<PAGE>
 
================================================================================



                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                  FORM 10-QSB

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

               For the quarterly period ended September 30, 1998.


                                       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 Small Business Issuer as Specified in its Charter)

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


                             3820 SOUTH HILL STREET
                         LOS ANGELES, CALIFORNIA 90037
                    (Address of Principal Executive Offices)


                                 (213) 234-9606
                          (Issuer's Telephone Number)

   Indicate by check whether the issuer: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act 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 the past 90
days.

                               Yes   X     No 
                                   -----      -----        

   State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:  Common Stock, par value $0.001
per share, 6,460,011 shares issued and outstanding as of October 30, 1998.

Transitional Small Business Disclosure Format (check one):

                              Yes             No   X
                                  -----          -----    
================================================================================

<PAGE>
 
                                              TAG-IT PACIFIC, INC.
                                              INDEX TO FORM 10-QSB

<TABLE> 
<CAPTION> 
                                                                                                           PAGE
                                                                                                           ----
<C>                      <S>                                                                               <C> 
PART I                    FINANCIAL INFORMATION 

Item 1.                   Condensed Financial Statements:
 
                          Condensed Consolidated Balance Sheets (unaudited) as of September 30, 1998
                           and December 31, 1997....................................................         3
 
                          Condensed Consolidated Statements of Operations (unaudited) for the 
                            Three Months and Nine Months Ended September 30, 1998 and 1997..........         4
                             
                          Condensed Consolidated Statements of Cash Flows (unaudited) for the
                           Nine Months Ended September 30, 1998 and 1997............................         5
                        
                          Notes to Condensed Consolidated Financial Statements......................         6
 
Item 2.                   Management's Discussion and Analysis of Financial Condition
                           and Results of Operations................................................         9
 
PART II                   OTHER INFORMATION
 
Item 2                    Changes in Securities and Use of Proceeds.................................         20
 
Item 5                    Other Information.........................................................         21
                                
Item 6                    Exhibits and Reports on Form 8-K...........................................        21
</TABLE>

                                       2
<PAGE>
 
                                     PART I
                             FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS.

                              TAG-IT PACIFIC, INC.
                     Condensed Consolidated Balance Sheets
                                  (unaudited)



<TABLE>
<CAPTION>
                                                                                          September 30,        December 31,
                                                                                              1998                 1997
                                                                                          -------------        ------------
<S>                                                                                       <C>                  <C>
      Assets

Current Assets:
   Cash.............................................................................       $   262,657         $    44,109
   Due from factor, net.............................................................           151,378                   -
   Accounts receivable, trade.......................................................         4,244,969           3,017,391
   Due from related parties.........................................................           163,624             138,418
   Inventories......................................................................         2,734,851           2,331,131
   Prepaid expenses and other current assets........................................           270,065             273,468
                                                                                           -----------         -----------
     Total current assets...........................................................         7,827,544           5,804,517

Property and Equipment (net of accumulate depreciation and amortization)............         1,260,097             974,309
Other assets.........................................................................           45,103             392,238
                                                                                           -----------         -----------
Total Assets.........................................................................      $ 9,132,744         $ 7,171,064
                                                                                           ===========         ===========

          Liabilities and Stockholders' Equity (Deficiency)

Current Liabilities:
   Bank overdraft....................................................................      $         -         $   306,565
   Due to factor, net................................................................                -           1,404,133
   Accounts payable..................................................................        2,061,688           3,977,568
   Accrued expenses..................................................................          675,125             628,086
   Line of Credit....................................................................        1,689,000                   -
   Current portion of long-term debt.................................................           66,849             463,708
   Current portion notes payable to related parties..................................          930,026             277,003
                                                                                           -----------         -----------
     Total current liabilities.......................................................        5,422,688           7,057,063

Long-term debt, less current portion.................................................                -              55,315
Notes payable to related parties, less current portion...............................                -           1,249,698
                                                                                           -----------         -----------
Total Liabilities....................................................................        5,422,688           8,362,076
                                                                                           -----------         -----------

Commitments and Contingencies (Note 4)

Stockholders' Equity (Deficiency):
   Preferred stock...................................................................                -                   -
   Common stock......................................................................            4,070               2,470
   Additional paid-in capital........................................................        5,583,266             957,530
   Accumulated deficit...............................................................       (1,877,280)         (2,151,012)
                                                                                           -----------         -----------
     Total Stockholders' Equity (Deficiency).........................................        3,710,056          (1,191,012)
                                                                                           -----------         -----------
Total Liabilities and Stockholders' Equity (Deficiency)..............................      $ 9,132,744         $ 7,171,064
                                                                                           ===========         ===========
</TABLE>
    See accompanying notes to condensed consolidated financial statements.

                                       3
<PAGE>
 
                              TAG-IT PACIFIC, INC.
                Condensed Consolidated Statements of Operations
                                  (unaudited)



<TABLE>
<CAPTION>
                                                         Three Months Ended                  Nine Months Ended
                                                           September 30,                       September 30,
                                                    -----------------------------       -----------------------------
                                                         1998             1997               1998            1997
                                                    ------------      ------------      ------------     ------------
<S>                                                 <C>                <C>              <C>              <C> 
Net sales....................................         $5,045,971        $6,301,498       $12,916,206      $14,893,746
Cost of goods sold...........................          3,283,871         4,067,854         8,270,344        9,409,092
                                                      ----------        ----------       -----------      -----------
    Gross profit.............................          1,762,100         2,233,644         4,645,862        5,484,654
 
Selling expenses.............................            484,809           558,960         1,155,586        1,344,626
General and administrative expenses..........            883,386         1,107,973         2,884,039        3,024,793
Write-off of printing division...............                  0                 0                 0          116,000
                                                      ----------        ----------       -----------      -----------
    Total operating expenses.................          1,368,195         1,666,933         4,042,625        4,485,419
 
Income (loss) from operations................            393,905           566,711           603,237          999,235
Interest expense.............................             56,094           267,330           180,383          663,702
                                                      ----------        ----------       -----------      -----------
Income (loss) before income taxes............            337,811           299,381           422,854          335,533
Provision for Income Taxes...................            101,612           104,712           149,122          188,712
                                                      ----------        ----------       -----------      -----------
    Net Income (Loss)........................         $  236,199        $  194,669        $  273,732       $  146,821
                                                      ==========        ==========        ==========       ==========
 
Basic earnings per share.....................         $     0.06        $     0.09        $     0.07       $     0.07          
                                                      ==========        ==========        ==========       ========== 
Diluted earnings per share...................         $     0.06        $     0.09        $     0.07       $     0.07
                                                      ==========        ==========        ==========       ========== 
</TABLE>

    See accompanying notes to condensed consolidated financial statements.

