SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment No. ) Filed by the Registrant /X/ Filed by a Party other than the Registrant / / Check the appropriate box: / / Preliminary Proxy Statement / / Preliminary Additional Materials /X/ Definitive Proxy Statement / / Definitive Additional Materials / / Soliciting Material Pursuant to Section240.14a-12 RAG SHOPS, INC. ----------------------------------------------------------------------- (Name of Registrant as Specified In Its Charter) RAG SHOPS, INC. ----------------------------------------------------------------------- (Name of Person(s) Filing Proxy Statement, if other than the Registrant) Payment of Filing Fee (Check the appropriate box): /X/ No fee required. / / Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11. (1) Title of each class of securities to which transaction applies: ---------------------------------------------------------- (2) Aggregate number of securities to which transaction applies: ---------------------------------------------------------- (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined): ---------------------------------------------------------- (4) Proposed maximum aggregate value of transaction: ---------------------------------------------------------- (5) Total fee paid: ---------------------------------------------------------- / / Fee paid previously with preliminary materials. / / Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. (1) Amount Previously Paid: ---------------------------------------------------------- (2) Form, Schedule or Registration Statement No.: ---------------------------------------------------------- (3) Filing Party: ---------------------------------------------------------- (4) Date Filed: ---------------------------------------------------------- NOTICE OF ANNUAL MEETING OF STOCKHOLDERS TO BE HELD THURSDAY, JANUARY 25, 2001 To the Stockholders of RAG SHOPS, INC.: Notice is hereby given that the 2001 Annual Meeting of Stockholders of Rag Shops, Inc., a Delaware corporation (the "Company"), will be held at 9:30 a.m. (Eastern Daylight Time) on Thursday, January 25, 2001, at the Regency House Hotel, 140 Highway 23 North, Pompton Plains, New Jersey, to consider and vote upon: 1. Election of two existing directors for a three-year term and the election of a nominee for a one year term. 2. Ratification of the selection by the Board of Directors of Grant Thornton LLP as independent public accountants for the Company's 2001 fiscal year. 3. Any other business that may properly come before the meeting. The Board of Directors has fixed the close of business on December 18, 2000, as the record date for the determination of stockholders entitled to receive notice of and to vote at said meeting. Stock transfer books will not be closed. To assure representation of your shares, YOU ARE REQUESTED, WHETHER OR NOT YOU PLAN TO BE PRESENT AT THE MEETING, TO COMPLETE, DATE, SIGN AND RETURN THE ACCOMPANYING PROXY IN THE ENCLOSED POSTAGE PREPAID ENVELOPE. If your shares are held of record by a broker, bank, or other nominee and you wish to vote your shares at the meeting, you must obtain and bring to the meeting a letter from the broker, bank, or other nominee confirming your beneficial ownership of the shares. By Order of the Board of Directors /s/ DORIS BERENZWEIG Doris Berenzweig SECRETARY Hawthorne, New Jersey December 22, 2000 --------------------- PROXY STATEMENT ------------------- ANNUAL MEETING OF STOCKHOLDERS The proxy accompanying this Proxy Statement is solicited by the Board of Directors of Rag Shops, Inc. (the "Company"). All proxies in the accompanying form, which are properly executed and duly returned, will be voted at the Annual Meeting of Stockholders to be held on Thursday, January 25, 2001, at 9:30 a.m, at the Regency House Hotel, 140 Highway 23 North, Pompton Plains, New Jersey, for the purposes set forth in the accompanying Notice of Annual Meeting. This proxy statement and the enclosed form of proxy are being mailed to stockholders on or about December 22, 2000. VOTING AND SOLICITATION OF PROXIES Only holders of record of the Company's common stock, par value $.01 per share (the "Common Stock"), at the close of business on December 18, 2000, will be entitled to notice of and to vote at the meeting. On that date there were issued and outstanding 4,801,583 shares of Common Stock. Each outstanding share of Common Stock is entitled to one vote on all matters to come before the meeting. The cost of soliciting proxies will be borne by the Company. In addition to the use of the mails, officers, directors and regular employees of the Company may solicit proxies personally or by telephone, telegraph or facsimile transmission. The Company also intends to request that brokerage houses, banks, custodians, nominees, and fiduciaries forward soliciting material to the beneficial owners of Common Stock held of record by such persons, and will reimburse such persons for their reasonable expenses in forwarding such material. The holders of a majority of the total shares of Common Stock issued and outstanding, whether present in person or represented by proxy, will constitute a quorum for the transaction of business at the meeting. The affirmative vote of a majority of the total shares of Common Stock represented in person or by proxy at the meeting is required for the election of directors and