                                                            Weighted
                                                Weighted     Average
                                                 Average    Remaining
                                    Number of   Exercise   Contractual     Intrinsic
EMPLOYEE AND DIRECTOR                Shares       Price    Life (Years)      Value
---------------------------------   ---------   --------   -----------     ---------
<S>                                 <C>          <C>          <C>         <C>
OPTIONS AS OF DECEMBER 31, 2005:
Outstanding......................   1,833,000    $3.46        6.02           $0.00
Vested and Expected to Vest......   1,809,000    $3.44        5.98           $0.00
Exercisable......................   1,788,000    $3.44        5.97           $0.00

OPTIONS AS OF SEPTEMBER 30, 2006:
Outstanding......................   4,822,635    $1.43        8.32        $1,640,430
Vested and Expected to Vest......   4,819,363    $1.43        8.31        $1,638,847
Exercisable......................   1,622,833    $3.31        5.40          $69,750
</TABLE>


        The aggregate  intrinsic  value  excludes  options that have an exercise
price in excess of market  price of the common stock as of December 31, 2005 and
September  30,  2006,  respectively.  Awards that are expected to vest take into
consideration, estimated forfeitures for awards not yet vested.

        The weighted average exercise prices,  remaining  contractual  lives and
aggregate  intrinsic  values  for  non-employee  warrants,  shares  and  options
granted, exercisable, and expected to vest as of December 31, 2005 and September
30, 2006 were as follows:

<TABLE>
<CAPTION>
                                                             Weighted
                                                 Weighted     Average
NON-EMPLOYEE                                      Average    Remaining
WARRANTS & OPTIONS AS OF             Number of   Exercise   Contractual   Intrinsic
DECEMBER 31, 2005:                    Shares      Price     Life (Years)    Value
----------------------------------   ---------   --------   -----------   ---------
<S>                                  <C>          <C>           <C>        <C>
Outstanding ......................   1,377,147    $4.36         2.6         $0.00
Vested and Expected to Vest ......   1,377,147    $4.36         2.6         $0.00
Exercisable ......................   1,377,147    $4.36         2.6         $0.00

WARRANTS AS OF SEPTEMBER 30, 2006:
Outstanding ......................   1,318,813    $4.13         2.53       $29,500
Vested and Expected to Vest ......   1,318,813    $4.13         2.53       $29,500
Exercisable ......................   1,293,813    $4.20         2.40       $19,500
</TABLE>


        The aggregate intrinsic value excludes warrants and options that have an
exercise  price in excess of the market price of the common stock as of December
31, 2005 and September 30, 2006, respectively.  Awards that are expected to vest
take into consideration, estimated forfeitures for awards not yet vested.

        The intrinsic  value of options  exercised in 2005,  2004, and 2003 were
$1,500;  $183,000;  and $261,000,  respectively.  The total fair value of awards
vested  during the years ended  December 31, 2005,  2004 and 2003 was  $220,000,


                                       14
<PAGE>


$55,000 and $140,000,  respectively.  The fair value of the awards  approximates
the values expensed for pro-forma purposes for these periods.

        As of  September  30,  2006,  there was  $695,866 of total  unrecognized
compensation costs related to non-vested share-based  compensation  arrangements
granted,  including  warrants.  This cost is expected to be recognized  over the
weighted-average period of 2.0 years.

        When options are exercised,  the Company's policy is to issue previously
registered,  unissued  shares of common  stock.  As of September  30, 2006,  the
Company had 2,501,977  unissued shares of common stock available in its plan. On
July 31, 2006, at the annual shareholders meeting an amendment to the 1997 Stock
Incentive Plan was adopted to increase the number of authorized shares under the
1997 Plan to a total of 6,000,000 shares.  The additional Plan shares authorized
on July 31, 2006 of 2,922,500 shares have not yet been registered.

NOTE 7            NEW ACCOUNTING PRONOUNCEMENTS

        Effective  January 1, 2006 the Company  implemented  FASB  Statement  of
Financial  Accounting  Standards (SFAS) No. 154,  "Accounting  Changes and Error
Corrections",  an amendment to accounting  Principles Bulletin (APB) Opinion No.
20,  "Accounting  Changes",  and SFAS No. 3,  "Reporting  Accounting  Changes in
Interim Financial Statements".  Though SFAS No. 154 carries forward the guidance
in APB No.20 and SFAS No.3 with respect to accounting  for changes in estimates,
changes  in  reporting  entity,  and the  correction  of  errors,  SFAS No.  154
established  new standards on accounting  for changes in accounting  principles,
whereby all such changes must be accounted for by  retrospective  application to
the financial  statements of prior periods unless it is  impracticable to do so.
SFAS No. 154 was effective for accounting  changes and error corrections made in
fiscal  years  beginning  after  December  15,  2005.  The  adoption of this new
standard did not have a material impact upon the Company's  financial  position,
results of operations or cash flows.

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

        In March 2006, the FASB issued SFAS No. 156,  "Accounting  for Servicing
of Financial  Assets"  ("SFAS No. 156"),  which provides an approach to simplify
efforts to obtain  hedge-like  (offset)  accounting.  This Statement amends FASB
Statement No. 140,  "Accounting for Transfers and Servicing of Financial  Assets
and  Extinguishments  of  Liabilities",  with  respect  to  the  accounting  for
separately recognized servicing assets and servicing liabilities.  The Statement
(1)  requires an entity to recognize a servicing  asset or  servicing  liability
each time it undertakes  an obligation to service a financial  asset by entering
into a servicing contract in certain situations;  (2) requires that a separately
recognized  servicing asset or servicing liability be initially measured at fair
value, if practicable;  (3) permits an entity to choose either the  amortization
method or the fair value  method for  subsequent  measurement  for each class of
separately recognized servicing assets or servicing liabilities;  (4) permits at
initial adoption a one-time reclassification of available-for-sale securities to
trading securities by an entity with recognized  servicing rights,  provided the
securities  reclassified  offset the  entity's  exposure  to changes in the fair
value  of the  servicing  assets  or  liabilities;  and  (5)  requires  separate
presentation of servicing assets and servicing liabilities subsequently measured


                                       15
<PAGE>


at fair value in the balance sheet and additional disclosures for all separately
recognized servicing assets and servicing liabilities. SFAS No. 156 is effective
for  all  separately  recognized  servicing  assets  and  liabilities  as of the
beginning of an entity's  fiscal year that begins after September 15, 2006, with
earlier  adoption  permitted  in  certain  circumstances.   The  Statement  also
describes  the manner in which it should be initially  applied.  The adoption of
this new standard did not have a material  impact upon the  Company's  financial
position, results of operations or cash flows.

         In June 2006, the FASB issued  Interpretation  No. 48,  "Accounting for
Uncertainty  in Income Taxes -- An  Interpretation  of FASB  Statement No. 109",
(FIN 48).  FIN 48  clarifies  the  accounting  for  uncertainty  in income taxes
recognized in an  enterprise's  financial  statements  in  accordance  with FASB
Statement  No. 109,  "Accounting  for Income  Taxes".  FIN 48 also  prescribes a
recognition  threshold and  measurement  attribute  for the financial  statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return that results in a tax benefit. Additionally, FIN 48 provides guidance
on  de-recognition,  income statement  classification of interest and penalties,
accounting in interim periods,  disclosure, and transition.  This interpretation
is effective for fiscal years  beginning after December 15, 2006. The Company is
currently  evaluating the effect that the application of FIN 48 will have on its
results of operations and financial position.

