** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

** **

**Washington, DC 20549**

** **

**FORM 10-K/A**

**(Amendment No. 2)**

** **
| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                  |
|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                            |
| ** ** | **For the fiscal year ended August 30, 2003**                                                                                                              |
|       |                                                                                                                                                            |
| **OR**     |
|       |                                                                                                                                                            |
| **o**      | **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  incorporation or organization) |   | (I.R.S. Employer  Identification  Number) |
|                                                             |
| **111 WAGARAW ROAD  HAWTHORNE, NEW JERSEY**                      | ** ** | **07506** |
| (Address of principal  executive  offices)                       |   | (Zip Code) |

 

Registrant’s telephone number, including area code **(973) 423-1303**

 

Securities registered pursuant to Section 12(b)of the Act: **NONE**

 

Securities registered pursuant to Section 12(g)of the Act:

 

**COMMON STOCK, $.01 PAR VALUE PERSHARE**

(Title of Class)

 

Indicate by check mark whether the registrant (1)has filed all reports required to be files by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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   ý                               No   o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K/A or anyamendment to this Form 10-K/A. ý

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange act Rule 12b-2).

Yes   o                               No   ý

 

As of October 27, 2003, there wereoutstanding 4,797,983 shares of Common Stock. Based on the price at which stockwas sold on that date, the approximate aggregate market value of such sharesheld by non-affiliates was $8,785,745.

 

DOCUMENTS INCORPORATED BYREFERENCE

 

Portions of the Registrant’s 2003 DefinitiveProxy Statement, which statement will be filed not later than 120 days afterthe end of the fiscal year covered by this Report, are incorporated byreference in Part III hereof.

 

Certain exhibits are incorporated byreference to the Company’s Registration Statement on Form S-1 and Amendment No.1 thereto, as listed in response to Item 14(a)(3).

 

 

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EXPLANATORY NOTE – AMENDMENT

 

This Amendment No. 2 to the Annual Report on Form10-K for the annual period ended August 30, 2003, as previously amended,is being filed to amend the following: (i) the Explanatory Note and Part II,Item 8. “Financial Statements and Supplementary Data”, Note 1 to Rag Shops’Notes to Consolidated Financial Statements, in each case, to provide greaterdetail regarding the Company’s previous disclosures about shares of commonstock received in connection with the demutualization of Principal FinancialGroup, Inc., (ii) Part I, Item 14. “Controls and Procedures” to correct andupdate the disclosures contained therein and (iii) to correct Part IV, Item 15.“Exhibits, Financial Statement Schedules and Reports on Form 8-K” to provideupdated certifications adopted pursuant to the Sarbanes-Oxley Act of 2002.

 

Forpurposes of this Form 10-K/A, and in accordance with Rule 12b-15 under theSecurities and Exchange Act of 1934, as amended, each item of the Form 10-K forthe annual period ended August 30, 2003, as originally filed on November 21,2003, and subsequently amended by Form 10-K/A, originally filed on January 28,2004 that was affected has been amended to the extent affected by thereferenced amendment/correction and restated in its entirety. All otherfinancial information and disclosures not otherwise amended hereby remainunchanged.

 

In December 2003, the Company received a checkfrom Principal Financial Group, Inc. (“Principal”) reflecting dividends payablein connection with common stock of Principal. Receipt of the dividend checkprompted a Company inquiry which revealed that, due to its ownership of certainlife insurance policies issued by Principal Life Insurance Company, asubsidiary of Principal, and maintained by the Company for certain keyexecutive officers, the Company had received 9,766 shares of Principal’s commonstock (the “Shares”) in December 2001 as consideration in thedemutualization of Principal’s predecessor. The effective date of the demutualization was in October 2001 andthe Shares were issued in December 2001 to one of the Company’s subsidiaries,the owner of the life insurance policies. The Shares were issued in book-entry form as uncertificated shares andmaintained in an account with Mellon Investor Services established by Principalin connection with its demutualization transaction. The Company had notpreviously recognized or recorded the Shares issued pursuant to such event asit did not discover the existence and its ownership of the common stock becausethe Company received no communications regarding the demutualization plan, thedemutualization compensation or the resultant issuance of the common stockuntil its receipt in December 2003 of the dividend check which promptedthe Company’s inquiries in this regard. Since the common stock was issued in book-entry form and since the Companycontinued to receive premium invoices relating to the insurance coverage, noother communications, indications or events occurred which would have promptedearlier inquiry and, therefore, earlier discovery of the stock.  Upon its inquiries, the Company determinedthat a prior dividend check had been issued in December 2002; this checkwas never received and, accordingly, never cashed (though upon thedetermination that such amount was owed to the Company, upon the Company’srequest, a replacement check was issued subsequently and cashed in January 2004).

