##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-Q þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarter Ended
January 29, 2005. OR oTransition 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 þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act
Rule 12b-2). Yes o No þ 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: 1,948,153 shares as of March 11, 2005.
Common Stock, $1Par Value   Class B: 817,846 shares as of March 11, 2005.   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 Sheets
    
    
    3-4Condensed Consolidated Statements of Operations
    
    
    5Condensed Consolidated Statements of Cash Flows
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7-9ITEM 2.
    
    Managements Discussion And Analysis of Financial
Condition and Results of Operations
    
    
    9-16ITEM 3.
    
    Quantitative and Qualitative Disclosures about
Market Risk
    
    
    16ITEM 4.
    
    Disclosure Controls and Procedures
    
    
    16-17PART II. OTHER INFORMATIONITEM 1.
    
    Legal Proceedings
    
    
    17ITEM 2.
    
    Changes in Securities and Use of Proceeds
    
    
    17ITEM 3.
    
    Defaults upon Senior Securities
    
    
    17ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    18ITEM 5.
    
    Other Information
    
    
    18ITEM 6.
    
    Exhibits
    
    
    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
ASSETS
(In thousands, except share and per share data) January 29, 2005
    
    
    July 31, 2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    13,424
    
    
    $
    2,463Accounts and notes receivable, net
    
    
    9,788
    
    
    
    11,270Inventories
    
    
    9,290
    
    
    
    14,810Assets held for sale from discontinued operations
    
    
    
    
    
    
    11,622Income tax receivable
    
    
    615
    
    
    
    676Prepaid expenses and other current assets
    
    
    492
    
    
    
    271Total current assets
    
    
    33,609
    
    
    
    41,112Property and equipment, net
    
    
    3,166
    
    
    
    3,342Other assets:Notes receivable
    
    
    29
    
    
    
    36Real estate held for investment
    
    
    1,542
    
    
    
    1,422Goodwill
    
    
    362
    
    
    
    362Cash surrender value of life insurance
    
    
    2,220
    
    
    
    2,220Trade names
    
    
    1,049
    
    
    
    1,049Other
    
    
    5
    
    
    
    5Total other assets
    
    
    5,207
    
    
    
    5,094Total assets
    
    $
    41,982
    
    
    $
    49,548
 See notes to condensed consolidated financial statements 3




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##### 



McRae Industries, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS EQUITY
(In thousands, except share and per share data) January 29, 2005
    
    
    July 31, 2004Liabilities and Shareholders EquityCurrent liabilities:Notes
payable, banks - current portion
    
    $
    58
    
    
    $
    621Accounts payable
    
    
    2,470
    
    
    
    4,672Accrued employee benefits
    
    
    269
    
    
    
    524Accrued payroll and payroll taxes
    
    
    621
    
    
    
    865Liabilities held for sale from discontinued operations
    
    
    
    
    
    
    4,587Other
    
    
    990
    
    
    
    1,049Total current liabilities
    
    
    4,408
    
    
    
    12,318Notes payable, banks, net of current portion
    
    
    503
    
    
    
    3,082Shareholders equity:Common stock:Class A, $1 par; Authorized 5,000,000 shares;
Issued and outstanding 1,943,553 and 1,943,543
shares, respectively
    
    
    1,943
    
    
    
    1,943Class B, $1 par; Authorized 2,500,000 shares;
Issued and outstanding 824,946 and 824,956 shares,
respectively
    
    
    825
    
    
    
    825Additional paid-in capital
    
    
    791
    
    
    
    791Retained earnings
    
    
    33,512
    
    
    
    30,589Total shareholders equity
    
    
    37,071
    
    
    
    34,148Total liabilities and shareholders equity
    
    $
    41,982
    
    
    $
    49,548
 NOTE:The condensed consolidated balance sheet at July 31, 2004 has been derived from
the audited financial statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete financial statements. See notes to condensed consolidated financial statements 4




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McRae Industries, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited) Three Months Ended
    
    
    Six Months EndedJanuary 29,
    
    
    January 31,
    
    
    January 29,
    
    
    January 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net revenues
    
    $
    15,525
    
    
    $
    14,896
    
    
    $
    35,958
    
    
    $
    30,919Cost of revenues
    
    
    11,762
    
    
    
    11,956
    
    
    
    27,567
    
    
    
    23,963Gross profit
    
    
    3,763
    
    
    
    2,940
    
    
    
    8,391
    
    
    
