-----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, QWhZF3r5kmAAPLqYesSbq4mYgEjOaNS8MX7vnaZj3NvYkcBMexo99jGdS6t3B8zW gWbKtrN4zLQBFi043L+w5w== 0000874385-04-000015.txt : 20040128 0000874385-04-000015.hdr.sgml : 20040128 20040127184444 ACCESSION NUMBER: 0000874385-04-000015 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020831 FILED AS OF DATE: 20040128 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/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-19194 FILM NUMBER: 04547486 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/A 1 a10k8-02ae.txt AMENDED FORM10K8-02A UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K/A (Amendment No.1) FOR ANNUAL AND TRANSITION REPORT PURSUANT TO SECTIONS 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURTIES EXCHANGE ACT OF 1934 For the fiscal year ended August 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURTIES 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 files by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), 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/A or any amendment to this Form 10-K/A. X --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange act Rule 12b-2). Yes No X ------- ------ As of October 31, 2002, there were outstanding 4,797,983 shares of Common Stock. Based on the price at which stock was sold on that date, the approximate aggregate market value of such shares held by non-affiliates was $10,000,515. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's 2002 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). EXPLANATORY NOTE - AMENDMENT This Form 10-K/A is being filed to amend and restate Rag Shops, Inc.'s audited consolidated financial statements for the fiscal year ended August 31, 2002. In December 2003, the Company received a check from Principal Financial Group, Inc. ("Principal") reflecting dividends payable in connection with common stock of Principal. Receipt of the dividend check prompted a Company inquiry which revealed that, due to its ownership of certain life insurance policies issued by Principal Life Insurance Company, a subsidiary of Principal, and maintained by the Company for certain key executive officers, the Company had received 9,766 shares of Principal's common stock (the "Shares") in December 2001 as consideration in the demutualization of Principal's predecessor. The effective date of the demutualization was in October 2001 and the Shares were issued in December 2001 to one of the Company's subsidiaries, the owner of the life insurance policies, in book-entry form as uncertificated shares and maintained in an account with Mellon Investor Services established by Principal in connection with its demutualization transaction. The Company had not previously recognized or recorded the Shares issued pursuant to such event. The Company has determined it will restate prior financial statements to properly reflect the transaction in the first quarter of fiscal 2002. In its restated financial statements, the Company has recorded the then fair market value ($180,671) of the Shares as part of operating income as of October 2001, in accordance with Emerging Issues Task Force Issue No. 99-4, "Accounting for Stock Received from the Demutualization of a Mutual Insurance Company". The Company has classified its holding in the Shares as "available-for-sale" pursuant to Statement of Financial Accounting Standards No. 115 "Accounting for Investments", whereby the investment will be carried at fair market value and subsequent changes in the market value of the investment will be reflected as an unrealized gain or loss in the stockholders' equity section of the balance sheets, net of deferred income taxes. Other Comprehensive Income will be presented for all periods pursuant to Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" either in the Consolidated Statements of Changes in Stockholders' Equity or Notes to Consolidated Financial Statements. Comprehensive income consists of net income or loss for the current period as well as income, expenses, gains or losses, net of income taxes arising during the period that are included in separate components of equity. It includes the unrealized gains and losses on the Company's available-for-sale security, net of taxes. The fair market value of the Shares as of the close of business on August 31, 2002 was $286,437. Please refer to amendments to periodic reports filed with the Securities and Exchange Commission for periods between December 1, 2001 and November 29, 2003 for related restatements. Refer to Note 1 - Recent Developments in the Notes to Condensed Consolidated Financial Statements. For purposes of this Form 10-K/A, and in accordance with Rule 12b-15 under the Securities and Exchange Act of 1934, as amended, each item of the Form 10-K for the fiscal year ended August 31, 2002, as originally filed on November 29, 2002, that was affected has been amended to the extent affected by the referenced correction and restated in its entirety. All other financial information and disclosures remain unchanged. 2 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 August 31, 2002 Rag Shops, Inc. operated 68 specialty retail stores that sell competitively priced craft and fabric merchandise. The Company caters to value conscious consumers who create decorative projects and 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 results. The Company's stores are destination-oriented and also attract shoppers from other stores located in the same shopping centers. As of August 31, 2002, the Company operated 36 retail stores in New Jersey, 18 in Florida, six in New York, five in Pennsylvania and three in Connecticut. The Company anticipates opening three stores and closing three stores during its fiscal year ending August 30, 2003. 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 1998.
FISCAL YEARS 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Stores open at beginning of period 66 65 69 66 66 Stores opened during period 4 5 0 5 2 Stores closed during period 2 4 4 2 2 Stores open at end of period 68 66 65 69 66 Retail square footage at end of period 764,600 707,800 663,300 695,400 642,000
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, scrapbooking, art, craft supplies and children's creative related products. Fabric items available at the Company's stores include apparel, quilting and home decorative fabrics, as well as trimmings, patterns and sewing notions. As of August 31, 2002, 63 stores offer custom picture framing. The Company also sells a wide variety of seasonal merchandise with special emphasis on the Spring, 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, dolls and specialized scrapbooks. 3 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 the Company's display staff, as well as store staff, 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 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. The Company primarily utilizes freestanding newspaper inserts and, secondarily, newspaper print advertisements. These newspaper inserts are also displayed at the front of each store and describe a calendar of promotions emphasizing special sales items, seasonal products and other currently popular merchandise. Approximately three million people regularly receive the freestanding newspaper inserts. For the Spring and Back-to-School seasons, and the 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. Historically the Company has 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 and stock levels at individual stores (aided by access to the Company's databases). 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. Orders for merchandise are entered into a scanning gun, downloaded 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. 4 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 55% 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 and debit cards. 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 and customer attraction to 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 China, Hong Kong, Korea, the Philippines and Taiwan. 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 August 31, 2002, the Company has approximately 1,475 employees, consisting of approximately 375 full time and 1,100 part time employees. Full time personnel consist of approximately 260 salaried and 115 hourly employees. All part time personnel are hourly employees. During seasonal peak periods, the Company hires temporary personnel. Approximately 53 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 2005. The Company considers its relationships with its employees to be good. TRADEMARKS The Company's trademark "THE RAG SHOP" was registered with the United States Patent and Trademark Office on September 9, 1969 for fabrics, wearing apparel and home furnishings; and has been renewed through September 9, 2009. Variations of this mark have been registered by the Company to stand for its retail services and for numerous goods sold by the Company at its retail outlets. These marks are all renewable indefinitely so long as the marks are used by the Company. 5 ITEM 2. PROPERTIES The Company's executive 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 2004. The Company leases approximately 50,000 square feet of additional warehouse space on a month-to-month basis to accommodate seasonal merchandise and expedite distribution of merchandise to stores. Such additional space was leased for the full twelve months of the year 2002 and is expected to be leased or replaced with other warehouse space of comparable or greater size for the full twelve months of 2003. The Company's stores, all of which are located in leased facilities, range in size from approximately 7,000 square feet to 20,000 square feet. The average size of the Company's stores is approximately 11,200 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 calendar year indicated. LEASE EXPIRATIONS YEAR NUMBER YEAR NUMBER ---- ------ ---- ------ 2003 2 2017 9 2004 2 2018 6 2005 2 2019 8 2006 1 2020 4 2008 3 2021 2 2011 3 2022 2 2012 2 2023 2 2013 4 2024 2 2014 1 2026 5 2016 4 2027 3 2031 1 Sixty-five 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 proceeding that is expected to have a material adverse effect on the Company's results of operations or financial position. 6 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 August 31, 2002. 7 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 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 AUGUST 31, 2002 First Quarter $ 2.400 $ 2.100 Second Quarter 4.400 2.100 Third Quarter 6.050 3.000 Fourth Quarter 6.630 3.350 FISCAL YEAR ENDED SEPTEMBER 1, 2001 First Quarter $ 2.750 $ 1.938 Second Quarter 3.000 2.000 Third Quarter 2.750 2.080 Fourth Quarter 2.800 2.050 On October 31, 2002, the closing price of the Common Stock was $4.320. The approximate number of stockholders of record of the Common Stock at October 31, 2002 was 316. 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 August 31, 2002 was $24,168,609. 8 ITEM 6. SELECTED FINANCIAL DATA The following table presents selected financial data derived from the audited consolidated financial statements of the Company for each of the five years in the period ended August 31, 2002. The selected financial data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto contained elsewhere in this report.
