**SECURITIES AND EXCHANGE COMMISSION**

 

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 
| **ý**                                              | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|---------------------------------------------------------|----------------------------------------------------------------------------------------------------|
|                                                    |                                                                                               |
| **For the quarterly period ended  March 31, 2004** |
|                                                    |                                                                                               |
| **o**                                                   | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE  EXCHANGE ACT**                         |

 

**Commission file no. 1-12888**

 

| **SPORT-HALEY,  INC.**                                             |
|--------------------------------------------------------------------|
| (Exact name of small business issuer as  specified in its charter) |
|                                                               |   |   |
| **COLORADO**                                                       |   | **84-1111669** |
| (State of other jurisdiction of  incorporation or organization)    |   | (I.R.S. Employer  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 mark whether the registrant (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days:  Yes  ý  No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act:  Yes  o  No  ý

 

Indicate the number of shares outstanding in each of the issuer’sclasses of common stock, as of the latest practicable date.

 

| **Class**                  |   | **Outstanding at May 12, 2004** |
|----------------------------|--------|---------------------------------|
| Common Stock, no par value |   | 2,450,252                       |

 

 

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**TABLEOF CONTENTS**

 
| **PART 1 – FINANCIAL  INFORMATION (UNAUDITED)** |                                                                                        |
|------------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                                 |                                                                                        |   |
| ITEM 1 –                                        | FINANCIAL STATEMENTS                                                                        |   |
|                                                 |                                                                                        |   |
|                                                 | BALANCE  SHEETS                                                                             |   |
|                                                 |                                                                                        |   |
|                                                 | STATEMENTS OF OPERATIONS                                                                    |   |
|                                                 |                                                                                        |   |
|                                                 | STATEMENTS OF CASH FLOWS                                                                    |   |
|                                                 |                                                                                        |   |
|                                                 | NOTES TO FINANCIAL STATEMENTS                                                               |   |
|                                                 |                                                                                        |   |
| ITEM 2 -                                             | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |
|                                                 |                                                                                        |   |
| ITEM 4 -                                             | CONTROLS  AND PROCEDURES                                                                    |   |
|                                                 |                                                                                        |   |
| **PART II - OTHER INFORMATION**                      |                                                                                        |
|                                                 |                                                                                        |   |
| ITEM 1                                               | LEGAL PROCEEDINGS                                                                           |   |
|                                                 |                                                                                        |   |
| ITEM 4                                               | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                        |   |
|                                                 |                                                                                        |   |
| ITEM 5                                               | OTHER INFORMATION                                                                           |   |
|                                                 |                                                                                        |   |
| ITEM 6                                               | EXHIBITS AND REPORTS ON FORM 8-K                                                            |   |
|                                                 |                                                                                        |   |
| **SIGNATURES**                                       |                                                                                        |
|                                                 |                                                                                        |   |
| **CERTIFICATIONS**                                   |                                                                                        |

 

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**SPORT-HALEY,INC.**

**BALANCE SHEETS**

 
|                                                                                                                            |   | **March 31,  2004** |       | **June 30,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|--------|
|                                                                                                                            |   | **(Unaudited)**          |       | **(***)**               |   |
| **ASSETS**                                                                                                                      |   |                     |       |                    |   |
|                                                                                                                            |   |                     |       |                    |   |
| Current assets:                                                                                                                 |   |                     |       |                    |   |
| Cash and cash equivalents                                                                                                       |   | $                        | 3,428,000  |                    | $      | 4,304,000 |   |
| Marketable securities                                                                                                           |   | 851,000                  |       | 2,181,000               |   |
| Accounts receivable, net of allowances of  $489,000 and $333,000, respectively                                                  |   | 5,122,000                |       | 4,719,000               |   |
| Inventories                                                                                                                     |   | 10,920,000               |       | 7,828,000               |   |
| Other current assets                                                                                                            |   | 296,000                  |       | 737,000                 |   |
| Income taxes receivable                                                                                                         |   | 120,000                  |       | 120,000                 |   |
| Deferred taxes                                                                                                                  |   | 332,000                  |       | 409,000                 |   |
| Total current assets                                                                                                            |   | 21,069,000               |       | 20,298,000              |   |
|                                                                                                                            |   |                     |       |                    |   |
| Property and equipment, net                                                                                                     |   | 1,109,000                |       | 1,014,000               |   |
| Deferred taxes                                                                                                                  |   | 135,000                  |       | 217,000                 |   |
| Other assets                                                                                                                    |   | 14,000                   |       | 16,000                  |   |
|                                                                                                                            |   |                     |       |                    |   |
| Total Assets                                                                                                                    |   | $                        | 22,327,000 |                    | $      | 21,545,000 |   |
|                                                                                                                            |   |                     |       |                    |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                   |   |                     |       |                    |   |
|                                                                                                                            |   |                     |       |                    |   |
| Current liabilities:                                                                                                            |   |                     |       |                    |   |
| Accounts payable                                                                                                                |   | $                        | 1,181,000  |                    | $      | 669,000 |   |
| Accrued commissions and other expenses                                                                                          |   | 1,450,000                |       | 449,000                 |   |
| Total current liabilities                                                                                                       |   | 2,631,000                |       | 1,118,000               |   |
|                                                                                                                            |   |                     |       |                    |   |
| Commitments and Contingencies (Note 3)                                                                                          |   | —                   |       | —                  |   |
|                                                                                                                            |   |                     |       |                    |   |
| 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; 2,450,252 and 2,444,585 shares issued and outstanding,  respectively |   | 9,886,000                |       | 9,868,000               |   |
| Additional paid-in capital                                                                                                      |   | 1,497,000                |       | 1,403,000               |   |
| Retained earnings                                                                                                               |   | 8,313,000                |       | 9,156,000               |   |
| Total shareholders’ equity                                                                                                 |   | 19,696,000               |       | 20,427,000              |   |
|                                                                                                                            |   |                     |       |                    |   |
| Total Liabilities and Shareholders’ Equity                                                                                 |   | $                        | 22,327,000 |                    | $      | 21,545,000 |   |

 

----

***                           Takenfrom the audited balance sheet at that date.

 

See accompanying notes to financialstatements.

 

3

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**SPORT-HALEY,INC.**

**STATEMENTS OFOPERATIONS**

 
|                                          |   | **Three  Months Ended  March 31,** |      | **Nine  Months Ended  March 31,** |   |
|-----------------------------------------------|--------|-----------------------------------------|-----------|----------------------------------------|--------|
|                                          |   | **2004**                                |      | **2003**                               |   | **2004** |   | **2003** |   |
|                                          |   | **(Unaudited)**                         |      | **(Unaudited)**                        |   | **(Unaudited)** |   | **(Unaudited)** |   |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Net sales                                     |   | $                                       | 5,365,000 |                                   | $      | 5,504,000 |   | $ | 14,440,000 |   | $ | 13,326,000 |   |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Cost of goods sold                            |   | 3,275,000                               |      | 3,215,000                              |   | 8,852,000 |   | 8,001,000 |   |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Gross profit                                  |   | 2,090,000                               |      | 2,289,000                              |   | 5,588,000 |   | 5,325,000 |   |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Selling, general and administrative  expenses |   | 2,534,000                               |      | 2,405,000                              |   | 6,380,000 |   | 5,813,000 |   |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Loss from operations                          |   | (444,000                                | )         | (116,000                               | )      | (792,000 | ) | (488,000 | ) |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Other income (expense), net                   |   | (18,000                                 | )         | (4,000                                 | )      | 107,000 |   | 101,000 |   |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Loss before provision for income taxes        |   | (462,000                                | )         | (120,000                               | )      | (685,000 | ) | (387,000 | ) |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| (Provision for) benefit from income taxes     |   | (231,000                                | )         | 41,000                                 |   | (158,000 | ) | 145,000 |   |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Net loss                                      |   | $                                       | (693,000  | )                                      | $      | (79,000 | ) | $ | (843,000 | ) | $ | (242,000 | ) |
|                                          |   |                                    |      |                                   |   |   |   |   |   |
| Basic and diluted loss per common share       |   | $                                       | (0.28     | )                                      | $      | (0.03 | ) | $ | (0.34 | ) | $ | (0.09 | ) |

 

See accompanying notes to financial statements.