the ratification of the appointment of independent public accountants. Since only affirmative votes are counted as votes in favor of these matters, abstentions and broker non-votes have the same effect as votes against these matters. Proxies and ballots will be tabulated by the inspectors of election. It is important that proxies be returned promptly. Therefore, whether or not you plan to attend in person, you are urged to execute and return your proxy in the enclosed envelope, to which no postage need be affixed if mailed in the United States. The proxy may be revoked at any time before it is exercised by filing with the Secretary of the Company an instrument revoking such proxy or a duly executed proxy bearing a later date, or by attending the meeting and voting in person. BENEFICIAL OWNERSHIP The following table sets forth information, as of December 1, 2000, as to the beneficial ownership of Common Stock (including shares which may be acquired within sixty days pursuant to stock options) of each director of the Company, each nominee for Director and each executive officer of the Company listed in the Summary Compensation Table below, all directors and executive officers as a group and persons known by the Company to beneficially own 5% of the Common Stock. Except as set forth below, no person beneficially owns 5% or more of the Common Stock. Unless otherwise 1 indicated, the address of each person below is care of the Company, 111 Wagaraw Road, Hawthorne, New Jersey 07506-2711. SHARES OF COMMON STOCK PERCENTAGE NAME OF OWNER BENEFICIALLY OWNED OF CLASS - ------------- ------------------ ---------- Stanley Berenzweig.......................................... 1,003,132(1) 20.5% Doris Berenzweig............................................ 1,066,942(1) 21.8% Dimensional Fund Advisors, Inc.............................. 324,660(2) 6.8% 1299 Ocean Avenue 11th Floor Santa Monica, CA 90101 Evan Berenzweig............................................. 258,675(3) 5.4% Judith Lombardo............................................. 205,125(3) 4.3% Steven Barnett.............................................. 205,125(3) 4.3% Fred J. Damiano............................................. 1,050 * Alan C. Mintz............................................... 17,100(4) 0.4% Mario Ciampi................................................ -0- * Leonard Settanni............................................ 10,000(5) 0.2% Bruce Miller................................................ 2,100(6) * All directors, nominees and executive officers as a group (10) persons.......................... 2,769,249 55.3% - ------------------------ (1) Excludes shares held by spouse and includes 102,900 shares beneficially owned by the Stanley and Doris Berenzweig Charitable Foundation, Inc. of which Mr. and Mrs. Berenzweig are trustees. Mr. and Mrs. Berenzweig each disclaim beneficial ownership of the shares held by the other and by the Foundation. (2) Based solely upon information set forth in a Schedule 13G filed with the Securities and Exchange Commission, dated February 3, 2000. (3) Includes 15,000 shares and 9,000 shares subject to presently exercisable stock options at $6.25 per share and $2.34 per share, respectively. (4) Includes 15,000 shares subject to presently exercisable stock options at $6.25 per share. (5) Represents shares subject to presently exercisable stock options at $3.188 per share. (6) Represents shares subject to presently exercisable stock options at $2.375 per share. * Less than 1 percent. 2 ELECTION OF DIRECTORS The Company's Certificate of Incorporation provides for the division of the Company's Board of Directors into three classes whose respective three-year terms of office expire in different years. Each year the directors in one class are elected to serve for a term of three years. Due to the resignation of a Class I Director on November 17, 2000 and the desire to add an additional independent director, a realignment was effected by the Board of Directors by (i) nominating Fred J. Damiano, presently a Class II Director, for election as a Class I Director and (ii) nominating Mario Ciampi, as an independent Class II Director. The Company's Class I Directors have terms expiring at the 2001 Annual Meeting, and until their respective successors are fully elected and qualified. The Company's Class II Directors have terms expiring at the 2002 Annual Meeting, and until their respective successors are fully elected and qualified. The officers of the Company are appointed by the Board of Directors to hold office until their successors are duly elected and qualified. Vacancies on the Board of Directors are filled by the remaining directors. Certain information regarding the two nominees for election as Class I directors at this year's Annual Meeting is set forth below. NAME AGE POSITION - ---- -------- -------- Stanley Berenzweig.................... 80 Chairman of the Board, Chief Executive Officer, Chief Operating Officer and Class I Director Fred J. Damiano....................... 