FORM 10-K

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

         For the fiscal year ended September 2, 2000

                                       OR

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

         For the transition period from _______ to _______

                           Commission File No. 0-19194

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

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

                 111 WAGARAW ROAD

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

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 filed 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. Yes X   No ___


<PAGE>


         As of October 31,  2000,  there were  outstanding  4,801,583  shares of
Common Stock.  Based on the price at which such stock was sold on that date, the
approximate  aggregate  market value of such shares held by  non-affiliates  was
$4,243,251.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the Registrant's  2000 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 2, 2000 Rag Shops,
Inc.  operated 65 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 profitability. The Company's stores are destination-oriented
and also attract shoppers from other stores located in the same shopping center.

         As of September 2, 2000,  the Company  operated 34 retail stores in New
Jersey,  19 in  Florida,  six in  Pennsylvania,  four  in New  York  and  two in
Connecticut.  The Company  anticipates  opening  five  stores and closing  three
stores during its fiscal year ending September 1, 2001. 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 1996:

<TABLE>
                                                                             FISCAL YEARS

                                                    2000            1999           1998           1997           1996
                                                    ----            ----           ----           ----           ----

<S>                                                   <C>             <C>            <C>            <C>            <C>
Stores open at beginning of period                    69              66             66             67             69
Stores opened during period                            0               5              2              4              1
Stores closed during period                            4               2              2              5              3
Stores open at end of period                          65              69             66             66             67
</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 2, 2000,  fifty-nine
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.


<PAGE>


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 fabric tables and 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.  In September 1996, the Company commenced
utilizing  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  sale items,
seasonal  products and other  currently  popular  merchandise.  Approximately  3
million people 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.  Generally,
the  Company  has  historically  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.  Commencing in January 1999 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.


<PAGE>


         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  61% 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.  The average sale per customer  transaction  is
approximately $13.00.

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 2, 2000, the Company has approximately 1,200 employees,
consisting of approximately 390 full time and 810 part time employees. Full time
personnel consist of approximately  220 salaried and 170 hourly  employees.  All
part time  personnel are hourly  employees.  During  seasonal peak periods,  the
Company hires temporary  personnel.  Approximately 39 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 in the United
States  Patent  Office  on  September  9,  1969  and  thereafter  renewed.  This
registration  is  renewable  indefinitely  so  long  as the  mark is used by the
Company.


<PAGE>


ITEM 2. PROPERTIES

         The Company's  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 2002. The Company expects to lease  approximately  50,000 square feet of
additional  warehouse  space for twelve  months of the year 2001, as compared to
eight months for the year 2000, to accommodate seasonal merchandise and expedite
distribution of merchandise to stores.

         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  10,300 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 year indicated.

                                LEASE EXPIRATIONS

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

  2001                    1                    2016               4
  2003                    2                    2017               9
  2004                    2                    2018               6
  2005                    2                    2019               8
  2006                    2                    2020               4
  2008                    3                    2021               2
  2010                    0                    2023               2
  2011                    4                    2024               2
  2012                    2                    2026               1
  2013                    5                    2027               2
  2014                    2

         Sixty-two  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.

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 2, 2000.


<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 was 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.
<TABLE>

                                                                                HIGH                     LOW
  FISCAL YEAR ENDED SEPTEMBER 2, 2000

<S>                                                                           <C>                      <C>
  First Quarter                                                               $ 2.438                  $1.625
  Second Quarter                                                                2.250                   1.813
  Third Quarter                                                                 2.344                   1.813
  Fourth Quarter                                                                3.094                   2.156

  FISCAL YEAR ENDED AUGUST 28, 1999

  First Quarter                                                               $ 2.875                 $2.3125
  Second Quarter                                                                2.875                    2.25
  Third Quarter                                                                  2.50                  1.9375
  Fourth Quarter                                                               2.5625                    2.00
</TABLE>

         On October 31, 2000, the closing price of the Common Stock was $2.0625.

         The approximate number of stockholders of record of the Common Stock at
October 31, 2000 was 421. 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 2,
2000 was $23,669,916.


<PAGE>


ITEM 6. SELECTED FINANCIAL DATA.
<TABLE>

                                                                                FISCAL YEAR ENDED (1)
                                              SEPTEMBER 2,        AUGUST 28,       AUGUST 29,       AUGUST 30,       AUGUST 31,
                                                 2000               1999             1998             1997              1996
                                                 ----               ----             ----             ----              ----

                                                            (IN THOUSANDS, EXCEPT COMMON STOCK DATA AND STATISTICS)
OPERATIONS

<S>                                            <C>              <C>              <C>              <C>                 <C>
Net sales                                      $ 100,208        $ 94,781         $ 90,566         $ 86,528            $ 83,767
Gross profit                                      36,543          33,915           32,772           31,044              30,440
Store expenses and general
   and administrative expenses                    34,582          33,163           31,167           30,578              29,500
Interest income (expense), net                        31            ( 83)             (61)            (115)               (161)
Income before income taxes and
    cumulative effect of change in
    accounting principle                           1,991             668            1,544              351                 779
Income before cumulative effect of
    change in accounting principle                 1,198             402              942              207                 520
Cumulative effect of change in
    accounting principle, net of tax                 198               0                0                0                   0
Net income                                       $ 1,396           $ 402            $ 942            $ 207               $ 520

