** **

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 
| x      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|--------|------------|----------------------------------------------------------------------------------------------------|
|   |       |                                                                                               |
|   |       | **For the quarterly period ended December 31,  2007**                                         |
|   |       |                                                                                               |
| o      | ** ** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                     |

 

**Commission File No. 0-51715**

 

**SPORT-HALEY,INC.**

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

 

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

 

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

(Address ofprincipal executive offices)

 

**(303)320-8800**

(Issuer’stelephone number including area code)

 

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

 

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

 

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

 

        Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct). Yes  o No  x

 

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

 

| **Class**                  | ** ** | **Outstanding at February 8, 2008** |
|----------------------------|------------|------------------------------------------|
| Common Stock, no par value |       | 2,284,490                                |

 

 

 

#### ****

#### ** **

**SPORT-HALEY, INC.**

**TABLE OF CONTENTS**

 
| **PART 1 — FINANCIAL  INFORMATION (UNAUDITED)** |
|-----------------------------------------------------------|
| ** **                                                |
|                                                      |   | ITEM 1 | — | CONDENSED CONSOLIDATED  FINANCIAL STATEMENTS |
|                                                      |   |   |   |   |
|                                                      |   |   | ** ** | CONDENSED CONSOLIDATED BALANCE  SHEETS |
|                                                      |   |   |   |   |
|                                                      |   |   | ** ** | CONDENSED CONSOLIDATED STATEMENTS  OF OPERATIONS |
|                                                      |   |   |   |   |
|                                                      |   |   | ** ** | CONDENSED CONSOLIDATED STATEMENTS OF  CASH FLOWS |
|                                                      |   |   |   |   |
|                                                      |   |   | ** ** | NOTES TO CONDENSED CONSOLIDATED FINANCIAL  STATEMENTS |
|                                                      |   |   |   |   |
|                                                      |   | ITEM 2 | — | MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|                                                      |   |   |   |   |
|                                                      |   | ITEM 3 | — | QUALITATIVE AND QUANTITATIVE DISCLOSURES  ABOUT MARKET RISK |
|                                                      |   |   |   |   |
|                                                      |   | ITEM 4 | — | CONTROLS AND PROCEDURES |
|                                                      |   |   |   |   |
| **PART II — OTHER INFORMATION**                 |
|                                                      |   |   |   |   |
|                                                      |   | ITEM 1 |   | LEGAL PROCEEDINGS |
|                                                      |   |   |   |   |
| ** **                                                |   | ITEM 1A |   | RISK FACTORS |
|                                                      |   |   |   |   |
|                                                      |   | ITEM 5 |   | OTHER INFORMATION |
|                                                      |   |   |   |   |
|                                                      |   | ITEM 6 |   | EXHIBITS |
|                                                      |   |   |   |   |
| **SIGNATURES**                                            |
|                                                      |   |   |   |   |
| **EXHIBITS**                                              |
|                                                      |   |   |   |   |
|                                                      |   | 31.1 |   | CERTIFICATION  OF DONALD W. JEWELL |
|                                                      |   |   |   |   |
|                                                      |   | 31.2 |   | CERTIFICATION  OF PATRICK W. HURLEY |
|                                                      |   |   |   |   |
|                                                      |   | 32.1 |   | CERTIFICATIONS  OF DONALD W. JEWELL AND PATRICK W. HURLEY |
|                                                           |  |  |  |  |  |  |  |

 

#### ** **

 

2

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**SPORT-HALEY, INC.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

 
| ** **                                                                                                               | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                               | ** ** | **2007**              | ** ** | **2007**          | ** ** |
| ** **                                                                                                               | ** ** | **(Unaudited)**       | ** ** | **(***)**         | ** ** |
|                                                                                                                     |       |                  |       |              |       |
| **ASSETS**                                                                                                               |       |                  |       |              |       |
| Current assets:                                                                                                          |       |                  |       |              |       |
| Cash and cash  equivalents                                                                                               |       | $                     | 2,678,000  |              | $          | 4,464,000 |   |
| Accounts  receivable, net of allowances of $401,000 and $374,000, respectively                                           |       | 2,633,000             |       | 3,066,000         |       |
| Inventories                                                                                                              |       | 6,685,000             |       | 5,814,000         |       |
| Prepaid expenses  and other                                                                                              |       | 364,000               |       | 203,000           |       |
| Total current  assets                                                                                                    |       | 12,360,000            |       | 13,547,000        |       |
|                                                                                                                     |       |                  |       |              |       |
| Property and equipment, net                                                                                              |       | 296,000               |       | 399,000           |       |
| Other assets                                                                                                             |       | 3,000                 |       | 3,000             |       |
|                                                                                                                     |       |                  |       |              |       |
| Total Assets                                                                                                             |       | $                     | 12,659,000 |              | $          | 13,949,000 |   |
|                                                                                                                     |       |                  |       |              |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                           |       |                  |       |              |       |
|                                                                                                                     |       |                  |       |              |       |
| Current liabilities:                                                                                                     |       |                  |       |              |       |
| Accounts payable                                                                                                         |       | $                     | 895,000    |              | $          | 1,566,000 |   |
| Accrued  royalties payable                                                                                               |       | 139,000               |       | 181,000           |       |
| Accrued commissions  payable                                                                                             |       | 198,000               |       | 214,000           |       |
| Accrued payroll                                                                                                          |       | 280,000               |       | 249,000           |       |
| Other                                                                                                                    |       | 186,000               |       | 179,000           |       |
| Total current  liabilities                                                                                               |       | 1,698,000             |       | 2,389,000         |       |
|                                                                                                                     |       |                  |       |              |       |
| Commitments and Contingencies:                                                                                           |       |                  |       |              |       |
| Minimum  royalties payable                                                                                               |       | 182,000               |       | 178,000           |       |
| Total contingent  liabilities                                                                                            |       | 182,000               |       | 178,000           |       |
|                                                                                                                     |       |                  |       |              |       |
| Total Liabilities                                                                                                        |       | 1,880,000             |       | 2,567,000         |       |
|                                                                                                                     |       |                  |       |              |       |
| Shareholders’ equity:                                                                                               |       |                  |       |              |       |
| Preferred stock,  no par value; 1,500,000 shares authorized; none issued and outstanding                                 |       | —                |       | —            |       |
| Common stock, no  par value; 15,000,000 shares authorized; 2,284,490 and 2,770,252 issued and  outstanding, respectively |       | 8,481,000             |       | 8,481,000         |       |
| Additional  paid-in capital                                                                                              |       | 1,621,000             |       | 1,621,000         |       |
| Retained  earnings                                                                                                       |       | 677,000               |       | 1,280,000         |       |
| Total  shareholders’ equity                                                                                         |       | 10,779,000            |       | 11,382,000        |       |
| Total Liabilities  and Shareholders’ Equity                                                                         |       | $                     | 12,659,000 |              | $          | 13,949,000 |   |

----

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

 

See accompanying notes to these condensed consolidated financialstatements.

 

 

3

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**SPORT-HALEY, INC.**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

 
| ** **                                                                                      | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                                      | ** ** | **December 31,**   | ** ** | **December 31,** | ** ** |
| ** **                                                                                      | ** ** | **2007**                | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                                      | ** ** | **(Unaudited)**         | ** ** | **(Unaudited)**       | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Net sales                                                                                       |       | $                       | 4,411,000  |                  | $          | 4,190,000 |   | $ | 7,939,000 |   | $ | 8,863,000 |   |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Cost of goods sold                                                                              |       | 2,611,000               |       | 2,562,000             |       | 4,802,000 |   | 5,684,000 |   |
| Impairments                                                                                     |       | 20,000                  |       | 73,000                |       | 174,000 |   | 122,000 |   |
| Total cost of goods sold                                                                        |       | 2,631,000               |       | 2,635,000             |       | 4,976,000 |   | 5,806,000 |   |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Gross profit                                                                                    |       | 1,780,000               |       | 1,555,000             |       | 2,963,000 |   | 3,057,000 |   |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Other Operating Costs:                                                                          |       |                    |       |                  |       |   |   |   |   |
| Selling, general  and administrative expenses                                                   |       | 1,646,000               |       | 1,691,000             |       | 3,371,000 |   | 3,412,000 |   |
| Royalty expense                                                                                 |       | 142,000                 |       | 152,000               |       | 268,000 |   | 362,000 |   |
| Total other  operating costs                                                                    |       | 1,788,000               |       | 1,843,000             |       | 3,639,000 |   | 3,774,000 |   |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Loss from operations                                                                            |       | (8,000                  | )          | (288,000              | )          | (676,000 | ) | (717,000 | ) |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Other income, net                                                                               |       | 32,000                  |       | 84,000                |       | 80,000 |   | 162,000 |   |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Income (loss) before  minority interest in subsidiary net income and provision for income taxes |       | 24,000                  |       | (204,000              | )          | (596,000 | ) | (555,000 | ) |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Minority interest in subsidiary net income                                                      |       | —                  |       | —                |       | — |   | (46,000 | ) |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Provision for income taxes                                                                      |       | —                  |       | (17,000               | )          | (7,000 | ) | (17,000 | ) |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Net income (loss)                                                                               |       | $                       | 24,000     |                  | $          | (221,000 | ) | $ | (603,000 | ) | $ | (618,000 | ) |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Basic earnings (loss) per common share                                                          |       | $                       | 0.01       |                  | $          | (0.08 | ) | $ | (0.26 | ) | $ | (0.22 | ) |
| Basic weighted average shares outstanding                                                       |       | 2,284,000               |       | 2,770,000             |       | 2,284,000 |   | 2,770,000 |   |
|                                                                                            |       |                    |       |                  |       |   |   |   |   |
| Diluted earnings (loss) per common share                                                        |       | $                       | 0.01       |                  | $          | (0.08 | ) | $ | (0.26 | ) | $ | (0.22 | ) |
| Diluted weighted average shares outstanding                                                     |       | 2,284,000               |       | 2,770,000             |       | 2,284,000 |   | 2,770,000 |   |

 

See accompanying notes to these condensed consolidated financialstatements.

