**FORM 10-K**

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**(Mark One)**

**x****                             ****ANNUAL REPORT PURSUANT TO SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the fiscal year ended June 30, 2006**

**OR**

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 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 areacode:  **(303)320-8800**

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

| **Title of each class** | ** ** | **Name of  each exchange on which registered** |
|-------------------------|------------|------------------------------------------------|
| None                    |       | None                                           |

 

Securities registered pursuant to section 12(g) of theExchange Act:**Common Stock, no par value per share**

Indicate by checkmark whether the registrant is a well-known seasoned issuer, as defined in Rule405 of the Securities Act.

Yes oNo x

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.

Yes oNo x

Indicate bycheckmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.              Yesx No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor 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 oAccelerated Filer o Non-acceleratedFiler x

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

As of December 31, 2005, the last business day of theregistrant’s most recently completed second fiscal quarter, the aggregatemarket value of the 2,770,252 shares of Common Stock (the Registrant’s onlycommon equity) held by non-affiliates was $12,745,000 based on the closing saleprice of the Registrant’s Common Stock on the NASDAQ Global MarketSM on such date. Forpurposes of the foregoing calculation only, each of the Registrant’s officersand directors is deemed to be an affiliate. This determination of affiliatestatus is not a conclusive determination for other purposes.

There were 2,770,252 shares of the Registrant’s CommonStock outstanding at the close of business on September 11, 2006.

DOCUMENTSINCORPORATED BY REFERENCE:**None**

 

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**PART I**

**ITEM1.  BUSINESS**

**General**

Sport-Haley,Inc. (“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 apparelcollections, known for their innovative designs, quality fabrics, generous fitsand classic styles, are primarily marketed in the premium and mid-pricemarkets, through a network of independent sales representatives anddistributors, to golf professional shops, country clubs, resorts and exclusivedepartment stores throughout the United States and by certain distributorswithin international markets. Sport Haley distributes Ben Hogan® apparelpursuant to a license agreement with Callaway Golf Company (“Callaway”). Appealfor the SPORT HALEY® and Ben Hogan® brand names are enhanced because golfprofessional shops, country clubs and resorts generally prefer to sell qualityapparel that is not broadly distributed in other retail markets. We have focusedour Sport Haley marketing efforts on expanding brand recognition and appeal forSPORT HALEY® and Ben Hogan® apparel 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 Sport Haley offers include optional customembroidering of our apparel with a personalized club, resort or corporate logo.Sport-Haley, Inc. was incorporated in Colorado in January 1991. The principal executiveoffices are located at 4600 East 48th Avenue, Denver, Colorado 80216-3215, andthe main telephone number is (303) 320-8800.

ReserveApparel Group LLC (“Reserve Apparel”), formed in November 2005, designs,purchases, contracts for the manufacture of, markets and distributes golfapparel and outerwear under the Top-Flite® label. In accordance with the LLCoperating agreement, as of June 30, 2006, Sport Haley owned a 51% interest inReserve Apparel and Explorer Gear USA, Inc. (“Explorer Gear”) owned a 49%interest. Effective September 21, 2006, Sport Haley purchased Explorer Gear’smembership interest, and thereafter Reserve Apparel has been wholly owned bySport Haley. To date, Reserve Apparel has marketed Top-Flite® apparelexclusively through Wal-Mart Stores, Inc. (“Wal-Mart”), pursuant to a licensingagreement with Callaway. Sport-Haley, Inc. consolidates the operations ofSport-Haley with Reserve Apparel for financial reporting purposes. Collectivelythroughout this report, Sport Haley and Reserve Apparel may be referred to asthe “Company”, “we”, “us” or “our”.

**Productsand Product Design**

SPORTHALEY® fashion apparel is comprised almost exclusively of women’s garments andaccessories, designed by utilizing classic styles with contemporary influencesintended to develop and maintain brand recognition and loyalty, on or off thegolf course. While each product in the SPORT HALEY® apparel line is soldseparately, the line is intentionally designed in groups with coordinatedstyles, color schemes and fabrics to encourage customers to purchase multiplegarments. SPORT HALEY® women’s fashion apparel is manufactured using a varietyof fabrics and weave patterns, including interlock, pique, French terry, jerseyand twill, and may feature a unique trim, a special fabric finish or extraneedlework. The SPORT HALEY® name has been highly recognized as a women’sfashion apparel brand within the premium and mid-priced golf apparel marketsfor over 20 years, in part, because of the cohesiveness of our design staff. CatherineB. Blair has provided direction for the SPORT HALEY® brand for over 14 years.Ms. Blair recognized that fashion designs within the women’s golf apparelmarket were trending toward technical performance fabrics and more athleticstyling. Therefore, we began designing our women’ fashion apparel to includemoisture wicking fabrics such as AEROCool and Dry-Tech 18. We also have begunto include a larger selection of more leading edge, younger looking, athleticstyle garments in our women’s collections. The technical performance fabricsand athletic style garments have been well received by our customers. Our SPORTHALEY® men’s apparel is comprised of only a few separate styles of polo shirtsin a few colors each, plus one outerwear piece in a few colors selections.

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Thefollowing table presents the suggested retail price ranges for various SPORTHALEY® apparel items:
| SPORT HALEY®         | ** ** | **Suggested Retail**  | ** ** | **SPORT HALEY®**  | ** ** | **Suggested Retail**                                      |
|---------------------------|------------|-----------------------|------------|------------------------|------------|-----------------------------------------------------------|
| **Women’s  Apparel** | ** ** | **Price Range**       | ** ** | **Men’s Apparel** | ** ** | **Price Range**                                           |
| Tops                      |       | $32 - $  64 |       | Shirts                 |       | $36 - $50                                                 |
| Shorts                    |       | $58 - $  68 |       | Outerwear              |       | $70          |
| Pants                     |       | $46 - $  78 |       |                   |       |                                                      |
| Sweaters                  |       | $44 - $  88 |       |                   |       |                                                      |
| Outerwear                 |       | $38 - $118            |       |                   |       |                                                      |
| Accessories               |       | $18 - $  44 |       |                   |       |                                                      |

 

Ben Hogan® men’sfashion apparel is designed utilizing elegant time-honored classic stylesintended to garner nearly instantaneous brand recognition. The Ben Hogan® labelhas been highly recognized within the golf apparel industry for the past fiveyears for continually providing elegant men’s fashion golf apparel ofimpeccable quality in keeping with the image of Mr. Hogan. While each productin the Ben Hogan® apparel line is sold separately, the line is intentionallydesigned in groups with coordinated styles, color schemes and fabrics toencourage customers to purchase multiple garments. Ben Hogan® apparel ismanufactured using a variety of fabrics, including wool, silk and cashmere, andweave patterns, including pique, jersey and twill, and most pieces feature aunique trim, a special fabric finish or extra needlework. Ben Hogan® men’sapparel is marketed in the premium-price markets to elite golf professionalshops, upscale resorts and exclusive department stores.

Thefollowing table presents the suggested retail price ranges for various BenHogan® apparel items:
| Ben Hogan®        | ** ** | **Suggested Retail**                                                  | ** ** |
|------------------------|------------|-----------------------------------------------------------------------|------------|
| **Men’s Apparel** | ** ** | **Price Range**                                                       | ** ** |
| Shirts                 |       | $70 - $   98                                           |       |
| Shorts                 |       | $72 - $  98                                                 |       |
| Pants                  |       | $94 - $138                                                            |       |
| Sweaters               |       | $84 - $374                                                            |       |
| Outerwear              |       | $76 - $322                                                            |       |
| Accessories            |       | $28            |       |

 

Weclosely coordinate the designing functions with our sales and productionoperations. The process for our design function for each collection of garmentsis a continual cycle of selecting fabric and weave patterns, coloring, styling,and sewing techniques, which includes supervising the production of prototypegarments. We primarily utilize in-house designers to develop our apparelcollections. Our design staff is responsible for negotiating prices and minimumquantities with suppliers, arranging for pattern and sample manufacturing, andcoordinating finished goods delivery schedules with production personnel. Thedesign staff also supervises the quality controls for inspection of fabricsamples, as well as the testing of fabric samples for die lots, shrinkage andcolorfastness. Key persons within our design and production staffs periodicallyvisit the international factories of certain of our suppliers that produceSPORT HALEY® and Ben Hogan® apparel in order to maintain the excellence ofbusiness relationships that have been established over several years and toassure that quality expectation standards and production schedules are met orexceeded.

SPORTHALEY® and Ben Hogan® apparel is generally received at our warehouse,embroidery and distribution facilities in Denver, Colorado. Many apparel items,primarily shirts and tops, are embroidered with the SPORT HALEY® or Ben Hogan®logo on a sleeve of the garment. Historically, approximately 80% of men’sapparel is custom embroidered with a golf course, country club, resort orcompany logo, whereas only approximately only 30% of women’s apparel issimilarly embroidered. We maintain an electronic library of over 10,000 customlogos and utilize ten computer-controlled embroidering machines, whichcumulatively have the capacity to embroider up to 4,000 custom logos each day.After being embroidered to the customer’s specifications, apparel receives afinal

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inspection byquality assurance personnel. Generally, customer orders are packaged andshipped from our Denver, Colorado facility.

Top-Flite® brandedgolf apparel is designed for distribution to large retail stores in thelow-price markets. Branded apparel is usually produced in mass quantities andusually utilizes much simpler designs and is of much lesser quality thanfashion apparel garments which are sold in the premium and mid-priced markets.While fashion golf apparel is generally designed for two separate sellingseasons each year, branded golf apparel is generally designed for four or moreshorter selling periods each year. Many of our Top-Flite® garments are designedutilizing basic performance fabrics made from polyester or other man-madematerials or from blends of natural and man-made materials.

Thefollowing table presents the suggested retail price ranges for various Top-Flite®apparel items:
| Top-Flite®        | ** ** | **Suggested Retail**                                      | ** ** |
|------------------------|------------|-----------------------------------------------------------|------------|
| **Men’s Apparel** | ** ** | **Price Range**                                           | ** ** |
| Shirts                 |       | $13 - $15                                                 |       |
| Shorts                 |       | $13          |       |
| Outerwear              |       | $15 - $17                                                 |       |

 

Wegenerally utilize third-party vendors in California to receive and distributeTop-Flite® apparel. Each receipt of Top-Flite® apparel generally consists ofseveral shipping containers of merchandise that need to be sorted andpalletized per specific instructions in accordance with purchase ordersreceived in advance from Wal-Mart. The vendors that we utilize for shipments ofTop-Flite® apparel are generally in the business of acting as a third-partyshipper to Wal-Mart for a large variety of other customers.

#### **LicenseAgreement**

InMay 2001, we entered into a license agreement with Spalding Sports Worldwide,Inc. (“Spalding”) that granted us the right to market men’s premium golfapparel under the Ben Hogan® brand name. In July 2002, the license agreementwas amended to expand the applicable territory covered by the agreement toinclude the United Kingdom, Sweden, Mexico and various Caribbean countries. Theoriginal license agreement had previously granted us the right to market BenHogan® apparel within the United States. In May 2003, Spalding changed itscorporate name to The Top-Flite Golf Company, Inc. (“Top-Flite Golf”). In June2003, the license agreement was amended to reflect Spalding’s name change toTop-Flite Golf and to grant us an additional license to market a full line ofgolf apparel bearing the Top-Flite® brand name in the United States and itsterritories, Mexico, Aruba, the Cayman Islands, Jamaica, the DominicanRepublic, 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.

#### **Salesand Marketing**

#### **Company Sales Overview**

In fiscal 2006, 54% of our net sales were comprised ofBen Hogan® apparel, SPORT HALEY® garments and accessories accounted for 31% ofour sales and 12% of our sales were comprised of Top-Flite® apparel. No singlecustomer accounted for 5% or more of our fiscal 2006 net sales, except thatsales of Top-Flite® apparel to Wal-Mart accounted for 12% of our net sales andsales to a major retail discount store, comprised of discontinued Ben Hogan®and SPORT HALEY® apparel from prior seasons, accounted for 9% of our net sales.

#### For more information about our reportable segments, see Note 13 to ourFinancial Statements filed under Part IV, Item 15(a)(1) of this report.

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#### **SPORT HALEY® and Ben Hogan®**

*Overview.* We continuallyimplement marketing strategies designed to enhance our position as ahigh-quality provider of fashion golf apparel by capitalizing on the marketawareness of the SPORT HALEY® and Ben Hogan® brand names to establish, maintainand improve distribution channels. We implement these strategies by: (i)enhancing distribution channels through our network of independent wholesalesales representatives in an effort to add new golf professional shops to ourcustomer base and maximize purchases from existing customers; (ii) diversifyingproduct lines by developing new styles and designs that are natural variationson our existing apparel designs in keeping with market trends; and, (iii)intensifying marketing efforts in the premium, mid-priced and specialty retailmarkets.

*Golf Professional Shops, Country Clubs and Resorts.*Domestic sales of SPORT HALEY® and Ben Hogan® apparel aresolicited primarily through a network of approximately 30 independent wholesalesales representatives who sell the apparel, on a commission basis, mainly togolf professional shops at country clubs, resorts, exclusive department storesand specialty retail stores in all of the 50 United States. Most of ourindependent sales representatives market both our SPORT HALEY® and Ben Hogan®apparel lines. The independent representatives, many of whom may also marketother golf-related items for other companies, are responsible for generatingnew business and serving customers within specific geographic territories.Since January 1997, we have maintained 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 25% of our gross sales in fiscal 2006. Historically, thevast majority of our sales have been to domestic customers. International salesrepresented less than 1% of our net sales in fiscal 2006.

OurSport Haley sales and marketing executives, including an eastern and a westernregional sales manager, are responsible for implementing marketing plans andsales programs, supervising and coordinating our network of independentwholesale sales representatives, providing customer service support and participatingin industry tradeshows. The sales and marketing executives support the salesactivities of our independent sales representatives and distributors bypersonally assisting and training the representatives, supporting theirparticipation in regional tradeshows, assigning specific customer servicepersonnel to assist them within respective geographic regions, advancing thedistribution of sample garments, providing detailed catalogs that presentpricing, sizing and style options for each collection of garments, andproviding access to a private electronic network designed to expedite salesorder processing. Via personal computers, each sales representative has accessto current and future inventory availability and may create and transmit ordersfrom remote locations. Remote computer access enhances the representatives’order processing speed and accuracy and reduces the risk of placing customerorders that cannot be timely delivered. The electronic network also interfaceswith our comprehensive management information system that provides key salesorder data to assist management with planning, production scheduling, salestrends and cost controls.

Ourcurrent marketing efforts include searching for additional distributionchannels to enhance the sales of Ben Hogan® apparel among the certaininternational territories specified within the license agreement byestablishing distribution agreements with individual distributors in therespective markets. However, the actual growth we have achieved within those marketshas been minimal.

Informationregarding our SPORT HALEY® and Ben Hogan® brands, as well as general corporateinformation, may be found on our respective websites. The websites weredesigned to individually portray the design images inherent in our SPORT HALEY®and Ben Hogan® brands. The SPORT HALEY® site, located at www.sporthaley.com,utilizes a distinctive contemporary and feminine feel. The Ben Hogan® site,located at www.benhoganapparel.com, generates a masculine sense through the useof dark rich colors and clubhouse photos of various exclusive country clubs.The corporate site, located at www.sporthaleyinc.com, includes a basiccorporate overview and links to pertinent investor relations information. Eachof the websites contains active links to one another. The SPORT HALEY® and BenHogan® websites each include a glimpse of current and future collectionofferings, design philosophies and locator systems that can direct retailcustomers to establishments that sell our apparel and wholesale customers toour independent sales representative in their respective geographic area. While

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we have not beenable to quantify the effectiveness of the locator systems, we believe that theyenhance our marketing efforts by enabling the end consumer to find our productlines in their area, thereby creating “pull through” sales for our currentretailers and affording new customers easy access to contact information forour independent sales representative in their respective geographic region.

Weintroduce our distinctive SPORT HALEY® and Ben Hogan® golf apparel collectionsfor the fall selling season at a major golf industry tradeshow that isgenerally held in January of each year in Orlando, Florida. Because many buyersfor golf resorts and professional shops attend this particular tradeshow, weusually book a significant number of customer orders at or following the show.Retailers attending the tradeshow also provide us with direct feedbackregarding apparel designs, fabrics, styles, fashion trends and other informationnecessary to assist management with the preparation of sales forecasts andproduction schedules.

Inorder to enhance the visibility of our SPORT HALEY® and Ben Hogan® apparel, wemay from time to time establish endorsement agreements with a limited number ofPGA and LPGA professionals. In accordance with an endorsement agreement, we maycompensate the respective professional with apparel allowances, cash and/orother compensation.

Weperiodically advertise our SPORT HALEY® and Ben Hogan® apparel in severalseparate golf industry publications, including those that are distributedprimarily to operators of golf professional shops. We also expend a portion ofour advertising budget to support the sales activities of our independent salesrepresentatives by supporting their participation in regional tradeshows.International distributors provide and pay for advertising, if any, in theirrespective geographic territories. In accordance with the license agreement,Callaway also advertises the Ben Hogan® brand in golf trade industrypublications and through other golf marketing channels.

Wemaintain a program that provided select customers with display fixturesdedicated to featuring SPORT HALEY® brand apparel. We also maintaina program that provides certain of our customers with distinctive fixturesdedicated to featuring Ben Hogan® apparel collections. Upon the customer’s agreement tomaintain a pre-determined amount of inventory for a specified period of time,the fixtures became the property of the customer for a nominal delivery fee.The display fixture programs encourage customers to reorder a sufficient amountof garments to maintain prominent displays of large selections of SPORT HALEY®and Ben Hogan® apparel in their stores.

*Corporate Market.*On a limitedbasis, we utilize a combination of our independent wholesale salesrepresentatives, sales management and executives to market SPORT HALEY® and BenHogan® apparel collections directly within corporate markets. While we believethat there is a natural synergy between the golf apparel market and thecorporate apparel market, because both markets can be served from some of thesame inventory, we do not maintain inventory levels sufficient to generatesignificant sales within corporate markets. We have developed a limited numberof direct corporate accounts, and have historically pursued this marketprimarily though promotional-product companies that source and distribute avariety of products for corporate fulfillment programs and special events.These promotional-product companies generally produce corporate catalogscontaining 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, including catalogs for a few Fortune 500 companies. Wedo not enter into formal agreements or contracts with these promotional-productcompanies, but we do agree that we will make available the products advertisedin any specific catalog during the period the catalog is being used, generallya one-year period. Because corporate apparel inventory must be maintained for alonger period of time and the classic styles of corporate apparel are generallynot designed for one specific selling season, we typically feature only onecollection of garments in our corporate collections each year. Corporate salesare made periodically throughout the year, and thus corporate sales are nothistorically quantifiable within the fixed or seasonal selling periods commonto the other SPORT HALEY® and Ben Hogan® apparel collections.

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Managementbelieves that synergies exist within corporate markets for Ben Hogan® appareland has recently initiated a program designed to capitalize upon perceivedopportunities within corporate markets to increase sales of Ben Hogan® apparel.

**Top-Flite®**

InNovember 2005, Callaway granted Sport Haley permission, with certainconditions, to allow Reserve Apparel to distribute Top-Flite® branded apparelexclusively to Wal-Mart within the United States. Reserve Apparel was formed tocombine the perceived synergies between Sport Haley and Explorer Gear.Principle members of the management of Explorer Gear are also the principlemembers of the management of a Canadian company which has distributedTop-Flite® apparel to Wal-Mart in Canada for several years. Therefore, ReserveApparel was structured to utilize the expertise of Explorer Gear with regard todesigning, sourcing and pricing branded apparel suitable for, obtaining salesfrom and distributing mass quantities of merchandise to Wal-Mart by exercising themarketing rights held by Sport Haley with regard to distributing apparelbearing the Top-Flite® brand.

Shortlyafter its formation, Reserve Apparel began experiencing numerous problems withthe distribution of Top-Flite® apparel. Production delays and other problemscaused the first shipments to Wal-Mart, made in March 2006, to be approximatelythree months late, and all but one subsequent shipment made in April, May andJune 2006 were similarly delayed. The tardiness of deliveries caused Wal-Martto require that the late shipments be made directly to stores, whichsignificantly increased our shipping costs. Had the merchandise been timelydelivered to us by the suppliers, we would have been able to ship themerchandise directly to Wal-Mart distribution centers, thereby incurring muchlower shipping costs.

InMarch 2006, Explorer Gear declined requests to fund their proportionate shareof Reserve Apparel’s costs, especially with regard to inventory purchases.Explorer Gear further requested that they be relieved of certain of theirduties, required per Reserve Apparel’s Operating Agreement, in order thatsubstantially all of the business operations of Reserve Apparel, includingdesigning, sourcing, pricing, soliciting sales and coordinating thedistribution of merchandise, could be transferred to the Sport Haley facilitiesin Denver, Colorado, to be managed under the direction of Sport Haleyexecutives. Therefore, in order to obtain merchandise to fulfill orders fromWal-Mart, Sport Haley began funding 100% of the inventory purchases of ReserveApparel beginning in March 2006. Amounts advanced by Sport Haley were recordedas loans to Reserve Apparel. While Sport Haley began facilitating the transferof Reserve Apparel operations to Denver in April 2006, Explorer Gear continuedwith their involvement in the management of deliveries of inventories fromsuppliers and the invoicing of shipments to Wal-Mart through June 2006.

InApril 2006, Reserve Apparel learned that Wal-Mart was dissatisfied with theperformance of Reserve Apparel especially with regard to the late deliveries.In May 2006, Sport Haley retained a consultant with more than twelve years ofexperience with regard to marketing apparel to Wal-Mart to assist ReserveApparel in its business dealings with Wal-Mart. The consultant, along withrepresentatives of Sport Haley, met with executives from Wal-Mart in May 2006.At the meeting, Wal-Mart executives again expressed their displeasure with theperformance of Reserve Apparel especially with regard to the poor sell-throughof the Top-Flite® merchandise in their stores, which they attributed to thepoor quality of the garments, lack of continuity between the products in theTop-Flite® apparel line and the late shipments. After the meeting with Wal-Martin May 2006, the consultant agreed to represent Reserve Apparel in businessdealings with Wal-Mart while acting as a consultant to the management of SportHaley.

Becauseof his long-standing relationship with Wal-Mart, the consultant wasinstrumental in retaining the Top-Flite® apparel orders for July and August2006 that had been booked with Wal-Mart for delivery in June and July 2006,respectively, even though Wal-Mart was greatly disappointed with theperformance of Reserve Apparel regarding the shipping delays and other problemsthat were incurred. The consultant negotiated with Wal-Mart and obtainedapproval to both accept late deliveries of the shipments and to allow ReserveApparel to ship the merchandise to Wal-Mart distribution centers rather thandirectly to stores. However, in August 2006, because one of Reserve Apparel’ssuppliers could not meet Wal-Mart’s extended deadline for receipt ofmerchandise, Wal-Mart cancelled a significant portion of the order which wouldhave otherwise been shipped to them in August 2006.

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InSeptember 2006, Sport Haley entered into an agreement with Explorer Gear,Explorer Headgear, Inc., and approved by Reserve Apparel, for the purchase ofExplorer Gear’s membership interest in Reserve Apparel and to settle anypotential claims between the parties. The agreement requires Sport Haley tomake a lump sum payment to Explorer Gear of $375,000. After Reserve Apparelbegan operations, certain disputes arose between the members concerning, amongothers, the formation, operation and performance of Reserve Apparel. SportHaley, Reserve Apparel, Explorer Gear and Explorer Headgear, Inc. have deniedany liability to one another. As part of the agreement, the parties have agreedto settle and resolve any asserted or potential claims against each other. Theparties have also agreed to mutual releases of all claims asserted, or whichcould have been asserted, against each other, and each party has continued todeny the merits of those claims asserted against it by the other. Upon enteringinto the agreement, Explorer Gear no longer owns any membership interest inReserve Apparel, which became a wholly-owned subsidiary of Sport Haley.

Product development and markets for apparel such asTop-Flite® garments follow a cycle different than for our SPORT HALEY® and BenHogan® brands. Branded apparel is generally developed for delivery within fourseparate periods, while SPORT HALEY® and Ben Hogan® apparel collections aredeveloped for two separate periods. Centralization of the business operations ofReserve Apparel to the Sport Haley facilities, combined with Wal-Mart’sdissatisfaction regarding Reserve’s performance, caused us to missopportunities to deliver product to Wal-Mart for their fourth buying period ofcalendar 2006 and first buying period of calendar 2007. Reserve Apparel alsomade arrangements with suppliers which have a history of supplying apparel toSport Haley to produce the new line of Top-Flite® apparel. We believe that thenew suppliers have the ability to produce and deliver Top-Flite® apparel toReserve Apparel in a timely manner. In August 2006, Reserve Apparel finalizedthe designing of a new line of Top-Flite® apparel, consisting of basic andfancy collections of garments comprised primarily of a variety of performancefabrics. The new Top-Flite® apparel line was presented to Wal-Mart apparelbuyers in September 2006. However, in late September 2006, Reserve Apparel wasnotified that Wal-Mart chose to develop their own line of golf apparel ratherthan to continue to purchase the Top-Flite® apparel line. The discontinuance ofTop-Flite® golf apparel in Wal-Mart stores allows us to refocus the directionthat we envision for the Top-Flite® brand. While we continue to believe thatTop-Flite® apparel could have produced mutually successful results had Wal-Martcontinued to purchase it from us, we believe that the style and quality ofproducts that we could offer under the Top-Flite® brand were restricted by thelimits imposed by Wal-Mart for golf apparel within their stores and that we canreadily expand the Top-Flite® apparel line to suit a number of other markets,which we have recently begun to explore.

**Competition**

Thefashion golf apparel market, both domestically and internationally, is highlyfragmented, and the market leader has a share of only between 10% and 15% ofthe total market, per the most recent “Darrell Survey” of the golf industry. Wecurrently consider Ashworth, Cutter & Buck, Polo, Fairway & Greene andEP Pro as our most significant competitors in the fashion golf apparel market.In addition to competing with fashion golf apparel manufacturers, our fashionapparel also competes with manufacturers of high quality men’s and women’ssportswear and general leisure wear such as Nike and Adidas. Many of these samefashion golf apparel and sportswear companies are also competitors in thecorporate market. The intense competition throughout both the fashion golf andcorporate apparel markets is defined primarily by brand recognition andloyalty, quality, price, styling and design, service and availability of shelfspace in the fashion golf apparel and leisure wear markets. Many of ourcompetitors have longer operating histories, better name recognition andgreater 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.

Thebranded apparel market is also highly fragmented, and many of our competitorswithin the fashion apparel market also operate within the branded apparelmarket. We estimate that branded apparel may account for as much as 90% of thetotal golf apparel market, and we have only begun to penetrate that market withour Top-Flite® apparel.

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**FinishedGoods Sourcing – Fashion Apparel**

Manyof the SPORT HALEY® and Ben Hogan® garments are made from 100% cotton fabrics.Certain men’s and women’s garments contain silk, wool, rayon or micro-fiber andcertain outerwear garments contain micro-fiber, fleece or nylon. The Company’sproduction personnel assist the design department with the sourcing of finishedgoods apparel, negotiating costs consistent with desired profit margins and theinspection of sample fabrics and garments prior to the commencement of actualproduction. Production personnel are also responsible for ensuringtimely-receipt of finished goods. We do not maintain any formal contractualarrangements with our suppliers, but we issue purchase orders as apparelpurchases are initiated.

Wecontract with several outside suppliers which produce garments in accordancewith our specifications regarding quality, fabrication and custom styling.Almost all of our purchases are denominated in United States dollars. We do notown or operate any domestic or foreign manufacturing facilities. While we donot maintain long-term contracts with any of our suppliers, we highly value thelong-term relationships that we have established with several separatesuppliers. We place orders with our suppliers as needed for delivery of specificquantities within particular date ranges by utilizing relationships we haveestablished with certain foreign agents and foreign or domestic factories. Infiscal 2006, we purchased approximately 98% of our SPORT HALEY® and Ben Hogan®apparel from a variety of foreign suppliers. In fiscal 2005, we purchased 57%, 7%,7% 6% and 5% of our finished apparel from five separate vendors, respectively.The loss of any of these significant vendors could cause substantial disruptionto the Company’s short-term ability to fulfill its customers’ orders of fashionapparel on a timely basis.

Wereceive sales orders for our SPORT HALEY® and Ben Hogan® spring and fallcollections over a period commencing when samples are first shown to customersand continuing through the respective selling seasons. Because the apparelindustry has long lead times, we must begin to schedule purchases andproduction of apparel collections in advance of sales order placements. Becausethe receiving and delivery of apparel collections is time-sensitive, managementdevotes considerable time and effort to the revision of sales projections, itemby item within our apparel collections. Our computerized management informationsystems provide management with key data that facilitates sales forecasting, producttracking and standard cost controls as well as providing perpetual inventoryrecords and inventory availability.

**FinishedGoods Sourcing – Branded Apparel**

Manyof the Top-Flite® garments are made from polyester or other man-made materialsor blends of natural and man-made materials. Explorer Gear contracted withoutside suppliers to produce all of the Top-Flite® apparel that has beendistributed to Wal-Mart to date. While one of those suppliers would beconsidered a significant vendor based upon the relative percentage ofTop-Flite® garments that they produced in relation to the total value of allTop-Flite® garments we produced in fiscal 2006, we do not anticipate placingany future orders with that supplier in the future. We plan to place future ordersfor Top-Flite® apparel with one or more of the suppliers we have traditionallyused for supplying SPORT HALEY® and/or Ben Hogan® apparel. Therefore, webelieve that the loss of the significant vendor will not cause substantialdisruption to our short-term ability to fulfill customer orders of brandedapparel on a timely basis.

Wegenerally utilize third-party vendors in California to receive and distributeTop-Flite® apparel. Each receipt of Top-Flite® apparel generally consists ofseveral shipping containers of merchandise that need to be sorted andpalletized per specific instructions in accordance with purchase ordersreceived in advance from Wal-Mart. The vendors that we utilize for shipments ofTop-Flite® apparel are generally in the business of acting as a third-partyshipper to Wal-Mart for a large variety of other customers. Because there arenumerous other companies that offer similar services, we do not believe thatthe loss of one or more third-party distribution vendor would cause substantialdisruption to our short-term ability to fulfill customer orders of brandedapparel on a timely basis.

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**SeasonalNature of Business**

Fashionapparel sales within the golf industry tend to be seasonal in nature, withdisproportionately higher sales occurring from early spring through earlysummer. Accordingly, our fashion apparel sales are disproportionately higherfrom January through June, which are our third and fourth quarters of eachfiscal year, than sales from July to December, which are our first and secondfiscal quarters. Pre-booked orders for our spring collections are generallysolicited from July through December, and customer deliveries for the springseason are generally shipped from November through April each year. Pre-bookedorders for our fall fashion collections are generally solicited from Januarythrough June, and customer deliveries for the fall season are generally shippedfrom May through October each year. Spring collections typically account forabout 60% of our annual fashion apparel sales, with the fall collectionsaccounting for the remaining sales.

**ManagementInformation Systems and Inventory Management**

Weutilize integrated computer systems to manage all business transactions,historical data and record keeping, including sourcing, warehousing,embroidering and shipping. The computer systems provide information to ourexecutives, management, all of our internal departments and our independentwholesale sales representatives. The electronic computer system used by ourindependent sales representatives interfaces with the main system to providerepresentatives with inventory information and order entry capability andallows the representatives to order against actual inventory availability. Thecomputer systems provide valuable information for forecasting such as analysesof sales histories, purchasing histories, and future customer commitments, allof which facilitate the management of our fashion apparel finished goodsinventories.

