** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**x**** QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d)****OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2007**

 

**o**** TRANSITION REPORT UNDER SECTION 13 OR15(d) OF THE****E****XCHANGE 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 80216-3215**

(Address ofprincipal executive offices)

 

**(303)320-8800**

(Issuer’stelephone number including area code)

 

Indicate by check mark whether the registrant (1)filed all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes  x   No  o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and non-acceleratedfiler” in Rule 12b-2 of the Exchange Act.

Largeaccelerated filer   o                                            Acceleratedfiler   o                                            Non-acceleratedfiler   x

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act. Yes  o   No  x

 

Indicatethe number of shares outstanding in each of the issuer’s classes of commonstock, as of the latest practicable date.

 

| **Class**                      | ** ** | **Outstanding at November 9, 2007** |
|--------------------------------|------------|-------------------------------------|
| **Common Stock, no par value** | ** ** | **2,284,490**                       |

 

 

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

 
| **PART 1 –FINANCIAL INFORMATION  (UNAUDITED)** |                                                                                        |
|-----------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                                |                                                                                        |   |
| ITEM  1                                             | CONDENSED CONSOLIDATED  FINANCIAL STATEMENTS                                                |   |
|                                                |                                                                                        |   |
|                                                | CONDENSED  CONSOLIDATED BALANCE SHEETS                                                      |   |
|                                                |                                                                                        |   |
|                                                | CONDENSED  CONSOLIDATED STATEMENTS OF OPERATIONS                                            |   |
|                                                |                                                                                        |   |
|                                                | CONDENSED  CONSOLIDATED STATEMENTS OF CASH FLOWS                                            |   |
|                                                |                                                                                        |   |
|                                                | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                        |   |
|                                                |                                                                                        |   |
| ITEM 2                                              | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |
|                                                |                                                                                        |   |
| ITEM 3                                              | QUALITATIVE  AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK                                 |   |
|                                                |                                                                                        |   |
| ITEM 4                                              | CONTROLS AND  PROCEDURES                                                                    |   |
|                                                |                                                                                        |   |
| **PART II  - OTHER INFORMATION**                    |                                                                                        |
|                                                |                                                                                        |   |
| ITEM 1                                              | LEGAL PROCEEDINGS                                                                           |   |
|                                                |                                                                                        |   |
| ITEM 1A                                             | RISK FACTORS                                                                                |   |
|                                                |                                                                                        |   |
| ITEM 5                                              | OTHER INFORMATION                                                                           |   |
|                                                |                                                                                        |   |
| ITEM 6                                              | EXHIBITS                                                                                    |   |
|                                                |                                                                                        |   |
| **SIGNATURES**                                      |                                                                                        |
|                                                |                                                                                        |   |
| **EXHIBITS**                                        |                                                                                        |   |
|                                                |                                                                                        |   |
| 31.1                                                | CERTIFICATION OF DONALD  W. JEWELL                                                          |   |
|                                                |                                                                                        |   |
| 31.2                                                | CERTIFICATION OF  PATRICK W. HURLEY                                                         |   |
|                                                |                                                                                        |   |
| 31.1                                                | CERTIFICATIONS OF  DONALD W. JEWELL AND PATRICK W. HURLEY                                   |   |

 

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**SPORT-HALEY, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                         | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                                         | ** ** | **2007**               | ** ** | **2007**          | ** ** |
| ** **                                                                                         | ** ** | **(Unaudited)**        | ** ** | **(***)**         | ** ** |
| **ASSETS**                                                                                         |       |                   |       |              |       |
|                                                                                               |       |                   |       |              |       |
| Current assets:                                                                                    |       |                   |       |              |       |
| Cash and cash  equivalents                                                                         |       | $                      | 3,137,000  |              | $          | 4,464,000 |   |
| Accounts  receivable, net of allowances of $387,000 and $374,000, respectively                     |       | 2,517,000              |       | 3,066,000         |       |
| Inventories                                                                                        |       | 6,729,000              |       | 5,814,000         |       |
| Prepaid expenses  and other                                                                        |       | 355,000                |       | 203,000           |       |
| Total current  assets                                                                              |       | 12,738,000             |       | 13,547,000        |       |
|                                                                                               |       |                   |       |              |       |
| Property and  equipment, net                                                                       |       | 345,000                |       | 399,000           |       |
| Other assets                                                                                       |       | 3,000                  |       | 3,000             |       |
|                                                                                               |       |                   |       |              |       |
|                                                                                               |       | $                      | 13,086,000 |              | $          | 13,949,000 |   |
|                                                                                               |       |                   |       |              |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                      | ** ** | ** **             | ** ** | ** **        | ** ** |
| ** **                                                                                         | ** ** | ** **             | ** ** | ** **        | ** ** |
| Current  liabilities:                                                                              |       |                   |       |              |       |
| Notes payable                                                                                      |       | $                      | 400,000    |              | $          | — |   |
| Accounts payable                                                                                   |       | 1,134,000              |       | 1,566,000         |       |
| Accrued  royalties payable                                                                         |       | 126,000                |       | 181,000           |       |
| Accrued  commissions payable                                                                       |       | 144,000                |       | 214,000           |       |
| Accrued payroll                                                                                    |       | 167,000                |       | 249,000           |       |
| Other                                                                                              |       | 182,000                |       | 179,000           |       |
| Total current  liabilities                                                                         |       | 2,153,000              |       | 2,389,000         |       |
|                                                                                               |       |                   |       |              |       |
| Commitments and  Contingencies:                                                                    |       |                   |       |              |       |
| Minimum  royalties payable                                                                         |       | 178,000                |       | 178,000           |       |
| Total contingent  liabilities                                                                      |       | 178,000                |       | 178,000           |       |
|                                                                                               |       |                   |       |              |       |
| Total  Liabilities                                                                                 |       | 2,331,000              |       | 2,567,000         |       |
|                                                                                               |       |                   |       |              |       |
| 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                                                                                 |       | 653,000                |       | 1,280,000         |       |
| Total  shareholders’ equity                                                                   |       | 10,755,000             |       | 11,382,000        |       |
|                                                                                               |       |                   |       |              |       |
|                                                                                               |       | $                      | 13,086,000 |              | $          | 13,949,000 |   |

 

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***  Taken from the audited balance sheet at thatdate

 

See accompanyingnotes to these condensed consolidated financial statements.

 

3

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**SPORT-HALEY, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                                            | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                            | ** ** | **September 30,**           | ** ** |
| ** **                                                                            | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                                                                            | ** ** | **(Unaudited)**                  | ** ** | **(Unaudited)** | ** ** |
|                                                                                  |       |                             |       |   |   |
| Net sales                                                                             |       | $                                | 3,528,000  |   | $ | 4,673,000 |   |
|                                                                                  |       |                             |       |   |   |
| Cost of goods  sold                                                                   |       | 2,191,000                        |       | 3,122,000 |   |
| Impairments                                                                           |       | 154,000                          |       | 49,000 |   |
| Total cost of  goods sold                                                             |       | 2,345,000                        |       | 3,171,000 |   |
|                                                                                  |       |                             |       |   |   |
| Gross profit                                                                          |       | 1,183,000                        |       | 1,502,000 |   |
|                                                                                  |       |                             |       |   |   |
| Other Operating  Costs:                                                               |       |                             |       |   |   |
| Selling, general  and administrative expenses                                         |       | 1,725,000                        |       | 1,721,000 |   |
| Royalty expense                                                                       |       | 126,000                          |       | 210,000 |   |
| Total other  operating costs                                                          |       | 1,851,000                        |       | 1,931,000 |   |
|                                                                                  |       |                             |       |   |   |
| Loss from  operations                                                                 |       | (668,000                         | )          | (429,000 | ) |
|                                                                                  |       |                             |       |   |   |
| Other income,  net                                                                    |       | 48,000                           |       | 78,000 |   |
|                                                                                  |       |                             |       |   |   |
| Loss before  minority interest in subsidiary net income and benefit from income taxes |       | (620,000                         | )          | (351,000 | ) |
|                                                                                  |       |                             |       |   |   |
| Minority  interest in subsidiary net income                                           |       | —                           |       | (46,000 | ) |
|                                                                                  |       |                             |       |   |   |
| Provision for  income taxes                                                           |       | 7,000                            |       | — |   |
|                                                                                  |       |                             |       |   |   |
| Net loss                                                                              |       | $                                | (627,000   | ) | $ | (397,000 | ) |
|                                                                                  |       |                             |       |   |   |
| Basic and  diluted loss per common share                                              |       | $                                | (0.27      | ) | $ | (0.14 | ) |
|                                                                                  |       |                             |       |   |   |
| Basic and  diluted weighted average shares outstanding                                |       | 2,284,000                        |       | 2,770,000 |   |

 

See accompanyingnotes to these condensed consolidated financial statements.

