talon_10q-063012.htm

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

PART I		FINANCIAL INFORMATION	Page

Item 1.		Financial Statements.	3

	Consolidated Balance Sheets as of June 30, 2012 (Unaudited) and December 31, 20113		3

	Consolidated Statements of Operations and Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)		4

	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011 (Unaudited)		5

	Notes to Consolidated Financial Statements		7

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations.	26

Item 3.		Quantitative and Qualitative Disclosures about Market Risk	34

Item 4.		Controls and Procedures	35

PART II		OTHER INFORMATION

Item 1.		Legal Proceedings	35

Item 1A.		Risk Factors	36

Item 6.		Exhibits	36

	June 30, 2012			December 31, 2011
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	7,424,588		$	5,749,341
Accounts receivable, net		4,076,217			3,777,771
Inventories, net		827,397			1,076,522
Prepaid expenses and other current assets		664,361			314,761
Total current assets		12,992,563			10,918,395

Property and equipment, net		936,625			1,092,609
Intangible assets, net		4,263,801			4,110,751
Other assets		192,630			236,411
Total assets	$	18,385,619		$	16,358,166

Liabilities, Preferred Stock and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable	$	8,205,573		$	6,607,041
Accrued expenses		1,588,130			1,543,465
Notes payable to related parties		-			239,942
Other notes and current portion of capital lease obligations		2,656			73,148
Total current liabilities		9,796,359			8,463,596

Capital lease obligations, net of current portion		2,025			10,461
Deferred income taxes		914,037			751,148
Other liabilities		182,136			379,803
Total liabilities		10,894,557			9,605,008

Commitments and contingencies (Note 10)

Series B Convertible Preferred Stock, $0.001 par value; 407,160 shares authorized, issued and outstanding		22,222,118			20,671,738
Stockholders’ Equity (Deficit):
Series A Preferred Stock, $0.001 par value; 250,000 shares authorized; no shares issued or outstanding		-			-
Common Stock, $0.01 par value, 100,000,000 shares authorized; 21,900,808 and 21,000,808 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively		21,901			21,001
Additional paid-in capital		58,205,925			57,948,111
Accumulated deficit		(73,034,797	)		(71,949,921	)
Accumulated other comprehensive income		75,915			62,229
Total stockholders’ equity (deficit)		(14,731,056	)		(13,918,580	)
Total liabilities, preferred stock and stockholders’ equity (deficit)	$	18,385,619		$	16,358,166

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Net sales	$	13,179,849		$	12,752,281		$	21,925,799		$	21,980,474
Cost of goods sold		8,821,120			8,688,943			14,796,314			15,026,583
Gross profit		4,358,729			4,063,338			7,129,485			6,953,891
Sales and marketing expenses		1,166,549			1,065,487			2,263,472			1,964,047
General and administrative expenses		2,217,822			1,996,713			4,365,481			4,279,211
Total operating expenses		3,384,371			3,062,200			6,628,953			6,243,258

Income from operations		974,358			1,001,138			500,532			710,633

Interest expense, net		19,723			23,193			41,760			41,633
Income before provision for income taxes		954,635			977,945			458,772			669,000
Provision for (benefit from) income taxes, net		283,501			321,620			(6,732	)		413,603
Net income	$	671,134		$	656,325		$	465,504		$	255,397

Series B Preferred Stock Liquidation Preference Increase		(775,190	)		(668,268	)		(1,550,380	)		(1,336,535	)
Loss applicable to Common Shareholders	$	(104,056	)	$	(11,943	)	$	(1,084,876	)	$	(1,081,138	)

Per share amounts:
Net income per share	$	0.03		$	0.03		$	0.02		$	0.01
Available to Preferred Shareholders		(0.03	)		(0.03	)		(0.07	)		(0.06	)
Basic and diluted net loss per share applicable to Common Shareholders	$	0.00		$	0.00		$	(0.05	)	$	(0.05	)

Weighted average number of common shares outstanding – Basic and diluted		21,900,808			20,367,154			21,752,456			20,329,503

Net income	$	671,134		$	656,325		$	465,504		$	255,397
Other comprehensive income (loss) -
Foreign currency translation		29,320			(18,878	)		13,686			(21,659	)
Total comprehensive income	$	700,454		$	637,447		$	479,190		$	233,738

	Six Months Ended June 30,
	2012			2011
Cash flows from operating activities:
Net income	$	465,504		$	255,397
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		272,460			312,924
(Gain) loss from disposal of equipment		(47,323	)		7,391
Amortization of deferred financing cost		15,000			15,000
Stock based compensation		258,714			560,808
Deferred income taxes, net		179,214			213,345
Bad debt expense (recoveries), net		13,374			(720	)
Inventory valuation provisions (recoveries), net		17,536			(42,317	)
Changes in operating assets and liabilities:
Accounts receivable		(276,813	)		(452,440	)
Inventories		231,786			298,446
Prepaid expenses and other current assets		(309,948	)		(54,546	)
Other assets.		12,714			19,798
Accounts payable and accrued expenses		1,636,159			2,208,028
Other liabilities		(197,667	)		32,978
Net cash provided by operating activities		2,270,710			3,374,092

Cash flows from investing activities:
Acquisitions of intangibles		(155,940	)		-
Proceeds from sale of equipment		168			55,000
Acquisitions of property and equipment		(122,683	)		(102,517	)
Net cash used in investing activities		(278,455	)		(47,517	)

Cash flows from financing activities:
Payment of notes payable to related parties		(240,957	)		-
Payment of other notes payable		(66,675	)		-
Payment of capital leases		(2,976	)		(2,906	)
Proceeds from exercise of stock options		-			12,030
Net cash provided by (used in) financing activities		(310,608	)		9,124

Net effect of foreign currency exchange translation on cash		(6,400	)		(3,370	)
Net increase in cash and cash equivalents		1,675,247			3,332,329
Cash and cash equivalents at beginning of period		5,749,341			2,795,284
Cash and cash equivalents at end of period	$	7,424,588		$	6,127,613

	Six Months Ended June 30,
	2012			2011
Cash received (paid) during the period for:
Interest paid	$	(188,436	)	$	(14,768	)
Interest received	$	1,703		$	2,068
Income tax paid, net (principally foreign)	$	(162,205	)	$	(97,802	)
Non-cash financing activities:
Series B preferred stock liquidation preference increase	$	(1,550,380	)	$	(1,336,535	)
RSU’s settlement in common stock	$	900		$	-
Interest accrued on notes payable	$	1,540		$	5,985
Effect of foreign currency translation on net assets	$	13,686		$	(21,659	)
Non-cash investing activities:
Equipment exchanged for dyeing services	$	47,379		$	-
Capital lease terminations	$	9,802		$	-

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 8 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, 2011. The balance sheet as of December 31, 2011 has been derived from the audited financial statements as of that date but omits certain information and footnotes required for complete financial statements.

A complete description of the Company’s Significant Accounting Policies is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, and should be read in conjunction with these unaudited consolidated financial statements. The Significant Accounting Policies noted below are only those policies that have changed materially or have supplemental information included for the periods presented here.

