FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURTIES EXCHANGE
    ACT OF 1934

                  For the fiscal year ended September 1, 2001

                                      OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURTIES EXCHANGE
    ACT OF 1934

    For the transition period from_____to _____

                      Commission File No. 0-19194

                                RAG SHOPS, INC.
            (Exact name of registrant as specified in its charter)

                   DELAWARE                           51-0333503
       (State or other jurisdiction of      (I.R.S. Employer Identification
        incorporation or organization)                  Number)

               111 WAGARAW ROAD
            HAWTHORNE, NEW JERSEY                        07506
       (Address of principal executive                (Zip Code)
                   offices)

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

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

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

                     COMMON STOCK, $.01 PAR VALUE
                           (Title of Class)

    Indicate by check mark whether the registrant (1) has filed all reports
    required to be files by Section 13 or 15(d) of the Securities Exchange
    Act of 1934 during the preceding 12 months, and (2) has been subject to
    such filing requirements for the past 90 days.
    Yes    X                      No ____
        -------

    Indicate by check mark if disclosure of delinquent filers pursuant to
    Item 405 of Regulation S-K is not contained herein, and will not be
    contained, to the best of registrant's knowledge, in definitive proxy
    or information statements incorporated by reference in Part III of this
    Form 10-K or any amendment to this Form 10-K.  X
                                                 -----


<PAGE>


As of October 31, 2001, there were outstanding 4,799,183 shares of Common Stock.
Based on the price at which stock was sold on that date, the approximate
aggregate market value of such shares held by non-affiliates was $5,267,364.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's 2001 Definitive Proxy Statement, which statement
will be filed not later than 120 days after the end of the fiscal year covered
by this Report, are incorporated by reference in Part III hereof.

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

[The remainder of this page is intentionally blank.]


<PAGE>


                                     PART I

ITEM 1. BUSINESS

GENERAL

Rag Shops, Inc., a Delaware corporation formed in April 1991, is the successor
by merger to a New Jersey corporation having the same name which was
incorporated in September 1984, as a holding company for numerous subsidiaries
that have operated retail stores since 1963. As of September 1, 2001 Rag Shops,
Inc. operated 66 specialty retail stores that sell competitively priced craft
and fabric merchandise. The Company caters to value conscious consumers who
create decorative accessories and sew. The Company believes that its wide
selection of currently popular merchandise, value-oriented pricing policy and
commitments to both customer service and advertising are principal factors
contributing to its results. The Company's stores are destination-oriented and
also attract shoppers from other stores located in the same shopping centers.

As of September 1, 2001, the Company operated 36 retail stores in New Jersey, 18
in Florida, five in Pennsylvania, five in New York and two in Connecticut. The
Company anticipates opening three stores and closing three stores during its
fiscal year ending August 31, 2002. The Company's expansion strategy is to grow
by expanding within areas from which it presently attracts customers and into
contiguous market areas, enabling the Company to capitalize on pre-existing
advertising and name recognition. The following table sets forth information
with respect to store openings and closings since fiscal 1997.

<TABLE>
<CAPTION>
                                                                            FISCAL YEARS

                                                    2001             2000            1999              1998             1997
                                                    ----             ----            ----              ----             ----

<S>                                                    <C>               <C>             <C>              <C>               <C>
Stores open at beginning of period                     65                69              66               66                67
Stores opened during period                             5                 0               5                2                 4
Stores closed during period                             4                 4               2                2                 5
Stores open at end of period                           66                65              69               66                66

Retail square footage at end of period            707,800           663,300         695,400          642,000           624,700
</TABLE>

PRODUCTS

The Company's stores offer a diverse and extensive assortment of value-priced
crafts, fabrics, and related items to creative craft and sewing consumers.

Each of the Company's stores offers craft, fabric and related products. Craft
items include silk flowers, wicker, picture frames, wood products, stitchery,
yarn, wearable art, art supplies and craft supplies. Fabric items available at
the Company's stores include apparel and home decorative fabrics, trimmings,
patterns and sewing notions. As of September 1, 2001, 62 stores offer custom
picture framing. The Company also sells a wide variety of seasonal merchandise
with special emphasis on the Easter, Back-to-School, Halloween and Christmas
seasons.

Through their purchase of craft, fabric and other items, used either
individually or in combination, the Company's customers can hand-make a wide
variety of finished products for personal use, gifts, home beautification and
seasonal decoration. For example, fabrics can be made into career, leisure,
children's, bridal and special occasion fashions, draperies and upholstery for
home decoration and hand made quilts and, from the Company's selection of craft
items, customers can create needle point and stitchery, personalized hand
painted apparel, floral arrangements and dolls.

MERCHANDISING AND ADVERTISING

The Company's marketing and merchandising strategy emphasizes the sale of
multiple products to be used by the customer to create a single project. To
assist customers in making their own selections and to encourage their purchase
of several products, the Company's stores display finished models that
incorporate a variety of merchandise in close proximity to where the components
are sold. The models are created by employees at the stores conforming to
Company guidelines.

Craft or sewing classes are offered monthly at a select number of each of the
Company's stores to further promote both specific products and store business.
During each class, participants complete a project using materials purchased
from the store at which the class is offered.

Merchandise at the Company's stores is displayed on conveniently arranged
fixtures to facilitate customer access. The general layout of merchandise,
adjusted seasonally and as otherwise necessary to adapt to marketing conditions,
is planned by the Company's management to give prominence to the types of
merchandise currently in demand.

Approximately five percent of the Company's net sales are expended on a 52-week
per year advertising program. The Company utilizes freestanding newspaper
inserts, alternating with newspaper print advertisements. These newspaper
inserts are also displayed at the front of each store and describe a calendar of
promotions emphasizing special sales items, seasonal products and other
currently popular merchandise. Approximately three million people regularly
receive the freestanding newspaper inserts.

For the Back-to-School season and holiday seasons of Easter, Halloween and
Christmas, the Company utilizes a fully developed merchandising program
including special inventory, layout, instructional ideas and promotions with
highly focused displays. During these peak seasons approximately 25% of store
selling space is devoted to seasonal merchandise.

SEASONALITY

The Company's business is seasonal, which the Company believes is typical of the
retail craft and fabric industry. The Company's highest sales and earnings
levels historically occur between September and December. Historically the
Company has operated at a loss during its fourth fiscal quarter, the June
through August summer period. The Company's results of operations depend
significantly upon the sales generated from September through December and any
material decrease in sales for such period could have a material adverse effect
upon the Company's profitability. See "Management's Discussion and Analysis of
Financial condition and Results of Operations-Seasonality."

STORE OPERATIONS

The Company's store operations are divided into seven geographic districts, each
managed by a district manager. Stores typically are staffed with a manager, an
assistant manager, one department head each for fabrics and crafts, sales
personnel, cashiers and stock clerks.

District managers supervise store management, monitor the Company's stores to
ensure compliance with procedures, policies and budgets, determine whether
adequate levels of merchandise are available at the stores and reallocate
merchandise among stores as dictated by selling trends at individual stores.
Store managers are responsible for operation of individual stores, including
recruiting and hiring store personnel.

Store managers place orders to replenish inventory from the Company's 85,000
square foot distribution center in Paterson, New Jersey, and may also directly
order certain core merchandise designated by management from the Company's
suppliers. Orders for merchandise are placed by the store manager on a regular
basis. Orders for merchandise are entered into a scanning gun, down loaded to a
computer in the store and polled by the Company's corporate data processing
system. Merchandise received at the Company's stores is entered into the store
computer and included in the polling. Deliveries from the distribution center
are made by Company-owned vehicles or by independent trucking companies.

Stores are generally open from 10:00 A.M. to 9:00 P.M. Monday through Saturday
and 11:00 A.M. to 6:00 P.M. on Sunday, with extended hours during the Christmas
season. All stores are operating with point-of-sale cash register systems.
Approximately 57% of receipts at the Company's stores are in the form of cash or
check, with the balance paid for with MasterCard, Visa, Discover or American
Express charge cards.

EXPANSION STRATEGY

While management does not believe there are significant geographic constraints
on the locations of future stores, the Company's strategy is to grow by
expanding within areas from which it presently attracts customers and into
contiguous market areas, enabling the Company to capitalize on pre-existing
advertising and name recognition. When deciding whether to open a new store, the
principal factors the Company typically evaluates are the amount of consumer
traffic generated by the market area, the demographic composition of the
customer base in the market area, store position in the shopping center, rent
structure, available media, advertising expense, and other costs associated with
opening the store. Historically, new stores tend to become profitable after six
to twenty-four months.

SOURCES OF SUPPLY

The Company purchases its merchandise from more than 300 suppliers. The
Company's merchandise is primarily purchased from domestic suppliers (including
distributors that import goods from the Far East) and the balance is acquired
directly from manufacturers in the Far East, including Hong Kong, Taiwan, Korea,
China and the Philippines. All of the merchandise purchased directly from
foreign manufacturers, consisting primarily of silk flowers, seasonal
merchandise and staple craft products, is sold under the Company's private
label. As is customary in the industry, the Company does not have any long-term
or exclusive contracts with any suppliers. The Company believes that alternate
sources of merchandise are readily available at comparable prices.

Consistent with industry practice, merchandise from manufacturers in the Far
East is ordered four to six months in advance to assure delivery prior to the
selling season for the merchandise. Letters of credit are frequently issued to
foreign manufacturers with specific terms regarding the merchandise ordered,
inspection prior to shipment, and time and place of delivery. The Company
assumes the risk of loss on a F.O.B. basis when goods are delivered to a shipper
and is insured against casualty losses arising during shipping.

