## **FORM 10-K**

## ** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**(Mark One)**
| **ý** | ** ** | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                               |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                              |
|       |       | **For the fiscal year ended  June 30, 2005**                                                                                                                                                                                                                                                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                                                                                              |
|       |       | **OR**                                                                                                                                                                                                                                                                                                                                                            |
|       |       |                                                                                                                                                                                                                                                                                                                                                              |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                           |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                        |
| ** ** | ** ** | **For the transition period from                             to                            ** |

 

**Commissionfile number:  33-74876-D**

 

**SPORT-HALEY, INC.**

(Exact Name ofRegistrant 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’stelephone number, including area code:  **(303) 320-8800**

 

Securitiesregistered pursuant to Section 12(b) of the Exchange Act:

 

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

 

Securities registeredpursuant to section 12(g) of the Exchange Act:

 

**CommonStock, no par value per share**

 

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

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).Yes oNo ý

 

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

 

As of December 31,2004, the last business day of the registrant’s most recently completed second fiscalquarter, the aggregate market value of the 2,306,635 shares of Common Stock(the Registrant’s only common equity) held by non-affiliates was $10,541,000 basedon the closing sale price of the Registrant’s Common Stock on the NasdaqNational Market® on such date. For purposes of the foregoing calculation only,each of the Registrant’s officers and directors is deemed to be an affiliate.This determination of affiliate status is not a conclusive determination forother purposes.

 

There were 2,770,252shares of the Registrant’s Common Stock outstanding at the close of business onSeptember 8, 2005. 

 

DOCUMENTSINCORPORATED BY REFERENCE:

 

**None**

 

 

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**PART I**

 

**ITEM 1.  BUSINESS**

 

**General**

 

Sport-Haley, Inc. (alsothe “Company”) designs, sources, markets and distributes men’s and women’sfashion golf apparel and outerwear under the SPORT HALEYTM and Ben Hogan® labels.Our fashion golf apparel collections, known for their innovative designs,quality fabrics, generous fits and classic styles, are primarily marketed inthe premium and mid-price markets, through a network of independent salesrepresentatives and distributors, to golf professional shops, country clubs,resorts and specialty retail stores, and to corporate, collegiate and othermarkets, throughout the United States and by certain distributors withininternational markets. We distribute Ben Hogan® apparel pursuant to a license agreementwith Callaway Golf Company (“Callaway”). Appeal for the SPORT HALEYTM and BenHogan® brand names are enhanced because golf professional shops, country clubsand resorts generally prefer to sell quality apparel that is not broadlydistributed in other retail markets. We have focused our marketing efforts onexpanding brand recognition and appeal for SPORT HALEYTM and Ben Hogan® apparelby continually improving the styling, sourcing and fabrications of our garmentsin order to continue to offer our customers high-quality garments atcompetitive prices. Other services thatwe offer include optional custom embroidering of our apparel with apersonalized club, resort or corporate logo. Sport-Haley, Inc. wasincorporated in Colorado in January 1991. The principal executive officesare located at 4600 East 48th Avenue, Denver, Colorado 80216-3215, and the maintelephone number is (303) 320-8800.

 

**Products and Product Design**

 

SPORT HALEYTM branded apparelis currently comprised almost exclusively of women’s garments and accessories, designedby utilizing classic styles with contemporary influences intended to developand maintain brand recognition and loyalty, on or off the golf course. Whileeach product in the SPORT HALEYTM apparel line is sold separately, it isdesigned in groups with coordinated styles, color schemes and fabrics toencourage customers to purchase multiple garments. SPORT HALEYTM branded apparelis manufactured using a variety of fabrics and weave patterns, includinginterlock, pique, French terry, jersey and twill, and may feature a uniquetrim, a special fabric finish or extra needlework. SPORT HALEYTM branded apparelis marketed in the premium and mid-price markets. Our SPORT HALEYTM men’sapparel for the spring 2006 season, introduced in July 2005, consists offour separate styles of polo shirts in several separate colors each plus oneouterwear piece in five separate colors.

 

The following tablepresents the suggested retail price ranges for various HALEY® apparel items:

 
| **SPORT  HALEYTM**    | ** ** | **Suggested Retail** | ** ** |
|---------------------------|------------|----------------------|------------|
| **Women’s  Apparel** | ** ** | **Price Range**      | ** ** |
| Tops                      |       | $                    | 26         | - | $ | 72 |   |
| Shorts                    |       | $                    | 38         | - | $ | 76 |   |
| Pants                     |       | $                    | 46         | - | $ | 80 |   |
| Sweaters                  |       | $                    | 56         | - | $ | 96 |   |
| Outerwear                 |       | $                    | 38         | - | $ | 134 |   |
| Accessories               |       | $                    | 18         | - | $ | 30 |   |
|                      |       |                 |       |   |   |   |   |
| **SPORT  HALEYTM**    | ** ** | **Suggested Retail** | ** ** |
| **Men’s  Apparel**   | ** ** | **Price Range**      | ** ** |
| Shirts                    |       | $                    | 36         | - | $ | 50 |   |
| Outerwear                 |       | $ 70            |       |

 

Ben Hogan® men’s apparel is designed utilizing eleganttime-honored classic styles intended to garner nearly instantaneous brandrecognition. While each product in the Ben Hogan® apparel line is soldseparately, it is designed in groups with coordinated styles, color schemes andfabrics to encourage customers to purchase multiple garments. Ben Hogan®apparel is manufactured using a variety of fabrics, including wool, silk andcashmere, and weave patterns, including pique, jersey and twill, and mostpieces feature a unique trim, a special fabric finish or extra

 

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needlework. Ben Hogan®men’s apparel is marketed in the premium-price markets to elite golfprofessional shops, upscale resorts and exclusive department stores.

 

The following tablepresents the suggested retail price ranges for various Ben Hogan® apparelitems:

 
| **Ben Hogan®**     | ** ** | **Suggested Retail** | ** ** |
|-------------------------|------------|----------------------|------------|
| **Men’s  Apparel** | ** ** | **Price Range**      | ** ** |
| Shirts                  |       | $                    | 70         | - | $ | 174 |   |
| Shorts                  |       | $                    | 68         | - | $ | 72 |   |
| Pants                   |       | $                    | 88         | - | $ | 124 |   |
| Sweaters                |       | $                    | 76         | - | $ | 194 |   |
| Outerwear               |       | $                    | 94         | - | $ | 974 |   |

 

We closely coordinate thedesigning functions with our sales and production operations. The process forour design function for each collection of garments is a continual cycle ofselecting fabric and weave patterns, coloring, styling, and sewing techniques, whichincludes supervising the production of prototype garments. We primarily utilizein-house designers to develop our apparel collections. Our design staff isresponsible for negotiating price and minimum quantities with suppliers,arranging for pattern and sample manufacturing, and coordinating finished goodsdelivery schedules with production personnel. The design staff also supervisesthe quality controls for inspection of fabric samples, as well as the testingof fabric samples for die lots, shrinkage and colorfastness. Key persons withinour design and production staffs periodically visit international and domesticfactories that produce SPORT HALEYTM and Ben Hogan® apparel in order to assurethat quality expectation standards and production schedules are met orexceeded.

 

Finished apparel isgenerally received at our warehouse, embroidery and distribution facilities inDenver, Colorado. Some apparel items, primarily shirts and tops, areembroidered with the SPORT HALEY® or Ben Hogan® sleeve logo. Approximately 80%of men’s apparel is custom embroidered with a golf course, country club, resortor company logo, whereas only approximately 30% of women’s apparel is similarlyembroidered. We maintain an electronic library of over 10,000 custom logos and utilizeten computer-controlled embroidering machines, which cumulatively have thecapacity to embroider up to 4,000 custom logos each day. After beingembroidered to the customer’s specifications, apparel receives a finalinspection by quality assurance personnel. Generally, customer orders arepackaged and shipped from our Denver, Colorado facility.

 

#### **Sales andMarketing**

#### ** **

*Overview.*We continually implement marketing strategies designed to enhance our positionas a high-quality provider of fashion golf apparel by capitalizing on themarket awareness of the SPORT HALEYTM and Ben Hogan® brand names to establish,maintain and improve distribution channels. We implement these strategies by: (i) enhancingdistribution channels through our network of independent wholesale salesrepresentatives in an effort to add new golf professional shops to our customerbase and maximize purchases from existing customers; (ii) diversifyingproduct lines by developing new styles and designs that are natural variationson our existing apparel designs; and, (iii) intensifying marketing effortsin the premium, mid-priced and specialty retail markets.

 

 In fiscal 2005, 53% of our apparel sales werecomprised of Ben Hogan® apparel, and SPORT HALEYTM garments and accessoriesaccounted for 47% of our apparel sales. No single customer accounted for 5% ormore of our fiscal 2005 net sales.

 

*GolfProfessional Shops, Country Clubs and Resorts.*Domestic salesof SPORT HALEYTM and Ben Hogan® apparel are solicited primarily through anetwork of approximately 30 independent wholesale sales representatives thatsell the apparel, on a commission basis, mainly to golf professional shops atcountry clubs, resorts, exclusive department stores and specialty retail storesin all of the 50 United States. Approximately 90% of our independent salesrepresentatives market both our SPORT HALEYTM and Ben Hogan® apparel lines. The

 

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independentrepresentatives, many of whom may also market other golf-related items, areresponsible for generating new business and serving customers within specificgeographic territories. Since January 1997, we have maintained buyingprograms with various entities whereby the participating golf professional shopoperators may purchase apparel directly from us in accordance with specific groupprograms. The group programs accounted for about 25% of our gross sales infiscal 2005. International sales are made through distributors in the UnitedKingdom, Caribbean Islands, Mexico and Japan, and to certain U.S. militarybases overseas. Historically, the vast majority of our sales have been to domesticcustomers. International sales represented less than 1% of our net sales infiscal 2005.

 

Our executive management continuesto attempt to expand the international sales of Ben Hogan® apparel among the certaininternational territories specified within the license agreement byestablishing and maintaining distribution agreements with individualdistributors in the respective markets. However, the actual growth we have achievedwithin those markets has been minimal.

 

Our sales and marketingexecutives are responsible for implementing marketing plans and sales programs,coordinating our network of independent wholesale sales representatives,providing customer service support and participating in industry tradeshows. Oursales and marketing executives support the sales activities of our independent salesrepresentatives and distributors by personally assisting and training therepresentatives, supporting their participation in regional tradeshows, assigningspecific customer service personnel to assist them within specific geographicregions, advancing the distribution of sample garments, providing detailedcatalogs that present pricing, sizing and style options for each collection ofgarments, and providing access to a private electronic network designed toexpedite sales order processing. Via personal computers, each salesrepresentative has access to current and future inventory availability and maycreate and transmit orders from remote locations. Remote computer access enhancesthe representatives’ order processing speed and accuracy and reduces the riskof placing customer orders that cannot be timely delivered. The electronicnetwork also interfaces with our comprehensive management information systemthat provides key sales order data to assist management with planning,production scheduling, sales trends and cost controls.

 

Information regarding ourSPORT HALEYTM and Ben Hogan® brands, as well as general corporate information,may be found on our respective websites. The websites were designed to individuallyportray the design images inherent in our SPORT HALEYTM and Ben Hogan® brands.The SPORT HALEYTM site, located at www.sporthaley.com, utilizes a distinctivecontemporary and feminine feel. The Ben Hogan® site, located atwww.benhoganapparel.com, generates a masculine sense through the use of darkrich colors and club house photos of various exclusive country clubs. Thecorporate site, located at www.sporthaleyinc.com, includes a basic corporateoverview and links to pertinent investor relations information. Each of thewebsites contains active links to one another. The SPORT HALEYTM and Ben Hogan®websites each include a glimpse of current and future collection offerings,design philosophies and locator systems that can direct retail customers to establishmentsthat sell our apparel and wholesale customers to our independent salesrepresentative in their respective geographic area. While we have not been ableto quantify the effectiveness of the locator systems, we believe that they enhanceour marketing efforts by enabling the end consumer to find our product lines intheir area, thereby creating “pull through” sales for our current retailers andaffording new customers easy access to contact information for our independentsales representative in their respective geographic region.

 

We introduce our distinctiveSPORT HALEYTM and Ben Hogan® golf apparel collections for the fall sellingseason at a major golf industry tradeshow that is generally held in January ofeach year in Orlando, Florida. Because many buyers for golf resorts andprofessional shops attend this particular tradeshow, we usually book asignificant number of customer orders at or following the show. Retailersattending the tradeshow also provide us with direct feedback regarding appareldesigns, fabrics, styles, fashion trends and other information necessary toassist management with the preparation of sales forecasts and productionschedules.

 

In order to enhance thevisibility of our SPORT HALEYTM and Ben Hogan® apparel, we may from time to timeestablish endorsement agreements with a limited number of PGA and LPGAprofessionals. In accordance with

 

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an endorsement agreement,we may compensate the respective professional with apparel allowances, cashand/or other compensation.

 

We periodically advertiseour SPORT HALEYTM and Ben Hogan® apparel in several separate golf industrypublications, including those that are distributed primarily to operators ofgolf professional shops. We also expend a portion of our advertising budget tosupport the sales activities of our independent sales representatives bysupporting their participation in regional tradeshows. Internationaldistributors provide and pay for advertising, if any, in their respectivegeographic territories. In accordance with the license agreement, Callaway GolfCompany also advertises the Ben Hogan® brand in golf trade industrypublications and through other golf marketing channels.

 

We maintain a programthat provided select customers with display fixtures dedicated to featuring SPORTHALEYTM brand apparel. We also maintain a program that provides certainof our customers with distinctive fixtures dedicated to featuring Ben Hogan® apparelcollections. Upon thecustomer’s agreement to maintain a pre-determined amount of inventory for aspecified period of time, the fixtures became the property of the customer fora nominal delivery fee. The display fixture programs encourage customers to reordera sufficient amount of garments to maintain prominent displays of largeselections of SPORT HALEYTM and Ben Hogan® apparel in their stores.

 

*CorporateMarket.*While we believe that there is a natural synergybetween the golf apparel market and the corporate apparel market, because bothmarkets can be served from some of the same inventory, we do not maintaininventory levels sufficient to generate significant sales within corporatemarkets. We have developed a limited number of direct corporate accounts, and havehistorically pursued this market primarily though promotional-product companiesthat source and distribute a variety of products for corporate fulfillmentprograms and special events. These promotional-product companies generallyproduce corporate catalogs containing apparel and other products that may beused for employee recognition, customer appreciation and other corporatepurposes. A promotional-product company may also source and supply a specificproduct or products for special events sponsored by a corporation. SPORT HALEYTMand Ben Hogan® apparel collections are currently included, or confirmed to beincluded, in a variety of catalogs, including catalogs for a few Fortune 500companies. We do not enter into formal agreements or contracts with thesepromotional-product companies, but we do agree that we will make available theproducts advertised in any specific catalog during the period the catalog isbeing used, generally a one-year period. Because corporate apparel inventorymust be maintained for a longer period of time and the classic styles ofcorporate apparel are generally not designed for one specific selling season, wetypically feature only one collection of garments in our corporate collections eachyear. Corporate sales are made periodically throughout the year, and thuscorporate sales are not historically quantifiable within the fixed or seasonalselling periods common to the other SPORT HALEYTM and Ben Hogan® apparelcollections. On a limited basis, we utilize a combination of our independentwholesale sales representatives, sales management and executives to market SPORTHALEYTM and Ben Hogan® apparel collections directly within corporate markets.

** **

*LicenseAgreement.*In May 2001, we entered into a license agreementwith Spalding Sports Worldwide, Inc. (“Spalding”) that granted us theright to market men’s premium golf apparel under the Ben Hogan® brand name. In July 2002,  the license agreement was amended to expandthe applicable territory covered by the agreement to include the UnitedKingdom, Sweden, Mexico and various Caribbean countries. The original license agreementhad previously granted us the right to market Ben Hogan® apparel within theUnited States. In May 2003, Spalding changed its corporate name to TheTop-Flite Golf Company, Inc. (“Top-Flite Golf”). In June 2003, the licenseagreement was amended to reflect Spalding’s name change to Top-Flite Golf andto grant us an additional license to market a full line of golf apparel bearingthe Top-FliteTM brand name in the United States and its territories, Mexico,Aruba, the Cayman Islands, Jamaica, the Dominican Republic, the Bahamas and theBritish Virgin Islands. In September 2003, Callaway Golf Company (“Callaway”)purchased substantially all of the assets of Top-Flite Golf including the BenHogan® and Top-FliteTM brand names licensed to us. Subsequently, Callaway requested that wedelay our planned launch of Top-FliteTM branded apparel. We maintain the rightto market men’s and women’s golf apparel bearing the Top-FliteTM brand name, inaccordance with the terms of the license agreement. Recently, we’ve haddiscussions with Callaway, and we plan to introduce collections of Top-FliteTMbranded apparel within the United States in the future.

 

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**Competition**

 

The fashion golf apparelmarket, both domestically and internationally, is highly fragmented, and themarket leader has a share of only between 10% and 15% of the total market, perthe most recent “Darrell Survey” of the golf industry. We currently consider Ashworth,Cutter & Buck, Polo, Fairways & Greene, Tehama and EP Pro as ourmost significant competitors in the fashion golf apparel market. In addition tocompeting with fashion golf apparel manufacturers, we must also compete withmanufacturers of high quality men’s and women’s sportswear and general leisurewear such as Nike and Adidas. Many of these same fashion golf apparel andsportswear companies are also competitors in the corporate market. The intensecompetition throughout both the fashion golf and corporate apparel markets isdefined primarily by brand recognition and loyalty, quality, price, styling anddesign, service and availability of shelf space in the fashion golf apparel andleisure wear markets. Many of our competitors have longer operating histories,better name recognition and greater financial, marketing and other resources.Because of the intense competition in the golf apparel and leisure wearmarkets, we cannot be assured of obtaining additional market share ormaintaining our current market share; and, market and general economicconditions may dictate reductions in selling prices that could result inreduced margins that could adversely impact our financial condition and theresults of our operations.

 

**Finished Goods Sourcing**

 

Many of the SPORT HALEYTMand Ben Hogan® garments are made from 100% cotton fabrics. Certain men’s andwomen’s garments contain silk, wool, rayon or micro-fiber and certain outerweargarments contain micro-fiber, fleece or nylon. The Company’s productionpersonnel assist the design department with the sourcing of finished goodsapparel, 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 initiate any formal contractualarrangements with our suppliers, but we issue purchase orders as apparelpurchases are initiated.

 

We contract with severaloutside suppliers which produce garments in accordance with our specificationsregarding quality, fabrication and custom styling. Almost all of our purchasesare denominated in United States dollars. We do not own or operate any domesticor foreign manufacturing facilities. While we do not maintain long-termcontracts with any of our suppliers, we highly value the long-termrelationships that we have established with several separate suppliers. Weplace orders with our suppliers as needed for delivery of specific quantitieswithin particular date ranges by utilizing relationships we have establishedwith certain foreign agents and foreign or domestic factories. In fiscal 2005, wepurchased approximately 95% of our SPORT HALEYTM and Ben Hogan® apparel from avariety of foreign suppliers. In fiscal 2005, we purchased 43%, 11%, 8%, 7%, 6% and 5% of our finishedapparel from six separate vendors, respectively. The loss of any of thesesignificant vendors could cause substantial disruption to the Company’sshort-term ability to fulfill its customers’ orders on a timely basis.

 

 We receive sales orders for our SPORT HALEYTMand Ben Hogan® spring and fall collections over a period commencing whensamples are first shown to customers and continuing through the respectiveselling seasons. Because the apparel industry has long lead times, we mustbegin to schedule purchases and production of apparel collections inadvance of sales order placements. Because the receiving and delivery ofapparel collections is time-sensitive, management devotes considerable time andeffort to the revision of sales projections, item by item within our apparelcollections. Our computerized management information systems provide managementwith key data that facilitates sales forecasting, product tracking and standardcost controls as well as providing perpetual inventory records and inventoryavailability. 

 

**Seasonal Nature of Business**

 

Fashion apparel sales withinthe golf industry tend to be seasonal in nature, with disproportionately highersales occurring from early spring through early summer. Accordingly, our salesare disproportionately higher from January through June, which are ourthird and fourth quarters of each fiscal year, than sales from July toDecember,

 

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which are our first andsecond fiscal quarters. Pre-booked orders for our spring collections aregenerally solicited from July through December, and customer deliveriesfor the spring season are generally shipped from November through April eachyear. Pre-booked orders for our fall collections are generally solicited from January throughJune, and customer deliveries for the fall season are generally shipped from May throughOctober each year. Spring collections typically account for about 60% ofour annual sales, with the fall collections accounting for the remaining sales.

 

**Management Information Systemsand Inventory Management**

 

We utilize integratedcomputer systems to manage all business transactions, historical data andrecord keeping, including sourcing, warehousing, embroidering and shipping. Thecomputer systems provide information to our executives, management, all of ourinternal departments and our independent wholesale sales representatives. Theelectronic computer system used by our independent sales representativesinterfaces with the main system to provide representatives with inventoryinformation and order entry capability and allows the representatives to orderagainst actual inventory availability. The computer systems provide valuable informationfor forecasting such as analyses of sales histories, purchasing histories, andfuture customer commitments, all of which facilitate the management of finishedgoods inventories.

 

After we implemented ouroperations software in January 2004, we discovered certain programming andhuman errors within the new system that adversely affected the software’sability to accurately compute the valuation of our finished goods inventoriesusing a weighted average method. We consider the programming and human errors,which caused us to use a standard cost assumption, to be a material weakness inour internal controls over financial reporting with respect to inventoryvaluation. The system was designed to utilize a series of complex valuationcomputations, and we determined that a manual reconstruction of the numerousamount of transactions affected by the programming and human errors wasimpracticable. This weakness in ourcontrols prevented us from relying upon the system-recorded transactions withrespect to inventory valuations during fiscal 2005 and 2004. Based uponanalyses performed to compare the landed cost components of our finished goodsinventories with respect to our standard cost components and analyses of theallocated overhead portion of our standard costs, we concluded with reasonableassurance that recomputing the value of our finished goods inventories using astandard cost method yielded a fair estimation of the value of our finishedgoods inventories. We used the standard cost method to value our finished goodsinventories from the fiscal quarter ended March 31, 2004, through thefiscal quarter ended March 31, 2005. At June 30, 2005, certaininventory items remained on hand that had been valued using the standard costmethod. The methods we use to determine the standard costs of our finished goodinventories have not changed since our initial analyses of such costs wereperformed in fiscal 2004. Had we been able to rely upon the system to properlycompute the cost of our finished goods inventories using the weighted averagemethod, we believe that the weighted average method would not have yielded amaterially different computation of the value than the standard cost methodthat we applied.

 

Thematerial weakness in our internal controls over financial reporting withrespect to inventory valuation impaired our ability to rely upon informationcreated by our computer system to fairly present, in all material respects, ourfinancial condition, results of operations and cash flows for fiscal 2005 and2004. The inability of our computer system to properly calculate the valuationof our finished goods inventories using a weighted average cost assumption alsoaffected the system-recorded amounts within our cost of goods sold during fiscal2005 and 2004. Costs associated with invoiced sales and returns as well asinventory adjustments are natural components of our cost of goods sold. Becausewe concluded with reasonable assurance that our using a standard costassumption yielded a fair estimation of our finished goods inventories during fiscal2005 and 2004, and because we consistently recorded adjustments to inventoriesas components of cost of goods sold, we believe with reasonable assurance thatour cost of goods sold are fairly stated for fiscal 2005 and 2004. Therefore,we believe that the procedures we applied to value our finished goodsinventories in fiscal 2005 and 2004 provide us with reasonable assurance thatour financial statements and the notes thereto fairly state, in all materialrespects, our financial condition, the results of our operations and our cashflows.

 

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 Based upon tests we performed subsequent to June 30,2005, we believe that the computer software has been properly programmed, andemployees have been adequately trained to utilize the system procedures, toaccurately compute our finished goods inventory valuations using a weightedaverage cost assumption beginning in fiscal 2006.

 

We maintain a significantamount of finished goods inventories to meet customers’ delivery expectationsand to support the continued increase in sales of Ben Hogan® apparel. Becauseof such factors as the long lead time between ordering and receiving packagedapparel from foreign vendors, receiving advance orders from and delivery offinished apparel to customers, and the considerable number of individual itemsthat comprise apparel collections within a single selling season, an excess offinished goods inventories remaining at the end of a selling season is commonwithin the golf apparel industry. Excess and previous seasons’ finished goodsinventory items usually must be marketed at reduced selling prices, whichnegatively affects gross margins. We utilize our computer systems to assistmanagement with controlling finished goods inventories by providing informationwith regard to sales forecasting, initial and reorders of finished apparel andwarehouse management. The computer system was designed to increase operatingefficiencies by providing better information with regard to sales forecasting,purchasing and inventory management. In fiscal 2005, we improved the methods weuse to assess the recoverability of our finished goods inventories. Wedeveloped a system to better estimate our anticipated future sales in order tobetter forecast inventories expected to remain at the end of a current orfuture distribution period. Having better information available to forecastquantities and mix of unsold inventories allows us to better estimate valuationsof excess inventories expected to be on hand in a future period. Having suchinformation also allows us to better plan marketing strategies for the sales ofsuch inventories through existing marketing channels and to better estimate theoverall recoverability of our finished goods inventories. We believe that themethods we now use to evaluate our finished goods inventories produce fairvaluations of our excess inventories, but, if actual market conditions are lessfavorable than those we have projected, additional allowances may be requiredor losses on dispositions may be recorded, thereby adversely affecting ourfinancial position and the results of our operations.

 

**OrderPlacement and Backlog**

** **

Advance sales orders forthe fall selling season are typically received by the beginning of June eachyear. Similarly, advance sales orders for the spring selling season aretypically received by the beginning of December each year. Due to economicdrivers such as the general economic health of and competition within the golfapparel industry, the overall USA economy and the geopolitical climate throughoutthe world, the trend in our advance sales orders indicates decreases in advancesales orders and increases in “at once” business. This trend adds to thedifficulty associated with sales forecasting and the timing of inventorypurchasing that is already complicated by the long lead times associated withprocuring finished product from overseas suppliers.

