##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-Q xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended October 30, 2004 OR o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________________ to ____________________ Commission file number 1-8578 McRae Industries, Inc.  Delaware
    
    56-0706710(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 400 North Main Street
Mt. Gilead, North Carolina 27306
(Address of principal executive offices) Telephone Number (910) 439-6147
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter periods that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days: Yes
o
          No
x Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act
Rule 12b-2). Yes o           No x Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practical date. Common Stock, $l Par ValueClass A: 1,942,553 shares as of December 15, 2004.
Common Stock, $1 Par ValueClass B: 823,446 shares as of December 15, 2004. 1




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McRae Industries, Inc. and Subsidiaries INDEX PART I. FINANCIAL INFORMATION ITEM 1.
    
    Condensed Consolidated Financial Statements
    
    Page No.Condensed Consolidated Balance Sheet
    
    
    3-4Condensed Consolidated Statement of Operations
    
    
    5Condensed Consolidated Statement of Cash Flows
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7-9ITEM 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    10-15ITEM 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    16ITEM 4.
    
    Controls and Procedures
    
    
    16-17PART II. OTHER INFORMATIONITEM 1.
    
    Legal Proceedings
    
    
    17ITEM 2.
    
    Changes in Securities and Use of Proceeds
    
    
    17ITEM 3.
    
    Default upon Senior Securities
    
    
    17ITEM 4.
    
    Submission of Matters to a Vote of Securities Holders
    
    
    17ITEM 5.
    
    Other Information
    
    
    17ITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    
    17-18Signatures
    
    
    19
 2




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PART I.     FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS McRae Industries, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited) October 30, 2004
    
    July 31, 2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,447
    
    
    $
    2,463Accounts and notes receivable, net
    
    
    12,503
    
    
    
    11,270Inventories
    
    
    10,973
    
    
    
    14,810Assets held for sale from discontinued operations
    
    
    
    
    
    
    11,622Income tax receivable
    
    
    15
    
    
    
    676Prepaid expenses and other current assets
    
    
    453
    
    
    
    271Total current assets
    
    
    34,391
    
    
    
    41,112Property and equipment, net
    
    
    3,298
    
    
    
    3,342Other assets:Notes receivable
    
    
    33
    
    
    
    36Real estate held for investment
    
    
    1,444
    
    
    
    1,422Goodwill
    
    
    362
    
    
    
    362Cash surrender value of life insurance
    
    
    2,220
    
    
    
    2,220Trademarks
    
    
    1,049
    
    
    
    1,049Other
    
    
    5
    
    
    
    5Total other assets
    
    
    5,113
    
    
    
    5,094$
    42,802
    
    
    $
    49,548
 See notes to condensed consolidated financial statements 3




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McRae Industries, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(Unaudited) October 30, 2004
    
    July 31, 2004Liabilities and Shareholders EquityCurrent liabilities:Notes payable, banks  current portion
    
    $
    58
    
    
    $
    621Accounts payable
    
    
    2,707
    
    
    
    4,672Accrued employee benefits
    
    
    691
    
    
    
    524Accrued payroll and payroll taxes
    
    
    571
    
    
    
    865Income taxes payable
    
    
    528Liabilities held for sale from discontinued operations
    
    
    
    
    
    
    4,587Other
    
    
    985
    
    
    
    1,049Total current liabilities
    
    
    5,540
    
    
    
    12,318Notes payable, banks, net of current portion
    
    
    517
    
    
    
    3,082Shareholders equity:Common stock:Class A, $1 par; Authorized 5,000,000
shares; Issued and outstanding,
and 1,943,543 shares, respectively
    
    
    1,943
    
    
    
    1,943Class B, $1 par; Authorized 2,500,000
shares; Issued and outstanding,
and 824,956 shares, respectively
    
    
    825
    
    
    
    825Additional paid-in capital
    
    
    791
    
    
    
    791Retained earnings
    
    
    33,186
    
    
    
    30,589Total shareholders equity
    
    
    36,745
    
    
    
    34,148$
    42,802
    
    
    $
    49,548
 See notes to condensed consolidated financial statements 4




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McRae Industries, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited) Three Months EndedOctober 30,
    
    November 1,2004
    
    2003Net revenues
    
    $
    20,434
    
    
    $
    16,023Costs and expenses:Cost of revenues
    
    
    15,842
    
    
    
