## **FORM 10-K**

## ** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**(MarkOne)**
| **x**      | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                                                                                      |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                |
| ** ** | ** ** | **For the  fiscal year ended June 30, 2008**                                                                                                                                                                                                                                                                                         |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                |
| **OR**     |
|       |       |                                                                                                                                                                                                                                                                                                                                      |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                                                                                  |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                |
| ** ** | ** ** | **for the  transition period from                            to                        ** |

 

**Commission file number:  0-51715**

 

**SPORT-HALEY, INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Colorado**                             | ** ** | **84-1111669**         |
|------------------------------------------|------------|------------------------|
| (State or Other Jurisdiction of          |       | (I.R.S. Employer       |
| Incorporation or Organization)           |       | Identification Number) |
|                                     |       |                   |
| **4600 East 48th Avenue**                |       |                   |
| **Denver, Colorado**                     | ** ** | **80216-3215**         |
| (Address of Principal Executive Offices) |       | (Zip Code)             |

 

Registrant’s telephone number, including area code:  **(303) 320-8800**

 

Securities registered pursuant to Section 12(b) of theExchange Act:

 

| **Title of each class**                  | ** ** | **Name of each exchange on which  registered** |
|------------------------------------------|------------|------------------------------------------------|
| **Common Stock, no par value per share** | ** ** | **NASDAQ Capital Market****SM**                |

 

Securities registered pursuant to section 12(g) of the ExchangeAct:

**None**

 

Indicate by checkmark whether the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.
|   | Yes o | No x |
|--------|-------|------|

 

Indicate by check markif the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.
|   | Yes o | No x |
|--------|-------|------|

 

Indicate bycheckmark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the Registrantwas required to file such reports), 
| and (2) has  been subject to such filing requirements for the past 90 days. | Yes x | No o |
|----------------------------------------------------------------------------------|-------|------|

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

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

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).Yes oNo x

 

As of December 31,2007, the last business day of the registrant’s most recently completed secondfiscal quarter, the aggregate market value of the 1,896,373 shares of CommonStock (the Registrant’s only common equity) held by non-affiliates was$3,963,000 based on the closing sale price of the Registrant’s Common Stock onthe NASDAQ Global MarketSMon such date. For purposes of the foregoing calculation only, each of theRegistrant’s officers and directors is deemed to be an affiliate. Thisdetermination of affiliate status is not a conclusive determination for otherpurposes.

 

There were2,284,490 shares of the Registrant’s Common Stock outstanding at the close ofbusiness on October 10, 2008.

 

DOCUMENTS INCORPORATED BY REFERENCE:

**None**

 

 

 

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**PART I**

 

**ITEM1.  BUSINESS**

 

**General**

 

Sport-Haley, Inc. (“Sport Haley”) consolidates the operations ofSport-Haley with Reserve Apparel Group LLC (“Reserve Apparel”) for financialreporting purposes. Collectively throughout this report, Sport Haley andReserve Apparel may be referred to as the “Company,” “we,” “us” or “our.”

 

Sport Haley designs, purchases, contracts for the manufacture of,markets and distributes men’s and women’s fashion golf apparel and outerwearunder the SPORT HALEY® and Ben Hogan® labels. Our fashion golf apparel collections,known for their innovative designs, quality fabrics, generous fits and classicstyles, are primarily marketed in the premium and mid-price markets, through anetwork of independent sales representatives and distributors, to golfprofessional shops, country clubs, resorts and exclusive department storesthroughout the United States. Sport Haley distributes Ben Hogan® apparelpursuant to a license agreement with Callaway Golf Company (“Callaway”). Wehave focused on expanding brand recognition and appeal for our SPORT HALEY® andBen Hogan® fashion apparel labels by continually improving the styling,sourcing and fabrications of the garments in order to continue to offer ourcustomers high-quality garments at competitive prices. Other services that we offer include optional custom embroideringof our fashion apparel with a personalized club, resort or corporate logo.Sport Haley was incorporated in Colorado in January 1991. The principalexecutive offices are located at 4600 East 48th Avenue, Denver, Colorado80216-3215, and the main telephone number is (303) 320-8800.

 

Reserve Apparel, formed in November 2005, designed, purchased,contracted for the manufacture of, marketed and distributed branded golfapparel and outerwear under the Top-Flite® label. Since September 21,2006, Reserve Apparel has been a wholly-owned subsidiary of Sport Haley. Priorto September 21, 2006, Sport Haley owned a 51% interest in Reserve Appareland Explorer Gear USA, Inc. (“Explorer Gear”) owned a 49% interest.Reserve Apparel distributed Top-Flite® apparel pursuant to a license agreementwith Callaway, which was amended in March 2008 to remove the Top-Flite®brand from the agreement, effective January 1, 2008.

 

**Productsand Product Design**

 

SPORT HALEY® fashion apparel is comprised almost exclusively of women’sgarments and accessories, designed by utilizing classic styles withcontemporary influences intended to develop and maintain brand recognition andloyalty, on or off the golf course. While each product in the SPORT HALEY®fashion apparel line is sold separately, the line is intentionally designed ingroups with coordinated styles, color schemes and fabrics to encouragecustomers to purchase multiple garments. SPORT HALEY® women’s fashion apparelis manufactured using a variety of fabrics and weave patterns, includinginterlock, pique, French terry, jersey and twill, and may feature a uniquetrim, a special fabric finish or extra needlework. The SPORT HALEY® brand hasbeen highly recognized within the premium and mid-priced fashion golf apparelmarkets for over 20 years, in part, because of the cohesiveness of our designstaff. Catherine B. Blair has provided direction for the SPORT HALEY® brand forover 16 years. Ms. Blair is keenly aware of fashion trends within thewomen’s golf apparel market and has maintained appeal for our SPORT HALEY®fashion apparel collections by including moisture wicking technical performancefabrics, such as Aerocool® and Dry-Tech® 18, and several leading edge, youngerlooking, athletic style garments, while maintaining the time-honored eleganceof the SPORT HALEY® brand. Certain of our premium priced SPORT HALEY® garmentsare trimmed with Swarovski® Austrian cut crystals, the unique and patentedcutting process which produces ultimate brilliance, and come with a “Made withCrystallized Swarovski® Elements” hangtag for authenticity. The technicalperformance fabrics, athletic style garments and Swarovski® trims have all beenwell received by our customers.

 

The following table presents the suggested retail price ranges forvarious SPORT HALEY® fashion apparel items:

 

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| **SPORT HALEY®**      | ** ** | **Suggested Retail**                                                      |
|----------------------------|------------|---------------------------------------------------------------------------|
| **Women’s Apparel**   | ** ** | **Price Range**                                                           |
| Tops                       |       | $  36   –   $  84            |
| Shorts, skirts  and skorts |       | $  58   –   $  84            |
| Pants                      |       | $  52   –   $  84            |
| Sweaters                   |       | $  84   –   $ 172                 |
| Outerwear                  |       | $  84   –   $ 148                 |
| Accessories                |       | $    9   –   $  52 |

 

Ben Hogan® men’s fashion apparel is designed utilizingelegant time-honored classic styles intended to garner nearly instantaneousbrand recognition. The Ben Hogan® label has been highly recognized within thegolf apparel industry for the past seven years for continually providingelegant men’s fashion golf apparel of impeccable quality in keeping with theimage of Mr. Hogan. Since its introduction in 2002, Ben Hogan® fashionapparel has been designed and sourced by Donald W. Jewell, who also serves asour Chief Executive Officer and President. While each product in the Ben Hogan®apparel line is sold separately, the line is intentionally designed in groupswith coordinated styles, color schemes and fabrics to encourage customers topurchase multiple garments. Ben Hogan® apparel is manufactured using a varietyof fabrics, including wool, silk, cashmere and moisture wicking cotton, and weavepatterns, including pique, jersey and twill, and most pieces feature a uniquetrim, a special fabric finish or extra needlework. Ben Hogan® men’s apparel ismarketed in the premium-price markets to elite golf professional shops, upscaleresorts and exclusive department stores.

 

The following table presents the suggested retail price ranges forvarious Ben Hogan® fashion apparel items:

 
| **Ben Hogan®** | ** ** | **Suggested Retail**                                                                                             |
|--------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|
| **Men’s Apparel**   | ** ** | **Price Range**                                                                                                       |
| Shirts                   |       | $  70   –   $  98                                                        |
| Shorts                   |       | $  72   –   $  98                                                        |
| Pants                    |       | $  94   –   $ 134                                                             |
| Sweaters                 |       | $  78   –   $ 238                                                             |
| Outerwear                |       | $  80   –   $ 374                                                             |
| Accessories              |       | $  28                  |

 

We closely coordinate the designing functions with our sales andproduction operations. The process for our design function for each collectionof garments is a continual cycle of selecting fabric and weave patterns,coloring, styling, and sewing techniques, which includes supervising theproduction of prototype garments. We primarily utilize in-house designers todevelop our apparel collections. Our design staff is responsible fornegotiating prices and minimum quantities with suppliers, arranging for patternand sample manufacturing, and coordinating finished goods delivery scheduleswith production personnel. The design staff also supervises the qualitycontrols for inspection of fabric samples, as well as the testing of fabricsamples for die lots, shrinkage and colorfastness. Key persons within ourdesign and production staffs periodically visit the international factories ofcertain of our suppliers that produce SPORT HALEY® and Ben Hogan® fashionapparel in order to maintain the close business relationships that have beenestablished over several years and to assure that quality expectation standardsand production schedules are met or exceeded.

 

#### **SPORT HALEY® and Ben Hogan® fashionapparel is generally received at our warehouse, embroidery and distributionfacilities in Denver, Colorado. Many apparel items, primarily shirts and tops,are embroidered with the SPORT HALEY® or Ben Hogan® logo on a sleeve of thegarment. Historically, a much greater percentage of our men’s fashion apparelis custom embroidered with a golf course, country club, resort or company logothan the percentage of our women’s fashion apparel which is similarlyembroidered. We maintain an electronic library of over 10,000 custom logos andutilize ten computer-controlled embroidering machines, which cumulatively havethe capacity to embroider up to 4,000 custom logos each day. After beingembroidered to the customer’s specifications, our fashion apparel receives afinal inspection by quality assurance personnel. Generally, customer orders arepackaged and shipped from our Denver, Colorado facility.**

 

Top-Flite® branded golf apparel was designedfor distribution to large retail stores in the low-price markets. 

 

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Branded apparel is usually produced in mass quantities and utilizesmuch simpler designs and is of much lesser quality than our fashion apparelgarments, which are sold in the premium and mid-priced markets. While fashiongolf apparel is generally designed for two separate selling seasons each year,branded golf apparel is generally designed for four or more shorter sellingperiods each year. Most of our Top-Flite® garments were designed utilizingbasic performance fabrics made from polyester or other man-made materials orfrom blends of natural and man-made materials. We discontinued marketingTop-Flite® branded apparel in November 2007.

 

#### **L**icenseAgreement

#### ** **

In May 2001, we entered into a license agreement with SpaldingSports Worldwide, Inc. (“Spalding”) that granted us the right to marketmen’s premium golf apparel under the Ben Hogan® brand name. In July 2002,the license agreement was amended to expand the applicable territory covered bythe agreement to include the United Kingdom, Sweden, Mexico and variousCaribbean countries. The original license agreement had previously granted usthe right to market Ben Hogan® apparel within the United States. In May 2003,Spalding changed its corporate name to The Top-Flite Golf Company, Inc. (“Top-FliteGolf”). In June 2003, the license agreement was amended to reflectSpalding’s name change to Top-Flite Golf and to grant us an additional licenseto market a full line of golf apparel bearing the Top-Flite® brand name in theUnited States and its territories, Mexico, Aruba, the Cayman Islands, Jamaica,the Dominican Republic, the Bahamas and the British Virgin Islands. In September 2003,Callaway purchased substantially all of the assets of Top-Flite Golf includingthe Ben Hogan® and Top-Flite® brand names licensed to us. Our license agreementwith Callaway requires us to pay royalties on sales of Ben Hogan® fashionapparel and Top-Flite® branded apparel and to meet certain minimum annual salesand royalties on a calendar year basis. Our sales of Top-Flite® branded apparelwere insufficient to meet either the minimum sales or royalty requirements forcalendar year 2007 under the license agreement. In March 2008, we reachedan agreement with Callaway to remove the Top-Flite® brand from the licenseagreement, effective January 1, 2008, whereby the unpaid minimum royaltiesdue to Callaway as of December 31, 2007, with respect to Top-Flite®apparel were extinguished and forgiven. In May 2008, we entered into a newagreement with Callaway, whereby we continue to be licensed to market and sellgolf apparel bearing the Ben Hogan® label. The new license agreement expandedthe applicable territory to include Canada and the European Union and extendedthe term until December 2013. Our sales of Ben Hogan® fashion apparel willbe insufficient to meet either the minimum sales or royalty requirements forcalendar year 2008 under the new license agreement. While we believe that wemaintain a satisfactory relationship with Callaway, we have not reached anunderstanding with Callaway and can currently give no assurance that Callawaywill not take the position that the new license agreement is subject totermination, due to our expected inability to meet the minimum sales androyalty requirements for calendar year 2008 with respect to Ben Hogan® fashionapparel.

 

#### **Sales and Marketing**

#### ** **

#### ***Company Sales Overview***

#### ** **

In fiscal 2008, 48% of our net sales were comprised of Ben Hogan®fashion apparel, SPORT HALEY® fashion apparel garments and accessoriesaccounted for 48% of our net sales and 1% of our net sales were comprised ofTop-Flite® branded apparel. Embroidery and shipping revenues comprised 3% ofour net sales in fiscal 2008. No single customer accounted for 5% or more ofour fiscal 2008 net sales, except that sales to a major retail discount store,comprised of discontinued Ben Hogan® and SPORT HALEY® apparel from priorseasons, accounted for 6% of our net sales.

 

#### **For more information about ourreportable segments, see Note 13 to our Financial Statements that is filedunder Part IV, Item 15(a)(1) of this report.**

#### ** **

#### ***SPORT HALEY® and Ben Hogan®***

#### ** **

We continually implement marketing strategies designed to enhance ourposition as a high-quality provider of fashion golf apparel by capitalizing onthe market awareness of the SPORT HALEY® and Ben Hogan® brand names toestablish, maintain and improve distribution channels. We implement thesestrategies by: (i) enhancing 

 

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distributionchannels through our network of independent wholesale sales representatives inan effort to add new golf professional shops to our customer base and maximizepurchases from existing customers; (ii) diversifying product lines bydeveloping new styles and designs that are natural variations on our existingapparel designs in keeping with market trends; and, (iii) intensifyingmarketing efforts in the premium, mid-priced and retail markets.

 

Domestic sales of SPORT HALEY® and Ben Hogan® fashion golf apparel aresolicited primarily through a network of approximately 30 independent wholesalesales representatives who sell the apparel in all 50 of the United States, on acommission basis, mainly to golf professional shops at country clubs andresorts. Most of our independent sales representatives market both our SPORTHALEY® and Ben Hogan® fashion apparel lines. The independent representatives,many of whom may also market other golf-related items for other companies, areresponsible for generating new business and serving customers within specificgeographic territories. We maintain buying programs with various entitieswhereby the participating golf professional shop operators may purchase appareldirectly from us in accordance with specific group programs. The group programsaccounted for about 29% of our gross sales in fiscal 2008. Historically, thevast majority of our sales have been to domestic customers. International salesrepresented less than 1% of our net sales in fiscal 2008.

 

Our executivessupport the sales activities of our independent sales representatives anddistributors by supporting their participation in regional tradeshows,assigning specific customer service personnel to assist them within respectivegeographic regions, advancing the distribution of sample garments, providingdetailed catalogs that present pricing, sizing and style options for eachcollection of garments, and providing access to a private electronic networkdesigned to expedite sales order processing. Via personal computers, each salesrepresentative has access to current and future inventory availability and maycreate and transmit orders from remote locations. Remote computer accessenhances the representatives’ order processing speed and accuracy and reducesthe risk of placing customer orders that cannot be timely delivered. Theelectronic network also interfaces with our comprehensive managementinformation system that provides key sales order data to assist management withplanning, production scheduling, sales trends and cost controls.

 

Our marketing efforts include searching for additional distributionchannels to enhance the sales of SPORT HALEY® and Ben Hogan® fashion apparelwithin corporate and retail markets. Our Managing Director of Sales — RetailDivision is responsible for identifying, opening and developing new accountsfor our Ben Hogan® fashion apparel within department and specialty retail storemarkets. We are also searching for ways to increase our Ben Hogan® fashionapparel among the certain international territories specified within thelicense agreement by seeking to establish distribution agreements withindividual distributors in the respective territories. However, the actualgrowth we have achieved within international markets has been minimal.

 

Information regarding our SPORT HALEY® and Ben Hogan® brands, as wellas general corporate information, may be found on our respective websites. Thewebsites were designed to individually portray the design images inherent inour SPORT HALEY® and Ben Hogan® brands. The SPORT HALEY® site, located atwww.sporthaley.com, utilizes a distinctive contemporary and feminine approach.The Ben Hogan® site, located at www.benhoganapparel.com, generates a masculinesense through the use of dark rich colors. The corporate site, located atwww.sporthaleyinc.com, includes a basic corporate overview and links topertinent investor relations information. Each of the websites contains activelinks to one another. The SPORT HALEY® and Ben Hogan® websites each include aglimpse of current and future collection offerings, design philosophies andlocator systems that can direct retail customers to establishments that sellour apparel and wholesale customers to our independent sales representative intheir respective geographic area. While we have not been able to quantify theeffectiveness of the locator systems, we believe that they enhance ourmarketing efforts by enabling the end consumer to find our product lines intheir area, thereby creating “pull through” sales for our current retailers andaffording new customers easy access to contact information for our independentsales representative in their respective geographic region. Near the end offiscal 2008, we enhanced our SPORT HALEY® and Ben Hogan® websites to includeonline retail stores that offer limited selections of our fashion apparel tothe general public at suggested retail prices. The online retail storesaccounted for less that 1% of our total sales for fiscal 2008.

 

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We introduce our distinctive SPORT HALEY® and Ben Hogan® golf apparelcollections for the fall selling season at a major golf industry tradeshow thatis generally held near the end of January of each year in Orlando,Florida. Because many buyers for golf resorts and professional shops attendthis particular tradeshow, we usually book a number of customer orders at orimmediately following the show. Retailers attending the tradeshow also provideus with direct feedback regarding apparel designs, fabrics, styles, fashiontrends and other information necessary to assist management with thepreparation of sales forecasts and production schedules.

 

In order to enhance the visibility of our SPORT HALEY® and Ben Hogan®apparel, we may from time to time establish endorsement agreements with alimited number of PGA and LPGA professionals. In accordance with an endorsementagreement, we may compensate the respective professional with apparelallowances, cash and/or other compensation. We did not have endorsement agreementswith any PGA or LPGA professionals during fiscal 2008.

 

We periodically advertise our SPORT HALEY® and Ben Hogan® apparel inseveral separate golf industry publications, including those that aredistributed primarily to operators of golf professional shops. We also expend aportion of our advertising budget to support the sales activities of ourindependent sales representatives by reimbursing part or all of the cost oftheir participation in regional tradeshows.

 

We maintain programs that have provided select customers with displayfixtures dedicated to featuring SPORT HALEY® or Ben Hogan®fashion apparel collections. Uponthe customer’s agreement to maintain a pre-determined amount of inventory for aspecified period of time, the fixtures became the property of the customer fora nominal delivery fee. The display fixture programs encourage customers toreorder a sufficient amount of garments to maintain prominent displays of largeselections of SPORT HALEY® and Ben Hogan® apparel in their stores.

 

On a limited basis, we have utilized a combination of our independentwholesale sales representatives, sales management and executives to marketSPORT HALEY® and Ben Hogan® apparel collections directly within corporatemarkets. While we believe that there is a natural synergy between the golfapparel market and the corporate apparel market, because both markets can beserved from some of the same inventory, we have not maintained inventory levelssufficient to generate significant sales within corporate markets. We havedeveloped a limited number of direct corporate accounts, and have historicallypursued this market primarily though promotional-product companies that sourceand distribute a variety of products for corporate fulfillment programs andspecial events. These promotional-product companies generally produce corporatecatalogs containing apparel and other products that may be used for employeerecognition, customer appreciation and other corporate purposes. Apromotional-product company may also source and supply a specific product orproducts for special events sponsored by a corporation. SPORT HALEY® and BenHogan® apparel collections are currently included, or confirmed to be included,in a variety of catalogs. We do not enter into formal agreements or contractswith these promotional-product companies, but we do agree that we will makeavailable the products advertised in any specific catalog during the period thecatalog is being used, generally a one-year period. Because corporate apparelinventory must be maintained for a longer period of time and the classic stylesof corporate apparel are generally not designed for one specific sellingseason, we typically feature only one collection of garments in our corporatecollections each year. Corporate sales are made periodically throughout theyear, and thus corporate sales are not historically quantifiable within thefixed or seasonal selling periods common to the other SPORT HALEY® and BenHogan® apparel collections.

 

*Top-Flite®*

 

Our Top-Flite® branded apparel was marketed by Reserve Apparel to massretailers and other big-box type high sales volume retail stores from November 2005to November 2007. Product development and markets for branded apparel suchas Top-Flite® garments follow production and sales cycles that differ fromcycles for our SPORT HALEY® and Ben Hogan® fashion apparel brands. Brandedapparel is generally developed for delivery within at least four separateperiods within any given year, while SPORT HALEY® and Ben Hogan® fashion apparelcollections are developed for two separate periods each year. We marketedTop-Flite® apparel pursuant to a license agreement with Callaway, which wasamended in March 2008 to remove the Top-Flite® brand from the agreement,effective January 1, 2008.

 

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**Competition**

 

The fashion golf apparel market, both domestically and internationally,is highly fragmented, and as new competitors enter the market others exit themarket every year. We currently consider Ashworth, Cutter & Buck,Polo, Fairway & Greene and EP Pro as our most significant competitorsin the fashion golf apparel market. Many of these same fashion golf apparel andsportswear companies are also competitors in the upscale retail and corporatemarkets. The intense competition throughout both the fashion golf, upscaleretail and corporate apparel markets is defined primarily by brand recognitionand loyalty, quality, price, styling and design, service and availability ofshelf space in the fashion golf apparel and leisure wear markets. In additionto competing with fashion golf apparel manufacturers, our fashion apparel alsocompetes with manufacturers of high quality men’s and women’s sportswear andgeneral leisure wear such as Nike, Adidas and Under Armour, each of which hasbecome more prominent within the fashion golf apparel market in recent years.The formidable presence of Nike, Adidas and Under Armour in the fashion golfapparel market has negatively affected sales of our Ben Hogan® fashion apparel overthe last couple of years. Previously, the fashion apparel market, primarilycomprised of golf professional shops, country clubs and resorts, preferred tosell quality apparel that was not broadly distributed in other retail markets.Fashion apparel brands, such as Ben Hogan®, appear to have been adverselyaffected by the penetration of Nike, Adidas and Under Armour, which are widelyrecognized brands in many other markets for sports and recreation equipment andapparel, into country club and resort markets. Furthermore, many of our fashionapparel competitors have longer operating histories, better name recognitionand greater financial, marketing and other resources. Because of the intensecompetition in the golf apparel and leisure wear markets, we cannot be assuredof obtaining additional market share or maintaining the current market share ofour fashion apparel collections; and, market and general economic conditionsmay dictate reductions in selling prices that could result in reduced marginsthat may adversely impact our financial condition and the results of ouroperations.

 

The branded apparel market is also highly fragmented, and many of ourcompetitors within the fashion apparel market also operate within the brandedapparel market. It is our understanding that branded apparel may account for asmuch as 90% of the total golf apparel market, and our efforts to penetrate thatmarket with the Top-Flite® brand were not successful.

 

**FinishedGoods Sourcing – Fashion Apparel**

 

Our production personnel assist our design department with the sourcingof SPORT HALEY® and Ben Hogan® finished goods apparel, negotiating costsconsistent with desired profit margins and the inspection of sample fabrics andgarments prior to the commencement of actual production. Production personnelare also responsible for ensuring timely receipt of finished goods. We do notmaintain any formal contractual arrangements with our suppliers, but we issuepurchase orders as apparel purchases are initiated.

 

We contract with several outside suppliers which produce garments inaccordance with our specifications regarding quality, fabrication and customstyling. Almost all of our purchases are denominated in United States dollars.We do not own or operate any domestic or foreign manufacturing facilities.While we do not maintain formal contracts with any of our suppliers, we highlyvalue the long-term relationships that we have established with severalseparate suppliers. We place orders with our suppliers as needed for deliveryof specific quantities within particular date ranges by utilizing relationshipswe have established with certain foreign agents and foreign or domesticfactories. In fiscal 2008, we purchased substantially all of our SPORT HALEY®and Ben Hogan® apparel from a variety of foreign suppliers, and we purchased60%, 11%, and 6% of our finished apparel from three separate suppliers,respectively. We maintain a close working relationship with a certain foreignperson who is responsible for maintaining relationships with and monitoring theperformance of certain of our foreign suppliers, including the two mostsignificant of our foreign suppliers. If we were to lose or terminate theservices of this individual or any of these significant suppliers, ourshort-term ability to fulfill customers’ orders of fashion apparel on a timelybasis could be substantially impaired, thereby negatively affecting ourfinancial position and the results of our operations.

 

We receive sales orders for our SPORT HALEY® and Ben Hogan® spring andfall collections over a period commencing when samples are first shown tocustomers and continuing through the respective selling seasons. 

 

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Because theapparel industry has long lead times, we must begin to schedule purchases andproduction of apparel collections in advance of sales order placements. Due tothe time-sensitive nature of the receiving and delivery of apparel collections,management devotes considerable time and effort to the revision of salesprojections, item by item within our apparel collections. Our computerizedinformation systems provide management with key data that facilitates salesforecasting, product tracking and standard cost controls as well as providingperpetual inventory records and inventory availability.

 

**FinishedGoods Sourcing – Branded Apparel**

 

We contracted with foreign suppliers to produce our Top-Flite® brandedapparel. Branded apparel is generally sold in large quantities, and factoriesgenerally require larger minimum orders for branded apparel than the minimumorders we are able to negotiate with suppliers for our fashion apparel.

 

**SeasonalNature of Business – Fashion Apparel**

 

Fashion apparel sales within the golf industry tend to be seasonal innature, with disproportionately higher sales occurring from early springthrough early summer. Accordingly, our fashion apparel sales aredisproportionately higher from January through June, which are our thirdand fourth quarters of each fiscal year, than sales from July to December,which are our first and second fiscal quarters. Advance sales orders for ourspring collections are generally solicited from July through December, andcustomer deliveries for the spring season are generally shipped from November throughApril each year. Advance sales orders for our fall fashion collections aregenerally solicited from January through June, and customer deliveries forthe fall season are generally shipped from May through October eachyear. Spring collections typically account for about 60% of our annual fashionapparel sales, with the fall collections accounting for the remainder.

 

**InformationSystems and Inventory Management**

 

We utilize integrated computer systems to manage all businesstransactions, historical data and record keeping, including sourcing,warehousing, embroidering and shipping. The computer systems provideinformation to our executives, management, all of our internal departments andour independent wholesale sales representatives. The electronic computer systemused by our independent sales representatives interfaces with the main systemto provide representatives with inventory information and order entrycapability and allows the representatives to order against actual inventoryavailability. The computer systems provide valuable information for forecastingsuch as analyses of sales histories, purchasing histories, and future customercommitments, all of which facilitate the management of our fashion apparelfinished goods inventories.

 

Our inventories, predominately comprised of finished goods, aregenerally valued at the lower of cost (weighted average) or market. Costsinclude amounts paid to suppliers for packaged apparel and/or materials andlabor, import costs, such as customs duties, freight-in and other miscellaneouscosts, and allocated overhead. We maintain a significant amount of fashionapparel finished goods inventories to meet customers’ delivery expectations.Because of such factors as the long lead time between ordering and receivingpackaged apparel from foreign vendors, receiving advance orders from anddelivery of finished apparel to customers, and the considerable number ofindividual items that comprise fashion apparel collections within a singleselling season, an excess of finished goods inventories remaining at the end ofa selling season is common within the golf apparel industry. Excess andprevious seasons’ fashion apparel finished goods inventory items usually mustbe marketed at reduced selling prices, which negatively affects gross margins.We utilize our computer systems to assist management with controlling fashionapparel inventories by providing information with regard to sales forecasting,initial and reorders of finished apparel and warehouse management. The computersystem was designed to increase operating efficiencies by providing betterinformation with regard to sales forecasting, purchasing and inventorymanagement. In fiscal 2005, we developed a system to better estimate ouranticipated future sales in order to better forecast fashion apparelinventories expected to remain at the end of a current or future distributionperiod. Having better information available to forecast quantities and mix ofunsold inventories allows us to better estimate valuations of excessinventories expected to be on hand in a future period. Having such informationalso allows us to better plan marketing strategies for the sales of suchinventories through existing marketing channels and to better estimate the 

 

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overallrecoverability of our finished goods inventories. In fiscal 2008, we developedalternative channels of distribution at higher selling prices than we hadpreviously been able to obtain for our excess inventories. However, due to theadverse market conditions during the three most recent selling seasons,especially with respect to our Ben Hogan® fashion apparel, we had a greateramount of excess inventories on hand at June 30, 2008, as compared withsuch inventories at June 30, 2007. We believe that the methods we use toevaluate our fashion apparel inventories produce fair valuations of our excessinventories, but, if actual market conditions are less favorable than those wehave projected, additional allowances may be required or losses on dispositionsmay be recorded, thereby adversely affecting our financial position and theresults of our operations.

 

Generally, branded apparel inventories are not prone to impairment,because we usually order branded apparel in quantities equal to specific customerorders, and under normal circumstances no branded apparel inventories remainupon shipment to the customer. We had no significant branded apparelinventories on hand at June 30, 2008.

 

**OrderPlacement and Backlog**

 

Advance sales orders for the fall fashion apparel selling season aretypically received by the beginning of May each year. Similarly, advancesales orders for the spring fashion apparel selling season are typicallyreceived by the beginning of November each year. Generally, we ship partialorders if they are at least 90% complete. We usually allow advance orders to bechanged or canceled up to 30 days prior to the scheduled shipping date of themerchandise. Generally, we do not sell our apparel on consignment and generallydo not accept returns of purchased apparel, other than apparel that isdefective or damaged or which was shipped to the customer after their specifieddelivery date. Our operations software affords us the ability to fulfill thevast majority of customer orders within customer-specified delivery dates,thereby reducing sales returns due to refused shipments for late delivery. As apercentage of net sales, sales returns were approximately 3% in fiscals 2008,2007 and 2006.

 

Historically, the backlog of orders has not materiallyimpacted our sales with respect to cancellations and rejections of back orders.Back orders are common occurrences within the apparel industry in general. Theamount of back orders outstanding at any particular time may be affected by anumber of factors, including the timely receipt of first-quality products fromsuppliers, which can impact an apparel distributor’s ability to ship garmentson time, and the timing of orders placed by customers. Accordingly, acomparison of our backlog of orders from period to period is not necessarilymeaningful and may not be indicative of actual shipments during any specificperiod. Our backlog of unfilled customer orders was less than $100,000 at June 30,2008, and the majority of those orders were shipped within the first month offiscal 2009.

 

#### **Payment Terms**

#### ** **

Generally, fashion apparel sales to customers are collectible within 30days of the sale. However, on a limited basis, we may offer discounted orextended payment terms of up to 90 days. On rare occasions, payment terms maybe extended on specific sales to as much as 180 days.

 

Payment terms were negotiated with branded apparel customers when theorder was obtained. Historically, branded apparel sales to customers werecollectible within 30 to 60 days of the sale.

 

**Trademarks**

 

We market women’s and a limited amount of men’s fashion golf apparelunder the SPORT HALEY® label. We have registered our current SPORT HALEY®trademarks with the United States Patent and Trademark Office. Certain of ourformer United States trademarks, which we had previously registered in a selectnumber of international jurisdictions and were no longer being utilized,expired during 2008.

 

We also market men’s fashion golf apparel under the Ben Hogan® label.Callaway has registered the Ben Hogan® trademark and the distinctive signatureof Mr. Hogan with the United States Patent and Trademark Office. Callawayalso has the right to use the Ben Hogan® trademark outside of the UnitedStates. We are licensed by

 

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Callaway to usethe Ben Hogan® trademark in the United States and certain other countries,subject to the terms of our license agreement with Callaway.

 

Callaway has registered the Top-Flite® trademark with the United StatesPatent and Trademark Office. We were licensed by Callaway to use the Top-Flite®trademark in the United States and certain other countries, subject to theterms of our license agreement with Callaway, as amended, through December 31,2007.

 

**Employees**

 

At June 30, 2008, we had 64 full-time employees and two part-timeemployees, including 25 full-time executive and administrative employees, threefull-time marketing and sales management employees, and 33 full-time and threepart-time personnel in inspection, packaging, embroidering and distributionoperations. The majority of our sales representatives are independent agents.None of our employees is a member of a trade union, and we consider ourrelations with our employees and agents to be satisfactory.

 

**ITEM 1A.****       RISKFACTORS**

 

Our business in general is subject to certain risks and uncertaintiesincluding the following:

 

**Markets for Our Products and Competition**

 

·      Our fashion apparel salesare seasonal, and historically sales from July through December, whichcomprise our first and second fiscal quarters, are weaker than sales from January throughJune, which comprise our third and fourth fiscal quarters.

 

·      We must continue tosuccessfully anticipate fashion trends, design apparel that is accepted byconsumers as fashionable and stylish and maintain an adequate product mixthereof in order to continue to have market acceptance. If we fail in theseendeavors, our sales will likely decline, thereby adversely affecting ouroperating results.

 

·      The market for golf apparelis extremely competitive, and price competition or industry consolidation couldweaken our competitive position. Some of our competitors are significantlylarger and more diversified than we are and have substantially greaterfinancial resources available for developing, sourcing and marketing theirproducts in the markets within which we operate. In order to maintain ourcompetitive position, we must effectively advertise and communicate within themarketplace and successfully penetrate our chosen distribution channels. We maynot be able to maintain or increase our market share in the distributionchannels in which we operate, and we may also face increased competition fromnew or existing competitors. As a result, we may experience lower sales orgreater operating costs, which would have an adverse effect on our margins andthe results of our operations.