FISCAL YEAR ENDED (1) August 31, August 31, September 1, September 2, August 28, August 29, 2002 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- ---- (Restated) (Previously Reported) (In thousands, except common stock data and statistics) OPERATIONS Net sales $110,672 $110,672 $100,888 $100,208 $ 94,781 $ 90,566 Gross profit 39,297 39,297 35,756 36,543 33,915 32,722 Store expenses and general and administrative expenses 38,809 38,809 35,740 34,582 33,163 31,167 Gain from demutualization 181 0 0 0 0 0 Interest income (expense), net 38 38 128 31 (83) (61) Income before income taxes and cumulative effect of change in accounting principle 706 526 143 1,991 668 1,544 Income before cumulative effect of change in accounting principle 389 290 46 1,198 402 942 Cumulative effect of change in accounting principle, net of tax 0 0 0 198 0 0 Net income $ 389 $ 290 $ 46 $ 1,396 $ 402 $ 942 COMMON STOCK DATA (2) Basic and diluted earnings per share: Income before cumulative effect of change in accounting principle $ .08 $ .06 $ .01 $ .25 $ .08 $ .20 Cumulative effect of change in accounting principle 0 0 0 .04 0 0 ------- ------- ------- ------- ------- ------ Net income $ .08 $ .06 $ .01 $ .29 $ .08 $ .20 Book value per share $ 5.04 $ 5.00 $ 4.94 $ 4.93 $ 4.59 $ 4.59 Weighted average shares and equivalents outstanding: Basic 4,799,183 4,799,183 4,801,583 4,813,476 4,744,408 4,740,063 Diluted 4,826,119 4,826,119 4,807,010 4,813,871 4,754,996 4,788,196 FINANCIAL POSITION Working capital $ 19,506 $ 19,220 $ 19,049 $ 19,640 $ 17,298 $ 17,095 Total assets 38,728 38,570 35,634 34,580 37,869 33,318 Short-term debt 0 0 0 0 6,570 2,194 Long-term debt 0 0 0 0 0 0 Stockholders' equity $ 24,169 $ 24,011 $ 23,720 $ 23,670 $ 22,104 $ 21,742
9
FISCAL YEAR ENDED (1) August 31, August 31, September 1, September 2, August 28, August 29, 2002 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- ---- (Restated) (Previously Reported) STATISTICS Net sales increase 9.7% 9.7% 0.7% 5.7% 4.7% 4.7% Comparable store net sales increase (decrease) (3) 4.9% 4.9% (0.7%) 4.2% 0.2% 3.2% Comparable store net sales increases on a 52 week aligned basis (3) 4.9% 4.9% 0.8% 2.5% 0.2% 3.2% Return on net sales, after income taxes 0.4% 0.3% 0.1% 1.4% 0.4% 1.0% Return on average stockholders' equity 1.6% 1.2% 0.2% 6.1% 1.8% 4.4% Average net sales per gross square foot (4) $ 153 $ 153 $ 146 $ 147 $ 141 $ 143 Average net sales per store (000's) (4) $ 1,668 $ 1,668 $ 1,534 $1,490 $1,399 $ 1,374 Stores open at end of period 68 68 66 65 69 66
(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 the fiscal year ended August 29, 1998 has been adjusted to give retroactive effect to the dividend. (3) Comparable store sales increases (decreases) for a fiscal year include stores commencing with their thirteenth consecutive entire fiscal month. Comparable store net sales increases on a 52 week aligned basis are arrived at by eliminating the unaligned 53rd week from fiscal 2000 before comparing the result with the prior and succeeding year. (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." 10 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 August 31, August 31, September 1, September 2, 2002 2002 2001 2000 ---- ---- ---- ---- (Restated) (Previously Reported) Net sales 100.0% 100.0% 100.0% 100.0% Cost of merchandise sold and occupancy costs 64.5 64.5 64.6 63.5 ------- ------- ------- ------- Gross profit 35.5 35.5 35.4 36.5 Store expenses 24.6 24.6 25.3 24.3 General and administrative expenses 10.5 10.5 10.1 10.2 Gain from demutualization 0.2 - - - ------- ------ ------ ------ Income from operations 0.6% 0.4% 0.0% 2.0% Net income 0.4% 0.3% 0.1% 1.4%
The Company's net sales increased in fiscal 2002 by $9,784,000 or 9.7%. Sales from comparable stores open at least one year increased $4,802,000 or 4.9%. Management believes the increases are due to continuing efforts to maintain better in-stock position, add new products and improve merchandise display that, along with positive industry trends, resulted in increases in both average sale and customer transactions during the fiscal year. Strong Christmas season sales also contributed. In fiscal 2001, the Company's net sales increased by $680,000 or 0.7%. Sales from comparable stores opened at least one year decreased $637,000 or 0.7%. The sales comparison is affected by the number of weeks contained in each fiscal year since fiscal 2000 includes a 53rd fiscal week while fiscal 2001 is based on a 52 week period. On a fully aligned, week-for-week comparative basis, net sales in fiscal 2001 increased by $2,206,000 or 2.2% over the comparable prior period due to increases in comparable store sales of $746,000 or 0.8%, in addition to new store sales of $1,460,000 net of the impact of closed stores. The comparable store sales increase was negatively affected in the Company's fiscal 2001 fourth quarter by an unsuccessful change in promotional strategy and later distribution of seasonal merchandise compared to fiscal 2000. Gross profit improved by $3,501,000 and 9.8% in fiscal 2002 as compared to the prior fiscal year. The improvement was principally due to the additional revenue cited above, as gross profit remained relatively unchanged year-to-year as a percent of net sales. Gross profit decreased $787,000, or 1.0% as a percent of net sales, in fiscal 2001 as compared to fiscal 2000. The percentage change in fiscal 2001 was primarily due to higher inventory shrinkage as compared to fiscal 2000, coupled with a combination of increases in occupancy and freight costs. Occupancy expense increased because of higher square footage and rent costs of new stores as compared to closed stores as well as contractual increases in rent for existing stores. Freight expense rose primarily due to higher unit costs. Store expenses increased by $1,637,000 or 6.4%, and, as a percentage of sales, decreased by 0.7% in fiscal 2002 as compared to 2001. The increase in fiscal 2002 was primarily due to an increase in payroll and payroll related expenses and rose in support of larger stores and higher sales. The decrease in store expenses as a percent of net sales was principally due to the ability of the Company to leverage expenses against the increase in net sales. Store expenses in fiscal 2001 increased by $1,249,000 or 5.1%, and, as a percentage of net sales, increased by 1.0% as compared to fiscal 2000 principally due to an increase in payroll and payroll related expenses that was primarily due to new store openings net of store closings, and additional costs incurred in connection with the Company's annual physical inventory to inaugurate a company 11 wide SKU (stock keeping unit) level inventory system to help improve the Company's sales performance and tighten inventory control. General and administrative expenses in fiscal 2002 increased by $1,392,000, or 0.4% as a percent of net sales, as compared to fiscal 2001. These increases were primarily attributable to additional payroll and payroll related expenses incurred in connection with filling executive and management positions that were vacant in the prior comparable period, plus increased insurance expenses. General and administrative expenses decreased by $90,000 or 0.9% in fiscal 2001, and, as a percentage of net sales, decreased by 0.1% as compared to fiscal 2000. The lower general and administrative expense in fiscal 2001 is primarily due to decreases in payroll and related expenses, and professional fees, partially offset by increases in property and