---

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SECURITIES AND EXCHANGE COMMISSIONWASHINGTON D.C. 20549

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Form 10-Q

(Mark one)

|ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended May 4, 2002

OR

|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission File Number 0-19536

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F.A.O., INC.(Exact name of registrant as specified by its charter)

California(State or other jurisdiction of
incorporation or organization)

95-3971414(I.R.S. Employer
Identification No.)


2520 Renaissance Blvd., King of Prussia, PA 19406(Address of principal executive offices) (Zip Code)

(610) 292-6600(Registrant's telephone number, including area code)

(Former
name, former address and former fiscal year, if changed since last report.)

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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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

Indicate
the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Common
Stock Outstanding as of June 14, 2002: 34,986,004 shares.

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F.A.O., INC.        INDEX TO FORM 10-Q  FOR THE THIRTEEN WEEK PERIOD  ENDED MAY 4, 2002

|PART IFINANCIAL INFORMATION
|----------------------------
|Item 1.                     
|                            
|                            
|                            
|                            
|Item 2.                     
|Item 3.                     
|PART IIOTHER INFORMATION   
|Item 4.                     
|Item 6.                     
|SIGNATURES                  

2

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F.A.O., INC.  CONSOLIDATED BALANCE SHEETS  (unaudited)

|                                     |                                                                                                                                                 | May 4, 2002                |             | February 2, 2002 |            
|------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ----------- | ---------------- | -----------
|ASSETS                               |                                                                                                                                                 |                            |             |                  |            
|Current assets:                      |                                                                                                                                                 |                            |             |                  |            
|                                     | Cash and cash equivalents                                                                                                                       |                            | $           | 2,542,000        |            
|                                     | Accounts and other receivables                                                                                                                  |                            |             | 9,269,000        |            
|                                     | Merchandise inventories                                                                                                                         |                            |             | 126,879,000      |            
|                                     | Prepaid catalog expenses                                                                                                                        |                            |             | 294,000          |            
|                                     | Other current assets                                                                                                                            |                            |             | 9,284,000        |            
|                                     |                                                                                                                                                 |                            |             |                  |            
|                                     |                                                                                                                                                 | Total current assets       |             |                  | 148,268,000
|                                     |                                                                                                                                                 |                            |             |                  |            
|Noncurrent assets:                   |                                                                                                                                                 |                            |             |                  |            
|                                     | Property, fixtures and equipment, net                                                                                                           |                            |             | 31,355,000       |            
|                                     | Deferred income tax benefit                                                                                                                     |                            |             | 1,400,000        |            
|                                     | Goodwill                                                                                                                                        |                            |             | 4,578,000        |            
|                                     | Other noncurrent assets                                                                                                                         |                            |             | 3,419,000        |            
|                                     |                                                                                                                                                 |                            |             |                  |            
|                                     |                                                                                                                                                 | Total noncurrent assets    |             |                  | 40,752,000 
|                                     |                                                                                                                                                 |                            |             |                  |            
|                                     |                                                                                                                                                 | $                          | 189,020,000 |                  | $          
|                                     |                                                                                                                                                 |                            |             |                  |            
|LIABILITIES AND SHAREHOLDERS' EQUITY |                                                                                                                                                 |                            |             |                  |            
|Current liabilities:                 |                                                                                                                                                 |                            |             |                  |            
|                                     | Accounts payable                                                                                                                                |                            | $           | 30,421,000       |            
|                                     | Mandatorily Redeemable Preferred Stock                                                                                                          |                            |             |                 |            
|                                     | Accrued expenses                                                                                                                                |                            |             | 17,238,000       |            
|                                     | Accrued salaries and wages                                                                                                                      |                            |             | 5,761,000        |            
|                                     | Current portion of long term lease obligation                                                                                                   |                            |             | 989,000          |            
|                                     | Acquisition Obligations                                                                                                                         |                            |             |                 |            
|                                     |                                                                                                                                                 |                            |             |                  |            
|                                     |                                                                                                                                                 | Total current liabilities  |             |                  | 54,409,000 
|                                     |                                                                                                                                                 |                            |             |                  |            
|Revolving Line of Credit             |                                                                                                                                                 |                            | 81,064,000  |                  |            
|Long term lease obligation           |                                                                                                                                                 |                            | 1,240,000   |                  |            
|Deferred rent                        |                                                                                                                                                 |                            | 2,022,000   |                  |            
|Subsidiary Subordinated Notes        |                                                                                                                                                 |                            | 16,038,000  |                  |            
|Junior Convertible Note              |                                                                                                                                                 |                            | 4,900,000   |                  |            
|                                     |                                                                                                                                                 |                            |             |                  |            
|                                     |                                                                                                                                                 | Total liabilities          |             |                  | 159,673,000
|                                     |                                                                                                                                                 |                            |             |                  |            
|Commitments and contingencies        |                                                                                                                                                 |                            |             |                  |            
|Shareholders' equity:                |                                                                                                                                                 |                            |             |                  |            
|                                     | Series B Preferred Stock                                                                                                                        |                            |             |                 |            
|                                     | Series E Preferred Stock                                                                                                                        |                            |             |                 |            
|                                     | Series F Preferred Stock                                                                                                                        |                            |             |                 |            
|                                     | Series G Preferred Stock                                                                                                                        |                            |             |                 |            
|                                     | Series H Preferred Stock                                                                                                                        |                            |             |                 |            
|                                     | Common stock and paid in capital (75,000,000 shares authorized at no par value; 30,426,504 and 12,965,501 issued and outstanding, respectively) |                            |             | 126,052,000      |            
|                                     | Accumulated deficit                                                                                                                             |                            |             | (96,705,000      | )          
|                                     |                                                                                                                                                 |                            |             |                  |            
|                                     |                                                                                                                                                 | Total shareholders' equity |             |                  | 29,347,000 
|                                     |                                                                                                                                                 |                            |             |                  |            
|                                     |                                                                                                                                                 | $                          | 189,020,000 |                  | $          
|                                     |                                                                                                                                                 |                            |             |                  |            