 

4

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**SPORT-HALEY,INC.**

**STATEMENTS OF CASHFLOWS**

 
|                                                                         |   | **Nine  Months Ended  March 31,** |     |
|------------------------------------------------------------------------------|--------|----------------------------------------|----------|
|                                                                         |   | **2004**                               |     | **2003** |   |
|                                                                         |   | **(Unaudited)**                        |     | **(Unaudited)** |   |
| **Cash flows from  operating activities:**                                   |   |                                   |     |   |   |
| Net loss                                                                     |   | $                                      | (843,000 | ) | $ | (242,000 | ) |
|                                                                         |   |                                   |     |   |   |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                                   |     |   |   |
| Depreciation and amortization                                                |   | 232,000                                |     | 273,000 |   |
| Deferred taxes and other                                                     |   | 158,000                                |     | (22,000 | ) |
| Allowance for doubtful accounts                                              |   | 189,000                                |     | 269,000 |   |
| Loss on sale of fixed assets                                                 |   | 4,000                                  |     | 20,000 |   |
| Common stock options                                                         |   | 95,000                                 |     | 62,000 |   |
| Cash provided (used) due to changes in  assets and liabilities:              |   |                                   |     |   |   |
| Accounts receivable                                                          |   | (592,000                               | )        | (905,000 | ) |
| Inventories                                                                  |   | (3,092,000                             | )        | (2,238,000 | ) |
| Other assets                                                                 |   | 457,000                                |     | 150,000 |   |
| Income taxes receivable                                                      |   | —                                 |     | 958,000 |   |
| Accounts payable                                                             |   | 512,000                                |     | (242,000 | ) |
| Accrued commissions and other expenses                                       |   | 1,001,000                              |     | (88,000 | ) |
|                                                                         |   |                                   |     |   |   |
| **Net cash used by  operating activities**                                   |   | (1,879,000                             | )        | (2,005,000 | ) |
|                                                                         |   |                                   |     |   |   |
| **Cash flows from investing  activities:**                                   |   |                                   |     |   |   |
| Redemption of held-to-maturity investments                                   |   | 3,629,000                              |     | 1,815,000 |   |
| Purchases of held-to-maturity investments                                    |   | (2,314,000                             | )        | (3,210,000 | ) |
| Sales of fixed assets                                                        |   | 5,000                                  |     | 12,000 |   |
| Purchase of fixed assets                                                     |   | (335,000                               | )        | (486,000 | ) |
|                                                                         |   |                                   |     |   |   |
| **Net cash provided  (used) by investing activities**                        |   | 985,000                                |     | (1,869,000 | ) |
|                                                                              |        |                                        |          |  |  |  |  |

 

See accompanying notes to financialstatements.

 

5

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|                                                   |   | **Nine  Months Ended  March 31,** |      |
|--------------------------------------------------------|--------|----------------------------------------|-----------|
|                                                   |   | **2004**                               |      | **2003** |   |
|                                                   |   | **(Unaudited)**                        |      | **(Unaudited)** |   |
|                                                   |   |                                   |      |   |   |
| **Cash flows from  financing activities:**             |   |                                   |      |   |   |
| Net proceeds from issuance of common stock             |   | $                                      | 18,000    |   | $ | — |   |
| Repurchase of common stock                             |   | —                                 |      | (801,000 | ) |
|                                                   |   |                                   |      |   |   |
| **Net cash provided  (used) by financing activities**  |   | 18,000                                 |      | (801,000 | ) |
|                                                   |   |                                   |      |   |   |
| **Net decrease in  cash and cash equivalents**         |   | (876,000                               | )         | (4,675,000 | ) |
|                                                   |   |                                   |      |   |   |
| **Cash and cash  equivalents, beginning**              |   | 4,304,000                              |      | 8,428,000 |   |
|                                                   |   |                                   |      |   |   |
| **Cash and cash  equivalents, ending**                 |   | $                                      | 3,428,000 |   | $ | 3,753,000 |   |
|                                                   |   |                                   |      |   |   |
| **Supplemental  disclosure of cash flow information:** |   |                                   |      |   |   |
|                                                   |   |                                   |      |   |   |
| Cash received during the period for:                   |   |                                   |      |   |   |
| Income taxes                                           |   | $                                      | —    |   | $ | 1,066,000 |   |
|                                                   |   |                                   |      |   |   |
| Cash paid during the period for:                       |   |                                   |      |   |   |
| Income taxes                                           |   | $                                      | —    |   | $ | — |   |
|                                                   |   |                                   |      |   |   |
| Interest                                               |   | $                                      | —    |   | $ | 9,000 |   |

 

See accompanying notes to financialstatements.

 

6

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**SPORT-HALEY,INC.**

**NOTES TO FINANCIALSTATEMENTS**

 

**NOTE 1****                                       CONDENSEDFINANCIAL STATEMENTS**

 

The unaudited financial statements included herein have been preparedby Sport-Haley, Inc. (the “Company”), in accordance with accounting principlesgenerally accepted in the United States of America for interim financialstatements and in accordance with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of theinformation and disclosures required by generally accepted accountingprinciples for complete financial statements. In the opinion of the Company’smanagement, all adjustments (consisting of normal recurring accruals) necessaryfor fair presentation have been included. The Company’s revenues are seasonal,and therefore the results of operations for the three months and nine monthsended March 31, 2004 may not be indicative of the results for the fullfiscal year. For further information, refer to the consolidated financialstatements and footnotes thereto for the year ended June 30, 2003,included in the Company’s filing on Form 10-K.

 

**NOTE 2****                                       INVENTORIES**

 

|                                     |   | **March 31,  2004** |       | **June 30,  2003** |   |
|------------------------------------------|--------|--------------------------|------------|-------------------------|--------|
| Inventories  consisted of the following: |   |                     |       |                    |   |
| Component                                |   | $                        | 489,000    |                    | $      | 673,000 |   |
| Finished  goods                          |   | 10,431,000               |       | 7,155,000               |   |
|                                     |   |                     |       |                    |   |
|                                     |   | $                        | 10,920,000 |                    | $      | 7,828,000 |   |

 

**NOTE 3****                                       COMMITMENTSAND CONTINGENCIES**

 

At March 31, 2004, theCompany had $469,000 in outstanding letters of credit that were issued toforeign suppliers in accordance with finished goods inventory purchasecommitments.

 

**NOTE 4****                                       REPURCHASEOF COMMON STOCK**

 

As of March 31, 2004,the Company’s Board of Directors had authorized the repurchase of up to2,820,000 shares of the Company’s issued and outstanding common stock. Theshares may be repurchased from time to time in open market transactions atprevailing market prices or privately negotiated transactions. The timing ofrepurchases and the actual number of shares repurchased at any time depend onmarket conditions, alternative uses of capital and other factors. The Companyhas no commitment to repurchase all or any portion of the shares. All sharesrepurchased by the Company are required to be canceled and returned to thestatus of authorized but unissued common stock.

 

7

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From the inception of the repurchase plan throughMarch 31, 2004, the Company had repurchased a total of 2,512,800 shares of itscommon stock at a cumulative cost of approximately $13,488,000.

 

**NOTE 5****                                       STOCK-BASEDCOMPENSATION**

 

The Company’s Stock OptionPlan (the “Plan”) expired by its terms on February 28, 2003. Optionagreements that were issued in accordance with the Plan prior toFebruary 28, 2003, generally remain in force until the earlier of theirexercise, the termination of a grantee’s employment or other relationship withthe Company or expiration by their terms. At March 31, 2004, there wereoutstanding options to purchase 1,175,447 shares of the Company’s common stockat exercise prices ranging from $2.71 to $9.78 per share and expiration datesbetween March 2005 and January 2013.