 

 

4

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**SPORT-HALEY, INC.**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

 
| ** **                                                                   | ** ** | **Six  Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                   | ** ** | **December 31,** | ** ** |
| ** **                                                                   | ** ** | **2007**              | ** ** | **2006** | ** ** |
| ** **                                                                   | ** ** | **(Unaudited)**       | ** ** | **(Unaudited)** | ** ** |
|                                                                         |       |                  |       |   |   |
| **Cash flows from operating activities:**                                    |       |                  |       |   |   |
| Net loss                                                                     |       | $                     | (603,000   | ) | $ | (618,000 | ) |
| Adjustments to reconcile net loss to net cash used  by operating activities: |       |                  |       |   |   |
| Depreciation and  amortization                                               |       | 106,000               |       | 147,000 |   |
| Impairments and  write-downs                                                 |       | 174,000               |       | 122,000 |   |
| Allowance for  doubtful accounts                                             |       | 60,000                |       | 60,000 |   |
| Minority interest                                                            |       | —                |       | 49,000 |   |
| Cash provided (used) due to changes in assets and  liabilities:              |       |                  |       |   |   |
| Accounts  receivable                                                         |       | 373,000               |       | 1,231,000 |   |
| Inventories                                                                  |       | (1,045,000            | )          | (384,000 | ) |
| Other assets                                                                 |       | (161,000              | )          | (120,000 | ) |
| Accounts payable                                                             |       | (671,000              | )          | (929,000 | ) |
| Accrued commissions  and other expenses                                      |       | (16,000               | )          | (295,000 | ) |
| Net cash used by  operating activities                                       |       | (1,783,000            | )          | (737,000 | ) |
|                                                                         |       |                  |       |   |   |
| **Cash flows from investing activities:**                                    |       |                  |       |   |   |
| Purchase of  fixed assets                                                    |       | (3,000                | )          | (19,000 | ) |
| Purchase of  minority interest                                               |       | —                |       | (375,000 | ) |
| Net cash used by  investing activities                                       |       | (3,000                | )          | (394,000 | ) |
|                                                                         |       |                  |       |   |   |
| **Cash flows from financing activities:**                                    |       |                  |       |   |   |
| Borrowings under  line of credit                                             |       | 1,000,000             |       | — |   |
| Repayments under  line of credit                                             |       | (1,000,000            | )          | — |   |
| Net cash  provided by financing activities                                   |       | —                |       | — |   |
|                                                                         |       |                  |       |   |   |
| **Net decrease in cash and cash equivalents**                                |       | (1,786,000            | )          | (1,131,000 | ) |
|                                                                         |       |                  |       |   |   |
| **Cash and cash equivalents, beginning**                                     |       | 4,464,000             |       | 8,492,000 |   |
|                                                                         |       |                  |       |   |   |
| **Cash and cash equivalents, ending**                                        |       | $                     | 2,678,000  |   | $ | 7,361,000 |   |
|                                                                         |       |                  |       |   |   |
| **Supplemental disclosure of cash flow  information:**                       |       |                  |       |   |   |
| Cash paid during  the period for:                                            |       |                  |       |   |   |
| Income taxes                                                                 |       | $                     | 7,000      |   | $ | 17,000 |   |

 

See accompanying notes to these condensed consolidated financialstatements.

 

 

5

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** **

**SPORT-HALEY, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1****                                       ****SIGNIFICANT ACCOUNTINGPOLICIES**

 

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

 

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

 

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

 

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

 

Certaininformation in footnote disclosures normally included in financial statementshas been condensed or omitted in accordance with the rules and regulationsof the Securities and Exchange Commission. The information included in this Form 10-Qshould be read in conjunction with financial statements and notes thereto andManagement’s Discussion and Analysis of Financial Condition and Results ofOperations for the year ended June 30, 2007, included in the Company’sfiling on Form 10-K.

 

*Reclassification* Certain priorperiod amounts have been reclassified to conform to the December 31, 2007,presentation. Such reclassifications had no affect on net income (loss) in anyof the periods presented.

 

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

 

6

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**SPORT-HALEY, INC.**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

expiration of certain timeperiods after the termination of a grantee’s employment (or other relationshipwith the Company) or expiration by their terms.

 

At December 31, 2007,there were outstanding options to purchase 586,000 shares of our common stockat exercise prices ranging from $2.71 to $9.78 per share and expiration datesbetween August 2008 and January 2013. All outstanding options arefully vested. No options were exercised during the three months ended December 31,2007, and 7,500 options expired. The Plan expired by its terms in February 2003,after which no options were granted. The expected life was determined basedupon the Plan’s vesting period and exercise behavior of the employees.

 

In January 2008, we adopted a new stock optionplan, entitled the Sport-Haley 2008 Stock Option Plan (the “2008 Plan”), whichwill be considered for approval by our shareholders at our annual meeting on February 21,2008. No options or other awards may be granted under the 2008 Plan untilshareholder approval has been obtained.

 

*Recent Pronouncements* In December 2007, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards No. 160 (“SFAS 160”), *“Noncontrolling Interestsin Consolidated Financial Statements — an amendment of ARB No. 51.”*The objective of SFAS 160 is to improve the relevance, comparability andtransparency of financial information that a reporting entity provides in itsconsolidated financial statements by establishing accounting and reportingstandards that require: (a) the ownership interests in subsidiaries heldby parties other than the parent to be clearly identified, labeled andpresented in the consolidated statement of financial position within equity,but separate from the parent’s equity; (b) the amount of consolidated netincome attributable to the parent and to the noncontrolling interest to beclearly identified and presented on the face of the consolidated statement ofincome; (c) changes in a parent’s ownership interest while the parentretains its controlling financial interest in its subsidiary to be accountedfor consistently; (d) when a subsidiary is deconsolidated, any retainednoncontrolling equity investment in the former subsidiary to be initiallymeasured at fair value; and (e) entities to provide sufficient disclosuresthat clearly identify and distinguish between the interests of the parent andinterests of the noncontrolling owners. SFAS 160 applies to all entities thatprepare consolidated financial statements, except not-for-profit organizations,but will affect only those entities that have an outstanding noncontrollinginterest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS160 is effective for fiscal years, and interim periods within those fiscalyears, beginning on or after December 15, 2008. Earlier adoption isprohibited. Our adoption of SFAS 160 upon its effective date is not expected tohave a material effect on our financial condition or the results of ouroperations.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 141(R) (“SFAS141R”), *“Business Combinations.”* The objectiveof SFAS 141R is to improve the relevance, representational faithfulness andcomparability of information that a reporting entity provides in its financialreports about a business combination and its effects. To accomplish that, SFAS141R establishes principles and requirements for how the acquirer: (a) recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed and any noncontrolling interest in the acquiree; (b) recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase; and, (c) determines what information to disclose toenable users of the 

 

 

7

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**SPORT-HALEY, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

financial statements toevaluate the nature and financial effects of the business combination. SFAS141R applies to all transactions or other events in which an acquiring entityobtains control of one or more businesses, including those sometimes referredto as “true mergers” or “mergers of equals” and combinations achieved withoutthe transfer of consideration, for example, by contract alone or through thelapse of minority veto rights. SFAS 141R applies to all business entities,including mutual entities that previously used the pooling of interests methodto account for some business combinations. SFAS 141R does not apply to: (a) theformation of a joint venture; (b) the acquisition of an asset or group ofassets that does not constitute a business; (c) a combination betweenentities or businesses under common control; and, (d) a combinationbetween not-for-profit organizations or the acquisition of a for-profitbusiness by a not-for-profit organization. The effective date of SFAS 141R isthe same as that of the related SFAS 160. Our adoption of SFAS 141R upon itseffective date is not expected to have a material effect on our financialcondition or the results of our operations.