56 Presently Class II Director STANLEY BERENZWEIG, who co-founded the Company in 1963, has been Chairman of the Board of the Company since August 1986, Chief Executive Officer and Director since April 1991 and Chief Operating Officer of the Company from September 1994 to April 1995. Mr. Berenzweig reassumed the office of Chief Operating Officer in November 2000. FRED J. DAMIANO has been a Director of the Company since April 1991 and an Executive Vice President of Haband Company, Inc., a direct marketer of clothing, since 1981. Mr. Damiano has been President of Fashion Outlets, Inc., a retail clothing operation, since October 1990. Certain information regarding the one nominee for election as a Class II director at this year's Annual Meeting is set forth below. NAME AGE POSITION - ---- -------- -------- Mario Ciampi.......................... 50 nominee for Class II Director MARIO CIAMPI has been the Senior Vice President of Store Development and Logistics for The Children's Place Retail Stores, Inc. since March 1996 and prior to that was a private consultant to the retail industry. 3 DIRECTORS CONTINUING IN OFFICE AND OTHER EXECUTIVE OFFICERS Certain information regarding Directors who are not standing for election at this year's Annual Meeting and executive officers who are not directors is set forth below: NAME AGE POSITION - ---- -------- -------- Steven B. Barnett..................... 53 Executive Vice President, Treasurer and Class III Director Judith Lombardo....................... 52 Senior Vice President and Class II Director Evan Berenzweig....................... 44 Senior Vice President and Class III Director Alan C. Mintz......................... 68 Class III Director Doris Berenzweig...................... 75 Secretary Bruce Miller.......................... 45 Vice President Stephen Provenzano.................... 40 Vice President, Chief Financial Officer Leonard M. Settanni................... 58 Vice President JUDITH LOMBARDO, who joined the Company in 1966, has been a Senior Vice President of the Company since August 1986 and a Director since April 1991. Ms. Lombardo was a Vice President from 1982 to 1986, and prior to 1982, she served the Company in various capacities in merchandising, advertising and store operations. STEVEN B. BARNETT, who joined the Company in 1984, has been Executive Vice President of the Company since July 2000 and Treasurer and a Director of the Company since April 1991. Mr. Barnett was the Chief Financial Officer of the Company from August 1986 to July 2000. From August 1986 to April 1991, Mr. Barnett was a Vice President of the Company and from December 1984 to August 1986 he was the Controller. EVAN BERENZWEIG, who joined the Company in 1980, has been a Senior Vice President since November 1994 and a Director of the Company since April 1991. Mr. Berenzweig served as the Treasurer of the Company from August 1986 to April 1991 and Vice President from April 1991 to November 1994, and, prior to 1986, he served the Company in various capacities in merchandising, store operations and distribution. ALAN C. MINTZ, a Certified Public Accountant, has been a Director of the Company since April 1991 and has been a partner in the firm of Mintz Rosenfeld & Company LLC, Certified Public Accountants, and its predecessors, since 1957. Mr. Mintz, through Mintz Rosenfeld & Company LLC, continues to render tax and consulting services to the Company DORIS BERENZWEIG, who is a co-founder of the Company, has been the Secretary of the Company since its inception and was a Director from that time until April 1991. STEPHEN PROVENZANO, who joined the Company in August 2000 as Vice President and Chief Financial Officer, was formerly Executive Vice President and Chief Financial Officer at Creativity Crafts, LLC, a craft specialty store retail chain, from November 1997 to January 2000. From 1994 to 1997 Mr. Provenzano was Treasurer of Rickel Home Centers, Inc. a chain of retail home improvement stores. Prior to 1994 Mr. Provenzano was with the Home Improvement division of Supermarkets General Corp. in various capacities in finance and operations. BRUCE MILLER, who joined the Company in 1993, has been Vice President Merchandising since May of 2000. From 1993 to 1997 Mr. Miller was a Merchandise Manager for the Company. Prior to 1993 Mr. Miller served in various capacities in merchandising at Consumers Distributing, a catalog retailer. 4 LEONARD M. SETTANNI, who joined the Company in January 1995 as Vice President of Management Information Systems, was formerly Vice President of Management Information Systems of Mothercare Stores, a maternity and children's specialty store retail chain, from July 1988 to April 1994. Stanley Berenzweig and Doris Berenzweig are husband and wife. Evan Berenzweig is their son. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Based on material provided to the Company, all forms and reports with respect to directors and executive officers of the Company were timely filed with the Securities and Exchange Commission. DIRECTORS' MEETINGS The Board of Directors met six times during fiscal year 2000. Each Director attended more than 75% of the combined number of meetings of both the Board of Directors and of any committees of the Board on which the Director served. COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors has established compensation, audit and option committees. The Compensation Committee consists of Fred J. Damiano, Alan C. Mintz and Stanley Berenzweig, the Audit Committee consists of Fred J. Damiano and Alan C. Mintz and the Option Committee consists of Stanley Berenzweig and Fred J. Damiano. The audit committee met two times and the option committee met three times in fiscal 2000. The compensation