COMMON STOCK DATA (2)

Basic and diluted earnings per share:
Income before cumulative effect of
    change in accounting principle                 $ .25           $ .08           $ .20             $ .04               $ .11
Cumulative effect of change in
    accounting principle                             .04               0               0                 0                   0
                                                   -----           -----           -----             -----               -----
Net income                                         $ .29           $ .08           $ .20             $ .04               $ .11

Book value per share                              $ 4.93          $ 4.59          $ 4.59            $ 4.39              $ 4.34
Weighted average shares and
   equivalents outstanding:
   Basic                                       4,813,476       4,744,408       4,740,063         4,740,063           4,740,063
   Diluted                                     4,813,871       4,754,996       4,788,196         4,764,977           4,740,672

FINANCIAL POSITION

Working capital                                 $ 19,640        $ 17,298         $ 17,095         $ 16,256            $ 16,985
Total assets                                      34,580          37,869           33,318           32,264              33,555
Short-term debt                                        0           6,570            2,194            3,119               1,762
Long-term debt                                         0               0                0              554               1,231
Stockholders' equity                            $ 23,670        $ 22,104         $ 21,742         $ 20,800            $ 20,593
</TABLE>








<PAGE>




<TABLE>

                                                                          FISCAL YEAR ENDED
(1)

                                            SEPTEMBER 2,       AUGUST 28,       AUGUST 29,      AUGUST 30,       AUGUST 31,
                                                2000              1999             1998            1997             1996
                                                ----              ----             ----            ----             ----

                                                        (IN THOUSANDS EXCEPT COMMON STOCK DATA AND STATISTICS)
STATISTICS

<S>                                               <C>              <C>             <C>              <C>           <C>
Net sales increase (decrease)                     5.7%             4.7%            4.7%             3.3%          (2.7%)
Comparable store net
sales increases (decreases) (3)                   4.2%             0.2%            3.2%             3.8%          (4.9%)
Return on net sales,
after income taxes                                1.4%             0.4%            1.0%             0.2%            0.6%
Return on average
stockholders' equity                              6.1%             1.8%            4.4%             1.0%            2.6%
Average net sales per
gross square foot (4)                             $147            $ 141           $ 143            $ 139           $ 135
Average net sales per
store (000's) (4)                               $1,490          $ 1,399         $ 1,374          $ 1,296         $ 1,214
Stores open at end of
period                                              65               69              66               66              67
</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.

(2)  Comparable store sales increases for a fiscal year include stores
     commencing with their thirteenth consecutive entire fiscal month.

(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."


<PAGE>


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>
                                                                        YEAR ENDED
                                               ----------------------------------------------------------
                                                        2000               1999               1998
                                                        ----               ----               ----
<S>                                                     <C>               <C>                <C>
Net sales                                               100.0%            100.0%             100.0%
Cost of merchandise sold
  and occupancy costs                                    63.5              64.2               63.8
                                                       -------           ------              ------
Gross profit                                             36.5              35.8               36.2
Store expenses                                           23.4              24.0               23.4
General and administrative expenses                      11.1              11.0               11.0
                                                      -------             ------             ------
Income from operations                                    2.0%              0.8%               1.8%


Net income                                                1.4%              0.4%               1.0%
</TABLE>

         The Company's net sales increased in fiscal 2000 by $5,427,000 or 5.7%.
Sales from  comparable  stores opened at least one year increased  $3,811,000 or
4.2%.  Sales in fiscal  2000  included a 53rd  fiscal  week,  which  amounted to
$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.  The  Company's  net sales  increased in fiscal 1999 by
$4,215,000  or 4.7% due to  increases in  comparable  store sales of $205,000 or
0.2% in addition to new store  sales of  $6,377,000  net of the impact of closed
stores.  Management believes that a planned inventory build up, initiated in the
third fiscal quarter of 1999 and  facilitated by the  implementation  of our new
automated store ordering system,  were the principal  factors for an increase in
comparable  store sales of 3.0% in the second half of fiscal 1999 as compared to
a decrease in comparable store sales of 1.9% in the first half of fiscal 1999.

         Gross profit  improved by  $2,628,000  and 0.7% as a percentage  of net
sales in fiscal 2000 as compared to fiscal  1999.  The  percentage  increase was
primarily due to favorable inventory shrinkage results and an improvement in the
initial  mark-up  on  seasonal  import  merchandise.   Gross  profit  percentage
decreased  by 0.4% in 1999 as  compared  to 1998  primarily  as a  result  of an
increase in occupancy costs.

