** **

**SECURITIESAND EXCHANGE COMMISSIONWASHINGTON, D.C.  20549**

**FORM 10-Q**

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

**For the quarterly period ended September 30, 2006**

**o****  TRANSITION REPORTUNDER SECTION 13 OR 15(d) OF THEEXCHANGE ACT**

**Commission File No. 0-51715**

**SPORT-HALEY,INC.**(Exact name of small business issuer as specified in itscharter)

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

** **

**4600 E. 48th Avenue, Denver, Colorado 80216**(Address of principal executive offices)

**(303)320-8800**(Issuer’s telephone number including area code)

Indicate by check markwhether the registrant (1) filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.  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.

| Large accelerated  filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act.  Yes  o    No  x

Indicate the number ofshares outstanding in each of the issuer’s classes of common stock, as of thelatest practicable date.

| **Class**                       |   | **Outstanding  at October 31, 2006** |
|---------------------------------|--------|--------------------------------------|
| **Common  Stock, no par value** |   | **2,770,252**                        |

 

 

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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**                                       |                                                                                        |       |

 

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**SPORT-HALEY,INC.CONDENSED CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                         | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                                         | ** ** | **2006**               | ** ** | **2006**          | ** ** |
| ** **                                                                                         | ** ** | **(Unaudited)**        | ** ** | **(***)**         | ** ** |
| **ASSETS**                                                                                         |       |                   |       |              |       |
| Current assets:                                                                                    |       |                   |       |              |       |
| Cash and cash  equivalents                                                                         |       | $                      | 6,895,000  |              | $          | 8,492,000 |   |
| Accounts  receivable, net of allowances of $461,000 and $446,000, respectively                     |       | 3,013,000              |       | 3,950,000         |       |
| Inventories                                                                                        |       | 5,356,000              |       | 4,775,000         |       |
| Prepaid expenses  and other                                                                        |       | 210,000                |       | 194,000           |       |
| Total current  assets                                                                              |       | 15,474,000             |       | 17,411,000        |       |
|                                                                                               |       |                   |       |              |       |
| Property and equipment,  net                                                                       |       | 538,000                |       | 613,000           |       |
| Goodwill                                                                                           |       | 270,000                |       | —            |       |
| Other assets                                                                                       |       | 3,000                  |       | 3,000             |       |
|                                                                                               |       | $                      | 16,285,000 |              | $          | 18,027,000 |   |
|                                                                                               |       |                   |       |              |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                     |       |                   |       |              |       |
| Current liabilities:                                                                               |       |                   |       |              |       |
| Accounts payable                                                                                   |       | $                      | 828,000    |              | $          | 1,836,000 |   |
| Accrued  royalties payable                                                                         |       | 210,000                |       | 386,000           |       |
| Accrued commissions  payable                                                                       |       | 179,000                |       | 211,000           |       |
| Accrued payroll                                                                                    |       | 309,000                |       | 386,000           |       |
| Other                                                                                              |       | 141,000                |       | 137,000           |       |
| Total current  liabilities                                                                         |       | 1,667,000              |       | 2,956,000         |       |
|                                                                                               |       |                   |       |              |       |
| Long-Term Liabilities:                                                                             |       |                   |       |              |       |
| Loan payable to  affiliate                                                                         |       | —                 |       | 34,000            |       |
| Total long-term  liabilities                                                                       |       | —                 |       | 34,000            |       |
|                                                                                               |       |                   |       |              |       |
| Commitments and  Contingencies (Notes 3 and 4)                                                     |       |                   |       |              |       |
|                                                                                               |       |                   |       |              |       |
| Total Liabilities                                                                                  |       | 1,667,000              |       | 2,990,000         |       |
|                                                                                               |       |                   |       |              |       |
| Minority Interest                                                                                  |       | —                 |       | 22,000            |       |
|                                                                                               |       |                   |       |              |       |
| 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; 2,770,252 shares issued and outstanding |       | 10,813,000             |       | 10,813,000        |       |
| Additional  paid-in capital                                                                        |       | 1,621,000              |       | 1,621,000         |       |
| Retained  earnings                                                                                 |       | 2,184,000              |       | 2,581,000         |       |
| Total  shareholders’ equity                                                                   |       | 14,618,000             |       | 15,015,000        |       |
|                                                                                               |       | $                      | 16,285,000 |              | $          | 18,027,000 |   |

----

***  Taken from the auditedbalance sheet at that date

See accompanying notes to these condensed consolidated financialstatements.

3

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**SPORT-HALEY,INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                                                            | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                            | ** ** | **September 30,**           | ** ** |
| ** **                                                                            | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                            | ** ** | **(Unaudited)**                  | ** ** | **(Unaudited)** | ** ** |
|                                                                                  |       |                             |       |   |   |
| Net sales                                                                             |       | $                                | 4,673,000  |   | $ | 4,011,000 |   |
|                                                                                  |       |                             |       |   |   |
| Cost of goods  sold                                                                   |       | 3,122,000                        |       | 2,641,000 |   |
| Impairments                                                                           |       | 49,000                           |       | 65,000 |   |
| Total cost of goods  sold                                                             |       | 3,171,000                        |       | 2,706,000 |   |
|                                                                                  |       |                             |       |   |   |
| Gross profit                                                                          |       | 1,502,000                        |       | 1,305,000 |   |
|                                                                                  |       |                             |       |   |   |
| Other Operating  Costs:                                                               |       |                             |       |   |   |
| Selling, general and administrative expenses                                          |       | 1,721,000                        |       | 1,724,000 |   |
| Royalty expense                                                                       |       | 210,000                          |       | 163,000 |   |
| Total other operating costs                                                           |       | 1,931,000                        |       | 1,887,000 |   |
|                                                                                  |       |                             |       |   |   |
| Loss from  operations                                                                 |       | (429,000                         | )          | (582,000 | ) |
|                                                                                  |       |                             |       |   |   |
| Other income,  net                                                                    |       | 78,000                           |       | 53,000 |   |
|                                                                                  |       |                             |       |   |   |
| Loss before  minority interest in subsidiary net income and benefit from income taxes |       | (351,000                         | )          | (529,000 | ) |
|                                                                                  |       |                             |       |   |   |
| Minority  interest in subsidiary net income                                           |       | (46,000                          | )          | — |   |
|                                                                                  |       |                             |       |   |   |
| Benefit from  income taxes                                                            |       | —                           |       | 1,000 |   |
|                                                                                  |       |                             |       |   |   |
| Net loss                                                                              |       | $                                | (397,000   | ) | $ | (528,000 | ) |
|                                                                                  |       |                             |       |   |   |
| Basic and  diluted loss per common share                                              |       | $                                | (0.14      | ) | $ | (0.20 | ) |
|                                                                                  |       |                             |       |   |   |
| Basic and diluted  weighted average shares outstanding                                |       | 2,770,000                        |       | 2,685,000 |   |

 

See accompanying notes to these condensed consolidated financialstatements.