Ourinventories, predominately comprised of finished goods, are generally valued atthe lower of cost (weighted average) or market. Costs include amounts paid tosuppliers for packaged apparel and/or materials and labor, import costs, suchas customs duties, freight-in and other miscellaneous costs, and allocatedoverhead. Since we implemented our operations software in January 2004,programming and human errors discovered within the system caused us to report amaterial weakness in our internal controls over financial reporting withrespect to inventory valuation. This weakness in our internal controlsprevented us from relying upon the system-recorded transactions with respect toinventory valuations during 2005 and 2004. We used a standard cost method tovalue our finished goods inventories from the fiscal quarter ended March 31,2004, through the fiscal quarter ended March 31, 2005. Had we been able to relyupon the system to properly compute the cost of our finished goods inventoriesusing the weighted average method, we believe that the weighted average methodwould not have yielded a materially different computation of the value than thestandard cost method that we applied.

Basedupon extensive tests that we performed near the end of fiscal 2006, we believethat the material weakness in our internal controls has been eradicated. Webelieve that the computer software has now been properly programmed, andemployees have been adequately trained to utilize the system procedures, torely upon the software to accurately compute our finished goods inventory valuationsusing a weighted average cost assumption. We also believe that the system hasbeen configured and employees are sufficiently monitored to ensure that allerrors, sufficient to cause a material weakness with regard to the costing ofour finished goods inventories, are unlikely to recur.

Wemaintain a significant amount of fashion apparel finished goods inventories tomeet customers’ delivery expectations. Because of such factors as the long leadtime between ordering and receiving packaged apparel from foreign vendors,receiving advance orders from and delivery of finished apparel to customers,and the considerable number of individual items that comprise fashion apparelcollections within a single selling season, an excess of finished goodsinventories remaining at the end of a selling season is common within the golfapparel industry. Excess and previous seasons’ fashion apparel finished goodsinventory items usually must be marketed at reduced selling prices, whichnegatively affects gross margins. We utilize our computer systems to assistmanagement with controlling fashion apparel inventories by providinginformation with regard to sales forecasting, initial and reorders of finishedapparel and warehouse management. The computer system was designed to increaseoperating efficiencies by providing better information with regard to salesforecasting, purchasing and inventory management. In fiscal 2005, we developeda system to better estimate our anticipated future sales in order to betterforecast fashion apparel inventories expected to remain at the end of a currentor future distribution period. Having better information

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available toforecast quantities and mix of unsold inventories allows us to better estimatevaluations of excess inventories expected to be on hand in a future period.Having such information also allows us to better plan marketing strategies forthe sales of such inventories through existing marketing channels and to betterestimate the overall recoverability of our finished goods inventories. Webelieve that the methods we use to evaluate our fashion apparel inventoriesproduce fair valuations of our excess inventories, but, if actual marketconditions are less favorable than those we have projected, additionalallowances may be required or losses on dispositions may be recorded, therebyadversely affecting our financial position and the results of our operations.

**OrderPlacement and Backlog**

Advancesales orders for the fall fashion apparel selling season are typically receivedby the beginning of June each year. Similarly, advance sales orders for thespring fashion apparel selling season are typically received by the beginningof December each year. Due to economic drivers such as the general economichealth of and competition within the golf apparel industry, the overall USAeconomy and the geopolitical climate throughout the world, the trend in ouradvance sales orders indicates decreases in advance sales orders and increasesin “at once” business. This trend adds to the difficulty associated with salesforecasting, fashion apparel inventory management and the timing of inventorypurchasing that is already complicated by the long lead times associated withprocuring finished product from overseas suppliers.

Generally,we ship partial orders if they are at least 90% complete. We usually allowadvance orders to be changed or canceled up to 30 days prior to the scheduledshipping date of the merchandise. Generally, we do not sell our apparel onconsignment and generally do not accept returns of purchased apparel, otherthan apparel that is defective or damaged or which was shipped to the customerafter their specified delivery date. Our new operations software affords us theability to ship merchandise within customer-specified delivery dates, therebyreducing sales returns due to refused shipments for late delivery. As apercentage of net sales, sales returns were approximately 3% in fiscal 2006, 6%in fiscal 2005 and 5% in fiscal 2004.

Historically, thebacklog of orders has not materially impacted our sales with respect tocancellations and rejections of back orders. Back orders are common occurrenceswithin the apparel industry in general. The amount of back orders outstandingat any particular time may be affected by a number of factors, including thetimely receipt of first-quality products from suppliers, which can impact anapparel distributor’s ability to ship garments on time, and the timing oforders placed by customers. Accordingly, a comparison of our backlog of ordersfrom period to period is not necessarily meaningful and may not be indicativeof actual shipments during any specific period. Our backlog of unfilledcustomer orders was less than $100,000 at both June 30, 2006 and 2005. Wefilled the majority of the June 30, 2006, back orders within the first fewmonths of fiscal 2007.

#### **PaymentTerms**

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

Perour contract with Wal-Mart, sales of branded apparel to them are payable bythem 30 days after their receipt of the merchandise.

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**Trademarks**

Wemarket women’s and a limited amount of men’s fashion golf apparel under theSPORT HALEY® label. We have registered our current SPORT HALEY® trademarks withthe United States Patent and Trademark Office. Certain of our former UnitedStates trademarks expired during 2006. We previously registered other of ourformer trademarks in a select number of international jurisdictions.

Wealso market men’s fashion golf apparel under the Ben Hogan® label. Callaway hasregistered the Ben Hogan® trademark and the distinctive signature of Mr. Hoganwith the United States Patent and Trademark Office. Callaway is also licensedto use the Ben Hogan® trademark outside of the United States. We are licensedby Callaway to use the Ben Hogan® trademark in the United States and certainother countries, subject to the terms of our license agreement with Callaway,as amended.

Callawayhas registered the Top-Flite® trademark with the United States Patent andTrademark Office. We are licensed by Callaway to use the Top-Flite® trademarkin the United States and certain other countries, subject to the terms of ourlicense agreement with Callaway, as amended.

**Employees**

AtJune 30, 2006, we had 67 full-time employees and one part-time employee,including 23 full-time executive and administrative employees, four full-timemarketing and sales management employees, and 40 full-time and one part-timepersonnel in inspection, packaging, embroidering and distribution operations.The majority of our sales representatives are independent agents. None of ouremployees is a member of a trade union, and we consider our relations with ouremployees and agents to be satisfactory.

**ITEM 1A. RISKFACTORS**

Ourbusiness in general is subject to certain risks including the following:

**Marketsfor Our Products and Competition**

·                  Our fashionapparel sales are seasonal, and historically sales from July through December,which comprise our first and second fiscal quarters, are weaker than sales fromJanuary through June, which comprise our third and fourth fiscal quarters.

·                  We must continueto successfully 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.

·                  The marketfor golf apparel is extremely competitive, and price competition or industryconsolidation could weaken our competitive position. Some of our competitorsare significantly larger and more diversified than we are and havesubstantially greater financial resources available for developing, sourcingand marketing their products. In order to maintain our competitive position, wemust effectively advertise and communicate within the marketplace andsuccessfully penetrate our chosen distribution channels. We may not be able tomaintain or increase our market share in the distribution channels in which weoperate, and we may also face increased competition from new competitors. As aresult, we may experience lower sales or greater operating costs, which wouldhave an adverse effect on our margins and the results of our operations.

·                  We maintaina significant level of finished goods inventories to support our fashionapparel sales volume and our limited corporate apparel program. Disposal ofexcess prior seasons’ fashion apparel inventories at reduced margins is aninherent characteristic within the golf apparel industry, but a significantamount of sales at the lower margins dictated by the disposition of excessinventories may impair our financial

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conditionand the results of our operations. Write-downs with regard to obsolete fashionapparel inventories could also continue to adversely affect our financialcondition.

**License Agreement**

·                  An ever increasing percentage of our netsales are derived from sales related to the license agreement with Callaway tomarket and distribute Ben Hogan® apparel, and we have consistently exceeded theminimum sales requirements of the license agreement with regard to Ben Hogan®apparel. While we believe that wemaintain a satisfactory relationship with Callaway, an early termination of thelicense agreement could negatively impact our financial position and results ofour operations significantly.

·                  The license agreement with Callaway includesminimum royalty payments with regard to sales of Top-Flite® branded apparel.Our Top-Flite® branded apparel has been marketed exclusively to Wal-Martthrough Reserve Apparel. In September 2006, Wal-Mart notified Reserve Apparelthat they plan to develop their own line of golf apparel rather than continuingto purchase Top-Flite® apparel. Until we establish other markets for Top-Flite®apparel which provide the annual sales amount required by Callaway to satisfythe minimum royalty payments due in accordance with the license agreement, wemay not be able to meet the minimum sales requirements and our financialposition and the results of our operations may be negatively impacted.

**Reliance Upon Third Parties**

·                  We depend ontimely delivery of finished garments from our suppliers. The loss of certainsuppliers, and/or delays in receiving garments from suppliers caused by variousfactors, including lost or reduced manufacturing capacity of significantsuppliers, labor shortages, timely performance of third parties, transportationdifficulties, and others, could adversely affect our ability to make timelydelivery of finished garments to our customers.

·                  Our significantreliance on foreign suppliers enhances the risk that revenues might beadversely affected if a foreign shipment were lost or significantly delayed. Wemaintain insurance for risk of loss including those relating to raw materialsinventories shipped between foreign vendors and finished goods inventoriesshipped from foreign suppliers to our distribution facilities in Denver,Colorado. However, significant reliance on foreign suppliers heightens the riskthat we could be left with inadequate or unsatisfactory recourse should thegoods received from the foreign suppliers be nonconforming.

·                  Our significantreliance on foreign suppliers sustains the risk that revenues might beadversely affected by changes in international trade quota systems for apparelor by deterioration in political and international trade relations between theUnited States of America and the foreign countries where the suppliers arelocated.

·                  We purchase significant amounts of finishedapparel from several separate foreign suppliers. While we believe that we couldobtain finished apparel from numerous other 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 our financial position and the resultsof our operations.

·                  We maintain aclose working relationship with a certain foreign person who is responsible formaintaining relationships with and monitoring the performance of certain of ourforeign suppliers. While we believe that we could utilize other such persons toperform similar services, if we wereto lose or terminate the services of this individual, our short-term ability tofulfill customers’ orders on a timely basis could be substantially impaired,thereby negatively affecting our financial position and the results of ouroperations.

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**Economy**

·                  The demandfor our products may decrease if the popularity of golf decreases or if otherfactors, such as adverse business conditions, a sluggish economy or inclementweather, cause golfers not to patronize golf professional shops.

·                  The increasedthreats of terrorist activities in the United States, the conflict in Iraq andother international conflicts may have adversely affected our sales. Business trends of the golf apparel industryclosely follow trends in the travel and leisure sectors of the United Stateseconomy. International conflicts and other geopolitical conditions resultingfrom threats or acts of war or terrorism and responses thereto may havecontinued to affect the travel and leisure sectors that had already beennegatively impacted by the general economic downturn experienced duringprevious years. Our sales could decrease if the USA economy weakens dueto these or other factors.

·                  We mayexperience an increase in the number and magnitude of delinquent oruncollectible customer accounts during periods of economic downturn.

·                  On a limitedbasis, we advance monies to certain of our independent wholesale salesrepresentatives under agreements whereby the sales representatives reimburse usas they earn monthly sales commissions. Our financial results may be adverselyaffected should the sales representatives not generate wholesale salessufficient to justify the amounts advanced to them under the agreements.

**Access to Capital**

·                  Our significant reliance on foreignsuppliers requires that we maintain satisfactory relationships with acommercial banking institution in order to have adequate access to capital tofinance inventory purchases from the foreign suppliers via import letters ofcredit. While we believe that we could obtain access to capital from othersources, if the commercial banking institution were to terminate or not renewthe line of credit agreement that we maintain with the institution, ourshort-term ability to purchase finished goods inventories from foreignsuppliers could be substantially impaired, thereby negatively affecting ourfinancial position and the results of our operations.

·                  We periodically maintain cash balances at acommercial bank in excess of the Federal Deposit Insurance Corporationinsurance limit of $100,000. While the financial position and liquidity of thecommercial bank has been exceedingly greater than our uninsured cash balancesat any point in time, if the financial position and/or liquidity of the bankwere to become impaired, our financial position and the results of ouroperations could be negatively affected.

**Computer Information Systems**

·                  Businesses ingeneral are ever increasingly dependent upon computer information systems. Wemust continually establish and sustain controls with regard to maintaining theintegrity of our technology, information systems and electronic data in orderto adequately manage business activities and control costs and expenses.

**Executive Officers and Key Employees**

·                  Because weoperate within strict seasonal periods, our business operations are heavilydependent upon our current executive officers and our key employees withinvarious areas of our operations including production and sales management. Theloss of any of our executive officers or key employees, or the inability toattract and retain qualified personnel, could prevent us from successfullyexercising our business strategies, delay the development and introduction ofnew seasonal apparel collections, damage the image of our brands and/or harmour ability to sell our products.

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Theremay be other factors not mentioned above, in the discussion below or includedin our other Securities and Exchange Commission filings that may cause actualresults to differ materially from any forward-looking statements. Neither theCompany nor any of its corporate officers or key employees assumes anyobligation to update any forward-looking statements as a result of newinformation, future events or developments, except as required by applicablesecurities laws.

**ITEM 2. PROPERTIES**

Ourexecutive offices and warehouse facilities are located in Denver, Colorado. InJuly 2006, we negotiated an extension of the lease through October 2011 for theentire 82,500 square feet of floor space at the Denver location. The Denverfacilities were leased at an annual base rent of approximately $265,000 infiscal 2006. We are obligated to pay the related taxes, insurance andmaintenance expenses for the leased space.

**ITEM 3. LEGALPROCEEDINGS**

Aspreviously reported, in September 2003, the United States Securities and ExchangeCommission (the “Commission” or the “SEC”) filed suit in the United StatesDistrict Court for the District of Colorado against Sport-Haley, Inc., RobertG. Tomlinson, our late Chairman and former Chief Executive Officer, and SteveS. Auger, our former Controller (the “Defendants”). The Commission filed anamended complaint in October 2003, which added one of our former auditors tothe action as a Defendant. After Mr. Tomlinson’s death, the Commission filed amotion to dismiss Mr. Tomlinson from the action without prejudice, and theCourt granted the motion. On January 17, 2006, the Court entered a FinalJudgment, pursuant to a settlement reached with the Commission, to resolve thepending claims in the civil action brought by the SEC against Sport-Haley, Inc.and our former Controller. The settlement had been considered by the Commissionin Washington D.C. and thereby approved on December 8, 2005. The settlement didnot call for Sport-Haley, Inc. to pay any fine, civil penalty or disgorgement.Pursuant to a written Consent entered into by Sport-Haley, Inc. as part of thesettlement, Sport-Haley, Inc. consented, without admitting or denying theallegations of the Complaint or Amended Complaint, to the entry of aninjunction enjoining the Company from violating §17(a)(2) and §17(a)(3) of theSecurities Act of 1933 (the “Securities Act”), which do not require proof ofscienter (an intent to deceive, manipulate or defraud), but may be based upon ashowing of negligence, §13(b)(2) and §15(d) of the Securities Exchange Act of1934 (the “Exchange Act”), and Rules 12b-20, 15d-1 and 15d-13 promulgatedthereunder. The settlement resulted in no injunction or adjudication againstSport-Haley, Inc. with respect to the claims alleging violations of §17(a)(1)of the Securities Act, §10(b) of the Exchange Act and Rule 10b-5 promulgatedthereunder, which each require proof of scienter.

Pursuantto a separate settlement with the SEC, the Court also entered a Final Judgmentwith respect to Mr. Auger, in which Mr. Auger consented, without admitting ordenying the allegations of the Complaint or Amended Complaint, to the entry ofan injunction enjoining him from violating various provisions of the federalsecurities laws and regulations and other relief.

InMarch 2001, as we previously announced, we retained legal counsel to possiblypursue claims against our former auditors in connection with damages we claimedwere suffered as a result of the restatements of our financial statements forfiscal years 1999 and 1998 and the corrections of material information for thequarterly periods of fiscal years 2000, 1999 and 1998. Also, we were previouslyadvised that the former auditors asserted certain claims against us, includingallegations of unpaid fees. Neither Sport-Haley, Inc. nor the former auditorsfiled any legal action to assert any of these disputed claims. During amediation session in November 2005, we reached an agreement in principle withthe former auditors to settle all disputed claims between the parties and theiraffiliates. On February 13, 2006, we entered into a written settlementagreement to resolve all pending claims between Sport-Haley, Inc., our formerauditors and certain of our former auditors’ current and former members, whichprovided for payments to Sport-Haley, Inc. totaling $525,000. Among other termsof the settlement agreement, the parties agreed to mutual releases of allclaims asserted against each other and each party has continued to deny themerits of those

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claims assertedagainst it by the other party. In accordance with a sharing agreement betweenSport-Haley, Inc. and one of its carriers for director and officer liabilityinsurance, we received 33% of the $525,000 in settlement proceeds, orapproximately $173,000, and the insurance carrier received the remainder topartially recover amounts the carrier had paid in connection with a previouslysettled class action securities lawsuit and defense costs the carrier hadreimbursed to us relating to the civil action lawsuit filed by the SEC.

Weare subject to various other legal proceedings and claims which arise in theordinary course of our business. Based upon information that is currentlyavailable, management does not believe that the total impact of the variousother legal proceedings will materially affect our financial position or theresults of our operations.

**PART II**

**ITEM 5. MARKET FOR REGISTRANT’SCOMMON EQUITY AND RELATED SHAREHOLDER MATTERS**

Our common stockis quoted on the NASDAQ Global MarketSM under the trading symbol “SPOR.” The followingtable sets forth the range of high and low sale prices of our common stock, asreported by The NASDAQ Global MarketSM,from July 1, 2003 through June 30, 2006. The prices set forth below reflectinterdealer quotations, without retail markups, markdowns or commissions, andmay not be representative of actual transactions.

|                       | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------|------------|----------|------------|---------|------------|
| **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   |       |
|                  |       |     |       |    |       |
| **Fiscal  Year 2005** |       |     |       |    |       |
| Fourth Quarter        |       | $        | 4.990      |    | $          | 2.970 |   |
| Third Quarter         |       | 4.370    |       | 4.000   |       |
| Second Quarter        |       | 4.889    |       | 3.830   |       |
| First Quarter         |       | 4.990    |       | 3.812   |       |
|                  |       |     |       |    |       |
| **Fiscal  Year 2004** |       |     |       |    |       |
| Fourth Quarter        |       | $        | 6.000      |    | $          | 5.000 |   |
| Third Quarter         |       | 6.090    |       | 4.230   |       |
| Second Quarter        |       | 4.590    |       | 3.840   |       |
| First Quarter         |       | 4.640    |       | 3.830   |       |

 

As of March 10, 2006, there were approximately 116holders of record of our common stock. We computed the number of record holdersby adding to the number of actual record holders as shown on the securitiesholder list obtained from our transfer agent the number of individualparticipants 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 that as ofMarch 10, 2006, our common stock was owned beneficially by approximately 850shareholders.

Holders of common stock are entitled to receive suchdividends as may be declared by our Board of Directors from time to time. InApril 2006, our Board of Directors declared a dividend of $0.25 per share thatwas paid to our beneficial shareholders who held such shares as of May 5, 2006.However, the Board of Directors does not anticipate that any dividends will bedeclared again in the foreseeable future.

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**ITEM 6.SELECTED FINANCIAL DATA**

The followingselected financial data should be read in conjunction with the FinancialStatements and related Notes thereto, appearing elsewhere in this report onForm 10-K, and “Management’s Discussion and Analysis of Financial Condition andResults of Operations.” The statements of operations data for each of thefiscal years in the three-year period ended June 30, 2006, and the balancesheets data at June 30, 2006 and 2005, are derived from the financialstatements of Sport-Haley, Inc. which have been audited by Hein &Associates LLP, an independent registered public accounting firm, as indicatedin their report included herein. The consolidated statements of operations datafor the fiscal year ended June 30, 2006, and the balance sheets data at June30, 2006, include the amounts of Sport-Haley, Inc. and our subsidiary, ReserveApparel Group LLC. The consolidated statements of operations data for the fiscalyear ended June 30, 2002, and the balance sheets data at June 30, 2002, includethe amounts of Sport-Haley, Inc. and our former wholly-owned subsidiary,B&L Sportswear, Inc., which ceased business operations in August 2001 andwas liquidated in May 2002. All significant inter-company transactions wereeliminated from the consolidated financial data. The selected financial dataprovided below is not necessarily indicative of the future results ofoperations or future financial performance of Sport-Haley, Inc.
| ** **                                                                     | ** ** | **Fiscal Year Ended June 30,**                 | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                     | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statements  of Operations Data  (2006 and 2002 Consolidated):**              | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                      |       | $                                                                  | 20,962     |   | $ | 22,041 |   | $ | 20,800 |   | $ | 19,196 |   | $ | 17,099 |   |
| Total cost of  goods sold                                                      |       | 14,050                                                             |       | 15,689 |   | 13,619 |   | 11,873 |   | 12,915 |   |
| Gross profit                                                                   |       | 6,912                                                              |       | 6,352 |   | 7,181 |   | 7,323 |   | 4,184 |   |
| Operating  expenses                                                            |       | 8,017                                                              |       | 9,833 |   | 8,737 |   | 8,026 |   | 6,886 |   |
| Loss from  operations                                                          |       | (1,105                                                             | )          | (3,481 | ) | (1,556 | ) | (703 | ) | (2,702 | ) |
| Other income and  expenses, net                                                |       | 438                                                                |       | 208 |   | 116 |   | 135 |   | 346 |   |
| Loss from  operations before (provision for) benefit from income taxes         |       | (667                                                               | )          | (3,273 | ) | (1,440 | ) | (568 | ) | (2,356 | ) |
| Minority  interest in subsidiary loss                                          |       | 259                                                                |       | 0 |   | 0 |   | 0 |   | 0 |   |
| (Provision for)  benefit from income taxes                                     |       | (7                                                                 | )          | (8 | ) | (746 | ) | 180 |   | 1,383 |   |
| Net loss                                                                       |       | $                                                                  | (415       | ) | (3,281 | ) | $ | (2,186 | ) | $ | (388 | ) | $ | (973 | ) |
|                                                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Loss per common  and equivalent shares outstanding (basic and diluted)         |       | $                                                                  | (0.15      | ) | $ | (1.29 | ) | $ | (0.89 | ) | $ | (0.15 | ) | $ | (0.33 | ) |
|                                                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Weighted average common  and equivalent shares outstanding (basic and diluted) |       | 2,749                                                              |       | 2,548 |   | 2,448 |   | 2,621 |   | 2,938 |   |

 
| ** **                                               | ** ** | **June 30,**                                                  | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                               | ** ** | **(in thousands, except per share data)** | ** ** |
| **Balance  Sheets Data:  (2006 and 2002 Consolidated):** | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Working capital                                          |       | $                                                                  | 14,455     |   | $ | 14,814 |   | $ | 17,503 |   | $ | 19,180 |   | $ | 20,766 |   |
| Total assets                                             |       | 18,027                                                             |       | 17,490 |   | 20,771 |   | 21,545 |   | 23,525 |   |
| Long-term debt                                           |       | 34                                                                 |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total  liabilities                                       |       | 3,012                                                              |       | 1,751 |   | 2,148 |   | 1,118 |   | 1,753 |   |
| Shareholders’  equity                               |       | 15,015                                                             |       | 15,739 |   | 18,623 |   | 20,427 |   | 21,772 |   |
| Net book value per  share of common stock                |       | $                                                                  | 5.42       |   | $ | 5.95 |   | $ | 7.37 |   | $ | 8.36 |   | $ | 7.97 |   |

 

The following table summarizes selectedquarterly financial information for each of the quarterly periods in the fiscalyears ended June 30, 2006 and 2005:

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| ** **                                                                            | ** ** | ** **                         | ** ** | **Year**        | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------------|------------|-----------------|------------|
| ** **                                                                            | ** ** | **Fiscal Quarter Ended** | ** ** | **Ended**       | ** ** |
| ** **                                                                            | ** ** | **Sep 30**                    | ** ** | **Dec 31** | ** ** | **Mar 31** | ** ** | **Jun 30** | ** ** | **Jun 30** | ** ** |
| **Quarterly  Financial Data – Unaudited  (in thousands, except per share data)** | ** ** | ** **                         | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Fiscal  2006 (Consolidated):**                                                      | ** ** | ** **                         | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                             |       | $                                  | 4,011      |            | $          | 4,429 |   | $ | 4,656 |   | $ | 7,866 |   | $ | 20,962 |   |
| Total cost of  goods sold                                                             |       | 2,706                              |       | 2,792           |       | 2,919 |   | 5,633 |   | 14,050 |   |
| Gross profit                                                                          |       | 1,305                              |       | 1,637           |       | 1,737 |   | 2,233 |   | 6,912 |   |
| Other operating  costs                                                                |       | 1,887                              |       | 1,613           |       | 2,162 |   | 2,355 |   | 8,017 |   |
| Other income and  expense, net                                                        |       | 53                                 |       | 77              |       | 237 |   | 71 |   | 438 |   |
| Minority  interest in subsidiary loss                                                 |       | 0                                  |       | 0               |       | 0 |   | 259 |   | 259 |   |
| (Provision for)  benefit from income taxes                                            |       | 1                                  |       | (2              | )          | (2 | ) | (4 | ) | (7 | ) |
| Net income  (loss)                                                                    |       | $                                  | (528       | )               | $          | 99 |   | $ | (190 | ) | $ | 204 |   | $ | (415 | ) |
|                                                                                  |       |                               |       |            |       |   |   |   |   |   |   |
| Earnings (loss)  per common share                                                     |       |                               |       |            |       |   |   |   |   |   |   |
| Basic                                                                                 |       | $                                  | (0.20      | )               | $          | 0.04 |   | $ | (0.07 | ) | $ | 0.08 |   | $ | (0.15 | ) |
| Diluted                                                                               |       | $                                  | (0.20      | )               | $          | 0.03 |   | $ | (0.07 | ) | $ | 0.07 |   | $ | (0.15 | ) |
|                                                                                  |       |                               |       |            |       |   |   |   |   |   |   |
| Weighted average  shares outstanding                                                  |       |                               |       |            |       |   |   |   |   |   |   |
| Basic                                                                                 |       | 2,685                              |       | 2,770           |       | 2,770 |   | 2,770 |   | 2,749 |   |
| Diluted                                                                               |       | 2,685                              |       | 2,968           |       | 2,770 |   | 2,968 |   | 2,749 |   |
|                                                                                  |       |                               |       |            |       |   |   |   |   |   |   |
| **Fiscal  2005:**                                                                     | ** ** | ** **                         | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                             |       | $                                  | 5,570      |            | $          | 5,000 |   | $ | 4,455 |   | $ | 7,016 |   | $ | 22,041 |   |
| Total cost of  goods sold                                                             |       | 3,800                              |       | 4,542           |       | 2,823 |   | 4,524 |   | 15,689 |   |
| Gross profit                                                                          |       | 1,770                              |       | 458             |       | 1,632 |   | 2,492 |   | 6,352 |   |
| Other operating  costs                                                                |       | 3,057                              |       | 2,516           |       | 2,287 |   | 1,973 |   | 9,833 |   |
| Other income and  expense, net                                                        |       | 11                                 |       | 52              |       | 75 |   | 70 |   | 208 |   |
| (Provision for)  benefit from income taxes                                            |       | 0                                  |       | 0               |       | (6 | ) | (2 | ) | (8 | ) |
| Net income  (loss)                                                                    |       | $                                  | (1,276     | )               | $          | (2,006 | ) | $ | (586 | ) | $ | 587 |   | $ | (3,281 | ) |
|                                                                                  |       |                               |       |            |       |   |   |   |   |   |   |
| Earnings (loss)  per common share                                                     |       |                               |       |            |       |   |   |   |   |   |   |
| Basic                                                                                 |       | $                                  | (0.52      | )               | $          | (0.77 | ) | $ | (0.23 | ) | $ | 0.23 |   | $ | (1.29 | ) |
| Diluted                                                                               |       | $                                  | (0.52      | )               | $          | (0.77 | ) | $ | (0.23 | ) | $ | 0.20 |   | $ | (1.29 | ) |
|                                                                                  |       |                               |       |            |       |   |   |   |   |   |   |
| Weighted average  shares outstanding                                                  |       |                               |       |            |       |   |   |   |   |   |   |
| Basic                                                                                 |       | 2,456                              |       | 2,545           |       | 2,545 |   | 2,564 |   | 2,548 |   |
| Diluted                                                                               |       | 2,456                              |       | 2,545           |       | 2,545 |   | 2,741 |   | 2,548 |   |

 

**ITEM 7.****                       MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

Statementsmade in this filing that are not historical facts are forward-lookingstatements. The reader should be aware that our actual results could differmaterially from those contained in forward-looking statements. When used inthis report, the words “may”, “will”, “will likely result”, “will continue”, “expect”,“anticipate”, “continue”, “estimate”, “plan”, “project”, “intend”, “believe”and similar expressions, variations or negative of these words, and anystatement regarding possible or assumed future results of operations of ourbusiness, the markets for our products, anticipated expenditures, regulatorydevelopments or competition, or other statements regarding matters that are nothistorical facts, are intended to identify forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934, although not all forward-looking statementscontain such identifying words. Such statements are based on management’scurrent expectations and are subject to risks, uncertainties and assumptions,including those risks set forth in Part I, Item 1A of this report, along withthe factors and risks set forth below. The reader should be aware that, shouldone or more of these risks or uncertainties materialize, or should underlyingassumptions prove incorrect, the actual plan of operations, business

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strategies,operating results and financial position of Sport-Haley, Inc. could differmaterially from those expressed in, or implied by, such forward-lookingstatements.

Factorsor risks that could cause actual results or circumstances to differ materiallyfrom those set forth or contemplated in forward-looking statements include, butare not limited to, the following:

·                  Ourability to respond to continual competition in our markets as well as theextent, timing and success of such competition;

·                  Ourability to expand into new markets and to effectively manage our growth;

·                  Accessto sufficient working capital to meet our operating and financial needs;

·                  Generaleconomic conditions or material adverse changes in markets we serve;

·                  Changesin, or failure to comply with, applicable legislation or governmentalregulation;

·                  Changesin tax laws or rates;

·                  Riskthat our analyses of these risks could be incorrect and that the strategiesdeveloped to address them could be unsuccessful;

·                  Changesin our accounting assumptions that regulatory agencies, including the SEC, mayrequire or that result from changes in the accounting rules or theirapplication, which could result in an impact on our earnings; and,

·                  Variousother factors discussed in this filing.

Theremay be other factors not mentioned above, or in Part I, Item 1A of this report,in the discussion below or included in our other SEC filings that may causeactual 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 applicablesecurities laws.