 

In February 2007,the FASB issued Statement of Financial Accounting Standards No. 159 (“SFAS159”), *“The Fair Value Option for Financial Assets andFinancial Liabilities — Including an Amendment of FASB Statement No. 115.”*SFAS 159 permits an entity to measure financial instruments and certain otheritems at estimated fair value as of specific election dates. The fair valueoption: (i) may generally be applied instrument by instrument; (ii) isirrevocable unless a new election date occurs; and, (iii) must be appliedto the entire instrument and not to only a portion of the instrument. Most ofthe provisions of SFAS 159 are elective. However, the amendment to SFAS 115, *“Accounting for Certain Investments in Debt and Equity Securities,”*applies to all entities that own securities that are classified as trading oravailable for sale. SFAS 159 is effective for fiscal years beginning after November 15,2007. Early adoption of SFAS 159 is permitted if the entity: (i) choosesearly adoption within the first 120 days of its fiscal year; (ii) has notyet issued financial statements for any interim period of such fiscal year; and(iii) elects to apply the provisions of FASB No. 157, *“Fair Value Measurements.”* We did not elect early adoption,and we have not evaluated the impact, if any, on our financial condition or theresults of our operations that would have been caused by early adoption of SFAS159.

 

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

 

**NOTE 2****                                       ****INVENTORIES**

 

| ** **                              | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                              | ** ** | **2007**              | ** ** | **2007**          | ** ** |
|                                    |       |                  |       |              |       |
| Inventories consisted of the following: |       |                  |       |              |       |
| Component                               |       | $                     | 480,000    |              | $          | 283,000 |   |
| Finished goods                          |       | 6,205,000             |       | 5,531,000         |       |
|                                    |       |                  |       |              |       |
|                                    |       | $                     | 6,685,000  |              | $          | 5,814,000 |   |

 

 

8

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**SPORT-HALEY, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

Included in finished goods inventories are allowances for inventorywrite-downs of $173,000 and $236,000 as of December 31, 2007, and June 30,2007, respectively.

 

**NOTE 3****                                       ****LINE OF CREDIT AGREEMENT**

 

We maintain arevolving line of credit agreement with a commercial bank. The revolving lineof credit agreement, renewed by amendment through December 5, 2008,provides for a maximum loan amount of $2,000,000, collateralized by acertificate of deposit held at the commercial bank in the amount of $2,000,000,which earns a market rate of interest. Borrowings under the line of creditagreement accrue interest at 1.250% plus the one-month LIBOR rate. We generallymaintain the line of credit to facilitate the issuance of letters of credit forinventory purchases from offshore suppliers and, if necessary, to fund anytemporary working capital needs. At December 31, 2007, and June 30,2007, respectively, we did not have any balances due on the line of credit.

 

Outstandingletters of credit reduce the amount available for borrowing under the line ofcredit agreement. At December 31, 2007, and June 30, 2007, we hadoutstanding letters of credit totaling $0 and $2,173,000, respectively.

 

**NOTE 4****                                       ****COMMITMENTS ANDCONTINGENCIES**

 

Our license agreement withCallaway requires us to pay royalties based upon sales of Ben Hogan® fashionapparel and Top-Flite® branded apparel. We record royalties as other operatingcosts in the periods when such sales are recognized. Certain terms of thelicense agreement provide for minimum royalties on a calendar year basis. Salesof Top-Flite® branded apparel were insufficient to meet the contractual minimumroyalty requirement of $188,000 for calendar 2007, with respect to Top-Flite®.At June 30, 2007, we accrued a contingent liability of $178,000, and at December 31,2007, we accrued an additional contingent liability of $4,000, with regard tothe Top-Flite® minimum royalty due to Callaway for calendar 2007. Sales ofTop-Flite® branded apparel were sufficient to meet the minimum royaltyrequirements under the Callaway license for calendar 2006.

 

**NOTE 5****                                       ****EARNINGS PER SHARE**

 

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

 

 

9

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**SPORT-HALEY, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                   | ** ** | **Three Months ended December 31, 2007**  | ** ** |
|----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                   | ** ** | **Net**                                        | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Income**                                     | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **(Loss)**                                     | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
|                                         |       |                                           |       |   |   |   |   |
| Basic earnings per share                     |       | $                                              | 24,000     |   | 2,284,000 |   | $ | 0.01 |   |
|                                         |       |                                           |       |   |   |   |   |
| Effect of dilutive securities options        |       | —                                         |       | — |   | — |   |
|                                         |       |                                           |       |   |   |   |   |
| Diluted earnings per share                   |       | $                                              | 24,000     |   | 2,284,000 |   | $ | 0.01 |   |
|                                         |       |                                           |       |   |   |   |   |
| ** **                                   | ** ** | **Six  Months ended December 31, 2007**   |       |
| ** **                                   | ** ** | **Net**                                        | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Income**                                     | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **(Loss)**                                     | ** ** | **Shares** | ** ** | **Per  Share** | ** ** |
|                                         |       |                                           |       |   |   |   |   |
| Basic loss per share                         |       | $                                              | (603,000   | ) | 2,284,000 |   | $ | (0.26 | ) |
|                                         |       |                                           |       |   |   |   |   |
| Effect of dilutive securities options**[A]** |       | —                                         |       | — |   | — |   |
|                                         |       |                                           |       |   |   |   |   |
| Diluted loss per share                       |       | $                                              | (603,000   | ) | 2,284,000 |   | $ | (0.26 | ) |
|                                         |       |                                           |       |   |   |   |   |
|                                         | ** ** | **Three  Months ended December 31, 2006** |       |
| ** **                                   | ** ** | **Net**                                        | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Income**                                     | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **(Loss)**                                     | ** ** | **Shares** | ** ** | **Per  Share** | ** ** |
|                                         |       |                                           |       |   |   |   |   |
| Basic loss per share                         |       | $                                              | (221,000   | ) | 2,770,000 |   | $ | (0.08 | ) |
|                                         |       |                                           |       |   |   |   |   |
| Effect of dilutive securities options**[A]** |       | —                                         |       | — |   | — |   |
|                                         |       |                                           |       |   |   |   |   |
| Diluted loss per share                       |       | $                                              | (221,000   | ) | 2,770,000 |   | $ | (0.08 | ) |
|                                         |       |                                           |       |   |   |   |   |
| ** **                                   |       | **Six  Months ended December 31, 2006**   |       |
| ** **                                   | ** ** | **Net**                                        | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Income**                                     | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **(Loss)**                                     | ** ** | **Shares** | ** ** | **Per  Share** | ** ** |
|                                         |       |                                           |       |   |   |   |   |
| Basic loss per share                         |       | $                                              | (618,000   | ) | 2,770,000 |   | $ | (0.22 | ) |
|                                         |       |                                           |       |   |   |   |   |
| Effect of dilutive securities options**[A]** |       | —                                         |       | — |   | — |   |
|                                         |       |                                           |       |   |   |   |   |
| Diluted loss per share                       |       | $                                              | (618,000   | ) | 2,770,000 |   | $ | (0.22 | ) |

----

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

 

 

10

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**SPORT-HALEY, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 6****                                       ****SEGMENT INFORMATION****:**

 

The consolidatedCompany has two operating segments which consist of designing, purchasing orcontracting for the manufacture of and wholesale sales of women’s and men’s (1) fashiongolf apparel and outerwear and (2) branded golf apparel. Our SPORT HALEY®and Ben Hogan® fashion golf apparel and outerwear collections are marketed bySport Haley in the premium and mid-priced markets through a network ofindependent wholesale sales representatives and distributors to golfprofessional shops, country clubs, resorts and exclusive department storeswithin the United States and on a limited basis by certain distributors withininternational markets. Our Top-Flite® men’s branded apparel has been marketedby Reserve Apparel to mass retailers and other big-box type high sales volumeretail stores. Ben Hogan® fashion apparel and Top-Flite® branded apparel aredistributed pursuant to a license agreement with Callaway.

 

Reserve Apparel distributedTop-Flite® apparel exclusively to Wal-Mart from March 2006 through August 2006,after which we were notified that Wal-Mart had chosen to develop its ownprivate label for golf apparel and discontinue selling Top-Flite® apparel. Weredesigned Top-Flite® branded apparel to include garments primarily comprisedof a variety of performance fabrics, and we aggressively marketed ourTop-Flite® apparel line to several mass retailers and big-box type high salesvolume retail stores. We expected our marketing efforts would result in theestablishment of business relationships with one or more mass retailers andother big-box type high sales volume retail stores. However, to date we haveonly received one order for Top-Flite® apparel from such a retailer for a testin 50 of its stores, which we began shipping in September 2007. Since ourconcerted efforts over the last year have failed to generate orders from amajor customer, we have discontinued marketing apparel bearing the Top-Flite®label.

 

At June 30, 2007,we recorded a contingent liability of $178,000, and at December 31, 2007,we recorded an additional contingent liability of $4,000, with regard tominimum royalties due in accordance with our license agreement for Top-Flite®branded apparel, which requires minimum royalties of $188,000 for such apparelin calendar year 2007. We recorded royalty expense of $9,000, including relatedmarketing fees, for calendar year 2007 on sales of Top-Flite® branded apparel.Sales of Top-Flite® branded apparel were sufficient to meet the minimum royaltyrequirement under the license agreement for calendar year 2006. We discontinued marketing Top-Flite® branded apparel in November 2007.

