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 February 28, 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 MARCH 31, 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 - February 28, 2004
(unaudited), March 1, 2003 (unaudited) and
August 30, 2003 3
Condensed consolidated statements of income - three and six
months ended February 28, 2004 (unaudited) and
March 1, 2003 (unaudited) 4
Condensed consolidated statements of cash flows - six
months ended February 28, 2004 (unaudited) and
March 1, 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 11-15
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 15
Item 4. Controls and Procedures 16
Part II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 17
CERTIFICATIONS 18-19
EXHIBITS
99.1 Certification
99.2 Certification
Page 2 of 19
RAG SHOPS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(All amounts in thousands)
February 28, March 1, August 30,
2004 2003 2003
---- ---- ----
(Unaudited) (Unaudited) (Note A)
ASSETS
CURRENT ASSETS:
Cash $ 1,439 $ 2,048 $ 835
Investment in common stock - 269 307
Merchandise inventories 30,075 28,525 31,995
Prepaid expenses 583 230 1,490
Other current assets 761 610 431
Deferred taxes 918 790 918
--------- --------- ---------
Total current assets 33,776 32,472 35,976
Property and equipment, net 4,258 4,648 4,580
Deferred income taxes 459 374 324
Other assets 31 35 29
--------- --------- ---------
TOTAL ASSETS $ 38,524 $ 37,529 $ 40,909
========= ========= =========
LIABILITIES AND STOCKHOLDERS'
EQUITY
CURRENT LIABILITIES:
Accounts payable-trade $ 9,587 $ 7,743 $ 11,432
Accrued expenses and other current liabilities 3,597 3,042 4,315
Accrued salaries and wages 1,114 1,055 1,103
Deferred Income 233 931 582
--------- --------- ---------
Total current liabilities 14,531 12,771 17,432
STOCKHOLDERS' EQUITY:
Common stock 48 48 48
Additional paid-in capital 6,235 6,235 6,235
Retained earnings 17,774 18,493 17,186
Unrealized gain on investment in common
stock, net of tax - 46 72
Treasury stock, at cost, 26,880 shares (64) (64) (64)
---------- ---------- ----------
Total stockholders' equity 23,993 24,758 23,477
--------- --------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 38,524 $ 37,529 $ 40,909
========= ========= =========
Note A: Derived from the August 30, 2003 audited balance sheet.
See notes to the condensed consolidated financial statements.
Page 3 of 19
RAG SHOPS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(All amounts in thousands, except share data)
Three Months Ended Six Months Ended
------------------ ----------------
February 28, March 1, February 28, March 1,
2004 2003 2004 2003
---- ---- ---- ----
Net sales $ 32,268 $ 30,672 $ 66,081 $ 64,029
Cost of merchandise
sold, occupancy and
distribution costs 21,356 20,675 43,666 42,361
--------- --------- --------- ---------
Gross profit 10,912 9,997 22,415 21,668
Selling, general and
administrative
expenses 10,524 9,837 21,603 20,574
--------- --------- --------- ---------
388 160 812 1,094
Gain from sale of securities 161 - 161 -
--------- --------- --------- ---------
Income from operations 549 160 973 1,094
Interest income (expense),
net 1 6 (24) 1
--------- --------- ---------- ---------
Income before provision
for income taxes 550 166 949 1,095
Provision for income
taxes 206 75 361 493
--------- --------- --------- ---------
Net income $ 344 $ 91 $ 588 $ 602
========= ========= ========= =========
EARNINGS PER
COMMON SHARE:
Basic and diluted $ .07 $ .02 $ .12 $ .13
========== ========== ========== ==========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:
Basic 4,797,983 4,797,983 4,797,983 4,797,983
========= ========= ========= =========
Diluted 4,829,344 4,816,793 4,833,658 4,828,015
========= ========= ========= =========
See notes to the condensed consolidated financial statements
Page 4 of 19
RAG SHOPS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(All amounts in thousands)
Six Months Ended
----------------
February 28, 2004 March 1, 2003
----------------- -------------
Cash flows from operating activities:
Net income $ 588 $ 602
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization 758 663
Loss on disposition of property and equipment - 34
Amortization of deferred income (349) (465)
Gain from sale of securities (161) -
Changes in assets and liabilities:
(Increase) decrease in:
Merchandise inventories 1,920 3,198
Prepaid expenses 825 1,019
Other current assets (330) (156)
Other assets (2) 8
Increase (decrease) in:
Accounts payable-trade (1,845) (2,565)
Accrued expenses and other current liabilities (718) 54
Accrued salaries and wages 11 (243)
--------- ---------
Net cash provided by operating activities 697 2,149
--------- ---------
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 (439) (1,060)
---------- ----------
Net cash used in investing activities (93) (1,060)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of note payable - bank 11,665 6,750
Repayments of note payable - bank (11,665) (6,750)
---------- ---------
Net cash provided by financing activities - -
--------- ---------
Net increase in cash 604 1,089
Cash, beginning of period 835 959
--------- ---------
Cash, end of period $ 1,439 $ 2,048