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

**CriticalAccounting Policies and Estimates**

Ourfinancial statements have been prepared in accordance with standards of thePublic Company Accounting Oversight Board (United States), which require us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and the related disclosures. A summary ofthose significant accounting policies can be found in the Footnotes to theFinancial Statements included in this Report on 10-K. 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 of finishedgoods, are generally valued at the lower of cost (weighted average) or market.Costs include amounts paid to suppliers for packaged apparel and/or materialsand labor, import costs, such as customs duties, freight-in and othermiscellaneous costs, and allocated overhead. Since

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we implemented ouroperations software in January 2004, programming and human errors discoveredwithin the system caused us to report a material weakness in our internal controlsover financial reporting with respect to inventory valuation. This weakness inour internal controls prevented us from relying upon the system-recordedtransactions with respect to inventory valuations during 2005 and 2004. We useda standard cost method to value our finished goods inventories from the fiscalquarter ended March 31, 2004, through the fiscal quarter ended March 31, 2005.Had we been able to rely upon the system to properly compute the cost of ourfinished goods inventories using the weighted average method, we believe thatthe weighted average method would not have yielded a materially differentcomputation of the value than the standard cost method that we applied.

Basedupon extensive tests that we performed near the end of fiscal 2006, we believethat the material weakness in our internal controls has been eradicated. Webelieve that the computer software has now been properly programmed, andemployees have been adequately trained to utilize the system procedures, torely upon the software to accurately compute our finished goods inventoryvaluations using a weighted average cost assumption. We also believe that thesystem has been configured and employees are sufficiently monitored to ensurethat all errors, sufficient to cause a material weakness with regard to thecosting of our finished goods inventories, are unlikely to recur.

Excess fashion apparel finished goods inventoriesare a natural component of a seasonal apparel business. While certain fashionapparel items will sell out in any particular selling season, quantities ofother fashion apparel items will remain at the end of each selling season. Wemarket previous seasons’ fashion apparel finished goods inventories at reducedwholesale prices to our customers in the normal course of business. Remainingexcess inventories are liquidated through other markets. In the ordinary courseof business, we maintain reserves for inventory write downs due to theobsolescence of discontinued or aging merchandise. We perform analyses on a quarterlybasis to identify unsold discontinued or aging merchandise and adjust ourreserves for inventory obsolescence to reduce the carrying value ofdiscontinued or aging merchandise to its estimated net realizable value. Thenet realizable value of the discontinued or aging merchandise is estimatedbased on management’s disposition plans and historical experiences.

Generally, branded apparel inventories are not proneto impairment, because we usually order branded apparel in exact quantities tosufficiently satisfy specific customer orders. However, branded apparelinventories remained on hand at June 30, 2006, because we shipped the Father’sDay order in June, five weeks later than requested by Wal-Mart. Due to thetardiness of that shipment Wal-Mart canceled the follow-up order, the apparelinventories for which we had already received, and we wrote the correspondinginventories down to the value that we expected to recover from selling thegoods to another market.

During fiscal 2006, we recorded fashion apparelinventories write-downs of $313,000, including a write-down of $28,000 duringthe fourth fiscal quarter, and we recorded branded apparel write-downs of$95,000 during the fourth fiscal quarter. While management believes that ourprocesses 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 expectedtax consequences in future years for differences between the tax bases ofassets and liabilities and their financial reporting amounts, based uponenacted tax laws and statutory tax rates applicable to the periods in which thedifferences are expected to affect taxable income. Our significant deferred taxassets are related to net operating loss carry forwards for federal and stateincome tax purposes, stock-based compensation and an unrealized loss for taxpurposes on a common stock investment. Governing regulations require that ouroperating losses be carried forward for income tax purposes. We haveestablished a valuation allowance to reduce deferred tax assets to the netamount expected to be recovered in future periods. The estimates for deferredtax assets and the corresponding valuation allowance require us to exercisecomplex judgments. We periodically review and adjust those estimates based uponthe most current information available. In accordance with SFAS 109 and basedupon a review at June 30, 2006, of our utilization of deferred tax

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assets,we maintained a valuation allowance that effectively reduces our net deferredtax assets to zero. While we continue to explore various strategies to returnthe Company to profitability, including sales of Top-Flite® branded apparel toWal-Mart in fiscal 2006, we cannot be certain that our efforts will result inthe generation of future profits. Because the recoverability of deferred taxassets is directly dependent upon future operating results, actualrecoverability of deferred tax assets may differ materially from our estimates.

*Allowancefor Doubtful Accounts*

Ourallowance for doubtful accounts reflects a reserve that reduces our customeraccounts receivable to the net amount estimated to be collectible. Estimatingthe credit worthiness of customers and the recoverability of customer accountsrequires us to exercise considerable judgment. In estimating the reserve foruncollectible accounts, we consider factors such as general economic andindustry-specific conditions, historical customer performance and anticipatedcustomer performance. From time to time, we also identify delinquent customeraccounts for which a specific reserve is required. At June 30, 2006, ourallowance for doubtful accounts totaled $291,000, including a specific reserveof $116,000 with respect to the potential non-recovery of a net amount due toReserve Apparel from a former inventory supplier. While we consider ourprocesses to be adequate to effectively quantify our exposure to doubtfulaccounts, changes in economic, industry or specific customer conditions mayresult in recoverability of our doubtful accounts that differs materially fromour estimates.

*Allowancefor Sales Returns*

Werecord allowances for sales returns as net adjustments to customer accountsreceivable. When recording an allowance, the net method reduces customeraccounts receivable and net sales by the estimated gross margin effect of theanticipated sales return. Generally, our selling terms preclude return of ourproducts subsequent to the sale. However, we have traditionally maintainedlimited programs that offer various customers the right to return certainfashion apparel items under predefined conditions, which we include as acomponent within our estimate of allowance for sales returns. We reviewhistorical data and consider factors such as general economic andindustry-specific conditions and anticipated customer performance whenevaluating the adequacy of our allowance for sales returns. At June 30, 2006,the Company’s allowance for sales returns was $155,000. Significant changes ingeneral economic or industry conditions may yield sales returns that differmaterially from our estimates

**RecentDevelopments**

OnSeptember 21, 2006, Sport Haley entered into an agreement with Explorer Gear andExplorer Headgear, Inc. which was approved by Reserve Apparel, for the purchaseof Explorer Gear’s membership interest in Reserve Apparel and to settle anypotential claims between the parties. The agreement requires Sport Haley tomake a lump sum payment to Explorer Gear of $375,000. After Reserve Apparelbegan operations, certain disputes arose between the members concerning, amongothers, the formation, operation and performance of Reserve Apparel. SportHaley, Reserve Apparel, Explorer Gear and Explorer Headgear, Inc. have deniedany liability to one another. As part of the agreement, the parties have agreedto settle and resolve any asserted or potential claims against each other. Theparties have also agreed to mutual releases of all claims asserted, or whichcould have been asserted, against each other, and each party has continued todeny the merits of those claims asserted against it by the other. Upon enteringinto the agreement, Explorer Gear no longer owned any membership interest inReserve Apparel, which became a wholly-owed subsidiary of Sport Haley.

Afterthe operations of Reserve Apparel were moved to our Denver, Colorado facility,Reserve Apparel designed a new line of Top-Flite® apparel, under the directionof Sport Haley management. The new Top-Flite® line, consisting of basic andfancy collections of garments comprised primarily of a variety of performancefabrics, was presented to Wal-Mart buyers in early September 2006. However, inlate September 2006, Reserve Apparel was notified that Wal-Mart had chosen todevelop its own brand of golf apparel rather than to continue purchasing ourTop-Flite® line. We expect to develop other markets and channels ofdistribution for our Top-Flite® apparel collections, including marketing thenewly designed Top-Flite® line to other mass retailers.

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Aspreviously reported, a Canadian apparel broker, which had handled severaldeliveries of Top-Flite® apparel to Reserve Apparel, applied a $291,000prepayment to satisfy a debt of Explorer Headgear, Inc. (a Canadian companyrelated to Explorer Gear by common ownership, management and employees) insteadof applying the amount as a deposit toward the production of finished goodsinventories which were planned to be provided to Reserve Apparel by theCanadian broker. The $291,000 deposit had been advanced to the Canadian brokerby Sport Haley as a payment on behalf of Reserve Apparel and was recorded bySport Haley as a member loan to Reserve Apparel. At June 30, 2006, the $291,000was included as an other receivable on the books of Reserve Apparel. We believethat the Canadian broker inappropriately misapplied the $291,000 deposit andhave demanded repayment from the broker. During May and June 2006, we receivedcertain assurances from the Canadian broker that this matter would be resolvedto our satisfaction. However, to date, there has been no resolution to thismatter.

Alsoas previously reported, an executive from Explorer Gear informed the managementof Reserve Apparel that the amount of $236,000, which was previously purportedby Explorer Gear to have been paid to the Canadian broker on behalf of ReserveApparel, had not been paid. At June 30, 2006, the $236,000 was included in theaccrued liabilities of Reserve Apparel.

InJune 2006, Reserve Apparel discovered that the Canadian broker had been paidtwice for the same delivery of Top-Flite® apparel to Reserve Apparel, in theamount of $177,000. Further, in August 2006, because the Canadian broker didnot meet Wal-Mart’s extended deadline for receipt of the merchandise, Wal-Martcanceled their order relating to the merchandise being provided by the Canadianbroker, which otherwise would have been shipped to Wal-Mart in August 2006.Consequently, Reserve Apparel canceled the purchase order with the Canadian broker,which was approximately in the amount of $267,000. We do not believe thatReserve Apparel is liable for payment to the Canadian broker with regard to thedelinquent goods which Wal-Mart would not accept. However, since it is ourunderstanding that the merchandise was in production when Wal-Mart canceledtheir order, we cannot give any assurances that the Canadian broker will notassert that Reserve Apparel is responsible for paying for these goods. As ofthe date of this report, we did not have any pending orders with the Canadianbroker, and we do not anticipate placing any orders with the Canadian brokerfor future delivery of Top-Flite® or any other apparel.

Weexpect to make further demands for repayment from the Canadian broker for the$291,000 deposit and the $177,000 overpayment, and, if we cannot reach anamicable resolution of this matter with the Canadian broker in the near future,we expect to initiate legal proceedings to recover the funds. While we expectto aggressively pursue full recovery from the Canadian broker, because of therelative ages of the misapplied deposit and overpayment and the nature of oursevered relationship with the Canadian broker, we recorded an allowance of$116,000 at June 30, 2006, with regard to the net amount due from the Canadianbroker.

**Resultsof Operations**

Thefollowing table sets forth the percentage of net sales represented by itemsincluded in or derived from our statements of income for its fiscal years endedJune 30, 2006, 2005 and 2004, 2003 and 2002:

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| ** **                                                                                                       | ** ** | **Fiscal Year Ended June 30, (2006 and 2002 Consolidated)** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2006**                                                                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales                                                                                                        |       | 100.0                                                                                               | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Cost of goods  sold                                                                                              |       | 67.0                                                                                                |       | 71.2 |   | 65.5 |   | 61.9 |   | 75.5 |   |
| Gross profit                                                                                                     |       | 33.0                                                                                                |       | 28.8 |   | 34.5 |   | 38.1 |   | 24.5 |   |
| Other operating  costs                                                                                           |       | 38.3                                                                                                |       | 44.6 |   | 42.0 |   | 41.8 |   | 40.3 |   |
| Loss from  operations                                                                                            |       | (5.3                                                                                                | )          | (15.8 | ) | (7.5 | ) | (3.7 | ) | (15.8 | ) |
| Other income and  expenses, net                                                                                  |       | 2.1                                                                                                 |       | 0.9 |   | 0.6 |   | 0.7 |   | 2.0 |   |
| Loss from  operations before minority interest in subsidiary loss and (provision for) benefit  from income taxes |       | (3.2                                                                                                | )          | (14.9 | ) | (6.9 | ) | (3.0 | ) | (13.8 | ) |
| Minority  interest in subsidiary loss                                                                            |       | 1.2                                                                                                 |       | 0.0 |   | 0.0 |   | 0.0 |   | 0.0 |   |
| (Provision for)  benefit from income taxes                                                                       |       | (0.0                                                                                                | )          | (0.0 | ) | (3.6 | ) | 1.0 |   | 8.1 |   |
| Net loss                                                                                                         |       | (2.0                                                                                                | )%         | (14.9 | )% | (10.5 | )% | (2.0 | )% | (5.7 | )% |

 

**Comparisonof Fiscal Years Ended June 30, 2006 and 2005**

Totalnet sales for fiscal 2006 were $20,962,000, a decrease of $1,079,000, or 5%, ascompared with sales of $22,041,000 for fiscal 2005. Net sales of fashionapparel for fiscal 2006 were $18,489,000, a decrease of $3,552,000, or 16%, ascompared with fashion apparel sales of $22,041,000 for fiscal 2005. Net salesof branded apparel for fiscal 2006 were $2,473,000.

Forfiscal 2006, net sales of Ben Hogan® apparel collections were $11,199,000, adecrease of $10,000, or 0%, from net sales of $11,209,000 in fiscal 2005, andnet sales of SPORT HALEY® apparel collections were $6,538,000 for fiscal 2006,a decrease of $3,248,000, or 33%, from net sales of $9,786,000 for fiscal 2005.In fiscal 2006, we began marketing Top-Flite® apparel exclusively to Wal-Mart,and net sales of Top-Flite® branded apparel were $2,473,000 for fiscal 2006. Webegan shipping Top-Flite® branded apparel to Wal-Mart in March 2006.

Themarket for women’s golf apparel appears to have been shrinking for the pastcouple of years, which has caused fierce competition among the brands vying forlimited shelf space within the market. While we are certainly disappointed withthe continued decrease in sales of our women’s fashion apparel collections, webelieve that the shrinking market may have bottomed out, and we anticipate thatour sales of women’s apparel will begin to increase slightly in future periods.SPORT HALEY® continues to be a highly recognized brand within the women’sapparel market, and we are continuing to develop plans to improve the strategicposition of the SPORT HALEY® brand within the women’s market.

Becausenet sales of Ben Hogan® apparel collections appear to have begun to flattenout, we implemented initiatives in fiscal 2006 to bolster our overall fashionapparel sales. In fiscal 2006, we hired a western regional sales manager whohas extensive experience within the golf apparel industry in the westerngeographical regions of the United States and Hawaii. We believe that thewestern regional manager complements the talents of our eastern regionalmanager, who has a similar amount of experience within the golf apparelindustry in the eastern geographical regions of the United States. Our regionalsales managers are responsible for maximizing our fashion apparel sales withintheir respective geographical regions by training and supervising ourindependent wholesale sales representatives and maintaining contacts with keyaccounts. In fiscal 2006, we also hired a customer service liaison with extensivemarketing experience within the golf apparel industry to provide white gloveservice to our key accounts and to help us market our SPORT HALEY® and BenHogan® fashion apparel brands to prestigious country clubs and resorts whichhave not done business with us in the past.

BenHogan® apparel and Top-Flite® apparel are marketed in accordance with a licenseagreement we maintain with Callaway, which we consider to be a key component ofour overall business strategies. While we have consistently exceeded theminimum calendar year sales requirements of the agreement with respect to BenHogan® apparel while maintaining a strong working relationship with Callaway,our trend of continuing increases in sales of licensed apparel sustains therisk of loss should the license agreement with Callaway be terminated by eitherparty.

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Grossprofit for fiscal 2006 was $6,912,000, an increase of $560,000, or 9%, ascompared with gross profit for fiscal 2005 of $6,352,000. The differencebetween the fiscal years was partially attributable to lower write-downs offashion apparel inventories in fiscal 2006 as compared with fiscal 2005.Write-downs of fashion apparel inventories negatively impacted our grossmargins by $408,000 in fiscal 2006 as compared with write-downs of $1,403,000in fiscal 2005. The difference between the fiscal years was also partiallyattributable to consolidating sales of fashion apparel with sales of brandedapparel in fiscal 2006.

Grossprofit for fiscal 2006 with regard to sales of branded apparel was $114,000,which yielded a 5% gross margin on branded apparel net sales for the respectiveperiod. We expect that our sales of Top-Flite® branded apparel should yieldgross margins of 25% or greater. Gross profit relating to Top-Flite® brandedapparel sales for fiscal 2006 was negatively impacted by production delays,extraordinary shipping charges and mark down money due to Wal-Mart. Productiondelays caused us to incur inbound freight charges of $70,000. Because theTop-Flite® merchandise was continually received late from our suppliers,Wal-Mart required that we ship the orders directly to each store rather than torespective Wal-Mart distribution centers as originally planned. We estimatethat additional shipping costs, incurred to ship orders directly to Wal-Martstores rather than to distribution centers, were in excess of $200,000 forfiscal 2006. Periodically, per our vendor agreement, Wal-Mart may request thatwe reimburse them for mark downs they have taken or plan to take on Top-Flite®apparel we have sold to them. It is our understanding that Wal-Mart typicallyrequests mark down money when sales of merchandise do not reasonably meet theirinternal expectations. Because we shipped Top-Flite® apparel for a Father’s Daypromotion five weeks late due to production delays, Wal-Mart lost early salesopportunities for the merchandise, and sell-through of the Top-Flite® apparelproduced for that promotion did not reasonably meet their expectations. Werecorded sales discounts of $168,000 in fiscal 2006 relating to mark downconcessions granted to Wal-Mart with respect to the Father’s Day promotion thatadversely affected our gross profit, accordingly. By June 30, 2006, weconsolidated the operations of Reserve Apparel to move substantially all of itsoperations to our Denver, Colorado facility. Before moving the operations toDenver, the product development, sourcing, logistics and sales invoicingoperations of Reserve Apparel had been performed in Toronto, Ontario, Canada,by employees of Explorer Gear, the minority interest. By consolidating theoperations of Reserve Apparel into our Denver operations, and utilizingsuppliers other than those which caused repeated production delays, we expectto improve the management of the entire production process and to achieve morereasonable margins on sales of Top-Flite® branded apparel in future periods.Since Wal-Mart recently informed us that they do not intend to purchaseTop-Flite® branded apparel in the near future, we will begin exploring othermarkets and channels of distribution for our Top-Flite® garments, includingmarketing Top-Flite® apparel to mass retailers other than Wal-Mart.

Grossmargin for fiscal 2006 was 33%, an increase of 4%, from 29% in fiscal 2005. Ourgross margins may not be comparable to other companies within the golf apparelindustry. We have consistently included the cost of merchandise sold, includingimport charges, in-bound freight, allocated overhead, freight out, embroiderycosts and other charges in our cost of goods sold. Our overhead allocationincludes our production costs plus a portion of our distribution costs, such asreceiving and inspection costs, but we include some of the other costs ofdistribution, such as a portion of our warehousing and other handling costs, inselling, general and administrative expenses. Our gross margins also include,on a consolidated basis, the operations of Reserve Apparel, which distributesTop-Flite® branded apparel to the mass retail market at much lower price pointsand gross margins than those expected to be achieved in the premium andmid-price markets where we distribute our SPORT HALEY® and Ben Hogan® fashionapparel brands. Other companies within the golf apparel industry may or may notoperate within the lower price markets. We include royalty payments, relatingto sales of licensed apparel, in selling, general and administrative expenses.

Selling,general and administrative expenses were $7,090,000 in fiscal 2006, a decreaseof $1,946,000, or 22%, from $9,036,000 in fiscal 2005. The decrease wasattributable to various factors. Included in fiscal 2005 expenses wereseverance and other compensation expenses paid to our late Chairman and formerChief Executive Officer. Subsequent to the death of our Chairman in September2004, we paid $650,000 in severance and other compensation to the late Chairman’sestate. Similarly, upon the departure of our former Chief Executive Officer inOctober 2004, we accrued $520,000 in severance and other compensation that isgenerally payable to the former

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executive over athree-year period ending in March 2008. The severance and other compensationamounts paid to our late Chairman and former Chief Executive Officer increasedour selling, general and administrative costs in fiscal 2005 by $1,170,000. Theseverance and other compensation expense paid to our former Chief ExecutiveOfficer had no effect on our selling, general and administrative expenses infiscal 2006. Salary and other payroll related expenses, net of severance andother compensation costs, totaled $3,116,000 in fiscal 2006, a decrease of$225,000, or 7%, from $3,341,000 in fiscal 2005. We attribute the remainder ofthe decrease in selling, general and administrative expenses to our continuedefforts to streamline our operations and to find additional ways to decreaseour overall operating expenses. As a percentage of sales, our selling, generaland administrative expenses were 34% and 41% for fiscal 2006 and 2005,respectively.

Royaltyexpense for fiscal 2006 was $927,000, an increase of $130,000, or 16%, from$797,000 for fiscal 2005. The increase in royalty expense was primarilyattributable to the introduction of Top-Flite® branded apparel in fiscal 2006.Royalty expense is due to Callaway in accordance with the license agreementthey previously granted to us to market golf apparel bearing the Ben Hogan® andTop-Flite® labels.

Totalother income, net, for fiscal 2006 was $438,000, an increase of $230,000, or111%, from $208,000 in fiscal 2005. Our other income, net, is generallycomprised of interest earned on cash and cash equivalent balances held atvarious financial institutions. The increase in other income, net, wasprimarily attributable to higher rates of interest earned during fiscal 2006 ascompared with fiscal 2005. Other income for fiscal 2006 also includes $157,000of the $173,000 recovered in the settlement we reached with our formerauditors. We offset legal expenses for fiscal 2006 with the remainder of thesettlement in the amount of $16,000.

Lossfrom operations before minority interest in subsidiary loss and provision forincome taxes for fiscal 2006 was $667,000, an improvement of $2,606,000, or80%, from a loss of $3,273,000 in fiscal 2005. While a substantial amount ofthe improvement was due to the factors discussed above, such as better controlsover fashion apparel inventories that resulted in lower write-downs of obsoleteor discontinued inventories in fiscal 2006, severance and other compensationexpense incurred in fiscal 2005 and not in fiscal 2006, lower overall payrolland related expenses in fiscal 2006, higher rates of interest earned on cashand cash equivalents in fiscal 2006 and the settlement recovery from our formerauditors in fiscal 2006, we believe that the improvement is also indicative ofmanagement’s concerted efforts to return the Company to profitability. Of the$667,000 loss incurred in fiscal 2006, only $150,000 related to the operationsof Sport Haley, as compared with $3,273,000 in fiscal 2005. The remaining$517,000 of the $667,000 fiscal 2006 loss was attributable to the operations ofReserve Apparel.

Basicand diluted losses per share were ($0.15) and ($1.29) for fiscal years 2006 and2005, respectively. Due to the net losses for the respective periods, alloutstanding options were anti-dilutive and therefore excluded from the loss pershare calculations.

**Comparisonof Fiscal Years Ended June 30, 2005 and 2004**

Netsales for fiscal 2005 were $22,041,000, an increase of $1,241,000, or 6%, ascompared with net sales of $20,800,000 for fiscal 2004. We attributed thedifference in net sales to factors such as the continued growth in sales of BenHogan® apparel collections offset by the discontinuance of our HALEY RESERVEmen’s fashion apparel and a continued decrease in sales of SPORT HALEY® women’sfashion apparel.

Forfiscal 2005, our net sales of Ben Hogan® apparel collections were $11,209,000,an increase of $4,257,000, or 61%, from net sales of $6,951,000 in fiscal 2004.The increase in net sales between the fiscal years is indicative of the growthwe achieved with our Ben Hogan® collections within the premium-priced golfapparel market.

Aspreviously reported, we discontinued our HALEY RESERVE men’s fashion apparelbeginning with our spring 2005 selling season, in part because of itsdiminishing sales and in part because we had expected to introduce Top-Flite®branded apparel in its place within our distribution channels. We beganshipping our spring 2005 apparel collections during November 2004. We believethat the discontinuance of our HALEY RESERVE men’s fashion

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apparel negativelyimpacted our fiscal 2005 sales by at least $2,500,000, the total of our netsales for such apparel during our spring 2004 selling season. Historically,sales within our HALEY branded apparel lines have been disproportionatelycomprised of greater sales of women’s apparel than of men’s apparel. Overall,net sales of our HALEY branded apparel decreased by $3,000,000, or 23%, fromnet sales of $12,786,000 for fiscal 2004 to net sales of $9,786,000 for fiscal2005. The continued decline in sales of our SPORT HALEY® women’s fashionapparel appeared to be related to a shrinking market for women’s golf apparel,because our customers appeared to be placing less importance on women’s fashiongolf apparel within their shops. In fiscal 2004, we consolidated our network ofindependent wholesale sales representatives to allow our most of ourrepresentatives to market both our SPORT HALEY® women’s collections and our BenHogan® men’s collections simultaneously.

Forfiscal 2005, Ben Hogan® branded apparel revenues accounted for 51%, HALEY®branded apparel revenues accounted for 44% and embroidering and shippingrevenues accounted for 5% of our net sales, respectively. Comparatively, forfiscal 2004, Ben Hogan® branded apparel revenues accounted for 33%, HALEY®branded apparel revenues accounted for 61% and embroidering and shippingrevenues accounted for 6% of our net sales, respectively.

Grossprofit for fiscal 2005 was $6,352,000, a decrease of $829,000, or 12%, ascompared with $7,181,000 in fiscal 2004. The difference in gross profit betweenthe fiscal years was primarily attributable to the following factors: (i)During fiscal 2005, we revised our procedures used to assess the recoverabilityof our finished goods inventories by using an improved method that calculatesthe estimated sales value based upon the quantities and mix of inventories thatare expected to remain at the end of the selling season, rather than anestimate based upon the total number of units on hand that we used previously.Using the new recoverability assessment method, the net effect of inventorywrite-downs negatively impacted our gross profit for fiscal 2005 by $1,403,000.Comparatively, in fiscal 2004, inventory write-downs negatively impacted ourgross profit by $635,000. (ii) In fiscal 2005, we disposed of a significantportion of our excess finished goods inventories relating to our fall 2004 andprior selling seasons. In December 2004, we sold substantially all of ourdiscontinued or aging finished goods inventories from the spring 2004 andearlier selling seasons to a major retailer. While we had previously estimatedthe recoverability of those inventories, we recognized an additional loss of$179,000 upon their disposition in December 2004. (iii) As previously reported,in conjunction with performing procedures recommended by the developer of oursoftware that were designed to correct a prior system malfunction, we performeda physical count of our finished goods inventories and performed a detailedreview of our component inventories at December 31, 2004. The physicalinventory caused us to reduce the value of our finished goods inventories by$53,000 and the detailed review caused us to reduce the value of our componentinventories by $300,000 at December 31, 2004. The reductions in value similarlyincreased our cost of goods sold at December 31, 2004, thereby negativelyimpacting our gross profit for the period.

Grossmargin for fiscal 2005 was 29%, a decrease of 6%, from 35% in fiscal 2004. Ourgross margins may not have been comparable to other companies within the golfapparel industry. We 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 were included as components of our net sales. Our overheadallocation included certain of our distribution costs, such as receiving,inspection and shipping costs, but we included some of the other costs ofdistribution, such as a portion of our warehousing and other handling costs, inselling, general and administrative expenses. We included royalty payments,relating to sales of licensed apparel, in other operating costs.

Selling,general and administrative expenses were $9,036,000 in fiscal 2005, an increaseof $831,000, or 10%, from $8,205,000 in fiscal 2004. The increase betweenfiscal years was due to a combination of several separate factors. Subsequentto the death of our Chairman in September 2004, we paid $650,000 in severanceand other compensation expense to the late Chairman’s estate. Similarly, uponthe departure of our former Chief Executive Officer in October 2004, we accrued$520,000 in severance and other compensation that is generally payable to theformer executive over a three-year period ending in March 2008. The death ofour former Chairman and the departure of our former Chief Executive Officercontributed to a decrease in our total salary and other payroll expenses forfiscal 2005. Salary and other payroll expenses, net of severance costs, totaled$3,341,000 in fiscal 2005,

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a decrease of$149,000, or 4%, from $3,490,000 in fiscal 2004. As we previously reported, nearthe end of December 2004, we performed a detailed analysis of the individualcategories of our selling, general and administrative expenses, and we used ourevaluation as a tool to streamline our operations further. As a percentage ofsales, our selling, general and administrative expenses were 41% and 39% forfiscal 2005 and 2004, respectively.

Royaltyexpense for fiscal 2005 was $797,000, an increase of $265,000, or 50%, from$532,000 for fiscal 2004. The increase in royalty expense between the fiscalyears was directly related to the increase in net sales of our Ben Hogan®apparel collections.

Totalother income, net, for fiscal 2005 was $208,000, an increase of $92,000, or79%, from $116,000 in fiscal 2004. The increase was primarily due to the differencebetween the fiscal years in the amounts of and the rates of interest earned oncash equivalents and marketable securities. During fiscal 2005, interest ratesearned on our near risk-free investments improved slightly over the nearlyall-time lows earned on such investments in fiscal 2004. Cash equivalents andmarketable securities were purchased from time to time in accordance withguidelines, which our Board of Directors previously approved, designed tomaximize the rates of return achieved on near risk-free investment balances.

Lossfrom operations before provision for income taxes for fiscal 2005 was($3,273,000), a difference of ($1,833,000), or 127%, from ($1,440,000) forfiscal 2004. Net loss for fiscal 2005 was ($3,281,000), a difference of ($1,095,000),or 50%, from ($2,186,000) for fiscal 2004. The proportional disparity betweenthe difference in losses from operations before provision for income taxes andthe difference in net loss arose because of the differences in the financialstatement effects of our valuations with respect to net deferred tax assetsbetween the fiscal years. The valuation of net deferred taxes between years maycause variations in effective tax rates that can vary significantly due todifferences between the methods of recording certain transactions for financialstatement purposes versus the methods for recognizing those transactions fortax purposes within the same fiscal period. Certain expenses recorded forfinancial statement purposes may not be deductible for tax purposes and certaindeductions for tax purposes may not be recorded for financial statementpurposes within the same fiscal year. For fiscal 2004, our provision for incometaxes was $746,000, primarily because we increased a valuation allowance toeffectively reduce our net deferred tax assets to zero. We periodically reviewand adjust our valuation for deferred tax assets based upon the most currentinformation available. Because of our trend of net losses in the 2005 andmost-recent prior years, we believed that it was more probable than not thatnone of our deferred tax assets would be recovered, and, in fiscal 2005, wemaintained the valuation allowance that effectively reduced our deferred taxassets to zero. Income tax expense for the period equaled taxes payable for theperiod plus the change during the period in our net deferred tax assets. Infiscal 2005 and 2004, we paid $8,000 and $0 in applicable federal and stateincome taxes, respectively.

Basicand diluted losses per share were ($1.29) and ($0.89) for fiscal years 2005 and2004, respectively. Due to the net losses for the respective fiscal years, alloutstanding options were anti-dilutive and therefore excluded from the loss pershare calculations.

**Liquidityand Capital Resources**

Ourprimary sources of liquidity are derived from our available cash and cashequivalents, cash flows from operations and a working capital line of creditwith a commercial bank. We require cash for our general working capitalpurposes. We do not anticipate requiring material amounts of cash for capitalexpenditures over the next 12 months. To the extent our cash balance is insufficient to finance our workingcapital needs, we may also make periodic borrowings under our revolving line ofcredit. Our working capital requirements are highly seasonal in nature,with greater requirements from approximately August through October andFebruary through April of each fiscal year due to the purchases of fashionapparel inventories for the spring/summer and fall/holiday selling seasons,respectively.

Working capital was $14,455,000 and $14,814,000 atJune 30, 2006 and 2005, respectively. Cash and cash equivalents plus marketablesecurities totaled $ 8,492,000 and $7,721,000 at June 30, 2006 and 2005,respectively. For purposes of the statements of cash flows, we consider allhighly liquid instruments purchased with an original

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maturityof three months or less, that are readily convertible to known amounts of cashand present an insignificant risk of change in value due to changes in interestrates, to be cash equivalents.