 

·      We maintain a significantlevel of finished goods inventories to support our fashion apparel sales volumeand our limited corporate apparel program. Disposal of excess prior seasons’fashion apparel inventories at reduced margins is an inherent characteristicwithin the golf apparel industry, but a significant amount of sales at thelower margins dictated by the disposition of excess inventories may impair ourfinancial condition and the results of our operations. Write-downs with regardto obsolete fashion apparel inventories may also adversely affect our financialcondition.

 

**LicenseAgreement**

 

·      Asubstantial portion of our net sales are governed by the license agreement wemaintain with Callaway. While we have historically exceeded the minimum salesrequirements of the license agreement with regard to Ben Hogan® fashionapparel, we expect that sales of Ben Hogan® fashion apparel for calendar year2008 will be insufficient to meet either the minimum sales or royaltyrequirements per the license agreement.While we believe that we maintain a satisfactory relationship withCallaway, we have not reached an 

 

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understanding with Callaway and can currently give no assurance thatCallaway will not take the position that the new license agreement is subjectto termination, due to our expected inability to meet the minimum sales androyalty requirements for calendar year 2008 with respect to Ben Hogan® fashionapparel. An early termination of the license agreement, with regard to BenHogan® fashion apparel, would negatively impact our financial position andresults of our operations.

 

·      Asignificant component of our business strategies and a large percentage of ourrevenues are reliant upon licensed sales of apparel pursuant to our agreementwith Callaway. Of our apparel lines, only our SPORT HALEY® women’s fashionapparel line is not a licensed brand. Our significant reliance upon sales oflicensed apparel indicates a lack of diversification which could negativelyimpact our business should our efforts to market and sell Ben Hogan® men’sfashion apparel be unsuccessful. Should our license agreement with Callaway beterminated, or not extended upon its scheduled expiration in December 2013,our business would suffer materially.

 

**RelianceUpon Third Parties**

 

·      We depend on timely deliveryof finished garments from our suppliers. The loss of certain suppliers, and/ordelays in receiving garments from suppliers caused by various factors,including lost or reduced manufacturing capacity of significant suppliers, laborshortages, timely performance of third parties, transportation difficulties,and others, could adversely affect our ability to make timely delivery offinished garments to our customers.

 

·      Our significant reliance on foreign suppliersenhances the risk that revenues might be adversely affected if a foreignshipment were lost or significantly delayed. We maintain insurance for risk ofloss including those relating to raw materials inventories shipped betweenforeign vendors and finished goods inventories shipped from foreign suppliersto our distribution facilities in Denver, Colorado. However, our significantreliance on foreign suppliers heightens the risk that we could be left withinadequate or unsatisfactory recourse should the goods received from theforeign suppliers be nonconforming.

 

·      Our significant reliance on foreign supplierssustains the risk that revenues might be adversely affected by changes ininternational trade quota systems for apparel or by deterioration in politicaland international trade relations between the United States of America and theforeign countries where the suppliers are located.

 

·      Wepurchase significant amounts of finished apparel from several separate foreignsuppliers. While we believe that we could obtain finished apparel from numerousother suppliers, if we were to lose or terminate the services of any of thesesignificant suppliers, our short-term ability to fulfill customers’ orders on atimely basis could be substantially impaired, thereby negatively affecting ourfinancial position and the results of our operations.

 

·      We maintain a close working relationship with acertain foreign person who is responsible for maintaining relationships withand monitoring the performance of certain of our foreign suppliers. While webelieve that we could utilize other such persons to perform similar services, if we were to lose or terminate the servicesof this individual, our short-term ability to fulfill customers’ orders on atimely basis could be substantially impaired, thereby negatively affecting ourfinancial position and the results of our operations.

 

**Economy**

 

·      The demand for our productsmay decrease if the popularity of golf decreases or if other factors, such asadverse business conditions, a sluggish economy or inclement weather, causegolfers not to patronize golf professional shops.

 

·      The increased threats of terrorist activities inthe United States, the conflict in Iraq and other international conflicts mayadversely affect our sales. Businesstrends of the golf apparel industry closely follow trends in the travel andleisure sectors of the United States economy. International conflicts and othergeopolitical 

 

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conditions resulting from threats or acts ofwar or terrorism and responses thereto may continue to affect the travel andleisure sectors that had already been negatively impacted by the generaleconomic downturn experienced during previous years. Our sales coulddecrease if the USA economy weakens due to these or other factors.

 

·      We may experience an increase in the number andmagnitude of delinquent or uncollectible customer accounts during periods ofeconomic downturn.

 

·      On a limited basis, we advance monies to certainof our independent wholesale sales representatives under agreements whereby thesales representatives reimburse us as they earn monthly sales commissions. Ourfinancial results may be adversely affected should the sales representativesnot generate wholesale sales sufficient to justify the amounts advanced to themunder the agreements and should they have insufficient financial resources torepay the outstanding balance of monies advanced by us to them.

 

**Access to Capital**

 

·      Oursignificant reliance on foreign suppliers requires that we maintainsatisfactory relationships with a commercial banking institution in order tohave adequate access to capital to finance inventory purchases from foreignsuppliers via import letters of credit. While we believe that we could obtainaccess to capital from other sources, if the commercial banking institutionwere to terminate or not renew the line of credit agreement that we maintainwith the institution, or should we have insufficient funds to collateralize theissuances of import letters of credit, our ability to purchase finished goodsinventories from foreign suppliers could be substantially impaired, therebynegatively affecting our financial position and the results of our operationsand impairing our ability to operate.

 

·      Weregularly maintain cash balances at a commercial bank in excess of the FederalDeposit Insurance Corporation insurance limit of $250,000. While the financialposition and liquidity of the commercial bank has been exceedingly greater thanour uninsured cash balances at any point in time, if the financial positionand/or liquidity of the bank were to become impaired, our financial positionand the results of our operations could be negatively affected to the extent ofaccount balances held at the financial institution in excess of the federallyinsured limit.

 

·      Subsequentto our payment to US Customs and Border Protection of duties and interestthereon with regard to the Prior Disclosure we are planning to voluntarilysubmit in October 2008, we may need to obtain additional sources ofcapital to sustain the working capital needs of our operations or our financialposition could be negatively affected and our ability to operate may beimpaired.

 

**Computer Information Systems**

 

·      Businesses in general are increasingly dependentupon computer information systems. We must continually establish and sustaincontrols with regard to maintaining the integrity of our technology,information systems and electronic data in order to adequately manage businessactivities and control costs and expenses. We rely heavily upon our computerinformation systems to record sales and other transactions and to maintainhistoric data, all of which is stored on network file servers. While weregularly maintain backup systems for our file servers, if any of our fileservers failed during a traumatic event or due to a power surge or otherelectronic failure, we could lose electronic data that is essential to ourbusiness operations.

 

**Executive Officers and Key Employees**

 

·      Because we operate within strict seasonalperiods, our business operations are heavily dependent upon our currentexecutive officers and our key employees within various areas of our operationsincluding production and sales management. The loss of any of our executiveofficers or key employees, or the inability to attract and retain qualifiedpersonnel, could prevent us from successfully executing our businessstrategies, delay 

 

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the development and introduction of new seasonal apparel collections,damage the image of our brands and/or harm our ability to sell our products.

 

There may be other factors not mentioned above, in the discussion belowor included in our other Securities and Exchange Commission filings that maycause actual results to differ materially from any forward-looking statements.Neither the Company nor any of its corporate officers or key employees assumesany obligation to update any forward-looking statements as a result of newinformation, future events or developments, except as required by applicable securitieslaws.

 

**ITEM 2.****          PROPERTIES**

 

Our executive offices and warehouse facilities are located in Denver,Colorado. We utilize the entire 82,500 square feet of office and warehousespace at the Denver location in accordance with an operating lease that extendsthrough October 2011. The Denver facilities were leased at an annual baserent of $278,000 in fiscal 2008. We are obligated to pay the related taxes,insurance maintenance and repair expenses for the leased space.

 

**ITEM 3.****          LEGALPROCEEDINGS**

 

As previously reported, in March 2007,Sport Haley and Reserve Apparel (the “Plaintiffs”) filed a lawsuit in theDistrict Court for the City and County of Denver in the State of Colorado. Thesuit alleges, among other things, that a former inventory broker to ReserveApparel, 1130746 Ontario Ltd., a Canadian corporation incorporated in theProvince of Ontario, Canada, d/b/a Originals Apparel Group Co., or OriginalsApparel Group, and Francis Tat-Mo Chan (the “Defendants”), knowingly,wrongfully and without authorization converted Plaintiff’s funds. Among otherthings, the Plaintiffs alleged that the Defendants misapplied an inventorydeposit of $291,135 paid to the Defendants in March 2006 by Sport Haley,which the Defendants used to offset certain amounts purportedly owed to theDefendants by Explorer Headgear, Inc., and that the Defendants failed toreturn $176,877 which was overpaid by Sport Haley as of July 2006. ThePlaintiffs have alleged claims against the Defendants for conversion andviolation of the Colorado civil theft statute as well as for unjust enrichmentand negligence. The Plaintiffs originally sought repayment of the $291,135 and$176,877 amounts and other relief. At the commencement of the trial, whichoccurred on September 23, 2008, the Plaintiffs agreed to withdraw theirclaim for the $176,877 amount that they previously alleged was overpaid to theDefendants. At the conclusion of the trial, the Court awarded judgment in thePlaintiff’s favor and against the Defendants, jointly and severally, in theamount of $291,135 with regard to the Plaintiff’s claims for conversion andunjust enrichment, and the Court dismissed all of the other claims.

 

We are subject to various other legal proceedings and claims whicharise in the ordinary course of our business. Based upon information that iscurrently available, management does not believe that the total impact of thevarious other legal proceedings will materially affect our financial positionor the results of our operations.

 

**PART II**

 

**ITEM 5.****          MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS**

 

Our common stockhas been quoted under the trading symbol “SPOR” on the NASDAQ Capital MarketSM since February 2008.Prior to February 2008, our common stock was quoted on the NASDAQ Global MarketSM. The following table sets forth the range of high andlow sale prices of our common stock, as reported by either The NASDAQ CapitalMarketSM orThe NASDAQ Global MarketSM, as applicable, fromJuly 1, 2005 through June 30, 2008. The prices set forth below reflectinterdealer quotations, without retail markups, markdowns or commissions, andmay not be representative of actual transactions.

 

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| **Fiscal Year 2008** | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------|------------|----------|------------|---------|------------|
| Fourth Quarter                 |       | $        | 2.560      |    | $          | 1.980 |   |
| Third Quarter                  |       | 2.800    |       | 1.840   |       |
| Second Quarter                 |       | 3.310    |       | 1.900   |       |
| First Quarter                  |       | 4.470    |       | 3.470   |       |
|                                |            |          |            |         |            |  |  |

 
| **Fiscal Year 2007** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|
| Fourth Quarter                 |       | $          | 4.450      |       | $          | 4.030 |   |
| Third Quarter                  |       | 5.260      |       | 3.950      |       |
| Second Quarter                 |       | 5.060      |       | 3.840      |       |
| First Quarter                  |       | 5.190      |       | 4.300      |       |
|                                |            |            |            |            |            |  |  |

 
| **Fiscal Year 2006** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|
| Fourth Quarter                 |       | $          | 6.000      |       | $          | 4.520 |   |
| Third Quarter                  |       | 5.380      |       | 4.510      |       |
| Second Quarter                 |       | 5.007      |       | 4.030      |       |
| First Quarter                  |       | 5.450      |       | 3.140      |       |
|                                |            |            |            |            |            |  |  |

 

As of August 21, 2008, there wereapproximately 99 holders of record of our common stock. We computed the numberof record holders by adding to the number of actual record holders as shown onthe securities holder list obtained from our transfer agent the number ofindividual participants or accounts held by the Depository Trust Company (“DTC”),according to securities position listings as defined in Rule 17Ad-8.  The vast majority of our common shares areheld in trust by Cede & Co., as nominee for the DTC. We estimate thatas of August 21, 2008, our common stock was owned beneficially byapproximately 400 shareholders.

 

Holders of common stock are entitled toreceive such dividends as may be declared by our Board of Directors from timeto time. No dividend was declared in fiscal 2008, and the Board of Directorsdoes not anticipate that any dividends will be declared in the foreseeablefuture.

 
| **ITEM 7.** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

 

Statements made in this filing that are not historical facts areforward-looking statements. The reader should be aware that our actual resultscould differ materially from those contained in forward-looking statements.When used in this report, the words “may,” “will,” “will likely result,” “willcontinue,” “expect,” “anticipate,” “continue,” “estimate,” “plan,” “project,” “intend,”“believe” and similar expressions, variations or negative of these words, andany statement 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 withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934, although not all forward-lookingstatements contain such identifying words. Such statements are based onmanagement’s current expectations and are subject to risks, uncertainties andassumptions, including those risks set forth in Part I, Item 1A of thisreport, along with the factors and risks set forth below. The reader should beaware that, should one or more of these risks or uncertainties materialize, orshould underlying assumptions prove incorrect, the actual plan of operations,business strategies, operating results and financial position of Sport-Haley, Inc.could differ materially from those expressed in, or implied by, suchforward-looking statements.

 

Factors or risks that could cause actual results or circumstances todiffer materially from those set forth or contemplated in forward-lookingstatements include, but are not limited to, the following:

 

·      Our ability to respond to continual competitionin our markets as well as the extent, timing and success of such competition;

 

·      Our ability to expand into new markets and toeffectively manage our growth;

 

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·      Access to sufficient working capital to meet ouroperating and financial needs;

 

·      General economic conditions or material adversechanges in markets we serve;

 

·      Changes in, or failure to comply with, applicablelegislation or governmental regulation;

 

·      Changes in tax laws or rates;

 

·      Risk that our analyses of these risks could beincorrect and that the strategies developed to address them could beunsuccessful;

 

·      Changes in our accounting assumptions thatregulatory agencies, including the SEC, may require or that results fromchanges in the accounting rules or their application, which could resultin an impact on our earnings; and,

 

·      Various other factors discussed in this filing.

 

There may be other factors not mentioned above, or in Part I, Item1A of this report, in the discussion below or included in our other SEC filingsthat may cause actual results to differ materially from any forward-lookingstatements. Neither the Company nor any of its corporate officers or keyemployees assumes any obligation to update any forward-looking statement as aresult of new information, future events or developments, except as required byapplicable securities laws.

 

*Thefollowing discussion should be read in conjunction with the FinancialStatements and Notes thereto.*

 

**CriticalAccounting Policies and Estimates**

 

Our financial statements have been prepared in accordance withstandards of the Public Company Accounting Oversight Board (United States),which require us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and the relateddisclosures. A summary of those significant accounting policies can be found inthe Footnotes to the Financial Statements included in this Report on Form 10-Kfor the fiscal year ended June 30, 2008. The estimates used by management are based upon our historicalexperiences combined with management’s understanding of current facts andcircumstances. Certain of our accounting policies are considered critical asthey are both important to the portrayal of our financial condition and theresults of our operations and require significant or complex judgments on thepart of management. We believe that the following critical accounting policiesaffect the more significant judgments and estimates used in the preparation ofour financial statements.

 

*Inventories*

 

Our inventories, predominately comprised offinished goods, are generally valued at the lower of cost (weighted average) ormarket. Costs include amounts paid to suppliers for packaged apparel and/ormaterials and 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 natural componentof a seasonal apparel business. While certain fashion apparel items will sellout in any particular selling season, quantities of other fashion apparel itemswill remain at the end of each selling season. We market excess fashion apparelfinished goods inventories at reduced wholesale prices to our customers in thenormal course of business. Remaining excess inventories are liquidated throughother markets. In the ordinary course of business, we maintain reserves forinventory write-downs due to the obsolescence of excess inventories. We performanalyses on a quarterly basis to identify unsold excess inventories and adjustour reserves for inventory obsolescence to reduce the carrying value of excessinventories to their estimated net realizable value, which is estimated basedon management’s disposition plans and historical experiences. Generally,branded apparel inventories are not prone to impairment, because we usuallyorder branded apparel in quantities per specific customer orders.

 

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During fiscal 2008, we recorded fashionapparel inventory write-downs of $210,000, including a write-down of $51,000during the fourth fiscal quarter. We recorded write-downs of $20,000 withregard to branded apparel during fiscal 2008. While management believes thatour processes produce fair valuations of obsolete inventories, if actual marketconditions are less favorable than those projected by management, additionalallowances may be required.

 

*DeferredIncome Taxes*

 

Deferred income taxes are recognized for the expected tax consequencesin future years for differences between the tax bases of assets and liabilitiesand their financial reporting amounts, based upon enacted tax laws andstatutory tax rates applicable to the periods in which the differences areexpected to affect taxable income. Our significant deferred tax assets arerelated to net operating loss carry forwards for federal and state income taxpurposes, stock-based compensation and an unrealized loss for tax purposes on acommon stock investment. Governing regulations require that our operatinglosses be carried forward for income tax purposes. We maintain a valuationallowance to reduce our deferred tax assets to the net amount expected to berecovered in future periods. The estimates for deferred tax assets and thecorresponding valuation allowance require us to exercise complex judgments. Weperiodically review and adjust those estimates based upon the most currentinformation available. In accordance with Statement of Financial AccountingStandards No. 109 (“SFAS 109”), *“Accounting for IncomeTaxes,”* and based upon a review at June 30, 2008, of ourutilization of deferred tax assets, we maintained a valuation allowance thateffectively reduces our net deferred tax assets to zero. While we continue toexplore various strategies to return the Company to profitability, includingincreasing our presence in retail markets for our SPORT HALEY® and Ben Hogan®fashion apparel, 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.

 

*Allowancefor Doubtful Accounts*

 

Our allowance for doubtful accounts reflects a reserve that reduces ourcustomer accounts receivable to the net amount estimated to be collectible.Estimating the credit worthiness of customers and the recoverability ofcustomer accounts requires us to exercise considerable judgment. In estimatingthe reserve for uncollectible accounts, we consider factors such as generaleconomic and industry-specific conditions, historical and anticipated customerperformance. From time to time, we also identify delinquent customer accountsfor which a specific reserve is required. At June 30, 2008, our allowancefor doubtful accounts totaled $218,000, including a specific reserve of$116,000 with respect to the potential non-recovery of a net amount due toReserve Apparel from a former inventory broker. In September 2008, theCourt awarded judgment in our favor and against the former inventory broker inthe amount of $291,135. In order to collect from the former broker, we willneed to domesticate the judgment in the province of Ontario, Canada. Sincecollection is not assured, we maintained the $116,000 reserve for potentialnon-recovery at June 30, 2008. While we consider our processes to beadequate to effectively quantify our exposure to doubtful accounts, changes ineconomic, industry or specific customer conditions may result in recoverabilityof our doubtful accounts that differs materially from our estimates.

 

*Allowancefor Sales Returns*

 

We record allowances for sales returns as net adjustments to customeraccounts receivable. When recording an allowance, the net method reducescustomer accounts receivable and net sales by the estimated gross margin effectof the anticipated sales return. Generally, our selling terms preclude returnof our products subsequent to the sale. However, we have traditionallymaintained limited programs that offer various customers the right to returncertain fashion apparel items under predefined conditions, which we include asa component within our estimate of allowance for sales returns. We reviewhistorical data and consider factors such as general economic andindustry-specific conditions and anticipated customer performance whenevaluating the adequacy of our allowance for sales returns. At June 30,2008, our allowance for sales returns was $80,000. Significant changes ingeneral economic or industry conditions may yield sales returns that differmaterially from our estimates.

 

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**RecentPronouncements**

 

In May 2008, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards No. 163 (“SFAS 163”), *“Accounting for Financial Guarantee Insurance Contracts – AnInterpretation of FASB Statement No. 60.”* Diversity exists inpractice in accounting for financial guarantee insurance contracts by insuranceenterprises under FASB Statement No. 60, *“Accountingand Reporting by Insurance Enterprises.”* SFAS 163 requires that aninsurance enterprise recognize a claim liability prior to an event of default(insured event) when there is evidence that credit deterioration has occurredin an insured financial obligation. SFAS 163 requires expanded disclosuresabout financial guarantee insurance contracts. The accounting and disclosurerequirements of SFAS 163 are expected to improve the quality of informationprovided to users of financial statements. Our adoption of SFAS 163 upon itseffective date is not expected to have a material effect on our financialcondition or the results of our operations.

 

In May 2008, the FASB issued Statement of Financial AccountingStandards No. 162 (“SFAS 162”), *“The Hierarchy ofGenerally Accepted Accounting Principles*(“GAAP”)*.”* The current GAAP hierarchy, as set forth in the AmericanInstitute of Certified Public Accountants (“AICPA”) Statement on AuditingStandards No. 69, *“The Meaning of PresentFairly in Conformity With Generally Accepted Accounting Principles,”*has been criticized because: (i) it is directed to the auditor rather thanthe entity; (ii) it is complex; and, (iii) it ranks FASB Statementsof Financial Accounting Concepts. The FASB believes that the GAAP hierarchyshould be directed to entities, because it is the entity (not its auditors)that is responsible for selecting accounting principles for financialstatements that are presented in conformity with GAAP. Accordingly, the FASBconcluded that the GAAP hierarchy should reside in the accounting literatureestablished by the FASB and is issuing SFAS 162 to achieve that result. SFAS162 is effective 60 days following the Securities and Exchange Commission’sapproval of the Public Company Accounting Oversight Board amendments to AU Section 411,*“The Meaning of Present Fairly in Conformity WithGenerally Accepted Accounting Principles.”* Our adoption of SFAS 162upon its effective date is not expected to have a material effect on ourfinancial condition or the results of our operations.

 

In March 2008, the FASB issued Statement of Financial AccountingStandards No. 161 (“SFAS 161”), *“Disclosures about DerivativeInstruments and Hedging Activities – an amendment of FASB Statement No. 133.”*FASB Statement No. 133 (“SFAS 131”), *“Accounting for DerivativeInstruments and Hedging Activities,”* establishes, among otherthings, the disclosure requirements for derivative instruments and for hedgingactivities. SFAS 161 amends and expands the disclosure requirements of SFAS 131with the intent to provide users of financial statements with an enhancedunderstanding of: (i) how and why an entity uses derivative instruments; (ii) howderivative instruments and related hedged items are accounted for under SFAS133 and its related interpretations; and, (iii) how derivative instrumentsand related hedged items affect an entity’s financial position, financialperformance and cash flows. To meet those objectives, SFAS 161 requiresqualitative disclosures about objectives and strategies for using derivatives,quantitative disclosures about fair value amounts of gains and losses onderivative instruments and disclosures about credit-risk-related contingentfeatures in derivative agreements. SFAS 161 is effective for fiscal years, andinterim periods within those fiscal years, beginning after November 15,2008, with earlier adoption encouraged. SFAS 161 further encourages, but does notrequire, comparative disclosures for earlier periods at initial adoption. We donot anticipate early adoption, and our adoption of SFAS 161 upon its effectivedate is not expected to have a material effect on our financial condition orthe results of our operations.

 

We have reviewed all recently issued, but not yet effective, accountingpronouncements and do not believe the future adoption of any suchpronouncements may be expected to cause a material impact on our financialcondition or the results of our operations.

 

**Resultsof Operations**

 

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

 

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include the valueof the fabric in the total declared value of the apparel. *See Part II,Item 9B for a detailed explanation of this matter.*

 

In order to correct the underpaid customs duties, in September 2008we began voluntarily preparing a Prior Disclosure that we expect to submit toUS Customs and Border Protection in October 2008. A Prior Disclosure is aspecific procedure proscribed by US Customs and Border Protection for thepurpose of identifying and correcting amounts which were previously declared oromitted from declaration. Our Prior Disclosure will correct amounts with regardto our imports for the five-year period immediately prior to the date the PriorDisclosure is submitted to US Customs and Border Protection.

 

Using the guidance set forth in Staff Accounting Bulletin No. 108(“SAB 108”), *“Considering the Effects of Prior YearMisstatements in Current Year Financial Statements,”*and FASBConcepts Statement No. 2, *“QualitativeCharacteristics of Accounting Information,”*we determined that thequantitative and qualitative effects with regard to correction of underpaidcustoms duties in prior years were immaterial in all cases. However, correctionof the underpaid customs duties within fiscal 2008 for the combined amount duefor fiscals 2007, 2006 and 2005 and the applicable portions of fiscal 2004would cause our 2008 financial statements to be materially misstated.Therefore, in accordance with SAB 108, we have corrected our fiscal 2007 and2006 financial statements included in this report for the aforementionedmatter.

 

The following table sets forth the percentage of net sales representedby items included in or derived from our consolidated statements of income forfiscal years ended June 30, 2008, 2007 (as corrected) and 2006 (ascorrected). The consolidated statements of operations data include the amountsof Sport Haley and Reserve Apparel.

 
| **Results of Operations Data**                                                    | ** ** | **Fiscal Year Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| **(2007 and 2006 Corrected)**                                                     | ** ** | **2008**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                                                                        |       | 100.0                                              | %          | 100.0 | % | 100.0 | % |
| Total cost of goods sold                                                                         |       | 62.9                                               |       | 65.3 |   | 67.6 |   |
| Gross profit                                                                                     |       | 37.1                                               |       | 34.7 |   | 32.4 |   |
| Total other operating costs                                                                      |       | 43.1                                               |       | 43.8 |   | 38.2 |   |
| Loss from operations                                                                             |       | (6.0                                               | )          | (9.1 | ) | (5.8 | ) |
| Other income and expenses, net                                                                   |       | 1.4                                                |       | 1.9 |   | 2.1 |   |
| Loss from operations before minority interest in  subsidiary loss and provision for income taxes |       | (4.6                                               | )          | (7.2 | ) | (3.7 | ) |
| Minority interest in subsidiary income/loss                                                      |       | 0.0                                                |       | (0.2 | ) | 1.2 |   |
| Provision for income taxes                                                                       |       | (0.0                                               | )          | (0.2 | ) | (0.0 | ) |
| Net loss                                                                                         |       | (4.6                                               | )%         | (7.6 | )% | (2.5 | )% |

 

**Comparisonof Fiscal Years Ended June 30, 2008 and 2007 (as corrected)**

 

Total net sales for fiscal 2008 were $17,117,000, a decrease of$1,776,000, or 9%, as compared with sales of $18,893,000 for fiscal 2007. Netsales of fashion apparel for fiscal 2008 were $16,399,000, a decrease of$389,000, or 4%, as compared with fashion apparel sales of $17,088,000 forfiscal 2007. Net sales of branded apparel for fiscal 2008 were $160,000, adecrease of $1,025,000, or 86%, as compared with branded apparel sales of$1,185,000 for fiscal 2007. The remainder of our net sales for fiscal 2008 and2007 were comprised of embroidery and shipping revenues.

 

Our consolidated gross margins may not be comparable to other companieswithin the golf apparel industry. We have consistently included the cost ofmerchandise sold, including import charges, in-bound freight, allocatedoverhead, freight out, embroidery costs and other charges in our cost of goodssold. Our overhead allocation includes our production costs plus a portion ofour distribution costs, such as receiving and inspection costs, but we includesome of the other costs of distribution, such as a portion of our warehousingand other handling costs, in selling, general and administrative expenses. Ourgross margins also include, on a consolidated basis, the operations of ReserveApparel, which distributed Top-Flite® branded apparel until November 2007to the mass retail market at much lower price points and gross margins thanthose expected to be achieved in the premium and mid-price markets 

 

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where wedistribute our SPORT HALEY® and Ben Hogan® fashion apparel brands. Otherfashion apparel companies within the golf industry may or may not also operatewithin the lower price markets. We include royalty payments, relating to salesof licensed apparel, in selling, general and administrative expenses.

 

*FashionApparel*

 

For fiscal 2008, net sales of SPORT HALEY® women’s fashion apparel were$8,170,000, an increase of $1,257,000, or 18%, from net sales of $6,913,000 forfiscal 2007.  We attribute the increaseto customer awareness of the SPORT HALEY® brand, our keen sense of observingfashion trends within the women’s golf apparel market and the cohesiveness ofour women’s design staff, which has kept the SPORT HALEY® brand fresh and inpace with customer demand for technical fabrics and athletic styling. Webelieve our SPORT HALEY® women’s fashion apparel is well positioned to weathercontinued competition within golf apparel markets and is also well suited forcertain retail markets, which we have begun to pursue.

 

For fiscal 2008, net sales of Ben Hogan® men’s fashion apparel were$8,229,000, a decrease of $1,946,000, or 19%, from net sales of $10,175,000 forfiscal 2007. We attribute the decrease primarily to further entrenchment ofbrands such as Nike, Adidas and Under Armour within the country club and resortmarkets in which we operate. Historically, the country club and resort marketspreferred to sell high-quality apparel that was not widely distributed in otherretail markets. Broad market acceptance of the polyester moisture-wicking andother performance garments offered by apparel brands such as Nike, Adidas andUnder Armour has continued to grow within the country club and resort markets.We believe that the penetration of Nike, Adidas and Under Armour into golfapparel markets has continued to dilute the value with regard to theexclusivity of fashion apparel brands such as Ben Hogan®. In order to bolstermarket acceptance of our Ben Hogan® fashion apparel, we’ve introducedmoisture-wicking cotton and cotton-blend garments and have also infused someyounger-looking, more athletic styled garments into our fashion collections. Wehave also continued to market Ben Hogan® fashion apparel to upscale retailstores and to corporate markets and expect that our efforts will achieveincreased sales within those markets in fiscal 2009. Ben Hogan® men’s fashionapparel is marketed in accordance with a license agreement we maintain withCallaway, which we consider to be a key component of our overall businessstrategies.

 

As a percentage of sales, gross profit of our fashion apparel was 37%for fiscal 2008 and was 35% for fiscal 2007, as corrected. Gross profit offashion apparel has increased somewhat since fiscal 2007 primarily because welocated alternative markets for our excess fashion apparel inventories infiscal 2008 that garnered higher sales prices for such apparel, and becausenegotiated prices for finished apparel purchased from foreign suppliers haveremained relatively unchanged over the same period. Excess inventories arecommon within the fashion apparel industry. We market excess fashion apparelinventories at reduced wholesale prices to our customers in the normal courseof business. Remaining excess inventories are liquidated through other markets.The valuation of excess inventories, when the market price for such inventoriesis lower than cost, negatively impacts our gross profit percentage, because areduction of inventory value causes a corresponding increase in our cost ofgoods sold, thereby reducing our gross profit. Gross profit with regard to ourfashion apparel was negatively impacted by $230,000 and $312,000 for fiscal2008 and 2007, respectively, by the adjustment of our finished goodsinventories to the lower of cost or market. The disposition of excessinventories also negatively impacts our gross profit percentage, even when suchinventories are properly valued to the lower of cost or market, because suchvaluation causes sales to be recorded with gross profit at or near zero. Infiscal 2008, we recorded net sales of $778,000 and loss of $1,000 with regardto the disposition of excess fashion apparel inventories. Comparatively, infiscal 2007, we recorded net sales of $543,000 and loss of $176,000 with regardto the disposition of excess fashion apparel inventories.

 

Selling, general and administrative expenses with regard to fashionapparel were $6,624,000 for fiscal 2008, an increase of $81,000, or 1%, from$6,705,000 in fiscal 2007. During fiscal 2008, decreases in sales commissions,audit and tax preparation fees, directors’ fees, shareholder costs, travelexpenses and depreciation expense were more than offset by increases insalaries and severance costs, computer expenses, shipping supplies and usetaxes. The decrease in sales commissions correlates to our comparative decreasein sales in fiscal 2008 when compared with sales in fiscal 2007. Severancecosts in fiscal 2008 consisted of $55,000 in compensation paid to our formereastern regional sales manager. We did not record any severance compensationcost in fiscal 2007. As a percentage of net

 

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fashion apparel sales, related selling, general and administrativeexpenses were 39% for fiscal 2008 as compared with 38% for fiscal 2007.

 

We recorded royalty expense of $569,000 for fiscal2008, a decrease of $106,000, or 16%, as compared with royalty expense of$675,000 for fiscal 2007. The decrease in royalty expense generally correspondsto the decrease in sales of Ben Hogan® fashion apparel over the comparativeperiod. Royalty expense with regard to fashion apparel is due to Callaway inaccordance with the license they previously granted us to market men’s fashionapparel bearing the Ben Hogan® label. While our sales have historicallygenerated royalties which have consistently exceeded the minimum annualroyalties required by the license agreement with regard to Ben Hogan® fashionapparel, we expect that royalties generated on sales of Ben Hogan® fashionapparel will be insufficient to meet the contractual minimum royaltyrequirement for calendar 2008. Accordingly, we recorded a contingent liabilityof $80,000 with regard to calendar year 2008 minimum royalties due for BenHogan® fashion apparel as of June 30, 2008.

 

Primarily due to the factors discussed above, lossfrom operations with regard to fashion apparel was ($838,000) for fiscal 2008,an improvement of $563,000, or 40%, from ($1,401,000) for fiscal 2007, ascorrected.

 

*Branded Apparel*

 

We previously considered Top-Flite® branded apparel,which we marketed pursuant to our licensing agreement with Callaway for suchapparel, to be a key component in our overall business strategies, designed toreturn the Company to sustained profitability. We marketed Top-Flite® brandedapparel to Wal-Mart and other mass retailers and big-box type high sales volumeretail stores from November 2005 to November 2007. Net sales ofTop-Flite® branded apparel for fiscal 2007 were $1,185,000, including sales toWal-Mart of $1,000,000. Net sales of Top-Flite® branded apparel for fiscal 2007were $160,000, primarily comprised of sales to a retailer for a test in 50 ofits stores. In March 2008, we reached an agreement with Callaway to removethe Top-Flite® brand from the license agreement, effective January 1,2008.

 

Our distribution of Top-Flite® branded apparel to themass retail market generally generated gross margins lower than those expectedto be achieved in the premium and mid-price markets where we distribute ourSPORT HALEY® and Ben Hogan® fashion apparel brands. Wholesale prices aregenerally expected to be much lower for branded apparel than for higher qualityfashion apparel, and gross margins are also expected to be lower for brandedapparel than for fashion apparel. Other companies within the golf apparelindustry may or may not operate within the lower-price branded apparel markets.As a percentage of net branded apparel sales, gross margins with respect tosales of branded apparel were 0% and 25% for fiscal 2008 and 2007,respectively.

 

Selling, general and administrative expenses were$178,000 with regard to branded apparel for fiscal 2008, a decrease of $204,000,or 53%, from $382,000 for fiscal 2007. The decrease in selling, general andadministrative expenses was primarily due to the discontinuance of ourmarketing efforts with regard to Top-Flite® branded apparel in November 2007.As a percentage of net branded apparel sales, related selling, general andadministrative expenses were 111% for fiscal 2008 and were 32% for fiscal 2007.

