<PAGE>




                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                    FORM 10-K

(MARK ONE)

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

                    FOR THE FISCAL YEAR ENDED JANUARY 1, 1999
                                       OR

|_|      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
         EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

                         COMMISSION FILE NUMBER 33-64140

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

                           DAL-TILE INTERNATIONAL INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                    DELAWARE                                   13-3548809
        (STATE OR OTHER JURISDICTION OF                     (I.R.S. EMPLOYER
         INCORPORATION OR ORGANIZATION)                    IDENTIFICATION NO.)

        7834 HAWN FREEWAY, DALLAS, TEXAS                           75217
    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                    (ZIP CODE)

                                 (214) 398-1411
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

                                                         NAME OF EACH EXCHANGE
               TITLE OF EACH CLASS                        ON WHICH REGISTERED
               -------------------                        -------------------
          COMMON STOCK, $.01 PAR VALUE                  NEW YORK STOCK EXCHANGE

        SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

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| No |_|

Indicate by check mark if disclosure of delinquent filers pursuant to Item 
405 of Regulation S-K is not contained herein, and will not be contained, to 
the best of registrant's knowledge, in definitive proxy or information 
statements incorporated by reference in Part III of this Form 10-K or any 
amendment to this Form 10-K. |X|

As of March 8, 1999, there were 53,566,996 shares of the Registrant's Common 
Stock outstanding. The aggregate market value of Common Stock held by 
non-affiliates of the Registrant at March 8, 1999 was $221,539,392 (based on 
the closing sale price of the Common Stock on March 8, 1999). This 
calculation does not reflect a determination that persons are affiliates for 
any other purposes.

                       DOCUMENTS INCORPORATED BY REFERENCE

               DOCUMENT                                    PART OF FORM 10-K
    ------------------------------                      INTO WHICH INCORPORATED
       PROXY STATEMENT FOR 1999                         -----------------------
    ANNUAL MEETING OF STOCKHOLDERS                             PART III

<PAGE>

                           DAL-TILE INTERNATIONAL INC.

                                    FORM 10-K

                                TABLE OF CONTENTS
<TABLE>
<CAPTION>
                                                                                                Page
                                                                                                ----
<S>                                                                                             <C>
                                                      PART I

Item 1.    Business..........................................................................    1
Item 2.    Properties........................................................................    9
Item 3.    Legal Proceedings.................................................................    10
Item 4.    Submission of Matters to a Vote of Security Holders...............................    11

                                                      PART II
Item 5.    Market for Registrant's Common Equity and Related
           Stockholder Matters...............................................................    11
Item 6.    Selected Financial Data...........................................................    12
Item 7.    Management's Discussion and Analysis of Financial
           Condition and Results of Operations...............................................    13
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk........................    22
Item 8.    Financial Statements and Supplementary Data.......................................    22
Item 9.    Changes in and Disagreements with Accountants
           on Accounting and Financial Disclosure............................................    22

                                                     PART III
Item 10.   Directors and Executive Officers of the Registrant................................    23
Item 11.   Executive Compensation............................................................    25
Item 12.   Security Ownership of Certain Beneficial Owners and
           Management........................................................................    26
Item 13.   Certain Relationships and Related Transactions....................................    26

                                                      PART IV
Item 14.   Exhibits, Financial Statement Schedules and Reports on
           Form 8-K..........................................................................    26
</TABLE>
<PAGE>

                                     PART I

ITEM 1.    BUSINESS

GENERAL

Dal-Tile International Inc., a Delaware corporation formed in 1987, believes 
that it is the largest manufacturer, distributor and marketer of ceramic tile 
in the United States, and one of the largest in the world. Unless the context 
otherwise requires, references herein to the "Company" and "Dal-Tile" shall 
refer to Dal-Tile International Inc. and its consolidated subsidiaries. 
Dal-Tile International Inc. is a holding company and conducts all its 
operations through its subsidiaries. References herein to fiscal year 1998 
refer to the fiscal year ended January 1, 1999.

Dal-Tile currently conducts its business in one industry segment, engaging in 
the manufacturing, distribution and marketing of glazed and unglazed wall, 
floor and mosaic tile. The Company operates with a significant level of 
vertical integration, combining what it believes to be North America's 
largest volume distribution system with modern manufacturing facilities 
located in the United States and Mexico. A full range of tile and stone 
products are offered, as well as installation materials and tools ("allied 
products") designed to appeal to a broad range of customers for both 
residential and commercial applications (new construction as well as 
remodeling). Products are sold through a network of 220 Company-operated 
sales centers to tile contractors, architects, design professionals, 
builders, developers and individual consumers. In addition, Dal-Tile is a 
significant supplier to the do-it-yourself and buy-it-yourself market by 
supplying home center retailers, such as The Home Depot and Lowe's. The 
Company's manufactured products are marketed under the brand names 
DALTILE(R), AMERICAN OLEAN(R) and HOME SOURCE(R). In addition, the Company 
resells other manufacturers' products under the respective manufacturers' 
trade names.

The Company commenced operations in 1947 as the Dallas Ceramic Company and 
established its first wall tile manufacturing facility and corporate 
headquarters in Dallas, TX. On January 9, 1990, AEA Investors Inc., a 
privately held corporation headquartered in New York ("AEA Investors"), 
arranged for Dal-Tile to acquire all the outstanding capital stock of 
Dal-Tile Corporation, its affiliated companies and certain related assets 
(the "AEA Acquisition"). On December 29, 1995, the Company completed the 
acquisition of all of the issued and outstanding stock of American Olean Tile 
Company, Inc. ("AO"), a wholly owned subsidiary of Armstrong World 
Industries, Inc. ("AWI"), and certain related assets of the ceramic tile 
operations of AWI (the "AO Acquisition").

DISTRIBUTION, SALES AND MARKETING

Products are distributed through three separate distribution channels 
consisting of (i) Company-operated sales centers, (ii) independent 
distributors and (iii) home center retailers. The business is organized into 
three strategic business units to address the specific customer needs of each 
distribution channel. Each strategic business unit is supported by a 
dedicated sales force.

Dal-Tile has three regional distribution centers strategically located in 
California, Maryland and Texas to improve customer service in each 
distribution channel through shorter lead times, increased order fill rates 
and improved on-time deliveries to its customers. In addition, the regional 
distribution centers enhance the ability to plan and schedule production and 
to manage inventory requirements.

<PAGE>

COMPANY-OPERATED SALES CENTERS

A network of 220 Company-operated sales centers located in the U.S., Canada 
and Puerto Rico distributes primarily the DALTILE brand product, serving 
customers in all 50 states and portions of Canada and Puerto Rico. For fiscal 
year 1998, a majority of the Company's net sales was made through its 
Company-operated sales centers in the United States and Canada.

In addition to sales center staff, this distribution channel is supported by 
a dedicated sales force of approximately 100 people. The DALTILE brand also 
has a group of over 30 sales representatives dedicated exclusively to the 
architectural community. The architectural community exercises significant 
influence over the specification of products utilized in commercial 
applications.

Sales centers are designed to serve as a "one-stop" source that provides 
customers with one of the ceramic tile industry's broadest product lines--a 
complete selection of glazed floor tile, glazed wall tile, glazed and 
unglazed mosaic tile, porcelain tile, quarry tile and stone products, as well 
as allied products. In addition to products manufactured by the Company, the 
sales centers carry a selection of purchased products to provide customers 
with a broader product line. The sales centers generally range in size from 
3,000 to 30,000 square feet and consist of a showroom dedicated to displaying 
the product offerings together with office space and a warehouse in which 
inventory is stocked. Sales center displays and inventories are designed to 
reflect local consumer preferences. The sales centers generally are located 
in light industrial areas rather than retail areas and generally occupy 
moderately priced leased space under three to five year leases.

The sales center distribution system has expanded from 210 sales centers in 
1994 to 220 sales centers at January 1, 1999. In the future, the Company may 
open additional sales centers in areas where factors such as population, 
construction activity, local economic conditions and usage of tile create an 
attractive environment for a sales center. From time to time, sales centers 
are closed in locations where economic and competitive conditions have 
changed.

INDEPENDENT DISTRIBUTORS

The independent distributor channel is serviced through a dedicated business 
unit, which includes 10 regional sales managers to serve the particular 
requirements of its customers. Currently, the AMERICAN OLEAN brand is 
distributed through approximately 175 independent distributor locations that 
service a variety of residential and commercial customers. The Company's 
strategy is to increase its presence in the independent distributor channel, 
particularly in tile products that are most commonly used in flooring 
applications.

Domestic sales within Mexico are made primarily through a network of 
independent retailers who are principally supplied by the Monterrey, Mexico 
manufacturing facility.

HOME CENTER RETAILERS

The Company believes it is one of the U.S. ceramic tile industry's largest 
suppliers to the do-it-yourself and buy-it-yourself markets through home 
center retailers, such as The Home Depot and Lowe's, serving more than 1,200 
home center retail outlets nationwide. The home center retailer channel has 
provided Dal-Tile with new sources of sales over the past five years and is 
expected to continue presenting growth opportunities.

                                       -2-

<PAGE>

ESTABLISHED BRANDS AND SPECIAL MARKETING PROGRAMS

The Company believes that it has two of the leading brand names in the U.S. 
ceramic tile industry--DALTILE and AMERICAN OLEAN. The roots of the DALTILE 
and AMERICAN OLEAN brand names date back approximately 50 years and 75 years, 
respectively.

The Company-operated sales centers distribute the DALTILE brand, which 
includes a fully integrated marketing program, emphasizing a focus on 
fashion. The product offering is based on the assessment of the needs of 
professional installers, designers, architects and builders, as well as a 
review of competitive products. The marketing program includes public 
relations support, merchandising (displays/sample boards, chip chests), 
literature/catalogs and an Internet website.

The AMERICAN OLEAN brand consists of a full product offering and is 
distributed through independent distributors. The brand is supported by a 
fully integrated marketing program, including public relations efforts, 
cooperative advertising programs for dealers and distributors, displays, 
merchandising (sample boards, chip chests), literature/catalogs and an 
Internet website.

In addition to distributing the DALTILE and AMERICAN OLEAN brands, home 
center retailers distribute a home center brand--HOME SOURCE.

The Company also has special marketing programs with Kohler(R) for bathroom 
and kitchen fixture color coordination and Laura Ashley(TM) for home 
furnishing accessories coordination. Through such programs, ceramic tile 
products and merchandising programs are developed to complement these product 
lines.

PRODUCTS AND PRODUCT DEVELOPMENT

Dal-Tile manufactures and sells different types of tile in various sizes and 
styles for commercial and residential use, as well as related trim and angle 
pieces. In addition, stone and allied products purchased from third-party 
manufacturers are sold. Management believes that "one-stop shopping," which 
requires a full product line at its Company-operated sales centers, is an 
important competitive advantage in servicing its core customers, especially 
tile contractors.

For fiscal year 1998, approximately 72% of net sales were 
Company-manufactured products, with the remainder being provided by other 
domestic manufacturers, as well as foreign manufacturers located principally 
in Italy, Spain and Mexico. The Company intends to increase the amount of 
Company-manufactured products as a percentage of net sales.

The Company believes that, due to technological innovations, the U.S. ceramic 
tile industry is increasing its fashion orientation, particularly in tile 
used in flooring applications. The Company has developed capabilities to 
produce fashionable and innovative tile products and to simulate natural 
products such as stone, marble and granite. In order to capitalize on the 
increased demand for, and higher margins available from, fashion-oriented 
tile products, the Company has (i) increased the number of new tile product 
introductions, (ii) focused on shortening product introduction cycle time, 
(iii) expanded its relationships with leading glaze and raw material 
manufacturers, (iv) focused on consumer preferences to deliver products 
consistent with current design trends and (v) continued its investment in 
research and development to further develop new products and manufacturing 
capabilities.

CUSTOMERS

Dal-Tile's core customers consist of large and small tile contractors, 
architects, design professionals, builders, developers, independent 
distributors and ceramic specialty retailers. The Company also sells to the 
do-it-yourself and buy-it-yourself market through relationships with home 
center retailers, such as The Home Depot and Lowe's, and is a significant 
supplier to this channel. The customer base is broad and 

                                      -3-

<PAGE>

diversified, consisting of more than 31,000 active accounts in the United 
States. In addition, the Company has sales to over 350 national accounts, 
including recognized national restaurant chains, such as McDonald's, Wendy's, 
Taco Bell and Denny's, and other national chain stores, such as Barnes & 
Noble book stores, Wal-Mart stores and Exxon service stations.

The Company does not rely on any one customer or group of customers for a 
material amount of its net sales. The largest customer for fiscal year 1998 
accounted for less than 10% of net sales, and the 10 largest customers 
accounted for approximately 19% of net sales in the same period.

MANUFACTURING

Currently, Dal-Tile operates nine tile manufacturing facilities with an 
aggregate annual manufacturing capacity of 378 million square feet. During 
the five year period 1994-1998, approximately $131 million has been invested 
in capital expenditures, principally for new plants and state-of-the-art 
equipment to increase manufacturing capacity, improve efficiency and develop 
new capabilities. Operating capacity has expanded from 251 million square 
feet to 378 million square feet during the same period. In fiscal year 1996, 
approximately 22 million square feet of state-of-the-art wall tile production 
capacity was established at the El Paso, TX facility and was increased to 
approximately 45 million square feet in fiscal year 1997. During fiscal year 
1998, approximately 22 million square feet of state-of-the-art wall tile 
production capacity was added at the Dallas, TX facility, which will replace 
less efficient production capacity at this location.

The Company commenced operations in Mexico at its Monterrey facility in 1955 
and since then has been manufacturing products at this facility for U.S. and 
Mexican consumption. The Monterrey location contains five distinct 
manufacturing facilities, three of which produce ceramic tile, one which 
produces frit (ground glass) and one which produces refractories. This 
location is the Company's largest manufacturing facility, representing 
approximately 42% of annual manufacturing capacity.

Dal-Tile also has a 49.99% interest in Recumbrimientos Interceramic, S.A. de 
C.V. ("RISA"), a Mexican joint venture with Interceramic, a leading Mexican 
manufacturer, which, pursuant to contractual arrangements, has agreed to 
supply the Company, at the Company's option, with up to 25 million additional 
square feet of floor tile annually.

Following the AO Acquisition, the Company consolidated wall tile production 
in early fiscal year 1996 by closing the Lansdale, PA and Jackson, TN wall 
tile facilities and consolidated a portion of mosaic tile production in late 
fiscal year 1996. In fiscal year 1997, the Company initiated the process of 
consolidating a portion of unglazed floor tile production by closing the 
Coleman, TX facility. In addition, production was suspended in late fiscal 
year 1997 at the Mt. Gilead, NC glazed floor tile facility, and the facility 
was closed during fiscal year 1998. As of January 1, 1999, the Company was 
pursuing the sale of the Mt. Gilead facility.

The Company believes that its manufacturing organization offers competitive 
advantages due to its ability to manufacture a differentiated product line 
consisting of one of the industry's broadest product offerings of colors, 
textures and finishes, as well as the industry's largest offering of trim and 
angle pieces and in its ability to utilize the industry's newest technology. 
The Company's manufacturing strategy is to maximize production at its lowest 
cost manufacturing facilities, continue ongoing improvements by implementing 
demonstrated best practices and continue to invest in manufacturing 
technology to lower its costs and develop new capabilities.

                                       -4-

<PAGE>

The following table summarizes the products currently manufactured at the 
Company's facilities:
<TABLE>
<CAPTION>
FACILITY                           PRODUCT TYPE
--------                           ------------
<S>                                <C>
Fayette, AL.....................   Unglazed quarry tile
Lewisport, KY...................   Unglazed quarry tile
Monterrey, Mexico...............   Glazed wall tile; glazed floor tile; glazed mosaic tile
Olean, NY.......................   Unglazed mosaic tile
Gettysburg, PA..................   Glazed and unglazed mosaic tile
Jackson, TN.....................   Glazed and unglazed mosaic tile
Conroe, TX......................   Glazed floor tile
Dallas, TX......................   Glazed wall tile
El Paso, TX.....................   Glazed wall tile
</TABLE>

While certain of the manufacturing facilities are described above as 
producing either "floor" or "wall" tile, tile consumers employ all sizes and 
varieties of tile products in all types of applications. The references to 
"floor" and "wall" serve to identify the most common application for the size 
and variety in question.

RAW MATERIALS

Dal-Tile manufactures (i) wall tile primarily from talc and clay, (ii) floor 
tile and glazed mosaic tile primarily from impure nepheline syenite and clay, 
(iii) unglazed ceramic mosaic tile primarily from pure nepheline syenite and 
clay and (iv) unglazed quarry tile from clay.

Talc represents the Company's largest tonnage raw material requirement. 
Dal-Tile owns long-term talc mining rights in Texas that satisfy all talc 
requirements and owns long-term clay mining rights in Alabama, Kentucky and 
Mississippi that satisfy nearly all clay requirements for producing unglazed 
quarry tile.

Clay is purchased in different grades for the manufacture of non-quarry tile. 
Management believes that there is an adequate supply of all grades of clay 
and that all are readily available from a number of independent sources.

The Company purchases all of its impure nepheline syenite requirements from 
Minnesota Mining and Manufacturing Company; however, management believes that 
there is an adequate supply of impure nepheline syenite which can be obtained 
from other sources. Pure nepheline syenite is purchased from Unimin 
Corporation, which is the only major supplier of this raw material in North 
America. Management believes that if there were a supply interruption of pure 
nepheline syenite, feldspar could be used in the production of mosaic tile. 
Feldspar can be purchased from a number of sources at comparable cost.

Glazes are used on a significant percentage of manufactured tile, consisting 
of a mixture of frit (ground glass), zircon, stains and other materials, with 
frit representing the largest ingredient. The Company manufactures 
approximately 69% of its frit requirements.

Management reviews its sources of raw materials periodically and may 
eliminate or reduce the use of certain raw materials based on the cost and 
chemical composition of alternative sources.

MANAGEMENT INFORMATION SYSTEMS

During fiscal year 1998, the Company focused on supply chain and logistics 
systems enhancements, financial system improvements and Year 2000 compliance. 
For fiscal year 1999, the Company plans to 

                                       -5-

<PAGE>

continue these initiatives. In addition, an agreement with AWI to provide 
mainframe data processing services will expire May 31, 1999. The Company has 
entered into an agreement to transfer the mainframe data processing function 
to IBM during the second quarter of fiscal year 1999.

COMPETITION

Sales of the Company's products are made in a highly competitive marketplace. 
Management estimates that over 100 tile manufacturers, more than half of 
which are based outside the United States, compete for sales of ceramic tile 
to customers located in the United States. Although the U.S. ceramic tile 
industry is highly fragmented at both the manufacturing and distribution 
levels, the Company believes that it is the largest manufacturer, distributor 
and marketer of ceramic tile in the United States, and one of the largest in 
the world. In addition to competition from domestic and foreign tile 
manufacturers, Dal-Tile encounters competition from manufacturers of products 
that serve as an alternative to tile. Competition in the tile industry is 
based on design, price, customer service and quality. The Company believes 
that it has a favorable competitive position as a result of its extensive 
North American distribution system and manufacturing capacity, together with 
its vertically integrated operations. In fiscal year 1998, approximately 64% 
of ceramic tile sales (by unit volume) in the United States consisted of 
imports, including approximately 7% manufactured by the Company in Mexico. In 
general, the proportion of U.S. ceramic tile sales attributable to imports 
has increased in recent years.

Dal-Tile products compete with numerous other wall and floor coverings for 
residential and commercial uses. Among such floor coverings are carpet, wood 
flooring, resilient flooring and stone products (such as marble, granite, 
slate and limestone tile). Among such wall coverings are paint, wallpaper, 
laminates and wood paneling. Ceramic tile products compete effectively as to 
price with carpeting, wood flooring and vinyl flooring, and are generally 
cheaper than natural stone products. Although the cost of installation of 
ceramic tile is higher than the cost of installation of carpet, wood flooring 
and some wall coverings, it is generally believed that ceramic tile has a 
lower cost over its useful life primarily due to ceramic tile's durability.