See accompanying notes to consolidated financial statements

3

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F.A.O., INC.  CONSOLIDATED STATEMENTS OF OPERATIONS  (unaudited)

|                                              |                                                  | Thirteen Weeks Ended |            
|--------------------------------------------- | ------------------------------------------------ | -------------------- | -----------
|
|Net sales:                                    |                                                  |                      |            
|                                              | Retail                                           |                      | $          
|                                              | Direct to customer                               |                      |            
|                                              | Shipping and handling revenues                   |                      |            
|                                              | Sales to RightStart.com, Inc.                    |                      |            
|                                              |                                                  |                      |            
|                                              |                                                  |                      | 87,856,000 
|Costs and expenses:                           |                                                  |                      |            
|                                              | Cost of goods sold, including distribution costs |                      |            
|                                              | Cost of shipping and handling                    |                      |            
|                                              | Cost of goods sold to RightStart.com, Inc.       |                      |            
|                                              |                                                  |                      |            
|                                              | Gross profit                                     |                      |            
|                                              |                                                  |                      |            
|Selling, general and administrative expenses: |                                                  |                      |            
|                                              | Operating expenses                               |                      |            
|                                              | Marketing and advertising expense                |                      |            
|                                              | General and administrative expense               |                      |            
|                                              | Pre-opening costs                                |                      |            
|                                              | Depreciation and amortization expense            |                      |            
|                                              |                                                  |                      |            
|                                              |                                                  |                      | 50,364,000 
|                                              |                                                  |                      |            
|Operating loss                                |                                                  |                      | (14,991,000
|Interest expense, net                         |                                                  |                      | 2,115,000  
|                                              |                                                  |                      |            
|Loss before income taxes                      |                                                  |                      | (17,106,000
|Income tax provision                          |                                                  |                      | 70,000     
|                                              |                                                  |                      |            
|Net loss                                      |                                                  | $                    | (17,176,000
|                                              |                                                  |                      |            
|Basic and diluted loss per share:             |                                                  |                      |            
|                                              | Net loss                                         |                      | $          
|                                              |                                                  |                      |            
|                                              | Weighted average number of shares outstanding    |                      |            
|                                              |                                                  |                      |            

See
accompanying notes to consolidated financial statements

4

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F.A.O., INC.  CONSOLIDATED STATEMENTS OF CASH FLOWS  (unaudited)

|                                                 |                                                                             | Thirteen Weeks Ended                                  |                                          
|------------------------------------------------ | --------------------------------------------------------------------------- | ----------------------------------------------------- | -----------------------------------------
|
|Cash flows from operating activities:            |                                                                             |                                                       |                                          
|                                                 | Net loss                                                                    |                                                       | $                                        
|                                                 | Adjustments to reconcile net loss to net cash used in operating activities: |                                                       |                                          
|                                                 |                                                                             | Depreciation and amortization                         |                                          
|                                                 |                                                                             | Deferred rent                                         |                                          
|                                                 |                                                                             | Amortization of debt issuance costs                   |                                          
|                                                 |                                                                             | Non-cash interest                                     |                                          
|                                                 |                                                                             | Change in assets and liabilities affecting operations |                                          
|                                                 |                                                                             |                                                       |                                          
|                                                 |                                                                             |                                                       | Net cash used in operating activities    
|                                                 |                                                                             |                                                       |                                          
|Cash flows from investing activities:            |                                                                             |                                                       |                                          
|                                                 | Additions to property, fixtures and equipment                               |                                                       |                                          
|                                                 | Purchase price adjustments                                                  |                                                       |                                          
|                                                 |                                                                             |                                                       |                                          
|                                                 |                                                                             |                                                       | Net cash used in investing activities    
|                                                 |                                                                             |                                                       |                                          
|Cash flows from financing activities:            |                                                                             |                                                       |                                          
|                                                 | Net borrowings on revolving line of credit                                  |                                                       |                                          
|                                                 | Increase (decrease) in bank overdraft                                       |                                                       |                                          
|                                                 | Payments on notes payable and capital leases                                |                                                       |                                          
|                                                 | Redemption of Series A preferred stock                                      |                                                       |                                          
|                                                 | Proceeds from common stock issued upon exercise of stock options            |                                                       |                                          
|                                                 | Payments on financing costs                                                 |                                                       |                                          
|                                                 |                                                                             |                                                       |                                          
|                                                 |                                                                             |                                                       | Net cash provided by financing activities
|                                                 |                                                                             |                                                       |                                          
|Net decrease in cash and cash equivalents        |                                                                             |                                                       | (269,000                                 
|Cash and cash equivalents at beginning of period |                                                                             |                                                       | 2,811,000                                
|                                                 |                                                                             |                                                       |                                          
|Cash and cash equivalents at end of period       |                                                                             | $                                                     | 2,542,000                                
|                                                 |                                                                             |                                                       |                                          

See
accompanying notes to consolidated financial statements

5

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F.A.O., INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (unaudited)

NOTE 1: Description of Business and Significant Accounting Policies

F.A.O., Inc. (formerly known as The Right Start, Inc., and referred to herein as "FAO," "we," "us," "our," the "Company" and similar designations)
is a specialty retailer of high quality developmental, educational and care products for infants and children and high quality toys, games, books and multimedia products for kids through age 12
conducted through The Right Start, Zany Brainy and the FAO Schwarz brands.

At
a special meeting held on March 26, 2002, the Company's shareholders voted to approve, among other things, the change of the Company's name from The Right Start, Inc. to
F.A.O., Inc., its reincorporation in the state of Delaware, and an amendment to the Company's articles of incorporation effecting an increase in its authorized common stock from
25 million shares to 75 million shares. Reincorporation is expected to be completed later this year after obtaining necessary consents.