 

The Company accounts for stock-based compensationusing the intrinsic value method prescribed in Accounting Principle BoardOpinion No. 25, “*Accounting for Stock Issuedto Employees*,” and related interpretations. The Company has electedto apply the disclosure-only provisions of Statement of Financial AccountingStandards (SFAS) No. 123, “*Accounting forStock-Based Compensation*,” as amended by SFAS No. 148, “*Accounting for Stock-Based Compensation – Transitionand Disclosure*.” Under the intrinsic value method, compensationexpense for stock options is recognized over the vesting period of the grantbased on the excess, if any, of the market price of the Company’s common stockat the date of grant over the stock option exercise price. As governed by thePlan, stock options were generally granted at or near fair market value on thedate of grant.

 

If the Company had accounted for stock-basedcompensation using the fair value method rather than the intrinsic valuemethod, the pro forma amounts of the Company’s net loss and loss per commonshare would have been reported as follows:

 

|                                                                       |   | **Nine  Months Ended March 31,** |     |
|----------------------------------------------------------------------------|--------|---------------------------------------|----------|
|                                                                       |   | **2004**                              |     | **2003** |   |
| Net loss - as reported                                                     |   | $                                     | (843,000 | ) | $ | (242,000 | ) |
| Effect of employee stock-based compensation  included in reported net loss |   | 60,000                                |     | 39,000 |   |
| Effect of employee stock-based compensation  per SFAS 123                  |   | (199,000                              | )        | (121,000 | ) |
| Net loss applicable to common stock - pro  forma                           |   | $                                     | (982,000 | ) | $ | (324,000 | ) |

 

8

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|                                                                                 |   | **Nine  Months Ended March 31,** |   |
|--------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                 |   | **2004**                              |   | **2003** |   |
| Basic and Diluted:                                                                   |   |                                  |   |   |   |
| Loss per share - as reported                                                         |   | $                                     | (0.34  | ) | $ | (0.09 | ) |
| Per share effect of employee  stock-based compensation included in reported net loss |   | 0.02                                  |   | 0.02 |   |
| Per share effect of employee  stock-based compensation per SFAS 123                  |   | (0.08                                 | )      | (0.05 | ) |
| Loss per share applicable to common stock -  pro forma                               |   | $                                     | (0.40  | ) | $ | (0.12 | ) |

 

**NOTE 6****                                       EARNINGSPER SHARE**

 

Effective with the year endedJune 30, 1998, the Company adopted the provisions of Statement ofFinancial Accounting Standards No. 128 (SFAS No. 128), *Earnings per Share*. SFAS No.128 requires the presentation of basic and diluted earnings (loss) per commonshare. The following table provides a reconciliation of the numerator anddenominator of basic and diluted earnings (loss) per common share:

 
|                                  |   | **Three  Months ended March 31, 2004** |     |
|---------------------------------------|--------|---------------------------------------------|----------|
|                                  |   | **Net  Income  (Loss)**                     |     | **Weighted  Average  Shares** |   | **Per Share** |   |
| Loss Per Common Share                 |   |                                        |     |   |   |   |   |
|                                  |   |                                        |     |   |   |   |   |
| Basic loss per share                  |   | $                                           | (693,000 | ) | 2,450,252 |   | $ | (0.28 | ) |
|                                  |   |                                        |     |   |   |   |   |
| Effect of dilutive securities options |   | —                                      |     | — |   | — |   |
|                                  |   |                                        |     |   |   |   |   |
| Diluted loss per share                |   | $                                           | (693,000 | ) | 2,450,252 |   | $ | (0.28 | ) |

 

9

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|                                  |   | **Nine Months  ended March 31, 2004** |     |
|---------------------------------------|--------|--------------------------------------------|----------|
|                                  |   | **Net  Income  (Loss)**                    |     | **Weighted  Average  Shares** |   | **Per Share** |   |
|                                  |   |                                       |     |   |   |   |   |
| Loss Per Common Share                 |   |                                       |     |   |   |   |   |
|                                  |   |                                       |     |   |   |   |   |
| Basic loss per share                  |   | $                                          | (843,000 | ) | 2,446,625 |   | $ | (0.34 | ) |
|                                  |   |                                       |     |   |   |   |   |
| Effect of dilutive securities options |   | —                                     |     | — |   | — |   |
|                                  |   |                                       |     |   |   |   |   |
| Diluted loss per share                |   | $                                          | (843,000 | ) | 2,446,625 |   | $ | (0.34 | ) |

 
|                                  |   | **Three  Months ended March 31, 2003** |    |
|---------------------------------------|--------|---------------------------------------------|---------|
|                                  |   | **Net  Income  (Loss)**                     |    | **Weighted  Average  Shares** |   | **Per Share** |   |
|                                  |   |                                        |    |   |   |   |   |
| Loss Per Common Share                 |   |                                        |    |   |   |   |   |
|                                  |   |                                        |    |   |   |   |   |
| Basic loss per share                  |   | $                                           | (79,000 | ) | 2,614,598 |   | $ | (0.03 | ) |
|                                  |   |                                        |    |   |   |   |   |
| Effect of dilutive securities options |   | —                                      |    | — |   | — |   |
|                                  |   |                                        |    |   |   |   |   |
| Diluted loss per share                |   | $                                           | (79,000 | ) | 2,614,598 |   | $ | (0.03 | ) |

 
|                                  |   | **Nine  Months ended March 31, 2003** |     |
|---------------------------------------|--------|--------------------------------------------|----------|
|                                  |   | **Net  Income  (Loss)**                    |     | **Weighted  Average  Shares** |   | **Per Share** |   |
|                                  |   |                                       |     |   |   |   |   |
| Loss Per Common Share                 |   |                                       |     |   |   |   |   |
|                                  |   |                                       |     |   |   |   |   |
| Basic loss per share                  |   | $                                          | (242,000 | ) | 2,670,999 |   | $ | (0.09 | ) |
|                                  |   |                                       |     |   |   |   |   |
| Effect of dilutive securities options |   | —                                     |     | — |   | — |   |
|                                  |   |                                       |     |   |   |   |   |
| Diluted loss per share                |   | $                                          | (242,000 | ) | 2,670,999 |   | $ | (0.09 | ) |

 

10

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**SPORT-HALEY,INC.**

**ITEM 2****MANAGEMENT’S DISCUSSION AND ANALYSIS OF**

**FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

Statements made in this filing that are not historical facts areforward-looking statements. The reader should be aware that our actual resultscould differ materially from those contained in forward-looking statements. TheCompany’s financial condition and the results of its operations will depend ona number of factors, including, but not limited to, the following: our abilityto control costs and expenses; our ability to successfully anticipate fashiontrends, design favorably accepted fashion golf apparel, effectively advertiseand communicate within the marketplace, and penetrate our chosen distributionchannels; risks associated with the trend of increasing sales with respect tolicensed apparel, such as the Ben Hogan® apparel collections; relations withand performance of suppliers; competition within golf apparel markets; businessconditions and growth in the fashion golf apparel market and the generaleconomy; political and international trade relations; changes in internationaltrade quota systems for apparel; consumer spending on golf apparel; generalglobal economic and political conditions resulting from threats or acts of waror terrorism and responses thereto; timely performance of third parties, suchas freight forwarders, including risks of labor disputes and/or labor strikes;changes in product mix; inventory risks due to shifts in market and/or priceerosion of purchased apparel; lost or reduced manufacturing capacity ofsignificant suppliers; loss or delay of shipments from foreign suppliers;access to capital; maintaining satisfactory relationships with commercialbanking institutions; and, establishing controls with regard to and maintainingthe integrity of technology and information systems. Additional information onthese and other factors that could affect the Company’s financial results isincluded in the discussion below and in the Company’s Form 10-K for the yearended June 30, 2003. There may be other factors not mentioned above, inthe discussion below or included in our Securities and Exchange Commission(“SEC”) filings that may cause actual results to differ materially from anyforward-looking statements. The reader should not place undue reliance on anyforward-looking statements. Neither the Company nor any of its corporateofficers or key employees assumes any obligation to update any forward-lookingstatements as a result of new information, future events or developments,except as required by securities laws.