         Store  expenses  increased by $766,000 or 3.4%,  and as a percentage of
sales  declined  by 0.6% 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 percentage of net sales was  principally  due to the ability of the Company
to leverage expenses against the increase in net sales. Store expenses increased
by  $1,497,000 or 7.1%,  and as a percentage of net sales  increased by 0.6%, in
fiscal 1999 as compared to fiscal 1998 principally due to an increase in payroll
and payroll related expenses that was primarily due to new store openings net of
store closings.

         General and  administrative  expenses  increased by $653,000 or 6.2% in
fiscal  2000  as  compared  to  fiscal   1999.   The  increase  in  general  and
administrative  expenses in fiscal 2000 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.  In fiscal 1999,
general and administrative expenses increased by $499,000 or 5.0% as compared to
fiscal  1998.  The  increase  was  primarily  due to an  increase in payroll and
payroll  related   expenses.   As  a  percentage  of  net  sales,   general  and
administrative  expenses remained  relatively  constant in fiscal 2000, 1999 and
1998 as the Company was able to leverage these expenses against increases in net
sales.
<PAGE>
          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.  Interest  expense,  net,
increased  in  fiscal  1999 as  compared  to  fiscal  1998 as a result of higher
borrowings  on the  Company's  line of credit to finance the  planned  inventory
build up. This increase was net of a decrease in interest on the Company's  term
loan which was paid in April 1999. See "Liquidity and Capital Resources."

         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.  The  effective  tax rate for 1999 was 39.9% as compared to 39.0% in 1998.
The increase is primarily due to a higher  effective  state and local income tax
rate.

         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.  Net income  decreased  by $540,000  for fiscal 1999 as
compared to fiscal 1998 due to the  increase in  operating  expenses,  which was
partially  offset by the  increase  in sales and the  related  increase in gross
profit.

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 the timing and duration
of holiday  selling seasons and the timing of new store openings and promotional
markdowns.

LIQUIDITY AND CAPITAL RESOURCES

         The Company's primary needs for liquidity are to maintain inventory for
the  Company's  existing  stores  and to fund the costs of opening  new  stores,
including capital  improvements,  initial inventory and pre-opening expenses. In
fiscal  2000 and fiscal  1999,  the  Company  relied on  short-term  borrowings,
internally  generated  funds and trade  credit made  available  by  suppliers to
finance inventories and new store openings.  At September 2, 2000, nearly all of
the Companies  financing was provided  through  internally  generated  funds and
trade credit.

         The Company's  working capital has increased  $2,342,000 in fiscal 2000
as  compared  to  fiscal  1999  primarily  as a result of a  reduction  in owned
inventory and the Company retaining its net income.

         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 (9.50% at September 2, 2000).  The
Company's term loan,  initiated  during the fiscal year ended August 31, 1996 to
finance  its new  point-of-sale  systems,  was paid in April  1999.  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 2, 2000, 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 borrowed under the line was $7,490,000, $7,010,000 and $2,785,000
in fiscal 2000,  fiscal 1999 and fiscal 1998,  respectively.  As of September 2,
2000 and August 28, 1999, $0 and $6,570,000, respectively, was outstanding under
the line of credit for direct  borrowings.  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's
point-of-sale and automated store ordering and receiving systems were completely
installed  in all stores as of July 1997 and March 1999,  respectively,  and are
fully operational.
<PAGE>
         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   significantly   affected  by  foreign   currency
fluctuation. At September 2, 2000, the Company had outstanding letters of credit
in the amount of $102,413.

         During 2000,  1999 and 1998, the Company had net cash provided by (used
in)  operating   activities  of   $7,537,000,   $(2,707,000)   and   $2,443,000,
respectively,  and used  $591,000,  $1,579,000  and $835,000,  respectively  for
purchases  of property and  equipment.  Cash  provided by  operating  activities
increased  in fiscal 2000  primarily  as a result of a decrease  in  merchandise
inventories,  an increase in trade payables and the Company's  ability to retain
its net income for the period.  In fiscal 2001, the Company expects to open five
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.

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  Company's
filings with the Securities and Exchange Commission).

RECENT ACCOUNTING STANDARDS

         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.

         In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 established accounting and reporting
standards for derivative instruments and requires recognition of all derivatives
as assets or liabilities in the statement of position and measurement of these
instruments at fair value. SFAS No. 133 is effective for the Company in the year
ending August 30, 2001. Management believes that adopting this statement will
not have a material impact on the financial position, results of operations or
cash flows of the Company.

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 2,
2000, 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's foreign currency exposure is not material and
the Company does not engage in regular hedging activities to minimize the impact
of  foreign  currency  fluctuations.  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  (9.50% at
September 2, 2000).

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                  See Item 14(a) 1 in Part IV.



<PAGE>



ITEM 9. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT.

         On  April  18,  2000 the  Company  dismissed  Deloitte  &  Touche,  LLP
("Deloitte  & Touche") as the  Company's  independent  auditor.  The decision to
change independent  auditors was unanimously  recommended by the Audit Committee
and unanimously approved by the Board of Directors of the Company.