    6,956Costs and expenses:Research & development
    
    
    289
    
    
    
    449
    
    
    
    629
    
    
    
    789Selling, general and
administrative
    
    
    2,811
    
    
    
    2,321
    
    
    
    5,887
    
    
    
    4,731Other expense (income), net
    
    
    (44
    )
    
    
    (25
    )
    
    
    (98
    )
    
    
    (53
    )Interest expense (income)
    
    
    9
    
    
    
    (11
    )
    
    
    31
    
    
    
    Total costs and expenses
    
    
    3,065
    
    
    
    2,734
    
    
    
    6,449
    
    
    
    5,467Earnings from operations before
income taxes and minority interest
    
    
    698
    
    
    
    206
    
    
    
    1,942
    
    
    
    1,489Provision for income taxes
    
    
    214
    
    
    
    82
    
    
    
    651
    
    
    
    544Minority shareholders interest in
earnings of subsidiary
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (5
    )Net earnings from continuing
operations
    
    
    484
    
    
    
    127
    
    
    
    1,291
    
    
    
    950Discontinued operations:Loss from discontinued operations
    
    
    (3
    )
    
    
    (228
    )
    
    
    (441
    )
    
    
    (649
    )Income tax benefit
    
    
    1
    
    
    
    87
    
    
    
    171
    
    
    
    247Estimated gain on disposal of
business,
net of income tax expense of
$1,376,000 in fiscal 2004
    
    
    
    
    
    
    
    
    
    
    2,174
    
    
    
    Net earnings
    
    $
    482
    
    
    $
    (14
    )
    
    $
    3,195
    
    
    $
    548Net earnings per common share-basic:Earnings from continuing operations
    
    
    .17
    
    
    
    .05
    
    
    
    .46
    
    
    
    .34Earnings (loss) from discontinued
operations
    
    
    
    
    
    
    (.05
    )
    
    
    .69
    
    
    
    (.14
    )Net earnings
    
    $
    .17
    
    
    $
    .00
    
    
    $
    1.15
    
    
    $
    .20Weighted average number of common
shares outstanding
    
    
    2,768,499
    
    
    
    2,768,499
    
    
    
    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 STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) Six Months EndedJanuary 29, 2005
    
    
    January 31, 2004Net cash provided by operating activities
    
    $
    5,194
    
    
    $
    1,799Cash flows from investing activities:Proceeds from sales of assets
    
    
    4
    
    
    
    1Purchase of land for investment
    
    
    (120
    )
    
    
    (59
    )Capital expenditures
    
    
    (113
    )
    
    
    (307
    )Net collections of long-term receivables
    
    
    7
    
    
    
    31Net cash used in investing activities
    
    
    (222
    )
    
    
    (334
    )Cash flows from financing activities:Principal repayments of notes payable
    
    
    (3,142
    )
    
    
    (285
    )Dividends paid
    
    
    (272
    )
    
    
    (230
    )Net cash used in financing activities
    
    
    (3,414
    )
    
    
    (515
    )Net cash provided by (used in) discontinued operations
    
    
    9,403
    
    
    
    (1,356
    )Net increase (decrease) in cash and cash equivalents
    
    
    10,961
    
    
    
    (406
    )Cash and cash equivalents at beginning of period
    
    
    2,463
    
    
    
    3,835Cash and cash equivalents at end of period
    
    $
    13,424
    
    
    $
    3,429
 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 regulations of the Securities and Exchange Commission (SEC).
Accordingly, they do not include all of the information and footnotes required by the accounting
principals 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 six months ended January 29, 2005 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 filed on Form 10-K/A with the SEC. 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, net of reserves of $1.1 million and $1.0 million, respectively,
consist of the following (in thousands): January 29, 2005
    
    
    July 31, 2004Raw materials
    
    $
    2,252
    
    
    $
    3,883Work-in-process
    
    
    930
    
    
    
    2,385Finished goods
    
    
    6,108
    
    
    
    8,542$
    9,290
    
    
    $
    14,810
 NOTE C - SUBSEQUENT EVENTS On March 7, 2005, the Company declared a cash dividend of $.08 per share on its Class A Common
Stock payable on April 1, 2005, to shareholders of record on March 18, 2005. 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 approximate $206,000 reduction in the purchase price, which is reflected in the
gain calculation. COPI has reviewed this calculation and has asserted a claim for an additional
$248,000 reduction. We disagree with COPIs assertion and have 7