                                       4
<PAGE>
 
                              TAG-IT PACIFIC, INC.
                Condensed Consolidated Statements of Cash Flows
                                  (unaudited)

<TABLE>
<CAPTION>
                                                                                                      Nine Months Ended
                                                                                                         September 30,
                                                                                              -----------------------------------
                                                                                                  1998                  1997
                                                                                              -------------         -------------
<S>                                                                                           <C>                   <C>
Increase (decrease) in cash
Cash flows from operating activities:
   Net income (loss)...................................................................         $   273,732           $   146,821
   Adjustments to reconcile net income (loss) to net cash
    used in operating activities:
      Depreciation.....................................................................             297,315               220,391
      Changes in operating assets and liabilities:
       Accounts receivable.............................................................          (1,378,956)             (578,277)
       Inventories.....................................................................            (403,720)             (642,551)
       Other assets....................................................................             347,135                18,490
       Prepaid expenses and other current assets.......................................               3,403               342,616
       Accounts payable................................................................          (1,915,880)              469,584
       Accrued expenses................................................................              47,039               454,539
                                                                                                -----------           -----------
   Net cash provided (used in) operating activities....................................          (2,729,932)              431,614

Cash Flows From Investing Activities:
  Loans to related parties.............................................................             (25,206)             (126,645)
  Acquisition of property and equipment................................................            (583,103)             (491,762)
                                                                                                -----------           -----------
  Net cash used in investing activities................................................            (608,309)             (618,407)

Cash Flows from Financing Activities:
  Bank overdraft.......................................................................            (306,565)              (83,725)
  Net advances from factor.............................................................          (1,404,133)              (39,643)
  Proceed from IPO, net................................................................           4,627,336                     -
  Proceed from bank line of credit.....................................................           1,689,000                     -
  Proceeds (repayment) from long-term debt.............................................            (452,174)               97,304
  Proceeds (repayment) from notes payable to related parties, net......................            (596,675)              322,800
                                                                                                -----------           -----------
Net cash provided (used in) financing activities.......................................           3,556,789               296,737
                                                                                                -----------           -----------

Net increase in cash...................................................................             218,548               109,943
Cash at beginning of period............................................................              44,109                 5,057
                                                                                                -----------           -----------
Cash at end of period..................................................................         $   262,657           $   115,000
                                                                                                ===========           ===========

 Supplemental Disclosures of Cash Flow Information:
   Cash paid during the period for:
     Interest..........................................................................         $   180,383           $   663,702
     Income taxes......................................................................         $    53,154           $     9,715
   Non-cash financing activity:
     Note payable converted to equity..................................................         $         0           $         0
</TABLE>



     See accompanying notes to condensed consolidated financial statements.

                                       5
<PAGE>
 
                              TAG-IT PACIFIC, INC.
            Notes to the Condensed Consolidated Financial Statements
                                  (unaudited)


   1.  PRESENTATION OF INTERIM INFORMATION

        In the opinion of the management of Tag-It Pacific, Inc. and
   Subsidiaries (collectively, the "Company"), the accompanying unaudited
   condensed consolidated financial statements include all normal adjustments
   considered necessary to present fairly the financial position as of September
   30, 1998, and the results of operation and cash flows for the nine months
   ended September 30, 1998 and 1997.  Interim results are not necessarily
   indicative of results for a full year.

        The condensed consolidated financial statements and notes are presented
   as permitted by Form 10-QSB, and do not contain certain information included
   in the Company's audited consolidated financial statements and notes for the
   year ended August 31, 1997.

   2.  NEW ACCOUNTING PRONOUNCEMENTS

     In 1997, the Financial Accounting Standards Board issued Statement of
   Financial Accounting Standards No. 129, "Disclosure of Information about
   Capital Structure" ("Statement 129"), which is effective for financial
   statements ending after December 15, 1997.  Statement 129 reinstates various
   securities disclosure requirements previously in effect under Accounting
   Principles Board Opinion No. 15, which had been superseded by Statement 128.
   The Company does not expect adoption of Statement 129 to have a material
   effect, if any, on its consolidated financial position or results of
   operation.

        During June 1997, the Financial Accounting Standards Board issued
   Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
   Income" ("Statement 130"), which is effective for financial statements with
   fiscal years beginning after December 15, 1997.  Statement 130 establishes
   standards for reporting and display of comprehensive income and its
   components in a full set of general purpose financial statements.  The
   Company has not determined the effect on its consolidated financial position
   or results of operations, if any, from the adoption of this statement.

        During June 1997, the Financial Accounting Standards Board issued
   Statement of Financial Accounting Standards No. 131, "Disclosure about
   Segments of an Enterprise and Related Information" ("Statement 131"), which
   is effective for financial statements with fiscal years beginning after
   December 15, 1997.  The new standard requires that public business
   enterprises report certain information about operating segments in complete
   sets of financial statements of the enterprise and in condensed financial
   statements of interim periods issued to stockholders.  It also requires that
   public business enterprises report certain information about their products
   and services, the geographic areas in which they operate and their major
   customers.  The Company does not expect adoption of Statement 131 to have a
   material effect, if any, on its consolidated results of operation.

   3.  EARNINGS PER SHARE

        The Company has adopted Financial Accounting Standards Board issued
   Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
   ("Statement 128"), which is effective for financial statements issued for the
   periods after December 15, 1997, including interim periods.  Statement 128
   requires the restatement of all prior period earnings per share ("EPS") data
   presented.

                                       6
<PAGE>
 
        The following is a reconciliation of the numerators and denominators of
   the basic and diluted earnings per share computations:


<TABLE>
<CAPTION>

                                                                    INCOME                       SHARES                PER SHARE
                                                                  (NUMERATOR)                (DENOMINATOR)               AMOUNT
                                                                  -----------                -------------             ---------
<S>                                                               <C>                        <C>                       <C>
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998:
----------------------------------------------

BASIC EARNINGS PER SHARE:

Income available to common stockholders......................        $236,199                    4,070,011                 $0.06

EFFECT OF DILUTIVE SECURITIES:

Options......................................................                                            -
Warrants.....................................................                                        7,828
Shares Issued................................................                                            -
                                                                     --------                    ---------                 -----
Income available to common stockholders......................        $236,199                    4,097,839                 $0.06
                                                                     ========                    =========                 =====
</TABLE>

<TABLE>
<CAPTION>

                                                                    INCOME                       SHARES                PER SHARE
                                                                  (NUMERATOR)                (DENOMINATOR)               AMOUNT
                                                                  -----------                -------------             ---------
<S>                                                               <C>                        <C>                       <C>
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998:
---------------------------------------------

BASIC EARNINGS PER SHARE:

Income available to common stockholders......................        $273,732                    3,881,440                $0.07

EFFECT OF DILUTIVE SECURITIES:

Options......................................................                                            -
Warrants.....................................................                                       41,607
Shares Issued................................................                                            -          
                                                                     --------                    ---------                -----
Income available to common stockholders......................        $273,732                    3,923,046                $0.07
                                                                     ========                    =========                =====
</TABLE>

        For the three months and nine months ended September 30, 1997 basic and
   diluted earning per share are the same amount based on weighted average
   shares of 2,085,609.

        Warrants to purchase 80,000, 110,000 and 35,555 shares of common stock
   at $6.00, $4.80 and $3.60, respectively,  were outstanding for the nine
   months ended September 30, 1998 but were not included in the computations of
   diluted earnings per share because the effect of exercise would have an
   antidilutive effect on earnings per share. Stock options to purchase 260,000
   shares of common stock at  $3.20 were outstanding for the nine months ended
   September 30, 1998 but were not included in the computations of diluted
   earnings per share because the effect of exercise would have an antidilutive
   effect on earnings per share.

        On January 23, 1998 the Company completed its initial public offering
   (the "IPO") and issued 1,600,000 shares of common stock at price of $4.00 per
   share.  In conjunction with the IPO the Company issued options to directors
   to purchase 65,000 shares of common stock at $3.20, warrants to legal counsel
   to purchase 35,555 shares of common stock at $3.60, warrants to underwriters
   to purchase 110,000 shares of common stock at $4.80, and warrants in
   connection with bridge financing to purchase 80,000 shares of common stock at
   $6.00.

                                       7
<PAGE>
 
   4.  CONTINGENCIES

        The Company is subject to certain legal proceedings and claims arising
   in connection with its business.  In the opinion of management, there are
   currently no claims that will have a material adverse effect on the Company's
   consolidated financial position, results of operations or cash flows.

