10-Q 1 a10q3-04e.txt FORM 10-Q FOR PERIOD ENDED MAY 29, 2004 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended May 29, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From ... to... Commission File No. 0-19194 RAG SHOPS, INC. (Exact name of registrant as specified in its charter) DELAWARE 51-0333503 (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 111 WAGARAW ROAD HAWTHORNE, NEW JERSEY 07506 (Address of principal executive (Zip Code) offices) (973) 423-1303 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes____ No__X__ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT JUNE 30, 2004 Common Stock, par value $.01 4,797,983 RAG SHOPS, INC. AND SUBSIDIARIES INDEX Page PART I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed consolidated balance sheets - May 29, 2004 (unaudited), May 31, 2003 (unaudited) and August 30, 2003 3 Condensed consolidated results of operations- three and nine months ended May 29, 2004 (unaudited) and May 31, 2003 (unaudited) 4 Condensed consolidated statements of cash flows - nine months ended May 29, 2004 (unaudited) and May 31, 2003 (unaudited) 5 Notes to condensed consolidated financial statements 6-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10-14 Item 3. Quantitative and Qualitative Disclosures About Market Risk 14-15 Item 4. Controls and Procedures 15 Part II - OTHER INFORMATION Items 1.-5. 16 Item 6. Exhibits and Reports on Form 8-K 16 SIGNATURES 16 CERTIFICATIONS 17-18 Page 2 of 18 RAG SHOPS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (All amounts in thousands)
May 29, May 31, August 30, 2004 2003 2003 ---- ---- ---- (Unaudited) (Unaudited) (Note A) ASSETS CURRENT ASSETS: Cash $ 1,041 $ 2,283 $ 835 Investment in common stock - 310 307 Merchandise inventories 29,577 27,449 31,995 Prepaid expenses 1,175 851 1,490 Other current assets 624 436 431 Deferred income taxes 918 790 918 --------- --------- --------- Total current assets 33,335 32,119 35,976 Property and equipment, net 4,301 4,686 4,580 Deferred income taxes 646 361 324 Other assets 31 33 29 --------- --------- --------- TOTAL ASSETS $ 38,313 $ 37,199 $ 40,909 ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Short-term bank borrowings $ 2,640 $ - $ - Accounts payable-trade 7,661 7,628 11,432 Accrued expenses and other current liabilities 3,785 3,533 4,315 Accrued salaries and wages 776 748 1,103 Deferred income 58 756 582 --------- --------- --------- Total current liabilities 14,920 12,665 17,432 STOCKHOLDERS' EQUITY: Common stock 48 48 48 Additional paid-in capital 6,235 6,235 6,235 Retained earnings 17,174 18,241 17,186 Unrealized gain on investment in common stock, net of tax - 74 72 Treasury stock, at cost, 26,880 shares (64) (64) (64) --------- --------- --------- Total stockholders' equity 23,393 24,534 23,477 --------- --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 38,313 $ 37,199 $ 40,909 ========= ========= =========
Note A: Derived from the August 30, 2003 audited balance sheet. See notes to the condensed consolidated financial statements. Page 3 of 18 RAG SHOPS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED RESULTS OF OPERATIONS (Unaudited) (All amounts in thousands, except share data)
Three Months Ended Nine Months Ended ------------------ ----------------- May 29, May 31, May 29, May 31, 2004 2003 2004 2003 ---- ---- ---- ---- Net sales $ 27,245 $ 27,920 $ 93,326 $ 91,949 Cost of merchandise sold, occupancy and distribution costs 18,243 18,733 61,909 61,094 --------- --------- --------- --------- Gross profit 9,002 9,187 31,417 30,855 Selling, general and administrative expenses 9,935 9,646 31,538 30,221 --------- --------- --------- --------- (933) (459) (121) 634 Gain from sale of securities - - 161 - --------- --------- --------- --------- Income (loss) from operations (933) (459) 40 634 Interest income (expense), net (9) 1 (33) 2 ---------- --------- ---------- --------- Income (loss) before income tax provision (benefit) (942) (458) 7 636 Income tax provision (benefit) (342) (207) 19 286 ---------- ---------- --------- --------- Net income (loss) $ (600) $ (251) $ (12) $ 350 ========== ========== ========== ========= EARNINGS (LOSS) PER COMMON SHARE: Basic and diluted $ (.13) $ (.05) $ - $ .07 ========== ========== ========== ========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: Basic 4,797,983 4,797,983 4,797,983 4,797,983 ========= ========= ========= ========= Diluted 4,797,983 4,797,983 4,797,983 4,825,987 ========= ========= ========= =========
See notes to the condensed consolidated financial statements Page 4 of 18 RAG SHOPS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (All amounts in thousands)
Nine Months Ended May 29, 2004 May 31, 2003 ------------ ------------ Cash flows from operating activities: Net income (loss) $ (12) $ 350 Adjustments to reconcile net income to cash provided by (used in) operating activities: Depreciation and amortization 1,213 1,007 Loss on disposition of property and equipment - 31 Amortization of deferred income (524) (640) Deferred income taxes (187) - Gain from sale of securities (161) - Changes in assets and liabilities: (Increase) decrease in: Merchandise inventories 2,418 4,274 Prepaid expenses 233 398 Other current assets (193) 18 Other assets (2) 10 Increase (decrease) in: Accounts payable-trade (3,771) (2,680) Accrued expenses and other current liabilities (530) 579 Accrued salaries and wages (327) (550) ---------- --------- Net cash provided by (used in) operating activities (1,843) 2,797 ---------- --------- Cash flows from investing activities: Proceeds from sale of securities 343 - Proceeds from sale of property and equipment 3 - Payments for purchases of property and equipment (937) (1,473) ---------- ---------- Net cash used in investing activities (591) (1,473) ---------- ---------- Cash flows from financing activities: Proceeds from issuance of note payable - bank 17,140 6,750 Repayments of note payable - bank (14,500) (6,750) ---------- --------- Net cash provided by financing activities 2,640 - --------- --------- Net increase in cash 206 1,324 Cash, beginning of period 835 959 --------- --------- Cash, end of period $ 1,041 $ 2,283 ========= ========= Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 45 $ 5 ========= ========= Income taxes $ 191 $ 57 ========= =========
See notes to the condensed consolidated financial statements Page 5 of 18 RAG SHOPS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE AND NINE MONTHS ENDED MAY 29, 2004 AND MAY 31, 2003 NOTE 1 - BASIS OF PRESENTATION The accompanying financial statements are unaudited, but in the opinion of management reflect all adjustments, which consist of normal recurring accruals necessary for a fair presentation of the consolidated financial statements for the interim periods. Since the Company's business is seasonal, the operating results for the three and nine months ended May 29, 2004 are not necessarily indicative of results for other quarters or the fiscal year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and notes included in the Company's Annual Report on Form 10-K/A for the year ended August 30, 2003 filed with the Securities and Exchange Commission in January 2004. Certain reclassifications have been made to prior year amounts in order to conform to the presentation for the current year. Accounting Policies Refer to the financial statements and notes included in the Company's Annual Report on Form 10-K/A for the complete disclosure of the Company's accounting policies. Certain policies are as follows: Cost of merchandise sold, distribution and occupancy costs include merchandise purchases, inbound freight costs, distribution costs, shrinkage provision, cooperative advertising, vendor allowances, vendor rebates, store rent and other store-related occupancy costs. Distribution costs have been reclassified to cost of merchandise sold as of the beginning of the quarter ended May 31, 2003. These expenses were previously included in selling, general and administrative expenses. All comparative periods have been restated. Cooperative advertising payments received from vendors have been reclassified to cost of merchandise sold as of the beginning of the quarter ended March 1, 2003. These payments were previously offset against advertising expenses. The amounts included in cost of merchandise sold related to cooperative advertising payments received was $358,000 and $1,177,000 for the three and nine months ended May 29, 2004, and $294,000 and $851,000 for the three and nine months ended May 31, 2003, respectively. All comparative periods have been restated. Advertising costs are expensed as incurred and are included in store expenses as part of selling, general and administrative expenses which amounted to $1,188,000 and $5,320,000 for the three and nine months ended May 29, 2004 and $1,332,000 and $5,076,000 for the three and nine months ended May 31, 2003, respectively. Recent Developments On February 25, 2004, the Company announced that it had retained the investment banking firm of SunTrust Robinson Humphrey to provide financial advisory services and review possible strategic alternatives for the Company, including, but not necessarily limited to, sale, merger or other corporate transactions, in an effort to maximize shareholder value. There is no assurance that any transaction will result from the engagement or that, if a transaction does occur, it will be on terms that all shareholders consider favorable. As of the date of this filing, the Company has no further developments to report. See Note 8. Page 6 of 18 Recent Accounting Pronouncements On March 31, 2004, the Financial Accounting Standards Board (FASB) issued a proposed Statement, Share-Based Payment that addresses the accounting