FAO
Schwarz

On
January 6, 2002, FAO Schwarz, Inc. (fka Toy Soldier, Inc.) ("FAO Schwarz"), a wholly owned subsidiary of the Company, completed the acquisition of certain assets
(and assumed liabilities of approximately $9.0 million) of KBB Retail Assets Corp. (fka F.A.O. Schwarz), including its Fifth Avenue store in New York and 21 other stores throughout the United
States, and the assets of its affiliate Quality Fulfillment Services, Inc. The acquisition was funded through the issuance of contingent convertible preferred stock (since converted) and the
issuance of $15.7 million (reduced from its original amount of $18 million due to a subsequent amendment of the purchase agreement) in aggregate principal amount of FAO Schwarz's 8%
Subordinated Notes due 2005 (the "Subsidiary Subordinated Notes").

Zany
Brainy

On
September 5, 2001, ZB Company, Inc. ("ZBCI"), a wholly-owned subsidiary of the Company, completed the acquisition of substantially all of the assets of Zany Brainy,
Inc., including 169 retail stores (and inventory in an additional 18 stores that were closed) in 34 states through a sale of assets and assignment of liabilities pursuant to sections 363 and 365 of
the U.S. Bankruptcy Code. As consideration, ZBCI agreed to pay the following: $7.5 million in cash and 1.1 million shares of the Company's common stock to the Zany Brainy estate for the
benefit of the unsecured creditors; $65.8 million (excluding renewed letters of credit) to the Zany Brainy, Inc. Debtor in Possession lender paid at the closing from the proceeds of a
Loan and Security Agreement between Wells Fargo Retail Finance, LLC (the "Bank") and ZBCI, dated September 5, 2001 (the "ZB Credit Facility"); $4.2 million which was offset by payments
due to investors; $1.1 million in bankruptcy-related professional fees that had been incurred prior to closing; $2.1 million paid into an escrow at the closing for Zany Brainy, Inc.
management retention bonuses; and certain lesser amounts. Additionally, ZBCI assumed certain other liabilities estimated at $39.5 million consisting of post-petition trade payables,
settlement amounts, other bankruptcy-related professional fees, sales and payroll taxes, accrued salaries and employee benefit obligations and customer gift certificates and merchandise credits. The
Company financed the Zany Brainy asset acquisition with the issuance of common stock and the proceeds from the issuance of contingent convertible preferred stock (since converted), contingent
convertible notes and the ZB Credit Facility.

The
Company also agreed to reimburse the Zany Brainy, Inc. creditors for up to $1 million for costs that may have been incurred by the creditors related to professional services.
To the extent any amounts were paid by the Company, they represented additional purchase price. During the period

6

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ended February 2, 2002 and the thirteen weeks ended May 4, 2002, $400,000 and $600,000, respectively, were paid. As of May 4, 2002, all obligations to the Zany Brainy, Inc.
estate have been paid.

Targoff-RS,
LLC

As
a condition to one of the equity investments used to fund the Zany Brainy asset acquisition, the Company acquired Targoff-RS, LLC which had acquired, in a private
foreclosure sale, assets including the online business, "www.RightStart.com", and the Right Start catalog business. The Company purchased Targoff-RS, LLC and its debt at an aggregate price
of $4.0 million through the issuance of contingent convertible preferred stock (since converted).

Accounting
Policies

There
have been no changes in the Company's significant accounting policies as set forth in the Company's financial statements for the year ended February 2, 2002 ("Fiscal 2001").
These unaudited consolidated financial statements as of May 4, 2002 and for the thirteen weeks then ended have been prepared in accordance with generally accepted accounting principles for
interim financial information and the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. These interim consolidated financial statements should be read in conjunction with the Company's Annual Report on
Form 10-K for Fiscal 2001. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been
included. Distribution costs have been reclassified to cost of goods sold for the thirteen weeks ended May 5, 2001 in order to conform prior year amounts to the current year presentation.

Seasonality

Operating
results for the thirteen week period ended May 4, 2002 are not indicative of the results that may be expected for the year ending February 1, 2003 ("Fiscal 2002")
because the Company is primarily a toy retailer and anticipates it will derive approximately 42% to 46% of its revenue and achieve all of its annual profitability in its fourth quarter.

Vendor
Incentives

For
the thirteen weeks ended May 4, 2002, the Company had marketing and advertising expenses of $1.8 million which is net of $1.4 million in vendor incentives. Cost
of goods sold for the thirteen weeks ended May 4, 2002 included an offset of $500,000 for vendor incentives.

Revenue
Recognition

For
direct to customer sales, revenue is recognized when the merchandise is delivered to the customer.

NOTE 2: Per Share Data

Basic per share data is computed by dividing the Company's loss available to common shareholders by the weighted average number of the Company's common shares
outstanding. Diluted per share data is computed by dividing the Company's loss available to common shareholders plus costs associated with dilutive securities by the weighted average number of shares
outstanding plus any potential

7

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dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock in each period.

Thirteen weeks endedMay 4, 2002

May 5, 2001Net loss

$
(17,176,000
)
$
(1,387,000
)Less:Preferred stock accretion


(90,000
)

(97,000
)Series D preferred dividends





(90,000
)Basic and diluted loss applicable to common shareholders

$
(17,266,000
)
$
(1,574,000
)Weighted average shares, basic and diluted(1)


20,463,671


5,617,275Loss per share, basic and diluted

$
(0.84
)
$
(0.28
)


---

Certain
securities of the Company were not included in the computation of diluted per share loss for the thirteen week periods because to do so would have been antidilutive for the
periods presented. Such securities include:

Common Stock Equivalents at:SecuritiesMay 4, 2002

May 5, 2001Options

4,690,913

1,589,021Series B Preferred Stock



550,000Series C Preferred Stock



1,866,650Series D Preferred Stock



2,245,000Warrants

569,000

479,000Junior Convertible Notes

3,426,573




NOTE 3: Supplemental Disclosure of Cash Flow Information

Interest paid amounted to $1,603,000 and $136,000 for the thirteen weeks ended May 4, 2002 and May 5, 2001, respectively. Cash paid for income taxes
was $25,000 and $16,000 for the thirteen weeks ended May 4, 2002 and May 5, 2001, respectively.

