U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB

 X     ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT 
------
 OF 1934
For the fiscal year ended December 31, 1996
_______ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE 
ACT OF 1934

For the transition period from ________to________
Commission file number 33-39263-NY

                           CABARET ROYALE CORPORATION
                 (Name of Small Business Issuer in its charter)


  Delaware                                                          22-2993070
(State or other jurisdiction                  (IRS Employer Identification No.)
or incorporation or organization)

                                  PO Box 794183
                            Dallas, Texas 75379-4183
                    (Address of principal executive offices)

Issuer's   telephone  number  including  area  code:   214-866-8366   
Securities registered under Section 12(b) of the Exchange Act:

                                      NONE

Securities registered under Section 12 (g) of the Exchange Act:

                                      NONE

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period  that the issuer was  required  to file such  reports),  and (2) has been
subject to such filing requirements for the past 90 days.

Yes X                                       No

Check if disclosure of delinquent filers in response to Item 405 of Regulation S
- B is not contained in this form, and no disclosure  will be contained,  to the
best of  issuers  knowledge,  in  definitive  proxy  or  information  statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
this Form 10-KSB.

State issuer's revenues for its most recent fiscal year:  $52,000.

State the  aggregate  market  value of the voting  stock held by  non-affiliates
computed by reference to the average bid and asked prices of the Common n Shares
as reported for March 20, 1996: $ nil.

State the number of the issuer's  Common shares  outstanding  on March 20, 1996:
7,298,854 *Class A Common Stock only; no Class B Common Stock outstanding

                       DOCUMENTS INCORPORATED BY REFERENCE

Form 8-K and 8-K/A dated  September  30, 1993,  Form 8-K dated January 30, 1995,
From 8-K dated  August 24, 1995 and  corresponding  From 8-K/A dated  August 24,
1995, Form 8-K dated December 23, 1995, and registration  statement on Form S-18
effective July 18, 1991. 

                           Total number of pages: 28
                           Exhibit Index on page: 13



<PAGE>



                                     PART I


ITEM 1.  DESCRIPTION OF BUSINESS
-------  -----------------------

     Registrant  was  initially  formed and  organized  in  September  1988 as a
general purpose Delaware corporation in search of an acceptable business,  which
Corporation  completed a public offering of certain of its securities in October
1991. In September  1993 the  Registrant  acquired all of the assets and assumed
all of the liabilities of Walhill Partners,  Ltd., a Texas limited  partnership,
and acquired certain assets of Cabaret Royale Corporation,  a Texas Corporation,
both being entities located and doing business in Dallas, Texas,  (collectively,
hereinafter, referred to as "Cabaret"), in exchange for 4,450,000 authorized but
previously  unissued shares of the Registrant's  common stock. Upon consummation
of the said  acquisition  voting  control of Registrant  was  transferred to the
controlling persons in Cabaret, and the members of the board of directors of the
Registrant  resigned in favor of the  nominees of said Cabaret  affiliates.  For
further information on the mechanics of the referenced acquisition review may be
made of the Form 8-K and Form 8-K/A  regarding such  acquisition  filed with the
Securities  and Exchange  Commission  ("SEC"),  dated  September  30, 1993,  and
incorporated  herein by  reference.  Effective  November 2, 1993 the  Registrant
changed its corporate name to Cabaret Royale Corporation.

     Registrant  is  now  a  Dallas-based  enterprise,   having  terminated  its
operations  in New York and having  only a minor  interest  in its  Mexico  City
operations, said locales being the only other operations recently handled by the
Registrant,  originally  having  featured  premier  cabaret  style topless adult
entertainment,  restaurant,  and bar  operations  and  continuing  to do so on a
limited basis through its Mexico City franchise,  but with insignificant  income
therefrom.  Dallas is the Registrant's  initial location and was established and
leased to an  operator  in  December  1988 and has since  undergone  significant
improvements  and  upgrading.  The Dallas  facility  was sold in late 1995.  The
market segment which Registrant's  business  operations were designed to address
is the discriminating  business patronage and convention  clientele who desire a
discrete  ambiance  set in opulent  surroundings.  The  Registrant  maintains an
insignificant  franchise  agreement  with an  investor  group  in  Mexico  which
established a Cabaret Royale club in Mexico City. The Mexico city club opened on
May 15, 1994.  Due to the  instability of the Mexican peso in 1995, the revenues
from the Mexico City franchise have been less than projected. The Registrant has
provided both assistance and support  concerning the design and  construction of
the Mexico City club before  opening  and,  since  opening,  procedural  advice,
promotional  support and materials.  It has come to the  Registrant's  attention
that on February 28, 1996, the governmental of Mexico effectively prohibited all
foreign  nationals  from working as topless  dancers in clubs  located in Mexico
City, Mexico. This included the club known as Club Royale,  which is a franchise
of Registrant.  The government of Mexico has informed all topless club operators
that only Mexican nationals may be employed in these clubs. In addition,  Mexico
levied a fine against Club Royale in the amount of $100,000.00  (U.S.). This has
had an adverse  effect on  franchise  income to  Registrant  since  Registrant's
franchise  agreement requires that it assist Club Royale in recruiting  American
women to work in the  club.  Further,  the  franchise  agreement  provides  that
certain  governmental  actions which materially impact Club Royale's  operations
may allow nonperformance of the franchise agreement by Club

                                       -2-

<PAGE>



Royale.   The   franchise   income  from  Club  Royale   presently   constitutes
substantially all of the Registrant's corporate income. Therefore, the continued
viability of Registrant in its historical business may be therefore questionable
at this time.  The ability of the  Registrant  to continue as a going concern is
dependent  on the  Registrant's  ability to develop  profitable  operations  and
obtain  additional  equity or  long-term  debt  financing.  With the sale of the
Dallas  facility and the decline of the Mexico City  franchise,  management does
not  expect  any  operating  activity  for the  foreseeable  future.  Therefore,
management  expects the  Registrant  to be in an inactive or dormant state until
such time as profitable  operations can be developed and the Company can resolve
its debt default issues.

     On December 23, 1995 the Registrant  signed with AAI  Investments,  Inc., a
Florida Corporation  (hereinafter the "Buyer") a contract for and closed on Sale
of their major asset,  the  restaurant/bar/nightclub  facility  located at 10723
Composite Drive, Dallas, Texas, with all associated real property, equipment and
facilities  owned by Registrant and located  there,  together with all rights to
such address and ownership rights to the name "Cabaret Royale'.  The Registrant,
pursuant to said contract,  closed on the described  transaction on December 23,
1995 and vacated the referenced premises as of December 30, 1995. Certain of the
Registrant's  debts and  liabilities  were also assumed by the said Buyer in the
described  transaction.  Other assets of the Registrant not directly  associated
with the facilities at 10723 Composite Drive,  Dallas,  Texas were not affected,
including  but not  limited  to  Registrant's  rights as  franchisor  of similar
facilities  located in Mexico City, Mexico operated as "Club Royale",  and other
liabilities  of the  Registrant.  Upon vacating the premises at 10723  Composite
Drive,  Dallas,  Texas,  the Registrant  relocated its business offices to 16135
Preston Road, Suite 121, Dallas, Texas,  telephone (214) 866-8366 fax (214) 866-
8797. The Buyer is an entity not affiliated  with the Registrant and no officers
and/or directors or their associates,  of the Registrant have any similar status
with the Buyer, nor do they have any stock interest therein.