Netcash provided by (used in) operating activities totaled $1,139,000, $3,134,000and ($1,893,000) for fiscal years 2006, 2005 and 2004, respectively. Theprimary components of adjustments to reconcile net loss to cash provided by(used in) operating activities were changes between fiscal years relating toimpairments and write-downs, deferred taxes, provisions for doubtful accountsand sales returns, accounts receivable, inventories, accounts payable, andaccrued commissions and other expenses.

·                  Adjustments for impairments andwrite-downs affected net cash provided by (used in) operating activities by$408,000 in fiscal 2005, $1,403,000 in fiscal 2004 and $707,000 in fiscal 2003.The effects on net cash provided by (used in) operating activities caused byimpairments and write-downs represent the expense effects of recordingimpairments and write-downs in the respective fiscal years. Because of theseasonal nature of the fashion apparel business, excess inventories left overat the end of each selling season (“previous seasons’ inventories”) are commonwithin the industry. Throughout each fiscal year, we market previous seasons’inventories through our ordinary marketing channels. At or near the end of eachfiscal quarter, we identify and revalue obsolete inventories, primarilyconsisting of previous seasons’ fashion apparel inventories, to estimateddisposition values. Write-down charges relating to excess inventories haveadversely affected our earnings and cash flows for the last several years. Infiscal 2004, we enacted initiatives directed to significantly reduce the levelsof finished goods inventories in order to minimize the future adverse financialeffects associated with the devaluation of obsolete fashion apparelinventories. In fiscal 2005, we sold a significant portion of our previousseasons’ fashion apparel inventories and refined our procedures to betterestimate the recoverability our finished goods inventories, and we establishednew procedures for purchasing fashion apparel inventories designed to minimizethe quantities expected to remain at the end of each selling season. In 2006,$95,000 of the $408,000 inventory write-down related to branded apparelinventories on hand at June 30, 2006. Generally, branded apparel inventoriesare not prone to impairment, because we usually order branded apparel in exactquantities to sufficiently satisfy specific customer orders. Branded apparelinventories remained on hand at June 30, 2006, because we shipped the Father’sDay order in June, five weeks later than requested by Wal-Mart. Due to thelateness of that shipment Wal-Mart canceled the follow-up order, the apparelinventories for which we had already received, and we wrote the correspondinginventories down to the value that we expected to recover from selling thegoods to another market.

·                  The effects on net cash provided by operatingactivities caused by changes in deferred taxes primarily represent the changein expected tax consequences in future years for differences between the taxbases of assets and liabilities and their financial reporting amounts, basedupon enacted tax laws and statutory tax rates applicable to the periods inwhich the differences are expected to affect taxable income. Our significant deferredtax assets are related to net operating loss carry forwards for federal andstate income tax purposes, stock-based compensation and an unrealized loss fortax purposes on a common stock investment. Governing regulations require thatour operating losses be carried forward for income tax purposes. We haveestablished a valuation allowance to reduce deferred tax assets to the netamount expected to be recovered in future periods. The estimates for deferredtax assets and the corresponding valuation allowance require us to exercisecomplex judgments. We periodically review and adjust those estimates based uponthe most current information available. In accordance with SFAS 109 and basedupon reviews at June 30, 2006, 2005 and 2004, of our utilization of deferredtax assets, we maintained a valuation allowance that effectively reduces ournet deferred tax assets to zero. While we continue to explore variousstrategies to return the Company to profitability, including the introductionof Top-Flite® branded apparel, we cannot be certain that our efforts willresult in the generation of future profits. Because the recoverability ofdeferred tax assets is directly dependent upon future operating results, actualrecoverability of deferred tax assets may differ materially from our estimates.Deferred taxes affected net cash provided by (used in) operating activities by$0 in fiscal 2006, $0 in fiscal 2005 and $746,000 in fiscal 2004.

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·                  The effects on net cash provided byoperating activities caused by changes in provisions for doubtful accounts andsales returns 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 $291,000 infiscal 2006, $377,000 in fiscal 2005 and $454,000 in fiscal 2004. Theallowances for 2006, 2005 and 2004 included specific reserves of $116,000,$151,000 and $175,000, respectively, with respect to certain customer accountsreceivable. We believe that the trend which indicates a general decrease in therequired allowance amount is primarily attributable to the changes incollection methods that we instituted in fiscal 2004. The changes in ourcollection methods help us to shorten the collection process with regard topast due accounts, thereby minimizing potentially uncollectible amounts. Ourallowances for customer sales returns at June 30 were $155,000 in fiscal 2006, $286,000in fiscal 2005 and $342,000 in fiscal 2004. The percentage of sales returnsdecreased dramatically in fiscal 2006. We attribute the decrease in 2006 toenhancements within our order reservation and shipping systems in late fiscal2005 that generally ensure our customers that they will receive merchandisethey have 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. The decrease in the allowance for sales returns infiscal 2005, as compared with the allowance in fiscal 2004, was primarily dueto the decrease in our customer accounts receivable at June 30, 2005, ascompared with the receivable balance at June 30, 2004. We also initiated areserve for the return of samples garments from our independent wholesale salesrepresentatives pursuant to a procedural change with regard to such samplegarments effective with the fall 2004 selling season which granted therepresentatives the right to return sample garments. During fiscal 2005, wediscontinued the policy that granted the representatives the right to returnsample garments. As of June 30, our allowances for sample garments were $0 infiscal 2006, $28,000 in fiscal 2005 and $332,000 in fiscal 2004. The relativedecrease in the allowance in fiscal 2005, as compared with the allowance infiscal 2004, was due to our discontinuance of the right to return policy effectivewith the spring 2006 marketing season. Provisions for doubtful accounts andsales returns affected net cash provided by (used in) operating activities byapproximately ($71,000) in fiscal 2006, ($205,000) in fiscal 2005 and $856,000in fiscal 2004.

·                  Accounts receivable, not including theeffects of provisions for doubtful accounts and sales returns, providedoperating cash of $616,000 in fiscal 2006, used operating cash of $1,656,000 infiscal 2005 and used operating cash of $1,846,000 in fiscal 2004. Accountsreceivable, net of allowances, decreased from $4,495,000 at June 30, 2005 to$3,950,000 at June 30, 2006. The decrease in fiscal 2006, as compared with thefiscal 2005 receivable balance, was primarily attributable to the shortening ofour collection cycle discussed above combined with differences in our net salesof fashion apparel for the month of June 2006 of $1,794,000 versus our netsales of fashion apparel for the month of June 2005 of $2,391,000.

·                  Inventories, not including the effects ofinventory write-downs, used operating cash of $1,030,000 in fiscal 2006,provided operating cash of $3,252,000 in fiscal 2005, and used operating cashof $1,687,000 in fiscal 2004. Our inventories increased slightly in fiscal2005, from $4,153,000 at June 30, 2005, to $4,775,000 at June 30, 2006. Of the$622,000 net increase, $335,000 related to branded apparel inventories anddeposits at June 30, 2006. We had no branded apparel inventories or deposits atJune 30, 2005. In fiscal 2005, we disposed of significant amounts of ourobsolete or aging finished goods inventories and implemented initiativesdesigned to further minimize the quantities of unsold inventories expected toremain at the end of a selling season, which we believe have allowed us to maintainreasonable inventory levels in fiscal 2006.

·                  Accounts payable provided operating cashof $1,255,000 in fiscal 2006, used operating cash of $799,000 in fiscal 2005,and provided operating cash of $792,000 in fiscal 2004. Accounts payableincreased from $582,000 at June 30, 2005, to $1,836,000 at June 30, 2006.Changes in accounts payable relate to differences in the timing between theyears in the recording and payments of expenditures for inventory purchases,ordinary business expenses and other.

·                  Accrued commissions and other expensesused operating cash of $49,000 in fiscal 2006, provided operating 

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cash of $402,000 infiscal 2005, and provided operating cash of $238,000 in fiscal 2004. Accruedcommissions and other expenses decreased from $1,169,000 at June 30, 2005, to$1,120,000 at June 30, 2006. The increase primarily relates to higher royaltiesdue on correspondingly higher Ben Hogan® sales for the fourth fiscal quarter,comparatively between the 2005 and 2004 fiscal years, and accrued severancecompensation payable to our former chief executive officer.

Netcash provided by (used in) investing activities totaled ($28,000), $363,000,and $1,221,000 for fiscal years 2006, 2005, and 2004, respectively. The primarycomponents of net cash provided by (used in) investing activities werematurities (purchases) of marketable securities and purchases and disposals offixed assets.

·                  Net maturities (purchases) of marketablesecurities provided investing activities cash of $539,000 in fiscal 2005 andprovided investing activities cash of $1,642,000 in fiscal 2004. Marketablesecurities decreased from $539,000 at June 30, 2004, to $0 at June 30, 2005. Nomarketable securities were purchased during fiscal 2006. Marketable securitiesprimarily consisted of United States government and mortgage-backed debtsecurities that matured within one year or less. Due to the short-term natureof the investments, we did not recognize material unrealized gains or losses onmarketable securities in fiscal 2006, 2005 or 2004. Therefore, the carryingvalues of marketable securities approximated their fair values.

·                  Purchases of fixed assets used investingactivities cash of $44,000, $176,000 and $427,000, in fiscal 2006, 2005, and2004, respectively. Property and equipment, at cost, decreased from $4,423,000at June 30, 2005, to $4,417,000 at June 30, 2006. As of June 30, 2006, asignificant portion of the fixed assets used in our operations were fullydepreciated. We do not anticipate making any significant fixed asset additionsin the near future.

·                  Dispositions of fixed assets providedinvesting activities cash of $16,000 in fiscal 2006, $0 in fiscal 2005 and$6,000 in fiscal 2004, respectively. We do not have a significant amount ofunutilized fixed assets, and we do not anticipate any significant assetdispositions in the near future.

Netcash provided by (used in) financing activities totaled ($340,000), $334,000,and $258,000 for fiscal 2006, 2005, and 2004, respectively. In fiscal 2006, wedeclared and paid a cash dividend to common shareholders, which used financingactivities cash of $693,000, and amounts advanced to Reserve Apparel byExplorer Gear, the minority interest, in excess of their proportionate share ofReserve Apparel’s net loss provided financing activities cash of $56,000. Netcash provided by financing activities in fiscal 2005 and 2004 related solely toexercises of stock options by former executive officers and another formeremployee.

Our long-term debtat June 30, 2006, consisted of the balance of amounts advanced to ReserveApparel by Explorer Gear. We had no long-term debt at June 30, 2005. SinceApril 1994, we have maintained a revolving line of credit with a commercialbank. The line of credit, which has been renewed through December 5, 2006,bears interest at the bank’s prime rate. The renewal provides for a maximumloan amount of $5,000,000 and is secured with a lien on substantially all ofour assets. We generally maintain the line of credit to facilitate the issuanceof letters of credit for inventory purchases from offshore suppliers and tofund any temporary working capital needs. The amended terms of the line ofcredit agreement require that we maintain minimum tangible net worth of notless than $14,000,000 and liquidity of $4,000,000.

In the ordinarycourse of our business, we enter into letters of credit arrangements with acommercial bank to facilitate the purchase of finished and packaged inventoryand/or raw fabric from various offshore suppliers. As of June 30, 2006 and2005, we had outstanding letters of credit totaling $509,000 and $2,012,000,respectively, relating to commitments to purchase finished goods inventoriesfrom various suppliers. Amounts outstanding on letters of credit reduce theamount available for borrowing under the line of credit. We had no outstandingborrowings under the line of credit at either June 30, 2006, or June 30, 2005.

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Historically,gross proceeds received from the exercise of stock options have fluctuatedsignificantly from year to year. We realized proceeds of $353,000, $334,000 and$258,000 in fiscal 2006, 2005 and 2004, respectively, from the exercise ofstock options.

Substantially allof our purchases from offshore manufacturers and sales to foreign distributorsare U.S. Dollar denominated and, consequently, we have no material currencyexchange risk. We believe that inflation has not materially affected theresults of our operations during the three most recent fiscal years.

**Off-BalanceSheet Arrangements**

During fiscal years 2006 and 2005, we did nothave any relationships or arrangements with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes.

**ContractualObligations**

The following table summarizes oursignificant contractual cash obligations as of June 30, 2006. Certain of thesecontractual obligations are reflected in our balance sheet, while others aredisclosed as future obligations under accounting principles generally acceptedin the United States.
|                                                                                          | ** ** | **Payments due by Period** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Cash   Obligations**                                             | ** ** | **Total**                                 | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 Years** | ** ** | **More than 5  Years** | ** ** |
| Long Term Debt  Obligations                                                              |       | $                                         | 34,000     |   | $ | — |   | $ | — |   | $ | — |   | $ | 34,000 |   |
| Capital Lease  Obligations                                                               |       | —                                    |       | — |   | — |   | — |   | — |   |
| Operating Lease  Obligations                                                             |       | 1,533,000                                 |       | 289,000 |   | 859,000 |   | 385,000 |   | — |   |
| Purchase  Obligations                                                                    |       | 509,000                                   |       | 509,000 |   | — |   | — |   | — |   |
| Minimum Royalty  Obligations Under License Arrangements                                  |       | 4,654,000                                 |       | 54,000 |   | 2,486,000 |   | 2,114,000 |   | — |   |
| Other Long-Term  Liabilities Reflected on the Registrant’s Balance Sheet under GAAP |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total                                                                                    |       | $                                         | 6,730,000  |   | $ | 852,000 |   | $ | 3,345,000 |   | $ | 2,499,000 |   | $ | 34,000 |   |

** **

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**ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSUREABOUT MARKET RISK**

Marketrisk representsthe risk of loss that may impact the financial position, results of operationsor cash flows due to adverse changes in financial and commodity market prices andrates. We are exposed to market risk with regard to changes in United Statesinterest rates. This exposure is directly related to our normal operating andfunding activities. Historically and as of June 30, 2006, we have not usedderivatives instruments or engaged in hedging activities. Our market risk hasnot changed significantly from June 30, 2005.

**InterestRate Risk**

Wemaintain a revolving line of credit agreement with a commercial bank thatprovides for interest at the bank’s prime rate. The agreement provides for amaximum loan amount of $5,000,000 collateralized by a lien on substantially allof our assets. We generally maintain the line of credit to facilitate theissuance of letters of credit for inventory purchases from offshore suppliersand, if necessary, to fund any temporary working capital needs. We did not haveany outstanding borrowings under the line of credit at June 30, 2006. Increasesin the bank’s prime rate could, however, increase the interest expense withrespect to future borrowings, including borrowings under the line of credit.Outstanding letters of credit reduce the amount available for borrowing underthe line of credit. We had outstanding letters of credit of approximately$509,000 at June 30, 2006.

Fromtime to time, we maintain short-term investments in low risk and no riskfinancial instruments, readily convertible into cash, which earn interest atvariable rates. Periodically, our cash balances held at financial institutionsexceed federally insured limits.

**ITEM8.   FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**
| INDEX                                                    | ** ** | ** ** |
|----------------------------------------------------------|------------|------------|
|                                                     |       |       |
| Index to  Financial Statements                           |       |       |
|                                                     |       |       |
| Report of  Independent Registered Public Accounting Firm |       |       |
|                                                     |       |       |
| Consolidated  Balance Sheets                             |       |       |
|                                                     |       |       |
| Consolidated  Statements of Operations                   |       |       |
|                                                     |       |       |
| Consolidated  Statement of Shareholders’ Equity     |       |       |
|                                                     |       |       |
| Consolidated  Statements of Cash Flows                   |       |       |
|                                                     |       |       |
| Notes to  Consolidated Financial Statements              |       |       |
|                                                     |       |       |
| Schedule II —  Valuation and Qualifying Accounts    |       |       |

 

**ITEM 9.****                                   CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

None.

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**ITEM 9A.       CONTROLS AND PROCEDURES**

**(a)****           Evaluation ofDisclosure Controls and Procedures.**Our management, with the participationof our Interim 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 Securities Exchange Act of 1934 asof the end of the period covered by this report. Based on that evaluation,management, including the Interim Chief Executive Officer and Chief FinancialOfficer, concluded that, as of the end of the period covered by this report,our disclosure controls and procedures were effective in reaching a reasonablelevel of assurance that:  (a) all materialinformation relating to the Company, required to be disclosed in this report,was made 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.

As discussed inPart I, Item 1, in *“Management InformationSystems and Inventory Management”* and in Part II, Item 7, in *“Critical Accounting Policies and Estimates,”* we no longerconsider the programming and human computational errors, which caused us to usea standard cost method during fiscal 2005 and 2004, to be a material weaknessin our internals control over financial reporting with respect to inventoryvaluation during the period covered by this report. Our inventories, predominatelycomprised of finished goods, are generally valued at the lower of cost(weighted average) or market. Costs include amounts paid to suppliers forpackaged apparel and/or materials and labor, import costs, such as customsduties, freight-in and other miscellaneous costs, and allocated overhead. Sincewe implemented our operations software in January 2004, programming and humanerrors discovered within the system caused us to report a material weakness inour internal controls over financial reporting with respect to inventoryvaluation. This weakness in our internal controls prevented us from relyingupon the system-recorded transactions with respect to inventory valuationsduring 2005 and 2004. We used a standard cost method to value our finishedgoods inventories from the fiscal quarter ended March 31, 2004, through thefiscal quarter ended March 31, 2005. Had we been able to rely upon the systemto properly compute the cost of our finished goods inventories using theweighted average method, we believe that the weighted average method would nothave yielded a materially different computation of the value than the standardcost method we applied.

Based uponextensive tests that we performed near the end of fiscal 2006, we believe thatthe material weakness in our internal controls has been eradicated. We believethat the computer software has now been properly programmed, and employees havebeen properly trained to utilize system procedures, to rely upon the softwareto accurately compute our finished goods inventory valuations using a weightedaverage cost assumption. We also believe that the system has been configuredand employees are sufficiently monitored to ensure that all errors, sufficientto cause a material weakness with regard to the costing of our finished goodsinventories, are unlikely to recur.

**(b)****           Changes in InternalControl Over Financial Reporting.**During the last quarter of fiscal 2006,we did not implement any changes in our internal controls over financialreporting that materially affected, or are reasonably likely to materiallyaffect, our internal controls over financial reporting.

Our management,including our Interim Chief Executive Officer and our Chief Financial Officer,does not expect that our disclosure controls and procedures or our internalcontrols over financial reporting will, in all instances, prevent all errorsand all fraud. A control system, no matter how well conceived or operated, canonly provide reasonable, not absolute, assurance that the objectives of thecontrol system are met. While our control systems provide a reasonableassurance level, the design of our control systems reflects the fact that thereare resource constraints, and the benefits of such controls were consideredrelative to their costs. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within the financial reports ofSport-Haley, Inc. have been detected. These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdownscan occur 

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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.

**ITEM 9B.       OTHER INFORMATION**

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

On September 21,2006, Sport Haley entered into an agreement with Explorer Gear and ExplorerHeadgear, Inc., which was approved by Reserve Apparel, for the purchase ofExplorer Gear’s membership interest in Reserve Apparel and to settle anypotential claims between the parties. The agreement requires Sport Haley tomake a lump sum payment to Explore Gear of $375,000. After Reserve Apparelbegan operations, certain disputes arose between the members concerning, amongothers, the formation, operation and performance of Reserve Apparel. SportHaley, Reserve Apparel, Explorer Gear and Explorer Headgear, Inc. have deniedany liability to one another. As part of the agreement, the parties have agreedto settle and resolve any asserted or potential claims against each other. Theparties have also agreed to mutual releases of all claims asserted, or whichcould have been asserted, against each other, and each party has continued todeny the merits of those claims asserted against it by the other. Upon enteringinto the agreement, Explorer Gear no longer owned any membership interest inReserve Apparel, which became a wholly-owned subsidiary of Sport-Haley.

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

In September 2006,Donald W. Jewell was appointed to serve as our Chief Executive Officer andPresident on a permanent basis for an annual salary of $325,000, retroactive toJuly 1, 2006, and he will no longer serve as our Senior Vice President. Untilsuch time as a new employment agreement is prepared, the other terms of theemployment agreement with Mr. Jewell, effective as of February 2001, asamended, will generally remain in effect.

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

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**PART III**

**ITEM 10.****                      DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

| Name                           | ** ** | **Age** | ** ** | **Position**                                        |
|--------------------------------|------------|---------|------------|-----------------------------------------------------|
|                           |       |    |       |                                                |
| Donald W. Jewell               |       | 55      |       | Chief Executive Officer and President               |
|                           |       |    |       |                                                |
| Patrick W.  Hurley             |       | 54      |       | Chief Financial Officer, Secretary and Treasurer    |
|                           |       |    |       |                                                |
| Catherine B.  Blair            |       | 55      |       | Vice President - Merchandising/Design               |
|                           |       |    |       |                                                |
| Mark Maley (5)                 |       | 41      |       | Former: Vice President - Sales                      |
|                           |       |    |       |                                                |
| Ronald J. Norick  (1)(2)(3)(4) |       | 64      |       | Director and Chairman of the Board                  |
|                           |       |    |       |                                                |
| James R.  TenBrook (1)(3)      |       | 58      |       | Director and Chairman of the Audit Committee        |
|                           |       |    |       |                                                |
| Mark J.  Stevenson (1)(2)(3)   |       | 68      |       | Director and Chairman of the Compensation Committee |
|                           |       |    |       |                                                |
| James H. Everest  (2)(3)       |       | 58      |       | Director                                            |

 

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(1)          Member of the AuditCommittee

(2)          Member of theCompensation Committee

(3)  Member of the Nominating Committee

(4)          Mr. Norick was appointedChairman of the Board effective October 1, 2004.

(5)          Mr. Maley served as ourVice President – Sales from January 2004 until his departure in December 2005.Mr. Maley served as our Director of Special Markets and Brands from July 2003to December 2003 and was previously an independent wholesale salesrepresentative for the Ben Hogan® apparel line.

Officers areappointed by and serve at the discretion of the Board of Directors. EachDirector holds office until the next annual meeting of shareholders or until asuccessor has been duly elected and qualified. All of our officers devotefull-time to our business and affairs. At June 30, 2006, the Board wascomprised of four non-employee Directors, all of whom we determined to be “independent”within the meaning of the applicable listing standards of The NASDAQ GlobalMarketSM (the “NASD Rules”).

*Donald W.Jewell*was appointed by our Board of Directors in October2004 to serve as our Interim Chief Executive Officer. Mr. Jewell was appointedin April 2005 to serve as our President and has served as our Senior Vice President since February 2001. Mr. Jewellserved as President for a term consistent with that of his service as ourInterim Chief Executive Officer. In September 2006, Mr. Jewell agreed to serveas our Chief Executive Officer and President on a permanent basis, and he willno longer serve as our Senior Vice President. From 1996 until joining us, Mr.Jewell was the founder, president and director of Jewell Apparel Group, aCanadian distributor of premium and mid-priced men’s golf apparel. Mr. Jewellbegan designing, sourcing and marketing golf apparel in 1993 while serving asthe president and chief executive officer of Jewell-Rung, positions that heheld from 1980 to 1996.

*PatrickW. Hurley* has served as our Secretary and Treasurer sinceNovember 1999, as our Controller from November 1999 to August 2006 and as ourChief Financial Officer since December 2000. Prior to joining us, Mr. Hurleywas employed as a senior staff accountant at Saltzman Hamma Nelson Massaro LLP,Denver, Colorado, where among other things, he supervised or participated inthe preparation of audited and unaudited financial statements and income taxreturns, and provided advice and training for business clients regardingselection and 

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implementation ofaccounting systems and procedures. Mr. Hurley is a certified public accountantand received a bachelor of science in accounting in 1991. Mr. Hurley is also amember of the American Institute of Certified Public Accountants and theColorado Society of Certified Public Accountants.

*CatherineB. Blair* has served as our Vice President -Merchandising/Design since her appointment in May 1996. Ms. Blair has been partof our design team since 1992, and was appointed Director of Design in 1995.Prior to joining us, Ms. Blair was a designer for a golfwear company and alsoworked as a freelance designer for companies such as Macy’s, Bloomingdale’s,Ann Taylor and The Gap.

*MarkMaley* served as our Vice President – Sales from January 2004through December 2005. Mr. Maley served as our Director of Special Markets and Brandsfrom July 2003 to December 2003 and was previously an independent wholesalesales representative for the Ben Hogan® apparel line. Prior to joining us, Mr.Maley served as general manager, director of golf and head professional forover seven years with Club Corporation of America. Mr. Maley is a member of thePGA.

**KeyEmployees**

*George E.(“Tom”) Tomlinson* has served as our Director – Operations andProduction since December 1997. Previously, Mr. Tomlinson served as ourwarehouse distribution manager from January 1993 until December 1997. Prior tojoining the Company in 1993, Mr. Tomlinson held various positions in othercompanies, including purchasing for Bonfils Blood Center. Mr. Tomlinson is thebrother of our late Chairman and Chief Executive Officer, Robert G. Tomlinson,and the uncle of our former Chief Executive Officer, Kevin M. Tomlinson.

*Barry L.Hyman* has served as our Eastern Regional Sales Manager sinceFebruary 2004 and served on an interim basis as our Western Regional SalesManager from December 2005 to February 2006. Mr. Hyman was an independentwholesale sales representative for our Ben Hogan® apparel lines from 2001 untilhis appointment as Eastern Regional Sales Manager. From 1990 to 2001, Mr. Hymanwas an independent sales representative for various companies in the golfapparel industry, including Jewell Apparel Group, Precept Golf, Greg Norman andthe Ben Hogan® Company.

*MichaelD. Doris* has served as our Western Regional Sales Managersince February 2006. Prior to joining the Company, Mr. Doris was the westernregional sales manager for Cutter & Buck, Inc. from 2002 to 2005 and asales representative 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 for suchcompanies as The Ben Hogan® Company and Slazenger Golf USA.

**IndependentDirectors**

*Ronald J.Norick* has been a Director since November 1993. In October2004, subsequent to the death of Robert G. Tomlinson, Mr. Norick was appointedby the Board of Directors to fill the newly-created non-officer position ofChairman of the Board. Mr. Norick also serves on the Audit, Compensation andNominating Committees of the Board. From April 1987 until April 1998, Mr.Norick served as the elected Mayor of the City of Oklahoma City, Oklahoma. From1960 to 1992, Mr. Norick served in various capacities, including serving aspresident from 1981 to 1992, of a closely-held printing company, which was acquiredby Reynolds & Reynolds in June 1992. Mr. Norick serves on a number ofcivic, community, educational, corporate and public boards, commissions andcommittees and is a director of Banc First Corporation, a publicly-heldcorporation based in Oklahoma City, Oklahoma. Mr. Norick also serves ascontrolling manager of Norick Investments Company LLC, a family-owned limitedliability company, which is engaged in investments.

*James R.TenBrook* has been a Director since March 2004. Mr. TenBrookhas served as the Chairman of the Audit Committee since March 2004 and alsoserves on the Nominating Committee. Mr. TenBrook is the president and ashareholder of Karsh Consulting, P.C. of Denver, Colorado, has been a certifiedpublic accountant since 1973, received his personal financial specialistcertification in 1994 and is a certified valuation analyst. Mr. TenBrook’s 

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practice consistsprimarily of litigation support, tax and estate planning. Mr. TenBrook is amember 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 the AmericanInstitute of Certified Public Accountants. We believe that Mr. TenBrook meetsthe definition of independence under both SEC and NASD Rules.

*Mark J.Stevenson* has been a Director since November 1993. Mr.Stevenson serves on the Audit Committee, the Compensation Committee (as itsChairman) and the Nominating Committee. Mr. Stevenson served as president andchief executive officer of Zenodata Corporation, a Colorado based financialservices software company, from March 2001 until his retirement in April 2005. InMay 2005, Zenodata Corporation made an assignment for the benefit of creditors.Mr. Stevenson held the positions of chairman of the board, president and chiefexecutive officer of Electronic Manufacturing Systems, Longmont, Colorado, acontract manufacturer serving the computer, data storage, telecommunicationsand medical equipment industries, from June 1994 until that company was mergedinto E-M-Solutions in January 1999. At that time, Mr. Stevenson was appointedexecutive chairman and chairman of the board of E-M-Solutions, which filed forbankruptcy protection in the Northern District of California in approximatelyNovember 2001 and was immediately purchased by Sanmina/SCI. From 1992 to 1994,Mr. Stevenson served as chairman of the board for Micro Insurance Software,Inc., Boulder, Colorado, a manufacturer of computer software oriented to theinsurance industry. Mr. Stevenson served on the Colorado Governor’s Commissionon Science and Technology for five years ending in 2004 and currently serves onthe Advisory Council of the University of Colorado Deming Center forEntrepreneurship. Mr. Stevenson formerly served as chairman of the AmericanElectronics Association, the nation’s largest high technology tradeassociation.

*James H.Everest* has been a Director since November 1993. Mr. Everestserves on the Compensation and Nominating Committees and served on the AuditCommittee until March 2004. Mr. Everest has served as president of the Jean I.Everest Foundation, Oklahoma City, Oklahoma, since 1991. The Jean I. EverestFoundation was organized by Mr. Everest’s father to conduct charitableactivities. Since 1984, Mr. Everest has been the managing partner of EverestBrothers, a general partnership active in oil and gas exploration anddevelopment and has also been engaged in managing his personal investments. Mr.Everest is a member of the Oklahoma Bar Association and the American BarAssociation and serves in a number of capacities for various civic andcommunity organizations.

**BoardCommittees**

The Board of Directorshas delegated certain of its authority to an Audit Committee, a CompensationCommittee and a Nominating Committee. The Audit Committee is comprised ofMessrs. Norick, Stevenson and TenBrook. The Compensation Committee is comprisedof Messrs. Stevenson, Norick and Everest. The Nominating Committee is comprisedof Messrs. Norick, TenBrook, Stevenson and Everest. Mr. TenBrook serves asChairman of the Audit Committee and Mr. Stevenson serves as Chairman of theCompensation Committee. No member of these three committees is a current orformer officer or employee of Sport-Haley, Inc. We have determined that eachmember of the Audit Committee, Compensation Committee and Nominating Committeequalifies as an “independent” director under the applicable NASD Rules.

*AuditCommittee*

The majorfunctions of the Audit Committee are to review and approve the scope of auditprocedures employed, to review and approve the audit reports rendered by ourindependent auditors and to approve the audit fee charged by the independentauditors. In addition, pursuant to the Sarbanes-Oxley Act of 2002 and rulespromulgated thereunder, the Audit Committee is responsible for, among otherthings, pre-approving all audit and non-audit services performed by theindependent auditors, approving the engagement of the auditors and receivingcertain reports from the independent auditors prior to the filing of the auditreport. The Audit Committee reports to the Board of Directors with respect tosuch matters and recommends the selection of independent auditors. James R.TenBrook has served as the Chairman of the Audit Committee since March 2004.The Audit Committee held four formal meetings during fiscal 2006. Each of themembers of the Audit Committee attended all of the meetings held during fiscal2006.

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Since March 2004,when James R. TenBrook was elected as Director and appointed to the AuditCommittee as its Chairman, the Board has determined that Mr. TenBrook meets thedefinition of an audit committee financial expert, as defined by SEC regulations.In addition, the board has determined that Mr. TenBrook also meets therequirements for independence under SEC rules and the applicable NASD Rules.

*CompensationCommittee*

The primaryfunction of the Compensation Committee is to review and make recommendations tothe Board with respect to the compensation, including bonuses, of our officersand to administer our Stock Option Plan. See *“CompensationCommittee Report”* included in Item 11 below. The CompensationCommittee held ­­­­one meeting in fiscal 2006, which all of its membersattended.