 

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

 

 

11

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**SPORT-HALEY, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

*CondensedConsolidated Balance Sheets Segment Information as of December 31, 2007,and June 30, 2007:*

 
| ** **                             | ** ** | **December 31, 2007** | ** ** | **June 30, 2007** | ** ** |
|----------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **Fashion**                | ** ** | **Branded**            | ** ** | **Fashion** | ** ** | **Branded** | ** ** |
| ** **                             | ** ** | **Apparel**                | ** ** | **Apparel**            | ** ** | **Apparel** | ** ** | **Apparel** | ** ** |
|                                   |       |                       |       |                   |       |   |   |   |   |
| Cash and cash equivalents              |       | $                          | 2,648,000  |                   | $          | 30,000 |   | $ | 4,354,000 |   | $ | 110,000 |   |
| Accounts receivable, net of allowances |       | $                          | 2,135,000  |                   | $          | 498,000 |   | $ | 2,713,000 |   | $ | 353,000 |   |
| Inventories                            |       | $                          | 6,666,000  |                   | $          | 19,000 |   | $ | 5,814,000 |   | $ | — |   |
| Total assets                           |       | $                          | 12,111,000 |                   | $          | 548,000 |   | $ | 13,482,000 |   | $ | 467,000 |   |
| Total liabilities                      |       | $                          | 1,463,000  |                   | $          | 417,000 |   | $ | 2,330,000 |   | $ | 237,000 |   |

 

*CondensedConsolidated Statements of Operations Segment Information for the Three MonthsEnded December 31, 2007 and 2006:*

 
| ** **                                    | ** ** | **Three Months Ended**     | ** ** | **Three Months Ended**     | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| ** **                                    | ** ** | **Fashion**                | ** ** | **Branded**                | ** ** | **Fashion** | ** ** | **Branded** | ** ** |
| ** **                                    | ** ** | **Apparel**                | ** ** | **Apparel**                | ** ** | **Apparel** | ** ** | **Apparel** | ** ** |
|                                          |       |                       |       |                       |       |   |   |   |   |
| Net sales                                     |       | $                          | 4,385,000  |                       | $          | 26,000 |   | $ | 4,190,000 |   | $ | — |   |
| Cost of goods sold                            |       | $                          | 2,585,000  |                       | $          | 26,000 |   | $ | 2,562,000 |   | $ | — |   |
| Impairments                                   |       | $                          | —     |                       | $          | 20,000 |   | $ | 73,000 |   | $ | — |   |
| Gross profit                                  |       | $                          | 1,800,000  |                       | $          | (20,000 | ) | $ | 1,555,000 |   | $ | — |   |
| Selling, general and  administrative expenses |       | $                          | 1,619,000  |                       | $          | 27,000 |   | $ | 1,624,000 |   | $ | 67,000 |   |
| Royalty expense                               |       | $                          | 138,000    |                       | $          | 4,000 |   | $ | 152,000 |   | $ | — |   |
| Income (loss) from operations                 |       | $                          | 43,000     |                       | $          | (51,000 | ) | $ | (221,000 | ) | $ | (67,000 | ) |

 

*CondensedConsolidated Statements of Operations Segment Information for the Six MonthsEnded December 31, 2007 and 2006:*

 
| ** **                                    | ** ** | **Six Months Ended**       | ** ** | **Six Months Ended**       | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| ** **                                    | ** ** | **Fashion**                | ** ** | **Branded**                | ** ** | **Fashion** | ** ** | **Branded** | ** ** |
| ** **                                    | ** ** | **Apparel**                | ** ** | **Apparel**                | ** ** | **Apparel** | ** ** | **Apparel** | ** ** |
|                                          |       |                       |       |                       |       |   |   |   |   |
| Net sales                                     |       | $                          | 7,793,000  |                       | $          | 146,000 |   | $ | 7,678,000 |   | $ | 1,185,000 |   |
| Cost of goods sold                            |       | $                          | 4,681,000  |                       | $          | 121,000 |   | $ | 4,799,000 |   | $ | 885,000 |   |
| Impairments                                   |       | $                          | 154,000    |                       | $          | 20,000 |   | $ | 122,000 |   | $ | — |   |
| Gross profit                                  |       | $                          | 2,958,000  |                       | $          | 5,000 |   | $ | 2,757,000 |   | $ | 300,000 |   |
| Selling, general and  administrative expenses |       | $                          | 3,243,000  |                       | $          | 128,000 |   | $ | 3,206,000 |   | $ | 206,000 |   |
| Royalty expense                               |       | $                          | 257,000    |                       | $          | 11,000 |   | $ | 298,000 |   | $ | 64,000 |   |
| Income (loss) from operations                 |       | $                          | (542,000   | )                          | $          | (134,000 | ) | $ | (747,000 | ) | $ | 30,000 |   |

 

 

12

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**SPORT-HALEY, INC.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 7****                                       ****LITIGATION****:**

 

As previouslyreported, in March 2007, Sport Haley and Reserve Apparel (the “Plaintiffs”)filed a lawsuit in the District Court for the City and County of Denver in theState of Colorado. The suit alleges, among other things, that a formerinventory broker to Reserve Apparel, 1130746 Ontario Ltd., a Canadiancorporation incorporated in the Province of Ontario, Canada, d/b/a OriginalsApparel Group Co., or Originals Apparel Group, and Francis Tat-Mo Chan (the “Defendants”),knowingly, wrongfully and without authorization converted Plaintiff’s funds.Among other things, the Plaintiffs alleged that the Defendants misapplied aninventory deposit of $291,000 paid to the Defendants in March 2006 bySport Haley, which the Defendants used to offset certain amounts purportedlyowed to the Defendants by Explorer Headgear, Inc., and that the Defendantsfailed to return $177,000 which was overpaid by Sport Haley as of July 2006.The Plaintiffs have alleged claims against the Defendants for conversion andviolation of the Colorado civil theft statute as well as for unjust enrichment.Plaintiffs seek repayment of the $291,000 and $177,000 amounts and otherrelief. The case has been scheduled for trial in May 2008. Based uponinformation that is currently available, we cannot determine whether thedecision or settlement of this lawsuit will materially affect our financialposition or the results of our operations.

 

 

13

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**SPORT-HALEY, INC.**

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

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This Report on Form 10-Q contains certain forward-lookingstatements, within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. The words “may,”“will,” “expect,” “anticipate,” “continue,” “estimate,” “project,” “intend,” “believe,”and similar expressions, variations or the negative of these words, and anystatement regarding possible or assumed future results of operations of ourbusiness, the markets for our products, anticipated expenditures, regulatorydevelopments or competition, or other statements regarding matters that are nothistorical facts, are intended to identify forward-looking statements, althoughnot all forward-looking statements contain such identifying words. The readershould be aware that our actual results could differ materially from thosecontained in forward-looking statements. Our financial condition and theresults of our operations will depend on a number of factors, including, butnot limited to, the following: our ability to successfully anticipate fashiontrends, design favorably accepted fashion golf apparel, effectively advertiseand communicate within the marketplace, and penetrate our chosen distributionchannels; competition within golf apparel markets; business conditions andgrowth in the fashion golf apparel market and the general economy; our abilityto successfully forecast sales and optimize inventory levels; our ability tosuccessfully manage risks associated with a high relative percentage of saleswith respect to licensed apparel, such as the Ben Hogan® apparel collections;loss of certain third party suppliers, and/or delays in receiving garments fromthird party suppliers caused by various factors, including lost or reducedmanufacturing capacity of significant suppliers, labor shortages, timely performanceof third parties, transportation difficulties, and others; significant delaysin deliveries from third party suppliers; unsatisfactory recourse with regardto nonconforming goods received from foreign suppliers; political andinternational trade relations; changes in international trade quota systems forapparel; significant reliance upon several individual foreign suppliers;reliance upon a certain foreign person responsible for maintainingrelationships with and monitoring the performance of certain of our significantforeign suppliers; consumer spending on golf apparel; general global economicand political conditions resulting from threats or acts of war or terrorism andresponses thereto; access to capital; maintaining satisfactory relationships withcommercial banking institutions; establishing controls with regard to andmaintaining the integrity of technology and information systems; and, relianceupon executive officers and key employees. Additional information on these andother factors that could affect our financial results is included in thediscussion below and in our Form 10-K for the year ended June 30,2007. There may be other factors not mentioned above, in the discussion belowor included in our Securities and Exchange Commission filings that may causeactual results to differ materially from any forward-looking statement. Thereader should not place undue reliance on any forward-looking statement.Neither the Company nor any of its corporate officers or key employees assumesany obligation to update any forward-looking statement as a result of newinformation, future event or development, except as required by securitieslaws.

 

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

 

##### **OVERVIEW**

##### ** **

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

 

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

 

 

14

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

styles,color schemes and fabrics to encourage customers to purchase multiple garments.SPORT HALEY® women’s fashion apparel includes a variety of fabrics and weavepatterns, including interlock, pique, French terry, jersey and twill, and mayfeature a unique trim, a special fabric finish or extra needlework. The SPORTHALEY® name has been highly recognized as a women’s fashion apparel brandwithin the premium and mid-priced golf apparel markets for over 20 years, inpart, because of the cohesiveness of our design staff. Catherine B. Blair, ourVice President — Merchandising and Design, has provided direction for the SPORTHALEY® brand for over 14 years. Ms. Blair is keenly aware of fashiontrends within the women’s golf apparel market and has kept our SPORT HALEY®fashion apparel collections on the leading edge of the market by including moisturewicking technical performance fabrics, such as Aerocool® and Dry-Tech® 18, andseveral leading edge, younger looking, athletic style garments, whilemaintaining the time-honored elegance of the SPORT HALEY® brand. Certain of ourpremium priced SPORT HALEY® garments are trimmed with Swarovski® Austrian cutcrystals, the unique and patented cutting process which produces ultimatebrilliance, and come with a “Made with Crystallized Swarovski® Elements”hangtag for authenticity. The technical performance fabrics, athletic stylegarments and Swarovski® trims have all been well received by our customers.

