##### 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)

(X Box)     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period endedNovember 30, 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   (X Box)    No   (Box)

On January 17, 2002 there were 6,754,643 shares of the Registrants Common
Stock outstanding.





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TABLE OF CONTENTS



|                           |                                                              |  |  |  |  |  |  | 
|-------------------------- | ------------------------------------------------------------ |  |  |  |  |  |  | 
|                           | 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. Reports on Form 8-K                                 
|EX-1.1                    



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##### Table of Contents



INDEX

|           |  |                       |  |         |  |                                      |  |                                                                                                                                         |    |      |   | 
|---------- |  | --------------------- |  | ------- |  | ------------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------- | -- | ---- | - | 
|           |  |                       |  |         |  |                                      |  |                                                                                                                                         |    | Page
|Part I.    |  | Financial Information |  |         |  |                                     
|          
|          
|          
|          
|           |  |                       |  | Item 1. |  | Financial Statements  Unaudited     |  |                                                                                                                                         |    |     
|          
|          
|          
|          
|           |  |                       |  |         |  |                                      |  | Consolidated Balance Sheet at November 30, 2001                                                                                         |    |      | 4 | 
|          
|          
|          
|          
|           |  |                       |  |         |  |                                      |  | Consolidated Statements of Operations and Comprehensive
Loss for the three and six months ended November 30,
2001 and November 30, 2000 |    |      | 5 | 
|          
|          
|          
|          
|           |  |                       |  |         |  |                                      |  | Consolidated Statements of Cash Flows for the six months
ended November 30, 2001 and November 30, 2000                                  |    |      | 6 | 
|          
|          
|          
|          
|           |  |                       |  |         |  |                                      |  | Notes to Consolidated Financial Statements                                                                                              |    |      | 7 | 
|          
|          
|          
|          
|           |  |                       |  | Item 2. |  | Managements Discussion and Analysis |  |                                                                                                                                         | 12 |     
|          
|          
|          
|          
|Part II.   |  | Other Information     |  |         |  |                                     
|          
|          
|          
|          
|           |  |                       |  | Item 1. |  | Legal Proceedings                    |  |                                                                                                                                         | 17 |     
|          
|          
|          
|          
|           |  |                       |  | Item 6. |  | Reports on Form 8-K                  |  |                                                                                                                                         | 17 |     
|          
|          
|          
|          
|Signatures |  |                       |  |         |  |                                      |  |                                                                                                                                         | 18 |     





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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 of 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.

3



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CETALON CORPORATION and Subsidiaries
CONSOLIDATED BALANCE SHEET
(unaudited)