 

Generally, we shippartial orders if they are at least 85% complete. We usually allow advanceorders to be changed or canceled up to 30 days prior to the scheduled shippingdate of the merchandise. Generally, we do not sell our apparel on consignmentand generally do not accept returns of purchased apparel, other than apparelthat is defective or damaged or which was shipped to the customer after theirspecified delivery date. Our new operations software affords us the ability toship merchandise within customer-specified delivery dates, thereby reducing salesreturns due to refused shipments for late delivery. As a percentage of netsales, sales returns were approximately 6% in fiscal 2005, 5% in fiscal 2004 and5% in fiscal 2003.

 

Historically, the backlog of orders has not materiallyimpacted our sales with respect to cancellations and rejections of back orders.Back orders are common occurrences within the apparel industry in general. Theamount of back orders outstanding at any particular time may be affected by anumber of factors, including the timely receipt of first-quality products fromsuppliers, which can impact an apparel distributor’s ability to ship garmentson time, and the timing of orders placed by customers. Accordingly, acomparison of the Company’s backlog of orders from period to period is notnecessarily meaningful and may not be indicative of actual shipments during anyspecific period. Our backlog of unfilled customer orders was less than $100,000at June 30, 2005, which compares to approximately $400,000 in back ordersas of June 30, 2004. We filled the majority of the June 30, 2005, backorders within the first few months of fiscal 2006.

 

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#### **Payment Terms**

#### ** **

Generally, sales tocustomers are collectible within 30 days of the sale. However, on a limitedbasis, we may offer discounted or extended payment terms of up to 90 days. Onrare occasions, payment terms may be extended on specific sales to as much as180 days.

 

**Trademarks**

 

We market women’s and alimited amount of men’s fashion golf apparel under the SPORT HALEYTM label. We havebegun the process to register our current SPORT HALEYTM trademarks with theUnited States Patent and Trademark Office. Certain of our former United Statestrademarks expired during 2005. We previously registered other of our former trademarksin a select number of international jurisdictions.    

 

We also market men’sfashion golf apparel under the Ben Hogan® label. Callaway has registered theBen Hogan® trademark and the distinctive signature of Mr. Hogan with theUnited States Patent and Trademark Office. Callaway is also licensed to use theBen Hogan® trademark outside of the United States. We are licensed by Callawayto use the Ben Hogan® trademark in the United States and certain othercountries, subject to the terms of our license agreement with Callaway, asamended.

 

Callaway has begun theprocess to register the Top-FliteTM trademark with the United States Patent andTrademark Office. We are licensed by Callaway to use the Top-FliteTM trademarkin the United States, and its territories and possessions, Mexico, Aruba, theCayman Islands, Jamaica, the Dominican Republic, the Bahamas and the BritishVirgin Islands.

 

**Employees**

 

At June 30, 2005, wehad 68 full-time and three part-time employees, including 23 full-time and onepart-time executive and administrative employees, three full-time marketing andcorporate sales employees, and 42 full-time and two part-time personnel ininspection, packaging, embroidering and distribution operations. The majorityof our sales representatives are independent agents. None of our employees is amember of a trade union, and we consider our relations with our employees andagents to be satisfactory.

 

**ITEM 2.  PROPERTIES**

 

Our executive offices andwarehouse facilities are located in Denver, Colorado. Prior to negotiating anextension of the lease in September 2001, we leased approximately 82,500square feet of floor space at the Denver location. In conjunction with thelease extension, we negotiated a reduction in the floor space leased at theDenver location. As of October 2001, we lease approximately 66,640 squarefeet of the available 82,500 square feet of floor space. The Denver facilitieswere leased at an annual base rent of approximately $255,000 in fiscal 2005. Weare obligated to pay our proportionate share of taxes, insurance andmaintenance expenses for the leased space.

 

**ITEM 3.   LEGAL PROCEEDINGS**

 

As previously reported,in September 2003, the United States Securities and Exchange Commission(the “Commission”) filed suit in the United States District Court for theDistrict of Colorado against Sport-Haley, Inc., Robert G. Tomlinson, our lateChairman and former Chief Executive Officer, and Steve S. Auger, our former Controller(the “Defendants”). The Commission filed an amended complaint in October 2003,which added one of our former auditors to the action as a Defendant. The suitseeks an injunction against future violations and other relief, includingdisgorgement, civil penalties and an order barring Mr. Tomlinson and Mr. Augerfrom serving as director or officer of any publicly held company. The suitalleges that the Defendants misrepresented inventories, period costs and losseson the sale of headwear equipment in annual and/or quarterly financialstatements for Sport-

 

9

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Haley’s fiscal years2000, 1999 and 1998. The amended complaint alleges that Sport-Haley, Inc.violated §17(a) of the Securities Act of 1933 (the “Securities Act”),§10(b), §13(b)(2) and §15(d) of the Securities Exchange Act of 1934(the “Exchange Act”) and various other rules promulgated thereunder. The amendedcomplaint further alleges that Mr. Tomlinson and Mr. Auger violated§17(a) of the Securities Act, §10(b) and §13(b)(5) of theExchange Act and Rules 10b-5 and 13b-2 thereunder. Finally, the suitalleges that Mr. Tomlinson and Mr. Auger aided and abetted Sport-Haley, Inc.in violation of §13(b)(2) and §15(d) of the Exchange Act and various rules promulgatedthereunder. The Commission’s suit primarily relates to errors in our previouslyissued financial statements that we previously reported when we voluntarilyrestated our financial statements for fiscal years 1999 and 1998 andsubsequently corrected material financial information for the quarterly periodsof fiscal years 2000, 1999 and 1998. The Defendants have answered theallegations of the amended complaint, denying the substantive allegations andasserting various defenses. Discovery in the action has concluded. No trialdate has yet been determined. Subject to our Bylaws and Colorado law, we agreedto indemnify Mr. Tomlinson and Mr. Auger, and we have advanced thecosts of their defenses, pending final adjudication of the Action. The costs ofdefense of the action by the Defendants are covered by the applicable liabilityinsurance, subject to a policy retention, which has been satisfied, and otherlimitations. After Mr. Tomlinson’s death in September 2004, theCommission filed a motion to dismiss Mr. Tomlinson from the action withoutprejudice, and the Court granted the motion. In July 2005, we submitted asettlement proposal to the Commission’s Denver regional office, which theparties agreed to amend in September 2005. If the amended settlementproposal is approved by the full Commission in Washington D.C., the litigationagainst us would end, without further material impact on our financial positionor the results of our operations. Counsel to Mr. Auger has informed usthat a settlement proposal has also been submitted to the Denver office on hisbehalf, which, if approved, would also end the litigation against him. TheCourt has issued an Order requiring the settlements, if approved by the fullCommission, be submitted to the Court by no later than October 30, 2005. Basedupon the information that is currently available, management cannot reasonablyestimate the amount of future costs that we will incur defending the Commission’sallegations if our amended settlement offer is not accepted. However, if thesuit were determined in favor of the Commission and against the Defendants, thepossible monetary penalties and other relief that we might be required to pay,and other relief, could further negatively impact our financial position andthe results of our operations.

 

In filing our annualreport on Form 10-K for fiscal 2000, we restated previously issuedfinancial statements. In March 2001, we retained legal counsel to possiblypursue claims against our former auditors in connection with damages sufferedas a result of the restatements of our financial statements for fiscal years1999 and 1998 and the corrections of material information for the quarterlyperiods of fiscal years 2000, 1999 and 1998. Also, counsel to the formerauditors previously advised us that the former auditors may file certain claimsagainst us, possibly including allegations of unpaid fees. Neither have we norour former auditors filed any legal action to assert any of these claims. Basedupon the information that is currently available, we do not believe the impact,if any, of an award to the former auditors, if they were to initiate a formalaction against us, would materially affect our financial position or theresults of our operations. The parties have scheduled a non-binding mediationsession before a neutral party in November 2005.

 

As of June 30, 2005,we had cumulatively incurred $1,100,000 in potentially recoverable costsrelated to the restatements of our fiscal year 1999 and 1998 financialstatements and the correction of material information for the fiscal quartersof years 2000, 1999 and 1998, an investigation and subsequent civil actioninitiated by the Commission and a class action lawsuit that has been settled.The policy retention for such costs has been satisfied, and one of ourinsurance carriers had reimbursed us $401,000 as of June 30, 2005. Amountsrecovered from our insurance carriers are generally offset against otherrelated legal expenses in the period within which they are recovered, orrecoverability is reasonably assured, except that amounts recovered areincluded in other income to the extent that such recovery exceeds legalexpenses for related matters incurred within the period for which the recoveryis recorded. We recorded offsets to legal expenses totaling $88,000, $204,000 infiscal years 2005 and 2004, respectively, and recorded other income of $109,000in fiscal year 2005 with regard to reimbursements from our insurance carriers.

 

10

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We are subject to variousother legal proceedings and claims which arise in the ordinary course of our business.Based upon 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.

 

**PART II**

 

**ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY ANDRELATED SHAREHOLDER MATTERS**

 

Our common stock is quoted on the Nasdaq NationalMarket® under the trading symbol “SPOR.” The following table sets forth therange of high and low sale prices of our common stock, as reported by TheNasdaq Stock Market®, from July 1, 2002 through June 30, 2005. Theprices set forth below reflect interdealer quotations, without retail markups,markdowns or commissions, and may not be representative of actual transactions.

 

| ** **           | ** ** | **High**   | ** ** | **Low**    | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| **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      |       |
|                 |       |       |       |       |       |
| **Fiscal Year 2003** |       |       |       |       |       |
| Fourth Quarter       |       | $          | 4.300      |       | $          | 3.700 |   |
| Third Quarter        |       | 4.000      |       | 3.150      |       |
| Second Quarter       |       | 3.500      |       | 3.180      |       |
| First Quarter        |       | 4.100      |       | 3.150      |       |

#  

As of April 8, 2005,we estimate that there were approximately 900 holders of record of our commonstock. The vast majority of our shares are held in “street name,” and theactual number of holders of record may differ from our estimate. Holders ofcommon stock are entitled to receive such dividends as may be declared by ourBoard of Directors from time to time. No dividends have been paid on our commonstock throughout the history of the Company, and the Board of Directors doesnot anticipate that dividends will be declared in the foreseeable future.

 

**ITEM 6.   SELECTED FINANCIAL DATA**

 

The following selectedfinancial data should be read in conjunction with the Financial Statements andrelated Notes thereto, appearing elsewhere in this report on Form 10-K,and “Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” The statements of operations data for each of the fiscal years inthe three-year period ended June 30, 2005, and the balance sheets data at June 30,2005 and 2004, are derived from the financial statements of Sport-Haley, Inc.which have been audited by Hein & Associates LLP, an independent registeredpublic accounting firm, as indicated in their report included herein. Theconsolidated statements of operations data for each of the fiscal years ended June 30,2002 and 2001, and the balance sheets data at June 30, 2002 and 2001,include the amounts of Sport-Haley, Inc. and our former wholly-ownedsubsidiary, B&L Sportswear, Inc., which ceased business operations in August 2001and was liquidated in May 2002. All significant inter-company transactionswere eliminated from the consolidated financial data. The selected financialdata provided below is not necessarily indicative of the future results ofoperations or future financial performance of Sport-Haley, Inc.

 

11

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| ** **                                                                     | ** ** | **Fiscal Year Ended June 30,**       | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                     | ** ** | **(in thousands, except per share data)** | ** ** |
| **Statements  of Operations Data  (2002 and 2001 Consolidated):**              | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                      |       | $                                         | 22,041     |   | $ | 20,800 |   | $ | 19,196 |   | $ | 17,099 |   | $ | 21,714 |   |
| Cost of goods  sold                                                            |       | 15,689                                    |       | 13,619 |   | 11,873 |   | 12,915 |   | 15,141 |   |
| Gross profit                                                                   |       | 6,352                                     |       | 7,181 |   | 7,323 |   | 4,184 |   | 6,573 |   |
| Operating  expenses                                                            |       | 9,833                                     |       | 8,737 |   | 8,026 |   | 6,886 |   | 7,967 |   |
| Impairment of  fixed assets                                                    |       | 0                                         |       | 0 |   | 0 |   | 0 |   | 254 |   |
| Loss from  operations                                                          |       | (3,481                                    | )          | (1,556 | ) | (703 | ) | (2,702 | ) | (1,648 | ) |
| Other income and  expenses, net                                                |       | 208                                       |       | 116 |   | 135 |   | 346 |   | 591 |   |
| Loss from  operations before (provision for) benefit from income taxes         |       | (3,273                                    | )          | (1,440 | ) | (568 | ) | (2,356 | ) | (1,057 | ) |
| (Provision for)  benefit from income taxes                                     |       | (8                                        | )          | (746 | ) | 180 |   | 1,383 |   | 291 |   |
| Net loss                                                                       |       | $                                         | (3,281     | ) | (2,186 | ) | $ | (388 | ) | $ | (973 | ) | $ | (766 | ) |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Loss per common  and equivalent shares outstanding (basic and diluted)         |       | $                                         | (1.29      | ) | $ | (0.89 | ) | $ | (0.15 | ) | $ | (0.33 | ) | $ | (0.22 | ) |
|                                                                           |       |                                      |       |   |   |   |   |   |   |   |   |
| Weighted average  common and equivalent shares outstanding (basic and diluted) |       | 2,548                                     |       | 2,448 |   | 2,621 |   | 2,938 |   | 3,439 |   |

 
| ** **                                                            | ** ** | **June 30,**                         | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                            | ** ** | **(in thousands, except per share data)** | ** ** |
| **Consolidated  Balance Sheets Data:  (2002 and 2001 Consolidated):** |       |                                      |       |   |   |   |   |   |   |   |   |
| Working capital                                                       |       | $                                         | 14,814     |   | $ | 17,503 |   | $ | 19,180 |   | $ | 20,766 |   | $ | 22,581 |   |
| Total assets                                                          |       | 17,490                                    |       | 20,771 |   | 21,545 |   | 23,525 |   | 25,383 |   |
| Long-term debt                                                        |       | 0                                         |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Total liabilities                                                     |       | 1,751                                     |       | 2,148 |   | 1,118 |   | 1,753 |   | 1,097 |   |
| Shareholders’ equity                                             |       | 15,739                                    |       | 18,623 |   | 20,427 |   | 21,772 |   | 24,286 |   |
| Net book value per share of common stock                              |       | $                                         | 5.95       |   | $ | 7.37 |   | $ | 8.36 |   | $ | 7.97 |   | $ | 7.42 |   |

 

12

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Thefollowing table summarizes selected quarterly financial information for each ofthe quarterly periods in the fiscal years ended June 30, 2005 and 2004:

 
| ** **                                                                            | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **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 2005:**                                                                      | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                             |       | $                        | 5,570      |       | $          | 5,000      |       | $          | 4,455      |       | $          | 7,016 |   | $ | 22,041 |   |
| 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 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      |       |
|                                                                                  |       |                     |       |       |       |       |       |       |       |       |       |
| **Fiscal 2004:**                                                                      | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                             |       | $                        | 4,312      |       | $          | 4,763      |       | $          | 5,365      |       | $          | 6,360 |   | $ | 20,800 |   |
| Cost of goods sold                                                                    |       | 2,672                    |       | 2,905      |       | 3,275      |       | 4,767      |       | 13,619     |       |
| Gross profit                                                                          |       | 1,640                    |       | 1,858      |       | 2,090      |       | 1,593      |       | 7,181      |       |
| Other operating costs                                                                 |       | 1,945                    |       | 1,901      |       | 2,534      |       | 2,357      |       | 8,737      |       |
| Other income and expense, net                                                         |       | 54                       |       | 71         |       | (18        | )          | 9          |       | 116        |       |
| (Provision for) benefit from income taxes                                             |       | 90                       |       | (17        | )          | (231       | )          | (588       | )          | (746       | )          |
| Net income (loss)                                                                     |       | $                        | (161       | )          | $          | 11         |       | $          | (693       | )          | $          | (1,343 | ) | $ | (2,186 | ) |
|                                                                                  |       |                     |       |       |       |       |       |       |       |       |       |
| Earnings (loss) per common share                                                      |       |                     |       |       |       |       |       |       |       |       |       |
| Basic                                                                                 |       | $                        | (0.07      | )          | $          | 0.01       |       | $          | (0.28      | )          | $          | (0.55 | ) | $ | (0.89 | ) |
| Diluted                                                                               |       | $                        | (0.07      | )          | $          | 0.00       |       | $          | (0.28      | )          | $          | (0.55 | ) | $ | (0.89 | ) |
|                                                                                  |       |                     |       |       |       |       |       |       |       |       |       |
| Weighted average shares outstanding                                                   |       |                     |       |       |       |       |       |       |       |       |       |
| Basic                                                                                 |       | 2,445                    |       | 2,445      |       | 2,450      |       | 2,471      |       | 2,448      |       |
| Diluted                                                                               |       | 2,445                    |       | 2,706      |       | 2,450      |       | 2,471      |       | 2,448      |       |

 

**ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

Statements made in thisfiling that are not historical facts are forward-looking statements. The readershould be aware that our actual results could differ materially from thosecontained in forward-looking statements. When used in this 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 any statement regarding possible orassumed future results of operations of our business, the markets for our products,anticipated expenditures, regulatory developments or competition, or otherstatements regarding matters that are not historical facts, are intended toidentify forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Actof 1934, although not all forward-looking statements contain such identifyingwords. Such statements are based on management’s current expectations and aresubject to risks, uncertainties and assumptions. The reader should be awarethat, should one or more of these risks or uncertainties materialize, or shouldunderlying assumptions prove incorrect, the actual plan of operations, businessstrategies, operating results and financial position of Sport-Haley, Inc.could differ materially from those expressed in, or implied by, suchforward-looking statements.

 

Our business in generalis subject to certain risks including the following:

 

•                  Thedemand for our products may decrease if the popularity of golf decreases or ifother factors, such as adverse business conditions, a sluggish economy orinclement weather, cause golfers not to patronize golf professional shops.

 

•                  Wemust continue to successfully anticipate fashion trends, design apparel that isaccepted by consumers as fashionable and stylish and maintain an adequateproduct mix thereof in order to continue to have market acceptance.

 

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•                  Oursales are seasonal, and historically sales from July through December, whichcomprise our first and second fiscal quarters, are weaker than sales from January throughJune, which comprise our third and fourth fiscal quarters.

 

•                  Themarket for golf apparel is extremely competitive; price competition or industryconsolidation could weaken our competitive position. In order to maintain our competitiveposition, we must effectively advertise and communicate within the marketplaceand successfully penetrate our chosen distribution channels.

 

•                  Wemaintain a significant level of finished goods inventories to support our salesvolume and our limited corporate apparel program. Disposal of excess priorseasons’ inventories at reduced margins is an inherent characteristic withinthe golf apparel industry, but a significant amount of sales at the lowermargins dictated by the disposition of excess inventories may impair ourfinancial condition and the results of our operations. Write-downs with regardto obsolete inventories could also continue to adversely affect our financialcondition.

 

•                  Wedepend on timely delivery of finished garments from our suppliers. The loss ofcertain suppliers, and/or delays in receiving garments from suppliers caused byvarious factors, including lost or reduced manufacturing capacity ofsignificant suppliers, labor shortages, timely performance of third parties,and transportation difficulties, and others, could adversely affect our abilityto make timely delivery of finished garments to our customers.

 

•                  Our significant reliance on foreignsuppliers enhances the risk that revenues might be adversely affected if aforeign shipment were lost or significantly delayed. We maintain insurance forrisk of loss including those relating to raw materials inventories shipped betweenforeign vendors and finished goods inventories shipped from foreign suppliersto our distribution facilities in Denver, Colorado. However, significantreliance on foreign suppliers heightens the risk that we would be left withinadequate or unsatisfactory recourse should the goods received from theforeign suppliers be nonconforming.

* *

•                  Our significant reliance on foreignsuppliers sustains the risk that revenues might be adversely affected bychanges in international trade quota systems for apparel or by deterioration inpolitical and international trade relations between the United States ofAmerica and the foreign countries where the suppliers are located.

* *

•                  We purchase significant amounts of finished apparel from several separateforeign suppliers. While we believe that we could obtain finished apparel fromnumerous other suppliers, if we were to lose or terminate the services of any ofthese significant suppliers, our short-term ability to fulfill customers’orders on a timely basis could be substantially impaired, thereby negativelyaffecting our financial position and the results of our operations. 

* *

•                  We maintain a close working relationshipwith a certain foreign person who is responsible for maintaining relationshipswith and monitoring the performance of certain of our foreign suppliers. Whilewe believe that we could utilize other such persons to perform similarservices, if we were to lose orterminate the services of this individual, our short-term ability to fulfillcustomers’ orders on a timely basis could be substantially impaired, therebynegatively affecting our financial position and the results of our operations.

 

•                  Our significant reliance on foreign suppliers requires that we maintainsatisfactory relationships with a commercial banking institution in order tohave adequate access to capital to finance inventory purchases from the foreignsuppliers via import letters of credit. While we believe that we could obtainaccess to capital from other sources, if the commercial banking institutionwere to terminate or not to renew the line of credit agreement that we maintainwith the institution, our short-term ability to purchase finished goodsinventories from foreign suppliers could be substantially impaired, therebynegatively affecting our financial position and the results of our operations.

 

14

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•                  An ever increasing percentage of our net sales are derived from salesrelated to the license agreement with Callaway to market and distribute BenHogan® apparel. While we believe that we maintain a satisfactory relationshipwith Callaway, an early termination of the license agreement could negativelyimpact our financial position and results of our operations significantly.

* *

•                  As previously reported, Sport-Haley, Inc., our late Chairman and ourformer Controller, have been named in a civil enforcement action by theSecurities and Exchange Commission (the “SEC”). We have incurred a significantamount of legal and other expenses defending the SEC action. Subject to theterms of applicable insurance coverage, we may incur additional expenses,including Company resources and executive time, in responding to and defendingthe action, which could negatively impact our financial position and theresults of our operations. We have submitted a settlement proposal to the SEC, but,if the settlement proposal is not approved by the full Commission, Sport-Haley, Inc.and the named individuals could be subject to certain civil penalties anddisgorgement, if the SEC action were successful, which could negatively impact ourfinancial position and the results of our operations.

* *

•                  The increased threats of terroristactivities in the United States, the conflict in Iraq and other internationalconflicts may have adversely affected our sales. Business trends of the golf apparel industry closely follow trends in thetravel and leisure sectors of the United States economy. Internationalconflicts and other geopolitical conditions resulting from threats or acts ofwar or terrorism and responses thereto may have continued to affect the traveland leisure sectors that had already been negatively impacted by the generaleconomic downturn experienced during previous years. Our sales coulddecrease if the USA economy weakens due to these or other factors.

* *

•                  We may experience an increase in thenumber and magnitude of delinquent or uncollectible customer accounts duringperiods of economic downturn.

* *

•                  Businesses in general are everincreasingly dependent upon computer information systems. We must continuallyestablish and sustain controls with regard to maintaining the integrity of our technologyand information systems in order to adequately manage business activities andcontrol costs and expenses.

* *

•                  On a limited basis, we advance moniesto certain of our independent wholesale sales representatives under agreementswhereby the sales representatives reimburse us as they earn monthly salescommissions. Our financial results may be adversely affected should the salesrepresentatives not generate wholesale sales sufficient to justify the amounts advancedto them under the agreements. 

* *

There may be otherfactors not mentioned above, in the discussion below or included in our otherSecurities and Exchange Commission filings that may cause actual results todiffer materially from any forward-looking statements. Neither the Company norany of its corporate officers or key employees assumes any obligation to updateany forward-looking statements as a result of new information, future events ordevelopments, except as required by applicable securities laws.

* *

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

 

**Critical Accounting Policies andEstimates**

** **

Our financial statementshave been prepared in accordance with standards of the Public CompanyAccounting Oversight Board (United States), which require us to make estimatesand judgments that affect the reported amounts of assets, liabilities, revenuesand expenses, and the related disclosures. A summary of those significantaccounting policies can be found in the Footnotes to the Financial Statementsincluded in this Report on 10-K. Theestimates used by management are based upon our historical experiences combinedwith management’s

 

15

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understandingof current facts and circumstances. Certain of our accounting policies areconsidered critical as they are both important to the portrayal of ourfinancial condition and the results of our operations and require significantor complex judgments on the part of management. We believe that the followingcritical accounting policies affect the more significant judgments andestimates used in the preparation of our financial statements.

 

Inventories,predominately comprised of finished goods, are generally valued at the lower ofcost (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. Afterwe implemented our operations software in January 2004, we discovered certainprogramming and human errors within the new system that adversely affected thesoftware’s ability to accurately compute the valuation of our finished goodsinventories using a weighted average method. We consider the programming andhuman errors, which caused us to use a standard cost method, to be a materialweakness in our internal controls over financial reporting with respect toinventory valuation. The system was designed to utilize a series of complexvaluation computations, and we determined that a manual reconstruction of thenumerous amount of transactions affected by the programming and human errorswas impracticable. This weakness in our controls prevented us from relying uponthe system-recorded transactions with respect to inventory valuations during fiscal2005 and 2004. Based upon analyses performed to compare the landed costcomponents of our finished goods inventories with respect to our standard costcomponents and analyses of the allocated overhead portion of our standardcosts, we concluded with reasonable assurance that recomputing the value of ourfinished goods inventories using a standard cost method yielded a fairestimation of the value of our finished goods inventories. We used the standardcost method to value our finished goods inventories from the fiscal quarterended March 31, 2004, through the fiscal quarter ended March 31, 2005.  At June 30, 2005, certain inventoryitems remained on hand that had been valued using the standard cost method. Themethods we use to determine the standard costs of our finished good inventorieshave not changed since our initial analyses of such costs were performed in fiscal2004. Had we been able to rely upon the system to properly compute the cost ofour finished goods inventories using the weighted average method, we believethat the weighted average method would not have yielded a materially differentcomputation of the value than the standard cost method that we applied.