 

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

 

Top-Flite®branded golf apparel was designed for distribution to large retail stores inthe low-price markets pursuant to our license agreement with Callaway. Brandedapparel is generally produced in mass quantities and usually utilizes muchsimpler designs and is of much lesser quality than the fashion apparel garmentswhich we sell in the premium and mid-priced markets. While our fashion golfapparel is generally designed for two separate selling seasons each year,branded golf apparel may be designed for four or more shorter selling periodseach year. Reserve Apparel distributed Top-Flite® apparel exclusively to Wal-Martfrom March 2006 through August 2006. However, in late September 2006,Reserve Apparel was notified that Wal-Mart had chosen to develop a line of golfapparel under a private label rather than to continue purchasing our Top-Flite®branded apparel. We redesigned Top-Flite® branded apparel to include garmentsprimarily comprised of a variety of performance fabrics, and we haveaggressively marketed our new Top-Flite® apparel line to several mass retailersand big-box type high sales volume retail stores. We expected our marketingefforts would result in the establishment of business relationships with one ormore mass retailers and other big-box type high sales volume retail stores.However, to date we have only received one order for Top-Flite® apparel from sucha retailer for a test in 50 of its stores, which we began shipping in September 2007.Since our concerted efforts failed to generate orders from a major customer, wediscontinued marketing apparel bearing the Top-Flite® label in November 2007.

#### ** **

 

15

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** **

**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

##### **FINANCIALCONDITION AND RESULTS OF OPERATIONS**

##### ** **

##### **CRITICAL ACCOUNTING POLICIESAND ESTIMATES**

##### ** **

Ourfinancial statements have been prepared in accordance with standards of thePublic Company Accounting Oversight Board (United States), which require us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and the related disclosures. A summary ofthose significant accounting policies can be found in the Footnotes to theFinancial Statements included in our Report on Form 10-K for the fiscalyear ended June 30, 2007. Theestimates used by management are based upon our historical experiences combinedwith management’s understanding of current facts and circumstances. Certain ofour accounting policies are considered critical as they are both important tothe portrayal of our financial condition and the results of our operations andrequire significant or complex judgments on the part of management. We believethat the following critical accounting policies affect the more significantjudgments and estimates used in the preparation of our financial statements.

 

*Inventories*

 

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

 

We recorded impairments of $0 and $174,000 withregard to fashion apparel inventories for the three-month and six-month periodsended December 31, 2007, respectively.Comparatively,we recorded impairments of $73,000 and $122,000 with regard to fashion apparelinventories for the three-month and six-month periods ended December 31,2006, respectively. We recorded impairments of $20,000 and $20,000 withregard to branded apparel for the three months and six months ended December 31,2007, respectively, due to a customer’s cancellation of a replenishment order.Comparatively, we did not record an impairment with regard to branded apparelinventories during the three months or six months ended December 31, 2006.

 

*Deferred Income Taxes*

 

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

 

 

16

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

net amount expected to be recovered in future periods. The estimatesfor deferred tax assets and the corresponding valuation allowance require us toexercise complex judgments. We periodically review and adjust those estimatesbased upon the most current information available. In accordance with Statementof Financial Accounting Standards No. 109 (“SFAS 109”), *“Accounting for Income Taxes,”* and based upon a review at December 31,2007, of our utilization of deferred tax assets, we maintained a valuationallowance that effectively reduces our net deferred tax assets to zero. Whilewe continue to explore various strategies to return the Company to sustainedprofitability, we cannot be certain that our efforts will result in thegeneration of future profits. Because the recoverability of deferred tax assetsis directly dependent upon future operating results, actual recoverability ofdeferred tax assets may differ materially from our estimates.

 

*Allowance for Doubtful Accounts*

 

Ourallowance for doubtful accounts reflects a reserve that reduces our customeraccounts receivable to the net amount estimated to be collectible. Estimatingthe credit worthiness of customers and the recoverability of customer accountsrequires us to exercise considerable judgment. In estimating the reserve foruncollectible accounts, we consider factors such as general economic andindustry-specific conditions, historical and anticipated customer performance.From time to time, we also identify delinquent customer accounts for which aspecific reserve is required. At December 31, 2007, our allowance for doubtfulaccounts totaled $262,000, including a specific reserve of $116,000 withrespect to the potential non-recovery of a net amount due to Reserve Apparelfrom a former inventory broker. While we consider our processes to be adequateto effectively quantify our exposure to doubtful accounts, changes in economic,industry or specific customer conditions may result in recoverability of ourdoubtful accounts that differs materially from our estimates.

 

*Allowance for Sales Returns*

 

Werecord allowances for sales returns as net adjustments to customer accountsreceivable. When recording an allowance, the net method reduces customeraccounts receivable and net sales by the estimated gross margin effect of theanticipated sales return. Generally, our selling terms preclude return of ourproducts subsequent to the sale. However, we have traditionally maintainedlimited programs that offer various customers the right to return certainfashion apparel items under predefined conditions, which we include as a componentwithin our estimate of allowance for sales returns. We review historical dataand consider factors such as general economic and industry-specific conditionsand anticipated customer performance when evaluating the adequacy of ourallowance for sales returns. At December 31, 2007, our allowance for salesreturns was $139,000. Significant changes in general economic or industryconditions may yield sales returns that differ materially from our estimates.

 

### **LIQUIDITY AND CAPITAL RESOURCES**

### ** **

The golf apparel businessis highly seasonal in nature, and the balance sheet amounts as of December 31,2007, may be more meaningful when compared with the amounts as of December 31,2006, rather than with the amounts at June 30, 2007.

 

Our primarysources of liquidity are comprised of available cash and cash equivalents, cashflows from operations and a working capital line of credit with a commercialbank. We require cash for general working capital purposes. We do notanticipate the requirements of material amounts of cash for capitalexpenditures over the remainder of the current fiscal year. Our working capitalrequirements are highly seasonal in nature, with greater requirements fromapproximately August through October and February

 

 

17

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

through April ofeach fiscal year, due to the purchases of finished goods inventories for thespring/summer and fall/holiday selling seasons, respectively.

 

Our net accountsreceivable decreased by $433,000, or 14%, to $2,633,000 at December 31,2007, from $3,066,000 at June 30, 2007. When compared with the December 31,2006, balance, our net accounts receivable balance at December 31, 2007,decreased by $26,000, or 1%, from $2,659,000. Historically, a significantnumber of our customers close their businesses for the winter months, beginningin October or November of each year. Because many of those businessowners prefer to settle their outstanding account balances prior to closing forthe winter, our net accounts receivable balance generally declines during oursecond fiscal quarter. Changes in our accounts receivable balances and relatedallowances provided operating cash of $433,000 and $1,291,000 for the six-monthperiods ended December 31, 2007 and 2006, respectively.

 

Our fashionapparel inventories increased by $852,000, or 15%, from $5,814,000 at June 30,2007, to $6,666,000 at December 31, 2007. However, our inventory requirementsare highly cyclical in nature. When compared with the balance of $5,037,000 at December 31,2006, our inventories at December 31, 2007, increased by $1,629,000, or32%, primarily due to increases in advance orders for our SPORT HALEY® women’sfashion apparel between the respective spring selling seasons and theimplementation of our on call program for our Ben Hogan® men’s and SPORT HALEY®women’s fashion apparel, which assures our customers in-stock availability fora variety of items within our basic collections. Our branded apparel inventories increased by $19,000, or 100%, from $0at June 30, 2007, to $19,000 at December 31, 2007. Branded apparelinventories were $0 at December 31, 2006. Branded apparel inventoriesremained on hand at December 31, 2007, due to the cancellation by aretailer of a replenishment order for Top-Flite® apparel. Our finished goodsinventories also may fluctuate from period to period due to the timingassociated with the delivery of ocean shipments, generally with terms of freeon board at the port of departure. Pending ocean deliveries of finishedgoods at December 31, 2007, June 30, 2007, and December 31,2006, totaled approximately $388,000, $1,255,000 and $658,000 respectively.Changes in our inventory balances used operating cash of $871,000 and $262,000for the six-month periods ended December 31, 2007 and 2006, respectively.