casualty insurance premiums and rent for the Company's distribution center. In fiscal 2002, interest income, net decreased from the prior fiscal year due to the material fall in interest rates on short-term investments in the first half of the current year compared to relative interest rate stability and higher interest rate availability during the prior comparable period. There was virtually no change in average invested balances during the two years. Interest income, net increased in fiscal 2001 as compared to fiscal 2000 because the Company entered fiscal 2001 without bank debt and was able to maintain that condition throughout the majority of the year, thus allowing an increase in investment of cash provided by operating activities over that experienced in fiscal 2000. See "Liquidity and Capital Resources." The effective tax rate for 2002 was 44.9% as compared to 67.8% in 2001. The decrease is primarily due to a lower effective state and local income tax rate. The effective tax rate for 2001 was 67.8% as compared to 39.7% in 2000. The increase is primarily due to a higher effective state and local income tax rate due to the effect of minimum tax requirements on lower income. Net income increased by $343,000 for fiscal 2002 as compared to fiscal 2001 as a result of the increase in net sales and due to the gain from demutualization, partially offset by increases in store and general and administrative expenses, and the decrease in interest income, net. Net income decreased by $1,350,000 for fiscal 2001 as compared to fiscal 2000 (a 53 week year) due to the decrease in gross profit and the increase in store expenses, which was partially offset by the decrease in general and administrative expenses and the increase in interest income, net. 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 (1) the timing and duration of holiday selling seasons, (2) the timing of new store openings and promotional markdowns and (3) every seven years, the retail calendar contains a 53rd week as compared to a 52 week year for all other years. 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 2002 and fiscal 2001, the Company relied on internally generated funds, trade credit made available by suppliers and short-term borrowings to finance inventories and new store openings. Nearly all of the Company financing was provided through internally generated funds and trade credit. The Company's working capital has increased $457,000 in fiscal 2002 as compared to 2001 primarily as a result of an increase in merchandise inventory partially offset by an increase in trade payables. 12 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. Borrowings under the line of credit bear interest at the bank's prime rate (4.75% at August 31, 2002). 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 August 31, 2002, 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 outstanding at a point in time under the line was $750,000, $545,000, and $7,490,000 during fiscal 2002, fiscal 2001 and fiscal 2000, respectively. There were no direct borrowings outstanding under the line of credit at August 31, 2002 or September 1, 2001. 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 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 affected by foreign currency fluctuation. At August 31, 2002, the Company had outstanding letters of credit in the amount of $159,690. During fiscal 2002, fiscal 2001 and fiscal 2000, the Company had net cash provided by operating activities of $1,356,000, $1,526,000 and $7,537,000, respectively, and used $1,359,000, $1,890,000 and $591,000, respectively for purchases of property and equipment. Cash provided by operating activities in fiscal 2002 resulted primarily from depreciation, and increases in trade payables and other current obligations, offset by an increase in merchandise inventory. In fiscal 2003, the Company expects to open three new stores and close three existing stores. Costs associated with opening of new stores, including capital expenditures, inventory and pre-opening expenses, approximated $825,000 per store in fiscal 2002. 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. The Company believes that its cash at August 31, 2002, working capital generated from operations and cash available from the bank line of credit will be sufficient for the Company's operating needs for at least the next 12 months. 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 and fabric retail industry, weather-related changes in the selling cycle, and other uncertainties (including those risk factors referenced in the Company's filings with the Securities and Exchange Commission). CRITICAL ACCOUNTING POLICIES Revenue is recognized when merchandise is sold to customers. 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. RECENT ACCOUNTING STANDARDS In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets" ("SFAS 144"). This statement is effective for fiscal years beginning after December 15, 2001. This supercedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", while retaining many of the requirements of such statement. After review of the provisions of this Statement, management's assessment is that the Statement has no material impact on the Company's financial position or results of operations. 13 In June 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal Activities ("SFAS 146"). SFAS 146 addresses the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 supersedes Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), and requires liabilities associated with exit and disposal activities to be expensed as incurred. SFAS 146 is effective for exit or disposal activities of the Company that are initiated after December 31, 2002. The Company is currently evaluating the impact of the Statement. 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 August 31, 2002, and during each of the three years in the period then ended, 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 does not have any foreign currency exposure. 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 (4.75% at August 31, 2002). There were no loans outstanding under any such line of credit at August 31, 2002 or September 1, 2001. The following table details future projected payments for the Company's significant contractual obligations as of August 31, 2002:
Computer and Other Technology Fiscal Year Ended Operating Leases Related Commitments Total 2003 $ 9,055,236 $ 386,364 $ 9,441,600 2004 8,009,700 120,317 8,130,017 2005 7,201,393 98,330 7,299,723 2006 6,020,264 54,670 6,074,934 2007 4,788,695 1,519 4,790,214 Thereafter 11,207,047 0 11,207,047 ---------- --------- ---------- $ 46,282,335 $ 661,200 $ 46,943,535 =========== ========= ==========