                                       8
<PAGE>
 
   ITEM 2.          MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        Tag-It Pacific, Inc. (the "Company") is a single-source provider of
   complete brand identity programs to manufacturers of fashion apparel and
   accessories as well as specialty retailers and mass merchandisers.  Such
   programs communicate a certain lifestyle, image or identity and enable the
   Company's customers to promote and differentiate their product line or brand.
   The Company also designs and produces high-quality paper, metal and injection
   molded boxes, woven and leather labels, paper-hanging and bar-coded tags,
   metal jean buttons, and custom shopping bags.  In addition, the Company
   designs and produces specialty private label products as well as related
   accessories and backpacks.

        The Company is the parent holding company of Tag-It, Inc., a California
   corporation, Tag-It Printing & Packaging Ltd., a BVI corporation, Tagit de
   Mexico, SA de CV, A.G.S. Stationery, Inc., a California corporation ("AGS
   Stationery") and Pacific Trim & Belt, Inc., a California corporation
   (collectively, the "Subsidiaries"), all of which were consolidated under a
   parent limited liability company on October 17, 1997 (the "Consolidation")
   and became wholly-owned subsidiaries of the Company immediately prior to the
   effective date of the Company's initial public offering in January 1998 (the
   "Offering").

        The following discussion and analysis, which should be read in
   connection with the Company's Financial Statements and accompanying
   footnotes, contain forward-looking statements that involve risks and
   uncertainties.  Important factors that could cause actual results to differ
   materially from the Company's expectations are set forth in "Factors That May
   Affect Future Results" below as well as those discussed elsewhere in this
   Form 10-QSB.  All subsequent written or oral forward-looking statements
   attributable to the Company or persons acting on its behalf are expressly
   qualified in their entirety by the "Factors That May Affect Future Results."
   Those forward-looking statements relate to, among other things, the Company's
   working capital requirements and need for additional financing.


   RESULTS OF OPERATIONS

        Net Sales.  Net sales decreased approximately $1,255,000 to $5.0 million
   (or 19.9%) for the three months ended September 30, 1998 from $6.3 million
   for the three months ended September 30, 1997.  The decrease in net sales was
   primarily a result of a $1.0 million decrease in net sales of specialty
   licensed products. This decrease resulted from the Company's decision to
   discontinue its specialty licensed product line in early 1998.  The remaining
   decrease in net sales resulted from a general decrease in the Company's other
   product lines.

        Net sales decreased approximately $1,978,000 to $12.9 million (or 13.3%)
   for the nine months ended September 30, 1998 from $14.9 million for the nine
   months ended September 30, 1997.  The decrease in net sales was primarily the
   result of a $1.3 million decrease in net sales of specialty licensed
   stationery products, including $180,000 of returns shipped in 1997, as well
   as general decreases in net sales of the other product lines. The sales
   decrease in tags and specialty packaging was due, in part, to management's
   efforts relating to the initial public offering (IPO), including the effect
   of an approximate 5-week delay of the IPO from December 1997 to January 1998,
   a period when substantial management focus on development of customer
   programs was required. In January 1998, the Company also started focusing on
   private label specialty stationery and de-emphasizing its specialty licensed
   product line, which was discontinued in the third quarter of 1998.

        Gross Profit.  Gross profit decreased approximately $472,000 to $1.8
   million (or 21.1%) for the three months ended September 30, 1998 from $2.2
   million for the three months ended September 30, 1997. Gross margin as a
   percentage of net sales decreased to approximately 34.9% as compared to 35.4%
   for the three months ended September 30, 1997.   The decrease in gross margin
   was primarily attributable to the decrease in sales of higher margin
   specialty licensed stationery products in 1998, offset by labor and other
   cost savings associated with

                                       9
<PAGE>
 
   normalized production at the Company's Mexico facility and lower overhead
   resulting from termination of printing operations in February 1997. Also, in
   connection with liquidating the discontinued specialty licensed product line
   inventory during the fourth quarter, the Company may have to sell the
   remaining inventory at reduced prices which could further decrease the
   Company's gross margin as a percentage of net sales.

        Gross profit decreased approximately $839,000 to $4.6 million (or 15.3%)
   for the nine months ended September 30, 1998 from $5.5 million for the nine
   months ended September 30, 1997.  Gross margin as a percentage of net sales
   decreased to approximately 36.0% as compared to 36.8% for the nine months
   ended September 30, 1997. The decrease in gross margin was primarily
   attributable to the decrease in net sales of higher margin specialty licensed
   stationery products and secondarily to lower overhead absorption, primarily
   as a result from lower net sales in 1998. The foregoing factors were offset
   by labor and other cost savings associated with normalized production at the
   Company's Mexico facility, and lower overhead resulting from termination of
   printing operations in February 1997. As mentioned above, the Company expects
   that discontinuing its specialty licensed stationery product line and the
   resulting sale of the remaining inventory, possibly at reduced prices, may
   result in a decreased gross margin as a percentage of net sales for the
   fourth quarter of 1998.

        Selling, General and Administrative Expenses.  Selling, general and
   administrative expenses decreased approximately $299,000 to $1.4 million for
   the three months ended September 30, 1998 from $1.7 million for the three
   months ended September 30, 1997.  As a percentage of net sales, these
   expenses increased to 27.1% in the three months ended September 30, 1998
   compared to 26.5% for the three months ended September 30, 1997 due to the
   combination of lower net sales and the increased expenses of hiring
   additional salesmen, and expanding its advertising and promotion efforts,
   offset by decreased expenses in specialty licensed stationery products.

        Selling, general and administrative expenses decreased approximately
   $327,000 to $4.0 million for the nine months ended September 30, 1998 from
   $4.4 million for the nine months ended September 30, 1997.  As a percentage
   of net sales, these expenses increased to 31.3% in the nine months ended
   September 30, 1998 compared to 29.3% for the nine months ended September 30,
   1997 due to the combination of lower net sales and the increased expenses of
   hiring additional salesmen, and expanding its advertising and promotion
   efforts, offset by decreased expenses in specialty licensed stationery
   products. A one-time incentive bonus of approximately $38,000 was paid to two
   salesmen in the quarter ended March 31, 1998 which the Company does not
   anticipate providing in the future.

        Printing Division Expense.  In the three months ended March 31, 1997,
   the Company incurred approximately $116,000 of incremental printing costs
   associated with its captive printing division which was closed in February
   1997.

        Interest Expense.  Interest expense decreased approximately $211,000 (or
   79.0%) to $56,000 for the three months ending September 30, 1998 from
   $267,000 for the three months ended September 30, 1997.  This decrease is
   attributable to decreased factoring expenses associated with decreased
   borrowings under the factoring arrangements due to proceeds received from the
   initial public offering in January.

        Interest expense decreased approximately $483,000 (or 72.8%) to $180,000
   for the nine months ended September 30, 1998 from $664,000 for the nine
   months September 30, 1997.  During the nine months ended September 30, 1998,
   the Company substantially reduced its use of factors, a trend which the
   Company intends to continue.  The Company intends to rely upon its $2 million
   line of credit which was established in April 1998.

        Provision for Income Taxes.  The provision for income taxes decreased
   approximately $3,000 to $102,000 for the three months ended September 30,
   1998 as compared to $105,000 for the three months ended September 30, 1997.
   The provision for income taxes decreased approximately $40,000 to $149,000
   for the nine months ended September 30, 1998 as compared to $189,000 for the
   nine months ended September 30, 1997.  Provision for income taxes has been
   made for each Subsidiary through October 17, 1997, the date of the
   consummation of the Consolidation.  Notwithstanding the Consolidation,
   operating losses from AGS Stationery were not available to

                                       10
<PAGE>
 
   offset taxable income of the Company's other Subsidiaries and in future
   periods may only be used to offset future AGS Stationery profits. Management
   has established a valuation allowance on the deferred tax asset because it is
   more likely than not that the deferred tax asset will not be realized. 