for share-based awards to employees, including employee-stock-purchase-plans (ESPPs). The FASB formally proposed to require companies to recognize the fair value of stock options and other stock-based compensation to employees. The proposed Statement would eliminate the ability to account for stock-based compensation transactions using the intrinsic value method under APB Opinion No. 25, "Accounting for Stock Issued to Employees", and generally would require instead that such transactions be accounted for using a fair-value-based method. The proposed requirements in the exposure draft would be effective for public companies as of the beginning of the first fiscal year beginning after December 15, 2004. The Company currently accounts for its stock-based compensation plans in accordance with APB Opinion No. 25. Therefore, if the FASB adopts this proposed statement, as currently drafted, the Company will have to recognize fair value of the stock-based compensation in the consolidated statement of income rather than disclosing the pro forma impact of the stock-based compensation as the Company currently does. Stock-Based Compensation The Company has a stock based compensation plan which is described more fully in Note 5. The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations in accounting for its plan. There has been no compensation expense recognized during the three and nine months ended May 29, 2004 and May 31, 2003 as all options have been issued with exercise prices equal to the underlying stock's market price. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock Based Compensation":
Three Months Ended Nine Months Ended ------------------ ----------------- May 29, May 31, May 29, May 31, 2004 2003 2004 2003 ---- ---- ---- ---- Net income (loss), as reported $ (600,000) $ (251,000) $ (12,000) $ 350,000 Deduct: Total stock based employee compensation determined under fair value based method for options granted, modified, or settled, net of related tax effect 8,000 2,000 23,000 3,000 ----------- ---------- ---------- ---------- Pro forma net income (loss) $ (608,000) $ (253,000) $ (35,000) $ 347,000 =========== =========== ========== ========== Earnings (loss) per share Basic - as reported $ (.13) $ (.05) $ - $ .07 =========== =========== =========== =========== Basic - pro forma $ (.13) $ (.05) $ (.01) $ .07 =========== =========== =========== =========== Diluted - as reported $ (.13) $ (.05) $ - $ .07 =========== =========== =========== =========== Diluted - pro forma $ (.13) $ (.05) $ (.01) $ .07 =========== =========== =========== ===========
Page 7 of 18 NOTE 2 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
Three Months Ended Nine Months Ended ------------------ ----------------- May 29, May 31, May 29, May 31, 2004 2003 2004 2003 ---- ---- ---- ---- Numerator for basic and diluted Earnings per share: Net income (loss) $ (600,000) $ (251,000) $ (12,000) $ 350,000 =============== =============== ============= ============ Denominator: Denominator for basic earnings per share-weighted average shares 4,797,983 4,797,983 4,797,983 4,797,983 Effect of dilutive securities: Employee stock options - - - 28,004 ------------- ------------- --------------- --------------- Denominator for diluted earnings per share adjusted weighted average shares and assumed conversions 4,797,983 4,797,983 4,797,983 4,825,987 ------------ ------------ ------------ ------------ Basic earnings (loss) per share $ (.13) $ (.05) $ - $ .07 ============= ============= ============= ============= Diluted earnings (loss) per share $ (.13) $ (.05) $ - $ .07 ============= ============= ============= =============
Stock options excluded from the above calculation, as the effect of such options would be anti-dilutive, aggregated 146,700 both for the three and nine months ended May 29, 2004, and 173,700 and 0 for the three and nine months ended May 31, 2003, respectively. NOTE 3 - 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. The Company utilizes a method that weights the cost-to-retail ratio using multiple inventory categories. Physical inventories are conducted in the fourth quarter of the fiscal year and reconciled to the Company's financial records to determine shrinkage for the current fiscal year. The Company's estimated shrinkage accrual, based on previous results, is adjusted to current results in the fourth quarter of the fiscal year. NOTE 4 - 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. Estimates have been made by management in several areas, including but not limited to the reserve for inventory shrinkage, and the provision for income taxes and deferred income taxes. Management bases its estimates and judgements on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from these estimates. Page 8 of 18 NOTE 5 - STOCK OPTION PLAN On January 23, 2003, the stockholders of the Company approved the Company's 2002 Stock Option Plan (the "2002 Plan"). A copy of the 2002 Plan is set forth in the Proxy Statement filed by the Company with the Securities and Exchange Commission on December 30, 2002. The Company's prior stock option plan expired by its terms. As of May 29, 2004 an aggregate of 57,000 options remain outstanding under the prior plan. A total of 750,000 shares of Common Stock have been reserved for issuance under the 2002 Plan. As of May 29, 2004, 109,700 options have been granted and 20,000 options were forfeited pursuant to the 2002 Plan. NOTE 6 - ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES The following table sets forth selected accrued expenses and other current liabilities consisting of the following:
As of: May 29, 2004 May 31, 2003 August 30, 2003 ------------ ------------ --------------- (Amounts in thousands) Straight line rent $ 990 $ 805 $ 882 Other accrued expenses and current liabilities 2,795 2,728 3,433 --------- --------- ---------- $ 3,785 $ 3,533 $ 4,315 ========== ========== ==========
NOTE 7 - SCHEDULE OF COMPREHENSIVE INCOME (LOSS) The Schedule of Comprehensive Income (Loss) is as follows:
Three Months Ended Nine Months Ended ------------------ ----------------- May 29, May 31, May 29, May 31, 2004 2003 2004 2003 ---- ---- ---- ---- (Amounts in thousands) Net income (loss) $ (600) $ (251) $ (12) $ 350 Other comprehensive income, net of taxes: Unrealized gain on investment in common stock - 28 - 16 Reversal of unrealized gain due to sale of securities - - (72) - ---------- ---------- ---------- ---------- Comprehensive income (loss) $ (600) $ (223) $ (84) $ 366 =========== ========== =========== ==========
As a result of the sale of securities from "investment in common stock" in the second quarter of the current fiscal year, the "unrealized gain on investment in common stock, net of tax", previously reported in stockholders' equity, has been realized in net income. NOTE 8 - COMMITMENTS The Company entered into letter agreements dated May 12, 2004 with each of eight employees for retention payments to such employee(s) in the event that a change in control (as defined under the Company's Change of Control Agreement) occurs on or before December 31, 2004 and the employee remains employed by the Company, or its successor, ninety (90) days after such change of control. The aggregate potential amount of the payments that could be made by the Company under these agreements equals $540,000. Page 9 of 18 NOTE 9 - CREDIT FACILITY The Company maintains a $10 million 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 of 4.00% which remained constant throughout the nine months ended May 29, 2004. The credit facility requires the Company to maintain a compensating balance of $400,000 which is included in cash in the accompanying balance sheet and is subject to interest charges if not met, in addition to certain financial covenants. Historically, the amount borrowed has varied based on the Company's seasonal requirements, generally reaching a maximum amount outstanding during the fourth quarter of each fiscal year. The maximum amount borrowed under the line was $3,970,000 and $1,635,000 during the nine month periods ended May 29, 2004 and May 31, 2003, respectively. There was $2,640,000 of direct borrowings outstanding under the line of credit at May 29, 2004 and no direct borrowings were outstanding at May 31, 2003. The Company intends to maintain the availability of a line of credit for seasonal working capital requirements and in order to be able to take advantage of future opportunities. At May 29, 2004, the Company had outstanding letters of credit in the aggregate amount of $306,000. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q 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). Our actual results could materially differ from those discussed in these forward-looking statements. Recent Developments On February 25, 2004, the Company announced that it had retained the investment banking firm of SunTrust Robinson Humphrey to provide financial advisory services and review possible strategic alternatives for the Company, including, but not necessarily limited to, sale, merger or other corporate transactions, in an effort to maximize shareholder value. There is no assurance that any transaction will result from the engagement or that, if a transaction does occur, it will be on terms that all shareholders consider favorable. As of the date of this filing, the Company has no further developments to report. Page 10 of 18 Results of Operations The Company operated 67 and 69 stores, and leased retail square footage of 805,700 and 798,000 at the end of the third fiscal quarter of 2004 and 2003, respectively. The following table sets forth, as a percentage of net sales, certain items appearing in the condensed consolidated statements of income for the indicated periods.