The Company is required to make judgments as to the collectability of accounts receivable based on established aging policy, historical experience and future expectations. The allowances for doubtful accounts represent allowances for customer trade accounts and that are estimated to be partially or entirely uncollectible. These allowances are used to reduce gross trade receivables to their net realizable value. The Company records these allowances based on estimates related to the following factors: (i) customer specific allowances; (ii) amounts based upon an aging schedule; and (iii) an estimated amount, based on our historical experience, for issues not yet identified. Bad debt expense, net on accounts receivable for the three and six months ended June 30, 2012 were $14,031 and $13,374, respectively. Bad debt recoveries on accounts receivable for the three and six months ended June 30, 2011 were $11,107 and $720, respectively.

Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, the fair value guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

The Company’s financial instruments include cash and cash equivalents, accounts receivable, other assets, accounts payable, accrued expenses and other liabilities. The book value of the financial instruments is representative of their fair values. In accordance with this guidance, the Company measures its cash equivalents at fair value. The Company’s cash equivalents are classified within Level 1. Cash equivalents are valued primarily using quoted market prices utilizing market observable inputs. At June 30, 2012 and December 31, 2011, cash equivalents consisted of money market funds measured at fair value on a recurring basis; fair value of the Company’s money market funds was approximately $511,000 and $1,822,000, respectively.

Intangible assets consist of our trade name, patents, licenses, intellectual property rights and technology. Intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually in accordance with the provisions of FASB Accounting Standards Codification (“ASC”) 350, “Intangibles - Goodwill and Other”. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives using the straight-line method, and are reviewed for impairment in accordance with the provisions of ASC 360, “Property, Plant and Equipment”. Costs incurred to renew or extend the term of recognized intangible assets are capitalized and amortized over the useful life of the asset. In September 2011, the FASB issued ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350) — Testing Goodwill for Impairment”. This amendment allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative impairment test. The amendment was effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption was permitted. The adoption of the guidance did not have an impact on our financial position, results of operations or cash flows.

On April 2, 2002, the Company entered into an Exclusive License and Intellectual Property Rights Agreement (the “License Agreement”) with Pro-Fit Holdings Limited (“Pro-Fit”). The License Agreement granted the Company the exclusive rights to sell or sublicense waistbands manufactured under patented technology developed by Pro-Fit for garments manufactured anywhere in the world for the United States market and all United States brands. The License Agreement had an indefinite term that extended for the duration of the trade secrets licensed under the License Agreement. The Company recorded an intangible asset amounting to $612,500 which has been fully amortized.

During the quarter ended March 31, 2012 we completed the acquisition from Pro-Fit and related companies all U.S. patents, applications, trademarks, rights and technology associated with the stretch waistband technology that we formerly exclusively licensed from Pro-Fit, and the License Agreement was terminated. During the quarter ended March 31, 2012 we acquired other intellectual property and assets related to certain products used with a variety of apparel products. The total purchase price and related fees for these acquisitions totaled $155,940, and is amortized based on the estimated useful lives of between 10 and 17 years.

The Company classifies conditionally redeemable convertible preferred shares, which includes preferred shares subject to redemption upon the occurrence of uncertain events not solely within our control, as temporary equity in the mezzanine section of the consolidated balance sheets, in accordance with the guidance enumerated in FASB ASC No. 480-10 “Distinguishing Liabilities from Equity”, FASB ASC No. 210 “Classification and Measurement of Redeemable Securities” and Rule 5-02.28 of Regulation S-X, when determining the classification and measurement of preferred stock.

The Company evaluated the conversion option of the convertible preferred shares in accordance with FASB ASC No. 470-20, “Debt with Conversion and Other Options”, Accounting for Convertible Securities with Beneficial Conversion Features (“BCF”) or Contingently Adjustable Conversion Ratios. A convertible financial instrument includes a BCF when the fair market value of the preferred stock is lower than the value of common stock when the preferred stock converts to common stock at the issuance date. The BCF shall be recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of the feature to additional paid-in capital.

When an equity instrument is not currently redeemable and it is probable that the equity instrument will become redeemable (for example, when the redemption depends solely on the passage of time), then a change in the redemption value is recognized immediately as it occurs, and the carrying amount of the instrument is adjusted to equal the adjusted redemption value. An increase in the carrying amount of the instrument reduces income available to common shareholders in the calculation of earnings per share.

Interest Expense, net – Interest expense reflects the cost of borrowing. Interest expense for the three and six months ended June 30, 2012 totaled $21,042 and $43,463, respectively. Interest expense for the three and six months ended June 30, 2011 totaled $24,687 and $43,701, respectively. Interest income consists of earnings from outstanding amounts due to the Company under interest bearing receivables. For the three and six months ended June 30, 2012 the Company recorded interest income of $1,319 and $1,703, respectively. For the three and six months ended June 30, 2011 the Company recorded interest income of $1,494 and $2,068, respectively.

On March 31, 2012, the Company elected to change its policy on the classification of interest and penalties associated with tax positions originally recorded in 2007 that could be subject to reversal upon a regulatory review. Per accounting guidance under FASB ASC 740 “Income Taxes” regarding uncertain income tax positions, we chose to use provision for (benefit from) income taxes, net instead of interest expense, net. This presentation is preferable in order to consolidate the uncertain income tax position into one classification on our Consolidated Statement of Operations and Comprehensive Loss. Historical amounts are insignificant, and due to immateriality the prior periods presented have not been adjusted to apply the new accounting method retrospectively in accordance with FASB ASC 250 “Accounting Changes and Error Corrections” (See Note 9).

The Company has operations and holds assets in various foreign countries. The local currency is the functional currency for the Company’s subsidiaries in China and India. Assets and liabilities are translated at end-of-period exchange rates while revenues and expenses are translated at the average exchange rates in effect during the period. Equity is translated at historical rates and the resulting cumulative translation adjustments are included as a component of accumulated other comprehensive income until the translation adjustments are realized. Included in accumulated other comprehensive income were a cumulative foreign currency translation gain of $75,915 and $62,229 at June 30, 2012 and December 31, 2011, respectively.

In the first quarter of 2012 we adopted FASB ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”) and ASU 2011-12, “Comprehensive Income (Topic 220)”, which amended ASC Topic 220, “Comprehensive Income”, and was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company chose the option provided by ASU 2011-05 to present the total of comprehensive income, the components of net income and the components of other comprehensive income in a single continuous statement. Adoption of the guidance did not have any impact on our results of operations or financial condition.

The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year. The accounting estimates that require the Company’s most significant, difficult and subjective judgments include the valuation allowance for accounts receivable and inventory, and the assessment of recoverability of long-lived assets and intangible assets, stock-based compensation and the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions). Actual results could differ materially from the Company’s estimates.

