Edgar Filing: TALON INTERNATIONAL, INC.

================================================================================

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 June 30, 2007.

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

Commission file number 1-13669

TALON INTERNATIONAL, INC.
(Exact Name of 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)

TAG-IT PACIFIC, INC.
(Former name, former address and former fiscal year,
if changed since last report)

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 AUGUST 14, 2007 THE ISSUER HAD 20,041,433 SHARES OF COMMON STOCK,
$.001 PAR VALUE, ISSUED AND OUTSTANDING.

================================================================================

TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)

INDEX TO FORM 10-Q

PART I FINANCIAL INFORMATION PAGE
----

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

Consolidated Balance Sheets as of June30, 2007 (unaudited)
and December 31, 2006 ............................................ 3

Consolidated Statements of Operations for the Three Months
and the Six Months Ended June 30, 2007 and 2006 (unaudited)....... 4

Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2007 and 2006 (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.......... 29

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

PART II OTHER INFORMATION

Item 1. Legal Proceedings................................................... 31

Item 1A. Risk Factors ....................................................... 31

Item 6. Exhibits ........................................................... 32

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)

CONSOLIDATED BALANCE SHEETS

June 30, December 31,
2007 2006
------------ ------------
Assets
Current Assets:
Cash and cash equivalents ..................... $ 3,822,264 $ 2,934,673
Restricted cash ............................... 9,500,000 --
Accounts receivable, net ...................... 6,040,757 4,664,766
Note receivable ............................... 1,450,051 1,378,491
Inventories, net .............................. 2,555,072 3,051,220
Recoverable legal costs ....................... 1,180,748 107,108
Prepaid expenses and other current assets ..... 675,063 433,926
------------ ------------
Total current assets ............................. 25,223,955 12,570,184

Property and equipment, net ...................... 5,575,712 5,623,040
Fixed assets held for sale ....................... 826,904 826,904
Note receivable, less current portion ............ 677,601 1,420,969
Due from related party ........................... 722,918 675,137
Other intangible assets, net ..................... 4,110,751 4,139,625
Other assets ..................................... 720,546 437,569
------------ ------------
Total assets ..................................... $ 37,858,387 $ 25,693,428
============ ============

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ............................... $ 6,391,504 $ 4,006,241
Accrued legal costs ............................ 1,267,167 427,917
Other accrued expenses ......................... 3,289,601 3,359,267
Demand notes payable to related parties ........ 85,176 664,970
Current portion of capital lease
obligations .................................. 395,294 432,728
Current portion of notes payable ............... 405,878 1,107,207
Secured convertible promissory notes ........... 12,488,490 12,472,622
------------ ------------
Total current liabilities ........................ 24,323,110 22,470,952

Capital lease obligations, less current
portion ........................................ 351,292 474,733
Notes payable, less current portion .............. 1,000,482 1,061,514
Revolver note payable ............................ 1,307,806 --
Term note payable ................................ 7,106,260 --
Other long term liabilities ...................... 83,651 --
------------ ------------
Total liabilities ................................ 34,172,601 24,007,199
------------ ------------

Commitments and contingencies

Stockholders' Equity:
Preferred stock Series A, $0.001 par value;
250,000 shares authorized; no
shares issued or outstanding ................ -- --

Common stock, $0.001 par value,
100,000,000 shares authorized; 20,041,433
shares issued and outstanding at June 30,
2007; 18,466,433 at December 31, 2006 ....... 20,041 18,466
Additional paid-in capital ..................... 54,341,135 51,792,502
Accumulated deficit ............................ (50,675,390) (50,124,739)
------------ ------------
Total stockholders' equity ....................... 3,685,786 1,686,229
------------ ------------
Total liabilities and stockholders' equity ....... $ 37,858,387 $ 25,693,428
============ ============

See accompanying notes to consolidated financial statements

TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ----------------------------
2007 2006 2007 2006
------------ ------------ ------------ ------------

Net sales ......................... $ 13,566,981 $ 14,246,087 $ 22,657,099 $ 24,884,303
Cost of goods sold ................ 9,484,488 10,118,850 15,827,411 17,914,341
------------ ------------ ------------ ------------
Gross profit ................... 4,082,493 4,127,237 6,829,688 6,969,962

Selling expenses .................. 841,326 674,894 1,547,561 1,220,519
General and administrative expenses 2,406,192 2,557,062 5,017,780 5,296,499
------------ ------------ ------------ ------------
Total operating expenses ....... 3,247,518 3,231,956 6,565,341 6,517,018

Income from operations ............ 834,975 895,281 264,347 452,944
Interest expense, net ............. 265,858 229,139 490,574 516,205
------------ ------------ ------------ ------------
Income (loss) before income taxes . 569,117 666,142 (226,227) (63,261)
Provision for income taxes ........ 78,624 11,500 78,624 11,500
------------ ------------ ------------ ------------
Net Income (loss) .............. $ 490,493 $ 654,642 $ (304,851) $ (74,761)
============ ============ ============ ============

Basic income (loss) per share ..... $ 0.03 $ 0.04 $ (0.02) $ (0.00)
============ ============ ============ ============
Diluted income (loss) per share ... $ 0.02 $ 0.04 $ (0.02) $ (0.00)
============ ============ ============ ============

Weighted average number of common
shares outstanding:
Basic .......................... 18,590,884 18,358,360 18,562,151 18,300,027
============ ============ ============ ============
Diluted ........................ 20,058,682 18,598,442 18,562,151 18,300,027
============ ============ ============ ============

See accompanying notes to consolidated financial statements.

TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

Six Months Ended June 30,
----------------------------
2007 2006
------------ ------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................... $ (304,851) $ (74,761)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization ............................................. 592,011 606,960
Amortization of deferred financing cost and debt discounts ................ 163,593 155,254
Increase (decrease) in allowance for doubtful accounts ................... 61,500 (919,312)
Decrease in inventory valuation reserves ................................. (165,280) (3,433,267)
Disposal of asset ......................................................... -- 8,502
Stock based compensation .................................................. 125,000 165,377
Changes in operating assets and liabilities:
Receivables, including related party ...................................... (1,485,273) 214,518
Inventories ............................................................... 661,428 5,453,233
Recoverable legal costs ................................................... (1,073,640) --
Prepaid expenses and other current assets ................................. (241,137) 74,016
Other Assets .............................................................. 35,207 (104,029)
Accounts payable and accrued expenses ..................................... 2,560,129 (94,087)
Accrued legal ............................................................. 769,467 129,020
Income taxes payable .................................................... 77,931 11,500
------------ ------------
Net cash provided by operating activities ................................ 1,776,085 2,192,924
------------ ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment ...................................... (514,812) (28,883)
Proceeds from sale of equipment ........................................... -- 2,500
------------ ------------
Net cash used by investing activities .................................... (514,812) (26,383)
------------ ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Collection of notes receivable ............................................. 671,808 84,514
Proceeds from exercise of stock options and warrants ....................... 42,746 --
Proceeds from issuance of stock and warrants, net of issuance costs ........ 2,313,711 --
Revolver note borrowings ................................................... 1,307,806 --
Term note borrowings, net of issuance costs ................................ 6,842,789 --
Repayment of capital leases ................................................ (160,875) (397,906)
Repayment of notes payable ................................................. (1,891,667) (153,630)
------------ ------------
Net cash from (used by) financing activities ........................... 9,126,318 (467,022)
------------ ------------

Net increase in cash and restricted cash ....................................... 10,387,591 1,699,519
Cash at beginning of period .................................................... 2,934,673 2,277,397
------------ ------------
Cash and restricted cash at end of period
$ 13,222,264 $ 3,976,916
============ ============

Supplemental disclosures of cash flow information: Cash received (paid) during
the period for:
Interest paid ............................................................ $ (477,176) $ (520,825)
Interest received ........................................................ $ 154,263 $ 159,874
Income tax paid .......................................................... $ 95,056 --
Non-cash financing activities:
Capital lease obligation ................................................. $ 35,809 $ --
Deferred financing cost .................................................. $ 203,434 $ --
Accounts payable & accrued legal converted to notes payable .............. $ -- $ 1,775,000

See accompanying notes to consolidated financial statements.

