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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 March 31, 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)

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

                                      None


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

                                  Yes |X| No |_|

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

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

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

AT MAY 19,  2006 THE ISSUER HAD  18,376,180  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 March 31, 2006
            and December 31, 2005 (unaudited)..................................3

            Consolidated Statements of Operations for the Three Months
            Ended March 31, 2006 and 2005 (unaudited)..........................4

            Consolidated Statements of Cash Flows for the
            Three Months Ended March 31, 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.........................................15

Item 3.     Quantitative and Qualitative Disclosures About Market Risk........30

Item 4.     Controls and Procedures...........................................30

PART II     OTHER INFORMATION

Item 1.     Legal Proceedings.................................................32

Item 1A.    Risk Factors .....................................................33

Item 6.     Exhibits..........................................................33


                                       2
<PAGE>


                                     PART I
                              FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS.
                              TAG-IT PACIFIC, INC.
                           CONSOLIDATED BALANCE SHEETS

                                   (unaudited)

                                                     March 31,      December 31,
                                                       2006            2005
                                                   ------------    ------------
                    Assets
Current Assets:
   Cash and cash equivalents ...................   $  3,026,623    $  2,277,397
   Trade accounts receivable, net ..............      6,278,327       5,652,990
   Note receivable .............................        942,309         662,369
   Inventories .................................      4,688,671       5,573,099
   Prepaid expenses and other current assets ...        275,381         618,577
                                                   ------------    ------------
     Total current assets ......................     15,211,311      14,784,432

Property and equipment, net of accumulated
   depreciation and amortization ...............      6,179,314       6,438,096
Fixed assets held for sale .....................        826,904         826,904
Note receivable, less current portion ..........      2,477,359       2,777,631
Due from related parties .......................        679,795         730,489
Other intangible assets, net ...................      4,233,250       4,255,125
Other assets ...................................        538,546         508,117
                                                   ------------    ------------
Total assets ...................................   $ 30,146,479    $ 30,320,794
                                                   ============    ============
     Liabilities and Stockholders' Equity
Current Liabilities:
   Accounts payable ............................   $  6,096,011    $  6,719,226
   Accrued legal costs .........................      2,640,783       2,520,111
   Other accrued expenses ......................      5,323,166       4,168,552
   Demand notes payable to related parties .....        664,971         664,971
   Current portion of capital lease obligations         441,086         590,884
   Current portion of notes payable ............        189,927         186,837
                                                   ------------    ------------
     Total current liabilities .................     15,355,944      14,850,581

Capital lease obligations, less current portion         757,752         856,495
Notes payable, less current portion ............      1,212,361       1,261,018
Secured convertible promissory notes ...........     12,448,624      12,440,623
                                                   ------------    ------------
     Total liabilities .........................     29,744,681      29,408,717
                                                   ------------    ------------
Contingencies and guarantees - (Note 4) ........           --              --

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, 30,000,000
     shares authorized; 18,241,045 shares
     issued and outstanding at March 31, 2006;
     18,241,045 at December 31, 2005 ...........         18,241          18,241
   Common stock, issuable under grants, 227,635
     shares at March 31, 2006 ..................        102,725            --
   Additional paid-in capital ..................     51,414,277      51,327,878
   Accumulated deficit .........................    (51,163,445)    (50,434,042)
                                                   ------------    ------------
Total stockholders' equity .....................        371,798         912,077
                                                   ------------    ------------
Total liabilities and stockholders' equity .....   $ 30,146,479    $ 30,320,794
                                                   ============    ============


          See accompanying notes to consolidated financial statements.


                                       3
<PAGE>


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

                                                  Three Months Ended March 31,
                                                ------------------------------
                                                    2006              2005
                                                ------------      ------------

Net sales ..................................     $ 10,638,216      $ 13,055,277
Cost of goods sold .........................        7,795,491         9,803,454
                                                 ------------      ------------
     Gross profit ..........................        2,842,725         3,251,823

Selling expenses ...........................          545,625           742,334
General and administrative expenses ........        2,817,131         3,727,260
                                                 ------------      ------------
     Total operating expenses ..............        3,362,756         4,469,594

Loss from operations .......................         (520,031)       (1,217,771)
Interest expense, net ......................          209,372           268,655
                                                 ------------      ------------
Loss before income taxes ...................         (729,403)       (1,486,426)
Provision for income taxes .................             --             162,017
                                                 ------------      ------------
     Net loss ..............................     $   (729,403)     $ (1,648,443)
                                                 ============      ============

Basic loss per share .......................     $      (0.04)     $      (0.09)
                                                 ============      ============
Diluted loss per share .....................     $      (0.04)     $      (0.09)
                                                 ============      ============

Weighted average number of common
  shares outstanding:
     Basic .................................       18,241,045        18,179,426
                                                 ============      ============
     Diluted ...............................       18,241,045        18,179,426
                                                 ============      ============


          See accompanying notes to consolidated financial statements.