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##### 



disputed this claim. Discontinued operations net revenues for the first six months of fiscal 2005, which consisted of
only one month of operations, amounted to $1.3 million as compared to $9.9 million for the first
six months of fiscal 2004. The net loss from discontinued operations for the first six months of
fiscal 2005 and fiscal 2004 amounted to $270,000 and $402,000, 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. NOTE E  SUMMARY OF BUSINESS SEGMENTS Three Months Ended
    
    
    Six Months EndedJanuary 29,
    
    
    January 31,
    
    
    January 29,
    
    
    January 31,(In thousands)
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Net
revenues from continuing operationsBar Code
    
    $
    2,943
    
    
    $
    2,655
    
    
    $
    5,745
    
    
    $
    4,911Military Boots
    
    
    6,478
    
    
    
    7,421
    
    
    
    17,994
    
    
    
    15,742Western/Work Boots
    
    
    5,919
    
    
    
    5,119
    
    
    
    12,007
    
    
    
    10,998Eliminations/Other
    
    
    185
    
    
    
    (299
    )
    
    
    212
    
    
    
    (732
    )15,525
    
    
    
    14,896
    
    
    
    35,958
    
    
    
    30,919Net
(loss) earnings from continuing operationsBar Code
    
    
    (340
    )
    
    
    (358
    )
    
    
    (794
    )
    
    
    (721
    )Military Boots
    
    
    286
    
    
    
    592
    
    
    
    1,217
    
    
    
    2,076Western/Work Boots
    
    
    423
    
    
    
    (178
    )
    
    
    1,036
    
    
    
    (165
    )Eliminations/Other
    
    
    329
    
    
    
    150
    
    
    
    483
    
    
    
    299698
    
    
    
    206
    
    
    
    1,942
    
    
    
    1,489Provision for income
taxes
    
    
    214
    
    
    
    82
    
    
    
    651
    
    
    
    544Minority shareholders
interest
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (5
    )Net earnings from
continuing
operations
    
    
    484
    
    
    
    127
    
    
    
    1,291
    
    
    
    950Earnings (loss) from
discontinued
operations, net
of tax expense (benefit)
    
    
    (2
    )
    
    
    (141
    )
    
    
    1,904
    
    
    
    (402
    )Net earnings (loss)
    
    $
    482
    
    
    $
    (14
    )
    
    $
    3,195
    
    
    $
    548
 8




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January 29,
    
    
    July 31,2005
    
    
    2004AssetsBar Code
    
    $
    5,483
    
    
    $
    4,810Military Boots
    
    
    7,141
    
    
    
    12,902Western/Work Boots
    
    
    11,270
    
    
    
    13,396Eliminations/Other
    
    
    18,088
    
    
    
    18,440$
    41,982
    
    
    $
    49,548
 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 including the financial information and managements
discussion and analysis contained therein. CRITICAL ACCOUNTING ESTIMATES 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 assets). Our most critical accounting estimates 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. Actual future performance may be different from managements projections. 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. 9




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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
included within our consolidated balance sheet. We 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 establish a valuation allowance. To the extent we establish a valuation allowance or
increase this allowance in a period, we 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 would 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 for the six months ended January 29, 2005, totaled approximately
$13.4 million as compared to approximately $2.5 million at July 31, 2004. Working capital at the
end of the first six months of fiscal 2005 amounted to $29.2 million, up slightly from $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 January 29, 2005. 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 2006. The $3.0 million credit line expires in November 2005. We believe that our current cash and cash equivalents, cash generated from operations, and
available lines of credit will be sufficient to meet our capital requirements for the remainder of
fiscal 2005. Our contractual commitments for fiscal 2005 are approximately $178,000. Selected cash flow data for the first six months of fiscal 2005 are presented below (in thousands): For the Six MonthsEndedJanuary 29, 2005Source (Use) of CashOperating activities:Net earnings from continuing operations adjusted for depreciation
    
    $
    1,579Accounts receivable
    
    
    1,482Inventories
    
    
    5,520Accounts payable
    
    
    (2,202
    )Net cash provided by operating activities
    
    
    5,194Net cash provided by discontinued operations
    
    
    9,403
 Net cash provided by operating activities for the first six months of fiscal 2005 totaled
approximately $5.2 million. Net earnings from continuing operations, adjusted for depreciation,
provided $1.6 million of cash. Trade accounts receivable provided $1.5 million of cash primarily
attributable to the timing of collection of accounts related to heavy first quarter sales with
declining second quarter sales to the U.S. Government. Inventory fell by approximately $5.5 million
primarily the result of higher than anticipated demand for western and work boot products and the
decline in military boot requirements by the U.S. 10