 

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

 

Total currentliabilities decreased by $691,000, or 29%, at December 31, 2007, to$1,698,000 from $2,389,000 at June 30, 2007. Total current liabilitiesdecreased by $34,000, or 2%, from $1,732,000 at December 31, 2006. Thedecrease of $34,000 when comparing the balance at December 31, 2007, withthe balance at December 31, 2006, was comprised of changes in various liabilitycategories. Our total current liabilities with regard to fashion apparel were$1,463,000 at December 31, 2007, a decrease of $12,000, or 1%, whencompared with total current liabilities of $1,475,000 at December 31,2006. The $12,000 decrease was attributable to a $9,000 decrease in tradeaccounts payable, a $55,000 decrease in accrued payroll expenses, a $24,000increase in accrued sales commissions, a $13,000 decrease in accrued royaltiespayable and a $41,000 increase in other accrued expenses. Included in accruedpayroll expenses at December 31, 2006, was the balance of $203,000 inseverance and other compensation payable to our former chief executive officer.Comparatively, at December 31, 2007, accrued payroll expenses included thebalance of $40,000 in severance and other compensation payable to our former 

 

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

chief executiveofficer and the balance of $80,000 in severance and other compensation payableto our former regional sales managers.

 

Due to thecombination of the factors discussed above, and others, during the six monthsended December 31, 2007, our operating activities used cash of $1,783,000.Comparatively, during the six months ended December 31, 2006, ouroperating activities used cash of $737,000.

 

For the six monthsended December 31, 2007, investing activities used cash of $3,000.Comparatively, for the six months ended December 31, 2006, investingactivities used cash of $394,000. As previously reported, on September 21,2006, Sport Haley entered into an agreement with Explorer Gear to purchase its49% ownership interest in Reserve Apparel for a lump sum cash payment of $375,000,since which time Reserve Apparel has been a wholly-owned subsidiary of SportHaley. During the six months ended December 31, 2007 and 2006, we expended$3,000 and $19,000, respectively, for the purchase of property and equipment,and $106,000 and $147,000, respectively, in depreciation and amortization wascharged to current operations.

 

We maintain arevolving line of credit agreement with a commercial bank. The revolving lineof credit agreement, renewed by amendment through December 5, 2008, providesfor an amended maximum loan amount of $2,000,000, collateralized by acertificate of deposit held at the commercial bank in the amount of $2,000,000,which earns a market rate of interest. . We generally maintain the line ofcredit to facilitate the issuance of letters of credit for inventory purchasesfrom offshore suppliers and, if necessary, to fund any temporary workingcapital needs. Borrowings under the amended line of credit agreement accrueinterest at 1.250% plus the one-month LIBOR rate. Prior to its most recentamendment, the revolving line of credit agreement provided for a maximum loanamount of $3,000,000 and interest accrued on borrowings at the bank’s primerate. No balances were due on the line of credit at either December 31,2007 or 2006. However, during the six months ended December 31, 2007, weborrowed $1,000,000 under the letter of credit agreement to fund temporaryworking capital needs, and our repayments during the six-month period totaled$1,000,000. At December 31, 2007 and 2006, we had $0 and $2,356,000,respectively, in outstanding letters of credit that were issued to foreignsuppliers in accordance with finished goods inventory purchase commitments.Outstanding letters of credit reduce the amount available for borrowing underthe line of credit agreement.

 

We believe thatcash on hand and cash generated from operations, as well as the ability toborrow under the bank line of credit, will be sufficient to meet our cashrequirements during the remainder of fiscal 2008. While we also havealternative sources of financing, including the factoring of customer accountsreceivable, we do not anticipate using alternative sources of financing duringthe remainder of fiscal 2008. However, our capital needs will depend on manyfactors, including the need to finance required inventory levels, the successof current sales and marketing programs, timely collections of trade accountsreceivable and various other factors.

 

### **RESULTS OF OPERATIONS**

### ** **

*Fashion apparel*

 

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

 

Net sales of fashion apparel for the three months ended December 31,2007, were $4,385,000, an increase of $195,000, or 5%, from net fashion apparelsales of $4,190,000 for the comparable three-month

 

 

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

period in the prior fiscal year. Net sales of fashion apparel for thesix months ended December 31, 2007, were $7,793,000, an increase of$115,000, or 1%, from net fashion apparel sales of $7,678,000 for thecomparable six-month period in the prior fiscal year. The increases in sales offashion apparel for the three and six-month periods were primarily comprised ofincreases in sales of SPORT HALEY® fashion apparel combined with offsettingdecreases in sales of Ben Hogan® fashion apparel between the respectiveperiods. Net sales of our SPORT HALEY® fashion apparel collections were$2,169,000 and $3,749,000 for the three and six months ended December 31,2007, respectively, increases of $297,000, or 16%, and $571,000, or 18%, fromnet sales of $1,872,000 and $3,178,000 for the three and six months ended December 31,2006, respectively. Net sales of our Ben Hogan® fashion apparel collectionswere $2,086,000 and $3,788,000 for the three and six months ended December 31,2007, respectively, decreases of $89,000, or 4%, and $435,000, or 10%, from netsales of $2,175,000 and $4,223,000 for the three and six months ended December 31,2006, respectively. The remainder of our fashion apparel net sales wascomprised of embroidery and shipping revenues. We expect the market acceptancefor our SPORT HALEY® women’s fashion apparel to continue to improve, because wehave continued to experience double digit percentage increases in advanceorders we have received for our women’s collections for our spring 2008 sellingseason. We attribute the decrease in Ben Hogan® fashion apparel sales primarilyto changes in the country club and resort markets in which we operate.Historically, the country club and resort markets preferred to sellhigh-quality apparel that was not broadly distributed within other retailmarkets. However, with the introduction and broad market acceptance ofmoisture-wicking and other performance garments within golf apparel markets,country clubs and resorts have begun to carry apparel brands such as Nike andAdidas, which are primarily comprised of performance fabrics and are globallydistributed into numerous markets other than country clubs and resorts. Webelieve that the broad penetration of Nike and Adidas into golf apparel marketshas diluted the value associated with the exclusivity of brands such as our BenHogan® fashion apparel brand, at least on a temporary basis. In order tobolster future sales of our Ben Hogan® fashion apparel, we have focused ourmarketing efforts on increasing our market presence in upscale retail storesand on penetrating further into corporate markets. We expect that our effortswill at a minimum generate sales of Ben Hogan® fashion apparel to another twoor three new upscale retail stores in fiscal 2008. We consider Ben Hogan®fashion apparel, which is marketed in accordance with a licensing agreement wemaintain with Callaway for such apparel, to be a key component of our fashionapparel business.

 

Gross profit with regard to our fashion apparel is generally affectedby sales discounts offered to customers in accordance with various marketingprograms, payment discounts offered to certain customers, dispositions ofexcess inventories at reduced sales prices and the valuation of excessinventories to the lower of cost or market. The disposition of excess fashionapparel inventories negatively impacts our gross profit percentage even whensuch inventories are properly valued to the lower of cost or market, becausesuch valuation causes sales to be recorded with gross profit at or near zero.For the three months and six months ended December 31, 2007, we recordednet sales of $295,000 and gross profit of $0 with regard to the disposition ofexcess fashion apparel inventories. Comparatively, for the six months ended December 31,2006, we recorded net sales of $366,000 and loss of $143,000 with respect tosales of excess fashion apparel inventories, which included net sales $184,000and loss of $118,000 during the three months ended December 31, 2006, withregard to the disposition of incomplete size runs from our fall 2006 sellingseason inventories for Ben Hogan® apparel collections. For the three months andsix months ended December 31, 2007, we recorded impairments of $0 and$154,000, respectively, with regard to the valuation of excess fashion apparelinventories to the lower of cost or market. Comparatively, for the three monthsand six months ended December 31, 2006, we recorded impairments of $73,000and $122,000, respectively, with regard to the valuation of excess fashionapparel inventories to the lower of cost or market. As percentage of net sales,gross profit of our fashion 

 

 

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

apparel, was 41% and 38% for the three months and six months ended December 31,2007, and was 37% and 34% for the three months and six months ended December 31,2006, respectively.

 

Ourgross margins may not be comparable to other companies within the golf apparelindustry. We have consistently included the cost of merchandise sold, includingimport charges, in-bound freight, allocated overhead, freight out, embroiderycosts and other charges in our cost of goods sold. Our overhead allocationincludes our production costs plus a portion of our distribution costs, such asreceiving and inspection costs, but we include some of the other costs ofdistribution, such as a portion of our warehousing and other handling costs, inselling, general and administrative expenses. We include royalty payments,relating to sales of licensed apparel, in selling, general and administrativeexpenses.

 

Selling, general and administrative expenses with regard to fashionapparel decreased by $5,000, or 0%, to $1,619,000 for the three months ended December 31,2007, from $1,624,000 for the comparable three-month period in the prior fiscalyear. Selling, general and administrative expenses with regard to fashionapparel increased by $37,000, or 1%, to $3,243,000 for the six months ended December 31,2007, from $3,206,000 for the comparable six-month period in the prior fiscalyear. The comparative increase for the six-month period was in general due toour accrual of $80,000 in severance and other compensation due to our formerregional sales managers. As a percentage of net sales, selling, general andadministrative expenses with regard to our fashion apparel were 37% and 42%,and 39% and 42%, for the three months and six months ended December 31,2007 and 2006, respectively.

 

We recorded royalty expense of $138,000 and$257,000, and $152,000 and $298,000, for the three months and six months ended December 31,2007 and 2006, respectively. The decrease in royalty expense directlycorrelates with our decrease in sales of Ben Hogan® fashion apparel for thecomparative periods. Royalty expense isdue to Callaway in accordance with the license they previously granted us tomarket men’s fashion apparel bearing the Ben Hogan® label.