EMPLOYEES

At January 1, 1999, the Company employed approximately 7,400 persons, 
approximately 3,000 of which were employed by its Mexican subsidiary. 
Approximately 8% of employees in the United States are represented by unions. 
Approximately 90% of the employees in Mexico are represented by a union under 
a collective bargaining agreement which was renewed as of January 22, 1999. 
The Company has not experienced a significant work stoppage in Mexico in over 
18 years and experienced only one brief work stoppage in the United States 
over that period. The Company believes that relations with its employees are 
good.

TRADEMARKS

The Company owns rights to certain material trademarks and trade names, 
including DALTILE, AMERICAN OLEAN, HOME SOURCE and DAL-MONTE(TM), which are 
used in the marketing of its products. The Company believes that breadth of 
product line, customer service and price are important in tile selection and 
that the trademarks and trade names themselves are important as source 
identifiers that help differentiate Company product lines from those of 
competitors.

ENVIRONMENTAL REGULATION

The Company is subject to various federal, state, local and foreign 
environmental laws and regulations, including those governing air emissions, 
wastewater discharges, the use, storage, treatment and disposal of solid and 
hazardous materials, and the remediation of contamination associated with 
such disposal. Because of the nature of its business, the Company has 
incurred, and will continue to incur, costs relating 

                                       -6-

<PAGE>

to compliance with such laws and regulations. A number of the Company's 
facilities have conducted tile manufacturing operations for many years and 
have used lead compounds and other hazardous materials in its glazing 
operations. The Texas environmental proceedings discussed below arose 
principally in connection with the Company's disposal of waste materials 
containing lead compounds prior to the AEA Acquisition. The Company also is 
involved in the remediation of historic contamination at certain of its other 
present and former facilities, as well as at other locations in the United 
States.

The Company is involved in post closure care projects with respect to two 
sites near its Dallas facility, which are proceeding under the oversight of 
the Texas Natural Resource Conservation Commission ("TNRCC"). In March 1991, 
the Company and the predecessor to the TNRCC agreed to an administrative 
order (the "1991 Order") relating to past waste disposal activities conducted 
prior to the AEA Acquisition. The 1991 Order related principally to the 
disposal by the Company of waste materials containing lead compounds in a 
gravel pit ("Elam") near the City of Mesquite's landfill in Dallas County 
during a period from 1980 to 1987, and the disposal of miscellaneous solid 
wastes that were contaminated by lead compounds at a Company-operated 
landfill located on Pleasant Run Road ("Pleasant Run") in Dallas County from 
1986 to May of 1990. Pursuant to the 1991 Order, the Company paid a 
non-deferred assessed penalty of $350,000 and contributed another $350,000 to 
a fund dedicated to environmental enhancement activities in Dallas County. 
The Company received notice from the TNRCC terminating the 1991 Order and 
releasing the Company from any obligation regarding the payment of deferred 
penalties. The Company's closure plan for Elam was approved by the TNRCC, 
remediation and other activities associated with the closure have been 
completed and a closure certification has been submitted for approval by the 
TNRCC. To date, the Company has incurred costs of approximately $3.9 million in
connection with the closure. The Company expects to recover at least 50% of 
such costs (a substantial portion of which has already been recovered) 
pursuant to the Settlement Agreement with two of the former owners of the 
Company described below, and the Company believes that any amounts not 
recovered pursuant to the Settlement Agreement will not have a material 
adverse effect on the Company. Pleasant Run has been remediated in accordance 
with a TNRCC-approved closure plan. In fiscal year 1993 and 1994, the Company 
settled tort actions alleging personal injury and property damage filed on 
behalf of certain residents and owners of property near Elam and Pleasant Run 
for an aggregate amount of approximately $1.4 million.

The remediation described above followed a related criminal investigation 
which led to the indictments and, in fiscal year 1993, the convictions of a 
former owner and a former senior executive officer of the Company on federal 
charges of violating environmental laws. The U.S. Attorney's Office for the 
Northern District of Texas (the "U.S. Attorney's Office"), which obtained the 
indictments, informed the Company in writing on April 22, 1992 that, based on 
information in the possession of the U.S. Attorney's Office, it had decided 
not to prosecute the Company for violations of environmental criminal 
statutes.

The Company is involved in an environmental remediation program with respect 
to the disposal of hazardous wastes prior to the AEA Acquisition at a third 
site near its Dallas facility. In October 1994, the Company, Master-Halco, 
Inc. (a manufacturing company not affiliated with the Company), certain third 
party individuals and the TNRCC agreed to an administrative order (the "1994 
Order") relating to, among other things, the alleged disposal of waste 
materials containing lead compounds generated by the Company and others at a 
gravel pit on Kleburg Road ("Walton") in Dallas prior to 1980. Pursuant to 
the 1994 Order, the Company has completed a remedial investigation and 
submitted a closure plan with respect to the Walton site subject to the 
approval of the TNRCC. In addition, pursuant to the 1994 Order, among other 
things, an administrative penalty of $213,200 assessed against the 
individuals has been deferred pending timely and satisfactory completion of 
the technical requirements in the 1994 Order. The Company has agreed to 
indemnify such individuals against any costs relating to the disposal of 
industrial solid waste at the site. Although the cost to remediate the Walton 
site cannot be predicted with certainty at this time, the Company believes, 
based on current estimates, that the remediation is reasonably likely to 

                                       -7-

<PAGE>

cost between approximately $10 million and $15 million. The Company expects 
to recover at least 50% of the foregoing costs pursuant to the Settlement 
Agreement with two of the former owners of the Company described below, and 
the Company believes that any amounts not recovered pursuant to the 
Settlement Agreement will not have a material adverse effect on the Company. 
In fiscal year 1994, an action alleging personal injury and property damage 
was filed against the Company and others on behalf of certain residents and 
owners of property near such site. In fiscal year 1994, the Company settled 
this action by agreeing to remediate soil contamination on the plaintiffs' 
property and agreeing to pay approximately $538,000.

On May 20, 1993, the Company entered into an agreement with Robert M. 
Brittingham and John G. Brittingham, two of the former owners of the Company 
(the "Settlement Agreement"), pursuant to which substantially all of the 
costs incurred to the date thereof by the Company (approximately $12 million) 
in respect of the 1991 Order, the three Dallas area sites described above and 
certain related matters, including certain of the notices of violation 
referred to above, have been repaid to the Company. Such former owners are 
also obligated, pursuant to the terms of the Settlement Agreement, to 
indemnify the Company against 50% of all expenditures incurred in connection 
with various environmental violations relating to the Company's U.S. 
operations occurring prior to the AEA Acquisition in excess of the $12 
million already paid, until such total excess expenditures reach a formula 
amount, and 100% of all such expenditures in excess of the formula amount. 
The Company's expenditures to date in respect of the matters described above 
have been or are expected to be indemnified in accordance with the terms of 
the Settlement Agreement (subject to the percentage limitations described 
above). Accordingly, the Company believes (taking into account the 
indemnification rights referred to above and the reserves it has established) 
that its liability for environmental violations occurring prior to the AEA 
Acquisition will not have a material adverse effect on the Company. The 
Company believes that these two former owners currently have assets far in 
excess of their potential liability under the Settlement Agreement, and, 
accordingly, the Company believes that they will be able to satisfy all of 
their obligations pursuant to their agreement with the Company. Future 
events, which cannot be predicted, could affect the ability of these former 
owners to satisfy their obligations. Therefore, no assurance can be given 
that they will be able to meet their obligations when they arise.

Under the Comprehensive Environmental Response, Compensation and Liability 
Act ("CERCLA") and similar state statutes, regardless of fault or the 
legality of original disposal, certain classes of persons, including 
generators of hazardous substances, are subject to claims for response costs 
by federal and state agencies. Such persons may be held jointly and severally 
liable for any such claims. The Company has been named as a potentially 
responsible party ("PRP") under CERCLA and similar state statutes with 
respect to the historic disposal of certain hazardous substances at various 
other sites in the United States. With respect to certain of these sites, the 
Company has entered into DE MINIMIS settlements; at certain other sites, the 
liability of the Company remains pending. Based on currently available 
information, the Company believes that its ultimate allocation of costs 
associated with the investigation and remediation of these pending sites will 
not, in the aggregate, have a material adverse effect on the Company's 
financial condition. In addition, subject to the terms of the Stock Purchase 
Agreement, dated as of December 21, 1995 (the "AO Acquisition Agreement"), 
pursuant to which the Company acquired AO, AWI agreed to indemnify the 
Company for various costs and expenses that may be incurred in the future by 
the Company arising out of pre-closing environmental conditions and 
activities with respect to AO. The Company believes that, based on currently 
available information and the terms and conditions of AWI's indemnification 
obligations under the AO Acquisition Agreement, any liability of AO that is 
reasonably likely to arise out of any of the sites at which AO has been named 
as a PRP as a result of pre-closing activities would not result in a material 
adverse effect on the Company.

The Company's manufacturing facilities generate wastes regulated under the
Resource Conservation and Recovery Act ("RCRA") and other U.S. federal and state
laws. The Company also generates non-

                                       -8-

<PAGE>

hazardous wastes and is engaged in recycling and pollution prevention 
programs. Compliance with current laws and regulations has not had, and is 
not expected to have, a material adverse effect on the Company, including 
with respect to its capital expenditures, earnings and competitive position.

Numerous aspects of the manufacture of ceramic tile currently require 
expenditures for environmental compliance. For example, the mixing of raw 
materials, preparation of glazes, and pressing, drying and firing of tile all 
are sources of air emissions that require expenditures for compliance with 
laws and regulations governing air emissions, including the purchase, 
operation and maintenance of control equipment to prevent or limit air 
emissions. Many of these manufacturing processes also currently result in the 
accumulation of dust that contains silica, thereby requiring expenditures for 
capital equipment in order to comply with Occupational Safety and Health 
Administration ("OSHA") regulations with respect to potential employee 
exposure to such dust. In addition, the rinsing of spray dryers and 
containers used for the preparation of glaze and tile body results in 
wastewater discharges that require expenditures for compliance with laws and 
regulations governing water pollution. Finally, certain of the Company's 
manufacturing processes, including the preparation of glaze, the assembly of 
certain tile and the operation and maintenance of equipment, at times result 
in the generation of solid and hazardous waste that require expenditures in 
connection with the appropriate handling, treatment, storage and disposal of 
such waste.

In addition, in light of the lengthy manufacturing history of the Company's 
facilities, it is possible that additional environmental issues and related 
matters may arise relating to past activities which the Company cannot now 
predict, including tort liability and liability under environmental laws. In 
particular, a number of the Company's facilities located in the United States 
used lead compounds in glaze materials. The Company's Mexican facilities 
continue to use lead compounds in their glaze materials on certain specially 
ordered tiles. Significant exposure to lead compounds may have adverse health 
effects. Although it is impossible to quantify the Company's liability, if 
any, in respect of these matters, including liability to individuals exposed 
to lead compounds, no claims relating to its use of lead compounds or waste 
disposal matters have been made against the Company except as set forth 
above. In addition, it is impossible to predict the effect which future 
environmental regulation in the United States, Mexico and Canada could have 
on the Company.

GEOGRAPHIC LOCATION

Financial information by geographic location for the three fiscal years ended 
January 1, 1999 is set forth in Note 13 to the Consolidated Financial 
Statements included in this report. See also Item 7, "Management's Discussion 
and Analysis of Financial Condition and Results of Operations--Liquidity and 
Capital Resources," below in this report.

ITEM 2.    PROPERTIES

The Company owns or leases manufacturing, distribution, office and sales 
facilities in the United States and Mexico, as described below.

MANUFACTURING, DISTRIBUTION AND OFFICE FACILITIES

The Company owns or leases 12 manufacturing, distribution and office 
facilities. The location, use and floor area of such facilities are described 
as follows:

                                       -9-

<PAGE>
<TABLE>
<CAPTION>
                                                                                                LEASED/
LOCATION                         USE                                            SQ. FEET        OWNED
--------                         ---                                            --------        -----
<S>                              <C>                                            <C>             <C>
Fayette, AL................      Manufacturing                                   276,467        Owned
Lewisport, KY..............      Manufacturing                                   270,836        Owned
Baltimore, MD..............      Distribution                                    315,000        Leased (1)
Monterrey, Mexico..........      Manufacturing, Distribution & Office          1,114,175        Owned
Olean, NY..................      Manufacturing                                   278,417        Owned
Gettysburg, PA.............      Manufacturing                                   218,609        Owned
Jackson, TN................      Manufacturing                                   655,211        Owned
Conroe, TX.................      Manufacturing                                   208,059        Owned
Dallas, TX.................      Manufacturing, Distribution & Office            753,536        Owned
Dallas, TX.................      Distribution                                    472,500        Leased (1)
El Paso, TX................      Manufacturing                                   161,714        Ground Leased (2)
Los Angeles, CA............      Distribution                                    410,515        Leased (1)
</TABLE>

(1)  The leases for the Baltimore, MD; Los Angeles, CA; and Dallas, TX
     facilities expire on February 28, 2006, April 30, 2007 and January 30,
     2003, respectively, and are subject to renewal options.

(2)  The ground lease expires on November 21, 2034.

The Company's Jacksonville, FL facility (leased) was closed in fiscal year 
1997 and the corresponding lease expires on May 31, 1999. The Company closed 
its Coleman, TX manufacturing facility in fiscal year 1997 and closed its Mt. 
Gilead, NC manufacturing facility in fiscal year 1998. As of January 1, 1999, 
the Company was pursuing the sale of the Mt. Gilead facility.

SALES CENTERS

As of January 1, 1999, the Company owned two sales centers aggregating 38,020 
square feet. Their location and floor area are as follows:
<TABLE>
<CAPTION>
LOCATION                                                                SQ. FEET
--------                                                                --------
<S>                                                                     <C>
Denver, CO.........................................................      22,500
San Antonio, TX....................................................      15,520
</TABLE>

In addition, 218 sales centers were leased as of January 1, 1999 (aggregating 
approximately 2.5 million square feet) pursuant to leases that extend for 
terms on average of three to five years with expiration dates primarily from 
1999-2004.

For a description of aggregate rental expenses with respect to its operating 
leases, see Note 12 to the Consolidated Financial Statements included herein 
relating to commitments and contingencies.

ITEM 3.    LEGAL PROCEEDINGS

In addition to the proceedings described under Item 1, 
"Business-Environmental Regulation," the Company is involved in various 
lawsuits arising in the normal course of business. In the opinion of 
management, the ultimate outcome of these lawsuits will not have a material 
adverse effect on the Company.

                                       -10-

<PAGE>

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

            None.

EXECUTIVE OFFICERS OF THE REGISTRANT

The information appearing in Item 10 hereof under the caption "Directors and 
Executive Officers of the Registrant" is incorporated by reference herein.

                                     PART II

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

MARKET INFORMATION FOR COMMON STOCK

The Company's Common Stock, par value $.01 per share (the "Common Stock"), is 
listed on the New York Stock Exchange under the symbol "DTL". The following 
table sets forth the high and low sale prices for the Common Stock as 
reported by the New York Stock Exchange from January 4, 1997, through January 
1, 1999:
<TABLE>
<CAPTION>
                                                                       HIGH                 LOW
                                                                       ----                 ---
                  <S>                                                  <C>                  <C>
                  January 4, 1997 to April 4, 1997                     19-3/4               14-1/2
                  April 5, 1997 to July 4, 1997                        18-7/8               12
                  July 5, 1997 to October 3, 1997                      18-3/8               13-5/8
                  October 4, 1997 to January 2, 1998                   14-11/16              9-1/2
                  January 3, 1998 to April 3, 1998                     14-1/8               10-1/2
                  April 4, 1998 to July 3, 1998                        15-3/16              12-5/16
                  July 4, 1998 to October 2, 1998                      14                    8-3/16
                  October 3, 1998 to January 1, 1999                   11-1/2                6
</TABLE>

HOLDERS

At March 8, 1999, there were 96 holders of record of Common Stock and 
53,566,996 shares of Common Stock outstanding.

DIVIDEND POLICY

The Company has not paid cash dividends on the Common Stock for the last 
three years. The Company currently intends to retain any earnings for use in 
its business and therefore does not anticipate paying any cash dividends on 
the Common Stock in the foreseeable future.

Moreover, the Company is a holding company with no operations or significant 
assets other than its investment in Dal-Tile Group Inc. ("Dal-Tile Group") 
and its 49.99% interest in RISA. Dal-Tile Group is a separate and distinct 
legal entity and has no obligation, contingent or otherwise, to make funds 
available to Dal-Tile, whether in the form of loans, dividends or other cash 
distributions. The bank credit agreement limits dividends, loans and other 
cash distributions from Dal-Tile Group to Dal-Tile, so that profits generated 
by Dal-Tile Group may not be available to Dal-Tile to pay cash dividends or 
repay indebtedness or otherwise. In light of these limitations, Dal-Tile 
Group will be prohibited from making such dividends, loans and other cash 
distributions, and Dal-Tile does not believe that Dal-Tile Group will be able 
to make such dividends, loans and other cash distributions in the foreseeable 
future.

                                       -11-

<PAGE>

ITEM 6.    SELECTED FINANCIAL DATA

The following selected financial data presented for fiscal years 1994 through 
1998 are derived from the Consolidated Financial Statements of the Company 
for such period, and should be read in conjunction with Item 7, "Management's 
Discussion and Analysis of Financial Condition and Results of Operations" and 
with the Consolidated Financial Statements including the related notes 
thereto included elsewhere herein:
<TABLE>
<CAPTION>
                                                                                     FISCAL YEAR ENDED
                                                      -----------------------------------------------------------------------------
                                                        JANUARY 1,      JANUARY 2,       JANUARY 3,            DECEMBER 31,
                                                                                                       ----------------------------
                                                         1999              1998            1997            1995           1994
                                                   ------------------ --------------- --------------- --------------- -------------
                                                                         (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                <C>                <C>             <C>             <C>             <C>
OPERATING DATA: (1)
      Net sales..................................      $ 751,785          $ 676,637     $   720,236       $ 474,812      $ 506,309
      Cost of goods sold.........................        396,112            404,728         369,731         225,364        268,272
                                                       ---------          ---------     -----------       ---------      ---------
      Gross profit...............................        355,673            271,909         350,505         249,448        238,037
      Expenses:
          Transportation.........................         55,988             58,425          47,125          33,535         32,068
          Selling, general and administrative....        222,790            277,515         190,911         134,193        132,887
          Provisions for merger integration 
           charges...............................              -                  -           9,000          22,430              -
          Amortization of goodwill...............          5,604              5,605           5,605           4,765          4,765
                                                       ---------          ---------     -----------       ---------      ---------
      Total operating expenses...................        284,382            341,545         252,641         194,923        169,720
                                                       ---------          ---------     -----------       ---------      ---------
      Operating income (loss) ...................         71,291            (69,636)         97,864          54,525         68,317
      Interest expense...........................         45,051             40,649          46,338          55,453         53,542
      Interest income............................            128                268           1,685           1,250          1,403
      Other income ..............................          1,264              1,220             129           2,994          1,341
                                                       ---------          ---------     -----------       ---------      ---------
     Income (loss) before income taxes and        
           extraordinary item....................         27,632           (108,797)         53,340           3,316         17,519
      Income tax provision ......................          3,604              1,439          18,914           1,176         10,614
                                                       ---------          ---------     -----------       ---------      ---------
      Income (loss) before extraordinary item....         24,028           (110,236)         34,426           2,140          6,905
      Extraordinary item - loss on early 
       retirement of debt, net of taxes..........              -                  -         (29,072)              -              -
                                                       ---------          ---------     -----------       ---------      ---------
      Net income (loss)..........................      $  24,028          $(110,236)    $     5,354       $   2,140      $   6,905
                                                       ---------          ---------     -----------       ---------      ---------
                                                       ---------          ---------     -----------       ---------      ---------
BASIC EARNINGS PER SHARE:
      Income (loss) before extraordinary item per   
       common share..............................      $    0.45          $   (2.06)    $      0.71     $      0.07      $    0.24
      Extraordinary item per common share........              -                  -           (0.60)              -              -
                                                       ---------          ---------     -----------       ---------      ---------
      Net income (loss) per common share.........      $    0.45          $   (2.06)    $      0.11     $      0.07      $    0.24
                                                       ---------          ---------     -----------       ---------      ---------
                                                       ---------          ---------     -----------       ---------      ---------
      Average outstanding common shares..........         53,487             53,435          48,473          28,743         28,587
                                                       ---------          ---------     -----------       ---------      ---------
                                                       ---------          ---------     -----------       ---------      ---------
DILUTED EARNINGS PER SHARE:
      Income (loss) before extraordinary item per   
       common share.............................       $    0.45          $   (2.06)    $      0.69     $      0.07      $    0.23
      Extraordinary item per common share.......               -                  -           (0.58)              -              -
                                                       ---------          ---------     -----------       ---------      ---------
      Net income (loss) per common share........       $    0.45          $   (2.06)    $      0.11     $      0.07      $    0.23
                                                       ---------          ---------     -----------       ---------      ---------
                                                       ---------          ---------     -----------       ---------      ---------
        Average outstanding common and          
        equivalent shares.......................          53,983             53,435          50,053          29,668         29,664
                                                       ---------          ---------     -----------       ---------      ---------
                                                       ---------          ---------     -----------       ---------      ---------
BALANCE SHEET DATA (AT END OF PERIOD): (2)
      Working capital................                  $ 117,615          $ 154,888     $   180,819       $ 152,128      $ 115,717
      Total assets...................                    640,808            672,069         688,497         672,393        488,417
      Total debt.....................                    500,432            557,091         465,858         527,816        492,753
      Long-term debt.................                    453,923            537,830         433,035         480,769        489,404
      Stockholders' equity (deficit).                     15,459              3,920         115,569           9,639       (103,823)
</TABLE>
                                       -12-
<PAGE>

(1)        Operating data for the fiscal years ended December 31, 1995 and
           December 31, 1994 excludes the results of operations of AO as the AO
           Acquisition occurred on December 29, 1995, and are not directly
           comparable to subsequent periods.