 

We recorded royalty expense of $9,000 and $242,000with regard to Top-Flite® branded apparel for fiscal 2008 and 2007, respectively.Royalty expense was due to Callaway in accordance with the license theypreviously granted us to market branded apparel bearing the Top-Flite® label.Because we anticipated that sales of Top-Flite® branded apparel would beinsufficient to meet the contractual minimum royalty requirement for calendar2007 for such apparel, we accrued a contingent liability and royalty expense of$178,000 at June 30, 2007. The remainder of our fiscal 2007 royaltyexpense with regard to branded apparel related to sales of Top-Flite® apparelthat we recorded during the three months ended September 30, 2006. In March 2008,we reached an agreement with Callaway to remove the Top-Flite® brand from thelicense agreement, effective January 1, 2008, whereby the unpaid minimum royaltiesdue to Callaway for calendar 2007 with respect to Top-Flite® apparel wereextinguished and forgiven.

 

Primarily due the factors listed above, loss fromoperations with regard to branded apparel for fiscal 2007 was ($188,000), animprovement of $136,000, or 42%, from ($324,000) for fiscal 2007.

 

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*Other income*

 

Total other income, net, for fiscal 2008 was $247,000,a decrease of $113,000, or 31%, from $360,000 for fiscal 2007. Historically,our other income, net, has been comprised of interest earned on cash and cashequivalent balances held at various financial institutions. Interest earned oncash and cash equivalent balances decreased significantly between fiscal 2008and 2007 due to the decrease in cash and cash equivalents from fiscal 2007 tofiscal 2008 and lower rates of interest earned on cash and cash equivalentbalances in fiscal 2008 as compared with fiscal 2007. Interest income totaled$112,000 for fiscal 2008, a decrease of $162,000, or 59%, from $274,000 forfiscal 2007. Other income, net, for fiscal 2008 included $178,000 recovered inthe agreement with Callaway to remove the Top-Flite® brand from the licenseagreement, effective January 1, 2008, whereby the unpaid minimum royaltiesdue to Callaway for calendar 2007 with respect to Top-Flite® apparel wereextinguished and forgiven. Other income, net, for fiscal 2008 also includes$44,000 in interest accrued on amounts due to US Customs and Border Protectionwith regard to our Prior Disclosure computations as of June 30, 2008.

 

*Net Loss*

 

Net loss for fiscal 2008 was ($794,000), animprovement of $646,000, or 45%, from ($1,440,000) for fiscal 2007, ascorrected. Our cumulative federal and state net operating loss carry forwardstotaled $7,754,000 and $9,690,000 as of June 30, 2008, that we estimatedmay be recoverable at income tax rates of 34% and 5%, respectively. Inaccordance with SFAS 109 and based upon a review at June 30, 2008, of ourutilization of deferred tax assets, we maintained a valuation allowance thateffectively reduces our net deferred tax assets to zero. While we continue toexplore various strategies to return the Company to profitability, includingexpanding our SPORT HALEY® and Ben Hogan® fashion apparel distribution channelswithin retail and corporate markets, we cannot be certain that our efforts willresult in the generation of future profits sufficient to offset our netoperation loss carry forwards prior to their expirations. Accordingly, we didnot record benefits from income taxes associated with the corresponding lossesfor fiscal 2008 or 2007.

 

*Earnings (loss) per share*

 

Basic and diluted loss per common share were ($0.35)and ($0.56) for fiscal 2008 and 2007, as corrected, respectively. Allsecurities options were anti-dilutive and therefore excluded from the per sharecalculations with respect to periods in which net losses were incurred.

 

*Book value*

 

Our book value per common share was $4.46 at June 30,2008, and was $4.81 at June 30, 2007, as corrected.

 

**Comparison of Fiscal Years Ended June 30,2007 (as corrected) and 2006 (as corrected)**

 

Total net sales for fiscal 2007 were $18,893,000, adecrease of $2,069,000, or 10%, as compared with sales of $20,962,000 forfiscal 2006. Net sales of fashion apparel for fiscal 2007 were $17,088,000, adecrease of $649,000, or 4%, as compared with fashion apparel sales of$17,737,000 for fiscal 2006. Net sales of branded apparel for fiscal 2007 were$1,185,000, a decrease of $1,288,000, or 52%, as compared with branded apparelsales of $2,473,000 for fiscal 2006. The remainder of our net sales for fiscal2007 and 2006 were comprised of embroidery and shipping revenues.

 

*Fashion Apparel*

 

For fiscal 2007, net sales of SPORT HALEY® women’sfashion apparel were $6,913,000, an increase of $375,000, or 6%, from net salesof $6,538,000 for fiscal 2006.  Webelieved that the shrinking market for women’s fashion golf apparel bottomedout in 2006, as evidenced not only by our increase in net sales of women’sfashion apparel in fiscal 2007, but also because we continued to experienceincreases in advance orders for our women’s collections. We believed that thecontinued increase in advance orders indicated that the trend of increasingsales of women’s apparel would continue throughout fiscal 2008.

 

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For fiscal 2007, net sales of Ben Hogan® men’s fashionapparel were $10,175,000, a decrease of $1,024,000, or 9%, from net sales of$11,199,000 for fiscal 2006. We attributed the decrease primarily to changes inthe country club and resort markets in which we operate. Historically, thecountry club and resort markets preferred to sell high-quality apparel that wasnot broadly distributed in other retail markets. However, with the introductionand broad market acceptance of moisture-wicking and other performance garmentswithin golf apparel markets, country clubs and resorts began to carry apparelbrands such as Nike and Adidas, which are primarily comprised of performancefabrics and are globally distributed into numerous markets other than countryclubs and resorts. We believed that the penetration of Nike and Adidas intogolf apparel markets diluted the value with regard to the exclusivity of brandssuch as our Ben Hogan® fashion apparel brand, at least on a temporary basis. Inorder to bolster future sales of our Ben Hogan® fashion apparel, weconcentrated our marketing efforts to upscale retail stores and to corporatemarkets. We expected that our efforts would at a minimum generate sales of BenHogan® fashion apparel to two or three new upscale retail stores in fiscal2008.

 

As a percentage of sales, gross profit of our fashionapparel was 35% for fiscal 2007, as corrected, and was 36% for fiscal 2006, ascorrected. Gross profit of fashion apparel remained relatively unchanged sincefiscal 2006 primarily because we recorded comparatively similar write-downs offashion apparel inventories in fiscal 2007 and 2006, and because negotiatedprices for finished apparel purchased from foreign suppliers remainedrelatively constant over the same period. Gross profit with regard to ourfashion apparel was negatively impacted by $312,000 and $313,000 for fiscal2007 and 2006, respectively, by the adjustment of our finished goodsinventories to the lower of cost or market. In fiscal 2007, we recorded netsales of $543,000 and loss of $176,000 with regard to the disposition of excessfashion apparel inventories. Comparatively, in fiscal 2006, we recorded netsales of $495,000 and loss of $80,000 with regard to the disposition of excessfashion apparel inventories.

 

Selling, general and administrative expenses withregard to fashion apparel were $6,705,000 for fiscal 2007, an increase of$84,000, or 1%, from $6,621,000 in fiscal 2006. During fiscal 2007, comparativeincreases in advertising and personnel expenses were partially offset bycomparative decreases in insurance, legal and investment banking expenses. Theincrease in advertising expenses primarily related to expanding ourparticipation in various golf or retail related tradeshows throughout thefiscal year. The increase in personnel expenses included comparatively highersalaries paid to our chief executive and other officers and key employeesduring fiscal 2007 as compared with fiscal 2006 plus salary and benefits withregard to a person we hired in August 2006 to implement corporate salesinitiatives to potentially bolster sales of fashion apparel. The comparativedecrease in insurance expenses primarily related to decreased premiums fordirectors and officers insurance coverage. Legal and investment bankingexpenses declined primarily because, in fiscal 2007, after we completed theself tender offer as a means of increasing shareholder value, we for the timebeing suspended our efforts to pursue strategic alternatives including but notlimited to selling the Company, seeking joint venture partners, engaging inrecapitalization, reviving our stock repurchase plan or pursuing anotherextraordinary transaction such as taking the Company private. As a percentageof net fashion apparel sales, related selling, general and administrativeexpenses were 38% for fiscal 2007 as compared with 36% for fiscal 2006.

 

We recorded royalty expense of $675,000 for fiscal2007, a decrease of $93,000, or 12%, as compared with royalty expense of$768,000 for fiscal 2006. The decrease in royalty expense generallycorresponded to the decrease in sales of Ben Hogan® fashion apparel over thecomparative period.

 

As previously reported, in September 2006, werecorded goodwill of $270,000 with regard to our purchase of the minorityinterest in Reserve Apparel from Explorer Gear. At June 30, 2007, wedetermined that the goodwill was sufficiently impaired per the guidance offeredby Statement of Financial Accounting Standards No. 142, *“Goodwill and Other Intangible Assets,”* to warrant impairingthe entire balance, because after purchasing the minority interest we wereunable to locate a significant customer for our Top-Flite® apparel.

 

Primarily due to the factors discussed above, income(loss) from operations with regard to fashion apparel was ($1,401,000) forfiscal 2007, as corrected, a difference of ($691,000), or 97%, from ($710,000)for fiscal 2006, as corrected.

 

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*Branded Apparel*

 

We considered Top-Flite® branded apparel, which wemarketed pursuant to our licensing agreement with Callaway for such apparel, tobe a key component in our overall business strategies, designed to return theCompany to sustained profitability. Net sales of Top-Flite® branded apparel forfiscal 2007 were $1,185,000, including sales to Wal-Mart of $1,000,000. Webegan shipping Top-Flite® branded apparel exclusively to Wal-Mart in March 2006,and we recorded sales of $2,473,000 to Wal-Mart in fiscal 2006. As previouslyreported, in late September 2006, Wal-Mart discontinued purchasingTop-Flite® branded apparel from us, opting instead to develop a line of golfapparel under a private label. Throughout fiscal 2007, we redesigned ourTop-Flite® apparel collection to include garments primarily comprised of avariety of performance fabrics, and we aggressively marketed the redesignedTop-Flite® branded apparel to a number of other mass retailers and certainbig-box type high sales volume retail stores. As of September 2007, wereceived only one order for Top-Flite® apparel from one such retailer for atest in 50 of its stores, which we began to deliver in September 2007. Wedid not obtain any other significant customers for Top-Flite® branded apparel.

 

As a percentage of net branded apparel sales, grossmargins with respect to sales of branded apparel were 25% and 5% for fiscal2007 and 2006, respectively. As previously reported, gross margins ofTop-Flite® branded apparel sales for fiscal 2006 were negatively impacted byproduction delays, extraordinary shipping charges and mark down money paid toWal-Mart. We did not incur any such unexpected extraordinary expenses in fiscal2007. Gross margins achieved in fiscal 2007 with respect to branded apparelsales were more in line with management expectations than gross marginsachieved in fiscal 2006.

 

Selling, general and administrative expenses were$382,000 with regard to branded apparel for fiscal 2007, a decrease of $87,000,or 19%, from $469,000 for fiscal 2006, primarily due to differences between thefiscal years in allocated management costs, which totaled $77,000 in fiscal2007 versus $327,000 in fiscal 2006. The $250,000 decrease in allocatedmanagement costs related to changes in the ownership of Reserve Apparel and theloss of the Wal-Mart account. Prior to our purchase of the minority interest inReserve Apparel from Explorer Gear in September 2006, allocated managementcosts included a portion of Sport Haley’s costs with regard to managing ReserveApparel and certain reimbursable expenses incurred by Explorer Gear on behalfof Reserve Apparel. Because Wal-Mart ceased purchasing Top-Flite® brandedapparel from us shortly after we purchased the minority interest, the businessoperations of Reserve Apparel were significantly reduced and we discontinuedour allocation of Sport Haley management costs to Reserve Apparel. Fiscal 2007selling, general and administrative expenses with regard to branded apparelincluded wages and benefits of $126,000 paid to a person we hired in November 2006to actively market Top-Flite® branded apparel to the mass retail and big-boxmarket suitable for such apparel. Prior to November 2006, this personprovided consulting services to us with regard to marketing our branded apparelto Wal-Mart and other mass retailers from approximately May 2006 to October 2006.Selling, general and administrative expenses with regard to branded apparel infiscal 2007 also included travel and other costs related to our marketingefforts and expenses related to our participation in various industry-relatedtradeshows. As a percentage of net branded apparel sales, related selling,general and administrative expenses were 32% for fiscal 2007 and were 19% forfiscal 2006.

 

We recorded royalty expense of $242,000 and $159,000with regard to Top-Flite® branded apparel for fiscal 2007 and 2006,respectively. Royalty expense is due to Callaway in accordance with the licensethey previously granted us to market branded apparel bearing the Top-Flite®label. Because we anticipated that sales of Top-Flite® branded apparel would beinsufficient to meet the contractual minimum royalty requirement for calendar2007 for such apparel, we accrued a contingent liability and royalty expense of$178,000 at June 30, 2007. The remainder of our fiscal 2007 royaltyexpense with regard to branded apparel related to sales of Top-Flite® apparelthat we recorded during the three months ended September 30, 2006. Salesof Top-Flite® branded apparel were sufficient to meet the minimum royaltyrequirement under the license agreement for calendar 2006.

 

Primarily due the factors listed above, income (loss)from operations with regard to branded apparel for fiscal 2007 was ($324,000),an improvement of $191,000, or 37%, from ($514,000) for fiscal 2006.

 

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*Other income*

 

Total other income, net, for fiscal 2007 was $360,000,a decrease of $78,000, or 18%, from $438,000 for fiscal 2006. Historically, ourother income, net, was comprised of interest earned on cash and cash equivalentbalances held at various financial institutions. Interest earned on cash andcash equivalent balances remained nearly constant between fiscal 2007 and 2006.Other income, net, for fiscal 2006 included $157,000 of the $173,000 recoveredin the settlement we reached with our auditors from prior to fiscal 2000. Weoffset legal expenses for fiscal 2006 with the remainder of the settlementamount of $16,000.

 

*Net income (loss)*

 

Net loss for fiscal 2007, as corrected, was ($1,440,000),a difference of ($906,000), or (170%), from ($534,000) for fiscal 2006, ascorrected. Our cumulative federal and state net operating loss carry forwardstotaled $7,135,000 and $9,325,000 as of June 30, 2007, that we estimatedmay be recoverable at income tax rates of 34% and 5%, respectively. Inaccordance with SFAS 109 and based upon a review at June 30, 2007, of ourutilization of deferred tax assets, we maintained a valuation allowance thateffectively reduces our net deferred tax assets to zero. Because we were notcertain that we would generate profits sufficient to offset the loss carryforwards prior to their expirations, we did not record benefits from incometaxes associated with the corresponding losses for fiscal 2007 or 2006.

 

*Earnings (loss) per share*

 

Basic and diluted loss per common share were ($0.56)and ($0.19) for fiscal 2007, as corrected, and 2006, as corrected,respectively. All securities options were anti-dilutive and therefore excludedfrom the per share calculations with respect to periods in which net losseswere incurred.

 

*Book value*

 

Our book value per common share was $4.81 at June 30,2007, as corrected, and was $5.37 at June 30, 2006, as corrected.

 

**Liquidity and Capital Resources**

 

Our primary sources of liquidity are derived from ouravailable cash and cash equivalents, cash flows from operations and a line ofcredit with a commercial bank, which is fully cash secured, for issuances ofletters of credit to facilitate finished goods inventory purchases fromoffshore suppliers. We require cash for our general working capital purposes. Our working capital requirements arehighly seasonal in nature, with greater requirements from approximately August throughOctober and February through April of each fiscal year due tothe purchases of fashion apparel inventories for the spring/summer andfall/holiday selling seasons, respectively. We do not anticipate requiringmaterial amounts of cash for capital expenditures over the next 12 months.

 

Working capital was$9,984,000 and $10,576,000 at June 30, 2008 and 2007, as corrected,respectively. Cash and cash equivalents plus marketable securities totaled $3,030,000 and $4,464,000 at June 30, 2008 and 2007, respectively. Forpurposes of the statements of cash flows, we consider all highly liquidinstruments purchased with an original maturity of three months or less to becash equivalents, if they are readily convertible to known amounts of cash andpresent an insignificant risk of change in value due to changes in interestrates. As of June 30, 2008, we had accrued $685,000 in import duties andinterest thereon due to US Customs and Border Protection with regard to thePrior Disclosure we expect to voluntarily submit to them in October 2008,the payment of which will negatively impact our cash on hand significantly.Therefore, in fiscal 2009, we may need to obtain additional sources of capitalto sustain the working capital needs of our operations.

 

Net cash provided by(used in) operating activities totaled ($1,427,000), ($1,277,000) and$1,139,000 for fiscal years 2008, 2007 and 2006, respectively. The primarycomponents of adjustments to reconcile net loss to cash provided by (used in)operating activities were changes between fiscal years relating to impairmentsand write-downs,

 

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provisions for doubtful accounts and sales returns,accounts receivable, inventories, accounts payable, and accrued commissions andother expenses.

 

·      Adjustments for impairments and write-downs affectednet cash provided by operating activities by $230,000 in fiscal 2008, $582,000in fiscal 2007 and $408,000 in fiscal 2006. The effects on net cash provided byoperating activities caused by impairments and write-downs represent theexpense effects of recording impairments and write-downs in the respectivefiscal years. Because of the seasonal nature of the fashion apparel business,excess inventories left over at the end of each selling season (“previousseasons’ inventories”) are common within the industry. Throughout each fiscalyear, we market previous seasons’ inventories through our ordinary marketingchannels. At or near the end of each fiscal quarter, we identify and revalueobsolete inventories, primarily consisting of previous seasons’ fashion apparelinventories, to estimated disposition values. In 2006, $95,000 of the $408,000inventory write-down related to branded apparel inventories on hand at June 30,2006. Generally, branded apparel inventories are not prone to impairment,because we usually order branded apparel in quantities sufficient to satisfyspecific customer orders. In fiscal 2007, we sold all remaining branded apparelinventories on hand at June 30, 2006, without recording a significant gainor loss on the sale. In fiscal 2007, in accordance with SFAS 142, we impaired$270,000 in goodwill which had been recorded upon our September 2006purchase of the minority interest in Reserve Apparel from Explorer Gear. At June 30,2007, we determined that the goodwill was sufficiently impaired per theguidance offered by SFAS 142 to warrant impairing the entire balance, becauseafter purchasing the minority interest we were not able to locate a significantcustomer for our Top-Flite® branded apparel.

 

·      The effects on net cash provided by operatingactivities caused by changes in provisions for doubtful accounts and salesreturns primarily represent the net expense effects of the changes inallowances for doubtful accounts and sales returns between the respectiveyears. As of June 30, our allowances for doubtful accounts were $196,000in fiscal 2008, $235,000 in fiscal 2007 and $291,000 in fiscal 2006. Theallowances for 2008, 2007 and 2006 each included a specific reserve of $116,000with respect to certain customer accounts receivable. In September 2008,the Court awarded judgment in our favor and against a former inventory brokerin the amount of $291,135. In order to collect from the former broker, we willneed to domesticate the judgment in the province of Ontario, Canada. Sincecollection is not assured, we maintained the $116,000 reserve for potentialnon-recovery at September 30, 2008. We believe that the trend whichindicates a general decrease in the required allowance amount is primarily attributableto the changes in collection methods that we instituted in fiscal 2004. Thechanges in our collection methods helped us to shorten the collection processwith regard to past due accounts, thereby minimizing potentially uncollectibleamounts. Our allowances for customer sales returns at June 30 were $80,000in fiscal 2008, $139,000 in fiscal 2007 and $155,000 in fiscal 2006. Thepercentage of sales returns decreased dramatically in fiscal 2006 and hasremained relatively unchanged from fiscal 2006 through fiscal 2008. Weattribute the relative stability in our percentage of sales returns toenhancements within our order reservation and shipping systems in late fiscal2005 that generally ensure our customers that they will receive merchandise theyhave ordered in advance from us within a very few days from the specificreceipt date they have requested. We believe that the system enhancements havesignificantly reduced the amount of our sales returns with respect to lateand/or incomplete shipments. Provisions for doubtful accounts and sales returnsaffected net cash provided by (used in) operating activities by $73,000 infiscal 2008, ($13,000) in fiscal 2007 and ($71,000) in fiscal 2006.

 

·      Accounts receivable, not including the effects ofprovisions for doubtful accounts and sales returns, provided operating cash of$202,000 in fiscal 2008, $897,000 in fiscal 2007 and $616,000 in fiscal 2006.Accounts receivable, net of allowances, decreased from $3,066,000 at June 30,2007 to $2,791,000 at June 30, 2008. The decrease in fiscal 2008, ascompared with the fiscal 2007 receivable balance, was primarily attributable toa corresponding decrease in net sales between fiscal 2008 and fiscal 2007.

 

·      Inventories, not including the effects of inventoryimpairments and write-downs, used operating cash of $291,000 in fiscal 2008,$1,373,000 in fiscal 2007, as corrected, and $1,052,000 in fiscal 2006, ascorrected. 

 

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Our fashion apparelinventories increased by $61,000 at June 30, 2008, to $5,947,000, whencompared with the balance of $5,886,000 at June 30, 2007, as corrected. Wehad no significant branded apparel inventories or deposits at June 30,2008 or 2007.

 

·      Accounts payable used operating cash of $621,000 infiscal 2008, used operating cash of $109,000 in fiscal 2007, as corrected, andprovided operating cash of $1,396,000 in fiscal 2006, as corrected. Accountspayable decreased from $2,042,000 at June 30, 2007, as corrected, to$1,421,000 at June 30, 2008. Accounts payable included $476,000 inadditional customs duties payable at June 30, 2007, as corrected, and$685,000 in additional customs duties and interest thereon at June 30,2008, payable to US Customs and Border Protection with regard to the PriorDisclosure we are preparing. Changes in accounts payable also related todifferences in the timing between the years in the recording and payments ofexpenditures for inventory purchases, ordinary business expenses and other.

 

·      Accrued royalties, commissions and other expenses usedoperating cash of $374,000 in fiscal 2008, $119,000 in fiscal 2007 and $49,000in fiscal 2006. Accrued royalties, commissions and other expenses decreasedfrom $1,001,000 at June 30, 2007, to $627,000 at June 30, 2008. Thecomparative decrease between the 2007 and 2006 fiscal years primarily relatesto lower royalties and sales commissions due on correspondingly lower BenHogan® sales between the fourth quarters of fiscal 2008 versus 2007, acomparative decrease of $98,000 in minimum royalties payable and a comparativedecrease of $102,000 in accrued severance compensation payable between June 30,2008 and 2007. At June 30, 2007, we recorded a contingent liability androyalty expense of $178,000 with regard to minimum royalties due with regard toour license agreement for Top-Flite® branded apparel, because we anticipatedthat sales of Top-Flite® branded apparel would be insufficient to meet thecontractual 2007 calendar year minimum requirement. In March 2008, wereached an agreement with Callaway to remove the Top-Flite® brand from thelicense agreement, effective January 1, 2008, whereby the unpaid minimumroyalties due to Callaway as of December 31, 2007, with respect toTop-Flite® apparel were extinguished and forgiven. Because our sales of BenHogan® fashion apparel were insufficient to meet either the minimum sales orroyalty requirements for the first six months of calendar year 2008 under thenew license agreement for such apparel, we recorded a contingent liability androyalty expense of $80,000 at June 30, 2008, with respect to Ben Hogan®fashion apparel. Minimum royalties for Ben Hogan® fashion apparel are payablein January for the preceding calendar year, per the new license agreement.The decrease in severance compensation payable primarily related to thedecrease of $120,000 which was payable to our former chief executive officer asof June 30, 2007. The former officer received severance compensationthrough March 2008.

 

Net cash used ininvesting activities totaled $207,000, $419,000 and $28,000 for fiscal years2008, 2007 and 2006, respectively. The primary components of net cash used ininvesting activities were purchase of minority interest, maturities (purchases)of marketable securities and purchases and disposals of fixed assets.

 

·      Purchase of minority interest used investingactivities cash of $375,000 in fiscal 2007. In September 2006, Sport Haleyentered into an agreement with Explorer Gear to purchase its 49% interest inReserve Apparel for a lump sum payment of $375,000, since which time ReserveApparel has been a wholly-owned subsidiary of Sport Haley.

 

·      Purchase of marketable securities used investingactivities cash of $200,000 in fiscal 2008. No marketable securities werepurchased during fiscal 2007 or 2006. Marketable securities at June 30,2008, consisted of a certificate of deposit held at US Bank NationalAssociation as collateral for our revolving line of credit with that financialinstitution. The certificate of deposit matures and the revolving line ofcredit expires in December 2008. Due to the nature of the investments, wedid not recognize material unrealized gains or losses on marketable securitiesin fiscal 2008, 2007 or 2006. Therefore, the carrying values of marketablesecurities approximated their fair values at June 30, 2008, 2007 and 2006.

 

·      Purchases of fixed assets used investing activitiescash of $7,000, $44,000 and $44,000, in fiscal 2008, 2007, and 2006,respectively. Property and equipment, at cost, decreased from $4,461,000 at June 30,2007, to

 

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$3,856,000 at June 30,2008. As of June 30, 2008, a significant portion of the fixed assets usedin our operations were fully depreciated. We do not anticipate making anysignificant fixed asset additions in the near future.

 

·      Dispositions of fixed assets provided investingactivities cash of $0 in fiscal 2008, $0 in fiscal 2007 and $16,000 in fiscal2006, respectively. We do not have a significant amount of unutilized fixedassets, and we do not anticipate any significant asset dispositions in the nearfuture.

 

Net cash used infinancing activities totaled $0, $2,332,000 and $340,000 for fiscal 2008, 2007,and 2006, respectively. The primary components of net cash used in financingactivities were borrowings and repayments under our line of credit, repurchaseof common stock, cash dividend on common shares and stock option exercises.

 

·      In fiscal 2008, we borrowed $1,850,000 and repaid$1,850,000 under a line of credit agreement to fund temporary working capitalneeds. In fiscal 2007, we borrowed $300,000 and repaid $300,000 under the lineof credit agreement to fund temporary working capital needs.  We made no borrowings under a line of creditagreement in fiscal 2006. We had no outstanding borrowings under the line ofcredit at either June 30, 2008 or 2007.

 

·      In January 2007, we commenced a modified “DutchAuction” tender offer to purchase shares of our common stock. In February 2007,in accordance with the terms of the related Offer to Purchase agreement, weused cash of $2,332,000 to purchase 485,762 shares of our common stock that hadbeen properly tendered. Upon completion of the tender offer, we had 2,284,490shares of our common stock outstanding.

 

·      In fiscal 2006, we declared and paid a cash dividendto common shareholders which used financing activities cash of $693,000. Nodividends were declared or paid in either fiscal 2008 or 2007, and our Board ofDirectors does not anticipate that any dividends will be declared in theforeseeable future.

 

·      Historically, gross proceeds from the exercise ofstock options have fluctuated significantly from year to year. We realizedproceeds of $353,000 from the exercise of stock options in fiscal 2006. Nostock options were exercised in fiscal 2008 or 2007.

 

·      We had no long-term debt at June 30, 2008 or2007.

 

Substantially all of our purchases from offshoremanufacturers and sales to foreign distributors are U.S. Dollar denominatedand, consequently, we have no material currency exchange risk. We believe thatinflation has not materially affected the results of our operations during thethree most recent fiscal years.

 

**Off-Balance Sheet Arrangements**

 

During eitherfiscal 2008 or 2007, we did not have any relationships or arrangements withunconsolidated entities or financial partnerships, such as entities oftenreferred to as structured finance or special purpose entities, which would havebeen established for the purpose of facilitating off-balance sheet arrangementsor other contractually narrow or limited purposes.

 

**ITEM 8.****        FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

**INDEX**

 
| ** **                                               | ** ** | **Page** |
|----------------------------------------------------------|------------|----------|
|                                                     |       |     |
| Index to Financial Statements                            |       | F-1      |
|                                                     |       |     |
| Report of Independent Registered Public Accounting  Firm |       | F-2      |
|                                                     |       |     |
| Report of Independent Registered Public Accounting  Firm |       | F-3      |

 

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| Consolidated Balance Sheets                          |   | F-4    |
|------------------------------------------------------|--------|--------|
|                                                 |   |   |
| Consolidated Statements of Operations                |   | F-5    |
|                                                 |   |   |
| Consolidated Statement of Shareholders’ Equity  |   | F-6    |
|                                                 |   |   |
| Consolidated Statements of Cash Flows                |   | F-7    |
|                                                 |   |   |
| Notes to Consolidated Financial Statements           |   | F-8    |
|                                                 |   |   |
| Schedule II – Valuation and Qualifying Accounts |   | F-32   |

 
| **ITEM 9.** | **CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

 

As previously reported, on October 19, 2006, ourindependent registered accountants, Hein & Associates LLP (“Hein”),declined to stand for re-election after the completion of the audit for theyear ended June 30, 2006, and the Audit Committee of our Board ofDirectors engaged the firm Gordon, Hughes & Banks, LLP to act as ourindependent registered public accountants beginning with the year ended June 30,2007.

 

During the second most recent previous fiscal year,and any subsequent interim period preceding Hein’s declination to stand forre-election, we did not have any disagreements with Hein on any matter ofaccounting principles or practices, financial statement disclosure or auditscope or procedure, which if not resolved to the satisfaction of Hein wouldhave caused them to make reference to the subject matter of such a disagreementin connection with the issuance of this report on Form 10-K. Further,there were no reportable events (as defined in Regulation S-K Item301(a)(1)(v)) in connection with our second most recent prior fiscal yearaudit, or in any subsequent interim period preceding Hein’s declination, exceptthat, as previously reported, upon implementation of our operations software inJanuary 2004 and continuing through the fiscal quarter ended March 31,2006, programming and human errors were discovered which caused us to report amaterial weakness in our internal controls over financial reporting withrespect to inventory valuation.

 
| **ITEM 9A.** | **CONTROLS AND PROCEDURES** |
|--------------|-----------------------------|

 

**(a)****    Evaluationof Disclosure Controls and Procedures.**We designed our disclosure controlsand procedures to provide reasonable assurance of achieving our desireddisclosure control objectives. We maintain disclosure controls and proceduresto ensure that information required to be disclosed in the reports we filepursuant to the Securities Act of 1934, as amended (the “Exchange Act”), arerecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the Securities and Exchange Commission, and thatsuch information is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer as appropriate, toallow timely decisions regarding required disclosure. In designing andevaluating the disclosure controls and procedures, management recognizes thatany control and procedure, no matter how well designed and operated, can onlyprovide reasonable assurance of achieving the desired control objectives, andin reaching a reasonable level of assurance management necessarily was requiredto apply its judgment in evaluating the cost-benefit relationship of possibledisclosure controls and procedures.

 

Our management, with theparticipation of our Chief Executive Officer and our Chief Financial Officer,conducted an evaluation of the effectiveness of our disclosure controls andprocedures pursuant to Rule 13a-15 under the Exchange Act as of the end ofthe period covered by this report. Based on that evaluation, management,including our Chief Executive Officer and our Chief Financial Officer,concluded that, as of the end of the period covered by this report, ourdisclosure controls and procedures were effective in reaching a reasonablelevel of assurance that: (a) all material information relating to the 

 

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Company, required to be disclosed in this report, wasmade known to management in a timely manner; and (b) information wasrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and regulations.

 

**(b)****    Management’s Annual Report onInternal Control over Financial Reporting.**Our management, including ourChief Executive Officer and our Chief Financial Officer, is responsible forestablishing and maintaining adequate internal control over financial reportingas defined in Rules 13a-15(f) and 15d-15(f) under the ExchangeAct. Internal control over financial reporting refers to the process designedby, or under the supervision of, our Chief Executive Officer and ChiefFinancial Officer, and effected by our Board of Directors, management and otherpersonnel, to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles, andincludes those policies and procedures that:

 

(i)    pertain to the maintenance ofrecords that in reasonable detail accurately and fairly reflect thetransactions and dispositions of our assets;

 

(ii)   provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat our receipts and expenditures are being made only in accordance with theauthorization of our management and directors; and,

 

(iii)  provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use ordisposition of our assets that could have a material effect on the financialstatements.

 

Our management, includingour Chief Executive Officer and our Chief Financial Officer, does not expectthat our internal controls over financial reporting will, in all instances,prevent all errors and all fraud. A control system, no matter how wellconceived or operated, can only provide reasonable, not absolute, assurancethat the objectives of the control system are met. While our control systemsprovide a reasonable assurance level, the design of our control systemsreflects the fact that there are resource constraints, and the benefits of suchcontrols were considered relative to their costs. Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within the financial reports of Sport-Haley, Inc. have been detected.These 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 can 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.

 

During fiscal 2008, underthe supervision of our Chief Executive Officer and our Chief Financial Officer,we completed the design, documentation and implementation of our internalcontrols over financial reporting. We believe that we have purposely designedour controls to provide reasonable assurance regarding the reliability of ourfinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. However,the Company was not in compliance with Section 404 of the Sarbanes-OxleyAct of 2002, as of June 30, 2008, and management cannot state whether ornot our internal controls over financial reporting are effective. We begantesting our controls by utilizing the framework set forth in the reportentitled *“Internal Control – Integrated Framework”*published by the Committee of Sponsoring Organizations of the TreadwayCommission, known as “COSO,” as a basis to evaluate the effectiveness of ourinternal controls over financial reporting, but did not complete the detailedtesting of all our controls by June 30, 2008.

 

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Further, in August 2008, we became aware that our controls wereineffective to prevent the underpayment of customs duties on certain of ourimports of fashion apparel purchased from foreign suppliers. *See Item 9B Other Information below for our detailed explanation ofthis matter.* We discovered that we were underpaying import dutieswith regard to fashion apparel received from foreign suppliers for which fabrichad been purchased from another foreign supplier, because the informationreceived by our customs agent had failed to include the value of the fabric inthe total declared value of the apparel. We determined that the underpayment ofcustoms duties revealed a significant deficiency in our internal controls overfinancial reporting, and in September 2008 our remediation proceduresincluded designing and implementing specific internal controls to ensure thatour customs broker receives complete and accurate information to compute thecorrect value to be declared for import customs valuations. We expect tocomplete the testing of all our controls by December 31, 2008.

 

**(c)****   AttestationReport of the Registered Public Accounting Firm.** This annual report on Form 10-Kdoes not include an attestation report of our independent registered publicaccounting firm regarding internal controls over financial reporting. Ourreport was not subject to attestation by our independent registered publicaccounting firm pursuant to temporary rules of the Securities and ExchangeCommission that permit us to provide only management’s report in this annualreport. Our independent registered public accounting firm issued an unqualifiedopinion on our financial statements for the year ended June 30, 2008,included in this report on Form 10-K.