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 36 $ 5
========= =========
Income taxes $ 121 $ 17
========= =========
See notes to the condensed consolidated financial statements
Page 5 of 19
RAG SHOPS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED FEBRUARY 28, 2004 AND MARCH 1, 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 six months ended February 28, 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 $446,000 and $819,000 for the three and six months ended February
28, 2004, and $219,000 and $557,000 for the three and six months ended March 1,
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
$1,639,000 and $4,132,000 for the three and six months ended February 28, 2004
and $1,476,000 and $3,744,000 for the and six months ended March 1, 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.
Page 6 of 19
Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force reached a consensus on Issue
No. 00-21, "Revenue Arrangements with Multiple Deliverables" ("Issue No.
00-21"), which requires that revenue from sales with multiple deliverables be
accounted for based on a determination of whether the multiple deliverables
qualify to be accounted for as separate units of accounting. The consensus is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company adopted the provision of this
statement, which did not have an impact in its consolidated financial position
or results of operations.
In May 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No.
150, "Accounting for Certain Instruments with Characteristics of Both
Liabilities and Equity" ("SFAS No. 150"), which establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. SFAS No. 150 requires that an
issuer classify a financial instrument that is within its scope, which may have
previously been reported as equity, as a liability or an asset in some
circumstances. SFAS No. 150 is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. The Company adopted the
provision of this statement, which did not have an impact in its consolidated
financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin 51, "Consolidation Financial Statements," for
entities that do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns or both. FIN 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. The Company's operations and financial position have not been affected by
the adoption of FIN 46. In December 2003, a modification to FIN 46 was issued
("FIN 46R"), which delayed the effective date until no later than fiscal periods
ending after March 15, 2004, and provided additional technical clarification to
implementation issues. The Company currently does not have any variable interest
entities as defined in FIN 46R.
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 six months ended February 28,
2004 and March 1, 2003 as all options have been issued with exercise prices
equal to the underlying stock's market price and there were no options granted
during these periods.
Page 7 of 19
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 Six Months Ended
------------------ ----------------
February 28, March 1, February 28, March 1,
2004 2003 2004 2003
---- ---- ---- ----
Net income as reported $ 344,000 $ 91,000 $ 588,000 $ 602,000
Deduct: Total stock based employee
Compensation determined under fair
Value based method for options granted,
Modified, or settled, net of related tax effect 6,000 1,000 15,000 1,000
------------- ------------ ------------- -------------
Pro forma net income $ 338,000 $ 90,000 $ 573,000 $ 601,000
============= ============ ============= =============
Earnings per share
Basic - as reported $ .07 $ .02 $ .12 $ .13
============= ============ ============= =============
Basic - pro forma $ .07 $ .02 $ .12 $ .13
============= ============ ============= =============
Diluted - as reported $ .07 $ .02 $ .12 $ .13
============= ============ ============= =============
Diluted - pro forma $ .07 $ .02 $ .12 $ .13
============= ============ ============= =============
NOTE 2 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
Three Months Ended Six Months Ended
------------------ ----------------
February 28, March 1, February 28, March 1,
2004 2003 2004 2003
---- ---- ---- ----
Numerator for basic and diluted Earnings per share:
Net income $ 344,000 $ 91,000 $ 588,000 $ 602,000
============== ============== ============ ============
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 31,361 18,810 35,675 30,032
------------- ------------- ------------- -------------
Denominator for diluted
Earnings per share adjusted
Weighted average shares
And assumed conversions 4,829,344 4,816,793 4,833,658 4,828,015
------------- ------------- ------------- -------------
Basic earnings per share $ .07 $ .02 $ .12 $ .13
============= ============= ============= =============
Diluted earnings per share $ .07 $ .02 $ .12 $ .13
============= ============= ============= =============
Stock options excluded from the above calculation, as the effect of such options
would be anti-dilutive, aggregated 10,000 and 0 for the three and six months
ended February 28, 2004 and 2,000 and 0 for the three and six months ended March
1, 2003, respectively.