         Deloitte & Touche's report on the Company's  financial  statements over
the last two years were  unqualified  and there were no  disagreements  existing
between  the  Company  and  Deloitte  & Touche  with  respect  to any  matter of
accounting  principles,  practices,  financial statement  disclosure or auditing
scope or procedure.

         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

ITEM 9A.  CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

          Not Applicable.


                                    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 2000  Definitive  Proxy Statement which the Company will file with
the  Securities  and Exchange  Commission  no later than 120 days  subsequent to
September 2, 2000.

ITEM 11.   EXECUTIVE COMPENSATION

         The information  required for this item is incorporated by reference to
the Company's 2000  Definitive  Proxy Statement which the Company will file with
the  Securities  and Exchange  Commission  no later than 120 days  subsequent to
September 2, 2000.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information  required for this item is incorporated by reference to
the Company's 2000  Definitive  Proxy Statement which the Company will file with
the  Securities  and Exchange  Commission  no later than 120 days  subsequent to
September 2, 2000.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information  required for this item is incorporated by reference to
the Company's 2000  Definitive  Proxy Statement which the Company will file with
the  Securities  and Exchange  Commission  no later than 120 days  subsequent to
September 2, 2000.


<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 Reports                                     F-2

          Consolidated Balance Sheets as of September 2, 2000 and
          August 28, 1999                                                  F-3

          Consolidated Statements of Income for the
          years ended September 2, 2000, August 28, 1999 and
          August 29, 1998                                                  F-4

          Consolidated Statements of Stockholders'
          Equity for the years ended September 2, 2000, August 28, 1999
          and  August 29, 1998                                             F-5

          Consolidated  Statements  of Cash  Flows for the years
          ended  September  2, 2000,  August 28, 1999 and August
          29, 1998 F-6

          Notes to Consolidated Financial Statements                       F-7

   (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                     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 20)
          27       Financial Data Schedule (Filed electronically with
                   SEC only)

   (c)    FINANCIAL STATEMENT SCHEDULES

          None

   (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 1, 2000.

                                                   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 BARNETT
   ----------------------
    Steven Barnett            Executive Vice President and    December 1, 2000
                              Director

   /S/ EVAN BERENZWEIG        Director                        December 1, 2000
   ----------------------
    Evan Berenzweig

   /S/ STANLEY BERENZWEIG     Principal Executive             December 1, 2000
   ----------------------
    Stanley Berenzweig        Officer and Director

   /S/ FRED J. DAMIANO        Director                        December 1, 2000
   ----------------------
    Fred J. Damiano

   /S/ JUDITH LOMBARDO        Director                        December  1, 2000
   ----------------------
    Judith Lombardo

   /S/ ALAN C. MINTZ          Director                        December 1, 2000
   ----------------------
    Alan C. Mintz

   /S/ STEPHEN PROVENZANO
   ----------------------
   Stephen Provenzano         Vice President and Chief        December 1, 2000
                              Financial Officer



<PAGE>



                                                           F-17

                                                     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

  24.1    Power of Attorney to sign Form 10-K
           (set forth on page 20)

  27       Financial Data Schedule
           (Filed electronically with SEC only)



--------------------------------

* 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  2,  2000 and the  related  consolidated
statements  of income,  changes in  stockholders'  equity and cash flows for the
year then  ended.  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 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 2, 2000,  and the results of their  operations and
their  cash  flows  for the year  then  ended,  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 8, 2000


<PAGE>



INDEPENDENT AUDITORS' REPORT

To the Board of Directors
and Stockholders

Rag Shops, Inc.
Hawthorne, New Jersey

We have audited the accompanying  consolidated  balance sheet of Rag Shops, Inc.
and  its  subsidiaries  as of  August  28,  1999  and the  related  consolidated
statements of income, changes in stockholders' equity and cash flows for each of
the two years in the period 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 audits.

We  conducted  our  audits  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 audits provide a reasonable basis for our opinion.

In our opinion,  such consolidated  financial  statements present fairly, in all
material respects, the financial position of Rag Shops, Inc. and subsidiaries as
of August 28, 1999, and the results of their operations and their cash flows for
each of the two years in the period ended August 28, 1999,  in  conformity  with
generally accepted accounting principles.

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


<PAGE>


RAG SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

<TABLE>
                                                                                    September 2,          August 28,
ASSETS                                                                                  2000                 1999
------                                                                                  ----                 ----
CURRENT ASSETS:
<S>                                                                                <C>                  <C>
     Cash                                                                          $   1,310,604        $    934,073
     Merchandise inventories                                                          27,805,318          30,563,118
     Prepaid expenses                                                                    483,314             536,754
     Other current assets                                                                 98,938             224,759
     Deferred income taxes                                                               852,046             804,746
                                                                                    ------------         -----------

                 Total current assets                                                 30,550,220          33,063,450

PROPERTY AND EQUIPMENT, NET                                                            3,613,215           4,489,952
DEFERRED INCOME TAXES                                                                    349,802             210,012
OTHER ASSETS                                                                              66,707             105,600
                                                                                     -----------         -----------