Three Months Ended Nine Months Ended ------------------ ----------------- May 29, May 31, May 29, May 31, 2004 2003 2004 2003 ---- ---- ---- ---- Net sales 100.0% 100.0% 100.0% 100.0% Cost of merchandise sold, occupancy and distribution costs 67.0 67.1 66.3 66.4 -------- -------- -------- -------- Gross profit 33.0 32.9 33.7 33.6 Selling general and administrative expenses 36.4 34.5 33.8 32.9 Gain from sale of securities - - 0.1 - -------- -------- -------- -------- Income (loss) from operations (3.4) (1.6) 0.0 0.7 -------- -------- -------- -------- Net income (loss) (2.2)% (0.9)% (0.0)% 0.4% -------- -------- -------- --------
The Company's net sales decreased by $675,000 or 2.4% and increased $1,377,000 or 1.5% for the three and nine months ended May 29, 2004, respectively, compared to the comparable prior year periods. The decrease in net sales for the three months ended May 29, 2004 resulted from a decrease in comparable store sales of $891,000 or 3.3% partially offset by an increase of $216,000 related to revenue from larger new store openings, net of sales reductions for smaller closed stores. The Company's comparable store sales include stores commencing with their thirteenth consecutive entire fiscal month, including stores that were expanded but excluding stores that were relocated, if any. Management believes sales for the three months ended May 29, 2004 were adversely affected by the shift of Memorial Day from fiscal May to fiscal June in 2004, one less newspaper circular in the three months ended May 29, 2004 that was utilized in the immediate prior quarter compared to the comparable prior year periods, the inability to offer new merchandise as a result of the Company's efforts to manage the increase in merchandise inventories, and management's continuing expenditures of time and resources on the exploration of strategic alternatives consistent with its prior announcements. The increase in net sales for the nine months ended May 29, 2004 was attributable to a $2,759,000 increase from the larger new store sales, net of sales reductions from the smaller closed stores, partially offset by a $1,382,000 or 1.5% decrease in comparable store sales. In addition to the aforementioned shift of Memorial Day, the inability to offer new merchandise and management's diversion of time and resources in the three months ended May 29, 2004, sales for the nine months ended May 29, 2004 were also adversely affected by inclement weather in the three months ended February 28, 2004 and by changes in the Company's advertising program, implemented in the fourth quarter of 2003 that continued during the first quarter of fiscal 2004. The Company divides its business into three broad categories - fabrics, crafts and floral. For the nine-month period this year, crafts sales increased significantly over the comparable prior year period reflecting the Company's expanded merchandising programs and industry strength. Fabric sales continued to trend downwards for the three-month and nine-month periods this year compared to last year. Fabric sales continued to be soft in the third quarter, especially in apparel fabrics. The Company attributes softness in this area to its decision to reduce space allocated to fabrics in its stores and to general softness in the Page 11 of 18 fabrics industry. Floral sales declined for the nine-month period this year compared to last year. We attribute the decline in floral sales to reductions in inventory during the nine months ended May 29, 2004 as we prepared for product line changes that are currently being implemented at the direction of our new floral buyer. Gross profit, as a percentage of net sales, increased by 0.1 % for the three and nine months ended May 29, 2004, compared to the prior comparable periods. The increase for the current quarter resulted from an increase in vendor participation programs and a decrease in the provision for inventory shrinkage due to favorable results experienced during the physical inventory conducted in the final quarter of fiscal 2003 as compared to the prior comparable period, that was offset by the increase in occupancy costs resulting from the Company's termination of the lease of an underperforming store that required a payment of $147,000 to settle all lease obligations and due to additional square footage and rent costs associated with new larger stores as compared to smaller closed stores as well as lease term renewal increases in rent for existing stores. The increase in gross profit, as a percentage of net sales, for the nine months ended May 29, 2004 compared to the comparable prior period was principally due to the decrease in the provision for shrinkage and an increase in vendor participation programs that was offset by an increase in occupancy costs, all as previously mentioned, and by an increase in promotional markdowns, primarily in the three months ended November 29, 2003. Selling, general and administrative expenses increased for the three and nine months ended May 29, 2004 by $289,000 and $1,317,000, respectively, from the comparable prior periods. The increase for the current quarter was principally attributable to $241,000 of professional fees incurred in connection with the retention of SunTrust Robinson Humphrey, as described above, and higher depreciation due to the acceleration for leasehold improvements of four closed stores aggregating $112,000 in the current quarter in accordance with Financial Accounting Standards Board Statement No.146 "Accounting for Costs Associated with Exit or Disposal Activities", such increases were partially offset by a decrease in advertising costs as a result of one less newspaper circular, as mentioned above. The increase for the nine months ended May 29, 2004 was primarily due to the increase in professional fees and depreciation, as previously mentioned, an increase in advertising expense as a result of additional advertising and market penetration in the six months ended February 28, 2004 compared to the comparable period last year and higher insurance costs as a result of adverse market conditions when the Company's primary insurance policies were renewed in the third and fourth quarters last year. Selling, general and administrative expenses, as a percentage of net sales, increased by 1.9% and 0.9% for the three and nine months ended May 29, 2004, respectively, compared to the comparable prior year periods principally due to these expenses increasing at a greater rate than net sales. Excluding the additional professional fees and depreciation mentioned above, selling, general and administrative expenses, as a percentage of net sales, increased by 0.6% for the three and nine months ended May 29, 2004 compared to the comparable prior year periods. Interest income, net, decreased $10,000 for the three months ended May 29, 2004 from the comparable prior period due to increased borrowings under the credit facility and a decrease in average investment levels. Interest income, net, decreased by $35,000 for the nine months ended May 29, 2004, as compared to the comparable prior year period, due to a decrease in average investment levels coupled with a decline in interest rates on short-term investments in the six months ended February 28, 2004 versus the comparable prior year period and increased borrowings under the credit facility, as mentioned above. See "Liquidity and Capital Resources". Net loss increased by $349,000 for the three months ended May 29, 2004, as compared to the prior comparable period. The increase in net loss resulted from a decrease in net sales and the related decrease in gross profit, in addition to an increase in selling, general and administrative expenses. Net income decreased by $362,000 for the nine months ended May 29, 2004, as compared to the prior period. The decrease in net income is primarily due to an increase in selling, general and administrative expenses that was partially offset by the increase in net sales and the related increase in gross profit in addition to the realized gain from the sale of securities. Page 12 of 18 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 traditionally occur between September and December. The Company has historically operated at a loss during the fourth quarter of its fiscal year, the June through August summer period. Year to year comparisons of quarterly results and comparable store sales can be affected by a variety of factors, including the timing and duration of holiday selling seasons and the timing of new store openings and promotional markdowns. Liquidity and Capital Resources The Company's primary needs for liquidity are to maintain inventory for the Company's existing stores and to fund the costs of opening new stores, including capital improvements, initial inventory and pre-opening expenses. During the nine months ended May 29, 2004, the Company relied on internally generated funds, credit made available by suppliers and short-term borrowings to finance inventories and new store openings. The Company's working capital decreased $129,000 for the nine months ended May 24, 2004 as compared to the August 30, 2003 amount. The Company maintains a $10 million 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 of 4.00% which remained constant throughout the nine months ended May 29, 2004. The credit facility requires the Company to maintain a compensating balance of $400,000 which is included in cash in the accompanying balance sheet and is subject to interest charges if not met, in addition to certain financial covenants. Historically, the amount borrowed has varied based on the Company's seasonal requirements, generally reaching a maximum amount outstanding during the fourth quarter of each fiscal year. The maximum amount borrowed under the line was $3,970,000 and $1,635,000 during the nine month periods ended May 29, 2004 and May 31, 2003, respectively. There was $2,640,000 of direct borrowings outstanding under the line of credit at May 29, 2004 and no direct borrowings were outstanding at May 31, 2003. The Company intends to maintain the availability of a line of credit for seasonal working capital requirements and in order to be able to take advantage of future opportunities. At May 29, 2004, the Company had outstanding letters of credit in the aggregate amount of $306,000. Net cash used by operating activities for the nine