TALON INTERNATIONAL, INC.
(FORMERLY 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 Talon International,
Inc. and its consolidated 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, 2006. The balance sheet as of December 31, 2006 has been
derived from the audited financial statements as of that date but omits certain
information and footnotes required for complete financial statements.

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

Certain reclassifications have been made to the prior year financial
statements to conform to the 2007 presentation.

NOTE 2. EARNINGS (LOSS) PER SHARE

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

THREE MONTHS ENDED JUNE 30, 2007: INCOME (LOSS) SHARES PER SHARE
------------ ------------ ------------

Basic Income per share:
Income available to common stockholders $ 490,493 18,590,884 $ 0.03

Effect of Dilutive Securities:
Options ............................... -- 1,463,278 (0.01)
Warrants .............................. -- 4,520 --
------------ ------------ ------------
Income available to common stockholders
$ 490,493 20,058,682 $ 0.02
============ ============ ============

THREE MONTHS ENDED JUNE 30, 2006:
Basic Income per share:
Income available to common stockholders $ 654,642 18,358,360 $ 0.04

Effect of Dilutive Securities:
Options ................................. -- 240,082 --
Warrants ................................ -- -- --
------------ ------------ ------------
Income available to common stockholders . $ 654,642 18,598,442 $ 0.04
============ ============ ============

SIX MONTHS ENDED JUNE 30, 2007:
Basic loss per share:
Loss available to common stockholders . $ (304,851) 18,562,151 $ (0.02)

Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
------------ ------------ ------------
Loss available to common stockholders ... $ (304,851) 18,562,151 $ (0.02)
============ ============ ============

SIX MONTHS ENDED JUNE 30, 2006:
Basic loss per share:
Loss available to common stockholders . $ (74,761) 18,300,027 $ (0.00)

Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
------------ ------------ ------------
Loss available to common stockholders
$ (74,761) 18,300,027 $ (0.00)
============ ============ ============

Warrants to purchase 3,193,813 shares of common stock exercisable at
between $0.95 and $5.06 per share, options to purchase 4,746,735 shares of
common stock exercisable at between $0.37 and $5.23 per share, and convertible
debt of $12,500,000 convertible at $3.65 per share, were outstanding for the
three and six months ended June 30, 2007. In connection with the Share-Based
Payment calculation (see note 3), 4,880,135 shares were included in the
computation of diluted income per share for the three month period ended June

30, 2007. These shares were not included in the computation of diluted loss per
share for the six months ended June 30, 2007 because exercise or conversion
would have an antidilutive effect on the loss per share.

Warrants to purchase 1,243,813 shares of common stock exercisable at
between $3.50 and $5.06 per share, options to purchase 4,434,888 shares of
common stock exercisable at between $0.37 and $5.23 per share, 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 and six
months ended June 30, 2006. In connection with the Share-Based Payment
calculation (see note 3), 2,775,135 shares were included in the computation of
diluted income per share for the three month period ended June 30, 2006. These
shares were not included in the computation of diluted loss per share for the
six months ended June 30, 2006 because exercise or conversion would have an
antidilutive effect on the loss per share.

NOTE 3. STOCK BASED COMPENSATION

The Company accounts for stock-based awards to employees and directors
in accordance with Statement of Financial Accounting Standards No. 123 revised,
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. Options issued to
consultants are accounted for in accordance with the provisions of Emerging
Issues Task Force (EITF) No. 96-18, "Accounting for Equity Instruments That Are
Issued to Others Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services".

There were 46,600 options granted to employees during the three and six
months ended June 30, 2007 at a weighted average exercise price of $1.02 per
share. The estimated fair value of options granted during the three and six
months ended June 30, 2007 was $31,700. Common shares of 1,500,000 and warrants
to acquire 2,100,000 shares of common stock were issued during the three and six
months ended June 30, 2007 to a non-employee in connection with a debt financing
facility at a weighted average exercise price of $1.05 per share for the
warrants and $0.001 per share for the common shares issued. The estimated total
fair value of the warrants and shares of common stock granted during the three
and six months was $2,879,020. The relative fair value of warrants and shares of
common stock issued, less financing costs, is accounted for as debt discount
related to the $9.5 million Term note entered into in June 2007. Assumptions
used to value options granted to employees were expected volatility of 69%,
expected term of 6.1 years, risk-free interest rate of approximately 5.0%, and
an expected dividend yield of zero. Assumptions used to value warrants granted
to non-employee were expected volatility of 78%, expected term of 5 years
(contractual life), risk-free interest rate of 5.0%, and expected dividend yield
of zero. In January, 2007, a consultant exercised options to acquire 75,000
shares of common stock. Cash received upon exercise was $42,750 or $0.57 per
share. At the time of exercise, the total intrinsic value of the options
exercised was approximately $72,000 (or $0.96 per share). Because the option
exercised was a non-qualified stock option, the Company will receive a tax
deduction for the intrinsic value amount.

As of June 30, 2007, the Company had approximately $537,000 of
unamortized stock-based compensation expense related to options issued to
employees and directors, which will be recognized over the weighted average
period of 2.3 years. This expected expense will change if any stock options are
granted or cancelled prior to the respective reporting periods or if there are
any changes required to be made for estimated forfeitures.

During the three months ended June 30, 2006, the Company did not grant
any stock-based awards to employees or non-employees. During the six months
ended June 30, 2006, the Company granted awards of stock for 225,388 shares at
an average market price of $0.45 per share and options to acquire 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, and awards
of stock and options to acquire 165,253 shares were granted to a consultant. The
estimated fair value of all awards granted during the six months was $666,000,
of which

$70,000 was accrued for as of December 31, 2005. Assumptions used to value
options granted to employees were expected volatility of 57%, 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 65%, expected term of 10 years
(contractual life), risk-free interest rate of 4.5%, and expected dividend yield
of zero.

The following table summarizes the activity in the Company's share based
plans during the three and six months ended June 30, 2007. At June 30, 2007 the
Company may issue additional awards to acquire up to a total of 2,502,877 shares
of common stock under the 1997 Plan.

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

EMPLOYEES AND DIRECTORS
Options and warrants outstanding - January 1, 2007 ..... 5,002,635 $ 1.41
Granted ........................................... -- --
Exercised ......................................... -- --
Cancelled ......................................... (299,500) $ 1.03
---------- ----------
Options and warrants outstanding - March 31, 2007 ...... 4,703,135 $ 1.44
Granted ........................................... 46,600 $ 1.02
Exercised ......................................... -- --
Cancelled ......................................... (3,000) $ 1.27
---------- ----------
Options and warrants outstanding - June 30, 2007 ....... 4,746,735 $ 1.44
========== ==========

NON-EMPLOYEES
Options and warrants outstanding - January 1, 2007 ..... 1,318,813 $ 4.13
Granted ........................................... -- --
Exercised ......................................... (75,000) $ .57
Cancelled ......................................... (150,000) $ 3.50
---------- ----------
Options and warrants outstanding - March 31, 2007 ...... 1,093,813 $ 4.46
Granted ........................................... 2,100,000 $ 1.05
Exercised ......................................... -- --
Cancelled ......................................... -- --
---------- ----------
Options and warrants outstanding - June 30, 2007 ....... 3,193,813 $ 2.22
========== ==========

NOTE 4. INVENTORIES

Inventories are stated at the lower of cost or market value and are all
categorized as 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: June 30, December
2007 31, 2006
---------- ----------
Finished goods ....................... $3,631,791 $4,293,220
Less reserves ........................ 1,076,720 1,242,000
---------- ----------
Total inventories .................... $2,555,071 $3,051,220
========== ==========

NOTE 5. INCOME TAXES

On January 1, 2007 the Company adopted the provisions of Financial
Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes-an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements and prescribes a recognition threshold and
measurement process for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on the recognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition associated with income tax
liabilities.