COMPETITION

The retail craft and fabric industry is highly competitive. The Company competes
with other national, regional and independent specialty craft and/or fabric
retailers and mass merchandisers, some of which have greater financial and other
resources than the Company. The Company believes it competes on the basis of
merchandise selection, customer service, price and advertising. Competitors
include A.C. Moore Arts & Crafts, Inc., Jo-Ann Stores, Inc., and Michaels
Stores, Inc.

EMPLOYEES

As of September 1, 2001, the Company has approximately 1,290 employees,
consisting of approximately 310 full time and 980 part time employees. Full time
personnel consist of approximately 210 salaried and 100 hourly employees. All
part time personnel are hourly employees. During seasonal peak periods, the
Company hires temporary personnel. Approximately 43 employees in the Company's
distribution center are covered by a collective bargaining agreement with Local
161 of the Union of Needletrades, Industrial and Textile Employees, AFL-CIO.
This agreement expires in March 2002. The Company considers its relationships
with its employees to be good.

TRADEMARKS

The Company's trademark "THE RAG SHOP" was registered with the United States
Patent and Trademark Office on September 9, 1969 for fabrics, wearing apparel
and home furnishings; and has been renewed through September 9, 2009. Variations
of this mark have been registered by the Company to stand for its retail
services and for numerous goods sold by the Company at its retail outlets. These
marks are all renewable indefinitely so long as the marks are used by the
Company.


<PAGE>


ITEM 2. PROPERTIES

The Company's executive office facilities and its Hawthorne, New Jersey store
occupy approximately 15,900 and 17,600 square feet, respectively, in the same
strip shopping center in Hawthorne, New Jersey. The store and offices are leased
from Momar Realty L.L.C., the two members of which are Stanley Berenzweig,
Chairman of the Board and Doris Berenzweig, Secretary. The Company's
distribution center and all of its other stores are leased from non-affiliates
of the Company.

The Company's 85,000 square foot distribution center is located in Paterson, New
Jersey. The Company believes that its distribution center is adequate for its
needs through the expiration of the current term of the lease in July 2004. The
Company leases approximately 50,000 square feet of additional warehouse space on
a month-to-month basis to accommodate seasonal merchandise and expedite
distribution of merchandise to stores. Such additional space was leased for the
full twelve months of the year 2001 and is expected to be leased for the full
twelve months of 2002.

The Company's stores, all of which are located in leased facilities, range in
size from approximately 6,200 square feet to 17,700 square feet. The average
size of the Company's stores is approximately 10,700 square feet with
approximately 90% of the area of each store representing selling space. The
Company seeks to open new stores in the range of approximately 15,000 to 20,000
square feet. However, the Company often maintains options to expand store size
and will exercise those options or otherwise enlarge particular stores as
circumstances warrant. The following table sets forth the number of store leases
due to expire, including options to renew, during the calendar year indicated.

                                LEASE EXPIRATIONS

       YEAR               NUMBER             YEAR             NUMBER
       ----               ------             ----             ------

       2002                 2                2016               4
       2003                 2                2017               9
       2004                 2                2018               6
       2005                 2                2019               8
       2006                 1                2020               4
       2008                 3                2021               3
       2011                 3                2023               2
       2012                 2                2024               2
       2013                 4                2026               4
       2014                 1                2027               2

Sixty-three of the above stores are located in strip shopping centers, and the
remaining three are free-standing buildings. The stores generally are located in
close proximity to population centers and other retail operations and are
usually on a major highway or thoroughfare, making them easily accessible by
automobile. All of the stores provide free parking.

The leases for the Company's stores are generally for a term of five years,
usually with four options to renew for five years each. Under most leases, the
Company is required to pay, in addition to fixed minimum rental payments,
additional rent based on charges for real estate taxes, common area maintenance
fees, utility charges and insurance premiums. Certain leases provide for
contingent rentals based on a percentage of sales.

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in various legal proceedings incidental to the conduct
of its business. The Company currently is not engaged in any legal proceedings
that is expected to have a material adverse effect on the Company's results of
operations or financial position.



<PAGE>


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company did not submit any matters to vote of its stockholders, through the
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year ended September 1, 2001.



<PAGE>


                                     PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

Effective September 24, 1999 the Company's Common Stock began trading on the
NASDAQ SmallCap Market ("NASDAQ") under the symbol "RAGS". The Company's Common
Stock previously traded on the NASDAQ National Market.

The following table sets forth, for the periods indicated, the high and low sale
prices of the Company's Common Stock as reported by NASDAQ. These prices reflect
interdealer prices and do not include retail mark-ups, mark-downs or
commissions, and do not necessarily represent actual transactions.

                                                    HIGH           LOW
          FISCAL YEAR ENDED SEPTEMBER 1, 2001

          First Quarter                                 $ 2.750       $ 1.938
          Second Quarter                                  3.000         2.000
          Third Quarter                                   2.750         2.080
          Fourth Quarter                                  2.800         2.050

          FISCAL YEAR ENDED SEPTEMBER 2, 2000

          First Quarter                                 $ 2.438       $ 1.625
          Second Quarter                                  2.250         1.813
          Third Quarter                                   2.344         1.813
          Fourth Quarter                                  3.094         2.156

On October 31, 2001, the closing price of the Common Stock was $2.360.

The approximate number of stockholders of record of the Common Stock at October
31, 2001 was 352. The number of beneficial owners whose shares are held by
banks, brokers and other nominees exceeds 950.

On June 28, 1999, the Company declared a 5% stock dividend on the Company's
common stock which was paid on August 10, 1999 to stockholders of record on July
14, 1999. The Company has not paid any cash dividends. The Company presently
intends to retain all earnings for the operation and expansion of its business
and does not anticipate paying cash dividends on its Common Stock in the
foreseeable future. Any future determination as to the payment of cash dividends
on the Common Stock will depend upon future earnings, results of operations,
capital requirements, the financial condition of the Company and any other
factors the Board of Directors of the Company may consider. In addition,
pursuant to the Company's bank line of credit, the Company is prohibited from
declaring dividends in any year in excess of its earnings for such year or which
would otherwise result in a violation of the Company's covenant to maintain a
tangible net worth (as defined in the line of credit commitment letter) of
$9,000,000. The Company's tangible net worth for the period ended September 1,
2001 was $23,720,421.


<PAGE>


ITEM 6.    SELECTED FINANCIAL DATA


<TABLE>
<CAPTION>
                                                                               FISCAL YEAR ENDED (1)
                                               September 1,      September 2,       August 28,        August 29,        August 30,
                                                   2001              2000              1999              1998              1997
                                                   ----              ----              ----              ----              ----

                                                              (In thousands, except common stock data and statistics)
OPERATIONS
<S>                                             <C>              <C>               <C>               <C>               <C>
Net sales                                       $  100,888       $  100,208        $   94,781        $   90,566        $   86,528
Gross profit                                        35,756           36,543            33,915            32,722            31,044
Store expenses and general
   and administrative expenses                      35,740           34,582            33,163            31,167            30,578
Interest income (expense), net                         128               31               (83)              (61)             (115)
Income before income taxes and
   cumulative effect of change in
   accounting principle                                143            1,991               668             1,544               351
Income before cumulative effect of
   change in accounting principle                       46            1,198               402               942               207
Cumulative effect of change in
   accounting principle, net of tax                      0              198                 0                 0                 0
Net income                                      $       46       $    1,396        $      402        $      942        $      207

COMMON STOCK DATA (2)

Basic and diluted earnings per share:
Income before cumulative effect of
   change in accounting principle               $      .01       $      .25        $      .08        $      .20        $      .04
Cumulative effect of change in
   accounting principle                                  0              .04                 0                 0                 0
                                              ------------     ------------      ------------      ------------      ------------

Net income                                      $      .01       $      .29        $      .08        $      .20        $      .04

Book value per share                            $     4.94       $     4.93        $     4.59        $     4.59        $     4.39
Weighted average shares and
   equivalents outstanding:
  Basic                                          4,801,583        4,813,476         4,744,408         4,740,063         4,740,063
  Diluted                                        4,807,665        4,813,871         4,754,996         4,788,196         4,764,977

FINANCIAL POSITION

Working capital                                 $   19,049       $   19,640        $   17,298        $   17,095        $   16,256
Total assets                                        35,634           34,580            37,869            33,318            32,264
Short-term debt                                          0                0             6,570             2,194             3,119
Long-term debt                                           0                0                 0                 0               554
Stockholders' equity                            $   23,720       $   23,670        $   22,104        $   21,742        $   20,800
</TABLE>




<PAGE>



<TABLE>
<CAPTION>
                                                                          FISCAL YEAR ENDED (1)
                                         September 1,       September 2,        August 28,         August 29,        August 30,
                                             2001               2000               1999               1998              1997
                                             ----               ----               ----               ----              ----

                                                          (In thousands except common stock data and statistics)
STATISTICS

<S>                                             <C>                <C>                <C>                <C>               <C>
Net sales increase                              0.7%               5.7%               4.7%               4.7%              3.3%
Comparable store net sales
  increase (decrease) (3)                      (0.7%)              4.2%               0.2%               3.2%              3.8%
Comparable store net sales
  increases on a 52 week
  aligned basis (3)                             0.8%               2.5%               0.2%               3.2%              3.8%
Return on net sales, after
  income taxes                                  0.1%               1.4%               0.4%               1.0%              0.2%
Return on average
  stockholders' equity                          0.2%               6.1%               1.8%               4.4%              1.0%
Average net sales per gross
  square foot (4)                          $    146           $    147           $    141           $     143          $    139
Average net sales per store
  (000's) (4)                              $  1,534           $  1,490           $  1,399           $   1,374          $  1,296
Stores open at end of
  period                                         66                 65                 69                  66                66
</TABLE>


(1)      Fiscal 2000 is a 53-week fiscal year. All other years shown are
         52-week fiscal years.