 

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**SPORT-HALEY,INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**           | ** ** |
| ** **                                                                   | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                                                                   | ** ** | **(Unaudited)**                  | ** ** | **(Unaudited)** | ** ** |
| **Cash  flows from operating activities:**                                   |       |                             |       |   |   |
| Net loss                                                                     |       | $                                | (627,000   | ) | $ | (397,000 | ) |
| Adjustments to  reconcile net loss to net cash used by operating activities: |       |                             |       |   |   |
| Depreciation and  amortization                                               |       | 54,000                           |       | 76,000 |   |
| Impairments and  write-downs                                                 |       | 154,000                          |       | 49,000 |   |
| Allowance for  doubtful accounts                                             |       | 30,000                           |       | 30,000 |   |
| Minority  interest                                                           |       | —                           |       | 49,000 |   |
| Cash provided  (used) due to changes in assets and liabilities:              |       |                             |       |   |   |
| Accounts  receivable                                                         |       | 519,000                          |       | 907,000 |   |
| Inventory                                                                    |       | (1,069,000                       | )          | (630,000 | ) |
| Other assets                                                                 |       | (152,000                         | )          | (16,000 | ) |
| Accounts payable                                                             |       | (432,000                         | )          | (1,008,000 | ) |
| Accrued  commissions and other expenses                                      |       | (204,000                         | )          | (281,000 | ) |
| Net cash used by  operating activities                                       |       | (1,727,000                       | )          | (1,221,000 | ) |
|                                                                         |       |                             |       |   |   |
| **Cash  flows from investing activities:**                                   |       |                             |       |   |   |
| Purchase of  fixed assets                                                    |       | —                           |       | (1,000 | ) |
| Purchase of  minority interest                                               |       | —                           |       | (375,000 | ) |
| Net cash used by  investing activities                                       |       | —                           |       | (376,000 | ) |
|                                                                         |       |                             |       |   |   |
| **Cash  flows from financing activities:**                                   |       |                             |       |   |   |
| Borrowings under  line of credit                                             |       | 700,000                          |       | — |   |
| Repayments under  line of credit                                             |       | (300,000                         | )          | — |   |
| Net cash  provided by financing activities                                   |       | 400,000                          |       | — |   |
|                                                                         |       |                             |       |   |   |
| **Net  decrease in cash and cash equivalents**                               |       | (1,327,000                       | )          | (1,597,000 | ) |
|                                                                         |       |                             |       |   |   |
| **Cash  and cash equivalents, beginning**                                    |       | 4,464,000                        |       | 8,492,000 |   |
|                                                                         |       |                             |       |   |   |
| **Cash  and cash equivalents, ending**                                       |       | $                                | 3,137,000  |   | $ | 6,895,000 |   |
|                                                                         |       |                             |       |   |   |
| **Supplemental  disclosure of cash flow information:**                       |       |                             |       |   |   |
| Cash received  during the period for:                                        |       |                             |       |   |   |
| Income taxes                                                                 |       | $                                | —     |   | $ | — |   |
| Cash paid during  the period for:                                            |       |                             |       |   |   |
| Income taxes                                                                 |       | $                                | 7,000      |   | $ | — |   |

 

See accompanying notes tothese condensed consolidated financial statements.

 

5

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**SPORT-HALEY, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 1****                                      SIGNIFICANTACCOUNTING POLICIES**

 

*Principlesof Consolidation*– Our condensed consolidated financialstatements include the accounts of Sport-Haley, Inc. (“Sport Haley”) and ReserveApparel Group LLC (“Reserve Apparel”). Sport Haley and Reserve Apparel maycollectively be referred to as “the Company,” “we,” “us” or “our.” Allsignificant inter-company transactions between Sport Haley and Reserve Apparelhave been eliminated.

 

*Nature ofOperations*– Sport Haley, organized as a Coloradocorporation in January 1991, designs, purchases or contracts for themanufacture of, markets and distributes women’s and men’s fashion golf appareland outerwear under the SPORT HALEY® and Ben Hogan® labels. Our fashion golfapparel collections, known for their innovative designs, quality fabrics,generous fits and classic styles, are primarily marketed in the premium andmid-priced markets, through a network of independent sales representatives anddistributors, to golf professional shops, country clubs, resorts and exclusivedepartment stores within the United States and by certain distributors withinvarious international markets. Ben Hogan® fashion golf apparel is distributedper the terms of a license agreement with Callaway Golf Company (“Callaway”).

 

Reserve Apparel,formed in November 2005, designs, purchases or contracts for the manufactureof, markets and distributes branded golf apparel and outerwear under theTop-Flite® label to mass retailers and other big-box, high sales volume retailstores. Since September 2006 Reserve Apparel has been a wholly-owned subsidiaryof Sport Haley.

 

*CondensedConsolidated Financial Statements* - Our condensedconsolidated balance sheets and interim condensed consolidated statements ofoperations and cash flows include all adjustments (consisting only of normalrecurring items) necessary for their fair representation. The preparation ofconsolidated financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues and expenses and the disclosure of contingent assets and liabilities.

 

Certain informationin footnote disclosures normally included in financial statements has beencondensed or omitted in accordance with the rules and regulations of theSecurities 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, 2007, included in the Company’s filingon Form 10-K.

 

*Reclassification*– Certain priorperiod amounts have been reclassified to conform to the September 30, 2007,presentation. Such reclassifications had no affect on net income (loss) in anyof the periods presented.

 

*Stock-Based Compensation* - Our StockOption Plan (the “Plan”) expired by its terms on February 28, 2003. Optionagreements that were issued in accordance with the Plan prior to February 28,2003, 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.

 

6

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At September 30, 2007, therewere outstanding options to purchase 593,500 shares of our common stock atexercise prices ranging from $2.71 to $9.78 per share and expiration datesbetween November 2007 and January 2013. No options were exercised during thethree months ended September 30, 2007, and no options expired.

 

In December 2004, the Financial Accounting Standards Board issuedStatement of Financial Accounting Standards No. 123(R) (“SFAS 123R”), *“Share-Based Payment,”* which is a revision of Statement ofFinancial Accounting Standards No. 123 (“SFAS 123”), *“Accountingfor Stock-Based Compensation.”* SFAS 123R is effective for annualperiods beginning after July 1, 2005, supersedes Accounting Principles BoardOpinion No. 25 (“APB 25”), *“Accounting for StockIssued to Employees,”* and amends Statement of Financial AccountingStandards No. 95, *“Statement of Cash Flows.”* SFAS123R requires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the statement of operations basedupon their fair values and rescinds the acceptance of pro forma disclosure.SFAS 123R permits two methods of adoption, a “modified prospective” method anda “modified retrospective” method. Under the modified prospective method,stock-based compensation cost is recognized, beginning with the effective date,based on the requirements of SFAS 123R for all share-based payments grantedafter the effective date and for all awards granted prior to the effective datethat remain unvested on the effective date. The modified retrospective methodincludes the requirements of the modified prospective method and also permitsrestatement of prior periods based on amounts previously reported in pro formadisclosures pursuant to SFAS 123 for either all periods presented or for onlyprior interim periods of the year of adoption. We adopted the modifiedprospective method prescribed in SFAS 123R, effective July 1, 2005.