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Government. The decrease in accounts payable used approximately $2.2 million of cash primarily
attributable to the timing of payments for inventory related to the military boot and western and
work boot businesses. Capital expenditures consisting primarily of production molds for the new bar code product totaled
approximately $113,000. For the first six months of fiscal 2005, we used approximately $3.1 million to reduce our long-term
debt obligations. Dividend payments amounted to approximately $272,000. The decrease in military boot requirements by the U.S. Government may adversely impact the
Companys liquidity over the long run. Off-Balance Sheet Arrangements We do not currently utilize any off-balance sheet financing arrangements and do not anticipate
doing so in the future. SECOND QUARTER FISCAL 2005 COMPARED TO SECOND QUARTER FISCAL 2004 Consolidated net revenues from continuing operations for the second quarter of fiscal 2005
amounted to $15.5 million as compared to $14.9 million for fiscal 2004. This increase in net
revenues resulted from higher demand for western and work boot business and bar code business
products and was partially offset by lower military boot requirements by the U.S. Government. Consolidated gross profit for the second quarter of fiscal 2005 amounted to $3.8 million, an
increase of 31.0% over the $2.9 million reported for fiscal 2004. As a percentage of net revenues,
gross profit for the second quarter of fiscal 2005 was 24.5% as compared to 19.5% for the same
period of fiscal 2004. This increase in gross profit was primarily due to increased net revenues
and higher margins on imported western and work boots. Consolidated research and development (R&D) from continuing operations for the second quarter of
fiscal 2005 amounted to $289,000 as compared to $449,000 for the same period of fiscal 2004 as the
new bar code product moved from the development stage to the production stage. Consolidated selling, general and administrative (SG&A) expenses from continuing operations
totaled $2.8 million, an increase of 21.7% over the $2.3 million reported for the second quarter of
fiscal 2004. As a percentage of net revenues, SG&A expenditures for the second quarter of fiscal
2005 were 18.1% as compared to 15.4% for the second quarter of fiscal 2004. This increase in SG&A
expenses resulted primarily from higher expenditures for sales commissions, advertising costs,
professional fees (including significant costs incurred to achieve compliance with the requirements
of Section 404 of the Sarbanes-Oxley Act of 2002), and employee benefit costs, which were partially
offset by lower group health insurance costs, primarily attributable
to the sale of our McRae Office Solutions business and bad debt expenses. As a result of the above, consolidated operating profit from continuing operations amounted to
$663,000 for the second quarter of fiscal 2005 as compared to consolidated operating profit from
continuing operations of $170,000 for the second quarter of fiscal 2004. 11




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##### 



Bar Code Business Net revenues for the bar code business for the second quarter of fiscal 2005 amounted to $2.9
million as compared to $2.7 million for fiscal 2004. This growth in net revenues resulted
primarily from an improved market for technology products. Our new product, which was introduced to
the market late in the second quarter, had only a minimal impact on net revenues. However, we
expect increased contributions from this product for the remainder of this fiscal year. Gross profit totaled $811,000 for the second quarter of fiscal 2005, up from $792,000 for the same
period of fiscal 2004 primarily attributable to the increase in net revenues. As a percentage of
net revenues, gross profit fell from 29.3% for the second quarter of fiscal 2004 to 28.0% for the
second quarter of fiscal 2005 primarily the result of lower margin resale products comprising a
larger percentage of the overall sales mix. Selling, general and administrative (SG&A) and research and development (R&D) costs for the second
quarters of both fiscal 2005 and 2004 amounted to approximately $1.2 million. R&D costs fell from
$450,000 for the second quarter of fiscal 2004 to $289,000 for the second quarter of fiscal 2005 as
the new bar code product moved from development to production. SG&A expenses increased
approximately $150,000 primarily attributable to higher sales and
marketing costs and professional fee
expenditures. As a result of the above, the bar code business loss from operations totaled $347,000 for the
second quarter of fiscal 2005 as compared to a loss from operations of $370,000 for the second
quarter of fiscal 2004. Military Boot Business Net revenues for the military boot business for the second quarter of fiscal 2005 amounted to
$6.5 million, a decrease of 12.2% from the $7.4 million reported for the same period of fiscal
2004. This decrease in net revenues resulted primarily from lower military boot requirements for
the U.S. Government (the Government), which was partially offset by slightly higher sales of
military boots to Israel. Gross profit for the second quarter of fiscal 2005 was approximately $856,000, down from $923,000
for the second quarter of fiscal 2004 primarily the result of reduced net revenues. As a
percentage of net revenues, gross profit grew from 12.5% for the second quarter of fiscal 2004 to
13.2% for the second quarter of fiscal 2005 primarily attributable to lower per unit costs
resulting from manufacturing efficiencies associated with increased production levels and a greater
proportion of higher margin sales to Israel in the sales mix. Selling, general and administrative expenses for the military boot business for the second quarter
of fiscal 2005 totaled approximately $569,000, an increase from the $338,000 reported for the
second quarter of fiscal 2004. This increase is primarily attributable to higher group health
insurance costs and professional fees due to an increased allocation
of overhead expenses related to
the sale of our McRae Office Solutions business. As a result of the above, the military boot business earnings from operations for the second
quarter of fiscal 2005 amounted to $287,000, as compared to $586,000 reported for the second
quarter of fiscal 2004. On September 30, 2004, the U.S. Government (the Government) exercised the first year option under
our Contract with the Government awarded to us on September 30, 2003 (the Contract). Since the
completion of the surge requirement in the first quarter of fiscal 2005, the Government has
reduced its production requirement and the minimum boot requirement under the Contract has been
reduced from 276,460 pair 12