*NominatingCommittee*

In 2004, the Boardof Directors voted to form a Nominating Committee, to be comprised of Messrs.Norick, TenBrook, Stevenson and Everest. The Nominating Committee recommends tothe Board the persons to be nominated for election as Directors at any meetingof stockholders, develops and recommends to the Board a set of corporategovernance principles applicable to the Company and oversees the evaluation ofthe Board. The Board has determined that each of the members of the NominatingCommittee is “independent,” as that term is defined by applicable NASD Rules.All of the members of the Nominating Committee met once during fiscal 2006.

Since forming theNominating Committee, adopting a formal charter, and adopting nominationprocedures, there have been no material changes to the procedures by whichsecurity holders may recommend nominees to our Board of Directors.

*BoardAttendance*

In fiscal 2006,the Board of Directors held 16 formal meetings. Each of the Directors attendedall Board meetings held during fiscal 2006, except that James H. Everest wasnot present at two meetings and Ronald J. Norick was not present at onemeeting.

**Code ofEthics**

In January 2004,we adopted a Code of Ethics for Senior Financial Officers, which applies to allsenior financial officers of the Company, including the Chief ExecutiveOfficer, the Chief Financial Officer, the Treasurer and any other personperforming similar functions. In addition, in May 2004, we adopted a Code ofConduct and Ethics for Directors, Officers and Employees, which is applicableto all of our directors, officers and employees. A copy of these codes may beobtained without charge by written request for copies of them addressed to:Corporate Secretary, Sport-Haley, Inc., 4600 E. 48th Avenue, Denver, CO  80216-3215.

**ITEM 11.     EXECUTIVE COMPENSATION**

*SummaryCompensation Table*. The following table sets forth the annual and long-term compensation forservices in all capacities to Sport-Haley, Inc. for the three fiscal yearsended June 30, 2006, of Donald W. Jewell, Interim Chief Executive Officer,President and Senior Vice President, Patrick W. Hurley, Chief FinancialOfficer, Secretary and Treasurer and Catherine B. Blair, Vice President –Merchandising/Design, the only executive officers whose total annual salary andbonus exceeded $100,000 during the year ended June 30, 2006, and Robert G.Tomlinson (deceased), Kevin M. Tomlinson, Robert W. Haley and Mark Maley (the “NamedOfficers”).

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|                                                | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **                 | ** ** | **Long Term  Compensation  Awards** | ** ** | ** **       | ** ** |
|------------------------------------------------|------------|------------|------------|------------------------------|------------|----------------------------|------------|------------------------------------------|------------|------------------|------------|
| ** **                                     | ** ** | **Fiscal** | ** ** | **Annual Compensation** | ** ** | **Securities  underlying** | ** ** | **All Other**                       | ** ** |
| **Name and Principal Position** | ** ** | **Year**   | ** ** | **Salary**                   | ** ** | **Bonus**                  | ** ** | **Options/SARs(#)**                      | ** ** | **Compensation** | ** ** |
| Donald W. Jewell (1)                           |       | 2006       |       | $                            | 200,000    |                       | $          | 64,000                                   | (2)        | $                | 0          |   | $ | 2,700 | (3) |
| Chief Executive Officer                        |       | 2005       |       | 198,100                      |       | 0                          |       | 0                                        |       | 2,600            | (3)        |
| and President                                  |       | 2004       |       | 144,000                      |       | 0                          |       | 0                                        |       | 2,000            | (3)        |
|                                           |       |       |       |                         |       |                       |       |                                     |       |             |       |
| Patrick W. Hurley                              |       | 2006       |       | 110,000                      |       | 12,000                     | (4)        | 0                                        |       | 1,500            | (3)        |
| Chief Financial Officer,                       |       | 2005       |       | 100,500                      |       | 0                          |       | 0                                        |       | 1,400            | (3)        |
| Secretary and Treasurer                        |       |       |       |                         |       |                       |       |                                     |       |             |       |
|                                           |       |       |       |                         |       |                       |       |                                     |       |             |       |
| Catherine B. Blair,                            |       | 2006       |       | 110,600                      |       | 3,000                      | (4)        | 0                                        |       | 1,500            | (3)        |
| Vice President –                          |       | 2005       |       | 106,400                      |       | 0                          |       | 0                                        |       | 1,500            | (3)        |
| Merchandising/Design                           |       | 2004       |       | 99,900                       |       | 0                          |       | 0                                        |       | 1,400            | (3)        |
|                                           |       |       |       |                         |       |                       |       |                                     |       |             |       |
| Robert G. Tomlinson                            |       | 2006       |       | 0                            |       | 0                          |       | 0                                        |       | 0                |       |
| (deceased) (5)                                 |       | 2005       |       | 59,500                       | (6)        | 0                          |       | 0                                        |       | 400              | (3)        |
|                                                |       | 2004       |       | 170,000                      |       | 0                          |       | 0                                        |       | 0                |       |
|                                           |       |       |       |                         |       |                       |       |                                     |       |             |       |
| Kevin M. Tomlinson (7)                         |       | 2006       |       | 0                            |       | 0                          |       | 0                                        |       | 2,600            | (3)        |
|                                                |       | 2005       |       | 174,000                      | (8)        | 0                          |       | 0                                        |       | 2,000            | (3)        |
|                                                |       | 2004       |       | 160,000                      |       | 0                          |       | 0                                        |       | 2,000            | (3)        |
|                                           |       |       |       |                         |       |                       |       |                                     |       |             |       |
| Robert W. Haley (9)                            |       | 2006       |       | 0                            |       | 0                          |       | 0                                        |       | 0                |       |
|                                                |       | 2005       |       | 0                            |       | 0                          |       | 0                                        |       | 2,000            | (3)        |
|                                                |       | 2004       |       | 112,000                      |       | 0                          |       | 0                                        |       | 2,000            | (3)        |
|                                           |       |       |       |                         |       |                       |       |                                     |       |             |       |
| Mark Maley (10)                                |       | 2006       |       | 98,400                       |       | 0                          |       | 0                                        |       | 1,500            | (3)        |
|                                                |       | 2005       |       | 138,200                      |       | 0                          |       | 0                                        |       | 1,800            | (3)        |
|                                                |       | 2004       |       | 118,500                      |       | 0                          |       | 0                                        |       | 900              | (3)        |
|                                                |            |            |            |                              |            |                            |            |                                          |            |                  |            |  |  |  |  |

 

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(1)               Mr. Jewell hasserved as our Senior Vice President since February 2001, our Interim ChiefExecutive Officer since November 2004 and our President since April 2005. InSeptember 2006, we appointed Mr. Jewell as our permanent Chief ExecutiveOfficer and President, and he will no longer serve as our Senior VicePresident.

(2)               Comprised of cashbonus of $50,000 paid in October 2005 plus transfer of title to a Company vehiclewith an estimated fair value of $14,000, effective September 30, 2005.

(3)               Comprised ofcontributions by the Company to the Named Officer’s 401(k) account plus termlife insurance premiums paid by the Company.

(4)               Comprised of cashbonus paid in October 2005.

(5)               Robert G.Tomlinson, Chairman, died on September 8, 2004. His 2005 annual salary and allother compensation amounts include such amounts paid to him until the date ofhis death and do not include the $650,000 in severance and other compensation paidto his estate in October 2004, per the terms of a settlement agreement.

(6)               Includes nettaxable fringe benefits of $3,900 for country club dues.

(7)               In October 2004,the Board elected not to renew the executive employment agreement betweenSport-Haley, Inc. and Kevin M. Tomlinson upon its expiration in March 2005. Mr.Tomlinson stepped down from his duties as our Chief Executive Officer andPresident in October 2004. His annual salary and all other compensation amountsfor 2005 include such amounts paid to him until the termination of theexecutive employment agreement in March 2005 and do not include payments forseverance and other compensation that he began receiving in April 2005, per theterms of an executive employment agreement. We paid Mr. Tomlinson $76,000 inseverance and other compensation in fiscal 2005. We paid Mr. Tomlinson $164,000and $76,000 in severance and other compensation in fiscal 2006 and 2005,respectively.

(8)               Includes nettaxable fringe benefits of $31,900 for country club dues, clothing allowanceand personal use of a company vehicle.

(9)               Robert W. Haleyresigned as our President, effective March 31, 2004. His 2005 and 2004 annualsalary and all other compensation amounts do not include the bi-weekly paymentsfor severance and other compensation that Mr. Haley began receiving in April2004. We paid Mr. Haley $114,000 and $38,000 in severance and othercompensation in fiscal 2005 and 2004, respectively.

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(10)         Mark Maley resigned asour Vice President – Sales in December 2005. Subsequent to his resignation, Mr.Maley did not receive any severance compensation, except that he continued toreceive override commission payments through May 2006 on sales for which thecustomer order was placed prior to his resignation.

*FiscalYear-End Options/Option Values Table.*
| ** **                     | ** ** | ** **           | ** ** | ** **   | ** ** | **Number of Securities **      | ** ** | **Value of Unexercised In-** | ** ** |
|--------------------------------|------------|----------------------|------------|--------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                     | ** ** | **Shares**           | ** ** | ** **   | ** ** | **Underlying Unexercised Options/** | ** ** | **the-Money(1) Options/SARs**          | ** ** |
| ** **                     | ** ** | **Acquired**         | ** ** | **Value**    | ** ** | **SARs at Fiscal Year-End**    | ** ** | **at Fiscal Year-End(2)**         | ** ** |
| **Name on Exercise** | ** ** | **on Exercise** | ** ** | **Realized** | ** ** | **Exercisable**                               | ** ** | **Unexercisable**                           | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| ** **                     | ** ** | ** **           | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Donald W. Jewell               |       | -0-                  |       | -0-          |       | 50,000                                        |       | -0-                                         |       | $ | 75,000 |   | $ | -0- |   |
| Patrick W. Hurley              |       | -0-                  |       | -0-          |       | 50,000                                        |       | -0-                                         |       | 81,000 |   | -0- |   |
| Catherine B. Blair             |       | -0-                  |       | -0-          |       | 50,000                                        |       | -0-                                         |       | 78,000 |   | -0- |   |
|                                |            |                      |            |              |            |                                               |            |                                             |            |  |  |  |  |  |  |

 

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(1)          Options are “in themoney” if the fair market value of the underlying securities exceeds theexercise or base price of the option.

(2)          The dollar values are calculated by determining the difference betweenthe fair market value of the securities underlying the options at fiscal yearend and the exercise or base price of the options. On June 30, 2006, the lasttrading date for the end of the 2006 fiscal year, the closing bid price for thecommon stock was $4.80.

**EmploymentAgreements**

We entered into anemployment agreement with Mr. Donald W. Jewell, effective February 1, 2001, toserve as our Senior Vice President. In January 2005, Mr. Jewell and the Companyentered into an agreement, effective November 1, 2005, whereby Mr. Jewellagreed, in addition to his duties, responsibilities and benefits under hisexisting employment agreement, to serve as our Interim Chief Executive Officerthrough June 30, 2005, subject to automatic monthly extensions, for a salary of$50,000 per year in addition to the salary he was entitled to receive forserving as our Senior Vice President. In April 2005, Mr. Jewell was appointedto serve as our President. The agreement, as amended, requires that Mr. Jewelldevote his full business time as our Interim Chief Executive Officer, Presidentand Senior Vice President, at an annual salary of $200,000, and such bonuses asawarded by the Board of Directors, and extends for a two-year term, subject toautomatic one-year extensions at the end of each year. In September 2006, Mr.Jewell agreed to serve as our Chief Executive Officer and President on apermanent basis for a salary of $325,000, retroactive to July 1, 2006, and hewill no longer serve as our Senior Vice President. Until such time as a newemployment agreement is prepared, the terms of the February 2001 agreement, asamended, will generally remain in effect. If we elect to terminate theagreement for other than “cause” (as defined in the agreement), or if Mr.Jewell were to terminate the agreement for cause, Mr. Jewell would be entitledto receive severance compensation equal to twelve months salary and 50% of thelast annual bonus paid to him. During the time he were to receive any suchseverance compensation, 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 terminate theagreement within sixty days of the change of control, then Mr. Jewell would beentitled to lump sum severance compensation equal to three times his annualsalary and bonus payments during the preceding 12 months. In the event oftermination due to a non-negotiated change in control, options previouslygranted to Mr. Jewell would become fully vested and exercisable on the date oftermination. In the event of a 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. If we were toterminate the agreement with cause, no unexercised options would beexercisable. The agreement contains a non-competition provision for twelvemonths following termination, provided Mr. Jewell could be released from thenon-competition clause if he were terminated without cause and if he hadelected to 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.

Effective December1, 2000, the Company entered into an employment agreement with Patrick W.Hurley.  The agreement, as amended,requires that Mr. Hurley devote his full business time as our Chief FinancialOfficer, Secretary, Treasurer and Controller, at an annual salary of $125,000,****and such bonuses as awarded by the Board of Directors, andextends for a one-year term, subject to automatic one-year extensions aftereach year. If we elect to

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terminate the agreementwithout “cause” (as defined in the agreement) or not to renew the agreementupon its expiration, or if Mr. Hurley terminates the agreement with or withoutcause, he is entitled to receive severance compensation equal to six months’salary, plus 50% of the last annual bonus paid to him. During the time he wereto receive any such severance compensation, Mr. Hurley 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 Mr.Hurley terminate the agreement within sixty days of the change of control, thenMr. Hurley is entitled to lump sum severance compensation equal to three timeshis annual salary and bonus payments during the preceding 12 months. In theevent of termination due to a non-negotiated change in control of Sport-Haley,Inc., options previously granted to Mr. Hurley would become fully vested andexercisable on the date of termination. In the event of a 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. If we were to terminate the agreement with cause, no unexercisedoptions would be exercisable. If Mr. Hurley becomes disabled during the term ofthe agreement, his full salary will be continued for one year from the date ofdisability.

Effective June 1,2005, we agreed to amend the employment agreement with Catherine B. Blair thatwas originally effective July 1, 1997. The amended agreement requires that Ms. Blair devote her full businesstime as our Vice President of Merchandising/Design, at an annual salary of$130,000,****and such bonuses as awarded by theBoard of Directors, and extends for a one-year term, subject to automaticone-year extensions after each year. If we elect to terminate the agreementwithout “cause” (as defined in the agreement) or not to renew the agreementupon its expiration, or if Ms. Blair terminates the agreement with or withoutcause, she is entitled to receive severance compensation equal to fifteenmonths’ salary, plus 50% of the bonus, if any, paid to her in the preceding 12months. During the time she were to receive any such severance compensation,Ms. Blair is entitled to participate in all employee benefit plans, at ourexpense. If there were to be a non-negotiated change in control of Sport-Haley,Inc., and either we or Ms. Blair terminate the agreement within sixty days ofthe change of control, then Ms. Blair is entitled to lump sum severancecompensation equal to three times her annual salary and bonus payments duringthe preceding 12 months. In the event of termination due to a non-negotiatedchange in control of Sport-Haley, Inc., options previously granted to Ms. Blairwould become fully vested and exercisable on the date of termination. In theevent of a termination by either party without cause, options previouslygranted would vest and become exercisable on a prorated basis from the date ofgrant to the date of termination. If we were to terminate the agreement with cause,no unexercised options would be exercisable. The agreement contains anon-competition provision for twelve months following termination, provided Ms.Blair could be released from the non-competition clause if she were terminatedwithout cause and if she had elected to forego any severance pay. If Ms. Blairbecomes disabled during the term of the agreement, her full salary will becontinued for one year from the date of disability.

Effective January1, 1997, Sport-Haley entered into an employment agreement with Mr. Robert G.Tomlinson. Mr. Tomlinson died on September 8, 2004. Mr. Tomlinson’s employmentagreement required that he devote his full business time as Chairman of theBoard at an annual salary of $230,000, as amended, be provided an automobile andsuch bonuses as awarded by the Board of Directors. The employment agreementextended for a three-year period, subject to automatic one-year extensions atthe end of each year. Because the agreement terminated upon Mr. Tomlinson’sdeath, Mr. Tomlinson’s estate was entitled to the same severance compensationas would have been applicable as if Mr. Tomlinson had terminated the agreementwith “cause”  (as defined in theagreement), or if we had terminated the agreement for other than cause, or ifthere were a change in control of Sport-Haley, Inc. The employment agreemententitled Mr. Tomlinson’s estate to receive, as a death benefit, severancecompensation in an amount equal to three times his annual salary and bonuspayments during the preceding 12 months. During the time his estate receivedsuch severance compensation, Mr. Tomlinson’s estate was entitled to participatein all employee benefit plans, at our expense. Provisions included in theemployment agreement entitled Mr. Tomlinson’s estate to receive such amount ina lump sum. Mr. Tomlinson agreed to a voluntary salary reduction in fiscal1999. From then until his death, Mr. Tomlinson received an annual salary of$170,000 per year instead of the $230,000 annual salary, which he was entitledto receive per the amended employment agreement. Subsequent to his death, adispute with Mr. Tomlinson’s estate ensued concerning the amount of severancecompensation to be paid as a death benefit and other compensation mattersrelating to the employment agreement. Mr. Tomlinson’s estate demanded a higherseverance amount and other compensation which it claimed was also due under theagreement. The Board of Directors negotiated an agreement in compromise withMr. Tomlinson’s estate regarding the death benefit amount and the

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other disputedcompensation. In accordance with the terms of the settlement agreement, we paida lump sum amount of $650,000 to Mr. Tomlinson’s estate in October 2004.Because the agreement was terminated for reasons other than with cause, all ofthe 125,000 options previously granted to Mr. Tomlinson became fully vested onthe date of Mr. Tomlinson’s death. In August 2005, the estate of Mr. Tomlinsonexercised and subsequently sold 100,000 of the options, and the remaining25,000 options expired thereafter.

EffectiveMarch 18, 2002, Sport-Haley entered into an employment agreement with Mr. KevinM. Tomlinson to act as the Company’s Chief Executive Officer. Mr. Tomlinson wassubsequently appointed as President pursuant to the terms of the employment agreement.The agreement required that he devote his full business time as our ChiefExecutive Officer, at an annual salary of $160,000, and such bonuses as awardedby the Board of Directors, and extended for a three-year term, subject toautomatic one-year extensions at the end of each year. If we were to terminatethe agreement for other than “cause” (as defined in the agreement), Mr.Tomlinson is entitled to receive severance compensation equal to 36 monthssalary and bonus and incentive payments over the last 12 months, payablemonthly over the 36-month period. In October 2004, our Board of Directorsapproved a resolution not to renew the executive employment agreement of Mr.Tomlinson, beyond the end of its term in March 2005, and Mr. Tomlinson subsequentlystepped down from his duties as our Chief Executive Officer and President.During the time he is receiving severance compensation, Mr. Tomlinson iseligible to participate in all employee benefit plans, at our expense. SinceMr. Tomlinson was terminated without cause, all of the 200,000 outstandingstock options previously granted to him became fully vested on the effectivedate of his termination. Mr. Tomlinson exercised and sold 100,000 of theoptions in June 2005, and the remaining 100,000 options expired thereafter. Theagreement contains a non-competition provision for one year followingtermination, provided Mr. Tomlinson could be released from the non-competeagreement since he was terminated without cause, if he had elected to foregoany severance pay. We began paying Mr. Tomlinson monthly severance compensationin April 2005.

Effective January1, 1997, Sport-Haley entered into an employment agreement with Mr. Robert W.Haley. In January 2004, Mr. Haley agreed to the termination of his employment effectiveMarch 31, 2004. The agreement required that he devote his full business time asour President or Senior Executive Officer at an annual salary of $160,000 andsuch bonuses as awarded by the Board of Directors. Mr. Haley agreed to avoluntary salary reduction in fiscal 1999. Since that time, Mr. Haley receivedan annual salary of $150,000 instead of the $160,000 annual salary, which hehad been entitled to receive per the employment agreement. The employmentagreement term extended through December 31, 1998, and was subsequentlyautomatically renewed for additional one-year terms. Because the agreement wasterminated for other than “cause” (as defined in the agreement), Mr. Haley wasentitled to receive bi-weekly severance compensation payments for one year fromthe date of termination totaling $150,000, his annual salary and bonus paymentsduring the preceding 12 months. The agreement contained a non-competitionprovision for one year following termination, provided Mr. Haley could bereleased from the non-compete agreement since he was terminated without cause,if he had elected to forego any severance pay. Mr. Haley received the bi-weeklyseverance compensation payments through March 31, 2005. Since Mr. Haley wasterminated without cause, all of the 75,000 outstanding stock optionspreviously granted to him became fully vested on the effective date of histermination. Mr. Haley exercised all 75,000 of the options in June 2004.

Effective January1, 2005, we entered into an amended employment agreement with Mark Maley, theoriginal agreement for which was effective January 1, 2004. Mr. Maley resignedin December 2005. The agreement required Mr. Maley to devote his full businesstime as our Vice President – Sales, at an annual salary of $135,000, and suchbonuses as might have been awarded by the Board of Directors, and extended fora one-year term, and then would have been subject to automatic one yearextensions at the end of each year. The amended agreement also entitled Mr.Maley to receive a 0.2% override on our gross annualized sales, less discountedsales of more than 50% from original suggested wholesale prices, returns andcredits. If we had elected to terminate the agreement without “cause” (asdefined in the agreement) or not to renew the agreement upon its expiration, orif Mr. Maley had terminated the agreement with cause, he would have beenentitled to severance payments equal to fifteen months salary, plus 50% of thelast annual bonus paid to him. In the event of a non-negotiated change of controlof Sport-Haley, Inc., and if either we or Mr. Maley had terminated theagreement within sixty days of the change of control, then Mr. Maley would havebeen entitled to severance compensation equal to three times his annual salaryand bonus payment during the preceding twelve months.****Theagreement contained a non-competition provision for twelve

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months followingtermination, provided Mr. Maley could be released from the non-compete clauseif he had been terminated without cause and if he had elected to forego anyseverance pay. If Mr. Maley had become disabled during the term of theagreement, his full salary would have continued for one year from the date ofdisability. Subsequent to his resignation, Mr. Maley did not receive anyseverance compensation, except that he continued to receive override commissionpayments through May 2006 on sales for which the customer order was placedprior to his resignation.

**DirectorFees**

No employeereceives any additional compensation for his services as a Director. For fiscal2006, each non-employee member of the Board of Directors received $10,000 peryear. The Chairman of the Board received an additional $50,000, the AuditCommittee Chairman received an additional $10,000, and the CompensationCommittee Chairman received an additional $2,500. Director compensation is paidquarterly.

**StockOption Plan**

We adopted a stockoption plan in 1993 (as amended, the “Option Plan”). The Option Plan providedfor the granting of incentive stock options within the meaning of Section 422of the Internal Revenue Code of 1986, as amended, non-qualified stockoptions and stock appreciation rights (“SARs”), up to a maximum number of2,150,000 shares. Non-qualified options could be granted to employees,directors and consultants of Sport-Haley, Inc., while incentive options couldonly be granted to employees. No options could be granted under the Option Plansubsequent to February 28, 2003, when the Option Plan expired by itsterms.  Options granted pursuant to theOption Plan prior to its expiration on February 28, 2003, remain exercisableaccording to the terms of their issuance.

The Option Plan isadministered by the Compensation Committee of our Board of Directors, whichdetermined the terms and conditions of the options and SARs granted under theOption Plan, including the exercise price, number of shares subject to theoption and the exercisability thereof.

The exerciseprices of incentive options granted under the Option Plan must have been atleast equal to the fair market values of the common stock of Sport-Haley on thedates of grant. In the case of an optionee who owns stock possessing more thanten percent of the total combined voting power of all classes of stock ofSport-Haley, Inc., the exercise price of incentive options could not be lessthan 110% of the fair market value of the common stock on the date of grant.The exercise prices of all non-qualified stock options granted under theOption Plan were determined by the Compensation Committee, but could not beless than 85% of the fair market value of the common stock. The terms of allnon-qualified stock options granted under the Option Plan could notexceed ten years and the terms of all incentive options could not exceed fiveyears.

The Option Planprovided our Board of Directors or the Compensation Committee thereof thediscretion to determine when options granted thereunder should becomeexercisable and the vesting period of such options. Upon termination of aparticipant’s employment or consulting relationship with Sport-Haley, Inc., allunvested options terminate and are no longer exercisable. Vested options remainexercisable for a specified period of time following the termination date. Thelength of such an extended exercise period generally ranges from 30 days to oneyear, depending on the nature and circumstances of the termination.

The Option Planprovided that, in the event we enter into an agreement providing for the mergerof Sport-Haley, Inc. into another corporation or the sale of substantially allof the assets of Sport-Haley, Inc., any outstanding unexercised option wouldbecome exercisable at any time prior to the effective date of such agreement.Upon the consummation of a merger or sale of assets, such options wouldterminate unless they were assumed or another option was substituted thereforby the successor corporation. As of June 30, 2006, all outstanding optionsgranted previously under the Option Plan were fully vested.

As of June 30,2006, a total of 678,500 non-qualified options were outstanding, with exerciseprices ranging from $2.71 to $9.78 per share and a weighted average exerciseprice per share of $3.88.

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**401(k)Plan**

In January 1996,we adopted a defined contribution savings plan (the “401(k) Plan”) to provideretirement income to our employees. The 401(k) Plan is intended to be qualifiedunder Section 401(a) of the Internal Revenue Code of 1986, as amended. The401(k) Plan covers all full-time employees who are at least 18 years of age andhave been employed at least three months. The 401(k) Plan is funded byvoluntary pre-tax salary deferral contributions from employees and throughmatching contributions by us of $0.25 on the dollar for employee deferrals ofthe first 5% of the employee’s annual compensation. Upon leaving the Company,each participant is 100% vested with respect to the participant’s contributionsand is vested based upon years of service with respect to our matchingcontributions. All contributions are invested as directed by the participant ininvestment funds available under the 401(k) Plan, as selected by the PlanAdministrator. Upon retirement, benefits are payable to each participant in asingle lump-sum cash payment or an actuarial equivalent form of annuity on thefirst day of the month following the participant’s retirement.

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

Under thesecurities laws of the United States, our directors, executive officers, andany persons holding more than ten percent of our common stock are required toreport their initial ownership of common stock and other equity securities andany subsequent changes in that ownership to the Securities and ExchangeCommission and Sport-Haley, Inc. Specific due dates for these reports have beenestablished and we are required to disclose in this annual report on Form 10-Kany failure to file, or late filing, of such reports with respect to the periodended June 30, 2006. Based solely on our review of the reports furnished to usand written representations that no other reports were required during fiscal2006, we believe that our officers, directors and beneficial owners of morethan ten percent of our common stock complied with all Section 16(a) filingrequirements.

**CompensationCommittee Report**

Notwithstandinganything to the contrary set forth in any of the previous filings made bySport-Haley, Inc. under the Securities Act of 1933, as amended, or theSecurities Exchange Act of 1934, as amended, that might incorporate futurefilings, including, but not limited to, this Report on Form 10-K, in whole orin part, the following Compensation Committee Report shall not be deemed to be “filed”with the Securities and Exchange Commission nor shall it be incorporated byreference into any such future filings.

This CompensationCommittee Report discusses our executive compensation policies and the basisfor the compensation paid to our executive officers, including our ChiefExecutive Officer, during fiscal 2006.

*CompensationPolicy*. Our policy with respect to executive compensation wasdesigned to:

·                  Adequatelyand fairly compensate executive officers in relation to their responsibilities,capabilities and contributions in a manner that is commensurate withcompensation paid by companies of comparable size or within the golf apparelindustry;

·                  Rewardexecutive officers for the achievement of short-term operating goals and forthe enhancement of the long-term value of Sport-Haley; Inc., and

·                  Alignthe interests of the executive officers with those of our shareholders.

The components ofcompensation paid to executive officers consist of: a) base salary; b)incentive compensation in the form of discretionary annual bonus payments; c)long-term incentive compensation in the form of awards under the Option Plan;and, d) various other benefits.

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*BaseSalary*.  For fiscal2006, the Compensation Committee reviewed the base salaries of our executiveofficers under their respective employment agreements. Annual adjustments tobase salaries, if any, were determined based upon a number of factors,including our performance (to the extent such performance can fairly beattributed or related to each executive officer’s performance), as well as thevalue of each executive officer’s responsibilities, capabilities andcontributions and internal compensation equity considerations. In addition, forfiscal 2006, the Compensation Committee reviewed the base salaries of ourexecutive officers in an attempt to ascertain whether those salaries fairlyreflect job responsibilities and prevailing market conditions and rates of pay.The Compensation Committee believes that base salaries for our executiveofficers have been reasonable in relation to our size and performance incomparison with the compensation paid by similarly sized companies or companieswithin the golf apparel industry. The Compensation Committee did not increasethe base pay of any of our executive officers in fiscal 2006.

*IncentiveCash Bonus Compensation*. The Compensation Committee feelsthat a relatively lower level of base salary and relatively higher level ofincentive compensation, in the form of bonuses and grants of options, mosteffectively aligns the interests of management with the interests of ourshareholders. The Compensation Committee also believes that its policyregarding incentive compensation is similar to policies of other companies ofcomparable size within the golf apparel industry. The decision of whether toaward incentive cash bonus compensation is based on a combination of theachievement of business targets and objectives and certain other financialmeasures which the Compensation Committee feels will dictate, in large part,our future operating results, and on an officer’s responsibilities,capabilities and contributions. The Compensation Committee has not prepared aformal written bonus incentive plan for executive officers, although theexecutive officers’ employment agreements generally provide that executives areeligible for discretionary bonuses of up to specified percentages of their basesalaries. The Compensation Committee awarded the following bonuses to ourexecutives in fiscal 2006 in recognition of their exemplary service: Donald W.Jewell - $50,000 cash bonus paid in October 2005 and transfer of the title to aCompany vehicle with an estimated value of $14,000, effective as of September30, 2005; Patrick W. Hurley - $12,000 cash bonus paid in October 2005; and,Catherine B. Blair - $3,000 cash bonus paid in October 2005. The CompensationCommittee also awarded the following bonuses to key employees in fiscal 2006:George E. (“Tom”) Tomlinson - $10,000 cash bonus paid in October 2005.

*Long-TermIncentive (Option) Compensation*.  The Compensation Committee also has authorityto select the executive officers and employees who will be granted options andother awards and to determine the timing, pricing and amount of any suchoptions or awards. As stated above, the Compensation Committee believes thatincentive compensation, in the form of bonuses and grants of options, mosteffectively aligns the interests of management with the interests of ourshareholders. Our stock option plan expired by its terms in February 2003.Accordingly, the Compensation Committee did not approve the grant of anyoptions to executives or directors in fiscal 2006.

*OtherBenefits*. Executive officers are eligible for variousbenefits, including health insurance plans generally available to all full-timeemployees. In addition, executive officers are eligible to participate in the401(k) Plan, also generally available to all employees, whereby the officersmay elect to defer part or all of their base and incentive cash compensation.We do not maintain any other plans or arrangements for the benefit of ourexecutive officers except to provide life insurance policies for the benefit ofcertain executive officers’ named beneficiaries. The Compensation Committeebelieves these benefits are reasonable in relation to the executivecompensation practices of other similarly sized companies or companies withinthe golf apparel industry.