 

The failure to recognize or record the Sharesresulted in an error in the previously issued financial statements whichprompted the Company to determine to restate prior financial statements toproperly reflect the transaction in the first quarter of fiscal year 2002.  In its restated financial statements, theCompany has recorded the then fair market value ($180,671) of the Shares aspart of operating income as of October 2001, in accordance with EmergingIssues Task Force Issue No. 99-4, “Accounting for Stock Received from theDemutualization of a Mutual Insurance Company”. The Company has classified itsholding in the Shares as “available-for-sale” pursuant to Statement ofFinancial Accounting Standards No. 115 “Accounting for Investments”, wherebythe investment will be carried at fair market value and subsequent changes inthe market value of the investment will be reflected as an unrealized gain orloss in the stockholders’ equity section of the balance sheets, net ofdeferred income taxes. Other Comprehensive Income will be presented for allperiods pursuant to Statement of Financial Accounting Standards No. 130 “ReportingComprehensive Income” either in the Consolidated Statements of Changes in Stockholders’Equity or Notes to Consolidated Financial Statements. Comprehensive incomeconsists of net income or loss for the current period as well as income,expenses, gains or losses, net of income taxes arising during the period thatare included in separate components of equity. It includes the unrealized gainsand losses on the Company’s available-for-sale security, net of taxes.

 

1

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Thefair market value of the Shares as of the close of business on August 30,2003 was $307,238. Please refer to amendments to periodic reports filed withthe Securities and Exchange Commission for periods between December 1,2001 and November 29, 2003 for related restatements. Refer to Note 1 –Recent Developments in the Notes to Consolidated Financial Statements.

 

2

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**FORWARD-LOOKING STATEMENTS**

 

This report contains certain forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended, which are intended to be covered by safe harbors createdhereby.  Such forward-looking statementsinclude those regarding the Company’s future results in light of currentmanagement activities, and involve known and unknown risks, includingcompetition within the craft and fabric retail industry, weather-relatedchanges in the selling cycle, and other uncertainties (including those riskfactors referenced in the Company’s filings with the Securities and ExchangeCommission).

 

**PART I**

 

**Item 14.  Controls and Procedures**

 

Disclosure controls and procedures are controls andother procedures of the Company that are designed to ensure that informationrequired to be disclosed by the Company in the reports that it files or submitsunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”) isproperly recorded, processed, summarized and reported, within the time periodsspecified in the SEC’s rules and forms. Disclosure controls and procedures include processes to accumulate andcommunicate relevant information to management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow for timelydecisions regarding required disclosures. Under the supervision and with the participation of our management,including our CEO and CFO, we conducted an evaluation of our disclosurecontrols and procedures within 90 days of the filing date of the Company’soriginal Annual Report on Form 10-K for the fiscal year ended August 30,2003. Based upon this evaluation, our management determined that the Company’sdisclosure controls and procedures were adequate.

 

While the Company has previously restated its consolidatedfinancial statements for the quarter ended March 1, 2003 to correct theCompany’s understatement of its merchandise inventory resulting from themodification of agreements relating to consignment arrangements between theCompany and two suppliers that transferred ownership at no cost to the Companyfor certain inventory previously received by the Company on a consignment basisthat was not recorded in the Company’s consolidated financial statements and,as such, the modifications of its agreements with such suppliers were uniqueand obscure transactions which occurred concurrently. Such modifications wereoutside of the Company’s usual and customary purchasing and procurement methodsand procedures and the changes in accounting necessitated by the modificationswere similarly atypical.

 

The Company has now further restated its financialstatements to reflect the issuance of common stock received upon thedemutualization of Principal Life Insurance Company (“Principal”) as more fullydescribed in Note 1 to the Notes to Consolidated Financial Statements.  The Company did not discover the existenceand its ownership of Principal’s common stock because the Company received nocommunications regarding the demutualization plan, the demutualizationcompensation or the resultant issuance of Principal’s common stock until itsreceipt in December 2003 of a check reflecting the second dividend paymentin connection with Principal’s common stock which prompted the Company’sinquiries in this regard.