(2)      On June 28, 1999, the Company declared a 5% stock dividend on
         the Company's common stock, which was paid on August 10, 1999 to
         stockholders of record on July 14, 1999. Share and per share data
         presented for all periods has been adjusted to give retroactive effect
         to the dividend.

(3)      Comparable store sales increases (decreases) for a fiscal year
         include stores commencing with their thirteenth consecutive entire
         fiscal month. Comparable store net sales increases on a 52 week aligned
         basis are arrived at by eliminating the unaligned 53rd week from fiscal
         2000 before comparing the result with the prior and succeeding year.

(4)      For purposes of calculating these amounts, the number of stores
         and the amount of gross square footage have been adjusted to reflect
         the number of months during the period that new stores were open. These
         amounts have not been adjusted to reflect the seasonal nature of the
         Company's net sales or the resulting impact of opening stores in
         different periods during the year. See "Management's Discussion and
         Analysis of Financial condition and Results of Operations-Seasonality."











ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
           RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

The following table sets forth as a percentage of net sales, certain items
appearing in the Company's Consolidated Income Statements for the indicated
years.

<TABLE>
<CAPTION>
                                                                                  YEAR ENDED
                                                              September 1,       September 2,        August 28,
                                                                  2001               2000               1999
                                                                  ----               ----               ----

<S>                                                                <C>               <C>                <C>
      Net sales                                                    100.0%            100.0%             100.0%
      Cost of merchandise sold and
        occupancy costs                                             64.5              63.5               64.2
                                                                  ------             -----             ------

      Gross profit                                                  35.5              36.5               35.8
      Store expenses                                                25.1              24.1               24.6
      General and administrative expenses                           10.3              10.4               10.4
                                                                  ------            ------             ------

      Income from operations                                         0.1%              2.0%               0.8%

      Net income                                                     0.1%              1.4%               0.4%
</TABLE>


The Company's net sales increased in fiscal 2001 by $680,000 or .7%. Sales from
comparable stores opened at least one year decreased $637,000 or .7%. The sales
comparison is affected by the number of weeks contained in each fiscal year
since fiscal 2000 includes a 53rd fiscal week while fiscal 2001 is based on a 52
week period. On a fully aligned, week-for-week comparative basis, net sales in
fiscal 2001 increased by $2,206,000 or 2.2% over the comparable prior period due
to increases in comparable store sales of $746,000 or .8%, in addition to new
store sales of $1,460,000 net of the impact of closed stores. The comparable
store sales increase was negatively affected in the Company's fiscal 2001 fourth
quarter by an unsuccessful change in promotional strategy and later distribution
of seasonal merchandise compared to fiscal 2000. Net sales increased in fiscal
2000 by $5,427,000 or 5.7%. Sales from comparable stores increased $3,811,000 or
4.2%. The 53rd fiscal week contributed sales of $1,529,000 or an increase of
1.6% of the sales increase over fiscal 1999. Management believes that
refinements to the presentation of its bi-weekly newspaper insert in addition to
an enhanced selection of promotional items in the fourth quarter of fiscal 2000
were significant factors in the improvement of comparable store sales.

Gross profit decreased $787,000, or 1.0% as a percent of net sales, in fiscal
2001 as compared to fiscal 2000. The percentage change was primarily due to a
return to historic inventory shrinkage results, as compared to the favorable
inventory shrinkage result experienced in fiscal 2000, coupled with a
combination of increases in occupancy and freight costs. Occupancy expense
increased because of higher square footage and rent costs of new stores as
compared to closed stores as well as contractual increases in rent for existing
stores. Freight expense rose primarily due to higher unit costs. Gross profit
improved by $2,628,000 and 0.7% in fiscal 2000 as compared to fiscal 1999. The
increase was primarily due to the favorable inventory shrinkage results and an
improvement in the initial mark-up on seasonal import merchandise.

Store expenses increased by $1,230,000 or 5.1%, and, as a percentage of net
sales, increased by 1.0% in fiscal 2001 as compared to fiscal 2000 principally
due to an increase in payroll and payroll related expenses that was primarily
due to new store openings net of store closings, and additional costs incurred
in connection with the Company's annual physical inventory to inaugurate a
company wide SKU (stock keeping unit) level inventory system to help improve the
Company's sales performance and tighten inventory control. Store expenses
increased by $839,000 or 3.6%, and, as a percentage of sales, decreased by .5%
in fiscal 2000 as compared to 1999. The increase in fiscal 2000 store expenses
was primarily due to an increase in payroll and payroll related expenses, an
extra week of expenses to support the 53rd fiscal week of sales and an increase
in credit card processing costs resulting from an increase in credit card
tenders. The increase in fiscal 2000 store expenses was partially offset by
reduced advertising expenses. The decrease in store expenses as a percent of net
sales was principally due to the ability of the Company to leverage expenses
against the increase in net sales.

General and administrative expenses decreased by $72,000 or .7% in fiscal 2001,
and, as a percentage of net sales, decreased by .1% as compared to fiscal 2000.
The lower general and administrative expense in fiscal 2001 is primarily due to
decreases in payroll and related expenses, and professional fees, partially
offset by increases in property and casualty insurance premiums and rent for the
Company's distribution center. In fiscal 2000, general and administrative
expenses increased by $580,000 or 5.9% as compared to fiscal 1999. The increase
is primarily due to an extra fiscal week of operating expenses, an increase in
payroll, due to higher bonuses earned by non-officers and an increase in the
amortization of restricted stock awards, and increases in health insurance costs
and professional fees. As a percentage of net sales, general and administrative
expenses remained relatively constant in fiscal 2000 and 1999 as the Company was
able to leverage these expenses against increases in net sales.

Interest income, net increased in fiscal 2001 as compared to fiscal 2000 because
the Company entered fiscal 2001 without bank debt and was able to maintain that
condition throughout the majority of the year, thus allowing an increase in
investment of cash provided by operating activities over that experienced in
fiscal 2000. Interest income, net increased in fiscal 2000 as compared to fiscal
1999 due to an increase in cash provided by operating activities and a decrease
in cash used for the purchase of property and equipment. These factors enabled
the Company to repay all borrowings under the Company's line of credit and
remain free of bank debt commencing in January 2000 through the end of the year.
See "Liquidity and Capital Resources."

The effective tax rate for 2001 was 67.8% as compared to 39.7% in 2000. The
increase is primarily due to a higher effective state and local income tax rate
due to minimum tax requirements. The effective tax rate for 2000 was 39.7% as
compared to 39.9% in 1999. The decrease is primarily due to a lower effective
state and local income tax rate.

Net income decreased by $1,350,000 for fiscal 2001 as compared to fiscal 2000
due to the decrease in gross profit and the increase in store expenses, which
was partially offset by the decrease in general and administrative expenses and
the increase in interest income, net. Net income increased by $995,000 for
fiscal 2000 as compared to fiscal 1999 due to the increase in net sales and
gross profit and a change in accounting for merchandise inventories that was
partially offset by an increase in operating expenses.

SEASONALITY

The Company's business is seasonal, which the Company believes is typical of the
retail craft and fabric industry. The Company's highest sales and earnings
levels historically occur between September and December. This period includes
the Back-to-School, Halloween and Christmas seasons. The Company has
historically operated at a loss during its fourth quarter, the June through
August summer period. See "Business - Seasonality."

Year to year comparisons of quarterly results and comparable store sales can be
affected by a variety of factors, including (1) the timing and duration of
holiday selling seasons, (2) the timing of new store openings and promotional
markdowns and (3) every seven years, the retail calendar, contains a 53rd week
as compared to a 52 week year for all other years.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary needs for liquidity are to maintain inventory for the
Company's existing stores and to fund the costs of opening new stores, including
capital improvements, initial inventory and pre-opening expenses. In fiscal 2001
and fiscal 2000, the Company relied on internally generated funds, trade credit
made available by suppliers and short-term borrowings to finance inventories and
new store openings. Nearly all of the Company financing was provided through
internally generated funds and trade credit.

The Company's working capital has decreased $591,000 in fiscal 2001 as compared
to 2000 primarily as a result of an increase in trade payables and other current
obligations partially offset by an increase in prepaid expenses.

The Company maintains a credit facility with a bank. The credit facility is
renewable annually on or before each December 31 and consists of a discretionary
unsecured line of credit for direct borrowings and the issuance and refinance of
letters of credit. The line of credit was increased from $8,000,000 to
$10,000,000 on August 31, 1999. Borrowings under the line of credit bear
interest at the bank's prime rate (6.50% at September 1, 2001). The credit
facility requires the Company to maintain a compensating balance of $400,000 in
addition to certain financial covenants which require a minimum defined working
capital and tangible net worth, a maximum ratio of debt to tangible net worth
and set limits on the payment of dividends. As of September 1, 2001, the Company
was in compliance with such covenants. Historically, the amount borrowed has
varied based on the Company's seasonal requirements, generally reaching a
maximum amount outstanding during the fourth quarter of each fiscal year. The
maximum amount outstanding at a point in time under the line was $545,000,
$7,490,000, and $7,010,000 during fiscal 2001, fiscal 2000 and fiscal 1999,
respectively. There were no direct borrowings outstanding under the line of
credit at September 1, 2001 or September 2, 2000. The Company intends to
maintain the availability of the line of credit for working capital requirements
and in order to be able to take advantage of future opportunities.

The Company purchases merchandise directly from manufacturers in the Far East.
These purchases are payable in United States dollars and are either by direct
payment or supported by letters of credit. The results of operations of the
Company have not been affected by foreign currency fluctuation. At September 1,
2001, the Company had outstanding letters of credit in the amount of $196,854.