*TaxConsiderations.*Beginning in 1994, the Internal Revenue Codelimited the federal income tax deductibility of compensation paid to a company’sChief Executive Officer and to each of the four most highly compensatedexecutive officers. For this purpose, compensation can include, in addition tocash compensation, the difference between the exercise price of stock optionsand the value of the underlying stock on the date of exercise. A company maydeduct compensation with respect to any of these individuals only to the extentthat during any fiscal year such compensation does not exceed $1 million ormeets certain other conditions (such as shareholder approval). Consideringcurrent compensation plans and policies and the exercise prices of currentlyoutstanding stock options held by the executive officers, the CompensationCommittee believes that, for the near future, there is little risk thatSport-Haley, Inc. will lose any significant tax deduction relating to executivecompensation. At such time, if any, that

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the deductibilityof executive compensation becomes an issue, modifications to compensation plansand policies will be considered by the Compensation Committee.

*CEOCompensation.*Donald W. Jewell has served as our InterimChief Executive Officer since November 2004. Mr. Jewell entered into anemployment agreement, effective November 1, 2004, to serve as Interim ChiefExecutive Officer through June 30, 2005, subject to automatic monthlyextensions until a successor Chief Executive Officer is appointed. In reviewingthe Chief Executive Officer’s compensation package, the Committee pursues thesame objectives that apply for other executive officers. The Committee’soverall goal is to set the Chief Executive Officer’s salary at a basecomparable to those of persons employed in similar capacities with competitorsthat are similar in industry size and performance. However, the actual levelapproved by the Committee may be higher or lower based upon the Committee’ssubjective evaluation of our annual and long-term performance, the individualperformance of the Chief Executive Officer, particularly with respect toleadership and strategic vision, and cash resources and needs.

The CompensationCommittee believes that the concepts discussed above further the shareholdersinterests and that officer compensation encourages responsible management. TheCompensation Committee considers the effect of management compensation onshareholder interests. In the past, the Board of Directors based its review inpart on the experiences of its own members and on information requested from managementpersonnel. These same factors will be used in the future when determiningofficer compensation.

This report wasfurnished by the members of the Compensation Committee: Mark J. Stevenson;Ronald J. Norick; and, James H. Everest.

**CompensationCommittee Interlocks and Insider Participation**

All of theCompensation Committee members are independent directors. None of these membersare or have ever been an officer or employee of Sport-Haley, Inc. or our formersubsidiary, nor have any of them had a relationship, which would requiredisclosure under the “Certain Relationship and Related Transactions” captionsof any of our filings with the Commission during the past three fiscal years.

**PerformanceGraph**

Notwithstanding anything to the contrary set forth in any of theprevious filings made by Sport-Haley, Inc. under the Securities Act of 1933, asamended, or the Securities Exchange Act of 1934, as amended, that mightincorporate future filings, including, but not limited to, this Report on Form10-K, in whole or in part, the following performance graph shall not be deemedto be incorporated by reference into any such future filings.

Set forth below is a line graph prepared by Zacks Investment Researchcomparing the yearly percentage change in our cumulative total shareholderreturn (share price appreciation plus dividends) on Sport-Haley, Inc. commonstock with the cumulative total return of (i) the NASDAQ US Market Index and(ii) the stocks of apparel manufacturers having Standard IndustrialClassification codes from 2300 through 2341, which is deemed as a marketweighted index of publicly traded peers, for the period from July 1, 2001through June 30, 2006 (the “Measurement Period”). The graph assumes that $100is invested on July 1, 2001, in each: our common stock; our publicly tradedpeers; and, the NASDAQ US Market Index. The graph also assumes that alldividends were reinvested (In May 2006, we paid a $0.25 per share dividend toour beneficial shareholders. No other dividends were paid by Sport-Haley, Inc.during the Measurement Period). Our shareholder return is calculated bydividing the difference between our share price at July 1, 2001, and each June30 of the Measurement Period by the share price at the beginning of theMeasurement Period.

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|                            | ** ** | **Fiscal Year Ended June 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **2001**                                           | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|                       |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Sport-Haley,  Inc.         |       | 100.00                                             |       | 124.00 |   | 136.34 |   | 166.69 |   | 98.99 |   | 159.99 |   |
| Industry Peer  Group Index |       | 100.00                                             |       | 96.63 |   | 88.63 |   | 115.30 |   | 126.20 |   | 138.53 |   |
| NASDAQ Market Index        |       | 100.00                                             |       | 67.73 |   | 75.11 |   | 94.79 |   | 92.10 |   | 98.06 |   |

 

**ITEM 12.****                      SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

The followingtable sets forth certain information regarding beneficial ownership of ourcommon stock as of September 11, 2006, by: (i) each person known bySport-Haley, Inc. to own beneficially more than 5% of the outstanding commonstock; (ii) each director or nominee; and, (iii) all executive officers anddirectors as a group. The information with respect to institutional investorsis generally derived from statements filed with the Securities and ExchangeCommission under §13(d) or §13(g) of the Securities Exchange Act. Each personhas sole voting and sole investment or dispositive power with respect to theshares shown except as noted.
|                                         | ** ** | **Shareholdings on September 11, 2006** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------------|------------|
| **Name and Address (1)** | ** ** | **Number of Shares (2)**                     | ** ** | **Percent of Class (3)** | ** ** |
| Donald W. Jewell  (4)                   |       | 50,000                                                      |       | 1.77 | % |
| Patrick W.  Hurley (4)                  |       | 50,000                                                      |       | 1.77 |   |
| Catherine B.  Blair (4)                 |       | 50,000                                                      |       | 1.77 |   |
| Ronald J. Norick  (5)                   |       | 285,617                                                     |       | 9.70 |   |
| James R.  TenBrook                      |       | -0-                                                         |       |   | * |
| Mark J.  Stevenson (4)                  |       | 100,000                                                     |       | 3.48 |   |
| James H. Everest  (6)                   |       | 265,000                                                     |       | 8.90 |   |
| Robert W. Haley                         |       | 61,500                                                      |       | 2.71 |   |

 

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| Daniel Zeff,  Zeff Holding Co., LLC,  Zeff Capital Partners ILP and  Spectrum Galaxy Fund Ltd. (7)  50 California Street, Suite 1500  San Francisco, CA 94111 |   | 229,026 |   | 8.27  |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|--------|-------|--------|
| Hillson Partners  Limited Partnership (8)  6900 Wisconsin Avenue, Suite 501  Bethesda, MD 20815                                                               |   | 218,293 |   | 7.88  |   |
| Dimensional Fund Advisors  Inc. (9)  1299 Ocean Avenue, 11th Floor  Santa Monica, California 90401                                                       |   | 206,600 |   | 7.46  |   |
| Fondren  Management LP (10)  1177 West Loop South, Suite 1625  Houston, TX 77027                                                                              |   | 159,492 |   | 5.76  |   |
| Tilson Growth  Fund, LP, Tilson Capital Partners, LLC  and Whitney Tilson (11)  175 East 62nd Street, #11A,  New York, NY 10021                               |   | 142,700 |   | 5.15  |   |
| Michael Cook  Asset Management, Inc. (12)  d/b/a Cook Mayer Taylor  5170 Sanderlin Avenue, Suite 200  Memphis, TN 38117                                       |   | 109,687 |   | 3.96  |   |
| All directors and  officers as a group  (Eight persons in total) (13)                                                                                         |   | 812,117 |   | 24.46 |   |

 

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| *    | The percentage beneficially owned does not exceed  one percent of the total outstanding shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (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 11, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (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 11, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (4)  | Consists solely of shares subject to currently  exercisable options or options which will become exercisable within 60 days  after the date hereof.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| (5)  | Includes 175,000 shares subject to currently  exercisable options or options which will become exercisable within 60 days  after the date hereof and 110,617 shares owned of record by entities affiliated  with Mr. Norick.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (6)  | Includes 175,000 shares subject to currently  exercisable options or within 60 days after the date hereof and includes  50,000 shares owned by a trust for which Mr. Everest acts as trustee, for  which he disclaims beneficial ownership.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (7)  | Daniel Zeff is the sole manager and member of Zeff  Holding Company, LLC, which serves as the general partner of Zeff Capital  Partners ILP. 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 and Zeff  Holding Company, LLC each disclaims, 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 ILP disclaims beneficial  ownership over all shares held by Spectrum Galaxy Fund Ltd. |
| (8)  | Hillson Partners Limited Partnership has sole voting  power and sole dispositive power over 218,293 shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (9)  | Dimensional Fund Advisors, Inc. is an investment  advisor company which beneficially owns 206,600 shares, which are owned of  record by its advisory clients. Dimensional Fund Advisors, Inc. disclaims  beneficial ownership of all such shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (10) | Fondren Management LP has sole voting power and sole  dispositive power over 159,492 shares. Such shares were purchased by Fondren  Management LP for the account of Fondren Partners LP, a Texas limited  partnership and Fondren Partners Offshore Ltd., a Cayman Islands exempted  limited company, of which Fondren Management LP is the investment manager.                                                                                                                                                                                                                                                                                                                                                                                          |
| (11) | Tilson Growth Fund, LP, a Delaware limited  partnership, Tilson Capital Partners, LLC, a Delaware limited liability  company and Whitney Tilson have shared voting and dispositive power over  142,700 shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (12) | Michael Cook Asset Management, Inc. has sole voting  power and sole dispositive power over 109,687 shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

 

49

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| (13) | Includes 600,000 shares of common stock subject to  currently exercisable options or options which will become exercisable within  60 days after September 11, 2006. Excludes shares of common stock as to which  officers and directors disclaim beneficial ownership. |
|------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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

The only equitycompensation plan maintained by Sport-Haley, Inc. is our Amended and Restated1993 Stock Option Plan (the “Option Plan”). The Option Plan was approved by ourshareholders in 1993 and was amended in 1997. The Option Plan expired by itsown terms on February 28, 2003. The following table contains informationregarding the equity compensation plan as of June 30, 2006.
| 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**     |       | 678,500                                                                                                                                                   | (1)        | $                                                                                                                | 3.88       | (2)                                                                                                                                                                                                                   | —     | (3) |
| ** **                                                      |       |                                                                                                                                                      |       |                                                                                                             |       |                                                                                                                                                                                                                  |       |
| **Equity  compensation plans not approved by security holders** |       | —                                                                                                                                                    |       | —                                                                                                           |       | —                                                                                                                                                                                                                |       |
| ** **                                                      |       |                                                                                                                                                      |       |                                                                                                             |       |                                                                                                                                                                                                                  |       |
| **Total**                                                       |       | 678,500                                                                                                                                                   |       | $                                                                                                                | 3.88       |                                                                                                                                                                                                                  | —     |   |

 

----

(1)           The total number of securities to be issuedupon exercise of outstanding options, warrants and rights consists of optionsfor the purchase of Sport-Haley, Inc. common stock granted pursuant to theOption Plan to employees, officers, directors, consultants, independent salesrepresentatives and golf tour professionals. The total number of securities tobe issued upon exercise of the options is stated, regardless of whether theoptions were vested as of June 30, 2006.

(2)           The outstanding options issued under the OptionPlan range in exercise price from $2.71 to $9.78 per share.

(3)           The Option Plan, as amended, expired by its terms on February 28, 2003.Therefore, no further options to purchase Sport-Haley, Inc. common stock may begranted under the Plan after that date.

**ITEM13.   CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

We adopted apolicy pursuant to which material transactions between Sport-Haley, Inc. andour executive officers, directors and principal shareholders (i.e. shareholdersowning beneficially 5% or more of the outstanding voting securities ofSport-Haley, Inc.), and any immediate family member of the foregoing, shall besubmitted to the Audit Committee for approval. For this purpose, a transactionis deemed material if such transaction, alone or together with a series ofsimilar transactions during the same fiscal year, involves an amount thatexceeds $60,000. No such transactions occurred in fiscal 2006.

**ITEM 14.       PRINCIPAL ACCOUNTANT FEES AND SERVICES**

**(1)****         Audit Fees.** Theaggregate fees billed by Hein & Associates LLP, our independent auditors,during fiscal years 2006 and 2005 for the audits of our annual financialstatements, the reviews of our quarterly financial statements included in Forms10-Q for the corresponding quarterly periods or the services that

50

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are normallyprovided by in connection with statutory and regulatory filings or engagementsfor those fiscal years totaled $119,000 and $73,000, respectively.

**(2)****         Audit-related Fees.**The aggregate fees billed by Hein & Associates LLP for assurance andrelated services that are reasonably related to the performance of the audit orreview of our financial statements that are not included in the “Audit Fees”described above totaled $8,000 and $5,000 for fiscal years 2006 and 2005,respectively.

**(3)****         Tax Fees.**The aggregate fees billed by Hein &Associates LLP in fiscal years 2006 and 2005 for professional services renderedfor tax compliance, tax advice and tax planning totaled $7,000 and $5,000,respectively, and consisted primarily of services with respect the preparationof federal and state income tax returns, advice with regard to federal andstate income tax audits and income tax planning.

**(4)****         All Other Fees.** Theaggregate fees billed by Hein & Associates LLP in fiscal years 2006 and2005, other than for the services reported in “Audit Fees,” “Audit Related Fees”or “Tax Fees” described above, totaled $0 and $0, respectively.

**(5)****         Audit Committee Approval Procedures.** Our independent auditorsreport to, and are engaged at the direction of, the Audit Committee, withannual approval by the shareholders. Effective May 2003, the Audit Committeeimplemented procedures for the pre-approval of audit and non-audit servicesperformed by the independent auditors. The Audit Committee has the soleauthority to pre-approve all audit and non-audit services provided by theindependent auditors and acts to assure that the independent auditors are notengaged to perform specific non-audit services proscribed by law or regulation.

**PART IV**

**ITEM 15.       EXHIBITS AND FINANCIAL STATEMENTSCHEDULES**

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

The followingdocuments are filed herewith or have been included as exhibits to previousfilings with the Securities and Exchange Commission and are incorporated hereinby this reference:

**(1)   Financial Statements**
| Index to financial  statements                           |   |
|----------------------------------------------------------|--------|
| Report of Independent Registered Public Accounting  Firm |   |
| Consolidated Balance Sheets                              |   |
| Consolidated of Operations                               |   |
| Consolidated Statements of Shareholders’ Equity     |   |
| Consolidated Statements of Cash Flows                    |   |
| Notes to Consolidated Financial Statements               |   |

 

**(2)   Financial Statement Schedules**

Schedule II –Valuation and Qualifying Accounts

**(3)   Exhibits**
| Exhibit No. | ** ** | **Document** |
|-------------|------------|--------------|
| */          | 3.1.2      |         | Amended and Restated Articles of Incorporation of Sport-Haley,  Inc. as filed on March 7, 1994 with the Secretary of State of the State  of Colorado. |
|        |       |         |   |
| –      | 3.2.3      |         | Amended and Restated By-laws of Sport-Haley,  Inc. as adopted January 10, 1996. |

 

51

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| x*     | 3.2.4    |   | Amendment to Amended and Restated By-laws of  Sport-Haley, Inc. adopted March 15, 2002.                                |
|--------|----------|--------|------------------------------------------------------------------------------------------------------------------------|
|   |     |   |                                                                                                                   |
| %      | 3.2.5    |   | Amendment to Amended and Restated Bylaws of  Sport-Haley, Inc. effective October 1, 2004.                              |
|   |     |   |                                                                                                                   |
| */     | 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.                                                             |
|   |     |   |                                                                                                                   |
| 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.                   |
|   |     |   |                                                                                                                   |
| **     | 10.2.5   |   | Employment Agreement, dated July 1, 1997, by and  between Catherine B. Blair 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.                       |
|   |     |   |                                                                                                                   |
| &  | 10.2.8.1 |   | Amendment to Employment Agreement, effective  December 1, 2004, by and between Patrick W. Hurley and Sport-Haley, Inc. |
|   |     |   |                                                                                                                   |
| @      | 10.2.9   |   | Employment Agreement, dated January 1, 2004, by and  between Mark Maley and Sport-Haley.                               |
|   |     |   |                                                                                                                   |
| &  | 10.2.9.1 |   | Amendment to Employment Agreement, effective January  1, 2005, by and between Mark Maley 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                                      |

 

52

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|        |   |   | and Sport-Haley.                                                                                                                                                                                            |
|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                        |
| II     | 10.3.2 |   | Business Loan Agreement, dated November 5, 1998, by  and between U.S. Bank National Association and Sport-Haley, Inc.                                                                                       |
|   |   |   |                                                                                                                                                                                                        |
| ##     | 10.3.5 |   | License Agreement, dated May 3, 2001, between  Spalding Sports Worldwide, Inc. and Sport-Haley, Inc. [*]                                                                                                    |
|   |   |   |                                                                                                                                                                                                        |
| x*     | 10.3.6 |   | Amendment to License Agreement, dated June 27, 2002,  between Spalding Sports Worldwide, Inc. and Sport-Haley, Inc.                                                                                         |
|   |   |   |                                                                                                                                                                                                        |
| +++    | 10.3.7 |   | Amendment No. 2 to License Agreement, dated June 6,  2003, between Sport-Haley, Inc. and The Top-Flite Golf Company [*]                                                                                     |
|   |   |   |                                                                                                                                                                                                        |
| ++     | 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.                                               |
|   |   |   |                                                                                                                                                                                                        |
| 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.                                           |
|   |   |   |                                                                                                                                                                                                        |
| */     | 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.                                                                             |
|   |   |   |                                                                                                                                                                                                        |
| ***    | 10.8   |   | Trademark License Agreement, dated August 22, 2006,  issued by United States Patent and Trademark Office to Sport-Haley 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 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 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                                            |

 

53

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----

| *      | 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)                                                                                                                                                                                                                                                                      |
| ##     | 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  Form 8-K filed on June 13, 2003 (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-Q filed on May 24, 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)                                                                                                                                                                                                                                                                        |
| ***    | Filed herewith.                                                                                                                                                                                                                                                                                                                                                                         |

 

54

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|                  |                                                                            | SPORT-HALEY,  INC.          |
|------------------|---------------------------------------------------------------------------------|-----------------------------|
|             |                                                                            |                        |
|             |                                                                            |                        |
| October 13, 2006 | 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 13, 2006 |
| Donald W. Jewell       |       | and President                        |                     |     |
|                   |       |                                 |                     |     |
|                   |       |                                 |                     |     |
| /s/ PATRICK W.  HURLEY |       |                                 | Chief Financial Officer, |     | October 13, 2006 |
| Patrick W.  Hurley     |       | Secretary and  Treasurer             |                     |     |
|                   |       |                                 |                     |     |
|                   |       |                                 |                     |     |
| /s/ RONALD J.  NORICK  |       |                                 | Director                 |     | October 13, 2006 |
| Ronald J. Norick       |       | and Chairman of  the Board           |                     |     |
|                   |       |                                 |                     |     |
|                   |       |                                 |                     |     |
| /s/ JAMES R.  TENBROOK |       |                                 | Director                 |     | October 13, 2006 |
| James R. TenBrook      |       | and Audit  Committee Chairman        |                     |     |
|                   |       |                                 |                     |     |
|                   |       |                                 |                     |     |
| /s/ MARK J.  STEVENSON |       |                                 | Director                 |     | October 13, 2006 |
| Mark J.  Stevenson     |       | and Compensation  Committee Chairman |                     |     |
|                   |       |                                 |                     |     |
|                   |       |                                 |                     |     |
| /s/ JAMES H.  EVEREST  |       |                                 | Director                 |     | October 13, 2006 |
| James H. Everest       |       |                                 |                     |     |

 

55

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**INDEX TO FINANCIAL STATEMENTS**
| **Report of Independent  Registered Public Accounting Firm** |   |   |
|--------------------------------------------------------------|--------|--------|
| ** **                                                   |   |   |
| **Consolidated  Balance Sheets**                             |   |   |
| ** **                                                   |   |   |
| **Consolidated Statements of  Operations**                   |   |   |
| ** **                                                   |   |   |
| **Consolidated  Statement of Shareholders’ Equity**     |   |   |
| ** **                                                   |   |   |
| **Consolidated Statements of  Cash Flows**                   |   |   |
| ** **                                                   |   |   |
| **Notes to  Consolidated Financial Statements**              |   |   |
| ** **                                                   |   |   |
| **Schedule  II - Valuation and Qualifying Accounts**         |   |   |

** **

F-1

----

** **

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

Board of DirectorsSport-Haley, Inc.Denver, Colorado

We have auditedthe accompanying consolidated balance sheets of Sport-Haley, Inc. as ofJune 30, 2006 and 2005, and the related consolidated statements ofoperations, shareholders’ equity and cash flows for each of the three years inthe period ended June 30, 2006. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

We conducted ouraudits in accordance with standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudits to obtain reasonable assurance about whether the consolidated financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Sport-Haley, Inc. asof June 30, 2006 and 2005, and the consolidated results of their operations andtheir cash flows for each of the three years in the period ended June 30, 2006,in conformity with accounting principles generally accepted in the UnitedStates of America.

Our audits weremade for the purpose of forming an opinion on the basic consolidated financialstatements taken as a whole. The schedule listed in the index of financialstatements is presented for purposes of complying with the Securities andExchange Commission’s rules and is not part of the basic consolidated financialstatements. This schedule has been subjected to the auditing procedures appliedin the audits of the basic consolidated financial statements and, in ouropinion, fairly states in all material respects the financial data required tobe set forth therein in relation to the basic consolidated financial statementstaken as a whole.

 
| HEIN & ASSOCIATES LLP |
|-------------------------------------|
| Denver, Colorado                    |
|                                |
| September 11, 2006                  |

*** ***

F-2

----

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

**CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                      | ** ** | **JUNE 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                      | ** ** | **2006**          | ** ** | **2005** | ** ** |
| **ASSETS**                                                                                                                      |       |              |       |   |   |
| **CURRENT  ASSETS:**                                                                                                            |       |              |       |   |   |
| Cash and cash equivalents                                                                                                       |       | $                 | 8,492,000  |   | $ | 7,721,000 |   |
| Accounts receivable, net of allowances of $446,000  and $691,000, respectively                                                  |       | 3,950,000         |       | 4,495,000 |   |
| Inventories                                                                                                                     |       | 4,775,000         |       | 4,153,000 |   |
| Prepaid expenses and other                                                                                                      |       | 194,000           |       | 196,000 |   |
| Total current assets                                                                                                            |       | 17,411,000        |       | 16,565,000 |   |
|                                                                                                                            |       |              |       |   |   |
| **PROPERTY  AND EQUIPMENT,**net                                                                                                 |       | 613,000           |       | 922,000 |   |
|                                                                                                                            |       |              |       |   |   |
| **OTHER  ASSETS**                                                                                                               |       | 3,000             |       | 3,000 |   |
|                                                                                                                            |       |              |       |   |   |
| **TOTAL  ASSETS**                                                                                                               |       | $                 | 18,027,000 |   | $ | 17,490,000 |   |
|                                                                                                                            |       |              |       |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                   |       |              |       |   |   |
| **CURRENT  LIABILITIES:**                                                                                                       |       |              |       |   |   |
| Accounts payable                                                                                                                |       | $                 | 1,836,000  |   | $ | 582,000 |   |
| Accrued royalties payable                                                                                                       |       | 386,000           |       | 294,000 |   |
| Accrued commissions payable                                                                                                     |       | 211,000           |       | 249,000 |   |
| Accrued payroll                                                                                                                 |       | 386,000           |       | 533,000 |   |
| Other                                                                                                                           |       | 137,000           |       | 93,000 |   |
| Total current liabilities                                                                                                       |       | 2,956,000         |       | 1,751,000 |   |
|                                                                                                                            |       |              |       |   |   |
| **LONG-TERM  LIABILITIES:**                                                                                                     | ** ** | ** **        | ** ** | ** ** | ** ** |
| Loan payable to affiliate                                                                                                       |       | 34,000            |       | — |   |
| Total long-term liabilities                                                                                                     |       | 34,000            |       | — |   |
| ** **                                                                                                                      | ** ** | ** **        | ** ** | ** ** | ** ** |
| **COMMITMENTS  AND CONTINGENCIES**(Notes 8 and 9)                                                                               |       |              |       |   |   |
|                                                                                                                            |       |              |       |   |   |
| **TOTAL  LIABILITIES**                                                                                                          |       | 2,990,000         |       | 1,751,000 |   |
| ** **                                                                                                                      | ** ** | ** **        | ** ** | ** ** | ** ** |
| **MINORITY  INTEREST**                                                                                                          |       | 22,000            |       | — |   |
|                                                                                                                            |       |              |       |   |   |
| **SHAREHOLDERS’  EQUITY:**                                                                                                 |       |              |       |   |   |
| Preferred stock, no par value; 1,500,000 shares  authorized; none issued and outstanding                                        |       | —            |       | — |   |
| Common stock, no par value; 15,000,000 shares  authorized; 2,770,252 and 2,645,252 shares issued and outstanding,  respectively |       | 10,813,000        |       | 10,460,000 |   |
| Additional paid-in capital                                                                                                      |       | 1,621,000         |       | 1,590,000 |   |
| Retained earnings                                                                                                               |       | 2,581,000         |       | 3,689,000 |   |
| Total shareholders’ equity                                                                                                 |       | 15,015,000        |       | 15,739,000 |   |
|                                                                                                                            |       |              |       |   |   |
| **TOTAL LIABILITIES AND  SHAREHOLDERS’ EQUITY**                                                                            |       | $                 | 18,027,000 |   | $ | 17,490,000 |   |

 

***See accompanying notes to theseconsolidated financial statements.***

F-3

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**
| ** **                                                                                           | ** ** | **FOR THE YEARS ENDED** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                           | ** ** | **JUNE 30,**                      | ** ** |
| ** **                                                                                           | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                 |       |                                   |       |   |   |   |   |
| **NET SALES**                                                                                        |       | $                                      | 20,962,000 |   | $ | 22,041,000 |   | $ | 20,800,000 |   |
|                                                                                                 |       |                                   |       |   |   |   |   |
| **COST OF GOODS SOLD**                                                                               |       |                                   |       |   |   |   |   |
| Cost of goods  sold                                                                                  |       | 13,642,000                             |       | 14,286,000 |   | 12,912,000 |   |
| Impairments                                                                                          |       | 408,000                                |       | 1,403,000 |   | 707,000 |   |
|                                                                                                 |       |                                   |       |   |   |   |   |
| Total cost of  goods sold                                                                            |       | 14,050,000                             |       | 15,689,000 |   | 13,619,000 |   |
| ** **                                                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **GROSS PROFIT**                                                                                     |       | 6,912,000                              |       | 6,352,000 |   | 7,181,000 |   |
| ** **                                                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **OTHER OPERATING COSTS:**                                                                           |       |                                   |       |   |   |   |   |
| Selling, general  and administrative expenses                                                        |       | 7,090,000                              |       | 9,036,000 |   | 8,205,000 |   |
| Royalty expense                                                                                      |       | 927,000                                |       | 797,000 |   | 532,000 |   |
| Total other  operating costs                                                                         |       | 8,017,000                              |       | 9,833,000 |   | 8,737,000 |   |
|                                                                                                 |       |                                   |       |   |   |   |   |
| **LOSS FROM OPERATIONS**                                                                             |       | (1,105,000                             | )          | (3,481,000 | ) | (1,556,000 | ) |
| ** **                                                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **OTHER INCOME AND (EXPENSE):**                                                                      |       |                                   |       |   |   |   |   |
| Interest income,  net                                                                                |       | 271,000                                |       | 107,000 |   | 66,000 |   |
| Other income                                                                                         |       | 182,000                                |       | 123,000 |   | 54,000 |   |
| Other expense                                                                                        |       | (15,000                                | )          | (22,000 | ) | (4,000 | ) |
| Total other  income                                                                                  |       | 438,000                                |       | 208,000 |   | 116,000 |   |
| ** **                                                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **LOSS FROM OPERATIONS BEFORE  MINORITY INTEREST IN SUBSIDIARY LOSS AND PROVISION FOR INCOME TAXES** |       | (667,000                               | )          | (3,273,000 | ) | (1,440,000 | ) |
|                                                                                                 |       |                                   |       |   |   |   |   |
| Minority Interest in  Subsidiary Loss                                                                |       | 259,000                                |       | — |   | — |   |
|                                                                                                 |       |                                   |       |   |   |   |   |
| Provision for income  taxes                                                                          |       | (7,000                                 | )          | (8,000 | ) | (746,000 | ) |
|                                                                                                 |       |                                   |       |   |   |   |   |
| **NET LOSS**                                                                                         |       | $                                      | (415,000   | ) | $ | (3,281,000 | ) | $ | (2,186,000 | ) |
|                                                                                                 |       |                                   |       |   |   |   |   |
| **NET LOSS PER SHARE:**                                                                              |       |                                   |       |   |   |   |   |
| Basic and  diluted                                                                                   |       | $                                      | (0.15      | ) | $ | (1.29 | ) | $ | (0.89 | ) |
|                                                                                                 |       |                                   |       |   |   |   |   |
| **WEIGHTED AVERAGE SHARES OUTSTANDING:**                                                             |       |                                   |       |   |   |   |   |
| Basic and diluted                                                                                    |       | 2,749,000                              |       | 2,548,000 |   | 2,448,000 |   |

 

***See accompanying notes to theseconsolidated financial statements.***

F-4

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

**STATEMENTOF SHAREHOLDERS’ EQUITY**
| ** **                           | ** ** | **COMMON STOCK** | ** ** | **ADDITIONAL  PAID-IN** | ** ** | **RETAINED** | ** ** | **TOTAL  SHAREHOLDERS’** | ** ** |
|--------------------------------------|------------|-----------------------|------------|-------------------------|------------|--------------|------------|-------------------------------|------------|
| ** **                           | ** ** | **SHARES**            | ** ** | **AMOUNT**              | ** ** | **CAPITAL**  | ** ** | **EARNINGS**                  | ** ** | **EQUITY** | ** ** |
| ** **                           | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **BALANCES,**July 1, 2003            |       | 2,444,585             |       | $                       | 9,868,000  |         | $          | 1,403,000                     |       | $ | 9,156,000 |   | $ | 20,427,000 |   |
| ** **                           | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | ** **                    | ** ** | ** ** | ** ** |
| Stock options  exercised             |       | 80,667                |       | 258,000                 |       | —       |       | —                        |       | 258,000 |   |
| Stock-based  compensation            |       | —                |       | —                  |       | 124,000      |       | —                        |       | 124,000 |   |
| Net loss                             |       | —                |       | —                  |       | —       |       | (2,186,000                    | )          | (2,186,000 | ) |
| ** **                           | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **BALANCES,**June 30, 2004           |       | 2,525,252             |       | 10,126,000              |       | 1,527,000    |       | 6,970,000                     |       | 18,623,000 |   |
| ** **                           | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | ** **                    | ** ** | ** ** | ** ** |
| Stock options  exercised             |       | 120,000               |       | 334,000                 |       | —       |       | —                        |       | 334,000 |   |
| Stock-based  compensation            |       | —                |       | —                  |       | 63,000       |       | —                        |       | 63,000 |   |
| Net loss                             |       | —                |       | —                  |       | —       |       | (3,281,000                    | )          | (3,281,000 | ) |
| ** **                           | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **BALANCES,**June 30, 2005           |       | 2,645,252             |       | 10,460,000              |       | 1,590,000    |       | 3,689,000                     |       | 15,739,000 |   |
| ** **                           | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | ** **                    | ** ** | ** ** | ** ** |
| 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                             |       | —                |       | —                  |       | —       |       | (415,000                      | )          | (415,000 | ) |
| ** **                           | ** ** | ** **            | ** ** | ** **              | ** ** | ** **   | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **BALANCES,**June  30, 2006          |       | 2,770,252             |       | $                       | 10,813,000 |         | $          | 1,621,000                     |       | $ | 2,581,000 |   | $ | 15,015,000 |   |

 