                                       4
<PAGE>


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

<CAPTION>
                                                            Three Months Ended March 31,
                                                            --------------------------
                                                               2006            2005
                                                            -----------    -----------
<S>                                                         <C>            <C>
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
    Net loss ............................................   $  (729,403)   $(1,648,443)
Adjustments to reconcile net loss to net cash used
  by operating activities:
   Depreciation and amortization ........................       305,304        555,148
   Increase (decrease) in allowance for doubtful accounts      (334,474)        74,941
    Increase (decrease) in inventory valuation reserves .    (2,850,093)          --
   Disposal of asset ....................................         8,502           --
   Stock based compensation .............................       189,124           --
Changes in operating assets and liabilities:
      Receivables, including related party ..............      (242,669)     1,351,809
      Inventories .......................................     3,734,521     (1,812,085)
      Prepaid expenses and other current assets .........       343,196       (504,565)
        Note Receivable and other assets a&oothero ......       (10,097)         1,581
      Accounts payable and accrued expenses .............       531,399        841,612
        Accrued legal expenses ..........................       120,672       (233,086)
                                                            -----------    -----------
Net cash used by operating activities ...................     1,065,982     (1,373,088)
                                                            -----------    -----------

Cash flows from investing activities:
    Acquisition of property and equipment ...............       (25,148)      (587,923)
     Proceeds from sale of equipment ....................         2,500           --
                                                            -----------    -----------
Net cash used by investing activities ...................       (22,648)      (587,923)
                                                            -----------    -----------

Cash flows from financing activities:
    Repayment of bank line of credit, net ...............          --          (15,824)
    Proceeds from exercise of stock options and warrants           --          254,541
    Repayment of capital leases .........................      (248,541)      (232,441)
    Repayment of notes payable ..........................       (45,567)      (642,673)
                                                            -----------    -----------
Net cash used by financing activities ...................      (294,108)      (636,397)
                                                            -----------    -----------

Net increase (decrease) in cash .........................       749,226     (2,597,408)
Cash at beginning of period .............................     2,277,397      5,460,662
                                                            -----------    -----------
Cash at end of period ...................................   $ 3,026,623    $ 2,863,254
                                                            ===========    ===========

Supplemental  disclosures of cash flow information:
Cash received (paid) during the period for:
      Interest paid .....................................   $  (257,737)   $  (358,887)
      Income taxes paid .................................   $      --      $   (32,071)
      Interest received .................................   $    36,696    $    14,009
Non-cash financing activities:
    Capital lease obligation ............................   $      --      $   270,597
</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 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 $51.1
million as of March 31, 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 attain  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.



NOTE 2.           EARNINGS PER SHARE

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


                                       6
<PAGE>


<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 2006:              LOSS           SHARES      PER SHARE
                                             -----------    -----------   -----------
<S>                                          <C>             <C>          <C>
Basic loss per share:
Loss available to common stockholders ....   $  (729,403)    18,241,045   $     (0.04)

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

THREE MONTHS ENDED MARCH 31, 2005:
Basic loss per share:
Loss available to common stockholders ....   $(1,648,443)    18,179,426   $     (0.09)

Effect of Dilutive Securities:
Options ..................................          --             --            --
Warrants .................................          --             --            --
                                             -----------    -----------   -----------
Loss available to common stockholders ....   $(1,648,443)    18,179,426   $     (0.09)
                                             ===========    ===========   ===========
</TABLE>


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

        Warrants to purchase  1,510,479  shares of common stock at between $3.50
and $5.06, options to purchase 1,872,000 shares of common stock at between $1.30
and $5.23 and convertible  debt of $500,000  convertible at $4.50 per share were
outstanding  for the three months ended March 31, 2005, but were not included in
the computation of diluted  earnings per share because the effect of exercise or
conversion would have an antidilutive effect on loss 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 first day of the  Company's  fiscal  year  2006.  The
Company's  financial  statements  as of and for the three months ended March 31,
2006  reflect  the  impact  of SFAS  123(R).  In  accordance  with the  modified
prospective  transition  method,  the Company's  financial  statements for prior
periods have not been  restated to reflect,  and do not  include,  the


                                       7
<PAGE>


impact of SFAS 123(R). There was no stock-based  compensation expense related to
employee or director  stock  options  recognized  during the three  months ended
March 31, 2005.  Stock-based  compensation  expense recognized under SFAS 123(R)
for  employee  and  directors  for the three  months  ended  March 31,  2006 was
$119,124.  Basic and diluted loss per share for the quarter ended March 31, 2006
would have been $(.03) per share,  if the Company had not adopted  SFAS  123(R),
compared to reported basic and diluted loss of $(.04) per share.