 

Prior to July1, 2005, we accounted for stock-basedcompensation using the intrinsic value method prescribed in APB 25 and relatedinterpretations and elected to apply the disclosure-only provisions of SFAS 123as amended by SFAS No. 148, “*Accounting forStock-Based Compensation – Transition and Disclosure*.” Under theintrinsic value method, compensation expense for stock options was recognizedover the vesting period of the grant based on the excess, if any, of the marketprice of our common stock at the date of grant over the stock option exerciseprice. As governed by the Plan, stock options were generally granted at or nearfair market value on the date of grant.

 

The Plan expired by its terms in February 2003.Accordingly, no options were granted since then. The expected life wasdetermined based upon the Plan’s vesting period and exercise behavior of theemployees.

 

Upon our adoption of the modified prospective methodprescribed in SFAS 123R, effective July 1, 2005, we recorded $31,000 instock-based compensation expense using the fair value method. We have not beenrequired to recognize any additional stock-based compensation expense, because,upon recording the $31,000 at July 1, 2005, the fair value of allemployee-related options had been fully amortized. Therefore, we have omittedthe comparison of pro forma amounts of net income (loss) and net income (loss)per share applicable to common stock.

 

*RecentPronouncements* – In February 2007, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards No.159 (“SFAS 159”), 

 

7

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*“The FairValue Option for Financial Assets and Financial Liabilities – Including anAmendment of FASB Statement No. 115.”* SFAS 159 permits anentity to measure financial instruments and certain other items at estimatedfair value as of specific election dates. The fair value option: (i) maygenerally be applied instrument by instrument; (ii) is irrevocable unless a newelection date occurs; and, (iii) must be applied to the entire instrument andnot to only a portion of the instrument. Most of the provisions of SFAS 159 areelective. However, the amendment to SFAS 115, *“Accountingfor Certain Investments in Debt and Equity Securities,”* applies toall entities that own securities that are classified as trading or availablefor sale. SFAS 159 is effective for fiscal years beginning after November 15,2007. Early adoption of SFAS 159 is permitted if the entity: (i) chooses earlyadoption within the first 120 days of its fiscal year; (ii) has not yet issuedfinancial statements for any interim period of such fiscal year; and (iii)elects to apply the provisions of FASB No. 157, *“Fair ValueMeasurements.”* We have not determined whether we will elect earlyadoption, and we have not evaluated the impact, if any, on our financialcondition or the results of our operations that may be caused by our adoptionof SFAS 159.

 

In June 2006, theFASB issued Interpretation No. 48 (“FIN 48”), *“Accountingfor Uncertainty in Income Taxes.”* FIN 48 requires the use of atwo-step approach for recognizing and measuring tax benefits taken or expectedto be taken in an income tax return and disclosures regarding uncertainties inincome tax positions. Only tax positions that meet the “more likely than not”recognition threshold at the effective date may be recognized upon adoption ofFIN 48. Our adoption of FIN 48, effective July 1, 2007, had no impact on ourfinancial condition and 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****                                      INVENTORIES**

 
| ** **                               | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                               | ** ** | **2007**               | ** ** | **2007**          | ** ** |
| Inventories  consisted of the following: |       |                   |       |              |       |
| Component                                |       | $                      | 350,000    |              | $          | 283,000 |   |
| Finished goods                           |       | 6,379,000              |       | 5,531,000         |       |
|                                     |       |                   |       |              |       |
|                                     |       | $                      | 6,729,000  |              | $          | 5,814,000 |   |

 

Included in finished goods inventories balances are allowances forinventory write-downs of $390,000 and $236,000 for September 30, 2007, and June30, 2007, respectively.

 

**NOTE 3****                                      LINEOF CREDIT AGREEMENT**

 

We maintain a revolving line of credit agreement with a commercialbank. The revolving line of credit agreement, renewed by amendment throughDecember 5, 2007, provides for a maximum loan amount of $3,000,000,collateralized by certificates of deposit totaling 

 

8

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$3,000,000 held at the commercial bank. Borrowings under the line ofcredit agreement accrue interest at the bank’s prime rate. The certificates ofdeposit earn market rates of interest. We generally maintain the line of creditto facilitate the issuance of letters of credit for inventory purchases fromoffshore suppliers and, if necessary, to fund any temporary working capitalneeds. Balances due on the line of credit totaled $400,000 and $0 atSeptember 30, 2007, and June 30, 2007, respectively.

 

Outstandingletters of credit reduce the amount available for borrowing under the line ofcredit agreement. At September 30, 2007, and June 30, 2007, we had outstandingletters of credit of $119,000 and $2,173,000, respectively, issued for purchaseobligations under outstanding purchase orders.

 

**NOTE 4****                                      COMMITMENTSAND CONTINGENCIES**

 

The licensing agreement withCallaway requires us to pay royalties based upon sales of Ben Hogan® fashionapparel and Top-Flite® branded apparel. We record royalties as other operatingcosts in the periods when such sales were recognized. Certain terms of thelicensing agreement provide for minimum royalties on a calendar year basis.While we expect that royalties generated on sales of Ben Hogan® fashion apparelwill exceed the contractual minimum royalty requirement for calendar 2007, weanticipate that sales of Top-Flite® branded apparel will be insufficient tomeet the contractual minimum royalty requirement of $188,000 for calendar 2007with respect to Top-Flite®. At June 30, 2007, we accrued a contingent liabilityof $178,000 with regard to the Top-Flite® minimum royalty due to Callaway forcalendar 2007. Sales of Top-Flite® branded apparel were sufficient to meet theminimum royalty requirements under the Callaway license for calendar 2006.

 

**NOTE 5****                                      EARNINGSPER SHARE**

 

Effective with the year ended June 30, 1998, we adopted theprovisions of Statement of Financial Accounting Standards No. 128 (SFAS 128), *Earnings per Share*. SFAS 128 requires the presentation ofbasic and diluted earnings (loss) per common share. The following tableprovides a reconciliation of the numerator and denominator of basic and dilutedearnings (loss) per common share:

 

9

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| ** **                                     | ** ** | **Three Months ended September 30, 2007** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Net**                                                            | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Loss**                                                           | ** ** | **Average Shares** | ** ** | **Per Share** | ** ** |
| Loss Per Common  Share                         |       |                                                               |       |   |   |   |   |
| Basic loss per  share                          |       | $                                                                  | (627,000   | ) | 2,284,000 |   | $ | (0.27 | ) |
| Effect of  dilutive securities options **[A]** |       | —                                                             |       | — |   | — |   |
|                                           |       |                                                               |       |   |   |   |   |
| Diluted loss per  share                        |       | $                                                                  | (627,000   | ) | 2,284,000 |   | $ | (0.27 | ) |

 
| ** **                                     | ** ** | **Three Months ended September 30, 2006** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Net**                                                            | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Loss**                                                           | ** ** | **Average Shares** | ** ** | **Per Share** | ** ** |
| Loss Per Common  Share                         |       |                                                               |       |   |   |   |   |
| Basic loss per  share                          |       | $                                                                  | (397,000   | ) | 2,770,000 |   | $ | (0.14 | ) |
| Effect of  dilutive securities options **[A]** |       | —                                                             |       | — |   | — |   |
|                                           |       |                                                               |       |   |   |   |   |
| Diluted loss per  share                        |       | $                                                                  | (397,000   | ) | 2,770,000 |   | $ | (0.14 | ) |

 

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**[A]**Due to the Company’s net losses, all options were anti-dilutive and thereforeexcluded from the loss per share calculations.

