-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Fl7V8nPonhQ963l8TFJ2MYKGr3jjqZgwBq4JXZ1XR8dqh5D+y8A9rSn9mSl8TMop 5IdLJG+AyYm/8sKB/skR6g== 0000874385-00-000005.txt : 20001205 0000874385-00-000005.hdr.sgml : 20001205 ACCESSION NUMBER: 0000874385-00-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000902 FILED AS OF DATE: 20001204 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RAG SHOPS INC CENTRAL INDEX KEY: 0000874385 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-HOBBY, TOY & GAME SHOPS [5945] IRS NUMBER: 510333503 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-19194 FILM NUMBER: 782562 BUSINESS ADDRESS: STREET 1: 111 WAGARAW RD CITY: HAWTHORNE STATE: NJ ZIP: 07506 BUSINESS PHONE: 9734231303 MAIL ADDRESS: STREET 1: 111 WAGARAW RD CITY: HAWTHORNE STATE: NJ ZIP: 07506 10-K 1 0001.txt 10K 9/2/2000 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 2, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______ Commission File No. 0-19194 RAG SHOPS, INC. (Exact name of registrant as specified in its charter) DELAWARE 51-0333503 (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 111 WAGARAW ROAD HAWTHORNE, NEW JERSEY 07506 (Address of principal executive (Zip Code) offices) Registrant's telephone number including area code: (973) 423-1303 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE (Title of Class) 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, and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes X No ___ As of October 31, 2000, there were outstanding 4,801,583 shares of Common Stock. Based on the price at which such stock was sold on that date, the approximate aggregate market value of such shares held by non-affiliates was $4,243,251. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's 2000 Definitive Proxy Statement, which statement will be filed not later than 120 days after the end of the fiscal year covered by this Report, are incorporated by reference in Part III hereof. Certain exhibits are incorporated by reference to the Company's Registration Statement on Form S-1 and Amendment No. 1 thereto, as listed in response to Item 14(a)(3). [The remainder of this page is intentionally blank.] PART I ITEM 1. BUSINESS GENERAL Rag Shops, Inc., a Delaware corporation formed in April 1991, is the successor by merger to a New Jersey corporation having the same name which was incorporated in September 1984, as a holding company for numerous subsidiaries that have operated retail stores since 1963. As of September 2, 2000 Rag Shops, Inc. operated 65 specialty retail stores that sell competitively priced craft and fabric merchandise. The Company caters to value conscious consumers who create decorative accessories and sew. The Company believes that its wide selection of currently popular merchandise, value-oriented pricing policy and commitments to both customer service and advertising are principal factors contributing to its profitability. The Company's stores are destination-oriented and also attract shoppers from other stores located in the same shopping center. As of September 2, 2000, the Company operated 34 retail stores in New Jersey, 19 in Florida, six in Pennsylvania, four in New York and two in Connecticut. The Company anticipates opening five stores and closing three stores during its fiscal year ending September 1, 2001. The Company's expansion strategy is to grow by expanding within areas from which it presently attracts customers and into contiguous market areas, enabling the Company to capitalize on pre-existing advertising and name recognition. The following table sets forth information with respect to store openings and closings since fiscal 1996: FISCAL YEARS 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Stores open at beginning of period 69 66 66 67 69 Stores opened during period 0 5 2 4 1 Stores closed during period 4 2 2 5 3 Stores open at end of period 65 69 66 66 67
PRODUCTS The Company's stores offer a diverse and extensive assortment of value-priced crafts, fabrics and related items to creative craft and sewing consumers. Each of the Company's stores offers craft, fabric and related products. Craft items include silk flowers, wicker, picture frames, wood products, stitchery, yarn, wearable art, art supplies and craft supplies. Fabric items available at the Company's stores include apparel and home decorative fabrics, trimmings, patterns and sewing notions. As of September 2, 2000, fifty-nine stores offer custom picture framing. The Company also sells a wide variety of seasonal merchandise with special emphasis on the Easter, Back-to-School, Halloween and Christmas seasons. Through their purchase of craft, fabric and other items, used either individually or in combination, the Company's customers can hand make a wide variety of finished products for personal use, gifts, home beautification and seasonal decoration. For example, fabrics can be made into career, leisure, children's, bridal and special occasion fashions, draperies and upholstery for home decoration and hand made quilts and, from the Company's selection of craft items, customers can create needle point and stitchery, personalized hand painted apparel, floral arrangements and dolls. MERCHANDISING AND ADVERTISING The Company's marketing and merchandising strategy emphasizes the sale of multiple products to be used by the customer to create a single project. To assist customers in making their own selections and to encourage their purchase of several products, the Company's stores display finished models that incorporate a variety of merchandise in close proximity to where the components are sold. The models are created by employees at the stores conforming to Company guidelines. Craft or sewing classes are offered monthly at a select number of each of the Company's stores to further promote both specific products and store business. During each class, participants complete a project using materials purchased from the store at which the class is offered. Merchandise at the Company's stores is displayed on conveniently arranged fabric tables and fixtures to facilitate customer access. The general layout of merchandise, adjusted seasonally and as otherwise necessary to adapt to marketing conditions, is planned by the Company's management to give prominence to the types of merchandise currently in demand. Approximately five percent of the Company's net sales are expended on a 52-week per year advertising program. In September 1996, the Company commenced utilizing freestanding newspaper inserts, alternating with newspaper print advertisements. These newspaper inserts are also displayed at the front of each store and describe a calendar of promotions emphasizing special sale items, seasonal products and other currently popular merchandise. Approximately 3 million people receive the freestanding newspaper inserts. For the Back-to-School season and holiday seasons of Easter, Halloween and Christmas, the Company utilizes a fully developed merchandising program including special inventory, layout, instructional ideas and promotions with highly focused displays. During these peak seasons approximately 25% of store selling space is devoted to seasonal merchandise. SEASONALITY The Company's business is seasonal, which the Company believes is typical of the retail craft and fabric industry. The Company's highest sales and earnings levels historically occur between September and December. Generally, the Company has historically operated at a loss during its fourth fiscal quarter, the June through August summer period. The Company's results of operations depend significantly upon the sales generated from September through December and any material decrease in sales for such period could have a material adverse effect upon the Company's profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Seasonality." STORE OPERATIONS The Company's store operations are divided into seven geographic districts, each managed by a district manager. Stores typically are staffed with a manager, an assistant manager, one department head each for fabrics and crafts, sales personnel, cashiers and stock clerks. District managers supervise store management, monitor the Company's stores to ensure compliance with procedures, policies and budgets, determine whether adequate levels of merchandise are available at the stores and reallocate merchandise among stores as dictated by selling trends at individual stores. Store managers are responsible for operation of individual stores, including recruiting and hiring store personnel. Store managers place orders to replenish inventory from the Company's 85,000 square foot distribution center in Paterson, New Jersey, and may also directly order certain core merchandise designated by management from the Company's suppliers. Orders for merchandise are placed by the store manager on a regular basis. Commencing in January 1999 orders for merchandise are entered into a scanning gun, down loaded to a computer in the store and polled by the Company's