***See accompanying notes to theseconsolidated financial statements.***

F-5

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

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

|                                                                                                  | ** ** | **FOR THE YEARS ENDED JUNE 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2006**                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                             |       |                                                      |       |   |   |   |   |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                       |       |                                                      |       |   |   |   |   |
| Net loss                                                                                         |       | $                                                         | (415,000   | ) | $ | (3,281,000 | ) | $ | (2,186,000 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in)  operating activities: |       |                                                      |       |   |   |   |   |
| Depreciation and  amortization                                                                   |       | 324,000                                                   |       | 352,000 |   | 327,000 |   |
| Impairments and  write-downs                                                                     |       | 408,000                                                   |       | 1,403,000 |   | 707,000 |   |
| Deferred taxes                                                                                   |       | —                                                    |       | — |   | 746,000 |   |
| Provisions for  doubtful accounts and sales returns                                              |       | (71,000                                                   | )          | (205,000 | ) | 856,000 |   |
| Stock-based  compensation expense                                                                |       | 31,000                                                    |       | 63,000 |   | 124,000 |   |
| Gain/loss on  disposal of assets                                                                 |       | 12,000                                                    |       | 22,000 |   | 4,000 |   |
| Minority  interest in subsidiary loss                                                            |       | 56,000                                                    |       | — |   | — |   |
| Changes in  assets and liabilities:                                                              |       |                                                      |       |   |   |   |   |
| Accounts  receivable                                                                             |       | 616,000                                                   |       | 1,656,000 |   | (1,846,000 | ) |
| Inventory                                                                                        |       | (1,030,000                                                | )          | 3,252,000 |   | (1,687,000 | ) |
| Prepaid expenses                                                                                 |       | 2,000                                                     |       | 272,000 |   | 32,000 |   |
| Other assets                                                                                     |       | —                                                    |       | (3,000 | ) | — |   |
| Accounts payable                                                                                 |       | 1,255,000                                                 |       | (799,000 | ) | 792,000 |   |
| Accrued  commissions and other expenses                                                          |       | (49,000                                                   | )          | 402,000 |   | 238,000 |   |
| Net cash  provided by (used in) operating activities                                             |       | 1,139,000                                                 |       | 3,134,000 |   | (1,893,000 | ) |
|                                                                                             |       |                                                      |       |   |   |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                        |       |                                                      |       |   |   |   |   |
| Purchase of  fixed assets                                                                        |       | (44,000                                                   | )          | (176,000 | ) | (427,000 | ) |
| Maturities  (purchases) of marketable securities                                                 |       | —                                                    |       | 539,000 |   | 1,642,000 |   |
| Proceeds from  the disposal of fixed assets                                                      |       | 16,000                                                    |       | — |   | 6,000 |   |
| Net cash  provided by (used in) investing activities                                             |       | (28,000                                                   | )          | 363,000 |   | 1,221,000 |   |
|                                                                                             |       |                                                      |       |   |   |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                       |       |                                                      |       |   |   |   |   |
| Cash dividend  paid on common shares                                                             |       | (693,000                                                  | )          | — |   | — |   |
| Stock option  exercises                                                                          |       | 353,000                                                   |       | 334,000 |   | 258,000 |   |
| Net cash  provided by (used in) financing activities                                             |       | (340,000                                                  | )          | 334,000 |   | 258,000 |   |
|                                                                                             |       |                                                      |       |   |   |   |   |
| **NET INCREASE (DECREASE) IN CASH  AND CASH EQUIVALENTS**                                        |       | 771,000                                                   |       | 3,831,000 |   | (414,000 | ) |
|                                                                                             |       |                                                      |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS,**  Beginning of year                                                |       | 7,721,000                                                 |       | 3,890,000 |   | 4,304,000 |   |
|                                                                                             |       |                                                      |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS,**End  of year                                                       |       | $                                                         | 8,492,000  |   | $ | 7,721,000 |   | $ | 3,890,000 |   |
|                                                                                             |       |                                                      |       |   |   |   |   |
| **SUPPLEMENTAL CASH FLOW  INFORMATION:**                                                         |       |                                                      |       |   |   |   |   |
| Cash payments  for:                                                                              |       |                                                      |       |   |   |   |   |
| Interest                                                                                         |       | $                                                         | —     |   | $ | — |   | $ | — |   |
| Income taxes                                                                                     |       | $                                                         | 7,000      |   | $ | 8,000 |   | $ | — |   |

 

***See accompanying notes to theseconsolidated financial statements.***

F-6

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

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

1.         **ORGANIZATIONAND SIGNIFICANT ACCOUNTING POLICIES**:

*Nature ofOperations* – Sport-Haley, Inc. (“Sport Haley”), organizedas a Colorado corporation in January 1991, designs, purchases, contracts forthe manufacture of, markets and distributes men’s and women’s fashion golfapparel and outerwear under the SPORT HALEY® and Ben Hogan® labels. Our fashiongolf apparel collections, known for their innovative designs, quality fabrics,generous fits and classic styles, are primarily marketed in the premium andmid-priced markets, through a network of independent sales representatives anddistributors, to golf professional shops, country clubs, resorts and exclusivedepartment stores within the United States and by certain distributors withinvarious international markets.

Reserve ApparelGroup LLC (“Reserve Apparel”), formed in November 2005, designs, purchases,contracts for the manufacture of, markets and distributes golf apparel andouterwear under the Top-Flite® label. In accordance with the LLC operatingagreement, Sport Haley owns a 51% interest in Reserve Apparel and Explorer GearUSA, Inc. (“Explorer”) owns a 49% interest. As of June 30, 2006, Sport Haleyhad contributed capital of $25,000 and advanced loans of $2,171,000 to ReserveApparel, including accrued interest of $13,000, and Explorer had contributedcapital of $25,000 and advanced loans of $290,000 to Reserve Apparel, includingaccrued interest of $3,000. In May and June 2006, a majority of the members ofReserve Apparel’s Management Committee approved the reclassifications to equitycapital of certain amounts previously classified as member loans. Thereclassifications increased the equity capital of Reserve Apparel and reducedamounts previously classified as member loans by $268,000 for Sport Haley and$256,000 for Explorer, respectively.

*Principlesof Consolidation* – Included in the 2006 consolidatedfinancial statements are the accounts of Sport Haley and Reserve Apparel (SportHaley and Reserve Apparel collectively referred to as the “Company”, “we”, “us”or “our”). All significant inter-company transactions between Sport Haley andReserve Apparel have been eliminated.

*Reclassification*– Certain prior amounts have been reclassified to conform to the year 2006presentation, but such reclassifications had no affect on net loss.

*MarketableSecurities* – Marketable securities generally consisted ofUnited States government and mortgage-backed debt securities that maturedwithin one year or less and were classified as held-to-maturity. Due to theshort-term nature of the investments, there were no material unrealized gainsor losses on these investments. As a result, the carrying values of marketablesecurities approximated their fair market values. No marketable securities wereheld, purchased or matured during 2006.

*Receivablesand Credit Policies* – Trade receivables consist ofuncollateralized customer obligations due under normal trade terms, generallyrequiring payment within 30 days of the invoice date. In most cases, individualtrade receivables apply to a specific identifiable sales invoice. Periodically,management reviews the estimated recoverability of trade receivables andreduces their carrying amount by utilizing a valuation allowance that reflectsmanagement’s best estimate of the amount that may not be collectible. From timeto time, management also identifies delinquent customer accounts and otherreceivables for which a specific reserve is required. At June 30, 2006, ourallowance for doubtful accounts included a specific reserve of $116,000 withrespect to the potential non-recovery of the net amount due to Reserve Apparelfrom a former inventory supplier.

F-7

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*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. Since we implemented our operations software in January 2004, programmingand human errors discovered within the system caused us to report a materialweakness in our internal controls over financial reporting with respect toinventory valuation. This weakness in our controls prevented us from relyingupon the system-recorded transactions with respect to inventory valuationsduring 2005 and 2004. We used a standard cost method to value our finishedgoods inventories from the fiscal quarter ended March 31, 2004, through thefiscal quarter ended March 31, 2005. Had we been able to rely upon the systemto properly compute the cost of our finished goods inventories using theweighted average method, we believe that the weighted average method would nothave yielded a materially different computation of the value than the standardcost method that we applied.

Basedupon extensive tests that we performed near the end of 2006, we believe thatthe material weakness has been eradicated. We believe that the computersoftware has now been properly programmed, and employees have been adequatelytrained to utilize the system procedures, to rely upon the software toaccurately compute our finished goods inventory valuations using a weightedaverage cost assumption. We also believe that the system has been configuredand that employees are sufficiently monitored to ensure that errors, sufficientto cause a material weakness with regard to the costing of our finished goodsinventories, are unlikely to recur.

Inventories arewritten down to market value as adjustments to reserves for inventoryobsolescence. Changes in the reserves for inventory obsolescence are reflectedin total cost of goods sold during the periods in which the reserve is recordedand the obsolete inventory is sold, respectively. Write-downs as a result ofinventory obsolescence totaled $408,000, $1,403,000 and $707,000 for 2006, 2005and 2004, respectively.

*Propertyand Equipment* – Property and equipment are stated athistorical cost. Depreciation is generally recorded over the estimated usefullives of the assets, ranging from three to twelve years, using thestraight-line method of depreciation. Leasehold improvements are stated athistorical cost and are generally amortized over the remaining life of thelease, using the straight-line method. Material expenditures that increase thelife of an asset are capitalized and depreciated over the estimated remaininguseful life of the asset. The costs of normal maintenance and repairs arecharged to operating expenses as incurred. Upon the disposition of assets, therelated cost and accumulated depreciation are removed from the books and therealized gain or loss, if any, is recognized in the year of the disposition.

*Impairmentof Long-Lived Assets* – The carrying values of long-livedassets are reviewed for impairment whenever events or changes in circumstancesindicate that such carrying values may not be recoverable. We do not performperiodic assessments of assets for impairment in the absence of suchinformation or indicators. Currently, management has no indication of anyevents or circumstances that would significantly impair any of our long-livedassets, primarily furniture, fixtures and equipment. An impairment charge, ifany, would be recorded for the excess of the carrying value of an asset over itsestimated fair value, as determined based upon estimates of future cash flows,third-party valuation or other measures determined appropriate for thecircumstances.

*RevenueRecognition* – The Company recognizes revenue inaccordance with Securities and Exchange Commission Staff Accounting BulletinNo. 104, *“Revenue Recognition, corrected copy,”*which requires that four basic criteria must be met before revenue can berecognized: (1) persuasive evidence of an arrangement exists; (2) delivery hasoccurred or services have been rendered; (3) the seller’s price to the buyer isfixed or 

F-8

----

determinable; and,(4) collectibility is reasonably assured. We generally record revenue uponshipment, primarily transported via common carrier with terms of FOB at thepoint of delivery to the carrier. Occasionally, we may implement limitedconsignment programs with certain of our customers. We generally recognizerevenue on consignment sales at the time of collection from the customer. On alimited basis, we also offer certain customers the right of return for certaininventory, which we include as a component within our estimate of allowance forsales returns.

*SalesIncentives* –The types of incentives that we offer to ourcustomers generally include sales discounts, terms discounts and free goods,which we include in the net sales line of our statement of operations. In theordinary course of our business, we may offer our customers sales discounts ofup to 25%, terms discounts of up to 10% or free goods of up to 5% off of our statedwholesale prices. The revenue effects of sales discounts and free goods arerecorded upon invoicing our customer for the related merchandise. We recordapplicable terms discounts upon receipt of payment from the customer. On alimited basis, we also participate in cooperative advertising with certain ofour customers. Charges for cooperative advertising are recorded as advertisingexpense in the period in which our payment is made or when we issue credit tothe customer’s account.

*Cost ofGoods Sold* – Our gross margins may not be comparable toother companies within the golf apparel industry. We have consistently includedthe cost of merchandise sold, including import charges, in-bound freight,allocated overhead and other charges, custom embroidery costs and freight-outin our cost of goods sold. Amounts invoiced to our customers for customembroidery as well as shipping and handling charges are included as componentsof our net sales. Our overhead allocation includes certain of our distributioncosts, such as receiving, inspection and shipping costs, but we include some ofthe other costs of distribution, such as a portion of our warehousing and otherhandling costs, in selling, general and administrative expense. Our grossmargins also include, on a consolidated basis, the operations of ReserveApparel, which distributes Top-Flite® apparel to the mass retail market at muchlower price points and gross margins that those expected to be achieved in thepremium and mid-price markets where we distribute our SPORT HALEY® and BenHogan® apparel brands. Other companies within the golf apparel industry may ormay not operate within the premium and mid-price markets as well as the massretail market. We include royalty payments, relating to sales of licensed apparel,in other operating costs.

*RecoverableDefense Expenses* – In March 2001, we retained legalcounsel to possibly pursue claims against our former auditors in connectionwith damages we claimed were suffered as a result of the restatements of ourfinancial statements for 1999 and 1998 and the corrections of materialinformation for the quarterly periods of 2000, 1999 and 1998. Also, we werepreviously advised that the former auditors asserted certain claims against us,including allegations of unpaid fees. Neither Sport-Haley, Inc., nor the formerauditors filed any legal action to assert any of these disputed claims. Duringa mediation session in November 2005, we reached an agreement in principle withthe former auditors to settle all disputed claims between the parties and theiraffiliates. In February 2006, we entered into a written settlement agreement toresolve all pending claims between Sport-Haley, Inc., our former auditors andcertain of our former auditors’ current and former members, which provided forpayments to Sport-Haley, Inc. totaling $525,000. Among other terms of thesettlement agreement, the parties agreed to mutual releases of all claimsasserted against each other and each party has continued to deny the merits ofthose claims asserted against it by the other party. In accordance with asharing agreement between Sport-Haley, Inc. and one of its insurance carriersfor directors and officer liability insurance, we received 33% of the $525,000in settlement proceedings, or $173,000, and the insurance carrier received theremainder to partially recover amounts the carrier had paid in connection witha 

F-9

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previously settledclass action securities lawsuit and defense costs the carrier had reimbursed tous relating to the civil action lawsuit filed against us by the Securities andExchange Commission.

Our officer anddirector liability insurance covered some of the expenses incurred inconnection with the restatements and subsequent legal proceedings. Amountsrecovered from our insurance carriers were generally offset against otherrelated legal expenses in the period within which they were recovered, orrecoverability was reasonably assured, except that amounts recovered wereincluded in other income to the extent that such recovery exceeded legalexpenses for related matters incurred within the period for which the recoverywas recorded. We recorded offsets to legal expenses totaling $10,000, $88,000and $204,000 and recorded other income of $0, $109,000 and $0 with regard toreimbursements from our insurance carriers for 2006, 2005 and 2004,respectively. Other income for 2006 also includes $157,000 of the net amountrecovered in the settlement we reached with our former auditors. We also offset2006 legal expenses by $16,000, the remainder of the $173,000 settlementamount.

*Advertising*– We expense 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 2006, 2005 or 2004. We include the following inadvertising expenses: costs of sales catalogs; tradeshow expenses; costs ofapparel used in promotional activities; print ads in golf and other publications;co-operative advertising costs; market research expenditures; amounts paid toprofessional golfers; and, various other items. Advertising expense was$837,000, $946,000, and $902,000 for 2006, 2005, and 2004, respectively.

*DeferredTaxes* – Deferred income taxes are recognized for the taxconsequences in future years for differences between the tax bases of assetsand liabilities and their financial reporting amounts at each year end, basedon enacted tax laws and statutory tax rates applicable to the periods in whichthe differences are expected to affect taxable income. Our significant deferredtax assets are related to net operating loss carry forwards for federal andstate income tax purposes, stock-based compensation and an unrealized loss fortax purposes on a common stock investment. Governing regulations require thatour operating losses be carried forward for income tax purposes. We haveestablished a valuation allowance to reduce our deferred tax assets to the netamount expected to be recovered in future periods. The estimates for deferredtax assets and the corresponding valuation allowance require us to exercisecomplex judgments. We periodically review and adjust those estimates based uponthe most current information available. In accordance with SFAS 109 and basedupon a review at June 30, 2006, of our utilization of deferred tax assets, wemaintained a valuation allowance that effectively reduces our net deferred taxassets to zero. While we have implemented several initiatives and continue toexplore other various strategies to return the Company to profitability,including sales of Top-Flite® branded golf apparel to Wal-Mart in 2006, wecannot guarantee that our efforts will result in the generation of futureprofits. Because the recoverability of deferred tax assets is directlydependent upon future operating results, actual recoverability of deferred taxassets may differ materially from our estimates. Income tax expense equalstaxes payable for the period plus the net change during the period in deferredtax assets and liabilities.

*Use ofEstimates* – The preparation of financial statements inconformity with generally accepted accounting principles in the United Statesof America requires management to make estimates and assumptions that affectcertain reported amounts and disclosures. Among others, significant estimatesinclude the allowance for doubtful accounts, sales returns and inventoryreserves and valuation allowances associated with deferred tax assets.Accordingly, actual results could differ from those estimates.

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*CertainRisks and Concentrations* – Our operations consist ofdesigning, purchasing, contracting for the manufacture of, marketing andwholesale distribution of golf apparel for men and women. Our headquarters arelocated in Denver, Colorado, and our customers are located throughout theUnited States and abroad. As of June 30, 2006, 2005 and 2004, the majority ofour receivables were from customers in the golfing industry. We performon-going credit evaluations, and management believes that we maintain adequateallowance for potential credit losses.

Beginning in 2001,we significantly increased our reliance on foreign suppliers that providefinished and packaged apparel. The increased reliance heightened the risk thatour revenues could be adversely affected if a foreign shipment or shipmentswere received late or lost. We maintain insurance for risk of loss relating togoods shipped from our foreign and domestic suppliers. However, our increasedreliance on foreign suppliers heightens the risk that we may be left withinadequate or unsatisfactory recourse should the goods received from theforeign suppliers be nonconforming. In 2006, 2005 and 2004, we purchasedsignificant amounts of our finished apparel from various foreign suppliers. Ifwe were to lose or terminate the services of any of these significantsuppliers, our short-term ability to fulfill customers’ orders on a timelybasis could be substantially impaired, thereby negatively affecting the resultsof our operations. In 2006, we purchased 57%, 7%, 7%, 6% and 5% of our finishedapparel from five foreign suppliers, respectively. Comparatively, in 2005, wepurchased 40, 12%, 9%, 7%, 6% and 5% of our finished apparel from six foreignsuppliers, respectively.

*Statementsof Cash Flows* – For purposes of the statements of cashflows, we consider all highly liquid instruments purchased with originalmaturities of three months or less, that are readily convertible to knownamounts of cash and present an insignificant risk of change in value due tochanges in interest rates, to be cash equivalents.

*FinancialInstruments* – We periodically maintain cash balances at acommercial bank in excess of the Federal Deposit Insurance Corporationinsurance limit of $100,000.

*ComprehensiveIncome (Loss)* – Comprehensive income is defined as allchanges in shareholders’ equity (deficit), exclusive of transactions withowners, such as capital investments. Comprehensive income includes net income(loss) and income or loss from changes in certain assets and liabilities thatare reported directly in equity. We had no items of other comprehensive incomefor 2006, 2005, or 2004.

*NetIncome (Loss) Per Share* – Basic earnings per share (EPS)is calculated by dividing the income or loss available to common shareholdersby the weighted average number of common shares outstanding for the period.Diluted EPS reflects the potential dilution that could occur if securities orother contracts to issue common stock were exercised or converted into commonstock. Due to losses reported in 2006, 2005 and 2004, all of our stock optionsoutstanding were anti-dilutive, and thus excluded from the loss per sharecalculations.

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*Stock-Based Compensation*– Our StockOption Plan (the “Plan”) expired by its terms on February 28, 2003. Optionagreements that were issued in accordance with the Plan prior to February 28,2003, generally remain in force until the earlier of their exercise, theexpiration of certain time periods after the termination of a grantee’semployment (or other relationship with the Company) or expiration by theirterms.

AtJune 30, 2006, there were outstanding options to purchase 678,500 shares of ourcommon stock at exercise prices ranging from $2.71 to $9.78 per share andexpiration dates between July 2006 and January 2013. During the year ended June30, 2006, 125,000 options were exercised and 35,000 options expired.

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

Previously, we accountedfor stock-based compensation using the intrinsic value method prescribed inAccounting Principles Board Opinion No. 25, “*Accountingfor Stock Issued to Employees*,” and related interpretations andelected to apply the disclosure-only provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 123, “*Accountingfor Stock-Based Compensation*,” as amended by SFAS No. 148, “*Accounting for Stock-Based Compensation*–*Transition andDisclosure*.”Under the intrinsic value method, compensation expense for stock options wasrecognized over the vesting period of the grant based on the excess, if any, ofthe market price of our common stock at the date of grant over the stock optionexercise price. As governed by the Plan, stock options were generally grantedat or near fair market value on the date of grant.

The Plan expiredby its terms in February 2003. Accordingly, no options were granted in 2006,2005 or 2004. The expected life was determined based on the Plan’s vestingperiod and exercise behavior of the employees.

If we had previouslyaccounted for stock-based compensation in interim periods using the fair valuemethod rather than the intrinsic value method, the pro forma amounts of our netloss and loss per common share would have been reported as follows:

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|                                                                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
|                                                                       |       |     |       |     |       |       |       |
| Net loss - as  reported                                                    |       | $        | (415,000   | )        | $          | (3,281,000 | )          | $ | (2,186,000 | ) |
| Effect of  employee stock-based compensation included in reported net loss |       | 31,000   |       | 63,000   |       | 124,000    |       |
| Effect of  employee stock-based compensation per SFAS 123                  |       | (31,000  | )          | (423,000 | )          | (422,000   | )          |
| Net loss  applicable to common stock - pro forma                           |       | $        | (415,000   | )        | $          | (3,641,000 | )          | $ | (2,484,000 | ) |
|                                                                       |       |     |       |     |       |       |       |
| Basic and  Diluted:                                                        |       |     |       |     |       |       |       |
| Loss per share –  as reported                                         |       | $        | (0.15      | )        | $          | (1.29      | )          | $ | (0.89 | ) |
| Effect of  employee stock-based compensation included in reported net loss |       | 0.01     |       | 0.03     |       | 0.05       |       |
| Effect of  employee stock-based compensation per SFAS 123                  |       | (0.01    | )          | (0.17    | )          | (0.17      | )          |
| Net loss applicable to  common stock - pro forma                           |       | $        | (0.15      | )        | $          | (1.43      | )          | $ | (1.01 | ) |

 

*RecentPronouncements* – In February 2006, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsNo. 155 (“SFAS 155”), “*Accounting for CertainHybrid Financial Instruments*,” which amends Statement of FinancialAccounting Standards No. 133 (“SFAS 133”), *“Accounting for DerivativeInstruments and Hedging Activities”* and Statement of FinancialAccounting Standards No. 140 (“SFAS 140”), “*Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities.*”SFAS 155 simplifies the accounting for certain derivatives embedded in otherfinancial instruments by allowing them to be accounted for as a whole, if theholder elects to account for the whole instrument on a fair value basis. SFAS155 also clarifies and amends certain other provisions of SFAS 133 and SFAS140. SFAS 155 is effective for all financial instruments acquired, issued orsubject to a remeasurement event occurring in fiscal years beginning afterSeptember 15, 2006. The adoption of SFAS 155 is not expected to cause amaterial impact on our financial condition or the results of our operations..

In March 2006, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 156 (“SFAS 156”), “*Accounting for Servicingof Financial Assets — An Amendment to FASB Statement No. 140*.” SFAS156 requires that all separately recognized servicing rights be initiallymeasured at fair value, if practicable. In addition, SFAS 156 permits an entityto choose between two measurement methods (an amortization method or a fairvalue measurement method) for each class of separately recognized servicingassets and liabilities. SFAS 156 is effective January 1, 2007. The adoption ofSFAS 156 is not expected to cause a material impact on our financial conditionor the results of our operations.

In June 2006, theFinancial Accounting Standards Board ratified the consensus reached by theEmerging Issues Task Force on EITF Issue No. 05-01 (“EITF 05-01”), *“Accounting for the Conversion of an*

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*InstrumentThat Becomes Convertible Upon the Issuer’s Exercise of a Call Option.”*EITF 05-01 applies to the issuance of equity securities to settle a debtinstrument that is not otherwise currently convertible but becomes convertibleupon the issuer’s exercise of call options, when the issuance of equitysecurities is pursuant to the instrument’s original conversion terms. Theadoption of EITF 05-01 is not expected to cause a material impact on ourfinancial condition or the results of our operations.

In July 2006, theFinancial Accounting Standards Board issued Interpretation No. 48 (“FIN 48”), *“Accounting for Uncertainty in Income Taxes – An Interpretation of FASBStatement No. 109.”* FIN 48 clarifies the application of FASBStatement No. 109 by defining a criterion that an individual tax position mustmeet for any part of the benefit of that position to be recognized in anenterprise’s financial statements and also provides guidance on measurement,derecognition, classification, interest and penalties, accounting for interimperiods and disclosure. FIN 48 is effective for our fiscal year commencing July1, 2007. At this time, we have not determined what effect, if any, our expectedadoption of FIN 48 will have on our financial condition or the results of ouroperations.

In September 2006,the Financial Accounting Standards Board issued Statements of FinancialAccounting Standards No. 157 (“SFAS 157”), *“Fair Value Measurements.”*SFAS 157 provides enhanced guidance for using fair value to measureassets and liabilities and responds to requests by investors for expandedinformation about the extent to which companies measure assets and liabilitiesat fair value, the information used to measure fair value and the effects offair value measurements on earnings. SFAS clarifies the principle that fair valueshould be based on the assumptions that participants would use when pricing anasset or liability. In support of this principle, SFAS 157 establishes a fairvalue hierarchy that prioritizes the information used to develop thoseassumptions. SFAS is effective beginning with the interim periods within ourfiscal year ending June 30, 2008. However, early adoption is permitted. At thistime, we have not determined what effect, if any, an early adoption of SFAS 157would have on our financial condition or the results of our operations.

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

2.         **FAIRVALUE OF FINANCIAL INSTRUMENTS:**

The carryingvalues of our financial instruments, principally consisting of cash and cashequivalents, marketable securities, accounts receivable and accounts payable,approximate their fair market values due to their short-term maturities

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3.         **CASH ANDCASH EQUIVALENTS**:

Cash and cashequivalents consist of the following at June 30:
|                                                                      | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                                 |       |      |       |      |       |
| Cash in banks                                                        |       | $         | 5,483,000  |      | $          | 4,815,000 |   |
| Short-term securities  (original maturities of three months or less) |       | 3,009,000 |       | 2,906,000 |       |
| Total cash and cash  equivalents                                     |       | $         | 8,492,000  |      | $          | 7,721,000 |   |

 

4.         **INVENTORIES**:

Inventoriesconsisted of the following at June 30:
|                             | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-----------------------------|------------|-----------|------------|-----------|------------|
|                        |       |      |       |      |       |
| Component  inventories      |       | $         | 366,000    |      | $          | 387,000 |   |
| Finished goods  inventories |       | 4,409,000 |       | 3,766,000 |       |
| Total inventories           |       | $         | 4,775,000  |      | $          | 4,153,000 |   |

 

Included infinished goods inventories balances are allowances for inventory write-downs of$276,000 and $629,000 for 2006 and 2005, respectively.

5.         **PROPERTYAND EQUIPMENT**:

Property andequipment are recorded at historical cost and are comprised of the following atJune 30:
|                                                              | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                         |       |       |       |       |       |
| Furniture and  fixtures                                      |       | $          | 1,417,000  |       | $          | 1,400,000 |   |
| Plant equipment                                              |       | 1,314,000  |       | 1,319,000  |       |
| Computer  software and equipment                             |       | 1,265,000  |       | 1,240,000  |       |
| Leasehold  improvements                                      |       | 410,000    |       | 408,000    |       |
| Other                                                        |       | 11,000     |       | 56,000     |       |
| Total property  and equipment                                |       | 4,417,000  |       | 4,423,000  |       |
| Less accumulated  depreciation, amortization, and impairment |       | (3,804,000 | )          | (3,501,000 | )          |
| Property and equipment,  net                                 |       | $          | 613,000    |       | $          | 922,000 |   |

 

Depreciation andamortization expense for 2006, 2005, and 2004 was $324,000, $352,000 and$327,000, respectively.

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6.         **LINE OFCREDIT AGREEMENT**:

We maintain a revolving line of credit agreement with a commercialbank. The revolving line of credit agreement, which was renewed throughDecember 5, 2006, provides for a maximum loan amount of $5,000,000,collateralized by a lien on substantially all of our assets, and for interestat the bank’s prime rate. In accordance with the amendment agreement, we mustmaintain minimum tangible net worth of $14,000,000 and liquidity of $4,000,000.We generally maintain the line of credit to facilitate the issuance of lettersof credit for inventory purchases from offshore suppliers and, if necessary, tofund any temporary working capital needs. We did not have any balances due onthe line of credit at June 30, 2006 or 2005, respectively.

Outstandingletters of credit reduce the amount available for borrowing under the line ofcredit agreement. At June 30, 2006 and 2005, we had outstanding letters ofcredit of $509,000 and $2,012,000, respectively.