 

**NOTE 6****                                      SEGMENTINFORMATION**

 

The consolidated Companyhas two operating segments which consist of designing, purchasing orcontracting for the manufacture of and wholesale sales of women’s and men’s (1)fashion golf apparel and outerwear and (2) branded golf apparel. Our SPORTHALEY® and Ben Hogan® fashion golf apparel and outerwear collections aremarketed by Sport Haley in the premium and mid-priced markets through a networkof independent wholesale sales representatives and distributors to golfprofessional shops, country clubs, resorts and exclusive department storeswithin the United States and on a limited basis by certain distributors withininternational markets. Our Top-Flite® men’s branded apparel is marketed byReserve Apparel to mass retailers and other big-box type high sales volumeretail stores. Ben Hogan® fashion apparel and Top-Flite® branded apparel aredistributed pursuant to a licensing agreement with Callaway.

 

Reserve Appareldistributed Top-Flite® apparel exclusively to Wal-Mart from March 2006 throughAugust 2006, after which we were notified that Wal-Mart had chosen to developits own private label for golf apparel and discontinue selling Top-Flite®apparel. We redesigned Top-Flite® branded apparel to include garments primarilycomprised of a variety of performance fabrics, and we have aggressivelymarketed our Top-Flite® apparel line to several mass retailers and big-box typehigh sales volume retail stores. We expected our marketing efforts would resultin the establishment of business relationships with one or more mass retailersand other big-box type high sales volume retail stores. However, to date wehave only received one order for Top-Flite® apparel from such a retailer for atest in 50 of its stores, which we began shipping in September 2007. Since our concertedefforts over the last year have failed to generate orders from a majorcustomer, we are 

 

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currently evaluating howmuch longer we will continue to market Top-Flite® branded apparel.

 

At June 30, 2007, werecorded a contingent liability of $178,000 with regard to minimum royaltiesdue in accordance with our license agreement for Top-Flite® branded apparel,which requires minimum royalties of $188,000 for such apparel in calendar year2007. Sales of Top-Flite® branded apparel were sufficient to meet the minimumroyalty requirement under the license agreement for calendar 2006.

 

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

 

*CondensedConsolidated Balance Sheets Segment Information as of September 30, 2007, andJune 30, 2007:*

* *
| ** **                              | ** ** | **September 30, 2007** | ** ** | **June 30, 2007** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **Fashion**                      | ** ** | **Branded**                 | ** ** | **Fashion** | ** ** | **Branded** | ** ** |
| ** **                              | ** ** | **Apparel**                      | ** ** | **Apparel**                 | ** ** | **Apparel** | ** ** | **Apparel** | ** ** |
|                                    |       |                             |       |                        |       |   |   |   |   |
| Cash and cash  equivalents              |       | $                                | 3,084,000  |                        | $          | 53,000 |   | $ | 4,354,000 |   | $ | 110,000 |   |
| Accounts  receivable, net of allowances |       | $                                | 2,045,000  |                        | $          | 472,000 |   | $ | 2,713,000 |   | $ | 353,000 |   |
| Inventories                             |       | $                                | 6,664,000  |                        | $          | 65,000 |   | $ | 5,814,000 |   | $ | — |   |
| Total assets                            |       | $                                | 12,496,000 |                        | $          | 590,000 |   | $ | 13,482,000 |   | $ | 467,000 |   |
| Total  liabilities                      |       | $                                | 1,901,000  |                        | $          | 430,000 |   | $ | 2,152,000 |   | $ | 237,000 |   |

 

*CondensedConsolidated Statements of Operations Segment Information for the Three MonthsEnded September 30, 2007 and 2006:*

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **September 30, 2007** | ** ** | **September 30, 2006** | ** ** |
| ** **                                    | ** ** | **Fashion**                      | ** ** | **Branded**                      | ** ** | **Fashion** | ** ** | **Branded** | ** ** |
| ** **                                    | ** ** | **Apparel**                      | ** ** | **Apparel**                      | ** ** | **Apparel** | ** ** | **Apparel** | ** ** |
|                                          |       |                             |       |                             |       |   |   |   |   |
| Net sales                                     |       | $                                | 3,408,000  |                             | $          | 120,000 |   | $ | 3,488,000 |   | $ | 1,185,000 |   |
| Cost of goods  sold                           |       | $                                | 2,096,000  |                             | $          | 95,000 |   | $ | 2,237,000 |   | $ | 885,000 |   |
| Impairments                                   |       | $                                | 154,000    |                             | $          | — |   | $ | 49,000 |   | $ | — |   |
| Gross profit                                  |       | $                                | 1,158,000  |                             | $          | 25,000 |   | $ | 1,201,000 |   | $ | 301,000 |   |
| Selling, general  and administrative expenses |       | $                                | 1,624,000  |                             | $          | 101,000 |   | $ | 1,582,000 |   | $ | 139,000 |   |
| Royalty expense                               |       | $                                | 119,000    |                             | $          | 7,000 |   | $ | 146,000 |   | $ | 64,000 |   |
| Income (loss)  from operations                |       | $                                | (585,000   | )                                | $          | (83,000 | ) | $ | (527,000 | ) | $ | 98,000 |   |

 

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**NOTE 7****                                      LEGALPROCEEDINGS**

 

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 suitalleges, 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. Among other things, the Plaintiffsalleged that the Defendants misapplied an inventory deposit of $291,000 paid tothe Defendants in March 2006 by Sport Haley, which the Defendants used tooffset certain amounts purportedly owed to the Defendants by Explorer Headgear,Inc., and that the Defendants failed to return $177,000 which was overpaid bySport Haley as of July 2006. The Plaintiffs have alleged claims against theDefendants for conversion and violation of the Colorado civil theft statute aswell as for unjust enrichment. Plaintiffs seek repayment of the $291,000 and$177,000 amounts and other relief. Based upon information that is currentlyavailable, we cannot determine whether the decision or settlement of thislawsuit will materially affect our financial position or the results of ouroperations.

 

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**ITEM 2MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

ThisReport on Form 10-Q contains certain forward-looking statements, within themeaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934. The words “may,” “will,” “expect,” “anticipate,”“continue,” “estimate,” “project,” “intend,” “believe,” and similarexpressions, variations or the negative of these words, and any statementregarding possible or assumed future results of operations of our business, themarkets for our products, anticipated expenditures, regulatory developments orcompetition, or other statements regarding matters that are not historicalfacts, are intended to identify forward-looking statements, although not allforward-looking statements contain such identifying words. The reader should beaware that our actual results could differ materially from those contained inforward-looking statements. Our financial condition and the results of ouroperations will depend on a number of factors, including, but not limited to,the following: our ability to successfully anticipate fashion trends, designfavorably accepted fashion golf apparel, effectively advertise and communicatewithin the marketplace, and penetrate our chosen distribution channels;competition within golf apparel markets; business conditions and growth in thefashion golf apparel market and the general economy; our ability tosuccessfully forecast sales and optimize inventory levels; our ability tosuccessfully manage risks associated with the trend of an increasing relativepercentage of sales with respect to licensed apparel, such as the Ben Hogan®apparel collections; establishing markets for our Top-Flite® apparel whichprovide the annual sales amount required by Callaway to satisfy the minimumroyalty payments due in accordance with the license agreement for Top-Flite®apparel; loss of certain third party suppliers, and/or delays in receivinggarments from third party suppliers caused by various factors, including lostor reduced manufacturing capacity or significant suppliers, labor shortages,timely performance of third parties, transportation difficulties, and others;significant delays in deliveries from third party suppliers; unsatisfactoryrecourse with regard to nonconforming goods received from foreign suppliers;political and international trade relations; changes in international tradequota systems for apparel; significant reliance upon several individual foreignsuppliers; reliance upon a certain foreign person, responsible for maintainingrelationships with and monitoring the performance of certain of our significantforeign suppliers; consumer spending on golf apparel; general global economicand political conditions resulting from threats or acts of war or terrorism andresponses thereto; access to capital; maintaining satisfactory relationshipswith commercial banking institutions; establishing controls with regard to andmaintaining the integrity of technology and information systems; and, relianceupon executive officers and key employees. Additional information on these andother factors that could affect our financial results is included in thediscussion below and in our Form 10-K for the year ended June 30, 2007. Theremay be other factors not mentioned above, in the discussion below or includedin our Securities and Exchange Commission filings that may cause actual resultsto differ materially from any forward-looking statement. The reader should notplace undue reliance on any forward-looking statement. Neither the Company norany of its corporate officers or key employees assumes any obligation to updateany forward-looking statement as a result of new information, future event ordevelopment, except as required by securities laws.