     The  Registrant   has  also  taken  steps  to  amend  its   certificate  of
incorporation  to  change  its  corporate  name  back  to its  original  name of
Exceptional  Enterprises  Inc.  There has been no change in the  identity of the
Registrant's  officers and directors,  except that in an unrelated  circumstance
the Registrant has had elected a new director,  Katia Hiles,  making the current
board of  directors  of the  Registrant  consist  of two  members,  to wit Salah
Izzedin and Katia Hiles.

ITEM 2.  DESCRIPTION OF PROPERTY
-------  -----------------------

     The Registrant leased limited office space at 16135 Preston Rd., Suite 121,
Dallas, Texas as its administrative  offices and had no other business premises.
The Registrant did not renew its lease at its  termination in 1997 and currently
utilizes a PO Box as its business address at PO Box 794183, Dallas, Texas 75379-
4183.



                                       -3-

<PAGE>



ITEM 3.  LEGAL PROCEEDINGS
--------------------------

     Registrant  is not  aware of any  pending  or  anticipated  material  legal
proceedings  involving  Registrant or its  affiliates  which,  in the opinion of
Registrant,  will, if successful,  materially  affect the status of Registrant's
business or assets except as set forth hereinbelow.

     The former contact  operator of the Dallas facility of the Registrant under
a now  terminated  operating  agreement,  Prive Corp.  ("Prive") and Priba Corp.
("Priba") are defendants in a lawsuit filed in the United States  District Court
for the Northern  District of Texas,  Dallas  Division in 1990 by two (2) former
waitresses,  Ann Marie Lindsey and Lindsey York,  alleging certain violations by
Prive and Priba of age  discrimination  and other  employment laws. This lawsuit
was  stayed  by  operation  of 11 U.S.C.  362 as a result  of Prive and  Priba's
bankruptcy  filings.  CRC (Dallas  Food &  Beverage)  Operating  Corp.  ("Food &
Beverage"),  the most  current  Operator  of the club  (prior  to its sale by th
Registrant), DNL Corporation (an assumed business name for Food & Beverage), and
Walhill Partners,  Ltd. (now Registrant) were added as party defendants.  Food &
Beverage has and intends to continue to  vigorously  defend such action.  Food &
Beverage and the  Registrant  are each strongly of the opinion that such lawsuit
is without merit. The trial in this case took place in October 1996. On or about
October 28, 1996 the jury returned a take nothing verdict in favor of Defendants
and  against  Plaintiffs  on all  claims/causes  of action  save and accept one.
Specifically, the jury was unable to reach a decision on Plaintiff Lindsey's age
discrimination  claim, and the court declared a mistrial as to this claim.  Both
Plaintiffs  and Defendants  filed a number of post-trial  Motions with the court
after October 28, 1996. As of this date,  the court has not ruled on same.  Once
this occurs, Plaintiff Lindsey's age discrimination case will need to be retried
(assuming that Lindsey  wishes to pursue same).  Additionally,  the  Plaintiff's
attorney has  indicated  that he will be appealing  the  remainder of the jury's
decision.  The  corporate  Defendants  intend to  vigorously  contest all future
claims, assertions and appeals of Lindsey and York.

     Food & Beverage,  among others, is a defendant in a case filed in the State
District  Court in Dallas  County,  Texas styled Cheri  Houston,  Plaintiff  vs.
Sherrye  Jinks,  et al. This a "dram shop" action  alleging that Food & Beverage
allowed an intoxicated dancer to leave its premises who later became involved in
an accident with the Plaintiff,  Cheri  Houston.  Food & Beverage is strongly of
the opinion that the lawsuit is without  merit and is  vigorously  defending the
same.  Food &  Beverage  does  not have  insurance  coverage  for  this  alleged
liability.

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

     In the fourth  quarter of fiscal year 1996 no matters  were  submitted  for
approval by shareholders of the Registrant.



                                       -4-

<PAGE>



                                     PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
-------  -----------------------------------------------------------------

MATTERS
-------

     The  Registrant's  initial  public  offering of units  consisting of common
stock and  warrants  to purchase  common  stock  closed on October 4, 1991,  and
trading in the common stock of the Registrant  commenced  October 5, 1991. There
has never been, to the best knowledge of  Registrant,  any market for or trading
in Registrant's  public warrants or initial  offering units. The public warrants
of Registrant  were redeemed  effective  December 9, 1993, with none having been
exercised  prior  thereto.  The common stock of  Registrant,until  October 1993,
traded  sporadically  without any material activity and, as of the first quarter
of 1995 and  forward  therefrom,  has not been  quoted.  The  securities  of the
Registrant have never traded on any organized exchange.

     The  Registrant's  Class A Common  Stock,  when traded,  is traded over the
counter on the NASD Electronic Bulletin Board.

     The high and low closing bid quotations in the over-the-counter  market for
the Registrant's  common stock as reported by the relevant market makers for the
quarterly periods from October 1993 through the date hereof are as follows:

Quarter Ended                               High Bid         Low Bid
-------------                               --------         -------

December 31, 1993                           2                1

March 31, 1994                              3 1/4            2 5/8

June 30, 1994                               4 1/4            1

September 30, 1994                          3                1

December 31, 1994                           2 1/4            1

March 30, 1995                              1                1

NO QUOTES AFTER FIRST QUARTER 1995

     Quotations represent inter-dealer  quotations without adjustment for retail
markups or markdowns of commissions  and may not  necessarily  represent  actual
transactions.

     At November 1, 1995, the approximate  number of holders of the Registrant's
Common Stock was 489. A few shares of the Registrant's  common stock are held of
record in brokerage accounts in street names and may or may not be held for more
than one  stockholder.  There has been no  significant  change in the  number of
shareholders since November 1995. The Company has not paid any cash dividends on
its common stock and does not  anticipate  paying  dividends in the  foreseeable
future.


                                       -5-

<PAGE>



ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-------------------------------------------------------------------------------

       OF OPERATIONS
       -------------

INTRODUCTION -

On September 30, 1993, Exceptional  Enterprises Inc. (:Registrant") acquired the
assets and assumed the  liabilities of Walhill  Partners,  Ltd.  ("Walhill"),  a
Texas limited  partnership  and acquired the trade name and trademark of Cabaret
Royale  Corporation,  a Texas  corporation.  After the acquisition,  Exceptional
changed its name to Cabaret Royale Corporation.

Registrant was originally  organized to acquire interest in business opportunity
and engage in and provide financial and management services to those businesses.
Walhill  was formed  for the  purpose  of owning a cabaret  facility  in Dallas,
Texas. the facility is leased to an operator  operating company which operates a
restaurant,  bar and cabaret  under the name Cabaret  Royale.  the  Registrant's
primary  source of income was derived  from the lease  payments  equal to 16% of
adjusted  gross  receipts  (minimum of $30,000 a month) during 1994,  and 12% of
adjusted gross receipts in 1995.