         In  September   2006,  the  FASB  issued  SFAS  No.  157,  "Fair  Value
Measurements" ("SFAS No. 157"), which establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures about
fair value  measurements.  SFAS No. 157 is effective  for  financial  statements
issued for fiscal  years  beginning  after  November  15,  2007.  The Company is
required to adopt the  provisions  of SFAS No. 157 as  applicable,  beginning in
fiscal year 2008.  The  adoption of this new  standard is not expected to have a
material impact upon the Company's financial position,  results of operations or
cash flows.

NOTE 8            GEOGRAPHIC INFORMATION

         The Company  specializes in the distribution of a full range of apparel
zipper and trim items to manufacturers of fashion apparel,  specialty  retailers
and mass  merchandisers.  There is not enough  difference  between  the types of
products  developed and distributed by the Company to account for these products
separately or to justify segmented reporting by product type.

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

                               Three Months Ended           Nine Months Ended
                                  September 30,               September 30,
                           -------------------------   -------------------------
Country / Region               2006         2005          2006          2005
------------------------   -----------   -----------   -----------   -----------

United States ..........   $ 1,205,400   $ 1,676,700   $ 3,143,800   $ 4,771,000
Asia ...................     7,206,900     4,092,300    21,940,700    14,427,500
Mexico .................       722,500       824,200     3,302,200     9,487,300
Dominican Republic .....     3,423,400     1,487,300     7,695,500     5,381,700
Other ..................       808,800     1,392,500     2,169,000     3,740,500
                           -----------   -----------   -----------   -----------
                           $13,367,000   $ 9,473,000   $38,251,200   $38,168,000
                           ===========   ===========   ===========   ===========


                                       16
<PAGE>


                                                 September 30,      December 31,
                                                     2006               2005
                                                 -----------         -----------
Long-lived Assets:
     United States .....................         $ 9,754,600         $10,493,900
     Asia ..............................             385,400             226,200
     Mexico ............................               9,600              23,700
     Dominican Republic ................             695,400             776,300
                                                 -----------         -----------

                                                 $10,845,000         $11,520,100
                                                 ===========         ===========


                                       17
<PAGE>


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

FORWARD LOOKING STATEMENTS

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

OVERVIEW

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

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

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

         During the third quarter of 2005 we  restructured  our trim business to
focus as an outsourced product development, sourcing and sampling department for
the  most  demanding   brands  and  retailers.   We  believe  that  trim  design
differentiation  among brands and retailers has become a critical marketing tool
for our  customers.  By  assisting  our  customers in the  development,  design,
sampling and sourcing of trim, we expect to achieve  higher margins for our trim
products, create long-term relationships with our customers, grow our sales to a
particular  customer by supplying trim for a larger  proportion of their brands,
and  better  differentiate  our  trim  sales  and  services  from  those  of our
competitors.  The  restructuring  (described more fully below)  discontinued the
supply of trim products in preassembled kits. We will continue to supply trim to
customers however we will not provide the trim components in a preassembled kit.
We plan to aggressively expand our trim business footprint  globally,  so we may
better  serve our apparel  factory  customers  in the field,  in addition to our
brand and retail customer.  We believe we can lead the industry in trim sourcing
by having both an intimate relationship with our brand and retail customers, and
having a distributed service  organization to serve our factory customers (those
that manufacture for the apparel brand and retailers) globally.


                                       18
<PAGE>


         Our Tekfit services provide manufacturers with the patented technology,
manufacturing  know-how and materials required to produce pants incorporating an
expandable   waistband.   These  products  are  currently  produced  by  several
manufacturers  for one  single  brand.  In  October  2006 our  exclusive  supply
contract with this single brand  expired.  With the expiration of this exclusive
contract we now have broader access to other customers and we intend to actively
expand this product offering to other brands. Orders have already been placed by
a new brand  customer  in October  2006 as a result of these  efforts.  However,
purchase  commitments  from the  previous  single  brand are expected to decline
significantly through the next two quarters,  and orders from new brands are not
expected to fully offset these declines in the near term. Consequently we expect
sales and earnings contributions from this product line to decline significantly
for at least the first half of 2007;  though we believe our sales of the product
will grow significantly as we market our products to new customers in the coming
months.

         Our efforts to expand this  product  offering to other  customers  have
also been limited by a licensing dispute. As described more fully in this report
under  Contingencies  and Guarantees  (see Note 5 to our unaudited  consolidated
financial  statements),  we are  presently in litigation  with Pro-Fit  Holdings
Limited related to our exclusively licensed rights to sell or sublicense stretch
waistbands manufactured under Pro-Fit's patented technology.

         The  revenues  we derive from the sale of  products  incorporating  the
stretch waistband technology,  represented approximately 21% of our consolidated
revenues for the nine months ended  September 30, 2006 and 2005, and accordingly
the results of operations and financial condition could be materially  adversely
affected if our dispute with  Pro-Fit is not  resolved in a manner  favorable to
us, or if we are  unsuccessful in securing new customers to replace the revenues
previously generated by the single brand.

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

         RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED       NINE MONTHS ENDED
                                                 SEPTEMBER 30,           SEPTEMBER 30,
                                             --------------------     --------------------
                                               2006        2005         2006        2005
                                             --------    --------     --------    --------
<S>                                             <C>         <C>          <C>         <C>
Net sales ................................      100.0%      100.0%       100.0%      100.0%
Cost of goods sold .......................       69.0       122.1         70.9        95.0
                                             --------    --------     --------    --------
Gross profit .............................       31.0       (22.1)        29.1         5.0
Selling expenses .........................        6.2         5.8          5.4         5.1
General and administrative expenses ......       20.7        51.8         21.5        51.5
Impairment of goodwill ...................       --           4.7         --           1.2
Restructuring costs ......................       --          24.1         --           6.0
Interest & Taxes .........................        1.6         0.0          1.5         0.0
                                             --------    --------     --------    --------
Operating (loss) income ..................        2.5%     (108.5)%        0.7%      (58.8)%
                                             --------    --------     --------    --------
</TABLE>


                                       19
<PAGE>


         SALES

         For the three  months  ended  September  30,  2006 and  2005,  sales by
geographic  region  based on the  location of the  customer as a  percentage  of
sales:

                                    THREE MONTHS ENDED       NINE MONTHS ENDED
                                      SEPTEMBER 30,            SEPTEMBER 30,
                                   --------------------    --------------------
COUNTRY / REGION                     2006        2005        2006        2005
--------------------------------   --------    --------    --------    --------
United States ..................        9.0%       17.7%        8.2%       12.5%
Asia ...........................       53.9%       43.2%       57.4%       37.8%
Mexico .........................        5.4%        8.7%        8.6%       25.8%
Dominican Republic .............       25.6%       15.7%       20.1%       14.1%
Other ..........................        6.1%       14.7%        5.7%        9.8%
                                   --------    --------    --------    --------
                                      100.0%      100.0%      100.0%      100.0%
                                   ========    ========    ========    ========

         Sales for the three months ended  September 30, 2006 were $13.4 million
or $3.9 million  (41%) more than sales for the three months ended  September 30,
2005.  Sales for the nine months ended  September 30, 2006 were $38.3 million or
$.1 million (.2%)  greater than sales for the same period in 2005.  The increase
in sales for the three months ended  September  30, 2006 as compared to the same
period  in 2005  reflects  double-digit  revenue  growth  in all of our  product
categories.  Sales in the three months ended  September 30, 2005 were negatively
impacted by the business  restructuring that began in the third quarter of 2005,
and also  included  sales of $1.4  million  of  thread  products,  whereas  only
liquidation  sales of these products  existed in 2006.  Thread product sales for
the three months ended September 30, 2006 and 2005 were not significant.  Thread
products  represented lower margin sales, and the discontinuance of this product
offering coincided with our discontinuance of selling preassembled trim kits and
allows us to focus more on other market  opportunities  such as zippers and trim
that we believe add more value.

