**Table ofContents**

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**SECURITIESAND 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 December 31,  2008**                                       |
|   |                                                                                             |
| **o**  | **TRANSITION REPORT UNDER SECTION 13 OR  15(d) OF THEEXCHANGE ACT**                    |

 

**Commission File No. 0-51715**

 

**SPORT-HALEY,INC.**

(Exact name ofsmall business issuer as specified in its charter)

 

| **COLORADO**                     | ** ** | **84-1111669**       |
|----------------------------------|------------|----------------------|
| (State of other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | Identification  No.) |

 

**4600 E. 48th Avenue, Denver, Colorado 80216**

(Address ofprincipal executive offices)

 

**(303)320-8800**

(Issuer’stelephone number including area code)

 

        Indicate by check mark whether the registrant (1) filedall reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes  x  No  o

 

        Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definition of “acceleratedfiler and non-accelerated filer” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer | o | Accelerated filer | o | Non-accelerated filer | o | Smaller Reporting Company | x |
|-------------------------|---|-------------------|---|-----------------------|---|---------------------------|---|

 

        Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).   

Yes  o  No  x

 

        Indicate the number of shares outstanding in each of theissuer’s classes of common stock, as of the latest practicable date.

 

| **Class**                      | ** ** | **Outstanding at February 6, 2009** |
|--------------------------------|------------|------------------------------------------|
| **Common Stock, no par value** | ** ** | **2,284,490**                            |

 

 

 

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**SPORT-HALEY, INC.TABLE OF CONTENTS**

 

 
| ** **                                                                |    |                                                                                                                                                          | **PAGE**   |
|---------------------------------------------------------------------------|---------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **PART ****1****—********FINANCIAL INFORMATION****(UNAUDITED)** |    |
|                                                                      |    |                                                                                                                                                          | ** ** |
|                                                                      | ITEM 1  | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                   | ** ** |
|                                                                      |    |                                                                                                                                                          | ** ** |
|                                                                      |    | CONDENSED CONSOLIDATED BALANCE SHEETS                                                                                                                         | 3          |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      |    | CONDENSED  CONSOLIDATED STATEMENTS OF OPERATIONS                                                                                                              | 4          |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      |    | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                                                                                               | 5          |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      |    | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                                                                                          | 6          |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | ITEM 2  | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF                                                                                                                 |       |
|                                                                      |    | FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                                                                                                                | 20         |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | ITEM 4  | CONTROLS  AND PROCEDURES                                                                                                                                      | 32         |
|                                                                      |    |                                                                                                                                                          |       |
| **PART II —  OTHER INFORMATION**                                |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | ITEM 1  | LEGAL  PROCEEDINGS                                                                                                                                            | 34         |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | ITEM 1A | RISK  FACTORS                                                                                                                                                 | 34         |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | ITEM 5  | OTHER  INFORMATION                                                                                                                                            | 34         |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | ITEM 6  | EXHIBITS                                                                                                                                                      | 35         |
|                                                                      |    |                                                                                                                                                          |       |
| **SIGNATURES**                                                            | 36      |
|                                                                      |    |                                                                                                                                                          |       |
| **EXHIBITS**                                                              |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | 10.3.9  | AMENDMENT NO. 1,  DATED FEBRUARY 18, 2009, TO LICENSE AGREEMENT, DATED MAY 27, 2008,  BETWEEN CALLAWAY GOLF COMPANY AND SPORT-HALEY, INC. |       |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | 31.1    | CERTIFICATION OF DONALD W. JEWELL                                                                                                                             |       |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | 31.2    | CERTIFICATION OF PATRICK W. HURLEY                                                                                                                            |       |
|                                                                      |    |                                                                                                                                                          |       |
|                                                                      | 32.1    | CERTIFICATIONS OF DONALD W. JEWELL AND PATRICK  W. HURLEY                                                                                                     |       |
|                                                                           |         |                                                                                                                                                               |            |  |  |  |

 

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**SPORT-HALEY, INC.CONDENSED CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                           | ** ** | **December 31,****2008** | ** ** | **June 30,****2008** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                                                                                           | ** ** | **(Unaudited)**               | ** ** | **(***)**                 |       |
|                                                                                                 |       |                          |       |                      |       |
| **ASSETS**                                                                                           |       |
| **CURRENT ASSETS**                                                                                   |       |                          |       |                      |       |
| Cash and cash  equivalents                                                                           |       | $                             | 1,621,000  |                      | $          | 2,830,000 |   |
| Marketable  securities                                                                               |       | —                        |       | 200,000                   |       |
| Accounts  receivable, net of allowances of  $323,000 and $278,000, respectively                      |       | 1,938,000                     |       | 2,791,000                 |       |
| Inventories                                                                                          |       | 6,822,000                     |       | 5,947,000                 |       |
| Prepaid expenses  and other                                                                          |       | 275,000                       |       | 264,000                   |       |
| Total current  assets                                                                                |       | 10,656,000                    |       | 12,032,000                |       |
|                                                                                                 |       |                          |       |                      |       |
| **PROPERTY AND EQUIPMENT****,** net                                                                  |       | 147,000                       |       | 197,000                   |       |
| Other assets                                                                                         |       | 3,000                         |       | 3,000                     |       |
|                                                                                                 |       |                          |       |                      |       |
| **TOTAL ASSETS**                                                                                     |       | $                             | 10,806,000 |                      | $          | 12,232,000 |   |
|                                                                                                 |       |                          |       |                      |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                        |       |
| **CURRENT LIABILITIES**                                                                              |       |                          |       |                      |       |
| Accounts payable                                                                                     |       | $                             | 594,000    |                      | $          | 736,000 |   |
| Accrued  royalties payable                                                                           |       | 63,000                        |       | 52,000                    |       |
| Accrued  commissions payable                                                                         |       | 114,000                       |       | 180,000                   |       |
| Accrued payroll  payable                                                                             |       | 31,000                        |       | 138,000                   |       |
| Accrued customs  duties payable                                                                      |       | 818,000                       |       | 685,000                   |       |
| Accrued other expenses  payable                                                                      |       | 184,000                       |       | 177,000                   |       |
|                                                                                                 |       | 1,804,000                     |       | 1,968,000                 |       |
|                                                                                                 |       |                          |       |                      |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                    |       |                          |       |                      |       |
| Minimum  royalties payable (current)                                                                 |       | —                        |       | 80,000                    |       |
|                                                                                                 |       |                          |       |                      |       |
| **TOTAL LIABILITIES - CURRENT**                                                                      |       | 1,804,000                     |       | 2,048,000                 |       |
|                                                                                                 |       |                          |       |                      |       |
| **SHAREHOLDERS’ EQUITY**                                                                        |       |                          |       |                      |       |
| Preferred stock,  no par value; 1,500,000 shares   authorized; none issued and outstanding           |       | —                        |       | —                    |       |
| Common stock, no  par value; 15,000,000 shares   authorized; 2,284,490 shares issued and outstanding |       | 8,481,000                     |       | 8,481,000                 |       |
| Additional  paid-in capital                                                                          |       | 1,621,000                     |       | 1,621,000                 |       |
| Retained  earnings (deficit)                                                                         |       | (1,100,000                    | )          | 82,000                    |       |
| Total  shareholders’ equity                                                                     |       | 9,002,000                     |       | 10,184,000                |       |
|                                                                                                 |       |                          |       |                      |       |
| **TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                  |       | $                             | 10,806,000 |                      | $          | 12,232,000 |   |

----

***  Taken from the audited balance sheet at thatdate.

 

See accompanying notes to these condensed consolidated financialstatements.

 

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**SPORT-HALEY, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                               | ** ** | **Three Months Ended   December 31,** | ** ** | **Six Months Ended   December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                   | ** ** | **2007**                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                               | ** ** | **(Unaudited)**                            | ** ** | **(Unaudited)**                          | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                               | ** ** | ** **                                 | ** ** | **As Corrected**                         | ** ** | ** ** | ** ** | **As Corrected** | ** ** |
| ** **                                               | ** ** | ** **                                 | ** ** | **(Note 2)**                             | ** ** | ** ** | ** ** | **(Note 2)** | ** ** |
| **NET SALES**                                            |       | $                                          | 3,225,000  |                                     | $          | 4,411,000 |   | $ | 6,049,000 |   | $ | 7,939,000 |   |
| ** **                                               |       |                                       |       |                                     |       |   |   |   |   |
| **COST OF GOODS SOLD**                                   |       |                                       |       |                                     |       |   |   |   |   |
| Cost of goods  sold                                      |       | 2,138,000                                  |       | 2,658,000                                |       | 3,914,000 |   | 4,891,000 |   |
| Impairments                                              |       | 53,000                                     |       | 20,000                                   |       | 331,000 |   | 174,000 |   |
| Total cost of  goods sold                                |       | 2,191,000                                  |       | 2,678,000                                |       | 4,245,000 |   | 5,065,000 |   |
|                                                     |       |                                       |       |                                     |       |   |   |   |   |
| **GROSS PROFIT**                                         |       | 1,034,000                                  |       | 1,733,000                                |       | 1,804,000 |   | 2,874,000 |   |
| ** **                                               |       |                                       |       |                                     |       |   |   |   |   |
| **OTHER OPERATING COSTS**                                |       |                                       |       |                                     |       |   |   |   |   |
| Selling, general  and   administrative expenses          |       | 1,252,000                                  |       | 1,646,000                                |       | 2,872,000 |   | 3,371,000 |   |
| Royalty expense                                          |       | 1,000                                      |       | 142,000                                  |       | 156,000 |   | 268,000 |   |
| Total other  operating costs                             |       | 1,253,000                                  |       | 1,788,000                                |       | 3,028,000 |   | 3,639,000 |   |
|                                                     |       |                                       |       |                                     |       |   |   |   |   |
| **LOSS FROM OPERATIONS**                                 |       | (219,000                                   | )          | (55,000                                  | )          | (1,224,000 | ) | (765,000 | ) |
| ** **                                               |       |                                       |       |                                     |       |   |   |   |   |
| Other income,  net                                       |       | 77,000                                     |       | 32,000                                   |       | 44,000 |   | 80,000 |   |
|                                                     |       |                                       |       |                                     |       |   |   |   |   |
| Provision for  income taxes                              |       | —                                     |       | —                                   |       | (2,000 | ) | (7,000 | ) |
|                                                     |       |                                       |       |                                     |       |   |   |   |   |
| **NET LOSS**                                             |       | $                                          | (142,000   | )                                        | $          | (23,000 | ) | $ | (1,182,000 | ) | $ | (692,000 | ) |
| ** **                                               |       |                                       |       |                                     |       |   |   |   |   |
| ** **                                               |       |                                       |       |                                     |       |   |   |   |   |
| ** **                                               |       |                                       |       |                                     |       |   |   |   |   |
| **NET LOSS PER SHARE**                                   |       |                                       |       |                                     |       |   |   |   |   |
| Basic and  diluted loss   per common share               |       | $                                          | (0.06      | )                                        | $          | (0.01 | ) | $ | (0.52 | ) | $ | (0.30 | ) |
|                                                     |       |                                       |       |                                     |       |   |   |   |   |
| **WEIGHTED AVERAGE SHARES OUTSTANDING**                  |       |                                       |       |                                     |       |   |   |   |   |
| Basic and  diluted weighted   average shares outstanding |       | 2,284,000                                  |       | 2,284,000                                |       | 2,284,000 |   | 2,284,000 |   |

 

See accompanying notes to these condensed consolidatedfinancial statements.

 

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**SPORT-HALEY, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                     | ** ** | **Six Months Ended   December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                     | ** ** | **2008**                                 | ** ** | **2007** | ** ** |
| ** **                                                                     | ** ** | **(Unaudited)**                          | ** ** | **(Unaudited)  As Corrected   (Note 2)** | ** ** |
|                                                                           |       |                                     |       |   |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                       |       |                                     |       |   |   |
| Net loss                                                                       |       | $                                        | (1,182,000 | ) | $ | (692,000 | ) |
| Adjustments to  reconcile net loss to net cash   used by operating activities: |       |                                     |       |   |   |
| Depreciation and  amortization                                                 |       | 91,000                                   |       | 106,000 |   |
| Impairments                                                                    |       | 331,000                                  |       | 174,000 |   |
| Allowance for  doubtful accounts                                               |       | 20,000                                   |       | 60,000 |   |
| Cash provided  (used) due to changes in assets   and liabilities:              |       |                                     |       |   |   |
| Accounts  receivable                                                           |       | 833,000                                  |       | 373,000 |   |
| Inventories                                                                    |       | (1,206,000                               | )          | (1,040,000 | ) |
| Other assets                                                                   |       | (11,000                                  | )          | (161,000 | ) |
| Accounts payable                                                               |       | (142,000                                 | )          | (671,000 | ) |
| Accrued expenses  and other                                                    |       | (102,000                                 | )          | 68,000 |   |
| Net cash used by  operating activities                                         |       | (1,368,000                               | )          | (1,783,000 | ) |
|                                                                           |       |                                     |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                       |       |                                     |       |   |   |
| Proceeds from  maturity of marketable securities                               |       | 200,000                                  |       | — |   |
| Purchase of  fixed assets                                                      |       | (41,000                                  | )          | (3,000 | ) |
| Net cash  provided (used) by investing activities                              |       | 159,000                                  |       | (3,000 | ) |
|                                                                           |       |                                     |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                       |       |                                     |       |   |   |
| Borrowings under  line of credit                                               |       | —                                   |       | 1,000,000 |   |
| Repayments under  line of credit                                               |       | —                                   |       | (1,000,000 | ) |
| Net cash  provided by financing activities                                     |       | —                                   |       | — |   |
|                                                                           |       |                                     |       |   |   |
| **NET DECREASE IN CASH AND CASH EQUIVALENTS**                                  |       | (1,209,000                               | )          | (1,786,000 | ) |
|                                                                           |       |                                     |       |   |   |
| **CASH AND CASH EQUIVALENTS****,**beginning of period                          |       | 2,830,000                                |       | 4,464,000 |   |
|                                                                           |       |                                     |       |   |   |
| **CASH AND CASH EQUIVALENTS****,**end of period                                |       | $                                        | 1,621,000  |   | $ | 2,678,000 |   |
|                                                                           |       |                                     |       |   |   |
| **SUPPLEMENTAL CASH FLOW INFORMATION**                                         |       |                                     |       |   |   |
| Cash paid during  the period for:                                              |       |                                     |       |   |   |
| Income taxes                                                                   |       | $                                        | 7,000      |   | $ | 7,000 |   |

 

See accompanying notes to these condensed consolidated financialstatements.