As a result of the implementation of FIN 48, the Company recognized an
increase in liabilities for unrecognized tax benefits of approximately $245,800,
which was accounted for as an increase in the January 1, 2007 accumulated
deficit.

The Company recognizes interest accrued related to unrecognized tax
benefits in interest expense and penalties in income tax expense. For the three
and six months ended June 30, 2007 the Company recognized accrued interest for
unrecognized tax benefits of approximately $4,000. There was no interest or
penalties recognized during the three months or six months ended June 30, 2006
for unrecognized tax benefits. At June 30, 2007 the Company had approximately
$37,875 accrued in interest and penalties associated with the unrecognized tax
liabilities.

NOTE 6. CONTINGENCIES AND GUARANTEES

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

On February 20, 2007, the Court denied class certification. Plaintiff moved the
court to reconsider the ruling, and also to intervene a new plaintiff to pursue
class certification. Both of those motions were denied on April 2, 2007. In
addition, the same day the Court granted defendants' motion for summary
judgment, and on or about April 5, 2007, the Court entered judgment in favor of
all defendants. On or about April 30, 2007, plaintiff filed a notice of appeal,
and his opening appellate brief is due on October 15, 2007. The Company believes
that this matter will be resolved in trial or in settlement within the limits of
its insurance coverage. However, the outcomes of this action or an estimate of
the potential losses, if any, related to the lawsuit cannot be reasonably
predicted, and an adverse resolution of the lawsuit could potentially have a
material adverse effect on the Company's financial position and results of
operations.

On April 16, 2004 the Company filed suit against Pro-Fit Holdings,
Limited ("Pro-Fit") in the U.S. District Court for the Central District of
California - TAG-IT PACIFIC, INC. V. PRO-FIT HOLDINGS, LIMITED, CV 04-2694 LGB
(RCx) -- asserting various contractual and tort claims relating to our exclusive
license and intellectual property agreement with Pro-Fit, seeking declaratory
relief, injunctive relief and damages. It is the Company's position that the
agreement with Pro-Fit gives us the exclusive rights in certain geographic areas
to Pro-Fit's stretch and rigid waistband technology. On June 5, 2006 the Court
denied the Company's motion for partial summary judgment, but did not find that
the Company breached its agreement with Pro-Fit and a trial is required to
determine issues concerning our activities in Columbia and whether other actions
by Pro-Fit constituted an unwillingness or inability to fill orders. The Court
also held that Pro-Fit was not "unwilling or unable" to fulfill orders by
refusing to fill orders with goods produced in the United States. The Court has
not yet set a date for trial of this matter. The Company has historically
derived a significant amount of revenue from the sale of products incorporating
the stretch waistband technology and 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, the Company will continue to incur
additional legal fees in increasing amounts as the case accelerates to trial.

A subsidiary, Tag-It de Mexico, S.A. de C.V., operated under the
Mexican government's Maquiladora Program, which entitled Tag-It de Mexico to
certain favorable treatment as respects taxes and duties regarding certain
imports. In July of 2005, the Mexican Federal Tax Authority asserted a claim
against Tag-It de Mexico alleging that certain taxes had not been paid on
imported products during the years 2000, 2001, 2002 and 2003. In October of
2005, the Company filed a procedural opposition to the claim and submitted
documents to the Mexican Tax Authority in opposition to this claim, supporting
the Company's position that the claim was without merit. The Mexican Federal Tax
Authority failed to respond to the opposition filed, and the required response
period by the Tax Authority has lapsed. In addition, a controlled entity
incorporated in Mexico (Logistica en Avios, S.A. de C.V.) through which the
Company conducted its operations in 2005, may be subjected to a claim or claims
from the Mexican Tax Authority, as identified directly above, and additionally
to other tax issues, including those arising from employment taxes. The Company
believes that any such claim is defective on both procedural and documentary
grounds and does not believe there will be a material adverse effect on us.

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

In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of the Company's
agreements that it has determined are within the scope of FIN 45:

In accordance with the bylaws of the Company, officers and directors
are indemnified for certain events or occurrences arising as a result of the
officer or director's serving in such capacity. The term of the indemnification
period is for the lifetime of the officer or director. The maximum potential
amount of 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 7. NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements"("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. SFAS No. 157 applies
under other accounting pronouncements that require or permit fair value
measurements, and does not require any new fair value measurements. The
application of SFAS No. 157 however may change current practice within an
organization. SFAS No. 157 is effective for all fiscal years beginning after
November 15, 2007, with earlier application encouraged. We do not believe that
SFAS No. 157 will have a material impact on our financial position, results of
operations or cash flows.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115," ("SFAS No. 159") which expands the use of fair value. Under
SFAS No. 159 a company may elect to use fair value to measure accounts and loans
receivable, available-for-sale and held-to-maturity securities, equity method
investments, accounts payable, guarantees, issued debt and other eligible
financial instruments. SFAS No. 159 is effective for years beginning after
November 15, 2007. We do not believe that SFAS No. 159 will have a material
impact on our financial position, results of operations or cash flows.

NOTE 8. GEOGRAPHIC INFORMATION

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

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

Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
Country / Region 2007 2006 2007 2006
----------- ----------- ----------- -----------
United States .......... $ 1,048,400 $ 1,025,100 $ 1,890,900 $ 1,938,400
Asia ................... 11,531,500 8,418,400 18,554,800 14,738,800
Mexico ................. 319,400 1,444,200 599,400 2,579,700
Dominican Republic ..... 269,600 2,631,300 654,700 4,272,100
Other .................. 398,100 727,100 957,300 1,355,300
----------- ----------- ----------- -----------
$13,567,000 $14,246,100 $22,657,100 $24,884,300
=========== =========== =========== ===========

June 30, December 31,
2007 2006
----------- -----------
LONG-LIVED ASSETS:
United States ........................ $ 9,459,100 $ 9,531,659
Asia ................................. 439,500 386,516
Mexico ............................... 1,400 5,078
Dominican Republic ................... 613,500 668,067
----------- -----------
$10,513,500 $10,591,320
=========== ===========

NOTE 9. DEBT FACILITY

On June 27, 2007 the Company entered into a Revolving Credit and Term
Loan Agreement with Bluefin Capital, LLC that provides for a $5.0 million
revolving credit loan and a $9.5 million term loan for a three year period
ending June 30, 2010. The revolving credit portion of the facility permits
borrowings based upon a formula including 75% the Company's eligible receivables
and 55% of eligible inventory, and provides for monthly interest payments at
prime plus 2%. The term loan bears interest at 8 1/2% annually with quarterly
interest payments. Both of the notes are secured by all of the assets of the
Company and mature on June 30, 2010. At closing the proceeds of the term loan
were deposited into a restricted cash escrow account and $3.0 million of the
borrowings available under the revolving credit note were reserved and held for
payment of the Company's $12.5 million convertible promissory notes maturing in
November 2007. During July 2007 waivers were obtained from all holders of the
convertible promissory notes allowing for early payment of their notes without
penalty, and as of July 31, 2007 all of the note holders had been paid in full.
At June 30, 2007 the convertible promissory notes payable are reflected in
current liabilities.