|                                                   |                                                                              |                                |           |              |            |  
|-------------------------------------------------- | ---------------------------------------------------------------------------- | ------------------------------ | --------- | ------------ | ---------- | -
|                                                   |                                                                              |                                |           | November 30,
|                                                   |                                                                              |                                |           | 2001        
|ASSETS                                             |                                                                              |                                |           |             
|                                                  
|                                                  
|                                                  
|                                                  
|CURRENT ASSETS:                                    |                                                                              |                                |           |             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Cash                                                                         |                                | $         | 189,810      |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accounts receivable                                                          |                                |           | 233,495      |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Inventory (Note 4)                                                           |                                |           | 1,586,653    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Prepaid expenses and other current assets                                    |                                |           | 52,717       |           
|                                                   |                                                                              |                                |           |             
|                                                   |                                                                              | Total current assets           |           |              | 2,062,675  |  
|                                                  
|                                                  
|                                                  
|                                                  
|PROPERTY AND EQUIPMENT, net                        |                                                                              |                                | 588,484   |             
|                                                  
|                                                  
|                                                  
|                                                  
|OTHER ASSETS, net (Note 5)                         |                                                                              |                                | 44,444    |             
|                                                   |                                                                              |                                |           |             
|TOTAL                                              |                                                                              | $                              | 2,695,603 |             
|                                                   |                                                                              |                                |           |             
|LIABILITIES AND SHAREHOLDERS DEFICIENCY           |                                                                              |                                |           |             
|                                                  
|                                                  
|                                                  
|                                                  
|CURRENT LIABILITIES:                               |                                                                              |                                |           |             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Bank overdraft                                                               |                                | $         | 15,574       |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accounts payable (Note 4)                                                    |                                |           | 2,937,197    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Due
to franchisees (Notes 3 and 4)                                           |                                |           | 162,524      |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Current
portion of settlement agreement liabilities (Notes 3 and 4)          |                                |           | 473,344      |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accrued liabilities                                                          |                                |           | 738,181      |           
|                                                   |                                                                              |                                |           |             
|                                                   |                                                                              | Total current liabilities      |           |              | 4,326,820  |  
|                                                  
|                                                  
|                                                  
|                                                  
|CONVERTIBLE
NOTE PAYABLE, NET OF DISCOUNT (Note 5) |                                                                              |                                | 812,500   |             
|                                                  
|                                                  
|                                                  
|                                                  
|SETTLEMENT
AGREEMENT LIABILITIES (Notes 3 and 4)   |                                                                              |                                | 1,225,986 |             
|                                                   |                                                                              |                                |           |             
|                                                   |                                                                              | Total liabilities              |           |              | 6,365,306  |  
|                                                   |                                                                              |                                |           |             
|COMMITMENTS AND CONTINGENCIES                      |                                                                              |                                |          |             
|                                                  
|                                                  
|                                                  
|                                                  
|SHAREHOLDERS DEFICIENCY (Note 2):                 |                                                                              |                                |           |             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Preferred stock, $.0001 par value, 50,000,000 authorized, none outstanding   |                                |           |              |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Common stock, $.0001 par value, 50,000,000 authorized, 6,185,654 outstanding |                                |           | 619          |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Additional paid-in-capital (Note 4)                                          |                                |           | 4,640,357    |           
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Treasury stock                                                               |                                |           | (100,000     | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Deferred compensation (Note 6)                                               |                                |           | (58,500      | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accumulated deficit (Note 2)                                                 |                                |           | (8,252,126   | )         
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Accumulated other comprehensive income                                       |                                |           | 99,947       |           
|                                                   |                                                                              |                                |           |             
|                                                   |                                                                              | Total shareholders deficiency |           |              | (3,669,703 | )
|                                                   |                                                                              |                                |           |             
|TOTAL                                              |                                                                              | $                              | 2,695,603 |             
|                                                   |                                                                              |                                |           |             

See accompanying notes to consolidated financial statements.