 

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** **

**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

** **
| **NOTE 1** | **SIGNIFICANT ACCOUNTING POLICIES** |
|------------|-------------------------------------|

 

*Principlesof Consolidation*Our condensed consolidated financial statements include the accounts ofSport-Haley, Inc. (“Sport Haley”) and Reserve Apparel Group LLC (“ReserveApparel”). Sport Haley and Reserve Apparel may collectively be referred to as “theCompany,” “we,” “us” or “our.” All significant inter-company transactionsbetween Sport Haley and Reserve Apparel have been eliminated.

 

*Nature ofOperations*Sport Haley, organized as a Colorado corporation in January 1991, designs,purchases or contracts for the manufacture of, markets and distributes women’sand men’s fashion golf apparel and outerwear under the SPORT HALEY® and BenHogan® labels. Our fashion golf apparel collections, known for their innovativedesigns, quality fabrics, generous fits and classic styles, are primarilymarketed in the premium and mid-priced markets through a network of independentsales representatives to golf professional shops, country clubs, resorts andexclusive department stores within the United States. Ben Hogan® fashion golfapparel is distributed per the terms of a license agreement with Callaway GolfCompany (“Callaway”).

 

Reserve Apparel,formed in November 2005, designed, purchased or contracted for themanufacture of, marketed and distributed branded golf apparel and outerwearunder the Top-Flite® label to mass retailers and other big-box, high salesvolume retail stores. Since September 2006 Reserve Apparel has been awholly-owned subsidiary of Sport Haley. Top-Flite® branded golf apparel wasdistributed per the terms of a license agreement with Callaway. We discontinuedmarketing Top-Flite® Branded apparel in November 2007, and in March 2008the license agreement was amended to remove the Top-Flite® brand, effective January 1,2008.

 

*CondensedConsolidated Financial Statements* Our condensed consolidated balance sheets and interimcondensed consolidated statements of operations and cash flows include alladjustments (consisting only of normal recurring items) necessary for theirfair representation. The preparation of consolidated financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses and thedisclosure of contingent assets and liabilities.

 

Certaininformation in footnote disclosures normally included in financial statementshas been condensed or omitted in accordance with the rules and regulationsof the Securities and Exchange Commission. The information included in this Form 10-Qshould be read in conjunction with financial statements and notes thereto andManagement’s Discussion and Analysis of Financial Condition and Results ofOperations for the year ended June 30, 2008, included in the Company’sfiling on Form 10-K.

 

*Reclassification* Certain priorperiod amounts have been reclassified to conform to the December 31, 2008,presentation. Such reclassifications had no affect on net income (loss) in anyof the periods presented.

 

*Marketable Securities* Marketablesecurities generally consisted of certificates of deposit that had an initialmaturity of greater than three months and were classified as held-to-maturity.Due to the short-term nature of the investments, there were no material

 

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**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

unrealized gains or losseson these investments. As a result, the carrying values of marketable securitiesapproximated their fair value.

 

*Accounts Receivable* Accountsreceivable contain amounts due from our independent wholesale salesrepresentatives, primarily for sample garments. The total of amounts due fromsales representatives represents less than 5% of our total accounts receivable.

 

*Stock-Based Compensation*In January 2008, we adopted a newstock option plan, entitled the Sport-Haley 2008 Stock Option Plan (the “2008Plan”), which was approved by our shareholders in February 2008. Under the2008 Plan, the Compensation Committee of the Company’s Board of Directors isauthorized to grant up to 50,000 non-qualified stock options and up to 150,000incentive stock options. No options or other awards have been granted under the2008 Plan.

 

Our former Stock Option Plan(the “Former Plan”) expired by its terms in February 2003. Optionagreements that were issued in accordance with the Former Plan prior to itsexpiration generally remain in force until the earlier of their exercise, theexpiration of certain time periods after the termination of a grantee’semployment (or other relationship with the Company) or expiration by theirterms.

 

At December 31, 2008,there were outstanding options to purchase 577,000 shares of our common stockat exercise prices ranging from $2.71 to $3.60 per share and expiration datesbetween January 2010 and January 2013. All outstanding options arefully vested. No options were exercised during the three months or six monthsended December 31, 2008. During the six months ended December 31,2008, 9,000 options expired.

 

*RecentPronouncements*In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162(“SFAS 162”), *“The Hierarchy of Generally AcceptedAccounting Principles*(“GAAP”)*.”* The currentGAAP hierarchy, as set forth in the American Institute of Certified PublicAccountants (“AICPA”) Statement on Auditing Standards No. 69, *“The Meaning of Present Fairly in Conformity With Generally AcceptedAccounting Principles,”* has been criticized because: (i) it isdirected to the auditor rather than the entity; (ii) it is complex; and, (iii) itranks FASB Statements of Financial Accounting Concepts. The FASB believes thatthe GAAP hierarchy should be directed to entities, because it is the entity(not its auditors) that is responsible for selecting accounting principles forfinancial statements that are presented in conformity with GAAP. Accordingly,the FASB concluded that the GAAP hierarchy should reside in the accountingliterature established by the FASB and is issuing SFAS 162 to achieve thatresult. SFAS 162 is effective 60 days following the Securities and ExchangeCommission’s approval of the Public Company Accounting Oversight Boardamendments to AU Section 411, *“The Meaning of Present Fairlyin Conformity With Generally Accepted Accounting Principles.”* Ouradoption of SFAS 162 upon its effective date is not expected to have a materialeffect on our financial condition or the results of our operations.

 

In March 2008, theFASB issued Statement of Financial Accounting Standards No. 161 (“SFAS 161”),*“Disclosures about Derivative Instruments andHedging Activities — an amendment of FASB Statement No. 133.”*FASB Statement No. 133 (“SFAS 131”), *“Accounting for DerivativeInstruments and Hedging Activities,”* establishes, among otherthings, the disclosure requirements for derivative instruments and for hedgingactivities.

 

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**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

SFAS 161 amends andexpands the disclosure requirements of SFAS 131 with the intent to provideusers of financial statements with an enhanced understanding of: (i) howand why an entity uses derivative instruments; (ii) how derivativeinstruments and related hedged items are accounted for under SFAS 133 and itsrelated interpretations; and, (iii) how derivative instruments and relatedhedged items affect an entity’s financial position, financial performance andcash flows. To meet those objectives, SFAS 161 requires qualitative disclosuresabout objectives and strategies for using derivatives, quantitative disclosuresabout fair value amounts of gains and losses on derivative instruments anddisclosures about credit-risk-related contingent features in derivativeagreements. SFAS 161 is effective for fiscal years, and interim periods withinthose fiscal years, beginning after November 15, 2008, with earlieradoption encouraged. SFAS 161 further encourages, but does not require,comparative disclosures for earlier periods at initial adoption. Our adoptionof SFAS 161 upon its effective date is not expected to materially affect ourfinancial condition or the results of our operations.

 

We have reviewedall other recently issued, but not yet effective, accounting pronouncements anddo not believe the future adoption of any such pronouncements may be expectedto cause a material impact on our financial condition or the results of ouroperations.

 
| **NOTE 2** | **CORRECTION OF PREVIOUSLY ISSUED  FINANCIAL STATEMENTS** |
|------------|-----------------------------------------------------------|

 

As previouslyreported, in August 2008, we determined that we were underpaying customsduties with regard to imported fashion apparel for which fabric had beenpurchased separately from another foreign supplier. This issue was brought toour attention by a third party and was not an intentional concealment or act onthe part of the Company or any of its officers, directors or employees. Forsuch imports, the information received by our customs agent had failed toinclude the value of the fabric in the total declared value of the apparel.

 

In order tocorrect the amount of duty payable to US Customs and Border Protection for suchimports, we voluntarily submitted a Prior Disclosure in November 2008. APrior Disclosure is a specific procedure proscribed by US Customs and BorderProtection for the purpose of identifying and correcting amounts which werepreviously declared or omitted from declaration. Our Prior Disclosure correctedamounts with regard to our imports for the five-year period immediately priorto the date the Prior Disclosure was submitted to US Customs and BorderProtection. In September 2008, we retained an import duties specialist toassist us with the Prior Disclosure. The specialist advised us that, upon ourdelivery of the Prior Disclosure and an agreement to pay the applicable amountsand interest thereon, it is highly unlikely (but we can give no assurance tothe contrary) that US Customs and Border Protection will assess further finesand/or penalties with regard to this matter. Therefore, we believe that uponacceptance of our Prior Disclosure and a related payment agreement with theNational Finance Center, US Customs and Border Protection will consider thismatter closed. Our Prior Disclosure totaled $812,000, including $97,000 inaccrued interest due thereon. At December 31, 2008, the balance due withregard to the Prior Disclosure totaled $818,000, including accrued interest of$103,000. To date, we have not been contacted by either US Customs and BorderProtection or the National Finance Center with regard to our Prior Disclosureor a payment arrangement therefor.

 

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** **

**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

As previouslyreported, in order to assess materiality with regard to the underpaid customsduties, we applied the concepts set forth in Staff Accounting Bulletin No. 108(“SAB 108”), *“Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements,”* issued by the Securities and Exchange Commission andFASB Concepts Statement No. 2, *“QualitativeCharacteristics of Accounting Information.”* We applied the ironcurtain and rollover approaches proscribed by SAB 108 to quantify the effectson the current and prior fiscal years caused by the underpaid customs duties.Per SAB 108, “[T]he iron curtain approach quantifies a misstatement based uponthe effects of correcting the misstatement existing in the balance sheet at theend of the current year, irrespective of the misstatements year(s) oforigination.” The rollover approach quantifies a misstatement based on theamount of the error originating in the income statement for the year in whichthe error occurred. Per FASB Concepts Statement No. 2, qualitativemateriality determinations are based upon whether “it is probable that thejudgment of a reasonable person relying upon the report would have been changedor influenced by the inclusion or correction of the item.”

 

Our qualitative and quantitative analyses under the rollover approacheach yielded results that indicated the correction of prior year financialstatement amounts was immaterial in each case. Our quantitative analysis underthe iron curtain approach yielded results that indicated application of theiron curtain method would have caused our fiscal 2008 financial statements to bematerially misstated. When analyzing materiality under the iron curtain androllover approaches, SAB 108 directs, “[A] registrant’s financial statementswould require adjustment when either approach results in quantifying amisstatement that is material, after considering all relevant quantitative andqualitative factors.” SAB 108 further instructs, “[A]fter all of the relevantquantitative and qualitative factors are considered, the prior year financialstatements should be corrected, even though such revision previously was andcontinues to be immaterial to the prior year financial statements. Correctingprior year financial statements for immaterial errors would not requirepreviously filed reports to be amended. Such correction may be made the next timethe registrant files the prior year financial statements.” Accordingly, we havecorrected our financial statements for the three-month and six-month periodsended December 31, 2007, which are included in this report on Form 10-Q.

 

Corrections of the Company’s prior period financial statements resultedin a reduction of $404,000 in total shareholders’ equity as of July 1,2007, which added to the $89,000 correction for the six months ended December 31,2007, brought the reduction in shareholders’ equity to $493,000 as of December 31,2007. The following comparison of condensed consolidated balance sheets as of December 31,2007, the comparisons of condensed consolidated statements of income for thethree months and six months ended December 31, 2007, and the comparison ofcondensed consolidated statements of cash flows for the six months ended December 31,2007, present the effects resulting from correcting the Company’s financialstatements for the aforementioned reason.