        Net Income (Loss).  Net income was $236,000 for the three months ended
   September 30, 1998 as compared to $195,000 for the three months ended
   September 30, 1997, due to the factors set forth above.  Net income of
   $274,000 for the nine months ended September 30, 1998 as compared to $147,000
   for the nine months ended September 30, 1997, due to the factors set forth
   above.


   LIQUIDITY AND CAPITAL RESOURCES

        During fiscal 1997 the Company satisfied its working capital
   requirements primarily through cash flows generated from operations,
   borrowings under factoring agreements with Heller Financial, Inc. ("Heller
   Financial") and Safcor, Inc. ("Safcor") and related party borrowings.
   Generally, the Company's borrowing requirements have been somewhat seasonal,
   with peak working capital need occurring at the end of the year. The Company
   has substantially reduced its use of factoring arrangements with Heller and
   Safcor as of September 30, 1998.

        Pursuant to the terms of its factoring agreements, the Company's factors
   purchase the Company's eligible accounts receivable and assume the credit
   risk only with respect to those accounts for which the factors have given
   prior approval. As of September 30, 1998, the amount factored without
   recourse was $150,000 and the amount due from the factor recorded as a
   current asset was $151,000.  Where the Company's factors do not assume the
   credit risk for a receivable, the collection risk associated with the
   receivable remains with the Company and if the factor, in its discretion,
   determines to advance against the receivable, the customer's payment
   obligation is recorded as a Company receivable and the advance from the
   factor is recorded as a current liability.

        The Company's initial public offering resulted in net proceeds to the
   Company of approximately $4,627,000.  As of September 30, 1998, $4,350,000
   had been applied and the remaining $276,000 was available for working capital
   and other purposes. The Company used a portion of the net proceeds from its
   public offering to satisfy the majority of its obligations existing under the
   Heller Financial and Safcor factoring arrangements.  The Company also used a
   portion of the proceeds to repay the senior subordinated secured notes held
   by Cruttenden Roth Bridge Fund, LLC and Beta Research Corporation in the
   principal amounts of $323,125 and $226,875, respectively.

        Effective May 1, 1998, the Company entered into a line of credit
   agreement with Sanwa Bank for $2 million to be used for working capital
   purposes.  The line of credit expires on May 31, 1999.  The line of credit
   interest rate is equal to the bank's reference rate and includes certain
   financial covenants relating to net worth, debt to net worth, current ratio,
   and profitability. As of September 30, 1998, the Company had an outstanding
   balance of $1,689,000 on the bank line of credit.

        As of September 30, 1998, the Company had outstanding related party debt
   of $930,000 (the "Related Party Indebtedness") at a weighted average rate of
   7.8% and non-related party debt of  $67,000. All Related Party Indebtedness
   is due and payable on the fifteenth day following the date of delivery of
   written demand for payment which may be delivered at any time after December
   31, 1998.

        Net cash (used in) provided by operating activities was approximately
   ($2,730,000) and $432,000 for the nine months ended September 30, 1998 and
   1997, respectively. Cash provided in the nine months ended September 30, 1997
   resulted primarily from increased accounts payable, prepaid expenses, and
   accrued expenses partially offset by decreases in accounts receivable and
   inventory.  Cash used in operations in the nine months ended September 30,
   1998 resulted primarily from decreased accounts payable, increased accounts
   receivables, inventory and expenses related to the Offering.

                                       11
<PAGE>
 
        Net cash used in investing activities was $608,000 and $618,000 for the
   nine months ended September 30, 1998 and 1997, respectively. Those activities
   related primarily to capital expenditures for production equipment, leasing
   of equipment and expenditures for office and assembly equipment in connection
   with the Mexico facility.

        Net cash provided by financing activities was approximately $3,557,000
   and $297,000 for the nine months ending September 30, 1998 and 1997,
   respectively. Net cash provided by financing activities for the nine months
   ended September 30, 1998 reflects proceeds from the IPO and bank line of
   credit; offset by reductions in advances from factors, related parties and
   non-related parties. Net cash provided for the nine months ending September
   30, 1997 resulted from net advances from related parties and factors.

        In October 1998 the Company received proceeds of $2,688,750 from the
   sale of 2,390,000 shares to KG Investments, LLC, a strategic investor, which
   will be used to fund a portion of its business growth plans and operations.
   The Company believes that it may need to obtain additional financing in order
   to provide  adequate liquidity to funds its business growth plans and
   operations during the next 12 months. The Company is continually evaluating
   various financing strategies to be utilized in expanding its business and to
   fund future growth or acquisitions.  The extent of the Company's future
   capital requirements will depend, however, on many factors, including but not
   limited to, results of operations, the size and timing of future
   acquisitions, if any, and the availability of additional financing. No
   assurance can be given that such additional financing will be available or
   that, if available, it can be obtained on terms favorable to the Company and
   its stockholders.  The Company's inability to obtain adequate funds would
   adversely affect the Company's operations and ability to implements its
   strategy.  In addition, any equity financing could result in dilution to the
   Company's stockholders.  See "Factors That May Affect Future Results  Future
   Capital Needs; Uncertainty of Additional Funding".


   NEW ACCOUNTING PRONOUNCEMENTS

        In 1997, the Financial Accounting Standards Board issued Statement of
   Financial Accounting Standards No. 129, "Disclosure of Information about
   Capital Structure" ("Statement 129"), which is effective for financial
   statements ending after December 15, 1997.  Statement 129 reinstates various
   securities disclosure requirements previously in effect under Accounting
   Principles Board Opinion No. 15, which had been superseded by Statement 128.
   The Company does not expect adoption of Statement 129 to have a material
   effect, if any, on its consolidated financial position or results of
   operation.

        During June 1997, the Financial Accounting Standards Board issued
   Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
   Income" ("Statement 130"), which is effective for financial statements with
   fiscal years beginning after December 15, 1997.  Statement 130 establishes
   standards for reporting and display of comprehensive income and its
   components in a full set of general purpose financial statements.  The
   Company has not determined the effect on its consolidated financial position
   or results of operations, if any, from the adoption of this statement.

        During June 1997, the Financial Accounting Standards Board issued
   Statement of Financial Accounting Standards No. 131, "Disclosure about
   Segments of an Enterprise and Related Information" ("Statement 131"), which
   is effective for financial statements with fiscal years beginning after
   December 15, 1997.  The new standard requires that public business
   enterprises report certain information about operating segments in complete
   sets of financial statements of the enterprise and in condensed financial
   statements of interim periods issued to stockholders.  It also requires that
   public business enterprises report certain information about their products
   and services, the geographic areas in which they operate and their major
   customers.  The Company does not expect adoption of Statement 131 to have a
   material effect, if any, on its consolidated results of operation.

                                       12
<PAGE>
 
   YEAR 2000 UPDATE

      General. The Company's Year 2000 Project (the "Project") has been divided
   into three major areas and is proceeding on schedule.  The Project is
   addressing the date-logic issues in hardware, software, and embedded computer
   chips being able to distinguish between the year 1900 and the year 2000.  In
   1997, the Company began its systems replacement program to improve access to
   business information through common, integrated computing systems with the
   use of programs primarily from Sage/State of The Art (MAS90).   The new
   systems, scheduled for completion by mid-1999, are expected to make
   approximately 80% of the company's business computer systems Year 2000
   compliant. Implementation of MAS90 programs are approximately 50% complete
   with the current versions utilized by the Company certified as Year 2000
   compliant. Remaining business software programs are expected to be made Year
   2000 compliant through the Project or they will be retired.  There are no
   other information technology projects which have been delayed due to the
   implementation of the Year 2000 Project.