 

**(d)****   Changesin Internal Control Over Financial Reporting.**Except as noted above, therehave been no significant changes in our internal controls over financialreporting as defined in Rules 13a-15(f) or 15d-15(f) under theExchange Act during the three months ended June 30, 2008, that materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

**ITEM 9B.****       OTHERINFORMATION**

 

In August 2008, we determined that we wereunderpaying customs duties with regard to imported fashion apparel for which fabrichad been purchased separately from another foreign supplier. This issue wasbrought to our attention by a third party and was not an intentionalconcealment or act on the part of the Company or any of its officers, directorsor employees. For such imports, the information received by our customs agenthad failed to include the value of the fabric in the total declared value ofthe apparel.

 

In order to correct the amount of duty payable to USCustoms and Border Protection for such imports, we began voluntarily preparinga Prior Disclosure in September 2008. A Prior Disclosure is a specificprocedure proscribed by US Customs and Border Protection for the purpose ofidentifying and correcting amounts which were previously declared or omittedfrom declaration. Our Prior Disclosure will correct amounts with regard to ourimports for the five-year period immediately prior to the date the PriorDisclosure is submitted to US Customs and Border Protection. We expect tosubmit our Prior Disclosure in October 2008. In September 2008, weretained an import duties consultant to assist us with the Prior Disclosure.The consultant has advised us that, upon our delivery of the Prior Disclosureand the payment of applicable amounts and interest thereon, it is highly unlikelythat US Customs and Border Protection will assess further fines and/orpenalties with regard to this matter. Therefore, we believe that upon deliveryof our Prior Disclosure and the related payment, US Customs and BorderProtection will consider this matter closed. We determined that additionalcustoms duties owed for fiscal 2008 and the applicable periods within the priorfour fiscal years totaled $641,000 and that interest due thereon totaled$44,000.

 

In order to assess materiality with regard to theunderpaid customs duties, we applied the concepts set forth in Staff AccountingBulletin No. 108 (“SAB 108”), *“Considering the Effectsof Prior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements,”* issued by the Securities and ExchangeCommission and FASB Concepts Statement No. 2, *“QualitativeCharacteristics of Accounting Information.”* We applied the ironcurtain and rollover approaches proscribed by SAB 108 to quantify the effectson the current and prior fiscal years caused by the underpaid customs duties.Per SAB 108,

 

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“The iron curtain approach quantifies a misstatement based upon theeffects of correcting the misstatement existing in the balance sheet at the endof the current year, irrespective of the misstatements year(s) oforigination.” The rollover approach quantifies a misstatement based on theamount of the error originating in the income statement for the year in whichthe error occurred. Per FASB Concepts Statement No. 2, qualitativemateriality determinations are based upon whether “it is probable that thejudgment of a reasonable person relying upon the report would have been changedor influenced by the inclusion or correction of the item.”

 

Our qualitative analysis and our quantitative analysisunder the rollover approach each yielded results that indicate the correctionof prior year financial statement amounts is immaterial in each case. Ourquantitative analysis under the iron curtain approach yielded results thatindicate application of the iron curtain method would cause our fiscal 2008financial statements to be materially misstated. When analyzing materialityunder the iron curtain and rollover approaches, SAB 108 directs, “[A]registrant’s financial statements would require adjustment when either approachresults in quantifying a misstatement that is material, after considering allrelevant quantitative and qualitative factors.” SAB 108 further instructs, “[A]fterall of the relevant quantitative and qualitative factors are considered, theprior year financial statements should be corrected, even though such revisionpreviously was and continues to be immaterial to the prior year financialstatements. Correcting prior year financial statements for immaterial errorswould not require previously filed reports to be amended. Such correction maybe made the next time the registrant files the prior year financial statements.”Accordingly, we have corrected our fiscal 2007 and fiscal 2006 financial statementsand our retained earnings as of July 1, 2005, which are submitted herewithin Part IV, Item 15.

 

**PART III**

 

**ITEM 10.****       DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

 
| **Name**                        | ** ** | **Age** | ** ** | **Position**                                           | ** ** | **# Years as Director** |
|---------------------------------|------------|---------|------------|--------------------------------------------------------|------------|----------------------------------------|
|                            |       |    |       |                                                   |       |                                   |
| Donald W. Jewell                |       | 57      |       | Chief Executive  Officer,                              |       | 1                                      |
|                            |       |    |       | President and  Director                                |       |                                   |
|                            |       |    |       |                                                   |       |                                   |
| Patrick W.  Hurley              |       | 56      |       | Chief Financial  Officer                               |       | —                                 |
|                            |       |    |       | Secretary and  Treasurer                               |       |                                   |
|                            |       |    |       |                                                   |       |                                   |
| Catherine B.  Blair             |       | 57      |       | Vice President -                                       |       | —                                 |
|                            |       |    |       | Merchandising/Design                                   |       |                                   |
|                            |       |    |       |                                                   |       |                                   |
| Ronald J. Norick  (2)(3)(4)     |       | 66      |       | Director and                                           |       | 14                                     |
|                            |       |    |       | Chairman of the  Board                                 |       |                                   |
|                            |       |    |       |                                                   |       |                                   |
| James R.  TenBrook (1)(2)(3)(4) |       | 60      |       | Director and  Chairman  of the Audit Committee         |       | 3                                      |
|                            |       |    |       |                                                   |       |                                   |
| Mark J.  Stevenson (1)(2)(3)(4) |       | 69      |       | Director and  Chairman  of the Compensation  Committee |       | 14                                     |
|                            |       |    |       |                                                   |       |                                   |
| William O.  Johnstone (1)(3)(4) |       | 60      |       | Director                                               |       | 1                                      |

 

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(1)   Memberof the Audit Committee

(2)   Memberof the Compensation Committee

(3)   Memberof the Nominating Committee

(4)   TheBoard of Directors has determined that this director is independent pursuant tothe applicable FINRA rules

 

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Officers are appointed by and serve at the discretion of the Board ofDirectors. Each Director holds office until the next annual meeting ofshareholders or until a successor has been duly elected and qualified, subjectto the terms and conditions of their respective employment agreements. All ofour officers devote full-time to our business and affairs.

 

*Donald W. Jewell*was appointed byour Board of Directors in October 2004 to serve as our Interim ChiefExecutive Officer. Mr. Jewell was appointed in April 2005 to serve asour President and has served as ourSenior Vice President since February 2001. Mr. Jewell served asPresident for a term consistent with that of his service as our Interim ChiefExecutive Officer. In September 2006, Mr. Jewell agreed to serve asour Chief Executive Officer and President on a permanent basis, and he nolonger serves as our Senior Vice President. In February 2007, Mr. Jewellwas elected to serve as a Director. From 1996 until joining us, Mr. Jewellwas the founder, president and director of Jewell Apparel Group, a Canadiandistributor of premium and mid-priced men’s golf apparel. Mr. Jewell begandesigning, sourcing and marketing golf apparel in 1993 while serving as thepresident and chief executive officer of Jewell-Rung, positions that he heldfrom 1980 to 1996.

 

*Patrick W. Hurley* has served asour Secretary and Treasurer since November 1999, as our Controller from November 1999to August 2006 and as our Chief Financial Officer since December 2000.Prior to joining us, Mr. Hurley was employed as a senior staff accountantat Saltzman Hamma Nelson Massaro LLP, Denver, Colorado, where among otherthings, he supervised or participated in the preparation of audited andunaudited financial statements and income tax returns, and provided advice andtraining for business clients regarding selection and implementation ofaccounting systems and procedures. Mr. Hurley is a certified publicaccountant and received a bachelor of science degree in accounting in 1991. Mr. Hurleyis also a member of the American Institute of Certified Public Accountants andthe Colorado Society of Certified Public Accountants.

 

*Catherine B. Blair* has served asour Vice President - Merchandising/Design since her appointment in May 1996.Ms. Blair has been part of our design team since 1992, and was appointedDirector of Design in 1995. Prior to joining us, Ms. Blair was a designerfor a golfwear company and also worked as a freelance designer for companiessuch as Macy’s, Bloomingdale’s, Ann Taylor and The Gap.

 

**KeyEmployees**

 

*George E. (“Tom”) Tomlinson* hasserved as our Director – Operations and Production since December 1997.Previously, Mr. Tomlinson served as our warehouse distribution managerfrom January 1993 until December 1997. Prior to joining the Companyin 1993, Mr. Tomlinson held various positions in other companies,including purchasing for Belle Bonfils Memorial Blood Center. Mr. Tomlinsonis the brother of our late Chairman and Chief Executive Officer, Robert G.Tomlinson, and the uncle of our former Chief Executive Officer, Kevin M.Tomlinson.

 

*Steve S. Barr* has served as ourManaging Director of Sales - Retail Division since November 2006 withresponsibilities including identifying, opening and developing new accounts forour Ben Hogan® fashion apparel and Top-Flite® branded apparel within departmentstore, specialty retail store and mass retail store markets. From May 2006through October 2006, Mr. Barr provided consulting services to usregarding our management of the Wal-Mart account for our Top-Flite® brandedapparel. From April 2005 through April 2006, Mr. Barr was thevice-president of sales for the men’s private label sportswear division ofOxford Industries, with responsibilities including managing Oxford Industries’Wal-Mart account and for establishing accounts with other mass retailers. From1998 until March 2005, Mr. Barr was employed by Tropical SportswearInt’l, a leading maker of both private label and branded apparel, serving assales director and most recently as senior vice president with responsibilityfor supervising the mass retail division. Mr. Barr received a bachelor ofscience degree in accounting in 1984.

 

*Barry L. Hyman* served as ourEastern Regional Sales Manager from February 2004 to November 2007and served on an interim basis as our Western Regional Sales Manager from December 2005to February 2006. Mr. Hyman was an independent wholesale salesrepresentative for our Ben Hogan® apparel lines from 2001 until his appointmentas Eastern Regional Sales Manager. From 1990 to 2001, Mr. Hyman was anindependent sales representative for various companies in the golf apparelindustry, including Jewell Apparel Group, Precept Golf, Greg Norman and the BenHogan® Company.

 

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*Michael D. Doris* served as ourWestern Regional Sales Manager from February 2006 to November 2007.Prior to joining the Company, Mr. Doris was the western regional salesmanager for Cutter & Buck, Inc. from 2002 to 2005 and a salesrepresentative for Cutter & Buck, Inc. from 1997 to 2002. Mr. Dorisserved as head golf professional and manager of various golf courses from 1994to 1997. From 1986 to 1994, Mr. Doris served as a sales representative forsuch companies as The Ben Hogan® Company and Slazenger Golf USA.

 

**IndependentDirectors**

 

*Ronald J. Norick* has been aDirector since November 1993. In October 2004, subsequent to thedeath of Robert G. Tomlinson, Mr. Norick was appointed by the Board ofDirectors to fill a non-officer position of Chairman of the Board, createdsubsequent to Mr. Tomlinson’s death. Mr. Norick also serves on theCompensation and Nominating Committees of the Board and served on the AuditCommittee of the Board until February 2007. From April 1987 until April 1998,Mr. Norick served as the elected Mayor of the City of Oklahoma City,Oklahoma. From 1960 to 1992, Mr. Norick served in various capacities,including serving as president from 1981 to 1992, of a closely-held printingcompany, which was acquired by Reynolds & Reynolds in June 1992. Mr. Norickserves on a number of civic, community, educational, corporate and publicboards, commissions and committees and is a director of BancFirst Corporation,a publicly-held corporation based in Oklahoma City, Oklahoma. Mr. Norickalso serves as controlling manager of Norick Investments Company LLC, afamily-owned limited liability company, which is engaged in investments.

 

*James R. TenBrook* has been aDirector since March 2004. Mr. TenBrook has served as the Chairman ofthe Audit Committee since March 2004 and also serves on the NominatingCommittee. Mr. TenBrook is the president and a shareholder of KarshConsulting, P.C. of Denver, Colorado, has been a certified public accountantsince 1973, received his personal financial specialist certification in 1994and is a certified valuation analyst. Mr. TenBrook’s practice consistsprimarily of litigation support, tax and estate planning. Mr. TenBrook isa member of the Colorado Society of Certified Public Accountants (“CSCPA”),served on the CSCPA’s board of directors from 1996-1999 and served on the CSCPAPersonal Financial Planning Committee from 1991-1994 (serving as Chairman ofthe Committee in 1993 and 1994). Mr. TenBrook is also a member of theAmerican Institute of Certified Public Accountants. We believe that Mr. TenBrookmeets the definition of independence under both SEC and FINRA Rules.

 

*Mark J. Stevenson* has been aDirector since November 1993. Mr. Stevenson serves on the AuditCommittee, the Compensation Committee (as its Chairman) and the NominatingCommittee. Mr. Stevenson served as president and chief executive officerof Zenodata Corporation, a Colorado based financial services software company,from March 2001 until his retirement in April 2005. In May 2005,Zenodata Corporation made an assignment for the benefit of creditors. Mr. Stevensonheld the positions of chairman of the board, president and chief executiveofficer of Electronic Manufacturing Systems, Longmont, Colorado, a contractmanufacturer serving the computer, data storage, telecommunications and medicalequipment industries, from June 1994 until that company was merged intoE-M-Solutions in January 1999. At that time, Mr. Stevenson wasappointed executive chairman and chairman of the board of E-M-Solutions, whichfiled for bankruptcy protection in the Northern District of California inapproximately November 2001 and was immediately purchased by Sanmina/SCI.From 1992 to 1994, Mr. Stevenson served as chairman of the board for MicroInsurance Software, Inc., Boulder, Colorado, a manufacturer of computersoftware oriented to the insurance industry. Mr. Stevenson served on theColorado Governor’s Commission on Science and Technology for five years endingin 2004 and currently serves on the Advisory Council of the University ofColorado Deming Center for Entrepreneurship. Mr. Stevenson formerly servedas chairman of the American Electronics Association, the nation’s largest hightechnology trade association.

 

*William O. Johnstone* has servedas a Director since February 2007. Mr. Johnstone is the manager andchief executive officer of Council Oaks Partners, LLC, a private equity firm inOklahoma City, Oklahoma. Mr. Johnstone is a director and vice chairman ofBancFirst Corporation, a publicly-traded banking corporation based in OklahomaCity, Oklahoma, of which Mr. Norick is also a director. Council OaksPartners, LLC, is a subsidiary of BancFirst Corporation. Mr. Johnstone isalso the chief executive officer of Council Oak Investment Corporation andCouncil Oak Real Estate, Inc., both of which are subsidiaries of BancFirstCorporation. From 1996 to 2001, Mr. Johnstone

 

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served as chairmanand co-chief executive officer of C-Teq, Inc., a company that provideddata processing services to financial institutions. From 1985 until 1996, Mr. Johnstoneserved as president and chairman of the board for City Bankshares, Inc.and its subsidiary, City Bank & Trust, Oklahoma City, Oklahoma.

 

*James H. Everest* served as aDirector from November 1993 until his resignation in October 2007 dueto health reasons. Mr. Everest served on the Compensation and NominatingCommittees until October 2007 and served on the Audit Committee until March 2004.Mr. Everest has served as president of the Jean I. Everest Foundation,Oklahoma City, Oklahoma, since 1991. The Jean I. Everest Foundation wasorganized by Mr. Everest’s father to conduct charitable activities. Since1984, Mr. Everest has been the managing partner of Everest Brothers, ageneral partnership active in oil and gas exploration and development and hasalso been engaged in managing his personal investments. Mr. Everest is amember of the Oklahoma Bar Association and the American Bar Association andserves in a number of capacities for various civic and community organizations.

 

**Compliancewith Section 16(a) of the Exchange Act**

 

Under the securities laws of the United States, our directors,executive officers and any persons holding more than ten percent of our commonstock are required to report their initial ownership of common stock and otherequity securities and any subsequent changes in that ownership to theSecurities and Exchange Commission and to Sport-Haley, Inc. Specific due datesfor these reports have been established and we are required to disclose in thisannual report on Form 10-K any failure to file, or late filing, of suchreports with respect to the period ended June 30, 2008. Based solely uponour review of the reports furnished to us and written representations that noother reports were required during fiscal 2008, we believe that our officers,directors and beneficial owners of more than ten percent of our common stockcomplied with all Section 16(a) requirements.

 

**BoardCommittees**

 

The Board of Directors has delegated certain of its authority to anAudit Committee, a Compensation Committee and a Nominating Committee. The AuditCommittee is comprised of Messrs. TenBrook, Stevenson and Johnstone. TheCompensation Committee is comprised of Messrs. Stevenson, Norick andTenBrook. The Nominating Committee is comprised of Messrs. Norick,TenBrook, Stevenson and Johnstone. Mr. TenBrook serves as Chairman of theAudit Committee and Mr. Stevenson serves as Chairman of the CompensationCommittee. No member of these three committees is a current or former officeror employee of Sport-Haley, Inc. or its current or former subsidiaries. Wehave determined that each member of the Audit Committee, Compensation Committeeand Nominating Committee qualifies as an “independent” director under theapplicable FINRA Rules.

 

*AuditCommittee*

 

The major functions of the Audit Committee are to discuss the scope ofaudit procedures employed, to review and approve the audit reports rendered byour independent auditors and to approve the audit fee charged by theindependent auditors. In addition, pursuant to the Sarbanes-Oxley Act of 2002and rules promulgated thereunder, the Audit Committee is responsible for,among other things, pre-approving all audit and non-audit services performed bythe independent auditors, approving the engagement of the auditors andreceiving certain reports from the independent auditors prior to the filing ofthe audit report. The Audit Committee reports to the Board of Directors withrespect to such matters and recommends the selection of independent auditors.James R. TenBrook has served as the Chairman of the Audit Committee since March 2004.

 

Since March 2004, when James R. TenBrook was elected as Directorand appointed to the Audit Committee as its Chairman, the Board has determinedthat Mr. TenBrook meets the definition of an audit committee financialexpert, as defined by SEC regulations. In addition, the Board has determinedthat Mr. TenBrook also meets the requirements for independence under SEC rules andthe applicable FINRA Rules.

 

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*CompensationCommittee*

 

The primary function of the Compensation Committee is to review andmake recommendations to the Board with respect to the compensation, includingbonuses, of our officers and to administer our Stock Option Plan. See *“Compensation Committee Report”* included in Item 11 below.

 

*NominatingCommittee*

 

The Nominating Committee recommends to the Board the persons to be nominatedfor election as Directors at any meeting of stockholders, develops andrecommends to the Board a set of corporate governance principles applicable tothe Company and oversees the evaluation of the Board. The Board has determinedthat each of the members of the Nominating Committee is “independent,” as thatterm is defined by applicable FINRA Rules

 

Since forming the Nominating Committee, adopting a formal charter, andadopting nomination procedures, there have been no material changes to theprocedures by which security holders may recommend nominees to our Board ofDirectors.

 

**Code ofEthics**

 

In January 2004, we adopted a Code of Ethics for Senior FinancialOfficers, which applies to all senior financial officers of the Company,including the Chief Executive Officer, the Chief Financial Officer, theTreasurer and any other person performing similar functions. In addition, in May 2004,we adopted a Code of Conduct and Ethics for Directors, Officers and Employees,which is applicable to all of our directors, officers and employees. A copy ofthese codes may be obtained without charge by written request for copies ofthem addressed to: Corporate Secretary, Sport-Haley, Inc., 4600 E. 48thAvenue, Denver, CO 80216-3215.

 

**ITEM 11.****       EXECUTIVECOMPENSATION**

 

**CompensationDiscussion and Analysis**

 

The following discussion and analysis provides information regardingour executive compensation objectives and principles, procedures, practices anddecisions, and is provided to help give perspective to the numbers andnarratives that follow the tables in this section. This discussion will focuson our objectives, principles, practices and decisions with regard to thecompensation of the following three named executive officers (the “NEOs”):

 

·              Donald W. Jewell –Chief Executive Officer and President

·              Patrick W. Hurley –Chief Financial Officer, Secretary and Treasurer

·              Catherine B. Blair –Vice President – Merchandising/Design

 

Compensation programs for our NEOs are determined and proposed by ourCompensation Committee and are approved by the Board of Directors. None of theNEOs are members of the Compensation Committee or otherwise had any role indetermining the compensation for themselves or other NEOs, although theCompensation Committee does receive input from the NEOs when consideringadjustments to base salary and other compensation components and the ChiefExecutive Officer’s recommendations with respect to compensation of the otherNEOs. The Compensation Committee conducts an annual review****ofour executive compensation programs to ensure that they meet the objectivesdescribed below. The Compensation Committee relies on its judgment in makingcompensation decisions after reviewing our performance and evaluating eachexecutive’s performance against established goals, leadership ability andresponsibilities, and current compensation arrangements. When setting totalcompensation for each of the NEOs, the Compensation Committee reviews each NEO’scurrent compensation, including equity and non-equity based compensation. TheCompensation Committee also evaluates through local surveys and human resourcepublications comparable base and incentive compensation ranges for similar jobdescriptions.

 

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**ExecutiveCompensation Objectives and Overview**

 

The overall objective of our executive compensation program is tocreate long-term value for our stockholders by attracting and retainingtalented executives, rewarding superior operating and financial performance,and aligning the long-term interests of our executives with those of ourstockholders. Accordingly, our executive compensation program incorporates thefollowing principles:

 

·    Compensation should be basedon individual job responsibility, demonstrated leadership ability, managementexperience, individual performance and achieving Company financial goals.Employees in positions of leadership and broad responsibility are generallycompensated by elements that are linked to our overall performance.

 

·    Compensation should reflectthe fair market value of the services received. We believe that a fair andcompetitive pay package for the NEOs is essential to attract and retaintalented executives in key positions.

 

·    Compensation is designed toreward NEOs based on both our short-term and long-term performance. Base salaryis tied to individual performance and market conditions for similar positions.Bonuses, if any, are tied to achievement of short-term quantitative performancegoals that we believe closely correlate to share value. Long-term performancehas historically been rewarded through equity-based awards such as stockoptions, the value of which depends on future share prices, and the realizationof which is contingent on satisfaction of vesting schedules requiring continuedservice with us.

 

**Elementsof Executive Compensation**

 

Our current executive compensation program is based upon four maincomponents, designed to be consistent with our compensation objectives: (1) basesalary; (2) annual incentive bonuses; (3) grants of stock options;and, (4) perquisites and other benefits.

 

The following is a more detailed explanation of the primary componentsof our executive compensation program.

 

*Base Salary.*Base salaries areset initially in each NEO’s respective executive employment agreement, and arereviewed annually by the Compensation Committee. Base salaries serve as theguaranteed cash portion of executive compensation. A base salary is intended tocompensate an executive for performing his or her job responsibilities on a day-to-daybasis and is intended to reflect that executive’s skill set as well as themarket value for that position. The Compensation Committee sets the base pay ofthe Chief Executive Officer. Base pay for other NEOs is set by the CompensationCommittee after reviewing the recommendation of the Chief Executive Officer.Annual adjustments are influenced by growth of our operations, revenues andprofitability, individual performance, changes in responsibility and otherfactors.

 

Each NEO’s base salary is generally fixed at the time the executive isfirst hired or is promoted to the executive officer level. In setting the basesalary, the Compensation Committee reviews job requirements and performanceexpectations, and conducts an informal market survey to determine thecompetitiveness of the base salary. The Compensation Committee reviews basesalaries annually and adjustments are made as appropriate to recognizeoutstanding individual performance, expanded duties, or changes in thecompetitive marketplace. In 2008, we increased the base salary of Catherine B.Blair, our Vice President — Merchandising/Design, to $160,000, as she has beenintegral to the success of our SPORT HALEY® women’s fashion apparel. Ms. Blairhas responsibility for designing and sourcing our SPORT HALEY® women’s fashionapparel. We did not adjust the base salary of any of our other NEOs in 2008.

 

The base salary for each of the named executive officers during 2008,according to their respective effective employment agreement, was as follows:

 

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| Donald W. Jewell    |   | Chief Executive  Officer and President            | $ | 325,000 |
|---------------------|--------|---------------------------------------------------|---|---------|
| Patrick W.  Hurley  |   | Chief Financial  Officer, Secretary and Treasurer | $ | 125,000 |
| Catherine B.  Blair |   | Vice President –  Merchandising/Design       | $ | 160,000 |

 

*Cash Bonuses.* The employmentagreements of each of our NEOs contain provisions allowing for annual incentivebonuses, at the discretion of the Compensation Committee, of up to 30% of theexecutive’s base salary, in accordance with our bonus plan.****Eachyear, depending upon the Company’s annual financial performance and otherobjectives, a determination is made as to whether an annual bonus is anecessary part of the overall executive compensation package.  In those years where it is determined that anannual bonus is merited, a bonus serves as the short-term incentivecompensation element of the executive compensation program and is intended toprovide an incentive for an executive to achieve a high level of corporate andindividual performance. The payout of annual bonuses to NEOs is subject to theapproval of the Compensation Committee following its review of executives’performances against the designated corporate and individual performancecriteria.****No bonuses were awarded to our NEOs in2008 or 2007, since key revenue and profit objectives were not achieved. During2006, we awarded a cash bonus to Mr. Jewell of $50,000 and transferredtitle in a Company automobile to him (with an estimated fair value of $14,000);we awarded Mr. Hurley a cash bonus of $12,000; and, we awarded Ms. Blaira cash bonus of $3,000.

 

*Long Term Incentives – Stock Options.*TheCompensation Committee believes that option grants provide significantperformance incentives and that long-term equity-based compensation is animportant element of our overall compensation program because it helps focusour executives on our long-term financial goals and operational performance andalso aligns the interests of our executives with those of our shareholders. Thepotential financial value offered through such options, along with the typicalvesting period, is also an important retention tool.

 

Historically, we have granted common stock options to our executiveofficers and directors as a form of long-term incentives. In January 2008,we adopted a new stock option plan, entitled the Sport-Haley 2008 Stock OptionPlan (the “2008 Plan”). Under the 2008 Plan, the Compensation Committee isauthorized to grant up to 50,000 non-qualified stock options and up to 150,000incentive stock options. No options or other awards have been granted under the2008 Plan.

 

We formerly adopted an Amended and Restated Stock Option Plan in 1993(the “Former Plan”). The Former Plan provided for the granting of incentivestock options within the meaning of Section 422 of the Internal RevenueCode of 1986, as amended, non-qualified stock options and stock appreciationrights (“SARs”). The Former Plan expired by its terms in February 2003.Options granted under the Former Plan typically vested over three years, whichprovided the recipient some incentive to remain with the Company.

 

The 2008 Plan and Former Plan are administered by the CompensationCommittee. Upon termination of a participant’s employment or consultingrelationship with Sport-Haley, all unvested options terminate and are no longerexercisable. Vested options remain exercisable for a specified period of timefollowing the termination date. The length of such an extended exercise periodgenerally ranges from 30 days to one year, depending on the nature andcircumstances of the termination.

 

Each of our NEOs has previously been granted options under the FormerPlan, all of which are currently vested and exercisable. The options granted toour NEOs under the Former Plan will expire, based upon the date of theirissuance, from January 2010 through February 2012. The CompensationCommittee did not utilize a specific formula as the basis for granting awardsunder our Former Plan. No options could be granted under the Former Plansubsequent to February 28, 2003, when the Option Plan expired by itsterms.

 

Options granted pursuant to the Former Plan prior to its expirationremain exercisable according to the terms of their issuance. All of the optionspreviously granted under the Former Plan are now fully vested. The exerciseprice of each incentive option granted under the Former Plan must have been atleast equal to the fair market value of the common stock of Sport-Haley on thedate of grant. In the case of an optionee who owned stock possessing more thanten percent of the total combined voting power of all classes of stock of SportHaley, the exercise price of incentive options could not be less than 110% ofthe fair market value of the Common Stock on the date of grant. The exercise

 

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price of allnon-qualified stock options granted under the Option Plan was determined by theCompensation Committee, but could not be less than 85% of the fair market valueof the Common Stock.

 

As of June 30, 2008, a total of 586,000 non-qualified options wereoutstanding, with exercise prices ranging from $2.71 to $9.78 per share and aweighted average exercise price per share of $3.15. During the quarter ended June 30,2008, no options were exercised and no options expired.

 

*Perquisites and Other Benefits.*Perquisites and other benefits provided to the NEOs include basic group healthcare coverage (the Company pays 80% of the NEO’s prorated premium for groupmedical insurance exclusive of spousal and dependent coverage), life insurance(the Company pays the premium for $50,000 of term life insurance per salariedemployee in a group plan), paid vacations and 401(k) plan employercontributions (the Company matches employee contributions up to 3% of theirannual compensation plus 50% of their contributions from 3 to 5% of theirannual compensation, within applicable federal limits). The CompensationCommittee believes that those benefits, which are detailed in the SummaryCompensation Table under the heading “All Other Compensation,” are reasonable,competitive and consistent with our overall executive compensation program. Inaddition, with regard to our Chief Executive Officer, we also pay for certainautomobile expenses and his golf club membership dues. We have also paid for apersonal assistant to our Chief Executive Officer, who primarily providednon-business related personal services.

 

**Terminationand Severance Benefits**

 

The Company has entered into an employment agreement with each of theNEOs. The Company’s executive employment contracts are generally based upon astandard form of agreement with various modifications, depending on theposition. Each employment agreement generally requires the executive officer todevote his or her full productive time and best efforts to the Company and tohold in confidence all trade secrets and proprietary information he or shereceives from the Company. The employment agreements set forth the base salary,incentive compensation, benefits and perquisites that the executive officer isentitled to as described above. The employment agreements also set forth thebenefits and rights, as described below, to which the executive officers areentitled upon termination of employment and upon a change-in-control of theCompany.

 

*Donald W. Jewell.*****With respect to our Chief Executive Officer and President,Donald W. Jewell, if we elect to terminate his employment for other than “cause”(as defined in the employment agreement), or if Mr. Jewell were toterminate the agreement for cause, Mr. Jewell would be entitled to receiveseverance compensation equal to twelve months salary and 50% of the last annualbonus paid to him. During the time he were to receive any such severancecompensation, Mr. Jewell is eligible to participate in all employeebenefit plans, at our expense. If there were to be a non-negotiated change incontrol of Sport-Haley, Inc., and either we or Mr. Jewell terminatethe agreement within sixty days of the change of control, then Mr. Jewellwould be entitled to lump sum severance compensation equal to three times hisannual salary and bonus payments during the preceding 12 months. In the eventof termination due to a non-negotiated change in control, options previouslygranted to Mr. Jewell would become fully vested and exercisable on thedate of termination. In the event of termination by either party without cause,options previously granted would vest and become exercisable on a proratedbasis from the date of grant to the date of termination.

 

*Patrick W. Hurley.* If we elect toterminate the executive employment agreement with Patrick W. Hurley, our ChiefFinancial Officer, Secretary and Treasurer, without “cause” (as defined in theagreement) or not to renew the agreement upon its expiration, or if Mr. Hurleyterminates the agreement with or without cause, he is entitled to receiveseverance compensation equal to six months’ salary, plus 50% of the last annualbonus paid to him. During the time he were to receive any such severancecompensation, Mr. Hurley is entitled to participate in all employeebenefit plans, at our expense. If there were to be a non-negotiated change incontrol of Sport-Haley, Inc., and either we or Mr. Hurley terminatethe agreement within sixty days of the change of control, then Mr. Hurleyis entitled to lump sum severance compensation equal to three times his annualsalary and bonus payments during the preceding 12 months. In the event

 

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of termination dueto a non-negotiated change in control of Sport-Haley, Inc., optionspreviously granted to Mr. Hurley would become fully vested and exercisableon the date of termination. In the event of termination by either party withoutcause, options previously granted would vest and become exercisable on aprorated basis from the date of grant to the date of termination.

 

*Catherine B. Blair.* If we electto terminate the executive employment agreement with Catherine B. Blair, ourVice President of Merchandising/Design, without “cause” (as defined in theagreement) or not to renew the agreement upon its expiration, or if Ms. Blairterminates the agreement with or without cause, she is entitled to receiveseverance compensation equal to fifteen months’ salary, plus 50% of the bonus,if any, paid to her in the preceding 12 months. During the time she were toreceive any such severance compensation, Ms. Blair is entitled toparticipate in all employee benefit plans, at our expense. If there were to bea non-negotiated change in control of Sport-Haley, Inc., and either we or Ms. Blairterminate the agreement within sixty days of the change of control, then Ms. Blairis entitled to lump sum severance compensation equal to three times her annualsalary and bonus payments during the preceding 12 months. In the event oftermination due to a non-negotiated change in control of Sport-Haley, Inc.,options previously granted to Ms. Blair would become fully vested andexercisable on the date of termination. In the event of termination by eitherparty without cause, options previously granted would vest and becomeexercisable on a prorated basis from the date of grant to the date oftermination.

 

**Tax andAccounting Considerations**

 

*Deductibilityof Executive Compensation*

 

Section 162(m) of the Internal Revenue Code, as amended,generally limits the deductibility of certain compensation in excess of$1,000,000 paid in any one year to either the Chief Executive Officer or any ofthe other three highest paid executive officers. Qualified performance-basedcompensation is not subject to limit if certain requirements are met. TheCompensation Committee periodically reviews and considers the deductibility ofexecutive compensation under Section 162(m) in designing ourcompensation programs and arrangements. While we will continue to monitor ourcompensation programs in light of Section 162(m), the CompensationCommittee intends to retain the flexibility necessary to provide totalcompensation that is consistent with our competitors and the market, ourcompensation philosophy and the Company’s best interests. As a result, theCompensation Committee may conclude that paying compensation at levels that arenot deductible under Section 162(m) is nevertheless in the bestinterests of the Company and our stockholders.

 

*Accountingfor Stock-Based Compensation*

 

Effective July 1, 2005, we adopted Statement of FinancialAccounting Standards No. 123(R), “*Share-Based Payment*”,which requires that we recognize as compensation expense the fair value of allstock-based awards, including stock options, granted to employees and others inexchange for services, over the requisite service period, under our stockoption plan.

 

**Equity orother Security Ownership Requirements or Guidelines**

 

We do not require our executive officers or directors to maintainownership of any specified amounts of our common stock. None of our NEOs ownshares of our common stock. One of our directors beneficially owns shares ofour common stock. *See* “Item 12. Security Ownershipof Certain Beneficial Owners and Management and Related Stockholder Matters”below.