 

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** **

**SPORT-HALEY,INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**COMPARISONOF CONDENSED CONSOLIDATED BALANCE SHEETS**

 
| ** **                                           | ** ** | **DECEMBER 31, 2007** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **As  Corrected**     | ** ** | **Effect  of   Correction** | ** ** | **As  Previously   Reported** | ** ** |
| ** **                                           | ** ** | **(Unaudited)**       | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                           | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **ASSETS**                                           |       |                  |       |   |   |   |   |
| **CURRENT ASSETS**                                   |       |                  |       |   |   |   |   |
| Cash and cash  equivalents                           |       | $                     | 2,678,000  |   | $ | — |   | $ | 2,678,000 |   |
| Accounts  receivable, net of allowances              |       | 2,633,000             |       | — |   | 2,633,000 |   |
| Inventories                                          |       | 6,752,000             |       | 67,000 |   | 6,685,000 |   |
| Prepaid expenses  and other                          |       | 364,000               |       | — |   | 364,000 |   |
| Total current  assets                                |       | 12,427,000            |       | 67,000 |   | 12,360,000 |   |
|                                                 |       |                  |       |   |   |   |   |
| **PROPERTY  AND EQUIPMENT, net**                     |       | 296,000               |       | — |   | 296,000 |   |
| OTHER ASSETS                                         |       | 3,000                 |       | — |   | 3,000 |   |
|                                                 |       |                  |       |   |   |   |   |
| **TOTAL  ASSETS**                                    |       | $                     | 12,726,000 |   | $ | 67,000 |   | $ | 12,659,000 |   |
|                                                 |       |                  |       |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’S EQUTY**        |       |                  |       |   |   |   |   |
|                                                 |       |                  |       |   |   |   |   |
| **CURRENT  LIABILITIES**                             |       |                  |       |   |   |   |   |
| Accounts payable                                     |       | $                     | 895,000    |   | $ | — |   | $ | 895,000 |   |
| Accrued  royalties payable                           |       | 139,000               |       | — |   | 139,000 |   |
| Accrued  commissions payable                         |       | 198,000               |       | — |   | 198,000 |   |
| Accrued payroll                                      |       | 280,000               |       | — |   | 280,000 |   |
| Accrued customs  duties payable                      |       | 560,000               |       | 560,000 |   | — |   |
| Other                                                |       | 186,000               |       | — |   | 186,000 |   |
|                                                 |       | 2,258,000             |       | 560,000 |   | 1,698,000 |   |
|                                                 |       |                  |       |   |   |   |   |
| **COMMITMENTS  AND CONTINGENCIES**                   |       |                  |       |   |   |   |   |
| Minimum  royalties payable (current)                 |       | 182,000               |       | — |   | 182,000 |   |
|                                                 |       |                  |       |   |   |   |   |
| **TOTAL  LIABILITIES - CURRENT**                     |       | 2,440,000             |       | 560,000 |   | 1,880,000 |   |
|                                                 |       |                  |       |   |   |   |   |
| **SHAREHOLDERS’  EQUITY**                       |       |                  |       |   |   |   |   |
| Preferred stock,  no par value                       |       | —                |       | — |   | — |   |
| Common stock, no  par value                          |       | 8,481,000             |       | — |   | 8,481,000 |   |
| Additional  paid-in capital                          |       | 1,621,000             |       | — |   | 1,621,000 |   |
| Retained  earnings                                   |       | 184,000               |       | (493,000 | ) | 677,000 |   |
| Total  shareholders’ equity                     |       | 10,286,000            |       | (493,000 | ) | 10,779,000 |   |
|                                                 |       |                  |       |   |   |   |   |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY** |       | $                     | 12,726,000 |   | $ | 67,000 |   | $ | 12,659,000 |   |

 

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** **

**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

** **

**COMPARISONOF CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                    | ** ** | **THREE MONTHS ENDED DECEMBER 31, 2007** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | ** **                               | ** ** | **Effect of** | ** ** | **As Previously** | ** ** |
| ** **                                    | ** ** | **As Corrected**                         | ** ** | **Correction** | ** ** | **Reported** | ** ** |
| ** **                                    | ** ** | **(Unaudited)**                          | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                    | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| **NET  SALES**                                |       | $                                        | 4,411,000  |   | $ | — |   | $ | 4,411,000 |   |
|                                          |       |                                     |       |   |   |   |   |
| **COST OF  GOODS SOLD**                       |       |                                     |       |   |   |   |   |
| Cost of goods  sold                           |       | 2,658,000                                |       | 47,000 |   | 2,611,000 |   |
| Inventory  impairments                        |       | 20,000                                   |       | — |   | 20,000 |   |
| Total cost of  goods sold                     |       | 2,678,000                                |       | 47,000 |   | 2,631,000 |   |
|                                          |       |                                     |       |   |   |   |   |
| **GROSS  PROFIT**                             |       | 1,733,000                                |       | (47,000 | ) | 1,780,000 |   |
|                                          |       |                                     |       |   |   |   |   |
| **OTHER  OPERATING COSTS**                    |       |                                     |       |   |   |   |   |
| Selling, general  and administrative expenses |       | 1,646,000                                |       | — |   | 1,646,000 |   |
| Royalty expense                               |       | 142,000                                  |       | — |   | 142,000 |   |
| Total other  operating costs                  |       | 1,788,000                                |       | — |   | 1,788,000 |   |
|                                          |       |                                     |       |   |   |   |   |
| **LOSS  FROM OPERATIONS**                     |       | (55,000                                  | )          | (47,000 | ) | (8,000 | ) |
|                                          |       |                                     |       |   |   |   |   |
| Other income,  net                            |       | 32,000                                   |       | — |   | 32,000 |   |
|                                          |       |                                     |       |   |   |   |   |
| Provision for  income taxes                   |       | —                                   |       | — |   | — |   |
|                                          |       |                                     |       |   |   |   |   |
| **NET  INCOME (LOSS)**                        |       | $                                        | (23,000    | ) | $ | (47,000 | ) | $ | 24,000 |   |
|                                          |       |                                     |       |   |   |   |   |
| **NET  INCOME (LOSS) PER SHARE**              | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                         |       | $                                        | (0.01      | ) | $ | (0.02 | ) | $ | 0.01 |   |
| Diluted                                       |       | $                                        | (0.01      | ) | $ | (0.02 | ) | $ | 0.01 |   |
| ** **                                    | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| **WEIGHTED  AVERAGE SHARES OUTSTANDING**      | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                         |       | 2,284,000                                |       | — |   | 2,284,000 |   |
| Diluted                                       |       | 2,284,000                                |       | — |   | 2,284,000 |   |

 

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**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

** **

**COMPARISONOF CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                    | ** ** | **SIX MONTHS ENDED DECEMBER 31, 2007** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                    | ** ** | ** **                             | ** ** | **Effect of** | ** ** | **As Previously** | ** ** |
| ** **                                    | ** ** | **As Corrected**                       | ** ** | **Correction** | ** ** | **Reported** | ** ** |
| ** **                                    | ** ** | **(Unaudited)**                        | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                    | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **NET SALES**                                 |       | $                                      | 7,939,000  |   | $ | — |   | $ | 7,939,000 |   |
|                                          |       |                                   |       |   |   |   |   |
| **COST OF  GOODS SOLD**                       |       |                                   |       |   |   |   |   |
| Cost of goods  sold                           |       | 4,891,000                              |       | 89,000 |   | 4,802,000 |   |
| Inventory  impairments                        |       | 174,000                                |       | — |   | 174,000 |   |
| Total cost of  goods sold                     |       | 5,065,000                              |       | 89,000 |   | 4,976,000 |   |
|                                          |       |                                   |       |   |   |   |   |
| **GROSS  PROFIT**                             |       | 2,874,000                              |       | (89,000 | ) | 2,963,000 |   |
|                                          |       |                                   |       |   |   |   |   |
| **OTHER  OPERATING COSTS**                    |       |                                   |       |   |   |   |   |
| Selling, general  and administrative expenses |       | 3,371,000                              |       | — |   | 3,371,000 |   |
| Royalty expense                               |       | 268,000                                |       | — |   | 268,000 |   |
| Total other  operating costs                  |       | 3,639,000                              |       | — |   | 3,639,000 |   |
|                                          |       |                                   |       |   |   |   |   |
| **LOSS  FROM OPERATIONS**                     |       | (765,000                               | )          | (89,000 | ) | (676,000 | ) |
|                                          |       |                                   |       |   |   |   |   |
| Other income,  net                            |       | 80,000                                 |       | — |   | 80,000 |   |
|                                          |       |                                   |       |   |   |   |   |
| Provision for  income taxes                   |       | (7,000                                 | )          | — |   | (7,000 | ) |
|                                          |       |                                   |       |   |   |   |   |
| **NET  INCOME (LOSS)**                        |       | $                                      | (692,000   | ) | $ | (89,000 | ) | $ | (603,000 | ) |
|                                          |       |                                   |       |   |   |   |   |
| **NET  INCOME (LOSS) PER SHARE**              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                         |       | $                                      | (0.30      | ) | $ | (0.04 | ) | $ | (0.26 | ) |
| Diluted                                       |       | $                                      | (0.30      | ) | $ | (0.04 | ) | $ | (0.26 | ) |
| ** **                                    | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **WEIGHTED  AVERAGE SHARES OUTSTANDING**      | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                         |       | 2,284,000                              |       | — |   | 2,284,000 |   |
| Diluted                                       |       | 2,284,000                              |       | — |   | 2,284,000 |   |

 

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**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

** **

**COMPARISONOF CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| ** **                                                                   | ** ** | **SIX MONTHS ENDED DECEMBER 31, 2007** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                             | ** ** | **Effect of** | ** ** | **As Previously** | ** ** |
| ** **                                                                   | ** ** | **As Corrected**                       | ** ** | **Correction** | ** ** | **Reported** | ** ** |
| ** **                                                                   | ** ** | **(Unaudited)**                        | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| ** **                                                                   | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                    | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                                      | (692,000   | ) | $ | (89,000 | ) | $ | (603,000 | ) |
| Adjustments to  reconcile net loss to net cash used by operating activities: |       |                                   |       |   |   |   |   |
| Depreciation and  amortization                                               |       | 106,000                                |       | — |   | 106,000 |   |
| Impairments                                                                  |       | 174,000                                |       | — |   | 174,000 |   |
| Allowance for  doubtful accounts                                             |       | 60,000                                 |       | — |   | 60,000 |   |
| Cash provided  (used) due to changes in assets and liabilities:              |       |                                   |       |   |   |   |   |
| Accounts  receivable                                                         |       | 373,000                                |       | — |   | 373,000 |   |
| Inventories                                                                  |       | (1,040,000                             | )          | 5,000 |   | (1,045,000 | ) |
| Other assets                                                                 |       | (161,000                               | )          | — |   | (161,000 | ) |
| Accounts payable                                                             |       | (671,000                               | )          | — |   | (671,000 | ) |
| Accrued expenses  and other                                                  |       | 68,000                                 |       | 84,000 |   | (16,000 | ) |
| Net cash used by  operating activities                                       |       | (1,783,000                             | )          | — |   | (1,783,000 | ) |
|                                                                         |       |                                   |       |   |   |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                    |       |                                   |       |   |   |   |   |
| Purchase of  fixed assets                                                    |       | (3,000                                 | )          | — |   | (3,000 | ) |
| Net cash used by  investing activities                                       |       | (3,000                                 | )          | — |   | (3,000 | ) |
|                                                                         |       |                                   |       |   |   |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                                    |       |                                   |       |   |   |   |   |
| Borrowings under  line of credit                                             |       | 1,000,000                              |       | — |   | 1,000,000 |   |
| Repayments under  line of credit                                             |       | (1,000,000                             | )          | — |   | (1,000,000 | ) |
| Net cash  provided by financing activities                                   |       | —                                 |       | — |   | — |   |
|                                                                         |       |                                   |       |   |   |   |   |
| **NET  DECREASE IN CASH AND CASH EQUIVALENTS**                               |       | (1,786,000                             | )          | — |   | (1,786,000 | ) |
|                                                                         |       |                                   |       |   |   |   |   |
| **CASH  AND CASH EQUIVALENTS,**                                              |       |                                   |       |   |   |   |   |
| beginning of  period                                                         |       | 4,464,000                              |       | — |   | 4,464,000 |   |
|                                                                         |       |                                   |       |   |   |   |   |
| **CASH  AND CASH EQUIVALENTS,**                                              |       |                                   |       |   |   |   |   |
| end of period                                                                |       | $                                      | 2,678,000  |   | $ | — |   | $ | 2,678,000 |   |
|                                                                         |       |                                   |       |   |   |   |   |
| **SUPPLEMENTAL  CASH FLOW INFORMATION**                                      | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during  the period for:                                            | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income taxes                                                                 |       | $                                      | 7,000      |   | $ | — |   | $ | 7,000 |   |

 

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| **NOTE 3** | **INVENTORIES** |
|------------|-----------------|

 

| ** **                               | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                               | ** ** | **2008**              | ** ** | **2008**          | ** ** |
| Inventories  consisted of the following: |       |                  |       |              |       |
| Component                                |       | $                     | 345,000    |              | $          | 331,000 |   |
| Finished goods                           |       | 6,477,000             |       | 5,616,000         |       |
|                                     |       |                  |       |              |       |
|                                     |       | $                     | 6,822,000  |              | $          | 5,947,000 |   |

 

 

Included in finished goods inventories are allowances for inventorywrite-downs of $469,000 and $168,000 as of December 31, 2008, and June 30,2008, respectively.

 
| **NOTE 4** | **LINE OF CREDIT AGREEMENT** |
|------------|------------------------------|

 

In September 2007,we entered into a business loan agreement with Bank of Oklahoma N.A. (“Bank ofOklahoma”), which was amended in October 2008. The amended business loanagreement, which expires on September 30, 2009, provides for a maximumloan amount of $3,000,000, collateralized by deposit amounts maintained at Bankof Oklahoma or its affiliates. While the maximum principal amount allowed underthe business loan agreement is $3,000,000, the Company may not borrow amountsunder the business loan agreement in excess of the combined amounts of itscollateralized deposits. We had no collateralized deposits, and therefore hadno borrowing availability under the business loan agreement, at December 31,2008. Borrowings under the business loan agreement accrue interest at the Bankof Oklahoma Financial (“BOKF”) National Prime Rate less 1.500%. We generallyentered into the business loan agreement to facilitate the issuance of lettersof credit for inventory purchases from offshore suppliers. We did not have anybalances due on the business loan agreement at December 31, 2008, or June 30,2008, respectively. Outstandingletters of credit reduce the amount available for borrowing under the businessloan agreement. At December 31, 2008, and June 30, 2008, we hadoutstanding letters of credit of $0 and $1,144,000, respectively, issuedthrough Bank of Oklahoma for purchase obligations under outstanding letters ofcredit.