TOTAL ASSETS                                                                         $34,579,944         $37,869,014
                                                                                     ===========         ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
     Note payable - bank                                                                     $ 0         $ 6,570,000
     Accounts payable - trade                                                          7,762,720           5,928,568
     Accrued expenses and other current
     liabilities                                                                       2,011,823           2,505,028
     Accrued salaries and wages                                                          893,123             604,769
     Income taxes payable                                                                242,362             156,912
                                                                                     -----------         -----------

                 Total current liabilities                                            10,910,028          15,765,277

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;
         4,828,463 shares and 4,837,763
         shares issued at September 2, 2000
         and August 28, 1999, respectively                                                48,285              48,378
     Additional paid-in capital                                                        6,242,293           6,267,827
     Unamortized restricted stock awards                                                 (12,100)           (207,488)
     Retained earnings                                                                17,455,512          16,059,094
     Treasury stock, at cost, 26,880 shares                                              (64,074)            (64,074)
                                                                                     ------------        ------------

Total stockholders' equity                                                            23,669,916          22,103,737
                                                                                     ------------        ------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                           $34,579,944         $37,869,014
                                                                                     ============        ============
</TABLE>

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


<PAGE>


RAG SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
                                                                               Fiscal Year Ended
                                                                               -----------------
                                                              September 2,         August 28,           August 29,
                                                                  2000                1999                 1998
                                                                  ----                ----                 ----


<S>                                                          <C>                   <C>                  <C>
NET SALES                                                    $100,207,583          $94,780,965          $90,565,996

COST OF MERCHANDISE SOLD AND
     OCCUPANCY COSTS                                           63,665,075           60,866,108           57,793,619
                                                               ----------           ----------           ----------

Gross profit                                                   36,542,508           33,914,857           32,772,377
                                                               ----------           ----------           ----------

OPERATING EXPENSES:
     Store expenses                                            23,463,230           22,697,097           21,199,678
     General and administrative

      expenses                                                 11,118,918           10,466,253            9,967,252
                                                               ----------           ----------           ----------

Total operating expenses                                       34,582,148           33,163,350           31,166,930
                                                               ----------           ----------           ----------

INCOME FROM OPERATIONS                                          1,960,360              751,507            1,605,447

INTEREST (INCOME) EXPENSE, Net                                    (30,562)              83,184               61,430
                                                               ----------           ----------           ----------

INCOME BEFORE PROVISION FOR INCOME
TAXES AND CUMULATIVE EFEECT OF
CHANGE IN ACCOUNTING PRINCIPLE                                  1,990,922              668,323            1,544,017

PROVISION FOR INCOME TAXES                                        793,000              266,700              602,500
                                                             ------------           ----------           ----------

INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE                                  1,197,922              401,623              941,517

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


NET INCOME                                                  $   1,396,418          $   401,623           $  941,517
                                                             ============           ==========            =========

BASIC AND DILUTED EARNINGS PER
COMMON SHARE:

    INCOME BEFORE CUMULATIVE EFFECT OF
    CHANGE IN ACCOUNTING PRINCIPLE                                   $.25                 $.08                 $.20

    CUMULATIVE EFFECT OF CHANGE IN
    ACCOUNTING PRINCIPLE                                             $.04                 $.00                 $.00
                                                             ------------           ----------            ---------

     NET INCOME                                                      $.29                 $.08                 $.20
                                                             ============           ==========            =========
</TABLE>

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


<PAGE>


RAG SHOPS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR YEARS ENDED AUGUST 29, 1998, AUGUST 28, 1999 AND SEPTEMEBER 2, 2000


<TABLE>
                                                          Additional    Unamortized
                                      Common Stock         Paid-In       Restricted       Retained        Treasury
                                   Shares       Dollars    Capital      Stock Awards      Earnings          Stock          Total
                                 ----------    --------   ----------    ------------      ---------       ---------      ---------

<S>                              <C>           <C>        <C>             <C>            <C>              <C>          <C>
BALANCE, AUGUST 30, 1997         4,514,400     $45,144    $6,039,162              $0     $14,715,954             $0    $20,800,260

Net income                               0           0             0               0         941,517              0        941,517
                                 ----------    --------   ----------    ------------     -----------       ---------    ----------


BALANCE, AUGUST 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        97,700         977       231,061        (232,038)              0              0              0
awards

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

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

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         9,000          90        17,352         (17,442)              0              0              0
awards

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

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

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
                                 ==========    ========   ===========    ============    ============      =========   ===========
</TABLE>