(2)        Balance sheet data for January 1, 1999, January 2, 1998, January 3,
           1997 and December 31, 1995 include the assets acquired and
           liabilities assumed from the AO Acquisition and are not directly
           comparable to December 31, 1994 data.

ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
           CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

For the fiscal year ended January 1, 1999, the Company's earnings 
substantially improved over fiscal year 1997. Significant sales and earnings 
growth were achieved during fiscal year 1998 due primarily to steps taken to 
reduce overall costs and improve customer service and the overall supply 
chain. Through improved production forecasting, distribution and delivery 
enhancements and refinements in order entry and invoicing processes, the 
supply chain was strengthened, which in turn allowed for better product 
availability and improved order fill rates.

Earnings improved due to the growth in sales and reductions in both 
transportation and general and administrative expenses. The reductions in 
transportation costs were achieved through improved positioning of 
inventories, the renegotiation of freight contracts and consolidation of 
carriers. The Company continued to reduce general and administrative expenses 
through elimination of unneeded overhead and lower bad debt expense and 
professional fees.

Significant improvements in cash flows were achieved as the Company focused 
on the management of working capital and reduced capital spending. Through 
the implementation of better collection and billing procedures, accounts 
receivable were reduced and days sales outstanding dropped from 60 days in 
fiscal year 1997 to 52 days in fiscal year 1998. The Company continued to 
improve the management of its inventories by providing better alignment of 
production requirements with sales demands. Net capital expenditures 
decreased approximately $34 million while still allowing for the completion 
of state-of-the-art manufacturing capacity at the Dallas, TX plant and 
installation of additional capacity at the Monterrey, Mexico facility.

On July 1, 1998, Armstrong World Industries, Inc.("AWI") completed its sale 
in a registered public offering of 10,350,000 shares of Dal-Tile common stock 
(the "Common Stock"), and on November 18, 1998, AWI completed the sale in a 
registered public offering of all of its remaining shares of the Common 
Stock. The Company did not receive any proceeds from the sale by AWI of the 
Common Stock.

ASSET WRITE-DOWNS AND OTHER CHARGES

FISCAL YEAR 1998

During fiscal year 1998, the Mt. Gilead, NC glazed floor manufacturing 
facility was closed and is currently being held for sale. Based on this 
decision, the Company reviewed the carrying value to determine the extent, if 
any, of impairment relating to the asset. An aggregate provision of $6.6 
million was recorded in cost of sales to reduce the carrying value of the 
facility to its estimated net realizable value. The provision was comprised 
of $1.7 million recorded during the second quarter of fiscal year 1998 based 
upon a preliminary estimate made by the Company and $4.9 million recorded 
during the 

                                       -13-

<PAGE>

fourth quarter of fiscal year 1998 based upon an independent appraisal. The 
provision in the fourth quarter was substantially offset by the release of 
excess reserves which were previously provided by the Company. At January 1, 
1999, the net book value of the facility was $2.0 million and was classified 
in machinery and equipment on the face of the balance sheet.

FISCAL YEAR 1997

During fiscal year 1997, the Company recorded charges of $90.1 million for
obsolete and slow-moving inventories, uncollectible trade accounts 
receivable, other non-productive assets and costs for restructuring of 
manufacturing, store operations and corporate administrative functions. The 
charges were comprised of $36.5 million in cost of sales, $3.5 million in 
transportation expenses and $50.1 million in selling, general and 
administrative expenses.

In response to deterioration in the aging of the Company's accounts 
receivable, the Company increased collection efforts and undertook detailed 
reviews of collectibility, and subsequently recorded an increase in the 
reserve for doubtful accounts of $21.3 million for fiscal year 1997. The 
write-down of uncollectible trade accounts receivable related to increases in 
receivables balances arising principally as a result of earlier sales 
initiatives that included, among other things, extended credit terms and 
efforts to expand the Company's customer base, and operational and systems 
integration issues that resulted in limited access by sales center personnel 
to certain account information. In addition, in an effort to improve customer 
service, authority to extend credit was decentralized and assigned to 
management at the retail sales centers. Sales resulting from these 
initiatives were a result of products being shipped under defined terms to 
customers, with the full expectation of invoiced amounts being paid in full 
within the terms of the sale. By the end of the second quarter of fiscal year 
1997, the sales initiatives, which began in the fourth quarter of fiscal year 
1996, were discontinued and the Company moved to a more centralized credit 
approval process and implemented more stringent credit policies.

The Company also extensively reviewed its finished product inventories, 
including various patterns, shapes and sizes. Management believes that delays 
in systems integration resulted in impaired inventory management, and, in 
particular, resulted in an imbalance in inventory mix. During the third 
quarter of fiscal year 1997, the Company's new management undertook an 
additional study of the business and its operations and determined that it 
would reduce the number of SKUs offered for sale by the Company and would 
discontinue additional patterns. These actions, coupled with the results of 
physical inventories and the delay in systems integration, resulted in a need 
to record fiscal year 1997 inventory provisions of $36.5 million, consisting 
of $14.2 million related to results of physical inventories, $15.7 million 
believed to be slow moving and/or obsolete or out of balance with other 
related products, $4.5 million to write-down certain other inventory accounts 
and $2.1 million to write-down raw materials.

The balance of the charges consisted of $6.7 million in respect of terminated 
employees, $6.2 million primarily related to liabilities incurred for lease 
terminations, executive search fees and other items, $8.5 million in respect 
of accrued expenses, primarily related to freight and insurance, $5.3 million 
in respect of fixed assets impairment and $5.6 million in respect of other 
charges, primarily related to write-down of notes, non-trade receivables and 
certain other assets.

As of January 1, 1999, reserves relating to the fiscal year 1997 charges for 
inventories, accounts receivable and other non-productive assets were 
depleted, and the Company substantially completed the work-down of all other 
charges incurred. Reserves of approximately $3.8 million relating to fiscal 
year 1997 initiatives to restructure the organization remain outstanding and 
are expected to effect future cash flows through the end of fiscal year 1999.

                                       -14-

<PAGE>

FISCAL YEAR 1996

On December 29, 1995, the Company acquired American Olean Tile Company, Inc. 
("AO") and certain related assets of the ceramic tile business (the "AO 
Acquisition") of AWI. In the first quarter of fiscal year 1996, the Company 
recorded an integration charge of $9.0 million in connection with the AO 
Acquisition and the Company's merger integration plan. The charge was for 
closings of duplicative sales centers, duplicative distribution centers, 
elimination of overlapping positions and the closing of a manufacturing 
facility. The Company completed these actions during fiscal year 1997. The 
primary components of the charge were $7.4 million for lease commitments, 
$1.3 million for severance and employee contracts and $0.3 million for shut 
down costs of the closed facilities.

As of January 1, 1999, the Company retained approximately $6.6 million of 
reserves primarily related to the continued expiration of lease commitments 
associated with sales centers that had been closed. Future cash outlays are 
anticipated to continue through the end of fiscal year 2004.

RESULTS OF OPERATIONS

The following table sets forth certain operating data as a percentage of net 
sales for the periods indicated:
<TABLE>
<CAPTION>
                                                                            FISCAL YEAR ENDED
                                                            -------------------------------------------------
                                                            JANUARY 1, 1999  JANUARY 2, 1998   JANUARY 3, 1997
                                                            ---------------  ---------------  ---------------
<S>                                                         <C>              <C>               <C>
Net sales..............................................           100.0%           100.0%            100.0%
Cost of goods sold.....................................            52.7             59.8              51.3
                                                            ---------------  ----------------  ----------------
Gross profit...........................................            47.3             40.2              48.7
Operating expenses.....................................            37.8             50.5              33.9
                                                            ---------------  ----------------  ----------------
                                                                    9.5            (10.3)             14.8
Non-recurring charges:
     Provision for merger integration charges..........               -                -               1.2
                                                            ---------------  ----------------  ----------------
Operating income (loss)................................             9.5            (10.3)             13.6
Interest expense (net).................................             6.0              6.0               6.2
Other income...........................................             0.2              0.2                 -
                                                            ---------------  ----------------  ----------------
Income (loss) before income taxes and
     extraordinary item................................             3.7            (16.1)              7.4
Income tax provision...................................             0.5              0.2               2.6
                                                            ---------------  ----------------  ----------------
Income (loss) before extraordinary item................             3.2            (16.3)              4.8
Extraordinary item, net of taxes.......................               -                -              (4.1)
                                                            ---------------  ----------------  ----------------
Net income (loss)......................................             3.2%           (16.3)%             0.7%
                                                            ---------------  ----------------  ----------------
                                                            ---------------  ----------------  ----------------
</TABLE>

FISCAL YEAR ENDED JANUARY 1, 1999 COMPARED TO FISCAL YEAR ENDED JANUARY 2, 
1998

NET SALES

Net sales increased $75.2 million, or 11.1%, to $751.8 million for fiscal 
year 1998 from $676.6 million for fiscal year 1997. The increase in net sales 
was due principally to improved customer service in all distribution channels 
realized through system and process enhancements, better product availability 
and the restructuring of the sales organization in late fiscal year 1997. Net 
sales through Company-operated sales centers increased $50.7 million, or 
10.7%, and same store sales increased approximately 10.3%. In 

                                       -15-

<PAGE>

addition, net sales increased within the independent distributor and Home 
Centers channels approximately $9.3 million, or 8.8%, and $7.2 million, or 
9.2%, respectively.

Net sales within Mexico increased $6.7 million to $25.2 million in fiscal 
year 1998 from $18.5 million in fiscal year 1997. This increase occurred as 
the Company increased its utilization of U.S. manufacturing capacity from its 
El Paso, TX and Dallas, TX facilities resulting in a larger allocation of the 
Company's Mexican production to be sold in Mexico.

GROSS PROFIT

Gross profit increased $83.8 million, or 30.8%, to $355.7 million in fiscal 
year 1998 from $271.9 million in fiscal year 1997. The increase in gross 
profit was due primarily to the growth in sales and lower manufacturing costs.

Gross margin increased to 47.3% for fiscal year 1998 from 40.2% for fiscal 
year 1997. This increase was due primarily to higher sales and lower 
manufacturing costs. During fiscal year 1998, overall manufacturing plant 
utilization increased from approximately 80% to 90% resulting in lower per 
unit manufacturing costs. Additionally, cost reductions were achieved through 
the closing of inefficient plants and shifting of production to low cost 
state-of-the-art facilities. Fiscal year 1997 results were negatively 
affected by inventory valuation adjustments of $36.5 million.

EXPENSES

Expenses decreased $57.1 million, or 16.7%, to $284.4 million in fiscal year 
1998 from $341.5 million in fiscal year 1997. The decrease was due primarily 
to reductions in staffing, lower bad debt expense and reduced professional 
service fees. Fiscal year 1997 was negatively affected by charges of $53.6 
million. These charges related to the write-down of uncollectible trade 
accounts receivable and other non-productive assets, adjustments to accrued 
expenses and various other charges relating to the implementation of fiscal 
year 1997 initiatives to restructure the organization.

Expenses as a percent of sales decreased to 37.8% in fiscal year 1998 from 
50.5% in fiscal year 1997. This decrease was the result of higher sales and 
the decreased expenses described above. In addition, freight expense as a 
percent of sales decreased to 7.4% for fiscal year 1998 versus 8.6% in fiscal 
year 1997.

OPERATING INCOME (LOSS)

Operating income (loss) increased to $71.3 million in fiscal year 1998, from 
a loss of $69.6 million in fiscal year 1997. Operating margin increased to 
9.5% from a negative operating margin of 10.3% for the previous fiscal year 
due primarily to increased sales, decreased manufacturing costs and decreased 
expenses.

INTEREST EXPENSE (NET)

Interest expense (net) increased $4.5 million, or 11.1%, to $44.9 million in 
fiscal year 1998 from $40.4 million in fiscal year 1997. Interest expense 
increased due to higher borrowing requirements through the end of fiscal year 
1997 and increased fees and interest rates in connection with the second and 
third quarter 1997 amendments to the Company's credit facility offset by 
decreases associated with the work-down of debt throughout fiscal year 1998.

                                       -16-

<PAGE>

INCOME TAXES

The income tax provisions for fiscal years 1998 and 1997 reflect Mexico tax 
liabilities and U.S. state and possession income tax based on taxable income 
in those jurisdictions.

No U.S. federal income tax expense was recorded for fiscal year 1998 due to 
an offsetting reduction in a valuation allowance recorded against U.S. 
federal deferred tax assets. No U.S. federal income tax benefit was recorded 
in fiscal year 1997 due to the Company establishing a valuation allowance in 
that year which offset any benefit of federal net operating losses and to 
reflect management's estimation as to the future utilization of the deferred 
tax assets. The valuation allowance will continue to be reassessed in future 
reporting periods.

PESO-U.S. DOLLAR EXCHANGE RATE

During the fourth quarter of fiscal year 1998, management reviewed the 
reporting requirements related to its Mexican operations. Based on this 
review, the Company changed its functional currency in Mexico to the U.S. 
dollar. The Company's Mexican facility is considered an extension of the U.S. 
parent and primarily a provider of ceramic tile to the Company's U.S. 
operations. Due to the U.S. parent's manufacturing requirements, fiscal year 
1998 domestic sales in Mexico were limited to approximately 3.4% of the 
Company's consolidated net sales. Prior to fourth quarter 1998, translation 
gains or losses relating to exchange rate changes were reported as a separate 
component of stockholders' equity. Due to the change in functional currency, 
translation gains or losses and foreign currency transaction gains or losses 
are recognized in other income and expense. During fiscal year 1998, the 
Company recorded translation and transaction gains of approximately $1.7 
million. Management utilizes foreign currency forward contracts to offset 
exposure to exchange rate changes. During fiscal years 1998 and 1997, the 
Company did not enter into any foreign currency forward contracts.

FISCAL YEAR ENDED JANUARY 2, 1998 COMPARED TO FISCAL YEAR ENDED JANUARY 3, 
1997 

NET SALES

Net sales decreased $43.6 million, or 6.1%, to $676.6 million for fiscal year 
1997 from $720.2 million for fiscal year 1996. The decrease in net sales was 
due principally to the negative impact on the Company-operated sales centers 
caused by the delay in systems integration and the consolidation throughout 
fiscal year 1996 and into fiscal year 1997 of redundant sales centers from 
the AO Acquisition. Sales within the Home Centers channel decreased 
approximately 10% compared to fiscal year 1996 due to price concessions and 
certain large customers working down their warehouse inventories. 
Additionally, net sales were negatively impacted by one less week in fiscal 
year 1997 as compared to fiscal year 1996. These decreases were offset by a 
4% increase in same store sales in the Company-operated sales centers and a 
10% increase in sales within the independent distributor channel due to the 
addition of 16 distributor locations.

During fiscal year 1997, the Company completed its sales center consolidation 
and substantially completed its information systems integration.

GROSS PROFIT

Gross profit decreased $78.6 million, or 22.4%, to $271.9 million in fiscal 
year 1997 from $350.5 million in fiscal year 1996. The decrease in gross 
profit was due in part to the 1997 second and third quarter charges for 
obsolete and slow-moving inventories. Sales declines and decreases in 
production levels also adversely impacted gross profit.

                                       -17-

<PAGE>

Gross margin (excluding the 1997 second and third quarter charges) decreased 
to 45.6% for fiscal year 1997 from 48.7% for fiscal year 1996. During the 
first half of fiscal year 1997, gross margin (excluding charges) was 48.4% 
and decreased to 42.7% in the second half of fiscal year 1997, primarily as a 
result of higher per unit manufacturing costs associated with reduced 
production levels. Additionally, during fiscal year 1997, gross margin 
decreased as a result of a higher percentage mix of sales within the 
independent distributor business unit. Sales through this channel carry lower 
gross margins than sales made through the Company's sales centers, but due to 
lower operating expense levels comparable operating margins are achieved.

EXPENSES

Expenses increased $88.9 million, or 35.2%, to $341.5 million in fiscal year 
1997 from $252.6 million in fiscal year 1996. The increase was due primarily 
to the second and third quarter charges, increased freight costs associated 
with the consolidation of eleven distribution centers to three 
mega-distribution centers, higher fixed costs for information technology and 
additional expenses to complete the AO integration.

Expenses as a percent of sales (excluding 1997 second and third quarter 
charges and the 1996 merger integration charge) increased to 42.6% in fiscal 
year 1997 from 33.9% in fiscal year 1996. These increases were the result of 
lower sales and the increased expenses described above.

During the fourth quarter of fiscal year 1997, the Company issued stock units 
under a stock appreciation rights agreement to certain executives which 
permit the holders, upon the satisfaction of certain conditions, to receive 
value in excess of the base price of the unit at the date of grant. Payment 
of the excess will be in cash, stock or a combination of cash and stock at 
the discretion of the Board of Directors. In connection with this agreement, 
non-cash expense of $5.9 million was recorded in the fourth quarter of fiscal 
year 1997.

OPERATING INCOME (LOSS)

Operating income (loss) decreased $167.5 million to a loss of $69.6 million 
in fiscal year 1997 from income of $97.9 million in fiscal year 1996. 
Operating margin (excluding 1997 second and third quarter charges and the 
1996 merger integration charge) decreased to 3.0% from 14.8% for the previous 
fiscal year due primarily to reduced sales, decreased production levels and 
increased expenses.

INTEREST EXPENSE (NET)

Interest expense (net) decreased $4.3 million, or 9.6%, to $40.4 million in 
fiscal year 1997 from $44.7 million in fiscal year 1996. Interest expense 
decreased due to interest savings from the refinancing of debt concurrent 
with the Company's initial public offering in the third quarter of fiscal 
year 1996. The decrease was partially offset by increases in debt levels and 
borrowing rates related to the second quarter amendment of the existing 
credit agreement and increases in fees and higher borrowing rates related to 
the third quarter 1997 amendment.