         Sales for the three months and nine months ended  September 30, 2006 as
compared to the same periods in 2005 also increased  despite lower sales of trim
products to our  customers  in Mexico and the shift of both the U.S.  and Mexico
production  from these areas to Asia and other worldwide  markets.  Sales within
the Asian  markets  for the three  and nine  months  ended  September  30,  2006
increased $3.1 million and $7.5 million,  respectively  over the same periods in
2005.  Sales  within the U.S.  and Mexico  for the three and nine  months  ended
September 30, 2006 declined $.6 million and $7.8 million, respectively, compared
with the same periods in 2005.  The net decrease is primarily  the result of the
shift of  apparel  production  from Latin  America  to Asia and other  worldwide
markets that began in 2004, and the resulting decrease in sales to our customers
in Mexico of trim products.  The Company responded to this shift with our growth
and expansion  activities in the Asian markets and with the restructuring  plans
implemented  in  2005  closing  the  Mexican  assembly  and  U.S.  manufacturing
facilities.

         COST OF SALES

         Cost of sales for the three  months ended  September  30, 2006 was $9.2
million or $2.3  million  (20%)  less than cost of sales for the same  period in
2005,  and Cost of sales for the nine months ended  September 30, 2006 was $27.1
million or $9.1  million  (25%)  less than cost of sales for the same  period in
2005.  The  reduction  in cost of sales  for the  three  and nine  months  ended
September 30, 2006 as compared to the same periods in 2005 was  attributable  to
costs associated with sales volume changes,  improved product margins  resulting
from our focus on higher margin sales,  reduced  distribution charges since more
products  are now sourced and  delivered  within the same  marketplace,  reduced
manufacturing and assembly overhead costs as these operations were closed in the
third quarter of 2005, and lower provisions for obsolescence as inventory levels
have been reduced and turns accelerated. A brief recap of


                                       20
<PAGE>


the  change in sales,  cost of sales  and  gross  margin  for the three and nine
months ended  September 30, 2006 as compared with the same periods in 2005 is as
follows:

<TABLE>
<CAPTION>
                                                         (Amounts in thousands)

                                               THREE MONTHS                   NINE MONTHS
                                         -------------------------     ------------------------
                                           AMOUNT          %(1)          AMOUNT          %(1)
                                         ----------     ----------     ----------     ----------
<S>                                      <C>                 <C>       <C>                  <C>
Sales increase .......................   $    3,894           41.1%    $       83            0.2%

COST OF SALES (INCREASE) DECREASE:
Cost of change in sales volumes ......       (1,569)         (13.6)           (33)          (0.1)
Improved margin on sales .............          374            3.2          2,165            6.0
Reduced freight and duty costs .......          394            3.4          1,693            4.7
Lower manufacturing & assembly costs .          106            0.9            777            2.1
Reduced obsolescence .................          (28)          (0.2)         1,113            3.1
Restructuring costs ..................        3,447           29.8          3,447            9.5
Other cost of sales ..................         (376)          (3.3)           (41)          (0.1)
                                         ----------     ----------     ----------     ----------
                                              2,348           20.2%         9,121           25.2%
                                         ----------                    ----------     ----------
        GROSS MARGIN INCREASE ........   $    6,242                    $    9,204
                                         ==========                    ==========
</TABLE>

(1)      Represents the percentage change in the 2006 period, as compared to the
         same period in 2005.

         SELLING EXPENSES

         Selling  expenses for the three months  ended  September  30, 2006 were
$0.9 million (6.8% of sales) as compared to $0.5 million (5.8% of sales) for the
same  period in 2005.  The  increase  in  selling  expense  for the  quarter  is
principally  due to  higher  marketing  and  promotion  costs  of  $283,000  and
increased  commissions of $95,000  partially offset by lower travel expenses and
employee costs.

         Selling expenses for the nine months ended September 30, 2006 were $2.1
million (4.9% of sales) as compared to $1.9 million (5.1% of sales) for the same
period in 2005. The increase in selling  expense for the period is due to higher
marketing and promotion costs of $232,000 and increased  commissions of $266,000
resulting  from a  compensation  program  implemented  in 2006,  offset by lower
employee  and  related  costs  in  the  U.S.  and  Mexico  associated  with  the
restructuring  plan  adopted  in 2005 of  $86,000  and the  reduction  of travel
related expenses of $221,000.

         GENERAL AND ADMINISTRATIVE EXPENSES

         General  and  administrative   expenses  for  the  three  months  ended
September  30, 2006 were $2.7  million or $4.9  million  (65%) less than for the
same period in 2005.  General and  administrative  expenses  for the nine months
ended  September 30, 2006 were $8.1 million or $14.2 million (64%) less than for
the same period in 2005.  General and  administrative  expense for the three and
nine months ended  September  30, 2005  included  $2.3 million in  restructuring
costs and $450,000 from the impairment of goodwill not included in 2006.

         Additional changes in general and administrative  expense for the three
months ended  September 30, 2006 as compared to the same period in 2005 includes
approximately:  $117,000 in stock based compensation not included in 2005; lower
legal and  professional  fees by $1.3 million;  lower employee costs by $300,000
resulting from staff reductions; lower bad debt expense by $250,000 due to fewer
provisions  and to  recoveries  of  $135,000;  and other lower  operating  costs
associated with travel, facilities, supplies, insurance, and other miscellaneous
costs of approximately $400,000.


                                       21
<PAGE>


         For the nine month period ended  September  30, 2006 as compared to the
same period of 2005,  the general and  administrative  costs  declined  from the
prior year by $11.5 million in addition to the reduction from the  restructuring
costs and goodwill impairment charges. This reduction was principally the result
of $6.6  million in  provisions  for bad debts  recorded  in 2005 as compared to
$530,000 in bad debt  recoveries  in 2006; a $1.7  million  decrease in employee
related costs associated with employee  reductions in the U.S.,  Mexico and Hong
Kong that we implemented  with our  restructuring  plan in 2005; lower legal and
professional fees by $1.3 million; reduced travel costs of $520,000; and overall
reductions  in  the  costs  of   facilities,   supplies,   insurance  and  other
miscellaneous costs of approximately  $800,000;  partially offset by $283,000 in
non-cash compensation costs recorded with the adoption of FAS 123(R).

         Effective  January 1, 2006,  we adopted FAS 123(R)  which  requires the
company to  recognize a non-cash  expense  associated  with options and warrants
issued to employees,  directors and  consultants.  For the three and nine months
ended  September  30, 2006 we incurred  $117,000 and $283,000,  respectively  of
costs associated with the  implementation  of this accounting  requirement.  The
majority of the recognized  cost is associated  with the option grants issued to
the executive management team in the first quarter of 2006.

         INTEREST EXPENSE

         Interest expense  decreased by  approximately  $106,000 to $159,000 for
the three months  ended  September  30, 2006,  as compared to the same period in
2005.  Interest expense decreased by approximately  $283,000 to $520,000 for the
nine months ended  September  30, 2006,  as compared to the same period in 2005.
The change for both the three and nine month  period from 2005 is due  primarily
to lower borrowings under a bank line of credit and certain notes.