 

Thematerial weakness in our internal controls over financial reporting withrespect to inventory valuation impaired our ability to rely upon informationcreated by our computer system to fairly present, in all material respects, ourfinancial condition, results of operations and cash flows for fiscal 2005 and2004. The inability of our computer system to properly calculate the valuationof our finished goods inventories using a weighted average cost assumption alsoaffected the system-recorded amounts within our cost of goods sold during fiscal2005 and 2004. Costs associated with invoiced sales and returns as well asinventory adjustments are natural components of our cost of goods sold. Becausewe concluded with reasonable assurance that our using a standard costassumption yielded a fair estimation of our finished goods inventories during fiscal2005 and 2004, and because we consistently recorded adjustments to inventoriesas components of cost of goods sold, we believe with reasonable assurance thatour cost of goods sold are fairly stated for fiscal 2005 and 2004. Therefore,we believe that the procedures we applied to value our finished goodsinventories in fiscal 2005 and 2004 provide us with reasonable assurance thatour financial statements and the notes thereto fairly state, in all materialrespects, our financial condition, the results of our operations and our cashflows.

 

 Based upon tests we performed subsequent to June 30,2005, we believe that the computer software has been properly programmed, andemployees have been adequately trained to utilize the system procedures, toaccurately compute our finished goods inventory valuations using a weightedaverage cost assumption beginning in fiscal 2006.

 

Excessfinished goods inventories are a natural component of a seasonal apparelbusiness. While certain finished goods items will sell out in any particularselling season, quantities of other finished goods items will remain at the endof each selling season. We market previous seasons’ finished goods inventoriesat reduced wholesale prices to our customers in the normal course of business.Remaining excess inventories are liquidated through other markets. In theordinary course of business, we maintain reserves for inventory write downs dueto the obsolescence of discontinued or aging merchandise. We perform analyseson a quarterly basis to identify unsold discontinued or aging merchandise and adjustour reserves for inventory obsolescence to reduce the carrying value ofdiscontinued or

 

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agingmerchandise to its estimated net realizable value. The net realizable value ofthe discontinued or aging merchandise is estimated based on management’s dispositionplans and historical experiences. During fiscal 2005, we recorded finishedgoods inventories write-downs of $1,403,000, including a write-down of $165,000during the fourth fiscal quarter. While management believes that our processesproduce fair valuations of obsolete inventories, if actual market conditionsare less favorable than those projected by management, additional allowancesmay be required.

 

Deferred income taxes arerecognized for the expected tax consequences in future years for differencesbetween the tax bases of assets and liabilities and their financial reportingamounts, based upon enacted tax laws and statutory tax rates applicable to theperiods in which the differences are expected to affect taxable income. Oursignificant deferred tax assets are related to net operating loss carry forwardsfor federal and state income tax purposes, stock-based compensation and anunrealized loss for tax purposes on a common stock investment. Governingregulations require that our operating losses be carried forward for income taxpurposes. We have established a valuation allowance to reduce deferred taxassets to the net amount expected to be recovered in future periods. Theestimates for deferred tax assets and the corresponding valuation allowancerequire us to exercise complex judgments. We periodically review and adjustthose estimates based upon the most current information available. Inaccordance with SFAS 109 and based upon a review at June 30, 2005, of our utilizationof deferred tax assets, we maintained a valuation allowance that effectivelyreduces our net deferred tax assets to zero. While we continue to explore variousstrategies to return the Company to profitability, we cannot be certain thatour efforts will result in the generation of future profits. Because therecoverability of deferred tax assets is directly dependent upon futureoperating results, actual recoverability of deferred tax assets may differmaterially from our estimates.

 

Our allowance fordoubtful accounts reflects a reserve that reduces our customer accountsreceivable to the net amount estimated to be collectible. Estimating the creditworthiness of customers and the recoverability of customer accounts requires usto exercise considerable judgment. In estimating the reserve for uncollectibleaccounts, we consider factors such as general economic and industry-specificconditions, historical customer performance and anticipated customerperformance. From time to time, we also identify delinquent customer accountsfor which a specific reserve is required. At June 30, 2005, our allowancefor doubtful accounts totaled $377,000, including specific reservesapproximating $151,000 with respect to certain delinquent customer accounts. Whilewe consider our processes to be adequate to effectively quantify our exposureto doubtful accounts, changes in economic, industry or specific customerconditions may result in recoverability of our doubtful accounts that differsmaterially from our estimates.

 

We record allowances forsales returns as net adjustments to customer accounts receivable. Whenrecording an allowance, the net method reduces customer accounts receivable andnet sales by the estimated gross margin effect of the anticipated sales return.Generally, our selling terms preclude return of our products subsequent to thesale. However, we have traditionally maintained limited programs that offersome customers the right to return certain finished goods items underpredefined conditions, which we include as a component within our estimate ofallowance for sales returns. We review historical data and consider factorssuch as general economic and industry-specific conditions and anticipatedcustomer performance when evaluating the adequacy of our allowance for salesreturns. At June 30, 2005, the Company’s allowance for sales returns was $286,000.Significant changes in general economic or industry conditions may yield salesreturns that differ materially from our estimates

 

During fiscal 2004, webegan offering our independent wholesale sales representatives the right toreturn sample garments, at the end of the related marketing period for suchmerchandise, at no charge to the sales representative. Previously, we invoicedthe sales representatives for sample garments at discounted wholesale prices. Theright to return offered to the representatives caused us to adopt a policy toaccount for the sample garments in a manner consistent with our accounting for consignedinventories, whereby we capitalize the cost of sales of such shipments. Further,we record an allowance to completely offset the amount receivable from therepresentatives for the garments and reverse the corresponding revenue effectof the sale. The sales representative’s accounts receivable balance, therelated allowance and inventory costs are adjusted and a sale is recorded whenthe sales representative reimburses us for the cost of sample garments or theterm for which the right of return was granted, expires. Upon

 

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return of the garments tous, the sales representative’s accounts receivable balance and the relatedallowance are adjusted accordingly, the corresponding revenue effect of thereturn is reversed and the inventory items are returned to stock. During 2005,we discontinued the program that granted our independent sales representativesthe right to return sample garments. At June 30, 2005, our allowance forreturns of sales representatives sample garments was $28,000. Because theshipments and returns of sample garments made under the right to return policymust be tracked and adjusted manually, actual shipments and returns made inaccordance with that policy may differ from our estimates.

 

**Results of Operations**

 

The following table setsforth the percentage of net sales represented by items included in or derivedfrom our statements of income for its fiscal years ended June 30, 2005, 2004and 2003, 2002 and 2001:

 
| ** **                                                             | ** ** | **Fiscal Year Ended June 30, (2002 and 2001 Consolidated)** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Net sales                                                              |       | 100.0                                                            | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Cost of goods  sold                                                    |       | 71.2                                                             |       | 65.5 |   | 61.9 |   | 75.5 |   | 69.7 |   |
| Gross profit                                                           |       | 28.8                                                             |       | 34.5 |   | 38.1 |   | 24.5 |   | 30.3 |   |
| Other operating  costs                                                 |       | 44.6                                                             |       | 42.0 |   | 41.8 |   | 40.3 |   | 36.7 |   |
| Impairment of  fixed assets                                            |       | 0.0                                                              |       | 0.0 |   | 0.0 |   | 0.0 |   | 1.2 |   |
| Loss from  operations                                                  |       | (15.8                                                            | )          | (7.5 | ) | (3.7 | ) | (15.8 | ) | (7.6 | ) |
| Other income and  expenses, net                                        |       | 0.9                                                              |       | 0.7 |   | 0.7 |   | 2.0 |   | 2.7 |   |
| Loss from  operations before (provision for) benefit from income taxes |       | (14.9                                                            | )          | (6.9 | ) | (3.0 | ) | (13.8 | ) | (4.9 | ) |
| (Provision for)  benefit from income taxes                             |       | (0.0                                                             | )          | (3.6 | ) | 1.0 |   | 8.1 |   | 1.4 |   |
| Net loss                                                               |       | (14.9                                                            | )%         | (10.5 | )% | (2.0 | )% | (5.7 | )% | (3.5 | )% |

 

**Comparison of Fiscal Years Ended June 30,2005 and 2004.** Net sales for fiscal 2005 were $22,041,000, anincrease of $1,241,000, or 6%, as compared with net sales of $20,800,000 forfiscal 2004. We attribute the difference in net sales to factors such as thecontinued growth in sales of Ben Hogan® apparel collections offset by thediscontinuance of our HALEY RESERVE men’s fashion apparel and a continueddecrease in sales of SPORT HALEYTM women’s fashion apparel.

 

For fiscal 2005, our netsales 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 increasein net sales between the fiscal years is indicative of the growth we haveachieved with our Ben Hogan® collections within the premium-priced golf apparelmarket. Ben Hogan® is marketed in accordance with a license agreement wemaintain with Callaway Golf Company (“Callaway”). The growth we have achievedwith the Ben Hogan® collections since the inception of the license agreementfar exceeds the minimum calendar year sales requirements of the agreement, andwe consider the license agreement with Callaway to be a key component of ouroverall business strategies. While we believe that we have a strong workingrelationship with Callaway, our trend of continuing increases in sales oflicensed apparel since the introduction of Ben Hogan® golf apparel collections,sustains a risk of loss should the license agreement with Callaway beterminated by either party.

 

As previously reported,we discontinued our HALEY RESERVE men’s fashion apparel beginning with ourspring 2005 selling season, in part because of its diminishing sales and inpart because we had expected to introduce Top-FliteTM branded apparel in itsplace within our distribution channels. We began shipping our spring 2005apparel collections during November 2004. We believe that thediscontinuance of our HALEY RESERVE men’s fashion apparel negatively impacted ourfiscal 2005 sales by at least $2,500,000, the total of our net sales for suchapparel during our spring 2004 selling season. Historically, sales within ourHALEY branded apparel have been disproportionately comprised of greater salesof women’s apparel than of men’s apparel. Overall, net sales of our HALEYbranded apparel decreased by $3,000,000, or 23%, from net sales of $12,786,000for fiscal 2004 to net sales

 

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of $9,786,000 for fiscal2005. The continued decline in sales of our SPORT HALEYTM women’s fashionapparel appears to be related to a shrinking market for women’s golf apparel, becauseour customers appear to be placing less importance on women’s fashion golfapparel within their shops. In fiscal 2004, we consolidated our network ofindependent wholesale sales representatives to allow our representatives tomarket both our SPORT HALEYTM women’s collections and our Ben Hogan® men’scollections simultaneously. We believe that the natural synergies between thetwo brands will assist us with mitigating the negative effects on ouroperations associated with a shrinking of the women’s golf apparel market.

 

For fiscal 2005, BenHogan® branded apparel revenues accounted for 51%, HALEY® branded apparel revenuesaccounted for 44% and embroidering and shipping revenues accounted for 5% ofour net sales, respectively. Comparatively, for fiscal 2004, Ben Hogan® brandedapparel revenues accounted for 33%, HALEY® branded apparel revenues accountedfor 61% and embroidering and shipping revenues accounted for 6% of our netsales, respectively.

 

Gross profit for fiscal2005 was $6,352,000, a decrease of $829,000, or 12%, as compared with$7,181,000 in fiscal 2004. The difference in gross profit between the fiscalyears was primarily attributable to the following factors: (i) Aspreviously reported, during fiscal 2005, we revised our procedures used toassess the recoverability of our finished goods inventories by using animproved method that calculates the estimated sales value based upon thequantities and mix of inventories that are expected to remain at the end of theselling season, rather than an estimate based upon the total number of units onhand that we used previously. Using the new recoverability assessment method, thenet effect of inventory write-downs negatively impacted our gross profit forfiscal 2005 by $1,403,000. Comparatively, in fiscal 2004, inventory write-downsnegatively impacted our gross profit by $635,000. (ii) In fiscal 2005, wedisposed of a significant portion of our excess finished goods inventoriesrelating to our fall 2004 and prior selling seasons. As we previously reported,in December 2004, we sold substantially all of our discontinued or agingfinished goods inventories from the spring 2004 and earlier selling seasons toa major retailer. While we had previously estimated the recoverability of thoseinventories, we recognized an additional loss of $179,000 upon theirdisposition in December 2004. Because we have not recognized a materialloss on additional dispositions of aging or obsolete finished goods inventoriesafter December 2004, we believe that the methods we now use to estimatethe recoverability of our finished goods inventories produce a fair estimate oftheir respective value. (iii) As previously reported, in conjunction withperforming procedures recommended by the developer of our software that weredesigned to correct a prior system malfunction, we performed a physical countof our finished goods inventories and performed a detailed review of ourcomponent inventories at December 31, 2004. The physical inventory causedus to reduce the value of our finished goods inventories by $53,000 and thedetailed review caused us to reduce the value of our component inventories by$300,000 at December 31, 2004. The reductions in value similarly increasedour cost of goods sold at December 31, 2004, thereby negatively impactingour gross profit for the period.

 

Gross margin for fiscal2005 was 29%, a decrease of 6%, from 35% in fiscal 2004. Our gross margins maynot be comparable to other companies within the golf apparel industry. We haveconsistently included the cost of merchandise sold, including import charges,in-bound freight, allocated overhead and other charges, custom embroidery costsand freight-out in our cost of goods sold. Amounts invoiced to our customersfor custom embroidery as well as shipping and handling charges are included ascomponents of our net sales. Our overhead allocation includes certain of ourdistribution costs, such as receiving, inspection and shipping costs, but weinclude some of the other costs of distribution, such as a portion of ourwarehousing and other handling costs, in selling, general and administrativeexpenses. We include royalty payments, relating to sales of licensed apparel,in other operating costs.

 

Selling, general andadministrative expenses were $9,036,000 in fiscal 2005, an increase of$831,000, or 10%, from $8,205,000 in fiscal 2004. The increase between fiscalyears was due to a combination of several separate factors. Subsequent to thedeath of our Chairman in September 2004, we paid $650,000 in severance andother compensation expense to the late Chairman’s estate. Similarly, upon thedeparture of our former Chief Executive Officer in October 2004, weaccrued $520,000 in severance and other compensation that is generally payableto the former executive over a three-year period ending in March 2008. Thedeath of our former Chairman and the

 

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departure of our formerChief Executive Officer contributed to a decrease in our total salary and otherpayroll expenses for fiscal 2005. Salary and other payroll expenses, net ofseverance costs, totaled $3,341,000 in fiscal 2005, a decrease of $149,000, or4%, from $3,490,000 in fiscal 2004. As we previously reported, near the end of December 2004,we performed a detailed analysis of the individual categories of our selling,general and administrative expenses, and we used our evaluation as a tool tostreamline our operations further. We are continuing to focus our efforts tofind additional ways to decrease our overall operating expenses. As apercentage of sales, our selling, general and administrative expenses were 41%and 39% for fiscal 2005 and 2004, respectively.

 

Royalty expense forfiscal 2005 was $797,000, an increase of $265,000, or 50%, from $532,000 forfiscal 2004. The increase in royalty expense between the fiscal years wasdirectly related to the increase in net sales of our Ben Hogan® apparelcollections.

 

Total other income, net,for fiscal 2005 was $208,000, an increase of $92,000, or 79%, from $116,000 infiscal 2004. The increase was primarily due to the difference between thefiscal years in the amounts of and the rates of interest earned on cashequivalents 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 are 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.

 

Loss from operationsbefore provision for income taxes for fiscal 2005 was ($3,273,000), adifference of ($1,833,000), or 127%, from ($1,440,000) for fiscal 2004. Netloss 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 between thedifference in losses from operations before provision for income taxes and thedifference 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 current andmost-recent prior years, we believe that it is more probable than not that noneof our deferred tax assets will be recovered, and, in fiscal 2005, wemaintained the valuation allowance that effectively reduces our deferred taxassets to zero. While we continue to explore strategic alternatives to returnthe Company to profitability, we cannot be certain that our efforts will resultin the generation of future profits. Because the recoverability of deferred taxassets is directly dependent upon future operating results, actualrecoverability of our deferred tax assets may differ materially from ourestimates. Income tax expense for the period equals 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.

 

Basic and diluted lossesper share were ($1.29) and ($0.89) for fiscal years 2005 and 2004,respectively. Due to the net losses for the respective fiscal years, alloutstanding options were anti-dilutive and therefore excluded from the loss pershare calculations.

 

**Comparison of Fiscal Years Ended June 30,2004 and 2003.**Net sales for fiscal 2004 were $20,800,000, anincrease of $1,604,000, or 8%, as compared with $19,196,000 for fiscal 2003.Theincrease was primarily attributable to a continued increase in the sales of BenHogan® apparel combined with a continued decline in the sales of SPORT HALEYTMapparel. The increase in Ben Hogan® apparel sales exhibits growth we achievedwithin the premium price market for such apparel and is indicative of our effectivestrategies to maximize revenues associated with the Callaway license agreement.The continued decline in sales of SPORT HALEYTM apparel greatly concerned us. Webelieved that the generally flat United States economy throughout fiscal 2004contributed greatly to the depressed

 

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sales of SPORT HALEYTMapparel. The sluggish economic conditions especially adversely affected salesof women’s golf apparel throughout fiscal 2004. Since women’s apparel comprisesa predominant portion of SPORT HALEYTM apparel sales, we may have been moresignificantly affected by the sluggish economic conditions than othercompetitors within the golf apparel industry. While the golf apparel market isbasically comprised of 75% men’s apparel and 25% women’s apparel, historically,our SPORT HALEYTM apparel sales have typically been comprised of 30% men’sapparel and 70% women’s apparel. Sales of SPORT HALEYTM men’s apparel steadily declinedfor several years and were considerably less in fiscal 2004 than in previousyears. Management spoke with a few long-time customers that have indicated theywere beginning to place less of an importance on stocking women’s golf apparelcollections. Therefore, we expected that the trend of increasing sales of BenHogan® apparel and declining sales of SPORT HALEYTM apparel may continue intothe foreseeable future.****We believethat there are natural synergies common to Ben Hogan® men’s apparel and SPORTHALEYTM women’s apparel. Thus, during fiscal 2004, we continued to consolidate ourindependent wholesale sales forces, and approximately 90% of our independentsales representatives marketed both brands at June 30, 2004. By marketingBen Hogan® men’s apparel in conjunction with SPORT HALEYTM women’s apparel, weattempt to maintain our market share with current women’s apparel customers andto expand the distribution channels for women’s apparel into markets that wehad previously only been able to penetrate via the marketing of Ben Hogan® men’sapparel, which has broader appeal within the golf apparel markets.

 

For fiscal 2004, the SPORTHALEYTM men’s and women’s lines accounted for 21% and 30% of total net sales,respectively. The SPORT HALEYTM Elements line accounted for 10% of total netsales, and Ben Hogan® apparel accounted for 33% of total net sales. Theremaining 6% was comprised of embroidering and shipping revenues.

 

For fiscal 2003, the SPORTHALEYTM men’s and women’s lines accounted for 29% and 34% of total net sales,respectively. The SPORT HALEYTM Elements line accounted for 8% of total netsales, and Ben Hogan® apparel accounted for 23% of total net sales. Theremaining 6% was comprised of embroidering and shipping revenues plus sales atthe retail factory outlet store, which we used to sell prior seasons’ and otherinventories at discounted retail prices. The retail factory outlet store wasclosed in January 2002.

 

Gross profit for fiscal2004 was $7,181,000, a decrease of $142,000, or 2%, as compared with $7,323,000in fiscal 2003. The decrease was primarily attributable to the continued buildup of excess and obsolete finished goods inventories during fiscal 2004. Whileexcess and obsolete inventories are common within any apparel business,maintaining a minimum level of such inventories is a critical factor to thesuccess an apparel business. Obsolete inventories are an especially criticalfactor to our success, because a significant portion of our inventories iscomprised of women’s apparel. While obsolete men’s golf apparel may be disposedof through several different outlets, market options available for the disposalof women’s golf apparel are very limited. Therefore, our obsolete women’sinventories are much more sensitive to devaluation than are our men’sinventories. Our management performs quarterly analyses of our obsoleteinventories and adjusts our reserve for inventory obsolescence to reduce thecarrying value of obsolete inventories to their estimated net realizable value.Adjustments to the inventory valuation allowance are included as a component ofour cost of goods sold. An increase in obsolete inventories in fiscal 2004 affectedcost of goods sold by $635,000, while a decrease in obsolete inventories infiscal 2003 affected cost of goods sold by ($895,000), respectively. 

 

Gross margin for fiscal2004 was 35%, a decrease of 3%, from 38% in fiscal 2003. The margin erosion infiscal 2004 was primarily attributable to the effects of our build-up in excessand obsolete finished goods inventories. Our management was extremely concernedabout the continued build up. In April 2004, we performed an extensiveevaluation of the processes we used for merchandise planning, productforecasting and excess inventory disposal. The evaluation spawned inventoryreduction initiatives for the disposal of excess inventories that utilized bothcurrent channels of distribution and large discount retail chains. Management expectedthat the inventory reduction initiatives and enhancements to our software systemswould enable us to significantly reduce the levels of our finished goodsinventories throughout fiscal 2005. Management expected to reduce our finishedgoods inventories to approximately $6,000,000 by December 31, 2004, and tofurther reduce them to around $5,000,000 by June 30, 2005.

 

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Selling, general andadministrative expenses for fiscal 2004 were $8,737,000, an increase of$711,000, or 9%, as compared with $8,026,000 in fiscal 2003. A significantportion of the increase was attributable to operating costs associated with BenHogan® apparel. Selling, general and administrative expenses with respect toBen Hogan® for fiscal 2004 were approximately $1,839,000, an increase of$355,000, or 24%, from $1,484,000 in fiscal 2003. Contributing factors included in the increased Ben Hogan® selling,general and administrative costs were: higher amount of royalties paid toCallaway and commissions paid to independent sales representatives on acorresponding increase in sales of Ben Hogan® apparel; and, other increases ingeneral expenses necessary to support the continued increase sales of BenHogan® apparel. Another contributing factor to the total increase in selling,general and administrative expenses was an increase in total personnelexpenses, a significant portion of which was attributable to severancecompensation of $150,000 payable to the Company’s former President upon histermination at March 31, 2004. Legal defense costs with respect to aSecurities and Exchange Commission investigation and civil enforcement actionand a class action lawsuit filed against Sport-Haley, Inc. and certain ofits current and former officers and directors continued to contribute toincreased selling, general and administrative expenses in fiscal 2004. Suchlegal costs approximated $402,000 and $103,000 in fiscal 2004 and 2003,respectively. In September 2004, the Company received a reimbursement ofapproximately $204,000 from one of its insurance carriers relating to legalcosts associated with the Securities and Exchange Commission civil action andclass action matters. The Company recorded the $204,000 as a receivable at June 30,2004, and offset fiscal 2004 legal expenses by the same amount. Subject to theterms of the applicable insurance policies, we expected to receive furtherreimbursements for the costs of defense of the Securities and Exchange Commissionaction as we had met the applicable retention amount. As a percentage of netsales, selling, general and administrative expenses were 42% for both fiscal2004 and 2003.

 

Totalother income, net, for fiscal 2004 was $116,000, a decrease of $19,000, or 14%,as compared with $135,000 in fiscal 2003. The decrease was primarily due to thedifference between the fiscal years in the amounts of, and the rates of interestearned on, cash equivalents and marketable securities. During fiscal 2004,interest rates on virtually risk-free investments continued at or near all-timelows. We continued to search for investment alternatives available within theguidelines approved by our Board of Directors in order to maximize the rates ofreturn achieved on cash equivalents and marketable securities.

 

Income(loss) from operations before (provision for) benefit from income taxes forfiscal 2004 was ($1,440,000), a decline of $872,000, or 154%, as compared with($568,000) in fiscal 2003. Net loss for fiscal 2004 was ($2,186,000), a declineof $1,798,000, or 463%, as compared with ($388,000) in fiscal 2003. Theproportional disparity between the difference in losses from operations beforeprovision for income taxes and the difference in net losses between the fiscalyears arose because of the differences in effective tax rates for financialstatement, as opposed to tax, purposes. The effective tax rate in any fiscalyear can vary significantly from the effective tax rate in another year due todifferences between the methods of recording certain transactions for financialstatement versus the methods of recognizing those transactions for taxpurposes. Certain deductions recognized for tax purposes may not be recordedfor financial purposes in the same fiscal year, and certain expenses recordedfor financial statement purposes may not be deductible for tax purposes in thesame fiscal year. The proportional disparity in (provision for) benefit fromincome taxes between fiscal 2004 and fiscal 2003 was primarily caused by differencesin the valuation of net deferred tax assets. Because of the Company’s trend ofnet losses in the current and most recent prior years, management believed thatit was more probable than not that none of our net deferred tax assets would berecovered. Therefore, we increased our valuation allowance at June 30,2004, to effectively reduce our net deferred tax assets to zero.

 

**Liquidity and Capital Resources**

 

Our primary sources ofliquidity are derived from our available cash and cash equivalents, cash flowsfrom operations and a working capital line of credit with a commercial bank. Werequire cash for our general working capital purposes. We do not anticipaterequiring material amounts of cash for capital expenditures over the next 12months. To the extent ourcash balance is insufficient to finance our working capital needs, we may alsomake periodic borrowings under our revolving line of credit. Our workingcapital requirements are highly seasonal in

 

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nature, with greaterrequirements from approximately August through October and February throughApril of each fiscal year due to the purchases of finished goodsinventories for the spring/summer and fall/holiday selling seasons,respectively.

 

Working capital was $14,814,000and $17,503,000 at June 30, 2005 and 2004, respectively. Cash and cashequivalents plus marketable securities totaled $ 7,721,000 and $4,429,000 at June 30,2005 and 2004, respectively. For purposes of the statements of cash flows, we considerall highly liquid instruments purchased with an original maturity of threemonths or less, that are readily convertible to known amounts of cash andpresent an insignificant risk of change in value due to changes in interestrates, to be cash equivalents.