committee did not meet in fiscal 2000. The Audit Committee reviews and examines detailed reports of the Company's independent public accountants; consults with the independent public accountants regarding internal accounting controls, audit results and financial reporting procedures; recommends the engagement and continuation of engagement of the Company's independent public accountants; and meets with, and reviews and considers recommendations of, the independent public accountants. The audit committee has adopted a formal written audit committee charter, a copy of which is attached to this proxy statement as Appendix I. The Option Committee administers the 1991 Stock Option Plan and the 1999 Incentive Stock Award Plan (collectively hereinafter referred to as the "Plans") and, to the extent provided by such Plans, determines the persons to whom options or awards are granted, the exercise price, term and number of shares covered by each option or award and the type of option or award to be granted. In addition, the Option Committee exercises all discretionary power regarding the Plans' operation. The Compensation Committee reviews the performance of senior management and key employees whose compensation is the subject of review and approval by the Committee; periodically reviews and recommends to the Board of Directors compensation arrangements for senior management and key employees; and periodically reviews the main elements of and administers the Company's compensation and benefit programs, other than the 1991 Stock Option Plan and the 1999 Incentive Stock Award Plan. EXECUTIVE COMPENSATION The following table sets forth the total annual compensation paid or accrued by the Company for services in all capacities for the Chief Executive Officer and all executive officers of the Company who were serving as such at the end of fiscal 2000 (the year ended September 2, 2000) whose aggregate compensation exceeded $100,000. 5 SUMMARY COMPENSATION TABLE ANNUAL COMPENSATION LONG TERM COMPENSATION NAME AND ---------------------- ---------------------- PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTION AWARDS(#) - ------------------ -------- ---------- --------- ---------------------- Stanley Berenzweig, Chief Executive Officer... 2000 175,000 -0- -0- 1999 175,000 -0- -0- 1998 172,402 -0- -0- Michael Aaronson (1).......................... 2000 180,000 -0- -0- 1999 176,385 -0- -0- 1998 166,978 -0- -0- Steven B. Barnett, Executive Vice President... 2000 145,000 -0- -0- 1999 145,000 -0- -0- 1998 142,846 -0- -0- Judith Lombardo, Senior Vice President........ 2000 145,000 -0- -0- 1999 145,000 -0- -0- 1998 142,471 -0- -0- Evan Berenzweig, Senior Vice President........ 2000 130,000 -0- -0- 1999 124,577 -0- -0- 1998 115,284 -0- -0- Bruce Miller, Vice President (2).............. 2000 109,997 6,500 6,500 Leonard Settanni, Vice President.............. 2000 115,000 -0- -0- 1999 113,192 -0- -0- 1998 108,077 -0- -0- - ------------------------ (1) Mr. Aaronson resigned as a Director and officer of the Company as of November 17, 2000. (2) Mr. Miller was elected Vice President as of May 9, 2000. 6 OPTION EXERCISES AND FISCAL YEAR-END VALUE TABLE The table set forth below shows the value of unexercised options held by the executive officers during fiscal 2000. On May 9, 2000 Mr. Miller was granted 6,500 shares exercisable at $1.86. On July 31, 2000 Mr. Provenzano was granted 50,000 shares exercisable at $2.328. VALUE OF UNEXERCISED NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS 9/2/00 OPTIONS 9/2/00($)(1) --------------------------- --------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- Stanley Berenzweig............................. -0- -0- N/A N/A Michael Aaronson(2)............................ 80,000 20,000 $11,050 $3,200 Steven Barnett................................. 24,000 6,000 1,440 960 Judith Lombardo................................ 24,000 6,000 1,440 960 Evan Berenzweig................................ 24,000 6,000 1,440 960 Bruce Miller................................... 2,100 7,900 263 4,335 Stephen Provenzano............................. -0- 50,000 -0- 8,600 Leonard Settanni............................... 10,000 -0- -0- -0- - ------------------------ (1) The closing price of the Common Stock on September 1, 2000 was $2.50. (2) Mr. Aaronson resigned as a Director and officer of the Company as of November 17, 2000. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. Messrs. Berenzweig, Damiano and Mintz were members of the Compensation Committee in fiscal 2000. Mr. Berenzweig is the Chief Executive Officer of the Company. Since 1964, the Company has leased its principal offices and its Hawthorne, New Jersey store from Momar Realty L.L.C. ("Momar"), the two members of which are Stanley Berenzweig and Doris Berenzweig. The offices and store are located in a strip shopping center owned by Momar. The initial term of the lease commenced on March 1, 1991, expires February 28, 2006 and provides for payment of an aggregate of $233,575 of basic rent for each of the second five years of the lease together with a proportionate share of the costs of maintaining common areas, insurance, real estate taxes, and other operating costs associated with the strip shopping center. The Company has exercised its first of four options to renew this lease, each for additional terms of five years. The basic rent for each term