         INCOME TAXES

         Income tax expense for the three and nine months  ended  September  30,
2006 was $55,000 and $66,000,  respectively associated with foreign income taxes
from  earnings  within  our  Asian  facilities.  Due to prior  operating  losses
incurred  within the year no benefit for domestic income taxes has been recorded
since  there is not  sufficient  evidence to  determine  that we will be able to
utilize our net operating loss carry forwards to offset future taxable income.

         Income tax  expense for the three and nine months  ended  September  30
2005 was $0.3  million  income tax benefit and $1.2  million  income tax expense
respectfully.  Income taxes for 2005 included an increase of $1.0 million in the
deferred tax asset valuation allowance, and a provision for earned income within
our foreign subsidiary.

LIQUIDITY AND CAPITAL RESOURCES

     The following table summarizes selected financial data at:

                                                SEPTEMBER 30,       DECEMBER 31,
                                                     2006                2005
                                                 -----------         -----------
Cash and cash equivalents ..............         $ 3,726,200         $ 2,277,400
Total assets ...........................         $27,673,800         $30,320,800
Current debt ...........................         $11,980,300         $14,850,600
Non-current debt .......................         $14,164,000         $14,558,100
Stockholders' equity ...................         $ 1,529,500         $   912,100


                                       22
<PAGE>


         CASH AND CASH EQUIVALENTS

         Cash and cash  equivalents for the nine months ended September 30, 2006
  increased  $1,449,000  from  December 31, 2005  principally  arising from cash
  generated  by  operating  activities,  net of  payments  on notes  payable and
  capital leases.

         Cash provided by operating  activities is our only recurring  source of
funds,  and was  approximately  $2.8 million for the nine months ended September
30,  2006.  The cash  provided by  operating  activities  during the nine months
resulted principally from:

Net earnings before non-cash expenses .....................         $ 1,570,000
Payments received from Notes Receivable ...................             317,000
Inventory reductions, net of reserves .....................           2,423,000
Receivable reductions, net of reserves ....................             685,000
Reduction of accounts payable .............................          (2,087,000)
Other .....................................................             (86,000)
                                                                    -----------
                                                                    $ 2,822,000

         During the nine  months  ended  September  30,  2006 a net  decrease in
inventory  of $2.4  million  resulted  from the  elimination  of $8.3 million in
inventory,  net of reserves  established against these products of $5.9 million.
Estimated  days of sales  included  in  inventory  at  September  30,  2006 were
approximately 46 days supply as compared to  approximately  149 days at December
31,  2005.  Accounts  receivable  for the period  declined by $1.7  million as a
result of  approximately  $0.6  million of reserved  accounts  written-off,  and
improved  overall  collections.  The estimated DSO (day's sales  outstanding) of
Accounts  Receivable at September 30, 2006 was 36 days, improved from 52 days at
December 31, 2005.  Accounts  receivable reserve reductions include $0.6 million
applied against the accounts  written-off,  and $0.5 million associated with the
collection of accounts reserved in prior years as a bad debt.

         Net  cash  used in  investing  activities  for the  nine  months  ended
September  30, 2006 was $323,000 as compared to $1.6 million for the nine months
ended  September  30,  2005.  The  cash  used in  investing  activities  in 2006
represents capital expenditures for leasehold improvements in China. In 2005 the
cash used for investing  activities  consisted primarily of capital expenditures
for zipper equipment and leasehold  improvements for the manufacturing  facility
in North Carolina.

         Net  cash  used in  financing  activities  for the  nine  months  ended
September  30, 2006 was  approximately  $1,050,000  and  primarily  reflects the
repayment of borrowings  under capital  leases and notes  payable.  For the nine
months ended  September 30, 2005 the cash used by financing  activities was $2.5
million and  represented  the repayment of notes payable,  a bank line of credit
and capital leases,  partially offset by funds raised from the exercise of stock
options and warrants.

         We currently satisfy our working capital requirements primarily through
cash flows generated from  operations.  As we continue to respond to the current
industry  trend of large retail  brands to outsource  apparel  manufacturing  to
offshore  locations,  our foreign  customers,  though backed by U.S.  brands and
retailers,   are  increasing.   This  makes  receivables  based  financing  with
traditional  U.S. banks more difficult.  Our current  borrowings may not provide
the level of financing we may need to expand into additional foreign markets. As
a result, we are continuing to evaluate non-traditional financing of our foreign
assets.

         We have incurred  significant legal fees in our litigation with Pro-Fit
Holdings  Limited.  Unless  the  case is  settled,  we will  continue  to  incur
additional legal fees in increasing amounts as the case accelerates to trial.


                                       23
<PAGE>


         We believe that our existing cash and cash  equivalents and anticipated
cash flows from our operating  activities will be sufficient to fund our minimum
working  capital  and  capital  expenditure  needs for at least the next  twelve
months. This conclusion is based on the assumption that we will be successful in
restructuring our operations in accordance with the  restructuring  plan adopted
in 2005, and that we will collect our note and accounts receivable in accordance
to  existing  terms.  If we are  unable  to  successfully  fully  implement  our
restructuring  initiative or collect the note receivable,  or 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 our failure to  implement  our
restructuring  initiative in accordance with our plan,  there may be substantial
doubt  about our  ability to  continue as a going  concern.  Our  auditors  have
included in their report on our financial statements for the year ended December
31, 2005 an explanatory paragraph expressing substantial doubt about our ability
to  continue  as a  going  concern  if we  fail to  successfully  implement  our
restructuring initiative.

         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,  Central  and  South  American  and  Caribbean  markets  and the  further
development  of our waistband  technology.  If our cash from  operations is less
than anticipated or our working capital  requirements  and capital  expenditures
are  greater  than we  expect,  we may need to raise  additional  debt or equity
financing in order to provide for our operations.  We are continually evaluating
various  financing  strategies to be used to expand our business and fund future
growth or acquisitions. There can be no assurance that additional debt or equity
financing  will be available on acceptable  terms or at all. If we are unable to
secure  additional  financing,  we may not be  able to  execute  our  plans  for
expansion,  including  expansion into foreign markets to promote our Talon brand
tradename, and we may need to implement additional cost savings initiatives.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

         The following  summarizes our contractual  obligations at September 30,
2006 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:

<TABLE>
<CAPTION>
                                                         PAYMENTS DUE BY PERIOD
                                  -------------------------------------------------------------------
                                                 LESS THAN      1 TO 3        4 TO 5         AFTER
CONTRACTUAL OBLIGATIONS              TOTAL        1 YEAR         YEARS         YEARS        5 YEARS
-------------------------------   -----------   -----------   -----------   -----------   -----------
<S>                               <C>           <C>           <C>           <C>           <C>
Demand notes payable to related
    parties (1)................   $   665,000   $   665,000   $         0   $         0   $         0
Capital lease obligations .....   $ 1,012,700   $   425,900   $   586,800   $         0   $         0
Operating leases ..............   $ 1,647,500   $   565,000   $ 1,082,500   $         0   $         0
Notes payable .................   $ 2,607,800   $ 1,495,200   $   495,400   $   617,200   $         0
Convertible notes payable .....   $12,464,600   $         0   $12,464,600   $         0   $         0
</TABLE>

(1)      The majority of notes payable to related parties are due on demand with
         the  remainder  due and payable on the fifteenth day following the date
         of delivery of written demand for payment, and include accrued interest
         payable through September 30, 2006.


                                       24
<PAGE>


         At September 30, 2006 and 2005, we did not have any relationships  with
unconsolidated  entities  or  financial  partnerships,  such as  entities  often
referred to as structured finance or special purpose entities,  which would have
been established for the purpose of facilitating  off-balance sheet arrangements
or other contractually  narrow or limited purposes.  As such, we are not exposed
to any  financing,  liquidity,  market or credit risk that could arise if we had
engaged in such relationships.