4

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**SPORT-HALEY,INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                             | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                             | ** ** | **September 30,**           | ** ** |
| ** **                                                                             | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                             | ** ** | **(Unaudited)**                  | ** ** | **(Unaudited)** | ** ** |
| **Cash  flows from operating activities:**                                             |       |                             |       |   |   |
| Net loss                                                                               |       | $                                | (397,000   | ) | $ | (528,000 | ) |
| Adjustments to reconcile net loss to net cash  provided(used) by operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                          |       | 76,000                           |       | 84,000 |   |
| Impairments and write-downs                                                            |       | 49,000                           |       | 65,000 |   |
| Allowance for doubtful accounts                                                        |       | 30,000                           |       | 15,000 |   |
| Common stock options                                                                   |       | —                           |       | 31,000 |   |
| Loss on disposal of assets                                                             |       | —                           |       | 11,000 |   |
| Minority interest                                                                      |       | 49,000                           |       | — |   |
| Cash provided (used) due to changes in assets and  liabilities:                        |       |                             |       |   |   |
| Accounts receivable                                                                    |       | 907,000                          |       | 1,673,000 |   |
| Inventory                                                                              |       | (630,000                         | )          | (680,000 | ) |
| Other assets                                                                           |       | (16,000                          | )          | (85,000 | ) |
| Accounts payable                                                                       |       | (1,008,000                       | )          | (43,000 | ) |
| Accrued commissions and other expenses                                                 |       | (281,000                         | )          | (220,000 | ) |
| Net cash provided(used) by operating activities                                        |       | (1,221,000                       | )          | 323,000 |   |
|                                                                                   |       |                             |       |   |   |
| **Cash  flows from investing activities:**                                             |       |                             |       |   |   |
| Proceeds from sale of fixed assets                                                     |       | —                           |       | 14,000 |   |
| Purchase of fixed assets                                                               |       | (1,000                           | )          | (5,000 | ) |
| Purchase of minority interest                                                          |       | (375,000                         | )          | — |   |
| Net cash provided (used) by investing activities                                       |       | (376,000                         | )          | 9,000 |   |
|                                                                                   |       |                             |       |   |   |
| **Cash  flows from financing activities:**                                             |       |                             |       |   |   |
| Issuance of common stock                                                               |       | —                           |       | 353,000 |   |
| Net cash provided by financing activities                                              |       | —                           |       | 353,000 |   |
|                                                                                   |       |                             |       |   |   |
| **Net  increase(decrease) in cash and cash equivalents**                               |       | (1,597,000                       | )          | 685,000 |   |
| ** **                                                                             |       |                             |       |   |   |
| **Cash  and cash equivalents, beginning**                                              |       | 8,492,000                        |       | 7,721,000 |   |
| ** **                                                                             |       |                             |       |   |   |
| **Cash  and cash equivalents, ending**                                                 |       | $                                | 6,895,000  |   | $ | 8,406,000 |   |
| ** **                                                                             |       |                             |       |   |   |
| **Supplemental  disclosure of cash flow information:**                                 |       |                             |       |   |   |
| Cash received during the period for:                                                   |       |                             |       |   |   |
| Income taxes                                                                           |       | $                                | —     |   | $ | 1,000 |   |
| Cash paid during the period for:                                                       |       |                             |       |   |   |
| Income taxes                                                                           |       | $                                | —     |   | $ | — |   |

 

See accompanying notes to these condensed consolidated financialstatements.

 

5

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** **

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

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

*Principlesof Consolidation*— Included in the September 30, 2006,consolidated financial statements are the accounts of Sport-Haley, Inc. (“SportHaley”) and Reserve Apparel Group LLC (“Reserve Apparel”). Sport Haley andReserve Apparel may collectively be referred to as “the Company”, “we”, “us” or“our”.

*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. In accordance with its operating agreement, Sport Haley owneda 51% interest in Reserve Apparel and Explorer Gear USA, Inc. (“Explorer Gear”)owned a 49% interest. On September 21, 2006, Sport Haley entered into anagreement with Explorer Gear to purchase its 49% membership interest in ReserveApparel for a lump sum payment of $375,000, since which time Reserve Apparelhas been a wholly-owned subsidiary of Sport Haley. Top-Flite® branded golfapparel is distributed per the terms of a license agreement with Callaway.

*CondensedFinancial Statements* - The accompanying 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 principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses and the disclosure of contingent assets andliabilities.

Certaininformation in footnote disclosures normally included in financial statementshas been condensed or omitted in accordance with the rules and regulations ofthe Securities and Exchange Commission. The information included in this Form10-Q should be read in conjunction with financial statements and notes theretoand Management’s Discussion and Analysis of Financial Condition and Results ofOperations for the year ended June 30, 2006, included in the Company’s filingon Form 10-K.

*Reclassification*— Certain priorperiod amounts have been reclassified to conform to the September 30, 2006,presentation. Such reclassifications had no affect on net income(loss) in anyof the periods presented.

6

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

*Stock-BasedCompensation* - Our Stock Option Plan (the “Plan”) expired by itsterms on February 28, 2003. Option agreements that were issued in accordancewith the Plan prior to February 28, 2003, generally remain in force until theearlier of their exercise, the expiration of certain time periods after thetermination of a grantee’s employment (or other relationship with the Company)or expiration by their terms.

AtSeptember 30, 2006, there were outstanding options to purchase 673,500 sharesof our common stock at exercise prices ranging from $2.71 to $9.78 per shareand expiration dates between February 2007 and January 2013. No options wereexercised during the three months ended September 30, 2006, and 5,000 optionsexpired.

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 123(R) (“SFAS 123R”), *“Share-Based Payment,”*which is a revision of Statement of Financial Accounting Standards No. 123, *“Accounting for Stock-Based Compensation.”* SFAS 123R iseffective for annual periods beginning after July 1, 2005, supersedesAccounting Principles Board Opinion No. 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 modified prospectivemethod prescribed in SFAS 123R, effective July 1, 2005.