 

All references to fiscal years correspondwith the fiscal year of Sport-Haley, Inc., which ends on June 30.

 

##### **OVERVIEW**

##### ** **

SportHaley designs, purchases or contracts for the manufacture of, markets anddistributes women’s and men’s fashion golf apparel and outerwear under theSPORT HALEY® and Ben Hogan® labels. We are represented by a network ofindependent wholesale sales representatives and employ two regional salesmanagers, each with responsibilities for both of our fashion apparel labels.Most of the independent wholesale sales representatives solicit sales of bothSPORT HALEY® and Ben Hogan® fashion apparel collections on our behalf.

 

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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 coordinatedstyles, color schemes and fabrics to encourage customers to purchase multiplegarments. SPORT HALEY® women’s fashion apparel includes a variety of fabricsand weave patterns, including interlock, pique, French terry, jersey and twill,and may feature a unique trim, a special fabric finish or extra needlework. TheSPORT HALEY® 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 14 years. Ms. Blair is keenly aware of fashion trendswithin the women’s golf apparel market and has kept our SPORT HALEY® fashionapparel collections on the leading edge of the market by including moisturewicking technical performance fabrics, such as Aerocool® and Dry-Tech® 18, andseveral 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 each productin the Ben Hogan® apparel line is sold separately, the line is intentionallydesigned in groups with coordinated styles, color schemes and fabrics toencourage customers to purchase multiple garments. Ben Hogan® apparel ismanufactured using a variety of fabrics, including wool, silk and cashmere, andweave patterns, including pique, jersey and twill, and most pieces feature aunique trim, a special fabric finish or extra needlework. Ben Hogan® men’sapparel is marketed in the premium-price markets to elite golf professionalshops, upscale resorts and exclusive department stores. We distribute BenHogan® apparel pursuant to our licensing agreement with Callaway.

 

Top-Flite®branded golf apparel is designed for distribution to large retail stores in thelow-price markets. Branded apparel is generally produced in mass quantities andusually utilizes much simpler designs and is of much lesser quality than thefashion apparel garments which we sell in the premium and mid-priced markets.While our fashion golf apparel is generally designed for two separate sellingseasons each year, branded golf apparel may be designed for four or moreshorter selling periods each year. Many of our Top-Flite® garments are designedutilizing basic performance fabrics made from polyester or other man-madematerials or from blends of natural and man-made materials. Reserve Appareldistributed Top-Flite® apparel exclusively to Wal-Mart from March 2006 throughAugust 2006. However, in late September 2006, Reserve Apparel was notified thatWal-Mart had chosen to develop a line of golf apparel under a private labelrather than to continue purchasing our Top-Flite® branded apparel. Weredesigned Top-Flite® branded apparel to include garments primarily comprisedof a variety of performance fabrics, and we have aggressively marketed our newTop-Flite® apparel line to several mass retailers and big-box type high salesvolume retail stores. We expected our marketing efforts would result in theestablishment of business relationships with one or more mass retailers andother big-box type high sales volume retail stores. However, to date we haveonly received one order for Top-Flite® 

 

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apparelfrom such a retailer for a test in 50 of its stores, which we began shipping inSeptember 2007. Since our concerted efforts over the last year have failed togenerate orders from a major customer, we are currently evaluating how muchlonger we will continue to market Top-Flite® branded apparel, which wedistribute pursuant to our licensing agreement with Callaway.

 

**CRITICALACCOUNTING 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 affect the reported amounts of assets,liabilities, revenues and expenses, and the related disclosures. A summary ofthose significant accounting policies can be found in the Footnotes to theFinancial Statements included in our Report on Form 10-K for the fiscal yearended June 30, 2007. The estimates usedby management are based upon our historical experiences combined withmanagement’s understanding of current facts and circumstances. Certain of ouraccounting policies are considered critical as they are both important to theportrayal of our financial condition and the results of our operations andrequire significant or complex judgments on the part of management. We believethat the following critical accounting policies affect the more significantjudgments and estimates used in the preparation of our 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, we maintainreserves 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 are not prone toimpairment, because we usually order branded apparel in quantities per specificcustomer orders.

 

We recorded impairments of $154,000 and $49,000 withregard to fashion apparel inventories for the three-month periods endedSeptember 30, 2007 and 2006, respectively.

 

*Deferred Income Taxes*

 

Deferred income taxes are recognized for theexpected tax consequences in future years for differences between the tax basesof assets and liabilities and their financial reporting amounts, based uponenacted tax laws and statutory tax rates applicable to the periods in which thedifferences are expected to affect taxable income. Our significant deferred taxassets are related to net operating loss carry forwards for federal and stateincome tax purposes, stock-based compensation and an unrealized loss for taxpurposes on a common stock investment. Governing regulations require that ouroperating losses be carried forward for income tax purposes. We maintain avaluation allowance to reduce deferred tax assets to the 

 

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net amount expected to be recovered in futureperiods. The estimates for deferred tax assets and the corresponding valuationallowance require us to exercise complex judgments. We periodically review andadjust those estimates based upon the most current information available. Inaccordance with Statement of Financial Accounting Standards No. 109 (“SFAS 109”),*“Accounting for Income Taxes,”* and basedupon a review at September 30, 2007, of our utilization of deferred tax assets,we maintained a valuation allowance that effectively reduces our net deferredtax assets to zero. While we continue to explore various strategies to returnthe Company to profitability, including finding additional markets for ourTop-Flite® branded apparel, we cannot be certain that our efforts will resultin the generation of future profits. Because the recoverability of deferred taxassets is directly dependent upon future operating results, actualrecoverability of deferred tax assets may differ materially from our estimates.

 

*Allowancefor 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 September 30, 2007, our allowance for doubtfulaccounts totaled $248,000, including a specific reserve of $116,000 withrespect to the potential non-recovery of a net amount due to Reserve Apparelfrom a former inventory broker. While we consider our processes to be adequateto effectively quantify our exposure to doubtful accounts, changes in economic,industry or specific customer conditions may result in recoverability of ourdoubtful accounts that differs materially from our estimates.

 

*Allowancefor 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 and industry-specificconditions and anticipated customer performance when evaluating the adequacy ofour allowance for sales returns. At September 30, 2007, our allowance for salesreturns was $139,000. Significant changes in general economic or industryconditions may yield sales returns that differ materially from our estimates.

 

### **LIQUIDITYAND CAPITAL RESOURCES**

### ** **

Thegolf apparel business is highly seasonal in nature, and our balance sheetamounts at September 30, 2007, may be more meaningful when compared with thecorresponding balance sheet amounts at September 30, 2006, rather than with thecorresponding balance sheet amounts at June 30, 2007.

 

Ourprimary sources of liquidity are comprised of available cash and cashequivalents, cash flows from operations and a working capital line of creditwith a commercial bank. We require cash for general working capital purposes.We do not anticipate the requirements of material amounts of cash for capitalexpenditures over the remainder of the current fiscal year. Our working capitalrequirements are highly 

 

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seasonalin nature, with greater requirements from approximately August through Octoberand February through April of each fiscal year, due to the purchases of finishedgoods inventories for the spring/summer and fall/holiday selling seasons,respectively.