RELATED PARTY TRANSACTIONS

         Prior to 2005 the  company  operated an apparel  trim supply  agreement
with Tarrant Apparel Group. Two of Tarrant's  executive officers and significant
shareholders  are also  significant  shareholders  of our  company.  The  supply
agreement  was  terminated  in  December  2004;  however we  continue to conduct
business with Tarrant Apparel Group on a limited basis.  Sales to Tarrant or its
affiliates for the nine months ended September 30, 2005 were $165,000.

         As of September 30, 2006 accounts  receivable  included $1,500 due from
Tarrant. At September 30, 2005 accounts receivable,  related party included $1.4
million due from Tarrant's  affiliate,  United Apparel Ventures.  United Apparel
Ventures paid this balance over a nine-month  period and it was fully paid as of
December 31, 2005.

         As of September  30, 2006 and December  31,  2005,  we had  outstanding
related-party  notes payable of $665,000,  at interest  rates ranging from 0% to
11%. The majority of related-party debt is due on demand, with the remainder due
and payable within 15 days of demand.  Accrued  interest  associated  with these
notes is included in other accrued liabilities.

         As of September 30, 2006 and December 31, 2005, we had  receivables due
from related  parties of $644,000 and $730,000,  respectively.  The  receivables
consist of unsecured  notes,  advances and accrued  interest  receivable  from a
former  officer and  stockholder  of the Company who is related to or affiliated
with a director of the Company. The notes and advances bear interest at 0%, 8.5%
and prime and, together with accrued interest, are due on demand.

         Consulting  fees paid to The Link Trading,  a company owned by a member
of our Board of  Directors,  amounted to $36,000 and  $108,000 for the three and
nine months  ended  September  30,  2006.  Consulting  fees paid to  Diversified
Investments, a company owned by a member of our Board of Directors,  amounted to
$37,500 and  $112,500 for the three and nine months  ended  September  30, 2006,
respectively.

         APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

         The  preparation of financial  statements in conformity with accounting
principles   generally  accepted  in  the  United  States  of  America  requires
management to make estimates and assumptions for the reporting  period and as of
the financial statement date. We base our estimates on historical experience and
on various  other  assumptions  that are  believed  to be  reasonable  under the
circumstances,  the results of which form the basis for making  judgments  about
the carrying values of assets and liabilities that are not readily apparent from
other sources.  These estimates and assumptions  affect the reported  amounts of
assets  and  liabilities,  the  disclosure  of  contingent  liabilities  and the
reported amounts of revenue and expense.  Actual results could differ from those
estimates.

         Critical  accounting  policies  are  those  that are  important  to the
portrayal of our financial  condition and results,  and which require us to make
difficult,  subjective and/or complex judgments.  Critical  accounting  policies
cover  accounting  matters  that are  inherently  uncertain  because  the future


                                       25
<PAGE>


resolution  of such  matters is  unknown.  We  believe  the  following  critical
accounting policies affect our more significant  judgments and estimates used in
the preparation of our consolidated financial statements:

         o        Accounts  receivable  balances  are  evaluated  on a continual
                  basis   and   allowances   are   provided   for    potentially
                  uncollectible  accounts based on management's  estimate of the
                  collectibility   of  customer   accounts.   If  the  financial
                  condition  of  a  customer   deteriorates,   resulting  in  an
                  impairment  of its  ability to make  payments,  an  additional
                  allowance may be required.  Allowance  adjustments are charged
                  to  operations in the period in which the facts that give rise
                  to the adjustments become known.

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

         o        We record  deferred tax assets arising from  temporary  timing
                  differences between recorded net income and taxable net income
                  when and if we believe that future earnings will be sufficient
                  to realize the tax benefit.  For those jurisdictions where the
                  expiration date of tax benefit carry-forwards or the projected
                  taxable  earnings  indicate that  realization is not likely, a
                  valuation  allowance is provided.  If we determine that we may
                  not realize all of our deferred  tax assets in the future,  we
                  will make an adjustment to the carrying  value of the deferred
                  tax asset,  which would be reflected as an income tax expense.
                  Conversely,  if we  determine  that we will realize a deferred
                  tax asset, which currently has a valuation allowance, we would
                  be required to reverse the valuation allowance, which would be
                  reflected  as an  income  tax  benefit.  We  believe  that our
                  estimate of deferred tax assets and  determination to record a
                  valuation   allowance   against   such  assets  are   critical
                  accounting  estimates because they are subject to, among other
                  things,  an  estimate  of  future  taxable  income,  which  is
                  susceptible  to change and  dependent  upon events that may or
                  may not occur, and because the impact of recording a valuation
                  allowance  may be  material  to  the  assets  reported  on the
                  balance  sheet  and  results  of   operations.   o  We  record
                  impairment  charges  when the carrying  amounts of  long-lived
                  assets are  determined  not to be  recoverable.  Impairment is
                  measured  by  assessing  the  usefulness  of  an  asset  or by
                  comparing  the  carrying  value of an asset to its fair value.
                  Fair value is typically determined using quoted market prices,
                  if available, or an estimate of undiscounted future cash flows
                  expected to result from the use of the asset and its  eventual
                  disposition.  The amount of  impairment  loss is calculated as
                  the excess of the carrying value over the fair value.  Changes
                  in market conditions and management strategy have historically
                  caused us to reassess  the carrying  amount of our  long-lived
                  assets.  Long-lived  assets are evaluated on a continual basis
                  and impairment  adjustments  are made based upon  management's
                  valuations.  As part of our 2005  restructuring  plan, certain
                  long-lived  assets,  primarily  machinery and equipment,  were
                  impaired and their values adjusted accordingly.


                                       26
<PAGE>


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

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

NEW ACCOUNTING PRONOUNCEMENTS

        Effective  January 1, 2006 the Company  implemented  FASB  Statement  of
Financial  Accounting  Standards (SFAS) No. 154,  "Accounting  Changes and Error
Corrections",  an amendment to accounting  Principles Bulletin (APB) Opinion No.
20,  "Accounting  Changes",  and SFAS No. 3,  "Reporting  Accounting  Changes in
Interim Financial Statements".  Though SFAS No. 154 carries forward the guidance
in APB No.20 and SFAS No.3 with respect to accounting  for changes in estimates,
changes  in  reporting  entity,  and the  correction  of  errors,  SFAS No.  154
established  new standards on accounting  for changes in accounting  principles,
whereby all such changes must be accounted for by  retrospective  application to
the financial  statements of prior periods unless it is  impracticable to do so.
SFAS No. 154 was effective for accounting  changes and error corrections made in
fiscal  years  beginning  after  December  15,  2005.  The  adoption of this new
standard did not have a material impact upon the Company's  financial  position,
or results of operations.