 

Subsequent to management’s identification of the notederrors in our financial statements, in each case, the errors were reported bymanagement to the Company’s Audit Committee and to its independent certified publicaccountants, Grant Thornton LLP, who, at the time, concurred with management’sassessment of the errors and their impact on the overall effectiveness of theCompany’s internal controls and procedures. Subsequent analyses by the auditors have resulted in the conclusion thatcertain material weaknesses in internal controls existed.  The auditors have provided a letter tomanagement and the Audit Committee, dated November 3, 2004 to such effect.

 

Management notes that, with respect to the inventoryunderstatement, the error in the inventory ledger was the direct result ofclerical error caused by the combination of personnel turnover, ineffectiveinstruction to processing personnel responsible for implementing the accountingeffect of the modifications and insufficient

 

3

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oversightand review.  In December 2003,subsequent to the discovery of the error but prior to the issuance of theweakness letter by the Company’s auditors, the Company established a two-tieredreview process for the inventory ledger involving review at both the floorsupervisor and controller levels which is intended to enhance theidentification of any issues in the computation of inventory in thefuture.  This modification of internalcontrols was part of the Company’s continuous evaluation and efforts to improveinternal controls though, not considered material enough to identify as achange in internal controls.

 

InOctober 2004, the Company ceased to be a public company.  The Company’s Chief Executive Officer andChief Financial Officer oversee the establishment of formalized policies andprocedures throughout the organization and fully evaluate the system ofinternal controls.  We believe that ourdisclosure controls and procedures have improved due to the scrutiny over suchmatters by our management.  We note,however, that a control system, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objective of thecontrol system are met.  Because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues have been detected.  These inherent limitations include therealities that judgments in decision-making can be faulty and breakdowns canoccur because of simple error or mistake. The design of any system of controls also is based, in part, on certainassumptions about the likelihood of future events and there can be no assurancethat any design will succeed in achieving its stated goals under all potentialfuture conditions.  However, we believethat our disclosure controls and procedures do provide reasonable assurancethat the objectives of our system of disclosure controls and procedures havebeen met.  Based, in part, upon the notedchanges, our CEO and CFO believe that, as of the filing date of this report,our disclosure controls and procedures were effective as of the end of theperiod covered by this report.

 

4

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**PART II**

 

**Item 8.  Financial Statements andSupplementary Data**

See Item 15(a) in Part IV.

 

**PART IV**

 

**Item 15.  Exhibits, FinancialStatement Schedules and Reports on Form 8-K**

 
| (a)    | FINANCIAL STATEMENTS                                                                                                                            |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|   | Report of Independent Registered Public Accounting Firm                                                                                         |
|   | Notes to Consolidated Financial Statements                                                                                                      |
|   |                                                                                                                                            |
| (b)    | REPORTS ON FORM 8-K – The Company did not file a Current Report on  Form 8-K during the last quarter of the period covered by this Report. |
|   |                                                                                                                                            |
| (c)    | EXHIBITS                                                                                                                                        |
|   |
| 23.1   |                                                                                                                                            | Consent of Independent Registered Public Accounting Firm |
| 31.1   |                                                                                                                                            | Certification of Acting Chief Executive Officer Pursuant to Exchange  Act Rule 13a-14(a)/15d-14(a) |
| 31.2   |                                                                                                                                            | Certification of Acting Chief Financial Officer Pursuant to Exchange  Act Rule 13a-14(a)/15d-14(a) |
| 32.1   |                                                                                                                                            | Certification of Acting Chief Executive Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) |
| 32.2   |                                                                                                                                            | Certification of Acting Chief Financial Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) |
|   |                                                                                                                                            |   |
| (d)    | FINANCIAL STATEMENT SCHEDULES – None are required.                                                                                         |
|        |                                                                                                                                                 |  |  |

 

5

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SIGNATURES

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Actof 1934, the Registrant has duly caused this report to be signed on its behalfby the undersigned thereunto, duly authorized.

 

 
| Dated: February  8, 2005 | RAG SHOPS, INC. |
|--------------------------|-----------------|
|                     |            |   |
|                     |            |   |
|                     | By:             | /s/ Stephen G. Marble |   |
|                     |            | Stephen G. Marble |
|                     |            | Acting Chief Executive Officer |
|                     |            |   |
|                     | By:             | /s/ Steven B. Barnett |   |
|                     |            | Steven B. Barnett |
|                     |            | Acting Principal  Financial Officer and  Acting Principal Accounting Officer |

 

6

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**RAG SHOPS, INC.**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

Thefollowing consolidated financial statements of Rag Shops, Inc. are included inresponse to Item 8:

 
|   | Report  of Independent Registered Public Accounting Firm                                                                                                                                             |   |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                                                                                                 |   |
|   | Consolidated  Statements of Changes in Stockholders’ Equity for the fiscal years ended  August 30, 2003 (restated), August 31, 2002 (previously restated)  and September 1, 2001 |   |
|   |                                                                                                                                                                                                 |   |
|   | Notes to  Consolidated Financial Statements                                                                                                                                                          |   |

 

F-1

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors ofRag Shops, Inc.