corporate data processing system. Merchandise received at the Company's stores is entered into the store computer and included in the polling. Deliveries from the distribution center are made by Company-owned vehicles or by independent trucking companies. Stores are generally open from 10:00 A.M. to 9:00 P.M. Monday through Saturday and 11:00 A.M. to 6:00 P.M. on Sunday, with extended hours during the Christmas season. All stores are operating with point-of-sale cash register systems. Approximately 61% of receipts at the Company's stores are in the form of cash or check, with the balance paid for with MasterCard, Visa, Discover or American Express charge cards. The average sale per customer transaction is approximately $13.00. EXPANSION STRATEGY While management does not believe there are significant geographic constraints on the locations of future stores, the Company's strategy is to grow by expanding within areas from which it presently attracts customers and into contiguous market areas, enabling the Company to capitalize on pre-existing advertising and name recognition. When deciding whether to open a new store, the principal factors the Company typically evaluates are the amount of consumer traffic generated by the market area, the demographic composition of the customer base in the market area, store position in the shopping center, rent structure, available media, advertising expense, and other costs associated with opening the store. Historically, new stores tend to become profitable after six to twenty-four months. SOURCES OF SUPPLY The Company purchases its merchandise from more than 300 suppliers. The Company's merchandise is primarily purchased from domestic suppliers (including distributors that import goods from the Far East) and the balance is acquired directly from manufacturers in the Far East, including Hong Kong, Taiwan, Korea, China and the Philippines. All of the merchandise purchased directly from foreign manufacturers, consisting primarily of silk flowers, seasonal merchandise and staple craft products, is sold under the Company's private label. As is customary in the industry, the Company does not have any long-term or exclusive contracts with any suppliers. The Company believes that alternate sources of merchandise are readily available at comparable prices. Consistent with industry practice, merchandise from manufacturers in the Far East is ordered four to six months in advance to assure delivery prior to the selling season for the merchandise. Letters of credit are frequently issued to foreign manufacturers with specific terms regarding the merchandise ordered, inspection prior to shipment and time and place of delivery. The Company assumes the risk of loss on a F.O.B. basis when goods are delivered to a shipper and is insured against casualty losses arising during shipping. COMPETITION The retail craft and fabric industry is highly competitive. The Company competes with other national, regional and independent specialty craft and/or fabric retailers and mass merchandisers, some of which have greater financial and other resources than the Company. The Company believes it competes on the basis of merchandise selection, customer service, price and advertising. Competitors include A.C. Moore Arts & Crafts, Inc., Jo-Ann Stores, Inc., and Michaels Stores, Inc. EMPLOYEES As of September 2, 2000, the Company has approximately 1,200 employees, consisting of approximately 390 full time and 810 part time employees. Full time personnel consist of approximately 220 salaried and 170 hourly employees. All part time personnel are hourly employees. During seasonal peak periods, the Company hires temporary personnel. Approximately 39 employees in the Company's distribution center are covered by a collective bargaining agreement with Local 161 of the Union of Needletrades, Industrial and Textile Employees, AFL-CIO. This agreement expires in March 2002. The Company considers its relationships with its employees to be good. TRADEMARKS The Company's trademark "THE RAG SHOP" was registered in the United States Patent Office on September 9, 1969 and thereafter renewed. This registration is renewable indefinitely so long as the mark is used by the Company. ITEM 2. PROPERTIES The Company's office facilities and its Hawthorne, New Jersey store occupy approximately 15,900 and 17,600 square feet, respectively, in the same strip shopping center in Hawthorne, New Jersey. The store and offices are leased from Momar Realty L.L.C., the two members of which are Stanley Berenzweig, Chairman of the Board and Doris Berenzweig, Secretary. The Company's distribution center and all of its other stores are leased from non-affiliates of the Company. The Company's 85,000 square foot distribution center is located in Paterson, New Jersey. The Company believes that its distribution center is adequate for its needs through the expiration of the current term of the lease in July 2002. The Company expects to lease approximately 50,000 square feet of additional warehouse space for twelve months of the year 2001, as compared to eight months for the year 2000, to accommodate seasonal merchandise and expedite distribution of merchandise to stores. The Company's stores, all of which are located in leased facilities, range in size from approximately 6,200 square feet to 17,700 square feet. The average size of the Company's stores is approximately 10,300 square feet with approximately 90% of the area of each store representing selling space. The Company seeks to open new stores in the range of approximately 15,000 to 20,000 square feet. However, the Company often maintains options to expand store size and will exercise those options or otherwise enlarge particular stores as circumstances warrant. The following table sets forth the number of store leases due to expire, including options to renew, during the year indicated. LEASE EXPIRATIONS YEAR NUMBER YEAR NUMBER ----- ---------- -------- ------- 2001 1 2016 4 2003 2 2017 9 2004 2 2018 6 2005 2 2019 8 2006 2 2020 4 2008 3 2021 2 2010 0 2023 2 2011 4 2024 2 2012 2 2026 1 2013 5 2027 2 2014 2 Sixty-two of the above stores are located in strip shopping centers, and the remaining three are free-standing buildings. The stores generally are located in close proximity to population centers and other retail operations and are usually on a major highway or thoroughfare, making them easily accessible by automobile. All of the stores provide free parking. The leases for the Company's stores are generally for a term of five years, usually with four options to renew for five years each. Under most leases, the Company is required to pay, in addition to fixed minimum rental payments, additional rent based on charges for real estate taxes, common area maintenance fees, utility charges and insurance premiums. Certain leases provide for contingent rentals based on a percentage of sales. ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings incidental to the conduct of its business. The Company currently is not engaged in any legal proceedings that is expected to have a material adverse effect on the Company's results of operations or financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company did not submit any matters to vote of its stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended September 2, 2000. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. Effective September 24, 1999 the Company's Common Stock began trading on the NASDAQ SmallCap Market ("NASDAQ") under the symbol "RAGS". The Company's Common Stock was previously traded on the NASDAQ National Market. The following table sets forth, for the periods indicated, the high and low sale prices of the Company's Common Stock as reported by NASDAQ. These prices reflect interdealer prices and do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions. HIGH LOW FISCAL YEAR ENDED SEPTEMBER 2, 2000 First Quarter $ 2.438 $1.625 Second Quarter 2.250 1.813 Third Quarter 2.344 1.813 Fourth Quarter 3.094 2.156 FISCAL YEAR ENDED AUGUST 28, 1999 First Quarter $ 2.875 $2.3125 Second Quarter 2.875 2.25 Third Quarter 2.50 1.9375 Fourth Quarter 2.5625 2.00