 

**Report ofthe Compensation Committee**

 

The following statement made by the Compensation Committee shall not bedeemed incorporated by reference into any filing under the Securities Act of1933, as amended, or the Securities Exchange Act of 1934, as amended, and shallnot otherwise be deemed filed under either of these Acts.

 

The Compensation Committee has reviewed and discussed with managementthe Compensation Discussion and Analysis required by Item 402(b) ofRegulation S-K, which precedes this report (see “Item 11. ExecutiveCompensation – Compensation Discussion and Analysis” above). Based on suchreview and discussion, the

 

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Compensation Committeerecommended to our Board that the Compensation Discussion and Analysis sectionbe included in this annual report on Form 10-K.

 
| * * | * * | *By the Compensation Committee  of the Board of Directors of Sport-Haley, Inc.* |
|----------|----------|--------------------------------------------------------------------------------------|
|     |     | Mark J. Stevenson, Chairman                                                          |
|     |     | Ronald J. Norick                                                                     |
|     |     | James R. TenBrook                                                                    |

 

**Compensation Committee Interlocksand Insider Participation**

 

The followingnon-employee directors currently serve on the Compensation Committee of theBoard of Directors: Mark J. Stevenson (Chairman), Ronald J. Norick and James R.TenBrook. There are no interlocks of executive officers or directors of theCompany serving on the Compensation Committee or equivalent committee ofanother entity, which has any director or executive officer serving on theCompensation Committee, other committees or the Board of Directors of theCompany.

 

**Summary Compensation Table**

 

The following table setsforth compensation information regarding our named executive officers for thelast three fiscal years ended June 30, 2008.

 

Elements of compensationfor our NEOs include salary, discretionary cash bonuses, options to purchaseshares of our common stock under our former stock option plan and otherperquisites and benefits. We do not have a pension plan, do not pay non-equityincentive plan based compensation and do not offer nonqualified deferredcompensation arrangements. We also did not grant stock awards in fiscal years2008, 2007 or 2006. As a result, columns related to these items have beenomitted from the table above. *See* “CompensationDiscussion and Analysis,” above.

 
| **Name  And  Principal  Position** | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)** | ** ** | **All Other  Compensation   ($)** | ** ** | **Total  ($)** | ** ** |
|------------------------------------|------------|----------|------------|-----------------|------------|----------------|------------|---------------------------------------------|------------|----------------|------------|
|                               |       |     |       |            |       |           |       |                                        |       |           |       |
| Donald W. Jewell  (1)              |       | 2008     |       | $               | 325,000    |           | $          | —                                      |       | $              | 27,000     | (2) | $ | 352,000 |   |
| Chief Executive                    |       | 2007     |       | 325,000         |       | —         |       | 78,000                                      | (2)        | 403,000        |       |
| Officer and President              |       | 2006     |       | 200,000         |       | 64,000         | (3)        | 32,000                                      | (2)        | 296,000        |       |
|                               |       |     |       |            |       |           |       |                                        |       |           |       |
| Patrick W.  Hurley                 |       | 2008     |       | 125,000         |       | —         |       | 8,000                                       | (6)        | 133,000        |       |
| Chief Financial                    |       | 2007     |       | 121,000         |       | —         |       | 3,000                                       | (4)        | 124,000        |       |
| Officer, Secretary  and Treasurer  |       | 2006     |       | 110,000         |       | 12,000         | (5)        | 2,000                                       | (4)        | 124,000        |       |
|                               |       |     |       |            |       |           |       |                                        |       |           |       |
| Catherine B.  Blair                |       | 2008     |       | 159,000         |       | —         |       | 11,000                                      | (4)        | 170,000        |       |
| Vice President –              |       | 2007     |       | 125,000         |       | —         |       | 7,000                                       | (4)        | 132,000        |       |
| Merchandising /  Design            |       | 2006     |       | 111,000         |       | 3,000          | (5)        | 2,000                                       | (4)        | 116,000        |       |
|                                    |            |          |            |                 |            |                |            |                                             |            |                |            |  |  |  |  |

 

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(1)     Mr. Jewell served as our Senior VicePresident since February 2001, our Interim Chief Executive Officer since November 2004and our President since April 2005. In September 2006, we appointed Mr. Jewellas our permanent Chief Executive Officer and President, and after that time heno longer serves as our Senior Vice President.

(2)     Mr. Jewell’s Other Compensation for 2008consisted of life insurance premiums paid by the Company, 401(k) plancontributions, medical insurance premiums, country club membership fees,automobile expenses and payments and benefits for a personal assistant($6,000). Mr. Jewell’s Other Compensation for 2007 consisted of lifeinsurance premiums paid by the Company, 401(k) plan contributions, medicalinsurance premiums, country club membership fees, automobile expenses,unreimbursed personal expenses and payments and benefits for a personalassistant ($53,000). Mr.

 

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Jewell’sOther Compensation for 2006 consisted of life insurance premiums paid by theCompany, 401(k) plan contributions, medical insurance premiums, automobileexpenses and payments and benefits for a personal assistant ($20,000).

(3)     Comprised of cash bonus of $50,000 paid in October 2005plus transfer of title to a Company vehicle with an estimated fair value of$14,000, effective September 30, 2005.

(4)     Comprised of contributions by the Company tothe Named Officer’s 401(k) account plus term life insurance premiums paidby the Company.

(5)     Comprised of cash bonus paid in October 2005.

(6)     Comprised of contributions by the Company tothe Named Officer’s 401(k) account plus term life insurance premiums paidby the Company and reimbursements for professional dues and seminars.

 

**Executive Employment Agreements**

 

We have entered into thefollowing executive employment agreements with our NEOs:

 

*Donald W.Jewell.* Effective February 1, 2001, we entered into anemployment agreement with Donald W. Jewell to serve as our Senior VicePresident. In January 2006, we and Mr. Jewell entered into anagreement, effective November 1, 2005, whereby Mr. Jewell agreed, inaddition to his duties, responsibilities and benefits under his existingemployment agreement, to serve as our Interim Chief Executive Officer through June 30,2005, subject to automatic monthly extensions. In April 2005, Mr. Jewellwas appointed to serve as our President. The agreement, as amended, requiresthat Mr. Jewell devote his full business time as our Interim ChiefExecutive Officer, President and Senior Vice President, at an annual salary of$200,000 and such bonuses, as awarded by our Board of Directors, and extendsfor a two-year term, subject to automatic one-year extensions at the end ofeach year. In September 2006, we appointed Mr. Jewell as ourpermanent Chief Executive Officer for a salary of $325,000, retroactive to July 1,2006, and he no longer serves as our Senior Vice President. Until such time asa new employment agreement is finalized, the terms of the February 2001agreement, as amended, will generally remain in effect. In addition, we agreedwith Mr. Jewell that we would provide for a personal assistant, withbenefits, for his use and personal service and to pay the membership dues for agolf club that Mr. Jewell uses primarily for business purposes. Theagreement contains a non-competition provision for twelve months followingtermination, provided that Mr. Jewell could be released from thenon-competition clause if he were terminated without cause and if he had electedto forego any severance pay. If Mr. Jewell becomes disabled during theterm of the agreement, his full salary will be continued for one year from thedate of disability.

 

*PatrickW. Hurley.* Effective December 1, 2000, we entered intoan employment agreement with Patrick W. Hurley. The agreement, as amended,requires that Mr. Hurley devote his full business time as our ChiefFinancial Officer, Secretary and Treasurer at an annual salary of $125,000 andsuch bonuses, as may be awarded by our Board of Directors, and extends for aone-year term, subject to automatic one-year extensions after each year. If Mr. Hurleybecomes disabled during the term of the agreement, his full salary will becontinued for one year from the date of disability.

 

*CatherineB. Blair.* Effective July 1, 2007, we entered into anamended employment agreement with Catherine B. Blair. The agreement requiresthat Ms. Blair devote her full business time as our Vice President ofMerchandising/Design at an annual salary of $160,000 for the term from July 1,2007, through June 30, 2008, and $175,000 for the term from July 1,2008, through June 30, 2009, and thereafter, and such bonuses, as may beawarded by our Board of Directors, and extends for a two-year term, subject toautomatic one-year extensions after each year. If Ms. Blair becomesdisabled during the term of the agreement, her full salary will be continuedfor one year from the date of disability.

 

**Outstanding Equity Awards at 2007Fiscal Year End**

 

The following table setsforth information regarding the outstanding equity awards to our NEOs at June 30,2007. We have not granted any stock awards to our NEOs during 2007 and,accordingly, we had no outstanding stock awards during 2007. Thus, the columnsrelated to stock awards have been omitted from the following table.

 

41

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| ** **                             | ** ** | **Option Awards**                                                                     | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| **Name**                               | ** ** | **Number of Securities  Underlying  Unexercised Options  (#)  Exercisable** | ** ** | **Number of Securities  Underlying  Unexercised Options  (#)  Unexercisable** | ** ** | **Option  Exercise  Price  ($)** | ** ** | **Option  Expiration  Date** | ** ** |
| Donald W. Jewell                       |       | 25,000                                                                                     |       | — |   | 3.00 |   | 08/01/11 |   |
| Chief Executive Officer  and President |       | 25,000                                                                                     |       | — |   | 3.60 |   | 02/12/12 |   |
|                                   |       |                                                                                       |       |   |   |   |   |   |   |
| Patrick W.  Hurley                     |       | 15,000                                                                                     |       | — |   | 3.00 |   | 01/05/10 |   |
| Chief Financial  Officer,              |       | 20,000                                                                                     |       | — |   | 3.00 |   | 07/02/11 |   |
| Secretary and  Treasurer               |       | 15,000                                                                                     |       | — |   | 3.60 |   | 02/12/12 |   |
|                                   |       |                                                                                       |       |   |   |   |   |   |   |
| Catherine B.  Blair                    |       | 15,000                                                                                     |       | — |   | 3.00 |   | 01/05/10 |   |
| VP –  Merchandising and           |       | 15,000                                                                                     |       | — |   | 3.00 |   | 07/02/11 |   |
| Design                                 |       | 20,000                                                                                     |       | — |   | 3.60 |   | 02/12/12 |   |

 

**Director Compensation**

 

The following table showscertain compensation information with respect to our non-employee directors forfiscal 2008. Our only director who is an employee of the Company, Donald W.Jewell, does not receive any additional compensation for serving as a director.Each of our non-employeedirectors receives an annual fee of $10,000 for serving as director. TheChairman of the Board, Chairman of the Audit Committee and Chairman of theCompensation Committee received additional fees of $30,000, $10,000 and $2,500in 2008, respectively. Director fees are paid quarterly. We did notgrant any stock awards or options to purchase our common stock our directorsduring 2008. Further, we do not have a non-equity incentive plan or pensionplan for our directors, nor do our directors receive any perquisites or otherbenefits, other than reimbursement of travel expenses. Accordingly, columnsrelated to these items were deleted from the following table.

 
| **Name**                                             | ** ** | **Fees earned or  paid in cash  ($)** | ** ** | **Total  ($)** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------|------------|
| Ronald J.  Norick, Chairman of the Board (1)         |       | $                                                         | 40,000     |           | $          | 40,000 |   |
| James R.  TenBrook, Audit Committee Chair (2)        |       | 20,000                                                    |       | 20,000         |       |
| Mark J.  Stevenson, Compensation Committee Chair (3) |       | 12,500                                                    |       | 12,500         |       |
| William O.  Johnstone                                |       | 10,000                                                    |       | 10,000         |       |
|                                                      |            |                                                           |            |                |            |  |  |

 

----

(1)     Mr. Norick received $30,000 incompensation for serving as the Chairman of the Board in addition to the$10,000 per year fee paid to all non-employee directors.

(2)     Mr. TenBrook received an additional$10,000 in compensation for serving as Chairman of the Audit Committee inaddition to the $10,000 per year fee paid to all non-employee directors.

(3)     Mr. Stevenson received an additional$2,500 in compensation for serving as Chairman of the Compensation Committee inaddition to the $10,000 per year fee paid to all non-employee directors.

 

Twoof our current non-employee directors received options to purchase our commonstock prior to the expiration of our former Option Plan in February 2003.As of June 30, 2008, each non-employee director had the following numberof fully-vested options to purchase our common stock:

 
| **Name**              | ** ** | **Options Outstanding at  June 30, 2008** | ** ** |
|-----------------------|------------|---------------------------------------------------------------|------------|
| Ronald J. Norick      |       | 150,000                                                       |       |
| Mark J.  Stevenson    |       | 75,000                                                        |       |
| James R.  TenBrook    |       | —                                                        |       |
| William O.  Johnstone |       | —                                                        |       |

 

42

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| **ITEM 12.** | **SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS** |
|--------------|-----------------------------------------------------------------------------------------------------|

 

The following table setsforth certain information regarding beneficial ownership of our common stock asof September 15, 2008, by: (i) each person known by Sport-Haley, Inc.to own beneficially more than 5% of the outstanding common stock; (ii) eachdirector or nominee; and, (iii) all executive officers and directors as agroup. The information with respect to institutional investors is generally derivedfrom statements filed with the Securities and Exchange Commission under §13(d) or§13(g) of the Securities Exchange Act. Each person has sole voting andsole investment or dispositive power with respect to the shares shown except asnoted.

 
| ** **                                | ** ** | **Shareholdings on September 15, 2008** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------|------------|
| **Name and Address (1)**   | ** ** | **Number of Shares (2)**                     | ** ** | **Percent of Class (3)** | ** ** |
| Donald W. Jewell  (4)                     |       | 50,000                                                      |       | 2.14 | % |
|                                      |       |                                                        |       |   |   |
| Patrick W.  Hurley (4)                    |       | 50,000                                                      |       | 2.14 |   |
|                                      |       |                                                        |       |   |   |
| Catherine B.  Blair (4)                   |       | 50,000                                                      |       | 2.14 |   |
|                                      |       |                                                        |       |   |   |
| Ronald J. Norick  (5)                     |       | 375,617                                                     |       | 15.43 |   |
|                                      |       |                                                        |       |   |   |
| James R.  TenBrook                        |       | 0                                                           |       | * |   |
|                                      |       |                                                        |       |   |   |
| Mark J.  Stevenson (4)                    |       | 75,000                                                      |       | 3.18 |   |
|                                      |       |                                                        |       |   |   |
| William O.  Johnstone                     |       | 0                                                           |       | * |   |
|                                      |       |                                                        |       |   |   |
| Daniel Zeff,  Zeff Holding Co., LLC,      |       |                                                        |       |   |   |
| Zeff Capital  Partners ILP and            |       |                                                        |       |   |   |
| Spectrum Galaxy  Fund Ltd. (6)            |       |                                                        |       |   |   |
| 50 California  Street, Suite 1500    |       |                                                        |       |   |   |
| San Francisco,  CA 94111                  |       | 539,663                                                     |       | 23.62 |   |
|                                      |       |                                                        |       |   |   |
| MicroCapital,  LLC, Ian P. Ellis          |       |                                                        |       |   |   |
| and MicroCapital  Fund, LP (7)            |       |                                                        |       |   |   |
| 623 Fifth  Avenue, Suite 2502        |       |                                                        |       |   |   |
| New York, NY  10022                       |       | 253,327                                                     |       | 11.09 |   |
|                                      |       |                                                        |       |   |   |
| Dimensional Fund  Advisors Inc. (8)       |       |                                                        |       |   |   |
| 1299 Ocean  Avenue, 11th Floor            |       |                                                        |       |   |   |
| Santa Monica, CA  90401                   |       | 205,995                                                     |       | 9.02 |   |
|                                      |       |                                                        |       |   |   |
| Hillson Partners  Limited Partnership (9) |       |                                                        |       |   |   |
| 6900 Wisconsin  Avenue, Suite 501    |       |                                                        |       |   |   |
| Bethesda, MD  20815                       |       | 159,415                                                     |       | 6.98 |   |
|                                      |       |                                                        |       |   |   |
| All directors  and officers as a group    |       |                                                        |       |   |   |
| (Seven persons  in total) (10)            |       | 600,617                                                     |       | 22.58 |   |

 

----

| *   |   | Less than 1%                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1) |   | Except as noted above,  the address for all persons listed is 4600 E. 48th Avenue, Denver, Colorado  80216.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (2) |   | Ownership includes both  outstanding common stock and shares issuable upon exercise of options that  are currently exercisable or will become exercisable within 60 days after  September 15, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (3) |   | All percentages are  calculated based on the number of outstanding shares in addition to shares  which a person or group has the right to acquire within 60 days of  September 15, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (4) |   | Consists solely of  shares subject to currently exercisable options which are fully vested .                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (5) |   | Includes 150,000 shares  subject to currently exercisable options or options which will become  exercisable within 60 days after the date hereof and 225,617 shares owned of  record by entities affiliated with Mr. Norick, of which shares  Mr. Norick has shared voting and dispositive power.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (6) |   | Daniel Zeff is the sole manager and member of Zeff Holding Company,  LLC, which serves as the general partner of Zeff Capital Partners I LP.  Mr. Zeff provides discretionary investment management services to Zeff  Capital Offshore Fund, a class of shares of Spectrum Galaxy Fund Ltd., a  company incorporated in the British Virgin Islands. Mr. Zeff  beneficially owns 539,663 shares of common stock, comprised of 198,312 shares  held by Spectrum Galaxy Fund Ltd. and 341,351 shares held by Zeff Capital Partners  I LP. Mr. Zeff and Zeff Holding Company, LLC each disclaim, for purposes  of Section 16 of the Securities Exchange Act of 1934, beneficial  ownership of such securities reported, except to the extent of his/its  indirect pecuniary interest therein. Each of Zeff Holding Company, LLC and  Zeff Capital Partners I LP disclaims beneficial ownership over all shares  held by Spectrum Galaxy Fund Ltd. |

 

43

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| (7)  |   | MicroCapital LLC is a Delaware limited liability company and a  registered investment adviser, whose managing member is Ian P. Ellis.  MicroCapital LLC acts as investment advisor and general partner to  MicroCapital Fund, LP. MicroCapital LLC and Mr. Ellis, the majority  owner and managing member of MircroCapital Fund, LP, have the right or the  power to direct the receipt of proceeds from the sale of common stock to  MicroCapital Fund, LP’s investment advisory clients. MicroCapital Fund, LP  and MicroCapital Ltd., a Cayman Islands company, are investment advisory  clients of MicroCapital LLC that beneficially own shares of Sport-Haley’s  common stock.                                                                                                                                                                       |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (8)  |   | Dimensional Fund Advisors LP (“Dimensional”) is a registered investment  advisor that beneficially owns 205,995 shares. Dimensional furnishes  investment advice to four investment companies registered under the  Investment Company Act of 1940, and serves as investment manager to certain  other commingled group trusts and separate accounts. These investment  companies, trusts and accounts are collectively referred to as the “Funds.”  In its role as investment advisor or manager, Dimensional possesses  investment and/or voting power over the 205,995 common shares described  herein and may be deemed to be the beneficial owner of the shares of the  Issuer held by the Funds. However, all securities reported in this schedule  are owned by the Funds, and Dimensional disclaims beneficial ownership of  such securities. |
| (9)  |   | Hillson Partners Limited Partnership has sole voting power and sole  dispositive power of 159,415 shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (10) |   | Includes 375,000 shares of common stock subject to currently  exercisable options or options which will become exercisable within 60  days after September 15, 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

 

###### **EquityCompensation Plan Information**

 

In January 2008,adopted a new stock option plan, entitled the Sport-Haley, Inc. 2008 StockOption Plan (the “2008 Plan”), which was approved by our shareholders in February 2008.Under the 2008 Plan, the Compensation Committee is authorized to grant up to50,000 non-qualified stock options and up to 150,000 incentive stock options.

 

We previouslyadopted our Amended and Restated 1993 Stock Option Plan (the “Former Plan”).The Former Plan was approved by our shareholders in 1993, was amended in 1997and expired by its terms in February 2003.

 

The followingtable contains information regarding the equity compensation plan as of June 30,2008.

 
| **Plan Category**                                          | ** ** | **(a)****Number of Securities to be  issued upon exercise of  outstanding options,  warrants and rights** | ** ** | **(b)  Weighted-average exercise  price of outstanding  options, warrants and  rights** | ** ** | **(c)  Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                      |       |                                                                                                                                                        |       |                                                                                                             |       |                                                                                                                                                                                                                  |       |
| **Equity  compensation plans approved by security holders**     |       | 586,000                                                                                                                                                     | (1)        | $                                                                                                                | 3.15       | (2)                                                                                                                                                                                                                   | 200,000    | (3) |
| **Equity  compensation plans not approved by security holders** |       | —                                                                                                                                                      |       | —                                                                                                           |       | —                                                                                                                                                                                                                |       |
| **Total**                                                       |       | 586,000                                                                                                                                                     |       | $                                                                                                                | 3.15       |                                                                                                                                                                                                                  | 200,000    |   |

 

----

| (1) |   | The  total number of securities to be issued upon exercise of outstanding options,  warrants and rights consists of options for the purchase of  Sport-Haley, Inc. common stock granted pursuant to the Former Plan to  directors, officers, employees, consultants and golf tour professionals. All  options were fully vested as of June 30, 2008. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | The  outstanding options issued under the Former Plan range in exercise price from  $2.71 to $9.78 per share.                                                                                                                                                                                                                                                  |

 

44

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| (3) |   | The  Former Plan, as amended, expired by its terms on February 28, 2003.  Therefore, no further options to purchase Sport-Haley, Inc. common stock  were granted under the Former Plan after that date. No options or other  awards have been granted under the 2008 Plan. |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**ITEM 13.****      ****CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE**

 

We adopted a policy thatrequires Board approval by a disinterested majority of the directors voting forany transaction in which one of our directors, nominees for director, executiveofficers or greater than five percent stockholders, or their immediate familymembers, have a material interest. All of our directors and executive officersare required at all times, but not less than annually, to disclose allrelationships they have with companies or individuals that have conductedbusiness with, or had an interest in, our Company. Our executive officersmonitor our operations, giving consideration to the disclosed relationships,and refer potential transactions to the Board of Directors for approval. TheBoard of Directors considers a related party transaction for its potentialeconomic benefit to us, to ensure the transaction is, among other things, onterms no less favorable to us than those involving unrelated parties, inaccordance with our policies and procedures, and that the transaction isproperly disclosed in our reports to shareholders.

 

Other than the employmentarrangements described elsewhere in this report and the transactions describedbelow, since July 1, 2007, there has not been, nor is there currentlyproposed, any transaction or series of similar transactions to which we were orwill be a party:

 

·      in which the amount involvedexceeds $120,000; and,

 

·      in which any director,nominee for director, executive officer, shareholder which beneficially ownsfive percent or more of our common stock or any member of their immediatefamily members, had or will have a direct or indirect material interest.

 

We have determined thatall of our directors, except Donald W. Jewell, are independent withinapplicable FINRA rules. Therefore, a majority of our Board of Directors, andeach member of the Audit, Compensation and Nominating Committees are independentwithin applicable FINRA rules. Further, each member of our Audit Committee isalso independent under SEC Rule 10A-3.

 

**ITEM 14.****       PRINCIPALACCOUNTANT FEES AND SERVICES**

 

**(1)****   Audit Fees.** The aggregatefees billed by Gordon, Hughes & Banks, LLP, our independent registeredpublic accountants, during fiscal year 2008 for the audit of our annualfinancial statements, the reviews of our quarterly financial statementsincluded in Forms 10-Q for the corresponding quarterly periods or the servicesthat are normally provided by in connection with statutory and regulatoryfilings or engagements for the 2008 fiscal year totaled $60,000.

 

The aggregate fees billedby Hein & Associates LLP, our former independent registered publicaccountants, during fiscal year 2008 for the audit of our annual financialstatements or the services that are normally provided by in connection withstatutory and regulatory filings or engagements for the 2008 fiscal yeartotaled $5,000.

 

The aggregate fees billedby Gordon, Hughes & Banks, LLP, our independent registered publicaccountants, during fiscal year 2007 for the audit of our annual financialstatements, the reviews of our quarterly financial statements included in Forms10-Q for the corresponding quarterly periods or the services that are normallyprovided by in connection with statutory and regulatory filings or engagementsfor the 2007 fiscal year totaled $64,000.

 

The aggregate fees billedby Hein & Associates LLP, our former independent registered publicaccountants, during fiscal year 2007 for the audit of our annual financialstatements or the services that are normally provided by in connection withstatutory and regulatory filings or engagements for the 2007 fiscal yeartotaled $3,000.

 

45

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**(2)****   Audit-related Fees.** Theaggregate fees billed by Gordon, Hughes & Banks, LLP, for assuranceand related services that are reasonably related to the performance of theaudit or review of our financial statements that are not included in the “AuditFees” described above totaled $0 for fiscal year 2008.

 

The aggregate fees billedby Hein & Associates LLP for assurance and related services that arereasonably related to the performance of the audit or review of our financialstatements that are not included in the “Audit Fees” described above totaled $0for fiscal year 2008.

 

The aggregate fees billedby Gordon, Hughes & Banks, LLP for assurance and related services thatare reasonably related to the performance of the audit or review of ourfinancial statements that are not included in the “Audit Fees” described abovetotaled $3,000 for fiscal year 2007.

 

The aggregate fees billedby Hein & Associates LLP for assurance and related services that arereasonably related to the performance of the audit or review of our financialstatements that are not included in the “Audit Fees” described above totaled$3,000 for fiscal year 2007.

 

**(3)****   Tax Fees.**The aggregate fees billed by Gordon, Hughes &Banks, LLP in fiscal years 2008 and 2007 for professional services rendered fortax compliance, tax advice and tax planning totaled $7,000 and $4,000,respectively, and consisted primarily of services with respect the preparationof federal and state income tax returns.

 

Theaggregate fees billed by Hein & Associates LLP in fiscal years 2007for professional services rendered for tax compliance totaled $5,000 andconsisted primarily of services with respect the preparation of federal andstate income tax returns.

 

**(4)****   All Other Fees.** Theaggregate fees billed by Gordon, Hughes & Banks, LLP in fiscal years2008 and 2007, other than for the services reported in “Audit Fees,” “AuditRelated Fees” or “Tax Fees” described above, totaled $0 and $0, respectively.

 

**(5)****   Audit Committee Approval Procedures.** Our independentregistered public accountants report to, and are engaged at the direction of,the Audit Committee, with annual approval by the shareholders. Since May 2003,the Audit Committee has maintained procedures for the pre-approval of audit andnon-audit services performed by independent registered public accountants. TheAudit Committee has the sole authority to pre-approve all audit and non-auditservices provided by independent registered public accountants and acts to assurethat independent registered public accountants are not engaged to performspecific non-audit services proscribed by law or regulation.

 

**PART IV**

 

**ITEM 15.****       EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**

 

**(a)   Exhibits, Financial Statements and FinancialStatement Schedules**

 

The following documentsare filed herewith or have been included as exhibits to previous filings withthe Securities and Exchange Commission and are incorporated herein by thisreference:

 

**(1)****   Financial Statements**

 

Indexto financial statements

Reportsof Independent Registered Public Accounting Firm

ConsolidatedBalance Sheets

ConsolidatedStatements of Operations

ConsolidatedStatements of Shareholders’ Equity

ConsolidatedStatements of Cash Flows

Notesto Consolidated Financial Statements

 

46

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**(2)****   Financial Statement Schedules**

 

Schedule II – Valuationand Qualifying Accounts

 

**(3)****   Exhibits**

 
| **Exhibit No.** |     | **Document** |
|----------------------|----------|--------------|
| #*                   | 3.1      |         | Amended and Restated  By-laws of Sport-Haley, Inc., as adopted February 21, 2007. |
|                 |     |         |   |
| */                   | 3.1.2    |         | Amended and Restated  Articles of Incorporation of Sport-Haley, Inc. as filed on March 7,  1994 with the Secretary of State for the State of Colorado. |
|                 |     |         |   |
| */                   | 4.1      |         | Form of Specimen  Certificate for Common Stock of Sport-Haley, Inc. |
|                 |     |         |   |
| #                    | 10.1.3   |         | 1993 Stock Option Plan,  effective March 1993, as amended. |
|                 |     |         |   |
| ~+                   | 10.1.4   |         | Sport-Haley, Inc.  2008 Stock Option Plan |
|                 |     |         |   |
| x                    | 10.2.1   |         | Employment Agreement,  dated January 1, 1997, by and between Robert G. Tomlinson and  Sport-Haley, Inc. |
|                 |     |         |   |
| III                  | 10.2.4   |         | Employment Agreement,  dated December 1, 1999, by and between Kevin Tomlinson and  Sport-Haley, Inc. |
|                 |     |         |   |
| xx                   | 10.2.4.1 |         | Employment Agreement,  dated March 18, 2002, by and between Kevin M. Tomlinson and  Sport-Haley, Inc. |
|                 |     |         |   |
| x                    | 10.2.6   |         | Employment Agreement,  dated January 1, 1997, by and between Robert W. Haley and Sport-Haley, Inc. |
|                 |     |         |   |
| ##                   | 10.2.7   |         | Employment Agreement,  dated February 1, 2001, by and between Donald W. Jewell and  Sport-Haley, Inc. |
|                 |     |         |   |
| &                | 10.2.7.1 |         | Letter agreement  effective November 1, 2004, amending Employment Agreement of Donald W.  Jewell and Sport-Haley, Inc. |
|                 |     |         |   |
| ##                   | 10.2.8   |         | Employment Agreement,  dated December 1, 2000, by and between Patrick W. Hurley and  Sport-Haley, Inc. |
|                 |     |         |   |
| &                | 10.2.8.1 |         | Amendment to Employment  Agreement, effective December 1, 2004, by and between Patrick W. Hurley  and Sport-Haley, Inc. |
|                 |     |         |   |
| &                | 10.2.10  |         | Employment Agreement,  effective December 20, 2004, by and between George E. Tomlinson and  Sport-Haley, Inc. |
|                 |     |         |   |
| &                | 10.2.11  |         | Employment Agreement,  effective December 20, 2004, by and between Barry L. Hyman and  Sport-Haley, Inc. |
|                 |     |         |   |
| +*                   | 10.2.12  |         | Employment Agreement,  effective February 7, 2006, by and between Michael D. Doris and  Sport-Haley, Inc. |
|                 |     |         |   |
| x                    | 10.2.13  |         | Form of standard  Endorsement Agreement by and between various golf professionals and  Sport-Haley. |
|                 |     |         |   |
| +~                   | 10.2.14  |         | Employment Agreement,  dated July 1, 2007, by and between Catherine B. Blair and  Sport-Haley, Inc. |

 

47

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| II     | 10.3.2 |   | Business Loan Agreement, dated November 5,  1998, by and between U.S. Bank National Association and  Sport-Haley, Inc.                                                                                             |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                         |
| #~     | 10.3.8 |   | License Agreement,  dated May 27, 2008, between Callaway Golf Company. and Sport-Haley, Inc.  [*]                                                                                                                  |
|   |   |   |                                                                                                                                                                                                                         |
| ++     | 10.4.1 |   | Lease Agreement, dated July 29, 1994, by and  among Thomas J. Hilb, individually, Thomas J. Hilb, as Trustee of the Connie  Hilb Trust, and Sport-Haley, Inc.                                                      |
|   |   |   |                                                                                                                                                                                                                         |
| x*     | 10.4.2 |   | Second Amendment to  Lease Agreement, dated September 28, 2001, by and between Thomas J.  Hilb, individually, and as trustee of the Connie Hilb Trust, and Sport-Haley.                                                 |
|   |   |   |                                                                                                                                                                                                                         |
| ~*     | 10.4.3 |   | Third Amendment to  Lease Agreement, dated July 11, 2006, by and between Thomas J. Hilb,  individually, and as trustee of the Connie Hilb Trust, and  Sport-Haley, Inc.                                            |
|   |   |   |                                                                                                                                                                                                                         |
| */     | 10.5   |   | Form of Independent Sales Representative  Agreement.                                                                                                                                                                    |
|   |   |   |                                                                                                                                                                                                                         |
| +      | 10.7   |   | Trademark  Registrations, dated February 21, 1995, issued by the United States  Patent and Trademark Office to Sport-Haley, Inc.                                                                                   |
|   |   |   |                                                                                                                                                                                                                         |
| ~*     | 10.8   |   | Trademark License  Agreement, dated August 22, 2006, issued by United States Patent and  Trademark Office to Sport-Haley, Inc. for our script SPORT HALEY logo.                                                    |
|   |   |   |                                                                                                                                                                                                                         |
| ~*     | 10.9   |   | Trademark License  Agreement, dated August 22, 2006, issued by United States Patent and  Trademark Office to Sport-Haley, Inc. for our script SPORT HALEY logo  superimposed over “SH” in block letters. |
|   |   |   |                                                                                                                                                                                                                         |
| ~*     | 10.10  |   | Trademark License  Agreement, dated August 22, 2006, issued by United States Patent and  Trademark Office to Sport-Haley, Inc. for our SPORT HALEY logo in block  letters.                                         |
|   |   |   |                                                                                                                                                                                                                         |
| *+     | 10.11  |   | Operating Agreement for  Reserve Apparel Group LLC.                                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                                                         |
| ~      | 10.12  |   | Agreement to Purchase  Limited Liability Company Membership Interest, Settlement and Mutual  Releases, dated September 21, 2006.                                                                                        |
|   |   |   |                                                                                                                                                                                                                         |
| *#     | 14.1   |   | Code of Ethics for  Senior Financial Officers.                                                                                                                                                                               |
|   |   |   |                                                                                                                                                                                                                         |
| &  | 14.2   |   | Code of Conduct and  Ethics for Directors, Officers and Employees.                                                                                                                                                           |
|   |   |   |                                                                                                                                                                                                                         |
| ***    | 31.1   |   | Certification of Donald  W. Jewell pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                         |
| ***    | 31.2   |   | Certification of  Patrick W. Hurley pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).                                                                                                                                  |
|   |   |   |                                                                                                                                                                                                                         |
| ***    | 32.1   |   | Certification of Donald  W. Jewell and Patrick W. Hurley Pursuant to 18 U.S.C. §1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002                                                        |

 