 

Ournet accounts receivable decreased by $549,000, or 18%, to $2,517,000 atSeptember 30, 2007, from $3,066,000 at June 30, 2007. When compared with theSeptember 30, 2006, balance of $3,013,000, our net accounts receivable balanceat September 30, 2007, decreased by $496,000, or 16%. Historically, net salesof our fashion apparel are weakest during our first fiscal quarter, and our netaccounts receivable balance relating to fashion apparel generally declinesduring our first fiscal quarter when compared with the balance at the previousfiscal year end. While a large portion of our fourth fiscal quarter fashionapparel sales are shipped in the month of June each year, fashion apparel salesare generally shipped more evenly throughout our first fiscal quarter. Becausea large portion of our fashion apparel sales are shipped with “Net 30” paymentterms, our accounts receivable collections are generally greater than our fashionapparel sales during our first fiscal quarter, because a significant portion ofour fashion apparel sales from the previous fiscal quarter are generallycollected by September 30 each year. Our net accounts receivable balancerelating to fashion apparel was $2,045,000 at September 30, 2007, a decrease of$399,000, or 16%, from the balance of $2,428,000 at September 30, 2006. Our netaccounts receivable balance relating to branded apparel was $472,000 atSeptember 30, 2007, a decrease of $113,000, or 19%, from the balance of$585,000 at September 30, 2006. Changes in our accounts receivable balancesprovided operating cash of $549,000 and $937,000 for the fiscal quarters endedSeptember 30, 2007 and 2006, respectively.

 

Inventorieshave increased by $915,000, or 16%, to $6,729,000 at September 30, 2007, from$5,814,000 at June 30, 2007. When compared with the balance at September 30,2006, our inventories increased by $1,373,000, or 26%, from $5,356,000. Thecomparative increase in our inventories from September 30, 2006, to September30, 2007, was primarily due to the timing of receipts of fashion apparelinventories with regard to our Spring 2008 selling season as compared withreceipts for our Spring 2007 selling season in the prior fiscal year. At September30, 2007, the vast majority of our initial orders for Spring 2008 fashionapparel inventories had been received into our warehouse. Historically, themajority of our fashion apparel inventories for the following spring sellingseason have been received during October each year. Branded apparel inventorieswere $65,000 at September 30, 2007. We had no branded apparel inventories atSeptember 30, 2006. Changes in our inventory balances used operating cash of$915,000 and $581,000 for the quarters ended September 30, 2007 and 2006,respectively.

 

Ourcontinued reliance on foreign suppliers sustains the risk that our revenuescould be adversely affected if a foreign shipment or shipments were receivedlate or lost. We maintain insurance for risk of loss relating to goods shippedfrom its foreign and domestic suppliers. However, our predominant reliance upona certain foreign person and certain significant foreign suppliers alsosustains the risk that we would be left with inadequate or unsatisfactory recourseshould the goods received from a foreign supplier be nonconforming.

 

Accountspayable and accrued expenses decreased by $636,000, or 27%, to $2,153,000 atSeptember 30, 2007, from $2,389,000 at June 30, 2007. Accounts payable andaccrued expenses increased by $86,000, or 5%, from $1,667,000 at September 30,2006. The $86,000 increase was comprised of an increase of $306,000 in tradeaccounts payable, a decrease of $84,000 in accrued royalties payable, adecrease of $35,000 in sales commissions payable, a decrease of $142,000 inaccrued payroll and an increase of $41,000 in other payables. The comparativeincreases in trade accounts and other payables relate to differences in thetiming of payments for expenses which were accrued at September 30, 2007, versus

 

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September30, 2006. The decreases in accrued royalties payable and sales commissionspayable relate to a corresponding decrease in net sales. The decrease inaccrued payroll expenses consisted primarily of a decrease in the amount ofseverance and other compensation payable to our former chief executive officer.Our balance of accrued severance and other compensation decreased by $164,000,to $80,000 at September 30, 2007, from $244,000 at September 30, 2006,respectively.

 

Dueto the combination of the factors discussed above, and others, our operatingactivities used cash of $1,727,000 for the three months ended September 30,2007. Comparatively, for the quarter ended September 30, 2006, our operatingactivities used cash of $1,221,000.

 

For the three months ended September 30, 2007and 2006, investing activities used cash of $0 and $376,000, respectively. InSeptember 2006, Sport Haley entered into an agreement with Explorer Gear topurchase its 49% ownership interest in Reserve Apparel for a lump sum cashpayment of $375,000, since which time Reserve Apparel has been a wholly-ownedsubsidiary of Sport Haley. During the three months ended September 30, 2007 and2006, we expended $0 and $1,000, respectively, for the purchase of property andequipment, and $54,000 and $76,000 in depreciation and amortization was chargedto current operations, respectively.

 

Wemaintain a revolving line of credit agreement with a commercial bank. Therevolving line of credit agreement, renewed by amendment through December 5,2007, provides for a maximum loan amount of $3,000,000, collateralized bycertificates of deposit totaling $3,000,000 held at the commercial bank.Borrowings under the line of credit agreement accrue interest at the bank’sprime rate. The certificates of deposit earn market rates of interest. Wegenerally maintain the line of credit to facilitate the issuance of letters ofcredit for inventory purchases from offshore suppliers and, if necessary, to fundany temporary working capital needs. Balances due on the line of credit totaled$400,000 and $0 at September 30, 2007, and June 30, 2007, respectively.Outstanding letters of credit reduce the amount available for borrowing underthe line of credit agreement. At September 30, 2007 and June 30, 2007, we hadoutstanding letters of credit of $119,000 and $2,173,000, respectively, issuedfor purchase obligations under outstanding purchase orders.

 

Webelieve that cash on hand and cash generated from operations, as well as theability to borrow under the bank line of credit, will be sufficient to meet ourcash requirements during the remainder of fiscal 2008. While we also havealternative sources of financing, including the factoring of customer accountsreceivable, we do not anticipate using alternative sources of financing duringthe remainder of fiscal 2008. However, our capital needs will depend on manyfactors, including the need to finance required inventory levels, the successof current sales and marketing programs, and potential cash requirementsrelated to the operations of Reserve Apparel and various other factors.

 

### **RESULTSOF OPERATIONS**

### ** **

*Fashionapparel*

 

Ourfashion apparel business is seasonal in nature, and sales occurring fromJanuary through June, which comprise our third and fourth quarters of eachfiscal year, are generally disproportionately higher than sales occurring fromJuly through December.

 

Netsales of fashion apparel for the three months ended September 30, 2007, were$3,408,000, a decrease of $80,000, or 2%, from net fashion apparel sales of$3,488,000 for the comparable three-month period 

 

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inthe prior fiscal year. The decrease in sales of fashion apparel for thecomparative three-month periods was primarily comprised of an increase in salesof SPORT HALEY® fashion apparel combined with a decrease in sales of Ben Hogan®fashion apparel between the respective periods. Net sales of our SPORT HALEY®fashion apparel collections were $1,580,000 and $1,306,000 for the three monthsended September 30, 2007 and 2006, respectively, an increase of $274,000, or21%. Net sales of our Ben Hogan® fashion apparel collections were $1,702,000and $2,048,000 for the three months ended September 30, 2007 and 2006,respectively, a decrease of $346,000, or 17%. The remainder of our fashionapparel net sales were comprised of embroidery and shipping revenues. We expectthe market acceptance for our SPORT HALEY® women’s fashion apparel to continueto improve, because we have continued to experience increases in advance orderswe have received for our women’s collections. We attribute the decrease in BenHogan® fashion apparel sales primarily to changes in the country club andresort markets in which we operate. Historically, the country club and resortmarkets preferred to sell high-quality apparel that was not broadly distributedwithin other retail markets. However, with the introduction and broad marketacceptance of moisture-wicking and other performance garments within golfapparel markets, country clubs and resorts have begun to carry apparel brandssuch as Nike and Adidas, which are primarily comprised of performance fabricsand are globally distributed into numerous markets other than country clubs andresorts. We believe that the penetration of Nike and Adidas into golf apparelmarkets has diluted the value associated with the exclusivity of brands such asour Ben Hogan® fashion apparel brand, at least on a temporary basis. In orderto bolster future sales of our Ben Hogan® fashion apparel, we have focused ourmarketing efforts on increasing our market presence in upscale retail storesand on penetrating further into corporate markets. We expect that our effortswill at a minimum generate sales of Ben Hogan® fashion apparel to two or threenew upscale retail stores in fiscal 2008. We consider Ben Hogan® fashionapparel, which is marketed in accordance with a licensing agreement we maintainwith Callaway for such apparel, to be a key component of our fashion apparelbusiness.