        During the quarter ended March 31, 2006,  the Company  granted awards of
stock for  227,635  shares  at an  average  market  price of $0.45 per share and
options to acquire  2,685,135  shares at an average  exercise price of $0.42 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  167,500
shares were  granted to a  consultant.  The  estimated  fair value of all awards
granted during the quarter was  $1,200,000,  of which $70,000 was accrued for in
accrued  liabilities as of December 31, 2005.  Assumptions used to value options
granted to employees  were  expected  volatility  of 140%,  expected term of 5.3
years to 6.1  years,  risk-free  interest  rate of  approximately  4.4%,  and an
expected  dividend yield of zero.  Assumptions  used to value options granted to
consultants  were  expected  volatility  of  160%,  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."

        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 to stock-based awards granted under the Company's stock option plans for the
three months ended March 31, 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).

<TABLE>
<CAPTION>
<S>                                                                               <C>
Net loss as reported for the three months ended March 31, 2005 ................   $(1,648,443)
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        (11,730)
                                                                                  -----------
Pro forma net loss for the three months ended March 31, 2005 ..................   $(1,660,173)
                                                                                  ===========
               ------------------------------------------------------
Net loss per share for the three months ended March 31, 2005:
As reported -- basic and diluted ..............................................   $     (0.09)
Pro forma -- basic and diluted ................................................   $     (0.09)
</TABLE>

        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 first quarter of fiscal 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 the first quarter of fiscal 2006
is


                                       8
<PAGE>


based on awards ultimately 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 quarter ended
March 31, 2006,  expected  forfeitures  is 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 quarter ended March,  31,
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.

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

         Inventories consist of the following:

                                                  March 31,         December 31,
                                                    2006                2005
                                                -----------          -----------

Finished goods .......................          $ 9,144,600          $12,879,100
Less reserves ........................            4,455,900            7,306,000
                                                -----------          -----------
Total inventories ....................          $ 4,688,700          $ 5,573,100
                                                ===========          ===========


                                       9
<PAGE>


NOTE 5.           CONTINGENCIES AND GUARANTEES

        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  is  scheduled  to be heard on June 19,  2006.
Pursuant to the Private Securities Litigation Reform Act, discovery is stayed in
the case.  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,  an adverse  resolution  the lawsuit  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.

         The Company has filed suit against Pro-Fit Holdings Limited in the U.S.
District Court for the Central District of California - Tag-It Pacific,  Inc. v.
Pro-Fit Holdings  Limited,  CV 04-2694 LGB (RCx) - based on various  contractual
and tort claims  relating to the Company's  exclusive  license and  intellectual
property agreement,  seeking declaratory relief,  injunctive relief and damages.
The agreement  with Pro-Fit  gives the Company the  exclusive  rights in certain
geographic areas to Pro-Fit's  stretch and rigid waistband  technology.  Pro-Fit
filed an answer  denying the material  allegations  of the complaint and filed a
counterclaim  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  unsupported  by fact.  In February  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  counterclaim  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 reply. At the Company's
request,  the Court  bifurcated  the  contract  issues for trial to  commence on
January 10, 2006.  The parties have filed  summary  judgment  motions  which may
dispose of some of the issues in this case prior to trial.  The remaining issues
will be tried at a later date. 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.

         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


                                       10
<PAGE>


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.

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 1997 Plan is administered by the Board of Directors,  or a
committee  appointed by the Board of Directors,  which determines the recipients
and terms of the awards granted.  As of December 31, 2005, the Company may issue
awards to acquire up to a total of  3,077,500  shares of common  stock under the
1997 Plan.  As of December 31, 2005,  there were awards  issued and  outstanding
under the 1997 Plan to acquire a total of 1,833,000 shares of common stock.

        In addition to those awards issued under the 1997 Plan,  the Company has
also issued  certain  warrants.  As of December  31, 2005,  there were  warrants
issued to acquire a total of  1,377,147  shares of common  stock.  The  weighted
average exercise prices,  remaining  contractual  lives and aggregate  intrinsic
values for employee  and board member  options  granted,  expected to vest,  and
exercisable as of December 31, 2005 were as follows:

<TABLE>
<CAPTION>
                                                                         Weighted
                                                        Weighted          Average
                                           Number        Average         Remaining
                                             Of         Exercise        Contractual      Intrinsic
                                           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-
Vested and Expected to Vest             1,809,000    $     3.44           5.98         $       -0-
Exercisable                             1,788,000    $     3.44           5.97         $       -0-
</TABLE>


                                       11
<PAGE>


        The  aggregate   intrinsic   value   excludes  those  options  that  are
"not-in-the-money"  as of December  31,  2005.  Awards that are expected to vest
take into  consideration  estimate  forfeitures  for awards not yet vested.  The
weighted  average  exercise prices,  remaining  contractual  lives and aggregate
intrinsic values for warrants granted,  exercisable,  and expected to vest as of
December 31, 2005 were as follows:

<TABLE>
<CAPTION>
                                                                         Weighted
                                                        Weighted          Average
                                           Number        Average         Remaining
                                             Of         Exercise        Contractual       Intrinsic
                                           Shares         Price        Life (Years)         Value
<S>                                     <C>          <C>                  <C>           <C>
WARRANTS AS OF DECEMBER 31, 2005:
Outstanding                             1,377,147    $     4.36           2.60          $      -0-
Vested and Expected to Vest             1,377,147    $     4.36           2.60          $      -0-
Exercisable                             1,377,147    $     4.36           2.60          $      -0-
</TABLE>


        The  aggregate   intrinsic   value  excludes  those  warrants  that  are
"not-in-the-money"  as of December  31,  2005.  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. The total fair value of awards vested during the
years  ended  December  31,  2005,  2004 and 2003  approximates  that  which was
expensed  for  pro-forma  purposes,  or  approximately  $220,000,   $55,000  and
$140,000, respectively.

        As of  December  31,  2005,  there  was  $42,200  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 1.2 years.

        When options are exercised,  the Company's policy is to issue previously
registered,  unissued  shares of commons  stock.  As of December 31,  2005,  the
Company had 1,244,500 registered but unissued shares of common stock available.

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.


                                       12
<PAGE>


        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.  We
are currently  evaluating  the impact of this new Standard,  but believe that it
will not have a material impact on 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
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.  We are currently
evaluating the impact of this Statement.

NOTE 7.           GEOGRAPHIC INFORMATION

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

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


                                       13
<PAGE>


                                                         THREE MONTHS ENDED
                                                             MARCH 31,
                                                 -------------------------------
                                                     2006               2005
                                                 -----------         -----------
Sales:
     United States .....................         $   913,300         $   587,500
     Asia ..............................           6,320,400           4,295,200
     Mexico ............................           1,135,500           4,621,600
     Dominican Republic ................           1,640,800           2,219,400
     Other .............................             628,200           1,331,600
                                                 -----------         -----------
                                                 $10,638,200         $13,055,300
                                                 ===========         ===========

                                                         THREE MONTHS ENDED
                                                             MARCH 31,
                                                 -------------------------------
                                                     2006               2005
                                                 -----------         -----------
Long-lived Assets:
     United States .....................         $10,244,100         $10,493,900
     Asia ..............................             212,900             226,200
     Mexico ............................              33,500              23,700
     Dominican Republic ................             749,000             776,300
                                                 -----------         -----------
                                                 $11,239,500         $11,520,100
                                                 ===========         ===========


NOTE  8.          SUBSEQUENT EVENT

        In May 2006,  the Company  received  notice by letter from The  American
Stock  Exchange  LLC  ("AMEX")  that the  Company  does not meet  certain of the
continued   listing   standards  as  set  forth  in  the  AMEX  Company   Guide.
Specifically,  the AMEX letter cited the Company's  failure,  as of December 31,
2005, to comply with: (i) Section 1003(a)(i) of the Company Guide because it had
shareholders'  equity  of  less  than  $2,000,000  and  losses  from  continuing
operations  and/or net losses in two out of our last  three most  recent  fiscal
years; and (ii) Section 1003(a)(ii) because it had shareholders'  equity of less
than $4,000,000 and losses from continuing operations and/or net losses in three
out of our four most recent fiscal years.

        In order to maintain an AMEX listing,  the Company is required to submit
a plan by June 15,  2006  advising  AMEX of the actions it has taken or plans to
take to regain compliance with the AMEX continued listing requirements within 18
months.  This plan is subject to the review and  approval  by AMEX.  There is no
assurance  that the Company's  plan will be accepted by AMEX or of the period of
time,  if any,  that AMEX will allow the Company to continue its listing  during
the plan period.  If the Company fails to timely submit this plan, AMEX does not
accept the plan for any reason,  or the Company  fails to perform in  accordance
with the plan, the Company will be subject to delisting procedures.


                                       14
<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. sells 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,  Tekfit,  and Trimfit.  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   distribution   relationships.   These
distribution   partners   will  be  required  to   maintain   excellent   zipper
manufacturing  capabilities and will adopt quality  manufacturing  procedures to
meet our high manufacturing  standards. The network of these manufacturers under
the Talon brand is expected to improve the  time-to-market  by  eliminating  the
typical setup and build-out phase for new manufacturing  capacity throughout the
world.  In the last quarter of 2004 and early 2005 we entered into six franchise
agreements for the sale of Talon zippers.  However, during 2005 several of these
initial  distribution  partners  experienced  delays  in  their  acquisition  of
necessary zipper  equipment,  and this in turn delayed the distribution of Talon
zippers within their respective  territories.  As a result of these delays,  and
other  performance  deficiencies,   the  initial  distribution  agreements  were
terminated.  We are in the process of changing our  distribution  agreements  to
better  serve the local and regional  markets and to provide  more  guidance and
flexibility in meeting our manufacturing standards.