Page 8 of 19
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.
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 February 28, 2004 an aggregate of 59,000 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 February 28, 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:
---------------------------------------------
February 28, 2004 March 1, 2003 August 30, 2003
----------------- ------------- ---------------
(Amounts in thousands)
Straight line rent $ 954 $ 768 $ 882
Other accrued expenses and current liabilities 2,643 2,274 3,433
--------- --------- ----------
$ 3,597 $ 3,042 $ 4,315
========== ========== ==========
Page 9 of 19
NOTE 7- SCHEDULE OF COMPREHENSIVE INCOME
The Schedule of Comprehensive Income is as follows:
Three Months Ended Six Three Months Ended
------------------ ----------------------
February 28, March 1, February 28, March 1,
2004 2003 2004 2003
---- ---- ---- ----
(Amounts in thousands)
Net income $ 344 $ 91 $ 588 $ 602
Other comprehensive income, net of taxes:
Unrealized loss on investment in
common stock - (10) - (12)
Reversal of unrealized gain due to sale
of securities (82) - (72) -
---------- ---------- ---------- ----------
Comprehensive income $ 262 $ 81 $ 516 $ 590
========== ========== ========== ==========
As a result of the sale of securities from "investment in common stock" in the
current quarter, the "unrealized gain on investment in common stock, net of
tax", previously reported in stockholders' equity, has been realized in net
income.
Page 10 of 19
RAG SHOPS, INC. AND SUBSIDIARIES
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.
Results of Operations
The Company operated 69 and 68 stores, and leased retail square footage of
809,500 and 769,600 at the end of the second 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 Six Months Ended
------------------ ----------------
February 28, March 1, February 28, March 1,
2004 2003 2004 2003
---- ---- ---- ----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of merchandise
Sold, occupancy and
distribution costs 66.2 67.4 66.1 66.2
---------- ---------- ---------- ----------
Gross profit 33.8 32.6 33.9 33.8
Selling general and
administrative expenses 32.6 32.1 32.7 32.1
Gain from sale of securities 0.5 - 0.2 -
---------- ----------- ---------- -----------
Income from operations 1.7 0.5 1.5 1.7
---------- ---------- ---------- ----------
Net Income 1.1% 0.3% 0.9% 0.9%
========== ========== ========== ==========
Page 11 of 19
The Company's net sales increased $1,596,000 and $2,052,000 for the three and
six months ended February 28, 2004, representing a 5.2% and 3.2% increase,
respectively, over the comparable prior periods. The increase in net sales for
the three months ended February 28, 2004 resulted from an increase in comparable
store sales of $89,000 or 0.3% and the balance of $1,507,000 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 February 28, 2004 were adversely affected by
December and January inclement weather in the northeast where our main
concentration of stores is located. The increase in net sales for the six months
ended February 28, 2004 was attributable to a $2,543,000 increase from the
larger new store sales, net of sales reductions from the smaller closed stores
partially offset by a $491,000 or 0.2% decrease in comparable store sales. In
addition to the aforementioned inclement weather, the six months ended February
28, 2004 were also adversely affected by changes in the Company's advertising
program, implemented in the fourth quarter of fiscal 2003 that continued during
the first quarter of fiscal 2004. However, management believes favorable results
from changes to the Company's advertising program instituted in December 2003
were a positive factor in achieving the increase in comparable store sales in
the three months ended February 28, 2004 notwithstanding the inclement weather
previously mentioned.
The Company divides its business into three broad categories - fabrics, crafts
and floral. For the six month period this year, crafts sales increased
significantly over the comparable prior year period reflecting the Company's
expanded programs and marketing. Fabric sales, while down for the six month
period this year compared to last year, began to show improvement late in the
current six month period resulting from improved in-stock position and changes
in our marketing program implemented in December 2003. Floral sales declined
slightly for the six month period this year compared to last year. We attribute
the slight decline in floral to reductions in inventory as we prepare for
product line changes to be implemented later in fiscal 2004.
