##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-QSB

Quarterly or Transitional Report Under Section 13 or 15(d) of the Securities
and Exchange Act of 1934 Quarterly or Transitional Report

(Mark One)

XBOX   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period endedAugust 31, 2001

OR

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

For the transition period from________________ to_______________

Commission file number000-32475

Cetalon Corporation
(Name of small business registrant as specified in its charter)

|                                                                    |  |                                                
|------------------------------------------------------------------- |  | -----------------------------------------------
|Nevada
State or other jurisdiction of incorporation or organization |  | 84-1408762
(I.R.S. Employer Identification No.)

|                                                                                                     |  |                      
|---------------------------------------------------------------------------------------------------- |  | ---------------------
|1801 Century Park East, Suite 1830, Los Angeles, California
(Address of principal executive offices) |  | 90067-2320
(Zip Code)

Registrants telephone number, including area code: (310) 843-3600

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 XBOX                      No XBOX

On October 12, 2001 there were 5,920,163 shares of the Registrants Common
Stock outstanding.





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TABLE OF CONTENTS



|                                           |                                                              |  |  |  |  |  |  | 
|------------------------------------------ | ------------------------------------------------------------ |  |  |  |  |  |  | 
|FORWARD - LOOKING INFORMATION             
|CONSOLIDATED BALANCE SHEET                
|                                           | CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
|                                           | CONSOLIDATED STATEMENTS OF CASH FLOWS                       
|Notes to Consolidated Financial Statements
|                                           | Item 2. Managements Discussion and Analysis                
|PART II. OTHER INFORMATION                
|                                           | Item 1. Legal Proceedings                                   
|                                           | Item 6. Exhibits and Reports on Form 8-K                    
|SIGNATURES                                



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INDEX

|           |  |                       |  |                                                                                                                             |  |     
|---------- |  | --------------------- |  | --------------------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                       |  |                                                                                                                             |  | Page
|           |  |                       |  |                                                                                                                             |  |     
|Part I     |  | Financial Information |  |                                                                                                                             | 
|          
|          
|          
|          
|           |  | Item 1.               |  | Financial Statements  Unaudited                                                                                            |  |     
|          
|          
|          
|          
|           |  |                       |  | Consolidated Balance Sheet at August 31, 2001                                                                               |  | 3   
|          
|          
|          
|          
|           |  |                       |  | Consolidated Statements of Operations and Comprehensive
Loss for the three months ended August 31, 2001 and
August 31, 2000 |  | 4   
|          
|          
|          
|          
|           |  |                       |  | Consolidated Statements of Cash Flows for the three months
ended August 31, 2001 and August 31, 2000                        |  | 5   
|          
|          
|          
|          
|           |  |                       |  | Notes to Consolidated Financial Statements                                                                                  |  | 6   
|          
|          
|          
|          
|           |  | Item 2.               |  | Managements Discussion and Analysis                                                                                        |  | 11  
|          
|          
|          
|          
|Part II    |  | Other Information     |  |                                                                                                                             | 
|          
|          
|          
|          
|           |  | Item 1.               |  | Legal Proceedings                                                                                                           |  | 15  
|          
|          
|          
|          
|           |  | Item 6.               |  | Exhibits and Reports on Form 8-K                                                                                            |  | 15  
|          
|          
|          
|          
|Signatures |  |                       |  |                                                                                                                             |  | 16  





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##### Table of Contents






FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-QSB contains
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, and Section 21E of the Securities Exchange
Act of 1934. These statements relate to future events or the
Companys future financial performance. The Company has
attempted to identify forward-looking statements by terminology
including anticipates, believes,
can, continue, could,
estimates, expects, intends,
may, plans, potential,
predicts, should, or will or the
negative of these terms or other comparable terminology. These
statements are only predictions, and forward-looking statements, and
involve known and unknown risks, uncertainties and other factors,
including the risks outlined under Business Risks
contained in Part I of the Companys Annual Report on Form
10-KSB for the fiscal year ended May 31, 2001, that may cause
the Companys actual results, levels of activity, performance or
achievements to be materially different from any future results,
levels or activity, performance or achievements expressed or implied
by these forward-looking statements. For all of these predictions and
forward-looking statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995.

Although the Company believes that the expectations
reflected in the forward-looking statements are reasonable, the
Company cannot guarantee future results, levels of activity,
performance, or achievements. The Companys expectations are as
of the date this Form 10-QSB is filed, and the Company does not
intend to update any of the forward-looking statements after the date
this Quarterly Report on Form 10-QSB is filed to conform these
statements to actual results, unless required by law.

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING
STATEMENTS.

Certain statements we make in this Quarterly Report
on Form 10-QSB (as well as in other public filings, our web site,
press releases, and oral statements made by Company management
and/or representatives), constitute forward-looking statements, which are
subject to risks and uncertainties. Please see our Annual Report on
Form 10-KSB for the fiscal year ended May 31, 2001, for a
broader discussion of such risks and uncertainties.



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##### Table of Contents






CETALON CORPORATION and Subsidiaries
CONSOLIDATED BALANCE SHEET
(unaudited)