During fiscal 2001, fiscal 2000 and fiscal 1999, the Company had net cash
provided by (used in) operating activities of $1,526,000, $7,537,000 and
$(2,707,000), respectively, and used $1,890,000, $591,000 and $1,579,000,
respectively for purchases of property and equipment. Cash provided by operating
activities in fiscal 2001 resulted primarily from depreciation, and increases in
trade payables and other current obligations, partially offset by an increase in
prepaid expenses. In fiscal 2002, the Company expects to open three new stores
and close three existing stores. Costs associated with opening of new stores,
including capital expenditures, inventory and pre-opening expenses have
historically approximated $350,000 per store. These costs will be financed
primarily from cash provided by operating activities, credit made available by
suppliers to finance inventories and, if necessary, from the Company's bank line
of credit. However, the Company will re-deploy assets of stores being closed to
the new stores as opportunities evolve in order to curtail the costs of opening
stores. The Company believes that its cash at September 1, 2001, working capital
generated from operations and cash available from the bank line of credit will
be sufficient for the Company's operating needs for at least the next 12 months.

FORWARD-LOOKING STATEMENTS

This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which are intended to be covered by
safe harbors created hereby. Such forward-looking statements include those
regarding the Company's future results in light of current management
activities, and involve known and unknown risks, including competition within
the craft 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).

RECENT ACCOUNTING STANDARDS

On July 20, 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 141, Business Combinations,
and SFAS 142, Goodwill and Intangible Assets. SFAS 141 is effective for all
business combinations completed after June 30, 2001. SFAS 142 is effective for
fiscal years beginning after December 15, 2001; however, certain provisions of
this Statement apply to goodwill and other intangible assets acquired between
July 1, 2001 and the effective date of SFAS 142. Major provisions of these
Statements and their effective dates for the Company are as follows:

o    all business combinations initiated after June 30, 2001 must use
     the purchase method of accounting. The pooling of interest method of
     accounting is prohibited except for transactions initiated before July 1,
     2001.

o    intangible assets acquired in a business combination must be
     recorded separately from goodwill if they arise from contractual or other
     legal rights or are separable from the acquired entity and can be sold,
     transferred, licensed, rented or exchanged, either individually or as part
     of a related contract, asset or liability.

o    goodwill, as well as intangible assets with indefinite lives,
     acquired after June 30, 2001, will not be amortized. Effective September 1,
     2002, all previously recognized goodwill and intangible assets with
     indefinite lives will no longer be subject to amortization.

o    effective September 1, 2002, goodwill and intangible assets with
     indefinite lives will be tested for impairment annually and whenever there
     is an impairment indicator.

o    all acquired goodwill must be assigned to reporting units for purposes of
     impairment testing and segment reporting.

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment of Disposal of Long-Lived Assets" ("SFAS
144"). This statement is effective for fiscal years beginning after December 15,
2001. This supercedes Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", while retaining many of the requirements of such statement.

Although it is still reviewing the provisions of these Statements, management's
preliminary assessment is that these Statements will not have a material impact
on the Company's financial position or results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the potential change in a financial instrument's value caused by
fluctuations in interest or currency exchange rates, or in equity and commodity
prices. The Company's activities expose it to certain risks that management
evaluates carefully to minimize earnings volatility. At September 1, 2001, and
during each of the three years in the period then ended, the Company was not a
party to any derivative arrangement and the Company does not engage in trading,
market-making or other speculative activities in the derivatives markets. The
Company does not have any foreign currency exposure. As discussed in Note 3 of
the Notes to Consolidated Financial Statements, loans outstanding under the
Company's unsecured line of credit bear interest at the bank's prime rate (6.50%
at September 1, 2001). There were no loans outstanding under any such line of
credit at September 1, 2001 or September 2, 2000.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                  See Item 14(a) in Part IV.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.


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 for the year
ended August 28, 1999 was 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.

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.

                                    PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required for this item is incorporated by reference to the
Company's 2001 Definitive Proxy Statement which the Company will file with the
Securities and Exchange Commission no later than 120 days subsequent to
September 1, 2001.

ITEM 11.   EXECUTIVE COMPENSATION

The information required for this item is incorporated by reference to the
Company's 2001 Definitive Proxy Statement which the Company will file with the
Securities and Exchange Commission no later than 120 days subsequent to
September 1, 2001.

ITEM 12.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required for this item is incorporated by reference to the
Company's 2001 Definitive Proxy Statement which the Company will file with the
Securities and Exchange Commission no later than 120 days subsequent to
September 1, 2001.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required for this item is incorporated by reference to the
Company's 2001 Definitive Proxy Statement which the Company will file with the
Securities and Exchange Commission no later than 120 days subsequent to
September 1, 2001.



<PAGE>


                                     PART IV

ITEM 14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

  (a)   FINANCIAL STATEMENTS                                       PAGE
        ---------------------
        Report of Independent Certified Public Accountants         F-1

        Independent Auditors' Report                               F-2

        Consolidated Balance Sheets as of September 1, 2001 and
        September 2, 2000                                          F-3

        Consolidated Statements of Income for the
        years ended September 1, 2001, September 2, 2000 and
        August 28, 1999                                            F-4

        Consolidated Statements of Stockholders'
        Equity for the years ended September 1, 2001, September
        2, 2000 and  August 28, 1999                               F-5

        Consolidated Statements of Cash Flows for
        the years ended September 1, 2001, September 2, 2000
        and August 28, 1999                                        F-6

        Notes to Consolidated Financial Statements                 F-7 - F-15

  (b)   EXHIBITS
        3.1*     Certificate of Incorporation of the Company
        3.2*     By-Laws of the Company
        10.1*    Promissory Note (Revolving) with Valley National
                 Bank
        10.2*    1991 Stock Option Plan
        10.3*    Lease between Momar Realty Co. and the Company,
                 dated as of March 1, 1991
        10.4**   1999 Incentive Stock Award Plan
        10.5**   Change in Registrants Certifying Accountant
        21.1     List of subsidiaries of the Company
        23.1     Consent of Grant Thornton LLP
        23.2     Consent of Deloitte & Touche LLP
        24.1     Power of Attorney to sign Form 10-K (set forth on page 16)
        27       Financial Data Schedule (Filed electronically with SEC only)

  (c)   FINANCIAL STATEMENT SCHEDULES
        -----------------------------
        None of these schedules are required.

  (d)   The Company did not file a Current Report on
        Form 8-K during the last quarter of the period covered
        by this Report.

*  Incorporated by reference to the Company's Registration Statement
   on Form S-1 and Amendment No. 1 thereto.
** Incorporated by reference to the Company's Registration Statement
   on Form S-8 filed on September 3, 1999.



<PAGE>



                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto, duly authorized, in the City of Hawthorne,
New Jersey, on December 14, 2001.

                                              RAG SHOPS, INC.
                                         By: /S/ STANLEY BERENZWEIG
                                         --------------------------
                                          STANLEY BERENZWEIG, Chairman

                                POWER OF ATTORNEY

Each of the undersigned hereby appoints Stanley Berenzweig and Steven Barnett as
his or her attorneys-in-fact to sign his or her name, in any and all capacities,
to any amendments to this Form 10-K and any other documents filed in connection
therewith to be filed with the Securities and Exchange Commission. Each of such
attorneys has the power to act with or without the others.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following person on behalf of the Registrant and in
the capacities and on the dates indicated.

   SIGNATURE                 TITLE(S)                      DATE

   /S/ STEVEN B. BARNETT     Executive Vice President and  December 14, 2001
   --------------------      Director
    Steven B. Barnett

   /S/ EVAN BERENZWEIG       Senior Vice President and     December 14, 2001
   --------------------      Director
    Evan Berenzweig

   /S/ STANLEY BERENZWEIG    Principal Executive           December 14, 2001
   ----------------------    Officer and Director
    Stanley Berenzweig

   /S/ MARIO CIAMPI          Director                      December 14, 2001
   ----------------
    Mario Ciampi

   /S/ FRED J. DAMIANO       Director                      December 14, 2001
   -------------------
    Fred J. Damiano

   /S/ FREDERICK A. GUNZEL   Vice President and Chief      December 14, 2001
   -----------------------   Financial Officer
   Frederick A. Gunzel

   /S/ JUDITH LOMBARDO       Senior Vice President and     December 14, 2001
   -------------------       Director
    Judith Lombardo

   /S/ ALAN C. MINTZ         Director                      December 14, 2001
   -----------------
    Alan C. Mintz





<PAGE>


                                 RAG SHOPS, INC.

                                INDEX TO EXHIBITS


  Exhibit                                                        Sequentially
  NUMBER   DESCRIPTION OF EXHIBITS                               NUMBERED PAGES

  3.1      Certificate of Incorporation of the Company                 *

  3.2      By-Laws of the Company                                      *

  10.1     Promissory Note (Revolving) with Commercial Lending         *
           Institution

  10.2     1991 Stock Option Plan                                      *

  10.3     Lease between Momar Realty Co. and the Company,             *
           dated as of March 1, 1991

  10.4     1999 Incentive Stock Award Plan                             **

  10.5     Change in Registrants Certifying Accountant                 **

  21.1     List of subsidiaries of the Company                         F-16

  23.1     Consent of Grant Thornton LLP

  23.2     Consent of  Deloitte & Touche LLP

  24.1     Power of Attorney to sign Form 10-K
            (set forth on page 17)



--------------------------------
*  Incorporated by reference to the Company's Registration Statement on Form
S-1 and Amendment No. 1 thereto.

** Incorporated by reference to the Company's Registration Statement on
Form S-8 filed on September 3, 1999.


<PAGE>




 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Board of Directors
 and Stockholders

Rag Shops, Inc.
Hawthorne, New Jersey

We have audited the accompanying consolidated balance sheets of Rag Shops, Inc.
and its Subsidiaries as of September 1, 2001 and September 2, 2000 and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the two years in the period ended September 1, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Rag Shops, Inc. and
Subsidiaries as of September 1, 2001 and September 2, 2000, and the results of
their operations and their cash flows for each of the two years in the period
ended September 1, 2001, in conformity with accounting principles generally
accepted in the United States of America.