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


<PAGE>


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

<TABLE>
                                                                                     Fiscal Year Ended
                                                                                     -----------------
                                                                        September 2,          August 28,          August 29,
                                                                           2000                 1999                1998
                                                                           ----                 ----                ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                      <C>                   <C>               <C>
Net income                                                               $1,396,418            $401,623          $  941,517
Adjustments to reconcile net income to
     net cash provided by (used in) operating activities:
      Depreciation and amortization                                       1,414,572           1,371,111           1,366,589
      Deferred income taxes                                                (187,090)            (98,400)            (73,200)
      Loss on disposition of property and equipment                          52,399              44,084              24,764
      Amortization of restricted stock awards                               169,761              24,550                   0
        Cumulative effect of change in accounting principle                (325,000)                  0                   0
Changes in assets and liabilities:
    (Increase) decrease in:
     Merchandise inventories                                              3,082,800          (4,104,490)         (1,335,591)
     Prepaid expenses                                                        53,440              (5,219)           (232,712)
     Other current assets                                                   125,821            (147,284)            164,822
     Other assets                                                            38,893               5,078             (45,924)
Increase (decrease) in:
     Accounts payable - trade                                             1,834,152            (626,931)          1,474,953
     Accrued expenses                                                      (493,205)            528,754             108,129
     Accrued salaries and wages                                             288,354             (13,343)           (193,916)
     Income taxes payable                                                    85,450             (86,909)            243,821
                                                                          ---------         -----------           ----------

Net cash provided by (used in) operating activities                       7,536,765          (2,707,376)           2,443,252
                                                                          ---------         -----------            ---------

CASH FLOWS FROM INVESTING ACTIVITIES:
     Proceeds from sale of property and equipment                               400               1,300               3,350
     Payments for purchases of property and equipment                      (590,634)         (1,578,888)           (834,671)
                                                                          ---------         -----------            ---------

Net cash (used in) investing activities                                    (590,234)         (1,577,588)           (831,321)
                                                                           ---------         -----------           ---------

CASH FLOWS FROM FINANCING ACTIVITIES:
     Proceeds from issuance of note payable - bank                        5,805,000          20,160,000          12,810,000


     Repayments of note payable - bank                                  (12,375,000)        (15,225,000)        (13,610,000)
     Repayments of long-term debt                                                 0            (547,873)           (679,476)
     Acquisition of treasury stock                                                0             (64,074)                  0
     Payment in lieu of stock dividend for fractional shares                      0                (139)                  0
                                                                       ------------          -----------         ----------

     Net cash provided by (used in) financing activities                 (6,570,000)          4,322,914          (1,479,476)
                                                                       ------------         -----------          ----------

NET INCREASE IN CASH                                                        376,531              37,950             132,455

CASH, BEGINNING OF YEAR                                                     934,073             896,123             763,668
                                                                        ------------        -----------         -----------

CASH, END OF YEAR                                                       $ 1,310,604         $   934,073         $   896,123
                                                                        ============        ===========         ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
 INFORMATION:

     Cash paid during the year for:

     Interest                                                          $   198,269          $    49,628         $   120,725
                                                                       ============         ===========         ===========
     Income taxes                                                      $ 1,002,981          $   373,992         $   464,206
                                                                       ============         ===========         ===========
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
<PAGE>
RAG SHOPS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED SEPTEMBER 2, 2000, AUGUST 28, 1999 AND AUGUST 29, 1998

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  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 August 29, 1998  ("1998") 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.

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).
<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

Management  of the  Company  believes  that the fair value of its line of credit
approximates its cost as of August 28, 1999. In management's  opinion,  the fair
value of its amounts outstanding under its line of credit approximate fair value
due to their variable 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. 13"). 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

In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 established accounting and reporting
standards for derivative instruments and requires recognition of all derivatives
as assets or liabilities in the statement of position and measurement of these
instruments at fair value. SFAS No. 133 is effective for the Company in the year
ending August 30, 2001. Management believes that adopting this statement will
not have a material impact on the financial position, results of operations or
cash flows of the Company.
<PAGE>


NOTE 2. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

<TABLE>
                                                                  Useful             September 2,         August 28,
                                                                  Lives                  2000                1999
                                                                  -----                  ----                ----

<S>                                                               <C>                 <C>                 <C>
Furniture and fixtures                                            5-10 years          $8,005,659          $8,118,597
Leasehold improvements                                              10 years           3,254,975           2,951,908
Transportation equipment                                           3-7 years             530,258             525,584
Data processing equipment                                            5 years           3,902,223           3,884,797
                                                                                      ----------          ----------

                                                                                      15,693,115          15,480,886
Less accumulated depreciation and
amortization                                                                          12,079,900          10,990,934
                                                                                      ----------          ----------

                                                                                     $ 3,613,215         $ 4,489,952
                                                                                      ==========          ==========
</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. The borrowings  outstanding  under
the line of  credit as of  September  2, 2000 and  August  28,  1999 were $0 and
$6,570,000,  respectively,  and the unused line of credit for direct  borrowings
and the issuance of letters of credit at September 2, 2000 was  $9,897,587.  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 2, 2000, the Company
was in compliance with such covenants.  Borrowings under the line of credit bear
interest  payable  quarterly  at the  bank's  prime  rate  (9.50%  and  8.25% at
September 2, 2000 and August 28,1999, respectively).