----

| *      | Certain confidential  portions of this Exhibit were omitted by means of redacting a portion of  the text where indicated. This exhibit, including the omitted portions, has  been filed separately with the Secretary of the Securities and Exchange  Commission pursuant to an application requesting confidential treatment under  Rule 24b-2 of the Securities Exchange Act of 1934. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| */     | Incorporated by  reference from Sport-Haley, Inc.’s Registration Statement on  Form SB-2 (File No. 33-74876-D)                                                                                                                                                                                                                                                                |
| +      | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-KSB filed  October 6, 1995 (File No. 33-74876-D)                                                                                                                                                                                                                                                             |
| ++     | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-KSB filed  September 14, 1994 (File No. 33-74876-D)                                                                                                                                                                                                                                                          |
| — | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-QSBA/1 filed  February 2, 1996 (File No. 33-74876-D)                                                                                                                                                                                                                                                         |
| #      | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-QSB filed on  May 12, 1997 (File No. 33-74876-D)                                                                                                                                                                                                                                                             |
| x      | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-KSB filed on  September 29,1997 (File No. 33-74876-D)                                                                                                                                                                                                                                                        |
| II     | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-Q filed on  February 16, 1999(File No. 333-18831)                                                                                                                                                                                                                                                            |
| III    | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-K filed on  November 3, 2000 (File No. 03374876-D)                                                                                                                                                                                                                                                           |

 

48

----

 
| ##    | Incorporated by reference from Sport-Haley, Inc.’s  Form 10-K filed on October 9, 2001 (File No. 033-74876-D)      |
|-------|-------------------------------------------------------------------------------------------------------------------------|
| xx    | Incorporated by reference from Sport-Haley, Inc.’s  Form 10-Q filed on May 10, 2002 (File No. 033-74876-D)         |
| x*    | Incorporated by reference from Sport-Haley, Inc.’s  Form 10-K filed on September 27, 2002 (File No. 033-74876-D)   |
| *#    | Incorporated by reference from Sport-Haley, Inc.’s  Schedule 14A filed on February 27, 2004 (File No. 033-74876-D) |
| %     | Incorporated by reference from Sport-Haley, Inc.’s  Form 10-K filed on October 13, 2004 (File No. 033-74876-D)     |
| & | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-Q fled on February 22, 2005 (File  No. 033-74876-D)    |
| **    | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-K filed on October 13, 2005 (File  No. 33-74876-D)     |
| *+    | Incorporated by  reference from Sport-Haley, Inc.’s Form 8-K filed on November 8, 2005 (File  No. 33-74876-D)      |
| +*    | Incorporated by  reference from Sport-Haley Inc.’s, Form 10-Q filed on May 22, 2006 (File No.  0-51715)            |
| ~     | Incorporated by reference  from Sport-Haley Inc.’s, Form 8-K filed on September 26, 2006 (File No.  0-51715)       |
| ~*    | Incorporated by  reference from Sport-Haley, Inc.’s Form 10-K filed on October 13, 2006 (File  No. 0-51715)        |
| #*    | Incorporated by  reference from Sport-Haley Inc.’s, Form 10-Q filed on May 14, 2007 (File No.  0-51715)            |
| +~    | Incorporated by  reference from Sport-Haley Inc.’s, Form 8-K filed on November 2, 2007 (File  No. 0-51715)         |
| ~+    | Incorporated by  reference from Sport-Haley Inc.’s, Form 10-Q filed on May 14, 2008 (File No. 0-51715)             |
| #~    | Incorporated by  reference from Sport-Haley Inc.’s, Form 8-K filed on May 30, 2008 (File No.  0-51715)             |
| ***   | Filed herewith.                                                                                                         |

 

49

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
|                  | SPORT-HALEY,  INC. |
|-----------------------|--------------------|
|                  |               |
|                  |               |
| October 14, 2008 | By:                | /s/ PATRICK  W. HURLEY |
|                  |               | Patrick  W. Hurley, Chief Financial Officer |

 

 

Pursuant to therequirements of the Securities Act of 1934, this report has been signed belowby the following persons on behalf of the registrant and in the capacities andon the dates indicated.

 
| **Signature**             | ** ** | **Title**                            | ** ** | **Date**               |
|---------------------------|------------|--------------------------------------|------------|------------------------|
|                      |       |                                 |       |                   |
| /s/ DONALD W. JEWELL      |       | Chief Executive  Officer,            |       | October 14,  2008 |
| Donald  W. Jewell         |       | President  and Director              |       |                   |
|                      |       |                                 |       |                   |
|                      |       |                                 |       |                   |
| /s/ PATRICK W. HURLEY     |       | Chief Financial  Officer,            |       | October 14,  2008 |
| Patrick  W. Hurley        |       | Secretary  and Treasurer             |       |                   |
|                      |       |                                 |       |                   |
|                      |       |                                 |       |                   |
| /s/ RONALD J. NORICK      |       | Director                             |       | October 14,  2008 |
| Ronald  J. Norick         |       | and  Chairman of the Board           |       |                   |
|                      |       |                                 |       |                   |
|                      |       |                                 |       |                   |
| /s/ JAMES R. TENBROOK     |       | Director                             |       | October 14,  2008 |
| James  R. TenBrook        |       | and  Audit Committee Chairman        |       |                   |
|                      |       |                                 |       |                   |
|                      |       |                                 |       |                   |
| /s/ MARK J. STEVENSON     |       | Director                             |       | October 14,  2008 |
| Mark  J. Stevenson        |       | and  Compensation Committee Chairman |       |                   |
|                      |       |                                 |       |                   |
|                      |       |                                 |       |                   |
| /s/ WILLIAM O.  JOHNSTONE |       | Director                             |       | October 14,  2008 |
| William  O. Johnstone     |       |                                 |       |                   |

 

50

----

 

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                                   | **PAGE** |
|--------------------------------------------------------------|----------|
|                                                         |     |
| **Report of Independent Registered Public  Accounting Firm** | F-2      |
|                                                         |     |
| **Report of Independent Registered Public Accounting Firm**  | F-3      |
|                                                         |     |
| **Consolidated Balance Sheets**                              | F-4      |
|                                                         |     |
| **Consolidated Statements of Operations**                    | F-5      |
|                                                         |     |
| **Consolidated Statement of Shareholders’  Equity**     | F-6      |
|                                                         |     |
| **Consolidated Statements of Cash Flows**                    | F-7      |
|                                                         |     |
| **Notes to  Consolidated Financial Statements**              | F-8      |
|                                                         |     |
| **Schedule II -  Valuation and Qualifying Accounts**         | F-32     |

 

F-1

----

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors

Sport-Haley, Inc.

Denver, Colorado

 

We have audited the accompanying consolidated balance sheets ofSport-Haley, Inc. as of June 30, 2008 and 2007 and the relatedconsolidated statements of operations, shareholders’ equity, and cash flows forthe years then ended. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits.

 

We conducted our audits in accordance with standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. The Companyis not required to have, nor were we engaged to perform, an audit of itsinternal control over financial reporting. Our audits included consideration ofinternal control over financial reporting as a basis for designing auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion of the effectiveness of the Company’s internal controlover financial reporting. Accordingly, we express no such opinion. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of Sport-Haley, Inc.as of June 30, 2008 and 2007 and the results of its operations and itscash flows for the years then ended in conformity with accounting principlesgenerally accepted in the United States of America.

 

Our audits were made for the purpose of forming an opinion on the basicconsolidated financial statements taken as a whole. The schedule listed in theindex of financial statements is presented for purposes of complying with theSecurities and Exchange Commission’s rules and is not part of the basicconsolidated financial statements. This schedule has been subjected to theauditing procedures applied in the audits of the basic consolidated financialstatements and, in our opinion, fairly states in all material respect thefinancial data required to be set forth therein in relation to the basicconsolidated financial statements taken as a whole.

 

 
| /s/ Gordon, Hughes & Banks, LLP |   |
|------------------------------------------|--------|
| Greenwood Village, Colorado              |
|                                     |
| October 7, 2008                     |

 

F-2

----

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Board of Directors

Sport-Haley, Inc. and Subsidiary

Denver, Colorado

 

We have audited the accompanying consolidated balance sheet ofSport-Haley, Inc. and Subsidiary as of June 30, 2006, and the relatedconsolidated statements of operations, shareholders’ equity and cash flows forthe period ended June 30, 2006. These consolidated financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudit.

 

We conducted our audit in accordance with standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe consolidated financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position ofSport-Haley, Inc and Subsidiary. as of June 30, 2006, and the results oftheir operations and their cash flows for the period ended June 30, 2006,in conformity with accounting principles generally accepted in the UnitedStates of America.

 

Our audit was made for the purpose of forming an opinion on the basicconsolidated financial statements taken as a whole. The schedule listed in theindex of consolidated financial statements is presented for purposes ofcomplying with the Securities and Exchange Commission’s rules and is notpart of the basic consolidated financial statements. This schedule has beensubjected to the auditing procedures applied in the audit of the basicconsolidated financial statements and, in our opinion, fairly states in allmaterial respects the financial data required to be set forth therein inrelation to the basic consolidated financial statements taken as a whole.

 
| /S/HEIN & ASSOCIATES LLP |   |
|----------------------------------------|--------|
|                                   |
| Denver, Colorado                       |
| October 9, 2008                   |

 

F-3

----

 

***SPORT-HALEY, INC.***

 

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                         | ** ** | **JUNE 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                         | ** ** | **2008**          | ** ** | **2007** | ** ** |
| ** **                                                                                         | ** ** | ** **        | ** ** | **As Corrected** | ** ** |
| ** **                                                                                         | ** ** | ** **        | ** ** | **(Note 2)** | ** ** |
| **ASSETS**                                                                                         |       |              |       |   |   |
| **CURRENT ASSETS**                                                                                 |       |              |       |   |   |
| Cash and cash equivalents                                                                          |       | $                 | 2,830,000  |   | $ | 4,464,000 |   |
| Marketable securities                                                                              |       | 200,000           |       | — |   |
| Accounts receivable, net of allowances of  $278,000 and $374,000, respectively                     |       | 2,791,000         |       | 3,066,000 |   |
| Inventories                                                                                        |       | 5,947,000         |       | 5,886,000 |   |
| Prepaid expenses and other                                                                         |       | 264,000           |       | 203,000 |   |
| Total current assets                                                                               |       | 12,032,000        |       | 13,619,000 |   |
|                                                                                               |       |              |       |   |   |
| **PROPERTY  AND EQUIPMENT,** net                                                                   |       | 197,000           |       | 399,000 |   |
| **OTHER  ASSETS**                                                                                  |       | 3,000             |       | 3,000 |   |
|                                                                                               |       |              |       |   |   |
| **TOTAL  ASSETS**                                                                                  |       | $                 | 12,232,000 |   | $ | 14,021,000 |   |
| ** **                                                                                         |       |              |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                     |       |              |       |   |   |
| **CURRENT  LIABILITIES**                                                                           |       |              |       |   |   |
| Accounts payable                                                                                   |       | $                 | 1,421,000  |   | $ | 2,042,000 |   |
| Accrued royalties payable                                                                          |       | 52,000            |       | 181,000 |   |
| Accrued commissions payable                                                                        |       | 180,000           |       | 214,000 |   |
| Accrued payroll                                                                                    |       | 138,000           |       | 249,000 |   |
| Other                                                                                              |       | 177,000           |       | 179,000 |   |
| Total current liabilities                                                                          |       | 1,968,000         |       | 2,865,000 |   |
|                                                                                               |       |              |       |   |   |
| **COMMITMENTS  AND CONTINGENCIES**(Notes 8 and 9)                                                  |       |              |       |   |   |
| Minimum royalties payable                                                                          |       | 80,000            |       | 178,000 |   |
| Total contingent liabilities                                                                       |       | 80,000            |       | 178,000 |   |
|                                                                                               |       |              |       |   |   |
| **TOTAL  LIABILITIES**                                                                             |       | 2,048,000         |       | 3,043,000 |   |
| ** **                                                                                         |       |              |       |   |   |
| **SHAREHOLDERS’  EQUITY**                                                                     |       |              |       |   |   |
| Preferred stock, no par value; 1,500,000  shares authorized; none issued and outstanding           |       | —            |       | — |   |
| Common stock, no par value; 15,000,000  shares authorized; 2,284,490 shares issued and outstanding |       | 8,481,000         |       | 8,481,000 |   |
| Additional paid-in capital                                                                         |       | 1,621,000         |       | 1,621,000 |   |
| Retained earnings                                                                                  |       | 82,000            |       | 876,000 |   |
| Total shareholders’ equity                                                                    |       | 10,184,000        |       | 10,978,000 |   |
|                                                                                               |       |              |       |   |   |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY**                                               |       | $                 | 12,232,000 |   | $ | 14,021,000 |   |

 

***See accompanying notes to these consolidatedfinancial statements.***

 

F-4

----

 

***SPORT-HALEY, INC.***

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                                                            | ** ** | **FOR THE YEARS ENDED  JUNE 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2008**                                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                                            | ** ** | ** **                                            | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** |
| ** **                                                                                            | ** ** | ** **                                            | ** ** | **(Note 2)** | ** ** | **(Note 2)** | ** ** |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **NET  SALES**                                                                                        |       | $                                                     | 17,117,000 |   | $ | 18,893,000 |   | $ | 20,962,000 |   |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **COST OF  GOODS SOLD**                                                                               |       |                                                  |       |   |   |   |   |
| Cost of goods sold                                                                                    |       | 10,533,000                                            |       | 12,032,000 |   | 13,761,000 |   |
| Inventory impairments                                                                                 |       | 230,000                                               |       | 312,000 |   | 408,000 |   |
| Total cost of goods sold                                                                              |       | 10,763,000                                            |       | 12,344,000 |   | 14,169,000 |   |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **GROSS  PROFIT**                                                                                     |       | 6,354,000                                             |       | 6,549,000 |   | 6,793,000 |   |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **OTHER  OPERATING COSTS**                                                                            |       |                                                  |       |   |   |   |   |
| Selling, general and administrative  expenses                                                         |       | 6,802,000                                             |       | 7,087,000 |   | 7,090,000 |   |
| Royalty expense                                                                                       |       | 578,000                                               |       | 917,000 |   | 927,000 |   |
| Goodwill impairment                                                                                   |       | —                                                |       | 270,000 |   | — |   |
| Total other operating costs                                                                           |       | 7,380,000                                             |       | 8,274,000 |   | 8,017,000 |   |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **LOSS  FROM OPERATIONS**                                                                             |       | (1,026,000                                            | )          | (1,725,000 | ) | (1,224,000 | ) |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **OTHER  INCOME AND (EXPENSE)**                                                                       |       |                                                  |       |   |   |   |   |
| Interest income                                                                                       |       | 112,000                                               |       | 275,000 |   | 271,000 |   |
| Other income                                                                                          |       | 196,000                                               |       | 104,000 |   | 182,000 |   |
| Interest expense                                                                                      |       | (61,000                                               | )          | (11,000 | ) | — |   |
| Other expense                                                                                         |       | —                                                |       | (8,000 | ) | (15,000 | ) |
| Total other income, net                                                                               |       | 247,000                                               |       | 360,000 |   | 438,000 |   |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **LOSS  FROM OPERATIONS BEFORE MINORITY INTEREST IN SUBSIDIARY LOSS AND PROVISION FOR  INCOME TAXES** |       | (779,000                                              | )          | (1,365,000 | ) | (786,000 | ) |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| Minority Interest in Subsidiary (Income)  Loss                                                        |       | —                                                |       | (46,000 | ) | 259,000 |   |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| Provision for income taxes                                                                            |       | (15,000                                               | )          | (29,000 | ) | (7,000 | ) |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **NET LOSS**                                                                                          |       | $                                                     | (794,000   | ) | $ | (1,440,000 | ) | $ | (534,000 | ) |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **NET LOSS  PER SHARE**                                                                               |       |                                                  |       |   |   |   |   |
| Basic and diluted                                                                                     |       | $                                                     | (0.35      | ) | $ | (0.56 | ) | $ | (0.19 | ) |
|                                                                                                  |       |                                                  |       |   |   |   |   |
| **WEIGHTED  AVERAGE SHARES OUTSTANDING**                                                              |       |                                                  |       |   |   |   |   |
| Basic and diluted                                                                                     |       | 2,284,000                                             |       | 2,580,000 |   | 2,749,000 |   |

 

***See accompanying notes to these consolidatedfinancial statements.***

 

F-5

----

 

***SPORT-HALEY, INC.***

 

**STATEMENTOF SHAREHOLDERS’ EQUITY**

 
| ** **                          | ** ** | ** **       | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **TOTAL**              | ** ** |
|-------------------------------------|------------|------------------|------------|----------------|------------|--------------|------------|------------------------|------------|
| ** **                          | ** ** | **COMMON STOCK** | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **SHAREHOLDERS’** | ** ** |
| ** **                          | ** ** | **SHARES**       | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**           | ** ** | **EQUITY** | ** ** |
| **BALANCES**as previously reported, |       |             |       |           |       |         |       |                   |       |   |   |
| July 1, 2005                   |       | 2,645,252        |       | $              | 10,460,000 |         | $          | 1,590,000              |       | $ | 3,689,000 |   | $ | 15,739,000 |   |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| **CORRECTIONS**(Note 2)             |       | —           |       | —         |       | —       |       | (146,000               | )          | (146,000 | ) |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| **BALANCES,**  July 1, 2005    |       |             |       |           |       |         |       |                   |       |   |   |
| (as corrected, Note 2)              |       | 2,645,252        |       | 10,460,000     |       | 1,590,000    |       | 3,543,000              |       | 15,593,000 |   |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| Stock options exercised             |       | 125,000          |       | 353,000        |       | —       |       | —                 |       | 353,000 |   |
| Stock-based compensation            |       | —           |       | —         |       | 31,000       |       | —                 |       | 31,000 |   |
| Cash dividend paid on common shares |       | —           |       | —         |       | —       |       | (693,000               | )          | (693,000 | ) |
| Net loss (as corrected, Note 2)     |       | —           |       | —         |       | —       |       | (534,000               | )          | (534,000 | ) |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| **BALANCES,**  June 30, 2006   |       |             |       |           |       |         |       |                   |       |   |   |
| (as corrected, Note 2)              |       | 2,770,252        |       | 10,813,000     |       | 1,621,000    |       | 2,316,000              |       | 14,750,000 |   |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| Repurchase common stock             |       | (485,762         | )          | (2,332,000     | )          | —       |       | —                 |       | (2,332,000 | ) |
| Net loss (as corrected, Note 2)     |       | —           |       | —         |       | —       |       | (1,440,000             | )          | (1,440,000 | ) |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| **BALANCES,**June 30, 2007     |       |             |       |           |       |         |       |                   |       |   |   |
| (as corrected, Note 2)              |       | 2,284,490        |       | 8,481,000      |       | 1,621,000    |       | 876,000                |       | 10,978,000 |   |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| Net loss                            |       | —           |       | —         |       | —       |       | (794,000               | )          | (794,000 | ) |
|                                |       |             |       |           |       |         |       |                   |       |   |   |
| **BALANCES,**June 30, 2008     |       | 2,284,490        |       | $              | 8,481,000  |         | $          | 1,621,000              |       | $ | 82,000 |   | $ | 10,184,000 |   |

 

***See accompanying notes to these consolidatedfinancial statements.***

 

F-6

----

 

***SPORT-HALEY, INC.***

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                                      | ** ** | **FOR THE YEARS ENDED JUNE 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2008**                                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                                      | ** ** | ** **                                                | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** |
| ** **                                                                                      | ** ** | ** **                                                | ** ** | **(Note 2)** | ** ** | **(Note 2)** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                       |       |                                                      |       |   |   |   |   |
| Net loss                                                                                        |       | $                                                         | (794,000   | ) | $ | (1,440,000 | ) | $ | (534,000 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |                                                      |       |   |   |   |   |
| Depreciation and amortization                                                                   |       | 209,000                                                   |       | 258,000 |   | 324,000 |   |
| Inventory impairments and write-downs                                                           |       | 230,000                                                   |       | 312,000 |   | 408,000 |   |
| Goodwill impairment                                                                             |       | —                                                    |       | 270,000 |   | — |   |
| Provisions for doubtful accounts and sales  returns                                             |       | 73,000                                                    |       | (13,000 | ) | (71,000 | ) |
| Stock-based compensation expense                                                                |       | —                                                    |       | — |   | 31,000 |   |
| Gain/loss on disposal of assets                                                                 |       | —                                                    |       | — |   | 12,000 |   |
| Minority interest in subsidiary loss                                                            |       | —                                                    |       | 49,000 |   | 56,000 |   |
| Changes in assets and liabilities:                                                              |       |                                                      |       |   |   |   |   |
| Accounts receivable                                                                             |       | 202,000                                                   |       | 897,000 |   | 616,000 |   |
| Inventory                                                                                       |       | (291,000                                                  | )          | (1,373,000 | ) | (1,052,000 | ) |
| Prepaid expenses and other assets                                                               |       | (61,000                                                   | )          | (9,000 | ) | 2,000 |   |
| Accounts payable                                                                                |       | (621,000                                                  | )          | (109,000 | ) | 1,396,000 |   |
| Accrued royalties, commissions and other                                                        |       | (374,000                                                  | )          | (119,000 | ) | (49,000 | ) |
| Net cash provided by (used in) operating  activities                                            |       | (1,427,000                                                | )          | (1,277,000 | ) | 1,139,000 |   |
|                                                                                            |       |                                                      |       |   |   |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                                       |       |                                                      |       |   |   |   |   |
| Purchase of marketable securities                                                               |       | (200,000                                                  | )          | — |   | — |   |
| Purchase of fixed assets                                                                        |       | (7,000                                                    | )          | (44,000 | ) | (44,000 | ) |
| Proceeds from the disposal of fixed assets                                                      |       | —                                                    |       | — |   | 16,000 |   |
| Purchase of minority interest                                                                   |       | —                                                    |       | (375,000 | ) | — |   |
| Net cash used in investing activities                                                           |       | (207,000                                                  | )          | (419,000 | ) | (28,000 | ) |
|                                                                                            |       |                                                      |       |   |   |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                                                       |       |                                                      |       |   |   |   |   |
| Borrowings under line of credit                                                                 |       | 1,850,000                                                 |       | 300,000 |   | — |   |
| Repayments under line of credit                                                                 |       | (1,850,000                                                | )          | (300,000 | ) | — |   |
| Repurchase common stock                                                                         |       | —                                                    |       | (2,332,000 | ) | — |   |
| Cash dividend paid on common shares                                                             |       | —                                                    |       | — |   | (693,000 | ) |
| Stock option exercises                                                                          |       | —                                                    |       | — |   | 353,000 |   |
| Net cash used in financing activities                                                           |       | —                                                    |       | (2,332,000 | ) | (340,000 | ) |
|                                                                                            |       |                                                      |       |   |   |   |   |
| **NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS**                                       |       | (1,634,000                                                | )          | (4,028,000 | ) | 771,000 |   |
|                                                                                            |       |                                                      |       |   |   |   |   |
| **CASH AND  CASH EQUIVALENTS, Beginning of year**                                               |       | 4,464,000                                                 |       | 8,492,000 |   | 7,721,000 |   |
|                                                                                            |       |                                                      |       |   |   |   |   |
| **CASH AND  CASH EQUIVALENTS, End of year**                                                     |       | $                                                         | 2,830,000  |   | $ | 4,464,000 |   | $ | 8,492,000 |   |
|                                                                                            |       |                                                      |       |   |   |   |   |
| **SUPPLEMENTAL  CASH FLOW INFORMATION**                                                         |       |                                                      |       |   |   |   |   |
| Cash payments for:                                                                              |       |                                                      |       |   |   |   |   |
| Interest                                                                                        |       | $                                                         | 17,000     |   | $ | 11,000 |   | $ | — |   |
| Income taxes                                                                                    |       | $                                                         | 15,000     |   | $ | 29,000 |   | $ | 7,000 |   |

 

***See accompanying notes to these consolidatedfinancial statements.***

 

F-7

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***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

1.          **ORGANIZATIONAND SIGNIFICANT ACCOUNTING POLICIES**:

 

*Principles of Consolidation*– Included in the 2008, 2007 and 2006 consolidated financial statements are theaccounts of Sport-Haley, Inc. (“Sport Haley”) and Reserve Apparel GroupLLC (“Reserve Apparel”). Sport Haley and Reserve Apparel may collectively bereferred to as “the Company,” “we,” “us” or “our.” All significantinter-company transactions between Sport Haley and Reserve Apparel have beeneliminated.

 

*Nature of Operations*– Sport Haley, organized as a Colorado corporation in January 1991,designs, purchases, contracts for the manufacture of, markets and distributesmen’s and women’s fashion golf apparel and outerwear under the SPORT HALEY® andBen Hogan® labels. Our fashion golf apparel collections, known for theirinnovative designs, quality fabrics, generous fits and classic styles, areprimarily marketed 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 UnitedStates. Ben Hogan® fashion golf apparel is distributed per the terms of alicense agreement with Callaway Golf Company (“Callaway”).

 

Reserve Apparel, formed in November 2005, designed, purchased,contracted for the manufacture of, marketed and distributed golf apparel andouterwear under the Top-Flite® label to mass retailers and other big-box, highsales volume retail stores. In accordance with the Reserve Apparel operatingagreement, Sport Haley initially owned a 51% interest in Reserve Apparel andExplorer Gear USA, Inc. (“Explorer Gear”) owned a 49% interest. On September 21,2006, Sport Haley entered into an agreement with Explorer Gear to purchase its49% interest in Reserve Apparel for a lump sum payment of $375,000, since whichtime Reserve Apparel has been a wholly-owned subsidiary of Sport Haley.Top-Flite® branded golf apparel was distributed per the terms of a licenseagreement with Callaway. We discontinued marketing Top-Flite® Branded apparelin November 2007, and in March 2008 the license agreement was amendedto remove the Top-Flite® brand, effective January 1, 2008.

 

*Marketable Securities*– Marketable securities generally consist of certificates of deposit that havean initial maturity of greater than three months and are classified asheld-to-maturity. Due to the short-term nature of the investments, there are nomaterial unrealized gains or losses on these investments. As a result, thecarrying values of marketable securities approximate their fair value.

 

*Receivables and Credit Policies*– Trade receivables consist of uncollateralized customer obligations due undernormal trade terms, generally requiring payment within 30 days of the invoicedate. In most cases, individual trade receivables apply to a specificidentifiable sales invoice. Periodically, management reviews the estimatedrecoverability of trade receivables and reduces their carrying amount by utilizinga valuation allowance that reflects management’s best estimate of the amountthat may not be collectible. From time to time, management also identifiesdelinquent customer accounts and other receivables for which a specific reserveis required. At both June 30, 2008 and 2007, our allowances for doubtfulaccounts of $197,000 and $235,000, respectively, included a specific reserve of$116,000 with respect to the potential non-recovery of the net amount due toSport Haley from a former inventory supplier to Reserve Apparel. In September 2008,the Court ruled in our favor and against the former inventory supplier in theamount of $291,135. In order to collect from the former supplier, we will needto domesticate the judgment in the province of Ontario, Canada. Sincecollection is not assured, we maintained the $116,000 reserve for potentialnon-recovery at June 30, 2008.

 

F-8

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

*Inventories* –Inventories are generally stated at the lower of cost (weighted average) ormarket. Costs include amounts paid to suppliers for packaged apparel and/ormaterials and labor, import costs, such as customs duties, freight-in and othermiscellaneous costs, and allocated overhead. Inventories are written down tomarket value as adjustments to reserves for inventory obsolescence. Changes inthe reserves for inventory obsolescence are reflected in total cost of goodssold during the periods in which the reserve is recorded and the obsoleteinventory is sold, respectively. Write-downs as a result of inventoryobsolescence totaled $230,000, $312,000 and $408,000 for 2008, 2007 and 2006,respectively.

 

*Property and Equipment*– Property and equipment are stated at historical cost. Depreciation isgenerally recorded over the estimated useful lives of the assets, ranging fromthree to twelve years, using the straight-line method. Leasehold improvementsare stated at historical cost and are generally amortized over the remaininglife of the lease, using the straight-line method. Material expenditures thatincrease the life of an asset are capitalized and depreciated over theestimated remaining useful life of the asset. The costs of normal maintenanceand repairs are charged to operating expenses as incurred. Upon the dispositionof assets, the related cost and accumulated depreciation are removed from thebooks and the realized gain or loss, if any, is recognized in the year of thedisposition.

 

*Impairment of Long-Lived Assets*– The carrying values of long-lived assets are reviewed for impairment wheneverevents or changes in circumstances indicate that such carrying values may notbe recoverable. We do not perform periodic assessments of assets for impairmentin the absence of such information or indicators. Currently, management has noindication of any events or circumstances that would significantly impair anyof our long-lived assets, primarily furniture, fixtures and equipment. Animpairment charge, if any, would be recorded for the excess of the carryingvalue of an asset over its estimated fair value, as determined based uponestimates of future cash flows, third-party valuation or other measuresdetermined appropriate for the circumstances.

 

*Revenue Recognition*– The Company recognizes revenue in accordance with Securities and ExchangeCommission Staff Accounting Bulletin No. 104, *“RevenueRecognition, corrected copy,”* which requires that four basiccriteria must be met before revenue can be recognized: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or serviceshave been rendered; (3) the seller’s price to the buyer is fixed ordeterminable; and, (4) collectibility is reasonably assured. We generallyrecord revenue upon shipment, primarily transported via common carrier withterms of FOB at the point of delivery to the carrier. Occasionally, we mayimplement limited consignment programs with certain of our customers. Wegenerally recognize revenue on consignment sales at the time of collection fromthe customer. On a very limited basis, we also offer certain customers theright of return for certain inventory, which we include as a component withinour estimate of allowance for sales returns.

 

*Sales Incentives*– The types of incentives that we offer to our customers generally includesales discounts, terms discounts and free goods, which we include in the netsales line of our statement of operations. In the ordinary course of ourbusiness, we may offer our customers sales discounts of up to 25%, termsdiscounts of up to 10% or free goods of up to 5% off of our stated wholesaleprices. The revenue effects of sales discounts and free goods are recorded uponinvoicing our customer for the related merchandise. We record terms discounts,if applicable, upon receipt of payment from the customer. On a limited basis,we also participate in cooperative advertising with certain of our customers.Charges for cooperative advertising are recorded as advertising expense in theperiod in which our payment is made or when we issue credit to the customer’saccount.

 

F-9

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

*Cost of Goods Sold*– Our gross margins may not be comparable to other companies within the golfapparel industry. We have consistently included the cost of merchandise sold,including import charges, in-bound freight, allocated overhead and othercharges, custom embroidery costs and freight-out in our cost of goods sold.Amounts invoiced to our customers for custom embroidery as well as shipping andhandling charges are included as components of our net sales. Our overheadallocation includes certain of our distribution costs, such as receiving,inspection and shipping 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 expense. Our gross margins also include, ona consolidated basis, the operations of Reserve Apparel, which distributedTop-Flite® apparel to the mass retail market at much lower price points andgross margins that those expected to be achieved in the premium and mid-pricemarkets where we distribute our SPORT HALEY® and Ben Hogan® apparel brands.Other companies within the golf apparel industry may or may not operate withinthe premium and mid-price markets as well as the mass retail market. We includeroyalty payments, relating to sales of licensed apparel, in other operatingcosts.

 

*Advertising* – Weexpense the production costs of advertising the first time the advertisingtakes place, except for direct-response advertising, which is capitalized andamortized over its expected period of future benefits. We had no capitalizeddirect response advertising for 2008, 2007 or 2006. We include costs for thefollowing in advertising expenses: sales catalogs; tradeshows; apparel used inpromotional activities; print ads in golf and other publications; marketinggroup fees; co-operative advertising; market research; amounts paid toprofessional golfers; and, various other items. Advertising expense was$920,000, $879,000 and $837,000 for 2008, 2007, and 2006, respectively.

 

*Deferred Taxes* –Deferred income taxes are recognized for the tax consequences in future yearsfor differences between the tax bases of assets and liabilities and theirfinancial reporting amounts, based on enacted tax laws and statutory tax ratesapplicable to the periods in which the differences are expected to affecttaxable income. Our significant deferred tax assets are related to netoperating loss carry forwards for federal and state income tax purposes,stock-based compensation and an unrealized loss for tax purposes on a commonstock investment. Governing regulations require that our operating losses be carriedforward for income tax purposes. We maintain a valuation allowance to reduceour deferred tax assets to the net amount expected to be recovered in futureperiods. The estimates for deferred tax assets and the corresponding valuationallowance require us to exercise complex judgments. We periodically review andadjust those estimates based upon the most current information available. Inaccordance with Statement of Financial Accounting Standards No. 109, *“Accounting for Income Taxes,”* and based upon a review at June 30,2008, of our utilization of deferred tax assets, we maintained a valuationallowance that effectively reduces our net deferred tax assets to zero. Whilewe continue to explore various strategies to return the Company toprofitability, 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.

 

*Use of Estimates*– The preparation of financial statements in conformity with generally acceptedaccounting principles in the United States of America requires management tomake estimates and assumptions that affect certain reported amounts anddisclosures. Our significant estimates include our allowance for doubtfulaccounts, allowance for sales returns, inventory reserves and valuationallowances associated with our deferred tax assets. Actual results could differfrom our estimates.

 

*Certain Risks and Concentrations*– Our operations consist of designing, purchasing, contracting for the 

 

F-10

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

manufacture of, marketing and wholesale distribution of golf apparelfor men and women. Our headquarters are located in Denver, Colorado, and ourcustomers are located throughout the United States and abroad. As of June 30,2008, 2007 and 2006, the majority of our receivables were from customers in thegolfing industry. We perform on-going credit evaluations, and managementbelieves that we maintain adequate reserves for potential credit losses.

 

We place significant reliance on foreign suppliers that providefinished and packaged apparel, which heightens the risk that our revenues couldbe adversely 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 significant reliance on foreignsuppliers heightens the risk that we may be left with inadequate orunsatisfactory recourse should the goods received from the foreign suppliers benonconforming. In 2008, 2007 and 2006, we purchased significant amounts of ourfinished apparel from various foreign suppliers. If we were to lose orterminate the services of any of these significant suppliers, our short-termability to fulfill customers’ orders on a timely basis could be substantiallyimpaired, thereby negatively affecting the results of our operations. In 2008,we purchased 60%, 11% and 6% of our finished apparel from three separateforeign suppliers. In 2007, we purchased 63%, 9% and 6%, and, in 2006, 57%, 7%,7%, 6% and 5% of our finished apparel from three and five separate foreignsuppliers, respectively.

 

*Statements of Cash Flows*– For purposes of the statements of cash flows, we consider all highly liquidinstruments purchased with original maturities of three months or less, thatare readily convertible to known amounts of cash and present an insignificantrisk of change in value due to changes in interest rates, to be cashequivalents.

 

*Financial Instruments*– We regularly maintain cash balances at a commercial bank in excess of theFederal Deposit Insurance Corporation insurance limit of $250,000.

 

*Comprehensive Income (Loss)*– Comprehensive income is defined as all changes in shareholders’ equity(deficit), exclusive of transactions with owners, such as capital investments.Comprehensive income includes net income (loss) and income or loss from changesin certain assets and liabilities that are reported directly in equity. We hadno items of other comprehensive income for 2008, 2007, or 2006, except for netloss.