 

Net cash provided by(used in) operating activities totaled $3,134,000, ($1,893,000) and ($1,398,000)for fiscal years 2005, 2004 and 2003, respectively. The primary components ofadjustments to reconcile net loss to cash provided by (used in) operatingactivities were changes between fiscal years relating to impairments andwrite-downs, deferred taxes, provisions for doubtful accounts and salesreturns, accounts receivable, inventories, income taxes receivable, accountspayable, and accrued commissions and other expenses.

 

•                  Adjustments for impairments andwrite-downs affected net cash provided by (used in) operating activities by $1,403,000in fiscal 2005, $707,000 in fiscal 2004 and $259,000 in fiscal 2003. Theeffects 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 apparel business, excess inventories left over at theend of each selling season (“previous seasons’ inventories”) are common withinthe 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’ inventories, to estimated disposition values.Write-down charges relating to excess inventories have adversely affected ourearnings and cash flows for the last several years. In fiscal 2004, we enactedinitiatives directed to significantly reduce the levels of finished goodsinventories in order to minimize the future adverse financial effect associatedwith the devaluation of obsolete inventories. In fiscal 2005, we sold a significantportion of our previous seasons’ inventories and refined our procedures tobetter estimate the recoverability our finished goods inventories, and we establishednew procedures for purchasing finished goods inventories designed to minimizethe quantities expected to remain at the end of each selling season.

 

•                  The effects on net cash provided byoperating activities caused by changes in deferred taxes primarily representthe change in expected tax consequences in future years for differences betweenthe tax bases of assets and liabilities and their financial reporting amounts. Wemaintain a valuation allowance to reduce our net deferred tax assets to the netamount expected to be recovered in future periods. In fiscal 2004, because ofthe Company’s trend of net losses in the current and most recent prior years, wedetermined that it was more probable than not that none of our deferred taxassets would be recovered. Accordingly, since June 30, 2004, we havemaintained a valuation allowance that effectively reduces our net deferred taxassets to zero. While we continue to explore various strategies to return theCompany to profitability, 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.Deferred taxes affected net cash provided by (used in) operating activities by$0 in fiscal 2005, $746,000 in fiscal 2004 and ($170,000) in fiscal 2003.

 

•                  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 in allowancesfor doubtful accounts and sales returns between the respective years. As of June 30,our allowances for doubtful accounts were $377,000 in fiscal 2005, $454,000 infiscal 2004 and $316,000 in fiscal 2003. The allowances for 2005 and 2004included specific reserves of $151,000 and $175,000 with respect to certaincustomer accounts receivable, respectively. We believe that the decrease in thefiscal 2005 allowance, when compared with fiscal 2004 allowance, isattributable to the changes in our collection methods that we instituted infiscal

 

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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 $286,000 in fiscal 2005,$342,000 in fiscal 2004 and $226,000 in fiscal 2003. The percentage of salesreturns has remained fairly constant for the last three fiscal years. The decreasein the allowance for sales returns in fiscal 2005, as compared with theallowance in fiscal 2004, was primarily due to the decrease in our customeraccounts receivable at June 30, 2005, as compared with the receivablebalance at June 30, 2004. We also initiated a reserve for the return ofsamples garments from our independent wholesale sales representatives pursuantto a procedural change with regard to such sample garments effective with thefall 2004 selling season which granted the representatives the right to returnsample garments. During fiscal 2005, we discontinued the policy that grantedthe representatives the right to return sample garments. As of June 30, ourallowances for sample garments were $28,000 in fiscal 2005, $332,000 in fiscal 2004and $0 in fiscal 2003. The relative decrease in the allowance in fiscal 2005,as compared with the allowance in fiscal 2004, was due to our discontinuance ofthe right to return policy effective with the spring 2006 marketing season. Provisionsfor doubtful accounts and sales returns affected net cash provided by (used in)operating activities by approximately ($205,000) in fiscal 2005, $856,000 infiscal 2004 and $484,000 in fiscal 2003.

 

•                  Accounts receivable, not including theeffects of provisions for doubtful accounts and sales returns, provided operatingcash of $1,656,000 in fiscal 2005, used operating cash of $1,846,000 in fiscal 2004and used operating cash of $1,068,000 in fiscal 2003. Accounts receivable, netof allowances, decreased from $5,946,000 at June 30, 2004 to $4,495,000 atJune 30, 2005. The decrease in fiscal 2005, as compared with the fiscal2004 receivable balance, was primarily attributable to the shortening of ourcollection cycle discussed above combined with differences in our net sales forthe month of June 2005 of $2,391,000 versus our net sales for the month ofJune 2004 of $3,036,000.

 

•                  Inventories, not including the effects ofinventory write-downs, provided operating cash of $3,252,000 in fiscal 2005, usedoperating cash of $1,687,000 in fiscal 2004, and used operating cash of $1,383,000in fiscal 2003. We reduced our inventories from $8,808,000 at June 30, 2004to $4,153,000 at June 30, 2005. In fiscal 2004, we enacted initiativesdirected to significantly reduce the levels of finished goods inventories inorder to minimize future adverse financial effects associated with excessquantities of finished goods inventories. In fiscal 2005, we disposed of significantamounts of our obsolete or aging finished goods inventories and implementedinitiatives designed to further minimize the quantities of unsold inventories expectedto remain at the end of a selling season.

 

•                  Income taxes receivable providedoperating cash of approximately $0 in fiscal 2005, $0 in fiscal 2004 and $1,071,000in fiscal 2003. The income taxes receivable in prior years affected net cashprovided by (used in) operating activities by the amounts recoverable viautilizing federal income tax carry backs and with cash deposits of income taxrefunds received. Our losses prior to fiscal 2003 exhausted the federal amountsrecoverable by utilizing net operating loss carry backs. Therefore, our net taxoperating losses generated in fiscal 2005, 2004 and 2003 may only be used tooffset future taxable income and have been included as a component of our netdeferred tax assets, accordingly. 

 

•                  Accounts payable used operating cash of $799,000in fiscal 2005, provided operating cash of $792,000 in fiscal 2004, and used operatingcash of $460,000 in fiscal 2003. Accounts payable decreased from $1,381,000 at June 30,2004 to $582,000 at June 30, 2005. Changes in accounts payable relate todifferences in the timing between the years in the recording and payments ofexpenditures for inventory purchases, ordinary business expenses and other.

 

•                  Accrued commissions and other expenses providedoperating cash of $402,000 in fiscal 2005, provided operating cash of $238,000in fiscal 2004, and used operating cash of $175,000 in fiscal 2003. Accruedcommissions and other expenses increased from $767,000 at June 30, 2004 to$1,169,000 at June 30, 2005. The increase primarily relates to higher royaltiesdue on correspondingly higher Ben Hogan® sales for the

 

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fourth fiscal quarter,comparatively between the 2005 and 2004 fiscal years, and accrued severancecompensation payable to our former chief executive officer.

 

Net cash provided by(used in) investing activities totaled $363,000, $1,221,000, and ($1,675,000)for fiscal years 2005, 2004, and 2003, respectively. The primary components ofnet cash provided by (used in) investing activities were maturities (purchases)of marketable securities and purchases and disposals of fixed assets.

 

•                  Net maturities (purchases) of marketablesecurities provided investing activities cash of $539,000 in fiscal 2005, providedinvesting activities cash of $1,642,000 in fiscal 2004, and used investingactivities cash of $1,076,000 in fiscal 2003. Marketable securities decreased from$539,000 at June 30, 2004 to $0 at June 30, 2005. Marketablesecurities primarily consisted of United States government and mortgage-backeddebt securities that matured within one year or less. Due to the short-termnature of the investments, we did not recognize material unrealized gains orlosses on marketable securities in fiscal 2005, 2004 or 2003. Therefore, thecarrying values of marketable securities approximated their fair values.

 

•                  Purchases of fixed assets used investingactivities cash of approximately $176,000, $427,000 and $611,000, in fiscal 2005,2004, and 2003, respectively. Property and equipment, at cost, increased from $4,368,000at June 30, 2004, to $4,423,000 at June 30, 2005. As of June 30,2005, a significant portion of the fixed assets used in our operations werefully depreciated.

 

Net cash provided by (usedin) financing activities totaled $334,000, $258,000, and ($1,051,000) for fiscal2005, 2004, and 2003, respectively. Net cash provided by financing activitiesin fiscal 2005 and 2004 related solely to exercises of stock options by former executiveofficers and another former employee. Net cash used in financing activities infiscal 2003 related solely to repurchases of common stock. Since December 1994,we have been authorized by our Board of Directors to repurchase shares ofSport-Haley, Inc. common stock. The Board’s authorization is based on itsbelief that our common stock is underpriced at times given our working capital,liquidity, assets, book value and future prospects. We have no commitment orobligation to purchase all or any portion of the authorized shares. The sharesmay be repurchased from time to time in the open market or in privatelynegotiated transactions depending upon market conditions and other factors. Allshares purchased are canceled and returned to the status of authorized butunissued common stock. We did not repurchase any shares during fiscal 2005 or2004. During fiscal 2003, we repurchased 286,400 shares of our common stock.Since the inception of the repurchase program through June 2005, werepurchased a total of 2,512,800 shares of our common stock at a cumulativecost of $13,488,000.

 

We had no long-term debtat June 30, 2005 or 2004. Since April 1994, we have maintained arevolving line of credit with a commercial bank. The line of credit, which hasbeen renewed through December 5, 2005, bears interest at the bank’s primerate. The renewal provides for a maximum loan amount of $5,000,000 and issecured with a lien on substantially all of our assets. We generally maintainthe line of credit to facilitate the issuance of letters of credit forinventory purchases from offshore suppliers and to fund any temporary workingcapital needs. The amended terms of the line of credit agreement require thatwe maintain minimum tangible net worth of not less than $14,000,000. We had nooutstanding borrowings under the line of credit at either June 30, 2005, orJune 30, 2004. 

 

In the ordinary course ofour business, we enter into letters of credit arrangements with a commercialbank to facilitate the purchase of finished and packaged inventory and/or rawfabric from various offshore suppliers. As of June 30, 2005 and 2004, wehad outstanding letters of credit totaling $2,012,000 and $2,665,000, respectively,relating to commitments to purchase finished goods inventories from varioussuppliers. Amounts outstanding on letters of credit reduce the amount availablefor borrowing under the line of credit.

 

Historically, grossproceeds received from the exercise of stock options have fluctuatedsignificantly from year to year. We realized proceeds of $334,000, $258,000 and$0 in fiscal 2005, 2004 and 2003, respectively, from the exercise of stockoptions.

 

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Substantially all of ourpurchases from offshore manufacturers and sales to foreign distributors areU.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-Balance Sheet Arrangements**

** **

During fiscal years 2005 and2004, we did not have any relationships or arrangements with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes.

 

**Contractual Obligations**

** **

The following tablesummarizes our significant contractual cash obligations as of June 30, 2005.Certain of these contractual obligations are reflected in our balance sheet,while others are disclosed as future obligations under accounting principlesgenerally accepted in the United States.

 
| ** **                                                                               | ** ** | **Payments due by Period** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations**                                                             | ** ** | **Total**                  | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 Years** | ** ** | **More than 5  Years** | ** ** |
| Long Term Debt  Obligations                                                              |       | $                          | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                                     |       |                       |       |   |   |   |   |   |   |   |   |
| Capital Lease  Obligations                                                               |       | —                     |       | — |   | — |   | — |   | — |   |
|                                                                                     |       |                       |       |   |   |   |   |   |   |   |   |
| Operating Lease  Obligations                                                             |       | 351,000                    |       | 250,000 |   | 101,000 |   | — |   | — |   |
|                                                                                     |       |                       |       |   |   |   |   |   |   |   |   |
| Purchase  Obligations                                                                    |       | 2,012,000                  |       | 2,012,000 |   | — |   | — |   | — |   |
|                                                                                     |       |                       |       |   |   |   |   |   |   |   |   |
| Minimum Royalty  Obligations Under License Arrangements                                  |       | 5,224,000                  |       | 51,000 |   | 2,141,000 |   | 1,922,000 |   | 1,110,000 |   |
|                                                                                     |       |                       |       |   |   |   |   |   |   |   |   |
| Other Long-Term  Liabilities Reflected on the Registrant’s Balance Sheet under GAAP |       | —                     |       | — |   | — |   | — |   | — |   |
|                                                                                     |       |                       |       |   |   |   |   |   |   |   |   |
| Total                                                                                    |       | $                          | 7,587,000  |   | $ | 2,313,000 |   | $ | 2,242,000 |   | $ | 1,922,000 |   | $ | 1,110,000 |   |

 

**ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUTMARKET RISK**

 

Market risk representsthe risk of loss that may impact the financial position, results of operationsor cash flows due to adverse changes in financial and commodity market pricesand rates. We are exposed to market risk with regard to changes in UnitedStates interest rates. This exposure is directly related to our normaloperating and funding activities. Historically and as of June 30, 2005, wehave not used derivatives instruments or engaged in hedging activities. Ourmarket risk has not changed significantly from June 30, 2004.

 

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**Interest Rate Risk**

** **

We maintain a revolvingline of credit agreement with a commercial bank that provides for interest atthe bank’s prime rate. The agreement provides for a maximum loan amount of $5,000,000collateralized by a lien on substantially all of our assets. We generallymaintain the line of credit to facilitate the issuance of letters of credit forinventory purchases from offshore suppliers and, if necessary, to fund anytemporary working capital needs. We did not have any outstanding borrowings theline of credit at June 30, 2005. Increases in the bank’s prime rate could,however, increase the interest expense with respect to future borrowings,including borrowings under the line of credit. Outstanding letters of creditreduce the amount available for borrowing under the line of credit. We hadoutstanding letters of credit of approximately $2,012,000 at June 30,2005.

 

From time to time, wemaintain short-term investments in low risk and no risk financial instruments,readily convertible into cash, which earn interest at variable rates. Periodically,our cash balances held at financial institutions exceed federally insured limits.

 

**ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 
| **INDEX**                                                  | ** ** | **Page** |
|------------------------------------------------------------|------------|----------|
|                                                       |       |     |
| Index to Financial  Statements                             |       | F-1      |
|                                                       |       |     |
| Report of Independent  Registered Public Accounting Firm   |       | F-2      |
|                                                       |       |     |
| Balance Sheets                                             |       | F-3      |
|                                                       |       |     |
| Statements of  Operations                                  |       | F-4      |
|                                                       |       |     |
| Statement of Shareholders’  Equity                    |       | F-5      |
|                                                       |       |     |
| Statements of Cash  Flows                                  |       | F-6      |
|                                                       |       |     |
| Notes to Financial  Statements                             |       | F-7      |
|                                                       |       |     |
| Schedule II –  Valuation and Qualifying Accounts |       | F-23     |

 

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

** **

None.

 

**ITEM 9A.    CONTROLSAND PROCEDURES**

** **

**(a)****         Evaluationof Disclosure Controls and Procedures.**Our management, with theparticipation of our Interim Chief Executive Officer and our Chief FinancialOfficer, conducted an evaluation of the effectiveness of our disclosurecontrols and procedures pursuant to Rule 13a-15 under the SecuritiesExchange Act of 1934 as of the end of the period covered by this report. Basedon that evaluation, management, including the Interim Chief Executive Officerand Chief Financial Officer, concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were effectivein reaching a reasonable level of assurance that:  (a) all material information relating tothe Company, required to be disclosed in this report, was made known tomanagement in a timely manner; and (b) information was recorded,processed, summarized and reported within the time periods specified in the SEC’srules and regulations.

 

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Asdiscussed in Part I, Item 1, in *“Management InformationSystems and Inventory Management”* and in Part II, Item 7, in *“Critical Accounting Policies and Estimates,”* we considerthe programming and human computational errors, which caused us to use astandard cost method, to be a material weakness in our internals control overfinancial reporting with respect to inventory valuation during the periodcovered by this report. After we implemented our operations software in January 2004,we discovered certain programming and human errors within the new system thatadversely affected the software’s ability to accurately compute the valuationof our finished goods inventories using a weighted average method. The systemwas designed to utilize a series of complex valuation computations, and wedetermined that a manual reconstruction of the numerous amount of transactionsaffected by the programming and human errors was impracticable. This weaknessin our controls prevented us from relying upon the system-recorded transactionswith respect to finished goods inventory valuation during the period covered bythis report. Based upon analyses performed to compare the landed cost componentsof our finished goods inventories with our respective standard cost componentsand analyses of the allocated overhead portion of our standard costs, we concludedthat recomputing the value of our finished goods inventories using a standardcost method yielded a fair estimation of the value of our finished goodsinventories. We used the standard cost method to value our finished goodsinventories from the fiscal quarter ended March 31, 2004, through thefiscal quarter ended March 31, 2005. At June 30, 2005, certaininventory items remained on hand that had been valued using the standard costmethod. The methods we use to determine the standard costs of our finishedgoods inventories have not changed since our initial analyses of such costswere performed in fiscal 2004. Had we been able to rely upon the system toproperly compute the cost of our finished goods inventories using the weightedaverage method, the Interim Chief Executive Officer and the Chief FinancialOfficer believe that the weighted average method would not have yielded amaterially different computation of the value than the standard cost methodthat we applied. The Interim Chief Executive Officer and the Chief FinancialOfficer believe that the procedures we applied to value our finished goodsinventories for the period covered by this report provide us with reasonableassurance that the Company’s disclosure controls and procedures were effectiveas of the end of the period covered by this report.

 

Thematerial weakness in our internal controls over financial reporting withrespect to inventory valuation impaired our ability to rely upon informationcreated by our computer system to fairly present, in all material respects, ourfinancial condition, results of operations and cash flows for the periodcovered by this report. The inability of our computer system to properlycalculate the valuation of our finished goods inventories also affected thesystem-recorded amounts within our cost of goods sold during the period coveredby this report. Costs associated with invoiced sales and returns as well asinventory adjustments are natural components of our cost of goods sold. Becausewe concluded with reasonable assurance that our using a standard costassumption yielded a fair estimation of our finished goods inventories duringthe period covered by this report, and because we consistently recordedadjustments to inventories as components of cost of goods sold during theperiod covered by this report, we believe with reasonable assurance that ourcost of goods sold are fairly stated during the period covered by this report.Therefore, the Interim Chief Executive Officer and Chief Financial Officerbelieve that the procedures we applied to value our finished goods inventories forthe period covered by this report provide us with reasonable assurance that ourreport fairly states, in all material respects, our financial condition,results of operations and cash flows.

 

Basedupon tests we performed subsequent to June 30, 2005, we believe that thecomputer software has been properly programmed, and employees have beenadequately trained to utilize the system procedures, to accurately compute ourfinished goods inventory valuations using a weighted average cost assumptionfor fiscal periods subsequent to this report.

 

**(b)****         Changes inInternal Control Over Financial Reporting.**During the last quarter offiscal 2005, we did not implement any changes in our internal controls overfinancial reporting that materially affected, or are reasonably likely tomaterially affect, our internal controls over financial reporting.

 

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

 

**ITEM 9B.  OTHER INFORMATION**

** **

Weentered into an amended employment agreement with Catherine B. Blair, effectiveJune 1, 2005, to continue serving as our Vice President –Merchandising/Design. A description of the amended agreement is included in *“Employment Agreements”* below. A copy of the amendedemployment agreement is attached to this filing as Exhibit 10.2.5.1.

 

**PART III**

 

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

 
| **Name**                       | ** ** | **Age**  | ** ** | **Position**                                                          |
|--------------------------------|------------|----------|------------|-----------------------------------------------------------------------|
|                           |       |     |       |                                                                  |
| Donald W. Jewell               |       | 54       |       | Interim Chief Executive  Officer, President and Senior Vice President |
|                           |       |     |       |                                                                  |
| Patrick W. Hurley              |       | 53       |       | Chief Financial  Officer, Secretary, Treasurer and Controller         |
|                           |       |     |       |                                                                  |
| Catherine B. Blair             |       | 54       |       | Vice President -  Merchandising/Design                                |
|                           |       |     |       |                                                                  |
| Mark Maley                     |       | 40       |       | Vice President - Sales                                                |
|                           |       |     |       |                                                                  |
| Robert G. Tomlinson (5)        |       | Deceased |       | Former: Chairman and  Director                                        |
|                           |       |     |       |                                                                  |
| Kevin M. Tomlinson (6)         |       | 45       |       | Former: Chief Executive  Officer, President and Director              |
|                           |       |     |       |                                                                  |
| Ronald J. Norick  (1)(2)(3)(4) |       | 63       |       | Director and Chairman  of the Board                                   |
|                           |       |     |       |                                                                  |
| James R. TenBrook  (1)(3)      |       | 57       |       | Director and Chairman  of the Audit Committee                         |
|                           |       |     |       |                                                                  |
| Mark J. Stevenson  (1)(2)(3)   |       | 67       |       | Director and Chairman  of the Compensation Committee                  |
|                           |       |     |       |                                                                  |
| James H. Everest (2)(3)        |       | 57       |       | Director                                                              |

 

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| (1) | Member of the Audit  Committee                                                                                                                       |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Member of the  Compensation Committee                                                                                                                |
| (3) | Member of the  Nominating Committee                                                                                                                  |
| (4) | Mr. Norick was  appointed Chairman of the Board effective October 1, 2004.                                                                 |
| (5) | Robert G. Tomlinson,  former Chairman and Director, died in September 2004.                                                                     |
| (6) | Kevin M. Tomlinson,  stepped down as Chief Executive Officer and President in October 2004,  and he resigned as Director in November 2004. |

 

Officers are appointed byand serve at the discretion of the Board of Directors. Each Director holdsoffice until the next annual meeting of shareholders or until a successor hasbeen duly elected and qualified. All of our officers devote full-time to ourbusiness and affairs. In October 2004, after the death of Robert G.Tomlinson, the Board of Directors approved a reduction of the Board from six tofive Directors. Our former Chief Executive Officer and President, Kevin M. Tomlinson,resigned from the Board in November 2004, and, in February 2005, theBoard of Directors reduced the number of Board members to four. At June 30,2005, the Board was comprised of four non-employee Directors, all of whom wedetermined to be “independent” within the meaning of the applicable listingstandards of The Nasdaq Stock Market® (the “NASD Rules”).

 

*Donald W.Jewell*was appointed by our Board of Directors in October 2004to 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 1, 2001. Mr. Jewellwill serve as President for a term consistent with that of his service as ourInterim Chief Executive Officer. Once a permanent Chief Executive Officer isappointed, we expect that Mr. Jewell will remain with us as our SeniorVice President. From 1996 until joining us, Mr. Jewell was the founder,president and director of Jewell Apparel Group, a Canadian distributor ofpremium and mid-priced men’s golf apparel. Mr. Jewell began designing,sourcing and marketing golf apparel in 1993 while serving as the president andchief executive officer of Jewell-Rung, positions that he held from 1980 to1996.

 

*PatrickW. Hurley* has served as our Secretary, Treasurer andController since November 1999 and as our Chief Financial Officer since December 2000.Prior to joining us, Mr. Hurley was employed as a senior staff accountant atSaltzman Hamma Nelson Massaro LLP, Denver, Colorado, where among other things,he supervised or participated in the preparation of audited and unauditedfinancial statements and income tax returns, and provided advice and trainingfor business clients regarding selection and implementation of accountingsystems and procedures. Mr. Hurley is a certified public accountant andreceived 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/Designsince her appointment in May 1996. Ms. Blair has been part of ourdesign team since 1992, and was appointed Director of Design in 1995. Prior tojoining 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* has served as our Vice President – Sales, since January 2004.  Mr. Maley served as our Director ofSpecial Markets and Brands from July 2003 to December 2003 and was previouslyan independent wholesale sales representative for the Ben Hogan® apparel line.Prior to joining us, Mr. Maley served as general manager, director of golfand head golf professional for over seven years with Club Corporation ofAmerica. Mr. Maley is a member of the PGA. 

 

*Robert G.Tomlinson* served as our Chairman and Director from October 1992until his death in September 2004 and served as our Chief ExecutiveOfficer from October 1992 until March 2002. Prior to joining us, Mr. Tomlinsonwas a partner in Tomlinson Enterprises, a real estate investment partnership,and was also engaged in the

 

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management of hispersonal investment portfolio. Mr. Tomlinson was the father of Kevin M.Tomlinson, our former Chief Executive Officer, President and Director.

 

*Kevin M.Tomlinson* was appointed as our Chief Executive Officer in March 2002and was elected as a Director in September 1999. Mr. Tomlinson wasappointed as our President in March 2004. Previously, Mr. Tomlinsonhad served as our Chief Operating Officer and Executive VicePresident-Operations from January 1999 until March 2002 and as ourVice President of Operations from December 1997 until January 1999. InOctober 2004, our Board of Directors approved a resolution not to renewthe executive employment agreement of Mr. Tomlinson beyond March 17,2005, the end of the term of the agreement. The Board and Mr. Tomlinsonagreed that he would continue to act as our Chief Executive Officer andPresident until a new or an interim chief executive officer was appointed orthe end of his employment agreement term, whichever occurred first. Mr. Tomlinsonstepped down from his duties as Chief Executive Officer and President upon theappointment of Donald W. Jewell as our Interim Chief Executive Officer on October 29,2004. In November 2004, Mr. Tomlinson resigned as a Director.

 

**Independent Directors**

** **

*Ronald J.Norick* has been a Director since November 1993. In October 2004,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, Compensationand Nominating Committees of the Board. From April 1987 until April 1998,Mr. Norick served as the elected Mayor of the City of Oklahoma City,Oklahoma. From 1960 to 1992, Mr. Norick served in various capacities,including serving as president from 1981 to 1992, of a closely-held printingcompany, which was acquired by Reynolds & Reynolds in June 1992. Mr. Norickserves on a number of civic, community, educational, corporate and publicboards, commissions and committees and is a director of Banc First Corporation,a publicly-held corporation based in Oklahoma City, Oklahoma. Mr. Norickalso serves as controlling manager of Norick Investments Company LLC, afamily-owned limited liability company, which is engaged in investments.