As of June 30, 2007 the Company had borrowed $9.5 million under the
term note, and $1,307,806 under the revolving credit note. The proceeds of the
term note were held in a restricted cash escrow for future payment of the
convertible promissory notes, and the proceeds of the borrowings under the
revolving credit note were used to pay the related party note payable and
accrued interest due to Mark Dyne, Chairman of the Board of the Company, in the
amount of $1,004,306, and to pay the initial loan and legal fees due at closing.

In connection with the Revolving Credit and Term Loan Agreement, the
Company issued 1,500,000 shares of common stock to the lender for $0.001 per
share, and issued 2,100,000 warrants for the purchase of common stock. The
warrants are exercisable over a five-year period and 700,000 warrants are
exercisable at $0.95 per share; 700,000 warrants are exercisable at $1.05 per
share; and 700,000 warrants are exercisable at $1.14 per share. The relative
fair value of the equity ($2,380,962, which includes a reduction for financing
costs) of the equity issued with this debt facility was allocated to
paid-in-capital and reflected as a debt discount to the face value of the term
note. This discount will be accreted over the term of the note and recognized as
additional interest cost as amortized. Costs associated with the debt facility
included debt fees, commitment fees, registration fees, and legal and
professional fees of $548,000. The costs allocable to the debt instruments are
reflected in other assets as deferred financing costs and are being amortized
over the term of the notes.

NOTE 10. SUBSEQUENT EVENTS

During July 2007 the Company obtained waivers from all of the
convertible promissory note holders to accept payment of their notes without
penalty. All of the restricted cash escrow funds, together with an additional
$3.0 million borrowed under the revolving credit note at July 31, 2007 were used
during the month to pay the convertible promissory notes in full.

On July 31, 2007, at the Company's annual meeting of stockholders, the
2007 Stock Plan was approved which replaces the 1997 Stock Plan upon its
expiration on October 1, 2007. The 2007 Stock Plan authorizes up to 2,600,000
shares of common stock for issuance pursuant to awards granted to individuals
under the plan. At June 30, 2007 2,502,877 shares were available for issuance
under the 1997 Stock Plan which expires on October 1, 2007 if not issued.

At June 30, 2007 we have an outstanding note receivable from Azteca
Production International, Inc. of $2,127,652. The note is receivable in monthly
installments over thirty-one months beginning March 1, 2006 and the payments
currently range from $133,000 - $267,000 per month until paid in full. Accounts
receivable at June 30, 2007 includes $219,900 due from Azteca, against which
$119,800 in checks from Azteca were being held. At August 1, 2007 $47,900 of
these checks had been collected. On April 11, 2007 a favorable verdict was
awarded to the plaintiff in a trademark infringement lawsuit in which Azteca is
a defendant and is now appealing. This adverse ruling against Azteca may impact
their ability to repay our note receivable. On July 1, 2007 we did not receive
the July 1st note payment on our note receivable from Azteca and we submitted a
notice of default. On July 23, 2007 we received an election from Azteca to defer
the July 1st payment for an additional 30 days from our default notice in
accordance with terms allowing this deferral in the note agreement. Accordingly,
the July 1st note payment is now due September 14, 2007. On August 1, 2007 we
did not receive the August 1st note payment and accordingly submitted a notice
of default to Azteca Production International, Inc. In accordance with the terms
of the note agreement, Azteca has a 30 day cure period to correct the existing
default. The outcome of these events or an estimate of the potential impact if
any, on the collectibility of our note receivable cannot be reasonably predicted
at this time. The failure to collect payments under this note could have a
material adverse effect on our financial position and results of operations.

On July 20, 2007 the Company changed its name from Tag-It Pacific, Inc.
to Talon International, Inc. and changed its AMEX trading symbol from TAG to
TLN.

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.

On July 20, 2007, we changed our corporate name from Tag-It Pacific,
Inc. to Talon International, Inc. in order to reflect our core marketing
strategy of focusing on growth opportunities in the global zipper market with
our Talon(R) brand zippers.

Talon International, Inc. designs, 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 and Tekfit. We
operate the business globally under three product groups.

We plan to increase our global expansion of Talon zippers through the
establishment of a network of Talon locations, distribution relationships, and
joint ventures. The network of global manufacturing and distribution locations
are expected to improve our global footprint and allow us to more effectively
serve apparel brands and manufacturers globally.

Our trim business focus is as an outsourced product development,
sourcing and sampling department for the most demanding brands and retailers. We
believe that trim design differentiation among brands and retailers has become a
critical marketing tool for our customers. By assisting our customers in the
development, design 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.

Our Tekfit services provide manufacturers with the patented technology,
manufacturing know-how and materials required to produce garments incorporating
an expandable waistband. These products historically have been produced by
several manufacturers for one single brand under an exclusive supply contract.
This contract expired in October 2006 and we now intend to expand this product
to other brands. Our expansion has been limited to date due to the exclusive
contract as well as licensing dispute. As

described more fully in this report under Contingencies and Guarantees (see Note
6 to our unaudited consolidated financial statements), we are presently in
litigation with Pro-Fit Holdings Limited regarding our exclusively licensed
rights to sell or sublicense stretch waistbands manufactured under Pro-Fit's
patented technology. As we have derived 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.

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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------- -----------------
2007 2006 2007 2006
------ ------ ------ ------
Net sales ............................ 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ................... 69.9 71.0 69.9 72.0
------ ------ ------ ------
Gross profit ......................... 30.1 29.0 30.1 28.0
Selling expenses ..................... 6.2 4.7 6.8 4.9
General and administrative expenses .. 17.7 18.5 22.1 21.9
Interest & taxes ..................... 2.5 1.1 2.5 1.5
------ ------ ------ ------
Net income (loss) .................... 3.7% 4.7% (1.3)% (0.3)%
====== ====== ====== ======

SALES

For the three months and six months ended June 30, 2007 and 2006, sales
by geographic region based on the location of the customer as a percentage of
sales were:

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------- -----------------
2007 2006 2007 2006
------ ------ ------ ------
United States ...................... 7.7% 7.2% 8.3% 7.8%
Asia ............................... 85.0% 59.1% 81.9% 59.2%
Mexico ............................. 2.4% 10.1% 2.6% 10.4%
Dominican Republic ................. 2.0% 18.5% 2.9% 17.2%
Other .............................. 2.9% 5.1% 4.3% 5.4%
------ ------ ------ ------
100.0% 100.0% 100.0% 100.0%
====== ====== ====== ======

Sales for the three months ended June 30, 2007 were $13.6 million or
$0.7 million (4.8%) less than sales for the three months ended June 30, 2006.
Sales for the six months ended June 30, 2007 were $22.7 million or $2.2 million
(8.9%) less than sales for the same period in 2006. The reduction in sales for
the three and six months ended June 30, 2007 as compared to the same period in
2006 is primarily attributable to lower sales of waistband products as a result
of the termination in October of 2006 of our exclusive sales contract for these
products. For the three and six months ended June 30, 2007 sales included $0.2
million and $0.6 million, respectively of waistband product sales, as compared
to sales of $2.5 million and $4.4 million, respectively of these products for
comparable periods in 2006.