    12,007Research & development
    
    
    304
    
    
    
    340Selling, general and administrative
    
    
    3,076
    
    
    
    2,411Other expense (income), net
    
    
    (54
    )
    
    
    (28
    )Interest expense
    
    
    22
    
    
    
    10Total costs and expenses
    
    
    19,190
    
    
    
    14,740Earnings from continuing operations before
income taxes and minority interest
    
    
    1,244
    
    
    
    1,283Provision for income taxes
    
    
    437
    
    
    
    462Minority shareholders interest
in earnings of subsidiary
    
    
    
    
    
    
    (2
    )Net earnings from continuing operations
    
    
    807
    
    
    
    823Discontinued operations:Income (loss) from operations of discontinued business
    
    
    (438
    )
    
    
    (421
    )Income tax benefit
    
    
    170
    
    
    
    160Estimated gain on disposal of business, net of income
tax
expense of $1,376,000 in fiscal 2004
    
    
    2,174
    
    
    
    Net earnings
    
    $
    2,713
    
    
    $
    562Net earnings per common share- basic:Earnings from continuing operations
    
    $
    .29
    
    
    $
    .29Earnings (loss) from discontinued operations
    
    
    .69
    
    
    
    (.09
    )Net earnings
    
    $
    .98
    
    
    $
    .20Weighted average number of
common shares outstanding
    
    
    2,768,499
    
    
    
    2,768,499
 See notes to condensed consolidated financial statements 5




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McRae Industries, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited) Three Months EndedOctober 30,
    
    November 1,2004
    
    2003Net cash provided by operating activities
    
    $
    1,868
    
    
    $
    640Cash flows from investing activities:Proceeds from sales of assets
    
    
    4
    
    
    
    1Purchase of trade names and other assets
    
    
    (22
    )
    
    
    (8
    )Capital expenditures
    
    
    (101
    )
    
    
    (53
    )Net collections of long-term receivables
    
    
    3
    
    
    
    15Net cash used in investing activities
    
    
    (116
    )
    
    
    (45
    )Cash flows from financing activities:Principal repayments of notes payable
    
    
    (3,128
    )
    
    
    (142
    )Dividends paid
    
    
    (116
    )
    
    
    (115
    )Net cash used in financing activities
    
    
    (3,244
    )
    
    
    (257
    )Net cash provided by (used in) discontinued
operations
    
    
    9,475
    
    
    
    (616
    )Net increase (decrease) in cash and cash equivalents
    
    
    7,983
    
    
    
    (278
    )Cash and cash equivalents at beginning of period
    
    
    2,464
    
    
    
    3,835Cash and cash equivalents at end of period
    
    $
    10,447
    
    
    $
    3,557
 Note: Non-cash operating
activities excluded from this statement of cash flows include
accounts receivable, ($894,000), accounts payable, $221,000, and
income tax provision $1,206,000, related to the sale of our office
products business. See notes to condensed consolidated financial statements 6




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McRae Industries, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) NOTE A  BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared by the
Company pursuant to the rules and regulation of the Securities and Exchange Commission (SEC).
Accordingly, they do not include all of the information and footnotes required by the accounting
principles generally accepted in the United States for complete financial statements. In addition,
all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair
presentation have been included. Operating results for the three months ended October 30, 2004 are
not necessarily indicative of the results that may be expected for the year ending July 30, 2005.
The interim condensed consolidated financial information should be read in conjunction with the
Companys July 31, 2004 audited consolidated financial statements and footnotes thereto included in
the McRae Industries, Inc. Annual Report on Form 10-K/A filed with
the SEC on December 23, 2004. Certain reclassifications have been made to the prior years financial statements to conform with
the current years presentation. In particular, our office products business, which was sold on
September 9, 2004, has been recorded as a discontinued operation for all periods in this report. NOTE B  INVENTORIES The components of inventory consist of the following (in thousands): October 30, 2004
    
    July 31, 2004Raw materials
    
    $
    2,272
    
    
    $
    3,883Work-in-process
    
    
    1,036
    
    
    
    2,385Finished goods
    
    
    7,665
    
    
    
    8,542$
    10,973
    
    
    $
    14,810
 NOTE C  SUBSEQUENT EVENTS On December 9, 2004, the Company declared a cash dividend of $.08 per share on its Class A Common
Stock payable on December 30, 2004 to shareholders of record on December 20, 2004. 7