	Net income			Shares		Per Share Amount
Three months ended June 30, 2012:
Basic net income (loss) per share:
Net income	$	671,134			21,900,808	$	0.03
Series B Preferred Stock Liquidation Preference Increase		(775,190	)				(0.03	)
Income (loss) applicable to Common Shareholders		(104,056	)		21,900,808		0.00

Effect of Dilutive Securities -
Options, Preferred Stock and RSUs		-			-		-
Diluted net income (loss) applicable to Common Shareholders	$	(104,056	)		21,900,808	$	0.00

Three months ended June 30, 2011:
Basic net income (loss) per share:
Net income	$	656,325			20,367,154	$	0.03
Series B Preferred Stock Liquidation Preference Increase		(668,268	)				(0.03	)
Income (loss) applicable to Common Shareholders		(11,943	)		20,367,154		0.00

Effect of Dilutive Securities -
Options, Preferred Stock and RSUs		-			-		-
Diluted net income (loss) applicable to Common Shareholders	$	(11,943	)		20,367,154	$	0.00

	Net income			Shares		Per Share Amount
Six months ended June 30, 2012:
Basic net income (loss) per share:
Net income income	$	465,504			21,752,456	$	0.02
Series B Preferred Stock Liquidation Preference Increase		(1,550,380	)				(0.07	)
Income (loss) applicable to Common Shareholders		(1,084,876	)		21,752,456		(0.05	)

Effect of Dilutive Securities -
Options, Preferred Stock and RSUs		-			-		-
Diluted net income (loss) applicable to Common Shareholders	$	(1,084,876	)		21,752,456	$	(0.05	)

Six months ended June 30, 2011:
Basic net income (loss) per share:
Net income	$	255,397			20,329,503	$	0.01
Series B Preferred Stock Liquidation Preference Increase		(1,336,535	)				(0.06	)
Income (loss) applicable to Common Shareholders		(1,081,138	)		20,329,503		(0.05	)

Effect of Dilutive Securities -
Options, Preferred Stock and RSUs		-			-		-
Diluted net income (loss) applicable to Common Shareholders	$	(1,081,138	)		20,329,503	$	(0.05	)

For the three and six months ended June 30, 2012, options to purchase 6,372,100 shares of common stock exercisable between $0.04 and $5.23 per share, RSU’s to settle for 10,057,000 common shares and Series B Preferred Stock to be converted to 40,716,000 shares of common stock were outstanding, but were not included in the computation of diluted net income (loss) per share applicable to common shareholders because they would have an antidilutive effect on the net income (loss) per share.

For the three and six months ended June 30, 2011, options to purchase 6,127,100 shares of common stock exercisable between $0.06 and $5.23 per share, RSU’s to settle for 11,557,000 common shares and Series B Preferred Stock to be converted to 40,716,000 shares of common stock were outstanding, but were not included in the computation of diluted net income (loss) per share because they would have an antidilutive effect on the net income (loss) per share.

Inventory valuation reserves are recorded for damaged, obsolete, excess and slow-moving inventory. The Company uses estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved 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.

We originally entered into a Revolving Credit and Term Loan Agreement (the “Loan Agreement”) on June 27, 2007 with Bluefin Capital, LLC (“Bluefin”). Bluefin subsequently assigned its rights and obligations under the Loan Agreement to an affiliate, CVC California, LLC (“CVC”). On July 30, 2010, the Company entered into a Recapitalization Agreement (the “Recapitalization Agreement”) with CVC in which the Company issued to CVC shares of the Company’s Series B Convertible Preferred Stock in payment of all of the outstanding obligations owed by the Company to CVC under the Loan Agreement, (see Note 7). On July 30, 2010, all of the outstanding obligations owed to CVC under the Loan Agreement became due and payable, consisting of outstanding borrowings and accrued interest of $11,548,098 under the term notes, and $5,158,587 under the revolving credit note, for a total of $16,706,685, and all of these outstanding obligations were converted into Series B Convertible Preferred Stock pursuant to the Recapitalization Agreement.

In connection with the Recapitalization Agreement, the Loan Agreement (now fully paid and expired) was amended to extend the maturity date from July 30, 2010 until July 31, 2012, reduce the maximum borrowings available under the Revolver to $3,000,000, amend the borrowing base to modify the advance rate applicable to eligible accounts receivable to 75% and modify the advance rate applicable to eligible inventory to 40%, eliminate loan maintenance fees, and modify the permissible amount of capital expenditures the Company can make in any fiscal year. The Company paid CVC a non-refundable fee in the amount of $60,000 in consideration of CVC entering into the amendment and making this facility available and paid a $50,000 commitment fee during the third quarter of 2011 to ensure the availability of the revolver through July 31, 2012. Upon execution of the amendment, CVC waived all prior events of default under the Loan Agreement. Borrowings under the Loan Agreement were secured by all of the Company’s assets.

Interest expense related to the Loan Agreement is composed of interest on debt, amortization of debt discount, and amortization of deferred financing costs. In total, the interest expense for the three and six months ended June 30, 2012 was $20,000 and $40,000, respectively. In total, the interest expense for the three and six months ended June 30, 2011 was $7,500 and $15,000, respectively. Total interest expense in the periods was comprised as follows:

On July 30, 2010, the Company entered into the Recapitalization Agreement with CVC, pursuant to which the Company issued to CVC an aggregate of 407,160 shares of a newly created series of the Company’s preferred stock, designated Series B Convertible Preferred Stock, $0.001 par value per share (the “Series B Preferred Stock”), in payment of an aggregate of $16,706,685 owed by the Company to CVC under the Loan Agreement. Certain rights, preferences, privileges and restrictions of the Series B Preferred Stock are summarized below.

Upon the liquidation, dissolution or winding up of the Company, each share of Series B Preferred Stock is entitled to receive upon the surrender and cancellation of such shares (and prior to any distribution to holders of other equity securities), an amount equal to $41.033 per share plus all accrued dividends (the “Liquidation Preference”). A merger, consolidation, share exchange or other reorganization resulting in a change in control of the Company, or any sale of all or substantially all of the Company’s assets, will be deemed a liquidation and winding up for purposes of the Company’s obligation to pay the Liquidation Preference.

The Series B Preferred Stock Liquidation Preference will increase with the accrual of dividends on the Liquidation Preference at the rate of 16% per annum, compounded annually. The dividends however are only payable to the holder in connection with the payment of the Liquidation Preference upon the liquidation, dissolution or winding up of the Company and in conjunction with the surrender of the Preferred Stock. No portion of the Liquidation Preference or the associated accrued dividends are convertible into common stock, nor will any portion of the Liquidation Preference or the accrued dividends be payable on shares of Series B Preferred Stock in the event of or following the conversion of such shares into common stock.

The Company has the right, at any time upon not less than thirty (30) days’ prior written notice to the holders of Series B Preferred Stock, to redeem the Series B Preferred Stock in whole (but not in part) for a price equal to the then-applicable Liquidation Preference. The holders of Series B Preferred Stock shall have the option, exercisable at any time and from time to time commencing on July 31, 2016, to require the Company to redeem any or all of the Series B Preferred Stock held by such holders, at the then-applicable Liquidation Preference amount.