 

All references to fiscal years are references to the Company’s fiscalyear, which ends on June 30.

 

##### **OVERVIEW**

##### ** **

Sport-Haley, Inc. designs, purchases, contracts for the manufacture ofand markets quality men’s and women’s fashion golf apparel and outerwear underthe HALEY® label and premium men’s apparel under the Ben Hogan® label. HALEY®fashion golf apparel, known for its innovative design, quality fabrics,generous fit and classic style, is primarily marketed in the premium andmid-priced markets through a network of independent sales representatives anddistributors to golf professional shops, country clubs and resorts across theUnited States and internationally. Ben Hogan® apparel is primarily marketed toelite golf professional shops, upscale resorts and exclusive department storeswithin the United States and by certain international distributors. The Companyis currently finalizing the product design and development of distributionchannels for lines of good quality men’s and women’s golf apparel under theTop-Flite® label that the Company expects to market primarily in thelower-priced and mid-priced markets, to golf professional shops and specialty retailstores throughout the United States and internationally. The Companydistributes Ben Hogan® and Top-Flite® apparel in accordance with a licensingagreement with the Top Flite Golf Company.

 

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The Company is represented by a network of approximately 40 independentsales representatives and employs a vice-president of sales and two regionalsales managers, each with responsibilities for all of the Company’s brandedlabels of apparel. Approximately half of the independent sales representativessolicit sales of both HALEY® and Ben Hogan® apparel on behalf of the Company.

 

Management believes that the Company’s sales on its more mature HALEY®brand have been negatively affected by the continuing difficult economicconditions faced by our customers in the golf industry. Per the most recentGolf Datatech survey, the number of rounds of golf played within the UnitedStates has decreased three years in a row, and has only recently shown signs ofimprovement. Golf hardware and apparel sales tend to closely follow the trendof rounds played. Management believes that, as economic conditions continue toimprove, the Company’s position within golf markets will yield correspondingincreases in sales and allow the Company to expand into new retail channels ofdistribution.

 

During fiscal 2003 and throughout fiscal 2004, the Company’s strategyhas been and continues to focus on stabilizing revenues associated with theHALEY® brand and growth of revenues associated with the Ben Hogan® brand, whichwas initially introduced in January 2002.

 

###### **RECENT DEVELOPMENTS**

###### ** **

As previously reported, in January 2004, the Company beganutilizing a new comprehensive computer system designed specifically for thegarment industry and tailored exclusively to the Company’s business operations.The new system integrated almost all of the Company’s information systems intoone common computer system. While each function of the new system was testedduring the implementation phase of the project, certain design and operationaldeficiencies were discovered upon utilization of the system. The design andoperational deficiencies primarily related to incorrect invoicing of salestransactions and accounting for inventory purchases.

 

During the months of January and February 2004, management,in conjunction with the Company’s software consultants, worked diligently tocorrect the malfunctioning system controls with respect to incorrect invoicingof sales transactions. Management had discovered that certain customer ordershad been shipped but no sales invoice had been generated by the computer systemand that, in certain instances, sales invoices were not mathematically correct.Because of custom controls that management had designed for the system with regardto accounting for a customer order, from the placement of the order throughdelivery of the merchandise to the customer, the Company was able to identifyand correct the sales invoicing malfunction. The Company’s software consultantsalso corrected the system malfunctions that produced sales invoices thatcontained mathematical errors, and the Company subsequently corrected therespective sales invoices. Management believes that the system controls withrespect to invoicing sales transactions have been substantially corrected andare now operating as they were designed.

 

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The Company designed an intricate system for recording its inventorypurchases in order to account for its finished goods inventories using anaverage cost method. The average cost method was designed to accumulate theactual costs of inventory purchases for each finished goods inventory item,combine the total costs of purchases together with previously accumulated costsfor each item and utilize an average cost per item when calculating the cost ofeach item sold. Because the Company imports most of its finished goodsinventories from offshore suppliers, the accumulation of actual costs for eachitem of finished goods inventories becomes a complicated series of accountingtransactions made up of many separate components of the total inventory cost.The Company generally includes vendor costs for packaged apparel, import costs,such as customs duties, freight-in and other, and applied overhead ascomponents of total inventory cost for each item in its finished goodsinventories.

 

Management discovered that, initially, the system for recordinginventory purchases was not functioning in the manner it was originallyintended. Management discovered that significant mistakes had occurred in therecording of inventory-related transactions that were caused by human error.Management also discovered that the system programming needed to be revised toensure the proper recording of the most complex of its inventory purchasetransactions. Because of the complexity of the system design with regard toinventory purchases and because of the amount of time spent previously withregard to correcting sales invoicing, the system programming corrections to theinventory purchasing functions were not completed until early May 2004.

 

Due to the complexity of the transactions with regard to inventorypurchasing and the numerous human errors discovered, management was not able tospecifically quantify the financial effect at March 31, 2004 of the errorsdiscovered with regard to inventory purchasing. Being wary not to overstate theCompany’s finished goods inventories at March 31, 2004, managementrecomputed the valuation of its finished goods inventories using a standardcost assumption. Management believes the standard cost assumption yields a fairestimation of the Company’s finished goods inventories at March 31, 2004.Similarly, being wary not to understate the Company’s liabilities, managementperformed a review of amounts paid subsequent to March 31, 2004 toestimate accrued liabilities with respect to inventory purchases as ofMarch 31, 2004. Management believes the estimate provides a fairestimation of the Company’s accrued inventory related liabilities at March 31,2004. Management also believes that the system controls with regard toinventory purchasing have been substantially corrected and that those controlsare now functioning as they were originally intended.

 

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

##### ** **

The Company’s condensed financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America, which require the Company to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andthe related disclosures. A summary of those significant accounting policies canbe found in the Company’s Notes to the Consolidated Financial Statementsincluded in its Report on 10-K for the year ended June 30, 2003, which wasfiled with the SEC on September 29, 2003. The estimates used by management are based upon the Company’s historicalexperiences combined with management’s understanding of current facts andcircumstances.

 

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Certain of the Company’s accounting policiesare considered critical as they are both important to the portrayal of theCompany’s financial condition and the results of its operations and requiresignificant or complex judgments on the part of management. On an ongoingbasis, management evaluates and adjusts those estimates accordingly. Managementbelieves that the following critical accounting policies affect the moresignificant judgments and estimates used in the preparation of the Company’sfinancial statements.

 

Inventories, predominately comprised offinished goods, are valued at the lower of cost or market. Excess finishedgoods inventories are a natural component of a seasonal apparel business. Whilecertain finished goods items will sell out in any particular selling season,quantities of other finished goods items will remain at the end of each sellingseason. The Company markets previous seasons’ finished goods inventories atreduced wholesale prices to its customers in the normal course of business.Remaining excess inventories are liquidated through other markets. An analysisof inventories is performed on a quarterly basis to identify unsolddiscontinued or aging merchandise. The net realizable value of the discontinuedor aging merchandise is estimated based on management’s disposition plans andhistorical experiences. The Company periodically adjusts its inventoryvaluation allowance to reduce the carrying amount of discontinued or agingmerchandise to its estimated net realizable value. Management evaluated itsdiscontinued or aging finished goods inventories and increased its relatedvaluation allowance by approximately $288,000 during the fiscal quarter endedMarch 31, 2004. While management believes that the Company’s processesproduce a fair valuation of inventories, if actual market conditions are lessfavorable than those projected by management, additional allowances may berequired.