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NOTE D  DISCONTINUED OPERATIONS On September 9, 2004, McRae Industries, Inc. entered into a definitive agreement under which it
sold substantially all the assets of its McRae Office Solutions, Inc. subsidiary to Connected
Office Products, Inc. (COPI). COPI is a subsidiary of TOPAC U.S.A., Inc., which is headquartered in
Irvine, California, and operates a network of wholly owned subsidiaries involved in the sales,
service, and distribution of office products. Under the terms of the Asset Purchase Agreement, COPI
purchased substantially all of the assets of McRae Office Solutions, Inc. for $11,000,000 subject
to adjustment based on the net book value of the acquired assets as
of August 28, 2004. Based on the Companys post-closing
calculation of the net book value of the acquired assets, the Company
expects an approximately $206,000 reduction in the purchase price.
The purchaser is in the process of reviewing the calculation of this
adjustment and it is subject to change depending on the
parties final agreement on the amount of the adjustment. Net revenues for the first quarter of fiscal 2005, which consisted of only one month of operations,
amounted to $1.3 million as compared to $5.4 million for the first quarter of fiscal 2004. The net
loss from operations for the first quarters of fiscal 2005 and fiscal 2004 amounted to $268,000 and
$261,000, respectively, net of income tax benefit. The estimated gain on the sale of the office products business assets totaled approximately $2.2
million net of a $1.4 million tax provision. 8




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NOTE E  SUMMARY OF BUSINESS SEGMENTS Three Months EndedOctober 30,
    
    November 1,2004
    
    2003(In thousands)Net revenues from continuing operationsBar Code
    
    $
    2,802
    
    
    $
    2,256Military Boots
    
    
    11,516
    
    
    
    8,321Western/Work Boots
    
    
    6,089
    
    
    
    5,879Eliminations/Other
    
    
    27
    
    
    
    (433
    )20,434
    
    
    
    16,023Net earnings (loss)
from continuing operationsBar Code
    
    
    (454
    )
    
    
    (363
    )Military Boots
    
    
    931
    
    
    
    1,484Western/Work Boots
    
    
    613
    
    
    
    13Eliminations/Other
    
    
    154
    
    
    
    1491,244
    
    
    
    1,283Provision for income taxes
    
    
    437
    
    
    
    462Minority shareholders interest
    
    
    
    
    
    
    (2
    )Net earnings from continuing operations
    
    
    807
    
    
    
    823Earnings (loss) from discontinued operations, net of tax
expense (benefit) of $1,206,000 and ($160,000),
respectively
    
    
    1,906
    
    
    
    (261
    )Net earnings
    
    $
    2,713
    
    
    $
    562October 30,
    
    July 31,2004
    
    2004AssetsBar Code
    
    $
    5,262
    
    
    $
    4,810Military Boots
    
    
    9,021
    
    
    
    12,902Western/Work Boots
    
    
    13,905
    
    
    
    13,396Eliminations/Other
    
    
    14,614
    
    
    
    18,440$
    42,802
    
    
    $
    49,548
 9




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the attached unaudited condensed
consolidated financial statements and notes thereto, and with the Companys Annual Report on Form
10-K/A for the fiscal year ended July 31, 2004, filed with the
SEC on December 23, 2004, including
the financial information and managements discussion and
analysis contained therein. As discussed in the Form 10-K/A,
including the Introductory Note thereto and in Note 15 to financial
statements therein, we filed the Form 10-K/A to restate our financial
statements for the fiscal year ended July 31, 2004 included in our
Form 10-K originally filed by us on October 29, 2004. The restatement
corrected compilation errors in our military boot operations
year-end physical inventory. Refer to Note 15 in the notes to the
financial statements included in the Form 10-K/A for a complete
description and quantification of the restatement. CRITICAL ACCOUNTING POLICIES Our timely preparation of financial reports and related disclosures requires us to use estimates
and assumptions that may cause actual results to be materially different from our estimated
results. Specifically, we use estimates when accounting for depreciation, amortization, useful lives for intangible assets, and asset valuation allowances
(including those for bad debts, inventory, and deferred income tax asset valuation allowances). Our
most critical accounting policies include the following: Intangible Assets We determine the utility of goodwill and trademarks based on estimated future cash flows and test
for impairment in accordance with applicable accounting pronouncements. We estimate future cash
flows based on historical performance and our knowledge of known factors likely to impact future
cash flows. Inventories Inventories are recorded at the lower of cost or market value. We regularly review inventory
quantities on hand and record a provision for excess and obsolete inventory based primarily on our
estimated forecast and demand requirements for the next twelve months. Actual demand and market
conditions may be different from those projected by our management. Revenue Recognition We recognize revenue under our current boot contract when the boots are inspected and accepted by
the Governments Quality Assurance Representative (QAR), thereby transferring ownership to the
Government. Pursuant to the contract, the boots become Government-owned property after inspection
and acceptance by the QAR. The boots are transferred and stored in our warehouse, which is a
designated storage facility approved by the Government, and accounted for as bill and hold sales
in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, Revenue
Recognition in Financial Statements. Income Taxes As part of the process of preparing our consolidated financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate. This process involves
us estimating our actual current exposure together with assessing temporary differences resulting
from differing treatment of items, such as leasing activity, allowances, and depreciation, for tax
and accounting purposes. These differences result in deferred tax assets and liabilities, which are 10