 

*James R.TenBrook* has been a Director since March 2004. Mr. TenBrookhas served as the Chairman of the Audit Committee since March 2004 andalso serves on the Nominating Committee. Mr. TenBrook is the president anda shareholder of Karsh Consulting, P.C. of Denver, Colorado, has been a certifiedpublic accountant since 1973, received his personal financial specialist certificationin 1994 and is a certified valuation analyst. Mr. TenBrook’s practiceconsists primarily of litigation support, tax and estate planning. Mr. TenBrookis a member of the Colorado Society of Certified Public Accountants (“CSCPA”),served on the CSCPA’s board of directors from 1996-1999 and served on the CSCPAPersonal Financial Planning Committee from 1991-1994 (serving as Chairman ofthe Committee in 1993 and 1994). Mr. TenBrook is also a member of theAmerican Institute of Certified Public Accountants. Karsh Consulting, P.C. hasperformed income tax services for several years for our late Chairman, ourformer Chief Executive Officer, certain trusts formed by the late Chairman, anda related entity. The fees paid to Mr. TenBrook’s firm for these taxservices have not exceeded $8,000 per year in the aggregate. While servicesrendered by the Karsh Consulting P.C. result in some pecuniary benefit to Mr. TenBrook,which is difficult to quantify, Mr. TenBrook believes that the directcompensation to him as a result of these engagements has been less than $500per year. We believe that Mr. TenBrook nevertheless meets the definitionof independence under both SEC and NASD Rules.

 

*Mark J.Stevenson* has been a Director since November 1993. Mr. Stevensonserves on the Audit Committee, the Compensation Committee (as its Chairman) andthe Nominating Committee. Mr. Stevenson served as president and chiefexecutive officer of Zenodata Corporation, a Colorado based financial servicessoftware company, from March 2001 until his retirement in April 2005.In May 2005, Zenodata Corporation made an assignment for the benefit ofcreditors. Mr. Stevenson held the positions of chairman of the board,president and chief executive officer of Electronic Manufacturing Systems,Longmont, Colorado, a contract manufacturer serving the computer, data storage,telecommunications and medical equipment industries, from June 1994 untilthat company was merged into E-M-Solutions in January 1999. At that time, Mr. Stevensonwas appointed executive chairman and chairman of the board of E-M-Solutions,which filed for bankruptcy protection in the Northern District of California inapproximately

 

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November 2001 andwas immediately purchased by Sanmina/SCI. From 1992 to 1994, Mr. Stevensonserved 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’sCommission on Science and Technology for five years ending in 2004 and currentlyserves on the Advisory Council of the University of Colorado Deming Center forEntrepreneurship. Mr. Stevenson formerly served as chairman of theAmerican Electronics 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 ofthe Jean I. Everest Foundation, Oklahoma City, Oklahoma, since 1991. The JeanI. Everest Foundation was organized by Mr. Everest’s father to conductcharitable activities. Since 1984, Mr. Everest has been the managingpartner of Everest Brothers, a general partnership active in oil and gasexploration and development and has also been engaged in managing his personalinvestments. Mr. Everest is a member of the Oklahoma Bar Association andthe American Bar Association and serves in a number of capacities for variouscivic and community organizations.

 

**Board Committees**

 

The Board of Directorshas delegated certain of its authority to an Audit Committee, a CompensationCommittee and a Nominating Committee. The Audit Committee is comprised of Messrs. Norick,Stevenson and TenBrook. The Compensation Committee is comprised of Messrs. Stevenson,Norick and Everest. The Nominating Committee is comprised of Messrs. Norick,TenBrook, Stevenson and Everest. Mr. TenBrook serves as Chairman of theAudit Committee and Mr. Stevenson serves as Chairman of the CompensationCommittee. No member of these three committees is a current or former officeror employee of Sport-Haley, Inc. We have determined that each member ofthe Audit Committee, Compensation Committee and Nominating Committee qualifiesas an “independent” director under the applicable NASD Rules.

 

*Audit Committee*

* *

The major functions ofthe Audit Committee are to review and approve the scope of audit proceduresemployed, to review and approve the audit reports rendered by our independentauditors and to approve the audit fee charged by the independent auditors. Inaddition, pursuant to the Sarbanes-Oxley Act of 2002 and rules promulgatedthereunder, the Audit Committee is responsible for, among other things,pre-approving all audit and non-audit services performed by the independentauditors, approving the engagement of the auditors and receiving certainreports from the independent auditors prior to the filing of the audit report.The Audit Committee reports to the Board of Directors with respect to suchmatters and recommends the selection of independent auditors. James R. TenBrookhas served as the Chairman of the Audit Committee since March 2004. TheAudit Committee held four formal meetings during fiscal 2005. Each of themembers of the Audit Committee attended all of the meetings held during fiscal 2005,except for Mark J. Stevenson, who attended all but one of the meetings.

 

As of March 2004,when James R. TenBrook was elected as Director and appointed to the AuditCommittee as its Chairman, the Board determined that Mr. TenBrook meetsthe definition of an audit committee financial expert, as defined by SECregulations. In addition, the board has determined that Mr. TenBrook alsomeets the requirements for independence under SEC rules and the applicableNASD Rules.

 

*Compensation Committee*

* *

The primary function ofthe Compensation Committee is to review and make recommendations to the Board withrespect to the compensation, including bonuses, of our officers and toadminister our Stock Option Plan. See *“Compensation CommitteeReport”* included in Item 11 below. The Compensation Committee held twomeetings in fiscal 2005, which all of its members attended.

 

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*Nominating Committee*

* *

In 2004, the Board of Directorsvoted to form a Nominating Committee, to be comprised of Messrs. Norick, TenBrook,Stevenson and Everest. The Nominating Committee recommends to the Board thepersons to be nominated for election as Directors at any meeting ofstockholders, 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. Allof the members of the Nominating Committee met once during fiscal 2005.

 

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.

 

*Board Attendance*

* *

In fiscal 2005, the Boardof Directors held ten formal meetings, three of which were attended by only theindependent directors prior to the November 2004 resignation of Kevin M.Tomlinson, the only employee director remaining subsequent to the September 2004death of Robert G. Tomlinson, our former Chairman. Each of the Directors attendedall board meetings held during fiscal 2005, except that James H. Everest wasnot present at two meetings and Mark J. Stevenson was not present at onemeeting. Kevin M. Tomlinson attended two meetings prior to his resignation fromthe Board. No Board meeting was held in fiscal 2005 prior to the death ofRobert G. Tomlinson.

 

**Code of Ethics**

** **

In January 2004, we adopteda Code of Ethics for Senior Financial Officers, which applies to all seniorfinancial officers of the Company, including the Chief Executive Officer, theChief Financial Officer, the Treasurer and any other person performing similarfunctions. In addition, in May 2004, we adopted a Code of Conduct andEthics for Directors, Officers and Employees, which is applicable to all of ourdirectors, officers and employees. A copy of these codes may be obtainedwithout charge by written request for copies of them addressed to: CorporateSecretary, 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, 2005, of Donald W. Jewell, Interim Chief Executive Officer,President and Senior Vice President, Patrick W. Hurley, Chief FinancialOfficer, Secretary, Treasurer and Controller, Catherine B. Blair, VicePresident – Merchandising/Design and Mark Maley, Vice President – Sales, theonly executive officers whose total annual salary and bonus exceeded $100,000during the year ended June 30, 2005, and Robert G. Tomlinson (deceased),Kevin M. Tomlinson and Robert W. Haley (the “Named Officers”).  

 

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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,                                             |       | 2005       |       | $                       | 198,100    |                      | -0         | -                                  | -0         | -                | $          | 2,600 | (1) |
| Interim Chief  Executive Officer,                             |       | 2004       |       | 144,600                 |       | -0                        | -          | -0                                 | -          | 2,000            | (1)        |
| President and  Senior Vice President                          |       | 2003       |       | 130,000                 |       | -0                        | -          | -0                                 | -          | 1,000            | (1)        |
|                                                          |       |       |       |                    |       |                      |       |                               |       |             |       |
| Patrick W. Hurley                                             |       | 2005       |       | 100,500                 |       | -0                        | -          | -0                                 | -          | 1,400            | (1)        |
| Chief Financial Officer,  Secretary, Treasurer and Controller |       |       |       |                    |       |                      |       |                               |       |             |       |
|                                                          |       |       |       |                    |       |                      |       |                               |       |             |       |
| Catherine B Blair,                                            |       | 2005       |       | 106,400                 |       | -0                        | -          | -0                                 | -          | 1,500            | (1)        |
| Vice President –  Merchandising/  Design                 |       | 2004       |       | 99,900                  |       | -0                        | -          | -0                                 | -          | 1,400            | (1)        |
|                                                          |       |       |       |                    |       |                      |       |                               |       |             |       |
| Mark Maley                                                    |       | 2005       |       | 138,200                 |       | -0                        | -          | -0                                 | -          | 1,800            | (1)        |
| Vice President -  Sales                                       |       | 2004       |       | 118,500                 |       | -0                        | -          | -0                                 | -          | 900              | (1)        |
|                                                          |       |       |       |                    |       |                      |       |                               |       |             |       |
| Robert G. Tomlinson                                           |       | 2005       |       | 59,500                  | (2)        | -0                        | -          | -0                                 | -          | 400              | (1)        |
| (deceased) (4)                                                |       | 2004       |       | 170,000                 |       | -0                        | -          | -0                                 | -          | -0               | -          |
|                                                          |       | 2003       |       | 170,000                 |       | -0                        | -          | -0                                 | -          | 2,000            | (1)        |
|                                                          |       |       |       |                    |       |                      |       |                               |       |             |       |
| Kevin M. Tomlinson (5)                                        |       | 2005       |       | 174,000                 | (3)        | -0                        | -          | -0                                 | -          | 2,600            | (1)        |
|                                                          |       | 2004       |       | 160,000                 |       | -0                        | -          | -0                                 | -          | 2,000            | (1)        |
|                                                          |       | 2003       |       | 160,000                 |       | -0                        | -          | -0                                 | -          | 2,000            | (1)        |
|                                                          |       |       |       |                    |       |                      |       |                               |       |             |       |
| Robert W. Haley (6)                                           |       | 2005       |       | -0                      | -          | -0                        | -          | -0                                 | -          | -0               | -          |
|                                                          |       | 2004       |       | 112,000                 |       | -0                        | -          | -0                                 | -          | 2,000            | (1)        |
|                                                          |       | 2003       |       | 150,000                 |       | -0                        | -          | -0                                 | -          | 2,000            | (1)        |
|                                                               |            |            |            |                         |            |                           |            |                                    |            |                  |            |  |  |

 

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(1)               Comprisedof contributions by the Company to the Named Officer’s 401(k) account plus termlife insurance premiums paid by the Company.

(2)               Includesnet taxable fringe benefits of $3,900 for country club dues.

(3)               Includesnet taxable fringe benefits of $31,900 for country club dues, clothingallowance and personal use of company vehicle.

(4)               RobertG. Tomlinson, Chairman, died on September 8, 2004. His 2005 annual salary andall other compensation amounts include such amounts paid to him until the dateof his death and do not include the $650,000 in severance and othercompensation paid to his estate in October 2004, per the terms of asettlement agreement.

(5)               InOctober 2004, the Board elected not to renew the executive employmentagreement between Sport-Haley, Inc. and Kevin M. Tomlinson upon itsexpiration in March 2005. Mr. Tomlinson stepped down from his dutiesas our Chief Executive Officer and President in October 2004. His annualsalary and all other compensation amounts for 2005 include such amounts paid tohim until the termination of the executive employment agreement in March 2005and do not include payments for severance and other compensation that he beganreceiving in April 2005, per the terms of an executive employmentagreement. We paid Mr. Tomlinson $76,000 in severance and othercompensation in fiscal 2005.

(6)               RobertW. Haley resigned as our President, effective March 31, 2004. His 2005 and2004 annual salary and all other compensation amounts do not include thebi-weekly payments for severance and other compensation that Mr. Haleybegan receiving in April 2004. We paid Mr. Haley $114,000 and $38,000in severance and other compensation in fiscal 2005 and 2004, respectively.

 

*Fiscal Year-End Options/OptionValues Table.*

 
| ** **                         | ** ** | ** **      | ** ** | ** **   | ** ** | **Number of Securities Underlying** | ** ** | **Value of Unexercised In-**       | ** ** |
|------------------------------------|------------|-----------------|------------|--------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                         | ** ** | **Shares**      | ** ** | ** **   | ** ** | **Unexercised Options/**            | ** ** | **the-Money(1) Options/SARs** | ** ** |
| ** **                         | ** ** | **Acquired**    | ** ** | **Value**    | ** ** | **SARs at Fiscal Year-End**         | ** ** | **at Fiscal Year-End(2)**          | ** ** |
| ** **                         | ** ** | **on Exercise** | ** ** | **Realized** | ** ** | **Exercisable**                     | ** ** | **Unexercisable**                  | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|                               |       |            |       |         |       |                                |       |                               |       |   |   |   |   |
| Donald W. Jewell                   |       | -0              | -          | -0           | -          | 50,000                              |       | -0                                 | -          | $ | -0 | - | $ | -0 | - |
| Patrick W. Hurley                  |       | -0              | -          | -0           | -          | 50,000                              |       | -0                                 | -          | -0 | - | -0 | - |
| Catherine B. Blair                 |       | -0              | -          | -0           | -          | 50,000                              |       | -0                                 | -          | -0 | - | -0 | - |
| Estate of Robert  G. Tomlinson (3) |       | -0              | -          | -0           | -          | 150,000                             |       | -0                                 | -          | $ | 19,500 |   | -0 | - |
| Kevin M. Tomlinson  (4)            |       | 100,000         |       | $            | 40,000     |                                | -0         | -                                  | -0         | - | -0 | - | -0 | - |
|                                    |            |                 |            |              |            |                                     |            |                                    |            |  |  |  |  |  |  |  |

 

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| (1) | Options are “in the  money” if the fair market value of the underlying securities exceeds the  exercise or base price of the option.                                                                                                                                                                                                                                                                                                                                                                                 |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The  dollar values are calculated by determining the difference between the fair  market value of the securities underlying the options at fiscal year end and  the exercise or base price of the options. On June 30, 2005, the last  trading date for the end of the 2005 fiscal year, the closing bid price for  the common stock was $2.97.                                                                                                                                                                           |
| (3) | All outstanding options  granted to Robert G. Tomlinson became fully vested and exercisable upon his  death in September 2004, pursuant to the terms of his executive  employment agreement. At the date of his death, 150,000 outstanding options  had been granted to Mr. Tomlinson. The Estate of Robert G. Tomlinson  exercised 125,000 of the options in September 2005, and 25,000 of the  options expired thereafter. At the dates of their exercises, the cumulative  value of the options was $81,000. |
| (4) | All outstanding options  granted to Kevin M. Tomlinson became fully vested and exercisable upon the  termination of his executive employment agreement in March 2005,  pursuant to its terms. At the date of his termination 200,000 outstanding  options had been granted to Mr. Tomlinson. He exercised and sold 100,000  of the options in June 2005, and the remaining 100,000 options expired  thereafter. At the dates of their exercises, the cumulative value of the  options was $40,000.              |

 

**Employment Agreements**

** **

We entered into anemployment agreement with Mr. Donald W. Jewell effective February 1,2001. The agreement, as amended, requires that Mr. Jewell devote his fullbusiness time as our Senior Vice President, at an annual salary of $150,000,and such bonuses as awarded by the Board of Directors, and extends for atwo-year term, subject to automatic one-year extensions at the end of eachyear. If we elect to terminate the agreement for other than “cause” (as definedin the agreement), or if Mr. Jewell were to terminate the agreement forcause, Mr. Jewell would be entitled to receive severance compensationequal to twelve months salary and 50% of the last annual bonus paid to him.During the time he were to receive any such severance compensation, Mr. Jewellis eligible to participate in all employee benefit plans, at our expense. Ifthere were to be a non-negotiated change in control of Sport-Haley, Inc.,and either we or Mr. Jewell terminate the agreement within sixty days ofthe change of control, then Mr. Jewell would be entitled to lump sumseverance compensation equal to three times his annual salary and bonus paymentsduring the preceding 12 months. In the event of termination due to a non-negotiatedchange in control, options previously granted to Mr. Jewell would becomefully vested and exercisable on the date of termination. In the event of atermination by either party without cause, options previously granted wouldvest and become exercisable on a prorated basis from the date of grant to thedate of termination. If we were to terminate the agreement with cause, nounexercised options would be exercisable. The agreement contains anon-competition provision for twelve months following termination, provided Mr. Jewellcould be released from the non-competition clause if he were terminated withoutcause and if he had elected to forego any severance pay. If Mr. Jewellbecomes disabled during the term of the agreement, his full salary will becontinued for one year from the date of disability. In January 2005, Mr. Jewelland the Company entered into an agreement, effective November 1, 2005,whereby Mr. Jewell agreed, in addition to his duties, responsibilities andbenefits under his existing employment agreement, to serve as our Interim ChiefExecutive Officer through June 30, 2005, subject to automatic monthlyextensions, for a salary of $50,000 per year in addition to the salary he isentitled to receive under his employment agreement to serve as our Senior VicePresident.

 

Effective December 1,2000, 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 ChiefFinancial Officer, Secretary, Treasurer and Controller, at an annual salary of$110,000,****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 Mr. Hurley terminates the agreement with orwithout cause, he is entitled to receive severance

 

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compensation equal to sixmonths’ salary, plus 50% of the last annual bonus paid to him. During the timehe were to receive any such severance compensation, Mr. Hurley is entitledto participate in all employee benefit plans, at our expense. If there were tobe a non-negotiated change in control of Sport-Haley, Inc., and either weor Mr. Hurley terminate the agreement within sixty days of the change ofcontrol, then Mr. Hurley is entitled to lump sum severance compensationequal to three times his annual salary and bonus payments during the preceding12 months. In the event of termination due to a non-negotiated change incontrol of Sport-Haley, Inc., options previously granted to Mr. Hurleywould 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 withcause, no unexercised options would be exercisable. If Mr. Hurley becomesdisabled during the term of the agreement, his full salary will be continuedfor one year from the date of disability.

 

Effective June 1, 2005,we agreed to amend the employment agreement with Catherine B. Blair that wasoriginally effective July 1, 1997. The amended agreement requires that Ms. Blair devote her fullbusiness time as our Vice President of Merchandising/Design, at an annualsalary of $110,000,****and suchbonuses as awarded by the Board of Directors, and extends for a one-year term,subject to automatic one-year extensions after each year. If we elect toterminate the agreement without “cause” (as defined in the agreement) or not torenew the agreement upon its expiration, or if Ms. Blair terminates theagreement with or without cause, she is entitled to receive severancecompensation equal to fifteen months’ salary, plus 50% of the bonus, if any,paid to her in the preceding 12 months. During the time she were to receive anysuch severance compensation, Ms. Blair is entitled to participate in allemployee benefit plans, at our expense. If there were to be a non-negotiatedchange in control of Sport-Haley, Inc., and either we or Ms. Blairterminate the agreement within sixty days of the change of control, then Ms. Blairis entitled to lump sum severance compensation equal to three times her annualsalary and bonus payments during the preceding 12 months. In the event of terminationdue to a non-negotiated change in control of Sport-Haley, Inc., optionspreviously granted to Ms. Blair would become fully vested and exercisableon the date of termination. In the event of a termination by either partywithout cause, options previously granted would vest and become exercisable ona prorated basis from the date of grant to the date of termination. If we wereto terminate the agreement with cause, no unexercised options would beexercisable. The agreement contains a non-competition provision for twelvemonths following termination, provided Ms. Blair could be released fromthe non-competition clause if she were terminated without cause and if she hadelected to forego any severance pay. If Ms. Blair becomes disabled duringthe term of the agreement, her full salary will be continued for one year fromthe date of disability.

 

We entered into an amendedemployment agreement with Mark Maley effective January 1, 2005, originallyeffective January 1, 2004. The agreement requires Mr. Maley to devotehis full business time as our Vice President – Sales, at an annual salary of$135,000, and such bonuses as may be awarded by the Board of Directors, and extendsfor a one-year term, subject to automatic one year extensions at the end ofeach year. The amended agreement also entitles Mr. Maley to receive a 0.2%override on our gross annualized sales, less discounted sales of more than 50%from original suggested wholesale prices, returns and credits. If we elect toterminate the agreement without “cause” (as defined in the agreement) or not torenew the agreement upon its expiration, or if Mr. Maley terminates theagreement with cause, he is entitled to severance payments equal to fifteenmonths salary, plus 50% of the last annual bonus paid to him. In the event of anon-negotiated change of control of Sport-Haley, Inc., and either we or Mr. Maleyterminate the agreement within sixty days of the change of control, then Mr. Maleyis entitled to severance compensation equal to three times his annual salaryand bonus payment during the preceding twelve months.****Theagreement contains a non-competition provision for twelve months followingtermination, provided Mr. Maley could be released from the non-compete clauseif he were terminated without cause and if he had elected to forego anyseverance pay. If Mr. Maley becomes disabled during the term of theagreement, his full salary will be continued for one year from the date ofdisability.

 

Effective January 1,1997, Sport-Haley entered into an employment agreement with Mr. Robert G.Tomlinson. Mr. Tomlinson died on September 8, 2004. Mr. Tomlinson’semployment agreement required that he devote his full business time as Chairmanof the Board at an annual salary of $230,000, as amended, be provided anautomobile and such bonuses as awarded by the Board of Directors. Theemployment agreement extended for a three-

 

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year period, subject toautomatic one-year extensions at the end of each year. Because the agreementterminated upon Mr. Tomlinson’s death, Mr. Tomlinson’s estate wasentitled to the same severance compensation as would have been applicable as ifMr. Tomlinson had terminated the agreement with “cause”  (as defined in the agreement), or if we hadterminated the agreement for other than cause, or if there were a change incontrol of Sport-Haley, Inc. The employment agreement entitled Mr. Tomlinson’sestate to receive, as a death benefit, severance compensation in an amountequal to three times his annual salary and bonus payments during the preceding 12months. During the time his estate received such severance compensation, Mr. Tomlinson’sestate was entitled to participate in all employee benefit plans, at ourexpense. Provisions included in the employment agreement entitled Mr. Tomlinson’sestate to receive such amount in a lump sum. Because the agreement wasterminated for reasons other than with cause, all options previously granted toMr. Tomlinson became fully vested on the date of Mr. Tomlinson’sdeath. Mr. Tomlinson agreed to a voluntary salary reduction in fiscal1999. From then until his death, Mr. Tomlinson received an annual salaryof $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 ofseverance compensation to be paid as a death benefit and other compensation mattersrelating to the employment agreement. Mr. Tomlinson’s estate demanded ahigher severance amount and other compensation which it claimed was also dueunder the agreement. The Board of Directors negotiated an agreement incompromise with Mr. Tomlinson’s estate regarding the death benefit amountand the other disputed compensation. In accordance with the terms of thesettlement agreement, we paid the lump sum amount of $650,000 to Mr. Tomlinson’sestate in October 2004.

 

Effective March 18,2002, Sport-Haley entered into an employment agreement with Mr. Kevin M. Tomlinsonto act as the Company’s Chief Executive Officer. Mr. Tomlinson wassubsequently appointed as President pursuant to the terms of the employmentagreement. 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. Tomlinsonis entitled to receive severance compensation equal to 36 months salary andbonus and incentive payments over the last 12 months, payable monthly over the36-month period. In October 2004, our Board of Directors approved aresolution not to renew the executive employment agreement of Mr. Tomlinson,beyond the end of its term in March 2005, and Mr. Tomlinsonsubsequently stepped down from his duties as our Chief Executive Officer andPresident. During the time he is receiving severance compensation, Mr. Tomlinsonis eligible 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 expiredthereafter. The agreement contains a non-competition provision for one yearfollowing termination, 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 severancecompensation in April 2005. 

 

Effective January 1,1997, Sport-Haley entered into an employment agreement with Mr. Robert W.Haley. In January 2004, Mr. Haley agreed to the termination of hisemployment effective March 31, 2004. The agreement required that he devotehis full business time as our President or Senior Executive Officer at anannual salary of $160,000 and such bonuses as awarded by the Board ofDirectors. Mr. Haley agreed to a voluntary salary reduction in fiscal1999. Since that time, Mr. Haley received an annual salary of $150,000instead of the $160,000 annual salary, which he had been entitled to receiveper the employment agreement. The employment agreement term extended through December 31,1998 and was subsequently automatically renewed for additional one-year terms. Becausethe agreement was terminated for other than “cause” (as defined in theagreement), Mr. Haley was entitled to receive bi-weekly severancecompensation payments for one year from the date of termination totaling$150,000, his annual salary and bonus payments during the preceding 12 months.The agreement contained a non-competition provision for one year followingtermination, provided Mr. Haley could be released from the non-competeagreement since he was terminated without cause, if he had elected to foregoany severance pay. Mr. Haley received the bi-weekly severance compensationpayments through March 31, 2005. Since Mr. Haley was terminatedwithout cause, all of the

 

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75,000 outstanding stockoptions previously granted to him became fully vested on the effective date ofhis termination. Mr. Haley exercised all 75,000 of the options in June 2004. 

 

**Director Fees**

** **

No employee receives anyadditional compensation for his services as a Director. For fiscal 2005, eachnon-employee member of the Board of Directors received $10,000 per year. TheChairman of the Board received an additional $50,000, the Audit CommitteeChairman received an additional $10,000, and the Compensation CommitteeChairman received an additional $2,500. Director compensation is paidquarterly.

 

**Stock Option Plan**

 

We adopted a stock optionplan in 1993 (as amended, the “Option Plan”). The Option Plan provided for thegranting of incentive stock options within the meaning of Section 422 ofthe Internal Revenue Code of 1986, as amended, non-qualified stock options andstock appreciation rights (“SARs”), up to a maximum number of 2,150,000 shares.Non-qualified options could be granted to employees, directors and consultantsof Sport-Haley, Inc., while incentive options could only be granted toemployees. No options could be granted under the Option Plan subsequent to February 28,2003, when the Option Plan expired by its terms.  Options granted pursuant to the Option Planprior to its expiration on February 28, 2003 remain exercisable accordingto the terms of their issuance.