 

Grossprofit with regard to our fashion apparel is generally affected by salesdiscounts offered to customers in accordance with various marketing programs,payment discounts offered to certain customers, dispositions of excess inventoriesat reduced sales prices and the valuation of excess inventories to the lower ofcost or market. The disposition of excess inventories negatively impacts ourgross profit percentage even when such inventories are properly valued to thelower of cost or market, because such valuation causes sales to be recordedwith gross profit at or near zero. For the three months ended September 30,2007, we did not record net sales with regard to the disposition of excessfashion apparel inventories. Comparatively, for the three months endedSeptember 30, 2006, we recorded net sales of $182,000 and gross profit of($25,000) with respect to sales of excess fashion apparel inventories. For thethree months ended September 30, 2007 and 2006, we recorded impairments of$154,000 and $49,000, respectively, with regard to the valuation of excessfashion apparel inventories to the lower of cost or market. As percentage ofnet sales, gross profit of our fashion apparel, was 34% and 34% for the threemonths ended September 30, 2007 and 2006, respectively.

 

Ourgross 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. We include royalty payments,relating to sales of licensed apparel, in selling, general and administrativeexpenses.

 

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Selling,general and administrative expenses with regard to fashion apparel increased by$42,000, or 3%, to $1,624,000 for the three months ended September 30, 2007,from $1,582,000 for the comparable three-month period in the prior fiscal year.The comparative increase was generally comprised of increases in advertising,tradeshow and personnel expenses combined with decreases in accounting,depreciation and various other expenses. As a percentage of net sales, selling,general and administrative expenses with regard to our fashion apparel were 48%and 45% for the three-month periods ended September 30, 2007 and 2006,respectively.

 

We recorded royalty expense of $119,000 and $146,000for the three months ended September 30, 2007 and 2006, respectively. Thedecrease in royalty expense directly correlates with our decrease in sales ofBen Hogan® fashionapparel for the same three-month periods. Royalty expense is due to Callaway in accordance with the license theypreviously granted us to market men’s fashion apparel bearing the Ben Hogan®label.

 

Income (loss) from operations with regard to fashionapparel for the three months ended September 30, 2007, was ($585,000), adifference of ($58,000), or 11%, from ($527,000) for the comparable three-monthperiod in the prior fiscal year. Our sales are historically weakest for thethree months ending September 30, our first fiscal quarter each year, than forany of our other fiscal quarterly periods, and, historically, we have not generatedincome from fashion apparel operations during the thee months ended September30 in any given fiscal year.

 

*Branded apparel*

 

Wepreviously considered Top-Flite® branded apparel, which we market pursuant toour licensing agreement with Callaway for such apparel, to be a key componentin our overall business strategies, designed to return the Company to sustainedprofitability. Net sales of Top-Flite® branded apparel of $120,000 for thethree months ended September 30, 2007, were comprised of the initial shipmentsto a retailer for a test in 50 of its stores. Net sales of Top-Flite® brandedapparel of $1,185,000 for the three months ended September 30, 2006, werecomprised of sales to Wal-Mart of $1,000,000 and sales of $185,000 to othermarkets for the disposition of our remaining branded apparel inventories. Weshipped Top-Flite® branded apparel to Wal-Mart from March 2006 through August2006. As previously reported, in late September 2006, we were notified thatWal-Mart had chosen to develop a line of golf apparel under a private labelrather than to continue purchasing our Top-Flite® branded apparel from us. Weredesigned Top-Flite® apparel to include garments primarily comprised of avariety of performance fabrics, and we have aggressively marketed the newbranded apparel line to several mass retailers and big-box type high salesvolume retail stores. We expected our marketing efforts woud result in theestablishment of business relationships with one or more mass retailers andother big-box type high sales volume retail stores. However, to date we haveonly received one order for Top-Flite® apparel from such a retailer for a testin 50 of its stores, which we began shipping in September 2007. Since ourconcerted efforts over the last year have failed to generate orders from amajor customer, we are currently evaluating how much longer we will continue tomarket Top-Flite® branded apparel.

 

Ourdistribution of Top-Flite® branded apparel to the mass retail market generallygenerates 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. Branded apparel is generally sold at much lower pricesthan for higher quality fashion apparel, and gross margins are also expected tobe lower for branded apparel than for fashion apparel. Other companies withinthe golf apparel industry may or may not operate within the lower-price brandedapparel markets. As a percentage of net sales, 

 

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grossmargins with respect to net sales of branded apparel were 21% and 25% for thethree months ended September 30, 2007 and 2006, respectively.

 

Selling,general and administrative expenses were $101,000 with regard to branded apparelfor the three months ended September 30, 2007, a decrease of $38,000, or 27%,from $139,000 for the three months ended September 30, 2006. The decrease wasprimarily due to differences between between the comparable three-month periodsin allocated management costs, which totaled $0 in the three months endedSeptember 30, 2007 versus $54,000 in the three months ended September 30, 2006.The decrease in allocated management costs related to changes in the ownershipof Reserve Apparel and the loss of the Wal-Mart account. Prior to our purchaseof the minority interest in Reserve Apparel from Explorer Gear in September2006, allocated management costs included a portion of Sport Haley’s costs withregard to managing Reserve Apparel and certain reimbursable expenses incurredby Explorer Gear on behalf of Reserve Apparel. Because Wal-Mart ceasedpurchasing Top-Flite® branded apparel from us shortly after we purchased theminority interest, the business operations of Reserve Apparel weresignificantly reduced and we discontinued our allocation of Sport Haleymanagement costs to Reserve Apparel. As a percentage of net branded apparelsales, related selling, general and administrative expenses were 84% and 12%for the three months ended September 30, 2007 and 2006, respectively.

 

We recorded royalty expense of $7,000 and $64,000for the three months ended September 30, 2007 and 2006, with respect to netsales of branded apparel, respectively. Royalty expense is due to Callaway inaccordance with the license they previously granted us to market brandedapparel bearing the Top-Flite® label.

 

Income (loss) from operations with regard to brandedapparel for the three months ended September 30, 2007, was ($83,000), adifference of ($181,000), or 185%, from $98,000 for the comparable three-monthperiod in the prior fiscal year.

 

*Other income*

 

Other income, net, was $48,000 for the three monthsended September 30, 2007, a decrease of $30,000, or 38%, from $78,000 for thecomparable three-month period in the prior fiscal year. Other income, net, wasprimarily derived from interest earned on cash and cash equivalent balancesheld at various financial institutions. The decrease was generally attributableto our lower balance of cash and cash equivalents during the respective periods.

 

*Net income (loss)*

 

Net loss for the three months ended September 30,2007, was ($627,000), a difference of ($230,000), or 58%, as compared with thenet loss of ($397,000) for the comparable three-month period in the priorfiscal year. We had federal and state net operating loss carry forwards of$7,451,000 and $9,642,000 at September 30, 2007, that we estimated may berecoverable at income tax rates of 34% and 5%, respectively. In accordance with SFAS 109 and based upon areview at September 30, 2007, of our utilization of deferred tax assets, wemaintained a valuation allowance that effectively reduces our net deferred taxassets to zero. While we continue to explore various strategies to return theCompany to profitability, including finding alternative markets for ourTop-Flite® branded apparel, we cannot be certain that our efforts will resultin the generation of future profitssufficient to offset our significant net operating loss carry forwards prior totheir expirations. Accordingly, we did not record benefits from 

 

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income taxes associated with the correspondinglosses for the respective three-month period ended September 30, 2007.

 

*Earnings(loss) per share*

 

Basicand diluted earnings (loss) per common share were ($0.27) and ($0.14) for thethree-month periods ended September 30, 2007 and 2006, respectively. Allsecurities options were anti-dilutive and therefore excluded from the per sharecalculations with respect to periods in which net losses were incurred.