will be increased by the greater of 15% of the basic rent paid for the previous five-year term or one-half of the percentage increase in the Consumer Price Index. During fiscal 2000, the Company paid Momar an aggregate of $338,265 of rent for these facilities. The Company believes that the terms of this lease are no less favorable to the Company than would be the terms obtained from an unaffiliated third party. In addition the Company, from time to time, receives tax, accounting and other financial consulting services from Mintz Rosenfeld & Company LLC, Certified Public Accountants ("Mintz Rosenfeld"). Mr. Mintz is a partner of Mintz Rosenfeld. During fiscal 2000, Mintz Rosenfeld received $75,539 for services rendered to the Company. BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION Decisions on compensation of the Company's executive officers generally are made by the Compensation Committee of the Board. The Compensation Committee is not responsible for the administration or determination of grants to be made under the Company's 1991 Stock Option Plan or 7 the 1999 Incentive Stock Award Plan (collectively hereinafter referenced to as the "Plans"). Decisions on awards under these Plans are made solely by the Option Committee. Pursuant to rules of the Securities and Exchange Commission designed to enhance disclosure of companies' policies toward executive compensation, there is set forth below a report submitted by Messrs. Berenzweig, Mintz and Damiano, in their capacities as the members of the Board's Compensation Committee, and Messrs. Berenzweig and Damiano, in their capacities as the members of the Board's Option Committee, addressing the Company's compensation policies for fiscal 2000 as they affected the Company's executive officers generally (including the executive officers set forth in the Summary Compensation Table above), and as they affected Mr. Berenzweig in his capacity as Chief Executive Officer of the Company. BACKGROUND In June 1991, the Company consummated its initial public offering ("IPO"). In contemplation of the IPO, the Company's executive compensation levels, plans and policies that have been followed subsequent to the IPO were established. As part of this process, initial salaries were established and the 1991 Stock Option Plan was adopted. The annual salaries of the individuals listed in the Summary Compensation Table (other than Michael Aaronson, Evan Berenzweig, Bruce Miller and Leonard Settanni) have not been increased since the IPO or their date of employment, if later. All of the named persons (other than Bruce Miller and Leonard Settanni) elected to temporarily reduce their base salaries by 10% effective January 28, 1996 as did one other officer of the Company. On January 27, 1997, all of the named persons who took the 10% reduction were restored half of the reduction to 95% of their base salaries in response to improved operations through that portion of the fiscal year. At that time the base salary of Evan Berenzweig was increased from $90,000 to $115,000 in connection with his performance of new responsibilities undertaken since February 1996 for store operations. In July 1997, Michael Aaronson's remaining 5% reduction was restored to 100% of his base salary. On January 19, 1998 (i) all of the named persons who took the 10% reduction effective January 28, 1996 and partially restored on January 27, 1997 were restored to their full base salaries, and (ii) Leonard Settanni was increased from $105,000 to $110,000 in response to improved operations. Effective January 1, 1999 base salary increases were effected for Michael Aaronson from $170,000 to $180,000; Evan Berenzweig from $115,000 to $130,000 and Leonard Settanni from $110,000 to $115,000. Effective November 13, 2000 a further base salary increase was effected for Mr. Settanni from $115,000 to $130,000. Further, Stanley Berenzweig, Michael Aaronson, Steven Barnett, Judith Lombardo and Evan Berenzweig were not paid any bonuses since fiscal year 1993 in light of the Company's financial performance. COMPONENTS OF EXECUTIVE COMPENSATION The primary components of the compensation of the Company's executive officers for fiscal 2000 consisted of salary and stock option grants. Bonuses were also potentially available. The salaries of Messrs. Berenzweig, Aaronson, Barnett, Provenzano, Miller, Settanni and Ms. Lombardo were set by the Compensation Committee and approved by the Board of Directors. The stock options granted under the Plan were granted by the Option Committee. The size of the grants to executive officers were determined generally by the Option Committee in accordance with the policy described below. COMPENSATION POLICIES TOWARD EXECUTIVE OFFICERS The Company's compensation policy toward executive officers is to base compensation on the perceived value of each executive officer considering such factors, which tend to be subjective, as the officer's ability to contribute to the Company's growth, efficiency and performance and the level of responsibility given to the officer. 