         During the third quarter of 2005 we  restructured  our trim business to
become 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 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


                                       15
<PAGE>


supply  trim  to  customers  who do not  engage  us to  serve  as an  outsourced
development, sourcing and sampling department; however, we will not provide this
trim in a preassembled kit.

         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.  We intend to expand this product to other
brands;  however  our  expansion  has been  limited  to date due to a  licensing
dispute.  As  described  more  fully  in this  report  under  Contingencies  and
Guarantees (see Note 4 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.  As we derive a significant
amount of revenue from the sale of products  incorporating the stretch waistband
technology, our business, results of operations and financial condition could be
materially  adversely  affected if our dispute with Pro-Fit is not resolved in a
manner favorable to us.

         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,
converting our Guatemala  facility from a  manufacturing  site to a distribution
center,  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 a result of this  restructuring,  we
will operate with fewer employees and will have lower  associated  operating and
distribution expenses.


                                       16
<PAGE>


RESULTS OF OPERATIONS

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

                                                            THREE MONTHS ENDED
                                                                 MARCH 31,
                                                            ------------------
                                                             2006         2005
                                                            ------      ------
Net Sales ..............................................     100.0 %     100.0 %
Cost of goods sold .....................................      73.3        75.1
                                                            ------      ------
Gross margin ...........................................      26.7        24.9
Selling expenses .......................................       5.1         5.7
General and administrative expenses ....................      26.5        28.5
                                                            ------      ------
Operating loss .........................................      (4.9)%      (9.3)%
                                                            ======      ======


         SALES

         For the three months ended March 31, 2006 and 2005, sales by geographic
region based on the location of the customer as a percentage of sales:

                                                              THREE MONTHS ENDED
                                                                   MARCH 31,
                                                              -----------------
                                                               2006       2005
                                                              ------     ------
United States ............................................       8.6%       4.5%
Asia .....................................................      59.4       32.9
Mexico ...................................................      10.7       35.4
Dominican Republic .......................................      15.4       17.0
Other ....................................................       5.9       10.2
                                                              ------     ------
    Total ................................................     100.0%     100.0%
                                                              ======     ======


         Sales for the three months  ended March 31, 2006 were $10.6  million or
$2.4  million  (18.5%)  less  than  sales for the same  period 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.  Sales
of our TEKFIT  waistband also decreased in 2006 and 2005 because of lower demand
from the single customer for this product.  We responded to these market changes
with a restructuring plan implemented in the third quarter of 2005 that included
reducing  our  operations  in Mexico and  focusing our efforts on the markets in
Asia.


                                       17
<PAGE>


         COST OF SALES

         Cost of  sales,  for the three  months  ended  March 31,  2006 was $7.8
million or $2.0  million  (20.5%) less than cost of sales for the same period in
2005, due to lower sales volume and a reduction in cost as a percentage of sales
from  75.1% in 2005 to 73.3% for the three  months  ended  March 31,  2006.  The
reduction in cost of sales as a  percentage  of sales is the result of our focus
on higher margin sales, and the reduction of assembly and manufacturing overhead
costs,  partially offset  (approximately 1.9 percentage points) by the impact of
$0.7  million of  inventory  liquidation  sales in the quarter at cost.  Cost of
sales,  for the three  months  ended  March 31,  2005  includes  overhead  costs
incurred in the startup of the  manufacturing  facility in North Carolina.  This
manufacturing facility was closed in the third quarter of FY 2005 in conjunction
with our restructuring plan adopted at that time.

         SELLING EXPENSES

         Selling  expenses  for the three  months ended March 31, 2006 were $0.5
million,  or $0.2  million  (26.5%)  less  than for the same  period in 2005 due
principally to employee  reductions in the U.S. and Mexico  associated  with the
restructuring plan adopted in 2005.

         GENERAL AND ADMINISTRATIVE EXPENSES

         General and  administrative  expenses  for the three months ended March
31,  2006 were $2.8  million,  or $0.9  million  (24.4%)  less than for the same
period in 2005.  The decrease is principally  the result of employee  reductions
within the U.S.,  Mexico and Hong Kong and the elimination of associated  costs,
completed with our restructuring plan implemented in the third quarter of fiscal
year 2005. These cost reductions were partially  offset by substantially  higher
legal,  audit and  professional  costs incurred in the first quarter of 2006, as
well as non-cash  compensation  costs  associated  with the adoption of FAS 123R
effective January 1, 2006.

         For the three months  ended March 31, 2006 we incurred  $1.2 million in
professional,  audit and legal fees associated mainly with the completion of our
year-end  audit of  fiscal  year  2005,  our  change in  independent  registered
auditors, and in litigation expenses associated with our Pro-Fit license dispute
and the shareholder class action complaint filed in October of 2005. These costs
represent  an increase of $0.5  million  over the  comparable  costs in the same
period of 2005, and we believe a substantial portion of the cost increase should
not occur in future periods.