Previously, we accountedfor stock-based compensation using the intrinsic value method prescribed inAccounting Principles Board Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” and related interpretations andelected to apply the disclosure-only provisions of Statement of FinancialAccounting Standards (SFAS) No. 123, “*Accountingfor Stock-Based Compensation*,” as amended by SFAS No. 148, “*Accounting for Stock-Based Compensation — Transitionand Disclosure*.” Under the intrinsic value method, compensationexpense for stock options was recognized over the vesting period of the grantbased on the excess, if any, of the market price of our common stock at thedate of grant over the stock option exercise price. As governed by the Plan,stock options were generally granted at or near fair market value on the dateof grant.

The Plan expired by itsterms in February 2003. Accordingly, no options were granted since then. Theexpected life was determined based upon the Plan’s vesting period and exercisebehavior of the employees.

7

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

If we had previouslyaccounted for stock-based compensation in interim periods using the fair valuemethod rather than the intrinsic value method, the pro forma amounts of our netloss and loss per common share would have been reported as follows:
|                                                                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| Net loss - as  reported                                                              |       | $                                                        | (397,000   | ) | $ | (528,000 | ) |
| Effect of  employee stock-based compensation included in reported net loss           |       | —                                                   |       | 31,000 |   |
| Effect of  employee stock-based compensation per SFAS 123                            |       | —                                                   |       | (31,000 | ) |
| Net loss  applicable to common stock (pro forma 2005)                                |       | $                                                        | (397,000   | ) | $ | (528,000 | ) |
|                                                                                 |       |                                                     |       |   |   |
| Basic and  Diluted:                                                                  |       |                                                     |       |   |   |
| Loss per share - as reported                                                         |       | $                                                        | (0.14      | ) | $ | (0.20 | ) |
| Per share effect of employee stock-based  compensation included in reported net loss |       | —                                                   |       | 0.01 |   |
| Per share effect of employee stock-based  compensation per SFAS 123                  |       | —                                                   |       | (0.01 | ) |
| Loss per share  applicable to common stock (pro forma 2005)                          |       | $                                                        | (0.14      | ) | $ | (0.20 | ) |

* *

*RecentPronouncements* — In September 2006, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsNo. 158 (“SFAS 158”), “*Accounting for DefinedBenefit Pensions and Other Post-Retirement Plans*,” which iseffective for financial statements for fiscal years ending after December 15,2006. SFAS 158 improves financial reporting by requiring an employer torecognize the over-funded or under-funded status of a defined benefitpost-retirement plan (other than a multi-employer plan) as an asset or aliability in the company’s statement of financial position and to recognizechanges in the funded status, in the year in which the changes occur, throughthe presentation of comprehensive income for a business or changes inunrestricted net assets for a not-for-profit organization. SFAS 158 alsoimproves financial reporting by requiring an employer to measure the fundedstatus of a plan as of the date of its year-end statement of financialposition, with limited exceptions. We do not maintain a defined benefit pensionplan and do not anticipate that adoption of SFAS will have a material impact onour financial condition or the results of our operations.

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

8

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

**NOTE 2****            INVENTORIES:**
|                                          | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                               | ** ** | **2006**               | ** ** | **2006**          | ** ** |
| Inventories  consisted of the following: |       |                   |       |              |       |
| Component                                |       | $                      | 162,000    |              | $          | 366,000 |   |
| Finished goods                           |       | 5,194,000              |       | 4,409,000         |       |
|                                     |       | $                      | 5,356,000  |              | $          | 4,775,000 |   |

 

Included in finished goods inventories balances are allowances forinventory write-downs of $76,000 and $276,000 for September 30, 2006, and June30, 2006, respectively.

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

We maintain arevolving line of credit agreement with a commercial bank. The revolving lineof credit agreement, renewed by amendment through December 5, 2006, providesfor a maximum loan amount of $5,000,000, collateralized by a lien on substantiallyall of our assets, and for interest at the bank’s prime rate. In accordancewith the amended agreement, we must maintain minimum tangible net worth of$14,000,000 and liquidity of $4,000,000. We generally maintain the line ofcredit to facilitate the issuance of letters of credit for inventory purchasesfrom offshore suppliers and, if necessary, to fund any temporary workingcapital needs. We did not have any balances due on the line of credit atSeptember 30, 2006, or June 30, 2006, respectively.

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

At September 30, 2006, and June 30, 2006, we had $185,000 and $509,000,respectively, in outstanding letters of credit that were issued to foreignsuppliers in accordance with finished goods inventory purchase commitments. Outstandingletters of credit reduce the amount available for borrowing under the line ofcredit agreement.

**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:
|                                                | ** ** | **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 | ) |

 

9

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

 
|                                                | ** ** | **Three Months ended September 30, 2005** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Net**                                                            | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Loss**                                                           | ** ** | **Average Shares** | ** ** | **Per Share** | ** ** |
| Loss Per Common  Share                         |       |                                                               |       |   |   |   |   |
| Basic loss per  share                          |       | $                                                                  | (528,000   | ) | 2,685,000 |   | $ | (0.20 | ) |
| **Effect  of dilutive securities options [A]** |       | —                                                             |       | — |   | — |   |
| ** **                                     |       |                                                               |       |   |   |   |   |
| Diluted loss per share                         |       | $                                                                  | (528,000   | ) | 2,685,000 |   | $ | (0.20 | ) |

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

**NOTE 6****            SEGMENTINFORMATION:**

The consolidatedCompany has two operating segments: designing, purchasing or contracting forthe manufacture of and wholesale sales of women’s and men’s (1) fashion golfapparel and outerwear and (2) branded golf apparel. Our SPORT HALEY® and BenHogan® fashion golf apparel and outerwear collections are marketed by SportHaley in the premium and mid-priced markets through a network of independentwholesale sales representatives and distributors to golf professional shops,country clubs, resorts and exclusive department stores within the United Statesand on a limited basis by certain distributors within international markets. OurTop-Flite® men’s branded apparel is marketed by Reserve Apparel to massretailers and other big-box type high sales volume retail stores. Ben Hogan®fashion apparel and Top-Flite® branded apparel are distributed pursuant to alicensing agreement with Callaway.