INCOME TAXES

The income tax provision for fiscal year 1997 represents amounts related to 
income from Mexican operations. Due to the significant loss in fiscal year 
1997 and prior year tax loss carryforwards, a valuation allowance was 
recorded against the net Federal and State deferred tax asset. This valuation 
allowance will be reassessed in future reporting periods.

                                       -18-

<PAGE>

INCOME (LOSS) BEFORE EXTRAORDINARY ITEM

Income (loss) before extraordinary item decreased $144.6 million to a loss of 
$110.2 million in fiscal year 1997 from income of $34.4 million in fiscal 
year 1996. The decrease was due primarily to the second and third quarter 
charges and reductions in operating income offset by lower interest and 
income tax expense.

PESO-U.S. DOLLAR EXCHANGE RATE

The Company's Mexican facility is primarily a provider of ceramic tile to the 
Company's U.S. operations and, in addition, sells ceramic tile in Mexico. In 
fiscal year 1997, domestic sales in Mexico represented approximately 3% of 
consolidated net sales. These sales are peso-denominated and the majority of 
the Mexican facility's cost of sales and operating expenses are 
peso-denominated. In fiscal year 1997, peso-denominated cost of sales and 
operating expenses represented approximately 7% of the Company's consolidated 
cost of sales and expenses. Exposure to exchange rate changes is favorable to 
operating results when the peso devalues against the U.S. dollar, since peso 
costs exceed peso revenues. As the peso appreciates against the U.S. dollar, 
the effect is unfavorable to operating results. In addition to the effect of 
exchange rate changes on operating results, foreign currency transaction 
gains or losses are recognized in other income and expense. During fiscal 
year 1997, the Company recorded a transaction gain of approximately $0.6 
million. Except for peso transactions, management utilizes foreign currency 
forward contracts to offset exposure to exchange rate changes, although the 
number and amount of such contracts are not significant. Since the exposure 
to exchange rate change is favorable when the peso devalues against the U.S. 
dollar and management does not expect the peso to appreciate significantly 
against the U.S. dollar in the near term, management has not entered into 
peso currency forward contracts during fiscal years 1997 and 1996.

LIQUIDITY AND CAPITAL RESOURCES

Funds available under the Company's existing bank credit agreement provided 
liquidity and capital resources for working capital requirements, capital 
expenditures and debt service. Cash provided by operating activities was 
$57.0 million in fiscal year 1998 versus cash used of $52.8 million in fiscal 
year 1997. This improvement was due primarily to increased profitability and 
improved management of working capital.

Net expenditures for property, plant and equipment were $5.8 million for 
fiscal year 1998, inclusive of $8.1 million in net cash proceeds from the 
first quarter sale of the Company's Lansdale, PA manufacturing facility. The 
expenditures were for routine capital improvements, the completion of the 
Dallas, TX plant expansion and costs to expand the Monterrey, Mexico 
manufacturing facility.

During the fourth quarter of fiscal year 1998, the Company amended certain 
financial covenants to provide increased flexibility under the existing bank 
credit agreement (as amended, the "Third Amended Credit Facility"). Under the 
Third Amended Credit Facility, the Company is required, among other things, 
to maintain certain financial covenants and has restrictions on incurring 
additional debt and limitations on cash dividends. The Company was in 
compliance with such covenants at January 1, 1999. A commitment fee at a rate 
per annum based on a pricing grid is payable quarterly.

Cash used in financing activities was $56.7 million for fiscal year 1998, 
which reflects revolver repayments and term debt amortization on the 
Company's Third Amended Credit Facility of $38.0 million and $13.5 million, 
respectively. Total availability as of January 1, 1999 under the Third 
Amended Credit Facility was $83.9 million. The Company believes cash flow 
from operating activities, 

                                       -19-

<PAGE>

together with borrowings available under the Company's Third Amended Credit 
Facility, will be sufficient to fund future working capital needs, capital 
expenditures and debt service requirements.

The Company periodically uses interest rate swap agreements to manage 
exposure to fluctuations in interest rates. These agreements involve the 
exchange of interest obligations on fixed and floating interest rate debt 
without the exchange of the underlying principal amounts. The differential 
paid or received on the agreements is recognized as an adjustment to interest 
expense over the term of the underlying swap agreement. The book value of the 
interest rate swap agreements represents the differential receivable or 
payable with a swap counterparty since the last settlement date. The 
underlying aggregate notional amount on which the Company had interest rate 
swap agreements outstanding was $300.0 million at January 1, 1999. Under the 
terms of the swap agreements, the Company pays a fixed interest rate of 
approximately 5.7%. As of January 1, 1999, the swap agreements had an 
aggregate fair value of $(3.2) million, with $100.0 million in effect until 
January 13, 2000 and $200.0 million in effect through January 16, 2001. There 
were no interest rate swap agreements during fiscal year 1997.

The peso devaluation and economic uncertainties in Mexico are not expected to 
have a significant impact on liquidity. Since the Company has no peso-based 
borrowings, high interest rates in Mexico are not expected to directly affect 
the Company.

The Company is involved in various proceedings relating to environmental 
matters and is currently engaged in environmental investigation and 
remediation programs at certain sites. The Company has provided reserves for 
remedial investigation and cleanup activities that the Company has determined 
to be both probable and reasonably estimable. The Company is entitled to 
indemnification with respect to certain expenditures incurred in connection 
with such environmental matters and does not expect that the ultimate 
liability with respect to such investigation and remediation activities will 
have a material effect on the Company's liquidity and financial condition.

The United States is a party to the General Agreement on Tariffs and Trade 
("GATT"). Under GATT, the United States currently imposes import duties on 
glazed ceramic tile from non-North American countries at 15%, to be reduced 
ratably to 8-1/2% by 2004. Accordingly, GATT may stimulate competition from 
non-North American manufacturers who now export, or who may seek to export, 
ceramic tile to the United States. The Company cannot predict with certainty 
the effect that GATT may have on the Company's operations.

In 1993, Mexico, the United States and Canada approved the North American 
Free Trade Agreement ("NAFTA"). NAFTA has, among other things, removed and 
will continue to remove, over a transition period, most normal customs duties 
imposed on goods traded among the three countries. In addition, NAFTA will 
remove or limit many investment restrictions, liberalize trade in services, 
provide a specialized means for settlement of, and remedies for, trade 
disputes arising thereunder, and will result in new laws and regulations to 
further these goals. Although NAFTA lowers the tariffs imposed on the 
Company's ceramic tile manufactured in Mexico and sold in the United States, 
it also may stimulate competition in the United States and Canada from 
manufacturers located in Mexico. The United States currently imposes import 
duties on glazed ceramic tile from Mexico of approximately 13%, although 
these duties on imports from Mexico are being phased out ratably under NAFTA 
by 2008. It is uncertain what ultimate effect NAFTA will have on the 
Company's results of operations.

EFFECTS OF INFLATION

The Company believes it has generally been able to enhance productivity to
offset increases in costs resulting from inflation in the U.S. and Mexico.
Inflation has not had a material impact on the results of operations for fiscal
years 1998, 1997 and 1996. However, any future increases in the inflation rate,

                                       -20-

<PAGE>


which affect financing costs, may negatively affect the Company's results of 
operations.

IMPACT OF YEAR 2000

Some of the Company's computer programs were written using two digits rather 
than four to define the applicable year. As a result, those computer programs 
have time-sensitive software that recognize a date using "00" as the year 
1900 rather than the year 2000. This could cause a system failure or 
miscalculations causing disruptions of operations, including, among other 
things, a temporary inability to process transactions, send invoices or 
engage in similar normal business activities.

The Company is continuing its efforts to modify and replace certain portions 
of its software and equipment so that its computer systems will function 
properly with respect to dates in the year 2000 and thereafter. The total 
Year 2000 cost is estimated at approximately $5.4 million and will be 
expensed as incurred. To date, the Company has completed the updating of 
"mission critical" software for Year 2000 date processing and has implemented 
these changes into the day-to-day business systems. In addition, customers, 
suppliers and carriers have been required to certify their readiness for Year 
2000. Through the end of fiscal year 1998, expenses totaling $3.5 million 
were incurred for Year 2000 activities.

The modification and testing of all "mission critical" software and 
equipment, including the testing of interrelationships of all components is 
estimated to be completed no later than the second quarter of fiscal year 
1999, which is prior to any anticipated impact on the Company's operating 
systems. Less critical activities, including the upgrade of stand-alone 
equipment and monitoring of supplier and carrier progress, will continue for 
the balance of fiscal year 1999. The Company believes that, with 
modifications to existing software and conversions to new software, the Year 
2000 issue will not pose significant operational problems for its computer 
systems. However, if such modifications and conversions are not made, or are 
not completed in a timely manner, the Year 2000 issue could have a material 
adverse impact on operations.

The cost of the project and the date by which the Company believes it will 
complete the Year 2000 modifications are based on management's best 
estimates, which were derived utilizing numerous assumptions of future 
events, including the continued availability of certain resources and other 
factors. However, there can be no guarantee that these estimates will be 
achieved and actual results could differ materially from those anticipated. 
Specific factors that might cause such material differences include, but are 
not limited to, the availability and cost of personnel trained in this area, 
the ability to locate and correct all relevant computer codes, 
non-performance of key software and hardware vendors and similar 
uncertainties.

In addition, material disruptions to the operations of the Company's major 
customers and suppliers as a result of Year 2000 issues could also have a 
material adverse impact on the Company's operations and financial condition. 
At present, the Company is preparing a detailed Year 2000 contingency plan. 
The contingency plan will include a more definitive risk assessment related 
to major customers and suppliers and how the Company plans to mitigate such 
risk. The plan is expected to be in place by the end of the third quarter of 
fiscal year 1999.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE 
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain statements contained in this filing are "forward-looking statements" 
within the meaning of the Private Securities Litigation Reform Act of 1995. 
Such statements are subject to risks, uncertainties and other factors, which 
could cause actual results to differ materially from future results expressed 
or implied by such forward-looking statements. Potential risks and 
uncertainties include, but are not limited to, the 

                                       -21-

<PAGE>

impact of competitive pressures and changing economic conditions on the 
Company's business and its dependence on residential and commercial 
construction activity, the fact that the Company is highly leveraged, Year 
2000 issues, currency fluctuations and other factors relating to the 
Company's foreign manufacturing operations, the impact of pending reductions 
in tariffs and custom duties and environmental laws and other regulations.

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The table below provides information regarding the Company's market-sensitive 
financial instruments and constitutes a forward-looking statement. The 
information is presented in U.S. dollars, which is the Company's reporting 
currency. Since all significant international operations use the U.S. dollar 
as the functional currency, the Company deems foreign currency risk to be 
minimal. The Company's major market risk exposure relates to changes in the 
general level of U.S. interest rates. To mitigate the impact of fluctuations 
in U.S. rates, the Company currently maintains approximately 60% of its debt 
as fixed rate by entering into interest rate swap agreements. Interest rate 
swap agreements are designated with a portion of the principal balance and 
term of a specific debt obligation. The Company does not enter into contracts 
for speculative purposes.
<TABLE>
<CAPTION>
                                                                                                         FAIR VALUE
                                                                                                         JANUARY 1,
EXPECTED MATURITY DATES                 1999       2000       2001       2002        2003    THEREAFTER     1999
(IN THOUSANDS)                       ---------- ---------- ---------- ----------- ---------- ---------- ------------
<S>                                  <C>        <C>        <C>        <C>         <C>        <C>          <C>
Total  debt:
       Fixed Rate...................   $ 3,633    $ 3,921    $ 2,885    $    879   $      -        $   -     $ 11,318
       Average Interest Rate........      8.3%       8.4%       8.5%        8.3%

       Variable Rate................   $42,876    $52,876    $52,876    $219,387   $120,800        $ 299     $489,114
       Average Interest Rate (a)....      7.3%       7.5%       7.3%        7.3%       7.9%         7.9%

Interest rate swaps:
       Pay Fixed/Receive Variable...   $ (900)    $   204    $    18    $      -   $      -        $   -     $(3,174)
       Average Pay .................      5.7%       5.7%       5.7%
       Average Receive..............      5.4%       5.8%       5.9%
</TABLE>

   (a)     The Term loans, revolver borrowings and other debt bear interest at
           weighted average variable rates based on implied forward rates in the
           yield curve at the reporting date plus an applicable margin ranging
           from 0.625%-2.75% depending upon the Company's leverage ratio (as
           defined under the Third Amended Credit Facility). The variable rate
           is equal to LIBOR (London Interbank Offered Rate) as announced from
           time to time. At January 1, 1999, the LIBOR interest rate in effect
           was 5.3% and applicable margins were 2.0% and 2.5% for the Term A
           loan / revolver borrowings and Term B loan, respectively.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements required by this item are set forth on pages F-1 
through F-23 below and the related financial statement schedule is set forth 
on page S-1 below.

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
           ACCOUNTING AND FINANCIAL DISCLOSURE

         None.

                                       -22-

<PAGE>

                                    PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The directors and executive officers of the Company are set forth below. 
Certain of the executive officers hold positions with Dal-Tile Corporation or 
Dal-Tile Mexico, each a subsidiary of the Company. All directors hold office 
until the annual meeting of stockholders following their election or until 
their successors are duly elected and qualified. Officers are appointed by 
the Board of Directors and serve at the discretion thereof.
<TABLE>
<CAPTION>
                    NAME                            AGE         POSITION OR OFFICE HELD
                    ----                            ---         -----------------------
<S>                                                 <C>         <C>
Jacques R. Sardas...........................         68         President, Chief Executive Officer and Chairman of the
                                                                Board of Directors
Charles J. Pilliod, Jr......................         80         Director
Douglas D. Danforth.........................         76         Director
John F. Fiedler.............................         60         Director
Vincent A. Mai..............................         58         Director
Norman E. Wells, Jr.........................         50         Director
Henry F. Skelsey............................         40         Director
John M. Goldsmith...........................         35         Director
W. Christopher Wellborn.....................         43         Executive Vice President, Chief Financial Officer and
                                                                Assistant Secretary
Mark A. Solls...............................         42         Vice President, General Counsel and Secretary
Dan L. Cooke................................         57         Vice President, Information Technology
William L. Justus...........................         44         Vice President, Logistics
William R. Hanks............................         45         Vice President, Manufacturing
David F. Finnigan ..........................         42         Vice President, Independent Distributor and Home Center 
                                                                Services Operations
D.D. "Gus" Agostinelli......................         53         Vice President, Human Resources
Javier Eugenio Martinez Serna...............         47         Vice President, Mexico Operations
Matthew J. Kahny............................         37         Vice President, Marketing
Harold G. Turk..............................         52         Vice President, Sales Centers Operations
H. Clay Orme................................         59         Vice President, Operations
Silvano Cornia..............................         39         Vice President, Research and Development
Scott R. Veldman............................         42         Treasurer
</TABLE>

JACQUES R. SARDAS, President, Chief Executive Officer and Chairman of the 
Board of Directors-Mr. Sardas has been President and Chief Executive Officer 
of the Registrant since July 1997 and Chairman of the Board of Directors 
since September 1997. Prior to joining the Company, Mr. Sardas was Chairman 
and Chief Executive Officer of Sudbury, Inc. from 1992 to 1997. Prior to 
that, he spent 34 years at Goodyear Tire & Rubber Company, concluding as 
President of Goodyear Worldwide Tire.

CHARLES J. PILLIOD, JR., Director-Mr. Pilliod has been a Director of the 
Registrant since March 1990 and served as Chairman of the Board of Directors 
from October 1993 through September 1997.  From October 1993 through April 
1994, Mr. Pilliod also served as President and Chief Executive Officer of the 
Registrant.  Mr. Pilliod served as U.S. Ambassador to Mexico from 1986 to 
1989.  Prior to that, he was the Chairman and Chief Executive Officer of 
Goodyear Tire & Rubber Company.  Mr. Pilliod is also a director of A. 
Schulman Inc. and Marvin & Palmer Associates, Inc.

DOUGLAS D. DANFORTH, Director-Mr. Danforth has been a Director of the 
Registrant since February 1997. He was Chairman and Chief Executive Officer 
of Westinghouse Corporation from December 1983 to December 1987.  Mr. 
Danforth is also a director of Sola International Inc.

JOHN F. FIEDLER, Director - Mr. Fiedler has been a Director of the Registrant 
since July 1998.  He is 

                                       -23-

<PAGE>

Chairman and Chief Executive Officer of Borg-Warner Automotive, Inc. Prior to 
joining Borg-Warner in June of 1994, he was Executive Vice President of The 
Goodyear Tire & Rubber Company where he was responsible for North American 
Tires. Mr. Fiedler's 29 year career with Goodyear included numerous sales, 
marketing and manufacturing positions in the U.S. and Far East.

VINCENT A. MAI, Director-Mr. Mai has been a Director of the Registrant since 
October 1989. Mr. Mai has been the President and Chief Executive Officer of 
AEA Investors (the managing member of DTI Investors LLC, a beneficial owner 
of Common Stock of the Registrant), since April 1989. For the preceding 15 
years, he was a Managing Director of Lehman Brothers Inc., an 
investment-banking firm. Mr. Mai is also a director of the Federal National 
Mortgage Association.

NORMAN E. WELLS, JR., Director-Mr. Wells has been a Director of the 
Registrant since December 1997. Mr. Wells joined Easco, Inc. as President and 
Chief Executive Officer in November 1996.  From March 1993 to November 1996, 
he was President and Chief Executive Officer of CasTech Aluminum Group Inc.

HENRY F. SKELSEY, Director-Mr. Skelsey has been a Director of the Registrant 
since October 1989. Since August 1998, Mr. Skelsey has been Executive Vice 
President and Chief Financial Officer of Tanning Technology Corporation, a 
system integration and solution business. From March 1988 until August 1998, 
Mr. Skelsey was a Managing Director of AEA Investors (the managing member of 
DTI Investors LLC, a beneficial owner of Common Stock of the Registrant), and 
since August 1998, Mr. Skelsey has acted as a consultant to AEA Investors.

JOHN M. GOLDSMITH, Director-Mr. Goldsmith has been a Director of the 
Registrant since April 1996. Mr. Goldsmith is a Managing Director of AEA 
Investors (the managing member of DTI Investors LLC, a beneficial owner of 
Common Stock of the Registrant), and has been associated with AEA Investors 
since 1989. Previously, he was a member of the Financial Services practice of 
Ernst & Young, an independent accounting firm.

W. CHRISTOPHER WELLBORN, Executive Vice President, Chief Financial Officer 
and Assistant Secretary-Mr. Wellborn has been Executive Vice President, Chief 
Financial Officer and Assistant Secretary of the Registrant since August 
1997. From June 1993 to August 1997, Mr. Wellborn was Senior Vice President 
and Chief Financial Officer of Lenox, Inc. Prior to Lenox, he was Vice 
President and Chief Financial Officer of Grand Metropolitan PLC's Alpo Pet 
Food Division.

MARK A. SOLLS, Vice President, General Counsel and Secretary-Mr. Solls has 
been Vice President, General Counsel and Secretary of the Registrant since 
January 1998.  From December 1994 to December 1997, he was Vice President and 
General Counsel for ProNet Inc.  Additionally, Mr. Solls has owned a private 
practice and worked as Counsel for several national health care companies.  
He is a Certified Mediator and a member of numerous legal associations.

DAN L. COOKE, Vice President, Information Technology-Mr. Cooke has been Vice 
President, Information Technology of the Registrant since January 1997. From 
1982 to 1996, he held various positions with PepsiCo in the Frito-Lay and 
Pizza Hut divisions, most recently as Pizza Hut Vice President, Information 
Technology. Prior to that, Mr. Cooke spent 17 years with IBM in sales and 
systems engineering management.