         In the first  quarter of 2006 we adopted  FAS 123R which  requires  the
company to  recognize a non-cash  expense  associated  with options and warrants
issued to employees, directors and consultants. For the three months ended March
31, 2006 we incurred  $119,000 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 2006.

     INTEREST EXPENSE

         Interest expense decreased by approximately $60,000 to $209,000 for the
three months  ended March 31,  2006,  as compared to the same period in 2005 due
primarily to lower borrowings under certain notes.


                                       18
<PAGE>


     INCOME TAXES

     There was no  provision  for income  taxes for the three months ended March
31, 2006 due to the  operating  losses  incurred and no benefit for income taxes
has been recorded  since there is not  sufficient  evidence to determine that we
will be able to utilize our net operating  loss  carryforwards  to offset future
taxable income.  Income taxes for the three months ended March 31, 2005 included
a provision for earned income in our foreign subsidiary.

LIQUIDITY AND CAPITAL RESOURCES

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

                                                         March 31,  December 31,
                                                           2006          2005
                                                        ----------    ----------
Cash and cash equivalents ..........................    $    3,027    $    2,277
Total assets .......................................        30,146        30,321
Current debt .......................................        15,356        14,850
Non-current debt ...................................        14,419        14,558
Stockholders' equity ...............................           372           912


     CASH AND CASH EQUIVALENTS

         Cash and cash  equivalents  increased  by $749,000 for the three months
ended March 31, 2006 from December 31, 2005 principally due to cash generated by
operating activities, and lower cash used in investing and financing activities.

         Cash provided by operating  activities is our only recurring  source of
funds, and was  approximately  $1.1 million for the three months ended March 31,
2006.  The increase in cash  provided by operating  activities  during the three
months resulted  principally from a $3.7 million  decrease in inventory,  net of
reserves of $3.2  million,  for a $0.5  million  net  increase;  a $0.3  million
reduction  in prepaid  purchases;  and a $0.4  million  reduction  in  operating
capital  requirements  offset in part by the loss from operations.  Cash used in
operating activities for the three months ended March 31, 2005 was approximately
$1.3 million  resulting from increased  inventories and prepaid  expenses offset
partially by a decrease in accounts receivable.

         Net cash used in investing  activities for the three months ended March
31, 2006 was $22,000 as compared to $588,000  for the three  months  ended March
31,  2005.  The  cash  used in the  first  quarter  of 2006  represents  capital
expenditures for replacement  computer  equipment.  In the first quarter of 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 three months ended March
31, 2006 was  approximately  $300,000 and  primarily  reflects the  repayment of
borrowings  under capital leases and notes  payable.  For the three months ended
March  31,  2005  the  cash  used  by  financing  activities  was  $636,000  and
represented the repayment of notes payable 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,  sales of equity securities and borrowings
from institutional investors and individual accredited investors.


                                       19
<PAGE>


         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.

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


                                       20
<PAGE>


CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

         The following summarizes our contractual  obligations at March 31, 2006
and the effects such obligations are expected to have on liquidity and cash flow
in future periods:

<TABLE>
<CAPTION>
                                                        Payments Due by Period
                                  ---------------------------------------------------------------------
                                                  Less than        1-3           4-5          After
   Contractual Obligations           Total         1 Year         Years         Years        5 Years
-------------------------------   -------------  ------------  -------------  ----------    -----------
<S>                             <C>            <C>           <C>            <C>           <C>
Demand notes payable to         $      875,200 $     875,200 $            - $         -   $          -
   related parties (1)
Capital lease obligations       $    1,198,800 $     342,300 $      856,000 $       500   $          -
Operating leases                $    1,892,000 $     628,000 $    1,126,000 $   138,000   $          -
Notes payable                   $    1,447,300 $     235,000 $      574,100 $   638,200   $          -
Convertible notes payable       $   12,448,600 $           - $   12,448,600 $         -   $          -
-------------------------------------------------------------------------------------------------------
</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 March 31, 2006.

         At March 31,  2006 and  2005,  we did not have any  relationships  with
unconsolidated  entities  or  financial  partnerships,  such as  entities  often
referred to as structured finance or special purpose entities,  which would have
been established for the purpose of facilitating  off-balance sheet arrangements
or other contractually  narrow or limited purposes.  As such, we are not exposed
to any  financing,  liquidity,  market or credit risk that could arise if we had
engaged in such relationships.

RELATED PARTY TRANSACTIONS

         Prior to 2005 we operated  under 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.  For the three months
ended March 31, 2006 sales to Tarrant Apparel Group were $25,300.  There were no
sales to Tarrant or its affiliates for the three months ended March 31, 2005.

         As of March 31, 2006  accounts  receivable  included  $206,400 due from
Tarrant.  At March 31, 2005 accounts  receivable,  related  party  included $4.5
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 March 31, 2006 and 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 March 31,  2006 and 2005,  we had  receivables  due from  related
parties of $680,000  and  $567,000,  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.