The acquisition, for accounting purposes, was recorded as a reverse acquisition,
with  Walhill  surviving  as  the  acquiror.   The  acquisition  accounting  was
equivalent  to the issuance of stock by Walhill for the net  monetary  assets of
Registrant, accompanied by a recapitalization. the stock was then distributed to
the partners of Walhill, and Walhill ceased to exist as an entity.

The Registrant  closed its New York  operations in late 1994 and sold its Dallas
operation in late 1995 and has  experienced a  significant  decrease in revenues
from its Mexico City franchise in 1995 and continuing to date.

RESULTS OF OPERATIONS

The following table sets forth the percentage  which the items in the statements
of operations bear to revenues for each period presented.



                                       -6-

<PAGE>



                             Year ended December 31,

                                           1996                  1995
                                           ----                  ----

Rental Revenues                            -                     70.38%
Franchise Fees                             100.0                  21.15
Other Income                               -                     8.47
TOTAL REVENUES                             100.0%                100.00%

Operating expenses:
  Depreciation & Amortization               --                   36.84
  Executive Compensation                    115.38               56.95
  Professional Fees                         336.08               21.15
  General & administrative                  67.66                16.08
  Bad debt expense                          48.08                25.70
Operating Income (Loss)                   (467.20)              (56.71)

Loss on sale of assets                     (97.00)             (329.80)
Interest income                            268.41                  .52
Interest expense                          (716.15)              (59.24)

Income (loss) from
  operations before provision
  for income taxes                        (993.71)             (445.52)

Income taxes (benefit)

Net loss                                  (993.71)             (445.52)


Revenues - Rent revenues in the twelve months ended  December 31, 1996 decreased
100%  compared  with the same period for the year ended  December 31, 1995.  The
decrease was due to sale of the Dallas  property and  operations and a slow down
in business overall due to more competition and internal problems experienced by
the  Registrant.  Franchise  fee revenue is derived from  franchise  location in
Mexico City,  and for the twelve months  during 1996 was $52,000,  a significant
decrease due to the economic decline in Mexico in general and material  internal
problems experienced by the franchise.

Depreciation and  Amortization - Depreciation and amortization  decreased to $ 0
because of the sale of assets.



                                       -7-

<PAGE>



General  and  Administrative  -  Executive  compensation  was  $60,000  for 1996
compared to $376,715 for 1995 due to elimination of all operations and decreases
accepted by the Executive in his salary.  Professional fees increased by $34,852
or 24.9% due to lawsuits coming to trial in 1996.

Bad Debt  Expense - Bad debt  expense  decreased to $25,000 in 1996 due to write
off of bad debt regarding Mexico  franchise,  all other bad debt regarding prior
assets having been included in prior years financials.

Net Income (Loss) - The 1996 Net Loss from continuing operations was $516,328, a
decrease of $2,428,955 due to sale of the Dallas facility.

Discontinued  Operations  - The 1996 Net Loss  from  continuing  operations  was
$(516,328) a decrease of $2,428.955  because of the  termination  of much of the
Registrant's  operations  by the  sale of  assets  and  closure  of the New York
business and resulting lesser operating costs, as a result of sale of assets and
discontinuance  of operations,  the 1996 loss being mainly  attributable to debt
service on existing loans.

LIQUIDITY AND CAPITAL RESOURCES

The Registrant has continued to operate with a working capital deficiency during
1996. Due to severe cash flow problems and slow pace of business, the Registrant
was compelled to sell its capital assets at significant discounts constituting a
material loss to the Registrant.  There has been no expansion of business and no
new business,  and the outlook by the Registrant is to eventually  terminate its
business  and/or  seek  other  sources  of income or  capital to meet its future
needs.  The franchise  operations  in Mexico City have been severly  hampered by
adverse  governmental  regulation and depressed  economy and income therefrom is
minimal and  constitutes  the only material source of income for the Registrant.
Registrant's  intent is to close its present  business,  and to pay its debts to
the extent it is able, without any defined future business plan.

ITEM 7.  FINANCIAL STATEMENTS
-------  --------------------

     The report of the Registrant's  Independent Auditors,  Financial Statements
and Notes to Financial Statements appear herein commencing on page F-1.

ITEM 8.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
-------     ---------------------------------------------------------------

            FINANCIAL DISCLOSURE
            --------------------

                                      NONE



                                       -8-

<PAGE>



                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS:        
-------  -------------------------------------------------------------        

         COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
         -------------------------------------------------
         
               DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Name                         Age               Position
----                         ---               --------

Salah Izzedin                48                President, Chairman of the Board,
                                               Chief Executive Officer, Director

Katia Hiles                  26                Director

     Salah Izzedin is the President,  Chairman of the Board and Chief  Executive
Officer and a Director of the Registrant  and, prior to closing the  transaction
wherein the Registrant  acquired the assets of Walhill Partners Ltd. and Cabaret
Royale Corporation  (hereinafter the  "Transaction"),  Mr. Izzedin had served in
similar  positions with said other  companies  since 1987. From 1983 until 1988,
Mr. Izzedin operated Rick's Restaurant and Bar in Houston,  Texas, a gentleman's
club.  Prior to 1983, Mr. Izzedin was the President of Oceanic Oil  Corporation,
the  representative  of various  European energy  interests in Central and South
America,  and otherwise engaged in various oil trading  activities.  Mr. Izzedin
holds a Bachelor of Business  Administration degree from the American University
of Beirut, a Master of Business  Administration  (Finance and Accounting) degree
from Columbia University Graduate School of Business,  and is a Certified Public
Accountant in the State of New York.

     Katia Hiles is a Director.  From 1989 through 1990 she held a position with
Irell & Mannela, a securities  litigation law firm. During 1992 through 1994 she
worked with Lehman Brothers  Investment  Banking group.  She holds a Bachelor of
Arts degree in Economics and a Bachelor of Arts degree in Political Science from
the  University of Houston,  and a Master of Business  Administration  degree in
Finance from the University of Southern California.

     Registrant  has no  securities  registered  pursuant  to  Section 12 of the
Exchange Act and is not thereby  subject to the filing  requirements  of Section
16(a), Registrant having terminated its registration of securities under Section
12(g) in November 1995.