---

|                                                   |                                                                                                                                                        |                                |           |            |            |  
|-------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------ | --------- | ---------- | ---------- | -
|                                                   |                                                                                                                                                        |                                |           | August 31,
|                                                   |                                                                                                                                                        |                                |           | 2001      
|ASSETS                                             |                                                                                                                                                        |                                |           |           
|                                                  
|                                                  
|                                                  
|                                                  
|CURRENT ASSETS:                                    |                                                                                                                                                        |                                |           |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Cash                                                                                                                                                   |                                | $         | 406,565    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accounts receivable                                                                                                                                    |                                |           | 295,792    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Inventory (Note 5)                                                                                                                                     |                                |           | 1,306,788  |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Prepaid expenses and other current assets (Note 5)                                                                                                     |                                |           | 99,674     |           
|                                                   |                                                                                                                                                        |                                |           |           
|                                                   |                                                                                                                                                        | Total current assets           |           |            | 2,108,819  |  
|                                                  
|                                                  
|                                                  
|                                                  
|PROPERTY AND EQUIPMENT, net                        |                                                                                                                                                        |                                | 589,222   |           
|                                                  
|                                                  
|                                                  
|                                                  
|OTHER ASSETS, net (Note 6)                         |                                                                                                                                                        |                                | 48,611    |           
|                                                   |                                                                                                                                                        |                                |           |           
|TOTAL                                              |                                                                                                                                                        | $                              | 2,746,652 |           
|                                                   |                                                                                                                                                        |                                |           |           
|LIABILITIES AND SHAREHOLDERS DEFICIENCY           |                                                                                                                                                        |                                |           |           
|                                                  
|                                                  
|                                                  
|                                                  
|CURRENT LIABILITIES:                               |                                                                                                                                                        |                                |           |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accounts payable                                                                                                                                       |                                | $         | 2,042,440  |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Due to franchisees (Notes 4 and 5)                                                                                                                     |                                |           | 215,509    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Current portion of settlement agreement liabilities (Notes 4 and 5)                                                                                    |                                |           | 569,012    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accrued liabilities                                                                                                                                    |                                |           | 385,675    |           
|                                                   |                                                                                                                                                        |                                |           |           
|                                                   |                                                                                                                                                        | Total current liabilities      |           |            | 3,212,636  |  
|                                                  
|                                                  
|                                                  
|                                                  
|CONVERTIBLE NOTE PAYABLE, NET OF DISCOUNT (Note 6) |                                                                                                                                                        |                                | 750,000   |           
|                                                  
|                                                  
|                                                  
|                                                  
|SETTLEMENT AGREEMENT LIABILITIES (Notes 4 and 5)   |                                                                                                                                                        |                                | 1,363,992 |           
|                                                   |                                                                                                                                                        |                                |           |           
|                                                   |                                                                                                                                                        | Total liabilities              |           |            | 5,326,628  |  
|                                                   |                                                                                                                                                        |                                |           |           
|COMMITMENTS AND CONTINGENCIES                      |                                                                                                                                                        |                                |          |           
|                                                  
|                                                  
|                                                  
|                                                  
|SHAREHOLDERS DEFICIENCY (Notes 2 and 3):          |                                                                                                                                                        |                                |           |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Preferred
stock, $.0001 par value, 50,000,000 authorized, none
outstandingCommon stock, $.0001 par value, 50,000,000 authorized,
5,641,993 outstanding |                                |           | 564        |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Additional paid-in-capital (Note 5)                                                                                                                    |                                |           | 3,931,182  |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Treasury stock (Note 3)                                                                                                                                |                                |           | (100,000   | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Deferred compensation (Note 7)                                                                                                                         |                                |           | (87,750    | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accumulated deficit (Note 2)                                                                                                                           |                                |           | (6,401,475 | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accumulated other comprehensive income                                                                                                                 |                                |           | 77,503     |           
|                                                   |                                                                                                                                                        |                                |           |           
|                                                   |                                                                                                                                                        | Total shareholders deficiency |           |            | (2,579,976 | )
|                                                   |                                                                                                                                                        |                                |           |           
|TOTAL                                              |                                                                                                                                                        | $                              | 2,746,652 |           
|                                                   |                                                                                                                                                        |                                |           |           

See accompanying notes to consolidated financial statements.

3



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CETALON CORPORATION and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(unaudited)

---

|                                                                                          |                                   |   |                               |         |      |   |           |        | 
|----------------------------------------------------------------------------------------- | --------------------------------- | - | ----------------------------- | ------- | ---- | - | --------- | ------ | 
|                                                                                          |                                   |   | Three Months Ended August 31,
|                                                                                          |                                   |   |                              
|                                                                                          |                                   |   | 2001                          |         | 2000
|                                                                                         
|SALES                                                                                     |                                   | $ | 1,415,494                     |         |      | $ | 1,251,916 |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|COST
OF SALES (Note 5)                                                                    |                                   |   | 907,889                       |         |      |   | 744,089   |       
|                                                                                          |                                   |   |                               |         |      |   |           |       
|GROSS PROFIT                                                                              |                                   |   | 507,605                       |         |      |   | 507,827   |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|SELLING, GENERAL, AND ADMINISTRATIVE
EXPENSES (Note 5 & 7)                                |                                   |   | 3,012,740                     |         |      |   | 836,062   |       
|                                                                                          |                                   |   |                               |         |      |   |           |       
|LOSS BEFORE OTHER INCOME (EXPENSE) AND INCOME TAXES                                       |                                   |   | (2,505,135                    | )       |      |   | (328,235  | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|OTHER INCOME (EXPENSE):                                                                   |                                   |   |                               |         |      |   |           |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Franchise fees (Note 5)                                                                   |                                   |   | 16,719                        |         |      |   | 20,024    |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Other income (Note 5)                                                                     |                                   |   | 705                           |         |      |   | 20,286    |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Interest expense (Note 4)                                                                 |                                   |   | (51,800                       | )       |      |   | (16,708   | )     
|                                                                                          |                                   |   |                               |         |      |   |           |       
|                                                                                          | Total other income (expense), net |   |                               | (34,376 | )    |   |           | 23,603 | 
|                                                                                          |                                   |   |                               |         |      |   |           |       
|LOSS BEFORE INCOME TAXES                                                                  |                                   |   | (2,539,511                    | )       |      |   | (304,632  | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|INCOME TAXES                                                                              |                                   |   |                              |         |      |   |          |       
|                                                                                          |                                   |   |                               |         |      |   |           |       
|NET LOSS (Note 2)                                                                         |                                   |   | (2,539,511                    | )       |      |   | (304,632  | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|OTHER
COMPREHENSIVE INCOME                                                                |                                   |   |                               |         |      |   |           |       
|Foreign currency translation                                                              |                                   |   | 3,548                         |         |      |   | (14,865   | )     
|                                                                                          |                                   |   |                               |         |      |   |           |       
|COMPREHENSIVE LOSS                                                                        |                                   | $ | (2,535,963                    | )       |      | $ | (319,497  | )     
|                                                                                          |                                   |   |                               |         |      |   |           |       
|BASIC AND DILUTED LOSS PER SHARE                                                          |                                   | $ | (.46                          | )       |      | $ | (.81      | )     
|                                                                                          |                                   |   |                               |         |      |   |           |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|WEIGHTED-AVERAGE NUMBER OF SHARES USED IN
COMPUTATION OF BASIC AND DILUTED LOSS PER SHARE |                                   |   | 5,519,295                     |         |      |   | 375,700   |       
|                                                                                          |                                   |   |                               |         |      |   |           |       

See accompanying notes to consolidated financial statements.