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


                                       21
<PAGE>


which form the basis for making  judgments  about the carrying  values of assets
and  liabilities  that  are not  readily  apparent  from  other  sources.  These
estimates and assumptions affect the reported amounts of assets and liabilities,
the disclosure of contingent liabilities and the reported amounts of revenue and
expense. Actual results could differ from those estimates.

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

         o        Accounts  receivable  balances  are  evaluated  on a continual
                  basis   and   allowances   are   provided   for    potentially
                  uncollectible  accounts based on management's  estimate of the
                  collectibility   of  customer   accounts.   If  the  financial
                  condition  of  a  customer   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


                                       22
<PAGE>


                  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  the  2005  Restructuring  Plan,  certain  long-lived
                  assets,  primarily machinery and equipment,  were impaired and
                  their values adjusted accordingly.

         o        Sales  are   recognized   when   persuasive   evidence  of  an
                  arrangement exists, product delivery has occurred,  pricing is
                  fixed or determinable,  and collection is reasonably  assured.
                  Sales  resulting  from  customer   buy-back   agreements,   or
                  associated  inventory storage arrangements are recognized upon
                  delivery  of the  products  to the  customer,  the  customer's
                  designated manufacturer,  our 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,
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.  We
are currently evaluating the impact this new Standard,  but believe that it will
not have a  material  impact on the  Company's  financial  position,  results of
operations or cash flows.


                                       23
<PAGE>


         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
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.  We are currently
evaluating the impact of this Statement.


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
EFFECTED 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
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:


                                       24
<PAGE>


         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.

         CONCENTRATION OF RECEIVABLES FROM OUR LARGER CUSTOMERS MAKES RECEIVABLE
BASED  FINANCING  DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGER  CUSTOMERS
FAIL TO PAY US, OUR CASH FLOW COULD BE SEVERELY  AFFECTED.  Our business  relies
heavily on a relatively  small number of customers.  This  concentration  of our
business  reduces the amount we can borrow from our  lenders  under  receivables
based financing  agreements.  If we are unable to collect any large  receivables
due us, our cash flow would be severely impacted.

         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.


                                       25
<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  4,  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
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


                                       26
<PAGE>


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.  Further,  the costs of insurance have increased
dramatically in recent years, and the availability of coverage has decreased. As
a result,  we cannot  assure you that we will be able to  maintain  our  current
levels of insurance at a reasonable cost, or at all.

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

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

         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.

         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 an Internet-based business-


                                       27
<PAGE>


to-business e-commerce system. To the extent that we fail to adequately continue
to update and maintain the hardware and software  implementing  the system,  our
customers may experience interruptions in service 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 customers'
ability to use the Managed Trim Solution to monitor and manage  various  aspects
of their 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

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


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<PAGE>


         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. We have been advised by AMEX that we
are  non-compliant  with certain listing  requirements  related to the number of
independent board members, and the number of members on our audit committee. The
AMEX has allowed the company until July 28, 2006 to regain compliance with these
matters.  We have been advised by AMEX that we are also  non-compliant  with the
minimum net equity listing  requirements and we must submit a plan acceptable to
AMEX by June 15,  2006 that  provides  for  increases  in our equity  beyond the
minimum $4.0 million  equity  within a timeframe  that is acceptable to AMEX. 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.  See Item 3
"Legal Proceedings" for discussion of certain tax claims.

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

         INSIDERS OWN A  SIGNIFICANT  PORTION OF OUR COMMON  STOCK,  WHICH COULD
LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As
of March 31, 2006, our officers and directors and their affiliates  beneficially
owned  approximately  10.5% 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 12.7% of the outstanding shares of our common stock at March
31, 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.


                                       29
<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.


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.  There were no hedging
contracts  outstanding as of March 31, 2006. Currency  fluctuations can increase
the price of our products to foreign  customers  which can adversely  impact the
level  of our  export  sales  from  time  to  time.  The  majority  of our  cash
equivalents  are held in United  States 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 March 31, 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 March 31, 2006, our disclosure  controls and procedures were not effective at
the reasonable  assurance  level due to the significant  deficiencies  described
below.

         In light of the significant  deficiencies described below, we performed
additional analysis and other post-closing procedures to ensure 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 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


                                       30
<PAGE>


that  represented   material  weaknesses  in  internal  control  over  financial
reporting which have caused management to conclude that our disclosure  controls
and procedures were not effective at the reasonable assurance level:

         In  conjunction  with  preparing  our Form  10-K for the  period  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,  decided  to restate  our  financial
statements  as of and for those  quarters  to  reflect  the  corrections  in the
application  of our  revenue  recognition  policies.  We  believe  this  control
weakness  has been  corrected  as of March  31,  2006  and did not  result  in a
material misstatement of our consolidated  financial statements for this interim
period.

         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 as of March 31, 2006 and did not result in a
material misstatement of our consolidated financial statements.