 

In May 2008, we amended the revolving line of credit agreementthat we maintained with US Bank National Association (“US Bank”) for the past several years.The amended revolving line of credit agreement, which expired on December 5,2008, provided for a maximum loan amount of $200,000, collateralized by acertificate of deposit held at US Bank in the amount of $200,000, which earneda market rate of interest. Borrowings under the amended line of creditagreement accrued interest at 1.250% plus the one-month LIBOR rate. At December 5,2007, the line of credit had previously been amended to provide for a maximumloan amount of $2,000,000, collateralized by a certificate of deposit held atUS Bank in the amount of $2,000,000. We generally maintained the line of creditto facilitate the issuance of letters of credit for inventory purchases fromoffshore suppliers and, if necessary, to fund any temporary working capital needs.We did not have any balances due on the line of credit at December 31,2008, or June 30, 2008, respectively. Outstanding letters of creditreduced the amount available for borrowing under the line of credit agreement.At December 31, 2008, and June 30, 2008, we had

 

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outstanding letters of credit of $0 and $0, respectively, issuedthrough US Bank for purchase obligations under outstanding letters of credit.

 
| **NOTE 5** | **COMMITMENTS AND CONTINGENCIES** |
|------------|-----------------------------------|

 

The license agreement withCallaway requires us to pay royalties based upon sales of Ben Hogan® fashionapparel. We record royalties governed by the license agreement with Callaway asother operating costs in the periods when such sales are recognized. Certainterms of the license agreement provide for minimum royalties on a calendar yearbasis. We expected that royalties generated on sales of Ben Hogan® fashionapparel would be insufficient to meet the contractual minimum royaltyrequirement for calendar 2008 and, accordingly, we had recorded a contingentliability totaling $164,000 with respect to the calendar year 2008 minimumroyalty requirement as of September 30, 2008. In February 2009, werenegotiated certain terms of the license agreement with Callaway, wherebyminimum royalties due for 2008 were reduced to $350,000. Because sales of BenHogan® apparel generated royalties in excess of $350,000 for 2008, at December 31,2008, we reversed the contingent liability of $164,000.

 
| **NOTE 6** | **EARNINGS PER SHARE** |
|------------|------------------------|

 

Effectivewith the year ended June 30, 1998, we adopted the provisions of Statementof Financial Accounting Standards No. 128 (“SFAS 128”), “*Earnings per Share*.*”* SFAS 128requires the presentation of basic and diluted earnings (loss) per commonshare. The following table provides a reconciliation of the numerator anddenominator of basic and diluted earnings (loss) per common share:

 
| ** **                                    | ** ** | **Three Months ended  December 31, 2008** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                    | ** ** | **Net  Income  (Loss)**                        | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share** | ** ** |
|                                          |       |                                           |       |   |   |   |   |
| Basic loss per  share                         |       | $                                              | (142,000   | ) | 2,284,000 |   | $ | (0.06 | ) |
|                                          |       |                                           |       |   |   |   |   |
| Effect of  dilutive securities options**[A]** |       | —                                         |       | — |   | — |   |
|                                          |       |                                           |       |   |   |   |   |
| Diluted earnings  per share                   |       | $                                              | (142,000   | ) | 2,284,000 |   | $ | (0.06 | ) |

 
| ** **                                    | ** ** | **Six Months ended  December 31, 2008** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                    | ** ** | **Net  Income  (Loss)**                      | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share** | ** ** |
|                                          |       |                                         |       |   |   |   |   |
| Basic loss per  share                         |       | $                                            | (1,182,000 | ) | 2,284,000 |   | $ | (0.52 | ) |
|                                          |       |                                         |       |   |   |   |   |
| Effect of  dilutive securities options**[A]** |       | —                                       |       | — |   | — |   |
|                                          |       |                                         |       |   |   |   |   |
| Diluted loss per  share                       |       | $                                            | (1,182,000 | ) | 2,284,000 |   | $ | (0.52 | ) |

 

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**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                     | ** ** | **Three Months ended December 31, 2007** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                     | ** ** | **Net Income (Loss)**                         | ** ** | **Weighted Average Shares** | ** ** | **Per Share** | ** ** |
|                                           |       |                                          |       |   |   |   |   |
| Basic  loss per share (as corrected)           |       | $                                             | (23,000    | ) | 2,284,000 |   | $ | (0.01 | ) |
|                                           |       |                                          |       |   |   |   |   |
| Effect  of dilutive securities options **[A]** |       | —                                        |       | — |   | — |   |
|                                           |       |                                          |       |   |   |   |   |
| Diluted  loss per share                        |       | $                                             | (23,000    | ) | 2,284,000 |   | $ | (0.01 | ) |
|                                           |       |                                          |       |   |   |   |   |
| ** **                                     | ** ** | **Six Months ended December 31, 2007**   | ** ** |
| ** **                                     | ** ** | **Net Income (Loss)**                         | ** ** | **Weighted Average Shares** | ** ** | **Per Share** | ** ** |
|                                           |       |                                          |       |   |   |   |   |
| Basic  loss per share (as corrected)           |       | $                                             | (692,000   | ) | 2,284,000 |   | $ | (0.30 | ) |
|                                           |       |                                          |       |   |   |   |   |
| Effect  of dilutive securities options **[A]** |       | —                                        |       | — |   | — |   |
|                                           |       |                                          |       |   |   |   |   |
| Diluted  loss per share                        |       | $                                             | (692,000   | ) | 2,284,000 |   | $ | (0.30 | ) |

----

**[A]** All securities options wereanti-dilutive and therefore excluded from the loss per share calculations dueto the loss for the period presented.

 
| **NOTE 7** | **SEGMENT  INFORMATION** |
|------------|--------------------------|

 

The consolidatedCompany has two operating segments which consist of designing, purchasing orcontracting for the manufacture of and wholesale sales of women’s and men’s: (1) fashiongolf apparel and outerwear; and, (2) branded golf apparel, which wediscontinued marketing as of November 2007. SPORT HALEY® and Ben Hogan®fashion golf apparel and outerwear collections are primarily marketed by SportHaley in the premium and mid-priced markets through a network of independentwholesale sales representatives to golf professional shops, country clubs,resorts and exclusive department stores within the United States. Top-Flite®men’s branded apparel was marketed by Reserve Apparel to mass retailers andother big-box type high sales volume retail stores within the United States.Ben Hogan® fashion apparel and Top-Flite® branded apparel have been distributedpursuant to a license agreement with Callaway.

 

Reserve Appareldistributed Top-Flite® apparel exclusively to Wal-Mart from March 2006through August 2006, after which we aggressively marketed Top-Flite®apparel to several mass retailers and big-box type high sales volume retailstores. We expected our marketing efforts would result in the establishment ofbusiness relationships with one or more mass retailers and other big-box typehigh sales volume retail stores. However, we only received one order forTop-Flite® apparel from such a retailer for a test in 50 of its stores, whichwe shipped in September and October 2007. Since our concerted effortsfailed to generate orders from a major customer, we discontinued marketingapparel bearing the Top-Flite® label in November 2007. In March 2008,we reached an agreement with Callaway to remove the Top-Flite® brand from thelicense agreement, effective January 1, 2008.

 

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**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

Condensedconsolidated balance sheets information and condensed consolidated statements ofoperations information for each of our segments are presented in the tablesbelow.

 

*CondensedConsolidated Balance Sheets Segment Information as of December 31, 2008,and June 30, 2008:*

 
| ** **                              | ** ** | **December 31, 2008** | ** ** | **June 30, 2008** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **Fashion Apparel**        | ** ** | **Branded Apparel**    | ** ** | **Total** | ** ** | **Fashion Apparel** | ** ** | **Branded Apparel** | ** ** | **Total** | ** ** |
| Cash  and cash equivalents              |       | $                          | 1,601      |                   | $          | 20 |   | $ | 1,621 |   | $ | 2,798 |   | $ | 32 |   | $ | 2,830 |   |
| Marketable  securities                  |       | —                     |       | —                 |       | — |   | 200 |   | — |   | 200 |   |
| Accounts  receivable, net of allowances |       | 1,821                      |       | 117                    |       | 1,938 |   | 2,439 |   | 352 |   | 2,791 |   |
| Inventories                             |       | 6,822                      |       | —                 |       | 6,822 |   | 5,947 |   | — |   | 5,947 |   |
| Prepaid  expenses                       |       | 275                        |       | —                 |       | 275 |   | 264 |   | — |   | 264 |   |
| Property  and equipment, net            |       | 147                        |       | —                 |       | 147 |   | 197 |   | — |   | 197 |   |
| Other  assets                           |       | 3                          |       | —                 |       | 3 |   | 3 |   | — |   | 3 |   |
| Total  Assets                           |       | $                          | 10,669     |                   | $          | 137 |   | $ | 10,806 |   | $ | 11,848 |   | $ | 384 |   | $ | 12,232 |   |
|                                    |       |                       |       |                   |       |   |   |   |   |   |   |   |   |
| Accounts  payable                       |       | $                          | 594        |                   | $          | — |   | $ | 594 |   | $ | 500 |   | $ | 236 |   | $ | 736 |   |
| Accrued  royalties payable              |       | 63                         |       | —                 |       | 63 |   | 52 |   | — |   | 52 |   |
| Accrued  commissions payable            |       | 114                        |       | —                 |       | 114 |   | 180 |   | — |   | 180 |   |
| Accrued  payroll                        |       | 31                         |       | —                 |       | 31 |   | 138 |   | — |   | 138 |   |
| Accrued  customs duties payable         |       | 818                        |       | —                 |       | 818 |   | 685 |   | — |   | 685 |   |
| Other  liabilities                      |       | 184                        |       | —                 |       | 184 |   | 177 |   | — |   | 177 |   |
|                                    |       | 1,804                      |       | —                 |       | 1,804 |   | 1,732 |   | 236 |   | 1,968 |   |
| Minimum  royalties payable (current)    |       | —                     |       | —                 |       | — |   | 80 |   | — |   | 80 |   |
| Total  Liabilities - Current            |       | $                          | 1,804      |                   | $          | — |   | $ | 1,804 |   | $ | 1,812 |   | $ | 236 |   | $ | 2,048 |   |

 