7.         **INCOMETAXES**:

The differencesbetween the U.S. Federal statutory rate and our effective rate are as followsat June 30:
|                                                   | ** ** | **2006** | ** ** | **2005**  | ** ** | **2004**   | ** ** |
|---------------------------------------------------|------------|----------|------------|-----------|------------|------------|------------|
|                                              |       |     |       |      |       |       |       |
| U.S. Federal  statutory rate                      |       | $        | (154,000   | )         | $          | (1,150,000 | )          | $ | (743,000 | ) |
| State income  taxes                               |       | (19,000  | )          | (157,000  | )          | (68,000    | )          |
| Change in  deferred tax valuation allowance       |       | 142,000  |       | 1,254,000 |       | 1,377,000  |       |
| Permanent  differences and other                  |       | 38,000   |       | 61,000    |       | 180,000    |       |
| Total current and  deferred tax expense (benefit) |       | $        | 7,000      |      | $          | 8,000      |       | $ | 746,000 |   |

 

The components of income tax expense (benefit) are as follows at June30:
|                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |     |       |
| Federal                       |       | $        | —     |     | $          | —   |       | $ | — |   |
| State                         |       | 7,000    |       | 8,000    |       | —   |       |
| Deferred                      |       | —   |       | —   |       | 746,000  |       |
| Income tax expense  (benefit) |       | $        | 7,000      |     | $          | 8,000    |       | $ | 746,000 |   |

 

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

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|                                                    | ** ** | **2005**    | ** ** | **2005**   | ** ** |
|----------------------------------------------------|------------|-------------|------------|------------|------------|
| ** **                                         | ** ** | ** **  | ** ** | **Long-**  | ** ** | **Long-** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Current** | ** ** | **Term**   | ** ** | **Current** | ** ** | **Term** | ** ** |
|                                               |       |        |       |       |       |   |   |   |   |
| Deferred tax  assets                               |       | $           | 262,000    |       | $          | 2,658,000 |   | $ | 344,000 |   | $ | 2,434,000 |   |
| Deferred tax  liabilities                          |       | —      |       | —     |       | — |   | — |   |
| Net deferred tax  asset before valuation allowance |       | 262,000     |       | 2,658,000  |       | 344,000 |   | 2,434,000 |   |
| Valuation  allowance                               |       | (262,000    | )          | (2,658,000 | )          | (344,000 | ) | (2,434,000 | ) |
| Net deferred tax asset                             |       | $           | —     |       | $          | — |   | $ | — |   | $ | — |   |

 

The types oftemporary differences between the tax bases of assets and liabilities and theirfinancial reporting amounts that give rise to a significant portion of thedeferred tax asset and liability and their appropriate tax effects are asfollows at June 30:
|                                                    | ** ** | ** **     | ** ** | **2006**    | ** ** | ** ** | ** ** | **2005**       | ** ** |
|----------------------------------------------------|------------|----------------|------------|-------------|------------|------------|------------|----------------|------------|
| ** **                                         | ** ** | **Temporary**  | ** ** | ** **  | ** ** | **Long-**  | ** ** | **Temporary**  | ** ** | ** ** | ** ** | **Long-** | ** ** |
| ** **                                         | ** ** | **Difference** | ** ** | **Current** | ** ** | **Term**   | ** ** | **Difference** | ** ** | **Current** | ** ** | **Term** | ** ** |
| Allowance for doubtful accounts                    |       | $              | 175,000    |        | $          | 65,000     |       | $              | —     |   | $ | 377,000 |   | $ | 140,000 |   | $ | — |   |
| Allowance for doubtful accounts – Subsidiary  |       | 59,000         |       | 22,000      |       | —     |       | —         |       | — |   | — |   |
| Reserve for sales  returns                         |       | 155,000        |       | 57,000      |       | —     |       | 286,000        |       | 106,000 |   | — |   |
| Accrued vacation                                   |       | 129,000        |       | 47,000      |       | —     |       | 84,000         |       | 31,000 |   | — |   |
| Accumulated  depreciation                          |       | 121,000        |       | —      |       | 45,000     |       | 19,,000        |       | — |   | 7,000 |   |
| Stock options                                      |       | 389,000        |       | —      |       | 144,000    |       | 479,000        |       | — |   | 177,000 |   |
| Unrealized loss  on investment                     |       | 234,000        |       | —      |       | 87,000     |       | 234,000        |       | — |   | 87,000 |   |
| Inventories                                        |       | 191,000        |       | 71,000      |       | —     |       | 182,000        |       | 67,000 |   | — |   |
| Federal net  operating losses                      |       | 5,904,000      |       | —      |       | 2,007,000  |       | 5,280,000      |       | — |   | 1,795,000 |   |
| State net  operating losses                        |       | 8,095,000      |       | —      |       | 375,000    |       | 7,952,000      |       | — |   | 368,000 |   |
| Net deferred tax  asset before valuation allowance |       |           |       | 262,000     |       | 2,658,000  |       |           |       | 344,000 |   | 2,434,000 |   |
| Valuation  allowance                               |       |           |       | (262,000    | )          | (2,658,000 | )          |           |       | (344,000 | ) | (2,434,000 | ) |
| Net deferred tax asset                             |       |           |       | $           | —     |       | $          | —         |       |   |   | $ | — |   | $ | — |   |
|                                                    |            |                |            |             |            |            |            |                |            |  |  |  |  |  |  |  |  |  |  |

 

The changes indeferred tax valuation allowances for 2006, 2005 and 2004 were $142,000,$1,254,000 and $1,377,000, respectively.

Federal netoperating loss carry forwards expire from 2023 through 2026. State netoperating loss carry forwards expire from 2021 through 2026.

8.         **OPERATINGLEASES**:

The Company leasesits corporate offices, production and warehouse facilities under an operatinglease that was extended through October 2011.

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Rent expenses for2006, 2005, and 2004, were $264,000, $255,000 and $232,000, respectively.

The future minimumlease payments under non-cancelable leases with initial terms of one year ormore as of June 30, 2006 are as follows:

| Years Ending  June 30, | ** ** | **Amount** | ** ** |
|----------------------------------|------------|------------|------------|
|                             |       |       |       |
| 2007                             |       | $          | 289,000    |   |
| 2008                             |       | 284,000    |       |
| 2009                             |       | 286,000    |       |
| 2010                             |       | 289,000    |       |
| 2011                             |       | 289,000    |       |
| Thereafter                       |       | 96,000     |       |
| Total                            |       | $          | 1,533,000  |   |

 

9.         **COMMITMENTSAND CONTINGENCIES**:

*Potential Claims* – We are subject to various legalproceedings and claims that arise in the ordinary course of our business. Basedupon the information that is currently available, management does not believethat the total impact of the various other legal proceedings will materiallyaffect our financial position or the results of our operations.

*Touring Professionals* – Pursuant to the terms of marketingagreements with certain touring professionals, we provide the professionalswith golf apparel. We did not compensate any tour professional in cash for2006.

*Employment Agreements*– We maintain several employment and non-compete agreements with officers andkey employees of the Company. The agreements are subject to automatic one-yearextensions. For 2006, employment and non-compete agreements provided forminimum salary levels totaling $728,000, excluding discretionary bonuses andseverance payments upon termination of employment without cause.

As previously reported,in October 2004, our Board of Directors approved a resolution not to renew theexecutive employment agreement of Kevin M. Tomlinson, our then Chief ExecutiveOfficer, President and Director, beyond the end of the term of the agreement onMarch 17, 2005. Per its terms, upon the non-renewal of the agreement, Mr.Tomlinson is entitled to receive severance compensation for a term of 36 monthsupon a termination of the agreement, equal to salary and bonus payments asshall have been paid to him during the most recent twelve-month period, andother 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 atJune 30, 2006 and 2005, are $285,000 and $449,000, respectively, relating toamounts due to Mr. Tomlinson with regard to severance and other compensation.In accordance with the terms of the employment agreement, Mr. Tomlinson isscheduled to receive monthly payments for severance and other compensationthrough March 17, 2008.

*License Agreements*– In May 2001, we entered into a license agreement with Spalding SportsWorldwide, 

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Inc. (“Spalding”) for therights to market a line of men’s premium golf apparel under the Ben Hogan®brand name.

In July 2002, we reachedan agreement with Spalding to amend the license agreement to expand theapplicable territory covered by the agreement to include the United Kingdom,Sweden, Mexico and various Caribbean countries. The original license agreementpreviously granted us the right to market Ben Hogan® apparel within the UnitedStates. We paid Spalding $50,000 in cash and an additional retail value of$50,000 in finished goods (at a cost to us of approximately $29,000) for therights to market Ben Hogan® apparel for a five year period ending December 31,2006, and a subsequent renewal period ending December 31, 2011.

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

In June 2003, we reachedan agreement with Top-Flite Golf to amend the license agreement to grant us theright to market lines of golf apparel under the Top-Flite® brand name withinthe United States, Sweden, Mexico and various Caribbean countries. We paidTop-Flite Golf $25,000 in cash for the rights to market Top-Flite® apparel forthe balance of the licensing period ending December 31, 2006, and a subsequentrenewal period ending December 31, 2011.

In September 2003,Callaway Golf Company (“Callaway”) purchased substantially all of the assets ofTop-Flite Golf including the Ben Hogan® and Top-Flite® brand names licensed tous.

In October 2005, Callawaygranted permission for Reserve Apparel Group LLC to distribute Top-Flite®branded apparel to Wal-Mart Stores, Inc. (“Wal-Mart”) through December 31,2006, subject to certain terms and conditions. We have recently entered intodiscussions with Callaway and believe that they will grant us permission tocontinue distributing Top-Flite® apparel to Wal-Mart and other large retailersthroughout the remaining term of the license agreement.

The original and amendedagreements require us to pay royalties based upon sales. We record royaltypayments governed by the license agreement with Callaway as other operatingcosts in the periods when such sales are recognized. Royalty payments withrespect to license agreements totaled $927,000, $797,000 and $532,000 for 2006,2005 and 2004, respectively.

10.       **SHAREHOLDERS’EQUITY**:

*Repurchase of Common Stock*– Our Board of Directors previously authorized the repurchase of up to2,820,000 shares 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 2006, 2005or 2004. Through June 30, 2006, we had cumulatively repurchased a total of2,512,800 shares of our common stock at a cost of $13,488,000.

*Preferred Stock–*The Articles of Incorporation of the Company authorize the issuance of amaximum of 1,500,000 shares of preferred stock. The Articles of Incorporationvest our Board of Directors with authority 

F-19

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to divide the class ofpreferred stock into separate series and to fix and determine the relativerights and preferences of the shares of any such series so established to thefull extent permitted by the laws of the State of Colorado and the Articles ofIncorporation. As of June 30, 2006, we had no preferred stock issued oroutstanding.

*Common Stock Options*– In March 1993, we adopted a Stock Option Plan (the “Plan”). The Plan, asoriginally adopted, provided for the reservation of 750,000 shares of ourcommon stock for issuance pursuant to the Plan. Since its adoption, as a resultof various actions, the number of shares reserved for issuance under the Planincreased to 2,150,000 shares. The Plan expired by its terms in February 2003.

Under the Plan, we could grantto employees, directors and consultants of the Company, and any subsidiarythereof, options to purchase common stock. Generally, granted options vest overthree years, 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 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 Plan prior to its expiration inFebruary 2003 will generally remain in force until the earlier of theirexercise, their expiration or the termination of an employment relationshipwith the Company.

At June 30, 2006, theCompany had outstanding options equal to 678,500 shares of common stock atprices ranging from $2.71 to $9.78 with expiration dates between 2007 and 2013.In 2006, 125,000 options were exercised and 35,000 options expired.

Activity under theCompany’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, 2003 |       | 1,195,000          |       | $                 | 3.50       |   | $2.71 - $8.63 |   | 82,697 |   | $ | 6.45 |   | $2.50 - $9.78 |   |
|          |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Exercised     |       | (80,667            | )          | $                 | 3.01       |   | $3.00 - $3.60 |   | — |   | — |   | — |   |
| Canceled      |       | (84,333            | )          | $                 | 4.53       |   | $3.00 - $8.50 |   | (15,682 | ) | $ | 3.65 |   | $2.50 - $7.50 |   |
| June 30, 2004 |       | 1,030,000          |       | $                 | 3.44       |   | $2.71 - $8.63 |   | 67,015 |   | $ | 7.11 |   | $3.00 - $9.78 |   |
|          |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Exercised     |       | (120,000           | )          | $                 | 2.78       |   | $2.71 - $3.60 |   | — |   | — |   | — |   |
| Canceled      |       | (125,000           | )          | $                 | 3.29       |   | $3.00 - $3.60 |   | (13,515 | ) | $ | 7.50 |   | $7.50 |   |
| 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 |   |

 

F-20

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Optionsoutstanding at June 30, 2006, vest as follows:
|                             | ** ** | **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, 2005 |       | 560,001            |       | $                 | 3.84       |   | $2.71 - $8.63 |   | 41,167 |   | $ | 4.03 |   | $3.00 - $9.78 |   |
|                        |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Vested during 2006          |       | 74,999             |       | $                 | 2.71       |   | $ | 2.71 |   | 2,333 |   | $ | 3.00 |   | $ | 3.00 |   |
|                        |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Vested as of June 30,  2006 |       | 635,000            |       | $                 | 3.70       |   | $2.71 – $8.63 |   | 43,500 |   | $ | 6.42 |   | $3.00 - $9.78 |   |
|                             |            |                    |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

If not exercised earlier, options outstanding as of June 30, 2006 willexpire 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 |       |               |       |              |       |   |   |   |   |   |   |   |   |
| 2007            |       | 75,000             |       | $                 | 8.63       |   | $ | 8.63 |   | 10,000 |   | $ | 7.56 |   | $6.50 - $8.63 |   |
| 2008            |       | —             |       | —            |       | — |   | 7,500 |   | $ | 8.63 |   | $ | 8.63 |   |
| 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          |       | 635,000            |       | $                 | 3.56       |   | $2.71 – $8.63 |   | 43,500 |   | $ | 6.95 |   | $3.00 - $9.78 |   |

 

We granted 400,000options in fiscal 2003 at approximately 85% of market price, and 304,000options were granted in fiscal 2002 at approximately 80% of market price, withweighted average fair values of $1.24 and $1.71 at the grant dates,respectively. All other options were granted at exercise prices thatapproximated the market prices on the dates of grant.

We followed theprovisions of SFAS 123**for allissuances of stock options to non-employees of the Company through June 30,2005. We followed the provisions of APB 25 for all grants of stock options toour employees prior to the expiration of the Plan by its terms in February2003. Generally, all stock options granted to our employees, pursuant to thePlan, were not compensatory. We adopted the modified prospective methodprescribed in SFAS 123R, effective July 1, 2005, and recognized $31,000 in stock-optioncompensation expense during our quarter ended September 30, 2005, accordingly.During 2006, 2005 and 

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2004, werecognized $31,000, $63,000 and $124,000, respectively, in stock-basedcompensation expense.

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

In the reconciliationof basic to diluted earnings (loss) per share, there were no reconciling itemsaffecting the numerator in any year presented. In 2006, 2005 and 2004, due toour net losses, all options, totaling 678,500, 838,500 and 1,097,015,respectively, were anti-dilutive and therefore excluded from the earnings(loss) per

sharecalculations.

12.       **RETIREMENT PLAN**:

In January 1996,the Company adopted a defined contribution savings plan (the “401(k) Plan”) toprovide retirement income to our employees. The 401(k) Plan is funded byvoluntary pre-tax salary deferral contributions from employees and throughmatching contributions by the Company of $0.25 on the dollar for employeedeferrals of the first 5% of a participating employee’s annual compensation.For 2006, 2005, and 2004, we contributed $16,000, $19,000 and $18,000,respectively, to the 401(k) Plan accounts of Company employees.

13.       **SEGMENT INFORMATION**:

The consolidatedCompany has two operating segments: designing, purchasing or contracting forthe manufacture of and wholesale sales of men’s and women’s (1) fashion golfapparel and outerwear and (2) branded apparel. Our Ben Hogan® and SPORT HALEY®fashion golf apparel and outerwear collections are marketed by Sport-Haley,Inc. in the premium and mid-priced markets through a network of independentwholesale sales representatives and distributors to golf professional shops,country clubs, resorts and exclusive department stores within the United Statesand on a limited basis by certain distributors within international markets.Currently, we distribute Top-Flite® men’s branded apparel exclusively throughWal-Mart. in the United States within the operations of Reserve Apparel GroupLLC. Ben Hogan® fashion apparel and Top-Flite® branded apparel are distributedpursuant to a licensing agreement with Callaway.

In November 2005,Callaway granted Sport Haley permission, with certain conditions, to allowReserve Apparel to distribute Top-Flite® branded apparel exclusively toWal-Mart within the United States. Reserve Apparel was formed to combine theperceived synergies between Sport Haley and Explorer Gear. Principle members ofthe management of Explorer Gear are also the principle members of themanagement of Explorer Headgear, Inc., a Canadian company which has distributedTop-Flite® apparel to Wal-Mart in Canada for several years. Therefore, ReserveApparel was structured to utilize the expertise of Explorer with regard todesigning, sourcing and pricing branded apparel suitable for, obtaining salesfrom and distributing mass quantities of merchandise to Wal-Mart by exercisingthe marketing rights held by Sport Haley with regard to distributing apparelbearing the Top-Flite® brand.

Shortly after itsformation, Reserve Apparel began experiencing numerous problems with thedistribution of Top-Flite® apparel. Production delays and other problems causedthe first shipments to Wal-Mart, made in March 2006, to be approximately threemonths late, and all but one subsequent shipment made in April, May 

F-22

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and June 2006 weresimilarly delayed. The tardiness of deliveries caused Wal-Mart to require thatthe late shipments be made directly to stores, which significantly increasedour shipping costs. Had the merchandise been timely delivered to us by thesuppliers, we would have been able to ship the merchandise directly to Wal-Martdistribution centers, thereby incurring much lower shipping costs.

In March 2006, themanagement of Explorer Gear declined requests to fund their proportionate shareof Reserve Apparel’s costs, especially with regard to inventory purchases.Explorer further requested that they be relieved of certain of their duties,required per Reserve Apparel’s Operating Agreement, in order that substantiallyall of the business operations of Reserve Apparel, including designing,sourcing, pricing, soliciting sales and coordinating the distribution ofmerchandise, could be transferred to the Sport Haley facilities in Denver,Colorado, to be managed under the direction of Sport Haley executives.Therefore, in order to obtain merchandise to fulfill orders from Wal-Mart,Sport Haley began funding 100% of the inventory purchases of Reserve Apparelbeginning in March 2006. Amounts advanced by Sport Haley were recorded as loansto Reserve Apparel. While Sport Haley began facilitating the transfer ofReserve Apparel operations to Denver in April 2006, Explorer Gear continuedwith their involvement in the management of deliveries of inventories fromsuppliers and the invoicing of shipments to Wal-Mart through June 2006.

Generally, brandedapparel inventories are not prone to impairment, because we usually orderbranded apparel in exact quantities to sufficiently satisfy specific customerorders. However, branded apparel inventories remained on hand at June 30, 2006,because we shipped branded apparel for a Father’s Day promotion in June 2006,five weeks later than requested by Wal-Mart. Due to the tardiness of thatshipment, Wal-Mart canceled the follow-up order, the apparel for which we hadalready purchased and received. Accordingly, we recorded a write-down of$95,000 in the fourth quarter of 2006 to value our branded apparel inventorieson hand at June 30, 2006, to the net amount we expected to recover from sellingthe goods to another market.

Our net sales andgross margin in 2006 with regard to branded apparel were affected by salesprice concessions granted to Wal-Mart for the Father’s Day promotion.Periodically, per our vendor agreement, Wal-Mart may request that we reimbursethem for mark downs they have taken or plan to take on Top-Flite® apparel wehave sold to them. It is our understanding that Wal-Mart typically requestsmarkdown money when sales of merchandise do not reasonably meet their internalprojections. Because we shipped Top-Flite® apparel for the Father’s Day promotionfive weeks late, Wal-Mart lost early sales opportunities for the merchandise,and sell-through of the Top-Fite® apparel produced for that promotion did notreasonably meet their expectations. We recorded sales discounts of $168,000 inthe fourth quarter of 2006 relating to markdown concessions granted to Wal-Martwith regard to the Father’s Day promotion.

Our cost of goodssold with regard to branded apparel was affected by the continual productiondelays incurred throughout 2006. We estimate that the production delays causedus to incur $70,000 in additional inbound freight charges in 2006. Further, weestimate that additional shipping costs included in our cost of goods sold,incurred to provide delivery of Top-Flite® orders directly to Wal-Mart storesrather than to their distribution centers as originally planned, were in excessof $200,000 for 2006.

Balance sheetsinformation and statements of operations information for each of our segmentsare presented in the tables below. The first shipments of Top-Flite® brandedapparel were made in March 2006. Therefore, the tables below only includesegment information for the quarter and year ended June 30, 2006.

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*BalanceSheets Segment Information as of June 30, 2006:*
|                                         | ** ** | **June 30, 2006** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **Fashion**                 | ** ** | **Branded** | ** ** |
| ** **                              | ** ** | **Apparel**                 | ** ** | **Apparel** | ** ** |
|                                    |       |                        |       |   |   |
| Cash and cash  equivalents              |       | $                           | 6,590,000  |   | $ | 1,902,000 |   |
| Accounts  receivable, net of allowances |       | $                           | 3,194,000  |   | $ | 756,000 |   |
| Inventories                             |       | $                           | 4,440,000  |   | $ | 335,000 |   |
| Total assets                            |       | $                           | 15,034,000 |   | $ | 2,993,000 |   |
| Current liabilities                     |       | $                           | 1,944,000  |   | $ | 1,012,000 |   |

 

*Statementsof Operations Segment Information for the Quarter and Year Ended June 30, 2006:*
|                                               | ** ** | **Quarter Ended**      | ** ** | **Year Ended**         | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **June 30, 2006** | ** ** | **June 30, 2006** | ** ** |
| ** **                                    | ** ** | **Fashion**                 | ** ** | **Branded**                 | ** ** | **Fashion** | ** ** | **Branded** | ** ** |
| ** **                                    | ** ** | **Apparel**                 | ** ** | **Apparel**                 | ** ** | **Apparel** | ** ** | **Apparel** | ** ** |
|                                          |       |                        |       |                        |       |   |   |   |   |
| Net sales                                     |       | $                           | 5,838,000  |                        | $          | 2,027,000 |   | $ | 18,489,000 |   | $ | 2,473,000 |   |
| Cost of goods  sold                           |       | $                           | 3,673,000  |                        | $          | 1,835,000 |   | $ | 11,378,000 |   | $ | 2,264,000 |   |
| Impairments                                   |       | $                           | 28,000     |                        | $          | 95,000 |   | $ | 313,000 |   | $ | 95,000 |   |
| Gross profit                                  |       | $                           | 2,137,000  |                        | $          | 96,000 |   | $ | 6,798,000 |   | $ | 114,000 |   |
| Selling, general  and administrative expenses |       | $                           | 1,638,000  |                        | $          | 331,000 |   | $ | 6,621,000 |   | $ | 469,000 |   |
| Royalty expense                               |       | $                           | 254,000    |                        | $          | 132,000 |   | $ | 768,000 |   | $ | 159,000 |   |
| Income (loss) from  operations                |       | $                           | 245,000    |                        | $          | (367,000 | ) | $ | (591,000 | ) | $ | (514,000 | ) |

 

13.       **SUBSEQUENTEVENTS**:

In September 2006,Sport Haley entered into an agreement with Explorer Gear and Explorer Headgear,Inc., which was approved by Reserve Apparel, for the purchase of Explorer Gear’smembership interest in Reserve Apparel and to settle any potential claimsbetween the parties. The agreement required Sport Haley to make a lump sumpayment to Explorer Gear of $375,000. After Reserve Apparel began operations,certain disputes arose between the members concerning, among others, theformation, operation and performance of Reserve 

F-24

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Apparel. SportHaley, Reserve Apparel, Explorer Gear and Explorer Headgear, Inc. have deniedany liability to one another. As part of the agreement, the parties have agreedto settle and resolve any asserted or potential claims against each other. Theparties have also agreed to mutual releases of all claims asserted, or whichcould have been asserted, against each other, and each party has continued todeny the merits of those claims asserted against it by the other. Upon enteringinto the agreement, Explorer Gear no longer owned any membership interest inReserve Apparel, which became a wholly-owned subsidiary of Sport Haley.

After theoperations of Reserve Apparel were moved to our Denver, Colorado facility,Reserve Apparel designed of a new line of Top-Flite® apparel, under thedirection of Sport Haley management. The new Top-Flite® apparel line,consisting of basic and fancy collections of garments comprised primarily of avariety of performance fabrics, was presented to Wal-Mart buyers in earlySeptember 2006. However, in late September 2006, Reserve Apparel was notifiedthat Wal-Mart had chosen to develop its own brand of golf apparel rather thanto continue purchasing our Top-Flite® line. We expect to develop other marketsand channels of distribution for our Top-Flite® apparel collections, includingmarketing the newly designed Top-Flite® line to other mass retailers.

As previouslyreported, a Canadian apparel broker, which had handled several deliveries ofTop-Flite® apparel to Reserve Apparel, applied a $291,000 prepayment to satisfya debt of Explorer Headgear, Inc. (a Canadian company related to Explorer Gearby common ownership, management and employees) instead of applying the amountas a deposit toward the production of finished goods inventories which wereplanned to be provided to Reserve Apparel by the Canadian broker. The $291,000deposit had been advanced to the Canadian broker by Sport Haley as a payment onbehalf of Reserve Apparel and was recorded by Sport Haley as a member loan toReserve Apparel. At June 30, 2006, the $291,000 was included as an otherreceivable on the books of Reserve Apparel. We believe that the Canadian brokerinappropriately misapplied the $291,000 deposit and have demanded repaymentfrom the broker. During May and June 2006, we received certain assurances fromthe Canadian broker that this matter would be resolved to our satisfaction.However, there has been no resolution to this matter.

Also as previouslyreported, an executive from Explorer Gear informed the management of ReserveApparel that the amount of $236,000, which was previously purported by ExplorerGear to have been paid to the Canadian broker on behalf of Reserve Apparel, hadnot been paid. At June 30, 2006, the $236,000 was included in the accruedliabilities of Reserve Apparel.

In June 2006,Reserve Apparel discovered that the Canadian broker had been paid twice for thesame delivery of Top-Flite® apparel to Reserve Apparel, in the amount of$177,000. Further, in August 2006, because the Canadian broker did not meetWal-Mart’s extended deadline for receipt of the merchandise, Wal-Mart canceledtheir order relating to the merchandise being provided by the Canadian broker,which otherwise would have been shipped to Wal-Mart in August 2006.Consequently, Reserve Apparel canceled the purchase order with the Canadianbroker, which was approximately in the amount of $267,000. We do not believethat Reserve Apparel is liable for payment to the Canadian broker with regardto the delinquent goods which Wal-Mart would not accept. However, since it isour understanding that the merchandise was in production when Wal-Mart canceledtheir order, we cannot give any assurances that the Canadian broker will notasset that Reserve Apparel is responsible for paying for these goods. As of thedate of this report, we did not have any pending orders with the Canadianbroker, and we do not anticipate placing any orders with the Canadian brokerfor future delivery of Top-Flite® or any other apparel.

F-25

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In October 2006,we made a formal demand for repayment from the Canadian broker for the $291,000deposit and the $177,000 overpayment, and, if an amicable resolution of thismatter is not reached with the Canadian broker in the near future, we expect toinitiate legal proceedings to recover the funds. While we expect toaggressively pursue full recovery from the Canadian broker, because of therelative ages of the misapplied deposit and overpayment and the nature of oursevered relationship with the Canadian broker, we recorded an allowance of$116,000 at June 30, 2006, with regard to the net amount due from the Canadianbroker.

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

The followingquarterly information is unaudited. In the opinion of management, all materialadjustments necessary to present fairly the results of operations of theCompany, for the periods presented, have been made. All such adjustments wereof a normal, recurring nature.
|                                    | ** ** | **Sep 30,** | ** ** | **Dec 31,** | ** ** | **Mar 31,** | ** ** | **Jun 30,** | ** ** |
|------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| **2006 Quarter Ended**   | ** ** | **2005**         | ** ** | **2005**         | ** ** | **2006**         | ** ** | **2006**         | ** ** |
| Net sales                          |       | $                | 4,011,000  |             | $          | 4,429,000        |       | $                | 4,656,000  |   | $ | 7,866,000 |   |
| Total cost of  goods sold          |       | 2,706,000        |       | 2,792,000        |       | 2,919,000        |       | 5,633,000        |       |
| Gross profit                       |       | $                | 1,305,000  |             | $          | 1,637,000        |       | $                | 1,737,000  |   | $ | 2,233,000 |   |
| Total operating  expenses          |       | $                | 1,887,000  |             | $          | 1,613,000        |       | $                | 2,162,000  |   | $ | 2,355,000 |   |
| Net income  (loss)                 |       | $                | (528,000   | )                | $          | 99,000           |       | $                | (190,000   | ) | $ | 204,000 |   |
| Basic earnings  (loss) per share   |       | $                | (0.20      | )                | $          | 0.04             |       | $                | (0.07      | ) | $ | 0.08 |   |
| Diluted earnings  (loss) per share |       | $                | (0.20      | )                | $          | 0.03             |       | $                | (0.07      | ) | $ | 0.07 |   |

 
|                                    | ** ** | **Sep 30,** | ** ** | **Dec 31,** | ** ** | **Mar 31,** | ** ** | **Jun 30,** | ** ** |
|------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **2005 Quarter  Ended**            | ** ** | **2004**    | ** ** | **2004**    | ** ** | **2005**    | ** ** | **2005**    | ** ** |
| Net sales                          |       | $           | 5,570,000  |        | $          | 5,000,000   |       | $           | 4,455,000  |   | $ | 7,016,000 |   |
| Total cost of  goods sold          |       | 3,800,000   |       | 4,542,000   |       | 2,823,000   |       | 4,524,000   |       |
| Gross profit                       |       | $           | 1,770,000  |        | $          | 458,000     |       | $           | 1,632,000  |   | $ | 2,492,000 |   |
| Total operating  expenses          |       | $           | 3,057,000  |        | $          | 2,516,000   |       | $           | 2,287,000  |   | $ | 1,973,000 |   |
| Net income  (loss)                 |       | $           | (1,276,000 | )           | $          | (2,006,000  | )          | $           | (586,000   | ) | $ | 587,000 |   |
| Basic earnings  (loss) per share   |       | $           | (0.52      | )           | $          | (0.77       | )          | $           | (0.23      | ) | $ | 0.23 |   |
| Diluted earnings (loss)  per share |       | $           | (0.52      | )           | $          | (0.77       | )          | $           | (0.23      | ) | $ | 0.20 |   |

** **

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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,                                  |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2004                                      |       | $                                              | 316,000    |                                                     | $          | 272,000                              |       | $                 | —     |   | $ | (134,000 | )(1) | $ | 454,000 |   |
| 2005                                      |       | $                                              | 454,000    |                                                     | $          | 180,000                              |       | $                 | —     |   | $ | (257,000 | )(1) | $ | 377,000 |   |
| 2006                                      |       | $                                              | 377,000    |                                                     | $          | 194,000                              |       | $                 | —     |   | $ | (280,000 | )(1) | $ | 291,000 |   |
|                                      |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| **ALLOWANCE FOR SALES RETURNS**           | ** ** | ** **                                     | ** ** | ** **                                               | ** ** | ** **                           | ** ** | ** **        | ** ** | ** ** | ** ** |
| June 30,                                  |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2004                                      |       | $                                              | 226,000    |                                                     | $          | 1,386,000                            |       | $                 | —     |   | $ | (1,270,000 | )(2) | $ | 342,000 |   |
| 2005                                      |       | $                                              | 342,000    |                                                     | $          | 2,112,000                            |       | $                 | —     |   | $ | (2,168,000 | )(2) | $ | 286,000 |   |
| 2006                                      |       | $                                              | 286,000    |                                                     | $          | 573,000                              |       | $                 | —     |   | $ | (704,000 | )(2) | $ | 155,000 |   |
|                                      |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| **ALLOWANCE FOR SAMPLE GARMENT  RETURNS** | ** ** | ** **                                     | ** ** | ** **                                               | ** ** | ** **                           | ** ** | ** **        | ** ** | ** ** | ** ** |
| June 30,                                  |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2004                                      |       | $                                              | —     |                                                     | $          | 368,000                              |       | $                 | —     |   | $ | (36,000 | )(2) | $ | 332,000 |   |
| 2005                                      |       | $                                              | 332,000    |                                                     | $          | 322,000                              |       | $                 | —     |   | $ | (626,000 | )(2) | $ | 28,000 |   |
| 2006                                      |       | $                                              | 28,000     |                                                     | $          | —                               |       | $                 | —     |   | $ | (28,000 | )(2) | $ | — |   |
|                                      |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| **ALLOWANCE FOR INVENTORY  OBSOLESCENCE** |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| June 30,                                  |       |                                           |       |                                                     |       |                                 |       |              |       |   |   |
| 2004                                      |       | $                                              | 456,000    |                                                     | $          | 707,000                              |       | $                 | —     |   | $ | (216,000 | )(3) | $ | 947,000 |   |
| 2005                                      |       | $                                              | 947,000    |                                                     | $          | 1,403,000                            |       | $                 | —     |   | $ | (1,721,000 | )(3) | $ | 629,000 |   |
| 2006                                      |       | $                                              | 629,000    |                                                     | $          | 313,000                              |       | $                 | —     |   | $ | (761,000 | )(3) | $ | 181,000 |   |

 

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(1) Written-offuncollectible accounts, net of recoveries of previously written-offuncollectible accounts.

(2) Gross salesreturns.

(3)Changes in allowance relating to sales and dispositions of inventoriespreviously written down.

F-27

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