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.
<PAGE>



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 2000,  1999 and 1998  amounted to
$7,362,792,  $7,382,116, and $6,633,633,  respectively,  and includes contingent
rentals  (computed  on a  percentage  of sales,  as  defined  in the  leases) of
$29,079, $22,499 and $17,287 respectively.

The Company  leases certain  premises from an entity  controlled by the majority
stockholders of the Company.  For the years 2000, 1999 and 1998, rental payments
under this agreement amounted to $338,265, $288,766, and $209,313, respectively.

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

                Fiscal Year Ended
                      2001                                 $7,154,918
                      2002                                  6,241,468
                      2003                                  4,994,188
                      2004                                  3,753,631
                      2005                                  3,203,963
                Thereafter                                  7,325,790
                                                            ---------

                                                          $32,673,958

Letters of Credit

In addition,  at September 2, 2000 the Company has outstanding letters of credit
for the purchase of merchandise inventories of approximately $102,413.

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 proceedings
that is expected to have a material  adverse effect on the Company's  results of
operations or financial position.
<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.
Prior year net income per share data has been  adjusted to reflect the  adoption
of SFAS No. 128.

<TABLE>
                                                                                 Fiscal Year Ended

                                                                2000                   1999                 1998
                                                                ----                   ----                 ----
<S>                                                          <C>                     <C>                 <C>
   Numerator for basic and diluted earnings per
       share:
       Income before cumulative effect of change in
       accounting principle                                  $ 1,197,922             $401,623            $941,517

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

      Net income                                            $  1,396,418          $   401,623          $  941,517
                                                            ============          ===========          ==========

   Denominator:
       Denominator for basic earnings per
       share-weighted average shares                           4,813,476            4,744,408           4,740,063

       Effect of dilutive securities:
       Employee stock options                                        395               10,588              48,133
                                                            ------------         ------------          ----------

       Denominator for diluted earnings
       per share-adjusted weighted
       average shares and assumed
       conversions                                             4,813,871            4,754,996           4,788,196
                                                            ============          ===========          ==========

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

       Cumulative effect of change in accounting
       principle                                                     .04                  .00                 .00
                                                             -----------          -----------          ----------


       Net income                                            $       .29           $      .08          $      .20
                                                             ===========          ===========          ==========
</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 all periods has been adjusted
to give retroactive effect to the dividend.
<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  2, 2000.  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.

Effective  August  31,  1996,  the  Company  has  adopted  the   disclosure-only
provisions of Statement of Financial  Accounting  Standards No. 123, "Accounting
for Stock-Based  Compensation  ("SFAS No. 123") ". Accordingly,  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 2000,  1998 and 1997,  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>
                                                                                  Fiscal Year Ended
                                                                      2000               1999              1998
                                                                      ----               ----              ----
<S>                                                               <C>                  <C>              <C>
   Net income-as reported                                         $1,396,418           $401,623         $941,517
   Net income-pro forma                                           $1,388,349           $395,292         $935,066
   Net income per share-as reported, basic and diluted            $      .29           $    .08         $    .20
   Net income per share proforma, basic and diluted               $      .29           $    .08         $    .20
</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
2000, fiscal 1999 and fiscal 1998: dividends yield of 0%, expected volatility of
30% (50% for 1999 and 1998),  risk-free  interest  rate of 5.0%,  5.0% and 4.5%,
respectively and expected lives of 10, 7.5 and 7.5 years, respectively.

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

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

<S>                                                        <C>            <C>                      <C>
      Outstanding, August 30, 1997                         306,050        $2.02-$11.76             $3.88
      Granted                                                2,000               $3.21             $3.21
      Canceled                                              (8,000)        $2.02-$5.94             $3.49
                                                           -------

      Outstanding, August 29, 1998                         300,050        $2.02-$11.76             $3.89
      Canceled                                            (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
      Canceled                                              (4,500)       $2.125-$3.00             $2.42
                                                           -------

      Outstanding, September 2, 2000                       332,300        $1.86-$11.76             $3.51
                                                           =======

      Exercisable, August 29, 1998                         156,050        $2.02-$11.76             $5.38
      Exercisable, August 28,1999                          197,700        $2.02-$11.76             $4.30
      Exercisable, September 2, 2000                       229,400        $2.02-$11.76             $4.02
</TABLE>
<PAGE>



The weighted-average  remaining contractual life of stock options outstanding at
September 2, 2000 is 4.9 years.  The majority of options 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  2, 2000,  107,900  shares have been issued  under the
Incentive Plan. On July 31, 2000, 80,300 of the outstanding shares vested. As of
September 2, 2000,  19,500 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  2,  2000,  8,100 of these  shares  remain to meet the
vesting  requirement.  The Company estimated the value of the stock issued based
on the market price on the date of grant.