As discussed in Note 1, the Company changed its method of calculating inventory
for the year ended September 2, 2000.

Grant Thornton  LLP
Edison, New Jersey
November 27, 2001





















                                       F-1


<PAGE>




INDEPENDENT AUDITORS' REPORT

To the Board of Directors
 and Stockholders

Rag Shops, Inc.
Hawthorne, New Jersey

We have audited the accompanying statements of income, changes in stockholders'
equity and cash flows of Rag Shops, Inc. and Subsidiaries for the year ended
August 28, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of operations and cash flows of Rag Shops, Inc.
and Subsidiaries for the year ended August 28, 1999, in conformity with
generally accepted accounting principles.

Deloitte & Touche LLP
Parsippany, New Jersey
November 11, 1999


                                      F-2
<PAGE>


RAG SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                 September 1,        September 2,
                                                                     2001                2000
                                                                     ----                ----

ASSETS
CURRENT ASSETS
<S>                                                             <C>                 <C>
   Cash                                                         $       953,224     $    1,310,604
   Merchandise inventories                                           27,806,578         27,805,318
   Prepaid expenses                                                   1,194,277            483,314
   Other current assets                                                 153,565             98,938
   Deferred income taxes                                                855,346            852,046
                                                                  -------------       ------------

                 Total current assets                                30,962,990         30,550,220

PROPERTY AND EQUIPMENT, NET                                           4,186,012          3,613,215
DEFERRED INCOME TAXES                                                   436,002            349,802
OTHER ASSETS                                                             49,485             66,707
                                                                  -------------     --------------

TOTAL ASSETS                                                    $    35,634,489    $    34,579,944
                                                                ================    ================

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
   Accounts payable - trade                                     $     8,348,552    $     7,762,720
   Accrued expenses and other current
     liabilities                                                      2,680,378          2,011,823
   Accrued salaries and wages                                           719,952            893,123
   Income taxes payable                                                 165,186            242,362
                                                                  -------------       ------------

                 Total current liabilities                           11,914,068         10,910,028

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
   Preferred stock, $.01 par value
     2,000,000 shares authorized;
     no shares issued or outstanding                                          0                  0
   Common stock, $.01 par value,
     13,000,000 shares authorized;
     4,826,063 (4,799,183) shares and 4,828,463 (4,801,583)
     shares issued (outstanding) at September 1, 2001
     and September 2, 2000, respectively                                 48,261             48,285
   Additional paid-in capital                                         6,237,666          6,242,293
   Unamortized restricted stock awards                                   (3,065)           (12,100)
   Retained earnings                                                 17,501,633         17,455,512
   Treasury stock, at cost, 26,880 shares                               (64,074)           (64,074)
                                                                  -------------       ------------

Total stockholders' equity                                           23,720,421         23,669,916
                                                                  -------------         ----------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                      $    35,634,489    $    34,579,944
                                                                ===============     ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.


                                      F-3
<PAGE>


RAG SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME

<TABLE>
<CAPTION>
                                                                               Fiscal Year Ended
                                                                               -----------------
                                                                September 1,      September 2,       August 28,
                                                                    2001              2000              1999
                                                                    ----              ----              ----

<S>                                                           <C>                <C>               <C>
NET SALES                                                        $100,887,768      $100,207,583      $ 94,780,965

COST OF MERCHANDISE SOLD AND
  OCCUPANCY COSTS                                                  65,131,965        63,665,075        60,866,108
                                                                -------------     -------------     -------------

Gross profit                                                       35,755,803        36,542,508        33,914,857
                                                                -------------     -------------     -------------

OPERATING EXPENSES:
  Store expenses                                                   25,380,995        24,150,617        23,311,717
  General and administrative
     expenses                                                      10,359,372        10,431,531         9,851,633
                                                                -------------     -------------     -------------

Total operating expenses                                           35,740,367        34,582,148        33,163,350
                                                                -------------     -------------     -------------

INCOME FROM OPERATIONS                                                 15,436         1,960,360           751,507

INTEREST INCOME (EXPENSE), Net                                        127,885            30,562           (83,184)
                                                                -------------     -------------     --------------

INCOME BEFORE PROVISION FOR INCOME
TAXES AND CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE                                        143,321         1,990,922           668,323

PROVISION FOR INCOME TAXES                                             97,200           793,000           266,700
                                                                -------------     -------------     -------------

INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE                                         46,121         1,197,922           401,623

CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE, NET OF INCOME
TAX EFFECT OF $127,000                                                      0           198,496                 0
                                                                -------------     -------------     -------------

NET INCOME                                                    $        46,121   $     1,396,418    $      401,623
                                                                =============     =============      ============

BASIC AND DILUTED EARNINGS PER
COMMON SHARE:

   INCOME BEFORE CUMULATIVE EFFECT OF
   CHANGE IN ACCOUNTING PRINCIPLE                                       $.01               $.25             $.08

   CUMULATIVE EFFECT OF CHANGE IN
   ACCOUNTING PRINCIPLE                                                    0                .04                0
                                                                        ----                ---             ----

   NET INCOME                                                           $.01               $.29             $.08
                                                                        ====               ====             ====
</TABLE>


The accompanying notes are an integral part of these consolidated financial
statements.


                                      F-4
<PAGE>


RAG SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR YEARS ENDED
AUGUST 28, 1999, SEPTEMBER 2, 2000 AND SEPTEMBER 1,2001

<TABLE>
<CAPTION>
                                                                        Additional    Unamortized
                                   Common Stock            Paid-In       Restricted      Retained        Treasury
                                Shares       Dollars       Capital         Stock         Earnings         Stock          Total
                                                                           Awards
BALANCE, AUGUST
<S>   <C>                      <C>          <C>          <C>             <C>          <C>              <C>            <C>
  29, 1998                     4,514,400      $ 45,144     $6,039,162      $       0    $ 15,657,471     $     0      $  21,741,777

Acquisition of treasury
  stock                                0             0              0              0               0     (64,074)           (64,074)

Issuance of restricted
  stock awards                    97,700           977        231,061       (232,038)              0           0                  0

Stock dividend                   225,663         2,257         (2,396)             0               0           0               (139)

Amortization of restricted
  stock awards                         0             0              0         24,550               0           0             24,550

Net income                             0             0              0              0         401,623           0            401,623
                             -----------   -----------  -------------   ------------  --------------   ---------     --------------

BALANCE, AUGUST
  28, 1999                     4,837,763        48,378      6,267,827       (207,488)     16,059,094     (64,074)        22,103,737

Issuance of restricted
  stock awards                     9,000            90         17,352        (17,442)              0           0                  0

Amortization of restricted
  stock awards                         0             0              0        169,761               0           0            169,761

Forfeiture of restricted
  stock awards                   (18,300)         (183)       (42,886)        43,069               0           0                  0

Net income                             0             0              0              0       1,396,418           0          1,396,418
                             -----------   -----------  -------------   ------------  --------------   ---------     --------------


BALANCE, SEPTEMBER
  2, 2000                      4,828,463        48,285      6,242,293        (12,100)     17,455,512     (64,074)        23,669,916

Amortization of restricted
  stock awards                         0             0              0          4,384               0           0              4,384

Forfeiture of restricted
  stock awards                    (2,400)          (24)        (4,627)         4,651               0           0                  0

Net income                             0             0              0              0          46,121           0             46,121
                             -----------   -----------  -------------   ------------  --------------   ---------     --------------


BALANCE, SEPTEMBER
  1, 2001                      4,826,063   $    48,261  $   6,237,666   $     (3,065)   $ 17,501,633   $ (64,074)    $   23,720,421
                             ===========    ==========   ============    ============    ===========    =========     =============
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.


                                      F-5
<PAGE>


RAG SHOPS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                      Fiscal Year Ended
                                                                                      -----------------
                                                                      September 1,      September 2,       August 28,
                                                                          2001              2000              1999
                                                                          ----              ----              ----

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                    <C>              <C>               <C>
Net income                                                             $      46,121    $   1,396,418     $     401,623
Adjustments to reconcile net income to net cash
  provided by (used in) operating activities:
    Depreciation and amortization                                          1,276,297        1,414,572         1,371,111
    Deferred income taxes                                                    (89,500)        (187,090)          (98,400)
    Loss on disposition of property and equipment                             34,136           52,399            44,084
    Amortization of restricted stock awards                                    4,384          169,761            24,550
    Cumulative effect of change in accounting principle                            0         (325,000)                0
Changes in assets and liabilities:
    (Increase) decrease in:
    Merchandise inventories                                                   (1,260)       3,082,800        (4,104,490)
    Prepaid expenses                                                        (710,963)          53,440            (5,219)
    Other current assets                                                     (54,627)         125,821          (147,284)
    Other assets                                                              17,222           38,893             5,078
Increase (decrease) in:
     Accounts payable - trade                                                585,832        1,834,152          (626,931)
     Accrued expenses                                                        668,555         (493,205)          528,754
     Accrued salaries and wages                                             (173,171)         288,354           (13,343)
     Income taxes payable                                                    (77,176)          85,450           (86,909)
                                                                        -------------    ------------      -------------

Net cash provided by (used in) operating activities                        1,525,850        7,536,765        (2,707,376)
                                                                        ------------     ------------      -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
     Proceeds from sale of property and equipment                              6,300              400             1,300
     Payments for purchases of property and equipment                     (1,889,530)        (590,634)       (1,578,888)
                                                                        ------------     ------------      ------------

Net cash used in investing activities                                     (1,883,230)        (590,234)       (1,577,588)
                                                                        ------------     ------------      ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
     Proceeds from issuance of note payable - bank                         1,090,000        5,805,000        20,160,000
     Repayments of note payable - bank                                    (1,090,000)     (12,375,000)      (15,225,000)
     Repayments of long-term debt                                                  0                0          (547,873)
     Acquisition of treasury stock                                                 0                0           (64,074)
     Payment in lieu of stock dividend for fractional shares                       0                0              (139)
                                                                        ------------     ------------      -------------

     Net cash provided by (used in) financing activities                           0       (6,570,000)        4,322,914
                                                                        ------------     ------------      ------------

NET (DECREASE) INCREASE IN CASH                                             (357,380)         376,531            37,950

CASH, BEGINNING OF YEAR                                                    1,310,604          934,073           896,123
                                                                        ------------     ------------      ------------

CASH, END OF YEAR                                                      $     953,224    $   1,310,604     $     934,073
                                                                        ============     ============      ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
   INFORMATION
     Cash paid during the year for:
     Interest                                                          $         561    $     198,269     $     49,628
                                                                        ============     ============      ===========
     Income taxes                                                      $     843,731    $   1,002,981     $    373,992
                                                                        ============     ============      ===========
</TABLE>
  The accompanying notes are an integral part of these consolidated financial
statements.