Sales within Asia increased $3.1 million, or 37% for the three months
ended June 30, 2007 and $3.8 million, or 26% for the six months ended June 30,
2007 as compared to the same periods in 2006. The

increase in sales within Asia is principally the result of increased sales of
Talon zippers and our continued expansion in China.

Sales of trim products for the three months and six months ended June
30, 2007 declined $1.4 million and $2.3 million, respectively as compared to the
same periods in 2006 principally as a result of lower sales of trim products to
our customers in Mexico and the U.S. as production shifted from these areas to
Asia and other worldwide markets, and as a result of sales of $0.8 million
recognized in the second quarter of 2006 associated with a revenue restatement
from a 2005 agreement.

GROSS MARGIN

Gross margin for the three months ended June 30, 2007 was $4.1 million,
essentially comparable to the gross margin of $4.1 million for the same period
in 2006. Gross margin for the six months ended June 30, 2007 was $6.8 million or
$0.1 million (2%) less than gross margin for the same period in 2006. The change
in gross margin for the three and six months ended June 30, 2007 as compared to
the same periods in 2006 was principally attributable to reduced costs
associated with lower overall sales volumes, lower direct margin resulting from
a change in the mix in product sales, reduced distribution charges since more
products are now sourced and delivered within the same marketplace, reduced
manufacturing and assembly overhead costs and lower inventory obsolescence and
management charges as inventory levels have been reduced and turns accelerated.
A brief recap of the change in gross margin for the three and six months ended
June 30, 2007 as compared with the same periods in 2006 is as follows:

(Amounts in thousands)
THREE MONTHS SIX MONTHS
---------------------------- ----------------------------
AMOUNT %(1) AMOUNT %(1)
------------ ------------ ------------ ------------

Gross margin (decrease) increase as a result of:
Lower volumes ................................ $ (234) (5.6) $ (791) (11.3)
Product margin mix ........................... (20) (0.5) (319) (4.6)
Vendor cost reductions negotiated in 2006 .... (261) (6.3) (261) (3.7)
Reduced freight and duty costs ............... 151 3.7 316 4.5
Lower manufacturing & assembly costs ......... 163 3.9 130 1.9
Reduced obsolescence & inventory costs ....... 109 2.7 639 9.2
Other cost of sales charges .................. 47 1.1 146 2.0
------------ ------------ ------------ ------------
Gross margin (decrease) ...................... $ (45) (1.0)% $ (140) (2.0)%
============ ============ ============ ============

(1) Represents the percentage change in the 2007 period, as compared to the
same period in 2006.

SELLING EXPENSES

Selling expenses for the three months ended June 30, 2007 were $0.8
million, or 6.2% of sales compared to $0.7 million or 4.7% of sales for the same
period in 2006. The increase in selling expense is principally due to the
increased number of sales offices and salespersons within China and their
associated compensation and travel costs, offset in part by lower royalty fees
on waistband products.

Selling expenses for the six months ended June 30, 2007 were $1.5
million or 6.8% of sales compared to $1.2 million or 4.9% of sales for the same
period in 2006. The increase in selling expense is principally due to the
increased number of sales offices and salesmen within China and their associated
compensation and travel costs and increased marketing cost associated with the
Talon brand offset in part by lower royalty fees on waistband products.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses for the three months ended June 30,
2007 were $2.4 million or $0.2 million less than for the same period in 2006.
General and administrative expenses for the six months ended June 30, 2007 were
$5.0 million or $0.3 million less than for the same period in 2006.

General and administrative expense for the three month period ended
June 30, 2007 increased by approximately $217,000 as a result of $53,000 in bad
debt provisions in 2007 compared to bad debt recoveries of $164,000 in 2006; by
$133,000 due to additional consulting fees on contracts with former employees;
and general and administrative expense decreased by approximately $156,000 as a
result of lower facility costs; by $275,000 in lower legal, audit and investor
costs; and by approximately $64,000 in other lower overall general and
administrative expenses.

For the six month period ended June 30, 2007 general and administrative
expenses as compared to the same period of 2006 declined by approximately $0.3
million. The net reduction reflected an increase of $439,000 as a result of
$42,000 in bad debt provisions in 2007 compared to bad debt recoveries of
$397,000 in 2006; offset by decreases in general and administrative expenses by
$164,000 resulting from lower facility costs; by $459,000 in lower legal, audit
and investor costs, and by approximately $95,000 in other lower general and
administrative costs.

INTEREST EXPENSE

Interest expense increased by approximately $37,000 to $266,000 for the
three months ended June 30, 2007, as compared to the same period in 2006. The
increase principally reflects lower interest earnings on cash and the note
receivable, in addition to higher debt amortization costs. Interest expense for
the six months ended June 30, 2007 decreased by approximately $25,000 to
$491,000, as compared to the same period in 2006. The change for the period from
2006 is due mainly to lower borrowings under a bank line of credit and certain
notes. Interest expense for the remaining term of the new debt facility entered
into in June 2007 will include approximately $0.2 million per quarter in
non-cash charges for debt accretion and deferred financing costs amortization.

INCOME TAXES

Income tax expense for the three and six months ended June 30 2007 was
$78,624 and for the three and six months ended June 30, 2006 the income tax
expense was $11,500. The tax expense in both 2007 and 2006 is associated with
foreign income taxes from earnings within our Asian facilities. Due to prior
operating losses incurred within the year no benefit for domestic income taxes
has been recorded since there is not sufficient evidence to determine that we
will be able to utilize our net operating loss carryforwards to offset future
taxable income.

LIQUIDITY AND CAPITAL RESOURCES

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

JUNE 30, 2007 DECEMBER 31, 2006
----------------- -----------------
Cash and cash equivalents ............... $ 3,822 $ 2,935
Total assets ............................ $ 28,358 $ 25,693
Current debt ............................ $ 11,835 $ 22,471
Non-current debt ........................ $ 12,838 $ 1,536
Stockholders' equity .................... $ 3,686 $ 1,686

CASH AND CASH EQUIVALENTS

Cash and cash equivalents for the six months ended June 30, 2007
increased $887,000 from December 31, 2006 principally arising from cash
generated by operating activities, and Restricted cash increased by $9.5
million from borrowings under a term loan agreement.

Cash provided by operating activities is our primary recurring source
of funds, and was approximately $1.8 million for the six months ended June 30,
2007. The cash provided by operating activities during the six months resulted
principally from net earnings before non-cash charges of $576,000; an increase
in trade accounts payable of $2,560,000; a net reduction of $496,000 in
inventory (a $661,000 reduction in inventory levels, net of established reserves
of $165,000); offset by an increase in current receivables of $1,424,000; an
increase in net recoverable legal fees of $304,000; and an increase in prepaid
expenses and other of $128,000.

During the six months ended June 30, 2006 established reserves for
uncollectible accounts receivable were applied to approximately $0.6 million of
accounts written-off, and approximately $0.3 million in reserves were eliminated
following the collection of previously reserved accounts. Cash used by operating
activities for the six months ended June 30, 2005 was $148,000.

Net cash used in investing activities for the six months ended June 30,
2007 was $515,000 as compared to $26,000 for the six months ended June 30, 2006.
These expenditures were principally associated with leasehold improvements in
new facilities, office equipment for new employees, improvements in our
technology systems and a marketing website acquisition. In 2006 the cash used
for investing activities consisted primarily of capital expenditures for
replacing computer equipment.