4



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CETALON CORPORATION and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

---

|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |          |        |         |         |  
|------------------------------------------------------ | --------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------- | ----------------------------------------- | ------ | ----------------------------- | ---------- | -------- | ------ | ------- | ------- | -
|                                                       |                                                                             |                                              |                                           |                                           |        | Three Months Ended August 31,
|                                                       |                                                                             |                                              |                                           |                                           |        |                              
|                                                       |                                                                             |                                              |                                           |                                           |        | 2001                          |            | 2000    
|                                                      
|CASH FLOWS PROVIDED BY (USED IN) OPERATING
ACTIVITIES: |                                                                             |                                              |                                           |                                           |        |                               |            |         
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net loss                                                                    |                                              | $                                         | (2,539,511                                | )      |                               | $          | (304,634 | )     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Adjustments to reconcile net loss to net cash used in
operating activities: |                                              |                                           |                                           |        |                               |            |          |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             | Depreciation and amortization                |                                           |                                           | 56,578 |                               |            |          | 19,090 |        
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             | Amortization of deferred compensation        |                                           |                                           | 61,200 |                               |            |          |        |        
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             | Changes in operating assets and liabilities: |                                           |                                           |        |                               |            |          |        |        
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             |                                              | Accounts receivable                       |                                           |        | (61,510                       | )          |          |        | 157,615 |        
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             |                                              | Inventory                                 |                                           |        | (668,757                      | )          |          |        | 101,400 |        
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             |                                              | Prepaid expenses and other current assets |                                           |        | 15,104                        |            |          |        | (15,496 | )      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             |                                              | Accounts payable                          |                                           |        | 1,517,497                     |            |          |        | (2,756  | )      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             |                                              | Due to franchisees                        |                                           |        | (58,888                       | )          |          |        | 14,774  |        
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                                                                             |                                              | Accrued liabilities                       |                                           |        | (12,886                       | )          |          |        | (57,990 | )      
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|                                                       |                                                                             |                                              |                                           | Net cash used in operating activities     |        |                               | (1,691,173 | )        |        |         | (87,997 | )
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|CASH FLOWS USED IN INVESTING ACTIVITIES:               |                                                                             |                                              |                                           |                                           |        |                               |            |         
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Purchase of property and equipment                                          |                                              |                                           | (207,847                                  | )      |                               |            | (544     | )     
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|                                                       |                                                                             |                                              |                                           | Net cash used in investing activities     |        |                               | (207,847   | )        |        |         | (544    | )
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|CASH FLOWS PROVIDED BY (USED IN)
FINANCING ACTIVITIES: |                                                                             |                                              |                                           |                                           |        |                               |            |         
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net proceeds from issuance of common stock                                  |                                              |                                           | 450,000                                   |        |                               |            |         |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Payment
on settlement agreement liabilities, net                            |                                              |                                           | (170,836                                  | )      |                               |            |         |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net
proceeds from related party loans and advances                          |                                              |                                           |                                          |        |                               |            | 111,471  |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net proceeds (repayment) on notes payable                                   |                                              |                                           | 1,000,000                                 |        |                               |            | (14,773  | )     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Deferred financing costs                                                    |                                              |                                           | (50,000                                   | )      |                               |            |         |       
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|                                                       |                                                                             |                                              |                                           | Net cash provided by financing activities |        |                               | 1,229,164  |          |        |         | 96,698  |  
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                |                                                                             |                                              | 4,053                                     |                                           |        |                               | 209        |         
|                                                      
|                                                      
|                                                      
|                                                      
|INCREASE (DECREASE) IN CASH                            |                                                                             |                                              | (665,803                                  | )                                         |        |                               | 8,366      |         
|                                                      
|                                                      
|                                                      
|                                                      
|CASH, BEGINNING OF PERIOD                              |                                                                             |                                              | 1,072,368                                 |                                           |        |                               | 14,194     |         
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|CASH, END OF PERIOD                                    |                                                                             | $                                            | 406,565                                   |                                           |        | $                             | 22,560     |         
|                                                       |                                                                             |                                              |                                           |                                           |        |                               |            |         
|SUPPLEMENTAL
DISCLOSURES OF CASH FLOW INFORMATION:     |                                                                             |                                              |                                           |                                           |        |                               |            |         
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Cash
paid during the three months ended for-                               
|Interest                                               |                                                                             | $                                            | 18,609                                    |                                           |        | $                             | 6,553      |         

See accompanying notes to consolidated financial statements.

5



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Notes to Consolidated Financial Statements

CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Three months ended August 31, 2001 and 2000
(Unaudited)

---

NOTE 1  GENERAL

The accompanying unaudited consolidated financial statements of Cetalon
Corporation and subsidiaries (Cetalon or the Company) have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for financial
statements. In the opinion of management, the accompanying consolidated
financial statements reflect all adjustments of a normal recurring nature and
necessary for a fair statement of the results for the interim periods
presented.

Because of the seasonal nature of the Companys business, the results of
operations for the three months ended August 31, 2001 and 2000 are not
necessarily indicative of the results to be expected for the full year. For
further information, refer to the financial statements and footnotes thereto
for the fiscal year ended May 31, 2001, included in the Companys Annual Report
on Form 10-KSB (File No. 000-32475) filed with the Securities and Exchange
Commission on October 2, 2001.