On October 31, 2000, the closing price of the Common Stock was $2.0625. The approximate number of stockholders of record of the Common Stock at October 31, 2000 was 421. The number of beneficial owners whose shares are held by banks, brokers and other nominees exceeds 950. On June 28, 1999, the Company declared a 5% stock dividend on the Company's common stock which was paid on August 10, 1999 to stockholders of record on July 14, 1999. The Company has not paid any cash dividends. The Company presently intends to retain all earnings for the operation and expansion of its business and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. Any future determination as to the payment of cash dividends on the Common Stock will depend upon future earnings, results of operations, capital requirements, the financial condition of the Company and any other factors the Board of Directors of the Company may consider. In addition, pursuant to the Company's bank line of credit, the Company is prohibited from declaring dividends in any year in excess of its earnings for such year or which would otherwise result in a violation of the Company's covenant to maintain a tangible net worth (as defined in the line of credit commitment letter) of $9,000,000. The Company's tangible net worth for the period ended September 2, 2000 was $23,669,916. ITEM 6. SELECTED FINANCIAL DATA. FISCAL YEAR ENDED (1) SEPTEMBER 2, AUGUST 28, AUGUST 29, AUGUST 30, AUGUST 31, 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- (IN THOUSANDS, EXCEPT COMMON STOCK DATA AND STATISTICS) OPERATIONS Net sales $ 100,208 $ 94,781 $ 90,566 $ 86,528 $ 83,767 Gross profit 36,543 33,915 32,772 31,044 30,440 Store expenses and general and administrative expenses 34,582 33,163 31,167 30,578 29,500 Interest income (expense), net 31 ( 83) (61) (115) (161) Income before income taxes and cumulative effect of change in accounting principle 1,991 668 1,544 351 779 Income before cumulative effect of change in accounting principle 1,198 402 942 207 520 Cumulative effect of change in accounting principle, net of tax 198 0 0 0 0 Net income $ 1,396 $ 402 $ 942 $ 207 $ 520 COMMON STOCK DATA (2) Basic and diluted earnings per share: Income before cumulative effect of change in accounting principle $ .25 $ .08 $ .20 $ .04 $ .11 Cumulative effect of change in accounting principle .04 0 0 0 0 ----- ----- ----- ----- ----- Net income $ .29 $ .08 $ .20 $ .04 $ .11 Book value per share $ 4.93 $ 4.59 $ 4.59 $ 4.39 $ 4.34 Weighted average shares and equivalents outstanding: Basic 4,813,476 4,744,408 4,740,063 4,740,063 4,740,063 Diluted 4,813,871 4,754,996 4,788,196 4,764,977 4,740,672 FINANCIAL POSITION Working capital $ 19,640 $ 17,298 $ 17,095 $ 16,256 $ 16,985 Total assets 34,580 37,869 33,318 32,264 33,555 Short-term debt 0 6,570 2,194 3,119 1,762 Long-term debt 0 0 0 554 1,231 Stockholders' equity $ 23,670 $ 22,104 $ 21,742 $ 20,800 $ 20,593
FISCAL YEAR ENDED (1) SEPTEMBER 2, AUGUST 28, AUGUST 29, AUGUST 30, AUGUST 31, 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- (IN THOUSANDS EXCEPT COMMON STOCK DATA AND STATISTICS) STATISTICS Net sales increase (decrease) 5.7% 4.7% 4.7% 3.3% (2.7%) Comparable store net sales increases (decreases) (3) 4.2% 0.2% 3.2% 3.8% (4.9%) Return on net sales, after income taxes 1.4% 0.4% 1.0% 0.2% 0.6% Return on average stockholders' equity 6.1% 1.8% 4.4% 1.0% 2.6% Average net sales per gross square foot (4) $147 $ 141 $ 143 $ 139 $ 135 Average net sales per store (000's) (4) $1,490 $ 1,399 $ 1,374 $ 1,296 $ 1,214 Stores open at end of period 65 69 66 66 67
(1) Fiscal 2000 is a 53-week fiscal year. All other years shown are 52-week fiscal years. (2) On June 28, 1999, the Company declared a 5% stock dividend on the Company's common stock, which was paid on August 10, 1999 to stockholders of record on July 14, 1999. Share and per share data presented for all periods has been adjusted to give retroactive effect to the dividend. (2) Comparable store sales increases for a fiscal year include stores commencing with their thirteenth consecutive entire fiscal month. (4) For purposes of calculating these amounts, the number of stores and the amount of gross square footage have been adjusted to reflect the number of months during the period that new stores were open. These amounts have not been adjusted to reflect the seasonal nature of the Company's net sales or the resulting impact of opening stores in different periods during the year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Seasonality." ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table sets forth as a percentage of net sales, certain items appearing in the Company's Consolidated Income Statements for the indicated years. YEAR ENDED ---------------------------------------------------------- 2000 1999 1998 ---- ---- ---- Net sales 100.0% 100.0% 100.0% Cost of merchandise sold and occupancy costs 63.5 64.2 63.8 ------- ------ ------ Gross profit 36.5 35.8 36.2 Store expenses 23.4 24.0 23.4 General and administrative expenses 11.1 11.0 11.0 ------- ------ ------ Income from operations 2.0% 0.8% 1.8% Net income 1.4% 0.4% 1.0%
The Company's net sales increased in fiscal 2000 by $5,427,000 or 5.7%. Sales from comparable stores opened at least one year increased $3,811,000 or 4.2%. Sales in fiscal 2000 included a 53rd fiscal week, which amounted to $1,529,000 or an increase of 1.6% of the sales increase over fiscal 1999. Management believes that refinements to the presentation of its bi-weekly newspaper insert in addition to an enhanced selection of promotional items in the fourth quarter of fiscal 2000 were significant factors in the improvement of comparable store sales. The Company's net sales increased in fiscal 1999 by $4,215,000 or 4.7% due to increases in comparable store sales of $205,000 or 0.2% in addition to new store sales of $6,377,000 net of the impact of closed stores. Management believes that a planned inventory build up, initiated in the third fiscal quarter of 1999 and facilitated by the implementation of our new automated store ordering system, were the principal factors for an increase in comparable store sales of 3.0% in the second half of fiscal 1999 as compared to a decrease in comparable store sales of 1.9% in the first half of fiscal 1999. Gross profit improved by $2,628,000 and 0.7% as a percentage of net sales in fiscal 2000 as compared to fiscal 1999. The percentage increase was primarily due to favorable inventory shrinkage results and an improvement in the initial mark-up on seasonal import merchandise. Gross profit percentage decreased by 0.4% in 1999 as compared to 1998 primarily as a result of an increase in occupancy costs. Store expenses increased by $766,000 or 3.4%, and as a percentage of sales declined by 0.6% in fiscal 2000 as compared to 1999. The increase in fiscal 2000 store expenses was primarily due to an increase in payroll and payroll related expenses, an extra week of expenses to support the 53rd fiscal week of sales and an increase in credit card processing costs, resulting from an increase in credit card tenders. The increase in fiscal 2000 store expenses was partially offset by reduced advertising expenses. The decrease in store expenses as a percentage of net sales was principally due to the ability of the Company to leverage expenses against the increase in net sales. Store expenses increased by $1,497,000 or 7.1%, and as a percentage of net sales increased by 0.6%, in fiscal 1999 as compared to fiscal 1998 principally due to an increase in payroll and payroll related expenses that was primarily due to new store openings net of store closings. General and administrative expenses increased by $653,000 or 6.2% in fiscal 2000 as compared to fiscal 1999. The increase in general and administrative expenses in fiscal 2000 is primarily due to an extra fiscal week of operating expenses, an increase in payroll, due to higher bonuses earned by non-officers and an increase in the amortization of restricted stock awards, and increases in health insurance costs and professional fees. In fiscal 1999, general and administrative expenses increased by $499,000 or 5.0% as compared to fiscal 1998. The increase was primarily due to an increase in payroll and payroll related expenses. As a percentage of net sales, general and administrative expenses remained relatively constant in fiscal 2000, 1999 and 1998 as the Company was able to leverage these expenses against increases in net sales. Interest income, net increased in fiscal 2000 as compared to fiscal 1999 due to an increase in cash provided by operating activities and a decrease in cash used for the purchase of property and equipment. These factors enabled the Company to repay all borrowings under the Company's line of credit and remain free of bank debt commencing in January 2000. Interest expense, net, increased in fiscal 1999 as compared to fiscal 1998 as a result of higher borrowings on the Company's line of credit to finance the planned inventory build up. This increase was net of a decrease in interest on the Company's term loan which was paid in April 1999. See "Liquidity and Capital Resources." The effective tax rate for 2000 was 39.7% as compared to 39.9% in 1999. The decrease is primarily due to a lower effective state and local income tax rate. The effective tax rate for 1999 was 39.9% as compared to 39.0% in 1998. The increase is primarily due to a higher effective state and local income tax rate. Net income increased by $995,000 for fiscal 2000 as compared to fiscal 1999 due to the increase in net sales and gross profit and a change in accounting for merchandise inventories that was partially offset by an increase in operating expenses. Net income decreased by $540,000 for fiscal 1999 as compared to fiscal 1998 due to the increase in operating expenses, which was partially offset by the increase in sales and the