The Series B Preferred Stock vote with the common stock as a single class on all matters submitted or required to be submitted to a vote of the Company’s stockholders, with each share of Series B Preferred Stock having a number of votes equal to the number of shares of common stock that may be acquired upon conversion thereof as of the applicable date of determination. Additionally, the Series B Preferred Stock have the right to vote as a separate class with respect to certain matters affecting the Series B Preferred Stock, including but not limited to (a) the creation or issuance of any other class or series of preferred stock, (b) any amendments with respect to the rights, powers, preferences and limitations of the Series B Preferred Stock, (c) paying dividends or distributions in respect of or redeem the Company’s common stock or any other junior securities; and (d) certain affiliate transactions. Any such vote shall require the affirmative vote or consent of a majority of the outstanding shares of Series B Preferred Stock.

As long as the outstanding Series B Preferred Stock represents 35% or more of the voting shares of the Company, on an as-converted to common stock basis, then (a) our Board of Directors shall consist of not more than seven members, (b) the holders of Series B Preferred Stock shall have the right to elect three directors if the Board has five or fewer total directors, and four directors if the Board has six or seven directors (the directors elected by the Series B Preferred Stock are referred to as the “Series B Directors”), and (c) those members serving on the Board who were not elected by holders of the Series B Preferred Stock shall have the right to designate all remaining directors. At least two of the Series B Directors must be, and remain at all times while serving as a director, an independent director that qualifies for service on the audit committee of a corporation with securities listed on the Nasdaq Stock Market as provided in Nasdaq Marketplace Rule 5605(c)(2) (or any successor thereto). Once the outstanding shares of Series B Preferred Stock represent less than 35% of the voting shares on an as-converted to common stock basis, then the entire Board will thereafter be elected by all stockholders having voting rights, voting as a single class.

The conversion of the term notes, revolver and related interest and fees into the Series B Preferred Stock (fair value of $17,277,600 as of July 30, 2010) was considered to be debt extinguishment according to the FASB ASC No.405 “Liabilities” and FASB ASC No. 470-50 “Debt, Modifications and Extinguishments” (“ASC 470-50”). Per ASC 470-50 a loss on extinguishment of debt of $570,915 was recorded on July 30, 2010 and is included in the Consolidated Statement of Operations for the year ended December 31, 2010. The loss on extinguishment is equal to the difference between fair value of the preferred stock and the fair value of the debt extinguished at the transaction date. The fair value of the Series B Preferred Stock on the issuance date was determined by the Company and independent valuation specialists using the option pricing valuation model.

The Company applied the guidance enumerated in FASB ASC No. 480 “Distinguishing Liabilities from Equity”, FASB ASC No. 210 “Classification and Measurement of Redeemable Securities” and Rule 5-02.28 of Regulation S-X, when determining the classification and measurement of preferred stock. The Company classifies conditionally redeemable convertible preferred shares, which includes preferred shares subject to redemption upon the occurrence of uncertain events not solely within the control of the Company, as temporary equity in the mezzanine section of the consolidated balance sheet. The Series B Preferred Stock is redeemable at the option of the holders after the sixth anniversary of issuance, which is not within the control of the Company.

The Company determined that there are no embedded features that would require separate reporting as derivative instruments. Therefore, the Company evaluated the conversion option of the convertible preferred shares under FASB ASC No. 470-20, “Debt with Conversion and Other Options”, Accounting for Convertible Securities with Beneficial Conversion Features (“BCF”) or Contingently Adjustable Conversion Ratios. A convertible financial instrument includes a BCF if the fair value of the instrument is lower than the fair value of shares of the common stock it is convertible into on the issuance date. The BCF shall be recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of the conversion feature to additional paid-in capital. The Company has recorded a BCF value of $1,283,343 in connection with the issuance of the Series B Preferred Stock on July 30, 2010.

The Series B Preferred Stock was initially recorded at the fair value of $17,277,600 as of July 30, 2010, reduced by the BCF ($1,283,343) as stated above and stock issuance costs ($190,744), for a net value of $15,803,513 as of July 30, 2010. The value of the Series B Preferred Stock was adjusted as follows as a consequence of its redemption features and the following approach is implemented by the Company:

The Series B Preferred Stock is not currently redeemable but it is probable that the preferred stock will become redeemable due to the redemption option available to the preferred stock holders on July 30, 2016. Changes in the redemption value are recognized immediately as they occur, and the carrying amount of the instrument is adjusted to equal the redemption value at the end of each reporting period. This method views the end of the reporting period as if it were also the redemption date for the Series B Preferred Stock. Accordingly, the adjustment of $903,172 to record the preferred stock at its redemption value (“Original issue discount”) was charged against the preferred stock carrying value and retained earnings during the year ended December 31, 2010. In addition, the resulting increase in the carrying amount of the Series B Preferred Stock reduces the income applicable to common shareholders reported in the calculation of earnings per share.

Concurrently with execution of the Recapitalization Agreement, on July 30, 2010, the Company entered into a Stockholders Agreement with CVC, and with Lonnie D. Schnell, Chief Executive Officer, Chief Financial Officer and a member of the Board of Directors of the Company, and Larry Dyne, President of the Company (“Messrs. Schnell and Dyne”), pursuant to which:

CVC agreed that in connection with any director nominees to be submitted to holders of the Company’s common stock for election at a stockholders’ meeting, a committee of our Board comprised solely of directors then serving on the Board who were not elected or appointed by holders of Series B Preferred Stock, acting by majority vote, shall have the right to designate all of the Board’s nominees for director to be elected by holders of the Company’s Common Stock.

Messrs. Schnell and Dyne agreed with CVC to vote their shares of Talon voting stock in favor of a merger or consolidation of the Company into or with another corporation or any share exchange, business combination or other such transaction in which the Company is a constituent party, or any sale of all or substantially all of the Company’s assets (a “Triggering Transaction”), in each case to the extent such transaction is first approved by CVC.

CVC agreed not to sell or otherwise transfer its shares of the Company’s voting securities, or to vote its shares of the Company’s voting securities in favor of any Triggering Transaction, at any time on or before July 31, 2011, other than in connection with a transaction that is approved by a majority of the Company’s voting shares (where, in calculating such majority, the votes attributable to CVC’s shares of the Company’s voting securities are excluded in the numerator but included in the denominator).

CVC agreed with Messrs. Schnell and Dyne that in connection with a Triggering Transaction, CVC, and any other holder of Series B Preferred Stock and shares of common stock acquired upon conversion thereof, shall pay to Messrs. Schnell and Dyne a portion (beginning at 5% and increasing to 10%) of the sales proceeds payable in the Triggering Transaction to CVC or such other holder in respect of such Series B Preferred Stock or conversion shares. Each of Messrs. Schnell and Dyne’s right to receive such portion of the sales proceeds is conditional upon the Triggering Transaction occurring (i) while employed by the Company or (ii) within 12 months following termination of employment with the Company for any reason other than termination of employment for “cause” or termination of employment by Messrs. Schnell or Dyne without “good reason” (as such terms are defined in their respective employment agreements).

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

The Company’s 2008 and 2007 Stock Incentive Plans, as amended, authorize up to 4,810,000 and 2,600,000 shares of common stock, respectively, for issuance pursuant to awards granted to individuals under the plans. The Company’s 1997 Stock Incentive Plan authorized the issuance of up to 6,000,000 shares of common stock pursuant to stock-based incentive awards granted to individuals.