In November 2005,Callaway granted Sport Haley permission, with certain conditions, to allowReserve Apparel to distribute Top-Flite® branded apparel exclusively toWal-Mart Stores, Inc. (“Wal-Mart”), within the United States. Reserve Apparelwas formed to combine the perceived synergies between Sport Haley and ExplorerGear. Principal members of the management of Explorer Gear are also theprincipal members of management of Explorer Headgear, Inc., a Canadian companywhich has distributed Top-Flite® apparel to Wal-Mart in Canada for severalyears. In March 2006, the management of Explorer Gear requested that they berelieved of certain of their duties, required per the Reserve Apparel OperatingAgreement, in order that substantially all of the business operations ofReserve Apparel, including designing, sourcing, pricing, soliciting sales andcoordinating the distribution of merchandise, which had been performed byExplorer Gear, could be transferred to the Sport Haley facilities in Denver,Colorado, to be managed under the direction of Sport Haley executives. WhileSport Haley began facilitating the transfer of Reserve Apparel operations toDenver in April 2006, Explorer Gear continued with their involvement in themanagement of deliveries of inventories from suppliers and the invoicing ofshipments to Wal-Mart through June 2006. On September 21, 2006, Sport Haleyentered into an agreement with Explorer Gear to purchase its 49% membershipinterest in Reserve Apparel for a lump sum cash payment of $375,000, sincewhich time Reserve Apparel has been a wholly-owned subsidiary of Sport Haley.

Reserve Appareldistributed Top-Flite® apparel exclusively to Wal-Mart from March 2006 throughAugust 2006. However, in late September 2006, Reserve Apparel was notified that

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

Wal-Mart hadchosen to develop a line of golf apparel under a private label rather than tocontinue purchasing our Top-Flite® branded apparel. We had presented a newlydesigned line of Top-Flite® apparel to Wal-Mart in early September whichconsisted of garments primarily comprised of a variety of performance fabrics.We believe there are several other markets for Top-Flite® branded golf apparel,and we have begun to aggressively market the new Top-Flite® apparel line to anumber of other mass retailers and other big-box type high sales volume retailstores.

Condensedconsolidated balance sheets information and condensed consolidated statementsof operations for each of our segments are presented in the tables below. Thefirst sales of Top-Flite® branded apparel were made in March 2006. Therefore,the tables below only include segment information for the three months endedSeptember 30, 2006.

*CondensedConsolidated Balance Sheets Segment Information as of September 30, 2006:*
|                                         | ** ** | **September 30, 2006** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **Fashion**                      | ** ** | **Branded** | ** ** |
| ** **                              | ** ** | **Apparel**                      | ** ** | **Apparel** | ** ** |
| Cash and cash  equivalents              |       | $                                | 4,335,000  |   | $ | 2,560,000 |   |
|                                    |       |                             |       |   |   |
| Accounts  receivable, net of allowances |       | $                                | 2,428,000  |   | $ | 585,000 |   |
|                                    |       |                             |       |   |   |
| Inventories                             |       | $                                | 5,356,000  |   | $ | — |   |
|                                    |       |                             |       |   |   |
| Total assets                            |       | $                                | 12,329,000 |   | $ | 3,145,000 |   |
|                                    |       |                             |       |   |   |
| Current liabilities                     |       | $                                | 1,335,000  |   | $ | 332,000 |   |

* *

*CondensedConsolidated Statements of Operation Segment Information for the Three MonthsEnded September 30, 2006:*
|                                               | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **September 30, 2006** | ** ** |
| ** **                                    | ** ** | **Fashion**                      | ** ** | **Branded** | ** ** |
| ** **                                    | ** ** | **Apparel**                      | ** ** | **Apparel** | ** ** |
| Net sales                                     |       | $                                | 3,488,000  |   | $ | 1,185,000 |   |
|                                          |       |                             |       |   |   |
| Cost of goods  sold                           |       | $                                | 2,237,000  |   | $ | 885,000 |   |
|                                          |       |                             |       |   |   |
| Impairments                                   |       | $                                | 49,000     |   | $ | — |   |
|                                          |       |                             |       |   |   |
| Gross profit                                  |       | $                                | 1,201,000  |   | $ | 301,000 |   |
|                                          |       |                             |       |   |   |
| Selling, general  and administrative expenses |       | $                                | 1,582,000  |   | $ | 139,000 |   |
|                                          |       |                             |       |   |   |
| Royalty expense                               |       | $                                | 146,000    |   | $ | 64,000 |   |
|                                          |       |                             |       |   |   |
| Income(loss) from  operations                 |       | $                                | (527,000   | ) | $ | 98,000 |   |

 

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

This Report on Form 10-Q contains certain forward-looking statements,within the meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities 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;  unsatisfactory recourse with regard tononconforming goods received from foreign suppliers; political andinternational trade relations; changes in international trade quota systems forapparel; significant reliance upon several individual foreign suppliers;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, 2006. 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 statements. The reader should notplace undue reliance on any forward-looking statements. Neither the Company norany of its corporate officers or key employees assumes any obligation to updateany forward-looking statements as a result of new information, future events ordevelopments, except as required by securities laws.

All references to fiscal years correspond with the fiscal year ofSport-Haley, Inc., which ends on June 30.

##### **OVERVIEW**

Sport-Haley, Inc. designs, purchases or contractsfor the manufacture of, markets and distributes women’s and men’s fashion golfapparel and outerwear under the SPORT HALEY® and Ben Hogan® labels. Weare represented by a network of independent wholesale sales representatives andemploy two regional sales managers, each with responsibilities for both of ourfashion apparel labels. Most of the independent wholesale sales representativessolicit sales of both SPORT HALEY® and Ben Hogan® 

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

fashionapparel collections on our behalf.

SPORTHALEY® fashion apparel is comprised almost exclusively of women’s garments andaccessories, designed by utilizing classic styles with contemporary influencesintended to develop and maintain brand recognition and loyalty, on or off thegolf course. While each product in the SPORT HALEY® apparel line is soldseparately, the line is intentionally designed in groups with 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 recognized that fashion designswithin the women’s golf apparel market were trending toward technicalperformance fabrics and more athletic styling and began designing our women’sfashion apparel to include moisture wicking fabrics such as AEROCool andDry-Tech 18 and to include a larger selection of more leading edge, youngerlooking, athletic style garments. The technical performance fabrics andathletic style garments have been well received by our customers.