related increase in gross profit. SEASONALITY The Company's business is seasonal, which the Company believes is typical of the retail craft and fabric industry. The Company's highest sales and earnings levels historically occur between September and December. This period includes the Back-to-School, Halloween and Christmas seasons. The Company has historically operated at a loss during its fourth quarter, the June through August summer period. See "Business - Seasonality." Year to year comparisons of quarterly results and comparable store sales can be affected by a variety of factors, including the timing and duration of holiday selling seasons and the timing of new store openings and promotional markdowns. LIQUIDITY AND CAPITAL RESOURCES The Company's primary needs for liquidity are to maintain inventory for the Company's existing stores and to fund the costs of opening new stores, including capital improvements, initial inventory and pre-opening expenses. In fiscal 2000 and fiscal 1999, the Company relied on short-term borrowings, internally generated funds and trade credit made available by suppliers to finance inventories and new store openings. At September 2, 2000, nearly all of the Companies financing was provided through internally generated funds and trade credit. The Company's working capital has increased $2,342,000 in fiscal 2000 as compared to fiscal 1999 primarily as a result of a reduction in owned inventory and the Company retaining its net income. The Company maintains a credit facility with a bank. The credit facility is renewable annually on or before each December 31 and consists of a discretionary unsecured line of credit for direct borrowings and the issuance and refinance of letters of credit. The line of credit was increased from $8,000,000 to $10,000,000 on August 31, 1999. Borrowings under the line of credit bear interest at the bank's prime rate (9.50% at September 2, 2000). The Company's term loan, initiated during the fiscal year ended August 31, 1996 to finance its new point-of-sale systems, was paid in April 1999. The credit facility requires the Company to maintain a compensating balance of $400,000 in addition to certain financial covenants which require a minimum defined working capital and tangible net worth, a maximum ratio of debt to tangible net worth and set limits on the payment of dividends. As of September 2, 2000, the Company was in compliance with such covenants. Historically, the amount borrowed has varied based on the Company's seasonal requirements, generally reaching a maximum amount outstanding during the fourth quarter of each fiscal year. The maximum amount borrowed under the line was $7,490,000, $7,010,000 and $2,785,000 in fiscal 2000, fiscal 1999 and fiscal 1998, respectively. As of September 2, 2000 and August 28, 1999, $0 and $6,570,000, respectively, was outstanding under the line of credit for direct borrowings. The Company intends to maintain the availability of the line of credit for working capital requirements and in order to be able to take advantage of future opportunities. The Company's point-of-sale and automated store ordering and receiving systems were completely installed in all stores as of July 1997 and March 1999, respectively, and are fully operational. The Company purchases merchandise directly from manufacturers in the Far East. These purchases are payable in United States dollars and are either by direct payment or supported by letters of credit. The results of operations of the Company have not been significantly affected by foreign currency fluctuation. At September 2, 2000, the Company had outstanding letters of credit in the amount of $102,413. During 2000, 1999 and 1998, the Company had net cash provided by (used in) operating activities of $7,537,000, $(2,707,000) and $2,443,000, respectively, and used $591,000, $1,579,000 and $835,000, respectively for purchases of property and equipment. Cash provided by operating activities increased in fiscal 2000 primarily as a result of a decrease in merchandise inventories, an increase in trade payables and the Company's ability to retain its net income for the period. In fiscal 2001, the Company expects to open five new stores and close three existing stores. Costs associated with opening of new stores, including capital expenditures, inventory and pre-opening expenses have historically approximated $350,000 per store. These costs will be financed primarily from cash provided by operating activities, credit made available by suppliers to finance inventories and, if necessary, from the Company's bank line of credit. However, the Company will re-deploy assets of stores being closed to the new stores as opportunities evolve in order to curtail the costs of opening stores. FORWARD-LOOKING STATEMENTS This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by safe harbors created hereby. Such forward-looking statements include those regarding the Company's future results in light of current management activities, and involve known and unknown risks, including competition within the craft retail industry, weather-related changes in the selling cycle, and other uncertainties (including those risk factors referenced in Company's filings with the Securities and Exchange Commission). RECENT ACCOUNTING STANDARDS In April 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Position No. 98-5 "Reporting on the Costs of Start-Up Activities" ("SOP"). This SOP requires the costs associated with start-up activities, such as opening a new store, be expensed as incurred. Effective August 29, 1999 the Company adopted this SOP. The adoption of this SOP did not have a material effect on the Company's results of operations. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 established accounting and reporting standards for derivative instruments and requires recognition of all derivatives as assets or liabilities in the statement of position and measurement of these instruments at fair value. SFAS No. 133 is effective for the Company in the year ending August 30, 2001. Management believes that adopting this statement will not have a material impact on the financial position, results of operations or cash flows of the Company. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the potential change in a financial instrument's value caused by fluctuations in interest or currency exchange rates, or in equity and commodity prices. The Company's activities expose it to certain risks that Management evaluates carefully to minimize earnings volatility. At September 2, 2000, the Company was not a party to any derivative arrangement and the Company does not engage in trading, market-making or other speculative activities in the derivatives markets. The Company's foreign currency exposure is not material and the Company does not engage in regular hedging activities to minimize the impact of foreign currency fluctuations. As discussed in Note 3 of the Notes to Consolidated Financial Statements, loans outstanding under the Company's unsecured line of credit bear interest at the bank's prime rate (9.50% at September 2, 2000). ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Item 14(a) 1 in Part IV. ITEM 9. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT. On April 18, 2000 the Company dismissed Deloitte & Touche, LLP ("Deloitte & Touche") as the Company's independent auditor. The decision to change independent auditors was unanimously recommended by the Audit Committee and unanimously approved by the Board of Directors of the Company. Deloitte & Touche's report on the Company's financial statements over the last two years were unqualified and there were no disagreements existing between the Company and Deloitte & Touche with respect to any matter of accounting principles, practices, financial statement disclosure or auditing scope or procedure. On April 18, 2000, in order to replace Deloitte & Touche the Company engaged Grant Thornton LLP ("Grant Thornton") as the Company's independent auditor and principal accountant to audit the Company's financial statements. The Company had not previously consulted Grant Thornton regarding either the application of accounting principles or any other reportable matter ITEM 9A. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not Applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required for this item is incorporated by reference to the Company's 2000 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to September 2, 2000. ITEM 11. EXECUTIVE COMPENSATION The information required for this item is incorporated by reference to the Company's 2000 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to September 2, 2000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required for this item is incorporated by reference to the Company's 2000 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to September 2, 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required for this item is incorporated by reference to the Company's 2000 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to September 2, 2000. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) FINANCIAL STATEMENTS PAGE --------------------- ---- Report of Independent Certified Public Accountants F-1 Independent Auditors Reports F-2 Consolidated Balance Sheets as of September 2, 2000 and August 28, 1999 F-3 Consolidated Statements of Income for the years ended September 2, 2000, August 28, 1999 and August 29, 1998 F-4 Consolidated Statements of Stockholders' Equity for the years ended September 2, 2000, August 28, 1999 and August 29, 1998 F-5 Consolidated Statements of Cash Flows for the years ended September 2, 2000, August 28, 1999 and August 29, 1998 F-6 Notes to Consolidated Financial Statements F-7 (b) EXHIBITS 3.1* Certificate of Incorporation of the Company 3.2* By-Laws of the Company 10.1* Promissory Note (Revolving) with Valley National Bank 10.2* 1991 Stock Option Plan 10.3* Lease between Momar Realty Co. and the Company, dated as of March 1, 1991 10.4** 1999 Incentive Stock Award Plan 10.5** Change in Registrants Certifying Accountant 21.1 List of subsidiaries of the Company F-16 23.1 Consent of Grant Thornton LLP 23.2 Consent of Deloitte & Touche LLP 24.1 Power of Attorney to sign Form 10-K (set forth on page 20) 27 Financial Data Schedule (Filed electronically with SEC only) (c) FINANCIAL STATEMENT SCHEDULES None (d) The Company did not file a Current Report on Form 8-K during the last quarter of the period covered by this Report. * Incorporated by reference to the Company's Registration Statement on Form S-1 and Amendment No. 1 thereto. ** Incorporated by reference to the Company's Registration Statement on Form S-8 filed on September 3, 1999. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Hawthorne, New Jersey, on December 1, 2000. RAG SHOPS, INC. By: /S/ STANLEY BERENZWEIG STANLEY BERENZWEIG, Chairman POWER OF ATTORNEY Each of the undersigned hereby appoints Stanley Berenzweig and Steven Barnett as his or her attorneys-in-fact to sign his or her name, in any and all capacities, to any amendments to this Form 10-K and any other documents filed in connection therewith to be filed with the Securities and Exchange Commission. Each of such attorneys has the power to act with or without the others. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the Registrant and in the capacities and on the dates indicated. SIGNATURE TITLE(S) DATE /S/ STEVEN BARNETT ---------------------- Steven Barnett Executive Vice President and December 1, 2000 Director /S/ EVAN BERENZWEIG Director December 1, 2000 ---------------------- Evan Berenzweig /S/ STANLEY BERENZWEIG Principal Executive December 1, 2000 ---------------------- Stanley Berenzweig Officer and Director /S/ FRED J. DAMIANO Director December 1, 2000 ---------------------- Fred J. Damiano /S/ JUDITH LOMBARDO Director December 1, 2000 ---------------------- Judith Lombardo /S/ ALAN C. MINTZ Director December 1, 2000 ---------------------- Alan C. Mintz /S/ STEPHEN PROVENZANO ---------------------- Stephen Provenzano Vice President and Chief December 1, 2000 Financial Officer F-17 RAG SHOPS, INC. INDEX TO EXHIBITS Exhibit Sequentially NUMBER DESCRIPTION OF EXHIBITS NUMBERED PAGES 3.1 Certificate of Incorporation of the Company * 3.2 By-Laws of the Company * 10.1 Promissory Note (Revolving) with Commercial Lending * Institution 10.2 1991 Stock Option Plan * 10.3 Lease between Momar Realty Co. and the Company, dated as of * March 1, 1991 10.4 1999 Incentive Stock Award Plan ** 10.5 Change in Registrants Certifying Accountant ** 21.1 List of subsidiaries of the Company F-16 23.1 Consent of Grant Thornton LLP 23.2 Consent of Deloitte & Touche 24.1 Power of Attorney to sign Form 10-K (set forth on page 20) 27 Financial Data Schedule (Filed electronically with SEC only) - -------------------------------- * Incorporated by reference to the Company's Registration Statement on Form S-1 and Amendment No. 1 thereto. ** Incorporated by reference to the Company's Registration Statement on Form S-8 filed on September 3, 1999. REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders Rag Shops, Inc. Hawthorne, New Jersey We have audited the accompanying consolidated balance sheets of Rag Shops, Inc. and its subsidiaries as of September 2, 2000 and the related consolidated statements of income, changes in stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Rag Shops, Inc. and subsidiaries as of September 2, 2000, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1, the Company changed its method of calculating inventory for the year ended September 2, 2000. Grant Thornton LLP Edison, New Jersey November 8, 2000 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders Rag Shops, Inc. Hawthorne, New Jersey We have audited the accompanying consolidated balance sheet of Rag Shops, Inc. and its subsidiaries as of August 28, 1999 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the two years in the period ended August 28, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Rag Shops, Inc. and subsidiaries as of August 28, 1999, and the results of their operations and their cash flows for each of the two years in the period ended August 28, 1999, in conformity with generally accepted accounting principles. Deloitte & Touche LLP Parsippany, New Jersey November 11, 1999 RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS September 2, August 28, ASSETS 2000 1999 - ------ ---- ---- CURRENT ASSETS: Cash $ 1,310,604 $ 934,073 Merchandise inventories 27,805,318 30,563,118 Prepaid expenses 483,314 536,754 Other current assets 98,938 224,759 Deferred income taxes 852,046 804,746 ------------ ----------- Total current assets 30,550,220 33,063,450 PROPERTY AND EQUIPMENT, NET 3,613,215 4,489,952 DEFERRED INCOME TAXES 349,802 210,012 OTHER ASSETS 66,707 105,600 ----------- ----------- TOTAL ASSETS $34,579,944 $37,869,014 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Note payable - bank $ 0 $ 6,570,000 Accounts payable - trade 7,762,720 5,928,568 Accrued expenses and other current liabilities 2,011,823 2,505,028 Accrued salaries and wages 893,123 604,769 Income taxes payable 242,362 156,912 ----------- ----------- Total current liabilities 10,910,028 15,765,277 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value 2,000,000 shares authorized; no shares issued or outstanding 0 0 Common stock, $.01 par value, 13,000,000 shares authorized; 4,828,463 shares and 4,837,763 shares issued at September 2, 2000 and August 28, 1999, respectively 48,285 48,378 Additional paid-in capital 6,242,293 6,267,827 Unamortized restricted stock awards (12,100) (207,488) Retained earnings 17,455,512 16,059,094 Treasury stock, at cost, 26,880 shares (64,074) (64,074) ------------ ------------ Total stockholders' equity 23,669,916 22,103,737 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $34,579,944 $37,869,014 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Fiscal Year Ended ----------------- September 2, August 28, August 29, 2000 1999 1998 ---- ---- ---- NET SALES $100,207,583 $94,780,965 $90,565,996 COST OF MERCHANDISE SOLD AND OCCUPANCY COSTS 63,665,075 60,866,108 57,793,619 ---------- ---------- ---------- Gross profit 36,542,508 33,914,857 32,772,377 ---------- ---------- ---------- OPERATING EXPENSES: Store expenses 23,463,230 22,697,097 21,199,678 General and administrative expenses 11,118,918 10,466,253 9,967,252 ---------- ---------- ---------- Total operating expenses 34,582,148 33,163,350 31,166,930 ---------- ---------- ---------- INCOME FROM OPERATIONS 1,960,360 751,507 1,605,447 INTEREST (INCOME) EXPENSE, Net (30,562) 83,184 61,430 ---------- ---------- ---------- INCOME BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFEECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,990,922 668,323 1,544,017 PROVISION FOR INCOME TAXES 793,000 266,700 602,500 ------------ ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,197,922 401,623 941,517 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF INCOME TAX EFFECT OF $127,000 198,496 0 0 ------------ ---------- --------- NET INCOME $ 1,396,418 $ 401,623 $ 941,517 ============ ========== ========= BASIC AND DILUTED EARNINGS PER COMMON SHARE: INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $.25 $.08 $.20 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $.04 $.00 $.00 ------------ ---------- --------- NET INCOME $.29 $.08 $.20 ============ ========== =========