months ended May 29, 2004 amounted to $1,843,000, and $937,000 was used for purchases of property and equipment. Net cash used by operating activities resulted primarily from a decrease in accounts payable-trade of $3,771,000 and a decrease in accrued expenses and other current liabilities of $530,000 that were partially offset by a decrease in merchandise inventories of $2,418,000. During the nine months ended May 29, 2004, the Company opened one store, closed two stores, relocated two stores and was operating sixty-seven stores at the end of the period. During the remainder of the fiscal year ending August 28, 2004, the Company will open one additional new store and anticipates relocating one store and not closing any stores. Costs associated with the opening of new stores, including capital expenditures, inventory and pre-opening expenses, approximated $725,000 per store in fiscal 2003. These costs associated with the contemplated store openings in fiscal 2004 will be financed primarily from cash provided by operating activities, credit made available by suppliers to finance inventories and 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 arise in order to curtail the costs of opening stores. The Company believes that its cash at May 29, 2004, 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. Page 13 of 18 Critical Accounting Policies Refer to the financial statements and notes included in the Company's Annual Report on Form 10-K/A for the complete disclosure of the Company's accounting policies. Certain policies are as follows: Cost of merchandise sold, distribution and occupancy costs include merchandise purchases, inbound freight costs, distribution costs, shrinkage provision, cooperative advertising, vendor allowances, vendor rebates, store rent and other store-related occupancy costs. Distribution costs have been reclassified to cost of merchandise sold as of the beginning of the quarter ended May 31, 2003. These expenses were previously included in selling, general and administrative expenses. All comparative periods have been restated. Cooperative advertising payments received from vendors have been reclassified to cost of merchandise sold as of the beginning of the quarter ended March 1, 2003. These payments were previously offset against advertising expenses. The amounts included in cost of merchandise sold related to cooperative advertising payments received was $358,000 and $1,177,000 for the three and nine months ended May 29, 2004, and $294,000 and $851,000 for the three and nine months ended May 31, 2003, respectively. All comparative periods have been restated. Advertising costs are expensed as incurred and are included in store expenses as part of selling, general and administrative expenses which amounted to $1,188,000 and $5,320,000 for the three and nine months ended May 29, 2004 and $1,332,000 and $5,076,000 for the and nine months ended May 31, 2003, respectively. Recent Accounting Standards On March 31, 2004, the Financial Accounting Standards Board (FASB) issued a proposed Statement, Share-Based Payment that addresses the accounting for share-based awards to employees, including employee-stock-purchase-plans (ESPPs). The FASB formally proposed to require companies to recognize the fair value of stock options and other stock-based compensation to employees. The proposed Statement would eliminate the ability to account for stock-based compensation transactions using the intrinsic value method under APB Opinion No. 25, "Accounting for Stock Issued to Employees", and generally would require instead that such transactions be accounted for using a fair-value-based method. The proposed requirements in the exposure draft would be effective for public companies as of the beginning of the first fiscal year beginning after December 15, 2004. The Company currently accounts for its stock-based compensation plans in accordance with APB Opinion No. 25. Therefore, if the FASB adopts this proposed statement, as currently drafted, the Company will have to recognize fair value of the stock-based compensation in the consolidated statement of income rather than disclosing the pro forma impact of the stock-based compensation as the Company currently does. Item 3. 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 May 29, 2004 and May 31, 2003, and during each of the quarters 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. Loans outstanding under the Company's unsecured line of credit bear interest at the bank's prime rate (4.00% at May 29, 2004). There was $2,640,000 of direct borrowings outstanding under the line of credit at May 29, 2004 and no direct borrowings were outstanding at May 31, 2003. Page 14 of 18 The following table details future projected payments for the Company's significant contractual obligations as of May 29, 2004:
Computer and Other Technology Operating Leases Related Commitments Total Three Months Ending: 2004 $ 2,445,809 $ 111,475 $ 2,557,284 Fiscal Year Ending: 2005 9,644,415 98,761 9,743,176 2006 8,381,106 55,061 8,436,167 2007 7,060,410 1,519 7,061,929 2008 5,767,464 0 5,767,464 Thereafter 13,150,174 0 13,150,174 ------------- ----------- ---------- $ 46,449,378 $ 266,816 $ 46,716,194 ============= =========== ==========
The Company entered into letter agreements dated May 12, 2004 with each of eight employees for retention payments to such employee(s) in the event that a change in control (as defined under the Company's Change of Control Agreement) occurs on or before December 31, 2004 and the employee remains employed by the Company, or its successor, ninety (90) days after such change of control. The aggregate potential amount of the payments that could be made by the Company under these agreements equals $540,000. Item 4. 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 as of the end of the period covered by this report, the Chief Executive and Acting 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. It should be noted that any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Page 15 of 18 PART II - OTHER INFORMATION Items 1.-5. Not Applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.1 Change of Control Agreement, effective May 12, 2004 made by the Company on behalf of John Alberto 10.2 Change of Control Agreement, effective May 12, 2004 made by the Company on behalf of Steven B. Barnett 10.3 Change of Control Agreement, effective May 12, 2004 made by the Company on behalf of Patricia Dahlem 10.4 Change of Control Agreement, effective May 12, 2004 made by the Company on behalf of Jeffrey C. Gerstel 10.5 Change of Control Agreement, effective May 12, 2004 made by the Company on behalf of Judith Lombardo 10.6 Change of Control Agreement, effective May 12, 2004 made by the Company on behalf of Bruce Miller 10.7 Change of Control Agreement, effective May 12, 2004 made by the Company on behalf of Leonard Settanni 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) 99.2 Certification of Acting Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) (b) No reports on Form 8-K have been filed during the quarter ended May 29, 2004. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. RAG SHOPS, INC. Date: July 13, 2004 /S/ Stanley Berenzweig Stanley Berenzweig Chairman of the Board and Chief Executive Officer Date: July 13, 2004 /S/ Steven B. Barnett --------------------- Steven B. Barnett Acting Principal Financial Officer, and Acting Principal Accounting Officer Page 16 of 18 CERTIFICATIONS I, Stanley Berenzweig, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Rag Shops, Inc.; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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 we 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 quarterly 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 quarterly report ( the "Evaluation Date"); and c) presented in this quarterly 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 (or persons performing the equivalent function): 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 quarterly 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 July 13, 2004 ---------------------- and Director Stanley Berenzweig Page 17 of 18 CERTIFICATIONS I, Steven B. Barnett, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Rag Shops, Inc.; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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 we 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 quarterly 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 quarterly report ( the "Evaluation Date"); and c) presented in this quarterly 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 (or persons performing the equivalent function): 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 quarterly 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, July 13, 2004 ---------------------- Acting Chief Financial Officer Steven B. Barnett Page 18 of 18 EXHIBIT 10.1 CHANGE OF CONTROL AGREEMENT THIS CHANGE OF CONTROL AGREEMENT (this "Agreement") is effective as of the 12th day of May, 2004 (the "Effective Date"), and made by RAG SHOPS, INC. on behalf of itself and its subsidiaries (collectively, the "Company") for the benefit of John Alberto (the "Employee"). WHEREAS, the Employee is currently employed by the Company; and WHEREAS, the Board of Directors of the Company or a committee thereof (collectively, the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued services and dedication of the Employee, notwithstanding the possibility or occurrence of a sale of the Company or a tender offer, merger, consolidation, dissolution or other corporate transaction involving the Company resulting in a change of control which would require the filing by the Company under the Securities Exchange Act of 1934, as amended, of a Current Report on Form 8-K (collectively, a "Change of Control"); and WHEREAS, in order to accomplish the foregoing objective, the Board has authorized and directed the Company to enter into this Agreement; NOW, THEREFORE, the Company hereby agrees for the benefit of the Employee as follows: 1. Change of Control Payment. In the event that prior to the termination of this Agreement (as determined in accordance with Section 3 hereof), (i) a Change of Control shall have occurred, and (ii) (A) the Employee's employment with the Company is terminated by the Company without Cause (as hereinafter defined) within the period ending ninety (90) calendar days after such Change of Control (the "Relevant Period") or (B) the Employee remains an employee of the Company for the entire Relevant Period, then the Company shall pay to the Employee (in addition to any other amounts that may be due and owing to the Employee by the Company), in a single lump sum payment within thirty (30) days after the Relevant Period, an amount equal to $30,000.00. 