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to 138,230 pair. In addition, we were not successful in securing a recent Government contract to
supplement our current Contract. As a result, on March 3, 2005 we decided to consolidate all
military boot production at our North Carolina plant by closing our Tennessee manufacturing
facility effective March 18, 2005. The closing of this plant will impact 120 employees and we
estimate will cause us to incur approximately $130,000 to $140,000 in severance costs. We are
currently evaluating asset impairment issues (the Tennessee manufacturing facility currently has a
book value of approximately $330,000) and other matters related to the plant closing. Western and Work Boot Business Net revenues for the western and work boot business for the second quarter of fiscal 2005
totaled $5.9 million, an increase of 15.7% over the $5.1 million reported for the second quarter of
fiscal 2004 primarily the result of increased demand for western and work boot products. Indicators
point to an emerging fashion trend for these products. Gross profit for the second quarter of fiscal 2005 amounted to $1.9 million as compared to $1.2
million for the second quarter of fiscal 2004 primarily attributable to increased net revenues and
higher margins associated with the shift from manufacturing to importing our western and work
boots. As a percentage of net revenues, gross profit increased from 23.5% for the second quarter of
fiscal 2004 to 32.2% for the second quarter of fiscal 2005. SG&A expenses for the second quarter of fiscal 2005 totaled $1.3 million as compared to $1.2
million for the same period for fiscal 2004. This increase in SG&A expenses resulted primarily
from higher expenditures for sales commissions, group health insurance, office supplies, and
advertising expenses, which were slightly offset by lower bad debt charges, sales and marketing
expenses, and professional fees. As a result of the above, operating profit for the western and work boot business for the second
quarter of fiscal 2005 amounted to $587,000 as compared to an operating loss of $38,000 for the
second quarter of fiscal 2004. FIRST SIX MONTHS FISCAL 2005 COMPARED TO FIRST SIX MONTHS FISCAL 2004 Consolidated net revenues from continuing operations for the first six months of fiscal 2005
amounted to $36.0 million as compared to $30.9 million for the first six months of fiscal 2004 as
all three of our main businesses posted increased net revenues which are further discussed below. Consolidated gross profit from continuing operations for the first six months of fiscal 2005
totaled $8.4 million as compared to $7.0 million for the first six months of fiscal 2004 primarily
the result of the increase in net revenues. As a percentage of net revenues, gross profit remained
consistent at approximately 23% for the first six months of both fiscal 2005 and fiscal 2004. Consolidated research and development (R&D) expenses from continuing operations for the first six
months of fiscal 2005 was $629,000, down from $789,000 reported for the first six months from
continuing operations of fiscal 2004. This decrease resulted from the completion of the
development stage of the new bar code product, which was introduced to the market in January 2005. Consolidated selling, general and administrative (SG&A) expenses from continuing operations for the
first six months of fiscal 2005 amounted to $5.9 million as compared to $4.7 million reported for
the same period of fiscal 2004. This 25.5% growth in SG&A costs is primarily the result of
increased expenditures for group health insurance, professional fees (including significant costs
incurred to achieve compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of
2002), sales commissions, 13