 

*Net Income (Loss) Per Share*– Basic earnings per share (EPS) is calculated by dividing the income or lossavailable to common shareholders by the weighted average number of commonshares outstanding for the period. Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock wereexercised or converted into common stock. Due to losses reported in 2008, 2007and 2006, all of our stock options outstanding were anti-dilutive, and thusexcluded from the loss per share calculations.

 

*Stock-Based Compensation* – In January 2008, we adopted a newstock option plan, entitled the Sport-Haley, Inc. 2008 Stock Option Plan(the “2008 Plan”), which was approved by our shareholders at our annual meetingthat was held on February 21, 2008, and continued on February 25,2008. Under the 2008 Plan, the Compensation Committee of the Company’s Board ofDirectors is authorized to grant up to 50,000 non-qualified stock options andup to 150,000 incentive stock options. No options or other awards have beengranted under the 2008 Plan.

 

F-11

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

Our former Stock Option Plan (the “Former Plan”)expired by its terms on February 28, 2003. Option agreements that were issuedin accordance with the Former Plan prior to February 28, 2003, generallyremain in force until the earlier of their exercise, the expiration of certaintime periods after the termination of a grantee’s employment (or otherrelationship with the Company) or expiration by their terms.

 

At June 30, 2008, there were outstandingoptions to purchase 586,000 shares of our common stock at exercise pricesranging from $2.71 to $9.78 per share and expiration dates between August 2008and January 2013. All options are fully vested. During the year ended June 30,2008, no options were exercised and 7,500 options expired.

 

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

 

Priorto July 1, 2005, we accounted for stock-based compensation using theintrinsic value method prescribed in APB 25 and related interpretations andelected to apply the disclosure-only provisions of SFAS 123, as amended by SFASNo. 148, “*Accounting for Stock-BasedCompensation – Transition and Disclosure*.” Under the intrinsic valuemethod, compensation expense for stock options was recognized over the vestingperiod of the grant based on the excess, if any, of the market price of ourcommon stock at the date of grant over the stock option exercise price. Asgoverned by the Plan, stock options were generally granted at or near fairmarket value on the date of grant. The expected life was determined based onthe Plan’s vesting period and exercise behavior of the employees.

 

Uponour adoption of the modified prospective method prescribed in SFAS 123R,effective July 1, 2005, we recorded $31,000 in stock-based compensationexpense using the fair value method. We have not been required to recognize anyadditional stock-based compensation expense, because upon recording the $31,000the fair value of all employee-related options had been fully amortized.Therefore, we have omitted the comparison of pro forma amounts of net income(loss) and net income (loss) per share applicable to common stock for 2008 and2007.

 

F-12

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                                                 | ** ** | **2006** | ** **   |
|----------------------------------------------------------------------------|------------|----------|--------------|
|                                                                       |       |     |         |
| Net loss - as corrected (Note 2)                                           |       | $        | (534,000     | ) |
| Effect of employee stock-based compensation  included in reported net loss |       | 31,000   |    |
| Effect of employee stock-based compensation  per SFAS 123                  |       | (31,000  | )            |
| Net loss applicable to common stock - pro  forma                           |       | $        | (534,000     | ) |
|                                                                       |       |     |         |
| Basic and Diluted:                                                         |       |     |         |
| Loss per share – as corrected (Note 2)                                |       | $        | (0.19        | ) |
| Effect of employee stock-based compensation  included in reported net loss |       | 0.01     |         |
| Effect of employee stock-based compensation  per SFAS 123                  |       | (0.01    | )            |
| Net loss applicable to common stock - pro  forma                           |       | $        | (0.19        | ) |

 

*Recent Pronouncements*– In May 2008, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 163 (“SFAS 163”), *“Accounting for Financial Guarantee Insurance Contracts — AnInterpretation of FASB Statement No. 60.”* Diversity exists inpractice in accounting for financial guarantee insurance contracts by insuranceenterprises under FASB Statement No. 60, *“Accountingand Reporting by Insurance Enterprises.”* SFAS 163 requires that aninsurance enterprise recognize a claim liability prior to an event of default(insured event) when there is evidence that credit deterioration has occurredin an insured financial obligation. SFAS 163 requires expanded disclosuresabout financial guarantee insurance contracts. The accounting and disclosurerequirements of SFAS 163 are expected to improve the quality of informationprovided to users of financial statements. Our adoption of SFAS 163 upon itseffective date is not expected to have a material effect on our financialcondition or the results of our operations.

 

In May 2008, the FASB issued Statement of Financial AccountingStandards No. 162 (“SFAS 162”), *“The Hierarchy ofGenerally Accepted Accounting Principles*(“GAAP”)*.”* The current GAAP hierarchy, as set forth in the AmericanInstitute of Certified Public Accountants (“AICPA”) Statement on AuditingStandards No. 69, *“The Meaning of PresentFairly in Conformity With Generally Accepted Accounting Principles,”*has been criticized because: (i) it is directed to the auditor rather thanthe entity; (ii) it is complex; and, (iii) it ranks FASB Statementsof Financial Accounting Concepts. The FASB believes that the GAAP hierarchyshould be directed to entities, because it is the entity (not its auditors)that is responsible for selecting accounting principles for financialstatements that are presented in conformity with GAAP. Accordingly, the FASBconcluded that the GAAP hierarchy should reside in the accounting literatureestablished by the FASB 

 

F-13

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

and is issuing SFAS 162 to achieve that result. SFAS 162 is effective60 days following the Securities and Exchange Commission’s approval of thePublic Company Accounting Oversight Board amendments to AU Section 411, *“The Meaning of Present Fairly in Conformity With Generally AcceptedAccounting Principles.”* Our adoption of SFAS 162 upon its effectivedate is not expected to have a material effect on our financial condition orthe results of our operations.

 

In March 2008, the FASB issued Statement of Financial AccountingStandards No. 161 (“SFAS 161”), *“Disclosures aboutDerivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133.”*FASB Statement No. 133 (“SFAS 131”), *“Accounting for DerivativeInstruments and Hedging Activities,”* establishes, among otherthings, the disclosure requirements for derivative instruments and for hedgingactivities. SFAS 161 amends and expands the disclosure requirements of SFAS 131with the intent to provide users of financial statements with an enhancedunderstanding of: (i) how and why an entity uses derivative instruments; (ii) howderivative instruments and related hedged items are accounted for under SFAS133 and its related interpretations; and, (iii) how derivative instrumentsand related hedged items affect an entity’s financial position, financialperformance and cash flows. To meet those objectives, SFAS 161 requiresqualitative disclosures about objectives and strategies for using derivatives,quantitative disclosures about fair value amounts of gains and losses onderivative instruments and disclosures about credit-risk-related contingentfeatures in derivative agreements. SFAS 161 is effective for fiscal years, andinterim periods within those fiscal years, beginning after November 15,2008, with earlier adoption encouraged. SFAS 161 further encourages, but doesnot require, comparative disclosures for earlier periods at initial adoption.We do not anticipate early adoption, and our adoption of SFAS 161 upon itseffective date is not expected to have a material effect on our financialcondition or the results of our operations.

 

We have reviewed all recently issued, but not yet effective, accountingpronouncements and do not believe the future adoption of any such pronouncementsmay be expected to cause a material impact on our financial condition or theresults of our operations.

 

2.          **CORRECTIONOF PREVIOUSLY ISSUED FINANCIAL STATEMENTS:**

 

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

 

In order to correct the amount of duty payable to US Customs and BorderProtection for such imports, we began voluntarily preparing a Prior Disclosurein September 2008. A Prior Disclosure is a specific procedure proscribedby US Customs and Border Protection for the purpose of identifying andcorrecting amounts which were previously declared or omitted from declaration.Our Prior Disclosure will correct amounts with regard to our imports for thefive-year period immediately prior to the date the Prior Disclosure issubmitted to US Customs and Border Protection. We expect to submit our PriorDisclosure on or about October 15, 2008. In September 2008, weretained an import duties specialist to assist us with the Prior Disclosure.The specialist has advised us that, upon our delivery of the Prior Disclosureand the payment of applicable amounts and interest thereon, it is highlyunlikely that US Customs and Border Protection will assess further fines and/orpenalties with regard to this matter. Therefore, we believe that upon deliveryof our Prior 

 

F-14

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

Disclosure and the related payment, US Customs and Border Protectionwill consider this matter closed. We determined that additional customs dutiesowed for fiscal 2008 and the applicable periods within the prior four fiscalyears totaled $641,000 and interest due thereon totaled $44,000.

 

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

 

Ourqualitative analysis and our quantitative analysis under the rollover approacheach yielded results that indicate the correction of prior year financial statementamounts is immaterial in each case. Our quantitative analysis under the ironcurtain approach yielded results that indicate application of the iron curtainmethod would cause our fiscal 2008 financial statements to be materiallymisstated. When analyzing materiality under the iron curtain and rolloverapproaches, SAB 108 directs, “[A] registrant’s financial statements wouldrequire adjustment when either approach results in quantifying a misstatementthat is material, after considering all relevant quantitative and qualitativefactors.” SAB 108 further instructs, “[A]fter all of the relevant quantitativeand qualitative factors are considered, the prior year financial statementsshould be corrected, even though such revision previously was and continues tobe immaterial to the prior year financial statements. Correcting prior yearfinancial statements for immaterial errors would not require previously filedreports to be amended. Such correction may be made the next time the registrantfiles the prior year financial statements.” Accordingly, we have corrected ourfiscal 2007 and fiscal 2006 financial statements and our retained earnings asof July 1, 2005.

 

Thefollowing comparison of consolidated statements of income for the years ended June 30,2007 and 2006, and the comparison of consolidated balance sheets as of June 30,2007, present the effects resulting from correcting the Company’s financialstatements for the aforementioned reason.

 

F-15

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**COMPARISON OF CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                                                           | ** ** | **For the Years Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2007**                                                  | ** ** | **2006** | ** ** |
| ** **                                                                                           | ** ** | ** **                                                | ** ** | **As Previously** | ** ** | ** ** | ** ** | **As Previously** | ** ** |
| ** **                                                                                           | ** ** | **As Corrected**                                     | ** ** | **Reported** | ** ** | **As Corrected** | ** ** | **Reported** | ** ** |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **NET SALES**                                                                                        |       | $                                                         | 18,893,000 |   | $ | 18,893,000 |   | $ | 20,962,000 |   | $ | 20,962,000 |   |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **COST OF GOODS SOLD**                                                                               |       |                                                      |       |   |   |   |   |   |   |
| Cost of goods sold                                                                                   |       | 12,032,000                                                |       | 11,893,000 |   | 13,761,000 |   | 13,642,000 |   |
| Inventory impairments                                                                                |       | 312,000                                                   |       | 312,000 |   | 408,000 |   | 408,000 |   |
| Total cost of goods sold                                                                             |       | 12,344,000                                                |       | 12,205,000 |   | 14,169,000 |   | 14,050,000 |   |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **GROSS PROFIT**                                                                                     |       | 6,549,000                                                 |       | 6,688,000 |   | 6,793,000 |   | 6,912,000 |   |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **OTHER OPERATING COSTS**                                                                            |       |                                                      |       |   |   |   |   |   |   |
| Selling, general and administrative expenses                                                         |       | 7,087,000                                                 |       | 7,087,000 |   | 7,090,000 |   | 7,090,000 |   |
| Royalty expense                                                                                      |       | 917,000                                                   |       | 917,000 |   | 927,000 |   | 927,000 |   |
| Goodwill impairment                                                                                  |       | 270,000                                                   |       | 270,000 |   | — |   | — |   |
| Total other operating costs                                                                          |       | 8,274,000                                                 |       | 8,274,000 |   | 8,017,000 |   | 8,017,000 |   |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **LOSS FROM OPERATIONS**                                                                             |       | (1,725,000                                                | )          | (1,586,000 | ) | (1,224,000 | ) | (1,105,000 | ) |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **OTHER INCOME AND (EXPENSE)**                                                                       |       |                                                      |       |   |   |   |   |   |   |
| Interest income                                                                                      |       | 275,000                                                   |       | 275,000 |   | 271,000 |   | 271,000 |   |
| Other income                                                                                         |       | 104,000                                                   |       | 104,000 |   | 182,000 |   | 182,000 |   |
| Interest expense                                                                                     |       | (11,000                                                   | )          | (11,000 | ) | — |   | — |   |
| Other expense                                                                                        |       | (8,000                                                    | )          | (8,000 | ) | (15,000 | ) | (15,000 | ) |
| Total other income, net                                                                              |       | 360,000                                                   |       | 360,000 |   | 438,000 |   | 438,000 |   |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **LOSS FROM OPERATIONS BEFORE MINORITY INTEREST IN  SUBSIDIARY LOSS AND PROVISION FOR INCOME TAXES** |       | (1,365,000                                                | )          | (1,226,000 | ) | (786,000 | ) | (667,000 | ) |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| Minority interest in subsidiary (income) loss                                                        |       | (46,000                                                   | )          | (46,000 | ) | 259,000 |   | 259,000 |   |
| Provision for income taxes                                                                           |       | (29,000                                                   | )          | (29,000 | ) | (7,000 | ) | (7,000 | ) |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **NET LOSS**                                                                                         |       | $                                                         | (1,440,000 | ) | $ | (1,301,000 | ) | $ | (534,000 | ) | $ | (415,000 | ) |
|                                                                                                 |       |                                                      |       |   |   |   |   |   |   |
| **NET LOSS PER SHARE**                                                                               |       |                                                      |       |   |   |   |   |   |   |
| Basic and diluted                                                                                    |       | $                                                         | (0.56      | ) | $ | (0.50 | ) | $ | (0.19 | ) | $ | (0.15 | ) |
| **WEIGHTED AVERAGE SHARES OUTSTANDING**                                                              |       |                                                      |       |   |   |   |   |   |   |
| Basic and diluted                                                                                    |       | 2,580,000                                                 |       | 2,580,000 |   | 2,749,000 |   | 2,749,000 |   |

 

F-16

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**COMPARISON OF CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                          | ** ** | **JUNE 30, 2007** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                          | ** ** | ** **                  | ** ** | **As Previously** | ** ** |
| ** **                                          | ** ** | **As Corrected**       | ** ** | **Reported** | ** ** |
|                                                |       |                        |       |   |   |
| **ASSETS**                                          |       |                        |       |   |   |
| **CURRENT  ASSETS**                                 |       |                        |       |   |   |
| Cash and cash equivalents                           |       | $                           | 4,464,000  |   | $ | 4,464,000 |   |
| Accounts receivable, net of allowances              |       | 3,066,000                   |       | 3,066,000 |   |
| Inventories                                         |       | 5,886,000                   |       | 5,814,000 |   |
| Prepaid expenses and other                          |       | 203,000                     |       | 203,000 |   |
| Total current assets                                |       | 13,619,000                  |       | 13,547,000 |   |
|                                                |       |                        |       |   |   |
| **PROPERTY AND EQUIPMENT, net**                     |       | 399,000                     |       | 399,000 |   |
| **OTHER ASSETS**                                    |       | 3,000                       |       | 3,000 |   |
|                                                |       |                        |       |   |   |
| **TOTAL ASSETS**                                    |       | $                           | 14,021,000 |   | $ | 13,949,000 |   |
|                                                |       |                        |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**      |       |                        |       |   |   |
| **CURRENT LIABILITIES**                             |       |                        |       |   |   |
| Accounts payable                                    |       | $                           | 2,042,000  |   | $ | 1,566,000 |   |
| Accrued royalties payable                           |       | 181,000                     |       | 181,000 |   |
| Accrued commissions payable                         |       | 214,000                     |       | 214,000 |   |
| Accrued payroll                                     |       | 249,000                     |       | 249,000 |   |
| Other                                               |       | 179,000                     |       | 179,000 |   |
| Total current liabilities                           |       | 2,865,000                   |       | 2,389,000 |   |
|                                                |       |                        |       |   |   |
| **COMMITMENTS AND CONTINGENCIES**                   |       |                        |       |   |   |
| Minimum royalties payable                           |       | 178,000                     |       | 178,000 |   |
| Total contingent liabilities                        |       | 178,000                     |       | 178,000 |   |
|                                                |       |                        |       |   |   |
| **TOTAL LIABILITIES**                               |       | 3,043,000                   |       | 2,567,000 |   |
|                                                |       |                        |       |   |   |
| **SHAREHOLDERS’ EQUITY**                       |       |                        |       |   |   |
| Preferred stock, no par value                       |       | —                      |       | — |   |
| Common stock, no par value                          |       | 8,481,000                   |       | 8,481,000 |   |
| Additional paid-in capital                          |       | 1,621,000                   |       | 1,621,000 |   |
| Retained earnings                                   |       | 876,000                     |       | 1,280,000 |   |
| Total shareholders’ equity                     |       | 10,978,000                  |       | 11,382,000 |   |
|                                                |       |                        |       |   |   |
| **TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY** |       | $                           | 14,021,000 |   | $ | 13,949,000 |   |

 

F-17

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

3.          **FAIR VALUE OF FINANCIAL INSTRUMENTS:**

 

The carrying values of our financial instruments,principally consisting of cash and cash equivalents, accounts receivable andaccounts payable, approximate their fair market values due to their short-termmaturities.

 

4.          **CASH ANDCASH EQUIVALENTS**:

 

Cash and cash equivalents consist of the following at June 30:

 
| ** **                                                           | ** ** | **2008** | ** ** | **2007**  | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|-----------|------------|
|                                                                 |       |     |       |      |       |
| Cash in banks                                                        |       | $        | 2,830,000  |      | $          | 1,417,000 |   |
| Short-term securities (original maturities of three  months or less) |       | —   |       | 3,047,000 |       |
| Total cash and cash equivalents                                      |       | $        | 2,830,000  |      | $          | 4,464,000 |   |

 

5.          **INVENTORIES**:

 

Inventories consisted of the following at June 30:

 
| ** **                 | ** ** | **2008**   | ** ** | **2007**              | ** ** |
|----------------------------|------------|------------|------------|-----------------------|------------|
| ** **                 | ** ** | ** ** | ** ** | **As Corrected** | ** ** |
| ** **                 | ** ** | ** ** | ** ** | **(Note 2)**     | ** ** |
|                       |       |       |       |                  |       |
| Component inventories      |       | $          | 331,000    |                  | $          | 283,000 |   |
| Finished goods inventories |       | 5,616,000  |       | 5,603,000             |       |
| Total inventories          |       | $          | 5,947,000  |                  | $          | 5,886,000 |   |

 

Includedin finished goods inventories balances are allowances for inventory write-downsof $168,000 and $236,000 for 2008 and 2007, respectively.

 

6.          **PROPERTYAND EQUIPMENT**:

 

Property and equipment are recorded at historical costand are comprised of the following at June 30:

 
| ** **                                                   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                         |       |       |       |       |       |
| Furniture and fixtures                                       |       | $          | 876,000    |       | $          | 1,419,000 |   |
| Plant equipment                                              |       | 1,314,000  |       | 1,314,000  |       |
| Computer software and equipment                              |       | 1,248,000  |       | 1,299,000  |       |
| Leasehold improvements                                       |       | 418,000    |       | 418,000    |       |
| Other                                                        |       | —     |       | 11,000     |       |
| Total property and equipment                                 |       | 3,856,000  |       | 4,461,000  |       |
| Less accumulated depreciation, amortization, and  impairment |       | (3,659,000 | )          | (4,062,000 | )          |
| Property and equipment, net                                  |       | $          | 197,000    |       | $          | 399,000 |   |

 

F-18

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Depreciation and amortization expense for 2008, 2007,and 2006 was $209,000, $258,000 and $324,000, respectively.

 

7.          **LINE OF CREDIT AGREEMENT**:

 

In September 2007, we entered into a businessloan agreement with Bank of Oklahoma N.A. (“Bank of Oklahoma”). The businessloan agreement, which expired on September 30, 2008, provided for amaximum loan amount of $3,000,000, collateralized by deposit amounts maintainedat Bank of Oklahoma or its affiliates. We expect to amend the business loanagreement in October 2008 under the same terms with an expiration date of September 30,2009. While the maximum principal amount allowed under the business loanagreement is $3,000,000, the Company may not borrow amounts under the businessloan agreement in excess of the combined amounts of its collateralizeddeposits. Borrowings under the business loan agreement accrue interest at theBank of Oklahoma Financial (“BOKF”) National Prime Rate less 1.500%. We generally entered into the business loanagreement to facilitate the issuance of letters of credit for inventorypurchases from offshore suppliers and, if necessary, to fund any temporaryworking capital needs. We did not have any balances due on the business loanagreement at June 30, 2008 or 2007, respectively. Outstandingletters of credit reduce the amount available for borrowing under the businessloan agreement. At June 30, 2008 and 2007, we had outstanding letters ofcredit of $1,144,000 and $0, respectively, issued through Bank of Oklahoma forpurchase obligations under outstanding letters of credit.

 

In May 2008, we amended the revolvingline of credit agreement that we have maintained with US Bank NationalAssociation (“US Bank”) for the past several years. The amended revolving lineof credit agreement, which expires on December 5, 2008, provides for amaximum loan amount of $200,000, collateralized by a certificate of depositheld at US Bank in the amount of $200,000, which earns a market rate ofinterest. Borrowings under the amended line of credit agreement accrue interestat 1.250% plus the one-month LIBOR rate. At June 30, 2007, the line ofcredit had previously been amended to provide for a maximum loan amount of$3,000,000, collateralized by a certificate of deposit held at US Bank in theamount of $3,000,000. We have generally maintained the line of credit tofacilitate the issuance of letters of credit for inventory purchases fromoffshore suppliers and, if necessary, to fund any temporary working capitalneeds. We did not have any balances due on the line of credit at June 30,2008 or 2007, respectively. Outstanding letters of credit reduce the amountavailable for borrowing under the line of credit agreement. At June 30,2008 and 2007, we had outstanding letters of credit of $0 and $2,173,000,respectively, issued through US Bank for purchase obligations under outstandingletters of credit.

 

8.          **INCOME TAXES**:

 

The differences between the U.S. Federal statutory rate and oureffective rate are as follows at June 30:

 
| ** **                                       | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |     |       |
| U.S. Federal statutory rate                      |       | $        | (307,000   | )        | $          | (378,000 | )          | $ | (250,000 | ) |
| State income taxes                               |       | (42,000  | )          | (51,000  | )          | (34,000  | )          |
| Change in deferred tax valuation allowance       |       | 238,000  |       | 454,000  |       | 188,000  |       |
| Permanent differences and other                  |       | 126,000  |       | 4,000    |       | 103,000  |       |
| Total current and deferred tax expense (benefit) |       | $        | 15,000     |     | $          | 29,000   |       | $ | 7,000 |   |

 

F-19

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

The components of income tax expense(benefit) are as follows at June 30:

 
| ** **                   | ** ** | **2008**   | ** ** | **2007**              | ** ** | **2006**              | ** ** |
|------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                   | ** ** | ** ** | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** |
|                         |       |       |       |                  |       | ** **            |       |
| Federal                      |       | $          | —     |                  | $          | —                |       | $ | — |   |
| State                        |       | 15,000     |       | 29,000                |       | 7,000                 |       |
| Deferred                     |       | —     |       | —                |       | —                |       |
| Income tax expense (benefit) |       | $          | 15,000     |                  | $          | 29,000                |       | $ | 7,000 |   |

 

The components of the netdeferred tax asset and net deferred tax liability recognized in theaccompanying balance sheets are as follows at June 30:

 
| ** **                                        | ** ** | **2008**    | ** ** | **2007 As Corrected** | ** ** |
|---------------------------------------------------|------------|-------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | ** **  | ** ** | **Long-**                       | ** ** | ** ** | ** ** | **Long-** | ** ** |
| ** **                                        | ** ** | **Current** | ** ** | **Term**                        | ** ** | **Current** | ** ** | **Term** | ** ** |
|                                              |       |        |       |                            |       |   |   |   |   |
| Deferred tax assets                               |       | $           | 270,000    |                            | $          | 3,388,000 |   | $ | 268,000 |   | $ | 3,152,000 |   |
| Deferred tax liabilities                          |       | —      |       | —                          |       | — |   | — |   |
| Net deferred tax asset before valuation allowance |       | 270,000     |       | 3,388,000                       |       | 268,000 |   | 3,152,000 |   |
| Valuation allowance                               |       | (270,000    | )          | (3,388,000                      | )          | (268,000 | ) | (3,152,000 | ) |
| Net deferred tax asset                            |       | $           | —     |                            | $          | — |   | $ | — |   | $ | — |   |

 

The types of temporary differences between the taxbases of assets and liabilities and their financial reporting amounts that giverise to a significant portion of the deferred tax asset and liability and theirappropriate tax effects are as follows at June 30:

 
| ** **                                        | ** ** | ** **     | ** ** | **2008**    | ** ** | ** ** | ** ** | **2007 as Corrected** | ** ** |
|---------------------------------------------------|------------|----------------|------------|-------------|------------|------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **Temporary**  | ** ** | ** **  | ** ** | **Long-**  | ** ** | **Temporary**                   | ** ** | ** ** | ** ** | **Long-** | ** ** |
| ** **                                        | ** ** | **Difference** | ** ** | **Current** | ** ** | **Term**   | ** ** | **Difference**                  | ** ** | **Current** | ** ** | **Term** | ** ** |
| Allowance for doubtful accounts                   |       | $              | 81,000     |        | $          | 30,000     |       | $                               | —     |   | $ | 119,000 |   | $ | 44,000 |   | $ | — |   |
| Allowance for doubtful accounts – Subsidiary |       | 116,000        |       | 43,000      |       | —     |       | 116,000                         |       | 43,000 |   | — |   |
| Reserve for sales returns                         |       | 81,000         |       | 30,000      |       | —     |       | 139,000                         |       | 51,000 |   | — |   |
| Accrued vacation                                  |       | 155,000        |       | 58,000      |       | —     |       | 158,000                         |       | 59,000 |   | — |   |
| Accumulated depreciation                          |       | 194,000        |       | —      |       | 72,000     |       | 173,000                         |       | — |   | 64,000 |   |
| Stock option compensation                         |       | 389,000        |       | —      |       | 144,000    |       | 389,000                         |       | — |   | 144,000 |   |
| Unrealized loss on investment                     |       | 234,000        |       | —      |       | 87,000     |       | 234,000                         |       | — |   | 87,000 |   |
| Inventory costs                                   |       | 295,000        |       | 109,000     |       | —     |       | 191,000                         |       | 71,000 |   | — |   |
| Federal net operating losses                      |       | 7,754,000      |       | —      |       | 2,636,000  |       | 7,134,000                       |       | — |   | 2,426,000 |   |
| State net operating losses                        |       | 9,690,000      |       | —      |       | 449,000    |       | 9,325,000                       |       | — |   | 431,000 |   |
| Net deferred tax asset before valuation allowance |       |           |       | 270,000     |       | 3,388,000  |       |                            |       | 268,000 |   | 3,152,000 |   |
| Valuation allowance                               |       |           |       | (270,000    | )          | (3,388,000 | )          |                            |       | (268,000 | ) | (3,152,000 | ) |
| Net deferred tax asset                            |       |           |       | $           | —     |       | $          | —                          |       |   |   | $ | — |   | $ | — |   |
|                                                   |            |                |            |             |            |            |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

F-20

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

The changes in deferred tax valuation allowances for2008, 2007 and 2006 were $238,000, $454,000 and $188,000, respectively.

 

Federal net operating losscarry forwards expire from 2023 through 2028. State net operating loss carryforwards expire from 2021 through 2028.

 

9.          **OPERATING LEASES**:

 

The Company leases its corporate offices, production and warehousefacilities under an operating lease that extends through October 2011.

 

Rent expenses for 2008, 2007, and 2006, were $289,000,$272,000 and $264,000, respectively.

 

The future minimum lease payments under non-cancelable leases withinitial terms of one year or more as of June 30, 2007, are as follows:

 
| **Years Ending  June 30,** | ** ** | **Amount** | ** ** |
|--------------------------------------|------------|------------|------------|
|                                 |       |       |       |
| 2009                                 |       | 293,000    |       |
| 2010                                 |       | 289,000    |       |
| 2011                                 |       | 289,000    |       |
| 2012                                 |       | 96,000     |       |
| Thereafter                           |       | —     |       |
| Total                                |       | $          | 967,000    |   |
|                                      |            |            |            |  |

 

10.        **COMMITMENTS AND CONTINGENCIES**:

 

*PotentialClaims* – Weare subject to various legal proceedings and claims that arise in the ordinarycourse of our business. Based upon the information that is currently available,management does not believe that the total impact of legal proceedings willmaterially affect our financial position or the results of our operations.

 

*Touring Professionals* – From time to time we maintain marketing agreements with certaintouring professionals, whereby we provide the professionals with golf apparel.We did not maintain any such agreements and we did not compensate any tourprofessionals in 2008.

 

*Employment Agreements* – Wemaintain several employment and non-compete agreements with officers and a keyemployee of the Company. The agreements are subject to automatic one-yearextensions. For 2008, employment and non-compete agreements provided forminimum salary levels totaling $735,000, excluding discretionary bonuses andseverance payments upon termination of employment.

 

As previously reported, in October 2004, our Board of Directorsapproved a resolution not to renew the executive employment agreement of KevinM. Tomlinson, our then Chief Executive Officer, President and Director, beyondthe end of the term of the agreement on March 17, 2005. Per its terms,upon the non-renewal of the agreement, Mr. Tomlinson was entitled toreceive severance compensation for a term of 36 

 

F-21

----

 

***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

months upon a termination of the agreement, equal to salary and bonuspayments as were been paid to him during the most recent twelve-month period,and other compensation, including certain costs relating to Mr. Tomlinson’sparticipation in all employee benefit plans during the time he is receivingsuch severance compensation. Included in our accrued payroll liabilities at June 30,2008 and 2007, are $0 and $121,000, respectively, relating to amounts due to Mr. Tomlinsonwith regard to severance and other compensation. In accordance with the termsof the employment agreement, Mr. Tomlinson received monthly payments forseverance and other compensation through March 17, 2008.

 

*License Agreements* – In May 2001,we entered into a license agreement with Spalding Sports Worldwide, Inc. (“Spalding”)for the rights to market a line of men’s premium golf apparel under the BenHogan® brand name.

 

In July 2002, we reached an agreement with Spalding to amend thelicense agreement to expand the applicable territory covered by the agreementto include the United Kingdom, Sweden, Mexico and various Caribbean countries.The original license agreement previously granted us the right to market BenHogan® apparel within the United States. We paid Spalding $50,000 in cash andan additional retail value of $50,000 in finished goods (at a cost to us ofapproximately $29,000) for the rights to market Ben Hogan® apparel for a fiveyear period ending December 31, 2006, and a subsequent renewal periodending December 31, 2011.

 

In May 2003, Spalding changed its corporate name to The Top-FliteGolf Company, Inc. (“Top-Flite Golf”).

 

In June 2003, we reached an agreement with Top-Flite Golf to amendthe license agreement to grant us the right to market lines of golf apparelunder the Top-Flite® brand name within the United States, Sweden, Mexico andvarious Caribbean countries. We paid Top-Flite Golf $25,000 in cash for therights to market Top-Flite® apparel for the balance of the licensing periodending December 31, 2006, and a subsequent renewal period ending December 31,2011.

 

In September 2003, Callaway Golf Company (“Callaway”) purchasedsubstantially all of the assets of Top-Flite Golf including the Ben Hogan® andTop-Flite® brand names licensed to us.

 

In October 2005, Callaway granted permission for Reserve ApparelGroup LLC to distribute Top-Flite® branded apparel to Wal-Mart Stores, Inc.(“Wal-Mart”) through December 31, 2006, subject to certain terms andconditions. Subsequently, Callaway has granted us permission to marketTop-Flite® apparel to numerous other large retailers throughout the remainingterm of the license agreement.

 

In March 2008, we reached an agreement with Callaway to remove theTop-Flite® brand from the license agreement, effective January 1, 2008.

 

In May 2008, we entered into a new license agreement with Callawaywhich continues our right to market golf apparel bearing the Ben Hogan® label.The new license agreement supersedes and replaces the prior license agreement,as amended, and expands the applicable territory to include Canada and theEuropean Union. The new license agreement also extends the term until December 31,2013, unless sooner terminated pursuant to the provisions of the agreement.

 

The original, amended and new license agreements require us to payroyalties based upon sales. We record royalty payments governed by the licenseagreement with Callaway as other operating costs in the periods 

 

F-22

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***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

when such sales are recognized. Royalty payments with respect to salesof apparel under the license agreements totaled $498,000, $739,000 and $927,000for 2008, 2007 and 2006, respectively. The agreements also provide for minimumroyalty payments on a calendar year basis. We expect that royalties generatedon sales of Ben Hogan® fashion apparel will insufficient to meet thecontractual minimum royalty requirement for calendar 2008 with regard to BenHogan® apparel and, accordingly, recorded a contingent liability of $80,000 at June 30,2008. Sales of Top-Flite® branded apparel were insufficient to meet thecontractual minimum royalty requirement for calendar 2007 with regard toTop-Flite®. Thus, at June 30, 2007, we accrued a contingent liability of$178,000 with regard to the Top-Flite® minimum royalty due to Callaway forcalendar 2007. The agreement that we reached with Callaway in March 2008to remove the Top-Flite® brand from the license agreement, effective January 1,2008, extinguished and forgave any unpaid minimum royalties due to Callaway asof December 31, 2007, with respect to Top-Flite® apparel. Therefore, in March 2008,we reversed the contingent liability with regard to Top-Flite® minimumroyalties for calendar 2007 and recorded miscellaneous income of $178,000. At June 30,2008, minimum future royalty obligations under license agreements, payable forcalendar years 2008 thru 2013, cumulatively totaled $4,487,000.

 

11.        **SHAREHOLDERS’ EQUITY**:

 

*Repurchase of Common Stock* –Our Board of Directors previously authorized the repurchase of up to 2,820,000shares of our issued and outstanding common stock. The shares may berepurchased from time to time in open market transactions at prevailing marketprices or privately negotiated transactions. All shares repurchased by us arerequired to be canceled and returned to the status of authorized but unissuedcommon stock. We have no commitment or obligation to repurchase all or anyportion of the shares, and we did not repurchase any shares during 2008 or2007. Through June 30, 2008, we had cumulatively repurchased a total of2,512,800 shares of our common stock at a cost of $13,488,000, not includingthe “Dutch Auction” tender offer described below.