 

Deferred income taxes are recognized for the expected tax consequencesin future years for differences between the tax bases of assets and liabilitiesand their financial reporting amounts, based upon enacted tax laws andstatutory tax rates applicable to the periods in which the differences areexpected to affect taxable income. The Company’s significant deferred taxassets are related to net operating loss carryforwards for federal and stateincome tax purposes, a change in accounting methods for federal income taxpurposes, stock options compensation and an unrealized loss for tax purposes ona common stock investment. Management periodically reviews and adjusts itsdeferred income tax estimates based upon the most current informationavailable. The Company established and maintains a valuation allowance toreduce deferred tax assets to a net amount expected to be recovered in futureperiods. At the end of the fiscal quarter ended March 31, 2004, managementevaluated the Company’s deferred tax assets and increased the valuationallowance with respect to the Company’s continuing net operating losses. Forthe quarter ended March 31, 2004, the Company recorded deferred income taxexpense of $231,000 associated with the revaluation of deferred tax assets.Because the recoverability of deferred tax assets is directly dependent uponthe actual future operating results of the Company, recoverability of deferredtax assets may differ materially from management’s estimates.

 

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The Company maintains an allowance for doubtful accounts for estimatedlosses resulting from the failure of customers to make required payments. TheCompany’s allowance for doubtful accounts reflects a reserve that reducescustomer accounts receivable to the net amount estimated to be collectible.Adjustments to the allowance for doubtful accounts are included in theCompany’s bad debt expense. Management evaluates the adequacy of the Company’sallowance for doubtful accounts by estimating the credit worthiness ofcustomers and the recoverability of customer accounts by estimating general,economic and industry-specific conditions, evaluating historical customerperformance and anticipating future performance. While management considers theCompany’s evaluation processes to be adequate to effectively quantify itsexposure to doubtful accounts, changes in economic, industry or specificcustomer conditions may result in a recoverability of the Company’s doubtfulaccounts that materially differs from management’s estimates, causing theCompany to increase its allowance for doubtful accounts.

 

The Company records its allowance for sales returns as a net adjustmentto customer accounts receivable. When recording an allowance, the net methodreduces customer accounts receivable and net sales by the estimated grossmargin effect of the anticipated sales return. Generally, the Company’s sellingterms preclude return of its products subsequent to the sale. However, theCompany has traditionally maintained limited programs that offer some customersthe right to return certain finished goods items under predefined conditions,and the percentage of the Company’s customers that refuse receipt ofmerchandise at the time of delivery has increased in recent periods. Managementreviews historical data and considers factors such as general, economic and industry-specificconditions and anticipated customer performance when evaluating the Company’sallowance for sales returns. Significant changes in general, economic orindustry conditions may yield sales returns that differ materially frommanagement’s estimates, causing the Company to increase its allowance for salesreturns.

 

### **LIQUIDITY AND CAPITAL RESOURCES**

### ** **

Because the golf apparel business is highly seasonal in nature, thebalance sheet amounts as of March 31, 2004 may be more meaningful whencompared with the balance sheet amounts as of March 31, 2003, rather thanwith the balance sheet amounts at June 30, 2003.

 

The Company’s primary sources of liquidity are comprised of itsavailable cash and cash equivalents, cash flows from operations and a workingcapital line of credit with a commercial bank. The Company requires cash forits general working capital purposes. Management does not anticipate therequirements of material amounts of cash for capital expenditures over theremainder of the current fiscal year. The Company’s working capitalrequirements are highly seasonal in nature, with greater requirements fromapproximately August through October and February throughApril of each fiscal year due to the purchases of finished goodsinventories for the spring/summer and fall/holiday selling seasons,respectively.

 

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Net accounts receivable increased by $403,000 to $5,122,000 atMarch 31, 2004, from $4,719,000 at June 30, 2003. Because of theseasonal nature of the Company’s business, the net accounts receivable balanceat March 31, 2004 may be more meaningfully compared with theMarch 31, 2003 balance of $4,722,000, rather than with the June 30,2003 balance. When compared with the March 31, 2003 balance, the netaccounts receivable balance at March 31, 2004 increased by $350,000, or7%, as compared with a decrease of approximately $139,000, or 3%, in net salesfor the comparative fiscal quarters. Management’s evaluation of the Company’sallowance for doubtful accounts revealed that, among other factors, theincrease in net accounts receivable is indicative of a trend whereby a growingpercentage of the Company’s customers are delaying payments of requiredamounts. Management considers the methods the Company currently uses forcollecting customer accounts receivable to be adequate. However, as a result ofmanagement’s evaluation of the recoverability of the Company’s accountsreceivable, at March 31, 2004, the Company increased its estimates withregard to the percentage of potentially unrecoverable amounts included in itscustomer accounts receivable.

 

Inventories increased by $3,092,000 to $10,920,000 at March 31,2004, from $7,828,000 at June 30, 2003. As discussed in “RecentDevelopments” above, management recomputed the valuation of its finished goodsinventories at March 31, 2004 using a standard cost assumption. Because ofthe seasonal nature of the Company’s business, the inventories balance atMarch 31, 2004 may be more meaningfully compared with the balance of$8,942,000 at March 31, 2003, rather than with the June 30, 2003balance. The 22% increase in inventories at March 31, 2004 when comparedwith the balance at March 31, 2003 of $8,942,000 primarily consisted ofcomparative increases in: (a) pending deliveries of ocean shipments of finishedgoods from foreign suppliers; (b) closeout inventories of prior seasons’women’s apparel; and, (c) Ben Hogan® apparel collections. Pending oceandeliveries of finished goods approximated $1,794,000 at March 31, 2004,and $662,000 at March 31, 2004, respectively. Management believes thatcloseout inventories of prior seasons’ women’s apparel increased primarilybecause the war in Iraq impacted late Spring 2003 bookings and spring sales ofHALEY® women’s apparel greater than it impacted bookings and sales of men’sapparel during the same period. During slow economic periods, wholesale buyersof golf apparel are more hesitant to order women’s products than to order men’sproducts. The Company was significantly impacted by the reduced Spring 2003bookings, because while the golf apparel market is generally comprised of 80%men’s products and 20% women’s products, the Company’s sales of HALEY® apparelare generally comprised of 30% men’s products and 70% women’s products.Management revised its inventory requirements and adjusted reorder quantitiesfor the Spring 2003 selling season, when possible, to minimize the excessinventories relating to that spring selling season. However, a significantamount of women’s inventory remains from the Spring 2003 selling season. Theincrease in Ben Hogan® finished goods inventories is required to support thecontinued increase in sales of Ben Hogan® apparel collections. As discussed above in “Critical AccountingPolicies and Estimates,” management evaluated the valuation of its finishedgoods inventories and increased its inventory valuation allowance byapproximately $288,000 during the fiscal quarter ended March 31, 2004. Asof the date of this report, management is negotiating with a major retaildiscount chain for the sale of a significant amount of the Company’s closeoutinventories.

 

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The Company’s continued reliance on foreign suppliers sustains the riskthat the Company’s revenues could be adversely affected if a foreign shipmentor shipments were received late or lost. The Company maintains insurance forrisk of loss relating to goods shipped from its foreign and domestic suppliers.However, the Company’s predominant reliance upon foreign suppliers, andsignificant reliance on two separate foreign suppliers, also sustains the riskthat the Company would be left with inadequate or unsatisfactory recourseshould the goods received from a foreign supplier be nonconforming. Due to acombination of several factors, during the nine months ended March 31,2004, the Company’s operating activities used cash of $1,879,000.Comparatively, during the nine months ended March 31, 2003, the Company’soperating activities used cash of $2,005,000.