8

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Changes
in assets and liabilities which increased (decreased) cash used in operating activities are as follows:

Thirteen weeks endedMay 4, 2002

May 5, 2001Accounts and other receivables

$
5,697,000

$
(535,000
)Merchandise inventories


(8,117,000
)

(209,000
)Prepaid catalog expenses


(213,000
)

Other current assets


(4,178,000
)

(11,000
)Other noncurrent assets


(419,000
)

5,000Accounts payable


4,699,000


1,226,000Accrued expenses


690,000


(24,000
)Accrued salaries and wages


(5,337,000
)

151,000$
(7,178,000
)
$
603,000


Non-cash
investing and financing activities:

Thirteen weeks endedMay 4, 2002

May 5, 2001Conversion of Series B Preferred Stock to common stock

$
188,000

$
Conversion of Series E Preferred Stock to common stock


11,919,000


Conversion of Series F Preferred Stock to common stock


3,996,000


Conversion of Series G Preferred Stock to common stock


5,500,000


Conversion of Series H Preferred Stock to common stock


20,000,000


Preferred dividend accretion


90,000


97,000Preferred dividend payable





90,000


NOTE 4: New Accounting Pronouncements

On June 29, 2001, Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" was approved by the Financial
Accounting Standards Board ("FASB"). SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. On an annual basis, and when there
is reason to suspect that their values have been diminished or impaired, these assets must be tested for impairment, and write-downs may be necessary. Although the Company has not yet completed the
first step of the transitional impairment analysis, the Company does not anticipate there will be a material effect on the Company's consolidated results of operations or financial position.

In
August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This standard supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The standard retains the previously existing accounting requirements related
to the recognition and measurement of the impairment of long-lived assets to be held and used, while expanding the measurement requirements of long-lived assets to be disposed
of by sale to include discontinued operations. It also expands on the previously existing reporting requirements for discontinued operations to include a component of an entity that either has been
disposed of or is classified as held for sale. SFAS No. 144 was adopted on February 3, 2002 and did not have a material effect on the Company's consolidated results of operations or
financial position.

In
November 2001, the Emerging Issues Task Force ("EITF") reached a consensus on EITF No. 01-09, "Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of the Vendor's Products)". FAO Schwarz, Inc.'s frequent shopper program awards customers with gift

9

---

certificates based on certain levels of purchases between the months of January and December. These gift certificates may be redeemed to purchase merchandise between the months of April and September
of the following year. These gift certificate liabilities are recorded as a reduction of revenue and a liability at the date of the initial sale based on the estimated amount of gift certificates to
be issued once the minimum level of purchases are obtained. The Company's policy with respect to consideration given to a customer currently does not extend beyond coupons and the FAO loyalty program.

In
March 2002, the EITF reached a consensus on issue No. 00-23, "Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25, Accounting for Stock Issued to Employees,and FASB Interpretation No. 44,Accounting for Certain Transactions involving
Stock Compensation." The Company has and will continue to issue stock options to its employees. If subsequent changes are made to the agreements, the transactions will be
adjusted and any additional compensation recorded in accordance with EITF No. 00-23.

NOTE 5: Segment Information

At May 4, 2002, the Company operated in two reportable segments; Direct to customer, which includes online and catalog operations, and Retail, which
includes activities related to the Company's retail stores. Both segments sell products to meet the needs of the parents of infants and other children.

The
accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from
operations before income taxes.

The
Company allocates costs for certain services provided by the Retail segment to the Direct to customer segment.

The
Company's reportable segments have operations that offer the same or similar products but have a different method of delivery to their customers.

Segment
information for the thirteen weeks ended May 4, 2002 is as follows:

|                                              |  | Total
Direct to Customers |           | Retail |   | Total       |  
|--------------------------------------------- |  | ------------------------- | --------- | ------ | - | ----------- | -
|Net sales                                     |  | $                         | 2,953,000 |        | $ | 84,903,000  |  
|Interest expense                              |  |                           | 6,000     |        |   | 2,109,000   |  
|Depreciation and amortization                 |  |                           | 24,000    |        |   | 1,465,000   |  
|Pre-opening costs                             |  |                           |          |        |   | 135,000     |  
|Pre-tax income (loss)                         |  |                           | 171,000   |        |   | (17,277,000 | )
|Total assets                                  |  |                           | 808,000   |        |   | 188,212,000 |  
|Additions to property, fixtures and equipment |  |                           |          |        |   | (780,000    | )

Prior
to the Company's acquisition of Targoff-RS, LLC, the Company operated in only one reportable segment, Retail. Accordingly, there is no comparable segment information
for the thirteen weeks ended May 5, 2001.

NOTE 6: Operating Results and Risks

Historically, the Company has incurred losses, though it expects to generate sufficient operating income in the fourth quarter to offset operating losses incurred
during the first three quarters of Fiscal 2002. The Company believes that its current cash on hand at June 12, 2002, cash flow from operations and the $127 million credit facility (the
"Consolidated Credit Facility") entered into by the Company, FAO Schwarz, ZBCI and the Bank will allow it to maintain its operations and fund working capital and capital expenditures for the current
fiscal year and Fiscal 2003. The Company's needs for additional

10

---

funding will depend upon several factors, including, but not limited to, generating sufficient cash flow from operations, the expenses or savings from integration of the Zany Brainy and FAO Schwarz
businesses into the Company's operations and the Company's dependence on independent manufacturers and suppliers and their credit terms. If additional capital is required to grow its business or
execute its business plan, the Company may seek to raise additional equity or incur additional debt. There can be no assurance given that adequate funds will be available to the Company on acceptable
terms or at all.