2. Cause. The term "Cause" shall mean (i) the willful failure of the Employee substantially to perform the duties of his employment (other than any such failure resulting from incapacity due to physical or mental illness) for at least five (5) days after a written demand for substantial performance is delivered to the Employee by the Company which specifically identifies the manner in which the Company believes the Employee has not substantially performed the duties of his employment; (ii) the Employee's engaging in conduct that constitutes neglect or willful misconduct in carrying out the duties of his employment or that is injurious to the Company or any of its affiliates; (iii) the Employee's arrest for, conviction of, or entering a plea of guilty, nolo contendere (or similar plea) to a crime that constitutes a felony or any crime of moral turpitude; (iv) the Employee's directly or indirectly selling, passing on or otherwise using or disclosing, without permission, any confidential information of the Company; or (v) the Employee's direct or indirect participation in business activities in competition with the Company. 3. Term. This Agreement shall become effective on the Effective Date and shall terminate on the earliest to occur of the following events: (i) on December 31, 2004, if no Change of Control has occurred prior to December 31, 2004; and (ii) on the date of the cessation of employment with the Company, (a) if the Employee ceases to be employed by the Company for any reason (including, without limitation, as a result of death, disability, resignation or termination with or without Cause) prior to the occurrence of a Change of Control or (b) if the Employee ceases to be employed by the Company for any reason other than termination of the employment by the Company without Cause after a Change of Control shall have occurred, but within the Relevant Period. 4. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. 5. Assignability. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. The Company shall require any corporation, entity, individual or other person who is the successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform, by a written agreement, all of the obligations of the Company under this Agreement, prior to or contemporaneously with a Change of Control. As used in this Agreement, the term "Company" shall mean the Company as defined above and any successor to its business and/or assets as described herein which assumes and agrees to perform this Agreement by operation of law, written agreement, or otherwise. 6. Waiver. This Agreement may not be changed or terminated without the prior written agreement of both the Company and the Employee. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any breach of the same or any other term or condition of this Agreement. 7. Severability. In the event any provision of this Agreement is found to be unenforceable or invalid, such provision shall be severable from this Agreement and shall not affect the enforceability or validity of any other provision of this Agreement. If any provision of this Agreement is capable to two constructions, one of which would render the provision void and the other that would render the provision valid, then the provision shall have the construction that renders it valid. 8. This Agreement Not a Contract of Employment For Any Reason. This Agreement is not a contract of employment and the terms of employment of the Employee including, without limitation, his or her status as an employee-at-will, shall not be affected in any way by this Agreement. The grant and delivery of this Agreement shall not be construed as conferring any legal rights upon the Employee for a continuation of employment, nor shall it interfere with the right of the Company or any subsidiary to discharge the Employee. IN WITNESS WHEREOF, the undersigned has duly executed this Agreement as of the Effective Date on behalf of the Company. RAG SHOPS, INC. By: /S/ Jeffrey C. Gerstel ----------------------------- Name: Jeffrey C. Gerstel Title: President EXHIBIT 10.2 CHANGE OF CONTROL AGREEMENT THIS CHANGE OF CONTROL AGREEMENT (this "Agreement") is effective as of the 12th day of May, 2004 (the "Effective Date"), and made by RAG SHOPS, INC. on behalf of itself and its subsidiaries (collectively, the "Company") for the benefit of Steven B. Barnett (the "Employee"). WHEREAS, the Employee is currently employed by the Company; and WHEREAS, the Board of Directors of the Company or a committee thereof (collectively, the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued services and dedication of the Employee, notwithstanding the possibility or occurrence of a sale of the Company or a tender offer, merger, consolidation, dissolution or other corporate transaction involving the Company resulting in a change of control which would require the filing by the Company under the Securities Exchange Act of 1934, as amended, of a Current Report on Form 8-K (collectively, a "Change of Control"); and WHEREAS, in order to accomplish the foregoing objective, the Board has authorized and directed the Company to enter into this Agreement; NOW, THEREFORE, the Company hereby agrees for the benefit of the Employee as follows: 1. Change of Control Payment. In the event that prior to the termination of this Agreement (as determined in accordance with Section 3 hereof), (i) a Change of Control shall have occurred, and (ii) (A) the Employee's employment with the Company is terminated by the Company without Cause (as hereinafter defined) within the period ending ninety (90) calendar days after such Change of Control (the "Relevant Period") or (B) the Employee remains an employee of the Company for the entire Relevant Period, then the Company shall pay to the Employee (in addition to any other amounts that may be due and owing to the Employee by the Company), in a single lump sum payment within thirty (30) days after the Relevant Period, an amount equal to $145,000.00. 2. Cause. The term "Cause" shall mean (i) the willful failure of the Employee substantially to perform the duties of his employment (other than any such failure resulting from incapacity due to physical or mental illness) for at least five (5) days after a written demand for substantial performance is delivered to the Employee by the Company which specifically identifies the manner in which the Company believes the Employee has not substantially performed the duties of his employment; (ii) the Employee's engaging in conduct that constitutes neglect or willful misconduct in carrying out the duties of his employment or that is injurious to the Company or any of its affiliates; (iii) the Employee's arrest for, conviction of, or entering a plea of guilty, nolo contendere (or similar plea) to a crime that constitutes a felony or any crime of moral turpitude; (iv) the Employee's directly or indirectly selling, passing on or otherwise using or disclosing, without permission, any confidential information of the Company; or (v) the Employee's direct or indirect participation in business activities in competition with the Company. 3. Term. This Agreement shall become effective on the Effective Date and shall terminate on the earliest to occur of the following events: (i) on December 31, 2004, if no Change of Control has occurred prior to December 31, 2004; and (ii) on the date of the cessation of employment with the Company, (a) if the Employee ceases to be employed by the Company for any reason (including, without limitation, as a result of death, disability, resignation or termination with or without Cause) prior to the occurrence of a Change of Control or (b) if the Employee ceases to be employed by the Company for any reason other than termination of the employment by the Company without Cause after a Change of Control shall have occurred, but within the Relevant Period. 4. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. 5. Assignability. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. The Company shall require any corporation, entity, individual or other person who is the successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform, by a written agreement, all of the obligations of the Company under this Agreement, prior to or contemporaneously with a Change of Control. As used in this Agreement, the term "Company" shall mean the Company as defined above and any successor to its business and/or assets as described herein which assumes and agrees to perform this Agreement by operation of law, written agreement, or otherwise. 6. Waiver. This Agreement may not be changed or terminated without the prior written agreement of both the Company and the Employee. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any breach of the same or any other term or condition of this Agreement. 7. Severability. In the event any provision of this Agreement is found to be unenforceable or invalid, such provision shall be severable from this Agreement and shall not affect the enforceability or validity of any other provision of this Agreement. If any provision of this Agreement is capable to two constructions, one of which would render the provision void and the other that would render the provision valid, then the provision shall have the construction that renders it valid. 