8 RELATIONSHIP OF CORPORATE PERFORMANCE TO EXECUTIVE COMPENSATION Any portion of compensation represented by stock options is directly related to future corporate performance. Stock option grants tie that portion of executive compensation attributable to the stock options to stock performance, since the options will only have value if and to the extent the market price of the Company's stock increases over the exercise price of the options. The Company's policy with respect to stock options is to use stock option grants to retain executives and motivate them to improve the Company's overall performance with the expectation that the value of the Company's Common Stock will thereafter increase. In determining the size of grants, the Option Committee considers various factors, including the relative position of the grantee and the grantee's perceived ability to influence the Company's performance, which tend to be subjective determinations. CHIEF EXECUTIVE OFFICER COMPENSATION Mr. Berenzweig's initial salary and bonus were specified in his employment agreement which was entered into in connection with the IPO and has since expired. This initial compensation package was designed to be competitive with compensation packages offered to other chief executive officers of leading specialty retailers and recognized the compensation arrangement that had been in place prior to the IPO. Mr. Berenzweig's salary has remained the same since the expiration of his employment agreement until January 28, 1996, when it was voluntarily and temporarily reduced by Mr. Berenzweig by 10%. This voluntary reduction was restored by 5% on each of January 27, 1997 and January 19, 1998 when it was restored to the full salary before the voluntary reduction. Further, as noted above, no bonus has been received by Mr. Berenzweig since fiscal year 1993. STANLEY BERENZWEIG FRED DAMIANO ALAN MINTZ Members of the Compensation Committee STANLEY BERENZWEIG FRED DAMIANO Members of the Option Committee 9 COMMON STOCK PERFORMANCE GRAPH The following line graph compares the cumulative total annual stockholder return on the Company's Common Stock during the past five fiscal years, based on the market price of the Common Stock and assuming reinvestment of dividends, with the cumulative total monthly return of the S&P 500 Index and the S&P Retail-Specialty Index. The graph is based on the assumption that $100 was invested on August 31, 1995 in the Company's Common Stock, the S&P 500 Index and the S&P Retail-Specialty Index. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC AUG-95 AUG-96 AUG-97 AUG-98 AUG-99 AUG-00 Rag Shops, Inc. 100 75.01 104.17 85.4 74.38 87.5 S&P 500 Index 100 118.73 166.99 180.51 252.39 293.58 S&P Retail-Specialty 100 122.53 132.06 79.8 66.11 60.31 DIRECTOR FEES Directors who are employees of the Company receive no additional compensation for services as a director. Directors not so employed receive an annual retainer of $5,000 and fees of $1,250 for each Board meeting attended, with no additional compensation for committee meetings attended. Commencing September 2000, audit committee members receive $500 for each audit committee meeting attended. RATIFICATION OF SELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS On April 18, 2000 the Company dismissed Deloitte & Touche, LLP ("Deloitte & Touche") as the Company's independent auditor. The decision to change independent auditors was unanimously recommended by the Audit Committee and unanimously approved by the Board of Directors of the Company. Deloitte & Touche's report on the Company's financial statements over the last two years were unqualified and there were no disagreements existing between the Company and Deloitte & Touche with respect to any matter of accounting principles, practices, financial statement disclosure or auditing scope or procedure. 10 On April 18, 2000, in order to replace Deloitte & Touche the Company engaged Grant Thornton LLP ("Grant Thornton") as the Company's independent auditor and principal accountant to audit the Company's financial statements. The Company had not previously consulted Grant Thornton regarding either the application of accounting principles or any other reportable matter The Board of Directors has selected Grant Thornton to serve as the independent public accountants of the Company for the fiscal year ending September 1, 2001. This selection will be submitted for ratification at the Annual Meeting. Representatives of Grant Thornton are expected to attend the Annual Meeting. They will have the opportunity to make a statement if they desire to do so and are expected to be available to respond to appropriate questions. AUDIT COMMITTEE REPORT In the course of the fiscal year and in preparation for the Annual Meeting, the Audit Committee has met, reviewed and discussed the audited financial statements with management; discussed with the independent auditors the relevant auditing standards as they apply to the Company; received from the Company's independent accountants the written disclosures and recommendations required to be provided to the Company by Statement on Auditing No. 61 (Communication with Audit Committees); and has discussed with the independent accountant these matters as well as the accountants independence as required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees). Management represented to the committee that the Company's consolidated financial statements were prepared in accordance with generally accepted accounting principles. Based on the foregoing, the audit committee members recommended to the entire Board that the audited financial statements be included in the Company's Annual Report on Form 10-K for the fiscal year ending September 