Net cash of $9,126,000 was generated from financing activities for the
six months ended June 30, 2007. $10,507,000 (net of issuance costs) was provided
by the issuance of common stock and warrants, and by borrowings under a new debt
facility (see Note 9) designated to payoff our existing convertible promissory
notes and to provide funds for future growth. The proceeds from this debt
facility initially included $9,500,000 that was funded to a restricted escrow
account to partially pay the $12,500,000 of outstanding convertible promissory
notes, and $1,004,000 was used to pay a related party note and associated
accrued interest. Approximately $374,000 was used primarily for the repayment of
borrowings under capital leases and notes payable partially offset by
collections on the note receivable and the proceeds of the exercise of stock
options. Additionally, net cash used by financing activities for the six months
ended June 30, 2006 was $467,000 and represented the repayment of notes payable
and capital leases, partially offset by funds collected from the note
receivable.

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

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 belief that our

strategic plan and the company's current structure will allow for continued
profitability; and that we will collect our note and accounts receivable in
accordance with existing terms.

If we are unable to collect our note and accounts 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 a
substantial decline in sales, we may default on our debt agreement. The event of
a default on the debt agreements will materially affect the business operations
in the long-term, however the on-going operations for 2007 are nevertheless
anticipated to substantially continue throughout the 2007 year-end.

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
trade name, and we may need to implement additional cost savings initiatives.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

The following summarizes our contractual obligations at June 30, 2007
and the effects such obligations are expected to have on liquidity and cash flow
in future periods:

PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------
LESS THAN 1 TO 3 4 TO 5 AFTER
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
----------- ----------- ----------- ----------- -----------

Demand notes payable to related
parties (1) ................. $ 209,500 $ 209,500 $ 0 $ 0 $ 0
Capital lease obligations ..... $ 831,600 $ 474,000 $ 357,600 $ 0 $ 0
Operating leases .............. $ 1,282,500 $ 492,100 $ 782,700 $ 7,700 $ 0
Notes payable ................. $15,421,500 $ 1,590,300 $13,236,100 $ 595,100 $ 0
Convertible notes payable (2) . $ 3,051,700 $ 3,051,700 $ 0 $ 0 $ 0
----------- ----------- ----------- ----------- -----------
Total Obligations ...... $20,796,800 $ 5,817,600 $14,376,400 $ 602,800 $ 0
=========== =========== =========== =========== ===========

(1) The majority of notes payable to related parties is due on demand with
the remainder due and payable on the fifteenth day following the date
of delivery of written demand for payment, and includes accrued
interest payable through June 30, 2007.

(2) Net of $9,500,000 held in escrow for payment of these notes.

At June 30, 2007 and 2006, 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

A director and significant shareholder of Tarrant Apparel Group is also
a significant shareholder of the Company. Sales to Tarrant for the three months
and six months ended June 30, 2007 were $139,900, and $140,000, respectively.
Sales to Tarrant for the three and six months ended June 30, 2006 were zero and
$1,000 respectively. As of June 30, 2007 there were accounts receivable of
$140,000 due from Tarrant, and at December 31, 2006 there were no amounts due
from Tarrant.

Colin Dyne, a director and stockholder of the Company is also a
director, officer and significant stockholder in People's Liberation, Inc.
During the three and six months ended June 30, 2007 we had sales of $65,600 and
$349,200, respectively, to subsidiaries of People's Liberation, Inc. For the
three and six months ended June 30, 2006 we had no sales to Peoples Liberation,
Inc. At June 30, 2007, accounts receivable included $56,500 outstanding from
People's Liberation subsidiaries. At December 31, 2006, accounts receivable of
$83,400 was outstanding from subsidiaries of People's Liberation, Inc.

Jonathan Burstein, a director of the Company, purchases products from
the Company through an entity operated by his spouse. For the three and six
months ended June 30, 2007 sales to this entity were $30,000 and $33,600,
respectively. Sales to this entity for the three and six months ended June 30,
2006 were $800 and $10,600, respectively. At June 30, 2007, $19,500 was included
in accounts receivable from this entity and at December 31, 2006 accounts
receivable included $18,400 due from this entity.

Due from related parties at June 30, 2007 includes $722,900 and at
December 31, 2006 includes $675,100 of unsecured notes, advances and accrued
interest receivable from Colin Dyne. The notes and advances bear interest at
7.5% and are due on demand.

Demand notes payable to related parties includes notes and advances to
parties related to or affiliated with Mark Dyne, Chairman of the Board of the
Company. The principal balance of Demand notes payable to related parties at
June 30, 2007 was $85,200 and at December 31, 2006 was $665,000. On June 27,
2007 a note payable to Mark Dyne in the principal amount of $665,000, plus
accrued interest of $339,000, was paid in full.

Consulting fees paid to Diversified Investments, a company owned by
Mark Dyne, amounted to $37,500 for the three months ended June 30, 2007 and
2006. Consulting fees paid for the six months ended June 30, 2007 and 2006 were
$75,000.

Consulting fees of $75,000 and $ 125,200 were paid for services
provided by Colin Dyne for the three months and six months ended June 30, 2007,
respectively. For the three and six months ended June 30, 2006 consulting fees
of $72,000 were paid to Colin Dyne. Consulting fees of $73,800 and $147,200 were
paid for services provided by Jonathan Burstein, for the three months and six
months ended June 30, 2007. No consulting fees were paid to Jonathan Burstein in
2006.

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

disclosure of contingent liabilities and the reported amounts of revenue and
expense. Actual results could differ from those estimates.

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

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

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

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

reassess the carrying amount of our long-lived assets.
Long-lived assets are evaluated on a continual basis and
impairment adjustments are made based upon management's
valuations.

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

o Upon approval of a restructuring plan by management, we record
restructuring reserves for certain costs associated with
facility closures and business reorganization activities as
they are incurred or when they become probable and estimable.
Such costs are recorded as a current liability. We record
restructuring reserves in compliance with SFAS 146 "Accounting
for Costs Associated with Exit or Disposal Activities",
resulting in the recognition of employee severance and related
termination benefits for recurring arrangements when they
became probable and estimable and on the accrual basis for
one-time benefit arrangements. We record other costs
associated with exit activities as they are incurred. Employee
severance and termination benefits are estimates based on
agreements with the relevant union representatives or plans
adopted by us that are applicable to employees not affiliated
with unions. These costs are not associated with nor do they
benefit continuing activities. Inherent in the estimation of
these costs are assessments related to the most likely
expected outcome of the significant actions to accomplish the
restructuring. Changing business conditions may affect the
assumptions related to the timing and extent of facility
closure activities. We review the status of restructuring
activities on a quarterly basis and, if appropriate, record
changes based on updated estimates.

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

In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value
measurements, and does not require any new fair value measurements. The
application of SFAS No. 157 however may change current practice within an
organization. SFAS No. 157 is effective for all fiscal years beginning after
November 15, 2007, with earlier application encouraged. We do not believe that
SFAS No. 157 will have a material impact on our financial position, results of
operations or cash flows.

accounts payable, guarantees, issued debt and other eligible financial
instruments. SFAS No. 159 is effective for years beginning after November 15,
2007. We do not believe that SFAS No. 159 will have a material impact on our
financial position, results of operations or cash flows.

CAUTIONARY STATEMENTS AND RISK FACTORS

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

OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY
AFFECTED IF WE ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING
OUR RIGHTS UNDER OUR EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY AGREEMENT 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
have derived a significant amount of revenues from the sale of products
incorporating the stretch waistband technology. Our business, results of
operations and financial condition could be materially adversely affected if we
are unable to reach a settlement in a manner acceptable to us and ensuing
litigation is not resolved in a manner favorable to us. Additionally, we have
incurred significant legal fees in this litigation, and unless the case is
settled, we will continue to incur additional legal fees in increasing amounts
as the case accelerates to trial.