 

Income (loss) from operations with regard tofashion apparel for the three months ended December 31, 2007, was $43,000,a difference of $264,000, or 119%, from ($221,000) for the comparablethree-month period in the prior fiscal year. Income (loss) from operations withregard to fashion apparel for the six months ended December 31, 2007, was($542,000), a difference of $205,000, or 27%, from ($747,000) for thecomparable six-month period in the prior fiscal year.

 

*Branded apparel*

 

We previously considered Top-Flite® branded apparel, which we marketedpursuant to our licensing agreement with Callaway for such apparel, to be a keycomponent in our overall business strategies, designed to return the Company tosustained profitability. Net sales of Top-Flite® branded apparel of $26,000 and$146,000 for the three months and six months ended December 31, 2007,respectively, were comprised of shipments to a retailer for a test in 50 of itsstores. Net sales of Top-Flite® branded apparel of $1,185,000 for the sixmonths ended December 31, 2006, were comprised of sales to Wal-Mart of$1,000,000 and sales of $185,000 to other markets. We shipped Top-Flite®branded apparel to Wal-Mart from March 2006 through August 2006. Aspreviously reported, in late September 2006, we were notified thatWal-Mart had chosen to develop a line of golf apparel under a private labelrather than to continue purchasing our Top-Flite® branded apparel from us. Weredesigned Top-Flite® apparel to include garments primarily comprised of avariety of performance fabrics and aggressively marketed the Top-Flite® brandedapparel line to several mass retailers and big-box type high sales volumeretail stores. We expected our marketing efforts would result in the establishmentof business relationships with one or more mass retailers and other big-boxtype high sales volume retail stores. However, our 

 

 

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

intensive efforts yielded only one order for Top-Flite® apparel fromsuch a retailer for a test in 50 of its stores, which we began shipping in September 2007.Since our concerted efforts failed to generate orders from a major customer, wediscontinued marketing Top-Flite® branded apparel in November 2007.

 

Ourdistribution of Top-Flite® branded apparel to the mass retail market generallygenerated gross margins lower than those expected to be achieved in the premiumand mid-price markets where we distribute our SPORT HALEY® and Ben Hogan®fashion apparel brands. Branded apparel is generally sold at much lower pricesthan for higher quality fashion apparel, and gross margins are also expected tobe lower for branded apparel than for fashion apparel. Other companies withinthe golf apparel industry may or may not operate within the lower-price brandedapparel markets. Gross profit with regard to our branded apparel has generallynot been affected by dispositions of excess inventories at reduced sales pricesand the valuation of excess inventories to the lower of cost or market, becausewe generally purchased quantities of branded apparel in amounts equal toquantities ordered by specific customers. However, since we generally purchasequantities sufficient to fulfill initial and anticipated replenishment orders,we may be left with excess branded apparel inventories if a customer cancels areplenishment order. A disposition of excess branded apparel inventories negativelyimpacts our gross profit percentage even when such inventories are properlyvalued to the lower of cost or market, because such valuation causes sales tobe recorded with gross profit at or near zero. For the three months and sixmonths ended December 31, 2007, we recorded impairments of $20,000 and$20,000, respectively, with regard to the valuation of excess branded apparelinventories to the lower of cost or market. Comparatively, for the three monthsand six months ended December 31, 2006, we did not record any impairmentswith regard to the valuation of excess branded apparel inventories to the lowerof cost or market. As percentage of net sales, gross profit of our brandedapparel, was (77%) and 3%, and 0% and 25%, for the three months and six monthsended December 31, 2007 and 2006, respectively.

 

Selling,general and administrative expenses were $27,000 and $128,000 with regard tobranded apparel for the three months and six months ended December 31,2007, decreases of $40,000, or 60%, and $78,000, or 38%, from $67,000 and$206,000 for the three months and six months ended December 31, 2006,respectively. The decrease was primarily due to differences between thecomparable periods in allocated management and personnel costs, which totaled$20,000 in the three months ended December 31, 2007 versus $56,000 in thethree months ended December 31, 2006, and $77,000 in the six months ended December 31,2007, versus $192,000 in the six months ended December 31, 2006. Thedecrease in allocated management costs related to changes in the ownership ofReserve Apparel and the loss of the Wal-Mart account. Prior to our purchase ofthe minority interest in Reserve Apparel from Explorer Gear in September 2006,allocated management costs included a portion of Sport Haley’s costs withregard to managing Reserve Apparel and certain reimbursable expenses incurredby Explorer Gear on behalf of Reserve Apparel. Because Wal-Mart ceasedpurchasing Top-Flite® branded apparel from us shortly after we purchased theminority interest, the business operations of Reserve Apparel weresignificantly reduced and we discontinued our allocation of Sport Haleymanagement costs to Reserve Apparel, effective October 1, 2006. From October 1,2006, through October 31, 2007, personnel costs allocated to our brandedapparel operations consisted of salaries and benefits paid to an executiveSport Haley hired in November 2006 primarily to market Top-Flite® apparelon behalf of Reserve Apparel. As a percentage of net branded apparel sales, relatedselling, general and administrative expenses were 88% and 17% for the sixmonths ended December 31, 2007 and 2006, respectively.

 

We recorded royalty expense of $4,000 and $11,000,and $0 and $64,000, for the three months and six months ended December 31,2007 and 2006, with respect to net sales of branded apparel, respectively.Royalty expense is due to Callaway in accordance with the license theypreviously granted us to market branded apparel bearing the Top-Flite® label.For the three months ended December 31, 2007, we 

 

 

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**SPORT-HALEY, INC.**

**ITEM 2 MANAGEMENT’S DISCUSSIONAND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

increased our accrual of minimum royalties due toCallaway for calendar year 2007 by $4,000. Previously, at June 30, 2007,we accrued $178,000 of minimum royalties due for calendar year 2007.

 

Income (loss) from operations with regard to brandedapparel were ($51,000) and ($134,000) for the three months and six months endedDecember 31, 2007, differences of $16,000, or 24%, and ($164,000), or547%, from ($67,000) and $30,000 for the three months and six months ended December 31,2006, respectively.

 

*Other income*

 

Other income, net, was $32,000 for the threemonths ended December 31, 2007, a decrease of $52,000, or 62%, from$84,000 for the comparable three-month period in the prior fiscal year. Otherincome, net, was $80,000 for the six months ended December 31, 2007, adecrease of $82,000, or 51%, from $162,000 for the comparable six-month periodin the prior fiscal year. Other income, net, was primarily derived frominterest earned on cash and cash equivalent balances held at various financialinstitutions. The decrease was generally attributable to our lower balance of cashand cash equivalents over the comparative periods.

 

*Net income (loss)*

 

Net income for the three months ended December 31,2007, was $24,000, a difference of $245,000, or 111%, as compared with the netloss of ($221,000) for the comparable three-month period in the prior fiscalyear. Net loss for the six months ended December 31, 2007, was ($603,000),a difference of $15,000, or 2%, as compared with the net loss of ($618,000) forthe comparable six-month period in the prior fiscal year. We had federal andstate net operating loss carry forwards of approxiamately $7.4 million and $9.6million at December 31, 2007, that we estimated may be recoverable atincome tax rates of 34% and 5%, respectively. In accordance with SFAS 109and based upon a review at December 31, 2007, of our utilization ofdeferred tax assets, we maintained a valuation allowance that effectivelyreduces our net deferred tax assets to zero. While we continue to explorevarious strategies to return the Company to profitability, including findingadditional markets for our SPORT HALEY® and Ben Hogan® fashion apparel brands,we cannot be certain that our efforts will result in the generation of futureprofits sufficient to offset oursignificant net operating loss carry forwards prior to their expirations.Accordingly, we did not record benefits from income taxes associated with thecorresponding losses for the respective six-month period ended December 31,2007.

 

*Earnings (loss) per share*

 

Basicand diluted earnings (loss) per common share were $0.01 and ($0.08) for thethree-month periods ended December 31, 2007 and 2006, respectively. Basicand diluted earnings (loss) per common share were ($0.26) and ($0.22) for thesix-month periods ended December 31, 2007 and 2006, respectively. Allsecurities options were anti-dilutive and therefore excluded from the per sharecalculations with respect to periods in which net losses were incurred.

 

*Bookvalue*

 

Ourbook value per common share was $4.72 at December 31, 2007, $4.98 at June 30,2007 and $5.20 at December 31, 2006.

 

 

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**SPORT-HALEY, INC.**

**ITEM 3QUALITATIVE AND QUANTITATIVE DISCLOSURES**

**ABOUT MARKET RISK**

 

Market risk representsthe risk of loss that may impact the financial position, results of operationsor cash flows due to adverse changes in financial and commodity market pricesand rates. We are exposed to market risk with regard to changes in UnitedStates interest rates. This exposure is directly related to our normaloperating and funding activities. Historically, and as of December 31,2007, we have not used derivative instruments or engaged in hedging activities.Our market risk has not changed significantly from September 30, 2007.

