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

The following discussion should be read in conjunction with the condensed consolidated financial statements, including the related notes, appearing in Item 1 of Part 1of this quarterly report on Form 10-Q, as well as our most recent annual report on Form 10-K for the year ended December 31, 2011.

This document contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 which are subject to risks and uncertainties. Forward-looking statements usually are denoted by words or phrases such as "believes," "expects," "projects," "estimates," "anticipates," "will likely result" or similar expressions. We wish to caution readers that all forward-looking statements are necessarily speculative and not to place undue reliance on forward-looking statements, which speak only as of the date made, and to advise readers that actual results could vary due to a variety of risks and uncertainties. We do not undertake any duty to update forward-looking statements after the date they are made or to conform them to actual results or to changes in circumstances or expectations.

References to "Taitron," the "Company," "we," "our" and "us" refer to Taitron Components Incorporated and its wholly owned and majority-owned subsidiaries, unless the context otherwise specifically defines.

Critical Accounting Policies and Estimates

Use of Estimates - Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States. These estimates have a significant impact on our valuation and reserve accounts relating to the allowance for sales returns, doubtful accounts, inventory reserves and deferred income taxes. Actual results could differ from these estimates.

Revenue Recognition - Revenue is recognized upon shipment of the merchandise, which is when legal transfer of title occurs. Reserves for sales allowances and customer returns are established based upon historical experience and our estimates of future returns. Sales returns for the three months ended June 30, 2012 and 2011 were $6,000 and $7,000, respectively and for the six months ended June 30, 2012 and 2011 were $21,000 and $14,000, respectively. The allowance for sales returns and doubtful accounts at June 30, 2012 and December 31, 2011 aggregated $86,000 and $92,000, respectively.

Inventory - Inventory, consisting principally of products held for resale, is recorded at the lower of cost (determined using the first in-first out method) or estimated market value. We had inventory balances in the amount of $12,149,000 and $12,801,000 at June 30, 2012 and December 31, 2011, respectively, which is presented net of valuation allowances of $4,673,000 and $4,233,000, respectively. We evaluate inventories to identify excess, high-cost, slow-moving or other factors rendering inventories as unmarketable at normal profit margins. Due to the large number of transactions and the complexity of managing and maintaining a large inventory of product offerings, estimates are made regarding adjustments to the cost of inventories. Based on our assumptions about future demand and market conditions, inventories are carried at the lower of cost or estimated market value. If our assumptions about future demand change, or market conditions are less favorable than those projected, additional write-downs of inventories may be required. In any case, actual amounts could be different from those estimated.

Overview

We distribute both brand name electronic components and private labeled original designed and manufactured electronic components ("ODM Components") and provide integrated services and solutions to support original equipment manufacturers ("OEMs") and original design manufacturers ("ODMs"). Our product offerings range from discrete semiconductors (transistors, diodes, etc.), optoelectronic devices and passive components to small electronic devices.

Due to ongoing economic recession and related decreased product demand, we are placing emphasis on increasing our sales to existing customers through further expansion of the number of different types of discrete components and other integrated circuits in our inventory and by attracting additional contract electronic manufacturers ("CEMs"), OEMs and electronics distributor customers. In addition, over the last four years we have developed our ODM service capabilities and added products developed through partnership agreements with offshore solution providers (OEMs and CEMs).

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Our core strategy of electronic components fulfillment, however, consists of carrying a substantial quantity and variety of products in inventory to meet the rapid delivery requirements of our customers. This strategy allows us to fill customer orders immediately from stock on hand. Although we believe better market conditions may return, we are focused on lowering our inventory balances and increasing our cash holdings. Our long-term strategy is to rely not only on our core strategy of component fulfillment service, but also the value-added engineering and turn-key services.

In accordance with Generally Accepted Accounting Principles, we have classified inventory as a current asset in our June 30, 2012, condensed consolidated financial statements representing approximately 83% of current assets and 59% of total assets. However, if all or a substantial portion of the inventory was required to be immediately liquidated, the inventory would not be as readily marketable or liquid as other items included or classified as a current asset, such as cash. We cannot assure you that demand in the discrete semiconductor market will increase and that market conditions will improve. Therefore, it is possible that further declines in our carrying values of inventory may result.