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

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

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

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

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

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

In October 2006, our exclusive supply agreement with Levi Strauss &
Co., pursuant to which we supplied Levi with TEKFIT waistbands for their Dockers
programs, expired. With the expiration of this contract we now have broader
access to other customers and we intend to actively expand this product offering
to other brands. Sales of this product to Levi are expected to end during the
second quarter of 2007 and to be significantly lower than in the previous year,
and orders from new brands are not expected to fully offset these declines for
several quarters, if at all. The revenues we derived from the sale of products
incorporating the stretch waistband technology represented approximately 19% of
our consolidated revenues for the years ended December 31, 2005 and 2006. A
failure to attract new customers for our TEKFIT waistbands could have a material
adverse effect on our sales and results of operations.

IF WE ARE NOT ABLE TO REGAIN COMPLIANCE WITH LISTING REQUIREMENTS, OUR
SHARES MAY BE REMOVED FROM LISTING ON AMEX. In May 2006 we were advised by AMEX
that we were non-compliant with the minimum net equity listing requirements and
we were afforded an opportunity to submit a plan to AMEX that provided for
increases in our equity beyond the minimum $4.0 million equity requirement
within an eighteen-month timeframe from

the date of the notice from AMEX. On August 3, 2006 AMEX accepted our plan to
regain compliance and has given us an extension until November 16, 2007 to
become compliant with the AMEX continued listing standards. During this period,
we will be subject to periodic review by the AMEX staff and failure to make
progress consistent with the plan or to regain compliance with continued listing
standards by the end of the extension period could result in being delisted from
the American Stock Exchange. In addition we have 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 COLLECT OUR NOTE RECEIVABLE. On April 11, 2007 a
favorable verdict was awarded to the plaintiff in a trademark infringement
lawsuit in which Azteca Production International, Inc. is a defendant. We have
an outstanding note from Azteca at June 30, 2007 of $2.1 million and this
adverse ruling against them may impact their ability to repay our note
receivable. The outcome of this event or an estimate of the potential impact if
any, on the collectibility of our note receivable cannot be predicted at this
time. The failure to collect payments under this note as scheduled could have a
material adverse effect on our financial position, results of operations and
cash flow. At August 1, 2007 Azteca had deferred its July 1, 2007 payment under
the terms of the agreement and was in default under its August payment
requirements (See note 10).

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

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

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

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

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

o The timing and magnitude of customers' marketing campaigns;

o The loss or addition of a major customer;

o The availability and pricing of materials for our products;

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

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 Part II, Item 1, "Legal Proceedings"
for a detailed description of this lawsuit.

THE OUTCOME OF LITIGATION IN WHICH WE HAVE BEEN NAMED AS A DEFENDANT IS
UNPREDICTABLE AND AN ADVERSE DECISION IN ANY SUCH MATTER COULD HAVE A MATERIAL
ADVERSE EFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS. We are
defendants in a number of litigation matters. These claims may divert financial
and management resources that would otherwise be used to benefit our operations.
Although we believe that we have meritorious defenses to the claims made in each
and all of the litigation matters to which we have been named a party, and
intend to contest each lawsuit vigorously, no assurances can be given that the
results of these matters will be favorable to us. An adverse resolution of any
of these lawsuits could have a material adverse effect on our financial position
and results of operations.

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

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

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

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

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

o Foreign trade disruptions;

o Import restrictions;

o Labor disruptions;

o Embargoes;

o Government intervention;

o Natural disasters; or

o Regional pandemics.

INTERNET-BASED SYSTEMS THAT WE RELY UPON FOR OUR ORDER TRACKING AND
MANAGEMENT SYSTEMS MAY EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE
REVENUES AND CUSTOMERS. To the extent that we fail to adequately update and
maintain the hardware and software implementing our integrated systems, our
customers may be delayed or interrupted due to defects in our hardware or our
source code. In addition, since our software is Internet-based, interruptions in
Internet service generally can negatively impact our ability to use our systems
to monitor and manage various aspects of our customer's trim needs. Such defects
or interruptions could result in lost revenues and lost customers.

THE REQUIREMENTS OF THE SARBANES-OXLEY ACT, INCLUDING SECTION 404, ARE
BURDENSOME, AND OUR FAILURE TO COMPLY WITH THEM COULD HAVE A MATERIAL ADVERSE
AFFECT ON OUR BUSINESS AND STOCK PRICE. Effective internal control over
financial reporting is necessary for us to provide reliable financial reports
and effectively prevent fraud. Section 404 of the Sarbanes-Oxley Act of 2002
requires us to evaluate and report on our internal control over financial
reporting beginning with our annual report on Form 10-K for the fiscal year
ending December 31, 2007. Our independent registered public accounting firm will
need to annually attest to our evaluation, and issue their own opinion on our
internal control over financial reporting beginning with our annual report on
Form 10-K for the fiscal year ending December 31, 2008. We are preparing for
compliance with Section 404 by strengthening, assessing and testing our system
of internal control over financial reporting to provide the basis for our
report. The process of strengthening our internal control over financial
reporting and complying with Section 404 is expensive and time consuming, and
requires significant management attention. Failure to implement required
controls, or difficulties encountered in their implementation, could cause us to
fail to meet our reporting obligations. If we or our auditors discover a
material weakness in our internal control over financial reporting, the
disclosure of that fact, even if the weakness is quickly remedied, could
diminish investors' confidence in our financial statements and harm our stock
price. In addition, non-compliance with Section 404 could subject us to a
variety of administrative sanctions, including the suspension of trading,
ineligibility for listing on one of the national securities exchanges, and the
inability of registered broker-dealers to make a market in our common stock,
which would further reduce our stock price.

THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors have
greater name recognition, longer operating histories and greater financial and
other resources than we do.

UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR
LITIGATION COSTS AND ADVERSELY AFFECT OUR SALES. We rely on trademark, trade
secret and copyright laws to protect our designs and other proprietary property
worldwide. We cannot be certain that these laws will be sufficient to protect
our property. In particular, the laws of some countries in which our products
are distributed or may be distributed in the future may not protect our products
and intellectual rights to the same extent as the laws of the United States. If
litigation is necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others, such litigation could result in substantial
costs and diversion of resources. This could have a material adverse effect on
our operating results and financial

condition. Ultimately, we may be unable, for financial or other reasons, to
enforce our rights under intellectual property laws, which could result in lost
sales.

IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY
BE SUED AND HAVE TO PAY LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR DISCONTINUE
SELLING OUR PRODUCTS. From time to time in our industry, third parties allege
infringement of their proprietary rights. Any infringement claims, whether or
not meritorious, could result in costly litigation or require us to enter into
royalty or licensing agreements as a means of settlement. If we are found to
have infringed the proprietary rights of others, we could be required to pay
damages, cease sales of the infringing products and redesign the products or
discontinue their sale. Any of these outcomes, individually or collectively,
could have a material adverse effect on our operating results and financial
condition.

COUNTERFEIT PRODUCTS ARE NOT UNCOMMON IN THE APPAREL INDUSTRY AND OUR
CUSTOMERS MAY MAKE CLAIMS AGAINST US FOR PRODUCTS WE HAVE NOT PRODUCED AND WE
MAY BE ADVERSELY IMPACTED BY THESE FALSE CLAIMS. Counterfeiting of valuable
trade names is commonplace in the apparel industry and while there are industry
organizations and federal laws designed to protect the brand owner, these
counterfeit products are not always detected and it can be difficult to prove
the manufacturing source of these products. Accordingly, we may be adversely
affected if counterfeit products damage our relationships with customers, and we
incur costs to prove these products are counterfeit, to defend ourselves against
false claims, or we may have to pay for false claims.