The accompanying notes are an integral part of these consolidated financial statements. RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR YEARS ENDED AUGUST 29, 1998, AUGUST 28, 1999 AND SEPTEMEBER 2, 2000 Additional Unamortized Common Stock Paid-In Restricted Retained Treasury Shares Dollars Capital Stock Awards Earnings Stock Total ---------- -------- ---------- ------------ --------- --------- --------- BALANCE, AUGUST 30, 1997 4,514,400 $45,144 $6,039,162 $0 $14,715,954 $0 $20,800,260 Net income 0 0 0 0 941,517 0 941,517 ---------- -------- ---------- ------------ ----------- --------- ---------- BALANCE, AUGUST 29, 1998 4,514,400 45,144 6,039,162 0 15,657,471 0 21,741,777 Acquisition of treasury stock 0 0 0 0 0 (64,074) (64,074) Issuance of restricted stock 97,700 977 231,061 (232,038) 0 0 0 awards Stock dividend 225,663 2,257 (2,396) 0 0 0 (139) Amortization of restricted 0 0 0 24,550 0 0 24,550 stock awards Net income 0 0 0 0 401,623 0 401,623 ---------- -------- ---------- ------------ ----------- -------- ---------- BALANCE, AUGUST 28, 1999 4,837,763 48,378 6,267,827 (207,488) 16,059,094 (64,074) 22,103,737 Issuance of restricted stock 9,000 90 17,352 (17,442) 0 0 0 awards Amortization of restricted 0 0 0 169,761 0 0 169,761 stock awards Forfeiture of restricted (18,300) (183) (42,886) 43,069 0 0 0 stock awards Net income 0 0 0 0 1,396,418 0 1,396,418 ---------- -------- ---------- ------------ ----------- -------- ---------- BALANCE, SEPTEMBER 2, 2000 4,828,463 $48,285 $6,242,293 $(12,100) $17,455,512 $(64,074) $23,669,916 ========== ======== =========== ============ ============ ========= ===========
The accompanying notes are an integral part of these consolidated financial statements. RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Fiscal Year Ended ----------------- September 2, August 28, August 29, 2000 1999 1998 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $1,396,418 $401,623 $ 941,517 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 1,414,572 1,371,111 1,366,589 Deferred income taxes (187,090) (98,400) (73,200) Loss on disposition of property and equipment 52,399 44,084 24,764 Amortization of restricted stock awards 169,761 24,550 0 Cumulative effect of change in accounting principle (325,000) 0 0 Changes in assets and liabilities: (Increase) decrease in: Merchandise inventories 3,082,800 (4,104,490) (1,335,591) Prepaid expenses 53,440 (5,219) (232,712) Other current assets 125,821 (147,284) 164,822 Other assets 38,893 5,078 (45,924) Increase (decrease) in: Accounts payable - trade 1,834,152 (626,931) 1,474,953 Accrued expenses (493,205) 528,754 108,129 Accrued salaries and wages 288,354 (13,343) (193,916) Income taxes payable 85,450 (86,909) 243,821 --------- ----------- ---------- Net cash provided by (used in) operating activities 7,536,765 (2,707,376) 2,443,252 --------- ----------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of property and equipment 400 1,300 3,350 Payments for purchases of property and equipment (590,634) (1,578,888) (834,671) --------- ----------- --------- Net cash (used in) investing activities (590,234) (1,577,588) (831,321) --------- ----------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of note payable - bank 5,805,000 20,160,000 12,810,000 Repayments of note payable - bank (12,375,000) (15,225,000) (13,610,000) Repayments of long-term debt 0 (547,873) (679,476) Acquisition of treasury stock 0 (64,074) 0 Payment in lieu of stock dividend for fractional shares 0 (139) 0 ------------ ----------- ---------- Net cash provided by (used in) financing activities (6,570,000) 4,322,914 (1,479,476) ------------ ----------- ---------- NET INCREASE IN CASH 376,531 37,950 132,455 CASH, BEGINNING OF YEAR 934,073 896,123 763,668 ------------ ----------- ----------- CASH, END OF YEAR $ 1,310,604 $ 934,073 $ 896,123 ============ =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 198,269 $ 49,628 $ 120,725 ============ =========== =========== Income taxes $ 1,002,981 $ 373,992 $ 464,206 ============ =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. RAG SHOPS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 2, 2000, AUGUST 28, 1999 AND AUGUST 29, 1998 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND NATURE OF BUSINESS Rag Shops, Inc. (the "Company"), a Delaware corporation formed in April 1991, is the successor by merger to a New Jersey Corporation having the same name which was incorporated in 1984. The Company operates a chain of retail craft and fabric stores through its subsidiaries are located in New Jersey, New York, Pennsylvania, Florida and Connecticut. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany transactions and balances have been eliminated. USE OF ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the Company's financial statements and accompanying notes to financial statements. Actual results could differ from those estimates. FISCAL YEAR The Company's fiscal year end is the Saturday closest to August 31. The financial statements for fiscal year ended September 2, 2000 ("2000") were comprised of 53 weeks. Fiscal years ended August 29, 1998 ("1998") and August 28, 1999 ("1999") were each comprised of 52 weeks. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentations. ADVERTISING EXPENSES Advertising costs are expensed as incurred. MERCHANDISE INVENTORIES Merchandise inventories (which are all finished goods) are stated at the lower of cost (first-in, first-out method) or market as determined by the retail inventory method. Effective August 29, 1999, the Company changed its method of calculating ending merchandise inventories under the retail inventory method. Prior to August 29, 1999, the Company utilized an average cost-to-retail ratio to value ending inventory. Effective August 30, 1999, the Company began utilizing a method that weights the cost-to-retail ratio using multiple inventory categories. Management believes that this change in accounting improves the measurement of the Company's profitability based upon a changing product mix. The cumulative effect of this accounting change has increased the Company's net income for fiscal 2000 by $198,496 (net of tax effect $127,000). PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the assets using straight-line and accelerated methods. Leasehold improvements are amortized by the straight-line method over an estimated useful life or the term of the related lease, whichever is shorter. For tax purposes, depreciation is computed using accelerated methods. The Company follows Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS No. 121"). This Statement established accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be held and used by an entity to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. REVENUE RECOGNITION Revenue is recognized when merchandise is sold to customers. FAIR VALUE OF FINANCIAL INSTRUMENTS Management of the Company believes that the fair value of its line of credit approximates its cost as of August 28, 1999. In management's opinion, the fair value of its amounts outstanding under its line of credit approximate fair value due to their variable rate. PRE-OPENING AND CLOSING STORE EXPENSES In April 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Position No. 98-5 "Reporting on the Costs of Start-Up Activities" ("SOP"). This SOP requires the costs associated with start-up activities, such as opening a new store, be expensed as incurred. Effective August 29, 1999 the Company adopted this SOP. The adoption of this SOP did not have a material effect on the Company's results of operations. All pre-opening costs incurred in connection with the opening of new retail stores are charged to expense when incurred. Costs associated with closing stores, which consists primarily of write-downs of leasehold improvements, are charged to expense at the time the decision to close a store is determined. STOCK BASED COMPENSATION The Company has adopted statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS No. 13"). As permitted under SFAS No. 123, the Company has elected to follow Accounting Principles Board opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees", and related interpretations in accounting for its employee stock options. Under APB No. 25, when the exercise price of the employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recorded. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 established accounting and reporting standards for derivative instruments and requires recognition of all derivatives as assets or liabilities in the statement of position and measurement of these instruments at fair value. SFAS No. 133 is effective for the Company in the year ending August 30, 2001. Management believes that adopting this statement will not have a material impact on the financial position, results of operations or cash flows of the Company. NOTE 2. PROPERTY AND EQUIPMENT Property and equipment consists of the following: Useful September 2, August 28, Lives 2000 1999 ----- ---- ---- Furniture and fixtures 5-10 years $8,005,659 $8,118,597 Leasehold improvements 10 years 3,254,975 2,951,908 Transportation equipment 3-7 years 530,258 525,584 Data processing equipment 5 years 3,902,223 3,884,797 ---------- ---------- 15,693,115 15,480,886 Less accumulated depreciation and amortization 12,079,900 10,990,934 ---------- ---------- $ 3,613,215 $ 4,489,952 ========== ==========