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

         In March 2006, the FASB issued SFAS No. 156,  "Accounting for Servicing
of Financial  Assets"  ("SFAS No. 156"),  which provides an approach to simplify
efforts to obtain  hedge-like  (offset)  accounting.  This Statement amends FASB
Statement No. 140,  "Accounting for Transfers and Servicing of Financial  Assets
and  Extinguishments  of  Liabilities",  with  respect  to  the  accounting  for
separately recognized servicing assets and servicing liabilities.  The Statement
(1)  requires an entity to recognize a servicing  asset or  servicing  liability
each time it undertakes  an obligation to service a financial  asset by entering
into a servicing contract in certain situations;  (2) requires that a separately
recognized  servicing asset or servicing liability be initially measured at fair
value, if practicable;  (3) permits an entity to choose either the  amortization
method or the fair value  method for  subsequent  measurement  for each class of
separately recognized servicing assets or servicing liabilities;  (4) permits at


                                       27
<PAGE>


initial adoption a one-time reclassification of available-for-sale securities to
trading securities by an entity with recognized  servicing rights,  provided the
securities  reclassified  offset the  entity's  exposure  to changes in the fair
value  of the  servicing  assets  or  liabilities;  and  (5)  requires  separate
presentation of servicing assets and servicing liabilities subsequently measured
at fair value in the balance sheet and additional disclosures for all separately
recognized servicing assets and servicing liabilities. SFAS No. 156 is effective
for  all  separately  recognized  servicing  assets  and  liabilities  as of the
beginning of an entity's  fiscal year that begins after September 15, 2006, with
earlier  adoption  permitted  in  certain  circumstances.   The  Statement  also
describes  the manner in which it should be initially  applied.  The adoption of
this new standard did not have a material  impact upon the  Company's  financial
position, or results of operations.

         In June 2006, the FASB issued  Interpretation  No. 48,  "Accounting for
Uncertainty  in Income Taxes -- An  Interpretation  of FASB  Statement No. 109",
(FIN 48).  FIN 48  clarifies  the  accounting  for  uncertainty  in income taxes
recognized in an  enterprise's  financial  statements  in  accordance  with FASB
Statement  No. 109,  "Accounting  for Income  Taxes".  FIN 48 also  prescribes a
recognition  threshold and  measurement  attribute  for the financial  statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return that results in a tax benefit. Additionally, FIN 48 provides guidance
on  de-recognition,  income statement  classification of interest and penalties,
accounting in interim periods,  disclosure, and transition.  This interpretation
is effective for fiscal years  beginning after December 15, 2006. The Company is
currently  evaluating the effect that the application of FIN 48 will have on its
results of operations and financial position.

         In  September   2006,  the  FASB  issued  SFAS  No.  157,  "Fair  Value
Measurements" ("SFAS No. 157"), which establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures about
fair value  measurements.  SFAS No. 157 is effective  for  financial  statements
issued for fiscal  years  beginning  after  November  15,  2007.  The Company is
required to adopt the  provisions  of SFAS No. 157 as  applicable,  beginning in
fiscal year 2008.  The  adoption of this new  standard is not expected to have a
material impact upon the Company's financial position,  results of operations or
cash flows.

CAUTIONARY STATEMENTS AND RISK FACTORS

         Several   of  the   matters   discussed   in  this   document   contain
forward-looking  statements  that  involve  risks  and  uncertainties.   Factors
associated with the  forward-looking  statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In  addition to other  information  contained  in this  report,  readers  should
carefully consider the following cautionary statements and risk factors.

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

         WHILE WE EXPECT THAT THE RESTRUCTURING WILL RESULT IN REDUCED OPERATING
COSTS AND IMPROVED  OPERATING RESULTS AND CASH FLOWS,  THERE CAN BE NO ASSURANCE
THAT THESE RESULTS WILL BE ACHIEVED. We recorded restructuring costs during 2005
of $6.4 million.  We face many  challenges  related to our decision to implement


                                       28
<PAGE>


this  restructuring  plan,  including that we may not execute the  restructuring
effectively,  and our expectation that we will benefit from greater efficiencies
may not be  realized.  Any  failure  on our part to  successfully  manage  these
challenges  or  other  unanticipated  consequences  may  result  in the  loss of
customers and sales, which could cause our results to differ materially from our
current expectations. The challenges we face include:

         o        Our ability to execute  successfully  through  business cycles
                  while we continue to implement the restructuring plan and cost
                  reductions;

         o        Our  ability  to  meet  and   achieve  the   benefits  of  our
                  cost-reduction goals and otherwise successfully adapt our cost
                  structures to continuing changes in business conditions;

         o        The risk that our  cost-cutting  initiatives  will  impair our
                  ability to develop  products  and  remain  competitive  and to
                  operate effectively;

         o        We may experience  delays in  implementing  our  restructuring
                  plan and incur additional costs;

         o        We may experience decreases in employee morale; and

         o        We  may  experience   unanticipated   expenses   winding  down
                  manufacturing  operations,  including  labor costs,  which may
                  adversely affect our results of operations in the short term.

         WE  MAY  BE  UNABLE  TO  CONTINUE  AS A  GOING  CONCERN  IF WE  DO  NOT
SUCCESSFULLY ACHIEVE CERTAIN OBJECTIVES.  If we are unable to successfully fully
implement  our  restructuring  initiative,  or collect the note  receivable,  or
experience  greater than  anticipated  reductions in sales, we may need to raise
additional  capital or further reduce the scope of our business 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 our  failure to
implement our  restructuring  initiative in accordance with our plan, or fail to
achieve  other  operating  objectives,  the Company may be  otherwise  unable to
achieve its goals or continue  its  operations.  Our auditors  have  included in
their report on our financial  statements for the year ending  December 31, 2005
an  explanatory  paragraph  expressing  substantial  doubt  about our ability to
continue as a going concern.

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

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

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

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

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

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

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


                                       29
<PAGE>


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

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

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

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

         o        The timing and magnitude of customers' marketing campaigns;

         o        The loss or addition of a major customer;

         o        The availability and pricing of materials for our products;

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

         o        Currency fluctuations;

         o        Delays caused by third parties; and

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

         Due to  these  factors,  it is  possible  that  in  some  quarters  our
operating  results  may be below  our  stockholders'  expectations  and those of
public market analysts.  If this occurs,  the price of our common stock could be
adversely affected.  In the past,  following periods of volatility in the market
price of a company's  securities,  securities class action  litigation has often
been  instituted  against such a company.  In October  2005, a securities  class
action lawsuit was filed against us. See footnote 5, Commitments,  Contingencies
and Guarantees for a detailed description of this lawsuit.

         THE OUTCOME OF LITIGATION  IN WHICH WE HAVE BEEN NAMED,  AS A DEFENDANT
IS  UNPREDICTABLE  AND AN  ADVERSE  DECISION  IN ANY SUCH  MATTER  COULD  HAVE A
MATERIAL ADVERSE AFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS.  We
are  defendants  in a number of  litigation  matters.  These  claims  may divert
financial and management  resources that would  otherwise be used to benefit our
operations.  Although we believe that we have meritorious defenses to the claims


                                       30
<PAGE>


made in each and all of the  litigation  matters  to which we have been  named a
party, and intend to contest each lawsuit vigorously, no assurances can be given
that the results of these matters will be favorable to us. An adverse resolution
of any of these lawsuits  could have a material  adverse affect on our financial
position and results of operations.

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

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

         OUR BUSINESS MODEL IS DEPENDENT ON  INTEGRATION OF INFORMATION  SYSTEMS
ON A GLOBAL  BASIS AND, TO THE EXTENT  THAT WE FAIL TO MAINTAIN  AND SUPPORT OUR
INFORMATION  SYSTEMS,  IT CAN RESULT IN LOST REVENUES.  We must  consolidate and
centralize the management  information from 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 corporate offices in California.  Our failure to
do so could  result in lost  revenues,  delayed  financial  reporting or adverse
effects on the information reported.

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

         IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES,  WE WILL
NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently,
we do not operate duplicate facilities in different geographic areas. Therefore,
in the  event of a  regional  disruption  where we  maintain  one or more of our
facilities,  it is unlikely  that we could shift our  operations  to a different
geographic  region and we may have to cease or curtail our operations.  This may
cause us to lose sales and customers.  The types of  disruptions  that may occur
include:

         o        Foreign trade disruptions;

         o        Import restrictions;

         o        Labor disruptions;

         o        Embargoes;

         o        Government intervention;

         o        Natural disasters; or

         o        Regional pandemics.