NOTE 7: Related Party Transactions

The Athanor Holdings, LLC investment agreement with the Company, entered into in connection with the Zany Brainy, Inc. asset acquisition, required that the
Company acquire Targoff-RS, LLC which had acquired in a private foreclosure sale assets including the online business, "www.RightStart.com", and the Right Start catalog business. The
Company purchased Targoff-RS, LLC and its debt (held in part by Mr. Fred Kayne, Mr. Richard Kayne and affiliates of KAIM, Inc.) at a price of $4.0 million
through the issuance of 1,800 shares of the Company's Series F Convertible Preferred Stock (the "Series F Preferred Stock"). The Series F Preferred Stock was converted into
1.8 million shares of the Company's common stock at an imputed price of approximately $2.22 per share on March 26, 2002. Messrs. Kayne are Directors of the Company.
Mr. Richard Kayne is the President, Chief Executive Officer and a Director of KAIM, Inc., and the principal stockholder of its parent company.

On
September 5, 2001, the Company also sold 2,200 shares of its Series G Convertible Preferred Stock (the "Series G Preferred Stock") for $5.5 million in cash
to Mr. Fred Kayne and affiliates of KAIM, Inc., which shares were converted into 2.2 million shares of the Company's common stock at an imputed price of approximately $2.50 per
share on March 26, 2002.

An
affiliate of KAIM, Inc. has provided certain management services to the Company and charged the Company for such services. Annual management fees of $75,000 were paid for such
services in the first quarter of Fiscal 2001. As of August 2001, the Company ceased to receive such management services.

In
November 2001, KAIM, Inc. investment affiliates provided the Bank, as agent under the Company's then existing credit facility, with a $5 million letter of credit
on behalf of ZBCI. In consideration for providing the letter of credit, the Company issued to Mr. Fred Kayne and affiliates of KAIM, Inc. five year warrants to purchase 100,000 shares of
its common stock at a price of $3.50 per share. The Bank returned the letter of credit in early January 2002 in accordance with its terms.

In
April 2002, KAIM, Inc. affiliates purchased a $2 million participation in the special term subline portion of the Consolidated Credit Facility.

NOTE 8: Other Developments

Contingencies

The
Company was sued by Oxygen Media, LLC ("Oxygen") in New York Supreme Court to recover the alleged value of cable television and internet media time allegedly provided or to be
provided to the Company and RightStart.com Inc. The claim is based on a term sheet that expressly stated that it was non-binding and is based on the purported value of advertising
services provided to RightStart.com Inc. Oxygen asserted that the Company and RightStart.com Inc. breached an express contractual obligation in the term sheet to negotiate in good faith
to reach an agreement that would have provided Oxygen with cash and in-kind marketing services equal to $13 million. Oxygen also asserted that the Company and
RightStart.com Inc. owe Oxygen $720,000 under an implied-in-fact contract or for services provided. The Company has filed a counter-claim to recover the excess value of
the services provided to Oxygen over any services provided by Oxygen and also brought a fraud claim

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seeking $58 million in damages. The Company filed a motion to dismiss Oxygen's complaint in the New York Supreme Court on the basis that the term sheet was non-binding by its terms
and therefore may not be the basis of a breach of contract claim. A hearing was held on January 14, 2002 and on May 6, 2002, the Court granted the Company's motion to dismiss Oxygen's
$13 million claim. Oxygen amended its complaint to add Targoff-RS, LLC as a defendant and to include a $20 million fraud claim. The Company cannot predict the outcome of this
litigation but intends to defend it vigorously.

From
time to time, the Company is named as a defendant in legal actions arising from its normal business activities. Although the amount of any liability that could arise with respect to
currently pending actions cannot be estimated, in the opinion of the Company, any such liability will not have a material adverse effect on its financial position or operating results.

Stock
Options

The
Company authorized an increase in the number of options issuable under the Company's 1991 Employee Stock Option Plan and a newly-adopted 2001 Stock Incentive Plan to an aggregate of
approximately 6.0 million shares of which approximately 538,000 are available for future grant. Shareholder approval for these actions was granted on March 26, 2002.

Debt
and Preferred Stock

On
March 26, 2002, a special meeting of shareholders was held for certain matters including the approval to exercise the conversion feature of the Company's Series E
Convertible Preferred Stock, Series F Preferred Stock, Series G Preferred Stock, and Series H Contingent Convertible Preferred Stock and its 4% Junior Convertible Note due 2004.
The shareholders also approved an amendment to the Company's Articles of Incorporation affecting an increase in authorized common stock from 25 million shares to 75 million shares.

Convertible
preferred stock converted into common stock during the thirteen weeks ended May 4, 2002 is as follows:

Security Converted

Shares

Converted into shares of Common StockConvertible Preferred Stock:Series B

2,000

66,667Series E

11,919

8,334,836Series F

1,800

1,800,000Series G

2,200

2,200,000Series H

20,000

5,000,000


NOTE 9: Subsequent Event

On
May 24, 2002, the Company completed a $27 million private placement of newly issued common stock. A total of 4.5 million shares at $6.00 per share was sold, which
resulted in net proceeds to the Company of approximately $26 million, after accounting for the placement agents' fees and expenses. The Company intends to use the net proceeds for general
corporate purposes, including the expansion of retail stores and working capital.