      Project. The Project is divided into three major phases: Infrastructure,
   Applications Software, and Third-Party suppliers and customers.  Each phase
   includes identification and assessment of Year 2000 compliance items
   determined to be material to the Company; repair and/or replacement of items
   determined not to be Year 2000 compliant; testing of material items; and
   implementation of contingency and business continuation planning.

      The Infrastructure section consists of hardware and systems software other
   than Applications Software.  This section is on schedule, and the Company
   estimates that approximately 50% of the activities related to this section
   have been completed as of September 30, 1998.  The testing phase is ongoing
   as system software and hardware is upgraded or replaced.  The Company has
   engaged a network consultant to assist in the program management of the
   Project.  Contingency planning is expected to commence in the first quarter
   of 1999.

      The Applications Software section includes both the conversion of
   applications software that is not Year 2000 compliant and, where available
   from the supplier, the replacement of such software.  The Company estimates
   that the software conversion phase was approximately 60% completed as of
   September 30, 1998.  The remaining conversions and testing is scheduled for
   completion by mid-1999, including integration of the Mexico and Hong Kong
   information systems to the Company's principal office in Los Angeles. The
   Company has engaged a software consultant to assist in the program management
   of the Project.  Current versions of MAS90 utilized by the Company are Year
   2000 compliant.  Contingency planning is expected to commence in the first
   quarter of 1999.

      The Third Party suppliers and customers section includes the process of
   identifying, prioritizing, and communicating with critical suppliers and
   customers about their plans and progress in addressing the Year 2000 problem.
   Detailed evaluation, via questionnaires, will be commenced in the fourth
   quarter of 1998.  Contingency planning is expected to commence in the first
   quarter of 1999 with follow-up reviews scheduled through the remainder of
   1999.

      Costs.  The total cost associated with required modifications to become
   Year 2000 compliant is not expected to be material to the Company's financial
   position.  The estimated cost of the Year 2000 Project is approximately
   $250,000 with approximately $150,000 expensed through September 30, 1998,
   representing replacement software and hardware upgrades.

      Risks.  The failure to correct a material Year 2000 problem could have a
   material adverse effect on the Company's results of operations and its
   ability to implement its business strategy.  Due to the general uncertainty
   inherent in the Year 2000 problem, resulting in part from the uncertainty of
   the Year 2000 readiness of third-party suppliers and customers, the Company
   is unable to determine at this time whether the consequences of Year 2000
   failures will have a material impact on the company's results of operations
   and financial condition.   The Year 2000 Project is expected to significantly
   reduce the Company's level of uncertainty and possibility of significant

                                       13
<PAGE>
 
   interruptions of normal operations relating to the Year 2000 problem and, in
   particular, about the Year 2000 compliance and readiness of its material
   suppliers and customers.



   FACTORS THAT MAY AFFECT FUTURE RESULTS

        The following is a discussion of certain factors that may affect the
   Company's financial condition and results of operations.

        Management of Business Changes; Potential Growth; Potential
   Acquisitions.  The Subsidiaries have been operated under family management
   since inception and have recently significantly expanded their operations.
   Such expansion has placed, and any future expansion, internally or through
   acquisitions, will place, significant demands on the Company's management,
   operational, administrative, financial and accounting resources.  Successful
   management of the Company's operations will require the Company to continue
   to implement and improve its financial and management information and
   reporting systems and procedures on a timely basis.  The Company's ability to
   manage its future growth, if any, will also require it to hire and train new
   employees, including management and operating personnel, and motivate and
   manage its new employees and integrate them into its overall operations and
   culture.  The Company recently has made additions to its management team and
   is in the process of improving its financial and management information and
   reporting systems to adapt to its new role as a public company, a process
   which is expected to continue.  The Company's failure to manage
   implementation of its growth strategies and to implement and improve its
   financial and management information and reporting systems would have a
   material adverse effect on the Company's results of operations and its
   ability to implement its growth strategy.

        In the future, the Company may acquire complementary companies, products
   or technologies, although no specific acquisitions currently are pending or
   under negotiation.  Acquisitions involve numerous risks, including adverse
   short-term effects on the combined business' reported operating results,
   impairments of goodwill and other intangible assets, the diversion of
   management's attention, the dependence on retention, hiring and training of
   key personnel, the amortization of intangible assets and risks associated
   with unanticipated problems or legal liabilities.

        Potential Fluctuations in Quarterly Operating Results; Seasonality.  The
   Company may in the future experience significant quarterly fluctuations in
   sales, operating income and cash flows as a result of certain factors,
   including the volume and timing of customer orders received during the
   quarter, the timing and magnitude of customers' marketing campaigns, the loss
   of a major customer, the availability and pricing of materials for the
   Company's products, increased selling, general and administrative expenses
   incurred in connection with acquisitions or the introduction of new products,
   the costs and timing of any future acquisitions, the timing and magnitude of
   capital expenditures, and changes in the Company's product mix or in the
   relative contribution to sales of the various Subsidiaries.  Due to the
   foregoing factors, it is possible that in some quarters the Company's
   operating results may be below the expectations of public market analysts and
   investors.  In such event, the price of the Company's Common Stock would
   likely be materially and adversely affected.

        In addition, most of the Company's customers are in the apparel
   industry, which historically has been subject to substantial cyclical
   variations.  The Company's business has experienced and is expected to
   continue to experience significant seasonality, in part due to customer
   buying patterns.  A recession in the general economy or uncertainties
   regarding future economic prospects that affect consumer spending habits
   could have a material adverse effect on the Company's financial condition and
   results of operations.

        Requirement for Integrated Information System.  The Consolidation and
   resulting centralized management of the Subsidiaries, implementation of the
   Company's growth strategies and the general strains of the Company's new role
   as a public company will place significant demands on the Company's financial
   and management 

                                       14
<PAGE>
 
   information and reporting systems and require that the Company significantly
   expand and improve its financial and operating controls. Additionally, the
   Company must update its computer systems to become Year 2000 compliant and
   effectively integrate the information systems of Hong Kong and Mexico to the
   Company's principal offices in Los Angeles. There are no assurances that the
   Company will be successful in implementing and improving its financial and
   management information reporting systems and staff, and the Company's failure
   to do so could have a material adverse effect on the Company's results of
   operations and its ability to implement its business strategy.

        Dependence on Key Customers; Absence of Long-Term Contracts with
   Customers.  The Company's two largest customers, Guess? and Swank (a licensee
   of Yves Saint Laurent, Kenneth Cole, Geoffrey Beene and Pierre Cardin),
   accounted for approximately 9.6% and 11.4%, respectively, of the Company's
   net sales (on a consolidated basis) for the nine months ended September 30,
   1998, and approximately 14.4% and 12.2%, respectively, of the Company's net
   sales (on a consolidated basis) for the year ended December 31, 1997.  There
   can be no assurance that the Company will be able to maintain the current
   level of sales derived from these or any other customer in the future.

        The Company generally does not enter into long-term sales contracts with
   its customers requiring them to make purchases from the Company.  The
   Company's sales are generally evidenced by a purchase order and similar
   documentation limited to a specific sale.  As a result, a customer from whom
   the Company generates substantial revenue in one period may not be a
   substantial source of revenue in a subsequent period.  In addition, the
   Company's customers generally have the right to terminate their relationships
   with the Company without penalty and on little or no notice.  In the absence
   of such long-term contracts, there can be no assurance that these customers
   will continue to engage the Company to design and produce products, and thus
   there can be no assurance that the Company will be able to maintain a
   consistent level of sales.

        The termination of the Company's business relationship with any of its
   significant customers or a material reduction in sales to a significant
   customer could have a material adverse effect on the Company's business,
   financial condition and results of operations.