The Recapitalization Agreement constituted a change of control of the Company and as a result, on July 30, 2010, all options previously granted to Lonnie Schnell and Larry Dyne became fully vested in accordance with provisions in their employment agreements and their option grants. On July 30, 2010 the Company entered into new executive employment agreements with Messrs. Schnell and Dyne and they each agreed to cancel all option grants previously awarded to them on or before December 31, 2007. Accordingly, options to purchase a total of 1,005,500 shares of common stock were cancelled effective July 30, 2010 (See Note 7).

As of June 30, 2012, the Company had $109,753 of unamortized stock-based compensation expense related to options issued to employees and directors, which will be recognized over the weighted average period of 2.2 years. As of June 30, 2011, unamortized stock-based compensation expense related to options issued to employees and directors was $172,064, which was to be recognized over the weighted average period of approximately 2.7 years.

On July 30, 2010, the Company awarded each of Lonnie Schnell and Larry Dyne a restricted stock unit award (an “RSU Award”) for 5,778,500 shares of the Company’s common stock. Each RSU Award vested 50% on August 30, 2011, and vests 10% on each date which is 18, 24, 30, 36 and 42 months following the grant date, subject to partial acceleration of vesting as part of the executives’ severance benefits and full acceleration of vesting upon a change in control of the Company. As of July 30, 2010, the RSU’s were valued at $2,263,384 which was reduced by the fair value of the options surrendered (see Stock Options above).

On August 30, 2010, Messrs. Schnell and Dyne elected to defer the settlement in common shares of 5,178,500 RSU’s beyond the vesting dates. On August 30, 2011, based on the deferral schedules, 600,000 common shares were issued upon settlement of a portion of vested units under the RSU Awards. At the time of the issuance of shares the intrinsic value of these RSU’s was $0.10 per share. On January 30, 2012, based on the deferral schedules, 900,000 common shares were issued upon settlement of a portion of vested units under the RSU Awards. At the time of the issuance of shares the intrinsic value of these RSU’s was $0.05 per share. Subsequent to June 30, 2012 1,500,000 common shares were issued upon settlement of a portion of vested units under the RSU Awards. At the time of the issuance of shares the intrinsic value of these RSU’s was $0.04 per share.

	Number of RSU’s									Weighted Average Grant date value per RSU
	Unvested			Vested			Total
RSU’s outstanding - December 31, 2011		5,778,500			5,178,500			10,957,000		$	0.196
Common stock vested		(1,155,700	)		1,155,700			-		$	0.196
Common stock issued		-			(900,000	)		(900,000	)	$	0.196
RSU’s outstanding – March 31, 2012 and June 30, 2012		4,622,800			5,434,200			10,057,000		$	0.196

Provision for (benefit from) income taxes, net for the three and six months ended June 30, 2012 was $283,501 and $(6,732), respectively. Provision for income taxes, net for the three and six months ended June 30, 2011 was $321,620 and $413,603, respectively. The net income tax benefit for the six months ended June 30, 2012 includes the elimination of a tax liability of $196,423 recorded in 2007 associated with tax positions that could have been subject to reversal upon a regulatory review. At March 31, 2012 the time limit for assessment of the tax liability expired and the liability was removed.

Net deferred tax assets were $0 and $16,324 as of June 30, 2012 and December 31, 2011, respectively. The deferred tax assets, net of tax liabilities and valuation reserves as of December 31, 2011, were associated primarily with the Company’s foreign operations and included in Other Assets. U.S. deferred income tax benefits, and a portion of foreign income tax benefits, were fully reserved and not recorded in the net deferred tax assets primarily because there is not sufficient evidence to determine that the Company will be able to utilize its net operating loss carryforwards to offset future taxable income.

Long term deferred income tax liabilities totaled $914,037 and $751,148 as of June 30, 2012 and December 31, 2011, respectively. The deferred income tax liability includes a tax basis difference related to the Company’s indefinite lived intangible asset and the balance of a tax liability recorded in 2007 for tax positions subject to regulatory review including accrued penalties and interest, and a property and equipment tax basis difference associated with the Company’s Hong Kong operation.

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

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

The Company enters into indemnification provisions under its agreements with investors and its agreements with other parties in the normal course of business, typically with suppliers, customers and landlords. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities or, in some cases, as a result of the indemnified party’s activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights, and 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.

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

The Company distributes its products internationally and has reporting requirements based on geographic regions. Revenues are attributed to countries based upon customer delivery locations and the net book value of long-lived assets (consisting of property and equipment and intangible) is attributed to countries based on the location of the assets, as follows:

Sales:	Three Months Ended June 30,				Six Months Ended June 30,
Country / Region	2012		2011		2012		2011
United States	$	967,002	$	914,864	$	1,868,271	$	1,796,911
Hong Kong		3,553,258		4,273,926		7,104,882		7,496,328
China		4,069,915		3,539,886		5,644,422		5,147,472
Bangladesh		696,247		374,558		1,140,441		1,367,182
Other		3,893,427		3,649,047		6,167,783		6,172,581
Total	$	13,179,849	$	12,752,281	$	21,925,799	$	21,980,474

At December 31, 2011, notes payable to related parties included a note and associated interest due to Lonnie D. Schnell, the Chief Executive Officer and Chief Financial Officer of the Company, in the amount of $41,159. The note was issued on August 6, 2009 in partial satisfaction of 2008 annual incentive amounts to which Mr. Schnell was entitled. The note payable and accrued interest was paid in full in January 2012.

Colin Dyne is a director, officer and significant stockholder of Sequential Brands Group, Inc. (formerly People’s Liberation, Inc., “Sequential Brands”) and is the brother of both Mark Dyne and Larry Dyne, the President of the Company. The Company had no sales to Sequential Brands during the three and six months ended June 30, 2012. The Company had sales to Sequential Brands during the three and six months ended June 30, 2011 of $81,824 and $139,003, respectively.

In November 2009, the Company entered into an agreement with Colin Dyne to pay a commission on the collected revenues associated with the sales of products to a specific retail brand. The agreement expired during fourth quarter of 2011. During the three and six months ended June 30, 2012 no commissions were earned under this agreement. During the three and six months ended June 30, 2011 commissions of $12,420 and $32,512 were earned under this agreement, respectively.

This report and other documents we file with the Securities and Exchange Commission 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 adequate liquidity to fund our operations and meet our other cash requirements, demand for our products and services, mix of revenue streams, ability to control or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, international businesses, and competitive position.

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. Amounts presented in this management’s discussion and analysis are rounded to the nearest thousand dollars, except per share amounts.

Talon International, Inc. designs, manufactures, 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 pursue the global expansion of our business through the establishment of Talon owned sales and distribution locations, and strategic manufacturing relationships. The manufacturing arrangements, in combination with Talon owned and affiliated facilities under the Talon brand, improve our time-to-market throughout the world by sourcing, finishing and distributing to apparel manufacturers in their local markets.