8. This Agreement Not a Contract of Employment For Any Reason. This Agreement is not a contract of employment and the terms of employment of the Employee including, without limitation, his or her status as an employee-at-will, shall not be affected in any way by this Agreement. The grant and delivery of this Agreement shall not be construed as conferring any legal rights upon the Employee for a continuation of employment, nor shall it interfere with the right of the Company or any subsidiary to discharge the Employee. IN WITNESS WHEREOF, the undersigned has duly executed this Agreement as of the Effective Date on behalf of the Company. RAG SHOPS, INC. By: /S/ Jeffrey C. Gerstel ---------------------------- Name: Jeffrey C. Gerstel Title: President EXHIBIT 10.3 CHANGE OF CONTROL AGREEMENT THIS CHANGE OF CONTROL AGREEMENT (this "Agreement") is effective as of the 12th day of May, 2004 (the "Effective Date"), and made by RAG SHOPS, INC. on behalf of itself and its subsidiaries (collectively, the "Company") for the benefit of Patricia Dahlem (the "Employee"). WHEREAS, the Employee is currently employed by the Company; and WHEREAS, the Board of Directors of the Company or a committee thereof (collectively, the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued services and dedication of the Employee, notwithstanding the possibility or occurrence of a sale of the Company or a tender offer, merger, consolidation, dissolution or other corporate transaction involving the Company resulting in a change of control which would require the filing by the Company under the Securities Exchange Act of 1934, as amended, of a Current Report on Form 8-K (collectively, a "Change of Control"); and WHEREAS, in order to accomplish the foregoing objective, the Board has authorized and directed the Company to enter into this Agreement; NOW, THEREFORE, the Company hereby agrees for the benefit of the Employee as follows: 1. Change of Control Payment. In the event that prior to the termination of this Agreement (as determined in accordance with Section 3 hereof), (i) a Change of Control shall have occurred, and (ii) (A) the Employee's employment with the Company is terminated by the Company without Cause (as hereinafter defined) within the period ending ninety (90) calendar days after such Change of Control (the "Relevant Period") or (B) the Employee remains an employee of the Company for the entire Relevant Period, then the Company shall pay to the Employee (in addition to any other amounts that may be due and owing to the Employee by the Company), in a single lump sum payment within thirty (30) days after the Relevant Period, an amount equal to $30,000.00. 2. Cause. The term "Cause" shall mean (i) the willful failure of the Employee substantially to perform the duties of his employment (other than any such failure resulting from incapacity due to physical or mental illness) for at least five (5) days after a written demand for substantial performance is delivered to the Employee by the Company which specifically identifies the manner in which the Company believes the Employee has not substantially performed the duties of his employment; (ii) the Employee's engaging in conduct that constitutes neglect or willful misconduct in carrying out the duties of his employment or that is injurious to the Company or any of its affiliates; (iii) the Employee's arrest for, conviction of, or entering a plea of guilty, nolo contendere (or similar plea) to a crime that constitutes a felony or any crime of moral turpitude; (iv) the Employee's directly or indirectly selling, passing on or otherwise using or disclosing, without permission, any confidential information of the Company; or (v) the Employee's direct or indirect participation in business activities in competition with the Company. 3. Term. This Agreement shall become effective on the Effective Date and shall terminate on the earliest to occur of the following events: (i) on December 31, 2004, if no Change of Control has occurred prior to December 31, 2004; and (ii) on the date of the cessation of employment with the Company, (a) if the Employee ceases to be employed by the Company for any reason (including, without limitation, as a result of death, disability, resignation or termination with or without Cause) prior to the occurrence of a Change of Control or (b) if the Employee ceases to be employed by the Company for any reason other than termination of the employment by the Company without Cause after a Change of Control shall have occurred, but within the Relevant Period. 4. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. 5. Assignability. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. The Company shall require any corporation, entity, individual or other person who is the successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform, by a written agreement, all of the obligations of the Company under this Agreement, prior to or contemporaneously with a Change of Control. As used in this Agreement, the term "Company" shall mean the Company as defined above and any successor to its business and/or assets as described herein which assumes and agrees to perform this Agreement by operation of law, written agreement, or otherwise. 6. Waiver. This Agreement may not be changed or terminated without the prior written agreement of both the Company and the Employee. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any breach of the same or any other term or condition of this Agreement. 7. Severability. In the event any provision of this Agreement is found to be unenforceable or invalid, such provision shall be severable from this Agreement and shall not affect the enforceability or validity of any other provision of this Agreement. If any provision of this Agreement is capable to two constructions, one of which would render the provision void and the other that would render the provision valid, then the provision shall have the construction that renders it valid. 8. This Agreement Not a Contract of Employment For Any Reason. This Agreement is not a contract of employment and the terms of employment of the Employee including, without limitation, his or her status as an employee-at-will, shall not be affected in any way by this Agreement. The grant and delivery of this Agreement shall not be construed as conferring any legal rights upon the Employee for a continuation of employment, nor shall it interfere with the right of the Company or any subsidiary to discharge the Employee. IN WITNESS WHEREOF, the undersigned has duly executed this Agreement as of the Effective Date on behalf of the Company. RAG SHOPS, INC. By: /S/ Jeffrey C. Gerstel ----------------------------- Name: Jeffrey C. Gerstel Title: President EXHIBIT 10.4 CHANGE OF CONTROL AGREEMENT THIS CHANGE OF CONTROL AGREEMENT (this "Agreement") is effective as of the 12th day of May, 2004 (the "Effective Date"), and made by RAG SHOPS, INC. on behalf of itself and its subsidiaries (collectively, the "Company") for the benefit of Jeffrey C. Gerstel (the "Employee"). WHEREAS, the Employee is currently employed by the Company; and WHEREAS, the Board of Directors of the Company or a committee thereof (collectively, the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued services and dedication of the Employee, notwithstanding the possibility or occurrence of a sale of the Company or a tender offer, merger, consolidation, dissolution or other corporate transaction involving the Company resulting in a change of control which would require the filing by the Company under the Securities Exchange Act of 1934, as amended, of a Current Report on Form 8-K (collectively, a "Change of Control"); and WHEREAS, in order to accomplish the foregoing objective, the Board has authorized and directed the Company to enter into this Agreement; NOW, THEREFORE, the Company hereby agrees for the benefit of the Employee as follows: 1. Change of Control Payment. In the event that prior to the termination of this Agreement (as determined in accordance with Section 3 hereof), (i) a Change of Control shall have occurred, and (ii) (A) the Employee's employment with the Company is terminated by the Company without Cause (as hereinafter defined) within the period ending ninety (90) calendar days after such Change of Control (the "Relevant Period") or (B) the Employee remains an employee of the Company for the entire Relevant Period, then the Company shall pay to the Employee (in addition to any other amounts that may be due and owing to the Employee by the Company), in a single lump sum payment within thirty (30) days after the Relevant Period, an amount equal to $100,000.00. 2. Cause. The term "Cause" shall mean (i) the willful failure of the Employee substantially to perform the duties of his employment (other than any such failure resulting from incapacity due to physical or mental illness) for at least five (5) days after a written demand for substantial performance is delivered to the Employee by the Company which specifically identifies the manner in which the Company believes the Employee has not substantially performed the duties of his employment; (ii) the Employee's engaging in conduct that constitutes neglect or willful misconduct in carrying out the duties of his employment or that is injurious to the Company or any of its affiliates; (iii) the Employee's arrest for, conviction of, or entering a plea of guilty, nolo contendere (or similar plea) to a crime that constitutes a felony or any crime of moral turpitude; (iv) the Employee's directly or indirectly selling, passing on or otherwise using or disclosing, without permission, any confidential information of the Company; or (v) the Employee's direct or indirect participation in business activities in competition with the Company. 3. Term. This Agreement shall become effective on the Effective Date and shall terminate on the earliest to occur of the following events: (i) on December 31, 2004, if no Change of Control has occurred prior to December 31, 2004; and (ii) on the date of the cessation of employment with the Company, (a) if the Employee ceases to be employed by the Company for any reason (including, without limitation, as a result of death, disability, resignation or termination with or without Cause) prior to the occurrence of a Change of Control or (b) if the Employee ceases to be employed by the Company for any reason other than termination of the employment by the Company without Cause after a Change of Control shall have occurred, but within the Relevant Period. 4. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. 5. Assignability. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. The Company shall require any corporation, entity, individual or other person who is the successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform, by a written agreement, all of the obligations of the Company under this Agreement, prior to or contemporaneously with a Change of Control. As used in this Agreement, the term "Company" shall mean the Company as defined above and any successor to its business and/or assets as described herein which assumes and agrees to perform this Agreement by operation of law, written agreement, or otherwise. 