                                       31
<PAGE>


         INTERNET-BASED   SYSTEMS  THAT  HOST  OUR  MANAGED  TRIM  SOLUTION  MAY
EXPERIENCE  DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS.  Our
Managed  Trim  Solution is designed  as an  Internet-based  business-to-business
e-commerce  system. To the extent that we fail to adequately update and maintain
the hardware and software of the system,  our customers orders 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 the Managed Trim Solution 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.

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

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

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

         o        Interest rates;

         o        Changes in accounting principles;

         o        Intellectual property and legal matters;

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

         o        Announcements of key developments by our competitors; and


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<PAGE>


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

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

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

         WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS.
We may consider strategic  acquisitions as opportunities  arise,  subject to the
obtaining of any  necessary  financing.  Acquisitions  involve  numerous  risks,
including  diversion  of our  management's  attention  away  from our  operating
activities.  We  cannot  assure  you  that we will not  encounter  unanticipated
problems or liabilities  relating to the  integration  of an acquired  company's
operations,  nor can we assure you that we will realize the anticipated benefits
of any future acquisitions.

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

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

         INSIDERS OWN A  SIGNIFICANT  PORTION OF OUR COMMON  STOCK,  WHICH COULD
LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As
of  September  30,  2006,  our  officers  and  directors  and  their  affiliates
beneficially  owned  approximately  20% of the outstanding  shares of our common
stock.  The Dyne family,  which  includes  Mark Dyne,  Colin Dyne,  and Jonathan
Burstein, who are also our directors;  Larry Dyne and the estate of Harold Dyne;
beneficially  owned  approximately  15% of the outstanding  shares of our common
stock at September  30, 2006.  As a result,  our officers and  directors and the
Dyne  family are able to exert  considerable  influence  over the outcome of any
matters  submitted to a vote of the holders of our common  stock,  including the
election of our Board of Directors. The voting power of these stockholders could
also  discourage  others  from  seeking  to acquire  control  of us through  the
purchase of our common stock, which might depress the price of our common stock.


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<PAGE>


         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.


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<PAGE>


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         All of our  sales  are  denominated  in United  States  dollars  or the
currency  of the  country in which our  products  originate.  We are  exposed to
market risk for fluctuations in the foreign currency  exchange rates for certain
product purchases that are denominated in British Pounds and Chinese Yuan. There
were no  hedging  contracts  outstanding  as of  September  30,  2006.  Currency
fluctuations  can increase the price of our products to foreign  customers which
can  adversely  impact  the level of our  export  sales  from time to time.  The
majority of our cash  equivalents are held in United States bank accounts and we
do not  believe we have  significant  market  risk  exposure  with regard to our
investments.

ITEM 4.  CONTROLS AND PROCEDURES

EVALUATION OF CONTROLS AND PROCEDURES

         We  conducted  an  evaluation,  with  the  participation  of our  Chief
Executive  Officer and Chief  Financial  Officer,  of the  effectiveness  of the
design and operation of our disclosure  controls and  procedures,  as defined in
Rules  13a-15(e) and  15d-15(e)  under the  Securities  Exchange Act of 1934, as
amended,  or the  Exchange  Act,  as of  September  30,  2006,  to  ensure  that
information  required to be disclosed by us in the reports filed or submitted by
us under 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.  Based on
that evaluation,  our Chief Executive  Officer and Chief Financial  Officer have
concluded that as of September 30, 2006, our internal  controls and  procedures,
and as a consequence,  our disclosure controls and procedures were not effective
at the reasonable assurance level.

         The  ineffectiveness  of our disclosure  controls and procedures arises
principally  from the material  weaknesses  in internal  control  identified  in
conjunction  with the  preparation  of our  Annual  Report  on Form 10-K for the
fiscal year ended December 31, 2005.  Additional  internal control processes and
controls  have been  implemented  since  the  identification  of these  material
weaknesses;  however,  given  that some of the  weaknesses  are with  respect to
processes  that are conducted  annually or  periodically,  it is not possible to
adequately  test  these  controls  on an  interim  basis to ensure  that the new
controls are effective.  Accordingly we have not relied on these  controls,  but
have performed  additional analysis and other post-closing  procedures to ensure
that our  consolidated  financial  statements  were prepared in accordance  with
generally  accepted  accounting  principles.  Accordingly,  we believe  that the
consolidated financial statements included in this report fairly present, in all
material respects, our financial condition, results of operations and cash flows
for the periods presented.

         A brief  summary  of the  material  weaknesses  identified  during  the
preparation of our Annual Report on Form 10-K for the fiscal year ended December
31, 2005 is described  below. The additional  analysis and remediation  steps we
have  implemented in our disclosure  controls and procedures also are summarized
below.

MATERIAL WEAKNESSES

         A material weakness is a control  deficiency (within the meaning of the
Public Company  Accounting  Oversight Board (PCAOB) Auditing  Standard No. 2) or
combination of control deficiencies that result in more than a remote likelihood
that a material  misstatement of the annual or interim financial statements will
not be prevented or detected.  Management  previously  identified  the following
deficiencies  that  represented  material  weaknesses  in internal  control over
financial reporting which have caused


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<PAGE>


management  to conclude that our  disclosure  controls and  procedures  were not
effective at the reasonable assurance level:

         In  conjunction  with  preparing our Annual Report on Form 10-K for the
fiscal year ended December 31, 2005, management reviewed our revenue recognition
practices  as they relate to the  recognition  of  revenues on certain  sale and
inventory storage transactions. As a result of this review, management concluded
that our controls over the  identification  and  monitoring of  assumptions  and
factors affecting the recording of revenue were not in accordance with generally
accepted accounting  principles and that our revenue for the quarters ended June
30, 2005 and September 30, 2005 had been misstated.  Based upon this conclusion,
management  with  concurrence  of our Audit  Committee  restated  our  financial
statements  as of and for those  quarters  to  reflect  the  corrections  in the
application of our revenue recognition policies. We believe the control weakness
identified  in  2005  has  been  corrected  and  did not  result  in a  material
misstatement of our  consolidated  financial  statements for the current interim
period or the first nine months of 2006.

         In fiscal  year 2005 we  previously  reported  the  failure to maintain
sufficient  documentation  supporting  inventory  costs necessary to effectively
analyze our  inventory for  lower-of-cost  or market  reserves.  We believe this
control   weakness  has  been  corrected  and  did  not  result  in  a  material
misstatement of our consolidated financial statements.

         In fiscal  year 2005 we failed  to  maintain  sufficient  documentation
supporting our perpetual inventory counts and our year end physical  inventories
were not effectively  controlled,  requiring a recount of our inventory balances
at year end. We believe we have  implemented  appropriate  procedures  to ensure
this  weakness is remedied;  however as of September 30, 2006 we have not tested
these  procedures.  This  control  deficiency  did  not  result  in  a  material
misstatement of our consolidated financial statements.

         To address these material  weaknesses,  management performed additional
analyses and other procedures to ensure that the financial  statements  included
herein fairly present, in all material respects, our financial position, results
of operations and cash flows for the periods presented.

REMEDIATION OF MATERIAL WEAKNESSES

         To remediate  the material  weaknesses in our  disclosure  controls and
procedures  identified above, we have done the following which correspond to the
material weaknesses identified above:

         We have  revised  our review  procedures  over the  application  of our
revenue recognition practices,  particularly as they relate to inventory storage
transactions. We have instituted additional control and disclosure procedures to
effectively  and timely  identify  such  transactions  including a review of all
major sale transactions by our disclosure committee.