Our primary business focus is on serving as an outsourced apparel zipper and trims supplier, product design and development, sampling and sourcing department for the most demanding brands and retailers. We believe that design differentiation among brands and retailers is a critical marketing tool for our customers. By assisting our customers in the design, development, sampling and sourcing of all trim components, we generally achieve higher margins for our products, create long-term relationships with our customers, grow our sales to a particular customer by serving a larger proportion of their brands and better differentiate our sales and services from those of our competitors. We are expanding our business globally, to better serve our apparel customers in the field, in addition to our brand and retail customer. We believe we can lead the industry in apparel accessories by having strong relationships with our brand and retail customers and having a distributed service organization to serve our factory customers globally.

Our Tekfit business provides manufacturers with the patented technology, manufacturing know-how, equipment and materials required to produce an expandable waistband. Our efforts to increase sales of this product in recent years have been limited by a licensing dispute. However, in March 2012, all parties involved in the dispute concluded a Settlement Agreement and Release that included an unconditional release of Talon and its related entities from all lawsuits, claims, liabilities, agreements, and contracts (among other potential claims) involved in the matter and pursuant to which we acquired all of the U.S. patents, licenses, rights and technology associated with the former exclusive license.

We typically experience seasonal fluctuations in sales volume consistent with the purchase demands of the apparel industry. In most years, these seasonal fluctuations result in lower sales volumes for our business in the first and fourth quarters of each year due to the seasonal buying patterns by the majority of our customers. The apparel retailers typically experience higher sales volumes during the second quarter associated with back-to-school sales and in the fourth quarter in association with year-end holiday purchases. Sales of our products can typically precede the retail sales patterns by 90 to 150 days. Backlogs of sales orders are not considered material in the industries in which we compete, which reduces the predictability and reinforces the volatility of these cyclical buying patterns on our sales volume.

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold		66.9			68.1			67.5			68.4
Gross profit		33.1			31.9			32.5			31.6
Sales and marketing expenses		8.9			8.4			10.3			8.9
General and administrative expenses		16.8			15.7			19.9			19.5
Interest expense, net		0.1			0.2			0.2			0.2
Provision for (benefit from) income taxes, net		2.2			2.5			0.0			1.8
Net income		5.1	%		5.1	%		2.1	%		1.2	%

Sales for the three months ended June 30, 2012 were $13,180,000, an increase of $428,000 or 3.3% compared to the same period in 2011. The increase reflected sales to new specialty apparel customers and new programs within key customer accounts, partially offset by a decline in the sales of generic zippers to price sensitive mass merchandise and licensing customers. Sales for the six months ended June 30, 2012 were $21,926,000, a slight decrease of $55,000 compared to the same period in 2011 due to the sharp decline in sales of generic zippers during the first quarter of 2012 substantially offset by the additional new programs and new customers.

Gross profit for the three months ended June 30, 2012 was $4,359,000 and 33.1% of sales reflecting increases of $295,000 and 1.2 percentage points of sales as compared to the same period in 2011. The increase in gross profit for the three months ended June 30, 2012 as compared to the same period in 2011 was principally attributable to increased sales volumes and improved product mix, partially offset by higher manufacturing overhead, freight and duty costs.

Gross profit for the six months ended June 30, 2012 was $7,129,000 and 32.5% of sales, and reflected increases of $176,000 and 0.9% of sales as compared to the same period in 2011. The increase in gross profit for the six months ended June 30, 2012 as compared to the same period in 2011 was principally attributable to improved product mix, partially offset by reduced overall sales volumes and higher manufacturing overhead, freight and duty costs.

	Three Months Ended June 30, 2012 compared to same period in 2011						Six Months Ended June 30, 2012 compared to same period in 2011
	$(1)			%(1)			$(1)			%(1)
Gross profit changes as a result of:
Higher (lower) volumes		170,000			4.2			(21,000	)		(0.4	)
Improved mix of products		207,000			5.1			332,000			4.8
Higher freight and duty costs		(39,000	)		(1.0	)		(45,000	)		(0.6	)
Higher manufacturing overhead costs		(43,000	)		(1.1	))		(90,000	)		(1.3	)
Gross profit change		295,000			7.2			176,000			2.5

Sales and marketing expenses for the three months ended June 30, 2012 totaled $1,167,000, an increase of $102,000 as compared to same period in 2011. Sales and marketing expenses for the six months ended June 30, 2012 were $2,263,000, an increase of $299,000 from the same period in 2011. Sales expenses increased mainly due to continued investment in our internal sales force and external sales representatives network in the U.S., Europe and Asia during 2011 and the first half of 2012 in an effort to significantly expand our presence in select product markets within the U.S., Europe and Asia.

General and administrative expenses for the three months ended June 30, 2012 totaled $2,218,000 or 16.8% of sales, which was an increase of $221,000 as compared to the same period in 2011. The increase resulted mainly from corporate consulting expenses of $145,000, higher legal fees of $69,000 for increased efforts to secure patent and trademark filings worldwide, and other cost increases of $105,000 which were partially offset by lower net compensation expenses of $98,000. General and administrative expenses for the six months ended June 30, 2012 were $4,365,000 or 19.9% of sales, which increased by $86,000 as compared to the same period in 2011. The increase was mainly driven by corporate consulting expenses of $184,000 and higher legal fees of $136,000 to secure patent and trademark filings worldwide, which were substantially offset by lower net compensation expense of $222,000 and other expense reductions of $12,000.

	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Amortization of deferred financing costs and debt discounts	$	8,000		$	8,000		$	15,000		$	15,000
Other interest expense		13,000			16,000			29,000			29,000
Interest expense		21,000			24,000			44,000			44,000
Interest income		(1,000	)		(1,000	)		(2,000	)		(2,000	)
Interest expense, net	$	20,000		$	23,000		$	42,000		$	42,000

Provision for income taxes, net for the three months ended June 30, 2012 was $284,000 as compared to $322,000 for the same period in 2011. Benefits from income taxes, net for the six months ended June 30, 2012 was $7,000 as compared to provision for income taxes, net of $414,000 for the same period in 2011. The benefits from income tax, net for the six months ended June 30, 2012 includes the elimination of a tax liability of $196,000 (including $70,000 accrued interest and penalties) originally established in 2007 associated with tax positions that could have been subject to reversal upon a regulatory review. At March 31, 2012 the time limit for assessment of the tax liability expired and the liability was removed. In 2007 we recorded a reserve of $246,000 for potential tax liabilities associated with tax positions that could be subject to reversal upon a regulatory review, and we have accrued interest and penalties that may be associated with these tax liabilities. (See Note 9 in the accompanying Notes to Consolidated Financial Statements).

During the six months ended June 30, 2012 the benefits from income taxes, net compared to the same period in 2011 reflects lower income tax expense and lower funds transfers resulting in lower withholding tax in our Asian operations. Deferred income tax assets, net are not reflected in our financial position, since there is not sufficient evidence to ensure that it is more likely than not that we will be able to utilize our domestic U.S. operating loss carry forwards (as well as a portion of our foreign net operating loss carry forwards) to offset future taxable income, and consequently the tax benefit of these losses is offset by a full valuation reserve.