Ben Hogan® men’s fashion apparel is designedutilizing elegant time-honored classic styles intended to garner nearlyinstantaneous brand recognition. The Ben Hogan® label has been widelyrecognized within the golf apparel industry for the past five years forcontinually providing elegant men’s fashion golf apparel of impeccable qualityin keeping with the image of Mr. Hogan. While each product in the Ben Hogan®apparel line is sold separately, the line is intentionally designed in groupswith coordinated styles, color schemes and fabrics to encourage customers topurchase multiple garments. Ben Hogan® apparel is manufactured using a varietyof fabrics, including wool, silk and cashmere, and weave patterns, includingpique, jersey and twill, and most pieces feature a unique trim, a specialfabric finish or extra needlework. Ben Hogan® men’s apparel is marketed in thepremium-price markets to elite golf professional shops, upscale resorts andexclusive department stores. We distribute Ben Hogan® apparel pursuant to ourlicensing agreement with Callaway.

Top-Flite® branded golf apparel is designed fordistribution to large retail stores in the low-price markets. Branded apparelis generally produced in mass quantities and usually utilizes much simplerdesigns and is of much lesser quality than the fashion apparel garments whichwe sell in the premium and mid-priced markets. While our fashion golf apparelis generally designed for two separate selling seasons each year, branded golfapparel is generally designed for four or more shorter selling periods eachyear. Many of our Top-Flite® garments are designed utilizing basic performancefabrics made from polyester or other man-made materials or from blends ofnatural and man-made materials. Reserve Apparel distributed Top-Flite® apparelexclusively to Wal-Mart from March 2006 through August 2006. However, in lateSeptember 2006, Reserve Apparel was notified that Wal-Mart had chosen todevelop a line of golf apparel under a private label rather than to continuepurchasing our Top-Flite® branded apparel. We had presented a newly designedline of Top-Flite® apparel to Wal-Mart in early September which consisted ofgarments primarily comprised of a variety of performance fabrics. We believethere are several other markets suitable for Top-Flite® branded golf apparel,and we have begun to aggressively market our newly designed Top-Flite® apparelline to a number of mass retailers and other big-box type high sales volumeretail stores. To date, we have not received any orders from such retailers. Wedistribute Top-Flite® apparel pursuant to our licensing agreement withCallaway.

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

**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, 2006. 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, wemaintain reserves for inventory write downs due to the obsolescence of excessinventories. We perform analyses on a quarterly basis to identify unsold excessinventories and adjust our reserves for inventory obsolescence to reduce thecarrying value of excess inventories to their estimated net realizable value.The net realizable value of excess inventories is estimated based on management’sdisposition plans and historical experiences. Generally, branded apparelinventories are not prone to impairment, because we usually order brandedapparel in quantities per specific customer orders.

During the quarter ended September 30, 2006, werecorded fashion apparel inventories write-downs of $49,000. We did not recorda write-down with regard to branded apparel inventories during the quarterended September 30, 2006.

*Deferred Income Taxes*

Deferred incometaxes are recognized for the expected tax consequences in future years fordifferences between the tax bases of assets and liabilities and their financialreporting amounts, based upon enacted tax laws and statutory tax ratesapplicable to the periods in which the differences are expected to affecttaxable income. Our significant deferred tax assets are related to netoperating loss carry forwards for federal and state income tax purposes,stock-based compensation and an unrealized loss for tax purposes on a commonstock investment. Governing regulations require that our operating losses becarried forward for income tax purposes. We maintain a valuation allowance toreduce deferred tax assets to the net amount expected to be recovered in futureperiods. The estimates for deferred tax assets and the 

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

correspondingvaluation allowance require us to exercise complex judgments. We periodically reviewand adjust those estimates based upon the most current information available.In accordance with SFAS 109 and based upon a review at September 30, 2006, ofour utilization of deferred tax assets, we maintained a valuation allowancethat effectively reduces our net deferred tax assets to zero. While we continueto explore various strategies to return the Company to profitability, includingfinding alternative markets for our Top-Flite® branded apparel, we cannot becertain that our efforts will result in the generation of future profits.Because the recoverability of deferred tax assets is directly dependent uponfuture operating results, actual recoverability of deferred tax assets maydiffer 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 customer performance and anticipatedcustomer performance. From time to time, we also identify delinquent customeraccounts for which a specific reserve is required. At September 30, 2006, ourallowance for doubtful accounts totaled $306,000, including a specific reserveof $116,000 with respect to the potential non-recovery of a net amount due toReserve Apparel from a former inventory broker. While we consider our processesto be adequate to effectively quantify our exposure to doubtful accounts,changes in economic, industry or specific customer conditions may result inrecoverability of our doubtful accounts that differs materially from ourestimates.

*Allowancefor Sales Returns*

Werecord allowances for sales returns as net adjustments to customer accountsreceivable. When recording an allowance, the net method reduces customer accountsreceivable 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, 2006, the Company’s allowancefor sales returns was $155,000. Significant changes in general economic or industryconditions may yield sales returns that differ materially from our estimates.

### **LIQUIDITY AND CAPITAL RESOURCES**

The golf apparelbusiness is highly seasonal in nature, and our balance sheet amounts atSeptember 30, 2006, may be more meaningful when compared with the balance sheetamounts at September 30, 2005, rather than with the balance sheet amounts atJune 30, 2006.

Our primarysources of liquidity are comprised of available cash and cash equivalents, cashflows from operations and a working capital line of credit with a commercialbank. We require cash for general working capital purposes. We do notanticipate 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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**SPORT-HALEY,INC.ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

seasonal innature, with greater requirements from approximately August through October andFebruary through April of each fiscal year, due to the purchases of finishedgoods inventories for the spring/summer and fall/holiday selling seasons,respectively.

Our net accountsreceivable decreased by $937,000, or 24%, to $3,013,000 at September 30, 2006,from $3,950,000 at June 30, 2006. When compared with the September 30, 2005,balance, the net accounts receivable balance at September 30, 2006, increasedby $206,000, or 7%, which was primarily attributable to the net accountsreceivable balance relating to branded apparel that increased by $585,000 from$0 during the same comparable period. Historically, net sales of our fashionapparel are weakest during our first fiscal quarter, and our net accountsreceivable balance relating to fashion apparel generally declines during our firstfiscal quarter when compared with the balance at the previous fiscal year end.While a large portion of our fourth fiscal quarter fashion apparel sales areshipped in the month of June each year, fashion apparel sales are generallyshipped more evenly throughout our first fiscal quarter. Because a largeportion of our fashion apparel sales are shipped with “Net 30” payment terms,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 $2,428,000 at September 30, 2006, a decrease of$379,000, or 14%, from the balance of $2,807,000 at September 30, 2005. Changesin our accounts receivable balances provided operating cash of $937,000 and$1,688,000 for the fiscal quarters ended September 30, 2006 and 2005,respectively.