Gross profit, as a percentage of net sales, increased by 1.2% for the current
quarter compared to the prior comparable period as a result of (i) an increase
in vendor participation programs, (ii) 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, (iii) a decrease in promotional markdowns, and (iv) a
decrease in the initial merchandise cost due to an increase in sales of
merchandise with greater profit margins that was partially offset by an increase
in freight costs. Gross profit, as a percentage of net sales, increased by 0.1%
for the six months ended February 28, 2004 compared to the comparable prior
period due to the decrease in the provision for shrinkage, increase in vendor
participation programs and decrease in the initial merchandise cost, all as
previously mentioned, that was partially offset by an increase in promotional
markdowns, primarily in the three months ended November 29, 2003 and an increase
in freight costs.
Selling, general and administrative expenses increased for the three and six
months ended February 28, 2004 by $687,000 and $1,029,000, respectively, from
the comparable prior periods. Additional payroll and payroll related expense,
increased advertising expense, and higher insurance costs and increased
professional fees were the primary causes of the increases. Selling payroll
increased in support of higher sales and increased store square footage due to
the new larger stores. Advertising expense increased as a result of additional
advertising and market penetration this year compared to the comparable periods
last year. Insurance costs rose as a result of adverse market conditions when
the Company's primary insurance policies were renewed in the third and fourth
fiscal quarters last year. The increase in professional fees arose from costs
related to the retention of SunTrust Robinson Humphrey as described above and
from costs related to the recently reported gain recognized from the
demutualization of an insurance company which had issued life insurance
policies on certain of the Company's executive officers. Selling, general and
administrative expenses, as a percentage of net sales, increased by 0.5% and
0.6% for the three and six months
Page 12 of 19
ended February 28, 2004, respectively, compared to the comparable prior periods
principally due to these expenses increasing at a greater rate than net sales.
Interest income, net, decreased $5,000 and $25,000 for the three and six months
ended February 28, 2004, respectively, from the comparable prior periods. This
decrease was attributable to increased borrowings under the credit facility and
a decrease in average investment levels, coupled with a decline in interest
rates on short-term investments versus the comparable prior periods. See
"Liquidity and Capital Resources".
Net income increased by $253,000 for the three months ended February 28, 2004,
as compared to the prior comparable period. The increase resulted from increased
sales and the related increase in gross profit, partially offset by an increase
in selling, general and adminstrative expenses and from a realized gain from the
sale of securities. Net income decreased by $14,000 for the six months ended
February 28, 2004, as compared to the prior period. The decrease is primarily
due to an increase in selling, general and administrative expenses that was
partially offset by the realized gain from the sale of securities.
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 six
months ended February 28, 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 increased $701,000 for the six months ended
February 28, 2004 as compared to the August 30, 2003 amount primarily because
the Company retained its net income for this period.
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 (4.00% at February 28, 2004). The credit
facility requires the Company to maintain a compensating balance of $400,000 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
six month periods ended February 28, 2004 and March 1, 2003, respectively. There
were no direct borrowings outstanding under the line of credit at February 28,
2004 or March 1, 2003. The Company intends to maintain the availability of a
line of credit for seasonal working capital requirements and in
Page 13 of 19
order to be able to take advantage of future opportunities.
Net cash provided by operating activities for the six months ended February 28,
2004 amounted to $697,000, and $439,000 was used for purchases of property and
equipment. Net cash from operating activities resulted primarily from net income
of $588,000, decreases in merchandise inventories of $1,920,000 and prepaid
expenses of $825,000 that were partially offset by decreases in accounts
payable-trade of $1,845,000 and accrued expenses and other current liabilities
of $718,000. During the six months ended February 28, 2004 the Company opened
one store, did not close, expand or relocate any stores and was operating
sixty-nine stores at the end of the period. During the remainder of the fiscal
year ending August 28, 2004, the Company anticipates opening one additional new
store, relocating two stores and closing two 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, if necessary, from the Company's bank line of
credit. However, the Company will re-deploy assets of stores being closed to the
new stores as opportunities arise in order to curtail the costs of opening
stores. The Company believes that its cash at February 28, 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.