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

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

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

o Interest rates;

o Changes in accounting principles;

o Intellectual property and legal matters;

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

o Announcements of key developments by our competitors; and

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

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

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

OUR ACTUAL TAX LIABILITIES MAY DIFFER FROM ESTIMATED TAX RESULTING IN
UNFAVORABLE ADJUSTMENTS TO OUR FUTURE RESULTS. The amount of income taxes we pay
is subject to ongoing audits by federal, state and foreign tax authorities. Our

estimate of the potential outcome of uncertain tax issues is subject to our
assessment of relevant risks, facts, and circumstances existing at that time.
Our future results may include favorable or unfavorable adjustments to our
estimated tax liabilities in the period the assessments are made or resolved,
which may impact our effective tax rate and our financial results.

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

INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD
LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As
of August 1, 2007, our officers and directors and their affiliates beneficially
owned approximately 19% 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 13% of the outstanding shares of our common stock at August 1,
2007. As a result, our officers and directors and the Dyne family are able to
exert considerable influence over the outcome of any matters submitted to a vote
of the holders of our common stock, including the election of our Board of
Directors. The voting power of these stockholders could also discourage others
from seeking to acquire control of us through the purchase of our common stock,
which might depress the price of our common stock.

WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED
SECURITY MEASURES IN RESPONSE TO TERRORISM. Our business depends on the free
flow of products and services through the channels of commerce. In response to
terrorists' activities and threats aimed at the United States, transportation,
mail, financial and other services may be slowed or stopped altogether.
Extensive delays or stoppages in transportation, mail, financial or other
services could have a material adverse effect on our business, results of
operations and financial condition. Furthermore, we may experience an increase
in operating costs, such as costs for transportation, insurance and security as
a result of the activities and potential delays. We may also experience delays
in receiving payments from payers that have been affected by the terrorist
activities. The United States economy in general may be adversely affected by
the terrorist activities and any economic downturn could adversely impact our
results of operations, impair our ability to raise capital or otherwise
adversely affect our ability to grow our business.

ITEM 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 Hong Kong dollars, Chinese yuans and
British pounds. There were no hedging contracts outstanding as of June 30, 2007
or December 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 dollars in various bank accounts and we do not believe we have
significant market risk exposure with regard to our investments. At June 30,
2007 the Revolving Credit Note of $1.3 million was subject to interest rate
fluctuations.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under the
Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities Exchange Commission's rules and forms, including to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is accumulated and communicated to our management,
including our principal executive and principal financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange
Act. Disclosure controls and procedures, no matter how well designed and
operated, can provide only reasonable, rather than absolute, assurance of
achieving the desired control objectives.

As of June 30, 2007, we conducted an evaluation, with the participation
of our Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of our disclosure controls and procedures. Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that as of June 30, 2007, our disclosure controls and procedures were
effective at a reasonable assurance level.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

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

PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On October 12, 2005, a shareholder class action complaint -- HUBERMAN
V.TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex) -- was filed against us
and certain of our current and former officers and directors in the United
States District Court for the Central District of California, alleging claims
under Section 10(b) and Section 20 of the Securities Exchange Act of 1934. A
lead plaintiff was appointed, and his amended complaint alleged that defendants
made false and misleading statements about our financial situation and our
relationship with certain of our large customers. The action was brought on
behalf of all purchasers of our publicly-traded securities during the period
from November 13, 2003 to August 12, 2005. On February 20, 2007, the Court
denied class certification. Plaintiff moved the court to reconsider the ruling,
and also to intervene a new plaintiff to pursue class certification. Both of
those motions were denied on April 2, 2007. In addition, the same day the Court
granted defendants' motion for summary judgment, and on or about April 5, 2007,
the Court entered judgment in favor of all defendants. On or about April 30,
2007, plaintiff filed a notice of appeal, and his opening appellate brief is due
on October 15, 2007. We believe that this matter will be resolved in trial or in
settlement within the limits of its insurance coverage. However, the outcomes of
this action or an estimate of the potential losses, if any, related to the
lawsuit cannot be reasonably predicted, and an adverse resolution of the lawsuit
could potentially have a material adverse effect on our financial position and
results of operations.

On April 16, 2004 we filed suit against Pro-Fit Holdings, Limited
("Pro-Fit") in the U.S. District Court for the Central District of California -
TAG-IT PACIFIC, INC. V. PRO-FIT HOLDINGS, LIMITED, CV 04-2694 LGB (RCx) --
asserting various contractual and tort claims relating to our exclusive license
and intellectual property agreement with Pro-Fit, seeking declaratory relief,
injunctive relief and damages. It is our position that the agreement with
Pro-Fit gives us the exclusive rights in certain geographic areas to Pro-Fit's
stretch and rigid waistband technology. On June 5, 2006 the Court denied our
motion for partial summary judgment, but did not find that we breached our
agreement with Pro-Fit and a trial is required to determine issues concerning
our activities in Columbia and whether other actions by Pro-Fit constituted an
unwillingness or inability to fill orders. The Court also held that Pro-Fit was
not "unwilling or unable" to fulfill orders by refusing to fill orders with
goods produced in the United States. The Court has not yet set a date for trial
of this matter. We have historically derived a significant amount of revenue
from the sale of products incorporating the stretch waistband technology and our
business, results of operations and financial condition could be materially
adversely affected if the dispute with Pro-Fit is not resolved in a manner
favorable to us. Additionally, we have incurred significant legal fees in this
litigation, and unless the case is settled, we will continue to incur additional
legal fees in increasing amounts as the case accelerates to trial.
We 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 an investment in the Company previously disclosed in our Annual
Report on Form 10-K for 2006 and is incorporated herein by reference.

ITEM 6. EXHIBITS

10.31.2(1) Amendment, dated May 25, 2007, to employment offer letter
between Tag-It Pacific, Inc. and Lonnie Schnell.

10.35 Revolving Credit and Tern Loan Agreement dated June 27,
2007, by and between Tag-It Pacific, Inc. and Bluefin
Capital, LLC.

10.36 Guaranty Agreement, dated June 27, 2007, by Talon
International, Inc., Tag-It, Inc., A.G.S. Stationary, Inc.,
Tag-It Pacific Limited, Tag-It Pacific (HK) Ltd., Tagit de
Mexico, S.A. de C. V., Talon Zipper (Shenzhen) Company,
Ltd., and Talon International, Pvt. Ltd. in favor of Bluefin
Capital, LLC.

10.37 Collateral Agreement, dated June 27, 2007, by and among
Tag-It Pacific, Inc., Talon International, Inc., Tag-It,
Inc., A.G.S. Stationary, Inc., Tag-It Pacific Limited,
Tag-It Pacific (HK) Ltd., Tagit de Mexico, S.A. de C. V.,
Talon Zipper (Shenzhen) Company, Ltd., and Talon
International, Pvt. Ltd. in favor of Bluefin Capital, LLC.

10.38 Registration Rights Agreement, dated June 27, 2007, by Talon
International, Inc., for the benefit of holders.
Incorporated by reference to Exhibit 4.10 to Registration
Statement on Form S-3 filed on August 10, 2007.

10.39 Form of Warrant issued to Bluefin Capital, LLC. Incorporated
by reference to Exhibit 4.10 to Registration Statement on
Form S-3 filed on August 10, 2007.

10.40 Promissory Note, dated June 27, 2007, executed by Colin Dyne
in favor of Tag-It Pacific, Inc.

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

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

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

(1) Indicates a management contract or compensatory plan.

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: August 14, 2007

TALON INTERNATIONAL, INC.

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