The balances of ourinventories have increased slightly since June 30, 2006. Inventories increasedby $581,000, or 12%, to $5,356,000 at September 30, 2006, from $4,775,000 atJune 30, 2006. When compared with the balance at September 30, 2005, ourinventories increased by $588,000, or 12%, from $4,768,000. The comparativeincrease in our inventories from September 30, 2005, to September 30, 2006, wasprimarily due to fashion apparel inventory purchases with regard to the Spring2007 selling season as compared with purchases for the Spring 2006 sellingseason in the prior fiscal year. At September 30, 2006, a majority of ourinitial orders for Spring 2007 fashion apparel inventories had been purchasedor was in transit at an earlier date than in the previous year. Generally, amajority of our purchases for the following spring selling season are receivedduring October each year. We had no branded apparel inventories at September30, 2006. Changes in our inventory balances used operating cash of $581,000 and$615,000 for the quarters ended September 30, 2006 and 2005, respectively.

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

Accounts payableand accrued expenses decreased by $1,289,000, or 44%, to $1,667,000 atSeptember 30, 2006, from $2,956,000 at June 30, 2006. Accounts payable andaccrued expenses increased by $179,000, or 12%, from $1,488,000 at September30, 2005, which was primarily attributable to our accounts payable balance withregard to branded apparel of $332,000 at September 30, 2006, as compared with$0 at September 30, 2005. Our accounts payable and accrued expenses balancewith regard to fashion apparel was $1,335,000 at September 30, 2006, a decreaseof $153,000, or 10%, when

 

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

compared with thebalance of $1,488,000 at September 30, 2005, primarily attributable todecreases in accrued payroll expenses, which decreased by $234,000, or 43%, to$309,000 from $543,000. The decrease in accrued payroll expenses consistedprimarily of a decrease in the amount of severance and other compensationpayable to our former chief executive officer and a decrease in accruedexecutive bonuses. Our balance of accrued severance and other compensationdecreased by $164,000, to $244,000 from $408,000, and our balance of accruedexecutive bonuses decreased by $77,000, to $0 from $77,000, from September 30,2005, to September 30, 2006, respectively.

Due to thecombination of the factors discussed above, and others, our operatingactivities used cash of ($1,221,000) for the three months ended September 30,2006. Comparatively, for the quarter ended September 30, 2005, our operatingactivities provided cash of $323,000.

For the three monthsended September 30, 2006, investing activities used cash of $376,000.Comparatively, for the three months ended September 30, 2005, investingactivities provided cash of $9,000. On September 21, 2006, Sport Haley enteredinto an agreement with Explorer Gear to purchase its 49% ownership interest inReserve Apparel for a lump sum cash payment of $375,000, since which timeReserve Apparel has been a wholly-owned subsidiary of Sport Haley. Thetransaction with Explorer Gear caused us to record $270,000 in goodwill withrespect to the purchase, which was calculated as the purchase price less loansand accrued interest payable to Explorer Gear as of the purchase date and lessthe capital balance of Explorer Gear as of the purchase date after allocationof their proportionate share of Reserve Apparel’s loss for the period ended onthe purchase date. While negotiating the purchase price, our Board of Directorsconsidered such factors as increased operating efficiencies gained by endingthe long-distance relationship with a foreign member and the overall potentialfor return on investment with regard to anticipated future sales of Top-Flite®branded apparel. During the three months ended September 30, 2006, we expended$1,000 for the purchase of property and equipment, and $76,000 in depreciationand amortization was charged to current operations.

We maintain arevolving line of credit agreement with a commercial bank. The revolving lineof credit agreement, renewed by amendment through December 5, 2006, providesfor a maximum loan amount of $5,000,000, collateralized by a lien onsubstantially all of our assets, and for interest at the bank’s prime rate. Inaccordance with the amended agreement, we must maintain tangible net worth of$14,000,000 and liquidity of $4,000,000. We generally maintain the line ofcredit to facilitate the issuance of letters of credit for inventory purchasesfrom offshore suppliers and, if necessary, to fund any temporary workingcapital needs. Outstanding letters of credit reduce the amount available forborrowing under the line of credit agreement. At September 30, 2006, we had$185,000 in outstanding letters of credit that were issued to foreign suppliersin accordance with finished goods inventory purchase commitments.

We believe thatcash on hand and cash generated from operations, as well as the ability toborrow under the bank line of credit, will be sufficient to meet our cashrequirements during the remainder of fiscal 2007. We also have alternativesources of financing, including the factoring of customer accounts receivable.We do not anticipate drawing on the line of credit or using alternative sourcesof financing during the remainder of fiscal 2007. However, our capital needswill depend on many factors, including the need to finance required inventorylevels, the success of current sales and marketing programs, and potential cashrequirements related to the operations of Reserve Apparel and various otherfactors.

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

### **RESULTS OF OPERATIONS**

Our business isseasonal in nature, and sales occurring from January through June, whichcomprise our third and fourth quarters of each fiscal year, are generallydisproportionately higher than sales occurring from July through December.

Net sales for thethree months ended September 30, 2006, were $4,673,000, an increase of$662,000, or 17%, from net sales of $4,011,000 for the comparable period in theprior fiscal year. The comparative increase in net sales was comprised of thedecrease in our sales of fashion apparel combined with our sales of brandedapparel during the three months ended September 30, 2006. Net sales of SPORTHALEY® apparel collections were $1,306,000 and $1,482,000 for the three monthsended September 30, 2006 and 2005, respectively. Net sales of Ben Hogan®apparel collections were $2,048,000 and $2,349,000 for the three months endedSeptember 30, 2006 and 2005, respectively. We believe the slight decrease insales is indicative of the current condition of intense competition for floorspace within the markets for our fashion apparel collections. Market conditionsfor women’s fashion golf apparel appear to be improving, and we have recentlyexperienced a slight increase in advance orders for our women’s collections.Ben Hogan® apparel is marketed in accordance with a licensing agreement wemaintain with Callaway Golf Company (“Callaway”) for such apparel. We considerthe licensing agreement with Callaway to be a key component of our businessstrategies. While we strive to maintain a good working relationship withCallaway, the trend for the last several periods, reflecting a higherconcentration of sales of licensed apparel within our total net sales for anygiven period, sustains a risk of loss, should the licensing agreement withCallaway be terminated by either party.