 

The Option Plan isadministered by the Compensation Committee of our Board of Directors. TheCompensation Committee determined the terms and conditions of the options andSARs granted under the Option Plan, including the exercise price, number ofshares subject to the option and the exercisability thereof.

 

The exercise prices ofincentive options granted under the Option Plan must have been at least equalto the fair market values of the common stock of Sport-Haley on the dates ofgrant. In the case of an optionee who owns stock possessing more than tenpercent of the total combined voting power of all classes of stock ofSport-Haley, Inc., the exercise price of incentive options could not beless than 110% of the fair market value of the common stock on the date ofgrant. 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 not exceed tenyears and the terms of all incentive options could not exceed five years.

 

The Option Plan provided ourBoard of Directors or the Compensation Committee thereof the discretion todetermine when options granted thereunder should become exercisable and thevesting period of such options. Upon termination of a participant’s employmentor consulting relationship with Sport-Haley, Inc., all unvested optionsterminate and are no longer exercisable. Vested options remain exercisable fora specified period of time following the termination date. The length of suchan extended exercise period generally ranges from 30 days to one year,depending on the nature and circumstances of the termination.

 

In January 2003, theBoard of Directors approved an amendment to the Option Plan which expresslygives discretion to the Compensation Committee to accelerate the vesting or exercisability ofan option granted pursuant to the Plan.

 

The Option Plan providedthat, in the event we enter into an agreement providing for the merger ofSport-Haley, Inc. into another corporation or the sale of substantiallyall of the assets of Sport-Haley, Inc., any outstanding unexercised optionwould become exercisable at any time prior to the effective date of suchagreement. Upon the consummation of a merger or sale of assets, such optionswould terminate unless they were assumed or another option was substitutedtherefor by the successor corporation.

 

As of June 30, 2005,a total of 838,500 non-qualified options were outstanding, with exercise pricesranging from $2.71 to $9.78 per share and a weighted average exercise price pershare of $3.78.

 

38

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**401(k) Plan**

 

In January 1996, weadopted 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, asamended. The 401(k) Plan covers all full-time employees who are at least 18years of age and have been employed at least three months. The 401(k) Plan isfunded by voluntary pre-tax salary deferral contributions from employees andthrough matching contributions by us of $0.25 on the dollar for employeedeferrals of the first 5% of the employee’s annual compensation. Upon leaving theCompany, each participant is 100% vested with respect to the participant’scontributions and is vested based upon years of service with respect to ourmatching contributions. All contributions are invested as directed by theparticipant in investment funds available under the 401(k) Plan, as selected bythe Plan Administrator. Upon retirement, benefits are payable to eachparticipant in a single lump-sum cash payment or an actuarial equivalent formof annuity on the first day of the month following the participant’sretirement.  

 

**Compliance with Section 16(a) ofthe Exchange Act**

 

Under the securities lawsof the United States, our directors, executive officers, and any personsholding more than ten percent of our common stock are required to report theirinitial ownership of common stock and other equity securities and anysubsequent changes in that ownership to the Securities and Exchange Commission andSport-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, 2005. Based solely on our review of the reports furnishedto us and written representations that no other reports were required duringfiscal 2005, we believe that our officers, directors and beneficial owners ofmore than ten percent of our common stock complied with all Section 16(a) filingrequirements.

 

**Compensation Committee Report**

 

Notwithstanding anythingto the contrary set forth in any of the previous filings made by Sport-Haley, Inc.under the Securities Act of 1933, as amended, or the Securities Exchange Act of1934, as amended, that might incorporate future filings, including, but notlimited to, this Report on Form 10-K, in whole or in part, the followingCompensation Committee Report shall not be deemed to be “filed” with theSecurities and Exchange Commission nor shall it be incorporated by referenceinto 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 2005.

 

*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-termincentive compensation in the form of awards under the Option Plan; and, d)various other benefits.

 

39

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*BaseSalary*.  For fiscal 2005,the Compensation Committee reviewed the base salaries of our executive officersunder their respective employment agreements. Annual adjustments to basesalaries, if any, were determined based upon a number of factors, including ourperformance (to the extent such performance can fairly be attributed or relatedto each executive officer’s performance), as well as the value of eachexecutive officer’s responsibilities, capabilities and contributions andinternal compensation equity considerations. In addition, for fiscal 2005, theCompensation Committee reviewed the base salaries of our executive officers inan attempt to ascertain whether those salaries fairly reflect jobresponsibilities and prevailing market conditions and rates of pay. TheCompensation Committee believes that base salaries for our executive officershave been reasonable in relation to our size and performance in comparison withthe compensation paid by similarly sized companies or companies within the golfapparel industry. The Compensation Committee increased the base pay of two of ourexecutive officers in fiscal 2005. The Compensation Committee increased thebase pay of Mr. Jewell in November 2004 from $150,000 to $200,000, foradditional compensation afforded to him per his agreement to serve as InterimChief Executive Officer, and the base pay of Mr. Hurley in December 2004from $87,500 to $110,000. In July 2005, the Compensation Committeeincreased the base pay of Ms. Blair from $102,500 to $110,000.

 

*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, ourfuture operating results, and on an officer’s responsibilities, capabilitiesand contributions. The Compensation Committee has not prepared a formal writtenbonus incentive plan for executive officers, although the executive officers’employment agreements generally provide that executives are eligible fordiscretionary bonuses of up to specified percentages of their base salaries.Although all of the executive officers’ contributions were noted and commended,the Compensation Committee did not award any bonuses to any of our executivesin fiscal 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 that incentivecompensation, in the form of bonuses and grants of options, most effectivelyaligns the interests of management with the interests of our shareholders. Ourstock option plan expired by its terms in February 2003. Accordingly, theCompensation Committee did not approve the grant of any options to executivesor directors in fiscal 2005.    

 

*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. Wedo not maintain any other plans or arrangements for the benefit of our executiveofficers except to provide life insurance policies for the benefit of certainexecutive officers’ named beneficiaries and a vehicle that was used by ourformer Chief Executive Officer. The Compensation Committee believes thesebenefits are reasonable in relation to the executive compensation practices ofother similarly sized companies or companies within the 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 that

 

40

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Sport-Haley, Inc.will lose any significant tax deduction relating to executive compensation. Atsuch time, if any, that the deductibility of executive compensation becomes anissue, modifications to compensation plans and policies will be considered bythe Compensation Committee.

 

*CEOCompensation.*Kevin M. Tomlinson served as our ChiefExecutive Officer until October 2004, when he stepped down from his dutiesupon the Board of Directors’ appointment of Donald W. Jewell as our InterimChief Executive Officer. Mr. Jewell entered into an employment agreement,effective November 1, 2004, to serve as Interim Chief Executive Officerthrough June 30, 2005, subject to automatic monthly extensions until asuccessor Chief Executive Officer is appointed. In reviewing the ChiefExecutive Officer’s compensation package, the Committee pursues the sameobjectives that apply for other executive officers. The Committee’s overallgoal is to set the Chief Executive Officer’s salary at a base comparable tothose of persons employed in similar capacities with competitors that aresimilar in industry size and performance. However, the actual level approved bythe Committee may be higher or lower based upon the Committee’s subjectiveevaluation of our annual and long-term performance, the individual performanceof the Chief Executive Officer, particularly with respect to leadership andstrategic vision, and cash resources and needs.

 

The Compensation Committee believes that the conceptsdiscussed above further the shareholders interests and that officercompensation encourages responsible management. The Compensation Committeeconsiders the effect of management compensation on shareholder interests. Inthe past, the Board of Directors based its review in part on the experiences ofits own members and on information requested from management personnel. Thesesame factors will be used in the future when determining officer compensation.

 

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

 

**Compensation Committee Interlocksand Insider Participation**

 

All of the CompensationCommittee members are independent directors. None of these members are or haveever been an officer or employee of Sport-Haley, Inc. or our former subsidiary,nor have any of them had a relationship, which would require disclosure underthe “Certain Relationship and Related Transactions” captions of any of ourfilings with the Commission during the past three fiscal years.

 

**Performance Graph**

 

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 wholeor in part, the following performance graph shall not be deemed to beincorporated by reference into any such future filings.

 

Setforth below is a line graph prepared by Zacks Investment Research comparing theyearly percentage change in our cumulative total shareholder return (shareprice appreciation plus dividends) on Sport-Haley, Inc. common stock withthe cumulative total return of (i) the Nasdaq US Market Index and (ii) thestocks of apparel manufacturers having Standard Industrial Classification codesfrom 2300 through 2341, which is deemed as a market weighted index of publiclytraded peers, for the period from July 1, 2000 through June 30, 2005 (the“Measurement Period”). The graph assumes that $100 is invested on July 1,2000, in each: our common stock; our publicly traded peers; and, the Nasdaq USMarket Index. The graph also assumes that all dividends were reinvested (therewere no dividends paid by Sport-Haley, Inc. during the MeasurementPeriod). Our shareholder return is calculated by dividing the differencebetween our share price at July 1, 2000, and each June 30 of theMeasurement Period by the share price at the beginning of the MeasurementPeriod.

 

41

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| ** **                 | ** ** | **Fiscal Year Ended June 30,** | ** ** |
|----------------------------|------------|-------------------------------------|------------|
| ** **                 | ** ** | **2000**                            | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|                       |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Sport-Haley, Inc.     |       | 100.00                              |       | 72.74 |   | 90.19 |   | 99.17 |   | 121.25 |   | 72.01 |   |
| Industry Peer  Group Index |       | 100.00                              |       | 91.58 |   | 88.71 |   | 81.40 |   | 105.91 |   | 115.94 |   |
| Nasdaq Market Index        |       | 100.00                              |       | 54.64 |   | 37.12 |   | 41.37 |   | 52.45 |   | 53.03 |   |

 

**ITEM 12. SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

** **

The following table setsforth certain information regarding beneficial ownership of our common stock asof September 8, 2005, by: (i) each person known by Sport-Haley, Inc.to own beneficially more than 5% of the outstanding common stock; (ii) eachdirector or nominee; and, (iii) all executive officers and directors as agroup. The information with respect to institutional investors is generallyderived from statements filed with the Securities and Exchange Commission underSection 13(d) or 13(g) of the Securities Exchange Act. Eachperson has sole voting and sole investment or dispositive power with respect tothe shares shown except as noted.

 

42

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| ** **                                           | ** ** | **Shareholdings on September 8, 2005** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| **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 |   |
| Mark Maley                                           |       | -0                                          | -          |   | * |
| Ronald J. Norick (5)                                 |       | 252,284                                     |       | 8.66 |   |
| James R. TenBrook                                    |       | -0                                          | -          |   | * |
| Mark J. Stevenson (4)                                |       | 91,667                                      |       | 3.20 |   |
| James H. Everest (6)                                 |       | 231,667                                     |       | 7.96 |   |
| Estate of Robert G. Tomlinson                        |       | 163,000                                     |       | 5.88 |   |
| Robert W. Haley                                      |       | 75,000                                      |       | 2.71 |   |
| Dimensional Fund Advisors Inc. (7)                   |       |                                        |       |   |   |
| 1299 Ocean  Avenue, 11th Floor                       |       |                                        |       |   |   |
| Santa Monica,  California 90401                      |       | 207,000                                     |       | 7.47 |   |
| Hillson Partners Limited Partnership (8)             |       |                                        |       |   |   |
| 6900 Wisconsin  Avenue, Suite 501               |       |                                        |       |   |   |
| Bethesda, MD  20815                                  |       | 274,600                                     |       | 9.91 |   |
| Michael Cook Asset Management, Inc. (9)         |       |                                        |       |   |   |
| d/b/a Cook Mayer  Taylor                             |       |                                        |       |   |   |
| 5170 Sanderlin  Avenue, Suite 200               |       |                                        |       |   |   |
| Memphis,  Tennessee 38117                            |       | 236,768                                     |       | 8.55 |   |
| Tilson Growth Fund, LP, Tilson Capital Partners, LLC |       |                                        |       |   |   |
| and Whitney  Tilson (10)                             |       |                                        |       |   |   |
| 175 East 62nd  Street, #11A,                         |       |                                        |       |   |   |
| New York, NY  10021                                  |       | 142,700                                     |       | 5.15 |   |
| All directors and officers as a group                |       |                                        |       |   |   |
| (Ten persons in  total) (11)                         |       | 913,618                                     |       | 28.15 |   |

 

----

| *    | 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 8, 2005.                                                                      |
| (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 8, 2005.                                                                                 |
| (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 141,667 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 141,667 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)  | Dimensional Fund Advisors, Inc. is an investment advisor company  which beneficially owns 207,000 shares, which are owned of record by its  advisory clients. Dimensional Fund Advisors, Inc. disclaims beneficial  ownership of all such shares.                  |
| (8)  | Hillson Partners Limited Partnership has sole voting power and sole  dispositive power over 274,600 shares.                                                                                                                                                                  |
| (9)  | Michael Cook Asset Management, Inc. has sole voting power and sole  dispositive power over 236,768 shares.                                                                                                                                                              |
| (10) | 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.                                                                |
| (11) | Includes 525,001 shares of common stock subject to currently  exercisable options or options which will become exercisable within 60  days after September 8, 2005.  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 andRestated 1993 Stock Option Plan (the “Option Plan”). The Option Plan wasapproved by our shareholders in 1993 and was amended in 1997. The Option Planexpired by its own terms on February 28, 2003. The following tablecontains information regarding the equity compensation plan as of June 30,2005.

 

43

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| **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**     |       | 838,500                                                                                                 | (1)        | $                                                                                       | 3.78       | (2)                                                                                                                                                       | 0          | (3) |
|                                                            |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                      |       |
| **Equity  compensation plans not approved by security holders** |       | 0                                                                                                       |       | —                                                                                  |       | 0                                                                                                                                                         |       |
|                                                            |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                      |       |
| **Total**                                                       |       | 838,500                                                                                                 |       | $                                                                                       | 3.78       |                                                                                                                                                      | 0          |   |

 

----

| (1) | The  total number of securities to be issued upon exercise of outstanding options,  warrants and rights consists of options for the purchase of  Sport-Haley, Inc. common stock granted pursuant to the Option Plan to  employees, officers, directors, consultants, independent sales representatives  and golf tour professionals. The total number of securities to be issued upon  exercise of the options is stated, regardless of whether the options were  vested as of June 30, 2005. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The  outstanding options issued under the Option Plan 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  can be granted under the Plan after that date. At the time the Plan expired,  a total of 1,180 options remained of the total of 2,150,000 options  authorized to be issued.                                                                                                                                                               |

 

 

**ITEM 13.   CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

We adopted a policypursuant to which material transactions between Sport-Haley, Inc. and our executiveofficers, directors and principal shareholders (i.e. shareholders owningbeneficially 5% or more of the outstanding voting securities of Sport-Haley, Inc.),and any immediate family member of the foregoing, shall be submitted to the AuditCommittee for approval. For this purpose, a transaction is deemed material ifsuch transaction, alone or together with a series of similar transactionsduring the same fiscal year, involves an amount that exceeds $60,000. No suchtransactions occurred in fiscal 2005.

 

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

** **

**(1)****         Audit Fees.**The aggregate fees billed by Hein & Associates LLP, our independentauditors, during fiscal years 2005 and 2004 for the audits of our annualfinancial statements, the reviews of our quarterly financial statementsincluded in Forms 10-Q for the corresponding quarterly periods or the servicesthat are normally provided by in connection with statutory and regulatoryfilings or engagements for those fiscal years totaled $73,000 and $67,000,respectively.

 

**(2)****         Audit-relatedFees.** The aggregate fees billed by Hein & Associates LLP forassurance and related services that are reasonably related to the performanceof the audit or review of our financial statements that are not included in the“Audit Fees” described above totaled $5,000 and $9,000 for fiscal years 2005 and2004, respectively.

 

44

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**(3)****         Tax Fees.**The aggregate fees billed by Hein &Associates LLP in fiscal years 2005 and 2004 for professional services renderedfor tax compliance, tax advice and tax planning totaled $5,000 and $3,000,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 OtherFees.** The aggregate fees billed by Hein & Associates LLP in fiscalyears 2005 and 2004, other than for the services reported in “Audit Fees,” “AuditRelated Fees” or “Tax Fees” described above, totaled $0 and $0, respectively.

 

**(5)****         Audit Committee Approval Procedures.**Our independent auditors report to, and are engaged at the direction of, theAudit Committee, with annual approval by the shareholders. Effective May 2003,the Audit Committee implemented procedures for the pre-approval of audit andnon-audit services performed by the independent auditors. The Audit Committeehas the sole authority to pre-approve all audit and non-audit services providedby the independent auditors and acts to assure that the independent auditorsare not engaged to perform specific non-audit services proscribed by law orregulation.

 

**PART IV**

 

**ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

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

 

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

 

**(1)****                                 FinancialStatements**

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

 

**(2)****                                 FinancialStatement 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. |
|                 |       |         |   |   |
| 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. |

 

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| */     |   | 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.                   |
|   |   |     |   |                                                                                                                              |
| x      |   | 10.2.5   |   | Employment Agreement,  dated July 1, 1997, by and between Catherine B. Blair and  Sport-Haley, Inc.                     |
|   |   |     |   |                                                                                                                              |
| ***    |   | 10.2.5.1 |   | Amended Employment  Agreement, effective June 1, 2005, 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.                |
|   |   |     |   |                                                                                                                              |
| x      |   | 10.2.11  |   | Form of standard  Endorsement Agreement by and between various golf professionals 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.  |

 

46

----

 
| ##     |   | 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. |
|   |   |   |   |                                                                                                                                                                         |
| */     |   | 10.5   |   | 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.                                             |
|   |   |   |   |                                                                                                                                                                         |
| – |   | 10.10  |   | Trademark License  Agreement, dated October 14, 1995, by and between W.L. Gore &  Associates, Inc. and Sport-Haley.                                            |
|   |   |   |   |                                                                                                                                                                         |
| *#     |   | 14.1   |   | Code of Ethics for  Senior Financial Officers.                                                                                                                               |
|   |   |   |   |                                                                                                                                                                         |
| &  |   | 14.2   |   | Code of Conduct and  Ethics for Directors, Officers and Employees.                                                                                                           |
|   |   |   |   |                                                                                                                                                                         |
| ***    |   | 31.1   |   | Certification of Donald  W. Jewell pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).                                                                                   |
|   |   |   |   |                                                                                                                                                                         |
| ***    |   | 31.2   |   | Certification of  Patrick W. Hurley pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).                                                                                  |
|   |   |   |   |                                                                                                                                                                         |
| ***    |   | 32.1   |   | Certification of Donald  W. Jewell and Patrick W. Hurley Pursuant to 18 U.S.C. §1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002        |

 

----

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

 

47

----

 

**SIGNATURES**

 

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

 

 
|                  | SPORT-HALEY,  INC.                                |
|-----------------------|---------------------------------------------------|
|                  |                                              |
|                  |                                              |
| October 13, 2005 | 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  |       |                                 | Interim Chief Executive  Officer,    |     | October 13,  2005 |   |
| Donald W. Jewell      |       | President  and Senior Vice President |                                 |     |                   |
|                  |       |                                 |                                 |     |                   |
| /s/ PATRICK W. HURLEY |       |                                 | Chief Financial  Officer, Secretary, |     | October 13,  2005 |   |
| Patrick W.  Hurley    |       | Treasurer  and Controller            |                                 |     |                   |
|                  |       |                                 |                                 |     |                   |
| /s/ RONALD J. NORICK  |       |                                 | Director                             |     | October 13,  2005 |   |
| Ronald J. Norick      |       | and  Chairman of the Board           |                                 |     |                   |
|                  |       |                                 |                                 |     |                   |
| /s/ JAMES R. TENBROOK |       |                                 | Director                             |     | October 13,  2005 |   |
| James R.  TenBrook    |       | and  Audit Committee Chairman        |                                 |     |                   |
|                  |       |                                 |                                 |     |                   |
| /s/ MARK J. STEVENSON |       |                                 | Director                             |     | October 13,  2005 |   |
| Mark J.  Stevenson    |       | and  Compensation Committee Chairman |                                 |     |                   |
|                  |       |                                 |                                 |     |                   |
| /s/ JAMES H. EVEREST  |       |                                 | Director                             |     | October 13,  2005 |   |
| James H. Everest      |       |                                 |                                 |     |                   |
|                       |            |                                      |                                      |          |                        |  |  |  |  |  |  |

 

48

----

 

**INDEX TO FINANCIAL STATEMENTS**

 
| ** **                                                   | **PAGE** |
|--------------------------------------------------------------|----------|
|                                                         |     |
| **Report of Independent Registered Public  Accounting Firm** | F-2      |
|                                                         |     |
| **Balance Sheets**                                           | F-3      |
|                                                         |     |
| **Statements of Operations**                                 | F-4      |
|                                                         |     |
| **Statement of Shareholders’ Equity**                   | F-5      |
|                                                         |     |
| **Statements of Cash Flows**                                 | F-6      |
|                                                         |     |
| **Notes to Financial Statements**                            | F-7      |
|                                                         |     |
| **Schedule II - Valuation and Qualifying Accounts**          | F-23     |

 

F-1

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

Board of Directors

Sport-Haley, Inc.

Denver, Colorado

 

We have audited the accompanying balance sheets of Sport-Haley, Inc. asof June 30, 2005 and 2004, and the related statements of operations,shareholders’ equity and cash flows for each of the three years in the period endedJune 30, 2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosuresin the financial 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 ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the financial position of Sport-Haley, Inc.as of June 30, 2005 and 2004, and the results of their operations and their cashflows for each of the three years in the period ended June 30, 2005, inconformity with accounting principles generally accepted in the United Statesof America.

 

Our audits were made for the purpose of forming an opinion on the basicfinancial statements taken as a whole. The schedule listed in the index offinancial statements is presented for purposes of complying with the Securitiesand Exchange Commission’s rules and is not part of the basic financialstatements. This schedule has been subjected to the auditing procedures appliedin the audits of the basic financial statements and, in our opinion, fairlystates in all material respects the financial data required to be set forththerein in relation to the basic financial statements taken as a whole.

 

HEIN & ASSOCIATES LLP

Denver, Colorado

 

August 18, 2005

 

F-2

----

 

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

 

**BALANCE SHEETS**

 
| ** **                                                                                                                      | ** ** | **JUNE 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------|------------|
| ** **                                                                                                                      | ** ** | **2005**     | ** ** | **2004** | ** ** |
|                                                                                                                            |       |         |       |   |   |
| **ASSETS**                                                                                                                      |       |         |       |   |   |
|                                                                                                                            |       |         |       |   |   |
| **CURRENT ASSETS:**                                                                                                             |       |         |       |   |   |
| Cash and cash  equivalents                                                                                                      |       | $            | 7,721,000  |   | $ | 3,890,000 |   |
| Marketable  securities                                                                                                          |       | —       |       | 539,000 |   |
| Accounts  receivable, net of allowances of $691,000 and $1,128,000, respectively                                                |       | 4,495,000    |       | 5,946,000 |   |
| Inventories                                                                                                                     |       | 4,153,000    |       | 8,808,000 |   |
| Prepaid expenses  and other                                                                                                     |       | 196,000      |       | 468,000 |   |
| Total current  assets                                                                                                           |       | 16,565,000   |       | 19,651,000 |   |
|                                                                                                                            |       |         |       |   |   |
| **PROPERTY  AND EQUIPMENT,**net                                                                                                 |       | 922,000      |       | 1,107,000 |   |
|                                                                                                                            |       |         |       |   |   |
| **OTHER  ASSETS**                                                                                                               |       | 3,000        |       | 13,000 |   |
|                                                                                                                            |       |         |       |   |   |
| **TOTAL  ASSETS**                                                                                                               |       | $            | 17,490,000 |   | $ | 20,771,000 |   |
|                                                                                                                            |       |         |       |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                   | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                                                                                                      | ** ** | ** **   | ** ** | ** ** | ** ** |
| **CURRENT  LIABILITIES:**                                                                                                       |       |         |       |   |   |
| Accounts payable                                                                                                                |       | $            | 582,000    |   | $ | 1,381,000 |   |
| Accrued  royalties payable                                                                                                      |       | 294,000      |       | 190,000 |   |
| Accrued  commissions payable                                                                                                    |       | 249,000      |       | 272,000 |   |
| Accrued payroll                                                                                                                 |       | 533,000      |       | 197,000 |   |
| Other                                                                                                                           |       | 93,000       |       | 108,000 |   |
| Total current  liabilities                                                                                                      |       | 1,751,000    |       | 2,148,000 |   |
|                                                                                                                            |       |         |       |   |   |
| **COMMITMENTS  AND CONTINGENCIES** (Notes 8 and 9)                                                                              |       |         |       |   |   |
|                                                                                                                            |       |         |       |   |   |
| **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; 2,645,252 and 2,525,252 shares  issued and outstanding, respectively |       | 10,460,000   |       | 10,126,000 |   |
| Additional  paid-in capital                                                                                                     |       | 1,590,000    |       | 1,527,000 |   |
| Retained  earnings                                                                                                              |       | 3,689,000    |       | 6,970,000 |   |
| Total shareholders’  equity                                                                                                |       | 15,739,000   |       | 18,623,000 |   |
|                                                                                                                            |       |         |       |   |   |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                            |       | $            | 17,490,000 |   | $ | 20,771,000 |   |

 

***Seeaccompanying notes to these financial statements.***

 

F-3

----

 

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

 