4



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

|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |        | 
|----------------------------------------------------------------------------------------- | --------------------------------- | - | ------------------ | ------- | ---------------- | - | ------------ | ------ | ------------ | - | ---------- | -------- | - | - | --------- | ------ | 
|                                                                                          |                                   |   | Three Months Ended |         | Six Months Ended
|                                                                                          |                                   |   |                    |         |                 
|                                                                                          |                                   |   | November 30,       |         | November 30,     |   | November 30, |        | November 30,
|                                                                                          |                                   |   | 2001               |         | 2000             |   | 2001         |        | 2000        
|SALES                                                                                     |                                   | $ | 1,919,828          |         |                  | $ | 767,440      |        |              | $ | 3,335,322  |          |   | $ | 2,019,356 |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|COST OF SALES (Note 4)                                                                    |                                   |   | 1,284,112          |         |                  |   | 450,821      |        |              |   | 2,192,001  |          |   |   | 1,194,910 |       
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|GROSS PROFIT                                                                              |                                   |   | 635,716            |         |                  |   | 316,619      |        |              |   | 1,143,322  |          |   |   | 824,446   |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|SELLING, GENERAL, AND ADMINISTRATIVE
EXPENSES (Notes 4 & 6)                               |                                   |   | 2,396,331          |         |                  |   | 718,183      |        |              |   | 5,409,071  |          |   |   | 1,554,245 |       
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|LOSS BEFORE OTHER INCOME (EXPENSE)
AND INCOME TAXES                                       |                                   |   | (1,760,615         | )       |                  |   | (401,564     | )      |              |   | (4,265,749 | )        |   |   | (729,799  | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|OTHER INCOME (EXPENSE):                                                                   |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Franchise fees (Note 4)                                                                   |                                   |   | 19,256             |         |                  |   | 20,377       |        |              |   | 35,975     |          |   |   | 40,401    |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Other income (Note 4)                                                                     |                                   |   |                   |         |                  |   | 19,851       |        |              |   | 705        |          |   |   | 40,137    |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Interest expense (Note 3)                                                                 |                                   |   | (109,292           | )       |                  |   | (16,660      | )      |              |   | (161,092   | )        |   |   | (33,368   | )     
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|                                                                                          | Total other income (expense), net |   |                    | (90,036 | )                |   |              | 23,568 |              |   |            | (124,412 | ) |   |           | 47,170 | 
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|LOSS BEFORE INCOME TAXES                                                                  |                                   |   | (1,850,651         | )       |                  |   | (377,996     | )      |              |   | (4,390,162 | )        |   |   | (682,629  | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|INCOME TAXES                                                                              |                                   |   |                   |         |                  |   |             |        |              |   |           |          |   |   |          |       
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|NET LOSS (Note 2)                                                                         |                                   |   | (1,850,651         | )       |                  |   | (377,996     | )      |              |   | (4,390,162 | )        |   |   | (682,629  | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|OTHER COMPREHENSIVE INCOME                                                                |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Foreign currency translation                                                              |                                   |   | 22,444             |         |                  |   | 65,924       |        |              |   | 25,992     |          |   |   | 51,059    |       
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|COMPREHENSIVE LOSS                                                                        |                                   | $ | (1,828,207         | )       |                  | $ | (312,072     | )      |              | $ | (4,364,170 | )        |   | $ | (631,570  | )     
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|BASIC AND DILUTED LOSS PER SHARE                                                          |                                   | $ | (0.31              | )       |                  | $ | (0.83        | )      |              | $ | (0.77      | )        |   | $ | (1.68     | )     
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       
|WEIGHTED-AVERAGE NUMBER OF SHARES
USED IN COMPUTATION OF BASIC AND
DILUTED LOSS PER SHARE |                                   |   | 5,884,581          |         |                  |   | 375,700      |        |              |   | 5,675,445  |          |   |   | 375,700   |       
|                                                                                          |                                   |   |                    |         |                  |   |              |        |              |   |            |          |   |   |           |       

See accompanying notes to consolidated financial statements.