6. Waiver. This Agreement may not be changed or terminated without the prior written agreement of both the Company and the Employee. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any breach of the same or any other term or condition of this Agreement. 7. Severability. In the event any provision of this Agreement is found to be unenforceable or invalid, such provision shall be severable from this Agreement and shall not affect the enforceability or validity of any other provision of this Agreement. If any provision of this Agreement is capable to two constructions, one of which would render the provision void and the other that would render the provision valid, then the provision shall have the construction that renders it valid. 8. This Agreement Not a Contract of Employment For Any Reason. This Agreement is not a contract of employment and the terms of employment of the Employee including, without limitation, his or her status as an employee-at-will, shall not be affected in any way by this Agreement. The grant and delivery of this Agreement shall not be construed as conferring any legal rights upon the Employee for a continuation of employment, nor shall it interfere with the right of the Company or any subsidiary to discharge the Employee. IN WITNESS WHEREOF, the undersigned has duly executed this Agreement as of the Effective Date on behalf of the Company. RAG SHOPS, INC. By: /S/ Stanley Berenzweig ------------------------- Name: Stanley Berenzweig Title: Chief Executive Officer EXHIBIT 10.5 CHANGE OF CONTROL AGREEMENT THIS CHANGE OF CONTROL AGREEMENT (this "Agreement") is effective as of the 12th day of May, 2004 (the "Effective Date"), and made by RAG SHOPS, INC. on behalf of itself and its subsidiaries (collectively, the "Company") for the benefit of Judith Lombardo (the "Employee"). WHEREAS, the Employee is currently employed by the Company; and WHEREAS, the Board of Directors of the Company or a committee thereof (collectively, the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued services and dedication of the Employee, notwithstanding the possibility or occurrence of a sale of the Company or a tender offer, merger, consolidation, dissolution or other corporate transaction involving the Company resulting in a change of control which would require the filing by the Company under the Securities Exchange Act of 1934, as amended, of a Current Report on Form 8-K (collectively, a "Change of Control"); and WHEREAS, in order to accomplish the foregoing objective, the Board has authorized and directed the Company to enter into this Agreement; NOW, THEREFORE, the Company hereby agrees for the benefit of the Employee as follows: 1. Change of Control Payment. In the event that prior to the termination of this Agreement (as determined in accordance with Section 3 hereof), (i) a Change of Control shall have occurred, and (ii) (A) the Employee's employment with the Company is terminated by the Company without Cause (as hereinafter defined) within the period ending ninety (90) calendar days after such Change of Control (the "Relevant Period") or (B) the Employee remains an employee of the Company for the entire Relevant Period, then the Company shall pay to the Employee (in addition to any other amounts that may be due and owing to the Employee by the Company), in a single lump sum payment within thirty (30) days after the Relevant Period, an amount equal to $145,000.00. 2. Cause. The term "Cause" shall mean (i) the willful failure of the Employee substantially to perform the duties of his employment (other than any such failure resulting from incapacity due to physical or mental illness) for at least five (5) days after a written demand for substantial performance is delivered to the Employee by the Company which specifically identifies the manner in which the Company believes the Employee has not substantially performed the duties of his employment; (ii) the Employee's engaging in conduct that constitutes neglect or willful misconduct in carrying out the duties of his employment or that is injurious to the Company or any of its affiliates; (iii) the Employee's arrest for, conviction of, or entering a plea of guilty, nolo contendere (or similar plea) to a crime that constitutes a felony or any crime of moral turpitude; (iv) the Employee's directly or indirectly selling, passing on or otherwise using or disclosing, without permission, any confidential information of the Company; or (v) the Employee's direct or indirect participation in business activities in competition with the Company. 3. Term. This Agreement shall become effective on the Effective Date and shall terminate on the earliest to occur of the following events: (i) on December 31, 2004, if no Change of Control has occurred prior to December 31, 2004; and (ii) on the date of the cessation of employment with the Company, (a) if the Employee ceases to be employed by the Company for any reason (including, without limitation, as a result of death, disability, resignation or termination with or without Cause) prior to the occurrence of a Change of Control or (b) if the Employee ceases to be employed by the Company for any reason other than termination of the employment by the Company without Cause after a Change of Control shall have occurred, but within the Relevant Period. 4. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. 5. Assignability. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. The Company shall require any corporation, entity, individual or other person who is the successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform, by a written agreement, all of the obligations of the Company under this Agreement, prior to or contemporaneously with a Change of Control. As used in this Agreement, the term "Company" shall mean the Company as defined above and any successor to its business and/or assets as described herein which assumes and agrees to perform this Agreement by operation of law, written agreement, or otherwise. 6. Waiver. This Agreement may not be changed or terminated without the prior written agreement of both the Company and the Employee. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any breach of the same or any other term or condition of this Agreement. 7. Severability. In the event any provision of this Agreement is found to be unenforceable or invalid, such provision shall be severable from this Agreement and shall not affect the enforceability or validity of any other provision of this Agreement. If any provision of this Agreement is capable to two constructions, one of which would render the provision void and the other that would render the provision valid, then the provision shall have the construction that renders it valid. 8. This Agreement Not a Contract of Employment For Any Reason. This Agreement is not a contract of employment and the terms of employment of the Employee including, without limitation, his or her status as an employee-at-will, shall not be affected in any way by this Agreement. The grant and delivery of this Agreement shall not be construed as conferring any legal rights upon the Employee for a continuation of employment, nor shall it interfere with the right of the Company or any subsidiary to discharge the Employee. IN WITNESS WHEREOF, the undersigned has duly executed this Agreement as of the Effective Date on behalf of the Company. RAG SHOPS, INC. By: /S/ Jeffrey C. Gerstel ----------------------------- Name: Jeffrey C. Gerstel Title: President EXHIBIT 10.6 CHANGE OF CONTROL AGREEMENT THIS CHANGE OF CONTROL AGREEMENT (this "Agreement") is effective as of the 12th day of May, 2004 (the "Effective Date"), and made by RAG SHOPS, INC. on behalf of itself and its subsidiaries (collectively, the "Company") for the benefit of Bruce Miller (the "Employee"). WHEREAS, the Employee is currently employed by the Company; and WHEREAS, the Board of Directors of the Company or a committee thereof (collectively, the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued services and dedication of the Employee, notwithstanding the possibility or occurrence of a sale of the Company or a tender offer, merger, consolidation, dissolution or other corporate transaction involving the Company resulting in a change of control which would require the filing by the Company under the Securities Exchange Act of 1934, as amended, of a Current Report on Form 8-K (collectively, a "Change of Control"); and WHEREAS, in order to accomplish the foregoing objective, the Board has authorized and directed the Company to enter into this Agreement; NOW, THEREFORE, the Company hereby agrees for the benefit of the Employee as follows: 1. Change of Control Payment. In the event that prior to the termination of this Agreement (as determined in accordance with Section 3 hereof), (i) a Change of Control shall have occurred, and (ii) (A) the Employee's employment with the Company is terminated by the Company without Cause (as hereinafter defined) within the period ending ninety (90) calendar days after such Change of Control (the "Relevant Period") or (B) the Employee remains an employee of the Company for the entire Relevant Period, then the Company shall pay to the Employee (in addition to any other amounts that may be due and owing to the Employee by the Company), in a single lump sum payment within thirty (30) days after the Relevant Period, an amount equal to $10,000.00. 2. Cause. The term "Cause" shall mean (i) the willful failure of the Employee substantially to perform the duties of his employment (other than any such failure resulting from incapacity due to physical or mental illness) for at least five (5) days after a written demand for substantial performance is delivered to the Employee by the Company which specifically identifies the manner in which the Company believes the Employee has not substantially performed the duties of his employment; (ii) the Employee's engaging in conduct that constitutes neglect or willful misconduct in carrying out the duties of his employment or that is injurious to the Company or any of its affiliates; (iii) the Employee's arrest for, conviction of, or entering a plea of guilty, nolo contendere (or similar plea) to a crime that constitutes a felony or any crime of moral turpitude; (iv) the Employee's directly or indirectly selling, passing on or otherwise using or disclosing, without permission, any confidential information of the Company; or (v) the Employee's direct or indirect participation in business activities in competition with the Company. 