 

*Bookvalue*

 

Ourbook value per common share was $4.71 at September 30, 2007, $4.98 at June 30,2007 and $5.28 at September 30, 2006.

 

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**ITEM 3 QUALITATIVE AND QUANTITATIVE DISCLOSURESABOUT MARKET RISK**

 

Market risk representsthe risk of loss that may impact the financial position, results of operationsor cash flows due to adverse changes in financial and commodity market pricesand rates. We are exposed to market risk with regard to changes in UnitedStates interest rates. This exposure is directly related to our normaloperating and funding activities. Historically, and as of September 30, 2007,we have not used derivative instruments or engaged in hedging activities. Ourmarket risk has not changed significantly from June 30, 2007.

 

**Interest Rate Risk**

 

We maintain a revolvingline of credit agreement with a commercial bank. The agreement provides for amaximum loan amount of $3,000,000 collateralized by certificate of depositsheld at the commercial bank totaling $3,000,000, which earn market rates ofinterest. Borrowings under the line of credit agreement accrue interest at thebank’s prime rate. Increases in the bank’s prime rate could increase theinterest expense with respect to borrowings under the line of credit. Wegenerally maintain the line of credit to facilitate the issuance of letters ofcredit for inventory purchases from offshore suppliers, and, if necessary, tofund any temporary working capital needs. Outstanding borrowings under the lineof credit totaled $400,000 at September 30, 2007. Outstanding letters of creditreduce the amount available for borrowing under the line of credit. We hadoutstanding letters of credit of $119,000 at September 30, 2007. We do not usederivative financial instruments to manage interest rate risk.

 

From time to time, wemaintain short-term investments in low risk and no risk financial instruments,readily convertible into cash, which earn interest at variable rates. Our cashbalances held at financial institutions regularly exceed federally insuredlimits.

 

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**ITEM 4 CONTROLS AND PROCEDURES**

 

**(a)  Evaluation of Disclosure Controls andProcedures**

 

Our management,with the participation of our Chief Executive Officer and our Chief FinancialOfficer, conducted an evaluation of the effectiveness of our disclosurecontrols and procedures pursuant to Rule 13a-15 under the Securities ExchangeAct of 1934 as of the end of the period covered by this report. Based on thatevaluation, management, including the Chief Executive Officer and ChiefFinancial Officer, concluded that, as of the end of the period covered by thisreport, our disclosure controls and procedures were effective in reaching areasonable level of assurance that: (a) all material information relating tothe Company, required to be disclosed in this report, was made known tomanagement in a timely manner; and (b) information was recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand regulations.

 

**(b)  Changes in Internal Controls Over FinancialReporting**

 

During our firstquarter of fiscal 2008, we did not implement any significant changes in ourinternal controls over financial reporting as defined in Rules 13a-15(f) or15d-15(f) that materially affected, or are reasonably likely to materiallyaffect, our internal controls over financial reporting.

 

Our management, including our Chief Executive Officer and our ChiefFinancial Officer, does not expect that our disclosure controls and proceduresor our internal controls over financial reporting will, in all instances,prevent all errors and all fraud. A control system, no matter how wellconceived or operated, can only provide reasonable, not absolute, assurancethat the objectives of the control system are met. While our control systemsprovide 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 inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within the financial reports of Sport-Haley, Inc. have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty, and that breakdowns can occur because of simple errors ormistakes. Additionally, a control can be circumvented by the individual act ofsome person, by collusion of two or more persons, or by management’s overrideof a specific control. The design of any system of controls is also based inpart on certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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**PART II**

**OTHERINFORMATION**

 

### **ITEM 1**                       LEGALPROCEEDINGS

### ** **

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 suitalleges, 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. Among other things, the Plaintiffsalleged that the Defendants misapplied an inventory deposit of $291,000 paid tothe Defendants in March 2006 by Sport Haley, which the Defendants used tooffset certain amounts purportedly owed to the Defendants by Explorer Headgear,Inc., and that the Defendants failed to return $177,000 which was overpaid bySport Haley as of July 2006. The Plaintiffs have alleged claims against theDefendants for conversion and violation of the Colorado civil theft statute aswell as for unjust enrichment. Plaintiffs seek repayment of the $291,000 and$177,000 amounts and other relief. Based upon information that is currentlyavailable, we cannot determine whether the decision or settlement of thislawsuit will materially affect our financial position or the results of ouroperations.

 

### **ITEM 1A**              RISK FACTORS

### ** **

Therehave been no material changes from the risk factors previously disclosed inItem 1A of our annual report on Form 10-K for the year ended June 30, 2007.

 

### **ITEM 5**                       OTHERINFORMATION

### ** **

(a)          On October 31, 2007, weentered into an amended executive employment agreement with Catherine B. Blairthat is effective July 1, 2007. The amended executive employment agreementrequires that Ms. Blair continue to devote her full business time as our VicePresident – Merchandising and Design, at an annual salary of $160,000 for our2008 fiscal year, and $175,000 per year thereafter, and such bonuses as awardedby the Compensation Committee of our Board of Directors. The amended agreementhas an initial two-year term, subject to automatic one-year extensions aftereach successive year. If we elect to terminate the amended agreement without “cause”(as defined in the agreement) or not to renew the agreement upon itsexpiration, or if Ms. Blair terminates the agreement with or without cause, Ms.Blair is entitled to receive severance compensation equal to fifteen months’salary plus 50% of the bonus, if any, paid to her in the preceding 12 months.During the time she were to receive any such severance compensation, Mr. Blairis entitled to participate in all employee benefit plans, at our expense. Ifthere were to be a non-negotiated change in control of Sport-Haley, Inc., andeither we or Ms. Blair terminate the agreement within sixty days of the changein control, Ms. Blair is entitled to receive lump sum severance compensationequal to two times her annual salary and bonus payments during the preceding 12months. The amended agreement contains a non-competition provision for twelvemonths following termination, provided Ms. Blair could be released from thenon-competition clause if she were terminated without cause and if she electedto forego any severance pay. If Ms. Blair becomes “totally disabled” (asdefined in the agreement) during the term of the agreement, her full salarywill be continued for one year from the date of total disability.

 

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                        OnNovember 8, 2007, we notified Barry L. Hyman, our Eastern Regional SalesManager, and Michael D. Doris, our Western Regional Sales Manager, that theirrespective positions were being eliminated and, therefore, they were beingterminated without cause, as defined in their respective employment agreements,effective November 9, 2007. Each of the employment agreements require a 90 dayperiod for notice of termination by the Company without cause. In addition,following the 90 day notice periods, Mr. Hyman is entitled to six months andMr. Doris is entitled to three months in severance compensation based upontheir respective base salaries. We are currently reassigning the dutiespreviously performed by Mr. Hyman and Mr. Doris between various of theCompany’s executive management and other personnel and do not plan to hire areplacement for either Mr. Hyman or Mr. Doris in the near future.

 

(b)         During the first quarter of fiscal 2008, wemade no material changes to the procedures by which our shareholders may recommendnominees to our Board of Directors.

 

### **ITEM 6**                       EXHIBITS

### ** **

Exhibit 31.1 –Certification of Donald W. Jewell pursuant to Exchange Act Rule13a-14(a)/15d-14(a)

 

Exhibit 31.2 –Certification of Patrick W. Hurley pursuant to Exchange Act Rule13a-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 of 2002

 

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**SIGNATURES**

 

In accordance with therequirements of the Securities Exchange Act of 1934, the Registrant caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |              |   |   | **SPORT-HALEY, INC.**                                       |
|--------|-------------------|--------|--------|-------------------------------------------------------------|
|   |              |   |   | (Registrant)                                                |
|   |              |   |   |                                                        |
|   |              |   |   |                                                        |
| Date:  | November 14, 2007 |   |   | /s/ PATRICK W. HURLEY                                       |   |
|   |              |   |   | Patrick W. Hurley                                           |
|   |              |   |   | Chief Financial Officer                                     |
|   |              |   |   | *  (Principal  Financial and Accounting Officer)* |

 

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