NOTE 3. NOTE PAYABLE - BANK The Company maintains a credit facility with a bank. The credit facility is renewable annually on or before each December 31 and currently consists of a discretionary unsecured line of credit for direct borrowings and the issuance and refinance of letters of credit. The line of credit was increased from $8,000,000 to $10,000,000 on August 31, 1999. The borrowings outstanding under the line of credit as of September 2, 2000 and August 28, 1999 were $0 and $6,570,000, respectively, and the unused line of credit for direct borrowings and the issuance of letters of credit at September 2, 2000 was $9,897,587. The facility requires the Company to maintain a compensating balance of $400,000 in addition to certain financial covenants which require a minimum defined working capital and tangible net worth, a maximum ratio of debt to tangible net worth and set limits on the payment of dividends. As of September 2, 2000, the Company was in compliance with such covenants. Borrowings under the line of credit bear interest payable quarterly at the bank's prime rate (9.50% and 8.25% at September 2, 2000 and August 28,1999, respectively). NOTE 4. LONG-TERM DEBT During the fiscal year ended August 31, 1996, the Company borrowed $2,000,000 ("term loan") under the terms of its credit facility with a bank to finance its new point-of-sale cash register software, data collection and computer systems. Interest on the term loan was payable monthly at a fixed interest rate of 7.5% effective March 1, 1998, formerly at 8%. The term loan was paid in April 1999. NOTE 5. COMMITMENTS AND CONTINGENCIES Leases The Company leases its facilities in accordance with operating leases, having initial terms of more than one year, which expire in various years through 2012. Substantially all of the leases contain renewal options. In addition, certain leases require that the Company pay its pro rata share of utilities, taxes, insurance and maintenance. Rent expense for 2000, 1999 and 1998 amounted to $7,362,792, $7,382,116, and $6,633,633, respectively, and includes contingent rentals (computed on a percentage of sales, as defined in the leases) of $29,079, $22,499 and $17,287 respectively. The Company leases certain premises from an entity controlled by the majority stockholders of the Company. For the years 2000, 1999 and 1998, rental payments under this agreement amounted to $338,265, $288,766, and $209,313, respectively. Future minimum annual rental commitments under non-cancelable operating leases are as follows: Fiscal Year Ended 2001 $7,154,918 2002 6,241,468 2003 4,994,188 2004 3,753,631 2005 3,203,963 Thereafter 7,325,790 --------- $32,673,958 Letters of Credit In addition, at September 2, 2000 the Company has outstanding letters of credit for the purchase of merchandise inventories of approximately $102,413. Legal Matters The Company is involved in various legal proceedings incidental to the conduct of its business. The Company currently is not engaged in any legal proceedings that is expected to have a material adverse effect on the Company's results of operations or financial position. NOTE 6. EARNINGS PER SHARE Basic and diluted earnings per share are calculated in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128"). In accordance with SFAS No. 128, basic net income per share has been computed based on the weighted average of common shares outstanding. Diluted net income per share gives the effect of outstanding stock options. All of the net income reported in the financial statements is available to common stockholders. Prior year net income per share data has been adjusted to reflect the adoption of SFAS No. 128. Fiscal Year Ended 2000 1999 1998 ---- ---- ---- Numerator for basic and diluted earnings per share: Income before cumulative effect of change in accounting principle $ 1,197,922 $401,623 $941,517 Cumulative effect of change in accounting principle, net of income taxes 198,496 0 0 ------------ ----------- ---------- Net income $ 1,396,418 $ 401,623 $ 941,517 ============ =========== ========== Denominator: Denominator for basic earnings per share-weighted average shares 4,813,476 4,744,408 4,740,063 Effect of dilutive securities: Employee stock options 395 10,588 48,133 ------------ ------------ ---------- Denominator for diluted earnings per share-adjusted weighted average shares and assumed conversions 4,813,871 4,754,996 4,788,196 ============ =========== ========== Basic and diluted earnings per share: Income before cumulative effect of change in accounting principle $ .25 $ .08 $ .20 Cumulative effect of change in accounting principle .04 .00 .00 ----------- ----------- ---------- Net income $ .29 $ .08 $ .20 =========== =========== ==========
On June 28, 1999, the Company declared a 5% stock dividend on the Company's common stock which was paid on August 10, 1999 to stockholders of record on July 14, 1999. Shares and per share data presented for all periods has been adjusted to give retroactive effect to the dividend. NOTE 7. STOCKHOLDERS' EQUITY Each share of common stock is entitled to one vote. In April 1991, the Company adopted the 1991 Stock Option Plan (the "Plan") covering employees and non-employee directors. The Plan permits options to purchase a total of 450,000 shares of common stock, of which 435,600 shares have been reserved by the Company as of September 2, 2000. Such options may be incentive stock options ("ISO") or nonqualified options. The term of an option will not exceed ten years and an option is exercisable as determined by the Option Committee of the Board of Directors. The exercise price of the shares covered by an ISO may not be less than the fair market value of the shares at the time of grant. The exercise price of the shares covered by a nonqualified option is determined by the Option Committee. The options granted are generally exercisable 40% after two years and 20% per year thereafter. Effective August 31, 1996, the Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation ("SFAS No. 123") ". Accordingly, no compensation cost has been recognized for the stock options awarded since they were granted at the fair market value on the date of grant. Had compensation cost for the Company's stock option plan been recorded based on the fair value at the grant date for awards in 2000, 1998 and 1997, consistent with the provisions of SFAS No. 123, the Company's net income and income per share would have been reduced to the pro forma amounts indicated below: Fiscal Year Ended 2000 1999 1998 ---- ---- ---- Net income-as reported $1,396,418 $401,623 $941,517 Net income-pro forma $1,388,349 $395,292 $935,066 Net income per share-as reported, basic and diluted $ .29 $ .08 $ .20 Net income per share proforma, basic and diluted $ .29 $ .08 $ .20
There were no options granted during fiscal 1999. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in fiscal 2000, fiscal 1999 and fiscal 1998: dividends yield of 0%, expected volatility of 30% (50% for 1999 and 1998), risk-free interest rate of 5.0%, 5.0% and 4.5%, respectively and expected lives of 10, 7.5 and 7.5 years, respectively. Information with respect to options granted under the Plan is as follows: Number of Exercise Price Weighted-Average Shares Per Share Exercise Price Outstanding, August 30, 1997 306,050 $2.02-$11.76 $3.88 Granted 2,000 $3.21 $3.21 Canceled (8,000) $2.02-$5.94 $3.49 ------- Outstanding, August 29, 1998 300,050 $2.02-$11.76 $3.89 Canceled (19,750) $2.22-$11.76 $6.51 ------- Outstanding, August 28, 1999 280,300 $2.02-$11.76 $3.70 Granted 56,500 $1.86-$2.325 $2.27 Canceled (4,500) $2.125-$3.00 $2.42 ------- Outstanding, September 2, 2000 332,300 $1.86-$11.76 $3.51 ======= Exercisable, August 29, 1998 156,050 $2.02-$11.76 $5.38 Exercisable, August 28,1999 197,700 $2.02-$11.76 $4.30 Exercisable, September 2, 2000 229,400 $2.02-$11.76 $4.02
The weighted-average remaining contractual life of stock options outstanding at September 2, 2000 is 4.9 years. The majority of options have an exercise price from $1.86 to $3.21. Effective July 20, 1999, the Company adopted the 1999 Incentive Stock Award Plan (the "Incentive Plan"). The Incentive Plan provides for the award of up to 300,000 shares of the Company's common stock (the "shares") to key employees (including non- executive officers), independent contractors or consultants as determined by the Option Committee of the Board of Directors. The Incentive Plan participants are entitled to dividends and to vote their respective shares, however, the sale or transfer of the shares is restricted during a vesting period. As of September 2, 2000, 107,900 shares have been issued under the Incentive Plan. On July 31, 2000, 80,300 of the outstanding shares vested. As of September 2, 2000, 19,500 shares had been forfeited by individuals who were no longer employed by the Company prior to the end of their required vesting period. As of September 2, 2000, 8,100 of these shares remain to meet the vesting requirement. The Company estimated the value of the stock issued based on the market price on the date of grant. Unamortized restricted stock awards was charged for the market value of the restricted shares at the date of grant. The unamortized restricted stock awards is shown as a reduction of stockholders' equity in the accompanying consolidated balance sheet and is being amortized ratably over the vesting period. In fiscal 2000 and fiscal 1999, $169,761 and $24,550 respectively were charged to expense relating to the Incentive Plan. On May 21, 1999 the Company's Board of Directors approved a discretionary program whereby the Company is authorized to purchase up to 200,000 shares of its outstanding common stock. As of September 2, 2000 and August 28, 1999, 26,880 shares are held in treasury. NOTE 8. INCOME TAXES The components of income tax expense relating to income consists of the following: Fiscal Year Ended September 2, August 28, August 29, 2000 1999 1998 ---- ---- ---- Federal: Current $ 920,090 $ 379,900 $ 570,200 Deferred (187,090) (173,100) (73,200) State: Current 187,000 (14,800) 105,500 Deferred 0 74,700 0 ---------- --------- -------- $ 920,000 $ 266,700 $ 602,500 ========= ========= =========