 

For the nine months ended March 31, 2004, investing activitiesprovided cash of $985,000. Comparatively, for the nine months endedMarch 31, 2003, investing activities used cash of $1,869,000. TheCompany’s cash flows from investing activities are primarily derived frompurchases and redemptions of held-to-maturity investments. Generally, theCompany’s held-to-maturity investments consist of short-term federal agencysecurities. During the nine months ended March 31, 2004, the Companyexpended approximately $335,000 for the purchase of property and equipment, andapproximately $231,000 in depreciation and amortization was charged to currentoperations. A significant component of the property and equipment purchasesincluded continued implementation costs for new comprehensive operationssoftware that the Company began utilizing in January 2004.

 

Accounts payable and accrued expenses increased by $1,513,000 to$2,631,000 at March 31, 2004 from $1,118,000 at June 30, 2003. Asdiscussed in “Recent Developments” above, management estimated the amount ofits accrued liabilities with respect to purchased inventories at March 31,2004 based upon a review of amounts paid to vendors subsequent toMarch 31, 2004. Because of the seasonal nature of the Company’s business,the accounts payable and accrued expenses balance at March 31, 2004 may bemore meaningfully compared with the balance of $1,423,000 at March 31,2003, rather than with the June 30, 2003 balance. The increase of$1,208,000 in current liabilities from March 31, 2003 to March 31,2004 was primarily related to differences in the accrued costs of in-transitocean shipments of finished goods inventories at the end of the respectivenine-month periods. At March 31, 2004, the accrued costs of in-transitinventories increased by approximately $1,000,000 when compared with theaccrued costs of in-transit inventories at March 31, 2003. The comparativeincrease in in-transit ocean shipments related to timing differences ofinventory deliveries for the respective fall 2004 and fall 2003 sellingseasons.

 

The Company maintains a line of credit with a commercial bank,primarily to facilitate the issuance of letters of credit for inventorypurchases from offshore suppliers. Outstanding letters of credit reduce theamount available for borrowing under the line of credit agreement. As ofMarch 31, 2004, the Company was in violation of a loan covenant for thisdebt instrument, which requires the Company to maintain total capital of atleast $20,000,000. As of the date of this report, the Company is negotiatingwith the bank for a waiver regarding the breach of this loan covenant, forwhich the bank has the right to terminate its commitments under the agreementand to exercise any other rights or remedies available. Because the Company hasnot borrowed against the line of credit during the past five years and the lineis primarily maintained to facilitate the issuance of letters of credit,management expects, but can give no reasonable assurance that, the bank willamicably negotiate a waiver of this breach.

 

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Management believes that cash on hand and cash generated fromoperations, as well as the ability to borrow under the bank line of credit,will be sufficient to meet the Company’s cash requirements during the remainderof fiscal 2004 and throughout fiscal 2005. The Company also has alternativesources of financing, including the factoring of customer accounts receivable.Although they are available to the Company, management does not anticipateusing alternative sources of financing during the remainder of fiscal 2004 orin fiscal 2005. However, the Company’s capital needs will depend on manyfactors, including the Company’s growth rate, the need to finance required inventorylevels, the success of various sales and marketing programs, expenses relatedto the defense of pending law suits and various other factors.

 

**RESULTS OF OPERATIONS**

 

The Company’s business is seasonal in nature, with disproportionatelyhigher sales occurring from January through June, which comprise theCompany’s third and fourth quarters of each fiscal year.

 

Net sales for the fiscal quarter ended March 31, 2004, were$5,365,000, a decrease of $139,000 or 3% from net sales of $5,504,000 for thesame three-month period in the prior fiscal year. Net sales for the nine monthsended March 31, 2004, were $14,440,000, an increase of $1,114,000 or 8%from net sales of $13,326,000 for the same nine-month period in the priorfiscal year. Net sales for the fiscal quarter ended March 31, 2004 differin comparability from net sales for the March 31, 2003 fiscal quarter, inpart because invoiced sales to the Company’s independent sales representativeswere not recorded in the March 2004 fiscal quarter due to a prospectivechange in internal policy with regard to the acceptance of returns of thatmerchandise after the conclusion of the advance marketing period for eachselling season. Because of the change in internal policy, prospectively, theindependent sales representatives have no obligation to purchase samplegarments used to solicit sales if the sample garments are returned to theCompany within a reasonable amount of time following the conclusion of theadvance marketing period for each selling season. Accordingly, the Company hasaltered its accounting for sales of sample garments to its independentrepresentatives to prospectively account for invoiced sales of those garmentsin a manner consistent with consigned inventories.

 

Management is disappointed with the performance of its HALEY® brandedapparel, especially with regard to continuing decreases in sales of its HALEY®men’s apparel. Competition within the golf apparel industry continues tointensify. While management believes that the quality and value of HALEY® men’sand women’s apparel meets or exceeds the quality and value of the othercompetitors’ apparel collections offered within the same markets, the Companycontinues to be frustrated with its inability to increase or maintain salesrevenues of its HALEY® products within the men’s apparel sector.

 

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Net sales of Ben Hogan® apparel were $1,608,000 and $4,349,000 for thefiscal quarter and nine months ended March 31, 2004, increases of $267,000and $1,595,000, or 20% and 58%, respectively, from net sales of $1,341,000 and$2,754,000 for the same fiscal quarter and nine-month period in the priorfiscal year. The relative percentage of the Company’s net sales relating to BenHogan® apparel is indicative of the Company’s efforts to increase revenues withregard to licensed apparel. The Ben Hogan® apparel is marketed in accordancewith a licensing agreement the Company maintains with The Top Flite GolfCompany (“Top Flite”) for such apparel. While the Company’s current sales trendindicating an increasing relative percentage of the Company’s sales related tolicensed apparel sustains a risk of loss, should the licensing agreement withTop Flite be terminated by either party, management considers the licensing agreementwith Top Flite as a key component to the Company’s business strategies. TheCompany continues to focus its marketing efforts on maximizing revenues withrespect to Ben Hogan® apparel sales and on successfully launching theTop-Flite® branded apparel lines. Because management also considers theultimate development of Top-Flite® branded apparel (under the same Top Flitelicensing agreement) key to the future success of the Company, management hasinvested a great deal of time in planning its introduction of the Top-Flite®brand.

 

The Company continues to direct its marketing efforts with the goals ofincreasing sales within established distribution channels and creating newmarkets for both its HALEY® and Ben Hogan® products, as well as creating distributionchannels for Top Flite® apparel lines. Management expects to introduce theinitial lines of Top Flite® apparel near the end of calendar year 2004. Basedupon bookings as of March 31, 2004 for expected future shipments,management expects the Company’s overall sales trend to continue to improvewithin the current fiscal year, when compared with the prior fiscal year.

 

The Company’s gross profit, as a percentage of net sales, was 39% and39% for the quarter and nine months ended March 31, 2004, respectively,and 42% and 40% for the same periods in the prior fiscal year. The decreases ingross profit percentages are primarily attributable to a buildup in closeoutinventories that must be sold at reduced prices. As discussed above, thebuildup in closeout inventories also caused the Company’s gross margin in thefiscal quarter ended March 31, 2004 to be impacted by the correspondingincrease in its inventory valuation allowance of $288,000. The Company did notrecord an inventory valuation charge during the fiscal quarter endedMarch 31, 2003. The disposal of closeout inventories negatively impactsthe Company’s gross margins, because even if the closeout inventories areproperly valued to the lower of cost or market, sales of large quantities ofcloseout inventories are normally marketed for sale at zero margins. Marginsfor the Company’s fourth quarter may similarly be negatively impacted, becausemanagement anticipates that a material amount of closeout inventories may bedisposed within that fiscal quarter.

 

The Company’s gross margins may not be comparable to other companieswithin the golf apparel industry. The Company has consistently included thecost of merchandise sold, including import charges, in-bound freight, allocatedoverhead, freight-out, embroidery costs and other charges in its cost of goodssold. The Company includes other costs of distribution in selling, general andadministrative expenses. The Company also includes royalty payments, relatingto sales of its licensed apparel brands, in selling, general and administrativeexpenses.