         We previously reported the failure 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 March 31, 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.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

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


                                       31
<PAGE>


internal control over financial reporting, other than the changes we implemented
as discussed above to address the material weaknesses.

                                     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 us and
certain of our current and former  officers and  directors in the United  States
District  Court for the Central  District of  California  alleging  claims under
Section 10(b) and Section 20 of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5  promulgated  thereunder.  The action is brought on behalf of all
purchasers of our publicly-traded securities during the period from November 14,
2003 to August 12, 2005. On January 23, 2006 the court heard  competing  motions
for  appointment of lead  plaintiff/counsel  and appointed Seth Huberman as lead
plaintiff. The lead plaintiff thereafter filed an amended complaint on March 13,
2006.  The  amended  complaint  alleges  that  the  defendants  made  false  and
misleading  statements about our financial  situation and our relationship  with
certain of our large customers  during a purported class period between November
13,  2003 and August  12,  2005.  It  purports  to state  claims  under  Section
10(b)/Rule  10b-5 and Section 20(a) of the  Securities  Exchange Act of 1934. We
filed a motion to dismiss the amended  complaint which motion is scheduled to be
heard on June 19, 2006.  Pursuant to the Private  Securities  Litigation  Reform
Act, discovery is stayed in the case.  Although we believe that we and the other
defendants have meritorious defenses to the class action complaint and intend to
contest the lawsuit  vigorously,  an adverse resolution the lawsuit could have a
material adverse effect on our financial position and results of operations.  At
this early stage of the  litigation,  we are not able to reasonably  predict the
outcome of this  action or estimate  potential  losses,  if any,  related to the
lawsuit.

         We have  filed  suit  against  Pro-Fit  Holdings  Limited  in the  U.S.
District Court for the Central  District of California - Tag-It Pacific,  Inc. v
Pro-Fit Holdings  Limited,  CV 04-2694 LGB (RCx) - based on various  contractual
and tort claims  relating to our  exclusive  license and  intellectual  property
agreement,  seeking  declaratory  relief,  injunctive  relief and  damages.  The
agreement with Pro-Fit gives us the exclusive rights in certain geographic areas
to Pro-Fit's  stretch and rigid  waistband  technology.  Pro-Fit filed an answer
denying the  material  allegations  of the  complaint  and filed a  counterclaim
alleging  various  contractual  and tort claims  seeking  injunctive  relief and
damages.  We  filed  a reply  denying  the  material  allegations  of  Pro-Fit's
pleading.  Pro-Fit has since  purported to terminate the  exclusive  license and
intellectual  property  agreement  based on the  same  alleged  breaches  of the
agreement that are the subject of the parties' existing  litigation,  as well as
on an additional  basis  unsupported  by fact. In February  2005, we amended our
pleadings  in the  litigation  to assert  additional  breaches by Pro-Fit of its
obligations under the agreement and under certain  additional letter agreements,
and for a declaratory  judgment that Pro-Fit's  patent No.  5,987,721 is invalid
and not  infringed  by us.  Thereafter,  Pro-Fit  filed an  amended  answer  and
counterclaim  denying the  material  allegations  of the amended  complaint  and
alleging  various  contractual  and tort claims  seeking  injunctive  relief and
damages.  Pro-Fit  further  asserted  that we infringed its United States Patent
Nos.  5,987,721  and  6,566,285.  We  filed  a  reply  denying  the  substantive
allegations  of the reply.  At our request,  the Court  bifurcated  the contract
issues for trial to commence on January 10, 2006. The parties have filed summary
judgment  motions  which may dispose of some of the issues in this case prior to
trial.  The  remaining  issues  will be tried at a later  date.  As we  derive a
significant  amount  of  revenue  from the sale of  products  incorporating  the
stretch waistband technology,  our business, results of operations and financial
condition could be materially  adversely affected if the dispute with Pro-Fit is
not  resolved  in a  manner  favorable  to us.  Additionally,  we have  incurred
significant  legal fees in this litigation,  and unless the case is settled will
continue  to incur  additional  legal  fees in  increasing  amounts  as the case
accelerates to trial.


                                       32
<PAGE>


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


ITEM 1A. RISK FACTORS

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


ITEM 6.  EXHIBITS

10.1     Executive  Employment  Agreement  dated March 16, 2006  between  Tag-It
         Pacific, Inc. and Stephen P. Forte.

10.2     Employment  offer letter dated March 16, 2006 between  Tag-It  Pacific,
         Inc. and Wouter van Biene.

10.3     Employment  offer letter dated March 16, 2006 between  Tag-It  Pacific,
         Inc. and Lonnie D. Schnell.

10.4     Employment  offer letter dated March 16, 2006 between  Tag-It  Pacific,
         Inc. and Jonathan Burstein.

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.


                                       33
<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:   May 22, 2006                     TAG-IT PACIFIC, INC.

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


                                       34