Our gross profit margins are subject to a number of factors, including product demand, strength of the U.S. dollar, our ability to purchase inventory at favorable prices and our sales product mix.

Results of Operations

Second quarter of 2012 versus 2011.

Net sales in the second quarter of 2012 totaled $1,416,000 versus $1,959,000 in the comparable period for 2011, a decrease of $543,000 or 27.7% over the same period last year.

Gross profit for the second quarter of 2012 was $272,000 versus $713,000 in the comparable period for 2011, and gross margin percentage of net sales was 19.2% in the second quarter of 2012 versus 36.4% in the comparable period for 2011. The overall decrease in gross margin percentage came from higher inventory reserves compared to the same period last year.

Selling, general and administrative expenses in the second quarter of 2012 totaled $603,000 versus $721,000 in the comparable period for 2011. The decrease of $118,000 or 16.4% was primarily attributed to decreases in salaries and benefits in our overseas divisions due to personnel reductions.

Interest expense, net of interest income, was $8,000 for the second quarter of 2012 and $12,000 in the comparable period for 2011. This decrease was primarily attributed adjustments to our investment in marketable securities for 2011.

Other income, net of other expense, in the second quarter of 2012 was $28,000 versus $14,000 in the comparable period for 2011. Other income was primarily derived from the rental income of available excess office space within our headquarters' facility in Valencia, CA.

Income tax provision in the second quarter of 2012 was $0 versus $1,000 in the comparable period for 2011, as we do not expect significant taxable income.

Net loss was $311,000 for the second quarter of 2012 versus $7,000 in the comparable period for 2011, an increase of $304,000 resulting from the reasons discussed above.

Six Months Ended June 30, 2012 versus Six Months Ended June 30, 2011.

Net sales in the six months ended June 30, 2012 was $3,100,000 versus $3,517,000 in the comparable period for 2011, a decrease of $417,000 or 11.9% over the same period last year.

Gross profit for the six months ended June 30, 2012 was $626,000 versus $1,181,000 in the comparable period for 2011, and gross margin percentage of net sales was approximately 20.2% for the six months ended June 30, 2012 and 33.6% for 2011, respectively. The overall decrease in gross margin percentage came from higher inventory reserves compared to the same period last year.

Selling, general and administrative ("SG&A") expenses in the six months ended June 30, 2012 totaled $1,240,000 versus $1,505,000 in the comparable period for 2011. The decrease of $265,000 or 17.6% was primarily attributed to decreases of salaries and benefits.

Interest expense, net of interest income, was $17,000 for the six months ended June 30, 2012 versus $38,000 in the comparable period for 2011.

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Other income, net of other losses, in the six months ended June 30, 2012 was $46,000 versus $44,000 in the comparable period for 2011.

Income tax provision was $1,000 for the six months ended June 30, 2012 and $1,000 in the comparable period for 2011.

Net loss was $586,000 for the six months ended June 30, 2012 versus $320,000 in the comparable period for 2011, an increase of $266,000 resulting from the reasons discussed above.

Liquidity and Capital Resources

We have financed our operations with funds generated from operating activities and borrowings under our revolving credit facility.

Cash flows provided by operating activities were $244,000 as opposed to used in of $465,000 for the six months ending June 30, 2012 and 2011, respectively. The increase of $709,000 in cash flows provided by operations compared with the prior period resulted from changes in operating assets and liabilities, primarily from reductions of restricted cash, inventory and accounts receivables compared to the prior period.

Cash flows used in investing activities were $355,000 and $440,000 for the six months ending June 30, 2012 and 2011, respectively, primarily attributed to our investment in marketable securities of Zowie Technology Corporation (see Note 5).

Inventory is included in current assets; however, it will take over one year for the inventory to turn. Hence, inventory would not be as readily marketable or liquid as other items included in current assets, such as cash.

We believe that funds generated from, or used in operations, in addition to existing cash balances are likely to be sufficient to finance our working capital and capital expenditure requirements for the foreseeable future. If these funds are not sufficient, we may secure new sources of short-term commercial loans, asset-based lending on accounts receivables or issue debt or equity securities.

Off-Balance Sheet Arrangements

As of June 30, 2012, we had no off-balance sheet arrangements.