        Dependence on Key Personnel.  The Company's success has and will
   continue to depend to a significant extent upon certain key management and
   design and sales personnel, many of whom would be difficult to replace,
   particularly Colin Dyne, its Chief Executive Officer and Harold Dyne, its
   President, neither of whom is bound by an employment agreement or the subject
   of key man insurance.  The Company intends to enter into employment
   agreements with Colin Dyne or Harold Dyne and also intends to obtain $1
   million key man life insurance on Colin Dyne. The loss of the services of one
   or more of these key executives and other key employees could have a material
   adverse effect on the Company, including the Company's ability to establish
   and maintain client relationships.  The Company's future success will depend
   in large part upon its ability to identify, attract, assimilate, retain and
   motivate personnel with a variety of design, sales, operating and managerial
   skills.  There can be no assurance that the Company will be able to retain
   and motivate its managerial, design, sales and operating personnel or attract
   additional qualified members to management, design or sales staff.

        Future Capital Needs; Uncertainty of Additional Funding.  The Company
   anticipates that it may need to obtain additional capital  to fund its
   business growth plans and operations during the next 12 months. To the extent
   that existing resources and future earnings are insufficient to fund the
   Company's activities, the Company will need to raise additional funds through
   debt or equity financings.  No assurance can be given that such additional
   financing will be available or that, if available, it can be obtained on
   terms favorable to the Company and its stockholders. Even if the Company is
   able to obtain alternative financing on acceptable terms, any decrease or
   material limitation on the amount of capital available to the Company under
   such arrangements will limit the ability of the Company to expand its sales
   levels and, therefore, would have a material adverse effect on the Company's
   financial position, operating results and cash flows.  In addition, any
   significant increases in interest rates will increase the cost of financing
   to the Company and would have a material adverse effect on the Company's
   financial position, operating results and cash flows.  In addition, any
   equity financing could result in 

                                       15
<PAGE>
 
   dilution to the Company's stockholders. The Company's inability to obtain
   adequate funds would adversely affect the Company's operations and ability to
   implement its strategy.

        Control by Existing Stockholders.  As of September 30, 1998, the
   Company's officers and directors (and their affiliates), owned approximately
   46.6% of the Company's outstanding shares; and the Dyne family (Harold Dyne,
   Mark Dyne, Colin Dyne, Larry Dyne and Jonathan Burstein) owned approximately
   46.2% of the Company's outstanding shares.  As a result, these stockholders,
   or the Dyne family acting as a group, effectively control the Company and its
   operations, including the election of at least a majority of the Company's
   Board of Directors and thus the policies of the Company.  The voting power of
   these stockholders could also serve to discourage potential acquirors from
   seeking to acquire control of the Company through the purchase of the Common
   Stock, which might have a depressive effect on the price of the Common Stock.

        Dependence on Limited Assembly Facilities.  Certain of the Company's
   products are assembled or finished at the foreign assembly facilities of the
   Company.  Since the Company does not currently operate duplicate facilities
   in different geographic areas, a disruption of the Company's manufacturing
   operations resulting from various factors, including human error, foreign
   trade disruptions, import restrictions, labor disruptions, embargos,
   government intervention or a natural disaster such as fire, earthquake or
   flood, could cause the Company to cease or limit its assembly or finishing
   operations and consequently could have a material adverse effect on the
   Company's business, financial condition and results of operations.

        Limited Sources of Supply.  The Company generally does not have long-
   term agreements with its key sources of supply.  Lead times for materials
   ordered by the Company can vary significantly and depend on factors such as
   the specific supplier, contract terms and demand for particular materials at
   a given time.  From time to time, the Company has experienced fluctuations in
   materials prices and disruptions in supply.  Shortages or disruptions in the
   supply of materials, or the inability of the Company to procure such
   materials from alternate sources at acceptable prices in a timely manner,
   could lead to the loss of customers due to the failure to timely meet orders
   which in turn could result in a material adverse effect on the Company's
   business, financial condition and results of operations.

        Fluctuating Paper Costs and Paper Shortages.  The cost of paper is a
   principal component of the price the Company charges for its paper products,
   including its high quality paper boxes, custom shopping bags, hang tags,
   packaging and stationery products. Historically, the Company has been able to
   pass on to its customers any increase or decrease in the cost of paper, and
   therefore maintain its gross margins on paper products during fluctuations in
   the cost of paper.  There can be no assurance, however, that the Company will
   continue to be able to pass increases in paper costs to its customers.  To
   the extent that the Company's customers are unwilling to absorb increases in
   paper costs, the Company's results of operations could be materially
   adversely affected.

        While capacity in the paper industry has remained relatively stable in
   recent years, increases or decreases in demand for paper have led to
   corresponding pricing changes and, in periods of high demand, to limitations
   on the availability of certain grades of paper, including grades utilized by
   the Company.  Any disruption in the Company's paper sources could cause
   shortages in needed materials which could have a material adverse effect on
   the Company's results of operations.  Although the Company actively manages
   its paper supply and has established strong relationships with its paper
   suppliers, the Company does not have any long-term agreements with its key
   paper suppliers and there can be no assurance that the Company's sources of
   paper supply will be adequate or, in the event that such sources are not
   adequate, that alternative sources can be developed in a timely manner.

        Competition.  The industries in which the Company competes are highly
   competitive and fragmented and include numerous local and regional companies
   that provide some or all of the services offered by the Company.  The Company
   also competes with United States and international design companies,
   distributors and manufacturers of tags, packaging products and trims.  Some
   of the Company's competitors, including Paxar, Inc., RVL, Inc, Copac
   International Packaging, Inc., Universal Button, Inc., and Scovill Fasteners,
   Inc., have greater 

                                       16
<PAGE>
 
   name recognition, longer operating histories and, in many cases,
   substantially greater financial and other resources than the Company.

        In addition, new competitors, potentially with substantially greater
   resources than the Company, may arise and may develop products which compete
   with the Company's products.  Moreover, there can be no assurance that new or
   proprietary technology will not be introduced by an existing or new
   competitor that may make some of the Company's products or services obsolete.
   To the extent that the Company is unable to compete successfully against its
   existing and future competitors, its business, operating results and
   financial condition would be materially adversely affected.  While the
   Company believes that it competes effectively within the value-added design
   and packaging industry, there are numerous factors that could reduce the
   Company's ability to compete effectively.

        Dependence Upon Guess? License.  The Company, through AGS Stationery,
   manufactures Guess? stationery products pursuant to an exclusive license with
   Guess? entered into as of March 1, 1996.  Net sales of Guess? stationery
   products accounted for 2.6% and 11.0% of the Company's consolidated net sales
   for the nine months ended September 30, 1998 and 1997, respectively.
   Effective August 7, 1998 the Company and Guess? mutually agreed to terminate
   the license.  However, the Company is allowed to sell-off any remaining
   inventory through December 1998.  The termination results in no payoff or
   penalties to either party and therefore, the Company does not expect any
   material adverse effect on the Company's business, operating results, and
   financial condition, other than the possibility that the Company will have to
   sell off the remaining inventory at reduced prices, thus decreasing its gross
   margin as a percentage of net sales.

        Risk of Product Returns.  The Company incurs expenses as a result of the
   return of products by customers, particularly in connection with customers of
   the Company's licensed stationery business.  Such returns may result from
   sale or return arrangements, defective goods, inadequate performance relative
   to customer expectations, shipping errors and other causes which are outside
   the Company's control.  Generally, returned items have limited or no value
   and the Company will be forced to bear the cost of such returns.  Product
   returns could result in loss of revenue or delay in market acceptance,
   diversion of development resources, damage to the Company's reputation, and
   increases service and warranty costs.  Any significant increase in the rate
   of product returns could have a material adverse effect on the Company's
   financial position, operating results, and cash flows.