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included within our consolidated balance sheet. We must then assess the likelihood that our
deferred tax assets will be recovered from future taxable income and to the extent we believe that
recovery is not likely, we must establish a valuation allowance. To the extent we establish a
valuation allowance or increase this allowance in a period, we must include an expense within the
tax provision in the statement of operations. Significant management judgment is required in
determining our provision for income taxes, our deferred tax assets and liabilities, and any
valuation allowance recorded against our net deferred tax assets. In the event that actual results
differ from these estimates or we adjust these estimates in future periods, we may need to
establish an additional valuation allowance, which could materially impact our financial position
and results of operations. FINANCIAL CONDITION AND LIQUIDITY Our cash and cash equivalents at the end of the first quarter of fiscal 2005 totaled $10.4 million
as compared to $2.5 million reported for the end of fiscal 2004. Working capital amounted to $28.9
million at the end of the first quarter of fiscal 2005 as compared to $28.8 million at July 31,
2004. Currently, we have two lines of credit with a bank totaling $4.75 million, all of which was
available at October 30, 2004. One credit line totaling $1.75 million (which is restricted to one
hundred percent of the outstanding accounts receivable due from the U.S. Government) expires in
January 2005. The $3.0 million credit line expires in November 2005. We believe that our current
cash and cash equivalents, cash generated from operations, and the available lines of credit will
be sufficient to meet our capital requirements for fiscal 2005. Our contractual commitments for
fiscal 2005 are approximately $178,000. Selected cash flow data for the first quarter of fiscal 2005 and 2004 are presented below (in
thousands of dollars): For the Quarters EndedOctober 30, 2004
    
    November 1, 2003Source (Use) of CashOperating activities:Net earnings adjusted for depreciation
and amortization
    
    $
    951
    
    
    $
    951Accounts receivable
    
    
    (399
    )
    
    
    (1,579
    )Inventories
    
    
    3,837
    
    
    
    1,942Accounts payable
    
    
    (2,186
    )
    
    
    (292
    )Income taxes
    
    
    (15
    )
    
    
    (357
    )Net cash provided by operating activities
    
    
    1,868
    
    
    
    640
 11




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Net cash provided by operating activities for the first quarter of fiscal 2005 amounted to
approximately $1.9 million. Net earnings from continuing operations, as adjusted for depreciation
and amortization, provided cash totaling approximately $951,000. Accounts receivable used
approximately $339,000 of cash primarily due to the timing of customer payments from seasonally higher first
quarter sales in the western and work boot business. This increase in accounts receivable
was partially offset by reduced receivables in the military boot and bar code businesses resulting
from the timing of customer payments as first quarter sales trailed higher fourth quarter sales.
Inventory reductions primarily attributable to lower military boot inventory as the U. S.
Government eased the surge requirement for military boots and higher than anticipated demand for
western and work boot products provided approximately $3.8 million of cash. The bar code business
used approximately $250,000 of cash to build inventory related to the production of the new bar
code product. Accounts payable balances fell by approximately $2.2 million primarily as a result of
the timing of vendor payments in the first quarter of fiscal 2005 for heavy inventory investment in
the military and western boot businesses ordered in the fourth quarter of fiscal 2004. Capital expenditures were approximately $101,000 primarily for equipment to produce the new bar
code product. Our debt service used approximately $3.15 million of cash for principal and interest payments
primarily to pay off the $3.1 million note for the western and work boot business. Dividends paid
during the first quarter amounted to nearly $116,000. Military boot sales to the U.S. Government are expected to decrease for this fiscal year as a
result of completion of the surge requirement. This decrease in military boot sales may have a
significant impact on the Companys liquidity. Off-Balance Sheet Arrangements We do not currently utilize any off-balance sheet financing arrangements and do not anticipate
doing so in the future. FIRST QUARTER FISCAL 2005, COMPARED TO FIRST QUARTER FISCAL 2004 Consolidated net revenues from continuing operations for the first quarter of fiscal 2005 totaled
$20.4 million as compared to $16.0 million for the first quarter of fiscal 2004. This increase in
net revenues is primarily attributable to the continued high demand for military combat boots for
the U.S. Government and improved sales in the bar code and western and work boot business. 12