**STATEMENTS OF OPERATIONS**

 
| ** **                                                                 | ** ** | **FOR THE YEARS ENDED  JUNE 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                 | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **NET  SALES**                                                             |       | $                                 | 22,041,000 |   | $ | 20,800,000 |   | $ | 19,196,000 |   |
| Cost of goods  sold                                                        |       | 15,689,000                        |       | 13,619,000 |   | 11,873,000 |   |
| **GROSS  PROFIT**                                                          |       | 6,352,000                         |       | 7,181,000 |   | 7,323,000 |   |
| **OTHER  OPERATING COSTS:**                                                |       |                              |       |   |   |   |   |
| Selling, general  and administrative expenses                              |       | 9,036,000                         |       | 8,205,000 |   | 7,700,000 |   |
| Royalty expense                                                            |       | 797,000                           |       | 532,000 |   | 326,000 |   |
| Total other  operating costs                                               |       | 9,833,000                         |       | 8,737,000 |   | 8,026,000 |   |
|                                                                       |       |                              |       |   |   |   |   |
| **LOSS  FROM OPERATIONS**                                                  |       | (3,481,000                        | )          | (1,556,000 | ) | (703,000 | ) |
| ** **                                                                 |       |                              |       |   |   |   |   |
| **OTHER  INCOME AND (EXPENSE):**                                           |       |                              |       |   |   |   |   |
| Interest income,  net                                                      |       | 107,000                           |       | 66,000 |   | 110,000 |   |
| Other income                                                               |       | 123,000                           |       | 54,000 |   | 45,000 |   |
| Other expense                                                              |       | (22,000                           | )          | (4,000 | ) | (20,000 | ) |
| Total other  income                                                        |       | 208,000                           |       | 116,000 |   | 135,000 |   |
|                                                                       |       |                              |       |   |   |   |   |
| **LOSS  FROM OPERATIONS BEFORE (PROVISION FOR) BENEFIT FROM INCOME TAXES** |       | (3,273,000                        | )          | (1,440,000 | ) | (568,000 | ) |
| (Provision for)  benefit from income taxes                                 |       | (8,000                            | )          | (746,000 | ) | 180,000 |   |
|                                                                       |       |                              |       |   |   |   |   |
| **NET  LOSS**                                                              |       | $                                 | (3,281,000 | ) | $ | (2,186,000 | ) | $ | (388,000 | ) |
|                                                                       |       |                              |       |   |   |   |   |
| **NET  LOSS PER SHARE:**                                                   |       |                              |       |   |   |   |   |
| Basic and  diluted                                                         |       | $                                 | (1.29      | ) | $ | (0.89 | ) | $ | (0.15 | ) |
|                                                                       |       |                              |       |   |   |   |   |
| **WEIGHTED  AVERAGE SHARES OUTSTANDING:**                                  |       |                              |       |   |   |   |   |
| Basic and  diluted                                                         |       | 2,548,000                         |       | 2,448,000 |   | 2,621,000 |   |

 

***Seeaccompanying notes to these financial statements.***

 

F-4

----

 

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

 

**STATEMENT OF SHAREHOLDERS’ EQUITY**

 
| ** **                   | ** ** | **COMMON STOCK** | ** ** | **ADDITIONAL  PAID-IN** | ** ** | **RETAINED** | ** ** | **TOTAL  SHAREHOLDERS’** | ** ** |
|------------------------------|------------|------------------|------------|-------------------------|------------|--------------|------------|-------------------------------|------------|
| ** **                   | ** ** | **SHARES**       | ** ** | **AMOUNT**              | ** ** | **CAPITAL**  | ** ** | **EARNINGS**                  | ** ** | **EQUITY** | ** ** |
|                         |       |             |       |                    |       |         |       |                          |       |   |   |
| **BALANCES,**July 1, 2002    |       | 2,730,985        |       | $                       | 10,919,000 |         | $          | 1,309,000                     |       | $ | 9,544,000 |   | $ | 21,772,000 |   |
|                         |       |             |       |                    |       |         |       |                          |       |   |   |
| Repurchases of  common stock |       | (286,400         | )          | (1,051,000              | )          | —       |       | —                        |       | (1,051,000 | ) |
| Stock-based  compensation    |       | —           |       | —                  |       | 94,000       |       | —                        |       | 94,000 |   |
| Net loss                     |       | —           |       | —                  |       | —       |       | (388,000                      | )          | (388,000 | ) |
|                         |       |             |       |                    |       |         |       |                          |       |   |   |
| **BALANCES,**June 30, 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 |   |

 

***Seeaccompanying notes to these financial statements.***

 

F-5

----

 

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

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

 
| ** **                                                                                       | ** ** | **FOR THE YEARS ENDED JUNE 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                             |       |                             |       |   |   |   |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                       |       |                             |       |   |   |   |   |
| Net loss                                                                                         |       | $                                | (3,281,000 | ) | $ | (2,186,000 | ) | $ | (388,000 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in)  operating activities: |       |                             |       |   |   |   |   |
| Depreciation and  amortization                                                                   |       | 352,000                          |       | 327,000 |   | 354,000 |   |
| Impairments and  write-downs                                                                     |       | 1,403,000                        |       | 707,000 |   | 259,000 |   |
| Deferred taxes                                                                                   |       | —                           |       | 746,000 |   | (170,000 | ) |
| Provisions for  doubtful accounts and sales returns                                              |       | (205,000                         | )          | 856,000 |   | 484,000 |   |
| Stock-based  compensation expense                                                                |       | 63,000                           |       | 124,000 |   | 94,000 |   |
| Gain/loss on  disposal of assets                                                                 |       | 22,000                           |       | 4,000 |   | 20,000 |   |
| Changes in  assets and liabilities:                                                              |       |                             |       |   |   |   |   |
| Accounts  receivable                                                                             |       | 1,656,000                        |       | (1,846,000 | ) | (1,068,000 | ) |
| Inventory                                                                                        |       | 3,252,000                        |       | (1,687,000 | ) | (1,383,000 | ) |
| Prepaid expenses                                                                                 |       | 272,000                          |       | 32,000 |   | (34,000 | ) |
| Taxes receivable                                                                                 |       | —                           |       | — |   | 1,071,000 |   |
| Other assets                                                                                     |       | (3,000                           | )          | — |   | (2,000 | ) |
| Accounts payable                                                                                 |       | (799,000                         | )          | 792,000 |   | (460,000 | ) |
| Accrued  commissions and other expenses                                                          |       | 402,000                          |       | 238,000 |   | (175,000 | ) |
| Net cash  provided by (used in) operating activities                                             |       | 3,134,000                        |       | (1,893,000 | ) | (1,398,000 | ) |
|                                                                                             |       |                             |       |   |   |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                       |       |                             |       |   |   |   |   |
| Purchase of  fixed assets                                                                        |       | (176,000                         | )          | (427,000 | ) | (611,000 | ) |
| Maturities  (purchases) of marketable securities                                                 |       | 539,000                          |       | 1,642,000 |   | (1,076,000 | ) |
| Proceeds from  the disposal of fixed assets                                                      |       | —                           |       | 6,000 |   | 12,000 |   |
| Net cash  provided by (used in) investing activities                                             |       | 363,000                          |       | 1,221,000 |   | (1,675,000 | ) |
|                                                                                             |       |                             |       |   |   |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                       |       |                             |       |   |   |   |   |
| Stock option  exercises                                                                          |       | 334,000                          |       | 258,000 |   | — |   |
| Repurchases of  common stock                                                                     |       | —                           |       | — |   | (1,051,000 | ) |
| Net cash  provided by (used in) financing activities                                             |       | 334,000                          |       | 258,000 |   | (1,051,000 | ) |
|                                                                                             |       |                             |       |   |   |   |   |
| **NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS**                                        |       | 3,831,000                        |       | (414,000 | ) | (4,124,000 | ) |
|                                                                                             |       |                             |       |   |   |   |   |
| **CASH  AND CASH EQUIVALENTS,**Beginning of year                                                 |       | 3,890,000                        |       | 4,304,000 |   | 8,428,000 |   |
|                                                                                             |       |                             |       |   |   |   |   |
| **CASH  AND CASH EQUIVALENTS,**End of year                                                       |       | $                                | 7,721,000  |   | $ | 3,890,000 |   | $ | 4,304,000 |   |
|                                                                                             |       |                             |       |   |   |   |   |
| **SUPPLEMENTAL  CASH FLOW INFORMATION:**                                                         |       |                             |       |   |   |   |   |
| Cash receipts  for:                                                                              |       |                             |       |   |   |   |   |
| Income tax  refunds                                                                              |       | $                                | —     |   | $ | — |   | $ | 1,066,000 |   |
| Cash payments  for:                                                                              |       |                             |       |   |   |   |   |
| Interest                                                                                         |       | $                                | —     |   | $ | — |   | $ | 9,000 |   |
| Income taxes                                                                                     |       | $                                | 8,000      |   | $ | — |   | $ | — |   |

 

***Seeaccompanying notes to these financial statements.***

 

F-6

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

*** ***

**NOTES TOFINANCIAL STATEMENTS**

 

1.                             **ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES**:

 

*Nature of Operations* –Sport-Haley, Inc., organized as a Colorado corporation in January 1991, designs,purchases, contracts for the manufacture of, markets and distributes men’s andwomen’s fashion golf apparel and outerwear under the SPORT HALEYTM and BenHogan® labels. Our fashion golf apparel collections, known for their innovativedesigns, quality fabrics, generous fits and classic styles, are primarily marketedin the premium and mid-priced markets, through a network of independent salesrepresentatives and distributors, to golf professional shops, country clubs,resorts and exclusive department stores within the United States and by certaindistributors within various international markets.

 

*Reclassification* – Certainprior amounts have been reclassified to conform to the year 2005 presentation.Such reclassifications had no affect on net loss.

 

*Marketable Securities* –Marketable securities generally consist of United States government andmortgage-backed debt securities that mature within one year or less and areclassified as held-to-maturity. Due to the short-term nature of theinvestments, there are no material unrealized gains or losses on theseinvestments. As a result, the carrying values of marketable securitiesapproximate their fair market values.

 

*Receivables and Credit Policies*– Trade receivables consist of uncollateralized customer obligations due undernormal trade terms, generally requiring payment within 30 days of the invoicedate. In most cases, individual trade receivables apply to a specificidentifiable sales invoice. Periodically, management reviews the estimatedrecoverability of trade receivables and reduces their carrying amount by utilizinga valuation allowance that reflects management’s best estimate of the amountthat may not be collectible.

 

*Inventories*– Inventories are generally stated at the lower of cost (weighted average) ormarket. 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. After we implemented ouroperations software in January 2004, we discovered certain programming andhuman errors within the new system that adversely affected the software’sability to accurately compute the valuation of our finished goods inventories usinga weighted average method. We consider the programming and human errors, whichcaused us to use the standard cost method, to be a material weakness in ourinternal controls over financial reporting with respect to inventory valuation.The system was designed to utilize a series of complex valuation computations,and management determined that a manual reconstruction of the numerous amountof transactions affected by the programming and human errors was impracticable.This weakness in our controls prevented us from relying upon thesystem-recorded transactions with respect to inventory valuations during 2005and 2004. Based upon analyses performedto compare the landed cost components of our finished goods inventories withrespect to our standard cost components and analyses of the allocated overheadportion of our standard costs, we concluded with reasonable assurance thatrecomputing the value of our finished goods inventories using a standard costmethod yielded a fair estimation of the value of our finished goodsinventories. We used the standard cost method to value our finished goodsinventories from the fiscal quarter ended March 31, 2004, through the fiscalquarter ended March 31, 2005. At June 30, 2005, certain inventory itemsremained on hand that had been valued using the standard cost method. Themethods we use to determine the standard costs of our finished good inventorieshave not changed since our initial analyses of such costs were performed in2004. Had we been able to rely upon the system to properly compute the cost ofour finished 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.

 

F-7

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Thematerial weakness in our internal controls over financial reporting withrespect to inventory valuation impaired our ability to rely upon informationcreated by our computer system to fairly present, in all material respects, ourfinancial condition, results of operations and cash flows for 2005 and 2004.The inability of our computer system to properly calculate the valuation of ourfinished goods inventories using a weighted average cost assumption alsoaffected the system-recorded amounts within our cost of goods sold during 2005and 2004. Costs associated with invoiced sales and returns as well as inventoryadjustments are natural components of our cost of goods sold. Because weconcluded with reasonable assurance that our using a standard cost assumptionyielded a fair estimation of our finished goods inventories during fiscals 2005and 2004, and because we consistently recorded adjustments to inventories ascomponents of cost of goods sold, we believe with reasonable assurance that ourcost of goods sold are fairly stated for 2005 and 2004. Therefore, we believethat the procedures we applied to value our finished goods inventories in 2005and 2004 provide us with reasonable assurance that our financial statements andthe notes thereto fairly state, in all material respects, our financialcondition, the results of our operations and our cash flows.

 

Basedupon tests we performed subsequent to June 30, 2005, we believe that thecomputer software has been properly programmed, and employees have beenadequately trained to utilize the system procedures, to accurately compute ourfinished goods inventory valuations using a weighted average cost assumptionbeginning in 2006.

 

Inventories are written down to market value asadjustments to reserves for inventory obsolescence. Changes in the reserves forinventory obsolescence are reflected in cost of goods sold during the periodsin which the reserve is recorded and the obsolete inventory is sold,respectively. Write-downs as a result of inventory obsolescence totaled $1,403,000,$707,000 and $259,000 for 2005, 2004 and 2003, respectively.

 

*Property and Equipment* –Property and equipment are stated at historical cost. Depreciation is generallyrecorded over the estimated useful lives of the assets, ranging from three totwelve years, using the straight-line method of depreciation. Leaseholdimprovements are stated at historical cost and are generally amortized over theremaining life of the lease, using the straight-line method. Materialexpenditures that increase the life of an asset are capitalized and depreciatedover the estimated remaining useful life of the asset. The costs of normalmaintenance and repairs are charged to operating expenses as incurred. Upon thedisposition of assets, the related cost and accumulated depreciation areremoved from the books and the realized gain or loss, if any, is recognized inthe year of the disposition.

 

*Impairment of Long-Lived Assets*– The carrying values of long-lived assets are reviewed for impairment wheneverevents or changes in circumstances indicate that such carrying values may notbe recoverable. We do not perform periodic assessments of assets for impairmentin the absence of such information or indicators. Currently, management has noindication of any events or circumstances that would significantly impair any ofour long-lived assets, primarily furniture, fixtures and equipment. An impairmentcharge, if any, would be recorded for the excess of the carrying value of anasset over its estimated fair value, as determined based upon estimates offuture cash flows, third-party valuation or other measures determinedappropriate for the circumstances.

 

*Revenue Recognition* – TheCompany recognizes revenue in accordance with Securities and ExchangeCommission Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognitionin Financial Statements,” as amended by SAB 101A and SAB 101B. SAB 101 requiresthat four basic criteria must be met

 

F-8

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before revenue can be recognized: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or services havebeen rendered; (3) the fee is determinable and fixed; and, (4) collectibilityis reasonably assured. We generally record revenue upon shipment, primarilytransported via common carrier with terms of FOB at the point of delivery tothe carrier. Occasionally, we may implement limited consignment programs withcertain of our customers. We generally recognize revenue on consignment salesat the time of collection from the customer. On a limited basis, we also offer certaincustomers the right of return for certain inventory, which we include as acomponent within our estimate of allowance for sales returns.

 

During 2004, we initiated a policy that granted our independentwholesale sales representatives the right to return sample garments, at the endof the related marketing period for such merchandise, at no charge to the salesrepresentative. Previously, we invoiced the representatives for sample garmentsat discounted wholesale prices.  Theright to return offered to the representatives caused us to adopt a policy toaccount for the sample garments in a manner consistent with our accounting for consignedinventories, whereby we capitalize the cost of the sample garments as acomponent of our finished goods inventories and reverse the cost of sales ofthe such invoiced shipments. Further, we record an allowance to completelyoffset the amount receivable from the representatives for the garments andreverse the corresponding revenue effect of the sale. The sales representative’saccounts receivable balance, the related allowance and inventory costs areadjusted and a sale is recorded when the representative reimburses us for thecost of the sample garments or the term, for which the right of return wasgranted, expires. Upon return of the garments to us, the sales representative’saccounts receivable balance and the related allowance are adjusted accordingly,the corresponding revenue effect of the return is reversed and the inventoryitems are returned to stock. During 2005, we discontinued the policy that grantedour independent sales representatives to right to return sample garments. Allowancesfor returns of sample garments totaled $28,000 and $332,000, and consignedinventories totaled $28,000 and $323,000 at June 30, 2005 and 2004,respectively. Because the shipments and returns of sample garments made underthe right to return policy must be tracked and adjusted manually, actualshipments and returns made in accordance with that policy may differ from ourestimates.

 

*Sales Incentives* –The typesof incentives that we offer to our customers generally include sales discounts,terms discounts and free goods, which we include in the net sales line of ourstatement of operations. In the ordinary course of our business, we may offerour customers sales discounts of up to 25%, terms discounts of up to 10% orfree goods of up to 5% off of our stated wholesale prices. The revenue effectsof sales discounts and free goods are recorded upon invoicing our customer forthe related merchandise. We record applicable terms discounts upon receipt ofpayment from the customer. On a limited basis, we also participate incooperative advertising with certain of our customers. Charges for cooperativeadvertising are recorded as advertising expense in the period in which our paymentis made or when we issue credit to the customer’s account.

 

*Cost of Goods Sold* – 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 and other charges, customembroidery costs and freight-out in our cost of goods sold. Amounts invoiced toour customers for custom embroidery as well as shipping and handling chargesare included as components of our net sales. Our overhead allocation includescertain of our distribution costs, such as receiving, inspection and shippingcosts, but we include some of the other costs of distribution, such as aportion of our warehousing and other handling costs, in selling, general andadministrative expense. We include royalty payments, relating to sales oflicensed apparel, in other operating costs.

 

F-9

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*Recoverable Defense Expenses*- As of June 30, 2005, we had cumulatively incurred $1,100,000 in potentiallyrecoverable costs related to the restatements of our 1999 and 1998 financialstatements and the correction of material information for the fiscal quartersof years 2000, 1999 and 1998, an investigation and subsequent civil actioninitiated by the Securities and Exchange Commission and a class action lawsuitthat has been settled. Our applicable officer and director liability insurancecovers some of the expenses incurred in connection with the restatements andsubsequent legal proceedings. The policy retention for such defense costs hasbeen satisfied, and one of our insurance carriers had reimbursed us $401,000 asof June 30, 2005. Amounts recovered from our insurance carriers are generallyoffset against other related legal expenses in the period within which they arerecovered, or recoverability is reasonably assured, except that amountsrecovered are included in other income to the extent that such recovery exceedslegal expenses for related matters incurred within the period for which therecovery is recorded. We recorded offsets to legal expenses totaling $88,000,$204,000 and $0 and recorded other income of $109,000, $0 and $0 with regard toreimbursements from our insurance carriers for 2005, 2004 and 2003,respectively.

 

*Advertising* – We expense theproduction costs of advertising the first time the advertising takes place,except for direct-response advertising, which is capitalized and amortized overits expected period of future benefits. We had no capitalized direct responseadvertising for 2005, 2004 or 2003. We include the following in advertisingexpenses: costs of sales catalogs; tradeshow expenses; costs of apparel used inpromotional activities; print ads in golf and other publications; marketresearch expenditures; amounts paid to professional golfers; and, various otheritems. Advertising expense was $946,000, $902,000, and $960,000 for 2005, 2004,and 2003, respectively.

 

*Deferred Taxes* – Deferredincome taxes are recognized for the tax consequences in future years fordifferences between the tax bases of assets and liabilities and their financialreporting amounts at each year end, based on enacted tax laws and statutory taxrates applicable to the periods in which the differences are expected to affecttaxable income. Our significant deferred tax assets are related to netoperating loss carry forwards for federal and state income tax purposes, stock-basedcompensation and an unrealized loss for tax purposes on a common stockinvestment. Governing regulations require that our operating losses be carriedforward for income tax purposes. We have established a valuation allowance toreduce our deferred tax assets to the net amount expected to be recovered infuture periods. The estimates for deferred tax assets and the correspondingvaluation allowance require us to exercise complex judgments. We periodicallyreview and adjust those estimates based upon the most current informationavailable. In accordance with SFAS 109 and based upon a review at June 30,2005, of our utilization of deferred tax assets, we maintained a valuationallowance that effectively reduces our net deferred tax assets to zero. Whilewe continue to explore various strategies to return the Company toprofitability, we cannot be certain that our efforts will result in thegeneration of future profits. Because the recoverability of deferred tax assetsis directly dependent upon future operating results, actual recoverability ofdeferred tax assets may differ materially from our estimates. Income taxexpense equals taxes payable for the period plus the net change during theperiod in deferred tax assets and liabilities.

 

*Use of Estimates* – Thepreparation of financial statements in conformity with generally acceptedaccounting principles in the United States of America requires management tomake estimates and assumptions that affect certain reported amounts anddisclosures. Among others, significant estimates include the allowance fordoubtful accounts, sales returns and inventory reserves and valuationallowances associated with deferred tax assets. Accordingly, actual resultscould differ from those estimates.

 

F-10

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*Certain Risks and Concentrations*– Our operations consist of designing, purchasing, contracting for themanufacture of, marketing and wholesale distribution of golf apparel for menand women. Our headquarters are located in Denver, Colorado, and our customersare located throughout the United States and abroad. As of June 30, 2005, 2004 and2003, the majority of our receivables were from customers in the golfingindustry. We perform on-going credit evaluations, and management believes that wemaintain adequate allowance for potential credit losses.

 

Beginning in 2001, we significantly increased our relianceon foreign suppliers that provide finished and packaged apparel. The increasedreliance heightened the risk that our revenues could be adversely affected if aforeign shipment or shipments were received late or lost. We maintain insurancefor risk of loss relating to goods shipped from our foreign and domesticsuppliers. However, our increased reliance on foreign suppliers heightens therisk that we may be left with inadequate or unsatisfactory recourse should thegoods received from the foreign suppliers be nonconforming. In 2005, 2004 and2003, we purchased significant amounts of our finished apparel from variousforeign suppliers. If we were to lose or terminate the services of any of thesesignificant suppliers, our short-term ability to fulfill its customers’ orderson a timely basis could be substantially impaired, thereby negatively affectingthe results of our operations. In 2005, we purchased 43%, 11%, 8%, 7%, 6% and5% of our finished apparel from six foreign suppliers, respectively. In 2004, wepurchased 43%, 11%, 8% and 8% of our finished apparel from four foreignsuppliers, respectively. Comparatively, we purchased 40% and 14% of our finishedapparel from two suppliers in 2003.

 

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

 

*Financial Instruments* – Weperiodically maintain cash balances at a commercial bank in excess of theFederal Deposit Insurance Corporation insurance limit of $100,000.

 

*Comprehensive Income (Loss)* –Comprehensive income is defined as all changes in shareholders’ equity(deficit), exclusive of transactions with owners, such as capital investments.Comprehensive income includes net income (loss) and income or loss from changesin certain assets and liabilities that are reported directly in equity. We hadno items of other comprehensive income for 2005, 2004, or 2003.

 

*Net Income (Loss) Per Share* –Basic earnings per share (EPS) is calculated by dividing the income or lossavailable to common shareholders by the weighted average number of commonshares outstanding for the period. Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock wereexercised or converted into common stock. Due to losses reported in 2005, 2004 and2003, all of our stock options outstanding were anti-dilutive, and thusexcluded from the loss per share calculations.

 

*Stock-Based Compensation* – Aspermitted under the Statements of Financial Accounting Standards No. 123 (“SFAS123”), *“Accountingfor Stock-Based Compensation,”* we account for our stock-basedcompensation with regard to options issued to employees in accordance with theprovisions of Accounting Principles Board Opinion No. 25, *“Accounting for StockIssued to Employees”* (“APB 25”). As such, for options granted toemployees and directors, compensation expense is recorded on a straight-linebasis over the shorter of the period that the services are provided or thevesting period, only if the current market price of the underlying

 

F-11

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stock exceeds the exercise price. Certain pro formanet income and earnings per share disclosures for employee stock option grantsare also included in the notes to the financial statements as if the fair valuemethod as defined in SFAS 123 had been applied. Transactions in equityinstruments with non-employees for goods or services are accounted for by thefair value method.

 

Had compensation cost for the Plan been determinedbased upon the fair value at the grant date for options granted, consistentwith the provisions of SFAS 123, our net loss and net loss per share would havebeen the pro forma amounts indicated below:

 
| ** **                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**   | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
|                                                                       |       |     |       |     |       |       |       |
| Net loss - as  reported                                                    |       | $        | (3,281,000 | )        | $          | (2,186,000 | )          | $ | (388,000 | ) |
| Effect of  employee stock-based compensation included in reported net loss |       | 63,000   |       | 124,000  |       | 59,000     |       |
| Effect of  employee stock-based compensation per SFAS 123                  |       | (423,000 | )          | (422,000 | )          | (275,000   | )          |
| Net loss  applicable to common stock - pro forma                           |       | $        | (3,641,000 | )        | $          | (2,484,000 | )          | $ | (604,000 | ) |
|                                                                       |       |     |       |     |       |       |       |
| Basic and  Diluted:                                                        |       |     |       |     |       |       |       |
| Loss per share –  as reported                                         |       | $        | (1.29      | )        | $          | (0.89      | )          | $ | (0.15 | ) |
| Effect of  employee stock-based compensation included in reported net loss |       | 0.03     |       | 0.05     |       | 0.02       |       |
| Effect of  employee stock-based compensation per SFAS 123                  |       | (0.17    | )          | (0.17    | )          | (0.10      | )          |
| Net loss  applicable to common stock - pro forma                           |       | $        | (1.43      | )        | $          | (1.01      | )          | $ | (0.23 | ) |

 

The fair value of each option grant under the Plan is estimatedon the date of grant using the Black-Scholes option-pricing model with thefollowing assumptions:

 
| ** **          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|
|                |       |     |       |     |       |     |       |
| Risk-free interest  |       | —   |       | —   |       | 2.2      | %          |
| Expected life       |       | —   |       | —   |       | 3 years  |       |
| Expected volatility |       | —   |       | —   |       | 46.0     | %          |
| Expected dividend   |       | —   |       | —   |       | —   |       |

 

The Plan expired by its terms in February 2003.Accordingly, no options were granted in 2005 or 2004. The expected life wasdetermined based on the Plan’s vesting period and exercise behavior of theemployees.