ITEM 10.  EXECUTIVE COMPENSATION
--------  ----------------------

     No officer or director of the Registrant has received or is under a present
contract to receive salaries or other annual  compensation  exceeding  $100,000,
except Salah  Izzedin whose annual salary is presently  $300,000.  In 1993,  the
Company  entered  into  a two  year  employment  agreement  with  the  Company's
President  calling for compensation of $300,000 per year. In 1996, the president
voluntarily reduced his compensation to $60,000 a year. At December 31, 1996 and
1995 the Company owed the President  $328,000 and $330,043 under this agreement.
There are no special benefit packages given to any officer or director,  but the
Registrant may and has reserved the right to institute such in

                                       -9-

<PAGE>



the future.  There are presenTly no stock  options,  warrants or other rights to
receive securities of the Registrant held by any officer or director.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------  --------------------------------------------------------------

     The  following  table  sets  forth  information  with  respect to the share
ownership,  as of March 1, 1997,  of those persons known to Registrant to be the
beneficial  owners  of more than 5% of  Registrant's  common  stock,  and of all
officers and directors of the Registrant, individually and as a group:


                  COMMON STOCK OWNED BENEFICIALLY AND OF RECORD
                  ---------------------------------------------
    
                             PERCENTAGE OF CLASS (1)
                             ------------------- ---

Name and Address                           Number                Percentage
----------------                           ------                ----------

Idona Corporation                          3,647,601             50.32%

Brian A. Travis                            2,400,000             33.11%

All officers and directors
as a group                                   0                     0%

(1) The table only includes  outstanding  shares of Registrant's  Class A Common
Stock.  The Registrant also has authorized for issuance but has not issued Class
B Common Stock which carries as its only  distinction  from Class A Common Stock
as increased per share voting right of 10 votes per share.  Class A Common Stock
carries  a  voting  right of one vote per  share.  All  Class B Common  Stock is
convertible on a share for share basis into Class A Common Stock. The table also
does  not  include  Class  A  Common  Stock  to be  issued  on  exercise  of any
outstanding warrants or conversions.  Those warrants,  and/or conversions which,
if  exercised,  would  require  issuance  of  restricted  Class A  Common  Stock
constituting  more  than 5% of  outstanding  stock  of such  class  (or  held by
officers or directors of Registrant),  are as follows.  The Class A Common Stock
to be issued upon  exercise  and/or  conversion  as listed  herein have attached
thereto  certain  limited  registration  rights.  Amount of Class A Common Stock
available Name Type of Security upon exercise

Water-Jel Technologies Inc.    warrant attached to                    500,000
                               convertible subordinated note
                               exercisable at $1.25 per share

Enrique Brodchandel            warrant attached to                    1,000,000
                               convertible subordinated note
                               exercisable at $1.25 per share

Jeshayahu Boymelgreen          warrant attached to                    1,000,000
                               convertible subordinated note
                               exercisable at $1.25 per share


                                      -10-

<PAGE>



Paramount Acquisition Inc.      warrant attached to                 700,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Werner Haase                    warrant attached to                 700,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Samuel M. Borofsky              warrant attached to                 600,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Avi Grossman                    warrant attached to                 200,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Allan L. Schrager               warrant attached to                 50,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Morgan L. Miller                warrant attached to                 100,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Vita A. & Nella J.              warrant attached to                 10,000
Colaninno                       convertible subordinated note
                                exercisable at $1.25 per share

Lucy Gugliotta                  warrant attached to                 10,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Thomas J. Piccone               warrant attached to                 10,000
                                convertible subordinated note
                                exercisable at $1.25 per share

David P. Dweck                  warrant attached to                 100,000
                                convertible subordinated note
                                exercisable at $1.25 per share

S.S. Dweck & Sons,              warrant attached to                 50,000
Inc., Pension Plan              convertible subordinated note
                                exercisable at $1.25 per share

Helen Dweck                     warrant attached to                 50,000
                                convertible subordinated note
                                exercisable at $1.25 per share

Stephen S. Dweck                warrant attached to                 20,000
                                convertible subordinated note
                                exercisable at $1.25 per share


                                      -11-

<PAGE>



Michael Jemal        warrant attached to                      50,000
                     convertible subordinated note
                     exercisable at $1.25 per share

Sammy Jemal          warrant attached to                      160,000
                     convertible subordinated note
                     exercisable at $1.25 per share

Shlomo Sitt          warrant attached to                      50,000
                     convertible subordinated note
                     exercisable at $1.25 per share

Evan Hedaya          warrant attached to                      50,000
                     convertible subordinated note
                     exercisable at $1.25 per share

Richard Dweck        warrant attached to                      200,000
                     convertible subordinated note
                     exercisable at $1.25 per share

C. Peter Cole        warrant attached to                      60,000
                     convertible subordinated note
                     exercisable at $1.25 per share

Randall J. Perry     $1.00                                    20,000

Debra Gallaro        $1.00                                    20,000
-------------        -----                                    ------

Total Warrants                                                5,710,000

All of these warrants and conversion  privileges are scheduled to expire by 1997
and are not expected by the Registrant to be exercised/converted  because of the
lack  of  any  appreciable  market  for  the  registrant's  securities,  and  no
appreciable market is expected to develop in the near future.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------  ----------------------------------------------

TRANSACTIONS AND BUSINESS RELATIONSHIPS WITH MANAGEMENT

     The Registrant has no material  debts  outstanding,  and has not engaged in
any transactions,  and has had no significant independent business relationships
with any of its officers and/or directors.



                                      -12-

<PAGE>



CHANGES IN CONTROL

     Registrant is not aware of any arrangements  which may at a subsequent date
result in a change in control of  Registrant  except  that if certain  warrants'
and/or convertible  subordinated  notes are transformed  through exercise and/or
conversion into Class A Common Stock of the Registrant there may be an effect on
change in control since certain of those latter convertible securities allow for
issuance of between 1,000,000 and 2,000,000 shares of Class A Common Stock which
in  each  instance  would  constitute  probably  a  minimum  of 14% of the  then
outstanding   Class  A  Common  Stock  of  the  Registrant,   although  no  such
exercise/conversion  is  expected by the  Registrant  because of the lack of any
appreciable market for the Registrant's securities, and no appreciable market is
expected to develop in the near future.

ITEM 13.  EXHIBITS, LISTS AND REPORTS ON FORM 8-K
--------  ---------------------------------------

(a) (1) Financial Statements
See Index to Financial Statements, infra

(2) No Financial Statement Schedules are filed as part of this report

(3)  Exhibits

         The exhibits filed as a part of this report are as follows:

                                                    EXHIBIT NO. AS FILED
EXHIBITS                                            WITH DOCUMENTS INDICATED
--------                                            ------------------------

2(a)  Asset Purchase Agreement between                       1
         Registrant and AAI Investment Inc.
         dated December 23, 1995 (1)

Footnotes to Exhibit Schedule:

(1) Filed with the  Securities and Exchange  Commission as exhibit,  numbered as
indicated above, to the Form 8-K of the Registrant, dated December 23, 1995.

(B)  REPORTS ON FORM 8-K

The  Forms  8-K  filed  by the  Registrant  with  the  Securities  and  Exchange
Commission for fiscal year 1993 to the date hereof are as follows:

1. Form 8-K dated  September 29, 1993 wherein  notice was given of the execution
of agreements  for the asset  purchase from Walhill  Partners,  Ltd. and Cabaret
Royale Corporation, a texas corporation.