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Consolidated gross profit from continuing operations for fiscal 2005 increased to $4.6 million over
the $4.0 million reported in fiscal 2004. This growth in gross profit is primarily the result of
higher net revenues and higher margins on imported western and work boots. Consolidated research and development from continuing operations for the first quarter of fiscal
2005 totaled $304,000, down from $340,000 for the first quarter of fiscal 2004 primarily
attributable to lower expenditures necessary to complete the new bar code product. Consolidated selling, general and administrative (SG&A) expenses from continuing operations totaled
$3.1 million for the first quarter of fiscal 2005 as compared to $2.4 million for the first quarter
of fiscal 2004. This increase in SG&A expenses was primarily the result of higher sales
commissions, group health insurance costs, and professional fees associated primarily with
compliance costs incurred to assess and improve our internal control over financial reporting as
required by Section 404 of the Sarbanes-Oxley Act of 2002 and related SEC rules. As a percentage of
net revenues from continuing operations, SG&A expenditures increased slightly from 15.0% for the
first quarter of fiscal 2004 to 15.2% for the first quarter of fiscal 2005. As a result of the above, consolidated earnings from continuing operations remained steady at
approximately $1.3 million for the first quarter of fiscal 2005 and 2004. Bar Code Business Net revenues for the bar code business totaled $2.8 million for the first quarter of fiscal 2005 as
compared to $2.3 million for the first quarter of fiscal 2004. This growth in net revenues
resulted primarily from increased sales of system hardware, ribbons, and label sales as a result of
an improved market for these products. Gross profit amounted to $721,000 for the first quarter of fiscal 2005 as compared to $681,000 for
the same period of fiscal 2004. This increase in gross profit was primarily the result of
increased net revenues for the first quarter of fiscal 2005. SG&A and research and development costs were $1.2 million for the first quarter of fiscal 2005 as
compared to $1.0 million for the first quarter of fiscal 2004. This increase in SG&A costs is
primarily the result of higher group health insurance and professional fees. As a percentage of net
revenues, SG&A expenditures decreased from 43.5% for the first quarter of fiscal 2004 as compared
to 42.9% for the first quarter of fiscal 2005. As a result of the above, the bar code business loss from operations totaled $451,000 for the first
quarter of fiscal 2005 as compared to an operating loss of $366,000 for the first quarter of fiscal
2004. Military Boot Business Net revenues for the military boot business for the first quarter of fiscal 2005 totaled $11.5
million as compared to $8.3 million for the first quarter of fiscal 2004. This growth in net
revenues was primarily attributable to increased military boot requirements for the U.S. Government
(the Government). 13