Net sales of Top-Flite® branded apparel were $1,185,000 for the threemonths ended September 30, 2006. We began shipping Top-Flite® branded men’sgolf apparel to Wal-Mart in March 2006. Net sales of branded apparel for thethree months ended September 30, 2006, were comprised of sales to Wal-Mart of$1,000,000 and sales of $185,000 to other markets for the disposition of ourremaining branded apparel inventories. In late September 2006, Wal-Martdiscontinued purchasing Top-Flite® branded golf apparel from us, opting insteadto develop a line of golf apparel under a private label. We believethere are several other markets for Top-Flite® branded golf apparel, and wehave begun to aggressively market the new Top-Flite® apparel line to a numberof other mass retailers and other big-box type high sales volume retail stores. While we expect to develop a businessrelationship with one or more mass retailer or big-box type store, to date wehave not received any orders for Top-Flite® apparel from such retailers. Due tothe length of time inherent within the business cycle for branded apparel, fromreceiving a sales order through delivery of packaged merchandise, we do notanticipate recording sales revenue with regard to Top-Flite® apparel for theremainder of our 2007 fiscal year.

Gross profit, as a percentage of net sales, was 32% for the quarterended September 30, 2006, and 33% for the same quarter in the prior fiscalyear. Our gross profit is generally affected by sales discounts offered tocustomers on various marketing programs, payment discounts offered to certaincustomers, dispositions of excess inventories at reduced sales prices and thevaluation of excess inventories to the lower of cost or market. The dispositionof excess inventories negatively impacts our gross profit percentage even whensuch inventories are properly valued to the lower of cost or market, becausesuch valuation causes sales to be recorded with gross profit at or near zero.For the three months ended September 30, 2006, we recorded net sales of$182,000 and gross profit(loss) of ($25,000) with respect to dispositions ofexcess inventories. Comparatively, for the three months ended September 30,2005, we recorded net sales of $539,000 and gross profit of $15,000 withrespect to sales of excess inventories. 

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

The valuation of inventories to the lower of cost or market alsonegatively impacts our gross profit percentage, because a reduction ofinventory value causes an increase in our cost of goods sold, thereby reducingour gross profit. Our gross profit was negatively impacted by $49,000 for thethree months ended September 30, 2006, by the adjustment of our fashion apparelfinished goods inventories to the lower of cost or market. Comparatively, ourgross profit was negatively impacted by $65,000 for the three months endedSeptember 30, 2005, by a similar lower of cost or market adjustment. During thethree months ended September 30, 2006, we did not record a write-down withregard to branded apparel inventories.

Our gross marginsmay not be comparable to other companies within the golf apparel industry. Wehave consistently included the cost of merchandise sold, including importcharges, in-bound freight, allocated overhead, freight out, embroidery costsand other charges in our cost of goods sold. Our overhead allocation includesour production costs plus a portion of our distribution costs, such asreceiving and inspection costs, but we include some of the other costs ofdistribution, such as a portion of our warehousing and other handling costs, inselling, general and administrative expenses. Our gross margins also include,on a consolidated basis, the operations of Reserve Apparel, which distributesTop-Flite® branded apparel to the mass retail market at much lower price pointsand gross margins lower than those expected to be achieved in the premium andmid-price markets where we distribute our SPORT HALEY® and Ben Hogan® fashionapparel brands. Other companies within the golf apparel industry may or may notoperate within the lower price markets. We include royalty payments, relatingto sales of licensed apparel, in selling, general and administrative expenses.

Our gross marginwith respect to net sales of our SPORT HALEY® and Ben Hogan® fashion golfapparel was 34% for the three months ended September 30, 2006, and was 33% forthe three months ended September 30, 2005, respectively. Our gross margin withrespect to net sales of Top-Flite® branded apparel for the three months endedSeptember 30, 2006, was 25%, a substantial improvement from margins we attainedon net sales of branded golf apparel in recent prior periods. We believe thatthe improved gross margin for branded apparel, achieved during the three monthsended September 30, 2006, is a direct result of moving the business operationsof Reserve Apparel to our Denver, Colorado facility and operating ReserveApparel under the direction of our Sport Haley executives.

Selling, generaland administrative expenses decreased by $3,000, or 0%, to $1,721,000 for thequarter ended September 30, 2006, from $1,724,000 for the same quarter in theprior fiscal year. The difference was primarily attributable to a decrease inthe selling, general and administrative expenses with regard to our fashionapparel segment plus the consolidation of the selling, general andadministrative expenses of our branded apparel segment. Selling, general andadministrative expenses with regard to our fashion apparel segment decreased to$1,582,000 for the three months ended September 30, 2006, from $1,724,000 forthe three months ended September 30, 2005. The overall decrease primarily wasattributable to a decrease of $94,000 in executive bonus compensation and adecrease in advertising expenses. Selling, general and administrative expenseswere $139,000 with regard to our branded apparel segment for the three monthsended September 30, 2006. As a percentage of net sales, selling, general andadministrative expenses with regard to our fashion apparel segment wereapproximately 45% and 43% for the three-month periods ended September 30, 2006and 2005, respectively. As a percentage of net sales, selling, general andadministrative expenses with regard to our branded apparel segment were 12% forthe three months ended September 30, 2006.

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

We recorded royalty expense of $146,000 and $163,000 for the quartersended September 30, 2006 and 2005, with regard to net sales of fashion golfapparel, respectively. We recorded royalty expense of $64,000 with respect tonet sales of branded golf apparel for the three months ended September 30,2006. 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 and branded apparel bearing the Top-Flite® label.

Net loss for the three months ended September 30, 2006, was ($397,000), adifference of $131,000, or 25%, as compared with the net loss of ($528,000) forthe same period in the prior fiscal year. At September 30, 2006, we had federaland state net operating loss carry forwards of $5,904,000 and $8,095,000 thatwe estimated may be recoverable at income tax rates of 34% and 5%,respectively. Inaccordance with SFAS 109 and based upon a review at September 30, 2006, of ourutilization of deferred tax assets, we maintained a valuation allowance thateffectively reduces our net deferred tax assets to zero. While we continue toexplore various strategies to return the Company to profitability, includingfinding alternative markets for our Top-Flite® branded apparel, we cannot becertain that our efforts will result in the generation of future profits sufficient to offset our significant netoperating loss carry forwards prior to their expirations. Accordingly, duringthe quarterly periods ended September 30, 2006 and 2005, we did not recordbenefits from income taxes associated with the corresponding losses for therespective three-month periods.