5



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

|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |        |         |         |  
|----------------------------------------------------------------------------------------- | ---------------------------------------------------- | --------------------------------------------------- | --------------------------------------------------- | ------- | ----------------------------- | ---------- | -------- | ------ | ------- | ------- | -
|                                                                                          |                                                      |                                                     |                                                     |         | Six Months Ended November 30,
|                                                                                          |                                                      |                                                     |                                                     |         |                              
|                                                                                          |                                                      |                                                     |                                                     |         | 2001                          |            | 2000    
|CASH FLOWS PROVIDED BY (USED IN)
OPERATING ACTIVITIES:                                    |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Net loss                                                                                  |                                                      | $                                                   | (4,390,162                                          | )       |                               | $          | (682,629 | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Adjustments to reconcile net loss to net cash provided by
(used in) operating activities: |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Depreciation and amortization                        |                                                     |                                                     | 120,950 |                               |            |          | 37,955 |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Amortization of deferred compensation                |                                                     |                                                     | 90,450  |                               |            |          |       |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Amortization of discount on convertible note payable |                                                     |                                                     | 62,500  |                               |            |          |       |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Changes in operating assets and liabilities:         |                                                     |                                                     |         |                               |            |          |        |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          |                                                      | Accounts receivable                                 |                                                     |         | (2,358                        | )          |          |        | 90,055  |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          |                                                      | Inventory                                           |                                                     |         | (963,222                      | )          |          |        | 339,566 |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          |                                                      | Prepaid expenses and other current assets           |                                                     |         | 61,937                        |            |          |        | 4,338   |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          |                                                      | Accounts payable                                    |                                                     |         | 2,428,278                     |            |          |        | 194,941 |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          |                                                      | Due to franchisees                                  |                                                     |         | (108,079                      | )          |          |        | 73,175  |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          |                                                      | Accrued liabilities                                 |                                                     |         | 355,817                       |            |          |        | (55,168 | )      
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                          |                                                      |                                                     | Net cash provided by (used in) operating activities |         |                               | (2,343,889 | )        |        |         | 2,233   |  
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|CASH FLOWS USED IN INVESTING ACTIVITIES:                                                  |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Purchase of property and equipment                                                        |                                                      |                                                     | (272,320                                            | )       |                               |            | (23,660  | )     
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                          |                                                      |                                                     | Net cash used in investing activities               |         |                               | (272,320   | )        |        |         | (23,660 | )
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|CASH FLOWS PROVIDED BY (USED IN)
FINANCING ACTIVITIES:                                    |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Net proceeds from issuance of common stock                                                |                                                      |                                                     | 1,159,230                                           |         |                               |            |         |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Payment on settlement agreement liabilities, net                                          |                                                      |                                                     | (383,648                                            | )       |                               |            |         |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Net proceeds from related party loans and advances                                        |                                                      |                                                     |                                                    |         |                               |            | 113,328  |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Net proceeds (repayment) on notes payable                                                 |                                                      |                                                     | 1,000,000                                           |         |                               |            | (29,180  | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Increase in bank overdraft                                                                |                                                      |                                                     | 15,574                                              |         |                               |            |         |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Deferred financing costs                                                                  |                                                      |                                                     | (50,000                                             | )       |                               |            |         |       
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                          |                                                      |                                                     | Net cash provided by financing activities           |         |                               | 1,741,156  |          |        |         | 84,148  |  
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                   |                                                      |                                                     | (7,505                                              | )       |                               |            | (2,264   | )     
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|INCREASE (DECREASE) IN CASH                                                               |                                                      |                                                     | (882,558                                            | )       |                               |            | 60,457   |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|CASH, BEGINNING OF PERIOD                                                                 |                                                      |                                                     | 1,072,368                                           |         |                               |            | 14,194   |       
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|CASH, END OF PERIOD                                                                       |                                                      | $                                                   | 189,810                                             |         |                               | $          | 74,651   |       
|                                                                                          |                                                      |                                                     |                                                     |         |                               |            |          |       
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                        |                                                      |                                                     |                                                     |         |                               |            |          |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          |                                                      | Cash paid during the six months ended for-
Interest |                                                     | $       | 47,292                        |            |          | $      | 23,213  |        

See accompanying notes to consolidated financial statements.

6



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##### Table of Contents






CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Six months ended November 30, 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. The interim financial statement contained in this
Form 10-QSB has not been reviewed by an independent public
accountant using professional standards and procedures for conducting
such reviews, as established by generally accepted auditing
standards, and therefore this Form 10-QSB does not contain any
report of any accountant.

Because of the seasonal nature of the Companys business, the results of
operations for the six months ended November 30, 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 trenches, which was initiated in October 2001. The Company has
received average cash equity line up to $776,729 as of November 30, 2001.
Prior to Cetalon initiating the equity line, the price per share stipulated
under the equity agreement, was revised to better reflect the market price for
Cetalons stock. The price per share went from $3.27 per share to $2.00 per
share. The Company has also received term sheets from various debt, equity and
strategic investors for investment commitments, which are currently under
consideration by the Company. The Company is also under negotiation with
various financial institutions to establish leasing facilities and bank lines,
which it anticipates will be available to the Company. 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.