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MANAGEMENT'S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking
Statements

This
report contains forward-looking statements based on our current expectations, assumptions, estimates and projections about our company and our industry. When used in this report,
the words "believes," "anticipates," "intends," "expects" and similar expressions are intended to identify such forward-looking statements. You will find these forward-looking statements at various
places throughout this report and the documents incorporated by reference, including amendments. We advise you to closely consider information contained in the "Risk Factors" section of our
Registration Statement on Form S-3 (No. 333-84438) when evaluating such forward-looking statements. These forward-looking statements involve risks, uncertainties
and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. You are cautioned not to unduly rely on any forward-looking statements.

Overview

F.A.O., Inc.
(formerly known as The Right Start, Inc., and referred to herein as "FAO," "we," "us," "our," the "Company" and similar designations) operates 256 retail
stores in 32 states throughout the United States as of June 12, 2002 and operated 65 retail stores as of May 5, 2001. The stores' product mix includes a wide variety of items to meet the
needs of infants, small children and their care givers and children through age 12 presented in three distinct formats identified by the brands FAO Schwarz, The Right Start and Zany Brainy.

The
following table sets forth the statement of operations data for the thirteen weeks ended May 4, 2002 and May 5, 2001. The current period represents consolidated
activity, which includes acquisitions and corporate overhead and The Right Start brand retail business. The Right Start brand retail business has been segregated for historical comparison purposes.
General and administrative

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expenses have been allocated to The Right Start in the thirteen weeks ended May 4, 2002 based on the consolidated percentage of sales.

|                                                 |              | Thirteen Weeks Ended May 4, 2002 |         | Thirteen Weeks Ended May 5, 2001 |      
|------------------------------------------------ | ------------ | -------------------------------- | ------- | -------------------------------- | -----
|
|
|
|Retail net sales                                 |              | $                                | 84,903  |                                  | 96.6 
|Direct to customer                               |              |                                  | 2,448   |                                  | 2.8  
|Shipping and handling                            |              |                                  | 505     |                                  | 0.6  
|Sales to RightStart.com, Inc.                    |              |                                  |        |                                  | 0.0  
|                                                 |              |                                  |         |                                  |      
|                                                 | Net sales    |                                  |         | 87,856                           |      
|Cost of goods sold, including distribution costs |              |                                  | 51,871  |                                  | 59.4 
|Shipping and handling                            |              |                                  | 612     |                                  | 121.2
|Cost of goods sold to RightStart.com, Inc.       |              |                                  |        |                                  | 0.0  
|                                                 |              |                                  |         |                                  |      
|                                                 | Gross profit |                                  |         | 35,373                           |      
|Selling, general and administrative expenses:    |              |                                  |         |                                  |      
|Operating expenses                               |              |                                  | 40,277  |                                  | 45.8 
|Marketing and advertising expense                |              |                                  | 1,815   |                                  | 2.1  
|General and administrative expense               |              |                                  | 6,648   |                                  | 7.5  
|Pre-opening costs                                |              |                                  | 135     |                                  | 0.2  
|Depreciation and amortization expense            |              |                                  | 1,489   |                                  | 1.7  
|                                                 |              |                                  |         |                                  |      
|                                                 |              |                                  | 50,364  |                                  | 57.3 
|Operating loss                                   |              |                                  | (14,991 | )                                | (17.0
|Interest expense, net                            |              |                                  | 2,115   |                                  | 2.4  
|                                                 |              |                                  |         |                                  |      
|Loss before income taxes                         |              |                                  | (17,106 | )                                | (19.4
|Income tax provision                             |              |                                  | 70      |                                  | 0.1  
|                                                 |              |                                  |         |                                  |      
|Net loss                                         |              | $                                | (17,176 | )                                | (19.5
|                                                 |              |                                  |         |                                  |      

Thirteen weeks ended May 4, 2002 compared with May 5, 2001

We consummated the acquisition of certain assets and assumption of certain liabilities of KBB Retail Assets Corp. (fka F.A.O. Schwarz) and its affiliate on
January 6, 2002 and the acquisition of the assets of Zany Brainy and the acquisition of Targoff-RS, LLC on September 5, 2001. Targoff-RS, LLC owned and operated
the Right Start brand direct-to-customer Internet and catalog business. These acquisitions and the direct to customer business are incremental to the first quarter Fiscal 2001
Right Start brand retail business and have been separately identified. Operating results for the prior periods are not comparable due to the manner in which the historical operations were conducted
compared to our current structure. Consequently, historical data for the acquired businesses' operating results for prior periods has been excluded from Management's Discussion and Analysis of Results
of Operations. The following discussion relates solely to The Right Start brand retail business for the thirteen weeks ended May 4, 2002 as compared to the thirteen weeks ended May 5,
2001.

Net Sales.Retail net sales consist of gross product sales to customers net of returns. Retail net sales decreased by
$507,000, or 4.6%, from $11.0 million in the thirteen weeks ended May 5, 2001 to $10.5 million in the current period. Same store sales, defined as sales attributed to stores that
have been open for at least 14 full fiscal months, were down by 1.7%; with mall-based stores experiencing a 6.2% decline and street location stores a 3.0% sales increase over prior year.
Sales not attributable to same store sales amounted to $861,000 in the thirteen weeks ended May 4, 2002 and $90,000 in the thirteen weeks ended May 5, 2001. In the prior year, sales for
the six stores closed or not operating in the current quarter amounted to $1.2 million.

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Cost of goods sold.Cost of goods sold consists primarily of the cost of products sold, inbound freight costs, inventory
shrinkage costs and costs related to the distribution and warehousing of our retail merchandise. Retail gross margin decreased to 43.1% in the current period from 44.8% in the prior year. The decrease
was primarily attributable to a 1.1% margin loss due to a shift in the retail mix to lower margin items and a 0.6% increase in distribution costs.