NOTE 2  PLANS REGARDING GOING CONCERN

The Company and its management recognize the Companys financial weaknesses and
cash flow concerns, which are characterized by recurring losses and
shareholders deficiency. The Company has developed operational and strategic
plans to improve the Companys long-term financial condition, and financial
sourcing strategies with the goal of providing working capital to the business.
The Company has signed an agreement with a group of investors for a $3.0
million equity line of credit, which is anticipated to be drawn down in 12
monthly tranches starting in October 2001. The Company has also received
term sheets from various equity investors for investment commitments of up to
$5.0 million, which are currently under consideration by the Company. The
Company is also in negotiation with various financial institutions to
establish leasing facilities and bank lines, which it anticipates will be
available to the Company by the end of the fiscal year. In addition to a
strategic growth plan, the Company has developed operational initiatives,
including marketing plans, customer programs, and enhanced associate training.
To maintain operating cash levels, the Company expects to periodically obtain
equity funding, attempting to balance cash needs and the shareholder dilution
that is created by the issuance of new shares. In addition, inventory
management and expense control policies and programs are being enhanced to
maximize the Companys working capital efficiency. While the Companys
strategic, operational, and financing plans are designed to improve the
Companys financial condition and meet its working capital needs, there can be
no assurance that the Company will be able to achieve its desired results or
that other factors may not cause the Companys financial condition to be
further weakened.

NOTE 3  CLAYDAN TRANSACTION AND SHARE EXCHANGE

The operations of the retail shops in Canada began in 1984 and were owned by
Claydan Enterprises, Inc. (Claydan), a privately-held British Columbia
corporation. Cetalon Corporation became the ultimate owner of the assets and
operations of Claydan in March 2001 through a series of business transactions,
among Cetalon, 1129 Holding Inc., a Delaware corporation (1129 Holding),
Cetalon Company of Canada (Cetalon Canada) and Claydan. Prior to the
completion of these transactions, the Company, 1129 Holdings, and Cetalon
Canada all had limited, if any, operational activities or assets.

6



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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Three months ended August 31, 2001 and 2000
(Unaudited)

On February 6, 2001, 1129 Holding and Cetalon Canada entered into an Asset
Purchase Agreement to acquire substantially all of Claydans assets and assume
substantially all of its recorded liabilities (the Claydan Transaction). To
effect the Claydan Transaction, 362,561 shares of 1129 Holdings stock was
exchanged for the net assets of Claydan. Upon the closing of the Claydan
Transaction, the acquired assets and business operations of Claydan constituted
virtually all the operating assets of Cetalon Canada and 1129 Holding.
Therefore, the Claydan Transaction was accounted for as a recapitalization of
Claydan, with the assets acquired and liabilities assumed recorded at their
existing basis of accounting. Cetalon Canada and 1129 Holding also adopted the
May 31 fiscal year-end of Claydan.

Effective March 12, 2001, approximately one month following the closing of the
Claydan Transaction, the Company, then an enterprise with limited operations,
whose common stock was quoted on the OTC Bulletin Board, entered into an
Agreement and Plan of Share Exchange with the stockholders of 1129 Holding (the
Share Exchange). As a result of the Share Exchange, 1129 Holding became a
wholly-owned subsidiary of the Company and, in conjunction with other share and
business transactions that occurred in or about the same time frame, more than
50 percent voting control of the Company changed in favor of 1129 Holdings
stockholders and operational control of the Company changed in favor of 1129
Holdings management. Pursuant to the terms of the Share Exchange, the Company
issued 2,064,802 shares of its common stock, $.0001 par value per share, to the
stockholders of 1129 Holding for an equal number of shares of common stock of
1129 Holding, which shares represented all of the outstanding shares of capital
stock of 1129 Holding.

Included in such other share transactions was the return by the majority
shareholder of 23,950,000 shares of the Companys common stock to its treasury
for cancellation in consideration of the payment by the Company of the sum of
$100,000. The majority shareholder was the Companys sole executive officer
and director immediately prior to the closing of the Share Exchange. As of
such time, the shares returned by him constituted approximately 90 percent of
the Companys then-issued and outstanding shares. The Company also paid
$200,000 to the majority shareholders consulting firm as a transaction fee in
connection with the Share Exchange.

Also included in such other business transactions, the sole remaining executive
officer and director of the Company resigned in favor of the officers and
directors of 1129 Holding, and the Company disposed of all of the capital stock
of its wholly owned subsidiary, Caps Wholesale Sporting Goods, Inc. (Caps).
The assets and business operations of Caps were insignificant prior to and as
of the date of the transactions.

Shortly before the closing of the Share Exchange, 1st Zamora Corporation (1st
Zamora), a Nevada corporation, sold 2,393,280 shares of the Companys common
stock, which were then owned by 1st Zamora, to various third-party investors.
1st Zamora had acquired such shares on December 29, 2000, from the Companys
former chief executive officer. Included in such share sales were 455,180
shares of the Companys common stock, which were purchased by certain
stockholders of 1129 Holding.

As a result of the Share Exchange and the other share and business
transactions, the Companys acquisition of 1129 Holding was accounted for as a
Reverse Acquisition because the stockholders of 1129 Holding, as the legal
acquiree, obtained more than 50 percent voting control of the Company, the
legal acquirer. Accordingly, for accounting purposes, 1129 Holding was treated
as the continuing reporting entity and Accounting Acquiror that acquired the
Company, which accounting treatment resulted in the Companys adopting of the
May 31 fiscal year-end of 1129 Holding. Under a reverse acquisition, the
equity section of the combined companies balance sheet reflects the par or
stated value of the legal acquirers outstanding equity securities and the
retained earnings or accumulated deficit of the accounting acquirer. Any
remaining amount of equity has been charged or credited to paid-in-capital. The
number of shares outstanding and used in the calculation of weighted-average
shares outstanding for earnings per share purposes have been retroactively
restated for the periods presented to reflect the additional shares issued in
connection with the recapitalization of Claydan and the Share Exchange.

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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Three months ended August 31, 2001 and 2000
(Unaudited)

As a result of these business transactions, the Company, through its
wholly-owned subsidiaries, continued substantially the same business operations
in which Claydan had been engaged. These financial statements and the
accompanying notes to consolidated financial statements present Cetalon
Corporation and Claydan as the continuation of the same business.