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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Six months ended November 30, 2001 and 2000
(Unaudited)

NOTE 3  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. months. For the year ended 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 4  RELATED PARTY TRANSACTIONS

The Companys shareholders or their relatives own certain franchises. As of
November 30, 2001, approximately $15,829 is payable to related franchisees and
are 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 $29,710 and $30,332 for the three months ended
November 30, 2001 and 2000, respectively. For the six months ended November
30, 2001 and 2000, combined fees paid by related franchisees was approximately
$45,566 and $46,445, respectively.

The Company has purchased certain inventory from a corporation owned by a
shareholder. For the three and six months ended November 30, 2000, the Company
purchased $29,409 and $123,980, respectively, 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 $19,851
and $40,137, respectively, for the three and six months ended November 30,
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. 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. During the three and six months ended November 30, 2001, the
Company incurred fees with Watley of $97,483 and $232,083, respectively, for
management and consulting services, which are included in selling, general, and
administrative expenses, and $52,500 and $77,500, respectively, for equity
financing placement fees, which have been recorded as a reduction to additional
paid in capital. Effective with November 01, 2001, The Watley Group, LLC
(Watley) provided notice of immediate termination of the agreement, which has
been accepted by Cetalon. During June 2001, the Company entered into a
month-to-month rental agreement with Watley,

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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Six months ended November 30, 2001 and 2000
(Unaudited)

for executive office space, which provides for monthly rent of approximately
$5,000 plus expense reimbursements. During the three and six months ended
November 30, 2001, the Company incurred fees with Watley of $15,088 and
$28,651, respectively, for rent, which are included in selling, general and
administrative expenses. As of November 30, 2001, the Company owed $17,044 to
Watley, and is included in accounts payable in the accompanying consolidated
balance sheet. Beginning November 1, 2001, all obligations for services under
the consulting agreement with Watley have been terminated.

At November 30, 2001, settlement agreement liabilities include $139,053 due to
a franchises owned by related parties.

NOTE 5  CONVERTIBLE NOTE PAYABLE

In August 2001, the Company received a $1,000,000 loan from a vendor who is
also a shareholder. Two directors of the Company are also executive officers 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 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 6  STOCK BASED COMPENSATION

On July 24, 2001 the Company adopted the 2001 Equity Incentive Plan (the
Plan) to provide stock-based compensation to employees, officers, 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 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
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 925,500 non-qualified stock options during the six months
ended November 30, 2001 at an exercise price of $0.85 per share. Fair market
values as of date of grant was $1.17, however there were 35,000 stock option
grants at the fair market value price as of the date of the stock option grant
for two of the Companys managers, their stock option grant date is October
26th and the price was $1.60 on that date, accordingly the Company is
recognizing compensation expense over the vesting period. No options have been
exercised or canceled during the six months ended November 30, 2001. No
supplemental stock options, stock bonus rights, or stock appreciation rights
were issued or are outstanding as of November 30, 2001.

During the six months ended November 30, 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 $90,450 was recorded for the six
months ended November 30, 2001.

The Company also granted 17,500 shares of restricted common stock to a former
employee of the Company and recorded compensation expense of $19,500.

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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Six months ended November 30, 2001 and 2000
(Unaudited)

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 specific sales goals. As of November 30,
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 six months ended November 30, 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
and six months ended November 30, 2001.

The estimated fair value of stock options and restricted common stock granted
during the three and six months ended November 30, 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 7  EXERCISE OF STOCK WARRANTS

On July 5, 2001, a shareholder exercised an option 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 each paid a $25,000 for equity
financing placement fees, which has been recorded as a reduction to additional
paid-in capital.

NOTE 8  REGISTRATION OF COMMON SHARES ON FORM S-8

On November 30, 2001 the Company filed a registration statement on Form S-8
with the Securities and Exchange Commission for the issuance of up to 1,550,000
shares of its $0.0001 par value common stock to be used for various future
issuances, including the Companys 2001 Equity Incentive Plan (the Plan).
The Plan was created to provide selected employees, directors, and consultants
of the Company, or its affiliates, with options to purchase the Companys
common stock or other equity interests in the Company. The Plan also allows
for the Company to grant stock bonuses, rights to purchase restricted stock,
and stock appreciation rights.