3. Term. This Agreement shall become effective on the Effective Date and shall terminate on the earliest to occur of the following events: (i) on December 31, 2004, if no Change of Control has occurred prior to December 31, 2004; and (ii) on the date of the cessation of employment with the Company, (a) if the Employee ceases to be employed by the Company for any reason (including, without limitation, as a result of death, disability, resignation or termination with or without Cause) prior to the occurrence of a Change of Control or (b) if the Employee ceases to be employed by the Company for any reason other than termination of the employment by the Company without Cause after a Change of Control shall have occurred, but within the Relevant Period. 4. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. 5. Assignability. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. The Company shall require any corporation, entity, individual or other person who is the successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform, by a written agreement, all of the obligations of the Company under this Agreement, prior to or contemporaneously with a Change of Control. As used in this Agreement, the term "Company" shall mean the Company as defined above and any successor to its business and/or assets as described herein which assumes and agrees to perform this Agreement by operation of law, written agreement, or otherwise. 6. Waiver. This Agreement may not be changed or terminated without the prior written agreement of both the Company and the Employee. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any breach of the same or any other term or condition of this Agreement. 7. Severability. In the event any provision of this Agreement is found to be unenforceable or invalid, such provision shall be severable from this Agreement and shall not affect the enforceability or validity of any other provision of this Agreement. If any provision of this Agreement is capable to two constructions, one of which would render the provision void and the other that would render the provision valid, then the provision shall have the construction that renders it valid. 8. This Agreement Not a Contract of Employment For Any Reason. This Agreement is not a contract of employment and the terms of employment of the Employee including, without limitation, his or her status as an employee-at-will, shall not be affected in any way by this Agreement. The grant and delivery of this Agreement shall not be construed as conferring any legal rights upon the Employee for a continuation of employment, nor shall it interfere with the right of the Company or any subsidiary to discharge the Employee. IN WITNESS WHEREOF, the undersigned has duly executed this Agreement as of the Effective Date on behalf of the Company. RAG SHOPS, INC. By: /S/ Jeffrey C. Gerstel ----------------------------- Name: Jeffrey C. Gerstel Title: President EXHIBIT 10.7 CHANGE OF CONTROL AGREEMENT THIS CHANGE OF CONTROL AGREEMENT (this "Agreement") is effective as of the 12th day of May, 2004 (the "Effective Date"), and made by RAG SHOPS, INC. on behalf of itself and its subsidiaries (collectively, the "Company") for the benefit of Leonard Settanni (the "Employee"). WHEREAS, the Employee is currently employed by the Company; and WHEREAS, the Board of Directors of the Company or a committee thereof (collectively, the "Board") has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued services and dedication of the Employee, notwithstanding the possibility or occurrence of a sale of the Company or a tender offer, merger, consolidation, dissolution or other corporate transaction involving the Company resulting in a change of control which would require the filing by the Company under the Securities Exchange Act of 1934, as amended, of a Current Report on Form 8-K (collectively, a "Change of Control"); and WHEREAS, in order to accomplish the foregoing objective, the Board has authorized and directed the Company to enter into this Agreement; NOW, THEREFORE, the Company hereby agrees for the benefit of the Employee as follows: 1. Change of Control Payment. In the event that prior to the termination of this Agreement (as determined in accordance with Section 3 hereof), (i) a Change of Control shall have occurred, and (ii) (A) the Employee's employment with the Company is terminated by the Company without Cause (as hereinafter defined) within the period ending ninety (90) calendar days after such Change of Control (the "Relevant Period") or (B) the Employee remains an employee of the Company for the entire Relevant Period, then the Company shall pay to the Employee (in addition to any other amounts that may be due and owing to the Employee by the Company), in a single lump sum payment within thirty (30) days after the Relevant Period, an amount equal to $50,000.00. 2. Cause. The term "Cause" shall mean (i) the willful failure of the Employee substantially to perform the duties of his employment (other than any such failure resulting from incapacity due to physical or mental illness) for at least five (5) days after a written demand for substantial performance is delivered to the Employee by the Company which specifically identifies the manner in which the Company believes the Employee has not substantially performed the duties of his employment; (ii) the Employee's engaging in conduct that constitutes neglect or willful misconduct in carrying out the duties of his employment or that is injurious to the Company or any of its affiliates; (iii) the Employee's arrest for, conviction of, or entering a plea of guilty, nolo contendere (or similar plea) to a crime that constitutes a felony or any crime of moral turpitude; (iv) the Employee's directly or indirectly selling, passing on or otherwise using or disclosing, without permission, any confidential information of the Company; or (v) the Employee's direct or indirect participation in business activities in competition with the Company. 3. Term. This Agreement shall become effective on the Effective Date and shall terminate on the earliest to occur of the following events: (i) on December 31, 2004, if no Change of Control has occurred prior to December 31, 2004; and (ii) on the date of the cessation of employment with the Company, (a) if the Employee ceases to be employed by the Company for any reason (including, without limitation, as a result of death, disability, resignation or termination with or without Cause) prior to the occurrence of a Change of Control or (b) if the Employee ceases to be employed by the Company for any reason other than termination of the employment by the Company without Cause after a Change of Control shall have occurred, but within the Relevant Period. 4. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without reference to the choice of law principles thereof. 5. Assignability. This Agreement is personal to the Employee and without the prior written consent of the Company shall not be assignable by the Employee. This Agreement shall inure to the benefit of and be enforceable by the Employee. This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. The Company shall require any corporation, entity, individual or other person who is the successor (whether direct or indirect, by purchase, merger, consolidation, reorganization, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform, by a written agreement, all of the obligations of the Company under this Agreement, prior to or contemporaneously with a Change of Control. As used in this Agreement, the term "Company" shall mean the Company as defined above and any successor to its business and/or assets as described herein which assumes and agrees to perform this Agreement by operation of law, written agreement, or otherwise. 6. Waiver. This Agreement may not be changed or terminated without the prior written agreement of both the Company and the Employee. The waiver of any breach of any term or condition of this Agreement shall not be deemed to constitute the waiver of any breach of the same or any other term or condition of this Agreement. 7. Severability. In the event any provision of this Agreement is found to be unenforceable or invalid, such provision shall be severable from this Agreement and shall not affect the enforceability or validity of any other provision of this Agreement. If any provision of this Agreement is capable to two constructions, one of which would render the provision void and the other that would render the provision valid, then the provision shall have the construction that renders it valid. 8. This Agreement Not a Contract of Employment For Any Reason. This Agreement is not a contract of employment and the terms of employment of the Employee including, without limitation, his or her status as an employee-at-will, shall not be affected in any way by this Agreement. The grant and delivery of this Agreement shall not be construed as conferring any legal rights upon the Employee for a continuation of employment, nor shall it interfere with the right of the Company or any subsidiary to discharge the Employee. IN WITNESS WHEREOF, the undersigned has duly executed this Agreement as of the Effective Date on behalf of the Company. RAG SHOPS, INC. By: /S/ Jeffrey C. Gerstel ----------------------------- Name: Jeffrey C. Gerstel Title: President 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. Section 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 Quarterly Report on Form 10-Q for the quarter ended May 29, 2004 (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 13th day of July 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. Section 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 Quarterly Report on Form 10-Q for the quarter ended May 29, 2004 (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 13th day of July 2004. /S/ Steven B. Barnett --------------------- Executive Vice President, Acting Chief Financial Officer