2, 2000. FRED DAMIANO ALAN MINTZ Members of the Audit Committee ANNUAL REPORT The Annual Report to Stockholders (including financial statements) for the fiscal year ended September 2, 2000 is mailed herewith to all stockholders. COPIES OF THE COMPANY'S FORM 10-K AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION MAY BE OBTAINED, WITHOUT CHARGE, BY WRITTEN REQUEST TO STEPHEN PROVENZANO, CHIEF FINANCIAL OFFICER AND MAY BE FOUND ON THE COMMISSION'S WEB SITE AT www.sec.gov OR AT THE COMPANY'S WEB SITE AT www.ragshop.com. OTHER MATTERS Management is not aware of any matters to come before the meeting which will require the vote of stockholders other than those matters indicated in the Notice of Meeting and this Proxy Statement. However, if any other matter calling for stockholder action should properly come before the meeting or any adjournments thereof, those persons named as proxies in the enclosed proxy form will vote thereon according to their best judgment. ADVANCE NOTICE FOR DIRECTOR NOMINATIONS The Company's Certificate of Incorporation provides that in order for a stockholder to nominate a candidate for election as a director at an annual meeting of stockholders or to propose business for consideration at such meeting, notice must be delivered to the Secretary of the Company not less than 60 days nor more than 90 days prior to the annual meeting. Based on the scheduled meeting date for this year's annual meeting, in order for a stockholder to propose director nominations at the 2002 Annual Meeting, the stockholder must deliver notice to the Secretary between October 27 and 11 November 26, 2001. Any stockholder desiring a copy of the Company's Certificate of Incorporation will be furnished one without charge upon written request to the Secretary. STOCKHOLDER PROPOSALS FOR 2002 ANNUAL MEETING Stockholder proposals (other than those regarding director nominations as described above) for the 2002 Annual Meeting must be received in writing by the Company on or before September 27, 2001 in order to be considered for inclusion in the Company's proxy material for such meeting. By Order of the Board of Directors /s/ DORIS BERENZWEIG Doris Berenzweig, SECRETARY Hawthorne, New Jersey December 22, 2000 12 APPENDIX I AUDIT COMMITTEE CHARTER ORGANIZATION There shall be a committee appointed by the Board of Directors of Rag Shops, Inc., a Delaware corporation (the "Corporation"), of not less than two (2) members and, and no later than June 30, 2001, of not less than three (3) members of the board of directors or as required by the Securities and Exchange Commission (the "SEC"), the applicable stock exchange regulations, or other applicable federal and state laws to be known as the audit committee (the "Committee"). The Committee shall be composed of members of the board of directors who are independent of the management of the Corporation and are free of any relationship that, in the opinion of the board of directors, would interfere with their exercise of independent judgment as a Committee member. The members of the Committee shall have the financial knowledge or experience to enable them to carry out their responsibilities and at least one member of the Committee shall have past employment experience in finance or accounting, requisite professional certification in accounting, or any other comparable experience or background which results in the individual's financial sophistication. STATEMENT OF POLICY The Committee shall provide assistance to the board of directors in fulfilling their responsibility to the stockholders, potential stockholders, and investment community relating to corporate accounting and reporting practices of the Corporation, and the quality and integrity of the financial reports of the Corporation. In so doing, it is the responsibility of the Committee to maintain free and open means of communication between the board of directors, the independent auditors, and the financial management of the Corporation. RESPONSIBILITIES In carrying out its responsibilities, the Committee believes its policies and procedures should remain flexible, in order to best react to changing conditions and to ensure to the board of directors and stockholders that the corporate accounting and reporting practices of the Corporation are in accordance with all requirements and are of the highest quality. In carrying out these responsibilities, the Committee will: - Review and recommend to the board of directors the independent auditors to be selected to audit the financial statements of the Corporation and its divisions and subsidiaries. - Meet with the independent auditors and financial management of the Corporation to review the scope of the proposed audit for the current year and the audit procedures to be utilized, and at the conclusion thereof review such audit, including any comments or recommendations of the independent auditors. - Review with the independent auditors, and financial and accounting personnel, the adequacy and effectiveness of the accounting and financial controls of the Corporation, and solicit any recommendations for the improvement of such internal control procedures or particular areas where new or more detailed control or procedures are desirable. Particular emphasis should be given to the adequacy of such internal controls to expose any payments, transactions, or procedures that might be