 

We have audited the accompanying consolidatedbalance sheets of Rag Shops, Inc. and Subsidiaries as of August 30, 2003and August 31, 2002, and the related consolidated statements ofoperations, changes in stockholders’ equity and cash flows for the three yearsin the period ended August 30, 2003. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Rag Shops, Inc. andSubsidiaries as of August 30, 2003 and August 31, 2002, and theconsolidated results of their operations and their consolidated cash flows foreach of the three years in the period ended August 30, 2003, in conformitywith accounting principles generally accepted in the United States of America.

 

Asdiscussed in Note 1 Recent Developments, the accompanying financial statementsas of and for the years ended August 30, 2003 and August 31, 2002have been restated.

 

 

GRANTTHORNTON LLP

 

 

Edison,New Jersey

November 13,2003,  except for the item titled “RecentDevelopments”

in Note 1, as to which the date is February 4, 2005

 

F-2

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**RAG SHOPS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’EQUITY**

**(Previously restated and restated)**

 
| ** **                                                   | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | **Unamortized  Restricted** | ** ** | ** **     | ** ** | **Unrealized  Gain on  Investment  in  Common** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|-----------------------------|------------|----------------|------------|-------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Stock**      | ** ** | **Retained**                | ** ** | **Stock, net** | ** ** | **Treasury**                                    | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **Shares**       | ** ** | **Dollars** | ** ** | **Capital**    | ** ** | **Awards**                  | ** ** | **Earnings**   | ** ** | **of taxes**                                    | ** ** | **Stock**  | ** ** | **Total**  | ** ** |
| ** **                                                   | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **                  | ** ** | ** **     | ** ** | **(See Note 1)**                                | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| BALANCE, SEPTEMBER 2, 2000                              |       | 4,828,463        |       | $           | 48,285     |           | $          | 6,242,293                   |       | $              | (12,100    | )                                               | $          | 17,455,512 |       | $          | 0          |   | $ | (64,074 | ) | $ | 23,669,916 |   |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Amortization of restricted stock awards                      |       | 0                |       | 0           |       | 0              |       | 4,384                       |       | 0              |       | 0                                               |       | 0          |       | 4,384      |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Forfeiture of restricted stock awards                        |       | (2,400           | )          | (24         | )          | (4,627         | )          | 4,651                       |       | 0              |       | 0                                               |       | 0          |       | 0          |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Net income                                                   |       | 0                |       | 0           |       | 0              |       | 0                           |       | 46,121         |       | 0                                               |       | 0          |       | 46,121     |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| BALANCE, SEPTEMBER 1, 2001                              |       | 4,826,063        |       | 48,261      |       | 6,237,666      |       | (3,065                      | )          | 17,501,633     |       | 0                                               |       | (64,074    | )          | 23,720,421 |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Amortization of restricted stock awards                      |       | 0                |       | 0           |       | 0              |       | 739                         |       | 0              |       | 0                                               |       | 0          |       | 739        |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Forfeiture of restricted stock awards                        |       | (1,200           | )          | (12         | )          | (2,314         | )          | 2,326                       |       | 0              |       | 0                                               |       | 0          |       | 0          |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Unrealized gain on investment in common stock, net Of  taxes |       | 0                |       | 0           |       | 0              |       | 0                           |       | 0              |       | 58,277                                          |       | 0          |       | 58,277     |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Net income                                                   |       | 0                |       | 0           |       | 0              |       | 0                           |       | 389,172        |       | 0                                               |       | 0          |       | 389,172    |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Total comprehensive income                                   |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       | 447,449    |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| BALANCE, AUGUST 31, 2002                                |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| (Previously Restated)                                        |       | 4,824,863        |       | 48,249      |       | 6,235,352      |       | 0                           |       | 17,890,805     |       | 58,277                                          |       | (64,074    | )          | 24,168,609 |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Unrealized gain on investment in common stock, net Of  taxes |       | 0                |       | 0           |       | 0              |       | 0                           |       | 0              |       | 14,166                                          |       | 0          |       | 14,166     |       |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Net loss                                                     |       | 0                |       | 0           |       | 0              |       | 0                           |       | (705,395       | )          | 0                                               |       | 0          |       | (705,395   | )          |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| Total comprehensive Income (loss)                            |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       | (691,229   | )          |
|                                                         |       |             |       |        |       |           |       |                        |       |           |       |                                            |       |       |       |       |       |
| BALANCE, AUGUST 30, 2003 (Restated) (See Note 1)   |       | 4,824,863        |       | $           | 48,249     |           | $          | 6,235,352                   |       | $              | 0          |                                            | $          | 17,185,410 |       | $          | 72,443     |   | $ | (64,074 | ) | $ | 23,477,380 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