WILLIAM L. JUSTUS, Vice President, Logistics-Mr. Justus has been Vice 
President, Logistics of the Registrant since September 1998.  From 1995 until 
he joined the Company, Mr. Justus was Vice President of Operations for 
Livingston Healthcare Services, Inc. From 1989 to 1995, Mr. Justus worked at 
Bayer Corporation, concluding as Director of Physical Logistics for Bayer's 
Agfa Division.

                                       -24-

<PAGE>

WILLIAM R. HANKS, Vice President, Manufacturing-Mr. Hanks has been Vice 
President, Manufacturing of the Registrant since February 1994. He has been 
with the Company since March 1985 and prior to 1994 served as General 
Manager, Assistant Plant Manager and Vice President, Manufacturing of one of 
the Company's floor tile facilities.

DAVID F. FINNIGAN, Vice President, Independent Distributor and Home Center 
Services Operations-Mr. Finnigan has been Vice President, Independent 
Distributor Operations since August 1997 and Vice President of Home Center 
Services Operations since March 1998. Previously, Mr. Finnigan held the 
position of Vice President, Sales Centers Operations at the Company. Prior to 
the AO Acquisition, he held various executive marketing positions with AO, 
AWI and Evans and Black.

D.D. "GUS" AGOSTINELLI, Vice President, Human Resources-Mr. Agostinelli 
joined the Registrant as the Vice President, Human Resources in January 1998. 
From 1994 to 1997, he worked for Alcoa Fujikura Ltd. as Vice President, 
Human Resources.  Additionally, Mr. Agostinelli held various Human Resource 
positions within PPG Industries.

JAVIER EUGENIO MARTINEZ SERNA, Vice President, Mexico Operations-Mr. Martinez 
has been Vice President, Mexico Operations of the Registrant since August 
1995. Prior to August 1995, he was a managing director of Materiales 
Ceramicos S.A. de C.V., a prior subsidiary of the Registrant, since December 
1985. From 1980 to 1985, Mr. Martinez was Vice President of Strategic 
Planning and Business Diversification of the food division of Protexa, a 
diversified oil services, construction and food products company in 
Monterrey, Mexico.

MATTHEW J. KAHNY, Vice President, Marketing-Mr. Kahny has been Vice 
President, Marketing of the Registrant since August 1997. From January 1996 
until July 1997, Mr. Kahny was Vice President, Independent Distributor 
Operations. From July 1983 through December 1995, he served at AO, then a 
subsidiary of AWI, where he became Business Team Manager, Floor Tile Products.

HAROLD G. TURK, Vice President, Sales Centers Operations-Mr. Turk has been 
Vice President, Sales Centers Operations of the Registrant since January 
1997. From January 1996 to December 1996, Mr. Turk was Vice President, Home 
Center Services of the Company. In 1995, Mr. Turk was Executive Vice 
President of Field Operations of the Company. In 1994, he was Executive Vice 
President of Marketing of the Company. From April 1991 through 1993, Mr. Turk 
was Executive Vice President of Sales and Marketing, Western Region of the 
Company. Mr. Turk was Vice President of Warehouse Administration and Sales 
of the Company from 1976 to 1991.

H. CLAY ORME, Vice President, Operations-Mr. Orme has been Vice President, 
Operations of the Registrant since March 1999. Prior to joining the Company, 
Mr. Orme spent 36 years at Goodyear Tire & Rubber Company, concluding as Vice 
President, Product Supply for Goodyear's Global Operations. His 
responsibilities included the supervision of eighty-five plants located in 
twenty-six countries and corporate facilities planning.

SILVANO CORNIA, Vice President, Research and Development-Mr. Cornia has been 
Vice President, Research and Development of the Registrant since January 
1994. Since July 1984, he has held various positions at the Company.

SCOTT R. VELDMAN, Treasurer-Mr. Veldman has been Treasurer of the Registrant 
since December 1998. From October 1997 to December 1998, he was Assistant 
Treasurer of the Company. Prior to that, Mr. Veldman worked with Borg-Warner 
Security Corporation for 11 years, most recently as Assistant Treasurer.

ITEM 11.   EXECUTIVE COMPENSATION

The information appearing in the sections captioned "Directors' 
Compensation", "Executive Compensation" and "Compensation Committee 
Interlocks and Insider Participation" in the Company's Proxy Statement for 
the 1999 Annual Meeting of Stockholders (the "1999 Proxy Statement") is 

                                       -25-

<PAGE>

incorporated by reference herein.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information appearing in the section "Principal Stockholders" in the 1999 
Proxy Statement is incorporated by reference herein.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information appearing in the section captioned "Certain Transactions" in 
the 1999 Proxy Statement is incorporated by reference herein.

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

         (a)    Documents to be filed as part of this report:

         1.     Financial Statements under Item 8:

See Index to Consolidated Financial Statements and Financial Statement 
Schedule included on page F-1 below in this report.

         2.     Financial Statement Schedule filed herewith:

See Index to Consolidated Financial Statements and Financial Statement 
Schedule included on page F-1 below in this report.

All other schedules are omitted either because they are not required or 
because the required information is included in the financial statements and 
notes thereto included herein. See Index to Consolidated Financial Statements 
and Financial Statement Schedule included on page F-1 below in this report.

         3.     List of Exhibits. Each management contract or compensatory
                plan or arrangement required to be filed as an Exhibit to this
                Form 10-K pursuant to Item 14(c) of this report is identified
                with an asterisk (*).
<TABLE>
<CAPTION>
     EXHIBIT
       NO.
     -------
     <S>      <C>
      2.1     Stock Purchase Agreement, dated as of December 21, 1995, by and
              among Dal-Tile International Inc., Armstrong Enterprises, Inc.,
              Armstrong Cork Finance Corporation and Armstrong World Industries,
              Inc. (Filed as Exhibit 2 to the Registrant's Current Report on
              Form 8-K filed on January 16, 1996 and incorporated herein by
              reference.)

      2.2     Agreement and Plan of Merger among Dal-Tile International Inc.,
              DTI Investors LLC and DTI Merger Company, dated as of August 7,
              1996 (Filed as Exhibit 2.1 to the Registrant's Form 10-Q filed on
              November 7, 1996 and incorporated herein by reference.)

                                       -26-

<PAGE>

<CAPTION>
     EXHIBIT
       NO.
     -------
     <S>      <C>
      3.1     Second Amended and Restated Certificate of Incorporation of the
              Company. (Filed as Exhibit 3.1 to the Registrant's Form 10-Q filed
              on November 7, 1996 and incorporated herein by reference).

      3.2     Amended and Restated  By-laws of the Company.  (Filed as Exhibit 
              3.2 to the  Registrant's  Registration Statement on Form S-1 (No. 
              333-5069) and incorporated herein by reference.)

     *4.1     Specimen form of certificate for Common Stock.

      4.2     Dal-Tile International Inc. 1990 Stock Option Plan (As Amended and
              Restated) (Filed as Exhibit 4.4 to the Registrant's Registration
              Statement on Form S-8 (No. 333-70879) and incorporated herein by
              reference.)

     10.1     Amended and Restated Employment Agreement, dated June 7, 1993, 
              between Dal-Tile Corporation and Harold G. Turk.  (Filed  as  
              Exhibit  10.2.3  to the  Registrant's  Registration  Statement  
              on Form S-1 (No. 33-64140) and incorporated herein by reference.)

     10.2     Credit and Guarantee Agreement, dated August 14, 1996 among
              Dal-Tile International Inc., Dal-Tile Group Inc., the several
              banks, financial institutions and other entities from time-to-time
              party thereto, Credit Suisse, as Documentation Agent, Goldman
              Sachs Credit Partners L.P., as Syndication Agent, and The Chase
              Manhattan Bank, as Administrative Agent. (Filed as Exhibit 10.1 to
              the Registrant's Form 10-Q filed on November 7, 1996 and
              incorporated herein by reference.)

     10.3     Pledge Agreement dated as of October 4, 1996, made by Dal-Tile
              Group Inc. in favor of The Chase Manhattan Bank, as Administrative
              Agent, relating to the pledge of Common Stock of Dal-Tile Mexico,
              S.A. de C.V. (Filed as Exhibit 10.2 to the Registrant's Form 10-Q
              filed on November 7, 1996 and incorporated herein by reference.)

     10.4     Pledge Agreement dated as of August 14, 1996, made by Dal-Tile
              International Inc. in favor of The Chase Manhattan Bank, as
              Administrative Agent, relating to the pledge of Common Stock of
              Dal-Tile Group Inc. (Filed as Exhibit 10.3 to the Registrant's
              Form 10-Q filed on November 7, 1996 and incorporated herein by
              reference.)

     10.5     Pledge Agreement dated as of August 14, 1996 made by Dal-Tile
              Group Inc. in favor of The Chase Manhattan Bank, as Administrative
              Agent, relating to the pledge of Common Stock of Dal-Tile
              Corporation (Filed as Exhibit 10.4 to the Registrant's Form 10-Q
              filed on November 7, 1996 and incorporated herein by reference.)

     10.6     Pledge Agreement dated as of October 4, 1996, made by Dal-Tile
              Group Inc. in favor of The Chase Manhattan Bank, as Administrative
              Agent, relating to the pledge of Common Stock of Dal-Tile Mexico,
              S.A. de C.V. (Filed as Exhibit 10.2 to the Registrant's Form 10-Q
              filed on November 7, 1996 and incorporated herein by reference.)

     10.7     Form of Indemnification  Agreement between Dal-Tile  International
              Inc. and its directors and officers.  (Filed as Exhibit  10.4 to 
              the  Registrant's  Registration  Statement  on Form S-1 (No. 
              33-64140) and incorporated herein by reference.)

                                       -27-

<PAGE>

<CAPTION>
     EXHIBIT
       NO.
     -------
     <S>      <C>
     10.8     Settlement Agreement dated as of May 20, 1993, among AEA Investors
              Inc., DTM Investors Inc., Dal-Tile Group Inc., Dal-Tile
              Corporation, Dal-Minerals Company and Robert M. Brittingham and
              John G. Brittingham. (Filed as Exhibit 10.5 to the Registrant's
              Registration Statement on Form S-1 (No. 33-64140) and incorporated
              herein by reference.)

     10.9     Employment Agreement, dated as of June 13, 1997, and amended as of
              October 10, 1997 between Dal-Tile International Inc. and Jacques
              R. Sardas. (Filed as Exhibit 10.17 to the Registrant's Form 10-K
              for fiscal year 1997 and incorporated herein by reference.)

     10.10    Amended and Restated Employment Agreement, dated as of July 17,
              1998 between Dal-Tile International Inc. and Jacques R. Sardas.
              (Filed as Exhibit 10.1 to the Registrant's Form 10-Q filed on
              August 7, 1998 and incorporated herein by reference.)

     10.11    Employment Agreement, dated as of August 25, 1997, and amended
              October 10, 1997, between Dal-Tile International Inc. and W.
              Christopher Wellborn. (Filed as Exhibit 10.18 to the Registrant's
              Form 10-K for fiscal year 1997 and incorporated herein by
              reference.

    *10.12    First Amendment to Employment Agreement,  dated as of November 24,
              1998 between Dal-Tile  International Inc. and W. Christopher Wellborn.

     10.13    Stock Appreciation Rights Agreements, dated as of October 10,
              1997, and amended February 20, 1998, between Dal-Tile
              International Inc. and each of Jacques R. Sardas, W. Christopher
              Wellborn, Dan L. Cooke, Marc Powell, and David F. Finnigan. (Filed
              as Exhibit 10.19 to the Registrant's Form 10-K for fiscal year
              1997 and incorporated herein by reference.)

     10.14    First Amendment, dated as of June 19, 1997, to the Credit and
              Guarantee Agreement (Filed as Exhibit 10.1 to the Registrant's
              Form 10-Q filed on November 17, 1997 and incorporated herein by
              reference).

     10.15    Second Amendment, dated as of September 30, 1997, to the Credit
              and Guarantee Agreement (Filed as Exhibit 10.2 to the Registrant's
              Form 10-Q filed on November 17, 1997 and incorporated herein by
              reference).

     10.16    Third Amendment, dated as of November 19, 1998, to the Credit and
              Guarantee Agreement (Filed as Exhibit 10.1 to the Registrant's
              Current Report on Form 8-K filed on January 20, 1999 and
              incorporated herein by reference).

     10.17    Collateral Agreement, dated as of June 19, 1997, made by Dal-Tile
              Group Inc. and certain of its subsidiaries in favor of the Chase
              Manhattan Bank, as Administration Agent. (Filed as Exhibit 10.22
              to the Registrant's Form 10-K for fiscal year 1997 and
              incorporated herein by reference.)

    +21.1     List of subsidiaries of Dal-Tile International Inc.

    +23.1     Consent of Ernst & Young LLP

    +27.1     Financial Data Schedule

-----------------
+ Filed herewith.

</TABLE>

                                       -28-

<PAGE>

       (b)        Reports on Form 8-K:
                  None.


       (c)        Exhibits:
                  See Item 14(a) above.


       (d)        Financial Statement Schedule
                  See Item 14(a) above.




                                       -29-

<PAGE>

                                   SIGNATURES

PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES 
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED 
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, ON THE 17TH DAY 
OF MARCH 1999.

                                       DAL-TILE INTERNATIONAL INC.



                                   By:            s/Jacques R. Sardas         
                                       ---------------------------------------
                                                   JACQUES R. SARDAS
                                       President, Chief Executive Officer and
                                       Chairman of the Board of Directors

                                       
                               POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS 
BELOW HEREBY CONSTITUTES AND APPOINTS JACQUES R. SARDAS AND/OR W. CHRISTOPHER 
WELLBORN AS HIS TRUE AND LAWFUL ATTORNEY-IN-FACT AND AGENT, WITH FULL POWER 
OF SUBSTITUTION AND RESUBSTITUTION, FOR HIM IN HIS NAME, PLACE AND STEAD, IN 
ANY AND ALL CAPACITIES, TO SIGN ANY AND ALL AMENDMENTS TO THIS REPORT AND ANY 
AND ALL DOCUMENTS IN CONNECTION THEREWITH, AND TO FILE THE SAME, WITH ALL 
EXHIBITS THERETO, AND ALL DOCUMENTS IN CONNECTION THEREWITH, WITH THE 
SECURITIES AND EXCHANGE COMMISSION, GRANTING UNTO SAID ATTORNEY-IN-FACT AND 
AGENT FULL POWER AND AUTHORITY TO DO AND PERFORM EACH AND EVERY ACT AND THING 
REQUISITE AND NECESSARY TO BE DONE IN AND ABOUT THE PREMISES, AS FULLY TO ALL 
INTENTS AND PURPOSES AS HE MIGHT OR COULD DO IN PERSON, AND HEREBY RATIFIES, 
APPROVES AND CONFIRMS ALL THAT HIS SAID ATTORNEY-IN-FACT AND AGENT, OR HIS 
SUBSTITUTE OR SUBSTITUTES, MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE 
HEREOF. 

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS 
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES AND 
ON THE DATES INDICATED.

<TABLE>
<CAPTION>
              SIGNATURE                                TITLE                                    DATE
              ---------                                -----                                    ----
<S>                                       <C>                                               <C>
/s/ Jacques R. Sardas                     President, Chief Executive Officer                March 17, 1999
--------------------------------          and Chairman of the Board of 
     JACQUES R. SARDAS                    Directors                    


/s/ W. Christopher Wellborn               Executive Vice President, Chief                   March 17, 1999
---------------------------------         Financial Officer and Assistant   
     W. CHRISTOPHER WELLBORN              Secretary (Principal Financial and
                                          Accounting Officer)               


/s/ John M. Goldsmith                     Director                                          March 17, 1999
-------------------------------
     JOHN M. GOLDSMITH


/s/ Charles J. Pilliod, Jr.               Director                                          March 17, 1999
---------------------------------
     CHARLES J. PILLIOD, JR.


/s/ Henry F. Skelsey                      Director                                          March 17, 1999
--------------------------------
     HENRY F. SKELSEY

                                       -30-

<PAGE>

<CAPTION>
              SIGNATURE                                TITLE                                    DATE
              ---------                                -----                                    ----
<S>                                       <C>                                               <C>
/s/ John F. Fiedler                       Director                                          March 17, 1999
-------------------------------
    JOHN F. FIEDLER


/s/ Douglas D. Danforth                   Director                                          March 17, 1999
-------------------------------
     DOUGLAS D. DANFORTH


/s/ Vincent A. Mai                        Director                                          March 17, 1999
--------------------------------
     VINCENT A. MAI


/s/ Norman E. Wells, Jr.                  Director                                          March 17, 1999
--------------------------------
     NORMAN E. WELLS, JR.
</TABLE>


                                       -31-
<PAGE>

<TABLE>
<CAPTION>
                                            DAL-TILE INTERNATIONAL INC.

                                    ITEM 14(A)-INDEX TO CONSOLIDATED FINANCIAL
                                    STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

                      FISCAL YEARS ENDED JANUARY 1, 1999, JANUARY 2, 1998 AND JANUARY 3, 1997

                                                     CONTENTS
<S>                                                                                                       <C>
Report of Independent Auditors.......................................................................     F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at January 1, 1999 and January 2, 1998...................................     F-3
Consolidated Statements of Operations for each of the three years in the period ended
January 1, 1999......................................................................................     F-4
Consolidated Statements of Stockholders' Equity for each of the three years in the period ended 
January 1, 1999......................................................................................     F-5
Consolidated Statements of Cash Flows for each of the three years in the period ended
January 1, 1999......................................................................................     F-6
Notes to Consolidated Financial Statements...........................................................     F-7
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
Schedule II-Valuation and Qualifying Accounts........................................................     S-1
</TABLE>

All other schedules for which provision is made in the applicable accounting 
regulations of the Securities and Exchange Commission are not required under 
the related instructions or are inapplicable and therefore have been omitted.

                                       F-1

<PAGE>


                        REPORT OF INDEPENDENT AUDITORS



The Board of Directors
Dal-Tile International Inc.

We have audited the accompanying consolidated balance sheets of Dal-Tile 
International Inc. as of January 1, 1999 and January 2, 1998, and the related 
consolidated statements of operations, stockholders' equity and cash flows 
for each of the three years in the period ended January 1, 1999. Our audits 
also included the financial statement schedule listed in the Index at Item 
14(a). These financial statements and schedule are the responsibility of the 
Company's management. Our responsibility is to express an opinion on these 
financial statements and schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above 
present fairly, in all material respects, the consolidated financial position 
of Dal-Tile International Inc. at January 1, 1999 and January 2, 1998, and 
the consolidated results of its operations and its cash flows for each of the 
three years in the period ended January 1, 1999, in conformity with generally 
accepted accounting principles. Also, in our opinion, the related financial 
statement schedule, when considered in relation to the basic financial 
statements taken as a whole, presents fairly in all material respects the 
information set forth therein.



                                               /s/ Ernst & Young

                                               Ernst & Young

Dallas, Texas
February 10, 1999

                                       F-2

<PAGE>

                                            DAL-TILE INTERNATIONAL INC.