NOTE 4  CREDITOR SETTLEMENT AGREEMENTS

During the period from January 2001 through April 2001, the Company entered
into Settlement Agreements totaling $1,700,000 with its major creditors,
including its trade vendors, notes payable holders, and related parties. The
Settlement Agreements offered creditors the following options for repayment of
the outstanding balance: 40 percent over 12 months, 60 percent over 24 months,
75 percent over 36 months, or 120 percent over 48 months. The Companys
creditors primarily selected either 40 percent over 12 months or 120 percent
over 48 months. For the year end May 31, 2001 the Company recorded approximately $52,000 as other income as a result of certain creditors
accepting settlement agreements, which was less than the balance owed to the creditor. Amounts owed under the Settlement Agreements have been
classified as current and long term according to the terms of repayment. The
amount that will ultimately be paid to the creditors in excess of the original
balances owed is being recorded as interest expense over the term of the
repayment.

NOTE 5  RELATED PARTY TRANSACTIONS

The Companys shareholders or their relatives own certain franchises. As of
August 31, 2001, approximately $85,421 is payable to related franchisees and
is included in due to franchisees in the accompanying balance sheet.

Combined franchise fees and advertising fees were paid by related franchisees
in the amounts of approximately $15,856 and $16,113 for the three months ended
August 31, 2001 and 2000, respectively.

The Company has purchased certain inventory from a corporation owned by a
shareholder. For the three months ended August 31, 2000, the Company purchased
$94,571 from the related corporation.

The Company received management fees from franchises owned by related parties
and the supplier owned by a shareholder of the Company in the amount of
$20,286 for the three months ended August 31, 2000. Such amounts are included
in other income.

During March 2001, the Company entered into a consulting agreement with the
Watley Group, LLC (Watley), a shareholder and an investment banking company
in which the Companys Chairman and Vice Chairman  Chief Executive Officer are
executive officers or directors. The agreement expires on February 6, 2002,
but automatically renews yearly for additional 12-month terms unless cancelled
with six months prior notice after the initial 12-month period. Services
provided by Watley include strategic and operational planning, providing senior
management for the Company, investment banking, debt or equity offering
placement, and acquisition assistance. The Company pays Watley $45,000 per
month, plus expenses, plus a percentage of transaction proceeds, ranging from
2.5 to 10 percent. During the three months ended August 31, 2001, the Company
incurred fees with Watley of $134,600 for management and consulting
services, which are included in selling, general, and administrative
expenses,
and $25,000 for equity financing placement fees, which have been
recorded as a reduction to additional paid-in capital. During June 2001, the Company entered
into a month-to-month rental agreement with Watley for executive office space, which provides for monthly
rent of approximately $6,000 plus expense reimbursements. During the three
months ended August 31, 2001, the Company incurred fees with Watley of $13,563
for rent, which are included in selling, general and administrative expenses.
As of August 31, 2001, Watley owed $35,795 to the Company, which is included in
prepaid expenses and other current assets in the accompanying consolidated
balance sheet.

At August 31, 2001, settlement agreement liabilities include $161,906 due to a
franchises owned by related parties.

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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Three months ended August 31, 2001 and 2000
(Unaudited)

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NOTE 6  CONVERTIBLE NOTE PAYABLE

In August 2001, the Company received a $1,000,000 loan from a vendor who is
also a shareholder. A director of the Company is also an executive officer of
the vendor/shareholder. The loan bears interest at 12 percent per annum and is payable
in full, with accrued interest, in August 2004. The Company, at its option,
has the right to repay up to one-third of the original note amount, without
penalty, each year during the term of the note. The note payable can be
converted, in whole or in part, into common stock of the Company at the option
of the creditor at any time after July 2002. The conversion price is the
lessor of 80 percent of the fair market value of the Companys common stock as
defined in the note payable, or $2.00, with a floor conversion price of $1.40.
The value of the conversion feature was determined to be $250,000, based on the
fair market value of the common stock of the Company on the commitment date and
the conversion price on the commitment date. This discount is being amortized
as interest expense over the one-year term to the date conversion is allowed.
Watley and another shareholder were each paid a $25,000 placement fee for the
transaction, which amounts are included in other assets in the accompanying
consolidated balance sheet. The fees are being amortized over the three-year
term of the loan.

NOTE 7  STOCK-BASED
COMPENSATION

On July 24, 2001 the Company adopted the 2001 Equity
Incentive Plan (the "Plan") to provide stock-based compensation to
employees, directors, and consultants. The plan provides for non
qualified stock options, supplemental stock options, stock bonus
rights, restricted share grants, and stock appreciation rights. The
maximum number of shares authorized under the Plan is 1,550,000. The
Plan provides that the exercise price of non qualified stock options
granted under the Plan is to be at fair market value on the date of
the grant. Supplemental stock options and restricted stock grants may
be issued at 85% of the fair market value on the date of the grant.
The options vest over a three years and expire after ten years. The
Plan provides for accelerated vesting for certain executives in the
event of a change of control or other events as defined by the Plan.

The Company granted 858,000 non qualified stock options
during the three months August 31, 2001 at an exercise price of $0.85
per share. Fair market values as of date of grant was $1.17,
accordingly the Company is recognizing compensation expense over the
vesting period. No options have been exercised or canceled during the
three months ended August 31, 2001. No supplemental stock options,
stock bonus rights, or stock appreciation rights were issued or are
outstanding as of August 31, 2001.

During the three months ended August 31, 2001, the
Company granted 100,000 shares of restricted common stock to an
officer of the Company. The restricted shares were recorded at $1.17
cents per share, with $117,000 recorded to additional paid-in-capital
and deferred compensation, which is being amortized over 12 months.
Amortization expense of $29,250 was recorded for the three months
ended August 31, 2001.

The Company also granted 30,000 shares of
restricted common stock to a former employee of the Company and
recorded compensation expense of $31,500.

Additionally, the Company has an incentive program
with certain employees whereby the employees may be granted shares of
restricted common stock based on the Company's retail stores
achieving specified sales goals. As of August 31, 2001, a total of
126,000 shares of restricted common stock are available for grant to
the employees, of which none have been granted.