F-3

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# **RAGSHOPS, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARS ENDED AUGUST 30, 2003, AUGUST 31, 2002 AND SEPTEMBER 1,2001**

 

# **NOTE1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RECENT DEVELOPMENTS**

# ** **

RECENT DEVELOPMENTS

 

In December 2003, the Company received a checkfrom Principal Financial Group, Inc. (“Principal”) reflecting dividends payablein connection with common stock of Principal. Receipt of the dividend checkprompted a Company inquiry which revealed that, due to its ownership of certainlife insurance policies issued by Principal Life Insurance Company, asubsidiary of Principal, and maintained by the Company for certain keyexecutive officers, the Company had received 9,766 shares of Principal’s commonstock (the “Shares”) in December 2001 as consideration in thedemutualization of Principal’s predecessor. The effective date of the demutualization was in October 2001 andthe Shares were issued in December 2001 to one of the Company’ssubsidiaries, the owner of the life insurance policies.  The Shares were issued in book-entry form asuncertificated shares and maintained in an account with Mellon InvestorServices established by Principal in connection with its demutualizationtransaction. The Company had not previously recognized or recorded the Sharesissued pursuant to such event as it did not discover the existence and itsownership of the common stock because the Company received no communicationsregarding the demutualization plan, the demutualization compensation or the resultantissuance of the common stock until its receipt in December 2003 of thedividend check which prompted the Company’s inquiries in this regard.  Since the common stock was issued inbook-entry form and since the Company continued to receive premium invoicesrelating to the insurance coverage, no other communications, indications orevents occurred which would have prompted earlier inquiry and, therefore,earlier discovery of the stock.  Upon itsinquiries, the Company determined that a prior dividend check had been issuedin December 2002; this check was never received and, accordingly, nevercashed (though upon the determination that such amount was owed to the Company,upon the Company’s request, a replacement check was subsequently issued andcashed in January 2004).

 

The failure to recognize or record the Sharesresulted in an error in the previously issued financial statements whichprompted the Company to determine to restate prior financial statements toproperly reflect the transaction in the first quarter of fiscal year 2002.  In its restated financial statements, theCompany has recorded the then fair market value ($180,671) of the Shares aspart of operating income as of October 2001, in accordance with EmergingIssues Task Force Issue No. 99-4, “Accounting for Stock Received from theDemutualization of a Mutual Insurance Company”. The Company has classified itsholding in the Shares as “available-for-sale” pursuant to Statement ofFinancial Accounting Standards No. 115 “Accounting for Investments”, wherebythe investment will be carried at fair market value and subsequent changes inthe market value of the investment will be reflected as an unrealized gain orloss in the stockholders’ equity section of the balance sheets, net ofdeferred income taxes. Other Comprehensive Income will be presented for allperiods pursuant to Statement of Financial Accounting Standards No. 130 “ReportingComprehensive Income” either in the Consolidated Statements of Changes inStockholders’ Equity or Notes to Consolidated Financial Statements.Comprehensive income consists of net income or loss for the current period aswell as income, expenses, gains or losses, net of income taxes arising duringthe period that are included in separate components of equity. It includes theunrealized gains and losses on the Company’s available-for-sale security, netof taxes.

 

Thefair market value of the Shares as of the close of business on August 30,2003 was $307,238. Please refer to amendments to periodic reports filed withthe Securities and Exchange Commission for periods between December 1,2001 and November 29, 2003 for related restatements.