 

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Selling, general and administrative expenses for the fiscal quarterended March 31, 2004, increased by $129,000, or 5%, to $2,534,000 from$2,405,000 for the same three-month period in the prior fiscal year. Selling,general and administrative expenses for the nine months ended March 31,2004, increased by $567,000, or 10%, to $6,380,000 from $5,813,000 for the samenine-month period in the prior fiscal year. Included in the 2004 fiscal quarterincrease are $150,000 in severance charges relating to the termination ofemployment of the Company’s former President. The year-over-year increases wereprimarily attributable to sales commissions due to independent salesrepresentatives on higher respective sales revenues, increased royalties due toTop-Flite for corresponding increases in revenues associated with Ben Hogan®branded apparel between the comparative periods and other expenses related tothe respective comparative increases in sales for the nine-month period. Salescommissions increased by $70,000 and $280,000 for the quarter and nine-monthperiod, respectively, when compared with the same periods in the prior fiscalyear. Royalties relating to Ben Hogan® apparel increased by $35,000 and$132,000 for the quarter and nine-month period, respectively, when comparedwith the same periods in the prior fiscal year. The Company continually refinesits business operations to operate as efficiently as possible, while attemptingto expand sales growth opportunities.

 

Selling, general and administrative expenses were approximately 47% and44% of net sales for the quarter and nine month period ended March 31,2004, as compared with 44% and 44% for the same periods in the prior fiscalyear.

 

The Company’s effective tax rates for the fiscal quarter and ninemonths ended March 31, 2004 were 50% and 23%, respectively. Comparatively,the Company’s effective tax rates for the fiscal quarter and nine months endedMarch 31, 2003 were 34% and 37%, respectively. The effective tax rate inany fiscal period can vary significantly from the effective tax rate in anotherperiod due to differences between the recognition of certain transactions forfinancial versus tax purposes. Certain deductions recognized for tax purposesmay not be expensed for financial statement purposes, and certain expensesrecorded for financial statement purposes may not be deductible for taxpurposes. The Company maintains a valuation allowance to reduce its net deferredtax assets to the amount expected to be recovered in a future period. Asdiscussed above in “Critical Accounting Policies and Estimates,” the Companyreevaluated its deferred tax asset valuation allowance during the fiscalquarter ended March 31, 2004 to adjust deferred tax assets for federal andstate income tax purposes to management’s estimate of the anticipated futurerecovery of the Company’s net tax loss carryforwards. Adjustments in theCompany’s estimates with regard to net deferred tax assets and thecorresponding valuation allowance caused the Company to report deferred incometax expense of $231,000 and $158,000 for the fiscal quarter and nine monthsended March 31, 2004, on pre-tax net losses of $462,000 and $685,000,respectively.

 

Net losses for the fiscal quarter and nine months ended March 31,2004, were $693,000 and $843,000, greater losses of $614,000 and $601,000, thanthe comparative net losses of $79,000 and $242,000 for the same fiscal quarterand nine-month periods in the prior fiscal year. The differences were primarilydue the numerous factors discussed above.

 

Both the basic and diluted losses per share were ($0.28) and ($0.34)for the fiscal quarter and nine months ended March 31, 2004, respectively.Both the basic and diluted losses per share were ($0.03) and ($0.09) for thesame periods in prior fiscal year.

 

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**SPORT-HALEY,INC.**

**ITEM 4****CONTOLS ANDPROCEDURES**

 

**(a)****     Evaluation of DisclosureControls and Procedures**

 

Management of the Company, with the participation of the ChiefExecutive Officer and the Chief Financial Officer, conducted an evaluation ofthe effectiveness of the Company’s disclosure controls and procedures pursuantto Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of theperiod covered by this report. Based on that evaluation, management, includingthe Chief Executive Officer and Chief Financial Officer, concluded that, as ofthe date of this report, the Company’s disclosure controls and procedures wereeffective in ensuring that: (a) all material information relating to theCompany, required to be disclosed in this report, has been made known tomanagement in a timely manner; and, (b) information was recorded, processed,summarized and reported within the time periods specified in the Security andExchange Commission’s rules and regulations.

 

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

 

During the third quarterof fiscal 2004, the Company did not institute any significant changes ininternal controls over financial reporting that materially affected, or arereasonably likely to materially affect, the Company’s internal controls overfinancial reporting, except that the Company completed the implementation ofnew management information software. The Company began utilizing the newsoftware in its business operations in January 2004. As described above in“Management’s Discussion and Analysis of Financial Condition and Results ofOperations – Recent Developments,” certain difficulties were encountered duringthe third fiscal quarter related to the implementation of the Company’s newsoftware system. The implementation difficulties encountered affected internalcontrols with respect to the recording of sales and the valuations ofinventories and current liabilities. Management enhanced the software systemcontrols, refined its shipping procedures and retrained certain distributiondepartment employees to ensure accuracy when recording sales transactions, andthe software programming was corrected and accounting and production departmentemployees were given further training to ensure that system controls withrespect to the valuations of inventories and current liabilities are operatingproperly. Management believes that the implementation difficulties have beensubstantially resolved on an ongoing basis and expects that all significantaspects of the new software system will be fully operational by July 2005.Management also believes that, when fully operational, the new system willsignificantly improve the Company’s internal controls with respect to orderprocessing, purchasing requirements and timing, receiving and shippingoperations and finished goods inventory management. On an ongoing basis,management will continue to test internal controls with respect to therecording of sales and the valuations of inventories and current liabilities aswell as other controls to ensure that the Company’s controls are operating asthey were designed.

 

TheCompany’s management, including the Chief Executive Officer and Chief FinancialOfficer, does not expect that the Company’s disclosure controls and proceduresor its 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 the Company’s controlsystems provide a reasonable assurance level, the design of its control systemsreflects the fact

 

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thatthere are resource constraints, and the benefits of such controls wereconsidered relative to their costs.

 

Becauseof the inherent limitations in all control systems, no evaluation of controlscan provide absolute assurance that all control issues and instances of fraud,if any, within the Company have been detected. These inherent limitationsinclude the realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple errors or mistakes. Additionally, acontrol may be circumvented by the individual act of some person, by collusionof two or more persons, or by management’s override of a specific control. Thedesign of any system of controls is also based in part on certain assumptionsabout the likelihood of future events, and there can be no assurance that anydesign will succeed in achieving its stated goals under all potential futureconditions. Because of the inherent limitations in a cost-effective controlsystem, misstatements due to error or fraud may occur and not be detected.

 

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**SPORT-HALEY,INC.**

**PART II**

**OTHERINFORMATION**

 

### **ITEM1**                           LEGALPROCEEDINGS

 

As previously reported, a former shareholder commenceda putative class action lawsuit against Sport-Haley, two of its officers anddirectors and one former officer and director (the “Defendants”). OnApril 29, 2004, the United States District Court for the District ofColorado (the “Court”) entered a Final Order and Judgment approving theSettlement of the class action that had been pending since October 2001.Pursuant to a settlement conference, on November 7, 2003, and a Memorandumof Understanding dated December 16, 2003, the parties to the class actionreached a preliminary agreement to settle the action against all parties,subject to court approval and other contingencies. The Court grantedpreliminary approval of the settlement on January 30, 2004, pursuant towhich approval, notice of the class action and proposed settlement weredistributed to applicable shareholders. The Court conducted a hearing on theproposed settlement on April 23, 2004. No members of the class opted outof the class or objected to the proposed settlement. In accordance with thesettlement agreement, the Defendants have paid to the class a total of$1,000,000, from which will be deducted certain administrative costs and awardsmade to the named Plaintiffs and to Plaintiffs’ counsel for attorneys’ fees andcosts. The settlement amount was funded from proceeds of the Defendants’liability insurance coverage. The Defendants continue to maintain that theyhave meritorious defenses to the class action claims, but have agreed to thesettlement for practical and other reasons. The Defendants have incurred significantcosts and expenses, including the uses of Company resources and executive time,defending the class action. Of those expenses, a considerable portion is notrecoverable by applicable insurance.