 

On January 3, 2007, we commenced a modified “Dutch Auction” tenderoffer to purchase shares of our common stock at a price neither greater than$5.30 nor less than $4.80 per share, net in cash. Pursuant to the terms of theOffer to Purchase, which was filed with the Securities and Exchange Commission(the “SEC” or “Commission”) on January 3, 2007, and subsequently distributedto shareholders, we offered to purchase up to 472,000 shares that were properlytendered and not withdrawn prior to the expiration of the offer at 12:00midnight Eastern Time on February 1, 2007. The Offer to Purchase requiredus to analyze the total number of shares tendered and the prices specified bythe tendering shareholders and to determine the lowest price per share withinthe stated range that enabled us to purchase up to 472,000 shares. The tenderoffer was not contingent upon any minimum number of shares being tendered andwas subject to a number of other terms and conditions specified in the Offer toPurchase.

 

None of the Company, our Board of Directors or the Depositary made anyrecommendation to any shareholder as to whether to tender or refrain fromtendering any shares or as to the price or prices at which shareholders choseto tender shares. Our Board of Directors and executive officers each advisedthat they did not intend to tender in the offer shares they held individuallyor through an affiliated entity. Shareholders were urged to read the TenderOffer Statement on Schedule TO, which included as exhibits the Offer toPurchase and the related Letter of Transmittal, as well as any amendments orsupplements to the Tender Offer Statement when they became available. On January 12,2007, we submitted an amended Schedule TO and an amended Offer to Purchase tothe Commission. We filed further amendments to the Schedule TO on February 6 

 

F-23

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***SPORT-HALEY, INC.***

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

and February 9, 2007.

 

On February 6, 2007, the Depositary for the tender offer providedus with the final tabulation of the tender offer results. In total, 1,357,698shares were properly tendered and not withdrawn at prices from $4.80 to $5.30per share. Of the total, 485,762 shares were tendered at $4.80 per share, whichexceeded by 13,762 shares the 472,000 shares we sought in the tender offer. In Section 1of the Offer to Purchase, we reserved the right, in our sole discretion, topurchase in the tender offer an additional number of shares over the 472,000shares we sought in the tender offer, not to exceed 2% of our outstandingcommon shares, without amending or extending the tender offer. On February 7,2007, we exercised our right, under Section 1 of the Offer to Purchase andapplicable SEC regulations, to accept for purchase all 485,762 shares tenderedat $4.80 per share, without proration. The 485,762 shares accepted for purchasein the tender offer represented approximately 171⁄2 percent of the common sharesoutstanding as of January 3, 2007.

 

On February 8, 2007, we transferred $2,332,000 to the Depositaryto fund the purchase of 485,762 shares of our common stock at a price of $4.80per share. The Depositary was instructed to promptly pay for the sharesaccepted for purchase in the tender offer and to return all other sharestendered which were not accepted for purchase or withdrawn. Upon completion ofthe tender offer, we had 2,284,490 shares of common stock outstanding.

 

*Preferred Stock –*TheArticles of Incorporation of the Company authorize the issuance of a maximum of1,500,000 shares of preferred stock. The Articles of Incorporation vest ourBoard of Directors with authority to divide the class of preferred stock intoseparate series and to fix and determine the relative rights and preferences ofthe shares of any such series so established to the full extent permitted bythe laws of the State of Colorado and the Articles of Incorporation. As of June 30,2008, we had no preferred stock issued or outstanding.

 

*Common Stock Options* – In January 2008, we adopted a newstock option plan, entitled the Sport-Haley 2008 Stock Option Plan (the “2008Plan”). Under the 2008 Plan, the Compensation Committee of our Board ofDirectors is authorized to grant up to 50,000 non-qualified stock options andup to 150,000 incentive stock options. No options or other awards have beengranted under the 2008 Plan.

 

Our former Stock Option Plan (the “Former Plan”) expired by its termsin February 2003. Under the Former Plan, we could grant to employees,directors and consultants of the Company, and any subsidiary thereof, optionsto purchase common stock. Generally, granted options vested over three-yearperiods, were granted at fair market value on the date of grant, expire10 years from that date, are non-transferable and cannot be exercised fora period of one year from the date of grant. The Former Plan, as restated, isadministered by the Compensation Committee, which, at its discretion,determined the number of options granted and applicable exercise periods.Option agreements issued in accordance with the Former Plan prior to itsexpiration in February 2003 will generally remain in force until theearlier of their exercise, their expiration or the termination of an employmentrelationship with the Company.

 

We granted 166,000 options in 2000 at approximately 86% of marketprice, 25,000 options in 2002 at 98% of market price, 304,000 options in 2002at 85% of market price and 400,000 options in 2003 at 85% of market price. Allother options were granted at exercise prices that approximated the marketprices on the dates of grant.

 

F-24

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***SPORT-HALEY,INC.***

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

We followed the provisions of SFAS 123**for all issuances of stock options to non-employees of theCompany through June 30, 2005. We followed the provisions of APB 25 forall grants of stock options to our employees prior to the expiration of theFormer Plan by its terms in February 2003. Generally, all stock optionsgranted to our employees, pursuant to the Plan, were not compensatory. Weadopted the modified prospective method prescribed in SFAS 123R, effective July 1,2005, and recognized $31,000 in stock-option compensation expense during ourquarter ended September 30, 2005, accordingly. During 2008, 2007 and 2006,we recognized $0, $0 and $31,000, respectively, in stock-based compensation expense.

 

At June 30, 2008, the Company had outstandingoptions equal to 586,000 shares of common stock at prices ranging from $2.71 to$9.78 with expiration dates between August 2008 and January 2013. In2007, no options were exercised and 7,500 options expired.

 

Activity under the Company’s Plan is set forth below:

 
| ** **          | ** ** | **Employees**      | ** ** | **Non-Employees** | ** ** |
|---------------------|------------|--------------------|------------|-------------------|------------|
| ** **          | ** ** | ** **         | ** ** | **Weighted**      | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **          | ** ** | ** **         | ** ** | **Average**       | ** ** | **Range of** | ** ** | ** ** | ** ** | **Average** | ** ** | **Range of** | ** ** |
| **Option**          | ** ** | **Number of** | ** ** | **Exercise**      | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Exercise** | ** ** |
| **Balances**        | ** ** | **Options**        | ** ** | **Price**         | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** | **Price** | ** ** |
|                |       |               |       |              |       |   |   |   |   |   |   |   |   |
| June 30,  2005 |       | 785,000            |       | $                 | 3.56       |   | $2.71 - $8.63 |   | 53,500 |   | $ | 6.95 |   | $3.00 - $9.78 |   |
|                |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Exercised           |       | (125,000           | )          | $                 | 2.83       |   | $2.71 - $3.00 |   | — |   | — |   | — |   |
| Canceled            |       | (25,000            | )          | $                 | 3.60       |   | $3.60 |   | (10,000 | ) | $ | 9.25 |   | $9.25 |   |
| June 30,  2006 |       | 635,000            |       | $                 | 3.70       |   | $2.71 - $8.63 |   | 43,500 |   | $ | 6.42 |   | $3.00 - $9.78 |   |
|                |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Exercised           |       | —             |       | —            |       | — |   | — |   | — |   | — |   |
| Canceled            |       | (75,000            | )          | $                 | 8.63       |   | $8.63 |   | (10,000 | ) | $ | 9.25 |   | $6.50 - $8.63 |   |
| June 30,  2007 |       | 560,000            |       | $                 | 3.04       |   | $2.71 - $3.60 |   | 33,500 |   | $ | 6.08 |   | $3.00 - $9.78 |   |
|                |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Exercised           |       | —             |       | —            |       | — |   | — |   | — |   | — |   |
| Canceled            |       | —             |       | —            |       | — |   | (7,500 | ) | $ | 8.63 |   | $8.63 |   |
| June 30,  2007 |       | 560,000            |       | $                 | 3.04       |   | $2.71 - $3.60 |   | 26,000 |   | $ | 5.35 |   | $3.00 - $9.78 |   |

 

F-25

----

 

***SPORT-HALEY,INC.***

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Options outstanding at June 30, 2008, vest asfollows:

 
| ** **                       | ** ** | **Employees**      | ** ** | **Non-Employees** | ** ** |
|----------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                       | ** ** | ** **         | ** ** | **Weighted**      | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **         | ** ** | **Average**       | ** ** | **Range of** | ** ** | ** ** | ** ** | **Average** | ** ** | **Range of** | ** ** |
| ** **                       | ** ** | **Number of** | ** ** | **Exercise**      | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Exercise** | ** ** |
| **Vesting**                      | ** ** | **Options**        | ** ** | **Price**         | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** | **Price** | ** ** |
|                             |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Vested as of June 30,  2007 |       | 560,000            |       | $                 | 3.04       |   | $2.71 - $3.60 |   | 26,000 |   | $ | 5.35 |   | $3.00 - $9.78 |   |
|                             |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Vested during 2008               |       | —             |       | —            |       | — |   | — |   | — |   | — |   |
|                             |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Vested as of June 30,  2008 |       | 560,000            |       | $                 | 3.04       |   | $2.71 – $3.60 |   | 26,000 |   | $ | 5.35 |   | $3.00 - $9.78 |   |

 

If not exercised earlier,options outstanding as of June 30, 2008 will expire as follows:

 
| ** **      | ** ** | **Employees**      | ** ** | **Non-Employees** | ** ** |
|-----------------|------------|--------------------|------------|-------------------|------------|
| ** **      | ** ** | ** **         | ** ** | **Weighted**      | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **      | ** ** | ** **         | ** ** | **Average**       | ** ** | **Range of** | ** ** | ** ** | ** ** | **Average** | ** ** | **Range of** | ** ** |
| ** **      | ** ** | **Number of** | ** ** | **Exercise**      | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Exercise** | ** ** |
| **Expiration**  | ** ** | **Options**        | ** ** | **Price**         | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** | **Price** | ** ** |
|            |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Expiring during |       |               |       |              |       |   |   |   |   |   |   |   |   |
| 2009            |       | —             |       | —            |       | — |   | 9,000 |   | $ | 9.78 |   | $9.78 |   |
| 2010            |       | 40,000             |       | $                 | 3.00       |   | $3.00 |   | — |   | — |   | — |   |
| 2011            |       | —             |       | —            |       | — |   | 10,000 |   | $ | 3.00 |   | $3.00 |   |
| 2012            |       | 295,000            |       | $                 | 3.31       |   | $3.00 - $3.60 |   | 7,000 |   | $ | 3.00 |   | $3.00 |   |
| 2013            |       | 225,000            |       | $                 | 2.71       |   | $2.71 |   | — |   | — |   | — |   |
|            |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Totals          |       | 560,000            |       | $                 | 3.04       |   | $2.71 – $3.60 |   | 26,000 |   | $ | 5.35 |   | $3.00 - $9.78 |   |

 

12.        **EARNINGS(LOSS) PER SHARE**:

 

In the reconciliation of basic to diluted earnings(loss) per share, there were no reconciling items affecting the numerator inany year presented. In 2008, 2007 and 2006, due to our net losses, all options,totaling 586,000, 593,500 and 678,500, respectively, were anti-dilutive andtherefore excluded from the earnings (loss) per share calculations.

 

F-26

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***SPORT-HALEY,INC.***

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

13.        **RETIREMENTPLAN**:

 

In January 1996, the Company adopted a definedcontribution savings plan (the “401(k) Plan”) to provide retirement incometo our employees. The 401(k) Plan is funded by voluntary pre-tax salarydeferral contributions from employees and through matching contributions by theCompany. Through December 31, 2006, the Company contributed $0.25 on thedollar for employee deferrals of the first 5% of a participating employee’sannual compensation. Effective January 1, 2007, the Company amended the401(k) Plan to adopt a Safe Harbor matching contribution, since which theCompany has contributed dollar for dollar on employee deferrals of the first3%, $0.50 on the dollar for employee deferrals from 3% to 4% and $0.50 on thedollar for employee deferrals from 4% to 5% of a participating employee’sannual compensation, unless otherwise restricted by prevailing governmentalregulations. For 2008, 2007 and 2006, the Company’s contributions to the 401(k) Planaccounts of Company employees totaled $70,000, $44,000 and $16,000,respectively.

 

14.        **SEGMENTINFORMATION**:

 

The consolidated Company has two operating segmentswhich consist of designing, purchasing or contracting for the manufacture ofand wholesale sales of women’s and men’s (1) fashion golf apparel andouterwear and (2) branded golf apparel, which we discontinued marketing asof November 2007. SPORT HALEY® and Ben Hogan® fashion golf apparel andouterwear collections are primarily marketed by Sport Haley in the premium andmid-priced markets through a network of independent wholesale salesrepresentatives and distributors to golf professional shops, country clubs,resorts and exclusive department stores within the United States. Top-Flite®men’s branded apparel was marketed by Reserve Apparel to mass retailers andother big-box type high sales volume retail stores within the United States. BenHogan® fashion apparel and Top-Flite® branded apparel have been distributedpursuant to a license agreement with Callaway.

 

Reserve Apparel distributed Top-Flite® apparelexclusively to Wal-Mart from March 2006 through August 2006, afterwhich we were notified that Wal-Mart had chosen to develop its own privatelabel 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 Top-Flite®apparel to several mass retailers and big-box type high sales volume retailstores. We expected our marketing efforts would result in the establishment ofbusiness relationships with one or more mass retailers and other big-box typehigh sales volume retail stores. However, we only received one order forTop-Flite® apparel from such a retailer for a test in 50 of its stores, whichwe shipped in September and October 2007. Since our concerted effortsfailed to generate orders from a major customer, we discontinued marketingapparel bearing the Top-Flite® label in November 2007.

 

At June 30, 2007, we recorded a contingentliability of $178,000, with regard to minimum royalties due for calendar year2007 in accordance with our license agreement for Top-Flite® branded apparel.In March 2008, we reached an agreement with Callaway to remove theTop-Flite® brand from the license agreement, effective January 1, 2008,whereby any unpaid minimum royalties due to Callaway as of December 31, 2007,with respect to Top-Flite® apparel were extinguished and forgiven. Therefore,in March 2008, we reversed the contingent liability with regard toTop-Flite® minimum royalties and recorded miscellaneous income of $178,000.

 

F-27

----

 

***SPORT-HALEY,INC.***

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Condensed consolidated balance sheets information andcondensed consolidated statements of operations for each of our segments arepresented in the tables below.

 

*Consolidated Balance Sheets Segment Information asof June 30, 2008 and 2007 (in thousands):*

 
| ** **                              | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **Fashion**                 | ** ** | **Branded**                 | ** ** | ** ** | ** ** | **Fashion** | ** ** | **Branded** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Apparel**                 | ** ** | **Apparel**                 | ** ** | **Total** | ** ** | **Apparel** | ** ** | **Apparel** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** | **As  Corrected** | ** ** | ** ** | ** ** | **As  Corrected** | ** ** |
| ** **                              | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** | **(Note 2)** | ** ** | ** ** | ** ** | **(Note 2)** | ** ** |
| Assets:                                 |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents              |       | $                           | 2,798      |                        | $          | 32 |   | $ | 2,830 |   | $ | 4,354 |   | $ | 110 |   | $ | 4,464 |   |
| Marketable  securities                  |       | 200                         |       | —                      |       | 200 |   | — |   | — |   | — |   |
| Accounts  receivable, net of allowances |       | 2,439                       |       | 352                         |       | 2,791 |   | 2,714 |   | 352 |   | 3,066 |   |
| Inventories                             |       | 5,947                       |       | —                      |       | 5,947 |   | 5,886 |   | — |   | 5,886 |   |
| Prepaid expenses                        |       | 264                         |       | —                      |       | 264 |   | 198 |   | 5 |   | 203 |   |
| Property and  equipment, net            |       | 197                         |       | —                      |       | 197 |   | 399 |   | — |   | 399 |   |
| Other assets                            |       | 3                           |       | —                      |       | 3 |   | 3 |   | — |   | 3 |   |
| Total Assets                            |       | $                           | 11,848     |                        | $          | 384 |   | $ | 12,232 |   | $ | 13,554 |   | $ | 467 |   | $ | 14,021 |   |
| Liabilities:                            | ** ** | ** **                  |       |                        |       |   |   |   |   |   |   |   |   |
| Accounts payable                        |       | $                           | 1,185      |                        | $          | 236 |   | $ | 1,421 |   | $ | 1,806 |   | $ | 236 |   | $ | 2,042 |   |
| Accrued  royalties payable              |       | 52                          |       | —                      |       | 52 |   | 181 |   | — |   | 181 |   |
| Accrued  commissions payable            |       | 180                         |       | —                      |       | 180 |   | 214 |   | — |   | 214 |   |
| Accrued payroll                         |       | 138                         |       | —                      |       | 138 |   | 249 |   | — |   | 249 |   |
| Other  liabilities                      |       | 177                         |       | —                      |       | 177 |   | 179 |   | — |   | 179 |   |
| Total Current  Liabilities              |       | 1,732                       |       | 236                         |       | 1,968 |   | 2,629 |   | 236 |   | 2,865 |   |
| Minimum  royalties payable              |       | 80                          |       | —                      |       | 80 |   | — |   | 178 |   | 178 |   |
| Total Contingent  Liabilities           |       | 80                          |       | —                      |       | 80 |   | — |   | 178 |   | 178 |   |
| Total  Liabilities                      |       | $                           | 1,812      |                        | $          | 236 |   | $ | 2,048 |   | $ | 2,629 |   | $ | 414 |   | $ | 3,043 |   |

 

F-28

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***SPORT-HALEY,INC.***

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

*Statements of Operations Segment Information forthe Quarters and Years Ended June 30, 2008, 2007, as corrected, and 2006,as corrected, (in thousands):*

 
| ** **                           | ** ** | **Quarter Ended June 30, 2008** | ** ** | **Year Ended June 30, 2008** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                           | ** ** | **Fashion**                                         | ** ** | **Branded**                                      | ** ** | ** ** | ** ** | **Fashion** | ** ** | **Branded** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Apparel**                                         | ** ** | **Apparel**                                      | ** ** | **Total** | ** ** | **Apparel** | ** ** | **Apparel** | ** ** | **Total** | ** ** |
| Net Sales                            |       | $                                                   | 4,424      |                                             | $          | 3 |   | $ | 4,427 |   | $ | 16,957 |   | $ | 160 |   | $ | 17,117 |   |
| Cost of goods  sold                  |       | 2,667                                               |       | 3                                                |       | 2,670 |   | 10,392 |   | 141 |   | 10,533 |   |
| Inventory  impairments               |       | 51                                                  |       | —                                           |       | 51 |   | 210 |   | 20 |   | 230 |   |
| Total cost of  goods sold            |       | 2,718                                               |       | 3                                                |       | 2,721 |   | 10,602 |   | 161 |   | 10,763 |   |
| Gross profit                         |       | 1,706                                               |       | —                                           |       | 1,706 |   | 6,355 |   | (1 | ) | 6,354 |   |
| Selling, general  and admin expenses |       | 1,484                                               |       | 46                                               |       | 1,530 |   | 6,624 |   | 178 |   | 6,802 |   |
| Royalty expense                      |       | 131                                                 |       | —                                           |       | 131 |   | 569 |   | 9 |   | 578 |   |
| Total other  operating costs         |       | 1,615                                               |       | 46                                               |       | 1,661 |   | 7,193 |   | 187 |   | 7,380 |   |
| Income (loss)  from operations       |       | 91                                                  |       | (46                                              | )          | 45 |   | (838 | ) | (188 | ) | (1,026 | ) |
| Other income,  net                   |       | (29                                                 | )          | —                                           |       | (29 | ) | 67 |   | 180 |   | 247 |   |
| Provision for  income taxes          |       | (4                                                  | )          | (2                                               | )          | (6 | ) | (6 | ) | (9 | ) | (15 | ) |
| Net income (loss)                    |       | $                                                   | 58         |                                             | $          | (48 | ) | $ | 10 |   | $ | (777 | ) | $ | (17 | ) | $ | (794 | ) |

 
| ** **                              | ** ** | **Quarter Ended June 30, 2007** | ** ** | **Year Ended June 30, 2007** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                              | ** ** | **Fashion**                                         | ** ** | **Branded**                                      | ** ** | ** ** | ** ** | **Fashion** | ** ** | **Branded** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Apparel**                                         | ** ** | **Apparel**                                      | ** ** | **Total** | ** ** | **Apparel** | ** ** | **Apparel** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **As  Corrected**                                   | ** ** | ** **                                       | ** ** | **As  Corrected** | ** ** | **As  Corrected** | ** ** | ** ** | ** ** | **As  Corrected** | ** ** |
| ** **                              | ** ** | **(Note 2)**                                   | ** ** | ** **                                       | ** ** | **(Note 2)** | ** ** | **(Note 2)** | ** ** | ** ** | ** ** | **(Note 2)** | ** ** |
| Net Sales                               |       | $                                                   | 4,757      |                                             | $          | — |   | $ | 4,757 |   | $ | 17,708 |   | $ | 1,185 |   | $ | 18,893 |   |
| Cost of goods  sold                     |       | 2,855                                               |       | —                                           |       | 2,855 |   | 11,147 |   | 885 |   | 12,032 |   |
| Inventory  impairments                  |       | 186                                                 |       | —                                           |       | 186 |   | 312 |   | — |   | 312 |   |
| Total cost of  goods sold               |       | 3,041                                               |       | —                                           |       | 3,041 |   | 11,459 |   | 885 |   | 12,344 |   |
| Gross profit                            |       | 1,716                                               |       | —                                           |       | 1,716 |   | 6,249 |   | 300 |   | 6,549 |   |
| Selling, general  and admin expenses    |       | 1,647                                               |       | 81                                               |       | 1,728 |   | 6,705 |   | 382 |   | 7,087 |   |
| Royalty expense                         |       | 181                                                 |       | 178                                              |       | 359 |   | 675 |   | 242 |   | 917 |   |
| Goodwill  impairment                    |       | 270                                                 |       | —                                           |       | 270 |   | 270 |   | — |   | 270 |   |
| Total other  operating costs            |       | 2,098                                               |       | 259                                              |       | 2,357 |   | 7,650 |   | 624 |   | 8,274 |   |
| Income (loss)  from operations          |       | (382                                                | )          | (259                                             | )          | (641 | ) | (1,401 | ) | (324 | ) | (1,725 | ) |
| Other income,  net                      |       | 57                                                  |       | 70                                               |       | 127 |   | 248 |   | 112 |   | 360 |   |
| Minority  interest in subsidiary income |       | —                                              |       | —                                           |       | — |   | — |   | (46 | ) | (46 | ) |
| Provision for  income taxes             |       | (1                                                  | )          | —                                           |       | (1 | ) | (22 | ) | (7 | ) | (29 | ) |
| Net income  (loss)                      |       | $                                                   | (326       | )                                                | $          | (189 | ) | $ | (515 | ) | $ | (1,175 | ) | $ | (265 | ) | $ | (1,440 | ) |

 

F-29

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***SPORT-HALEY,INC.***

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 
| ** **                            | ** ** | **Quarter Ended June 30, 2006** | ** ** | **Year Ended June 30, 2006** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                            | ** ** | **Fashion**                                         | ** ** | **Branded**                                      | ** ** | ** ** | ** ** | **Fashion** | ** ** | **Branded** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Apparel**                                         | ** ** | **Apparel**                                      | ** ** | **Total** | ** ** | **Apparel** | ** ** | **Apparel** | ** ** | **Total** | ** ** |
| ** **                            | ** ** | **As  Corrected**                                   | ** ** | ** **                                       | ** ** | **As  Corrected** | ** ** | **As  Corrected** | ** ** | ** ** | ** ** | **As  Corrected** | ** ** |
| ** **                            | ** ** | **(Note 2)**                                   | ** ** | ** **                                       | ** ** | **(Note 2)** | ** ** | **(Note 2)** | ** ** | ** ** | ** ** | **(Note 2)** | ** ** |
| Net Sales                             |       | $                                                   | 5,839      |                                             | $          | 2,027 |   | $ | 7,866 |   | $ | 18,489 |   | $ | 2,473 |   | $ | 20,962 |   |
| Cost of goods  sold                   |       | 3,688                                               |       | 1,836                                            |       | 5,524 |   | 11,497 |   | 2,264 |   | 13,761 |   |
| Inventory  impairments                |       | 28                                                  |       | 95                                               |       | 123 |   | 313 |   | 95 |   | 408 |   |
| Total cost of  goods sold             |       | 3,716                                               |       | 1,931                                            |       | 5,647 |   | 11,810 |   | 2,359 |   | 14,169 |   |
| Gross profit                          |       | 2,123                                               |       | 96                                               |       | 2,219 |   | 6,679 |   | 114 |   | 6,793 |   |
| Selling, general  and admin expenses  |       | 1,638                                               |       | 331                                              |       | 1,969 |   | 6,621 |   | 469 |   | 7,090 |   |
| Royalty expense                       |       | 254                                                 |       | 132                                              |       | 386 |   | 768 |   | 159 |   | 927 |   |
| Total other  operating costs          |       | 1,892                                               |       | 463                                              |       | 2,355 |   | 7,389 |   | 628 |   | 8,017 |   |
| Income (loss)  from operations        |       | 231                                                 |       | (367                                             | )          | (136 | ) | (710 | ) | (514 | ) | (1,224 | ) |
| Other income,  net                    |       | 71                                                  |       | —                                           |       | 71 |   | 438 |   | — |   | 438 |   |
| Minority interest  in subsidiary loss |       | —                                              |       | 259                                              |       | 259 |   | — |   | 259 |   | 259 |   |
| Provision for  income taxes           |       | (4                                                  | )          | —                                           |       | (4 | ) | (7 | ) | — |   | (7 | ) |
| Net income  (loss)                    |       | $                                                   | 298        |                                             | $          | (108 | ) | $ | 190 |   | $ | (279 | ) | $ | (255 | ) | $ | (534 | ) |

 

15.        **LEGALPROCEEDINGS**:

 

As previously reported, in March 2007,Sport Haley and Reserve Apparel (the “Plaintiffs”) filed a lawsuit in theDistrict Court for the City and County of Denver in the State of Colorado. Thesuit alleges, among other things, that a former inventory broker to ReserveApparel, 1130746 Ontario Ltd., a Canadian corporation incorporated in theProvince of Ontario, Canada, d/b/a Originals Apparel Group Co., or OriginalsApparel Group, and Francis Tat-Mo Chan (the “Defendants”), knowingly,wrongfully and without authorization converted Plaintiff’s funds. Among otherthings, the Plaintiffs alleged that the Defendants misapplied an inventorydeposit of $291,135 paid to the Defendants in March 2006 by Sport Haley,which the Defendants used to offset certain amounts purportedly owed to theDefendants by Explorer Headgear, Inc., and that the Defendants failed toreturn $176,877 which was overpaid by Sport Haley as of July 2006. ThePlaintiffs have alleged claims against the Defendants for conversion andviolation of the Colorado civil theft statute as well as for unjust enrichmentand negligence. The Plaintiffs originally sought repayment of the $291,135 and$176,877 amounts and other relief. At the commencement of the trial, whichoccurred on September 23, 2008, the Plaintiffs agreed to withdraw theirclaim for the $176,877 amount that they previously alleged was overpaid to theDefendants. At the conclusion of the trial, the Court awarded judgment in thePlaintiff’s favor and against the Defendants, jointly and severally, in theamount of $291,135 with regard to the Plaintiff’s claims for conversion andunjust enrichment, and the Court dismissed all of the other claims.

 

F-30

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***SPORT-HALEY,INC.***

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

16.        **SELECTEDQUARTERLY FINANCIAL DATA (UNAUDITED)**:

 

The following quarterly information is unaudited. Inthe opinion of management, all material adjustments necessary to present fairlythe results of operations of the Company, for the periods presented, have beenmade. All such adjustments were of a normal, recurring nature.

 
| ** **                         | ** ** | **Sep 30,**      | ** ** | **Dec 31,**      | ** ** | **Mar 31,**      | ** ** | **Jun 30,** | ** ** |
|------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|------------------|------------|
| **2008 Quarter Ended**   | ** ** | **2007**              | ** ** | **2007**              | ** ** | **2008**              | ** ** | **2008**         | ** ** |
| ** **                         | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** | ** **       | ** ** |
| ** **                         | ** ** | **(Note 2)**     | ** ** | **(Note 2)**     | ** ** | **(Note 2)**     | ** ** | ** **       | ** ** |
|                               |       |                  |       |                  |       |                  |       |             |       |
| Net sales                          |       | $                     | 3,528,000  |                  | $          | 4,411,000             |       | $                | 4,751,000  |   | $ | 4,427,000 |   |
| Total cost of  goods sold          |       | 2,387,000             |       | 2,679,000             |       | 2,976,000             |       | 2,721,000        |       |
| Gross profit                       |       | $                     | 1,141,000  |                  | $          | 1,732,000             |       | $                | 1,775,000  |   | $ | 1,706,000 |   |
| Total other  operating costs       |       | $                     | 1,851,000  |                  | $          | 1,788,000             |       | $                | 2,080,000  |   | $ | 1,661,000 |   |
| Net income  (loss)                 |       | $                     | (669,000   | )                     | $          | (24,000               | )          | $                | (111,000   | ) | $ | 10,000 |   |
| Basic earnings  (loss) per share   |       | $                     | (0.29      | )                     | $          | (0.01                 | )          | $                | (0.05      | ) | $ | 0.00 |   |
| Diluted earnings  (loss) per share |       | $                     | (0.29      | )                     | $          | (0.01                 | )          | $                | (0.05      | ) | $ | 0.00 |   |

 
| ** **                         | ** ** | **Sep 30,**      | ** ** | **Dec 31,**      | ** ** | **Mar 31,**      | ** ** | **Jun 30,**      | ** ** |
|------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| **2007 Quarter Ended**   | ** ** | **2006**              | ** ** | **2006**              | ** ** | **2007**              | ** ** | **2007**              | ** ** |
| ** **                         | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** | **As Corrected** | ** ** |
| ** **                         | ** ** | **(Note 2)**     | ** ** | **(Note 2)**     | ** ** | **(Note 2)**     | ** ** | **(Note 2)**     | ** ** |
|                               |       |                  |       |                  |       |                  |       |                  |       |
| Net sales                          |       | $                     | 4,673,000  |                  | $          | 4,190,000             |       | $                     | 5,273,000  |   | $ | 4,757,000 |   |
| Total cost of  goods sold          |       | 3,207,000             |       | 2,653,000             |       | 3,443,000             |       | 3,041,000             |       |
| Gross profit                       |       | $                     | 1,466,000  |                  | $          | 1,537,000             |       | $                     | 1,830,000  |   | $ | 1,716,000 |   |
| Total other  operating costs       |       | $                     | 1,931,000  |                  | $          | 1,843,000             |       | $                     | 2,143,000  |   | $ | 2,357,000 |   |
| Net income  (loss)                 |       | $                     | (433,000   | )                     | $          | (239,000              | )          | $                     | (253,000   | ) | $ | (515,000 | ) |
| Basic earnings  (loss) per share   |       | $                     | (0.16      | )                     | $          | (0.09                 | )          | $                     | (0.10      | ) | $ | (0.23 | ) |
| Diluted earnings  (loss) per share |       | $                     | (0.16      | )                     | $          | (0.09                 | )          | $                     | (0.10      | ) | $ | (0.23 | ) |

 

F-31

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**SCHEDULE II**

 

**SPORT-HALEY, INC.**

**VALUATIONAND QUALIFYING ACCOUNTS**

 
| **COLUMN A**                        | ** ** | **COLUMN B**                              | ** ** | **COLUMN C**                                        | ** ** | **COLUMN D**                    | ** ** | **COLUMN E** | ** ** |
|------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------|------------|-------------------|------------|
| ** **                               | ** ** | ** **                                     | ** ** | **ADDITIONS**                                            | ** ** | ** **                           | ** ** | ** **        | ** ** |
| ** **                               | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged to  Revenues, Costs  and  Expenses** | ** ** | **Charged to  Other  Accounts** | ** ** | **Deductions**    | ** ** | **Balance  at End  of Period** | ** ** |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| **ALLOWANCE FOR DOUBTFUL ACCOUNTS**      |       |                                           |       |                                                     |       |                                 |       |              |       |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| June 30,                            |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2006                                     |       | $                                              | 377,000    |                                                     | $          | 194,000                              |       | $                 | —     |   | $ | (280,000 | )(1) | $ | 291,000 |   |
| 2007                                     |       | $                                              | 291,000    |                                                     | $          | 26,000                               |       | $                 | —     |   | $ | (82,000 | )(1) | $ | 235,000 |   |
| 2008                                     |       | $                                              | 235,000    |                                                     | $          | 75,000                               |       | $                 | —     |   | $ | (113,000 | )(1) | $ | 197,000 |   |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| **ALLOWANCE  FOR SALES RETURNS**         |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| June 30,                            |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2006                                     |       | $                                              | 286,000    |                                                     | $          | 573,000                              |       | $                 | —     |   | $ | (704,000 | )(2) | $ | 155,000 |   |
| 2007                                     |       | $                                              | 155,000    |                                                     | $          | 581,000                              |       | $                 | —     |   | $ | (597,000 | )(2) | $ | 139,000 |   |
| 2008                                     |       | $                                              | 139,000    |                                                     | $          | 578,000                              |       | $                 | —     |   | $ | (636,000 | )(2) | $ | 81,000 |   |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| **ALLOWANCE FOR SAMPLE GARMENT RETURNS** |       |                                           |       |                                                     |       |                                 |       |              |       |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| June 30,                            |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2006                                     |       | $                                              | 28,000     |                                                     | $          | —                               |       | $                 | —     |   | $ | (28,000 | )(2) | $ | — |   |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| **ALLOWANCE FOR INVENTORY OBSOLESCENCE** |       |                                           |       |                                                     |       |                                 |       |              |       |
|                                     |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| June 30,                            |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2006                                     |       | $                                              | 629,000    |                                                     | $          | 408,000                              |       | $                 | —     |   | $ | (856,000 | )(3) | $ | 181,000 |   |
| 2007                                     |       | $                                              | 181,000    |                                                     | $          | 312,000                              |       | $                 | —     |   | $ | (257,000 | )(3) | $ | 236,000 |   |
| 2008                                     |       | $                                              | 236,000    |                                                     | $          | 230,000                              |       | $                 | —     |   | $ | (298,000 | )(3) | $ | 168,000 |   |

 

----

(1) Written-off uncollectible accounts, net of recoveries ofpreviously written-off uncollectible accounts.

(2) Gross sales returns.

(3) Changes in allowance relating to sales and dispositions ofinventories previously written down.

 

F-32

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