 

F-4

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The following tables show the impact of therestatement from the previously filed financial statements, as of August 30,2003 and for the fiscal year then ended:

 
| ** **                                                                                    | ** ** | **Previously  Reported** | ** ** | **Adjustments**            | ** ** | **Restated** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|--------------|------------|
| ** **                                                                                    | ** ** | ** **               | ** ** | **(Amounts in thousands)** | ** ** | ** **   | ** ** |
|                                                                                          |       |                     |       |                       |       |         |       |
| Current assets – Investment in common stock                                              |       | $                        | —     |                       | $          | 307          |       | $ | 307 |   |
| Deferred income taxes – long term                                                        |       | 459                      |       | (135                       | )          | 324          |       |
| Stockholders’ equity – Unrealized gain on investment  in common stock, net of taxes |       | —                   |       | 72                         |       | 72           |       |
| Stockholders’ equity – Retained earnings                                            |       | 17,086                   |       | 100                        |       | 17,186       |       |
| Other comprehensive income                                                                    |       | —                   |       | 14                         |       | 14           |       |
| Total comprehensive income                                                                    |       | (705                     | )          | 14                         |       | (691         | )          |
|                                                                                               |            |                          |            |                            |            |              |            |  |  |  |

 

The following tables show the impact of therestatement from the previously filed financial statements, as of August 31,2002 and for the fiscal year then ended:

 
| ** **                                                                                    | ** ** | **Previously  Reported**                              | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                                                                                    | ** ** | **(Amounts in thousands except  earnings per share)** | ** ** |
| ** **                                                                                    | ** ** | ** **                                            | ** ** | ** **      | ** ** | ** **   | ** ** |
| Current assets – Investment in common stock                                              |       | $                                                     | —     |            | $          | 286          |       | $ | 286 |   |
| Deferred income taxes – long term                                                        |       | 497                                                   |       | (129            | )          | 368          |       |
| Stockholders’ equity – Unrealized gain on investment  in common stock, net of taxes |       | —                                                |       | 58              |       | 58           |       |
| Stockholders’ equity – Retained earnings                                            |       | 17,791                                                |       | 100             |       | 17,891       |       |
| Gain from demutualization                                                                     |       | —                                                |       | 181             |       | 181          |       |
| Provision for income taxes                                                                    |       | 236                                                   |       | 81              |       | 317          |       |
| Net income                                                                                    |       | 289                                                   |       | 100             |       | 389          |       |
| Other comprehensive income                                                                    |       | —                                                |       | 58              |       | 58           |       |
| Total comprehensive income                                                                    |       | 289                                                   |       | 158             |       | 447          |       |
| Earnings per share – Basic                                                               |       | $                                                     | 0.06       |            | $          | 0.02         |       | $ | 0.08 |   |
| Earnings per share – Diluted                                                             |       | $                                                     | 0.06       |            | $          | 0.02         |       | $ | 0.08 |   |

 

The Company did not previously file a Schedule ofComprehensive Income as there were no differences between net income and totalcomprehensive income. The Schedule of Comprehensive Income is as follows:

 
| ** **                                    | ** ** | **Fiscal Year Ended**      | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **August 30,  2003**  | ** ** | **August 31,  2002** | ** ** |
| ** **                                    | ** ** | **(Amounts in thousands)** | ** ** |
|                                          |       |                       |       |   |   |
| Net income (loss)                             |       | $                          | (705       | ) | $ | 389 |   |
| Other comprehensive income, net of taxes:     |       |                       |       |   |   |
| Unrealized gain on investment in common Stock |       | 14                         |       | 58 |   |
|                                          |       |                       |       |   |   |
| Total comprehensive income (loss)             |       | $                          | (691       | ) | $ | 447 |   |

 

F-5

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**RAG SHOPS, INC.**

 

INDEX TO EXHIBITS

 

 
| **EXHIBITS  NUMBER** | ** ** | **DESCRIPTION OF EXHIBIT**                                                   | ** ** |
|----------------------|------------|------------------------------------------------------------------------------|------------|
|                 |       |                                                                         |       |
| 23.1                 |       | Consent  of Independent Registered Public Accounting Firm                    |       |
| 31.1                 |       | Certification of Acting Chief Executive  Officer Pursuant to                 |       |
|                 |       | Exchange Act Rule 13a-14(a)/15d-14(a)                                        |       |
| 31.2                 |       | Certification of Acting Chief Financial  Officer Pursuant to                 |       |
|                 |       | Exchange Act Rule 13a-14(a)/15d-14(a)                                        |       |
| 32.1                 |       | Certification  of Acting Chief Executive Officer Pursuant to                 |       |
|                 |       | Section 906  of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) |       |
| 32.2                 |       | Certification  of Acting Chief Financial Officer Pursuant to                 |       |
|                 |       | Section 906  of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) |       |

 

E-1

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