deemed illegal or otherwise improper. Further, the Committee periodically should review company policy statements to determine their adherence to the code of conduct. - Review the proposed audit plans for the coming year, and the coordination of such plans with the independent auditors. I-1 - Review the financial statements contained in the annual report on Form 10-K and interim financial statements contained in the quarterly reports on Form 10-Q with management and the independent auditors to determine that the independent auditors are satisfied with the disclosure and content of the financial statements to be presented to the stockholders. If the quarterly report states that the interim financial statements have been reviewed by the independent auditors, the Committee shall obtain a report of such review from the independent auditors and provide for such report to be included in the quarterly report. Any changes in accounting principles should be reviewed. - Provide sufficient opportunity for the independent auditors to meet with the members of the Committee without members of management present. Among the items to be discussed in these meetings are the independent auditors' evaluation of the Corporation's financial, and accounting auditing personnel, and the cooperation that the independent auditors received during the course of the audit. - Review accounting and financial human resources and succession planning within the Corporation. - Submit the minutes of all meetings of the audit committee to, or discuss the matters discussed at each committee meeting with, the board of directors. - Investigate, within the scope of its duties, any matter brought to its attention with the power to retain outside counsel for this purpose, if, in its judgment, that is appropriate. - In reviewing the financial statements contained in the annual report on Form 10-K, the Committee shall provide the Board of Directors with a written report stating whether: i) The Committee reviewed and discussed the audited financial statements with management; ii) The Committee has discussed with the independent auditors the matters required to be discussed by SAS 61 (Codification of Statements on Auditing Standards); iii) The Committee has received the written disclosures and the letter from the independent accountants required by Independence Standards Board Standard No. 1, and has discussed with the independent accountant the independent accountant's independence; and iv) Based upon (i) through (iii), the Committee recommended to the Board of Directors that the audited financial statements be included in the Corporation's Annual Report on Form 10-K for the latest fiscal year for filing with the SEC. - Review all of the Corporation's filings with the SEC to ensure that the rules and regulations relating to the Corporation's financial statements are complied with. - Comply with the rules and regulations regarding the requirements of the Corporation's financial statements and of the composition and conduct of an audit committee as may be required by SEC regulations; applicable stock exchange requirements or other applicable federal and state law. Dated May 31, 2000 I-2 RAG SHOPS, INC. 111 WAGARAW ROAD HAWTHORNE, NEW JERSEY 07506 THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS The undersigned hereby appoints STANLEY BERENZWEIG and STEVEN BARNETT as Proxies, each with power to appoint his substitute, and hereby authorizes either of them to represent and to vote, as designated on the reverse side, all the shares of the Common Stock of Rag Shops, Inc. held of record by the undersigned on December 18, 2000 at the Annual Meeting of Rag Shops, Inc. Stockholders to be held on January 25, 2001 or any adjournment thereof. IMPORTANT - PLEASE SIGN AND DATE ON THE BACK OF CARD. RETURN PROXY CARD PROMPTLY USING THE ENCLOSED ENVELOPE; NO POSTAGE NECESSARY IMPORTANT YOUR PROMPT RESPONSE WILL SAVE THE EXPENSE OF ADDITIONAL MAILINGS. IF YOUR ADDRESS HAS CHANGED, PLEASE BE SURE TO NOTIFY THE COMPANY PROMPTLY 1. ELECTION OF THREE DIRECTORS: STANLEY BERENZWEIG FRED J. DAMIANO MARIO CIAMPI / / FOR / / WITHHELD ALL NOMINEES FROM ALL NOMINEES FOR ALL NOMINEES LISTED ABOVE, EXCEPT VOTE WITHHELD AS TO THE FOLLOWING NOMINEES (IF ANY): 2. TO RATIFY THE APPOINTMENT OF GRANT & THORNTON LLP AS THE COMPANY'S INDEPENDENT AUDITORS FOR THE FISCAL YEAR ENDING SEPTEMBER 1, 2001. / / FOR / / AGAINST / / ABSTAIN This proxy when properly executed will be voted in the manner directed by the undersigned stockholder. If no direction is made, this proxy will be voted FOR Proposals 1 and 2. The Board of Directors recommends a vote FOR all nominees for election as Directors. In their discretion, the Proxies are authorized to vote upon such other business as may properly come before the meeting. ____________________________________ Signature Title Date ____________________________________ Signature Title Date PLEASE SIGN EXACTLY AS NAME APPEARS HEREON. JOINT OWNERS SHOULD EACH SIGN. IF SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR, TRUSTEE OR GUARDIAN, GIVE FULL TITLE AS SUCH. IF A CORPORATION, PARTNERSHIP OR OTHER ENTITY, SIGN IN FULL ENTITY NAME BY AUTHORIZED PERSON. IT IS IMPORTANT THAT YOUR SHARES ARE REPRESENTED AT THIS MEETING, WHETHER OR NOT YOU ATTEND IN PERSON. TO MAKE SURE YOUR SHARES ARE REPRESENTED, WE URGE YOU TO COMPLETE AND MAIL THE PROXY CARD ABOVE.