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
2000 and fiscal 1999, $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  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>
                                                                                    Fiscal Year Ended
                                                                        September 2,     August 28,    August 29,
                                                                           2000            1999           1998
                                                                           ----            ----           ----
<S>                                                                       <C>            <C>           <C>
        Federal:
        Current                                                           $  920,090     $  379,900    $  570,200
        Deferred                                                            (187,090)      (173,100)      (73,200)

        State:
        Current                                                              187,000        (14,800)      105,500
        Deferred                                                                   0         74,700             0
                                                                          ----------      ---------      --------


                                                                          $  920,000     $  266,700    $  602,500
                                                                           =========      =========     =========
</TABLE>
<PAGE>




   The deferred income tax arises from the following temporary differences:

<TABLE>
                                                                                     Fiscal Year Ended
                                                                        September 2,      August 28,    August 29,
                                                                            2000             1999           1998
                                                                            ----             ----           ----

<S>                                                                       <C>              <C>           <C>
        Uniform inventory capitalization                                  $  (10,400)      $ 89,100      $ 10,200
        Depreciation                                                         108,290         59,600        59,600
        Straight-line of leases                                               31,500         16,100         3,400
        Amortization of incentive stock awards                                57,700          8,300             0
        Increase in valuation allowance                                            0        (74,700)            0
                                                                           ---------      ---------     ---------

                                                                           $ 187,090       $ 98,400      $ 73,200
                                                                           =========       ========      ========
</TABLE>

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

<TABLE>
                                                                                    Fiscal Year Ended
                                                                          September 2,     August 28,   August 29,
                                                                              2000            1999          1998
                                                                              ----            ----          ----

<S>                                                                            <C>            <C>          <C>
        Statutory tax rate                                                     34.0%          34.0%        34.0%
        State and local income taxes,
        net of federal income tax benefit                                      5.3             5.9          4.5
        Other                                                                  0.4             0.0          0.5
                                                                              -----          -----        -----

        Effective tax rate                                                     39.7%          39.9%        39.0%
                                                                              =====          =====        =====
</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  $6,489,000 of net  operating  losses in multiple
states which expire on various dates from 2007 to 2020.

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

<TABLE>
                                                                                      Fiscal Year Ended
                                                                               2000                       1999
                                                                               ----                       ----
  <S>                                                                          <C>                      <C>
Current deferred income tax asset:
  Uniform inventory capitalization                                           $  786,046               $  796,446
  Amortization of restricted stock awards                                        66,000                    8,300
                                                                              ---------                ---------
                                                                                852,046                  804,746
                                                                              ---------                ---------
  Non-current deferred income tax assets:

  Straight-line of leases                                                       162,673                  131,173
  Difference between book and tax depreciation methods                          187,129                   78,839
  Net operating losses for State purposes                                       484,539                  487,584
  Valuation allowance                                                          (484,539)                (487,584)
                                                                              ---------                ---------
                                                                                349,802                  210,012
                                                                              ---------                ---------

  Total deferred income tax asset                                            $1,201,848               $1,014,758
                                                                              =========                =========
</TABLE>
<PAGE>


NOTE 9. EMPLOYEE BENEFIT PLAN

Effective  January 1, 1996, the Company adopted 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 eligibility  service. The Company did
not make any  discretionary  contributions  to the 401(k) plan for fiscal  years
2000, 1999 and 1998.

NOTE 10. QUARTERLY RESULTS (UNAUDITED)

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

<TABLE>
                                                                            Fiscal Quarter Ended
                                                       Nov. 27,        Feb. 26,         May 27,          Sept. 2,
   Fiscal 2000                                           1999            2000             2000           2000 (a)
   -----------                                           ----            ----             ----           --------
<S>                                                   <C>              <C>             <C>                <C>
   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>

<TABLE>
                                                                          Fiscal Quarter Ended
                                                       Nov. 28,        Feb. 27,         May 28,          Aug. 29,
   Fiscal 1999                                           1998            1999             1999             1999
   -----------                                           ----            ----             ----             ----
<S>                                                   <C>              <C>             <C>                <C>
   Net sales                                          $26,695          $25,061         $22,430            $20,595
   Gross profit                                        10,017            9,152           7,569              7,176
   Net income (loss)                                    1,009              254             (78)              (783)
   Earnings (loss) per common share (b):

      Basic & Diluted                                     .21              .05            (.02)              (.16)
</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.

(b) Earnings (loss) per common share  calculations for each quarter are restated
to reflect accounting  changes required under Statement of Accounting  Standards
No.128, Earnings per Share and the 5% stock dividend declared June 28, 1999. See
Note 6.
<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                              New York


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 8, 2000  accompanying  the consolidated
financial statements of Rag Shops, Inc. and subsidiaries appearing in the Annual
Report on Form 10-k for the year ended  September 2, 2000. 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 30, 2000


<PAGE>



                                  EXHIBIT 23.2

                                 RAG SHOPS, INC.

                          INDEPENDENT AUDITORS' CONSENT

We consent to the  incorporation  by  reference  in the  Registration  Statement
number 333-86489 of Rag Shops, Inc. on Form S-8 of our report dated November 11,
1999,  appearing in this Annual  Report on Form 10-K of Rag Shops,  Inc. for the
year ended September 2, 2000.

Deloitte & Touche LLP
Parsippany, New Jersey
November 29, 2000