Both the basic anddiluted losses per share were ($0.14) for the quarter ended September 30, 2006.Both the basic and diluted losses per share were ($0.20) for the same quarterin the prior fiscal year. Due to our net losses for the respective periods, alloptions were anti-dilutive and therefore excluded from the loss per sharecalculations.

Our book value pershare was $5.28 at September 30, 2006, $5.42 at June 30, 2006, and $5.63 atSeptember 30, 2005.

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**SPORT-HALEY,INC.ITEM 3 QUALITATIVE AND QUANTITATIVEDISCLOSURES ABOUT 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, 2006,we have not used derivative instruments or engaged in hedging activities. Ourmarket risk has not changed significantly from June 30, 2006.

**InterestRate Risk**

We maintain arevolving line of credit agreement with a commercial bank that provides forinterest at the bank’s prime rate. The agreement provides for a maximum loanamount of $5,000,000 collateralized by a lien on substantially all of ourassets. The bank also requires that we maintain tangible net worth of$14,000,000 and liquidity of $4,000,000. We generally maintain the line ofcredit to facilitate the issuance of letters of credit for inventory purchasesfrom offshore suppliers, and, if necessary, to fund any temporary workingcapital needs. At September 30, 2006, we did not have any outstandingborrowings under the line of credit. Increases in the bank’s prime rate could,however, increase the interest expense with respect to future borrowings,including borrowings under the line of credit. Outstanding letters of creditreduce the amount available for borrowing under the line of credit. We hadoutstanding letters of credit of $185,000 at September 30, 2006. We do not usederivative financial instruments to manage interest rate risk.

From time to time,we maintain short-term investments in low risk and no risk financialinstruments, readily convertible into cash, which earn interest at variablerates. Periodically, our cash balances held at financial institutions exceedfederally insured limits.

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

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

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 to the Company, required to be disclosed inthis report, was made known to management in a timely manner; and (b)information was recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and regulations.

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

During the first quarter of fiscal 2007, we did notinstitute any significant changes in internal controls over financial reportingas defined in Rules 13a-15(f) or 15d-15(f) that materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

Our management, including the Chief Executive Officer and the 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. These inherentlimitations include the realities that judgments in decision-making can befaulty, and that breakdowns can occur because of simple errors or mistakes.Additionally, a control may be circumvented by the individual act of someperson, by collusion of two or more persons, or by management’s override of aspecific control. The design of any system of controls is also based in part oncertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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

### **ITEM 1****             LEGALPROCEEDINGS**

We are subject tovarious legal proceedings and claims which arise in the ordinary course of ourbusiness. Based upon information that is currently available, management doesnot believe that the ultimate resolution of these routine matters will have amaterial adverse affect on our financial position or the results of ouroperations.

### **ITEM 1A****          RISKFACTORS**

There have been nomaterial changes from the risk factors previously disclosed in Item 1A of ourannual report on Form 10-K for the year ended June 30, 2006.

### **ITEM 5****             OTHERINFORMATION**

On August 28,2006, the Board of Directors accepted Patrick W. Hurley’s surrender of thetitle of Controller, an officer position. Mr. Hurley will continue to serve asChief Financial Officer, Secretary and Treasurer. The Company hired aController as a non-officer to provide assistance in the accounting department.

On September 21,2006, Sport Haley entered into an agreement with Explorer Gear and Explorer Headgear,Inc., which was approved by Reserve Apparel, for the purchase of Explorer Gear’smembership interest in Reserve Apparel and to settle any potential claimsbetween the parties. The agreement requires Sport Haley to make a lump sumpayment to Explore Gear of $375,000. After Reserve Apparel began operations,certain disputes arose between the members concerning, among others, theformation, operation and performance of Reserve Apparel. Sport Haley, ReserveApparel, Explorer Gear and Explorer Headgear, Inc. have denied any liability toone another. As part of the agreement, the parties have agreed to settle andresolve any asserted or potential claims against each other. The parties havealso agreed to mutual releases of all claims asserted, or which could have beenasserted, against each other, and each party has continued to deny the meritsof those claims asserted against it by the other. Upon entering into theagreement, Explorer Gear no longer owned any membership interest in ReserveApparel, which became a wholly-owned subsidiary of Sport-Haley.

On September 22,2006, Reserve Apparel was notified that Wal-Mart had chosen to develop its ownbrand of golf apparel rather than to purchase our Top-Flite® line, which hadbeen presented to them earlier in September 2006. The discontinuance ofTop-Flite® golf apparel in Wal-Mart stores allows us to refocus the directionthat we envision for the Top-Flite® brand. While we continue to believe thatTop-Flite® apparel could have produced mutually successful results had Wal-Martcontinued to purchase it from us, we believe that the style and quality ofproducts that we could offer under the Top-Flite® brand were restricted by thelimits imposed by Wal-Mart for golf apparel within their stores and that we canreadily expand the Top-Flite® apparel line to suit a number of other markets,which we have recently begun to explore.

In September 2006,Donald W. Jewell was appointed to serve as our Chief Executive Officer andPresident on a permanent basis for an annual salary of $325,000, retroactive toJuly 1, 

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

2006, and he willno longer serve as our Senior Vice President. Until such time as a newemployment agreement is prepared, the other terms of the employment agreementwith Mr. Jewell, effective as of February 2001, as amended, will generallyremain in effect.

Effective October1, 2006, the Compensation Committee of our Board of Directors raised the annualsalaries of Catherine B. Blair, Patrick W. Hurley and George E. (“Tom”)Tomlinson to $130,000, $125,000 and $110,000, respectively.

On October 19,2006, our independent registered public accountants, Hein & Associates LLP,declined to stand for re-election after the completion of the audit for theyear ended June 30, 2006, and the Audit Committee of our Board of Directorsengaged the firm Gordon, Hughes & Banks, LLP to act as our independentregistered public accountants for the fiscal year ending June 30, 2007.

### **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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**SPORT-HALEY,INC.SIGNATURES**

In accordance withthe requirements of the Securities Exchange Act of 1934, the Registrant causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.
| ** **               | **SPORT-HALEY, INC.**                           |
|--------------------------|-------------------------------------------------|
|                     | (Registrant)                                    |
|                     |                                            |
| Date: November  14, 2006 | /s/ PATRICK W. HURLEY                           |
|                     | Patrick W.  Hurley                              |
|                     | Chief Financial  Officer                        |
| * *                 | *(Principal  Financial and Accounting Officer)* |

 

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