2.  Form 8-K dated  September  30,  1993  wherein  the  closing  on the  Walhill
Partners/Cabaret  Royale asset purchase was disclosed and disclosure was made of
the resignation of the Registrant's auditors, BDO Seidman, with subsequent filed
Form  8-K/A  disclosing  financial  information  on  such  closing  and  further
disclosing the amendment to Registrant's  certificate of incorporation to change
its corporate name to Cabaret Royale Corporation, and a later filed Form 8-K/A

                                      -13-

<PAGE>



including  the  confirmation  letter  from BDO  Seidman  of  statements  made by
Registrant regarding such auditor's resignation.

3. Form 8-K dated  November 30, 1993  disclosing the engagement by Registrant of
new auditors, Belew, Averitt & Company, CPA.

4.  Form 8-K  dated  January  27,  1994  disclosing  the  closing  on the  asset
acquisition  between  Registrant  and CAT  Entertainment  Corp.,  and disclosing
amendment  of  Registrant's   certificate  of   incorporation  to  increase  its
authorized  stock and divide such into  classes,  and  further to  disclose  the
resignation of Joanne Bertolini as a director of the Registrant.

5. Form 8-K dated August 24, 1995  disclosing the termination of the contractual
agreement  with current  auditors  Belew,  Averitt & Company,  CPA and the later
filed 8-K/A including the confirmation letter from Belew, Averitt & Company, CPA
of statements made by the Registrant regarding such auditor's  termination.  The
Form 8-K also disclosed the engagement by the Registrant of new auditors,  Swalm
&  Associates,  P.C. The Form 8-K also  disclosed the election of a new board of
directors, and officers.

6. Form 8-K dated December 23, 1995  disclosing sale by Registrant of its Dallas
facilities,  movement of its principal offices,  and steps taken toward amending
its certificate of incorporation to change its corporate name.

7. Form 8-K dated  February  28,  1996  disclosing  material  discord  regarding
operations of Registrant's franchise operations in Mexico City, Mexico.


                                      -14-

<PAGE>



                          INDEX TO FINANCIAL STATEMENTS



                                                                           Page
                                                                           ----

Independent auditor's report                                               F-1

Financial statements:

         Balance sheet as of December 31, 1996                             F-2

         Statements of operations for the years ended
            December 31, 1996 and 1995                                     F-3

         Statements of changes in stockholders' equity (deficit)
             for the years ended December 31, 1996 and 1995
                                                                           F-4

         Statements of cash flows for the years ended
            December 31, 1996 and 1995                                     F-5

         Notes to financial statements                                     F-6

All other  schedules and financial  statements are omitted  because they are not
applicable or the required  information is shown in the financial  statements or
notes thereto.

                                      -15-

<PAGE>





                          INDEPENDENT AUDITOR'S REPORT


The Board of Directors
Cabaret Royale Corporation

We have audited the accompanying  balance sheet of Cabaret Royale Corporation as
of December  31,  1996 and the  related  statements  of  operations,  changes in
stockholders'  equity  (deficit) and cash flows for the years ended December 31,
1996  and  1995.  These  financial  statements  are  the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects, the financial position of Cabaret Royal Corporation as of
December 31, 1996 and the results of its  operations  and its cash flows for the
years ended December 31, 1996 and 1995, in conformity  with  generally  accepted
accounting principles.

As discussed in Note 10 to the financial statements, a majority of the Company's
revenue  was  derived  from an  affiliated  entity,  upon which the  Company was
economically dependant.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company will  continue as a going  concern.  As discussed in Note 3, the Company
has suffered recurring losses from operations, has a working capital deficit, is
in  default  on certain  of its debt,  and is  without a revenue  source.  These
factors raise  substantial  doubt about the  Company's  ability to continue as a
going concern.  Management's plans in regard to these matters are also described
in Note 3. The financial  statements do not include any  adjustments  that might
result from the outcome of this uncertainty.



Swalm & Associates, P. C.
Richardson, Texas
February 21. 1997


                                       F-1

<PAGE>



                           CABARET ROYALE CORPORATION
<TABLE>
<CAPTION>

                                  Balance Sheet
                                December 31, 1996

                                     Assets
                                     ------


Current assets:
<S>                                                                            <C>           
  Cash and cash equivalents                                                    $        9,853
  Account receivable franchise, net of
    allowance for doubtful accounts (Note 7)                                              -
  Prepaid expenses                                                                      3,609
  Current portion of note receivable (Note 4)                                          71,787
  Federal income tax refund (Note 8)                                                    3,409
                                                                                  ------------

         Total current assets                                                          88,658

Note receivable, net of current portion (Note 4)                                    1,275,450
                                                                                  ------------

                                                                                  $ 1,364,108

                 Liabilities and Stockholders' Equity (Deficit)

Current liabilities:
  Accounts payable - Trade                                                        $    75,239
  Accrued interest payable                                                            655,601
  Other accrued expenses                                                              380,043
  Bridge financing notes payable (Note 5)                                           2,835,000
  Current portion of long-term debt (Note 4)                                           71,787
  Other notes payable                                                                  63,634
                                                                                   -----------

         Total current liabilities                                                  4,081,304

Long-term debt, net of current portion, (Note 4)                                    1,275,450
                                                                                   -----------

Commitments and contingencies (Notes 3, 5, 9, 10, and 11)                                 -

Stockholders' equity (deficit) (Notes 6 and 9):
 Class A Common stock, $.001 par, 50,000,000
    shares authorized, 7,298,854 outstanding                                            7,299
 Class B Common Stock, $.001 par, 10,000,000
    shares authorized, none outstanding                                                    -
 Additional paid-in capital                                                         5,308,572
 Retained earnings (deficit)                                                       (9,308,517)
                                                                                  ------------

         Total stockholders' equity (deficit)                                      (3,992,646)

                                                                                $   1,364,108

</TABLE>


                 See accompanying notes to financial statements.

                                       F-2

<PAGE>


<TABLE>
<CAPTION>

                           CABARET ROYALE CORPORATION

                            Statements of Operations
                     Years ended December 31, 1996 and 1995


                                                                               1996                    1995
                                                                               ----                    ----

<S>                                                                   <C>                      <C>         
Rental income (Note 10)                                                $           -            $    465,554
Franchise fees (Note 7)                                                    52,000                    142,184
Other income                                                                     -                    53,795
                                                                       -----------               -----------

                                                                           52,000                    661,533
                                                                       ------------               ----------
Operating expenses:
  Depreciation and amortization                                                  -                   243,698
  Executive compensation                                                   60,000                    376,715
  Professional fees                                                       174,763                    139,911
  General and administrative                                               34,662                    106,375
  Bad debt expense (Note 10)                                               25,000                    169,988
                                                                      -------------               ----------

Total operating expenses                                                  294,425                  1,036,687
                                                                       -----------                ----------
Operating loss                                                         (  242,425)              (    375,154)
                                                                     -----------                 -----------

Other income (expenses):
  Loss on sale of assets (Note 4)                                   (      50,440)               (2,181,720)
  Interest income                                                         148,935                     3,500
  Interest expense                                                   (    372,398)              (   391,909)
                                                                     -----------                  ----------

                                                                     (    273,903)               (2,570,129)
                                                                     -----------                   ---------

Loss before income taxes                                             (    516,328)               (2,945,283)
Income taxes (benefit) (Note 8)                                                  -                        -
                                                                  -----------------         ----------------

Net Income (loss)                                                   $ (   516,328)             $ (2,945,283)
                                                                      ==========                   =========


Income (loss) per share                                         $ (           .07)        $ (           .40)
                                                                   ==============            ==============

Weighted average shares outstanding                                     7,298,854                 7,298,854
                                                                        =========                 =========




</TABLE>


                 See accompanying notes to financial statements.