        International Business.  For the year ended December 31, 1997, and the
   nine months ended September 30, 1998,  approximately 40% of the Company's
   products were purchased, assembled or finished outside the United States,
   principally in Hong Kong and Mexico, and the Company intends to continue to
   purchase, assemble or finish a similar or greater percentage of its products
   outside of the United States in the future.  The Company's international
   business is subject to numerous risks, including the need to comply with a
   wide variety of foreign and United States export and import laws, changes in
   export or import controls, tariffs and other regulatory requirements, the
   imposition of governmental controls, political and economic instability,
   trade restrictions, the difficulty of administering business overseas and
   general economic conditions.  The inability of a contractor or supplier to
   ship orders in a timely manner could cause the Company to miss the delivery
   date requirements of its customers for those items, which could result in the
   cancellation of orders, refusal to accept deliveries or a reduction in sales
   price.  Although the Company's international operations are denominated
   principally in United States dollars, purchases from foreign vendors and
   sales to foreign customers may also be affected by changes in demand
   resulting from fluctuations in interest and currency exchange rates,
   including the recent Asian currency fluctuations.  There can be no assurance
   that these factors will not have a material adverse effect on the Company's
   business and results of operations.  In addition, the Company cannot predict
   the effects the above risks will have on its business arrangements with its
   customers, contractors or suppliers.  If any such risks were to render the
   conduct of business in a particular country undesirable or impractical, or if
   the Company's current contractors or suppliers were to cease doing business
   with the Company for any reason, the Company's financial position, operating
   results and cash flows could be adversely affected.

                                       17
<PAGE>
 
             Shared Responsibilities of Chairman. The Company's Chairman, Mark
   Dyne, also serves as Chief Executive Officer and Chairman of Brilliant
   Digital Entertainment, Inc. ("Brilliant"), as the joint managing director of
   Sega Ozisoft Pty., Limited ("Sega Ozisoft"), a director of Monto Holdings
   Pty. Ltd. ("Monto Holdings") and Nu-Metro Multimedia Pty. Ltd. ("Nu-Metro"),
   and a co-owner and director of Packard Bell Australia Pty. Ltd. ("Packard
   Bell NEC Australia").  Mr. Dyne is a shareholder of Sega Enterprises
   (Australia) Pty. Ltd., which operates a $70 million interactive indoor theme
   park in Darling Harbor in Sydney, Australia.  Brilliant is a production and
   development studio involved in the production of a new generation of digital
   entertainment that is being distributed over the internet and on CD-ROM.
   Sega Ozisoft is an Australia-distributor of software products for many
   leading publishers.  Monto Holdings is a private investment holding company,
   Nu-Metro is a South African based distributor of multi-media software
   products and Packard Bell NEC Australia is one of the leading manufacturers
   and distributors of personal computers through the Australian mass merchant
   channel.  Mr. Dyne is not required to spend a certain amount of time at the
   Company nor is he able to devote his full time and resources to the Company.

        Holding Company Structure.  The Company is a holding company with no
   substantial operations and, consequently, is dependent on dividends and other
   payments from the Subsidiaries for virtually all of its cash flow, including
   cash flow for management salaries and overhead, to service debt, to make
   equity investments and to finance its growth.

        No Earthquake Insurance.  The Company's principal executive offices are
   located in Los Angeles, California -- an area which often experiences
   earthquakes.  The Company faces the risks that it may experience uninsured
   property damage and/or sustain interruption of its business and operations.
   The Company does not currently carry insurance against earthquake-related
   risks.

        Limited Proprietary Protection.  The Company relies on trademark, trade
   secret and copyright laws to protect its designs and other proprietary
   property.  The Company does not have United States or foreign patents or
   patent applications currently pending.  If litigation is necessary in the
   future to enforce the Company's intellectual property rights, to protect the
   Company's 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 and could have a material adverse effect on
   the Company's business, operating results and financial condition.
   Ultimately, the Company may be unable, for financial or other reasons, to
   enforce its rights under intellectual property laws, and the laws of certain
   countries in which the Company's products are or may be distributed may not
   protect the Company's products and intellectual rights to the same extent as
   the laws of the United States.

        The Company believes that its products do not infringe any validly
   existing proprietary rights of third parties.  Although the Company has
   received no communication from third parties alleging the infringement of
   proprietary rights of such parties, there can be no assurance that third
   parties will not assert infringement claims in the future and the Company
   could be subject to such claims in the future.  Any such third party claims,
   whether or not meritorious, could result in costly litigation or require the
   Company to enter into royalty or licensing agreements.  There can be no
   assurance that any such licenses would be available on acceptable terms, if
   at all, or that the Company would prevail in any such litigation.  If the
   Company were found to have infringed upon the proprietary rights of third
   parties, it could be required to pay damages, cease sales of the infringing
   products and redesign or discontinue such products, any of which could have a
   material adverse effect on the Company's business, operating results and
   financial condition.

        Shares Eligible for Future Sale.  Future sales of Common Stock by
   existing stockholders could adversely affect the prevailing market price of
   the Common Stock and the Company's ability to raise capital in the equity
   markets.  The Company has 6,460,011 shares of Common Stock outstanding.  Of
   those shares, 1,680,000 shares are freely tradeable without restriction or
   further registration under the Securities Act, unless purchased by
   "affiliates" of the Company as that term is defined in Rule 144 under the
   Securities Act ("Rule 144").  The remaining 4,780,011 shares of Common Stock
   outstanding are "restricted securities," as that term is defined by Rule 144,
   and are also subject to the holding period, volume and manner of sale
   limitations of Rule 144.  Under 

                                       18
<PAGE>
 
   certain lock-up agreements, the officers, directors and other stockholders,
   holding an aggregate of 2,277,894 shares of Common Stock, have agreed that
   they will not, directly or indirectly, sell, assign or otherwise transfer any
   shares of Common Stock owned by them until January 1999, without the prior
   written consent of Cruttenden Roth Incorporated. Upon expiration of the lock-
   up agreements, such 2,277,894 shares of Common Stock will become eligible for
   sale, subject to compliance with the volume and manner of sale limitations of
   Rule 144. The Company also registered the shares of Common Stock reserved for
   issuance pursuant to the Company's 1997 Stock Incentive Plan (the "1997
   Plan"). As of September 30, 1998, options to purchase 260,000 shares of
   Common Stock and warrants to purchase 287,631 shares of Common Stock had been
   granted, none of which had been exercised. The availability for sale, as well
   as actual sales, of currently outstanding shares of Common Stock, and shares
   of Common Stock issuable upon the exercise of options and warrants, may
   depress the prevailing market price for the Common Stock and could adversely
   affect the terms upon which the Company would be able to obtain additional
   equity financing.

        Environmental Regulations.  Certain of the Subsidiaries use hazardous
   materials in their manufacturing operations.  As a result, the Company is
   subject to federal, state and local regulations governing the storage, use
   and disposal of such materials.  The use and disposal of hazardous materials
   involves the risk that the Company could be required to incur substantial
   expenditures for preventive or remedial action, reduction of chemical
   exposure, or waste treatment or disposal.  The liability in the event of an
   accident or the costs of such actions could exceed the Company's resources or
   otherwise have a material adverse effect on the Company's business, financial
   condition or results of operations.