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Gross profit totaled approximately $1.8 million for the first quarter of both fiscal 2005 and
fiscal 2004. As a percentage of net revenues, gross profit fell from 21.8% for the first quarter of
fiscal 2004 to 15.7% for the first quarter of fiscal 2005, primarily the result of lower per unit
selling prices under the new Contract awarded to us on September 30, 2003 and higher per unit
manufacturing costs due to lower production levels in the first quarter of fiscal 2005. SG&A expenses for the first quarter of fiscal 2005 increased to $805,000 over the $334,000
reported in the same period for fiscal 2004. This increase was primarily the result of increased health
insurance costs and professional fees due in part to an increased
allocation of overhead expenses due to the sale of our McRae Office
Solutions business. As a result of the above, the military boot business earnings from operations amounted to
approximately $1.0 million for the first quarter of fiscal 2005 as compared to $1.5 million for the
first quarter of fiscal 2004. On September 30, 2004, the Government exercised the first year option under the Contract awarded on
September 30, 2003. This option provides for a minimum and maximum boot requirement of 276,460 pair
and 1,077,552 pair, respectively. Currently, the Government has not provided any specific
quantities to be purchased or definite delivery dates, which has required us to lower current
production levels. Western and Work Boot Business Net revenues for the western and work boot business for the first quarter of fiscal 2005 totaled
$6.1 million as compared to $5.9 million reported for the first quarter of fiscal 2004. Gross profit for the first quarter of fiscal 2005 was $2.1 million, an increase from the $1.5
million reported for the first quarter of fiscal 2004. This 40.0% increase was primarily
attributable to higher margins associated with the shift from manufacturing to importing our
western and work boots. SG&A expenses for the first quarter of fiscal 2005 amounted to $1.4 million as compared to $1.3
million for the first quarter of fiscal 2004. This slight increase is a result of increased sales
commissions, advertising, and office supplies, which were offset by lower professional fees and bad
debt expenses. As a result of the above, operating profit for the western and work boot business increased to
$747,000 for the first quarter of fiscal 2005 as compared to $146,000 for the first quarter of
fiscal 2004. Discontinued Operations On September 9, 2004, McRae
Industries, Inc. entered into a definitive agreement under which it
sold substantially all the assets of its McRae Office Solutions, Inc.
subsidiary to Connected Office Products, Inc. (COPI). COPI is a
subsidiary of TOPAC U.S.A., Inc., which is headquartered in Irvine,
California, and operates a network of wholly owned subsidiaries
involved in the sales, service, and distribution of office products.
Under the terms of the Asset Purchase Agreement, COPI purchased
substantially all of the assets of McRae Office Solutions, Inc. for
$11,000,000 subject to adjustment based on the net book value of the
acquired assets as of August 28, 2004. Based on the Companys
post-closing calculation of the net book value of the acquired
assets, the Company expects an approximately $206,000 reduction in
the purchase price. The purchaser is in the process of reviewing the
calculation of this adjustment and it is subject to change depending
on the parties final agreement of the amount of the
adjustment. Net revenues for the first
quarter of fiscal 2005, which consisted of only one month of
operations, amounted to $1.3 million as compared to $5.4 million
for the first quarter of fiscal 2004. The net loss from operations
for the first quarters of fiscal 2005 and fiscal 2004 amounted to
$268,000 and $261,000, respectively, net of income tax benefit. The estimated gain on the
sale of the office products business assets totaled approximately
$2.2 million net of a $1.4 million tax provision. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS There were no accounting standards issued for the first quarter of fiscal 2005 that were applicable
to us. 14




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FORWARD-LOOKING STATEMENTS In addition to historical information, this Annual Report includes certain forward-looking
statements as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Important factors that could cause actual results or events to
differ materially from those projected, estimated, assumed or anticipated in any such
forward-looking statements include: the effect of competitive products and pricing, risks unique to
selling goods to the Government (including variation in the Governments requirements for our
products and the Governments ability to terminate its contracts with vendors), loss of key
customers, acquisitions, supply interruptions, additional financing requirements, our expectations
about future Government orders for military boots, loss of key management personnel, our ability to
successfully develop new products and services, and the effect of general economic conditions in
our markets. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to the impact of interest rate changes related to the aggregate $4.75 million lines
of credit and a term loan through our military boot business (the term loan through our wholly
owned subsidiary, Dan Post Boot Company was paid off in September 2004). As of October 30, 2004,
there was no outstanding indebtedness under the lines of credit and approximately $386,000 was
outstanding on a term loan. We do not buy or sell derivative financial instruments for trading
purposes. Borrowings under these credit facilities described above bear interest at rates based
upon the Prime Rate or the Prime Rate less a margin of one-half percent offered by the
applicable lender. We have not entered into any swap agreements or engaged in any other hedging
activities with respect to this variable rate indebtedness. A 10% increase in the interest rates
under these credit facilities would increase annual interest expense by approximately $1,600
(assuming that our aggregate borrowings under the credit facilities averaged $377,000 during
a fiscal year). ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES Under the supervision and with the participations of our management, including the Chief Executive
Officer and Vice President of Finance, we have evaluated the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and Vice President of Finance have
concluded that, except as discussed below, these disclosure controls and procedures are effective
to provide reasonable assurance that information required to be disclosed by us in reports that we
file under the Securities and Exchange Act of 1934 is recorded, processed, summarized, and
reported, within the time periods specified in Securities and Exchange Commission rules and forms.
It should be noted that in designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control objectives, and management
necessarily is required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. We have designed our disclosure controls and procedures to reach
a level of reasonable assurance of achieving desired control objectives and, based on the
evaluation described above, our Chief Executive 15