 

F-12

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*Recent Pronouncements* – InDecember 2004, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 123(R) (“SFAS 123R”), “*Share-BasedPayment*,” which is a revision of Statement of Financial AccountingStandards No. 123 (“SFAS 123”), “*Accounting for Stock-BasedCompensation*.” SFAS 123R is effective for annual periods beginningafter June 15, 2005, supersedes Accounting Principles Board Opinion No. 25, “*Accounting for Stock Issued to Employees*,” and amendsStatement of Financial Accounting Standards No. 95, “*Statement ofCash Flows*.” SFAS 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thestatement of operations based upon their fair values and will rescind theacceptance of pro forma disclosure. SFAS 123R permits two methods of adoption,a “modified prospective” method and a “modified retrospective” method. Underthe modified prospective method, stock-based compensation cost is recognized,beginning with the effective date, based on the requirements of SFAS 123R forall share-based payments granted after the effective date and for all awardsgranted prior to the effective date that remain unvested on the effective date.The modified retrospective method includes the requirements of the modifiedprospective method and also permits restatement of prior periods based onamounts previously reported in pro forma disclosures pursuant to SFAS 123 foreither all periods presented or for only prior interim periods of the year ofadoption. SFAS 123R will be effective with our quarter ending September 30,2005. We have not yet completed an evaluation but expect the adoption of SFAS123R to have an effect on our financial statements similar to the pro formaeffects reported above.

 

In December 2004, the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standards No. 153 (“SFAS 153”),“*Exchanges of Nonmonetary Assets*,” whichchanges the guidance in Accounting Principles Board Opinion No. 29 (“APB 29”),“*Accounting for Nonmonetary Transactions*.”SFAS 153 amends APB 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception forexchanges on nonmonetary assets that do not have commercial substance. Anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. SFAS153 is effective during fiscal years beginning after June 15, 2005. We do notbelieve the adoption of SFAS 153 will have a material impact on our financialcondition or the results of our operations.

 

In May 2005, the Financial Accounting Standards Boardissued Statement of Financial Accounting Standards No. 154 (“SFAS 154”), *“Accounting for Changes and Error Corrections – a replacement of APBOpinion No. 20 and FASB Statement No. 3.”* SFAS 154 changes therequirements with regard to the accounting for and reporting of the adoption ofa change in an accounting principle. The provisions of SFAS 154 require, unlessimpracticable, retrospective application to prior periods presented infinancial statements for: (1) all voluntary changes in an accounting principle;and, (2) changes required by the adoption of a new accounting pronouncement, ifa specific transition period is not provided within the pronouncement. SFAS 154also requires that a change in depreciation, amortization or depletion methodfor long-lived, non-financial assets be accounted for as a change in anaccounting estimate, which requires prospective application of the new method.SFAS 154 is effective for all changes in an accounting principle made in fiscalyears beginning after December 15, 2006. We plan to adopt SFAS 154 beginningwith our fiscal year 2007. Because SFAS 154 is directly dependent upon futureevents, we cannot determine what effect, if any, our expected adoption of SFAS154 will have on our financial condition or the results of our operations.

 

*Segments* – We have onesegment: designing, purchasing, contracting for the manufacture of, marketing anddistributing men’s and women’s fashion golf apparel and outerwear. Theinformation for this segment is the information used by our chief decisionmaker to evaluate operating performance.

 

F-13

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

 

Thecarrying values of our financial instruments, principally consisting of cashand cash equivalents, marketable securities, accounts receivable and accountspayable, approximate their fair market values due to their short-termmaturities.

 

3.                             **CASH AND CASH EQUIVALENTS**:

 

Cash and cash equivalents consist of the following atJune 30:

 
| ** **                                                           | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                                 |       |      |       |      |       |
| Cash in banks                                                        |       | $         | 4,815,000  |      | $          | 1,180,000 |   |
| Short-term securities (original maturities of three  months or less) |       | 2,906,000 |       | 2,710,000 |       |
| Total cash and cash equivalents                                      |       | $         | 7,721,000  |      | $          | 3,890,000 |   |

 

4.                             **INVENTORIES**:

 

Inventories consisted of the following at June 30:

 
| ** **                 | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|----------------------------|------------|-----------|------------|-----------|------------|
|                       |       |      |       |      |       |
| Component inventories      |       | $         | 387,000    |      | $          | 470,000 |   |
| Finished goods inventories |       | 3,766,000 |       | 8,338,000 |       |
| Total inventories          |       | $         | 4,153,000  |      | $          | 8,808,000 |   |

 

5.                             **PROPERTY AND EQUIPMENT**:

 

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

 
| ** **                                                   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                         |       |       |       |       |       |
| Furniture and fixtures                                       |       | $          | 1,400,000  |       | $          | 1,377,000 |   |
| Plant equipment                                              |       | 1,319,000  |       | 1,321,000  |       |
| Computer software and equipment                              |       | 1,240,000  |       | 1,208,000  |       |
| Leasehold improvements                                       |       | 408,000    |       | 406,000    |       |
| Other                                                        |       | 56,000     |       | 56,000     |       |
| Total property and equipment                                 |       | 4,423,000  |       | 4,368,000  |       |
| Less accumulated depreciation, amortization, and  impairment |       | (3,501,000 | )          | (3,261,000 | )          |
| Property and equipment, net                                  |       | $          | 922,000    |       | $          | 1,107,000 |   |

 

Depreciation and amortization expense for 2005, 2004,and 2003 was $352,000, $327,000 and $354,000, respectively.

 

F-14

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6.                             **LINE OF CREDIT AGREEMENT**:

 

We maintain a revolving line of credit agreement with a commercialbank. The revolving line of credit agreement, which was renewed throughDecember 5, 2005, provides for interest at the bank’s prime rate. The agreementprovides for a maximum loan amount of $5,000,000 collateralized by a lien onsubstantially all of our assets. We generally maintain the line of credit tofacilitate the issuance of letters of credit for inventory purchases fromoffshore suppliers and, if necessary, to fund any temporary working capitalneeds. The amended the terms of the agreement require us to maintain tangiblenet worth at the end of each fiscal quarter in the amount of at least $14,000,000.We did not have any balances due on the line of credit at June 30, 2005 and2004, respectively.

 

Outstanding letters of credit reduce the amountavailable for borrowing under the line of credit agreement. At June 30, 2005 and2004, we had outstanding letters of credit of $2,012,000 and $2,665,000,respectively.

 

7.                             **INCOME TAXES**:

 

The differences between the U.S. Federal statutoryrate and our effective rate are as follows at June 30:

 
| ** **                                       | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|-----------|------------|-----------|------------|----------|------------|
|                                             |       |      |       |      |       |     |       |
| U.S. Federal statutory rate                      |       | $         | (1,150,000 | )         | $          | (743,000 | )          | $ | (194,000 | ) |
| State income taxes                               |       | (157,000  | )          | (68,000   | )          | (28,000  | )          |
| Change in deferred tax valuation allowance       |       | 1,254,000 |       | 1,377,000 |       | 35,000   |       |
| Permanent differences and other                  |       | 61,000    |       | 180,000   |       | 7,000    |       |
| Total current and deferred tax expense (benefit) |       | $         | 8,000      |      | $          | 746,000  |       | $ | (180,000 | ) |

 

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

 
| ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |     |       |
| Federal                      |       | $        | —     |     | $          | —   |       | $ | (14,000 | ) |
| State                        |       | 8,000    |       | —   |       | 4,000    |       |
| Deferred                     |       | —   |       | 746,000  |       | (170,000 | )          |
| Income tax expense (benefit) |       | $        | 8,000      |     | $          | 746,000  |       | $ | (180,000 | ) |

 

F-15

----

 

Thecomponents of the net deferred tax asset and net deferred tax liabilityrecognized in the accompanying balance sheets are as follows at June 30:

 
| ** **                                         | ** ** | **2005**    | ** ** | **2004**   | ** ** |
|----------------------------------------------------|------------|-------------|------------|------------|------------|
| ** **                                         | ** ** | ** **  | ** ** | **Long-**  | ** ** | ** ** | ** ** | **Long-** | ** ** |
| ** **                                         | ** ** | **Current** | ** ** | **Term**   | ** ** | **Current** | ** ** | **Term** | ** ** |
|                                               |       |        |       |       |       |   |   |   |   |
| Deferred tax assets                                |       | $           | 344,000    |       | $          | 2,434,000 |   | $ | 441,000 |   | $ | 1,083,000 |   |
| Deferred tax liabilities                           |       | —      |       | —     |       | — |   | — |   |
| Net deferred tax  asset before valuation allowance |       | 344,000     |       | 2,434,000  |       | 441,000 |   | 1,083,000 |   |
| Valuation allowance                                |       | (344,000    | )          | (2,434,000 | )          | (441,000 | ) | (1,083,000 | ) |
| Net deferred tax asset                             |       | $           | —     |       | $          | — |   | $ | — |   | $ | — |   |

 

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

 
| ** **                                         | ** ** | ** **     | ** ** | **2005**    | ** ** | ** ** | ** ** | **2004**       | ** ** |
|----------------------------------------------------|------------|----------------|------------|-------------|------------|------------|------------|----------------|------------|
| ** **                                         | ** ** | **Temporary**  | ** ** | ** **  | ** ** | **Long-**  | ** ** | **Temporary**  | ** ** | ** ** | ** ** | **Long-** | ** ** |
| ** **                                         | ** ** | **Difference** | ** ** | **Current** | ** ** | **Term**   | ** ** | **Difference** | ** ** | **Current** | ** ** | **Term** | ** ** |
| Allowance for  doubtful accounts                   |       | $              | 377,000    |        | $          | 140,000    |       | $              | —     |   | $ | 454,000 |   | $ | 168,000 |   | $ | — |   |
| Reserve for  sales returns                         |       | 286,000        |       | 106,000     |       | —     |       | 342,000        |       | 127,000 |   | — |   |
| Prepaid expenses                                   |       | —         |       | —      |       | —     |       | 207,000        |       | 76,000 |   | — |   |
| Accrued vacation                                   |       | 84,000         |       | 31,000      |       | —     |       | 101,000        |       | 37,000 |   | — |   |
| Accumulated  depreciation and impairment           |       | 19,000         |       | —      |       | 7,000      |       | (19,000        | )          | — |   | 7,000 |   |
| Stock options                                      |       | 479,000        |       | —      |       | 177,000    |       | 610,000        |       | — |   | 226,000 |   |
| Unrealized loss  on investment                     |       | 234,000        |       | —      |       | 87,000     |       | 234,000        |       | — |   | 87,000 |   |
| Inventories                                        |       | 182,000        |       | 67,000      |       | —     |       | 88,000         |       | 33,000 |   | — |   |
| Federal net  operating losses                      |       | 5,280,000      |       | —      |       | 1,795,000  |       | 1,631,000      |       | — |   | 554,000 |   |
| State net  operating losses                        |       | 7,952,000      |       | —      |       | 368,000    |       | 4,507,000      |       | — |   | 209,000 |   |
| Net deferred tax  asset before valuation allowance |       |           |       | 344,000     |       | 2,434,000  |       |           |       | 441,000 |   | 1,083,000 |   |
| Valuation  allowance                               |       |           |       | (344,000    | )          | (2,434,000 | )          |           |       | (441,000 | ) | (1,083,000 | ) |
| Net deferred tax  asset                            |       |           |       | $           | —     |       | $          | —         |       |   |   | $ | — |   | $ | — |   |
|                                                    |            |                |            |             |            |            |            |                |            |  |  |  |  |  |  |  |  |  |  |

 

The changes in deferred tax valuation allowances for 2005,2004 and 2003 were $1,254,000, $1,377,000 and $35,000, respectively.

 

Federal net operating loss carry forwards expire from2023 through 2025. State net operating loss carry forwards expire from 2021through 2025.

 

8.                             **OPERATING LEASES**:

 

The Company leases its corporate offices, productionand warehouse facilities under an operating lease that

 

F-16

----

 

was extended through October 2006.

 

Rentexpenses for 2005, 2004, and 2003, were $255,000, $232,000 and $264,000,respectively.

 

The future minimum lease payments under non-cancelableleases with initial terms of one year or more as of June 30, 2005 are asfollows:

 

| **Years  Ending  June 30,** | ** ** | **Amount** | ** ** |
|-----------------------------|------------|------------|------------|
|                        |       |       |       |
| 2006                        |       | $          | 250,000    |   |
| 2007                        |       | 94,000     |       |
| 2008                        |       | 7,000      |       |
| Total                       |       | $          | 351,000    |   |

 

9.                             **COMMITMENTS AND CONTINGENCIES**:

 

*PotentialClaims* – In filing our annual report on Form 10-K for fiscal2000, we restated previously issued financial statements. In March 2001, weretained legal counsel to possibly pursue claims against our former auditors inconnection with damages suffered as a result of the restatements of our financialstatements for 1999 and 1998 and the corrections of material financialinformation for the quarterly periods of 2000, 1999 and 1998. Also, counsel tothe former auditors previously advised us that the former auditors may filecertain claims against us, possibly including allegations of unpaid fees.Neither have we nor our former auditors filed any legal action to assert any ofthese claims. Based upon the information that is currently available,management does not believe that the impact, if any, of an award to the formerauditors, if they were to initiate a formal action against us, would materiallyaffect our financial position or the results of our operations. The partieshave scheduled a non-binding mediation session before a neutral party inNovember 2005.

 

In September 2003, the United States Securities andExchange Commission (the “Commission”) filed suit in the United States DistrictCourt for the District of Colorado against Sport-Haley, Inc., our late Chairmanand former Chief Executive Officer, Robert G. Tomlinson, and our former controller,Steve S. Auger (the “Defendants”). The suit was amended by the Commission inOctober 2003 to add one of our former auditors to the action as a Defendant. Thesuit seeks an injunction against future violations and other relief, includingdisgorgement, civil penalties and an order barring either Mr. Tomlinson or Mr.Auger from serving as a director or officer of any publicly held company. Thesuit alleges that the Defendants misrepresented inventories, period costs andlosses on the sale of headwear equipment in annual and/or quarterly financialstatements for 2000, 1999 and 1998. The Commission’s suit primarily relates toerrors in our previously issued financial statements that we previouslyreported when we voluntarily restated our financial statements for 1999 and1998 and subsequently corrected material financial information for thequarterly periods of 2000, 1999 and 1998. The Defendants have answered theallegations of the amended complaint, denying the substantive allegations andasserting various defenses. Discovery in the action has concluded. No trialdate has yet been determined. The Company, subject to its Bylaws and Coloradolaw, agreed to indemnify Mr. Tomlinson and Mr. Auger and we have advanced thecosts of their defense, pending final adjudication of the Action. The costs ofdefense of the action by the Defendants are covered by our applicable liabilityinsurance, subject to the policy limits and a retention which has beensatisfied, and other limitations. After Mr. Tomlinson’s death in

 

F-17

----

 

September, 2004, the Commission filed a motion todismiss Mr. Tomlinson from the action without prejudice, and the Court grantedthe motion. In July 2005, we submitted a settlement proposal to the Commission’sDenver regional office, which the parties agreed to amend in September 2005. Ifthe amended settlement proposal is approved by the full Commission inWashington D.C., the litigation against us would end, without further materialimpact on our financial position or the results of our operations. Counsel forMr. Auger has informed us that a settlement proposal has also been submitted tothe Denver office on Mr. Auger’s behalf, which, if approved, would also end thelitigation against him. The Court has issued an Order requiring that thesettlements, if approved by the full Commission, be submitted to the Court byno later than October 30, 2005. Based upon the information that is currentlyavailable, management cannot reasonably estimate the amount of future coststhat we will incur defending the Commission’s allegations if our amended settlementoffer is not accepted. However, if the suit were continued and determined infavor of the Commission and against the Defendants, the possible monetarypenalties that we might be required to pay, and other relief, could further negativelyimpact our financial position and the results of our operations.

 

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

 

*Touring Professionals* – Pursuant to the terms of marketingagreements with certain touring professionals, we provide the professionals withgolf apparel. We did not compensate any tour professional in cash for 2005.

 

*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 2005, employment and non-compete agreements provided forminimum salary levels totaling $738,000, excluding discretionary bonuses andseverance payments upon termination of employment without cause.

 

As previously reported, inSeptember 2004, our Chairman died. The employment agreement between the Companyand the Chairman entitled the Chairman’s estate to receive, as a death benefit,severance compensation in a lump sum amount equal to three times the annualsalary and bonus paid to the Chairman in the twelve months preceding his death.The late Chairman received salary of $170,000 over the twelve months precedinghis death and no bonus. A dispute with the Chairman’s estate ensued concerningthe amount of severance compensation and other matters relating to the Chairman’semployment agreement. The Chairman’s estate demanded a higher severance amountand other compensation which it claimed was also due under the agreement. TheBoard of Directors negotiated an agreement in compromise with the Chairman’sestate regarding the death benefit amount and the other disputed compensation.In accordance with the terms of the settlement agreement for this mater, wepaid the lump sum amount of $650,000 to the Chairman’s estate in October 2004.Accordingly, we recorded compensation expense in the amount of $650,000 duringthe fiscal quarter ended September 30, 2004.

 

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 receiving suchseverance compensation.

 

F-18

----

 

Mr. Tomlinson was alsoentitled to reimbursement for legal expenses he incurred with respect toexercising his right to obtain professional counsel regarding termination ofthe contract. Accordingly, we recorded severance and other compensation of$520,000 during the quarter ended December 31, 2004. Included in our accruedpayroll liabilities at June 30, 2005, is the sum of $449,000 relating to futureamounts due to Mr. Tomlinson with regard to severance and other compensation inaccordance with the agreement.

 

*License Agreements*– In May 2001, we entered into a license agreement with Spalding SportsWorldwide, Inc. (“Spalding”) for the rights to market a line of men’s premiumgolf 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-FliteGolf”).

 

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-FliteTM 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-FliteTM 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-FliteTM brand names licensed tous. Subsequently, Callaway requested that we delay our planned launch ofTop-FliteTM branded apparel. We maintain the right to market men’s and women’sgolf apparel bearing the Top-FliteTM brand name in accordance with the terms of thelicense agreement. Recently, we’ve had discussions with Callaway, and we planto introduce collections of Top-FliteTM branded apparel within the United Statesin the future.

 

The original and amendedagreements require us to pay royalties based upon sales. We record royaltypayments governed by the license agreement with Callaway as other operating costsin the periods when such sales are recognized. Royalty payments with respect tolicense agreements totaled $797,000, $532,000 and $326,000 for 2005, 2004 and2003, 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 2005.Through June 30, 2005, we had cumulatively repurchased a total of 2,512,800shares 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 to

 

F-19

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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, 2005, 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 couldgrant to employees, directors and consultants of the Company, and anysubsidiary thereof, options to purchase common stock. Generally, grantedoptions vest over three years, were granted at fair market value on the date ofgrant, expire 10 years from that date, are non-transferable and cannot beexercised for a period of one year from the date of grant. The Plan, asrestated, is administered by the Compensation Committee, which, at itsdiscretion, 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, 2005, theCompany had outstanding options equal to 838,500 shares of common stock atprices ranging from $2.71 to $9.78 with expiration dates between 2006 and 2013.In 2005, 120,000 options were exercised and 138,515 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, 2002 |       | 894,501       |       | $                 | 4.44       |   | $3.00 - $8.63 |   | 84,457 |   | $ | 6.37 |   | $2.50 - $9.78 |   |
|          |       |          |       |              |       |   |   |   |   |   |   |   |   |
| Granted       |       | 400,000       |       | $                 | 2.71       |   | $2.71 |   | — |   | — |   | — |   |
| Canceled      |       | (99,501       | )          | $                 | 8.63       |   | $8.63 |   | (1,760 | ) | $ | 2.50 |   | $2.50 |   |
| 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 |   |

 

F-20

----

 

Options outstanding at June 30, 2005, 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, 2004  |       | 470,002       |       | $                 | 3.98       |   | $2.71 - $8.63 |   | 51,167 |   | $ | 7.13 |   | $3.00 - $9.78 |   |
|           |       |          |       |              |       |   |   |   |   |   |   |   |   |
| Vested during  |       |          |       |              |       |   |   |   |   |   |   |   |   |
| 2005           |       | 239,999       |       | $                 | 2.99       |   | $2.71 - $3.60 |   | 2,333 |   | $ | 3.00 |   | $3.00 |   |
| Vested as of   |       |          |       |              |       |   |   |   |   |   |   |   |   |
| June 30, 2005  |       | 710,001       |       | $                 | 3.65       |   | $2.71 - $8.63 |   | 53,500 |   | $ | 6.95 |   | $3.00 - $9.78 |   |
|           |       |          |       |              |       |   |   |   |   |   |   |   |   |
| Vesting during |       |          |       |              |       |   |   |   |   |   |   |   |   |
| 2006           |       | 74,999        |       | $                 | 2.71       |   | $2.71 |   | — |   | — |   | — |   |
|           |       |          |       |              |       |   |   |   |   |   |   |   |   |
| Totals         |       | 785,000       |       | $                 | 3.56       |   | $2.71 – $8.63 |   | 53,500 |   | $ | 6.95 |   | $3.00 - $9.78 |   |

 

If not exercised earlier,options outstanding as of June 30, 2005 will expire as follows:

 
| ** **      | ** ** | **Employees** | ** ** | **Non-Employees** | ** ** |
|-----------------|------------|---------------|------------|-------------------|------------|
| ** **      | ** ** | ** **    | ** ** | **Weighted**      | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **      | ** ** | ** **    | ** ** | **Average**       | ** ** | **Range of** | ** ** | ** ** | ** ** | **Average** | ** ** | **Range of** | ** ** |
| ** **      | ** ** | **Number of** | ** ** | **Exercise**      | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Exercise** | ** ** |
| **Expiration**  | ** ** | **Options**   | ** ** | **Price**         | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** | **Price** | ** ** |
|            |       |          |       |              |       |   |   |   |   |   |   |   |   |
| Expiring during |       |          |       |              |       |   |   |   |   |   |   |   |   |
| 2006            |       | 150,000       |       | $                 | 2.95       |   | $2.71 - $3.60 |   | 10,000 |   | $ | 9.25 |   | $9.25 |   |
| 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          |       | 785,000       |       | $                 | 3.56       |   | $2.71 – $8.63 |   | 53,500 |   | $ | 6.95 |   | $3.00 - $9.78 |   |

 

400,000 options were granted in fiscal 2003 atapproximately 85% of market price, and 304,000 options were granted in fiscal2002 at approximately 80% of market price, with weighted average fair values of$1.24 and $1.71 at the grant dates, respectively. All other options weregranted at exercise prices that approximated the market prices on the dates ofgrant. The weighted average fair value of all options granted during fiscal2002 was $1.07 per share.

 

F-21

----

 

Since 1997, we have followed the provisions of SFAS123**for all issuances of stock options tonon-employees of the Company. We follow the provisions of APB 25 for all grantsof stock options to our employees. Generally, all stock options granted to ouremployees, pursuant to the Plan, were not compensatory. During 2005, 2004 and 2003,we recognized $63,000, $124,000 and $94,000, respectively, in stock-based compensationexpense.

 

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

 

In the reconciliation of basic to diluted earnings pershare, there were no reconciling items affecting the numerator in any yearpresented. In 2005, 2004 and 2003, due to our net losses, all options, totaling838,500, 1,097,015 and 1,277,697, respectively, were anti-dilutive andtherefore excluded from the earnings (loss) per share calculations.

 

12.                       **RETIREMENT PLAN**:

 

In January 1996, the Company adopted a definedcontribution savings plan (the “401(k) Plan”) to provide retirement income to ouremployees. The 401(k) Plan is funded by voluntary pre-tax salary deferralcontributions from employees and through matching contributions by the Companyof $0.25 on the dollar for employee deferrals of the first 5% of aparticipating employee’s annual compensation. For 2005, 2004, and 2003, wecontributed $19,000, $18,000 and $19,000, respectively, to the 401(k) Planaccounts of Company employees.

 

F-22

----

 

**SCHEDULE II**

 

**SPORT-HALEY, INC.**

**VALUATION AND 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,                                  |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| 2003                                      |       | $                                    | 76,000     |                                          | $          | 437,000                         |       | $              | —     |   | $ | (197,000 | )(1) | $ | 316,000 |   |
| 2004                                      |       | $                                    | 316,000    |                                          | $          | 272,000                         |       | $              | —     |   | $ | (134,000 | )(1) | $ | 454,000 |   |
| 2005                                      |       | $                                    | 454,000    |                                          | $          | 180,000                         |       | $              | —     |   | $ | (257,000 | )(1) | $ | 377,000 |   |
|                                      |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| **ALLOWANCE  FOR SALES RETURNS**          |       |                                 |       |                                          |       |                            |       |           |       |   |   |
|                                      |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| June 30,                                  |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| 2003                                      |       | $                                    | 180,000    |                                          | $          | 1,084,000                       |       | $              | —     |   | $ | (1,038,000 | )(2) | $ | 226,000 |   |
| 2004                                      |       | $                                    | 226,000    |                                          | $          | 1,386,000                       |       | $              | —     |   | $ | (1,270,000 | )(2) | $ | 342,000 |   |
| 2005                                      |       | $                                    | 342,000    |                                          | $          | 2,112,000                       |       | $              | —     |   | $ | (2,168,000 | )(2) | $ | 286,000 |   |
|                                      |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| **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 |   |
|                                      |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| **ALLOWANCE  FOR INVENTORY OBSOLESCENCE** |       |                                 |       |                                          |       |                            |       |           |       |   |   |
|                                      |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| June 30,                                  |       |                                 |       |                                          |       |                            |       |           |       |   |   |
| 2003                                      |       | $                                    | 1,351,000  |                                          | $          | 259,000                         |       | $              | —     |   | $ | (1,154,000 | )(3) | $ | 456,000 |   |
| 2004                                      |       | $                                    | 456,000    |                                          | $          | 707,000                         |       | $              | —     |   | $ | (216,000 | )(3) | $ | 947,000 |   |
| 2005                                      |       | $                                    | 947,000    |                                          | $          | 1,403,000                       |       | $              | —     |   | $ | (1,721,000 | )(3) | $ | 629,000 |   |

 

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

(2) Actual sales returns.

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

 

F-23

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