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Item 15(a) in Part IV. 14 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 2002 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to August 31, 2002. ITEM 11. EXECUTIVE COMPENSATION The information required for this item is incorporated by reference to the Company's 2002 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to August 31, 2002. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required for this item is incorporated by reference to the Company's 2002 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to August 31, 2002. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required for this item is incorporated by reference to the Company's 2002 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to August 31, 2002. ITEM 14. CONTROLS AND PROCEDURES The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures performed within 90 days of the filing date of this report, the Chief Executive and Chief Financial officers of the Company concluded that the Company's disclosure controls and procedures were adequate. The Company made no significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation of those controls by the Chief Executive and Acting Chief Financial officers. 15 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) FINANCIAL STATEMENTS PAGE Report of Independent Certified Public Accountants F-1 Consolidated Balance Sheets as of August 31, 2002 (restated) and September 1, 2001 F-2 Consolidated Statements of Income for the years ended August 31, 2002 (restated), September 1, 2001 and September 2, 2000 F-3 Consolidated Statements of Stockholders' Equity for the years ended August 31, 2002 (restated), September 1, 2001 and September 2, 2000 F-4 - F-5 Consolidated Statements of Cash Flows for the years ended August 31, 2002 (restated), September 1, 2001 and September 2, 2000 F-6 Notes to Consolidated Financial Statements F-7 - F-16 (b) The Company did not file a Current Report on Form 8-K during the last quarter of the period covered by this Report. (c) 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 23.1 Consent of Grant Thornton LLP 24.1 Power of Attorney to sign Form 10-K/A (set forth on page 17) 27 Financial Data Schedule (Filed electronically with SEC only) 99.1 Certification 99.2 Certification (d) FINANCIAL STATEMENT SCHEDULES None of these schedules are required. * 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. 16 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 January 27, 2004. 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/A 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 B. BARNETT Executive Vice President and January 27, 2004 ---------------------- Director Steven B. Barnett /S/ STANLEY BERENZWEIG Principal Executive January 27, 2004 ---------------------- Officer and Director Stanley Berenzweig /S/ MARIO CIAMPI Director January 27, 2004 ---------------- Mario Ciampi /S/ FRED J. DAMIANO Director January 27, 2004 -------------------- Fred J. Damiano /S/ JEFFREY C. GERSTEL President and January 27, 2004 ---------------------- Director Jeffrey C. Gerstel /S/ JUDITH LOMBARDO Senior Vice President and January 27, 2004 -------------------- Director Judith Lombardo /S/ ALAN C. MINTZ Director January 27, 2004 ------------------ Alan C. Mintz 17 CERTIFICATIONS I, Stanley Berenzweig, certify that: 1. I have reviewed this annual report on Form 10-K/A of Rag Shops, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report on January 27, 2004; and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. SIGNATURE TITLE(S) DATE /S/ STANLEY BERENZWEIG Principal Executive January 27, 2004 - ---------------------- and Director Stanley Berenzweig 18 CERTIFICATIONS I, Steven B. Barnett, certify that: 1. I have reviewed this annual report on Form 10-K/A of Rag Shops, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report on January 27, 2004; and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. SIGNATURE TITLE(S) DATE /S/ STEVEN B. BARNETT Executive Vice President January 27, 2004 - --------------------- and Acting Chief Financial Steven B. Barnett Officer 19 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 23.1 Consent of Grant Thornton LLP 24.1 Power of Attorney to sign Form 10-K/A (set forth on page 17) 99.1 Certification 99.2 Certification - -------------------------------- * 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 Board of Directors and Stockholders Rag Shops, Inc. We have audited the accompanying consolidated balance sheets of Rag Shops, Inc. and Subsidiaries as of August 31, 2002 and September 1, 2001 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended August 31, 2002. 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 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Rag Shops, Inc. and Subsidiaries as of August 31, 2002 and September 1, 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended August 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 Merchandise Inventories, the Company changed its method of calculating inventory for the year ended September 2, 2000. As discussed in Note 1 Recent Developments, the accompanying financial statements as of and for the years ended August 31, 2002 have been restated. GRANT THORNTON LLP Edison, New Jersey November 13, 2002, except for the item titled "Recent Developments" in Note 1, as to which the date is January 23, 2004 F-1 RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
August 31, August 31, September 1, 2002 2002 2001 ---- ---- ---- (Restated) (Previously (See Note 1) (Reported) ASSETS CURRENT ASSETS Cash $ 958,852 $ 958,852 $ 953,224 Investment in common stock 286,437 0 0 Merchandise inventories 30,327,095 30,327,095 27,806,578 Prepaid expenses 1,248,932 1,248,932 1,194,277 Other current assets 453,858 453,858 153,565 Deferred income taxes 789,846 789,846 855,346 ----------- ----------- ----------- Total current assets 34,065,020 33,778,583 30,962,990 PROPERTY AND EQUIPMENT, NET 4,250,885 4,250,885 4,186,012 DEFERRED INCOME TAXES 368,492 497,102 436,002 OTHER ASSETS 43,194 43,194 49,485 ----------- ----------- ----------- TOTAL ASSETS $ 38,727,591 $ 38,569,764 $ 35,634,489 =========== =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable - trade $ 10,307,909 $ 10,307,909 $ 8,348,552 Accrued expenses and other current liabilities 2,797,432 2,797,432 2,680,378 Accrued salaries and wages 1,297,857 1,297,857 719,952 Income taxes payable 155,784 155,784 165,186 ----------- ----------- ----------- Total current liabilities 14,558,982 14,558,982 11,914,068 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value 2,000,000 shares authorized; No shares issued or outstanding 0 0 0 Common stock, $.01 par value, 13,000,000 shares authorized; 4,824,863 (4,797,983) shares and 4,826,063 (4,799,183) shares issued (outstanding) at August 31, 2002 and September 1, 2001, respectively 48,249 48,249 48,261 Additional paid-in capital 6,235,352 6,235,352 6,237,666 Unamortized restricted stock awards 0 0 (3,065) Retained earnings 17,890,805 17,791,255 17,501,633 Unrealized gain on investment in common stock, net of taxes 58,277 0 0 Treasury stock, at cost, 26,880 shares (64,074) (64,074) (64,074) ----------- ----------- ----------- Total stockholders' equity 24,168,609 24,010,782 23,720,421 ----------- ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 38,727,591 $ 38,569,764 $ 35,634,489 =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-2 RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Fiscal Year Ended ----------------- August 31, August 31, September 1, September 2, 2002 2002 2001 2000 ---- ---- ---- ---- (Restated) (Previously (See Note 1) Reported) NET SALES $110,672,263 $110,672,263 $100,887,768 $100,207,583 COST OF MERCHANDISE SOLD AND OCCUPANCY COSTS 71,375,224 71,375,224 65,131,965 63,665,075 ---------- ---------- ---------- ---------- Gross profit 39,297,039 39,297,039 35,755,803 36,542,508 ---------- ---------- ---------- ---------- OPERATING EXPENSES: Store expenses 27,249,108 27,249,108 25,572,373 24,323,794 General and administrative expenses 11,560,192 11,560,192 10,167,994 10,258,354 ---------- ---------- ---------- ---------- Total operating expenses 38,809,300 38,809,300 35,740,367 34,582,148 ---------- ---------- ---------- ---------- 487,739 487,739 15,436 1,960,360 Gain from demutualization 180,671 0 0 0 ---------- ---------- ---------- ---------- INCOME FROM OPERATIONS 668,410 487,739 15,436 1,960,360 INTEREST INCOME, Net 37,783 37,783 127,885 30,562 ---------- ---------- ---------- ---------- INCOME BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 706,193 525,522 143,321 1,990,922 PROVISION FOR INCOME TAXES 317,021 235,900 97,200 793,000 ---------- ---------- ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 389,172 289,622 46,121 1,197,922 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF INCOME TAX EFFECT OF $127,000 0 0 0 198,496 ---------- ---------- ---------- ---------- NET INCOME $ 389,172 $ 289,622 $ 46,121 $ 1,396,418 =========== =========== =========== =========== BASIC AND DILUTED EARNINGS PER COMMON SHARE: INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $ .08 $ .06 $ .01 $ .25 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 0 0 0 .04 ---------- ---------- ---------- ---------- NET INCOME $ .08 $ .06 $ .01 $ .29 ========== =========== ============ ==========