Operating expense.Retail operating expense consists of store operational expenses and retail personnel costs. Retail
operating expense was $3.8 million in the current quarter as compared to $4.2 million for the same period last year. The $381,000 or 9.1% decrease primarily reflects decreased sales
volume, a 0.8% decrease in retail administration costs and a reduction of 0.7% in store operating expense. Retail operating expense as a percentage of retail net sales decreased from 37.9% in the
prior year period to 36.1% in the current quarter. The decrease as a percentage of sales is primarily due to a reduction in retail administration costs.

Marketing and advertising expense.Retail marketing and advertising expense generally consists of print advertising in
national and regional publications, as well as promotional mailings to our customers. Marketing and advertising expense remained relatively flat at $122,000 and $144,000 for the thirteen weeks ended
May 4, 2002 and May 5, 2001, respectively.

General and administrative expenses.General and administrative expenses decreased as a percentage of sales from 9.5% to 7.6%
during the thirteen week period ended May 4, 2002 compared to the same period of the prior year as a result of general and administrative expenses being allocated to a larger retail operating
base.

Pre-opening costs.Pre-opening costs consist primarily of non-recurring marketing,
advertising, and other expenses related to the opening of new store locations. Pre-opening costs decreased $80,000 from $83,000 in the first quarter of Fiscal 2001 to $3,000 in the same
period this year. The decrease results from the lack of new store openings in the current quarter versus the expense related to three new stores for the prior year period.

Depreciation and amortization.Depreciation and amortization expense increased $101,000 or 15.9% from $636,000 in the first
13 weeks of Fiscal 2001 to $737,000 for the same period in Fiscal 2002. The increase was due to the additional assets placed in service related to new stores.

Interest expense, net.Interest expense increased to $449,000 in the first quarter of Fiscal 2002 from $221,000 in the same
period for Fiscal 2001. The $228,000 increase is primarily due to higher outstanding borrowings, the result of funding FAO Schwarz's working capital needs and interest attributable to the Junior
Convertible Note.

Income tax provision.Provision for income taxes is related to state income taxes. No federal or state income tax benefit was
recorded for the thirteen weeks ended May 4, 2002 due to the uncertainty of realizing tax benefits in future years.

On
a consolidated basis, as of February 2, 2002, we had net operating loss carryforwards for federal tax purposes of $33.7 million and for state tax purposes of
$14.3 million. Due to an ownership change for tax purposes that occurred in March 2002, there are limitations on the amount of the loss carryforwards that can be used annually. These
carryforwards expire in fiscal years ending 2002 through 2022.

Liquidity and Capital Resources

We are primarily a toy retailer and anticipate that we will derive approximately 42% to 46% of our revenue and achieve all of our annual profitability in the
fourth fiscal quarter. Consequently, we are dependent upon the use of our Amended and Restated Loan and Security Agreement with Wells Fargo

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Retail Finance, LLC (the "Bank") which combined the facilities we previously maintained separately for ZB Company, Inc, and for ourself and FAO Schwarz, Inc. (the "Consolidated Credit
Facility") to provide the necessary liquidity to fund our operations and capital expenditures through the first three quarters of the fiscal year. The prior facilities consisted of a loan and security
agreement between the Bank, us and FAO Schwarz, Inc. which permitted aggregate borrowings of $17.5 million, was due in January 2005 and carried an interest rate at the time of
termination of 8.0% per annum and a loan and security agreement between the Bank, as agent and ZB Company, Inc. which permitted aggregate borrowings of $115 million, was due in
September 2004 and carried an interest rate at the time of termination of 7.2% per annum. The Consolidated Credit Facility matures October 6, 2004 and consists of (i) a standard
revolving line of credit of up to $115 million under which borrowings bear interest, at our election, at an initial rate of 3.5% over the London Interbank Offered Rate ("LIBOR") or 1.50% over a
base rate announced by Wells Fargo Bank from time to time, and (ii) an additional special term subline of up to $12 million under which borrowings bear interest at a rate of 7% per annum
over the base rate announced by LaSalle National Bank, but not less than 12% per annum. As of June 12, 2002, the Wells Fargo Bank base rate was 6.25%. The Consolidated Credit Facility allows us
to borrow up to 75% of accounts receivable not to exceed $7.5 million, plus 85% of the undrawn amount of letters of credit plus, (A) so long as the special term subline remains
outstanding, (1) during the period between April 30, 2002 and October 31, 2002 up to 100% of the net retail liquidation value net of expenses ("NRLV") of our eligible inventory,
(2) between October 31, 2002 and December 31, 2002 up to 95% of NRLV of our eligible inventory and (3) anytime thereafter 90% of NRLV of our eligible inventory based on a
trailing 5 day average but never in excess of 95% of NRLV and (B) when the special term subline is no longer in effect, 87.5% of the NRLV of our eligible inventory through
August 2002 and 85% of the NRLV of our eligible inventory thereafter.

The
amount available to us under the Consolidated Credit Facility borrowing formula fluctuates primarily with our level of inventory and the amounts due to our suppliers. At
June 13, 2002, the amount available under the Consolidated Credit Facility was approximately $21.4 million. Management expects that we will continue to have sufficient availability
throughout the year based on our business plan and the borrowing formula under the Consolidated Credit Facility.

During
the first quarter of Fiscal 2002, operating activities used $22.3 million of cash compared to using $106,000 in the comparable period of Fiscal 2001. In the current year
period, investing activity consisted of $1.7 million for fixed asset additions and purchase price adjustments compared to $569,000 for fixed asset additions for the prior year period.
Borrowings on our revolving lines of credit provided the primary source of funds for the current period.

Our
ability to fund our operations and maintain compliance with the Consolidated Credit Facility is dependent on our ability to generate sufficient cash flow from operations. During an
economic
downturn we expect to see reduced sales at our existing stores with our mall stores experiencing the largest impact. With the recent acquisitions of Zany Brainy and FAO, the upcoming fourth quarter
operating results are extremely important in determining the amount of liquidity and capital resources available for the next 12 months. We continually look for ways to improve operating
results, increase inventory turnover and obtain better payment terms from suppliers.