The Company granted 50,000 stock options to certain
directors in March 2001 at an exercise price of $0.25 per share.
Compensation cost of $28,000 was recorded for the three months ended
August 31, 2001 because the exercise price was less than fair
value.

Had compensation cost for the Company's stock-based
compensation plans been determined based on the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation" the Company's net loss
would have increased by approximately $48,000 for the three months
ended August 31, 2001.

The estimated fair value of stock options and
restricted common stock granted during the three months ended August
31, 2001 pursuant to SFAS No. 123 was approximately $951,000. The
amount is based on the following assumptions: no expected dividends,
a discount rate of 3.7%, volatility of 100%, and an expected life of
7 years.

NOTE 8  EXERCISE OF STOCK WARRANTS

On July 5, 2001, a shareholder exercised a
warrant to purchase 238,095 shares of
the Company at a price of $2.10 per share, or aggregate consideration of
$500,000. Watley and another shareholder were each paid a $25,000 for
equity financing placement fees, which has been recorded as a
reduction to additional paid-in capital.

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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Three months ended August 31, 2001 and 2000
(Unaudited)

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NOTE 9  RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended, is effective for
the Company beginning June 1, 2001. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities measured at fair
value. The adoption of SFAS No. 133 did not have a material impact on the
Companys financial position or results of operations.

SFAS No. 141, Business Combinations, is effective July 1, 2001 and
establishes accounting and reporting standards to reflect only the purchase
method of accounting for business combinations. The adoption of SFAS No. 141
did not have a material impact on the Companys financial statements.

NOTE 10  COMMENTS AND CONTINGENCIES

Certain Key Senior Executives of the Company have
entered into employment agreements with the Company. The agreements
include provisions regarding change of control of the Company, as
defined, such as acceleration of stock options and certain severance
benefits including salary continuation, entitlement to bonus payments
and medical benefit coverage's for a specified period of time. The
agreements also provide for severance payments in the event of
termination for reasons other than cause.

NOTE 11  SUBSEQUENT EVENTS

In September 2001, the Company entered into an equity line of credit agreement
with several investors. The investors agreed to purchase up to $3,000,000 of
newly-issued common stock of the Company over the next 12 months
at a price equivalent to 90% of fair market value at the date of the
purchase. The investors
agreed to purchase a minimum of $250,000 per month and are able to accelerate
the
minimum purchase with the Companys consent.

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Item 2. Managements Discussion and Analysis

Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. The Companys actual results could materially differ from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in this section, as well as in
the sections entitled Stores, Distribution, Information Systems, Competition,
Government Regulation, and Business Risks included in the Companys Form 10-KSB
for the year ended May 31, 2001.

Overview

Cetalon Corporation, formerly Sportsmans Wholesale Co., and its subsidiaries
are engaged in retailing nutritional and personal care products through
licensed retail departments in Sears Canada and Sears U.S. department stores.
The Company operates its store within a store locations under the name Sears
Health Food and Fitness Shops in Canada and under the name Sears Health Food
and Nutrition Centers in the United States. As of October 12, 2001, the
Company operates 46 Sears Health Food and Fitness Shops in Canada (including 12
locations through franchisees) and 10 Sears Health Food and Nutrition Centers
in the United States (all in California).

During the three months ended August 31, 2001, the Company opened 10 new owned
retail stores (all in the United States), and closed no owned stores. No
franchise stores were opened or closed in the Unites States or Canada during
the three months ended August 31, 2001.

Claydan Transaction and Share Exchange

In early 2001, the Company and its subsidiaries entered into a series of
transactions that altered the ultimate ownership of the operating assets of the
business and created the new consolidated entity that exists as of August 31,
2001.

On February 6, 2001, 1129 Holding and Cetalon Canada entered into an Asset
Purchase Agreement to acquire substantially all of Claydans assets and assume
substantially all of its recorded liabilities (the Claydan Transaction). To
effect the Claydan Transaction, 362,561 shares of 1129 Holdings stock was
exchanged for the net assets of Claydan. Upon the closing of the Claydan
Transaction, the acquired assets and business operations of Claydan constituted
virtually the entire operating assets of Cetalon Canada and 1129 Holding.
Therefore, the Claydan Transaction was accounted for as a recapitalization of
Claydan with the assets acquired and liabilities assumed recorded at their
existing basis of accounting. Cetalon Canada and 1129 Holding also adopted the
May 31 fiscal year-end of Claydan.

Effective March 12, 2001, approximately one month following the closing of the
Claydan Transaction, the Company, then an enterprise with limited operations,
whose common stock was eligible to be quoted on the OTC Bulletin Board, entered
into an Agreement and Plan of Share Exchange with the stockholders of 1129
Holding (the Share Exchange). As a result of the Share Exchange, 1129
Holding became a wholly-owned subsidiary of the Company and, in conjunction
with other share and business transactions that occurred in or about the same
time frame, more than 50% voting control of the Company changed in favor of
1129 Holdings stockholders and operational control of the Company changed in
favor of 1129 Holdings management. Pursuant to the terms of the Share
Exchange, the Company issued 2,064,802 shares of its $.0001 par value common
stock to the stockholders of 1129 Holding for an equal number of shares of
common stock of 1129 Holding, which shares represented all of the outstanding
shares of capital stock of 1129 Holding.

Included in such other share transactions was the return by the majority
shareholder of 23,950,000 shares of the Companys common stock to its treasury
for cancellation in consideration of the payment by the Company of the sum of
$100,000. The majority shareholder was the Companys sole executive officer
and director immediately prior to the closing of the Share Exchange. As of
such time, the shares returned by him constituted approximately 90% of the
Companys then-issued and outstanding shares.

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Also included in such other business transactions, the sole remaining executive
officer and director of the Company resigned in favor of the officers and
directors of 1129 Holding and the Company disposed of all of the capital stock
of its wholly-owned subsidiary, Caps Wholesale Sporting Goods, Inc. (Caps).
The assets and business operations of Caps were insignificant prior to and as
of the date of the transactions.