	June 30, 2012			December 31, 2011

Cash and cash equivalents	$	7,425,000		$	5,749,000
Total assets	$	18,386,000		$	16,358,000
Current liabilities	$	9,796,000		$	8,464,000
Long term liabilities	$	1,099,000		$	1,141,000
Preferred stock	$	22,222,000		$	20,672,000
Stockholders’ equity (deficit)	$	(14,731,000	)	$	(13,919,000	)
Total equity and preferred stock	$	7,491,000		$	6,753,000

Cash and cash equivalents increased by $1,675,000 at June 30, 2012 as compared to December 31, 2011, principally due to cash provided by operating activities of $2,271,000, offset by acquisition of intangibles of $156,000, acquisition of property and equipment of $123,000, payment of notes payable to related parties of $241,000 and payment of other note payable of $67,000.

	Six Months Ended June 30,
	2012			2011
Net income before non-cash expenses	$	1,174,000		$	1,322,000
Reduced inventory		232,000			298,000
Increased accounts receivable		(277,000	)		(452,000	)
Increased accounts payable and accrued expenses		1,636,000			2,208,000
Other increases in operating capital		(494,000	)		(2,000	)
Cash provided by operating activities	$	2,271,000		$	3,374,000

Net cash (used in) investing activities for the six months ended June 30, 2012 and 2011 was $(278,000) and $(48,000), respectively, due to acquisition of intangibles in 2012 of $156,000 and due to acquisition of property and equipment of $123,000 and $103,000, respectively, offset by proceeds from sale of equipment in amount of $168 and $55,000, respectively, for the six months ended June 30, 2012 and 2011.

Net cash (used in) provided by financing activities for the six months ended June 30, 2012 and 2011 was $(311,000) and $9,000, respectively, reflecting payment of notes payable to related parties and other notes payable in the amount of $241,000 and $67,000 respectively during the six months ended June 30, 2012, proceeds from exercise of stock options of $12,000 during the six months ended June 30, 2011, and repayment of borrowings under capital leases during the six months ended June 30, 2012 and 2011 of $3,000.

On June 27, 2007, we entered into a Revolving Credit and Term Loan Agreement (the “Loan Agreement”) with Bluefin Capital, LLC that provided for a $5.0 million revolving credit facility and a $9.5 million term loan, each with a three year term originally maturing June 30, 2010, and subsequently extended to July 30, 2010. Bluefin Capital subsequently assigned its rights and obligations under the Loan Agreement to an affiliate, CVC California, LLC. Borrowings under the Loan Agreement were secured by all of our assets.

On July 30, 2010, we entered into a Recapitalization Agreement in which we issued to CVC shares of Series B Preferred Stock in payment of all of the outstanding obligations owed by us under the Loan Agreement. At that date, we had outstanding borrowings and accrued interest of $11,548,000 under the term notes and $5,159,000 under the revolving credit note, all of which was exchanged for the Series B Preferred Stock. See Note 4 in the accompanying Notes to Consolidated Financial Statements.

In connection with the Recapitalization Agreement, we amended the Loan Agreement to extend the maturity date of the Loan Agreement from July 30, 2010 until July 31, 2012, reduce the maximum borrowings available under the Revolver to $3,000,000, amend the borrowing base to modify the advance rate applicable to eligible accounts receivable to 75% and modify the advance rate applicable to eligible inventory to 40%, eliminate loan maintenance fees, and modify the permissible amount of capital expenditures we can make in any fiscal year. The financial covenants continued to exist through the maturity date. We paid CVC a non-refundable fee in the amount of $60,000 in consideration of CVC entering into the amendment and paid a $50,000 commitment fee during the third quarter of 2011 to ensure the availability of the revolver through July 31, 2012. Upon execution of the amendment, CVC waived all prior events of default under the Loan Agreement.

The outstanding balance (including accrued interest) of our notes payable to related parties at June 30, 2012 and December 31, 2011 was $0 and $240,000, respectively. Included in the balance at December 31, 2011 was a demand note which bore interest at 10%, had no scheduled monthly payments and was due within fifteen days following demand. The demand note totaled $199,000 as of December 31, 2011, and was paid in full in March 2012 for $200,000. The balance of the notes payable to related parties of $41,000 as of December 31, 2011 represented our note payable to an officer. The note bore 6% interest annually and was paid in full in accordance with its terms in January 2012.

We have satisfied our working capital requirements primarily through cash flows generated from operations and borrowings under our credit facility. As we continue to expand globally with our apparel manufacturing in offshore locations, our customers are substantially all foreign-based and foreign-owned entities. We continue to evaluate both financing and equity options to provide capital if needed to fund our expansion and on-going operations. If we experience greater than anticipated reductions in sales, we may need to borrow or raise additional capital, or further reduce the scope of our business in order to fund our on-going operations or to satisfy our future short-term operating requirements. The extent of our future long-term capital requirements will depend on many factors, including our results of operations, future demand for our products, the size and timing of possible acquisitions, our borrowing base availability limitations and our expansion into foreign markets. Our need for additional long-term financing may include the integration and expansion of our operations to exploit our rights under our Talon trade name, and the expansion of our operations in the Asian and European markets. If our cash from operations is less than anticipated or our working capital requirements and capital expenditures are greater than we expect, we may need to raise additional debt or equity financing in order to provide for our operations.

At June 30, 2012 and December 31, 2011, 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 do not have any of the risks associated with financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

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:

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

Inventories are stated at the lower of cost, determined using the first-in, first-out (“FIFO”) basis, or market value and are all substantially finished goods. The costs of inventory include the purchase price, inbound freight and duties, conversion costs and certain allocated production overhead costs. Inventory is evaluated on a continual basis and reserve adjustments are made based on management’s estimate of future sales value, if any, of specific inventory items. Inventory reserves are recorded for damaged, obsolete, excess, impaired and slow-moving inventory. We use estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory. Reserve adjustments are made for the difference between the cost of the inventory and the estimated market value, if lower, and charged to operations in the period in which the facts that give rise to these adjustments become known.

Market value of inventory is estimated based on the impact of market trends, an evaluation of economic conditions and the value of current orders relating to the future sales of this type of inventory. Inventory reserve is reduced following legacy inventory sale and write-off of reserved inventory and increased by additions to reserve for slow moving inventory.

We record deferred tax assets and liabilities 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. A deferred income tax liability related to indefinite lived intangibles should not be offset against deferred income tax assets. We believe that our estimate of deferred tax assets and liabilities and determination to record a valuation allowance against such assets are critical accounting estimates because they are subject to, among other things, an estimate of future taxable income, which is susceptible to change and dependent upon events that may or may not occur, and because the impact of recording a valuation allowance may be material to the assets reported on the balance sheet and results of operations. See Note 9 in the accompanying Notes to Consolidated Financial Statements.

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

We are currently involved in various lawsuits, claims and inquiries, most of which are routine to the nature of the business and in accordance with FASB ASC 450, “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. We believe that we have meritorious defenses to these claims and that the claims are either covered by insurance or would not have a material effect on our consolidated financial position or results of operations if adversely determined against us.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities Exchange Commission's rules and forms, including to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act.