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** **

**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

*CondensedConsolidated Statements of Operations Segment Information for the Three Monthsand Six Months Ended December 31, 2008 and 2007, as corrected:*

 
| ** **                           | ** ** | ** **                                    | ** ** | **Three Months Ended December 31, 2007** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **Three Months Ended December 31, 2008** | ** ** | **(As Corrected)**                            | ** ** |
| ** **                           | ** ** | **Fashion Apparel**                           | ** ** | **Branded Apparel**                           | ** ** | **Total** | ** ** | **Fashion Apparel** | ** ** | **Branded Apparel** | ** ** | **Total** | ** ** |
| Net Sales                            |       | $                                             | 3,225      |                                          | $          | — |   | $ | 3,225 |   | $ | 4,385 |   | $ | 26 |   | $ | 4,411 |   |
| Cost of goods  sold                  |       | 2,138                                         |       | —                                        |       | 2,138 |   | 2,632 |   | 26 |   | 2,658 |   |
| Inventory  impairments               |       | 53                                            |       | —                                        |       | 53 |   | — |   | 20 |   | 20 |   |
| Total cost of  goods sold            |       | 2,191                                         |       | —                                        |       | 2,191 |   | 2,632 |   | 46 |   | 2,678 |   |
| Gross profit                         |       | 1,034                                         |       | —                                        |       | 1,034 |   | 1,753 |   | (20 | ) | 1,733 |   |
| Selling, general  and admin expenses |       | 1,248                                         |       | 4                                             |       | 1,252 |   | 1,619 |   | 27 |   | 1,646 |   |
| Royalty expense                      |       | 1                                             |       | —                                        |       | 1 |   | 138 |   | 4 |   | 142 |   |
| Total other  operating costs         |       | 1,249                                         |       | 4                                             |       | 1,253 |   | 1,757 |   | 31 |   | 1,788 |   |
| Loss from  operations                |       | (215                                          | )          | (4                                            | )          | (219 | ) | (4 | ) | (51 | ) | (55 | ) |
| Other income  (expense), net         |       | 77                                            |       | —                                        |       | 77 |   | 32 |   | — |   | 32 |   |
| Provision for  income taxes          |       | —                                        |       | —                                        |       | — |   | — |   | — |   | — |   |
| Net income  (loss)                   |       | $                                             | (138       | )                                             | $          | (4 | ) | $ | (142 | ) | $ | 28 |   | $ | (51 | ) | $ | (23 | ) |
|                                 |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
|                                 |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| ** **                           | ** ** | ** **                                    | ** ** | **Six Months Ended December 31, 2007**   | ** ** |
| ** **                           | ** ** | **Six Months Ended December 31, 2008**   | ** ** | **(As Corrected)**                            | ** ** |
| ** **                           | ** ** | **Fashion Apparel**                           | ** ** | **Branded Apparel**                           | ** ** | **Total** | ** ** | **Fashion Apparel** | ** ** | **Branded Apparel** | ** ** | **Total** | ** ** |
| Net Sales                            |       | $                                             | 6,049      |                                          | $          | — |   | $ | 6,049 |   | $ | 7,793 |   | $ | 146 |   | $ | 7,939 |   |
| Cost of goods  sold                  |       | 3,914                                         |       | —                                        |       | 3,914 |   | 4,770 |   | 121 |   | 4,891 |   |
| Inventory  impairments               |       | 331                                           |       | —                                        |       | 331 |   | 154 |   | 20 |   | 174 |   |
| Total cost of  goods sold            |       | 4,245                                         |       | —                                        |       | 4,245 |   | 4,924 |   | 141 |   | 5,065 |   |
| Gross profit                         |       | 1,804                                         |       | —                                        |       | 1,804 |   | 2,869 |   | 5 |   | 2,874 |   |
| Selling, general  and admin expenses |       | 2,831                                         |       | 41                                            |       | 2,872 |   | 3,243 |   | 128 |   | 3,371 |   |
| Royalty expense                      |       | 156                                           |       | —                                        |       | 156 |   | 257 |   | 11 |   | 268 |   |
| Total other  operating costs         |       | 2,987                                         |       | 41                                            |       | 3,028 |   | 3,500 |   | 139 |   | 3,639 |   |
| Loss from  operations                |       | (1,183                                        | )          | (41                                           | )          | (1,224 | ) | (631 | ) | (134 | ) | (765 | ) |
| Other income  (expense), net         |       | 44                                            |       | —                                        |       | 44 |   | 79 |   | 1 |   | 80 |   |
| Provision for  income taxes          |       | (2                                            | )          | —                                        |       | (2 | ) | — |   | (7 | ) | (7 | ) |
| Net income  (loss)                   |       | $                                             | (1,141     | )                                             | $          | (41 | ) | $ | (1,182 | ) | $ | (552 | ) | $ | (140 | ) | $ | (692 | ) |

 

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**SPORT-HALEY, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 
| **NOTE 8** | **LITIGATION** |
|------------|----------------|

 

As previously reported, in March 2007, Sport Haley and ReserveApparel (the “Plaintiffs”) filed a lawsuit in the District Court for the Cityand County of Denver in the State of Colorado. The suit alleged, among otherthings, that a former inventory broker to Reserve Apparel, 1130746 OntarioLtd., a Canadian corporation incorporated in the Province of Ontario, Canada,d/b/a Originals Apparel Group Co., or Originals Apparel Group, and FrancisTat-Mo Chan (the “Defendants”), knowingly, wrongfully and without authorizationconverted Plaintiff’s funds. At the conclusion of the trial in September 2008,the Court awarded judgment in the Plaintiff’s favor and against the Defendants,jointly and severally, in the amount of $291,135. On November 4, 2008, theDefendants filed an appeal of the District Court’s judgment in the ColoradoCourt of Appeals, citing various issues proposed to be raised on appeal. Theappeal is pending. At this time, we cannot determine whether the Court ofAppeals will affirm or reverse, in whole or in part, the District Court’sjudgment.

 

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**SPORT-HALEY, INC.****ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This Report on Form 10-Q contains certain forward-lookingstatements, within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. The words “may,”“will,” “expect,” “anticipate,” “continue,” “estimate,” “project,” “intend,” “believe,”and similar expressions, variations or the negative of these words, and anystatement regarding possible or assumed future results of operations of ourbusiness, the markets for our products, anticipated expenditures, regulatorydevelopments or competition, or other statements regarding matters that are nothistorical facts, are intended to identify forward-looking statements, althoughnot all forward-looking statements contain such identifying words. The readershould be aware that our actual results could differ materially from thosecontained in forward-looking statements. Our financial condition and theresults of our operations will depend on a number of factors, including, butnot limited to, the following: our ability to successfully anticipate fashiontrends, design favorably accepted fashion golf apparel, effectively advertiseand communicate within the marketplace, and penetrate our chosen distributionchannels; competition within golf apparel markets; business conditions andgrowth in the fashion golf apparel market and the general economy; our abilityto successfully forecast sales and optimize inventory levels; our ability tosuccessfully manage risks associated with licensed apparel, such as the BenHogan® apparel collections; loss of certain third party suppliers, and/ordelays in receiving garments from third party suppliers caused by variousfactors, including lost or reduced manufacturing capacity of significantsuppliers, labor shortages, timely performance of third parties, transportationdifficulties, and others; significant delays in deliveries from third partysuppliers; unsatisfactory recourse with regard to nonconforming goods receivedfrom foreign suppliers; political and international trade relations; changes ininternational trade quota systems for apparel; significant reliance uponseveral individual foreign suppliers; reliance upon a certain foreign personresponsible for maintaining relationships with and monitoring the performanceof certain of our significant foreign suppliers; consumer spending on golfapparel; general global economic and political conditions resulting fromthreats or acts of war or terrorism and responses thereto; access to capital;maintaining satisfactory relationships with commercial banking institutions;establishing controls with regard to and maintaining the integrity oftechnology and information systems; and, reliance upon executive officers andkey employees. Additional information on these and other factors that couldaffect our financial results is included in the discussion below and in our Form 10-Kfor the year ended June 30, 2008. There may be other factors not mentionedabove, in the discussion below or included in our Securities and ExchangeCommission filings that may cause actual results to differ materially from anyforward-looking statement. The reader should not place undue reliance on anyforward-looking statement. Neither the Company nor any of its corporateofficers or key employees assumes any obligation to update any forward-lookingstatement as a result of new information, future event or development, exceptas required by securities laws.

 

All references to fiscal years are references to SportHaley’s fiscal year, which ends on June 30.

 

##### **OVERVIEW**

##### ** **

Sport-Haley, Inc.designs, purchases or contracts for the manufacture of, markets and distributeswomen’s and men’s fashion golf apparel and outerwear under the SPORT HALEY® andBen Hogan® labels. Weare represented by a network of independent wholesale sales representatives,most of whom solicit sales of both SPORT HALEY® and Ben Hogan® fashion apparelcollections on our behalf.

 

SPORTHALEY® fashion apparel is comprised almost exclusively of women’s garments andaccessories, designed by utilizing classic styles with contemporary influencesintended to develop and maintain brand recognition and loyalty, on or off thegolf course. While each product in the SPORT HALEY® apparel line is soldseparately, the line is intentionally designed in groups with coordinated

 

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styles,color schemes and fabrics to encourage customers to purchase multiple garments.SPORT HALEY® women’s fashion apparel includes a variety of fabrics and weavepatterns, including interlock, pique, French terry, jersey and twill, and mayfeature a unique trim, a special fabric finish or extra needlework. The SPORTHALEY® name has been highly recognized as a women’s fashion apparel brandwithin the premium and mid-priced golf apparel markets for over 20 years, inpart, because of the cohesiveness of our design staff. Catherine B. Blair, ourVice President — Merchandising and Design, has provided direction for the SPORTHALEY® brand for over 16 years. Ms. Blair is keenly aware of fashiontrends within the women’s golf apparel market and has kept our SPORT HALEY®fashion apparel collections on the leading edge of the market by includingmoisture wicking technical performance fabrics, such as Aerocool® and Dry-Tech®18, and several leading edge, younger looking, athletic-style garments, whilemaintaining the time-honored elegance of the SPORT HALEY® brand. Certain of ourpremium priced SPORT HALEY® garments are trimmed with Swarovski® Austrian cutcrystals, the unique and patented cutting process which produces ultimatebrilliance, and come with a “Made with Crystallized Swarovski® Elements”hangtag for authenticity. The technical performance fabrics, athletic-stylegarments and Swarovski® trims have all been well received by our customers.

 

BenHogan® men’s fashion apparel is designed utilizing elegant time-honored classicstyles intended to garner nearly instantaneous brand recognition. The BenHogan® label has been widely recognized within the golf apparel industry forseveral years for continually providing elegant men’s fashion golf apparel ofimpeccable quality in keeping with the image of Mr. Hogan. While eachproduct in the Ben Hogan® apparel line is sold separately, the line isintentionally designed in groups with coordinated styles, color schemes andfabrics to encourage customers to purchase multiple garments. Ben Hogan®apparel is manufactured using a variety of fabrics, including wool, silk andcashmere, and weave patterns, including pique, jersey and twill, and mostpieces feature a unique trim, a special fabric finish or extra needlework. BenHogan® men’s apparel is marketed in the premium-price markets to elite golfprofessional shops, upscale resorts and exclusive department stores. Wedistribute Ben Hogan® apparel pursuant to our license agreement with Callaway.

 

Top-Flite®branded golf apparel was designed for distribution to large retail stores inthe low-price markets pursuant to our license agreement with Callaway. Brandedapparel is generally produced in mass quantities and usually utilizes muchsimpler designs and is of much lesser quality than the fashion apparel garmentswhich we sell in the premium and mid-price markets. While our fashion golfapparel is generally designed for two separate selling seasons each year,branded golf apparel may be designed for four or more shorter selling periodseach year. Reserve Apparel distributed Top-Flite® apparel exclusively toWal-Mart from March 2006 through August 2006, after which weaggressively marketed the Top-Flite® apparel line to several mass retailers andbig-box type high sales volume retail stores. While we expected our marketing effortswould result in the establishment of business relationships with one or moremass retailers and other big-box type high sales volume retail stores, we onlyreceived one order for Top-Flite® apparel from such a retailer for a test in 50of its stores, which we shipped in September and October 2007. Sinceour concerted efforts failed to generate orders from a major customer, wediscontinued marketing apparel bearing the Top-Flite® label in November 2007, and in March 2008 the licenseagreement with Callaway was amended to remove the Top-Flite® brand, effective January 1,2008.

 

##### **CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

##### ** **

Ourfinancial statements have been prepared in accordance with standards of thePublic Company Accounting Oversight Board (United States), which require us tomake estimates and judgments that

 

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affectthe reported amounts of assets, liabilities, revenues and expenses, and therelated disclosures. A summary of those significant accounting policies can befound in the Footnotes to the Financial Statements included in our Report on Form 10-Kfor the fiscal year ended June 30, 2008. The estimates used by management are based upon our historicalexperiences combined with management’s understanding of current facts andcircumstances. Certain of our accounting policies are considered critical asthey are both important to the portrayal of our financial condition and theresults of our operations and require significant or complex judgments on thepart of management. We believe that the following critical accounting policiesaffect the more significant judgments and estimates used in the preparation ofour financial statements.

 

*Inventories*

 

Our inventories, predominately comprised of finishedgoods, are generally valued at the lower of cost (weighted average) or market.Costs include amounts paid to suppliers for packaged apparel and/or materialsand labor, import costs, such as customs duties, freight-in and othermiscellaneous costs, and allocated overhead. Excess fashion apparelinventories, consisting of discontinued or aging merchandise, are a naturalcomponent of a seasonal apparel business. While certain fashion apparel itemswill sell out in any particular selling season, quantities of other fashionapparel items will remain at the end of each selling season. We market excessfashion apparel finished goods inventories at reduced wholesale prices to ourcustomers in the normal course of business. Remaining excess inventories areliquidated through other markets. In the ordinary course of business, wemaintain reserves for inventory write-downs due to the obsolescence of excessinventories. We perform analyses on a quarterly basis to identify unsold excessinventories and adjust our reserves for inventory obsolescence to reduce thecarrying value of excess inventories to their estimated net realizable value,which is estimated based on management’s disposition plans and historicalexperiences. Generally, branded apparel inventories were not prone toimpairment, because we usually ordered branded apparel in quantities perspecific customer orders.