         We have implemented  additional  documentation  control procedures over
the assumptions and factors affecting our inventory costs and reserves to ensure
that  inventory  balances are  appropriately  supported and reduced to their net
realizable values on a timely basis.  These controls include the segregation and
review of selected inventory adjustment  transactions and management analysis of
inventory cost and reserve changes during the reporting period.

         We  have  modified  our  physical   inventory  process  procedures  and
instructions to ensure that the  appropriate  documentation  regarding  physical
inventories  is maintained  and  controlled,  and that the physical  counting of
inventories is performed at regular intervals.


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<PAGE>


CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

         There  were  no  significant  changes  in our  internal  controls  over
financial  reporting  that occurred  during the nine months ended  September 30,
2006 that have  materially  affected,  or are  reasonably  likely to  materially
affect, our internal control over financial reporting, other than the changes we
implemented as discussed above to address the material weaknesses.


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<PAGE>


                                     PART II
                                OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         On October 12, 2005, a shareholder class action complaint-- Huberman vs
Tag-It Pacific,  Inc., et al., Case No.  CV05-7352  R(Ex)--was filed against the
Company and certain of the Company's  current and former  officers and directors
in the United  States  District  Court for the Central  District  of  California
alleging  claims under Section 10(b) and Section 20 of the  Securities  Exchange
Act of 1934, as amended,  and Rule 10b-5 promulgated  thereunder.  The action is
brought on behalf of all purchasers of the Company's publicly-traded  securities
during the period from November 14, 2003 to August 12, 2005. On January 23, 2006
the court heard competing motions for appointment of lead  plaintiff/counsel and
appointed Seth Huberman as lead plaintiff.  The lead plaintiff  thereafter filed
an amended  complaint on March 13, 2006. The amended  complaint alleges that the
defendants made false and misleading  statements  about the Company's  financial
situation  and its  relationship  with certain of its large  customers  during a
purported  class  period  between  November  13,  2003 and August 12,  2005.  It
purports to state claims under Section 10(b)/Rule 10b-5 and Section 20(a) of the
Securities  Exchange  Act of 1934.  The  Company  filed a motion to dismiss  the
amended  complaint,  which  motion  was  denied by the  Court on July 17,  2006.
Although the Company  believes that it and the other defendants have meritorious
defenses  to the class  action  complaint  and  intend to  contest  the  lawsuit
vigorously,  if there is an adverse  resolution to the lawsuit the results could
have a material adverse effect on the Company's  financial  position and results
of operations. At this early stage of the litigation, the Company is not able to
reasonably  predict the outcome of this action or estimate  potential losses, if
any, related to the lawsuit.

         On April 16,  2004,  the Company  filed suit against  Pro-Fit  Holdings
Limited  ("Pro-Fit")  in the U.S.  District  Court for the  Central  District of
California - Tag-It Pacific,  Inc. v. Pro-Fit Holdings  Limited,  CV 04-2694 LGB
(RCx) - asserting various  contractual and tort claims relating to 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 the  exclusive  rights in
certain geographic areas to Pro-Fit's stretch and rigid waistband technology. On
September 17, 2004, Pro-Fit filed an answer denying the material  allegations of
the complaint and filed  counterclaims  alleging  various  contractual  and tort
claims seeking injunctive relief and damages.  The Company filed a reply denying
the material  allegations of Pro-Fit's pleading.  Pro-Fit has since purported to
terminate the exclusive license and intellectual property agreement based on the
same  alleged  breaches of the  agreement  that are the subject of the  parties'
existing litigation, as well as on an additional basis. On February 9, 2005, and
again on June 16, 2005,  the Company  amended its pleadings in the litigation to
assert additional breaches by Pro-Fit of its obligations under the agreement and
under certain additional letter agreements,  and for a declaratory judgment that
Pro-Fit's  patent No.  5,987,721  is invalid and not  infringed  by the Company.
Thereafter,  Pro-Fit  filed an amended  answer  and  counterclaims  denying  the
material  allegations of the amended complaint and alleging various  contractual
and tort claims seeking injunctive relief and damages.  Pro-Fit further asserted
that  the  Company  infringed  its  United  States  Patent  Nos.  5,987,721  and
6,566,285.  The Company filed a reply denying the substantive allegations of the
amended counterclaims. At the Company's request, the Court bifurcated the breach
of contract issues for trial.  The parties have filed summary  judgment  motions
which may dispose of some of the issues in this case prior to trial.  On June 5,
2006 the Court denied one of the Company's motions for summary judgment, holding
that  the  issue of  whether  U.S.  Patent  No.  6,566,285  relating  to  curved
waistbands,  was  licensed  to the  Company  presented  a disputed  question  of
material  fact which could not be resolved  without a trial.  On August 17, 2006
the Court denied the Company's  motion for partial summary judgment holding that
summary  adjudication that the Company did not breach its agreement with Pro-Fit
by engaging in certain  activities  in Columbia was not  appropriate.  The Court
also held that  Pro-Fit  was not  "unwilling  or unable"  to  fulfill  orders by
refusing to fill orders with goods produced in the United States.  The Court did
not find that the Company breached its agreement with Pro-


                                       38
<PAGE>


Fit and, again, a trial is required to determine issues concerning the Company's
activities  in Columbia  and whether  other  actions by Pro-Fit  constituted  an
unwillingness or inability to fill orders.  Mediation to attempt to resolve this
case is scheduled to occur on December 11, 2006.  No trial date is currently set
for trial of any issues. As the Company derives a significant  amount of revenue
from the sale of products  incorporating the stretch waistband  technology,  the
Company's  business,  results of  operations  and financial  condition  could be
materially  adversely  affected if the dispute with Pro-Fit is not resolved in a
manner  favorable  to  the  Company.  Additionally,  the  Company  has  incurred
significant  legal fees in this litigation,  and unless the case is settled will
continue  to incur  additional  legal  fees in  increasing  amounts  as the case
accelerates to trial.

         We  currently  have  pending  a  number  of  other  claims,  suits  and
complaints that arise in the ordinary course of its business. We believe that we
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  affect on our  consolidated  financial  condition  if adversely
determined against us.

ITEM 1A. RISK FACTORS

         A restated  description of the risk factors associated with the Company
is included  under  "Cautionary  Statements  and Risk  Factors" in  Management's
Discussion  and  Analysis of  Financial  Condition  and Results of  Operations,"
contained  in Item 2 of Part I of this  report.  This  description  includes any
material  changes  to  and  supersedes  the  description  of  the  risk  factors
associated  with the Company  previously  disclosed in the Company's 2005 Annual
Report on Form 10-K and is incorporated herein by reference.

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

         For information  regarding our Annual Meeting of Stockholders,  held on
July 31, 2006,  see Item 8.01 of our Current  Report on Form 8-K filed on August
4, 2006, which is incorporated herein by reference.

ITEM 6.  EXHIBITS

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

         3.1.1    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 on November 4,
                  1998.

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

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

         10.7     Amended and Restated 1997 Stock Incentive Plan. *

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

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

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

         * Management contract or compensatory plan or arrangement.


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<PAGE>


                                   SIGNATURES

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


Dated:   November 13, 2006                      TAG-IT PACIFIC, INC.

                                                /s/ Lonnie D. Schnell
                                                --------------------------------
                                                By:      Lonnie D. Schnell
                                                Its:     Chief Financial Officer


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