The accompanying notes are an integral part of these consolidated financial statements. F-3 RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR YEARS ENDED SEPTEMBER 2, 2000, SEPTEMBER 1, 2001, AND AUGUST 31, 2002
Unrealized Gain on Investment Unamortized in Additional Restricted Common Common Stock Paid-In Stock Retained Stock, net Treasury Shares Dollars Capital Awards Earnings of taxes Stock Total (See Note 1) BALANCE, AUGUST 28, 1999 4,837,763 $48,378 $6,267,827 $ (207,488) $16,059,094 $ 0 $ (64,074) $22,103,737 Issuance of restricted stock awards 9,000 90 17,352 (17,442) 0 0 0 0 Amortization of restricted stock awards 0 0 0 169,761 0 0 0 169,761 Forfeiture of restricted stock awards (18,300) (183) (42,886) 43,069 0 0 0 0 Net income 0 0 0 0 1,396,418 0 0 1,396,418 -------- ------- --------- --------- --------- --------- ------ --------- BALANCE, SEPTEMBER 2, 2000 4,828,463 48,285 6,242,293 (12,100) 17,455,512 0 (64,074) 23,669,916 Amortization of restricted stock awards 0 0 0 4,384 0 0 0 4,384 Forfeiture of restricted stock awards (2,400) (24) (4,627) 4,651 0 0 0 0 Net income 0 0 0 0 46,121 0 0 46,121 -------- ------- --------- --------- --------- --------- ------ -------- BALANCE, SEPTEMBER 1, 2001 4,826,063 48,261 6,237,666 (3,065) 17,501,633 0 (64,074) 23,720,421 Amortization of restricted stock awards 0 0 0 739 0 0 0 739 Forfeiture of restricted stock awards (1,200) (12) (2,314) 2,326 0 0 0 0 Net income 0 0 0 0 289,622 0 0 289,622 -------- ------- --------- --------- --------- --------- ------ -------- BALANCE, AUGUST 31, 2002 (Previously Reported) 4,824,863 $48,249 $6,235,352 $ 0 $17,791,255 $ 0 $ (64,074) $24,010,782 ========= ====== ========= ========= ========== ========= ========= ==========
F-4
Unrealized Gain on Investment Unamortized in Additional Restricted Common Common Stock Paid-In Stock Retained Stock, net Treasury Shares Dollars Capital Awards Earnings of taxes Stock Total (See Note 1) BALANCE, SEPTEMBER 1, 2001 4,826,063 $48,261 $6,237,666 $ (3,065) $ 17,501,633 $ 0 $ (64,074) $23,720,421 Amortization of restricted stock awards 0 0 0 739 0 0 0 739 Forfeiture of restricted stock awards (1,200) (12) (2,314) 2,326 0 0 0 0 Unrealized gain on investment in common stock, net of taxes 0 0 0 0 0 58,277 0 58,277 Net income 0 0 0 0 389,172 0 0 389,172 ------- Total comprehensive income 447,449 -------- ------- ---------- ---------- ----------- -------- -------- ------- BALANCE, AUGUST 31, 2002 (Restated) (See Note 1) 4,824,863 $48,249 $6,235,352 $ 0 $ 17,890,805 $ 58,277 $ (64,074) $24,168,609 ========= ====== ========= ========= ========== ======= ========= ==========
The accompanying notes are an integral part of these consolidated financial statements. F-5 RAG SHOPS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended ----------------- August 31, August 31, September 1, September 2, 2002 2002 2001 2000 ---- ---- ---- ---- (Restated) (Previously (See Note 1) Reported) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 389,172 $ 289,622 $ 46,121 $ 1,396,418 Adjustments to reconcile net income to net cash Provided by operating activities: Depreciation and amortization 1,224,726 1,224,726 1,276,297 1,414,572 Gain from demutualization (180,671) 0 0 0 Deferred income taxes 85,521 4,400 (89,500) (187,090) Loss on disposition of property and equipment 60,705 60,705 34,136 52,399 Amortization of restricted stock awards 739 739 4,384 169,761 Cumulative effect of change in accounting 0 0 0 (325,000) principle Changes in assets and liabilities: (Increase) decrease in: Merchandise inventories (2,520,517) (2,520,517) (1,260) 3,082,800 Prepaid expenses (54,655) (54,655) (710,963) 53,440 Other current assets (300,293) (300,293) (54,627) 125,821 Other assets 6,291 6,291 17,222 38,893 Increase (decrease) in: Accounts payable - trade 1,959,357 1,959,357 585,832 1,834,152 Accrued expenses 117,054 117,054 668,555 (493,205) Accrued salaries and wages 577,905 577,905 (173,171) 288,354 Income taxes payable (9,402) (9,402) (77,176) 85,450 ----------- ----------- ----------- ---------- Net cash provided by operating activities 1,355,932 1,355,932 1,525,850 7,536,765 ---------- ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of property and equipment 9,040 9,040 6,300 400 Payments for purchases of property and equipment (1,359,344) (1,359,344) (1,889,530) (590,634) ---------- ---------- ---------- ---------- Net cash used in investing activities (1,350,304) (1,350,304) (1,883,230) (590,234) ---------- ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of note payable - bank 4,075,000 4,075,000 1,090,000 5,805,000 Repayments of note payable - bank (4,075,000) (4,075,000) (1,090,000) (12,375,000) ---------- ---------- ---------- ----------- Net cash used in financing activities 0 0 0 (6,570,000) ---------- ---------- ---------- ---------- NET INCREASE (DECREASE) IN CASH 5,628 5,628 (357,380) 376,531 CASH, BEGINNING OF YEAR 953,224 953,224 1,310,604 934,073 ---------- ---------- ---------- ---------- CASH, END OF YEAR $ 958,852 $ 958,852 $ 953,224 $ 1,310,604 ========= ========= ========= ========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest $ 3,248 $ 3,248 $ 561 $ 198,269 ========= ========= ========= ========== Income taxes $ 98,042 $ 98,042 $ 843,731 $ 1,002,981 ========= ========= ========= ==========