                                            CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                           JANUARY 1,            JANUARY 2,
                                                                              1999                  1998
                                                                         ----------------       ----------------
                                                                                     (IN THOUSANDS)
<S>                                                                      <C>                    <C>
ASSETS
Current assets:
    Cash......................................................              $    1,546             $    7,488
    Trade accounts receivable.................................                  93,331                 96,296
    Inventories...............................................                 138,418                130,747
    Prepaid expenses..........................................                   4,213                  3,120
    Other current assets......................................                  17,319                 18,438
                                                                         ----------------       ----------------
          Total current assets................................                 254,827                256,089
Property, plant and equipment, at cost:
    Land......................................................                  12,364                 17,205
    Leasehold improvements....................................                  12,193                 11,067
    Buildings.................................................                  75,995                 75,134
    Machinery and equipment...................................                 179,479                183,806
    Construction in process...................................                   8,029                 12,020
                                                                         ----------------       ----------------
                                                                               288,060                299,232
Accumulated depreciation......................................                  86,058                 71,547
                                                                         ----------------       ----------------
                                                                               202,002                227,685
Goodwill, net of amortization.................................                 147,796                152,560
Finance costs, net of amortization............................                   6,687                  6,599
Tradename and other assets, net of amortization...............                  29,496                 29,136
                                                                         ================       ================
          Total assets........................................               $ 640,808              $ 672,069
                                                                         ================       ================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Trade accounts payable....................................               $  28,684            $    18,231
    Accrued expenses..........................................                  59,420                 55,043
    Accrued interest payable..................................                     490                  2,287
    Current portion of long-term debt.........................                  46,509                 19,261
    Income taxes payable......................................                     169                    801
    Deferred income taxes.....................................                   1,930                    863
    Other current liabilities.................................                      10                  4,715
                                                                         ----------------       ----------------
          Total current liabilities...........................                 137,212                101,201

Long-term debt................................................                 453,923                537,830
Other long-term liabilities...................................                  32,639                 27,230
Deferred income taxes.........................................                   1,575                  1,888
Commitments and contingencies
Stockholders' equity:
    Common stock..............................................                     535                    534
    Additional paid-in capital................................                 436,182                436,100
    Accumulated deficit.......................................                (346,858)              (370,886)
    Accumulated other comprehensive loss......................                 (74,400)               (61,828)
                                                                         ----------------       ----------------
          Total stockholders' equity..........................                  15,459                  3,920
                                                                         ================       ================
          Total liabilities and stockholders' equity..........               $ 640,808              $ 672,069
                                                                         ================       ================
</TABLE>
                                                See accompanying notes.

                                       F-3

<PAGE>

                                              DAL-TILE INTERNATIONAL INC.

                                         CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                                    FISCAL YEAR ENDED
                                                                  ------------------------------------------------------
                                                                    JANUARY 1,         JANUARY 2,          JANUARY 3,
                                                                       1999               1998                1997
                                                                  ----------------   ----------------    ---------------
                                                                          (IN THOUSANDS, EXCEPT PER SHARE DATA)
    <S>                                                            <C>                <C>                  <C>          
    Net sales...............................................          $ 751,785          $ 676,637           $ 720,236
    Cost of goods sold......................................            396,112            404,728             369,731
                                                                  ----------------   ----------------    ---------------
                                                                        355,673            271,909             350,505
    Operating expenses:
       Transportation.......................................             55,988             58,425              47,125
       Selling, general and administrative..................            222,790            277,515             190,911
       Provision for merger integration charges.............                  -                  -               9,000
       Amortization of goodwill and tradename...............              5,604              5,605               5,605
                                                                  ----------------   ----------------    ---------------
    Total operating expenses................................            284,382            341,545             252,641
                                                                  ----------------   ----------------    ---------------
    Operating income (loss).................................             71,291            (69,636)             97,864
    Interest expense........................................             45,051             40,649              46,338
    Interest income.........................................                128                268               1,685
    Other income............................................              1,264              1,220                 129
                                                                  ----------------   ----------------    ---------------
    Income (loss) before income taxes and extraordinary item             27,632           (108,797)             53,340
    Income tax provision....................................              3,604              1,439              18,914
                                                                  ----------------   ----------------    ---------------
    Income (loss) before extraordinary item.................             24,028           (110,236)             34,426  
    Extraordinary item - loss on early retirement of                                                                    
      debt, net of taxes....................................                  -                  -             (29,072) 
                                                                  ----------------   ----------------    ---------------
    Net income (loss).......................................          $  24,028          $(110,236)        $     5,354
                                                                  ================   ================    ===============
    BASIC EARNINGS PER SHARE
    Income (loss) before extraordinary item per common share          $    0.45          $   (2.06)        $      0.71
    Extraordinary item per common share.....................                                                           
                                                                              -                  -               (0.60)
                                                                  ----------------   ----------------    ---------------
    Net income (loss) per common share......................          $    0.45          $   (2.06)        $     0.11   
                                                                  ================   ================    ===============
    Average outstanding common shares.......................             53,487             53,435              48,473  
                                                                  ================   ================    ===============
    DILUTED EARNINGS PER SHARE
    Income (loss) before extraordinary item per common share          $    0.45          $   (2.06)        $      0.69
    Extraordinary item per common share.....................                  -                  -               (0.58)
                                                                  ----------------   ----------------    ---------------
    Net income (loss) per common share......................          $    0.45          $   (2.06)        $      0.11
                                                                  ================   ================    ===============
    Average outstanding common and equivalent shares........             53,983             53,435              50,053
                                                                  ================   ================    ===============
</TABLE>
                                              See accompanying notes.

                                       F-4
<PAGE>
                                          DAL-TILE INTERNATIONAL INC.

                                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                                ACCUMULATED
                                       PREVIOUS      CONVERTED    ADDITIONAL                       OTHER
                                        COMMON        COMMON       PAID-IN     ACCUMULATED    COMPREHENSIVE
                                        STOCK          STOCK       CAPITAL       DEFICIT           LOSS           TOTAL  
                                    -------------    ---------    ----------   -----------    -------------     ---------
<S>                                 <C>              <C>          <C>           <C>            <C>                 <C>   
BALANCE AT DECEMBER 31, 1995....... $     41           $    -     $ 334,035    $ (266,004)     $ (58,433)       $   9,639
Stock conversion...................      (41)             454          (413)            -              -                -
Proceeds from AWI in connection
with the AO Acquisition............        -                -           650             -              -              650
Stock issued in connection with
the Initial Public Offering.........       -               80       101,828             -              -          101,908

Comprehensive income (loss):
Net income..........................       -                -             -         5,354              -            5,354
Currency translation adjustment.....       -                -             -             -         (1,982)          (1,982)
                                                                                                                ---------
Total comprehensive income..........       -                -             -             -              -            3,372
                                    -------------    ---------    ----------   -----------    -------------     ---------
BALANCE AT JANUARY 3, 1997..........       -              534       436,100      (260,650)       (60,415)         115,569
Comprehensive income (loss):
Net loss............................       -                -             -      (110,236)             -         (110,236)
Currency translation adjustment.....       -                -             -             -         (1,413)          (1,413)
                                                                                                                ---------
Total comprehensive loss............       -                -             -             -              -         (111,649)
                                    -------------    ---------    ----------   -----------    -------------     ---------
BALANCE AT JANUARY 2, 1998..........       -              534       436,100      (370,886)       (61,828)           3,920
Common stock registration
expenses............................       -                -        (1,030)            -              -           (1,030)
Proceeds from common stock
issue...............................       -                1         1,112             -              -            1,113

Comprehensive income (loss):
Net income..........................       -                -             -        24,028              -           24,028
Currency translation adjustment.....       -                -             -             -        (12,572)         (12,572)
                                                                                                                ---------
Total comprehensive income..........       -                -             -             -              -           11,456
                                    -------------    ---------    ----------   -----------    -------------     ---------
BALANCE AT JANUARY 1, 1999.......... $     -           $  535     $ 436,182    $ (346,858)     $ (74,400)       $  15,459
                                    =============    =========    ==========   ===========    =============     =========
</TABLE>
                                              See accompanying notes.

                                       F-5
<PAGE>

                                              DAL-TILE INTERNATIONAL INC.

                                         CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                                    FISCAL YEAR ENDED
                                                                    --------------------------------------------------
                                                                     JANUARY 1,        JANUARY 2,        JANUARY 3,
                                                                         1999              1998             1997
                                                                    --------------    --------------    --------------
                                                                                     (IN THOUSANDS)
<S>                                                                 <C>               <C>               <C>           
OPERATING ACTIVITIES
Net income (loss) ..............................................        $  24,028         $(110,236)        $   5,354
 Adjustments to reconcile net income (loss) to net cash provided
    by (used in) operating activities:
       Depreciation and amortization ...........................           27,873            24,543            24,017
       Extraordinary loss ......................................                -                 -            29,072
       Impairment of long-lived assets .........................            6,625                 -                 -
       Provision for losses on accounts receivable .............            7,024            27,805             5,781
       Foreign exchange transaction (gain) loss ................           (2,407)              339               (59)
       Deferred income tax provision (benefit) .................            1,995              (475)           13,539

       Changes in operating assets and liabilities:
              Trade accounts receivable ........................           (5,091)             (688)          (25,752)
              Inventories ......................................          (14,956)           10,845           (39,607)
              Other assets .....................................           (3,194)           (7,420)              217
              Trade accounts payable and accrued expenses ......           14,955             4,442             6,854
              Accrued interest payable .........................           (1,797)           (1,004)          (14,105)
              Other liabilities ................................            1,901              (958)          (23,995)
                                                                        ---------         ---------         ---------
 Net cash provided by (used in) operating activities ...........           56,956           (52,807)          (18,684)

INVESTING ACTIVITIES
 Expenditures for property, plant and equipment, net ...........           (5,776)          (40,074)          (42,039)

FINANCING ACTIVITIES
 Borrowings under long-term debt ...............................          149,808           111,007           451,000
 Borrowings under Term B loan ..................................                -           125,000                 -
 Borrowings under previous bank credit facility ................                -                 -            63,723
 Repayment of long-term debt ...................................         (206,467)          (19,968)         (576,679)
 Repayment of long-term debt from Term B loan ..................                -          (122,000)                -
 Fees associated with debt refinancing and stock registration ..           (1,118)           (3,576)          (42,765)
 Proceeds from issuance of common stock ........................            1,113                 -           102,558
                                                                        ---------         ---------         ---------
 Net cash provided by (used in) financing activities ...........          (56,664)           90,463            (2,163)

 Effect of exchange rate changes on cash .......................             (458)              (93)              (80)
                                                                        ---------         ---------         ---------
 Net increase (decrease) in cash ...............................           (5,942)           (2,511)          (62,966)
 Cash at beginning of year .....................................            7,488             9,999            72,965
                                                                        =========         =========         =========
 Cash at end of year ...........................................        $   1,546         $   7,488         $   9,999
                                                                        =========         =========         =========
</TABLE>
                                                See accompanying notes.

                                       F-6

<PAGE>
                          DAL-TILE INTERNATIONAL INC.       
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                JANUARY 1, 1999             

1.     ORGANIZATION

Dal-Tile International Inc. (the "Company"), a holding company, owns the 
outstanding capital stock of its sole direct subsidiary, Dal-Tile Group Inc. 
(the "Group"), and conducts its operations through the Group. The Group also 
conducts substantially all of its operations through its subsidiaries. 
Dal-Tile International Inc., as a stand-alone holding company, has no 
operations (see Note 15).

The Group is a multinational manufacturing and distribution company operating 
in the United States, Mexico and Canada. The Group offers a full range of 
glazed and unglazed ceramic tile products and accessories. The Group's 
products are sold principally through its extensive network of 
Company-operated sales centers. The Group also distributes products through 
independent distributors and sells to home center retailers and flooring 
dealers.

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements reflect the consolidation of all 
accounts of the Company, which includes the Group and the Group's wholly 
owned subsidiaries:
<TABLE>
<CAPTION>
                                                                  FORM OF ENTITY
                                                             --------------------------
<S>                                                          <C>
Dal-Tile Group Inc........................................            U.S. Corporation
Dal-Tile Corporation......................................            U.S. Corporation
Tileways, Inc.............................................            U.S. Corporation
DTM/CM Holdings, Inc......................................            U.S. Corporation
R&M Supplies, Inc. .......................................            U.S. Corporation
Dal-Minerals Company .....................................            U.S. Corporation
Dal-Tile Mexico, S.A. de C.V. ("Dal-Tile Mexico").........         Mexican Corporation
Dal-Tile of Canada Inc....................................        Canadian Corporation
</TABLE>

During 1998, the Company merged the operations of Materiales Ceramicos, S.A. 
de C.V., a Mexican Corporation, into Dal-Tile Mexico.

Significant intercompany transactions and balances have been eliminated in 
consolidation.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted 
accounting principles requires management to make estimates and assumptions 
that affect the reported amounts of assets and liabilities and disclosures of 
contingent assets and liabilities at the date of the financial statements and 
the reported amounts of revenues and expenses during the reporting period. 
Actual results could differ from those estimates.

                                       F-7

<PAGE>

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with maturities of three 
months or less to be cash equivalents.

INVENTORIES

U.S. finished products inventories are valued at the lower of cost (last-in, 
first-out ("LIFO")) or market, while U.S. raw materials and goods-in-process 
inventories are valued at the lower of cost (first-in, first-out ("FIFO")) or 
market. Mexican and Canadian inventories are valued at the lower of cost 
(FIFO) or market.

DEPRECIATION

Depreciation for financial reporting purposes is determined using the 
straight-line method. Estimated useful lives are as follows:
<TABLE>
<CAPTION>
                                                                            YEARS
                                                                    ----------------------
<S>                                                                 <C>
Leasehold improvements.......................................           Life of lease
Buildings....................................................               20-30
Machinery and equipment......................................                3-15
</TABLE>

INTANGIBLE ASSETS

Goodwill and tradename, which represent the excess cost over the fair value 
of net assets acquired, are amortized on a straight-line basis over the 
expected period to be benefited of 40 years and 25 years, respectively. 
Accumulated amortization relating to goodwill at January 1, 1999 and January 
2, 1998 was $66,654,000 and $61,890,000, respectively. Accumulated 
amortization relating to tradename at January 1, 1999 and January 2, 1998 was 
$2,520,000 and $1,680,000, respectively. The carrying values of goodwill, 
tradename and other long-lived assets are reviewed periodically to determine 
whether they may be impaired. If an impairment exists, the impairment loss is 
measured by comparing the fair value of the business unit's long-lived assets 
to their carrying amount.

FINANCE COSTS

Finance costs incurred in connection with financings are being amortized over 
the term of the related debt on a straight-line basis. Accumulated 
amortization at January 1, 1999 and January 2, 1998 was approximately 
$2,358,000 and $1,112,000, respectively.

ADVERTISING EXPENSES

Advertising and promotion expenses are charged to income during the period in 
which they are incurred. Advertising and promotion expenses incurred for the 
fiscal years 1998, 1997 and 1996 amounted to $14,353,000, $16,722,000 and 
$14,627,000, respectively.

STOCK OPTIONS

The Company grants stock options for a fixed number of shares to employees 
with an exercise price equal to the fair value of the underlying common stock 
at the date of grant. The Company has elected to follow 

                                       F-8

<PAGE>

Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to 
Employees" ("APB 25"), and related interpretations in accounting for its 
employee stock options because the alternative fair value accounting provided 
for under Statement of Financial Accounting Standards No. 123, "Accounting 
for Stock-Based Compensation" ("SFAS 123"), requires the use of option 
valuation models that were not developed for use in valuing employee stock 
options. Under APB 25, no compensation expense is recognized because the 
exercise price of the Company's employee stock options equals the market 
price of the underlying stock on the date of grant.

RETIREMENT PLANS

The Company maintains a defined contribution 401(k) plan for eligible 
employees. A participant may contribute up to 15% of his total annual 
compensation (annual base pay for union participants) to the plan. 
Contributions by the Company to the plan are at the discretion of its Board 
of Directors. Currently, the Company matches 50% of any non-union 
participant's contribution to the plan up to 6% of the employee's total 
annual compensation. Dal-Tile Mexico maintains a defined benefit plan for 
eligible employees with funding policies based on local statutes.

FOREIGN CURRENCY TRANSLATION

The Company's Mexican operations use the U.S. dollar as their functional 
currency. Translation gains or losses are reflected in the consolidated 
statements of operations. Gains and losses resulting from foreign currency 
transactions are reflected currently in the consolidated statements of 
operations. The Company experienced foreign currency transaction gains 
(losses) of $1,727,000, $558,000 and $(80,000) for the years ended January 1, 
1999, January 2, 1998 and January 3, 1997, respectively.

FINANCIAL INSTRUMENTS

The carrying amounts of cash, trade accounts receivable and trade accounts 
payable approximate fair value because of the short maturity of those 
instruments. The carrying amount of the Company's long-term debt approximates 
its fair value, which the Company estimates based on incremental rates of 
comparable borrowing arrangements.

CONCENTRATIONS OF CREDIT RISK

The Company is engaged in the manufacturing and distribution of glazed and 
unglazed ceramic tile products and accessories in the United States and 
Mexico and the distribution of such manufactured products in Canada. The 
Company grants credit to customers, substantially all of whom are dependent 
upon the construction economic sector. The Company continuously evaluates its 
customers' financial condition and periodically requires payments to its 
customers to be issued on behalf of the customer and the Company. In 
addition, the Company frequently obtains liens on property to secure accounts 
receivable.

Trade accounts receivable are net of an allowance for losses from 
uncollectible accounts of $9,581,000 and $13,160,000 at January 1, 1999 and 
January 2, 1998, respectively.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the 1998 
presentation.

                                       F-9

<PAGE>

NET INCOME (LOSS) PER SHARE

In 1997, the Financial Accounting Standards Board issued Statement No. 128, 
"Earnings Per Share" ("SFAS 128"). SFAS 128 replaced the calculation of 
primary and fully diluted earnings per share with basic and diluted earnings 
per share. Unlike primary earnings per share, basic earnings per share 
excludes any diluted effects of options, warrants and convertible securities. 
Diluted earnings per share is very similar to the previously reported fully 
diluted earnings per share.
<TABLE>
<CAPTION>
                                                                          FISCAL YEAR ENDED
                                                           -----------------------------------------------
                                                             JANUARY 1,       JANUARY 2,        JANUARY 3,
                                                                1999             1998              1997
                                                           --------------     ----------        ----------
                                                                 (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                        <C>                <C>               <C>
BASIC EARNINGS PER SHARE
Income (loss) before extraordinary item .............        $  24,028        $(110,236)        $  34,426
Extraordinary item ..................................                -                -           (29,072)
                                                           -----------        ---------         ---------
Net income (loss) ...................................        $  24,028        $(110,236)        $   5,354
                                                           ===========        =========         =========
Average common shares outstanding ...................           53,487           53,435            48,473

Net income (loss) per common share ..................        $    0.45        $   (2.06)        $    0.11
                                                           ===========        =========         =========
DILUTED EARNINGS PER SHARE
Income (loss) before extraordinary item .............        $  24,028        $(110,236)        $  34,426
Extraordinary item ..................................                -                -           (29,072)
                                                           -----------        ---------         ---------
Net income (loss) ...................................        $  24,028        $(110,236)        $   5,354
                                                           ===========        =========         =========

Average common shares outstanding ...................           53,487           53,435            48,473
Effect of dilutive stock options ....................              496                -             1,580
                                                           -----------        ---------         ---------
Average common shares outstanding (assuming dilution)           53,983           53,435            50,053

Net income (loss) per common share ..................        $    0.45        $   (2.06)        $    0.11
                                                           ===========        =========         =========
</TABLE>

Options to purchase 1,694,000 shares of common stock at prices ranging from 
$8.69 to $9.01 per share were outstanding during the fourth quarter of fiscal 
year 1998, but were not included in the computation of diluted earnings per 
share for fiscal year 1998 because the options' exercise price was greater 
than the average market price of the common shares during each quarter of 
fiscal year 1998 in which the options were outstanding.

Options to purchase 6,597,371 shares of common stock at prices ranging from 
$9.01 to $13.75 per share were outstanding at January 2, 1998, but were not 
included in the computation of diluted earnings per share for fiscal year 
1997. Due to the Company's net loss for the year, these options would have 
had an antidilutive effect on earnings per share.

Options to purchase 50,000 shares of common stock at $19.75 per share were 
outstanding during the fourth quarter of fiscal year 1996 but were not 
included in the computation of diluted earnings per share for fiscal year 
1996 because the options' exercise price was greater than the average market 
price of the common shares during each quarter of fiscal year 1996 in which 
the options were outstanding.