 

As previously reported, on September 26, 2003, the United StatesSecurities and Exchange Commission (the “Commission”) filed suit in the UnitedStates District Court for the District of Colorado against Sport-Haley, itsChairman and former Chief Executive Officer, Robert G. Tomlinson, and itsformer Controller, Steve S. Auger (the “Defendants”). The Commission filed anamended complaint on October 29, 2003, which added one of the Company’sformer auditors to the action as a Defendant. The suit seeks an injunctionagainst future violations and other relief, including disgorgement, civilpenalties and an order barring Mr. Tomlinson and Mr. Auger from serving as adirector or officer of any publicly held company. The suit alleges that theDefendants misrepresented inventories, period costs and losses on the sale ofheadwear equipment in annual and/or quarterly financial statements for theCompany’s fiscal years 2000, 1999 and 1998. The amended complaint alleges thatthe Company violated §17(a) of the Securities Act of 1933 (the “SecuritiesAct”), §10(b), §13(b)(2) and §15(d) of the Securities Exchange Act of 1934 (the“Exchange Act”) and various other rules promulgated thereunder.

 

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The amended complaint further alleges that Mr. Tomlinson and Mr. Augerviolated §17(a) of the Securities Act, §10(b) and §13(b)(5) of the Exchange Actand Rules 10b-5 and 13b-2 thereunder. Finally, the suit alleges that Mr.Tomlinson and Mr. Auger aided and abetted the Company’s violations of §13(b)(2)and §15(d) of the Exchange Act and various rules promulgated thereunder. TheCommission’s suit primarily relates to errors in the Company’s previouslyissued financial statements that the Company previously reported when itvoluntarily restated its financial statements for fiscal years 1999 and 1998and subsequently corrected material financial information for the quarterlyperiods of fiscal years 2000, 1999 and 1998. The Defendants have answered theallegations of the Amended Complaint, denying the substantive allegations andasserting various defenses. Discovery in the action has recentlyconcluded.  No trial date has yet beendetermined.

 

The Defendants intend to vigorously defend the Commission’sallegations, which the Defendants believe are without merit. Based upon theinformation that is currently available, management cannot reasonably estimatethe amount of future costs that the Company will incur defending theCommission’s allegations. However, if the suit were determined in favor of theCommission and against the Defendants, the possible monetary penalties andother relief that the Company might be required to pay could negatively impactthe Company’s financial position and the results of its operations.

 

As previously reported, the Company retained legal counsel to possiblypursue claims against its former auditors in connection with damages sufferedas a result of the restatements of its financial statements for the fiscalyears ended June 30, 1999 and 1998 and the corrections of materialfinancial information for the quarterly periods of the fiscal years endedJune 30, 2000, 1999 and 1998. Further, counsel to the former auditors hasadvised the Company that the former auditors may bring certain claims againstthe Company. Management believes that the claims threatened by the formerauditors relate to allegations of unpaid fees. Each party continues to deny anyliability to the other party. Neither the Company nor its former auditors haveyet filed any legal action to assert any of these claims. During the threemonths ended March 31, 2004, the Company expended approximately $103,000,and, as of that date, the Company had cumulatively incurred approximately$828,000 in expenses related to the restatements of its financial statementsand material quarterly information, the investigation and subsequent civilaction commenced by the Commission and the class action lawsuit. While theCompany maintains its rights to pursue claims against its former auditors, theCompany has elected to treat amounts expended for legal and other costs, that arepotentially recoverable from the former auditors and the Company’s insurancecarriers, as selling, general and administrative expenses in the periodsincurred. If such amounts are recovered in future periods, the Company willtreat amounts recovered as other income in the periods such amounts arereceived. At March 31, 2004, at least $127,000 of such amounts, in excessof the policy deductible for such matters, was recoverable from one of theCompany’s insurance carriers.

 

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The Company is subject to various other legalproceedings and claims which arise in the ordinary course of its business. Inthe opinion of management, the amount of ultimate liability with respect tothose actions will not materially affect the financial position the Company orthe results of its operations.

 

### **ITEM 4**                                             SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

 

Sport-Haley, Inc. held its annual meeting ofshareholders on March 31, 2004. The following matters were considered andapproved by the shareholders:

 

A.            The following six directors were elected tohold office for one-year terms or until their successors are elected andqualified:

 
|                |   | **Votes  For** |   | **Votes  Against  or Withheld** |   | **Total  Voted** |   |
|---------------------|--------|----------------|--------|---------------------------------|--------|------------------|--------|
|                |   |           |   |                            |   |             |   |
| Robert G. Tomlinson |   | 2,022,013      |   | 346,461                         |   | 2,368,474        |   |
| Kevin M. Tomlinson  |   | 2,335,288      |   | 33,186                          |   | 2,368,474        |   |
| Mark J. Stevenson   |   | 2,346,288      |   | 22,186                          |   | 2,368,474        |   |
| Ronald J. Norick    |   | 2,349,638      |   | 18,836                          |   | 2,368,474        |   |
| James H. Everest    |   | 2,349,638      |   | 18,836                          |   | 2,368,474        |   |
| James R. TenBrook   |   | 2,354,238      |   | 14,236                          |   | 2,368,274        |   |

 

B.              To ratify appointment of Hein +Associates LLP as the independent certified public accountants for Sport-Haley,Inc.

 
| Votes For        |   | 2,316,044 |   |
|------------------|--------|-----------|--------|
| Votes Against    |   | 15,700    |   |
| Votes Abstaining |   | 36,730    |   |
| Total Voted      |   | 2,368,474 |   |

### ** **

### **ITEM 5**                           OTHER INFORMATION

### ** **

### **Effective March 31, 2004, the Company’s formerPresident, Robert W. Haley, terminated his employment with the Company. Mr.Haley’s severance package included the continuation of his salary for one yearin exchange for his agreement not to enter into activities that are or may becompetitive with, or which might place Mr. Haley in a competing position tothat of, the Company during that one-year period. Upon Mr. Haley’s terminationof employment, the Company included $150,000 in selling, general andadministrative expenses relating to his severance agreement.**

 

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### **ITEM 6**                           EXHIBITS AND REPORTS ON FORM8-K

 

(A) EXHIBITS

 

Exhibit 10.1 – Employment agreement between Sport-Haley, Inc. and MarkMaley dated February 22, 2004

 

Exhibit 31.1 – Certification of Kevin M. Tomlinson

 

Exhibit 31.2 – Certification of Patrick W. Hurley

 

Exhibit 32.1 – Certifications of Kevin M. Tomlinson and Patrick W.Hurley pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002

 

(B) REPORTS ON FORM 8-K

 

On February 12, 2004, the Company filed a Form 8-K to report thatthe Company had issued a news release dated February 10, 2004, whichannounced its financial results for the fiscal quarter ended December 31,2003.

 

On May 6, 2004, the Company filed a Form 8-K to report that the Companyhad issued a news release dated May 4, 2004, which announced that the UnitedStates District Court for the District of Colorado entered on April 29,2004 its Final Order and Judgment approving the settlement of the class actionthat had been pending since October 2001 against the Company, two officersand directors and one former officer and director.

 

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#### **SIGNATURES**

 

In accordance with the requirements of the Securities Exchange Act of1934, the Registrant caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|   |         | **SPORT-HALEY, INC.**   |
|--------|--------------|-------------------------|
|   |         | (Registrant)            |
|   |         |                    |
|   |         |                    |
| Date:  | May 24, 2004 |                    | /s/ Kevin M. Tomlinson |   |
|   |         | Kevin M. Tomlinson      |
|   |         | Chief Executive Officer |
|   |         |                    |
|   |         |                    |
| Date:  | May 24, 2004 |                    | /s/ Patrick W. Hurley |   |
|   |         | Patrick W. Hurley       |
|   |         | Chief Financial Officer |
|        |              |                         |  |  |  |

 

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