The accompanying notes are an integral part of these consolidated financial statements. F-6 RAG SHOPS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED AUGUST 31, 2002, SEPTEMBER 1, 2001 AND SEPTEMBER 2, 2000 NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RECENT DEVELOPMENTS 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 which 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 31, 2002 ("2002") and September 1, 2001 ("2001") 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. Advertising expense net of co-op advertising was $4,196,085, $4,161,928 and $4,107,476 for 2002, 2001 and 2000, respectively. 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 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 F-7 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 In management's opinion, the fair value of amounts outstanding under its line of credit approximate fair value due to their variable interest rate. PRE-OPENING AND CLOSING STORE EXPENSES 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. 123"). 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 DEVELOPMENTS In December 2003, the Company received a check from Principal Financial Group, Inc. ("Principal") reflecting dividends payable in connection with common stock of Principal. Receipt of the dividend check prompted a Company inquiry which revealed that, due to its ownership of certain life insurance policies issued by Principal Life Insurance Company, a subsidiary of Principal, and maintained by the Company for certain key executive officers, the Company had received 9,766 shares of Principal's common stock (the "Shares") in December 2001 as consideration in the demutualization of Principal's predecessor. The effective date of the demutualization was in October 2001 and the Shares were issued in December 2001 to one of the Company's subsidiaries, the owner of the life insurance policies, in book-entry form as uncertificated shares and maintained in an account with Mellon Investor Services established by Principal in connection with its demutualization transaction. The Company had not previously recognized or recorded the Shares issued pursuant to such event. The Company has determined it will restate prior financial statements to properly reflect the transaction in the first quarter of fiscal 2002. In its restated financial statements, the Company has recorded the then fair market value ($180,671) of the Shares as part of operating income as of October 2001, in accordance with Emerging Issues Task Force Issue No. 99-4, "Accounting for Stock Received from the Demutualization of a Mutual Insurance Company". The Company has classified its holding in the Shares as "available-for-sale" pursuant to Statement of Financial Accounting Standards No. 115 "Accounting for Investments", whereby the investment will be carried at fair market value and subsequent changes in the market value of the investment will be reflected as an unrealized gain or loss in the stockholders' equity section of the balance sheets, net of deferred income taxes. Other Comprehensive Income will be presented for all periods pursuant to Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" either in the Consolidated Statements of Changes in Stockholders' Equity or Notes to Consolidated Financial F-8 Statements. Comprehensive income consists of net income or loss for the current period as well as income, expenses, gains or losses, net of income taxes arising during the period that are included in separate components of equity. It includes the unrealized gains and losses on the Company's available-for-sale security, net of taxes. The fair market value of the Shares as of the close of business on August 31, 2002 was $286,437. Please refer to amendments to periodic reports filed with the Securities and Exchange Commission for periods between December 1, 2001 and November 29, 2003 for related restatements. The following tables show the impact of the restatement from the previously filed financial statements, as of August 31, 2002 and for the fiscal year then ended:
Restated Previously -------- Reported Adjustments (See Note 1) -------- ----------- (Amounts in thousands except earnings per share) Current assets - Investment in common stock $ - $ 286 $ 286 Deferred income taxes - long term 497 (129) 368 Stockholders' equity - Unrealized gain on investment in common stock, net of taxes - 58 58 Stockholders' equity - Retained earnings 17,791 100 17,891 Gain from demutualization - 181 181 Provision for income taxes 236 81 317 Net income 289 100 389 Other comprehensive income - 58 58 Total comprehensive income 289 158 447 Earnings per share - Basic $ 0.06 $ 0.02 $ 0.08 Earnings per share - Diluted $ 0.06 $ 0.02 $ 0.08
The Company did not previously file a Schedule of Comprehensive Income as there were no differences between net income and total comprehensive income. The Schedule of Comprehensive Income is as follows: Fiscal Year Ended ----------------- August 31, September 1, 2002 2001 ---- ---- (Amounts in thousands) Net income $ 389 $ 46 Other comprehensive income, net of taxes: Unrealized gain on investment in common stock 58 - ------------ ------------ Total comprehensive income $ 447 $ 46 ============ ============ RECENT ACCOUNTING PRONOUNCEMENTS In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment of Disposal of Long-Lived Assets" ("SFAS 144"). This statement is effective for fiscal years beginning after December 15, 2001. This supercedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", while retaining many of the requirements of such statement. After review of the provisions of this Statement, management's assessment is that the Statement has no material impact on the Company's financial position or results of operations. F-9 In June 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal Activities ("SFAS 146"). SFAS 146 addresses the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 supersedes Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), and requires liabilities associated with exit and disposal activities to be expensed as incurred. SFAS 146 is effective for exit or disposal activities of the Company that are initiated after December 31, 2002. The Company is currently evaluating the impact of the Statement. NOTE 2. PROPERTY AND EQUIPMENT Property and equipment consists of the following:
Useful August 31, September 1, Lives 2002 2001 ----- ---- ---- Furniture and fixtures 5-10 years $ 9,697,500 $ 9,070,071 Leasehold improvements 10 years 3,889,181 3,582,809 Transportation equipment 3-7 years 573,132 600,706 Data processing equipment 5 years 4,371,559 4,232,438 ----------- ----------- 18,531,372 17,486,024 Less accumulated depreciation and Amortization 14,280,487 13,300,012 ----------- ----------- $ 4,250,885 $ 4,186,012 ============ ============
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. There were no direct borrowings outstanding under the line of credit at both August 31, 2002 and September 1, 2001 and the unused line of credit for direct borrowings and the issuance of letters of credit at August 31, 2002 was $9,840,310. 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 August 31, 2002, the Company was in compliance with such covenants. Borrowings under the line of credit bear interest payable quarterly at the bank's prime rate (4.75% and 6.50% at August 31, 2002 and September 1, 2001, respectively). NOTE 4. 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 2002, 2001 and 2000 amounted to $8,789,191, $8,175,209, and $7,651,778, respectively, and includes contingent rentals (computed on a percentage of sales, as defined in the leases) of $40,211, $28,050 and $29,079 respectively. The Company leases certain premises from an entity controlled by the majority stockholders of the Company. For the years 2002, 2001 and 2000, rental payments under this agreement amounted to $349,269, $340,349 and $338,265, respectively. F-10 Future minimum annual rental commitments under non-cancelable operating leases are as follows: Fiscal Year Ended 2003 $9,055,236 2004 8,009,700 2005 7,201,393 2006 6,020,264 2007 4,788,695 Thereafter 11,207,047 ---------- $46,282,335 ========== Letters of Credit In addition, at August 31, 2002 the Company has outstanding letters of credit for the purchase of merchandise inventories of approximately $159,690. 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 proceeding that is expected to have a material adverse effect on the Company's results of operations or financial position. NOTE 5. 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.