                                      F-6
<PAGE>


  RAG SHOPS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 1, 2001, SEPTEMBER 2, 2000 AND AUGUST 28, 1999

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND NATURE OF BUSINESS

Rag Shops, Inc. (the "Company"), a Delaware corporation formed in April 1991, is
the successor by merger to a New Jersey Corporation having the same name which
was incorporated in 1984. The Company operates a chain of retail craft and
fabric stores through its subsidiaries which are located in New Jersey, New
York, Pennsylvania, Florida and Connecticut.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly owned. All significant intercompany
transactions and balances have been eliminated.

USE OF ESTIMATES

The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the Company's financial statements and
accompanying notes to financial statements. Actual results could differ from
those estimates.

FISCAL YEAR

The Company's fiscal year end is the Saturday closest to August 31. The
financial statements for fiscal year ended September 2, 2000 ("2000") were
comprised of 53 weeks. Fiscal years ended September 1, 2001 ("2001") and August
28, 1999 ("1999") were each comprised of 52 weeks.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current year
presentations.

ADVERTISING EXPENSES

Advertising costs are expensed as incurred. Advertising expense net of co-op
advertising was $4,161,928, $4,107,476 and $4,201,776 for the years ended
September 1, 2001, September 2, 2000 and August 28, 1999, respectively.

MERCHANDISE INVENTORIES

Merchandise inventories (which are all finished goods) are stated at the lower
of cost (first-in, first-out method) or market as determined by the retail
inventory method. Effective August 29, 1999, the Company changed its method of
calculating ending merchandise inventories under the retail inventory method.
Prior to August 29, 1999, the Company utilized an average cost-to-retail ratio
to value ending inventory. Effective August 30, 1999, the Company began
utilizing a method that weights the cost-to-retail ratio using multiple
inventory categories. Management believes that this change in accounting
improves the measurement of the Company's profitability based upon a changing
product mix. The cumulative effect of this accounting change has increased the
Company's net income for fiscal 2000 by $198,496 (net of tax effect $127,000).


                                      F-7
<PAGE>


PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is computed over the
estimated useful lives of the assets using straight-line and accelerated
methods. Leasehold improvements are amortized by the straight-line method over
an estimated useful life or the term of the related lease, whichever is shorter.
For tax purposes, depreciation is computed using accelerated methods.

The Company follows Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" ("SFAS No. 121"). This Statement established accounting
standards for the impairment of long-lived assets, certain identifiable
intangibles and goodwill related to those assets to be held and used, and for
long-lived assets and certain identifiable intangibles to be held and used by an
entity to be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.

REVENUE RECOGNITION

Revenue is recognized when merchandise is sold to customers.

FAIR VALUE OF FINANCIAL INSTRUMENTS

In management's opinion, the fair value of amounts outstanding under its line of
credit approximate fair value due to their variable interest rate.

PRE-OPENING AND CLOSING STORE EXPENSES

In April 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Position No. 98-5 "Reporting on the Costs of Start-Up Activities"
("SOP"). This SOP requires the costs associated with start-up activities, such
as opening a new store, be expensed as incurred. Effective August 29, 1999 the
Company adopted this SOP. The adoption of this SOP did not have a material
effect on the Company's results of operations.

All pre-opening costs incurred in connection with the opening of new retail
stores are charged to expense when incurred. Costs associated with closing
stores, which consists primarily of write-downs of leasehold improvements, are
charged to expense at the time the decision to close a store is determined.

STOCK BASED COMPENSATION

The Company has adopted statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" ("SFAS No. 123"). As permitted under
SFAS No. 123, the Company has elected to follow Accounting Principles Board
opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees", and
related interpretations in accounting for its employee stock options. Under APB
No. 25, when the exercise price of the employee stock options equals or exceeds
the market price of the underlying stock on the date of grant, no compensation
expense is recorded.

RECENT ACCOUNTING PRONOUNCEMENTS

On July 20, 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 141, Business Combinations,
and SFAS 142, Goodwill and Intangible Assets. SFAS 141 is effective for all
business combinations completed after June 30, 2001 SFAS 142 is effective for
fiscal years beginning after December 15, 2001; however, certain provisions of
this Statement apply to goodwill and other intangible assets acquired between
July 1, 2001 and the effective date of SFAS 142. Major provisions of these
Statements and their effective dates for the Company are as follows:

o    all business combinations initiated after June 30, 2001 must use
     the purchase method of accounting. The pooling of interest method of
     accounting is prohibited except for transactions initiated before July 1,
     2001.

                                      F-8
<PAGE>
o    intangible assets acquired in a business combination must be
     recorded separately from goodwill if they arise from contractual or other
     legal rights or are separable from the acquired entity and can be sold,
     transferred, licensed, rented or exchanged, either individually or as part
     of a related contract, asset or liability.

o    goodwill, as well as intangible assets with indefinite lives,
     acquired after June 30, 2001, will not be amortized. Effective September 1,
     2002, all previously recognized goodwill and intangible assets with
     indefinite lives will no longer be subject to amortization.

o    effective September 1, 2002, goodwill and intangible assets with
     indefinite lives will be tested for impairment annually and whenever there
     is an impairment indicator.

o    all acquired goodwill must be assigned to reporting units for purposes of
     impairment testing and segment reporting.

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment of Disposal of Long-Lived Assets" ("SFAS
144"). This statement is effective for fiscal years beginning after December 15,
2001. This supercedes Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", while retaining many of the requirements of such statement.

Although it is still reviewing the provisions of these Statements, management's
preliminary assessment is that these Statements will not have a material impact
on the Company's financial position or results of operations.

NOTE 2. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

<TABLE>
<CAPTION>
                                                               Useful                September 1,            September 2,
                                                                Lives                    2001                    2000
                                                                -----                    ----                    ----
<S>                                                           <C>                    <C>                     <C>
Furniture and fixtures                                        5-10 years             $    9,070,071          $    8,005,659
Leasehold improvements                                          10 years                  3,582,809               3,254,975
Transportation equipment                                       3-7 years                    600,706                 530,258
Data processing equipment                                        5 years                  4,232,438               3,902,223
                                                                                      -------------           -------------

                                                                                         17,486,024              15,693,115

Less accumulated depreciation and
  amortization                                                                           13,300,012              12,079,900
                                                                                     --------------          --------------

                                                                                     $    4,186,012          $    3,613,215
                                                                                       ============            ============
</TABLE>

NOTE 3. NOTE PAYABLE - BANK

The Company maintains a credit facility with a bank. The credit facility is
renewable annually on or before each December 31 and currently consists of a
discretionary unsecured line of credit for direct borrowings and the issuance
and refinance of letters of credit. The line of credit was increased from
$8,000,000 to $10,000,000 on August 31, 1999. There were no direct borrowings
outstanding under the line of credit at both September 1, 2001 and September 2,
2000 and the unused line of credit for direct borrowings and the issuance of
letters of credit at September 1, 2001 was $9,803,146. The facility requires the
Company to maintain a compensating balance of $400,000 in addition to certain
financial covenants which require a minimum defined working capital and tangible
net worth, a maximum ratio of debt to tangible net worth and set limits on the
payment of dividends. As of September 1, 2001, the Company was in compliance
with such covenants. Borrowings under the line of credit bear interest payable
quarterly at the bank's prime rate (6.50% and 9.50% at September 1, 2001 and
September 2, 2000, respectively).


                                      F-9
<PAGE>
NOTE 4. LONG-TERM DEBT

During the fiscal year ended August 31, 1996, the Company borrowed $2,000,000
("term loan") under the terms of its credit facility with a bank to finance its
new point-of-sale cash register software, data collection and computer systems.
Interest on the term loan was payable monthly at a fixed interest rate of 7.5%
effective March 1, 1998, formerly at 8%. The term loan was paid in April 1999.

NOTE 5. COMMITMENTS AND CONTINGENCIES

Leases
The Company leases its facilities in accordance with operating leases, having
initial terms of more than one year, which expire in various years through 2012.
Substantially all of the leases contain renewal options. In addition, certain
leases require that the Company pay its pro rata share of utilities, taxes,
insurance and maintenance. Rent expense for 2001, 2000 and 1999 amounted to
$8,175,209, $7,651,778, and $7,382,116, respectively, and includes contingent
rentals (computed on a percentage of sales, as defined in the leases) of
$28,050, $29,079 and $22,499 respectively.

The Company leases certain premises from an entity controlled by the majority
stockholders of the Company. For the years 2001, 2000 and 1999, rental payments
under this agreement amounted to $340,349, $338,265 and $288,766, respectively.