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Officer and Vice President of Finance concluded that our disclosure controls and procedures were
effective at reaching that level of reasonable assurance, except as discussed below. In connection with the audit
of our consolidated financial statements for the fiscal year
ended July 31, 2004, our independent auditors informed us that they had discovered significant
deficiencies in our internal control over financial reporting that in
the aggregate constituted material weaknesses under
standards established by the Public Company Accounting Oversight Board. These deficiencies, which
were noted across all of the Companys operating divisions, are generally the result of
incompatible duties, undocumented controls, lack of monitoring controls and the lack of an internal
audit function. Additionally, the discovery of compilation errors in the military boot
operations fiscal 2004 year-end inventory required us to
restate our financial
statements as of July 31, 2004 and for the
fiscal year then ended included in our Annual Report on Form 10-K originally filed
by us on October 29, 2004. Upon completion by our independent auditors of their review of the
accounting for inventory in our financial statements as previously
reported for fiscal 2004, our independent auditors
informed us that in their view there were material internal control
weaknesses related to the compilation of the Companys inventory. Certain of these internal
control weaknesses may also constitute deficiencies in the Companys disclosure controls. We have performed
substantial additional procedures in an effort to ensure that these internal control deficiencies do
not lead to further material misstatements in our consolidated financial
statements. We have initiated corrective actions to address these internal control deficiencies, and will
continue to evaluate the effectiveness of our disclosure controls and internal controls and
procedures on an ongoing basis, taking corrective action as appropriate. There were no changes in our internal control over financial reporting that occurred during the
first quarter of fiscal 2005 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. However,
during the second quarter of fiscal 2005 we initiated certain
corrective actions to address certain of the internal control
deficiencies that have been identified, including several relating to
our accounting for inventory at our military boot operation. PART II. OTHER INFORMATION Item 1. Legal Proceedings While from time to time we are engaged in litigation incidental to our business, we are not
currently party to any material legal proceedings. Items 2, 3, 4, and 5. These items are not applicable and have been omitted. Item 6. Exhibits and Reports on Form 8-K (a)
    
    
    Exhibits3.1
    
    
    Certificate of Incorporation (Incorporated by reference to
Exhibit 3.1 to the registrants Form S-14, Registration No. 2-85908).
 16




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3.2
    
    
    Amendment to the Certificate of Incorporation (Incorporated by
reference to Exhibit 3 to the registrants Form 10-K for the year ended August
1, 1987).3.3
    
    
    Restated Bylaws of the registrant effective May 29, 2001.
(Incorporated by reference to Exhibit 3.3
to the registrants Form 10-K for the year ended July 28, 2001).31.1
    
    
    Rule 13a-14(a)/15d-14(a) Certification for D. Gary McRae,
President and CEO (Filed herein). Page 19-20.31.2
    
    
    Rule 13a-14(a)/15d-14(a) Certification for Marvin G. Kiser,
Sr., Vice President of Finance (Filed herein). Page 21-22.32.1
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (18 U.S.C. Section 1350), for D. Gary McRae, President and CEO (Filed
herein) Page 23.32.2
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (18 U.S.C. Section 1350), for Marvin G. Kiser, Sr., Vice President of
Finance (Filed herein). Page 24.(b)
    
    
    On September 9, 2004, we filed a Form 8-K to report the sale of our McRae
Office Solutions unit to Connected Office Products, Inc. pursuant to an Asset Purchase
Agreement among McRae Industries, Inc., McRae Office Solutions, Inc., TOPAC U.S.A.,
Inc., and Connected Office Products, Inc.
 17




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. McRae Industries, Inc.(Registrant)Date:
    
    December 23, 2004
    
    By:
    
    /s/ D. Gary McRaeD. Gary McRae
President and CEO
(Principal Executive Officer)Date:
    
    December 23, 2004
    
    By:
    
    /s/ Marvin G. Kiser, Sr.Marvin G. Kiser, Sr.
(Principal Accounting Officer)
 18