NEW ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board issued Statement No. 
133, "Accounting for 

                                       F-10


<PAGE>

Derivative Instruments and Hedging Activities" ("SFAS 133"), which is 
required to be adopted in years beginning after June 15, 1999. Because of the 
Company's minimal use of derivatives, management does not anticipate that the 
adoption of SFAS 133 will have a significant effect on earnings or the 
financial position of the Company.

3.   INVENTORIES

Inventories consist of the following:
<TABLE>
<CAPTION>
                                                                                     JANUARY 1,      JANUARY 2,
                                                                                        1999            1998
                                                                                     ------------    ------------
                                                                                           (IN THOUSANDS)
<S>                                                                                   <C>            <C>
Finished products in U.S. .................................................           $ 119,508       $ 110,323
Finished products in Mexico................................................               3,822           4,307
Finished products in Canada................................................               2,019           2,266
Goods-in-process...........................................................               4,053           3,960
Raw materials..............................................................               9,016           9,891
                                                                                     ------------    ------------
Total inventories..........................................................           $ 138,418       $ 130,747
                                                                                     ============    ============
</TABLE>

If U.S. finished products inventories were shown at current costs 
(approximating the FIFO method) rather than at LIFO values, inventories would 
have been $1,600,000 lower and $2,200,000 higher than reported at January 1, 
1999 and January 2, 1998, respectively.

During fiscal year 1998, inventory quantities in six of the Company's LIFO 
pools were reduced. This reduction resulted in the liquidation of LIFO 
inventory quantities carried at higher costs prevailing in prior years as 
compared with the fiscal year 1998 costs, the effect of which decreased net 
income by approximately $772,000, or $0.01 per share (basic and diluted).

During fiscal year 1997, inventory quantities in three of the Company's LIFO 
pools were reduced. This reduction resulted in the liquidation of LIFO 
inventory quantities carried at higher costs prevailing in prior years as 
compared with the fiscal year 1997 costs, the effect of which decreased net 
income by approximately $691,000, or $0.01 per share (basic and diluted).

4.   INITIAL PUBLIC OFFERING

During the third quarter of fiscal year 1996, the Company completed an 
initial public offering (the "Offering") of its common stock and a concurrent 
private placement of its common stock. The Offering of 7,316,343 shares of 
common stock, including the underwriter over allotment, raised $102,428,802 
of gross proceeds with net proceeds, after underwriting commission and 
expenses, amounting to $92,557,930. The private placement of 714,286 shares 
of common stock raised $10,000,000 of proceeds with total net proceeds from 
the Offering and private placement amounting to $102,557,930. In connection 
with the Offering and private placement, the Company effected a 
re-capitalization of its capital stock. Pursuant to a common stock 
conversion, all of the classes of the Company's previously outstanding common 
stock were converted into 45,404,472 shares of a single class of common 
stock. In addition, all outstanding options to purchase Dal-Tile's capital 
stock were converted into options to purchase 4,204,747 shares of common 
stock.

                                       F-11

<PAGE>

5.  LONG-TERM DEBT

Long-term debt consists of the following:
<TABLE>
<CAPTION>
                                                                                  JANUARY 1,         JANUARY 2,
                                                                                     1999               1998
                                                                                ---------------    ---------------
                                                                                             (IN THOUSANDS)
<S>                                                                              <C>                 <C>
 Term A Loan, interest due quarterly at LIBOR plus 2% (approximately 7.3% at
     January 1, 1999), principal due in variable quarterly installments through
     December 31, 2002, collateralized by certain assets of the
     Company.....................................................................  $ 205,000          $ 217,500
 Term B Loan, interest due quarterly at LIBOR plus 2-1/2% (approximately
     7.8% at January 1, 1999), principal due in variable quarterly installments
     through December 31, 2003, collateralized by certain
     assets of the Company.......................................................    124,000            125,000

 Revolving line of credit, interest due quarterly at blended LIBOR rates plus 2%
     (approximately 7.5% at January 1, 1999), principal due
     December 31, 2002, collateralized by certain assets of the Company..........    152,050            190,000
 Other, principally borrowings to fund capital additions.........................     19,382             24,591
                                                                                   ---------          ---------
                                                                                     500,432            557,091
 Less current portion............................................................     46,509             19,261
                                                                                   ---------          ---------
                                                                                   $ 453,923          $ 537,830
                                                                                   =========          =========
</TABLE>

Concurrent with the Offering, the Company entered into a new bank credit 
agreement (the "New Bank Credit Agreement") which, along with the proceeds 
from the Offering and private placement, were used to repay substantially all 
of the Company's debt. The New Bank Credit Agreement included a term loan of 
$275,000,000 ("Term A Loan") and a revolving line of credit of $250,000,000.

During the second quarter of fiscal year 1997, the Company completed a new 
$125,000,000 Term B loan facility which made certain modifications to the New 
Bank Credit Agreement (the "Amended Credit Facility"). The proceeds of the 
Term B loan were used to repay $50,000,000 of the Term A Loan and $72,000,000 
of the existing revolving line of credit. The Amended Credit Facility did not 
modify the Term A Loan amortization schedule.

During the third quarter of fiscal year 1997, the Company amended certain 
financial covenants to provide increased flexibility under the Amended Credit 
Facility (as amended, the "Second Amended Credit Facility"). In connection 
with the Second Amended Credit Facility, the Company's borrowing rate was 
increased 50 basis points over the previously existing rates (which now range 
from 2 to 2-1/2% over LIBOR).

During the fourth quarter of fiscal year 1998, the Company amended certain 
financial covenants to provide increased flexibility under the Second Amended 
Credit Facility (as amended, the "Third Amended Credit Facility"). Under the 
Third Amended Credit Facility, the Company is required, among other things, 
to maintain certain financial covenants and has restrictions on incurring 
additional debt and limitations on cash dividends. The Company was in 
compliance with such covenants at January 1, 1999. A commitment fee at a rate 
per annum based on a pricing grid is payable quarterly.

As of January 1, 1999, the Company had availability of approximately 
$83,854,000 on the revolving line of credit. The availability is net of 
$14,096,333 in letters of credit for foreign inventory purchases and 

                                       F-12

<PAGE>

industrial revenue bond financing transactions.

The Company periodically uses interest rate swap agreements to manage 
exposure to fluctuations in interest rates. These agreements involve the 
exchange of interest obligations on fixed and floating interest rate debt 
without the exchange of the underlying principal amounts. The differential 
paid or received on the agreements is recognized as an adjustment to interest 
expense over the term of the underlying swap agreement. The book value of the 
interest rate swap agreements represents the differential receivable or 
payable with a swap counterparty since the last settlement date. The 
underlying aggregate notional amount on which the Company had interest rate 
swap agreements outstanding was $300,000,000 at January 1, 1999. Under the 
terms of the swap agreements, the Company pays a fixed interest rate of 
approximately 5.7%. As of January 1, 1999, the swap agreements had an 
aggregate fair value of $(3,174,000), with $100,000,000 in effect until 
January 13, 2000 and $200,000,000 in effect through January 16, 2001. There 
were no interest rate swap agreements during fiscal year 1997.

Aggregate maturities of long-term debt for the five years subsequent to 
January 1, 1999 (in thousands) are:
<TABLE>
       <S>                                              <C>
       1999..........................................   $    46,509
       2000..........................................        56,796
       2001..........................................        55,761
       2002..........................................       220,267
       2003..........................................       120,800
</TABLE>

Total interest cost incurred for the fiscal years 1998, 1997 and 1996 
amounted to approximately $45,173,000, $41,817,000 and $47,706,000, 
respectively, of which approximately $122,000, $1,168,000 and $1,368,000, 
respectively, was capitalized to property, plant and equipment. Total 
interest paid was $45,712,000, $41,899,000 and $52,857,000 for the fiscal 
years ended January 1, 1999, January 2, 1998 and January 3, 1997, 
respectively.

6.     EXTRAORDINARY ITEM

In connection with the refinancing and early extinguishment of debt during 
the fiscal year ended January 3, 1997, the Company recorded an extraordinary 
charge of $44,800,000 ($29,072,000, net of tax) for prepayment premiums on 
certain debt repaid, the write-off of existing deferred financing fees and a 
termination fee paid in connection with the termination of the Company's 
management agreement with AEA Investors.

7.     CAPITAL STRUCTURE

Common stock consists of the following:
<TABLE>
<CAPTION>
                                                                                     JANUARY 1,      JANUARY 2,
                                                                                        1999            1998
                                                                                     ------------    ------------
                                                                                           (IN THOUSANDS)
<S>                                                                                  <C>             <C>
Common stock, $0.01 par value--authorized shares--200,000,000, issued and
    outstanding shares--53,552,246 at January 1, 1999 and 53,435,101 at 
    January 2, 1998.................................................................  $     535       $     534
                                                                                     ============    ============
</TABLE>

At January 1, 1999, the Company has authorized 11,100,000 shares of preferred 
stock, none of which were outstanding. Holders of common stock are entitled 
to one vote per share on all matters to be voted 

                                       F-13

<PAGE>

upon by the stockholders, including the election of directors. Holders of 
common stock do not have cumulative voting rights and, therefore, holders of 
a majority of the shares voting for the election of directors can elect all 
the directors. In such event, the holders of the remaining shares will not be 
able to elect any directors.

Holders of common stock are entitled to receive such dividends as may be 
declared from time to time by the Board of Directors out of funds legally 
available therefore, after payment of dividends required to be paid on 
outstanding preferred stock, if any, and subject to the terms of the 
agreements governing the Company's long-term debt. In the event of the 
liquidation, dissolution or winding up of the Company, the holders of common 
stock are entitled to share pro rata in all assets remaining after payment of 
liabilities, subject to prior distribution rights of preferred stock then 
outstanding, if any. The common stock has no preemptive, conversion or 
redemption rights and is not subject to further calls or assessments by the 
Company.

8.       ASSET WRITE-DOWNS AND OTHER CHARGES

FISCAL YEAR 1998

During fiscal year 1998, the Mt. Gilead, NC glazed floor manufacturing 
facility was closed and is currently being held for sale. Based on this 
decision, the Company reviewed the carrying value to determine the extent, if 
any, of impairment relating to the asset. An aggregate provision of 
$6,625,000 was recorded in cost of sales to reduce the carrying value of the 
facility to its estimated net realizable value. The provision was comprised 
of $1,700,000 recorded during the second quarter of fiscal year 1998 based on 
a preliminary estimate made by the Company and $4,925,000 recorded during the 
fourth quarter of fiscal year 1998 based upon an independent appraisal. The 
provision in the fourth quarter was substantially offset by the release of 
excess reserves which were previously provided by the Company. At January 1, 
1999, the net book value of the facility was $2,000,000 and was classified in 
machinery and equipment on the face of the balance sheet.

FISCAL YEAR 1997

During fiscal year 1997, the Company recorded charges of $90,100,000 for 
obsolete and slow-moving inventories, uncollectible trade accounts 
receivable, other non-productive assets and costs for restructuring of 
manufacturing, store operations and corporate administrative functions. The 
charges were comprised of $36,500,000 in cost of sales, $3,500,000 in 
transportation expenses and $50,100,000 in selling, general and 
administrative expenses.

In response to deterioration in the aging of the Company's accounts 
receivable, the Company increased collection efforts and undertook detailed 
reviews of collectibility, and subsequently recorded an increase in the 
reserve for doubtful accounts of $21,300,000 for fiscal year 1997. The 
write-down of uncollectible trade accounts receivable related to increases in 
receivables balances arising principally as a result of earlier sales 
initiatives that included, among other things, extended credit terms and 
efforts to expand the Company's customer base, and operational and systems 
integration issues that resulted in limited access by sales center personnel 
to certain account information. In addition, in an effort to improve customer 
service, authority to extend credit was decentralized and assigned to 
management at the retail sales centers. Sales resulting from these 
initiatives were a result of products being shipped under defined terms to 
customers, with the full expectation of invoiced amounts being paid in full 
within the terms of the sale. By the end of the second quarter of fiscal year 
1997, the sales initiatives, which began in the fourth quarter of fiscal year 
1996, were discontinued and the Company moved to a more centralized credit 

                                       F-14

<PAGE>

approval process and implemented more stringent credit policies.

The Company also extensively reviewed its finished product inventories, 
including various patterns, shapes and sizes. Management believes that delays 
in systems integration resulted in impaired inventory management, and, in 
particular, resulted in an imbalance in inventory mix. During the third 
quarter of fiscal year 1997, the Company's new management undertook an 
additional study of the business and its operations and determined that it 
would reduce the number of SKUs offered for sale by the Company and would 
discontinue additional patterns. These actions, coupled with the results of 
physical inventories and the delay in systems integration, resulted in a need 
to record fiscal year 1997 inventory provisions of $36,500,000, consisting of 
$14,200,000 related to results of physical inventories, $15,700,000 believed 
to be slow-moving and/or obsolete or out of balance with other related 
products, $4,500,000 to write-down certain other inventory accounts and 
$2,100,000 to write-down raw materials.

The balance of the charges consisted of $6,700,000 in respect of terminated 
employees, $6,200,000 primarily related to liabilities incurred for lease 
terminations, executive search fees and other items, $8,500,000 in respect of 
accrued expenses, primarily related to freight and insurance, $5,300,000 in 
respect of fixed assets impairment and $5,600,000 in respect of other 
charges, primarily related to write-down of notes, non-trade receivables and 
certain other assets.

As of January 1, 1999, reserves relating to the fiscal year 1997 charges for 
inventories, accounts receivable and other non-productive assets were 
depleted, and the Company substantially completed the work-down of all other 
charges incurred. Reserves of approximately $3,800,000 relating to fiscal 
year 1997 initiatives to restructure the organization remain outstanding and 
are expected to effect future cash flows through the end of fiscal year 1999.

FISCAL YEAR 1996

On December 29, 1995, the Company acquired American Olean Tile Company, Inc. 
and certain related assets of the ceramic tile business (the "AO 
Acquisition") of Armstrong World Industries, Inc. ("AWI"). In the first 
quarter of fiscal year 1996, the Company recorded an integration charge of 
$9,000,000 in connection with the AO Acquisition and the Company's merger 
integration plan. The charge was for closings of duplicative sales centers, 
duplicative distribution centers, elimination of overlapping positions and 
the closing of a manufacturing facility. The Company completed these actions 
during fiscal year 1997. The primary components of the charge were $7,400,000 
for lease commitments, $1,300,000 for severance and employee contracts and 
$300,000 for shut down costs of the closed facilities.

 As of January 1, 1999, the Company retained approximately $6,600,000 of 
reserves primarily related to the continued expiration of lease commitments 
associated with sales centers that had been closed. Future cash outlays are 
anticipated to continue through the end of fiscal year 2004.

                                       F-15

<PAGE>

9.     INCOME TAXES

Income (loss) before income taxes and extraordinary items relating to 
operations is as follows:
<TABLE>
<CAPTION>
                                                                      FISCAL YEAR ENDED
                                                    -------------------------------------------------------
                                                     JANUARY 1,           JANUARY 2,          JANUARY 3,
                                                        1999                 1998                1997
                                                    --------------       -------------       --------------
                                                                        (IN THOUSANDS)
<S>                                                 <C>                  <C>                 <C>
United States...........................              $  12,905           $ (116,249)          $  45,812
Mexico..................................                 14,827                7,879               7,603
Other...................................                   (100)                (427)                (75)
                                                    --------------       -------------       --------------
                                                      $  27,632           $ (108,797)          $  53,340
                                                    ==============       =============       ==============
</TABLE>

The components of the provision for income taxes include the following:
<TABLE>
<CAPTION>
                                                                        FISCAL YEAR ENDED
                                                     ------------------------------------------------------
                                                    JANUARY 1,           JANUARY 2,           JANUARY 3,
                                                       1999                 1998                 1997
                                                  ----------------     ---------------      ---------------
                                                                       (IN THOUSANDS)
<S>                                                <C>                 <C>                    <C>
U.S. state - current......................           $     262             $       -           $  3,060
U.S. - deferred...........................               1,286                     -             (1,590)
                                                  ----------------     ---------------      ---------------
                                                         1,548                     -              1,470

Mexico - current..........................               1,876                 2,082              1,716
Mexico - deferred.........................                 180                  (643)                 -
                                                  ----------------     ---------------      ---------------
                                                         2,056                 1,439              1,716
                                                  ----------------     ---------------      ---------------
Total with extraordinary item.............               3,604                 1,439              3,186
Tax effect of extraordinary item..........                   -                     -             15,728
                                                  ----------------     ---------------      ---------------
       Total before extraordinary item....           $   3,604             $   1,439           $ 18,914
                                                  ================     ===============      ===============
</TABLE>
Principal reconciling items from income tax provision (benefit) computed at 
the U.S. statutory rate of 35% and the provision for income taxes for the 
fiscal years ended January 1, 1999, January 2, 1998 and January 3, 1997 are as 
follows:

<TABLE>
<CAPTION>
                                                                      FISCAL YEAR ENDED
                                                    -------------------------------------------------------
                                                      JANUARY 1,           JANUARY 2,           JANUARY 3, 
                                                         1999                 1998                 1997
                                                    --------------     ---------------        -------------
                                                                       (IN THOUSANDS)
<S>                                                 <C>                  <C>                  <C>
Provision (benefit) at U.S. statutory rate          $    9,671           $   (37,958)         $   2,989
Amortization of goodwill..................               1,667                 1,668              1,668
State income tax..........................               1,006                (5,489)             3,751
Foreign loss not benefited................                  35                   149                 26
Difference between U.S. and Mexico
       statutory rate.....................                 884                   709                684
Mexico inflationary indexing
      and other...........................              (2,267)               (2,028)            (1,629)
Valuation allowance.......................              (7,679)               44,107            (10,134)
Non-permanently reinvested foreign
       earnings...........................                   -                     -              5,571
Other.....................................                 287                   281                260
                                                    --------------     ---------------        -------------
       Total with extraordinary item......          $    3,604           $     1,439          $   3,186
                                                    ==============     ===============        =============
</TABLE>
                                       F-16
<PAGE>

Deferred income taxes reflect the net tax effects of temporary differences 
between the carrying amounts of assets and liabilities for financial 
reporting purposes and the amounts used for income tax purposes. Significant 
components of the Company's deferred tax liabilities are as follows:

<TABLE>
<CAPTION>
                                                                JANUARY 1,            JANUARY 2, 
                                                                   1999                  1998
                                                              ---------------      ---------------
                                                                        (IN THOUSANDS)
<S>                                                            <C>                   <C>
Deferred tax liabilities:
Book basis of property, plant and equipment over tax ..        $    17,777            $   18,707
Book basis of other assets over tax....................             10,866                10,640
Other, net.............................................              8,323                 6,983
                                                              ----------------     ---------------
     Total deferred tax liabilities....................             36,966                36,330
                                                              ----------------     ---------------
Deferred tax assets:
Tax basis of inventories over book.....................              9,326                 5,519
Tax basis of other assets over book....................              1,287                 1,325
Net operating loss carryforwards.......................             45,741                52,518
Expenses not yet deductible for tax....................             13,535                18,324
                                                              ----------------     ---------------
     Total deferred tax assets.........................             69,889                77,686
Valuation allowance for deferred tax assets............            (36,428)              (44,107)
                                                              ----------------     ---------------
Net deferred tax assets................................             33,461                33,579
                                                              ----------------     ---------------
Net deferred tax liabilities...........................       $      3,505           $     2,751
                                                              ================     ===============
</TABLE>

Total income tax payments, net of refunds received, during the fiscal years 
ended January 1, 1999, January 2, 1998 and January 3, 1997, were $1,836,000, 
$3,206,000 and $1,989,000, respectively. The Company has U.S. federal net 
operating loss carryforwards of approximately $118,000,000, which expire in 
the years 2008 - 2018. The net operating loss carryforwards will be available 
to offset regular U.S. taxable income during the carryforward period.