The deferred income tax arises from the following temporary differences: Fiscal Year Ended September 2, August 28, August 29, 2000 1999 1998 ---- ---- ---- Uniform inventory capitalization $ (10,400) $ 89,100 $ 10,200 Depreciation 108,290 59,600 59,600 Straight-line of leases 31,500 16,100 3,400 Amortization of incentive stock awards 57,700 8,300 0 Increase in valuation allowance 0 (74,700) 0 --------- --------- --------- $ 187,090 $ 98,400 $ 73,200 ========= ======== ========
The effective tax rate differs from the Federal statutory rate as follows: Fiscal Year Ended September 2, August 28, August 29, 2000 1999 1998 ---- ---- ---- Statutory tax rate 34.0% 34.0% 34.0% State and local income taxes, net of federal income tax benefit 5.3 5.9 4.5 Other 0.4 0.0 0.5 ----- ----- ----- Effective tax rate 39.7% 39.9% 39.0% ===== ===== =====
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company's state deferred tax asset has been reduced by a valuation allowance based on current evidence indicating that it is not more likely than not that the future benefits of these temporary differences will be realized. The Company has approximately $6,489,000 of net operating losses in multiple states which expire on various dates from 2007 to 2020. The tax effect of significant items comprising the Company's deferred income tax assets are as follows: Fiscal Year Ended 2000 1999 ---- ---- Current deferred income tax asset: Uniform inventory capitalization $ 786,046 $ 796,446 Amortization of restricted stock awards 66,000 8,300 --------- --------- 852,046 804,746 --------- --------- Non-current deferred income tax assets: Straight-line of leases 162,673 131,173 Difference between book and tax depreciation methods 187,129 78,839 Net operating losses for State purposes 484,539 487,584 Valuation allowance (484,539) (487,584) --------- --------- 349,802 210,012 --------- --------- Total deferred income tax asset $1,201,848 $1,014,758 ========= =========
NOTE 9. EMPLOYEE BENEFIT PLAN Effective January 1, 1996, the Company adopted a voluntary 401(k) savings plan. All non-union employees of the Company are eligible to participate on or after reaching age 21 and completing one year of eligibility service. The Company did not make any discretionary contributions to the 401(k) plan for fiscal years 2000, 1999 and 1998. NOTE 10. QUARTERLY RESULTS (UNAUDITED) The following is a summary of selected quarterly financial data (in thousands of dollars, except per share amounts): Fiscal Quarter Ended Nov. 27, Feb. 26, May 27, Sept. 2, Fiscal 2000 1999 2000 2000 2000 (a) ----------- ---- ---- ---- -------- Net sales $28,186 $26,492 $22,730 $22,799 Gross profit 10,719 9,578 8,053 8,193 Income before cumulative effect of change in accounting principle 980 518 250 (550) Cumulative effect of change in accounting principle 198 - - - Net income (loss) 1,178 518 250 (550) Basic and diluted income (loss) per common share: Income (loss) before cumulative effect of change in accounting principle .20 .11 .05 (.11) Cumulative effect of change in accounting principle .04 - - - Net income (loss) per common share .24 .11 .05 (.11)
Fiscal Quarter Ended Nov. 28, Feb. 27, May 28, Aug. 29, Fiscal 1999 1998 1999 1999 1999 ----------- ---- ---- ---- ---- Net sales $26,695 $25,061 $22,430 $20,595 Gross profit 10,017 9,152 7,569 7,176 Net income (loss) 1,009 254 (78) (783) Earnings (loss) per common share (b): Basic & Diluted .21 .05 (.02) (.16)
The sum of the four quarters may not equal the full year computation due to rounding. (a) Included in the net loss of the fiscal quarter ended September 2, 2000 were credits of approximately $120,000 or $0.02 per share as a result of an extra fiscal week of sales and $130,000 or $0.03 per share based on the Company's favorable shrinkage results. (b) Earnings (loss) per common share calculations for each quarter are restated to reflect accounting changes required under Statement of Accounting Standards No.128, Earnings per Share and the 5% stock dividend declared June 28, 1999. See Note 6. EXHIBIT 21.1 RAG SHOPS, INC. LIST OF SUBSIDIARY COMPANIES Name State Incorporated RSL, Inc. Delaware Mobile Fabrics, Inc. New Jersey The Rag Shop/Glen Burnie, Inc. Maryland The Rag Shop, Inc. New York Rag Shop/Wayne, Inc. New Jersey Rag Shop/Parsippany, Inc. New Jersey Rag Shop/Edison, Inc. New Jersey The Rag Shop/West Orange, Inc. New Jersey The Rag Shop/Middletown, Inc. New Jersey The Rag Shop/Toms River, Inc. New Jersey The Rag Shop/Hamilton Square, Inc. New Jersey The Rag Shop/Hazlet, Inc. New Jersey The Rag Shop/Howell, Inc. New Jersey The Rag Shop/Ocean, Inc. New Jersey The Rag Shop/Sayreville, Inc. New Jersey The Rag Shop/Bricktown, Inc. New Jersey The Rag Shop/Totowa, Inc. New Jersey The Rag Shop/North Lauderdale, Inc. Florida The Rag Shop/West Palm Beach, Inc. Florida The Rag Shop/Palm Beach Gardens, Inc. Florida The Rag Shop/Lancaster, Inc. Pennsylvania The Rag Shop/Sunrise, Inc. Florida The Rag Shop/Lantana, Inc. Florida The Rag Shop/York, Inc. Pennsylvania The Rag Shop/Selinsgrove, Inc. Pennsylvania The Rag Shop/Pembroke Pines, Inc. Florida The Rag Shop/Jacksonville, Inc. Florida The Rag Shop/Olean, Inc. New York The Rag Shop/Boca Raton, Inc. Florida The Rag Shop/Port Richey, Inc. Florida The Rag Shop/Deptford, Inc. New Jersey The Rag Shop/Deerfield, Inc. Florida The Rag Shop/Jacksonville-San Jose, Inc. Florida The Rag Shop/Rostraver, Inc. Pennsylvania The Rag Shop/Evesham, Inc. New Jersey The Rag Shop/Allentown, Inc. Pennsylvania The Rag Shop/Jensen Beach, Inc. Florida The Rag Shop/Jacksonville-Orange Park, Inc. Florida The Rag Shop/Jacksonville-Regional, Inc. Florida The Rag Shop/Boro Park, Inc. New York The Rag Shop/Secaucus, Inc. New Jersey The Rag Shop/North Bergen, Inc. New Jersey The Rag Shop/Coral Springs, Inc. Florida The Rag Shop/Turnersville, Inc. New Jersey The Rag Shop/Hialeah, Inc. Florida (continued) RAG SHOPS, INC. LIST OF SUBSIDIARY COMPANIES NAME STATE INCORPORATED Name State Incorporated The Rag Shop/Hollywood, Inc. Florida The Rag Shop/Binghamton, Inc. New York The Rag Shop/Lacey, Inc. New Jersey The Rag Shop/West Boca Raton, Inc. Florida The Rag Shop/Ocala, Inc. Florida The Rag Shop/Fishkill, Inc. New York The Rag Shop/Hampden, Inc. Pennsylvania The Rag Shop/East Norriton, Inc. Pennsylvania The Rag Shop/Wall Township, Inc. New Jersey The Rag Shop/Northern Lights, Inc. New York The Rag Shop/Linden, Inc. New Jersey The Rag Shop/Burlington, Inc. New Jersey The Rag Shop/Kingstown, Inc. Rhode Island The Rag Shop/Norwalk, Inc. Connecticut The Rag Shop/East Hollywood, Inc. Florida The Rag Shop/Edgewater, Inc. New Jersey The Rag Shop/Danbury, Inc. Connecticut The Rag Shop/Voorhees, Inc. New Jersey The Rag Shop/College Point New York Each of the above does business under the name "The Rag Shop." EXHIBIT 23.1 RAG SHOPS, INC. CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated November 8, 2000 accompanying the consolidated financial statements of Rag Shops, Inc. and subsidiaries appearing in the Annual Report on Form 10-k for the year ended September 2, 2000. We hereby consent to the incorporation by reference of said report in the Registration Statement of Rag Shops, Inc. and subsidiaries on Form S-8 (File No. 333-86489, effective September 3, 1999). Grant Thornton LLP Edison, New Jersey November 30, 2000 EXHIBIT 23.2 RAG SHOPS, INC. INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the Registration Statement number 333-86489 of Rag Shops, Inc. on Form S-8 of our report dated November 11, 1999, appearing in this Annual Report on Form 10-K of Rag Shops, Inc. for the year ended September 2, 2000. Deloitte & Touche LLP Parsippany, New Jersey November 29, 2000 EX-27 2 0002.txt FDS 10K
5 12-MOS SEP-2-2000 AUG-29-1999 SEP-2-2000 1,310,604 0 0 0 27,805,318 30,550,220 15,693,114 12,079,899 34,579,944 10,910,028 0 0 0 48,285 23,621,631 34,579,944 100,207,583 100,207,583 63,665,075 98,247,223 0 0 (30,562) 1,990,922 793,000 1,197,922 0 0 198,496 1,396,418 .29 .29
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