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CETALON CORPORATION and Subsidiaries
Notes to Consolidated Financial Statements
Six months ended November 30, 2001 and 2000
(Unaudited)

NOTE 9  FINANCIAL ADVISORY AGREEMENT

On October 30, 2001, the Company entered into an agreement with Rubin
Investment Group, Inc. (RIG) for financial advisory services. As
consideration for RIGs services, the Company issued 50,000 shares of its
common stock to RIG, and options to purchase 500,000 shares at $1.75 per share
and 250,000 shares at $2.00 per share respectively of the Companys common
stock that were registered on November 30, 2001.

NOTE 10  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 11  COMMITMENTS 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 coverages is for a specified
period of time. The agreements also provide for severance payments in the
event of termination for reasons other than cause.

NOTE 12  SUBSEQUENT EVENTS

On December 04, 2001, the Company entered into an investment banking agreement
with Wells Fargo Van Kasper LLC (WFVK). WFVK agreed to provide the Company
with investment banking services for business acquisitions being pursued by the
Company, and for a private placement of equity, equity-related, and debt
securities up to $25,000,000. The Company was required to pay a non-refundable
retainer of $75,000 to WFVK upon the signing of the agreement, and was required
to pay $250,000 to WFVK upon completion of a business acquisition. Subsequent
to the finalization of this agreement, the Company decided not to pursue this
agreement and did not complete the conditions to initiate the agreement. In
addition based on the Companys merger/acquisition options the Company is
evaluating a revised proposal from WFVK.

On December 12, 2001 Anthony J. Bryan, Chairman of the Board of Directors, and
John A. Bryan, Chief Executive Officer and Vice Chairman of the Board of
Directors, have resigned from the Company. Key members of the Companys senior
management team will report to the Board of Directors on an interim basis until
a new CEO is appointed.

On December 31, 2001 Sears Canada Inc. has contacted the Company and advised
that certain terms and conditions of the Companys license with Sears Canada
are not being met. The Companys management team is working on remedies to
those concerns with Sears Canada. Sears Canada has indicated to the Company that
it has until January 31, 2002 to provide resolution adequate to Sears Canada to
address its concerns.

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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 January 14, 2002, the
Company operates 46 Sears Health Food and Fitness Shops in Canada (including 10
locations through franchisees) and 10 Sears Health Food and Nutrition Centers
in the United States (all in California).