Deferred tax assets are required to be reduced by a valuation allowance if it 
is more likely than not that some portion or all of the deferred tax assets 
will not be realized. Realization of the future benefits related to the 
deferred tax assets is dependent on many factors, including the Company's 
ability to generate U.S. taxable income within the near to medium term. 
Management has considered these factors in determining the valuation 
allowance retained in fiscal year 1998.

U.S. tax rules impose limitations on the use of net operating loss 
carryforwards following certain changes in ownership. If such a change were 
to occur with respect to the Company, the limitation could reduce the amount 
of deductions that would be available to offset future taxable income each 
year, starting with the year of the ownership change.

A company operating in Mexico is generally required by law to contribute 10% 
of pre-tax profits (subject to certain adjustments) directly to employees. 
These mandatory charges were not deductible for Mexican income tax purposes 
during the fiscal years ended January 1, 1999, January 2, 1998 and January 3, 
1997 and, for financial statement presentation purposes, have been classified 
as components of income tax expense. Total tax provision amounts accrued by 
Dal-Tile Mexico for this obligation amounted to approximately $810,000, 
$327,000 and $390,000 for the fiscal years ended January 1, 1999, January 2, 
1998 and January 3, 1997, respectively.

10.    RELATED PARTY TRANSACTIONS

AEA Investors Inc., a majority stockholder, previously provided management, 
consulting and financial 

                                       F-17

<PAGE>

services to the Company for fees and expenses. The Company incurred fees and 
expenses for such services of $485,000 for the fiscal year ended January 3, 
1997. Such services included, but were not necessarily limited to, advice and 
assistance concerning the strategy, planning and financing of the Company, as 
needed from time to time. The management arrangement was terminated during 
fiscal year 1996, and AEA Investors was paid a termination fee of $4,000,000 
in connection therewith. Certain directors and officers of the Company also 
serve as officers of AEA Investors.

During fiscal year 1996, the Company entered into an agreement with AWI to 
provide mainframe data processing services. The agreement expires on May 31, 
1999. Payments made under this agreement were $6,749,000, $6,147,000 and 
$2,549,000 for the fiscal years ended January 1, 1999, January 2, 1998 and 
January 3, 1997, respectively.

11.    STOCK PLANS

The Company has a stock option plan (the "Plan") that provides for the 
granting of options for up to 10,586,425 shares of its common stock to key 
employees of the Company. Options granted under the Plan prior to January 1, 
1996 vest 20% at the date of the grant and 20% on each successive anniversary 
of the date of the grant until fully vested. Options granted on or after 
January 1, 1996 vest 25% at the date of the grant and 25% on each successive 
anniversary of the date of the grant until fully vested. In each case, the 
options expire on the tenth anniversary of the date of the grant; however, 
these terms may be modified on an individual grant basis at the discretion of 
the Company's Board of Directors.

Stock option activity under the Plan is summarized as follows (option data 
shown below is after giving effect to the Company's options conversion):

<TABLE>
<CAPTION>
                                                                                                WEIGHTED
                                                       NUMBER OF            RANGE OF             AVERAGE
                                                         SHARES         EXERCISE PRICES      EXERCISE PRICE
                                                     ---------------    -----------------    ----------------
<S>                                                     <C>             <C>                  <C>
Outstanding at December 31, 1995............             2,595,347        $         9.01               9.01
       Granted..............................             1,695,535          9.91 - 19.75              10.20
       Canceled.............................              (185,048)                 9.01               9.01
                                                     ---------------    -----------------    ----------------

Outstanding at January 3, 1997..............             4,105,834          9.01 - 19.75               9.50
       Granted..............................             3,215,174         12.63 - 17.00              13.41
       Canceled.............................              (723,637)         9.01 - 19.75              10.44
                                                     ---------------    -----------------    ----------------

Outstanding at January 2, 1998..............             6,597,371          9.01 - 13.75              11.30
       Granted..............................             3,770,000          8.69 - 11.31               8.92
       Canceled.............................              (110,024)         9.01 - 13.69              11.26
                                                    -----------------    ----------------    ----------------

Outstanding at January 1, 1999..............     (1)    10,257,347        $ 8.69 - 11.94           $   9.73
                                                     ===============    =================    ================
</TABLE>

(1)      In February 1998, 2,675,000 stock options with a price range of $13.69
         to $13.75 were repriced to the current fair value price of $11.94. In
         December 1998, 3,617,279 stock options with a price range of $9.44 to
         $13.69 were repriced to the current fair value price of $9.01.

The Company has reserved 10,586,425 shares of common stock for options, 
329,078 of which are ungranted at January 1, 1999 and are for future issuance 
under the Plan.

                                       F-18

<PAGE>

At January 1, 1999, January 2, 1998 and January 3, 1997, there were 5,051,347 
options exercisable at a weighted average exercise price of $9.84, 4,200,159 
options exercisable at a weighted average exercise price of $10.07 and 
2,986,372 options exercisable at a weighted average exercise price of $9.30, 
respectively.

The following table summarizes information with regard to stock options 
outstanding at January 1, 1999:

<TABLE>
<CAPTION>
                                                                                      WEIGHTED AVERAGE
EXERCISE                                                                OPTIONS          REMAINING
PRICE                                                                 OUTSTANDING     CONTRACTUAL LIFE
--------                                                              -----------     ----------------
<S>                                                                   <C>             <C>
$   8.69............................................................. 1,064,000       9.94 years
    9.01............................................................. 6,058,481       6.13 years
    9.91.............................................................   709,866       0.57 years
   11.94............................................................. 2,425,000       8.78 years
</TABLE>

In accordance with the provisions of SFAS 123, the Company applies APB 25 and 
related interpretations in accounting for its stock option plan, and, 
accordingly, does not recognize compensation cost. If the Company had elected 
to recognize compensation cost based on the fair value of the options granted 
at grant date as prescribed by SFAS 123, net income (loss) and earnings 
(loss) per share would have been reduced to the pro forma amounts indicated 
in the table below:

<TABLE>
<CAPTION>
                                                                             FISCAL YEAR ENDED
                                                              -------------------------------------------------
                                                               JANUARY 1,        JANUARY 2,        JANUARY 3,
                                                                  1999              1998              1997
                                                              --------------    --------------    -------------
                                                                   (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                               <C>              <C>                <C>
Net income (loss)-- as reported.................................  $ 24,028         $ (110,236)        $ 5,354
Net income (loss)-- pro forma...................................    14,929           (112,150)          3,827
Earnings (loss) per share (basic and diluted) --
as reported.....................................................      0.45              (2.06)           0.11
Earnings (loss) per share (basic and diluted)-- pro forma.......      0.28              (2.10)           0.08
</TABLE>

The pro forma effects on net income (loss) for the fiscal years ended January 
1, 1999, January 2, 1998 and January 3, 1997 are not representative of the 
pro forma effect on net income (loss) in future years because they do not 
take into consideration pro forma compensation expense related to grants made 
prior to 1995.

The weighted average fair value at date of grant for options granted during 
the fiscal years ended January 1, 1999, January 2, 1998 and January 3, 1997 
was $4.03, $5.62 and $2.93 per option, respectively. The fair value of the 
options at the date of grant was estimated using the binomial model with the 
following weighted average assumptions:

<TABLE>
<CAPTION>
                                                                             FISCAL YEAR ENDED
                                                              -------------------------------------------------
                                                               JANUARY 1,        JANUARY 2,        JANUARY 3,
                                                                  1999              1998              1997
                                                              --------------    --------------    -------------
<S>                                                            <C>               <C>               <C>
Expected life (years).....................................          3                 3                3
Interest rate.............................................       5.25%             5.96%            5.08%
Volatility................................................       61.9%             53.5%            33.6%
Dividend yield............................................       0.00%             0.00%            0.00%
</TABLE>

                                       F-19

<PAGE>

The Company has issued stock units under a stock appreciation rights 
agreement to certain executives which permit the holders to receive value in 
excess of the base price of the unit at the date of grant. Payment of the 
excess will be in cash, stock or a combination of cash and stock at the 
discretion of the Board of Directors. The total value to be received is 
subject to a ceiling. During the fourth quarter of fiscal year 1997, the 
Company granted 2,710,000 stock units at a base price of $9.01 per unit. 
These stock units vest at various dates through fiscal year 2000 provided 
certain conditions are met. The Company recorded stock unit compensation 
expense of approximately $1,770,000 and $5,900,000 for the fiscal years ended 
January 1, 1999 and January 2, 1998, respectively.

12.  COMMITMENTS AND CONTINGENCIES

The Company leases substantially all of its sales centers and various 
distribution, manufacturing and transportation equipment under terms of 
noncancelable operating leases. Certain leases contain escalation charges. 
The minimum aggregate annual lease payments subsequent to January 1, 1999 are 
as follows (in thousands):

<TABLE>
<CAPTION>
        <S>                                                         <C>
        1999....................................................    $   28,965
        2000....................................................        18,294
        2001....................................................        14,366
        2002....................................................        11,433
        2003....................................................         7,691
        Thereafter..............................................        16,483
                                                                    -----------
                                                                    $   97,232
                                                                    -----------
                                                                    -----------
</TABLE>

Rental expense amounted to approximately $33,269,000, $31,075,000 and 
$24,166,000 for the fiscal years ended January 1, 1999, January 2, 1998 and 
January 3, 1997, respectively.

The Company is subject to federal, state, local and foreign laws and 
regulations relating to the environment and to work places. Laws that affect 
or could affect the Group's United States operations include, among others, 
the Clean Air Act, the Clean Water Act, the Resource Conservation and 
Recovery Act and the Occupational Safety and Health Act. The Company believes 
that it is currently in substantial compliance with such laws and the 
regulations promulgated thereunder.

The Company is involved in various proceedings relating to environmental 
matters. The Company, in the past, has disposed or arranged for the disposal 
of substances, which are now characterized as hazardous and currently is 
engaged in the cleanup of hazardous substances at certain sites. It is the 
Company's policy to accrue liabilities for remedial investigations and 
cleanup activities when it is probable that such liabilities have been 
incurred and when they can be reasonably estimated. The Company has provided 
reserves, which management believes are adequate to cover probable and 
estimable liabilities of the Company with respect to such investigations and 
cleanup activities, taking into account currently available information and 
the Company's contractual rights of indemnification. However, estimates of 
future response costs are necessarily imprecise due to, among other things, 
the possible identification of presently unknown sites, the scope of 
contamination of such sites, the allocation of costs among other potentially 
responsible parties with respect to any such sites and the ability of such 
parties to satisfy their share of liability. Accordingly, there can be no 
assurance that the Company will not become involved in future litigation or 
other proceedings or, if the Company were found to be responsible or liable 
in any litigation or proceeding, that such costs would not be material to the 
Company.

                                       F-20

<PAGE>

The Company is also a defendant in various lawsuits arising from normal 
business activities. In the opinion of management, the ultimate liability 
likely to result from the contingencies described above is not expected to 
have a material adverse effect on the Company's consolidated financial 
condition, results of operations or liquidity.

13.    GEOGRAPHIC AREA OPERATIONS

The Company currently conducts its business in one industry segment, engaging 
in the manufacturing and distribution of glazed and unglazed ceramic tile 
products and accessories. The Company operates manufacturing facilities in 
the United States and Mexico and distributes products through wholly owned 
sales centers in the United States, Canada and Puerto Rico and nonaffiliated 
distributors in the United States and Mexico. Intercompany sales between 
geographic areas are accounted for at amounts that are generally above cost 
and in compliance with rules and regulations of governing tax authorities. 
Such intercompany sales are eliminated in the consolidated financial 
statements.

Financial information by geographical area is summarized below:

<TABLE>
<CAPTION>
                                                                          FISCAL YEAR ENDED
                                                          ------------------------------------------------------
                                                            JANUARY 1,         JANUARY 2,         JANUARY 3,
                                                               1999               1998               1997
                                                          ---------------    ---------------    ----------------
                                                                             (IN THOUSANDS)
<S>                                                          <C>               <C>               <C>
Consolidated revenue:
Unaffiliated customers:
     United States ..................................        $ 716,075         $ 648,529         $ 695,532
     Mexico .........................................           25,242            18,533            17,927
     Other ..........................................           10,468             9,575             6,777
                                                          ---------------    ---------------    --------------
         Total consolidated revenue from unaffiliated
           customers ................................        $ 751,785         $ 676,637         $ 720,236
                                                          ===============    ===============    ==============
Intercompany revenue:
     United States ..................................        $   5,462         $   4,348         $   4,057
     Mexico .........................................           74,533            71,802            61,526
     Eliminations/other .............................          (79,995)          (76,150)          (65,583)
                                                          ---------------    ---------------    --------------
         Total consolidated revenue .................        $ 751,785         $ 676,637         $ 720,236
                                                          ===============    ===============    ==============
Consolidated operating income (loss):
     United States ..................................        $  60,558         $ (76,686)        $  90,175
     Mexico .........................................           10,608             7,508             7,339
     Eliminations/other .............................              125              (458)              350
                                                          ---------------    ---------------    --------------
         Total consolidated operating income (loss)          $  71,291         $ (69,636)        $  97,864
                                                          ===============    ===============    ==============
Consolidated identifiable assets:
     United States ..................................        $ 580,719         $ 613,882         $ 623,444
     Mexico .........................................           56,435            53,637            54,889
     Eliminations/other .............................            3,654             4,550            10,164
                                                          ---------------    ---------------    --------------
         Total consolidated identifiable assets .....        $ 640,808         $ 672,069         $ 688,497
                                                          ===============    ===============    ==============
</TABLE>

14.  CHANGE IN FISCAL YEAR

During 1996, the Company changed its fiscal year end from December 31 to a 52 
or 53 week year ending on the Friday nearest December 31. Accordingly, the 
1996 fiscal year ended on January 3, 1997 (and included 53 weeks) whereas the 
previous fiscal year ended on December 31 (and included 52 weeks). 

                                       F-21

<PAGE>

The change was made to help facilitate the financial closing process. The 
effect of the change was to increase net sales for fiscal year 1996 by 
approximately $6,000,000. The impact of the change on net income for fiscal 
year 1996 was not material.

15.     CONDENSED UNCONSOLIDATED FINANCIAL STATEMENTS

Provided below are the condensed unconsolidated financial statements of 
Dal-Tile International Inc.:

<TABLE>
<CAPTION>
                                                                   JANUARY 1,      JANUARY 2,
                                                                      1999            1998
                                                                   ----------      ----------
                                                                          (IN THOUSANDS)
<S>                                                                 <C>            <C>
Condensed balance sheets:
Cash .......................................................        $    59        $    59
Other assets ...............................................          9,500          9,151
Investment in Dal-Tile Group Inc., net of accumulated losses          7,667              -
                                                                   ----------      ----------
Total assets ...............................................        $17,226        $ 9,210
                                                                   ==========      ==========
Senior secured zero coupon notes ...........................        $     -        $   157
Other liabilities ..........................................          1,767          1,232
Accumulated losses, net of investment in Dal-Tile Group Inc.              -          3,901
Stockholders' equity .......................................         15,459          3,920
                                                                   ----------      ----------
Total liabilities and stockholders' equity .................        $17,226        $ 9,210
                                                                   ==========      ==========
</TABLE>
<TABLE>
<CAPTION>
                                                                                 FISCAL YEAR ENDED
                                                                -----------------------------------------------------
                                                                 JANUARY 1,         JANUARY 2,          JANUARY 3,
                                                                    1999               1998                1997
                                                                --------------     --------------     ---------------
                                                                                  (IN THOUSANDS)
<S>                                                               <C>                 <C>              <C>
Condensed statements of operations:
     Equity in net income (loss) of Dal-Tile            
      Group Inc. ......................................           $  24,140           $ (110,739)      $   11,841
     Other expense (income)............................                  99                 (520)            (511)
     Interest income...................................                   -                    -              921
     Interest expense..................................                  13                   17            7,919
                                                                --------------     --------------     ---------------
     Net income (loss).................................           $  24,028           $ (110,236)     $     5,354
                                                                ==============     ==============     ===============
Condensed statements of cash flows:
     Cash flow used in operating activities............           $     (80)          $     (129)     $    (6,303)
     Financing activities:
     Proceeds from sale of stock and equity infusion...               1,113                    -          102,558
     Investment in Dal-Tile Group Inc..................                   -                   91          (18,134)
     Fees associated with debt refinancing and stock
             registration..............................                (876)                   -           (9,457)
     Repayment of long-term debt.......................                (157)                   -          (98,938)
                                                                --------------     --------------     ---------------
     Net increase (decrease) in cash...................                   -                  (38)         (30,274)
     Cash at beginning of period.......................                  59                   97           30,371
                                                                --------------     --------------     ---------------
        Cash at end of period..........................           $      59           $       59      $        97
                                                                ==============     ==============     ===============
</TABLE>

                                       F-22

<PAGE>

16.    SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a tabulation of the unaudited quarterly results of 
operations for the fiscal years ended January 1, 1999 and January 2, 1998:

<TABLE>
<CAPTION>
                                                         FIRST        SECOND        THIRD         FOURTH
                                                        QUARTER       QUARTER      QUARTER       QUARTER
                                                      -----------   -----------  -----------   -----------
                                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                     <C>           <C>          <C>           <C>
Fiscal year ended January 1, 1999:
  Net sales ....................................        $ 185,831     $ 190,907    $ 194,068     $ 180,979
  Gross profit .................................           87,328        88,527       92,676        87,142
  Operating income .............................           13,961        17,845       20,882        18,603
  Net income ...................................              828         5,447        9,936         7,817
  Per share:
      Net income - basic........................             0.02          0.10         0.19          0.15
                 - assuming dilution ...........             0.02          0.10         0.18          0.15
Fiscal year ended January 2, 1998:
  Net sales ....................................        $ 167,409     $ 173,742    $ 177,731     $ 157,755
  Gross profit .................................           83,188        73,609       46,270        68,842
  Operating income (loss) ......................           17,303       (11,891)     (64,675)      (10,373)
  Net income (loss) ............................            6,527       (13,803)     (80,939)      (22,021)
  Per share:
      Net income (loss) - basic.................             0.12         (0.25)       (1.51)        (0.41)
                        - assuming dilution.....             0.12         (0.25)       (1.51)        (0.41)
</TABLE>

Second quarter 1998 gross profit results have been restated to reflect the 
reclassification of a $1,700,000 provision to reduce the carrying value of 
the Mt. Gilead, NC manufacturing facility. This provision was originally 
recorded in selling, general and administrative expenses. Operating income 
was not impacted by this reclassification. During the fourth quarter of 
fiscal year 1998, an additional provision of $4,925,000 was recorded to 
further reduce the carrying value. This decrease in gross profit was 
substantially offset by the release of excess reserves which were previously 
provided by the Company (see Note 8).

The sum of quarterly per share amounts does not necessarily equal the annual 
amount reported, as per share amounts are computed separately for each 
quarter and the full year based on respective weighted average of common and 
common equivalent shares outstanding.

                                       F-23

<PAGE>

                                                                    SCHEDULE II

                          DAL-TILE INTERNATIONAL INC.

                       VALUATION AND QUALIFYING ACCOUNTS

    FISCAL YEARS ENDED JANUARY 1, 1999, JANUARY 2, 1998 AND JANUARY 3, 1997

Allowance for Losses from Uncollectible Accounts:

<TABLE>
<CAPTION>
                                                ADDITIONS CHARGED
                              BALANCE AT           TO COSTS AND                (a)            BALANCE AT END OF
                         BEGINNING OF PERIOD         EXPENSES               DEDUCTIONS              PERIOD
                         --------------------- ----------------------- ------------------- ----------------------
                                                                 (IN THOUSANDS)
<S>                      <C>                    <C>                         <C>               <C>
1998................            $ 13,160          $   7,024                 $ 10,603             $   9,581
1997................              12,750             27,805                   27,395                13,160
1996................               9,389              5,781                    2,420                12,750
</TABLE>

(a)  Uncollectible accounts written off, net of recoveries.




                                       S-1