Shortly before the closing of the Share Exchange, 1st Zamora Corporation, a
Nevada corporation (1st Zamora), sold 2,393,280 shares of the Companys
common stock, which were then owned by 1st Zamora, to various third-party
investors. 1st Zamora had acquired such shares on December 29, 2000, from the
Companys former chief executive officer. Included in such share sales were
455,180 shares of the Companys common stock that were purchased by certain
stockholders of 1129 Holding.

As a result of the Share Exchange and the other share and business
transactions, the Companys acquisition of 1129 Holding was accounted for as a
Reverse Acquisition because the stockholders of 1129 Holding, as the legal
acquiree, obtained more than 50% voting control of the Company, the legal
acquirer. Accordingly, for accounting purposes, 1129 Holding was treated as
the continuing reporting entity and Accounting Acquiror that acquired the
Company, which accounting treatment resulted in the Company adopting the May 31
fiscal year-end of 1129 Holding.

As a result of these business transactions, the Company, through its
wholly-owned subsidiaries, continued substantially the same business operations
in which Claydan had been engaged.

Results of Operations

The following table presents the percent to sales of certain items included in
the Companys consolidated statements of operations, unless otherwise
indicated:

|                                                    |  |                    |        |          |  |  |       |   
|--------------------------------------------------- |  | ------------------ | ------ | -------- |  |  | ----- | --
|                                                    |  | Three Months Ended
|                                                    |  |                   
|                                                    |  | Aug. 31,           |        | Aug. 31,
|                                                    |  | 2001               |        | 2000    
|                                                    |  |                    |        |         
|Statement of Operations Data:                       |  |                    |        |          |  |  |       |   
|                                                   
|                                                   
|                                                   
|                                                   
|Sales                                               |  |                    | 100.0  | %        |  |  | 100.0 | % 
|                                                   
|                                                   
|                                                   
|                                                   
|Cost of sales                                       |  |                    | 64.1   |          |  |  | 59.4  |   
|                                                    |  |                    |        |          |  |  |       |   
|Gross profit                                        |  |                    | 35.9   |          |  |  | 40.6  |   
|                                                   
|                                                   
|                                                   
|                                                   
|Selling, general, and administrative expenses       |  |                    | 212.8  |          |  |  | 66.8  |   
|                                                    |  |                    |        |          |  |  |       |   
|Loss before other income (expense) and income taxes |  |                    | (176.9 | )        |  |  | (26.2 | ) 
|                                                   
|                                                   
|                                                   
|                                                   
|Franchise fees                                      |  |                    | 1.2    |          |  |  | 1.6   |   
|                                                   
|                                                   
|                                                   
|                                                   
|Other income (expense)                              |  |                    | 0.0    |          |  |  | 1.6   |   
|                                                   
|                                                   
|                                                   
|                                                   
|Interest expense                                    |  |                    | (3.7   | )        |  |  | (1.3  | ) 
|                                                    |  |                    |        |          |  |  |       |   
|Net loss before income taxes                        |  |                    | (179.4 | )%       |  |  | (24.3 | )%
|                                                    |  |                    |        |          |  |  |       |   

Three Months Ended August 31, 2001 Compared to Three Months Ended August 31, 2000

Sales were approximately $1.4 million for the
three months ended August 31, 2001, compared to approximately
$1.25 million for the three months ended August 31, 2000. The increase in sales
was due to the opening of ten new stores in the United States in June 2001. The
US sales were approximately $0.2 million for the three
months ended August 31, 2001. The Canadian
operation sales were approximately $1.2 million for the three months ended August 31, 2001, compared to approximately $1.25 million for the three months ended August 31, 2000. The decrease in sales in Canada of 4%, was mainly caused by reduced inventory levels at the stores.

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Gross profit, defined as sales less cost of sales, decreased as a percentage of
net sales to 35.9% for the three months ended August 31, 2001 from 40.6% for
the same period in the prior year. The decrease in gross profit as a
percentage of net sales was mainly the result of discounting certain
overstocked products in Canada stores and lower initial gross margins in the
United States stores.

Selling, general and administrative expenses
increased as a percentage of net sales to 212.8% for the three months
ended August 31, 2001, from 66.8% for the three months ended
August 31, 2000. This increase resulted from the start up of
store and corporate operations in the United States during 2001,
including business strategy consulting, public relations, investor
communications, grand opening advertising, other store pre-opening
costs, and pre-opening temporary store labor. Total selling, general
and administrative expenses for the US operation was approximately
$2.1 million, which is comprised of $0.9 million (44%) start up costs
and $1.2 million (56%) other selling, general and administrative
expenses. Total selling, general and
administrative expenses for the Canadian operation (excluding the
U.S. costs) were approximately $0.9 million or 78.8% as a percentage of
net sales for the three months
ended August 31, 2001, compared to approximately $0.8 million
or 66.8% as percentage of net sales for the three months ended August 31, 2000. The approximately 11%
increase was due to additional advertising and fixed operating costs,
such as payroll.

The Companys loss before other income and income taxes increased $2.3 million
to $2.5 million for the three months ended August 31, 2001, from $0.3 million
for the three months ended August 31, 2000. This increase was the result of
the significant increase in selling, general and administrative expenses
described above.

Interest
expense increased to approximately $52,000 for the three months ended August
31, 2001 from approximately $17,000 for the three months ended August 31, 2000
due to the long-term settlement agreements entered into by Company and its
vendors during from January to April 2001.

Net income tax benefits were not recognized during the three months ended
August 31, 2001 or 2000 due to the valuation allowance established by the
Company.

As a result of the above, the Company reported a net loss of approximately
$2.5 million for the three months ended August 31, 2001 compared to a net loss
of approximately $0.3 million for the three months ended August 31, 2000.

Liquidity and Capital Resources

The Company has financed its operations and expansion program to date
principally through debt issuances, advances from
related parties, and equity infusions. Additional sources of financing have
included vendor terms on inventory purchases. The events that occurred on
September 11, 2001, have caused disruption of the domestic and
foreign  capital markets. Such events have had a material adverse
effect on the timing, pricing, and availability to the Company of
required cash infusions of equity or debt.