 

**InterestRate Risk**

 

We maintain a revolvingline of credit agreement with a commercial bank that provides for interest atthe bank’s prime rate. The agreement provides for a maximum loan amount of$2,000,000 collateralized by a certificate of deposit held at the commercialbank in the amount of $2,000,000, which earns a market rate of interest.Borrowings under the line of credit agreement accrue interest at 1.250% plusthe one-month LIBOR rate. We generally maintain the line of credit tofacilitate the issuance of letters of credit for inventory purchases from offshoresuppliers, and, if necessary, to fund any temporary working capital needs. Wedid not have any outstanding borrowings under the line of credit at December 31,2007. Increases in the one-month LIBOR rate could, however, increase theinterest expense with respect to future borrowings, including borrowings underthe line of credit. Outstanding letters of credit reduce the amount availablefor borrowing under the line of credit. We had no outstanding letters of creditat December 31, 2007. We do not use derivative financial instruments tomanage interest rate risk.

 

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

 

 

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**SPORT-HALEY, INC.**

**ITEM 4CONTROLS AND PROCEDURES**

 

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

 

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

 

**(b)****                     ****Changes in InternalControls Over Financial Reporting**

 

During our second quarter of fiscal 2008, we did notinstitute any significant changes in internal controls over financial reportingas defined in Rules 13a-15(f) or 15d-15(f) that materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

Our management, including the Chief ExecutiveOfficer and the Chief Financial Officer, does not expect that our disclosurecontrols and procedures or our internal controls over financial reporting will,in all instances, prevent all errors and all fraud. A control system, no matterhow well conceived or operated, can only provide reasonable, not absolute,assurance that the objectives of the control system are met. While our controlsystems provide a reasonable assurance level, the design of our control systemsreflects the fact that there are resource constraints, and the benefits of suchcontrols were considered relative to their costs. Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within the financial reports of Sport-Haley, Inc. have been detected.These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerrors or mistakes. Additionally, a control may be circumvented by theindividual act of some person, by collusion of two or more persons, or bymanagement’s override of a specific control. The design of any system ofcontrols is also based in part on certain assumptions about the likelihood offuture events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Because ofthe inherent limitations in a cost-effective control system, misstatements dueto error or fraud may occur and not be detected.

#### ** **

 

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** **

**SPORT-HALEY, INC.**

**PART II**

**OTHER INFORMATION**

 

### **ITEM 1**                          LEGAL PROCEEDINGS

### ** **

As previouslyreported, in March 2007, Sport Haley and Reserve Apparel (the “Plaintiffs”)filed a lawsuit in the District Court for the City and County of Denver in theState of Colorado. The suit alleges, among other things, that a formerinventory broker to Reserve Apparel, 1130746 Ontario Ltd., a Canadiancorporation incorporated in the Province of Ontario, Canada, d/b/a OriginalsApparel Group Co., or Originals Apparel Group, and Francis Tat-Mo Chan (the “Defendants”),knowingly, wrongfully and without authorization converted Plaintiff’s funds.Among other things, the Plaintiffs alleged that the Defendants misapplied aninventory deposit of $291,000 paid to the Defendants in March 2006 bySport Haley, which the Defendants used to offset certain amounts purportedlyowed to the Defendants by Explorer Headgear, Inc., and that the Defendantsfailed to return $177,000 which was overpaid by Sport Haley as of July 2006.The Plaintiffs have alleged claims against the Defendants for conversion andviolation of the Colorado civil theft statute as well as for unjust enrichment.Plaintiffs seek repayment of the $291,000 and $177,000 amounts and otherrelief. The case has been scheduled for trial in May 2008. Based uponinformation that is currently available, we cannot determine whether thedecision or settlement of this lawsuit will materially affect our financialposition or the results of our operations.

 

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

### ** **

There have been no material changes from the risk factors previouslydisclosed in Item 1A of our annual report on Form 10-K for the year ended June 30,2007.

 

### **ITEM 5**                          OTHER INFORMATION

### ** **

(a)          As previously reported, on October 31, 2007, weentered into an amended executive employment agreement with Catherine B. Blairthat is effective July 1, 2007. The amended executive employment agreementrequires that Ms. Blair continue to devote her full business time as ourVice President — Merchandising and Design, at an annual salary of $160,000 forour 2008 fiscal year, and $175,000 per year thereafter, and such bonuses asawarded by the Compensation Committee of our Board of Directors. The amendedagreement has an initial two-year term, subject to automatic one-yearextensions after each successive year. If we elect to terminate the amendedagreement without “cause” (as defined in the agreement) or not to renew theagreement upon its expiration, or if Ms. Blair terminates the agreementwith or without cause, Ms. Blair is entitled to receive severancecompensation equal to fifteen months’ salary plus 50% of the bonus, if any,paid to her in the preceding 12 months. During the time she were to receive anysuch severance compensation, Ms. Blair is entitled to participate in allemployee benefit plans, at our expense. If there were to be a non-negotiatedchange in control of Sport-Haley, Inc., and either we or Ms. Blairterminate the agreement within sixty days of the change in control, Ms. Blairis entitled to receive lump sum severance compensation equal to two times herannual salary and bonus payments during the preceding 12 months. The amendedagreement contains a non-competition provision for twelve months followingtermination, provided Ms. Blair could be released from the non-competitionclause if she were terminated without cause and if she elected to forego anyseverance pay. If Ms.

 

 

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Blair becomes “totallydisabled” (as defined in the agreement) during the term of the agreement, herfull salary will be continued for one year from the date of total disability

 

As previouslyreported, on November 8, 2007, we notified Barry L. Hyman, our EasternRegional Sales Manager, and Michael D. Doris, our Western Regional SalesManager, that their respective positions were being eliminated and, therefore,they were being terminated without cause, as defined in their respectiveemployment agreements, as of November 9, 2007. Each of the employmentagreements require a 90 day period for notice of termination (the “noticeperiod”) by the Company without cause. Therefore, the notice periods continuedthrough, and the effective date of their terminations was, February 9,2008, during which time we continued to compensate them in accordance with theterms of their respective employment agreements. In addition, following the 90day notice periods, Mr. Hyman is entitled to six months in severancecompensation based upon his respective base salary and Mr. Doris isentitled to three months in severance compensation, subject to non-competitionprovisions. Mr. Doris accepted a position with one of our competitors in December 2007,and thus is no longer entitled to severance compensation following the noticeperiod. At December 31, 2007, notice period and severance compensationpayable to Mr. Hyman and Mr. Doris totaled $80,000.

 

On October 4,2007, James H. Everest submitted a letter, dated October 3, 2007, to theCompany, whereby he requested that he be allowed to resign from our Board ofDirectors due to health issues. The Board of Directors accepted Mr. Everest’sresignation, effective October 3, 2007, and opted not to fill the seatvacated by Mr. Everest.

 

On November 15,2007, we reported that on November 13, 2007, we received a letter from TheNasdaq Stock Market (“Nasdaq”) notifying us of Nasdaq’s position that for theprevious 30 consecutive days our common stock had not maintained a minimummarket value of publicly held shares of $5,000,000, as required for continuedinclusion in The Nasdaq Global Market (“Global Market”), pursuant to NasdaqMarketplace rule 4450(a)(2). Publicly held shares exclude those held byofficers, directors and persons holding over 10% of our common stock. Nasdaqadvised that, pursuant to Rule 4450(e)(1), we would be provided 90 calendardays, or until February 11, 2008, to regain compliance. Nasdaq furthersuggested that we consider preparing an application to transfer our securitiesto The Nasdaq Capital Market (“Capital Market”). To transfer, we must satisfythe continued inclusion requirements for the Capital Market, which aregenerally less restrictive than the continued inclusion requirements for theGlobal Market. If compliance with the Global Market inclusion requirementscould not be demonstrated and Nasdaq did not receive our application totransfer our securities to the Capital Market by February 11, 2008, Nasdaqadvised that their staff would provide notification to us that our securitieswould be delisted. Nasdaq’s letter stated that if we submited a Capital Markettransfer application and we paid the applicable listing fees by February 11,2008, the initiation of delisting proceedings would be stayed pending Nasdaqstaff’s review our the transfer application. On January 10, 2008, wesubmitted a Capital Market transfer application, and on or about January 22,2008, we had paid the applicable listing fees in full.

 

 

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On February 1,2008, we reported that on January 31, 2008, we received a letter fromNasdaq notifying us that Nasdaq’s staff approved our application to transferour securities to the Capital Market. Nasdaq further advised in an email thatthe effective date of the transfer was February 4, 2008.

 

(b)         During the second quarter of fiscal 2008,we made no material changes to the procedures by which our shareholders mayrecommend nominees to our Board of Directors.

### ** **

### **ITEM 6         EXHIBITS**

### ** **

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

 

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

 

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

 

 

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**SPORT-HALEY, INC.**

**SIGNATURES**

 

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

 
| ** **                    | **SPORT-HALEY, INC.**                           |
|-------------------------------|-------------------------------------------------|
|                          | (Registrant)                                    |
|                          |                                            |
| Date: February 11,  2008 | /s/ PATRICK W. HURLEY                           |
|                          | Patrick W. Hurley                               |
|                          | Chief Financial Officer                         |
| * *                      | *(Principal Financial and  Accounting Officer)* |

 

 

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