        Effect of Certain Charter Provisions; Stockholders' Rights Plan; Anti-
   Takeover Effects of Certificate of Incorporation, Bylaws and Delaware Law.
   The Company's Board of Directors has the authority to issue up to 3,000,000
   shares of Preferred Stock and to determine the price, rights, preferences,
   privileges and restrictions, including voting rights, of those shares without
   any further vote or action by the stockholders.  The Preferred Stock could be
   issued with voting, liquidation, dividend and other rights superior to those
   of the Common Stock. In October 1998, the Company adopted a stockholder's
   rights plan (the "Rights Agreement") and, in connection therewith,
   distributed one preferred share purchase right for each outstanding share of
   the Company's Common Stock outstanding on November 6, 1998.  Pursuant to the
   Rights Agreement, upon the occurrence of certain triggering events related to
   an unsolicited takeover attempt of the Company, each purchase right not owned
   by certain hostile acquirers will entitle its holder to purchase shares of
   the Company's Series A Preferred Stock at a value below the then current
   market value of the preferred stock.  The holders of the Series A Preferred
   Stock will have voting rights equivalent to the holders of the Common Stock.
   The rights of the holders of Common Stock will be subject to, and may be
   adversely affected by, the rights of the holders of the shares purchase
   rights and of any Preferred Stock that may be issued in the future.  The
   issuance of Preferred Stock, while providing desirable flexibility in
   connection with possible acquisitions and other corporate purposes, could
   have the effect of making it more difficult for a third party to acquire a
   majority of the outstanding voting stock of the Company.  Further, certain
   provisions of the Company's Certificate of Incorporation and Bylaws and of
   Delaware law could delay or make more difficult a merger, tender offer or
   proxy contest involving the Company.

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<PAGE>
 
                                    PART II

                               OTHER INFORMATION



   ITEM 2.   CHANGES IN SECURITIES AND USE OF PROCEEDS

        In January 1998, in connection with the purchase of $550,000 of Bridge
   Notes, Cruttenden Roth Bridge Fund, LLC and Beta Research Corporation
   received Bridge Warrants to purchase 47,000 shares and 33,000 shares,
   respectively, of Common Stock.  The Bridge Warrants will be exercisable for a
   period of four years, commencing January 23, 1999, at an initial per share
   exercise price of $6.00.  The Bridge Warrants provide for demand and
   piggyback registration rights. The issuance and sale of these securities was
   made in reliance on Section 4(2) of the Securities Act as a transaction not
   involving any public offering.

        Also in January 1998, in connection with the Company's initial public
   offering, the Company granted to Cruttenden Roth Incorporated and Josephtal &
   Co. Inc. (the "Representatives") warrants to purchase up to 110,000 shares of
   Common Stock (the "Representatives' Warrants").  The Representatives'
   Warrants will be exercisable for a period of four years, commencing January
   23, 1999, at an initial per share exercise price of $4.80.  Neither the
   Representatives' Warrants nor the shares of Common Stock issuable upon
   exercise thereof may be transferred, assigned or hypothecated until one year
   from the date of the Offering, except that they may be assigned, in whole or
   in part, (i) to individuals who are either officers or partners of the
   Representatives, or (ii) by will or the laws of descent and distribution or
   (iii) to certain successor of the Representatives.  Any profit realized by
   the Representatives on the sale of securities issuable upon exercise of the
   Representatives' Warrants may be deemed to be additional compensation.  The
   issuance and sale of these securities was made in reliance on Section 4(2) of
   the Securities Act as a transaction not involving any public offering.

        The Company's Registration Statement on Form SB-2 (File No. 333-38397)
   relating to the offer and sale (the "Offering") of an aggregate of 1,680,000
   shares (the "Shares") of Common Stock, par value $0.001 per share (the
   "Common Stock"), of the Company was declared effective by the Securities and
   Exchange Commission (the "Commission") on January 23, 1998.  Of the 1,680,000
   shares of Common Stock registered under the Registration Statement, 1,600,000
   shares were sold by the Company and 80,000 shares were sold by a stockholder
   of the Company (the "Selling Stockholder").

        The Offering closed on January 28, 1998.  All of the Shares registered
   were sold in the Offering at an aggregate price of $4.00 per share, for
   aggregate proceeds of $6,400,000 and $320,000 to the Company and the Selling
   Stockholder, respectively.  After deducting underwriting discounts and
   commissions of $0.32 per share, the Selling Stockholder received net proceeds
   of $294,400 and the Company received net proceeds equal to $5,888,000 less
   expenses of $1,260,664 incurred in connection with the Offering  (all of
   which were paid or are payable by the Company). Of the $1,260,664, $134,400
   represents non-accountable expenses payable to the underwriters.  Cruttenden
   Roth Incorporated and Josepthal & Co. Inc. were the co-managing underwriters.

        The Offering resulted in net proceeds ("Net Proceeds") to the Company of
   approximately $4,627,000. As of September 30, 1998, the Company had applied
   an aggregate of approximately $4,350,000 of the Net Proceeds as follows:  (i)
   $2,463,000 to repay certain indebtedness  (of which approximately $597,000
   was paid to officers, directors, stockholders and/or other affiliates of the
   Company), (ii) $500,000 to develop a national sales and marketing network,
   including hiring additional sales personnel, (iii) $340,000 to acquire
   computer & production equipment, (iv) $410,000 to purchase inventories, and
   (v) $637,000 for working capital.  As of September 30, 1998, the Company had
   invested the remaining $276,000 of the Net Proceeds in short-term interest
   bearing securities.

                                       20
<PAGE>
 
        As required by Rule 463 of the Securities Act, the Company will disclose
   the application of the remaining Net Proceeds in the Company's periodic
   report for the year ending December 31, 1998 and, to the extent necessary, in
   subsequent periodic reports filed by the Company pursuant to Section 13(a) or
   15(d) of the Exchange Act.

        On October 16, 1998, the Company sold 2,390,000 shares of its Common
   Stock to KG Investment, LLC for an aggregate purchase price of $2,688,750 (or
   $1.125 per share).  KG Investment, LLC has agreed that it will not seek to
   dispose of its shares prior to October 16, 2000, except to certain affiliated
   parties, without the prior written consent of the Company.  KG Investment,
   LLC has also agreed to certain additional restrictions on the transfer and
   voting of the shares it purchased and has been granted piggyback registration
   rights.  The issuance and sale of these securities was made in reliance on
   Rule 506 and Section 4(2) of the Securities Act as a transaction not
   involving any public offering.

        In October 1998, the Company adopted a stockholder's rights plan and, in
   connection therewith, distributed one preferred share purchase right for each
   outstanding share of the Company's Common Stock outstanding on November 6,
   1998.  Upon the occurrence of certain events, each purchase right not owned
   by certain hostile acquirers will entitle its holder to purchase shares of
   the Company's Series A Preferred Stock at a value below the then current
   market value of the preferred stock.  The holders of the Series A Preferred
   Stock will have voting rights equivalent to the holders of the Common Stock.
   The rights of the holders of Common Stock will be subject to, and may be
   adversely affected by, the rights of the holders of the share purchase rights
   and of any Preferred Stock that may be issued in the future.


 
   ITEM 5.   OTHER INFORMATION

        Effective May 1, 1998, the Company entered into a $2 million line of
   credit agreement with Sanwa Bank to be used for working capital purposes and
   expires on May 31, 1999.  The Line of Credit interest rate is equal to the
   bank's reference rate and includes certain financial covenants relating to
   net worth, debt to net worth, current ratio, and profitability.

 

   ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

        (a)  Exhibits:

             Exhibit 27.1  Financial Data Schedule

 
        (b)  Reports on Form 8-K.

             No reports on Form 8-K were filed during the period covered by this
             transition report.

                                       21
<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.


   Date: November 6, 1998             TAG-IT PACIFIC, INC.
                                     
                                     
                                      By: /s/ Francis Shinsato
                                         -------------------------------------
                                              Francis Shinsato
                                              Chief Financial Officer
                                              (Principal Financial & Accounting 
                                              Officer)

                                       22