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employee benefit costs and advertising, which were partially offset by decreased expenditures for
sales and marketing costs, and bad debt charges. As a result of the above, net earnings from continuing operations for the first six months of
fiscal 2005 totaled $1.9 million as compared to $1.4 million reported for the first six months from
continuing operations of fiscal 2004. Bar Code Business Net revenues for the first six months of fiscal 2005 totaled $5.7 million, as compared to the
$4.9 million reported for the first six months of fiscal 2004. This growth in net revenues
resulted primarily from an improving market for bar code products and the introduction of our new
bar code product. Gross profit for the first six months of fiscal 2005 grew to $1.6 million, up from $1.5 million for
the first six months of fiscal 2004 primarily attributable to the increase in net revenues. As a
percentage of net revenues, gross profit decreased to 28.1% for the first six months of fiscal 2005
as compared to 30.6% reported for the first six months of fiscal 2004. This decline in gross profit
resulted primarily from lower margin purchased products being a greater part of the overall sales
mix. SG&A and R&D expenses for the first six months of fiscal 2005 amounted to $2.4 million as compared
to $2.2 million reported for the first six months of fiscal 2004. R&D expenditures fell $160,000
for the first six months of fiscal 2005 as compared to the same period of fiscal 2004 as a result
of the completion of the new bar code products development phase and movement to the production
phase. SG&A expenses totaled $1.7 million for the first six months of fiscal 2005 as compared to
$1.4 million for the first six months of fiscal 2004. This increase in SG&A expenses resulted
primarily from higher expenditures for sales commissions, group health insurance, and professional
fees, which were partially offset by lower expenditures for travel expenses. As a result of the above, the bar code business loss from operations for the first six months of
fiscal 2005 amounted to $798,000 as compared to an operating loss of $738,000 for the first six
months of fiscal 2004. Military Boot Business Net revenues for the military boot business for the first six months of fiscal 2005 amounted
to $18.0 million as compared to $15.7 million for the first six months of fiscal 2004. This 14.6%
increase in net revenues is primarily the result of the Governments surge requirement being in
effect for a greater portion of the fiscal 2005 period as compared to the fiscal 2004 period. Gross profit amounted to $2.6 million for the first six months of fiscal 2005 as compared to $2.7
million for the first six months of fiscal 2004. As a percentage of net revenues, gross
profit decreased from the 17.2% reported for the first six months of fiscal 2004 to 14.4%
for the same period of fiscal 2005. These declines in gross profit resulted primarily from lower
sales prices associated with the option year contract with the Government. SG&A expenditures for the first six months of fiscal 2005 amounted to approximately $1.4 million as
compared to $671,000 for the first six months of fiscal 2004. This increase resulted primarily
from higher expenditures for group health insurance and professional fees resulting from increased
allocation of overhead expenses due to the sale of our McRae Office Solutions business. As a result of the above, net earnings from operations for the first six months of fiscal 2005
amounted to $1.2 million as compared to the $2.1 million reported for the first six months of
fiscal 2004. 14




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Western and Work Boot Business Net revenues for the western and work boot business for the first six months of fiscal 2005
totaled $12.0 million up from $11.0 million for the first six months of fiscal 2004 primarily
attributable to stronger demand for western and work boot products. Gross profit for the first six months of fiscal 2005 amounted to $4.0 million, a 48.1% increase
over the $2.7 million reported for the same period of fiscal 2004. Gross profit as a percentage of
net revenues grew from 24.5% for the first six months of fiscal 2004 to 33.3% for the same period
of fiscal 2005. This improvement in gross profit was primarily attributable to increased net
revenues and higher margins associated with the shift from manufacturing to importing our western
and work boots. SG&A expenditures for the first six months of fiscal 2005 were approximately $2.7 million as
compared to $2.5 million for the first six months of fiscal 2004. This increase in SG&A expenses
was primarily the result of higher expenditures for sales commissions, advertising, and employee
benefit costs. These expenditures were partially offset by lower charges for professional fees and
bad debts. As a result of the above, the western and work boot business earnings from operations for the first
six months of fiscal 2005 amounted to $1.3 million as compared to $108,000 reported for the first
six months 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 approximate $206,000 reduction in the purchase price, which is reflected in the gain
calculation. COPI has reviewed this calculation and has asserted a claim for an additional $248,000
reduction. We disagree with COPIs assertion and have disputed this claim. Discontinued operations net revenues for the first six months of fiscal 2005, which consisted of
only one month of operations, amounted to $1.3 million as compared to $9.9 million for the first
six months of fiscal 2004. The net loss from discontinued operations for the first six months of
fiscal 2005 and fiscal 2004 amounted to $270,000 and $402,000, 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 In November 2004, Statement of Financial Accounting Standards (SFAS) No. 151, Inventory
Costs, an amendment of ARB No. 43, Chapter 4 was issued to clarify the accounting for abnormal
amounts of facility expense, freight, handling costs, and wasted material (spoilage). We are
currently evaluating how this standard applies to our business. SFAS No. 151 will be effective for
us in fiscal 2006. In December 2004, SFAS No. 152, Accounting for Real Estate Time-Sharing Transactions was issued
to amend several components of FASB Statements No. 66 and No. 67. This standard is not applicable
to our business. 15