During the three months ended November 30, 2001, the Company opened two new
owned retail stores (all in Canada) and closed no owned stores. No franchise
stores were opened or closed in the United States or Canada during the three
months ended November 30, 2001. The Company acquired one franchise store in
Canada during the three months ended November 30, 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 November 30,
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 Acquirer 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 |       | Six Months Ended
|                                                    |  |                    |       |                 
|                                                    |  | Nov. 30            |       | Nov. 30          |  | Nov. 30, |       | Nov. 30,
|                                                    |  | 2001               |       | 2000             |  | 2001     |       | 2000    
|                                                    |  |                    |       |                  |  |          |       |         
|Statement of Operations Data:                       |  |                    |       |                  |  |          |       |          |  |  |        |    |  |  |       |   
|                                                   
|                                                   
|                                                   
|                                                   
|Sales                                               |  |                    | 100.0 | %                |  |          | 100.0 | %        |  |  | 100.0  | %  |  |  | 100.0 | % 
|                                                   
|                                                   
|                                                   
|                                                   
|Cost of sales                                       |  |                    | 66.9  |                  |  |          | 58.7  |          |  |  | 65.7   |    |  |  | 59.2  |   
|                                                    |  |                    |       |                  |  |          |       |          |  |  |        |    |  |  |       |   
|Gross profit                                        |  |                    | 33.1  |                  |  |          | 41.3  |          |  |  | 34.3   |    |  |  | 40.8  |   
|                                                   
|                                                   
|                                                   
|                                                   
|Selling, general, and administrative expenses       |  |                    | 124.8 |                  |  |          | 93.6  |          |  |  | 162.2  |    |  |  | 77.0  |   
|                                                    |  |                    |       |                  |  |          |       |          |  |  |        |    |  |  |       |   
|Loss before other income (expense) and income taxes |  |                    | (91.7 | )                |  |          | (52.3 | )        |  |  | (127.9 | )  |  |  | (36.2 | ) 
|                                                   
|                                                   
|                                                   
|                                                   
|Franchise fees                                      |  |                    | 1.0   |                  |  |          | 2.6   |          |  |  | 1.1    |    |  |  | 2.0   |   
|                                                   
|                                                   
|                                                   
|                                                   
|Other income (expense)                              |  |                    | 0.0   |                  |  |          | 2.6   |          |  |  | 0.0    |    |  |  | 2.0   |   
|                                                   
|                                                   
|                                                   
|                                                   
|Interest expense                                    |  |                    | (5.7  | )                |  |          | (2.2  | )        |  |  | (4.8   | )  |  |  | (1.6  | ) 
|                                                    |  |                    |       |                  |  |          |       |          |  |  |        |    |  |  |       |   
|Net loss before income taxes                        |  |                    | (96.4 | )%               |  |          | (49.3 | )%       |  |  | (131.6 | )% |  |  | (33.8 | )%
|                                                    |  |                    |       |                  |  |          |       |          |  |  |        |    |  |  |       |   

Three Months Ended November 30, 2001 Compared to Three Months Ended November 30, 2000

Sales were approximately $1.9 million for the three months ended November 30,
2001, compared to approximately $0.8 million for the three months ended
November 30, 2000. The increase in sales was due to a significant increase in
sales in the Companys Canadian locations and the opening of ten new stores in
the United States in June 2001. The U.S. sales were approximately $0.3 million
for the three months ended November 30, 2001. The Canadian operation sales
were approximately $1.6 million for the three months ended November 30, 2001,
compared to approximately $0.8 million for the three months ended November 30,
2000. The increase in sales in Canada of 115.0% was mainly the result of a
larger advertising program during the three months ended November 30, 2001 as
compared to the three months ended November 30, 2000 and on
improved in stock
position over the prior year. The Company incurred approximately $425,000 of
net advertising expense in Canada during the three months ended November 30,
2001, compared to approximately $100,000 of net advertising expense for the
same period in the previous year.

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Gross profit, defined as sales less cost of sales, decreased as a percentage of
net sales to 33.1% for the three months ended November 30, 2001 from 41.3% for
the same period in the prior year. The decrease in gross profit as a
percentage of net sales was mainly the result of certain an aggressive
promotional advertising campaign in the Canadian operations to drive traffic
and sales.

Selling, general and administrative expenses increased as a percentage of net
sales to 124.8% for the three months ended November 30, 2001, from 93.6% for
the three months ended November 30, 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. Total selling, general and administrative expenses for the US
operation was approximately $1.0 million, which is comprised of $0.3 million
(30%) stores operating expenses and $0.7 million (70%) other selling, general
and administrative expenses. Total selling, general and administrative
expenses for the Canadian operation (excluding the U.S. costs) were
approximately $1.4 million or 84.8% as a percentage of net sales for the three
months ended November 30, 2001, compared to approximately $0.7 million or 93.6%
as percentage of net sales for the three months ended November 30, 2001. The
decrease as a percentage of net sales was due to better leveraging of store and
corporate labor expenses.

The Companys loss before other income and income taxes increased $1.4 million
to $1.8 million for the three months ended November 30, 2001, from $0.4 million
for the three months ended November 30, 2000. This increase was the result of
the significant increase in selling, general and administrative expenses
described above.