Cash used in operations was $1,691,173 for the three months ended August 31,
2001, compared to cash used in operations of $87,997 for the same period in the
prior year. The significant increase in cash used in operations was primarily
caused by the start-up of the United States operations during the three months
ended August 31, 2001. During the period from January 2001 through April 2001,
the Company entered into Settlement Agreements totaling approximately
$1,700,000 with its major creditors, including its trade vendors, notes payable
holders, and related parties. The Settlement Agreements offered the creditors
the following options for repayment of the outstanding balance: (i) 40% over 12
months, (ii) 60% over 24 months, (iii) 75% over 36 months, or (iv) 120% over 48
months. The Companys creditors primarily selected either 40% over 12 months
or 120% over 48 months.

The Company has used cash in investing activities since inception to purchase
leaseholds, fixtures and equipment for new stores. Net cash used in investing
activities was $207,847 for the three months ended August 31, 2001, as compared
to $544 for the same period in the prior year.

Net cash provided by or used in financing activities consist primarily of
repayments on the Companys settlement agreement liabilities and proceeds from
equity infusions.

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The Companys primary long-term capital requirements consist of opening new
stores, costs related to closing and/or acquisition of franchise operations,
and investments in capital improvements/working capital.

All of the Companys stores are located within Sears department stores. The
Company pays Sears a commission based on net sales as part of the Sears License
Agreements. The Company expects to open, contingent upon the approval of
Sears, a significant amount of new stores during the next few years. These
locations generally require capital expenditures of $30,000 for fixtures and
equipment and leasehold improvements. Additionally, store openings require
cash of approximately $20,000 for inventory, before accounts payable financing.

Earlier this year the Company negotiated extended terms on a significant
portion of its trade payables, notes payable, and related party advances due to
cash flow constraints. The Company has had inventory levels reduced in its
stores due to reduced availability of cash to make purchases but had
significantly increased these levels by the summer of 2001. The Company has
relied on equity investment infusions of cash to continue operations. If the
Company is unable to generate and maintain positive operating cash flows and
operating income in the future, or continue to obtain equity financing, it
would likely require funding from other sources. If needed, the Companys
inability to raise capital would materially and adversely harm the Companys
business and financial condition. To the extent that additional capital is
raised through the sale of equity or convertible debt securities, the issuance
of these securities could result in dilution to the Companys stockholders.

Seasonality and Inflation

The Companys business is subject to some seasonal fluctuations and it
typically realizes lesser sales volume and operating profits during the summer
months. In addition, because Sears department stores typically draw customers
from a large trade area, sales may be impacted by adverse weather or travel
conditions.

The Companys results of operations and financial position are presented based
upon historical cost. Although the Company cannot accurately anticipate the
effect of inflation on its operations, it does not believe inflation is likely
to have a material adverse effect on its net sales or results of operations.

Recent Accounting Pronouncements

Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended, is effective for
the Company beginning June 1, 2001. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities measured at fair
value. The adoption of SFAS No. 133 did not have a material impact on the
Companys financial position or results of operations.

SFAS No. 141, Business Combinations, is effective July 1, 2001 and
establishes accounting and reporting standards to reflect only the purchase
method of accounting for business combinations. The adoption of SFAS No. 141
did not have a material impact on the Companys financial statements.

SFAS No. 142, Goodwill and Other Intangible Assets, is effective December 15,
2001 and establishes accounting and reporting standards for goodwill and other
intangible assets. The adoption of SFAS No. 142 will not have a material
impact on the Companys financial statements.

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PART II. OTHER INFORMATION




Item 1. Legal Proceedings

On July 13, 2001 Natural Bridge, Inc. filed a Writ of Summons against the
Company styled, Natural Bridge, Inc. v.
Claydan Enterprises, Inc., John Danylowich and Cetalon Corporation, in the
Court of Common Pleas, Civil Trial Division, Philadelphia Country, docket
number 1614. Plaintiff has requested relief according to proof at trial.
Plaintiffs complaint alleges that the Company assisted Claydan Enterprises Inc.
with breaching the terms of a term sheet. Management believes that the
allegations are without merit and intends to defend the Companys position
vigorously.

From time to time, the Company may be engaged in litigation in the ordinary
course of business or in respect of which it is insured or the cumulative
effect of which litigation the Companys management does not believe may
reasonably be expected to be materially adverse. With respect to existing
claims or litigation, the Companys management does not believe that they will
have a material adverse effect on the Companys financial condition, results of
operations, or future cash flows.




Item 6. Exhibits and Reports on Form 8-K

(a) 
Exhibits

None


(b)  Reports on Form 8-K

During the three months ended August 31, 2001,
the Company filed the following Current Reports on
Form 8-K:



|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | On June 12, 2001, the Company filed a Current
Report in which it provided further disclosure of certain legal and
accounting analysis of the transaction first disclosed in the
Company's Current Report filed on March 16, 2001, and announced
the adoption of May 31 as the Company's fiscal year end.                                                                                                                                                                            
|  
|2. | On June 22, 2001, the Company filed a Current
Report in which it announced its decisions to engage Deloitte & Touche LLP as the Company's independent auditors and not to renew
Tanner + Co.'s engagement.                                                                                                                                                                                                                                                                          
|  
|3. | On August 9 and 14, 2001, the Company filed
amended Current Reports on Form 8-K to its Current Report filed on
March 16, 2001, in which the Company announced the completion of
a series of transactions among the Company, its first-tier
wholly-owned subsidiary, 1129 Holdings, Inc., and its second-tier
wholly-owned subsidiary, Cetalon Company of Canada. Included in the
August amendments to the Current Report were the financial statements
of Cetalon Company of Canada.

15



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##### Table of Contents






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, on
October 26, 2001.

| |  |                     |  |                                                                                                     
| |  | ------------------- |  | ----------------------------------------------------------------------------------------------------
| |  | CETALON CORPORATION
|
| |  | By:                 |  | /s/ A.

John A. Bryan, Jr.
A. John A. Bryan, Jr.
Chief Executive Officer
Principal Executive Officer
|
| |  | By:                 |  | /s/

Neil T. Watanabe
Neil T. Watanabe
Chief Financial Officer
Principal Financial Officer          

16