 

We believe that the recent significant downturn inthe United States economy negatively impacted the value of our excess fashionapparel inventories, and we adjusted the carrying value of our excess fashionapparel inventories, accordingly. We adjusted our reserve for inventoryobsolescence and recorded impairments of $53,000 and $331,000 with regard tofashion apparel inventories for the three-month and six-month periods ended December 31,2008. Comparatively, we adjusted our reserve for inventory obsolescence andrecorded impairments of $20,000 and $174,000 with regard to fashion apparelinventories for the three-month and six-month periods ended December 31,2007, as corrected. The balances of our reserves for inventory obsolescencetotaled $469,000, 168,000 and $173,000 at December 31, 2008, June 30,2008, and December 31, 2007, respectively. While we believe that ourprocesses produce fair valuations of our excess inventories, if actual futuremarket conditions are less favorable than those projected by management,additional allowances may be required.

 

*Deferred Income Taxes*

 

Deferred income taxes are recognized for the expected tax consequencesin future years for differences between the tax bases of assets and liabilitiesand their financial reporting amounts, based upon enacted tax laws andstatutory tax rates applicable to the periods in which the differences areexpected to affect taxable income. Our significant deferred tax assets arerelated to net operating loss carry forwards for federal and state income taxpurposes, stock-based compensation and an unrealized loss for tax purposes on acommon stock investment. Governing regulations require that our operatinglosses be carried forward for income tax purposes. We maintain a valuationallowance to reduce deferred tax assets to the

 

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net amount expected to be recovered in future periods. The estimatesfor deferred tax assets and the corresponding valuation allowance require us toexercise complex judgments. We periodically review and adjust those estimatesbased upon the most current information available. In accordance with Statementof Financial Accounting Standards No. 109 (“SFAS 109”), *“Accounting for Income Taxes,”* and based upon a review at December 31,2008, of our utilization of deferred tax assets, we maintained a valuationallowance that effectively reduces our net deferred tax assets to zero. Whilewe continue to explore various strategies to return the Company toprofitability, including increasing our presence in retail markets for ourSPORT HALEY® and Ben Hogan® fashion apparel, we cannot be certain that ourefforts will result in the generation of future profits. Because therecoverability of deferred tax assets is directly dependent upon futureoperating results, actual recoverability of deferred tax assets may differmaterially from our estimates.

 

*Allowance for Doubtful Accounts*

 

Ourallowance for doubtful accounts reflects a reserve that reduces our customeraccounts receivable to the net amount estimated to be collectible. Estimatingthe credit worthiness of customers and the recoverability of customer accountsrequires us to exercise considerable judgment. In estimating the reserve foruncollectible accounts, we consider factors such as general economic andindustry-specific conditions, historical and anticipated customer performance.From time to time, we also identify delinquent customer accounts for which aspecific reserve is required. At December 31, 2008, our allowance for doubtfulaccounts totaled $242,000, including a specific reserve of $175,000 withrespect to the potential non-recovery of a net amount due to Reserve Apparelfrom a former inventory broker. In September 2008, the Court awardedjudgment in our favor and against the former inventory broker and its principalin the amount of $291,135. In November, 2008, the former inventory broker filedan appeal of the District Court’s judgment in the Colorado Court of Appeals,citing various issues proposed to be raised on appeal. In order to collect fromthe former broker, assuming the Court of Appeals affirms the judgment weobtained from the District Court, we will need to domesticate the judgment inthe province of Ontario, Canada. Since collection of the previously awardedjudgment is not assured, we have maintained a reserve for potentialnon-recovery in the amount of $175,000. While we consider our processes to beadequate to effectively quantify our exposure to doubtful accounts, changes ineconomic, industry or specific customer conditions may result in recoverabilityof our doubtful accounts that differs materially from our estimates.

 

*Allowance for Sales Returns*

 

Werecord allowances for sales returns as net adjustments to customer accountsreceivable. When recording an allowance, the net method reduces customeraccounts receivable and net sales by the estimated gross margin effect of theanticipated sales return. Generally, our selling terms preclude return of ourproducts subsequent to the sale. However, we have traditionally maintainedlimited programs that offer various customers the right to return certainfashion apparel items under predefined conditions, which we include as acomponent within our estimate of allowance for sales returns. We reviewhistorical data and consider factors such as general economic andindustry-specific conditions and anticipated customer performance whenevaluating the adequacy of our allowance for sales returns. At December 31,2008, our allowance for sales returns was $81,000. Significant changes ingeneral economic or industry conditions may yield sales returns that differmaterially from our estimates.

 

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### ** **

**LIQUIDITY AND CAPITAL RESOURCES**

### ** **

The golf apparel business is highly seasonal in nature, and we believethat our balance sheet amounts at December 31, 2008, are more meaningfulwhen compared with the corresponding balance sheet amounts at December 31,2007, rather than with the corresponding balance sheet amounts at June 30,2008.

 

Our primary sources of liquidity are derived from our available cashand cash equivalents and cash flows from operations. We require cash for ourgeneral working capital purposes. Our working capital requirements are highlyseasonal in nature, with greater requirements from approximately August throughOctober and February through April of each fiscal year, due tothe purchases of finished goods inventories for the spring/summer andfall/holiday selling seasons, respectively. We do not anticipate requiringmaterial amounts of cash for capital expenditures over the next 12 months.

 

Working capital was $8,852,000, $9,984,000 and $10,480,000 at December 31,2008, June 30, 2008, and December 31, 2007, as corrected,respectively. Cash and cash equivalents totaled $1,621,000, $2,830,000 and$2,678,000 at December 31, 2008, June 30, 2008, and December 31,2007, respectively. For purposes of the statements of cash flows, we considerall highly liquid instruments purchased with an original maturity of threemonths or less to be cash equivalents, if they are readily convertible to knownamounts of cash and present an insignificant risk of change in value due tochanges in interest rates. As of December 31, 2008, we had accrued$818,000 in import duties due to US Customs and Border Protection, includingaccrued interest thereon of $103,000, with regard to the Prior Disclosure wesubmitted in November 2008. We expect to negotiate the terms of a paymentplan with the National Finance Center. If we are required to pay the entirebalance of import duties and interest in a lump sum payment with regard to thePrior Disclosure, our cash on hand will be significantly impacted and we mayneed to obtain additional sources of capital to sustain the working capitalneeds of our operations. However, we can give no assurance that such sources ofcapital will be available to us, given the current status of capital markets inthe United States and other factors. Our capital needs will depend on manyfactors, including the need to finance required inventory levels, the successof current sales and marketing programs, and our ability to timely collectcustomer accounts receivable.

 

When compared with the June 30, 2008, balance of $2,791,000, ournet accounts receivable balance at December 31, 2008, decreased by$853,000, or 31%, to $1,938,000. Our net accounts receivable balance at December 31,2008, decreased by $695,000, or 26%, when compared with the December 31,2007, balance of $2,633,000. The decreases correlate with correspondingdecreases in net sales between the comparable periods. Our net accountsreceivable balance relating to fashion apparel was $1,821,000 at December 31,2008, a decrease of $618,000, or 25%, from the balance of $2,439,000 at June 30,2008, and a decrease of $314,000, or 15%, from the balance of $2,135,000 at December 31,2007. Our net accounts receivable balance relating to branded apparel was$117,000 at December 31, 2008, a decrease of $235,000, or 67%, from thebalance of $352,000 at June 30, 2008, and a decrease of $381,000, or 77%,from the balance of $498,000 at December 31, 2007. Changes in our accountsreceivable balances provided operating cash of $853,000 and $433,000 for thefiscal quarters ended December 31, 2008 and 2007, respectively.

 

Our fashionapparel inventories increased by $875,000, or 15%, from $5,947,000 at June 30,2008, to $6,822,000 at December 31, 2008. Due to the cyclical nature ofour business, our fashion apparel inventories are typically higher at December 31than at June 30. Our fashion apparel inventories increased by $847,000, or14%, from $5,886,000 at June 30, 2007, as corrected, to $6,733,000 at December 31,2007, as corrected. When compared with the balance of $6,733,000 at December 31,2007,

 

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**SPORT-HALEY, INC.****ITEM 2MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

as corrected, ourinventories at December 31, 2008, increased by $89,000, or 1%. Our branded apparel inventories were lessthan $1,000 at December 31, 2008, and June 30, 2008, and were $19,000at December 31, 2007. Fluctuations in our finished goods inventories arecaused in part by the timing associated with the delivery of ocean shipments,generally with terms of free on board at the port of departure. Pendingocean deliveries of finished goods at December 31, 2008, June 30,2008, and December 31, 2007, totaled approximately $435,000, $264,000 and$388,000 respectively. Changes in our inventory balances used operating cash of$875,000 and $866,000 for the six-month periods ended December 31, 2008and 2007, as corrected, respectively.

 

Our continuedreliance on foreign suppliers sustains the risk that our revenues could beadversely affected if a foreign shipment or shipments were received late orlost. We maintain insurance for risk of loss relating to goods shipped from ourforeign and domestic suppliers. However, our predominant reliance upon acertain foreign person and certain significant foreign suppliers also sustainsthe risk that we would be left with inadequate or unsatisfactory recourseshould the goods received from a foreign supplier be nonconforming.

 

Total liabilitiesdecreased by $244,000, or 12%, at December 31, 2008, to $1,804,000 from$2,048,000 at June 30, 2008. Primarily due to the cyclical nature andtiming of payments for inventory purchases, our liabilities typically decreaseat December 31 when compared to June 30. Total liabilities decreasedby $602,000, or 20%, at December 31, 2007, to $2,440,000 from $3,042,000at June 30, 2007. At December 31, 2008, total liabilities decreasedby $636,000, or 26%, from $2,440,000 at December 31, 2007, as corrected.The decrease between the comparative December 31 amounts was comprised ofthe following: $301,000 decrease in trade accounts payable; $258,000 decreasein accrued royalties payable; $84,000 increase in accrued sales commissionspayable; $249,000 decrease in accrued payroll payable; $2,000 increase in otheraccrued expenses; and, $182,000 decrease in minimum royalties payable. The decrease intrade accounts payable relate to the differences between the nature and timingof payments, and the decreases in accrued royalties payable and salescommissions payable relate to a corresponding decrease in net sales between thecomparative three month periods ended December 31, 2008 and 2007, ascorrected. At December 31,2007, accrued payroll expenses included $40,000 in severance and othercompensation payable to our former chief executive officer and $80,000 inseverance and other compensation payable to our former regional sales managers.Accrued severance and other compensation was $0 at December 31, 2008. Theformer chief executive officer received severance compensation through March 2008and one of our former regional sales managers received severance compensationthrough August 2008. Changes in our total liabilities used operating cashof $244,000 and $603,000 for the six-month periods ended December 31, 2008and 2007, as corrected, respectively.

 

Due to thecombination of the factors discussed above, and others, during the six monthsended December 31, 2008, our operating activities used cash of $1,368,000.Comparatively, during the six months ended December 31, 2007, ouroperating activities used cash of $1,783,000.

 

For the six monthsended December 31, 2008, investing activities provided cash of $159,000,primarily from the maturity of a marketable security. Comparatively, for thesix months ended December 31, 2007, investing activities used cash of$3,000. During the six months ended December 31, 2008 and 2007, weexpended $41,000 and $3,000, respectively, for the purchase of property andequipment, and $91,000 and $106,000, respectively, in depreciation andamortization was charged to current operations.

 

In September 2007,we entered into a business loan agreement with Bank of Oklahoma N.A. (“Bank ofOklahoma”), which was amended in October 2008. The amended business loanagreement, which expires

 

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on September 30,2009, provides for a maximum loan amount of $3,000,000, collateralized bydeposit amounts maintained at Bank of Oklahoma or its affiliates. While themaximum principal amount allowed under the business loan agreement is$3,000,000, the Company may not borrow amounts under the business loanagreement in excess of the combined amounts of its collateralized deposits. Wehad no collateralized deposits, and therefore had no borrowing availabilityunder the business loan agreement, at December 31, 2008. Borrowings underthe business loan agreement accrue interest at the Bank of Oklahoma Financial (“BOKF”)National Prime Rate less 1.500%. We generally entered intothe business loan agreement to facilitate the issuance of letters of credit forinventory purchases from offshore suppliers. We did not have any balances dueon the business loan agreement at December 31, 2008, or June 30,2008, respectively. Outstandingletters of credit reduce the amount available for borrowing under the businessloan agreement. At December 31, 2008, and June 30, 2008, we hadoutstanding letters of credit of $0 and $1,144,000, respectively, issuedthrough Bank of Oklahoma for purchase obligations under outstanding letters ofcredit.