Interest expense increased to approximately $109,000 for the three months ended
November 30, 2001 from approximately $17,000 for the three months ended
November 30, 2000 due to the long-term settlement agreements entered into the
Company and its vendors during from January to April 2001.

Net income tax benefits were not recognized during the three months ended
November 30, 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 $1.9
million for the three months ended November 30, 2001 compared to a net loss of
approximately $0.4 million for the three months ended November 30, 2000.

Six Months Ended November 30, 2001 Compared to Three Months Ended November 30, 2000

Sales were approximately $3.3 million for the six months ended November 30,
2001, compared to approximately $2.0 million for the six months ended November
30, 2000. The increase in sales was due to a significant increase in sales in
the Companys Canadian locations and the opening of ten new stores in the
United States in June 2001. The U.S. sales were approximately $0.5 million for
the six months ended November 30, 2001. The Canadian operation sales were
approximately $2.9 million for the six months ended November 30, 2001, compared
to approximately $2.0 million for the six months ended November 30, 2000. The
increase in sales in Canada of 41.3% was mainly the result of a larger
advertising program during the three months ended November 30, 2001 as compared
to the three months ended November 30, 2000. The Company incurred
approximately $570,000 of net advertising expense in Canada during the six
months ended November 30, 2001, compared to approximately $150,000 of net
advertising expense for the same period in the previous year.

Gross profit, defined as sales less cost of sales, decreased as a percentage of
net sales to 34.3% for the six months ended November 30, 2001 from 40.8% for
the same period in the prior year. The decrease in gross profit as a
percentage of net sales was mainly the result of an aggressive promotional
advertising campaign in Canada stores to drive traffic and sales and lower
initial gross margins in the United States stores as a result of special grand
opening price reduction offers.

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Selling, general and administrative expenses increased as a percentage of net
sales to 162.2% for the six months ended November 30, 2001, from 77.0% for the
six months ended November 30, 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 $3.1 million, which is comprised of $1.2 million
(39%) start up costs and $1.9 million (61%) other selling, general and
administrative expenses. Total selling, general and administrative expenses
for the Canadian operation (excluding the U.S. costs) were approximately $2.3
million or 82.1% as a percentage of net sales for the six months ended November
30, 2001, compared to approximately $1.6 million or 77.0% as percentage of net
sales for the six months ended November 30, 2001. The increase was primarily
due to additional advertising expenses incurred during the six months ended
November 30, 2001 as compared to the same period in the previous year.

The Companys loss before other income and income taxes increased $3.6 million
to $4.3 million for the six months ended November 30, 2001, from $0.7 million
for the six months ended November 30, 2000. This increase was the result of
the significant increase in selling, general and administrative expenses
described above.

Interest expense increased to approximately $161,000 for the six months ended
November 30, 2001 from approximately $33,000 for the six months ended November
30, 2000 due to the long-term settlement agreements entered into the Company
and its vendors during from January to April 2001.

Net income tax benefits were not recognized during the six months ended
November 30, 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 $4.4
million for the six months ended November 30, 2001 compared to a net loss of
approximately $0.7 million for the six months ended November 30, 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.

Cash used in operations was $2,343,889 for the six months ended November 30,
2001, compared to cash provided by operations of $2,233 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 six
months ended November 30, 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 $272,320 for the six months ended November 30, 2001, as compared
to $23,660 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 has
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 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. Reports on Form 8-K



| | (a) | Reports on Form 8-K                                                                               
| | --- | --------------------------------------------------------------------------------------------------
|
| |     | During the three months ended November 30, 2001, the Company filed no
Current Reports on Form 8-K.

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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 January 17, 2002.

| |  |                     |  |                                                                                          
| |  | ------------------- |  | -----------------------------------------------------------------------------------------
| |  | CETALON CORPORATION
|
|
|
|
| |  | By:                 |  | /s/ Neil T. Watanabe
Neil T. Watanabe
Chief Financial Officer
Principal Financial Officer

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