Our
expansion plans have changed with the acquisitions of the Zany Brainy and FAO Schwarz businesses. We have currently suspended our search for stand alone Right Start locations, but we
are in the process of opening Right Start stores within the four walls of our existing Zany Brainy stores. We believe that many of the existing Zany Brainy stores have excess floor space which will be
better utilized by these "store-in-a-store" additions. We expect to open 130 of these additions over the next twelve months beginning in the second quarter of
Fiscal 2002. The capital outlay for these additions is expected to average approximately $30,000 to $35,000 per store. Our ability to execute any expansion will be dependent on future operating
results.

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Upon
completing the "store-in-a-store" expansion, we expect to open new "Combo Stores" that will contain both a Zany Brainy and a Right Start. We
currently anticipate opening up to 20 to 30 Combo Stores in Fiscal 2003.

On
May 24, 2002, the Company completed a $27 million private placement of newly issued common stock. A total of 4.5 million shares at $6.00 per share were sold,
which resulted in net proceeds to the Company of approximately $26 million, after accounting for the placement agents' fees and expenses. The Company intends to use the net proceeds for general
corporate purposes, including the expansion of retail stores and working capital.

We
believe that cash flow from operations and borrowings under the Consolidated Credit Facility will provide sufficient liquidity to fund operations for the current fiscal year and
Fiscal 2003. If, however, we were to experience a significant decrease in cash flow from operations we may be required to obtain additional financing. There can be no assurance, however, that such
additional financing would be available on terms favorable to the Company at such time or at all.

On
March 26, 2002, the Company's Series E Convertible Preferred Stock, Series F Convertible Preferred Stock, Series G Convertible Preferred Stock,
Series H Contingent Convertible Preferred Stock and the remaining Series B Convertible Preferred Stock were converted to common stock.

Impact of Inflation

The impact of inflation on the results of operations has not been significant during our last three fiscal years.

Seasonality

We are primarily a toy retailer and we anticipate we will derive approximately 42% to 46% of our revenue and achieve all of our annual profitability in our fourth
quarter.

Other Matters

New Accounting Requirements

On June 29, 2001, Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" was approved by the Financial
Accounting Standards Board ("FASB"). SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. On an annual basis, and when there
is reason to suspect that their values have been diminished or impaired, these assets must be tested for impairment, and write-downs may be necessary. Although we have not yet completed the first step
of the transitional impairment analysis, we do not anticipate that there will be a material effect on our consolidated results of operations or financial position.

In
August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This standard supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The standard retains the previously existing accounting requirements related
to the recognition and measurement of the impairment of long-lived assets to be held and used, while expanding the measurement requirements of long-lived assets to be disposed
of by sale to include discontinued operations. It also expands on the previously existing reporting requirements for discontinued operations to include a component of an entity that either has been
disposed of or is classified as held for sale. SFAS 144 was adopted on February 3, 2002 and did not have a material effect on our consolidated results of operations or financial
position.

In
November 2001, the Emerging Issues Task Force ("EITF") reached a consensus on EITF No. 01-09, "Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of

17

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the Vendor's Products)". FAO Schwarz, Inc.'s frequent shopper program awards customers with gift certificates based on certain levels of purchases between the months of January and December.
These gift certificates may be redeemed to purchase merchandise between the months of April and September of the following year. These gift certificate liabilities are recorded as a reduction of
revenue and a liability at the date of the initial sale based on the estimated amount of gift certificates to be issued once the minimum level of purchases are obtained. Our policy with respect to
consideration given to a customer currently does not extend beyond coupons and the FAO loyalty program.

In
March 2002, the EITF reached a consensus on issue No. 00-23, "Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25, Accounting for Stock Issued to Employees,and FASB Interpretation No. 44,Accounting for Certain Transactions involving
Stock Compensation". We have and will continue to issue stock options to our employees. If subsequent changes are made to the agreements, the transactions will be adjusted and
any additional compensation recorded in accordance with EITF No. 00-23.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the ordinary course of operations, we face no significant market risk from derivative instruments. Our purchase of imported products subjects us to a minimal
amount of foreign currency risk. Foreign currency risk is that risk associated with recurring transactions with foreign companies, such as purchases of goods from foreign vendors. If the strength of
foreign currencies increases compared to the United States dollar, the price of imported products could increase. We have no commitments, however, for future purchases with foreign vendors and,
additionally, we have the ability to source many products domestically in the event of significant import price increases.

See
"Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources" above for a discussion of our debt obligations,
the interest rates of which are linked to the prime rate or LIBOR. For every $1 million in debt outstanding under the Consolidated Credit Facility, an increase of 0.25% in our interest would
cost us an additional $25,000 per year. We have not entered into any derivative financial instruments to manage interest rate risk, currency risk or for speculative purposes and we are currently not
evaluating the future use of these instruments.

18

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PART II

Item 4. Submission of Matters to a Vote of Security Holders

On March 26, 2002, we asked our shareholders to approve, and they did approve:



We
expect to reincorporate in Delaware when we are able to obtain all necessary consents

Item 6. Exhibits and Reports on Form 8-K

The Company has filed Current Reports on Form 8-K, including two reports dated March 26, 2002, one as amended April 9, 2002, a
report dated May 1, 2002, and a report dated June 4, 2002.

The
following exhibits of F.A.O., Inc. are included herein:

Exhibit Number

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned and
thereunto duly authorized.

|                    |  | F.A.O., INC.                                                         
|------------------- |  | ---------------------------------------------------------------------
|Date: June 18, 2002 |  | /s/JERRY R. WELCHJerry R. Welch Chief Executive Officer and President
|Date: June 18, 2002 |  | /s/RAYMOND P. SPRINGERRaymond P. Springer Chief Financial Officer    

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