Future minimum annual rental commitments under non-cancelable operating leases
are as follows:

     Fiscal Year Ended
                                     2002                  $    8,054,680
                                     2003                       7,707,917
                                     2004                       6,448,357
                                     2005                       5,536,338
                                     2006                       4,388,879
                                  Thereafter                    8,741,191
                                                            -------------

                                                           $   40,877,362


Letters of Credit
In addition, at September 1, 2001 the Company has outstanding letters of credit
for the purchase of merchandise inventories of approximately $196,854.

Legal Matters
The Company is involved in various legal proceedings incidental to the conduct
of its business. The Company currently is not engaged in any legal proceeding
that is expected to have a material adverse effect on the Company's results of
operations or financial position.


                                      F-10
<PAGE>


NOTE 6. EARNINGS PER SHARE

Basic and diluted earnings per share are calculated in accordance with Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No.
128"). In accordance with SFAS No. 128, basic net income per share has been
computed based on the weighted average of common shares outstanding. Diluted net
income per share gives the effect of outstanding stock options. All of the net
income reported in the financial statements is available to common stockholders.

<TABLE>
<CAPTION>
                                                                                Fiscal Year Ended
                                                               September 1,        September 2,         August 28,
                                                                   2001                2000                1999
                                                                   ----                ----                ----
   Numerator for basic and diluted earnings per
       share:
<S>                                                             <C>                 <C>                 <C>
       Income before cumulative effect of change in
       accounting principle                                $     46,121             $  1,197,922        $    401,623

       Cumulative effect of change in accounting
       principle, net of income taxes                                 0                  198,496                   0
                                                               --------              -----------         -----------

       Net income                                               $46,121             $  1,396,418        $    401,623
                                                                 ======              ===========             =======

   Denominator:
       Denominator for basic earnings per
       share-weighted average shares                          4,801,583                4,813,476           4,744,408

       Effect of dilutive securities:
       Employee stock options                                     6,082                      395              10,588
                                                            -----------              -----------         -----------

       Denominator for diluted earnings
       per share-adjusted weighted
       average shares and assumed
       conversions                                            4,807,665                4,813,871           4,754,996
                                                              =========                =========           =========

   Basic and diluted earnings per share:
       Income before cumulative effect of change in
       accounting principle                                $        .01             $       .25         $        .08

       Cumulative effect of change in accounting
       principle                                                      -                     .04                    -
                                                             ----------              ----------           ----------

       Net income                                          $        .01             $       .29         $        .08
                                                            ===========              ==========          ===========
</TABLE>

On June 28, 1999, the Company declared a 5% stock dividend on the Company's
common stock which was paid on August 10, 1999 to stockholders of record on July
14, 1999. Shares and per share data presented for the year ended August 28, 1999
has been adjusted to give retroactive effect to the dividend.

Stock options excluded from the above calculation, as the effect of such options
would be anti-dilutive, aggregated 17,750 in fiscal 2001, 323,800 in fiscal 2000
and 117,800 in fiscal 1999.


                                      F-11
<PAGE>


NOTE 7. STOCKHOLDERS' EQUITY

Each share of common stock is entitled to one vote.

In April 1991, the Company adopted the 1991 Stock Option Plan (the "Plan")
covering employees and non-employee directors. The Plan permits options to
purchase a total of 450,000 shares of common stock, of which 435,600 shares have
been reserved by the Company as of September 1, 2001. Such options may be
incentive stock options ("ISO") or nonqualified options. The term of an option
will not exceed ten years and an option is exercisable as determined by the
Option Committee of the Board of Directors. The exercise price of the shares
covered by an ISO may not be less than the fair market value of the shares at
the time of grant. The exercise price of the shares covered by a nonqualified
option is determined by the Option Committee. The options granted are generally
exercisable 40% after two years and 20% per year thereafter.

No compensation cost has been recognized for the stock options awarded since
they were granted at the fair market value on the date of grant. Had
compensation cost for the Company's stock option plan been recorded based on the
fair value at the grant date for awards in 2001, 2000 and 1999, consistent with
the provisions of SFAS No. 123, the Company's net income and income per share
would have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                                                         Fiscal Year Ended
                                                                      2001                      2000                     1999
                                                                      ----                      ----                     ----
<S>                                                              <C>                      <C>                       <C>
Net income-as reported                                           $        46,121          $     1,396,418           $       401,623
Net income -pro forma                                            $        29,790          $     1,388,349           $       395,292
Net income per share-as reported, basic and diluted              $           .01          $           .29           $           .08
Net income per share pro forma, basic and diluted                $           .01          $           .29           $           .08
</TABLE>

There were no options granted during fiscal 1999. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions used for grants in fiscal
2001 and fiscal 2000: dividends yield of 0%, expected volatility of 49% and 30%,
respectively, risk-free interest rate of 5.7% and 5.0% respectively and expected
lives of 10 years. The weighted average grant date fair value of options issued
during fiscal year 2001 and 2000 was $1.50 and $0.97, respectively.

Information with respect to options granted under the Plan is as follows:

<TABLE>
<CAPTION>
                                                          Number of               Exercise Price           Weighted-Average
                                                            Shares                  Per Share               Exercise Price

<S>                                                           <C>                    <C>                         <C>
Outstanding, August 29, 1998                                  300,050                $2.02-$11.76                $3.89
Forfeited or Expired                                          (19,750)               $2.22-$11.76                $6.51
                                                           ----------

Outstanding, August 28, 1999                                  280,300                $2.02-$11.76                $3.70
Granted                                                        56,500                $1.86-$2.325                $2.27
Forfeited or Expired                                           (4,500)               $2.125-$3.00                $2.42
                                                           ----------

Outstanding, September 2, 2000                                332,300                $1.86-$11.76                $3.51
Granted                                                        25,000                   $2.21                    $2.21
Forfeited or Expired                                         (250,550)               $2.34-$6.25                 $3.88
                                                             --------
Outstanding, September 1, 2001                                106,750                $1.86-$11.76                $2.64
                                                             ========


Exercisable, August 28, 1999                                  197,700                $2.02-$11.76                $4.30
Exercisable, September 2, 2000                                229,400                $2.02-$11.76                $4.02
Exercisable, September 1, 2001                                 63,250                $2.02-$11.76                $2.94
</TABLE>


                                      F-12
<PAGE>


The weighted-average remaining contractual life of stock options outstanding at
September 1, 2001 is 6.3 years and at September 2, 2000 is 4.9 years. The
majority of options as of September 1, 2001 have an exercise price from $1.86 to
$3.21.

Effective July 20, 1999, the Company adopted the 1999 Incentive Stock Award Plan
(the "Incentive Plan"). The Incentive Plan provides for the award of up to
300,000 shares of the Company's common stock (the "shares") to key employees
(including non-executive officers), independent contractors or consultants as
determined by the Option Committee of the Board of Directors. The Incentive Plan
participants are entitled to dividends and to vote their respective shares,
however, the sale or transfer of the shares is restricted during a vesting
period. As of September 1, 2001, 107,900 shares have been issued under the
Incentive Plan. On July 31, 2000, 80,300 of the outstanding shares vested. As of
September 1, 2001, 21,900 shares had been forfeited by individuals who were no
longer employed by the Company prior to the end of their required vesting
period. As of September 1, 2001, 5,700 of these shares remain unvested. The
Company estimated the value of the stock issued based on the market price on the
date of grant.

The grant date weighted average fair value of stock awards granted in 1999 was
$2.34.

Unamortized restricted stock awards was charged for the market value of the
restricted shares at the date of grant. The unamortized restricted stock awards
is shown as a reduction of stockholders' equity in the accompanying consolidated
balance sheet and is being amortized ratably over the vesting period. In fiscal
2001, 2000 and fiscal 1999, $4,384, $169,761 and $24,550 respectively were
charged to expense relating to the Incentive Plan.

On May 21, 1999 the Company's Board of Directors approved a discretionary
program whereby the Company is authorized to purchase up to 200,000 shares of
its outstanding common stock. As of September 1, 2001, September 2, 2000 and
August 28, 1999, 26,880 shares are held in treasury.

NOTE 8. INCOME TAXES

The components of income tax expense relating to income consists of the
following:

<TABLE>
<CAPTION>
                                                                      Fiscal Year Ended
                                            September 1, 2001         September 2, 2000           August 28, 1999
                                            -----------------         -----------------           ---------------

           Federal:
<S>                                             <C>                        <C>                       <C>
           Current                              $     121,300              $     920,090             $     379,900
           Deferred                                   (89,500)                  (187,090)                 (173,100)

           State:
           Current                                     65,400                    187,000                   (14,800)
           Deferred                                         0                          0                    74,700
                                                 ------------               ------------              ------------

                                                $      97,200              $     920,000             $     266,700
                                                 ============               ============              ============
</TABLE>


                                      F-13
<PAGE>


The deferred income tax arises from the following temporary differences.

<TABLE>
<CAPTION>
                                                                              Fiscal Year Ended
                                                     September 1, 2001         September 2, 2000            August 28, 1999
                                                     -----------------         -----------------            ---------------

<S>                                                       <C>                      <C>                        <C>
   Uniform inventory capitalization                       $       1,600            $     (10,400)             $      89,100
   Depreciation                                                  48,200                  108,290                     59,600
   Straight-line of leases                                       38,000                   31,500                     16,100
   Amortization of incentive stock awards                         1,700                   57,700                      8,300
   Increase in valuation allowance                                    0                        0                    (74,700)
                                                           ------------             ------------               ------------

                                                          $      89,500            $     187,090              $      98,400
                                                           ============             ============               ============
</TABLE>

The effective tax rate differs from the Federal statutory rate as follows:

<TABLE>
<CAPTION>
                                                                              Fiscal Year Ended
                                                     September 1, 2001         September 2, 2000           August 28, 1999
                                                     -----------------         -----------------           ---------------

<S>                                                              <C>                      <C>                        <C>
   Statutory tax rate                                            34.0%                    34.0%                      34.0%
   State and local income taxes,
     net of federal income tax benefit                           30.1                      5.3                        5.9
   Effect of permanent differences and
     other                                                        3.7                      0.4                        0.0
                                                               ------                   ------                     ------

   Effective tax rate                                            67.8%                    39.7%                      39.9%
                                                               ======                   ======                     ======
</TABLE>

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The Company's state
deferred tax asset has been reduced by a valuation allowance based on current
evidence indicating that it is not more likely than not that the future benefits
of these temporary differences will be realized.