 

In May 2008, we amended the revolving line of credit agreementthat we maintained with US Bank National Association (“US Bank”) for the pastseveral years. The amended revolving line of credit agreement, which expired onDecember 5, 2008, provided for a maximum loan amount of $200,000,collateralized by a certificate of deposit held at US Bank in the amount of$200,000, which earned a market rate of interest. Borrowings under the amendedline of credit agreement accrued interest at 1.250% plus the one-month LIBORrate. At December 5, 2007, the line of credit had previously been amendedto provide for a maximum loan amount of $2,000,000, collateralized by acertificate of deposit held at US Bank in the amount of $2,000,000. Wegenerally maintained the line of credit to facilitate the issuance of lettersof credit for inventory purchases from offshore suppliers and, if necessary, tofund any temporary working capital needs. We did not have any balances due onthe line of credit at December 31, 2008, or June 30, 2008,respectively. Outstanding letters of credit reduced the amount available forborrowing under the line of credit agreement. At December 31, 2008, and June 30,2008, we had outstanding letters of credit of $0 and $0, respectively, issuedthrough US Bank for purchase obligations under outstanding letters of credit.

 

 RESULTS OF OPERATIONS

 

Total net sales for the three months ended December 31, 2008, were$3,225,000, a decrease of $1,186,000, or 27%, from total net sales of$4,411,000 for the three months ended December 31, 2007, primarily due toa decrease in net sales of fashion apparel as explained below. Net sales offashion apparel for the three months ended December 31, 2008, were$3,225,000, a decrease of $1,160,000, or 26%, from net sales of fashion apparelof $4,385,000 for the three months ended December 31, 2007. Net sales ofbranded apparel for the three months ended December 31, 2008 and 2007, ascorrected, were $0 and $26,000, respectively. Our net sales for the three months ended December 31, 2008 and2007, respectively, also include embroidery and shipping revenues.

 

Total net sales for the six months ended December 31, 2008, were$6,049,000, a decrease of $1,890,000, or 24%, from total net sales of$7,939,000 for the six months ended December 31, 2007, primarily due to adecrease in net sales of fashion apparel as explained below. Net sales offashion apparel for the six months ended December 31, 2008, were$6,049,000, a decrease of $1,744,000, or 22%, from net sales of fashion apparelof $7,793,000 for the six months ended December 31, 2007. Net sales ofbranded apparel for the six months ended December 31, 2008 and 2007, ascorrected, were $0 and $146,000, respectively. Our net sales for the six months ended December 31, 2008 and 2007,respectively, also include embroidery and shipping revenues.

 

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**SPORT-HALEY, INC.****ITEM 2MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Our consolidatedgross margins may not be comparable to other companies within the golf apparelindustry. We have consistently included the cost of merchandise sold, includingimport charges, in-bound freight, allocated overhead, freight out, embroiderycosts and other charges in our cost of goods sold. Our overhead allocationincludes our production costs plus a portion of our distribution costs, such asreceiving and inspection costs, but we include some of the other costs ofdistribution, such as a portion of our warehousing and other handling costs, inselling, general and administrative expenses. Our gross margins also include,on a consolidated basis, the operations of Reserve Apparel, which distributedTop-Flite® branded apparel until November 2007 to the mass retail marketat much lower price points and gross margins than those expected to be achievedin the premium and mid-price markets where we distribute our SPORT HALEY® andBen Hogan® fashion apparel brands. Other fashion apparel companies within thegolf industry may or may not also operate within the lower price markets. Weinclude royalty payments, relating to sales of licensed apparel, in selling,general and administrative expenses.

 

*Fashion apparel*

 

Our fashion apparel business is seasonal in nature, and sales occurringfrom January through June, which comprise our third and fourth quarters ofeach fiscal year, are generally disproportionately higher than sales occurringfrom July through December.

 

Net sales of fashion apparel for the three months ended December 31,2008, were $3,225,000, a decrease of $1,160,000, or 26%, from net sales offashion apparel of $4,385,000 for the three months ended December 31,2007. Net sales of fashion apparel for the six months ended December 31,2008, were $6,049,000, a decrease of $1,744,000, or 22%, from net sales offashion apparel of $7,793,000 for the six months ended December 31, 2007.The decrease in sales of fashion apparel for the comparative three-month andsix-month periods was primarily comprised of decreases in sales of SPORT HALEY®and Ben Hogan® fashion apparel between the respective periods. Net sales of ourSPORT HALEY® fashion apparel collections were $2,079,000 and $2,169,000 for thethree months ended December 31, 2008 and 2007, respectively, a decrease of$90,000, or 4%, and were $3,542,000 and $3,749,000 for the six months ended December 31,2008 and 2007, respectively, a decrease of $207,000, or 6%. Net sales of ourBen Hogan® fashion apparel collections were $1,059,000 and $2,086,000 for thethree months ended December 31, 2008 and 2007, respectively, a decrease of$1,027,000, or 49%, and were $2,321,000 and $3,788,000 for the six months endedDecember 31, 2008 and 2007, respectively, a decrease of $1,467,000, or39%. The remainder of our fashion apparel net sales for the three months andsix months ended December 31, 2008 and 2007, were comprised of embroideryand shipping revenues. We consider the weakening United States economy to be alarge contributing factor to the decrease in our fashion apparel sales. Webelieve that our SPORT HALEY® fashion apparel brand may be better positioned tomaintain market share in weak economic times than our Ben Hogan® fashion apparelbrand, which is subject to greater competition within the country club andresort markets in which we primarily operate. Historically, the country cluband resort markets have preferred to sell high-quality apparel that was notwidely distributed within other retail markets. However, the broad marketacceptance of major apparel brands such as Nike, Adidas and Under Armour, whichare primarily comprised of performance fabrics and are globally distributedinto numerous markets other than country clubs and resorts, appear to havediluted the value associated with the exclusivity of fashion apparel brandssuch as Ben Hogan®. We consider Ben Hogan® fashion apparel, which is marketedin accordance with a licensing agreement we maintain with Callaway for such apparel,to be a key component of our fashion apparel business, and we have continued tofocus our marketing efforts with regard to Ben Hogan® fashion apparel onincreasing our market presence in upscale retail stores and on penetratingfurther into corporate markets, in order to

 

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bolster future sales. Over the past year, we have introduced Ben Hogan®fashion apparel to a few upscale retail stores and we have continued to searchfor ways to increase our presence in the corporate market, but net sales to datehave not been significant within either of those markets.

 

Gross profit with regard to our fashion apparel is generally affectedby sales discounts offered to customers in accordance with various marketingprograms, payment discounts offered to certain customers, dispositions ofexcess inventories at reduced sales prices and the valuation of excessinventories to the lower of cost or market. The disposition of excessinventories negatively impacts our gross profit percentage even when suchinventories are properly valued to the lower of cost or market, because suchvaluation causes sales to be recorded with gross profit at or near zero. We believe that the recent significantdownturn in the United States economy negatively impacted the value of ourexcess fashion apparel inventories, and we reduced the carrying value of ourexcess fashion apparel inventories accordingly. For the three months ended December 31,2008, we recorded net sales of $88,000 and loss of $11,000, with regard to thedisposition of excess fashion apparel inventories. For the six months ended December 31,2008, we recorded net sales of $131,000 and loss of $9,000, with regard to thedisposition of excess fashion apparel inventories. For the three monthsand six months ended December 31, 2007, we recorded net sales of $295,000and gross profit of $0 with regard to the disposition of excess fashion apparelinventories. For the three months and six months ended December 31, 2008,we recorded impairments of $53,000 and $331,000, respectively, with regard tothe valuation of excess fashion apparel inventories to the lower of cost ormarket. Comparatively, for the three months and six months ended December 31,2007, we recorded impairments of $0 and $154,000, respectively, with regard tothe valuation of excess fashion apparel inventories to the lower of cost ormarket. As percentage of net sales, gross profit of our fashion apparel, was32% and 30% for the three months and six months ended December 31, 2008,and was 41% and 38% for the three months and six months ended December 31,2007, as corrected, respectively.

 

Selling, general and administrative expenses with regard to fashionapparel decreased by $371,000, or 23%, to $1,248,000 for the three months endedDecember 31, 2008, from $1,619,000 for the comparable three-month periodin the prior fiscal year. Selling, general and administrative expenses withregard to fashion apparel decreased by $412,000, or 13%, to $2,831,000 for thesix months ended December 31, 2008, from $3,243,000 for the comparablesix-month period in the prior fiscal year. The decrease between the comparativesix-month periods was generally comprised of increases in advertising,tradeshow and legal and other expenses that were more than offset by decreasesin personnel costs due to layoffs and job eliminations, sales commissions oncorrespondingly lower sales and less significant decreases in various otherexpenses. As a percentage of net sales, selling, general and administrativeexpenses with regard to our fashion apparel were 39% and 47%, for the threemonths ended December 31, 2008, and were 37% and 42%, for the six monthsended December 31, 2007, as corrected, respectively.

 

We recorded royalty expense of $1,000 and$142,000 for the three months, and $156,000 and $268,000, for the six monthsended December 31, 2008 and 2007, respectively. The decrease in royaltyexpense was attributable to a corresponding decrease in sales of Ben Hogan® fashionapparel for the comparative periods and to the reversal of our September 2008accrual for minimum royalties. Royaltyexpense is due to Callaway in accordance with the license they previouslygranted us to market men’s fashion apparel bearing the Ben Hogan® label. In February 2009,we renegotiated certain terms of the license agreement with Callaway, wherebyminimum royalties due for 2008 were reduced to $350,000. Because sales of BenHogan® apparel generated royalties in excess of $350,000 for 2008, at December 31,2008, we

 

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reversed the contingent liability of$164,000, which we had recorded as of September 30, 2008, by reducingroyalty expense by $84,000 and recording other income of $80,000.

 

Loss from operations with regard to fashionapparel for the three months ended December 31, 2008, was ($215,000), adifference of ($211,000), or 5,275%, from ($4,000) for the comparablethree-month period in the prior fiscal year, as corrected. Loss from operationswith regard to fashion apparel for the six months ended December 31, 2008,was ($1,183,000), a difference of ($552,000), or 87%, from ($631,000) for thecomparable six-month period in the prior fiscal year, as corrected.

 

*Branded apparel*

 

We previously considered Top-Flite® branded apparel, which we marketedpursuant to our licensing agreement with Callaway for such apparel, to be a keycomponent in our business strategies, designed to return the Company tosustained profitability. We marketed Top-Flite® branded apparel to Wal-Mart andother mass retailers and big-box type high sales volume retail stores from November 2005to November 2007. Net sales of Top-Flite® branded apparel of $26,000 and$146,000 for the three months and six months ended December 31, 2007, werecomprised of shipments to a retailer for a test in 50 of its stores. Since ourconcerted efforts failed to generate orders from a major customer, wediscontinued marketing apparel bearing the Top-Flite® label in November 2007, and in March 2008 the licenseagreement with Callaway was amended to remove the Top-Flite® brand, effective January 1,2008.

 

Ourdistribution of Top-Flite® branded apparel to the mass retail market generallygenerated gross margins lower than those expected to be achieved in the premiumand mid-price markets where we distribute our SPORT HALEY® and Ben Hogan®fashion apparel brands. Wholesale prices are generally expected to be muchlower for branded apparel than for higher quality fashion apparel, and grossmargins are also expected to be lower for branded apparel than for fashionapparel. Other companies within the golf apparel industry may or may notoperate within the lower-price branded apparel markets. As a percentage of netsales, gross margins with respect to net sales of branded apparel were (77%)and 3% for the three months and six months ended December 31, 2007.

 

Selling,general and administrative expenses were $4,000 with regard to branded apparelfor the three months ended December 31, 2008, a decrease of $23,000, or85%, from $27,000 for the three months ended December 31, 2007. Selling,general and administrative expenses were $41,000 with regard to branded apparelfor the six months ended December 31, 2008, a decrease of $87,000, or 68%,from $128,000 for the three months ended December 31, 2007. The decreasein selling, general and administrative expenses was primarily due to thediscontinuance of our marketing efforts with regard to Top-Flite® brandedapparel in November 2007. Selling, general and administrative expenses forthe three months and six months ended December 31, 2008, primarilyconsisted of legal expenses with regard to the September 2008 trial of alawsuit we previously filed against a former inventory broker. As a percentageof net branded apparel sales, related selling, general and administrativeexpenses were  0% and 0%, for the threemonths ended December 31, 2008, and were 104% and 88%, for the six monthsended December 31, 2007, as corrected, respectively.

 

Royalty expense was due to Callaway through December 31,2007, in accordance with the license they previously granted us to marketbranded apparel bearing the Top-Flite® label. We recorded royalty expense of $0and $0 for the three months ended December 31, 2008, and we recordedroyalty expense of $4,000 and $11,000 for the six months ended December 31,2007, with respect to net sales of branded apparel.

 

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**SPORT-HALEY, INC.****ITEM 2MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Loss from operations with regard to branded apparelwas ($4,000) and ($41,000) for the three months and six months ended December 31,2008, differences of $47,000, or 92%, and $93,000, or 69%, from ($51,000) and($134,000) for the three months and six months ended December 31, 2007,respectively.