                                       F-3

<PAGE>



<TABLE>
<CAPTION>


                           CABARET ROYALE CORPORATION

             Statements of Changes in Stockholders' Equity (Deficit)
                     Years ended December 31, 1996 and 1995




                                                 Common Stock             Additional
                                                                           paid-in              Retained           Total
                                            Shares          Amount          capital              earnings      equity (deficit)
                                            ------          ------          -------              --------      ----------------

<S>                                         <C>               <C>           <C>              <C>                     <C>     
Balance December 31, 1994,                  7,298,854         $ 7,299       $ 5,308,572      $ (5,846,906)     $ (   531,035)

Net Income                                                -           -           -            (2,945,283)        (2,945,283)
                                            ---------------   ---------     ----------------   ---------            ---------

Balance December 31, 1995                   7,298,854           7,299         5,308,572        (8,792,189)        (3,476,318)

Net loss                                                   -         -             -          (   516,328)       (   516,328)
                                            ----------------  --------      --------------    -----------          ----------

Balance December 31, 1996                   7,298,854         $ 7,299       $ 5,308,572      $ (9,308,517)      $ (3,992,646)
                                            =========           =====         =========         =========         =========




</TABLE>

                 See accompanying notes to financial tatements.

                                       F-4

<PAGE>



                           CABARET ROYALE CORPORATION

                            Statements of Cash Flows
                     Years ended December 31, 1996 and 1995

<TABLE>
<CAPTION>


                                                          1996                      1995
                                                          ----                      ----


Cash flows from operating activities:
<S>                                                  <C>                  <C>          
 Income (loss) from continuing operations            $ (516,328)          $ (2,945,283)
   Noncash revenues, expenses, gains and losses
     included in loss from operations:
       Depreciation and amortization                          -                243,698
       Loss on sale of assets (note 4)                        -              2,181,720
       Loss on collection of note receivable             50,440                      -
   Net (increase) decrease in:
       Prepaid expenses                              (    2,926)                 1,128
       Accounts receivable - affiliates                  11,510                 81,936
   Net increase (decrease) in:
       Accounts payable                                  30,262           (     76,707)
       Accrued expenses                                 285,426                504,967
                                                        -------            -----------

  Net cash provided by (used in)
         operating activities                          (141,616)        (       8,541)
                                                        -------            -----------

Cash flows from investing activities:
   Collection of note receivable                        150,000                 -
   Sale of property and equipment                           -                  25,000
                                                     -------------        ------------

Net cash provided by investing activities               150,000                25,000
                                                        -------           ------------

Cash flows from financing activities:
   Proceeds from notes payable                              -                 150,000
   Payment on notes payable                                 -            (     31,000)
   Payments on long term debt and capital leases            -            (     64,578)
                                                      ------------        -----------

Net cash provided by financing activities                   -                  54,422
                                                       ------------      ------------

Net increase in cash and cash equivalents                 8,384                70,881

Cash and cash equivalents (overdrafts)at
beginning of year                                         1,469          (     69,412)
                                                      ---------           -----------

Cash and cash equivalents at end of year             $    9,853         $        1,469
                                                       ========           ============


</TABLE>


                 See accompanying notes to financial statements.

                                       F-5

<PAGE>


                           CABARET ROYALE CORPORATION

                          Notes to Financial Statements
                           December 31, 1996 and 1995


1.       ORGANIZATION AND BUSINESS OPERATIONS
--       ------------------------------------

Exceptional Enterprises Inc. (Exceptional) was organized to acquire interests in
business  opportunities  and  engage in and  provide  financial  and  management
services to those businesses.


Walhill Partners, Ltd. (Walhill) a Texas limited partnership, was formed for the
purpose  of  owning  a  restaurant,  bar and club  facility  in  Dallas,  Texas.
Walhill's  operations consisted of leasing the facility to an affiliated company
which operated under the name Cabaret Royale.

On  September  30,  1993,  Exceptional  acquired  the  assets  and  assumed  the
liabilities  of Walhill  and  acquired  the  "Cabaret  Royale"  trade  names and
trademarks from Cabaret Royale Corporation, a Texas corporation. The acquisition
of Walhill by Exceptional was accounted for as a reverse acquisition.  Under the
reverse  acquisition,  Walhill was  effectively  the  acquirer  of  Exceptional.
Subsequent to the  acquisition,  Exceptional  changed its name to Cabaret Royale
Corporation.


2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
--       ------------------------------------------

Consolidation  policy - The Company's  policy is to consolidate  the accounts of
Cabaret Royal Corporation and all majority owned  subsidiaries  under control of
the parent company.

Cash  equivalents  - For purposes of the  statement  of cash flows,  the Company
considers all short-term investments with original maturities of three months or
less to be cash equivalents.

Income taxes - In 1993, the Company  adopted  Statement of Financial  Accounting
Standards No. 109 (SFAS 109),  "Accounting for Income Taxes".  SFAS 109 requires
an asset and liability approach to financial accounting for income taxes. In the
event differences between the financial reporting basis and the tax basis of the
Company's  assets  and  liabilities  result in  deferred  tax  assets,  SFAS 109
requires an  evaluation of the  probability  of being able to realize the future
benefits  indicated  by such  assets.  A valuation  allowance  is provided for a
portion or all of the deferred tax assets when there is an uncertainty regarding
the Company's ability to recognize the benefits of the assets in future years.

Loss per share - Per share information is computed using weighted average common
and common equivalent shares outstanding during the respective periods. Warrants
are common stock equivalents,  however, they are not included in the computation
of loss per common share since the effect would be anti-dilutive.



                                       F-6

<PAGE>


                           CABARET ROYALE CORPORATION

                          Notes to Financial Statements
                           December 31, 1996 and 1995


3.       BASIS OF PRESENTATION
--       ---------------------

The accompanying  financial  statements have been prepared  assuming the Company
will continue as a going concern;  they do not include any adjustments  that may
be  necessary  relating to the amounts,  classification  and  recoverability  of
recorded asset amounts and amounts and  classification of recorded  liabilities.
The going concern basis might not be appropriate  since the Company has incurred
substantial  operating losses in 1996 and 1995 and as December 31, 1996, current
liabilities  exceed current assets and the Company is in default on various note
payable agreements (Note 5).

The ability of the Company to continue as a going  concern is  dependent  on the
Company's ability to develop profitable  operations and obtain additional equity
or  long-term  debt  financing.  With the sale of the  Dallas  facility  and the
decline of the Mexico City  franchise,  management does not expect any operating
activity for the foreseeable future.  Therefore,  management expects the Company
to be in an inactive or dormant state until such time as  profitable  operations
can be developed and the Company can resolve its debt default issues.