Fiscal Year Ended August 31, August 31, September 1, September 2, 2002 2002 2001 2000 ---- ---- ---- ---- (Restated) (Previously (See Note 1) Reported) Numerator for basic and diluted earnings per Share: Income before cumulative effect of change in Accounting principle $ 389,172 $ 289,622 $ 46,121 $1,197,922 Cumulative effect of change in accounting principle, net of income taxes 0 0 0 198,496 --------- --------- --------- --------- Net income $ 389,172 $ 289,622 $ 46,121 $1,396,418 ========= ========= ========= ========= Denominator: Denominator for basic earnings per share-weighted average shares 4,799,183 4,799,183 4,801,583 4,813,476 Effect of dilutive securities: Employee stock options 26,936 26,936 5,427 395 --------- --------- --------- --------- Denominator for diluted earnings per share-adjusted weighted average shares and assumed conversions 4,826,119 4,826,119 4,807,010 4,813,871 ========= ========= ========= =========
F-11
Fiscal Year Ended August 31, August 31, September 1, September 2, 2002 2002 2001 2000 ---- ---- ---- ---- (Restated) (Previously (See Note 1) Reported) Basic and diluted earnings per share: Income before cumulative effect of change in accounting principle $ .08 $ .06 $ .01 $ .25 Cumulative effect of change in accounting principle - - - .04 -------- -------- -------- --------- Net income $ .08 $ .06 $ .01 $ .29 ======== ======== ======== ========
Stock options excluded from the above calculation, as the effect of such options would be anti-dilutive, aggregated 2,250 in 2002, 17,750 in 2001 and 323,800 in 2000. NOTE 6. 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 permitted options to purchase a total of 450,000 shares of common stock, of which 435,600 shares were reserved by the Company as of April 18, 2001. 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. The Plan expired on April 18, 2001. However, the Company intends to extend the Plan termination date and grant options on a minimum of 90,000 shares upon extension of the Plan. Such options are not included in the tables below. 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 (the last grant dates under the Plan prior to expiration), 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 2002 2002 2001 2000 ---- ---- ---- ---- (Restated) (Previously (See Note 1) Reported) Net income-as reported $ 389,172 $ 289,622 $ 46,121 $ 1,396,418 Net income-pro forma $ 388,198 $ 288,648 $ 34,455 $ 1,388,349 Net income per share-as reported, basic and $ .08 $ .06 $ .01 $ .29 diluted Net income per share pro forma, basic and $ .08 $ .06 $ .01 $ .29 diluted
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: dividends yield of 0%, expected volatility of 30%, risk-free interest rate of 5.0% and expected life of 10 years. The weighted average grant date fair value of options issued during fiscal year 2000 was $0.97. F-12 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 28, 1999 280,300 $2.02-$11.76 $3.70 Granted 56,500 $1.86-$2.325 $2.27 Forfeited or Expired (4,500) $2.125-$3.00 $2.42 -------- Outstanding, September 2, 2000 332,300 $1.86-$11.76 $3.51 Granted 0 Forfeited or Expired (250,550) $2.340-$6.250 $3.88 -------- Outstanding, September 1, 2001 81,750 $1.86-$11.76 $2.77 Granted 0 Forfeited or Expired (3,500) $2.340-$12.375 $6.64 -------- Outstanding, August 31, 2002 78,250 $1.86-$11.76 $2.59 ======== Exercisable, September 2, 2000 229,400 $2.02-$11.76 $4.02 Exercisable, September 1, 2001 63,250 $2.02-$11.76 $2.94 Exercisable, August 31, 2002 73,950 $2.02-$11.76 $2.64
The weighted-average remaining contractual life of stock options outstanding at August 31, 2002 is 4.4 years and at September 1, 2001 is 5.3 years. The majority of options as of August 31, 2002 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 August 31, 2002, 107,900 shares have been issued under the Incentive Plan. On July 31, 2000, 80,300 of the outstanding shares vested. On March 31, 2002, an additional 4,500 shares vested. As of August 31, 2002, 23,100 shares had been forfeited by individuals who were no longer employed by the Company prior to the end of their required vesting period and no shares remain unvested. 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 2002, 2001, and 2000, $739, $4,384 and $169,761, 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 August 31, 2002, September 1, 2001 and September 2, 2000, 26,880 shares are held in treasury. F-13 NOTE 7. INCOME TAXES The components of income tax expense relating to income consists of the following:
Fiscal Year Ended August 31, 2002 August 31, 2002 September 1, 2001 September 2, 2000 --------------- --------------- ----------------- ----------------- (Restated) (Previously (See Note 1) Reported) Federal: Current $ 157,800 $ 157,800 $ 121,300 $ 920,090 Deferred 85,521 4,400 (89,500) (187,090) State: Current 73,700 73,700 65,400 187,000 ---------- ---------- ---------- ---------- $ 317,021 $ 235,900 $ 97,200 $ 920,000 ========== ========== ========== ==========
The deferred income tax (expense) benefit arises from the following temporary differences.