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In December 2004, SFAS No. 153, Exchange of Non-Monetary Assets was issued to amend APB Opinion
No. 29 to eliminate the exception for non-monetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of non-monetary assets that do not have
commercial substance. We are currently evaluating how this standard applies to our business. SFAS
No. 153 will be effective for us in fiscal 2006. In December 2004, SFAS No. 123 (revised 2004), Share-Based Payment, was issued to establish
standards for the accounting for transactions in which an entity exchanges its equity instruments
for goods or services. We currently have no plans to participate in transactions of this type. SFAS
No. 123 (revised 2004) will be effective for us in fiscal 2006. FORWARD-LOOKING STATEMENTS In addition to historical information, this Quarterly 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 (the term loan through our military boot business was paid off in February 2005 and
the term loan through our wholly owned subsidiary, Dan Post Boot Company was paid off in September
2004). As of January 29, 2005, 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- 16




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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 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 the inventory restatement 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. 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. Other than these actions, there
were no changes in our internal control over financial reporting that occurred during the second
quarter of fiscal 2005 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. 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 and 3. These items are not applicable and have been omitted. 17




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Item 4. Submission of Matters to a Vote of Security Holders At the Companys Annual Meeting of Stockholders held on December 16, 2004, the following
individuals were elected to the Board of Directors: Votes For
    
    
    Votes WithheldClass A
    
    Class B
    
    
    Class A
    
    Class BD. Gary McRae
    
    N/A
    
    
    720,056
    
    
    N/A
    
    
    152William H. Swan
    
    N/A
    
    
    720,056
    
    
    N/A
    
    
    152Hilton J. Cochran
    
    N/A
    
    
    720,051
    
    
    N/A
    
    
    157Victor A. Karam
    
    N/A
    
    
    720,056
    
    
    N/A
    
    
    152James W. McRae
    
    N/A
    
    
    720,056
    
    
    N/A
    
    
    152Brady W. Dickson
    
    1,778,319
    
    
    N/A
    
    
    23,031
    
    
    N/AMarvin G. Kiser, Sr.
    
    1,471,514
    
    
    N/A
    
    
    386,824
    
    
    N/A
 The following proposal was approved at the Companys Annual Meeting: Affirmative Votes
    
    
    Negative Votes
    
    
    Votes WithheldClass A
    
    
    Class B
    
    
    Class A
    
    
    Class B
    
    
    Class A
    
    
    Class BRatify the
appointment of
Grant Thornton LLP
as an independent
registered public
accounting firm for
the current fiscal
year
    
    
    1,794,157
    
    
    
    720,159
    
    
    
    7,122
    
    
    
    46
    
    
    
    71
    
    
    
    3
 Item 5. Other Information This item is not applicable and has been omitted. Item 6. Exhibits  3.1
    Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 to the
Registrants Form S-14, Registration No. 2-85908).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 20.31.2
    Rule 13a-14(a)/15d-14(a) Certification for Marvin G. Kiser, Sr., Vice President
of Finance (Filed herein). Page 21.32.1
    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 22.32.2
    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 23. 18




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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:March 15, 2005
    
    By:
    
    /s/D. Gary McRaeD. Gary McRaePresident and CEO(Principal Executive Officer)Date:March 15, 2005
    
    By:
    
    /s/Marvin G. Kiser, Sr.Marvin G. Kiser, Sr.(Principal Accounting Officer)
 19