4.       SALE OF DALLAS FACILITY
--       -----------------------

On December  23,  1995 the company  sold it major  operating  asset,  the Dallas
restaurant , bar and club facility and all associated  equipment and real estate
to an unrelated  party for  $1,800,000.  The  consideration  was paid $25,000 in
cash, assumption of $1,574,000 in liabilities  (including $150,000 borrowed from
the purchaser prior to the sale) and $200,440 in a note receivable.  As a result
of the sale the company recognized a loss on sale of $2,181,720.

The liabilities assumed in connection with the sale of the building included two
mortgage  notes  payable.  These  notes  have not been  formally  assumed by the
purchaser  from the  lender,  however,  the  purchaser  has  made  the  required
payments.  Therefore,  the  purchasers  commitment  to assume the notes has been
recorded as a note  receivable  and the  Company's  obligation to the lender has
remained as a note payable until such time as the purchaser formally assumes the
notes.  Management  believes  that the notes  will be  formally  assumed  by the
purchaser as soon as  practicable.  Title to the building has transferred to the
new owner.

Future principal amounts due/payable under the mortgage notes are as follows:


              December, 31 1997                  $      71,787
                           1998                         79,447
                           1999                         87,924
                           2000                         97,310
                           2001                        107,700
                           Thereafter                   903,069
                                                     ----------
                           Total                     $ 1,347,237
                                                       =========



                                       F-7

<PAGE>


                           CABARET ROYALE CORPORATION

                          Notes to Financial Statements
                           December 31, 1996 and 1995


4.       SALE OF DALLAS FACILITY (CONTINUED):
--       ------------------------------------

In November,  1996, due to cash flow problems,  the company  negotiated an early
collection of the$200,440  note  receivable for $150,000  resulting in a loss of
$50,440.


5.       BRIDGE FINANCING NOTES PAYABLE
--       ------------------------------

During  1994,  the  Company  borrowed  an  aggregate  $2,835,000  by  issuing 8%
convertible  subordinated  notes.  The  proceeds  from the  notes  were  used to
renovate and provide  operating capital to a facility in New York City (see Note
9). The notes and related  accrued  interest  were  payable on August 31,  1994.
These notes are currently in default.

Each note is convertible, at the option of the holder, into Class A Common Stock
at the price then offered by the Company in any private or public  offering.  In
connection with the issuance of the convertible  subordinated notes, the Company
issued  2,835,000  warrants to purchase Class A Stock,  exercisable at $2.50 per
share. The warrants provide that if the related notes were not repaid by May 31,
1994, the number of shares  subject to warrants  doubled.  The warrants  further
provide that if the related notes were not repaid by July 31, 1994, the exercise
price  decreased to $1.25 per share.  The  warrants  expire three years from the
date of issuance.

In exchange for  providing  the  subordinated  financing  described  above,  two
individuals  received a total of 760,000 warrants  (300,000 to related party) to
purchase  a  corresponding  number  of Class A Stock  at  $1.00 a  share.  These
warrants were valued for  financial  statement  purposes at $.25 per share.  The
warrants expire two years from the date of issuance.


6.       CAPITAL TRANSACTIONS
--       --------------------

Common  Stock - On January  26,  1994,  the  Company  amended  its  articles  of
incorporation  to increase the number of authorized  shares of common stock from
10,000,000 to 60,000,000,  and  designated  50,000,000 of such shares as Class A
Common  Stock  (Class A Stock) and  10,000,000  of such shares as Class B Common
Stock  (Class B Stock).  Class B Stock can be  converted to one share of Class A
Stock and Class B Stock has a 10-to-1 voting right.

Warrants - At December 31, 1996, the Company had 5,710,000 common stock purchase
warrants outstanding.  Each warrant is exercisable for one share of common stock
at a purchase price ranging from $1.00 to $1.25 per share.  The warrants  expire
in 1997 (5,670,000) and 1998 (40,000).  Warrant activity for the two year period
ended December 31, 1996 consists of the following:





                                       F-8

<PAGE>

<TABLE>
<CAPTION>


                           CABARET ROYALE CORPORATION

                          Notes to Financial Statements
                           December 31, 1996 and 1995


6.       CAPITAL TRANSACTIONS (CONTINUED):
--       ---------------------------------
                                                                          Warrants                       Price
                                                                          --------                       -----


<S>                                                                         <C>                               <C>  
                  Balance December 31, 1994                                 10,470,000                $1.00 - $2.50

                  Options granted                                                    -                        -

                  Warrants exercised                                                 -                        -

                  Warrants expired                                                   -                        -

                  Balance December 31, 1995                                 10,470,000                $1.00 - $2.50

                  Options granted                                                    -                        -

                  Warrants exercised                                                 -                        -

                  Warrants expired                                           4,760,000                $1.00 - $2.50
                                                                           -----------


                  Balance December 31, 1996                                  5,710,000                $1.00 - $1.25
                                                                           ===========

</TABLE>


7.       FRANCHISE AGREEMENT
--       -------------------

Effective  May,  1994 the Company  entered into a franchise  agreement  with the
operator of a Mexico  City Club.  Under the  agreement  the Mexico City Club has
right to use the Cabaret Royale name and trademarks as well as receive  guidance
and  assistance  in  developing  operating  procedures,   promotional  programs,
administrative  and hiring practices,  among other things, in exchange for a fee
ranging from 5% to 12% of gross revenues depending on club volume. In July, 1996
the Company and the  franchisee  renegotiated  the fee to $5,000 a month through
December,  1996.  As of December  31, 1996 the Mexico City club owed the Company
$25,000  under this  arrangement.  Due to poor  economic  conditions  in Mexico,
declining operations in the Mexico club and inconsistent collection history, the
$25,000 has been included in allowance for doubtful  accounts.  The Company does
not expect any future revenue from this relationship.

As part of its franchise support services,  the Company regularly  recruited and
trained  entertainers  for the Mexico City Club.  Management  maintains that the
entertainers  are  employees of the Mexico City Club and that the  franchisee is
responsible for all related taxes. However, as a result of related Department of
Labor and Internal  Revenue Services actions (see Note 11), the Company may have
contingent payroll tax consequences with respect to this practice.

8.       INCOME TAXES
--       ------------

SFAS 109  provides for  deferred  tax assets for such item as  depreciation  and
amortization  timing  differences and net operating loss carry forwards.  Due to
the Company's  recent  history of operating  losses all such deferred tax assets
have been fully offset by valuation  allowances due to  uncertainties  regarding
realization of the tax benefits in future years.




                                       F-9

<PAGE>


                           CABARET ROYALE CORPORATION

                          Notes to Financial Statements
                           December 31, 1996 and 1995


8.       INCOME TAXES (CONTINUED):
--       -------------------------

In 1994, a portion of the Company's net operating  loss was carried back against
taxes paid for 1993 net income  resulting  in a refund due of $3,409.  Remaining
net  operating  losses will be carried  forward and  available to offset  future
taxable income through the year 2010.