Fiscal Year Ended August 31, 2002 August 31, 2002 September 1, 2001 September 2, 2000 --------------- --------------- ----------------- ----------------- (Restated) (Previously (See Note 1) Reported) Uniform inventory capitalization $ 2,200 $ 2,200 $ 1,600 $ (10,400) Depreciation 12,200 12,200 48,200 108,290 Straight-line of leases 48,900 48,900 38,000 31,500 Amortization of incentive stock awards (67,700) (67,700) 1,700 57,700 Gain from demutalization (81,121) 0 0 0 ------------ ----------- ----------- ----------- $ (85,521) $ (4,400) $ 89,500 $ 187,090 ============ ============ =========== ===========
The effective tax rate differs from the Federal statutory rate as follows:
Fiscal Year Ended August 31, 2002 August 31, 2002 September 1, 2001 September 2, 2000 --------------- --------------- ----------------- ----------------- (Restated) (Previously (See Note 1) Reported) Statutory tax rate 34.0% 34.0% 34.0% 34.0% State and local income taxes, net of federal income tax benefit 9.3 9.3 30.1 5.3 Effect of permanent differences and other 1.6 1.6 3.7 0.4 ----- ----- ----- ----- Effective tax rate 44.9% 44.9% 67.8% 39.7% ===== ===== ===== =====
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 $7,702,000 of net operating losses in multiple entities and multiple states which expire on various dates from 2003 to 2017. F-14 The tax effect of significant items comprising the Company's deferred income tax assets are as follows:
Fiscal Year Ended ----------------- August 31, 2002 August 31, 2002 September 1, 2001 --------------- --------------- ----------------- (Restated) (Previously (See Note 1) Reported) Current deferred income tax assets: Uniform inventory capitalization $ 789,846 $ 789,846 $ 787,646 Amortization of restricted stock awards 0 0 67,700 --------- --------- --------- 789,846 789,846 855,346 --------- --------- --------- Non-current deferred income tax assets: Gain from demutualization (128,610) 0 0 Straight-line of leases 249,573 249,573 200,673 Difference between book and tax depreciation methods 247,529 247,529 235,329 Net operating losses for State purposes 721,597 721,597 620,205 Valuation allowance (721,597) (721,597) (620,205) --------- --------- --------- 368,492 497,102 436,002 --------- --------- --------- Total deferred income tax asset $ 1,158,338 $ 1,286,948 $ 1,291,348 ========== ========== =========
NOTE 8. EMPLOYEE BENEFIT PLAN The Company has 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 eligible service. The Company did not make any contributions to the 401(k) plan for 2002, 2001 and 2000. NOTE 9. QUARTERLY RESULTS (UNAUDITED) The following is a summary of selected quarterly financial data (in thousands of dollars, except per share amounts):
Fiscal Quarter Ended -------------------- December 1, December 1, March 2, June 1, August 31, 2002 2001(a) 2001 2002 2002 2002 - ---- ---- ---- ---- ---- ---- (Restated) (Previously Reported) Net sales $ 32,552 $ 32,552 $ 28,931 $ 25,523 $ 23,667 Gross profit 12,281 12,281 9,836 9,324 7,856 Net income (loss) 1,490 1,390 129 90 (1,320) Earnings (loss) per common share: Basic & Diluted .31 .29 .03 .02 (.27)
F-15 Fiscal Quarter Ended -------------------- December 2, March 3, June 2, September 1, 2001 2000 2001 2001 2001 - ---- ---- ---- ---- ---- Net sales $ 30,048 $ 25,760 $ 23,692 $ 21,388 Gross profit 11,442 8,995 8,379 6,940 Net income (loss) 1,282 44 46 (1,326) Earnings (loss) per common share: Basic & Diluted .27 .01 .01 (.27)
The sum of the four quarters may not equal the full year computation due to rounding. (a) The following table shows the impact of the restatement related to the dumutualization of the life insurance policies (see Note 1 "Recent Developments") from the previously filed financial statements as of December 1, 2001 and for the three months then ended (unaudited):
Previously Reported Adjustments Restated -------- ----------- -------- (Amounts in thousands except earnings per share) Current assets - Investment in common stock $ - $ 224 $ 224 Deferred income taxes - long term 436 (100) 336 Stockholders' equity - Unrealized gain on investment in common stock, net of taxes - 24 24 Stockholders' equity - Retained earnings 18,892 100 18,992 Gain from demutualization - 181 181 Provision for income taxes 888 81 969 Net income 1,390 100 1,490 Other comprehensive income 0 24 24 Total comprehensive income 1,390 124 1,514 Earnings per share - Basic and diluted $ 0.29 $ 0.02 $ 0.31
The Company did not previously file a Schedule of Comprehensive Income as there were no differences between net income and total comprehensive income. The Schedule of Comprehensive Income is as follows:
Three Months Ended ------------------ December 1, December 2, 2001 2000 ---- ---- (Amounts in thousands) Net income $ 1,490 $ 1,282 Other comprehensive income, net of taxes: Unrealized gain on investment in common stock 24 - ------------ ------------ Total comprehensive income $ 1,514 $ 1,282 ============ ============
F-16 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 RAG SHOPS, INC. LIST OF SUBSIDIARY COMPANIES NAME STATE INCORPORATED Name tate 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, Inc. New York The Rag Shop/Franklin, Inc. New Jersey The Rag Shop/Kinnelon, Inc. New Jersey The Rag Shop/Waterbury, Inc. Connecticut 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 reissued our report dated November 13, 2002, except for the item titled "Recent Developments" in Note 1, as to which the date is January 23, 2004, accompanying the consolidated financial statements of Rag Shops, Inc. and Subsidiaries included in the Form 10-K/A for the year ended August 31, 2002. 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 2, 1999). GRANT THORNTON LLP Edison, New Jersey January 23, 2004 EXHIBIT 99.1 RAG SHOPS, INC. CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (18 U.S.C.ss.1350) The undersigned, Stanley Berenzweig, the Chief Executive Officer of Rag Shops, Inc. (the "Company"), has executed this Certification in connection with the filing with the Securities and Exchange Commission of the Company's Annual Report on Form 10-K/A for the fiscal year ended August 31, 2002 (the "Report"). The undersigned hereby certifies that: - The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and - - the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. - IN WITNESS WHEREOF, the undersigned has executed this Certification as of the 27th day of January, 2004. /s/ Stanley Berenzweig ---------------------- Chief Executive Officer EXHIBIT 99.2 RAG SHOPS, INC. CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (18 U.S.C. ss.1350) The undersigned, Steven B. Barnett, the Acting Chief Financial Officer of Rag Shops, Inc. (the "Company"), has executed this Certification in connection with the filing with the Securities and Exchange Commission of the Company's Annual Report on Form 10-K/A for the fiscal year ended August 31, 2002 (the "Report"). The undersigned hereby certifies that: - the Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and - - the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. - IN WITNESS WHEREOF, the undersigned has executed this Certification as of the 27th day of January, 2004. /s/ Steven B. Barnett --------------------- Acting Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----