 

*Other income*

 

Other income, net, was $77,000 for the threemonths ended December 31, 2008, an increase of $45,000, or 141%, from$32,000 for the three months ended December 31, 2007, as corrected. Otherincome, net, was $44,000 for the six months ended December 31, 2008, adecrease of $36,000, or 45%, from $80,000 for the six months ended December 31,2007, as corrected. Other income, net, generally consisted of interest earnedon cash and cash equivalent balances held at various financial institutions,interest due on customs duties owed with regard to our Prior Disclosure, thatwe submitted to US Customs and Border Protection in November 2008, andother miscellaneous income. The increase for the comparable three-month periodswas generally attributable to our lower balance of cash and cash equivalentsduring the respective periods plus the accrual during the three months ended December 31,2008, of $12,000 in accrued interest due with regard to our Prior Disclosurecombined with the reversal of $80,000 at December 31, 2008, for minimumroyalties that had been accrued at June 30, 2008, with regard to our BenHogan® apparel sales. The decrease for the comparable three-month periods wasgenerally attributable to our lower balance of cash and cash equivalents duringthe respective periods plus the accrual during the six months ended December 31,2008, of $62,000 in accrued interest due with regard to our Prior Disclosure.

 

*Net Loss*

 

Net loss for the three months ended December 31,2008, was ($142,000), a difference of ($119,000), or 517%, as compared with thenet loss of ($23,000) for the three months ended December 31, 2007, ascorrected. Net loss for the six months ended December 31, 2008, was($1,182,000), a difference of ($490,000), or 71%, as compared with the net lossof ($692,000) for the six months ended December 31, 2007, as corrected. Wehad federal and state net operating loss carry forwards of $8,813,000 and$10,750,000 at December 31, 2008, that we estimated may be recoverable atincome tax rates of 34% and 5%, respectively. In accordance with SFAS 109and based upon a review at December 31, 2008, of our utilization ofdeferred tax assets, we maintained a valuation allowance that effectivelyreduces our net deferred tax assets to zero. We continue to explore variousstrategies to return the Company to profitability, including maintaining marketshare for our SPORT HALEY® fashion apparel and recovering market share for ourBen Hogan® fashion apparel within our core business of resort and country clubmarkets, as well as expanding our SPORT HALEY® and Ben Hogan® fashion appareldistribution channels deeper into retail and corporate markets. However, wecannot be certain that our efforts will result in the generation of futureprofits sufficient to offset our significantnet operating loss carry forwards prior to their expirations. Accordingly, wedid not record benefits from income taxes associated with the correspondinglosses for the respective three-month  orsix-month periods ended December 31, 2008.

 

*Earnings (loss) per share*

 

Basicand diluted losses per common share were ($0.06) and ($0.01) for thethree-month periods ended December 31, 2008 and 2007, as corrected,respectively. Basic and diluted losses per common share were ($0.52) and($0.30) for the six-month periods ended December 31, 2008 and 2007, ascorrected,

 

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respectively.All securities options were anti-dilutive and therefore excluded from the pershare calculations with respect to periods in which net losses were incurred.

 

*Book value*

 

Ourbook value per common share was $3.94 at December 31, 2008, $4.46 at June 30,2008, and $4.72 at December 31, 2007, as corrected.

 

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**SPORT-HALEY, INC.ITEM 4 CONTROLS AND PROCEDURES**

 
| **(a)** | **Evaluation  of Disclosure Controls and Procedures** |
|---------|-------------------------------------------------------|

 

We designed ourdisclosure controls and procedures to provide reasonable assurance of achievingour desired disclosure control objectives. We maintain disclosure controls andprocedures to ensure that information required to be disclosed in the reportswe file pursuant to the Securities Act of 1934, as amended (the “Exchange Act”),are recorded, processed, summarized and reported within the time periodsspecified in the rules and forms of the Securities and ExchangeCommission, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and our Chief FinancialOfficer as appropriate, to allow timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,management recognizes that any control and procedure, no matter how welldesigned and operated, can only provide reasonable assurance of achieving thedesired control objectives, and in reaching a reasonable level of assurancemanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible disclosure controls and procedures.

 

Our management, with the participation of our ChiefExecutive Officer and our Chief Financial Officer, conducted an evaluation ofthe effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15under the Exchange Act as of the end of the period covered by this report.Based on that evaluation, management, including our Chief Executive Officer andour Chief Financial Officer, concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were effective inreaching a reasonable level of assurance that: (a) all materialinformation relating to the Company, required to be disclosed in this report,was made known to management in a timely manner; and (b) information wasrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and regulations.

 
| **(b)** | **Changes  in Internal Controls Over Financial Reporting** |
|---------|------------------------------------------------------------|

 

Our management,including our Chief Executive Officer and our Chief Financial Officer, does notexpect that our internal controls over financial reporting will, in allinstances, prevent all errors and all fraud. A control system, no matter howwell conceived or operated, can only provide reasonable, not absolute,assurance that the objectives of the control system are met. While our controlsystems provide a reasonable assurance level, the design of our control systemsreflects the fact that there are resource constraints, and the benefits of suchcontrols were considered relative to their costs. Because of the inherent limitationsin all control systems, no evaluation of controls can provide absoluteassurance that all control issues and instances of fraud, if any, within thefinancial reports of Sport-Haley, Inc. have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty, and that breakdowns can occur because of simple errors or mistakes.Additionally, a control can be circumvented by the individual act of someperson, by collusion of two or more persons, or by management’s override of aspecific control. The design of any system of controls is also based in part oncertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

As previously reported, during fiscal 2008, under thesupervision of our Chief Executive Officer and our Chief Financial Officer, wecompleted the design, documentation and implementation of our internal controlsover financial reporting. We believe that we have purposely designed ourcontrols to provide reasonable assurance regarding the reliability of ourfinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted

 

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accounting principles. However, the Company was not incompliance with Section 404 of the Sarbanes-Oxley Act of 2002, as of June 30,2008, and management could not state whether or not our internal controls overfinancial reporting are effective. We began testing our controls by utilizingthe framework set forth in the report entitled *“InternalControl — Integrated Framework”* published by the Committee ofSponsoring Organizations of the Treadway Commission, known as “COSO,” as abasis to evaluate the effectiveness of our internal controls over financialreporting, but did not complete the detailed testing of all our controls by June 30,2008. Further, as previously reported, in August 2008, we became awarethat our controls were ineffective to prevent the underpayment of customsduties on certain of our imports of fashion apparel purchased from foreignsuppliers. We discovered that we were underpaying import duties with regard tofashion apparel received from foreign suppliers for which fabric had beenpurchased from another foreign supplier, because the information received byour customs agent had failed to include the value of the fabric in the totaldeclared value of the apparel. We determined that the underpayment of customsduties revealed a significant deficiency in our internal controls overfinancial reporting, and in September 2008 our remediation proceduresincluded designing and implementing specific internal controls to ensure thatour customs broker receives complete and accurate information to compute thecorrect value to be declared for import customs valuations. In January 2009,we completed the design of a plan to test all of our controls over financialreporting by April 2009.

 

Except as noted above, there have been no significantchanges in our internal controls over financial reporting, as defined in Rules 13a-15(f) or15d-15(f) under the Exchange Act, during the three months ended December 31,2008, that materially affected, or are reasonably likely to materially affect,our internal controls over financial reporting.

 

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**SPORT-HALEY, INC.PART IIOTHER INFORMATION**

 
| **ITEM****1** | **LEGAL PROCEEDINGS** |
|---------------|-----------------------|

### ** **

As previously reported, in March 2007, SportHaley and Reserve Apparel (the “Plaintiffs”) filed a lawsuit in the DistrictCourt for the City and County of Denver in the State of Colorado. The suitalleged, among other things, that a former inventory broker to Reserve Apparel,1130746 Ontario Ltd., a Canadian corporation incorporated in the Province ofOntario, Canada, d/b/a Originals Apparel Group Co., or Originals Apparel Group,and Francis Tat-Mo Chan (the “Defendants”), knowingly, wrongfully and withoutauthorization converted Plaintiff’s funds. At the conclusion of the trial in September 2008,the Court awarded judgment in the Plaintiff’s favor and against the Defendants,jointly and severally, in the amount of $291,135. On November 4, 2008, theDefendants filed an appeal of the District Court’s judgment in the ColoradoCourt of Appeals, citing various issues proposed to be raised on appeal. Theappeal is pending. At this time, we cannot determine whether the Court ofAppeals will affirm or reverse, in whole or in part, the District Court’sjudgment.

 
| **ITEM****1****A** | **RISK FACTORS** |
|--------------------|------------------|

### ** **

There have been no material changes from the riskfactors previously disclosed in Item 1A of our annual report on Form 10-Kfor the year ended June 30, 2008.

 
| **ITEM****5** | **OTHER INFORMATION** |
|---------------|-----------------------|

### ** **

(a)                As previously reported, we received aletter from the Nasdaq Stock Market, Inc. (“Nasdaq”), dated November 14,2008, notifying us of Nasdaq’s position that the Company is not in compliancewith the rules for continued listing on the Nasdaq Capital Market,specifically Nasdaq Marketplace Rule 4310(c)(14), because our annualreport on Form 10-K for the year ended June 30, 2008, did not containa completed management report on internal controls over financial reporting asrequired by Section 404 of the Sarbanes-Oxley Act of 2002. As initiallyreported in our Form 10-K, while we began testing our internal controls,we did not complete the detailed testing of our internal controls overfinancial reporting by June 30, 2008. Therefore, Nasdaq advised that,pursuant to Nasdaq rules, the Company was provided with 60 calendar days, oruntil January 13, 2009, to submit a plan to regain compliance. Nasdaqadvised us, that following review of our plan by the Nasdaq staff (“Staff”),the Staff may grant us an exception, up to 180 days from the due date of ournoncompliant Form 10-K, or until April 13, 2009, to regaincompliance. On January 13, 2009, we provided Nasdaq with our plan toregain compliance, including detailed examples of tests to be performed on ourinternal controls over financial reporting. We received a letter from Nasdaq,dated February 10, 2009, notifying us that the Staff had reviewed our planto regain compliance and that the Company had been granted an extension until April 13,2009, to complete the detailed testing of all of our controls over financialreporting and to file an amended Form 10-K for the year ended June 30,2008. In the event we do not complete the testing and file the amended Form 10-Kby April 13, 2009, the Nasdaq letter further advised that the Staff wouldprovide written notification that our securities would be delisted. We expectto complete the testing and file the amended Form 10-K by the extensiondeadline of April 13, 2009.

 

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**SPORT-HALEY, INC.PART IIOTHER INFORMATION**

 

                              On February 18, 2009, we reached anagreement with Callaway to amend the terms of our license agreement with them.Terms of the amendment provide us with non-exclusive licenses to develop,manufacture, market and distribute golf apparel bearing the Ben Hogan® and TourEdition® trademarks through December 31, 2013, providing that Callaway mayterminate the agreement upon 60 days advance written notice. The amendment alsoprovides for substantial reductions in the minimum annual royalty requirementsfor calendar years 2008 through 2013. Based upon the reduced annual minimumroyalty requirement for calendar 2008, we reversed the $164,000 contingentliability that we had recorded as of September 31, 2008, by reducing royalty expense by $84,000 and recording other income of$80,000 at December 31,2008. A copy of the amendment, with certain portions omitted pursuant to aRequest for Confidential Treatment, is attached as Exhibit 10.3.9 and isincorporated herein by this reference.

 

(b)               During the second quarter of fiscal 2009, we made nomaterial changes to the procedures by which our shareholders may recommendnominees to our Board of Directors.

 
| **ITEM****6** | **EXHIBITS** |
|---------------|--------------|

### ** **

*Exhibit 10.3.9— Amendment No. 1, dated February 18, 2009, to License Agreement,dated May 27, 2008, between Callaway Golf Company and Sport-Haley, Inc.

 

Exhibit 31.1 —Certification of Donald W. Jewell pursuant to Exchange Act Rule 13a-14(a)/15d-14(a)

 

Exhibit 31.2 —Certification of Patrick W. Hurley pursuant to Exchange Act Rule 13a-14(a)/15d-14(a)

 

Exhibit 32.1 —Certifications of Donald W. Jewell and Patrick W. Hurley pursuant to 18 U.S.C.§1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002

 

*Certainconfidential portions of this Exhibit were omitted by means of redacting aportion of the text where indicated. This exhibit, including the omittedportions, has been filed separately with the Secretary of the Securities andExchange Commission pursuant to an application requesting confidentialtreatment under Rule 24b-2 of the Securities Exchange Act of 1934.

 

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**SPORT-HALEY, INC.SIGNATURES**

 

In accordance withthe requirements of the Securities Exchange Act of 1934, the Registrant causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| ** ** | ** **              | ** ** | ** ** | ** ** | **SPORT-HALEY,  INC.**                          |
|------------|-------------------------|------------|------------|------------|-------------------------------------------------|
|       |                    |       |       |       | (Registrant)                                    |
|       |                    |       |       |       |                                            |
| Date:      | February 19,  2009 |       |       |       | /s/ PATRICK W.  HURLEY                          |
|       |                    |       |       |       | Patrick W.  Hurley                              |
|       |                    |       |       |       | Chief Financial  Officer                        |
| * *   | * *                | * *   | * *   | * *   | *(Principal  Financial and Accounting Officer)* |

 

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