9.       CAT ENTERTAINMENT
--       -----------------

On January 7, 1994,  the Company  made an  unsecured  loan of  $2,000,000  to an
unrelated  company,  which was used to renovate a facility in New York City.  On
February 24, 1994, the Company acquired,  from Brian A. Travis  ("Travis"),  the
outstanding common stock of CAT Entertainment  ("CAT") which owned the leasehold
for the New York facility.  As consideration  for the  acquisition,  the Company
issued 2,400,000 shares of Class A Common Stock,  1,000,000 warrants to purchase
Class A Common Stock at $2.50 a share and 1,000,000 warrants to purchase Class A
Common Stock at $5.00 a share. The acquisition was accounted for as a purchase.

The  warrants  are  subject  to  adjustments   corresponding  to  those  in  the
convertible  note  warrants  (see Note 5). As a result,  warrants  increased  to
4,000,000 shares and the exercise price decreased to $1.25. The warrants expired
in  1996,  two  years  from  the  date of  issuance  . In  connection  with  the
acquisition, the $2,000,000 loan was transferred to CAT.

The New York club  opened for  business in March 1994.  CAT  incurred  operating
losses of $5,375,205  during 1994 and closed the club on December 31, 1994. Such
action resulted in subsequent  default on the New York facility's rent agreement
and ultimately the loss of the facility and its leasehold improvements.

On January 25, 1995,  CAT filed a voluntarily  petition for relief under Chapter
11 of the Federal  Bankruptcy  Code.  On January  31, 1995 the Company  sold its
stock  of CAT to an  unrelated  entity  for  $100.  On  April  6,  1995 the U.S.
Bankruptcy  Court  converted  the  bankruptcy  filing to a Chapter 7 liquidation
proceeding  under the Federhe  U.S.  Bankruptcy  Court  closing  the  bankruptcy
proceeding  as a "no asset" case.  As a result,  CAT's assets and the  company's
investment  in and  advances  to CAT  were  written  off at  December  31,  1994
resulting in a loss on disposal of $5,700,472. In January 1995, the Company sold
equipment  from CAT to a related  party for  $69,000 to raise  funds for payroll
obligations.  The Company  does not expect to incur any  significant  additional
losses from CAT.

The company has initiated a lawsuit against the seller of CAT alleging fraud and
breech of contract. The Company seeks return of its stock and other damages.






                                      F-10

<PAGE>


                           CABARET ROYALE CORPORATION

                          Notes to Financial Statements
                           December 31, 1996 and 1995


9.       CAT ENTERTAINMENT (CONTINUED):
--       ------------------------------

In connection with the purchase of CAT, CAT's operation of the New York club and
the bankruptcy of CAT, the Company may have various  contingent  claims asserted
against it or which it may assert  against  others.  The Company  believes  that
there will not be any further adverse  effects to the financial  statements as a
result of its ownership of CAT.


10.      RELATED PARTY TRANSACTIONS
---      --------------------------

During  1995,  the  Company's  Dallas  real  estate  facility  was  leased by an
affiliated  operating  company  ("Dallas  Food  and  Beverage").  The  agreement
required the  affiliated  company to pay rent equal to 12% of its adjusted gross
receipts (minimum $20,000 per month) as well as various operating  expenses such
as insurance and real estate taxes, through December 31, 2004 with two five year
extensions  at the option of the tenant.  At December 31, 1995,  the Company had
accounts  receivable from this affiliated company of $161,258.  During 1996, the
affiliated  company  discontinued  operations  due to  cash  flow  problems  and
$159,258 was written off to bad debt expense.

Unaudited  financial   information  of  the  Dallas  Food  and  Beverage's  1995
operations are as follows:

                  Revenues                         $ 4,619,459
                  Cost of sales                        603,693
                  Operating expenses                 3,949,053
                                                     ---------

                  Net Income                     $      66,713
                                                    ===========

Dallas Food and Beverage is party to a lawsuit  alleging  violation of the Texas
Dram Shop & Liquor Liability  Statute.  Management  intends to vigorously defend
against the lawsuit.

During  1995  affiliates  of  certain  management  members  operated  concession
activities in the Dallas real estate facility  without rental costs.  Management
believes  these  concessions  earned  insignificant  revenues  but  enhanced and
supported the operations of the facility.  The concession was closed in 1995 due
to poor operating results.

11.      COMMITMENTS AND CONTINGENCIES
---      -----------------------------

In 1993,  the Company  entered  into a two year  employment  agreement  with the
Company's  President calling for compensation of $300,000 per year. In 1996, the
president  voluntarily  reduced his  compensation to $60,000 a year. At December
31, 1996 the Company owed the President $328,000 under this agreement.



                                      F-11

<PAGE>


                           CABARET ROYALE CORPORATION

                          Notes to Financial Statements
                           December 31, 1996 and 1995



11.      COMMITMENTS AND CONTINGENCIES (CONTINUED):
---      ------------------------------------------

An affiliate of the Company, which was a former lessee of the Dallas real estate
facility (before Dallas Food and Beverage), lost a lawsuit filed in U.S. Federal
district  court  brought by the U.S.  Department of Labor.  The lawsuit  claimed
certain  entertainers were employees of such affiliate,  rather than independent
contractors.   The  affiliate  and  the  Company  president  (as  an  individual
defendant)  reached a settlement  with the U.S.  Department  of Labor for claims
against  them for unpaid  payroll.  Although  the Company was not a party to the
above  proceedings,  the results of the suits and  settlement  could  negatively
impact the Company.

The Company also is involved in various legal actions incidental to its business
including the Texas Dram Shop and Liquor  Liability Statue case mentioned above.
In the Company's opinion, none of these proceedings will have a material adverse
effect on the Company's financial position.

12.      SUPPLEMENTAL CASH FLOW INFORMATION:
---      -----------------------------------

Interest  paid during 1996 and 1995 was $0 and  $163,643  respectively.  Noncash
Investing and Financing Activities consist of the following:

In 1995,  the company sold property plant and equipment with a net book value of
$3,990,244  cash of $25,000,  a note  receivable  of $200,440 and  assumption of
$1,574,560 in liabilities (including $150,000 due the purchaser).

In 1996,  $57,159 of principal and $140,976 of related  interest was paid by the
purchaser of the Dallas facility directly to the mortgage note holder (Note 4).


                                      F-12

<PAGE>



         In  accordance  with  Section  13 or 15(d)  of the  Exchange  Act,  the
registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized.

                           CABARET ROYALE CORPORATION

BY    /S/ Salah Izzedin
--    -----------------
         Salah Izzedin, President

DATE:  4-15-97

IN ACCORDANCE WITH THE EXCHANGE ACT, THIS REPORT HAS BEEN SIGNED
BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN
THE CAPACITIES AND ON THE DATED INDICATED.

BY:  /S/ Salah Izzedin
---  -----------------
         Salah Izzedin, President and director

DATE:  4-15-97


BY: /s/ Katia Hiles, Director
-----------------------------
         Katia Hiles, director


DATE: 4-15-97

                                      F-13