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 $446,000 and $819,000 for the three and six months ended February
28, 2004, and $219,000 and $557,000 for the three and six months ended March 1,
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
$1,639,000 and $4,132,000 for the three and six months ended February 28, 2004
and $1,476,000 and $3,744,000 for the and six months ended March 1, 2003,
respectively.
Recent Accounting Standards
In November 2002, the Emerging Issues Task Force reached a consensus on Issue
No. 00-21, "Revenue Arrangements with Multiple Deliverables" ("Issue No.
00-21"), which requires that revenue from sales with multiple deliverables be
accounted for based on a determination of whether the multiple deliverables
qualify to be accounted for as separate units of accounting. The consensus is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company adopted the provision of this
statement, which did not have an impact in its consolidated financial position
or results of operations.
Page 14 of 19
In May 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No.
150, "Accounting for Certain Instruments with Characteristics of Both
Liabilities and Equity" ("SFAS No. 150"), which establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. SFAS No. 150 requires that an
issuer classify a financial instrument that is within its scope, which may have
previously been reported as equity, as a liability or an asset in some
circumstances. SFAS No. 150 is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. The Company adopted the
provision of this statement, which did not have an impact in its consolidated
financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin 51, "Consolidation Financial Statements," for
entities that do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns or both. FIN 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. The Company's operations and financial position have not been affected by
the adoption of FIN 46. In December 2003, a modification to FIN 46 was issued
("FIN 46R"), which delayed the effective date until no later than fiscal periods
ending after March 15, 2004, and provided additional technical clarification to
implementation issues. The Company currently does not have any variable interest
entities as defined in FIN 46R.
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 February 28, 2004 and
March 1, 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 February 28, 2004). There were no loans outstanding under any such line of
credit at February 28, 2004 or March 1, 2003.
The following table details future projected payments for the Company's
significant contractual obligations as of February 28, 2004:
Computer and
Other Technology
Operating Leases Related Commitments Total
Six Months Ending:
2004 $ 4,927,340 $ 222,945 $ 5,150,285
Fiscal Year Ending:
2005 9,205,138 98,761 9,303,899
2006 7,818,207 55,061 7,873,268
2007 6,409,210 1,519 6,410,729
2008 5,116,264 0 5,116,264
Thereafter 10,024,058 0 10,024,058
------------- ----------- ----------
$ 43,500,217 $ 378,286 $ 43,878,503
============== =========== ============
Page 15 of 19
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 16 of 19
RAG SHOPS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders of the Company was held on January 13,
2004. Mr. Stanley Berenzweig was elected a Class I Director by a vote of
4,580,427 shares in favor and 136,608 shares withheld and Mr. Fred J.
Damiano was elected a Class I Director by a vote of 4,546,178 shares in
favor and 170,857 shares withheld. Mr. Jeffrey Gerstel, Ms. Judith Lombardo
and Mr. Mario Ciampi, Class II Directors, and Mr. Steven B. Barnett and Mr.
Alan C. Mintz, Class III Directors, will continue to serve for their term
expiring in 2005 and 2006, respectively.
The selection of the firm of Grant Thornton LLP as auditors for the
Company's fiscal year ending August 28, 2004 was ratified by a vote of
4,686,999 in favor, 28,189 against, 1,847 abstaining and there were zero
broker non-votes.
No other matters were considered by the Stockholders at said Annual Meeting.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
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) Reports on Form 8-K filed during the quarter ended February 28, 2004:
Report on Form 8-K, filed with the Securities and Exchange Commission on
February 25, 2004, reporting information pursuant to Items 5 and 7.
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: April 13, 2004 /S/ Stanley Berenzweig
----------------------
Stanley Berenzweig
Chairman of the Board and
Chief Executive Officer
Date: April 13, 2004 /S/ Steven B. Barnett
---------------------
Steven B. Barnett
Acting Principal Financial Officer, and
Acting Principal Accounting Officer
Page 17 of 19
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 April 13, 2004
- ---------------------- and Director
Stanley Berenzweig
Page 18 of 19
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, April 13, 2004
- ---------------------- Acting Chief Financial Officer
Steven B. Barnett
Page 19 of 19
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 February 28, 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 April 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 February 28, 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 April 2004.
/S/ Steven B. Barnett
---------------------
Executive Vice President,
Acting Chief Financial Officer