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

On April 16, 2004, we originally filed suit against Pro-Fit Holdings, Limited in the U.S. District Court for the Central District of California – Tag-It Pacific, Inc. v. Pro-Fit Holdings, Limited, CV 04-2694 LGB (RCx) -- asserting various contractual and tort claims relating to our exclusive license and intellectual property agreement with Pro-Fit, seeking declaratory relief, injunctive relief and damages. Other related actions were subsequently filed by the parties. In 2008 Pro-Fit and certain related companies were placed into administration in the United Kingdom and filed petitions under Chapter 15 of Title 11 of the United States Code. Consequently, all litigation against Pro-Fit was stayed. In September 2011, we signed a Settlement Agreement and Release with Pro-Fit and the other parties involved in the litigation and administration proceedings. The Settlement Agreement provided for the unconditional release of Talon and related entities from all claims involved in the matter, a stipulation requesting that the US District Court dismiss the action, and our acquisition of all of the U.S. patents, licenses, rights and technology associated with our former exclusive license. The Settlement Agreement provides for no damages paid by any party and for dismissal of all actions with prejudice, and was formally completed by the parties in March 2012.

In May 2012, we instituted a lawsuit against Adidas America, Inc. in the U.S. District Court for the Central District of California asserting claims of trademark infringement, unfair competition, deceptive trade practices and related claims, under both U.S. and California law. The claims arise out of Adidas's use of the "TechFit" mark for its apparel, which we assert infringes our previously registered "Tekfit" trademark. We are seeking an injunction prohibiting Adidas from using the TechFit mark, as well as an accounting of profits, compensatory damages, recovery of legal fees, and punitive damages. The amount of potential damages is not quantifiable based on the information available to us at this time. On May 21, 2012, Adidas filed a counterclaim against Talon seeking to cancel our Tekfit U.S. trademark registrations and recovery of legal fees. The parties are currently engaged in written discovery, and a scheduling hearing is currently planned for September 2012. We intend to continue to pursue our claims and defend against any counterclaims.

We currently have pending various claims and complaints that arise in the ordinary course of our business. We believe that we have meritorious defenses to these claims and that the claims are either covered by insurance or would not have a material effect on our consolidated financial condition if adversely determined against us.

Exhibit No.	Description
10.16.1	Amendment No. 1 to Executive Employment Agreement, dated June 15, 2012, between Talon International, Inc. and Lonnie D. Schnell.
10.17.1	Amendment No. 1 to Executive Employment Agreement, dated June 15, 2012, between Talon International, Inc. and Larry Dyne.
31.1	Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*	XBRL Instance
101.SCH*	XBRL Taxonomy Extension Schema
101.CAL*	XBRL Taxonomy Extension Calculation
101.DEF*	XBRL Taxonomy Extension Definition
101.LAB*	XBRL Taxonomy Extension Labels
101.PRE*	XBRL Taxonomy Extension Presentation

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

	June 30, 2012			December 31, 2011

Finished goods	$	1,227,390		$	1,561,974
Less reserves		(399,993	)		(485,452	)
Total inventories	$	827,397		$	1,076,522

Series B Preferred Stock as of December 31, 2011	$	20,671,738
Series B Preferred Stock liquidation preference increase		775,190
Series B Preferred Stock as of March 31, 2012	$	21,446,928
Series B Preferred Stock liquidation preference increase		775,190
Series B Preferred Stock as of June 30, 2012	$	22,222,118

	Number of Shares			Weighted Average Exercise Price
Employees and Directors
Options outstanding - January 1, 2012		6,142,100		$	0.22
Cancelled		(200,000	)	$	0.16
Options outstanding - March 31, 2012		5,942,100		$	0.23
Granted		630,000		$	0.05
Cancelled		(200,000	)	$	0.13
Options outstanding - June 30, 2012		6,372,100		$	0.21

	June 30, 2012		December 31, 2011
Long-lived Assets:
United States	$	4,626,138	$	4,443,691
Hong Kong		477,469		629,373
China		96,819		129,977
Other		-		319
Total	$	5,200,426	$	5,203,360

	June 30, 2012			December 31, 2011


Tradename	$	4,110,751		$	4,110,751

Exclusive license and intellectual property rights		155,940			612,500
Accumulated amortization		(2,890	)		(612,500	)
Exclusive license and intellectual property rights, net		153,050			-
Intangible assets, net	$	4,263,801		$	4,110,751

	Three months ended June 30, 2012
	Talon		Trim		Tekfit			Consolidated
Net sales	$	6,887,780	$	6,288,016	$	4,053		$	13,179,849
Cost of goods sold		4,936,172		3,862,935		22,013			8,821,120
Gross profit (loss)	$	1,951,608	$	2,425,081	$	(17,960	)		4,358,729
Operating expenses									3,384,371
Income from operations								$	974,358

	Three months ended June 30, 2011
	Talon		Trim		Tekfit		Consolidated
Net sales	$	7,299,479	$	5,450,562	$	2,240	$	12,752,281
Cost of goods sold		5,348,390		3,340,015		538		8,688,943
Gross profit	$	1,951,089	$	2,110,547	$	1,702		4,063,338
Operating expenses								3,062,200
Income from operations							$	1,001,138

	Six months ended June 30, 2012
	Talon		Trim		Tekfit			Consolidated
Net sales	$	11,344,095	$	10,576,700	$	5,004		$	21,925,799
Cost of goods sold		8,139,997		6,633,948		22,369			14,796,314
Gross profit (loss)	$	3,204,098	$	3,942,752	$	(17,365	)		7,129,485
Operating expenses									6,628,953
Income from operations								$	500,532

	Six months ended June 30, 2011
	Talon		Trim		Tekfit		Consolidated
Net sales	$	12,781,001	$	9,197,233	$	2,240	$	21,980,474
Cost of goods sold		9,272,461		5,753,510		612		15,026,583
Gross profit	$	3,508,540	$	3,443,723	$	1,628		6,953,891
Operating expenses								6,243,258
Income from operations							$	710,633

	Three Months Ended June 30,						Six Months Ended June 30,
Region	2012			2011			2012			2011
United States		7.3	%		7.2	%		8.5	%		8.2	%
Hong Kong		27.0			33.5			32.4			34.1
China		30.9			27.8			25.7			23.4
Bangladesh		5.3			2.9			5.2			6.2
Other		29.5			28.6			28.2			28.1
		100.0	%		100.0	%		100.0	%		100.0	%

	Payments Due by Period ($)
			Less than		1-3		After
Contractual Obligations	Total		1 Year		Years		4 Years
Capital lease obligations	$	5,000	$	4,000	$	1,000	$	-
Operating leases		728,000		457,000		266,000		5,000
Total Obligations	$	733,000	$	461,000	$	267,000	$	5,000



Dated: August 13, 2012	By:	/s/ Lonnie D. Schnell
		Lonnie D. Schnell
		Chief Executive Officer and Chief Financial Officer
		(Principal Executive Officer and Principal Financial Officer)


		/s/ James E. Reeder
		James E. Reeder
		Vice President, Corporate Controller
		(Principal Accounting Officer)