The Company has approximately $8,419,000 of net operating losses in multiple
entities and multiple states which expire on various dates from 2007 to 2021.

The tax effect of significant items comprising the Company's deferred income tax
assets are as follows:

<TABLE>
<CAPTION>
                                                                                       Fiscal Year Ended
                                                                                 2001                      2000
                                                                                 ----                      ----
   Current deferred income tax assets:
<S>                                                                         <C>                       <C>
   Uniform inventory capitalization                                         $     787,646             $     786,046
   Amortization of restricted stock awards                                         67,700                    66,000
                                                                             ------------              ------------
                                                                                  855,346                   852,046
                                                                             ------------              ------------

   Non-current deferred income tax assets:
   Straight-line of leases                                                        200,673                   162,673
   Difference between book and tax depreciation  methods                          235,329                   187,129
   Net operating losses for State purposes                                        620,205                   484,539
   Valuation allowance                                                           (620,205)                 (484,539)
                                                                             ------------              ------------
                                                                                  436,002                   349,802
                                                                             ------------              ------------

   Total deferred income tax asset                                          $   1,291,348             $   1,201,848
                                                                                =========                 =========
</TABLE>


                                      F-14
<PAGE>


NOTE 9. EMPLOYEE BENEFIT PLAN

The Company has a voluntary 401(k) savings plan. All non-union employees of the
Company are eligible to participate on or after reaching age 21 and completing
one year of eligible service. The Company did not make any contributions to the
401(k) plan for fiscal years 2001, 2000 and 1999.

NOTE 10. QUARTERLY RESULTS (UNAUDITED)

The following is a summary of selected quarterly financial data (in thousands of
dollars, except per share amounts):

<TABLE>
<CAPTION>
                                                                                  Fiscal Quarter Ended
                                                        December 2,           March 3,             June 2,           September 1,
Fiscal 2001                                                2000                 2001                2001                 2001
-----------
<S>                                                      <C>                  <C>                 <C>                  <C>
Net sales                                                $    30,048          $    25,760         $    23,692          $    21,388
Gross profit                                                  11,442                8,995               8,379                6,940
Net income (loss)                                              1,282                   44                  46               (1,326)

Earnings (loss) per common share:
  Basic & Diluted                                                .27                  .01                 .01                (.27)
                                                                                  Fiscal Quarter Ended
                                                       November 27,         February 26,           May 27,           September 2,
Fiscal 2000                                                1999                 2000                2000                 2000
-----------
Net sales                                                $    28,186          $    26,492         $    22,730          $    22,799
Gross profit                                                  10,719                9,578               8,053                8,193
Income before cumulative effect of change
  in accounting principle                                        980                  518                 250                 (550)
Cumulative effect of change in accounting
  principle                                                      198                    -                   -                    -
Net income (loss)                                              1,178                  518                 250                 (550)

Basic and diluted income (loss) per common share:
   Income (loss) before cumulative effect
   of change in accounting principle                             .20                  .11                 .05                (.11)
   Cumulative effect of change in
   accounting principle                                          .04                    -                   -                    -
   Net income (loss) per common share                            .24                  .11                 .05                (.11)
</TABLE>

The sum of the four quarters may not equal the full year computation due to
rounding.

(a) Included in the net loss of the fiscal quarter ended September 2, 2000 were
credits of approximately $120,000 or $0.02 per share as a result of an extra
fiscal week of sales and $130,000 or $0.03 per share based on the Company's
favorable shrinkage results.



                                      F-15
<PAGE>



EXHIBIT 21.1

                                 RAG SHOPS, INC.

                          LIST OF SUBSIDIARY COMPANIES

   Name                                                     State Incorporated

   RSL, Inc.                                                Delaware
   Mobile Fabrics, Inc.                                     New Jersey
   The Rag Shop/Glen Burnie, Inc.                           Maryland
   The Rag Shop, Inc.                                       New York
   Rag Shop/Wayne, Inc.                                     New Jersey
   Rag Shop/Parsippany, Inc.                                New Jersey
   Rag Shop/Edison, Inc.                                    New Jersey
   The Rag Shop/West Orange, Inc.                           New Jersey
   The Rag Shop/Middletown, Inc.                            New Jersey
   The Rag Shop/Toms River, Inc.                            New Jersey
   The Rag Shop/Hamilton Square, Inc.                       New Jersey
   The Rag Shop/Hazlet, Inc.                                New Jersey
   The Rag Shop/Howell, Inc.                                New Jersey
   The Rag Shop/Ocean, Inc.                                 New Jersey
   The Rag Shop/Sayreville, Inc.                            New Jersey
   The Rag Shop/Bricktown, Inc.                             New Jersey
   The Rag Shop/Totowa, Inc.                                New Jersey
   The Rag Shop/North Lauderdale, Inc.                      Florida
   The Rag Shop/West Palm Beach, Inc.                       Florida
   The Rag Shop/Palm Beach Gardens, Inc.                    Florida
   The Rag Shop/Lancaster, Inc.                             Pennsylvania
   The Rag Shop/Sunrise, Inc.                               Florida
   The Rag Shop/Lantana, Inc.                               Florida
   The Rag Shop/York, Inc.                                  Pennsylvania
   The Rag Shop/Selinsgrove, Inc.                           Pennsylvania
   The Rag Shop/Pembroke Pines, Inc.                        Florida
   The Rag Shop/Jacksonville, Inc.                          Florida
   The Rag Shop/Olean, Inc.                                 New York
   The Rag Shop/Boca Raton, Inc.                            Florida
   The Rag Shop/Port Richey, Inc.                           Florida
   The Rag Shop/Deptford, Inc.                              New Jersey
   The Rag Shop/Deerfield, Inc.                             Florida
   The Rag Shop/Jacksonville-San Jose, Inc.                 Florida
   The Rag Shop/Rostraver, Inc.                             Pennsylvania
   The Rag Shop/Evesham, Inc.                               New Jersey
   The Rag Shop/Allentown, Inc.                             Pennsylvania
   The Rag Shop/Jensen Beach, Inc.                          Florida
   The Rag Shop/Jacksonville-Orange Park, Inc.              Florida
   The Rag Shop/Jacksonville-Regional, Inc.                 Florida
   The Rag Shop/Boro Park, Inc.                             New York
   The Rag Shop/Secaucus, Inc.                              New Jersey
   The Rag Shop/North Bergen, Inc.                          New Jersey
   The Rag Shop/Coral Springs, Inc.                         Florida
   The Rag Shop/Turnersville, Inc.                          New Jersey
   The Rag Shop/Hialeah, Inc.                               Florida
                                                                   (continued)

<PAGE>



                                 RAG SHOPS, INC.

                          LIST OF SUBSIDIARY COMPANIES

NAME STATE INCORPORATED

    Name                                                     State Incorporated

    The Rag Shop/Hollywood, Inc.                             Florida
    The Rag Shop/Binghamton, Inc.                            New York
    The Rag Shop/Lacey, Inc.                                 New Jersey
    The Rag Shop/West Boca Raton, Inc.                       Florida
    The Rag Shop/Ocala, Inc.                                 Florida
    The Rag Shop/Fishkill, Inc.                              New York
    The Rag Shop/Hampden, Inc.                               Pennsylvania
    The Rag Shop/East Norriton, Inc.                         Pennsylvania
    The Rag Shop/Wall Township, Inc.                         New Jersey
    The Rag Shop/Northern Lights, Inc.                       New York
    The Rag Shop/Linden, Inc.                                New Jersey
    The Rag Shop/Burlington, Inc.                            New Jersey
    The Rag Shop/Kingstown, Inc.                             Rhode Island
    The Rag Shop/Norwalk, Inc.                               Connecticut
    The Rag Shop/East Hollywood, Inc.                        Florida
    The Rag Shop/Edgewater, Inc.                             New Jersey
    The Rag Shop/Danbury, Inc.                               Connecticut
    The Rag Shop/Voorhees, Inc.                              New Jersey
    The Rag Shop/College Point, Inc.                         New York
    The Rag Shop/Franklin, Inc.                              New Jersey
    The Rag Shop/Kinnelon, Inc.                              New Jersey
    The Rag Shop/Waterbury, Inc.                             Connecticut


Each of the above does business under the name "The Rag Shop."



<PAGE>



                                  EXHIBIT 23.1

                                 RAG SHOPS, INC.

               CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

We have issued our report dated November 27, 2001, accompanying the consolidated
financial statements included in the Annual Report of Rag Shops, Inc. and
Subsidiaries on Form 10-K as of September 1, 2001. We hereby consent to the
incorporation by reference of said report in the Registration Statement of Rag
Shops, Inc. and Subsidiaries on Form S-8 (File No. 333-86489, effective
September 3, 1999).

Grant Thornton  LLP
Edison, New Jersey
November 27, 2001


<PAGE>


                                  EXHIBIT 23.2

                                 RAG SHOPS, INC.

               CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


We consent to the incorporation by reference in the Registration Statement No.
333-86489 of Rag Shops, Inc. and Subsidiaries on Form S-8 of our report dated
November 11, 1999, relating to the Company's financial statements for the year
ended August 28, 1999, appearing in this Annual Report on Form 10-K of Rag
Shops, Inc. and Subsidiaries for the year ended September 1, 2001.



DELOITTE & TOUCHE LLP
Parsippany, New Jersey

December 3, 2001